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1927 Supreme(SC) 4
Privy Council
Blanesburgh, Phillimore, Wrenbury, Shaw, Justice Lord Chancellor, JJ.
William Richard Doughty -Appellant
Versus
Commissioner of Taxes -Resopndent
Privy Council Appeal No. 92 of 1926
Decided On : 21-01-1927
Roscoe, Shden, Clarkson, Miss Joan, F.O. Langley, G.J.W. Farwell, C.L. King, M. Myers, Godlee and Quincey, Matori, Mackrell, Massey and Co., A.M. Latter
Profit from the sale of a whole business concern is generally a capital gain and not taxable as income. In transfers to a company owned by the vendors, over-valuation of assets for shares does not constitute taxable profit but merely affects the shares' value.
Headnote:(A) Income Tax - Sale of a whole concern - Profit arising from the sale of a whole business, when compared with the price given for the business or its book value, does not generally give rise to a profit taxable as income.
(B) Realization sale vs. Trading profit - In a business consisting of buying and selling, a profit from the sale of all stock might be assessable; however, where a transfer of all assets is made for shares in a company owned by the vendors, and no separate sale of stock is effected, it is a slump transaction. If assets are over-estimated, the vendors gain nothing as the value of the shares is correspondingly reduced.
Facts of the case:
Partners in a wholesale merchant business converted their partnership into a private limited company. The assets, including goodwill and stock, were transferred to the company in exchange for shares and the assumption of liabilities. The tax authority sought to assess income tax on the difference between the book value of the stock and the value attributed to it during the transfer.
Findings of Court:
The transaction was a slump transaction. The vendors did not realize an actual profit by over-estimating the value of assets transferred to a company of which they were the sole shareholders; such over-estimation merely resulted in the watering of the shares.
Issues: Whether the increase in the valuation of stock-in-trade during the transfer of a partnership business to a private limited company constitutes taxable income.
Ratio Decidendi: The sale of a whole concern is typically a capital transaction. In the absence of a separate sale of stock, a transfer of assets for shares to a company owned by the vendors does not produce taxable income, as any over-valuation of assets does not result in a financial gain for the vendors but rather reduces the actual value of the shares they receive.
Result: Appeal allowed.
Legal Category Hierarchy
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tax law
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income tax
- realization of assets
- capital vs income
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income tax
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company law
- partnership conversion
- share capital
Lord Phillimore. -
This is an appeal from the judgment of the Court of Appeal of New Zealand reversing the decision of Stout, C. J., on an application by the Commissioner of Taxes seeking to assess the appellant to income-tax in the sum of £6,010 in respect of income for the year ending on March 31st, 1921.
On the proceedings taken in respect of this assessment a case was stated by the Commissioner which, according to the practice in New Zealand, was traversable and was accordingly traversed by the present appellant in his answer, and the matter came in the first instance before a Magistrate and was decided in favour of the Commissioner. His decision was, however, appealable both on grounds of fact and law to a Judge of the High Court, in this case Stout, C. J. The decision of the C. J. is final on fact, but not on a matter of law.
The circumstances are these: The appellant and one Arthur John George carried on business at Wellington as wholesale soft goods merchants and drapers in partnership. On the 25th June 1920 they converted their partnership into a private limited company, of which they were the only two shareholders. The company had a nominal capital of £175,000 in £1 shares 100,000 of which were ordinary, 25,000 were A preference shares and 50,000 were B preference shares.
The arrangement, which was embodied in an agreement dated 25th June 1920 was that the partners as vendors should sell to the company and the company should purchase as from 20th January then past, the goodwill of the business, the leaseholds, plant, machinery, book debts, the benefit of pending contracts, all cash bills and notes, and generally all property to which the vendors were entitled in connexion with the business.
Part of the consideration for the sale was the allotment to the vendors of £76,000 paid-up shares, £30,000 ordinary shares to George and £30,000 to the appellant, and £16,000 B preference shares to George. The residue of the consideration was the undertaking by the company to satisfy all the liabilities and engagements of the firm.
The vendors contracted not to carry on the business of a draper independently of the company, and they stated that they had in certain proportions subscribed the Memorandum of Association for all the 175,000 shares in the company, each thus according to his proportion rendering himself liable to that extent for the debts of the company.
The last balance sheet of the old partnership stood as follows :
Liabilities £ s. d.
Capital account ... 48,774 12 0
Sundry creditors ... 10,366 17 5
Deposits at interest ... 2,238 7 6
Bills payable current ... 36,053 12 2
________________
£97,433 1 9
________________
Assets £ s. d
Furniture and fittings ... 513 18 4
Cash at bank ... 106 11 3
Cash on hand and customs ... 432 7 11
Sundry debtors ... 45,151 17 0
Bills receivable current ... 5,896 3 3
War loans ... 1,974 12 6
Stock in hand ... 43,357 18 10
________________
£97,433 9 1
________________
This should be corrected in one respect as £7,800 was due for unpaid income tax, thereby reducing the capital account from £48,774 12s. 0d. to £40,974 12s. 0d.
The partners having fixed the pries at which they sold, if it could be called a sale, their business to the company, it remained to adjust the figures on the last balance sheet in accordance with this arrangement, £76,000 being evidently more than the sum standing to the credit of the capital account; and, in order to effect this, the item on the asset side "stock in hand £43,357 18s. 10d. "was replaced by an item "stock and goodwill £78, 383 6s 10d."
It appears from the evidence of the accountant who made out these accounts that he suggested that the figure for goodwill might be taken as £20,000, and that this view was accepted by the outgoing partners. This left as the residue of the item £58,383-6-10, or £15,025-8-0, as the difference between the value of the stock-in-trade as shown in the partners's last balance sheet and the value of the stock-in-trade as it might be deemed to be taken over b
