Studies in the History of Tax Law - Volume 3 9781474200660, 9781841139562

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Preface These are the papers given in July 2006 at the third Tax Law History Conference organised by the Centre for Tax Law which is part of the Law Faculty of the University of Cambridge. The original plan was to publish them in 2008 but the pressure on law publishers to produce work in time for the United Kingdom Research Assessment Exercise meant that some less urgent works got pushed back. The conference itself was held in the still beautiful surroundings of Lucy Cavendish College and would have been impossible without sponsorship from the Chartered Institute of Taxation. As ever the papers were followed by discussions in out and out of the formal proceedings. It remains for me to thank those who gave papers or participated in other ways in what is becoming an important part of the academic tax law life in the United Kingdom. Sincere thanks go also Christine Houghton and all the staff of Lucy Cavendish College who made us so welcome and to the President and Fellows of the college for allowing us to stay in their college. Finally, thanks go to Richard Hart and his editorial team for taking this publishing project on and to Mel Hamill as the Managing Editor for all her hard work. Cambridge July 2009

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Acknowledgement The Centre for Tax Law gratefully acknowledges the support of the Chartered Institute of Taxation in connection with the conferences for which the papers in this volume were written.

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Contributors Dr John Avery Jones, CBE Judge of the Upper Tribunal (Finance and Tax Chamber), Special Commissioner and Visiting Professor, London School of Economics. Cynthia Coleman Associate Professor of Taxation in the Faculty of Law, University of Sydney, Australia. Martin Daunton Master of Trinity Hall and Professor of Economic History, University of Cambridge. Nicolas Delalande Université Paris I Sorbonne- Panthéon/Collège de France, IHMC, France. Kathryn James Assistant Lecturer, Faculty of Law, Monash University, Australia. Dr Margaret McKerchar Associate Professor in the Faculty of Law at the University of New South Wales, Australia. David Oliver Assistant Director at the Centre for Tax Law, University of Cambridge. John Pearce Solicitor’s Office, HM Revenue and Customs. Philip Ridd Law Reporter, formerly Solicitor of Inland Revenue. Chantal Stebbings Professor of Law and Legal History, University of Exeter. Andreas Thier Professor of Legal History, Canon Law, Legal Theory and Private Law, University of Zurich, Switzerland John Tiley Fellow of Queens’ College, Cambridge and Professor of Tax Law at the University of Cambridge. David Todd Research fellow at Trinity Hall and the Centre for History and Economics, Cambridge. Henk Vording Professor of Tax Law at Leiden University, The Netherlands. Onno Ydema Professor of Tax History at Leiden University, The Netherlands, and an Attorney at Greenberg Traurig, LLP, Amsterdam.

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1 The Rise and Fall of Progressive Income Taxation in the Netherlands (1795–2001) HENK VORDING AND ONNO YDEMA ABSTRACT This paper offers an overview of the thinking on personal income taxation in the Netherlands over the last two centuries. The starting point is the short-lived 1795 income tax, and the subject finds its logical finale in the Income Tax Act 2001. In between lies first a century of mainly theoretical debate up to the adoption of the income taxes of 1892 and 1893, and thereafter a century of growing practical issues concerning the role, scope and effectiveness of the income tax. This paper focuses on the rhetoric of income taxation: the way in which arguments relating to the fundamental characteristics of income taxation—the concept of income and the tax rate structure—were developed and accepted in the political debate. It also explores how the idea of progressive income taxation was put to the test in the Netherlands with doubtful success up to 1940. In a brief last section, post-1945 developments towards a less progressive tax are discussed.

I. THE FIRST DISCUSSIONS ON PROGRESSIVE INCOME TAXATION (1795)

T

HE NETHERLANDS WAS comparatively late in accepting personal income taxation in 1892 and 1893. But the first experiments were as early as those in Britain. At the start of the Dutch Batavian Republic (1795–1806) several experiments with taxation of actual income were in force, even at progressive rates. These experiments failed, mainly because the tax officials had few tools to check the tax returns. The most interesting aspect of these early experiences is that objections to progressive taxation were phrased explicitly and extensively, in a way that foreshadowed much of the later debate on income taxation.

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Already in 1795, shortly after the Ancien Régime had been replaced, the Finance Committee of the city of Amsterdam presented a report to the new state Government, with its objections to a proposal for progressive taxation. The report, quoting Rousseau, advocates proportional taxes not only by referring to the equality of all citizens, but also by referring to the benefits enjoyed from the state: According to the nature of the social contract, which is based on freedom and equality, each member of society is obliged to contribute to the costs of public expenditure, in a just correspondence with his wealth, as the expenditure is necessary for the protection and safekeeping of each specific property. If, for example, for the security of all properties in society a fourth part should be contributed, each citizen should sacrifice a fourth part of his wealth, irrespective of the size of his wealth, albeit large or small, to keep the remaining three fourths thereof.

The Committee added in general terms that the resentment is not the amount of tax imposed, but the disproportion of the levy. This undoubtedly reflects the famous words of Thomas Hobbes in 1657: ‘Neither are men wont so much to grieve at the burthen it self, as at the inequality.’1 Any learned observer in the late eighteenth century would have recognised the argument. In his mind he would have considered Hobbes’ admonition, that: ‘they who equally share in the peace, should also pay an equall part either by contributing their Monies, or their labours to the Common-weal’. To the 1795 Committee, an ‘equall part’ meant a proportionate part. The sole concession would be a threshold for an amount directly related to the costs of living of the tax subjects and their families. So far as this was not directly the consequence of the recently adopted revolutionary doctrines, the framers clearly had an eye for the misery of the poor: ‘one should determine [the minimum for subsistence] in all cases rather too liberal than too narrow’. The main argument that the Committee raised against progression was the arbitrariness of the system. ‘If one would have one citizen pay more than the other, who should determine the boundaries of the inequality?’ It therefore advocated ‘a solid foundation that would exclude all arbitrariness and absurdities’. Furthermore, the Committee recognised a theoretical problem in the early sacrifice theory, which aimed at assuring equal treatment of citizens according to neutral criteria. As theorists like Graslin had argued earlier in the eighteenth century, at high levels of personal income, the value of additional income tends to become zero, in which case additional taxation represents no personal sacrifice. As a logical consequence of the sacrifice theory, the rate should from that point on be 100 per cent. The report remarks: 1

Th Hobbes, The Citizen 13.10. Online edition available at: www.constitution.org.

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one can see that this would be preposterous, and this clearly demonstrates the confusions and uncertainties one will encounter if one does not build on solid grounds.

In itself this conclusion of the Committee agreed with the traditional view that the primary task of the state is to protect property; the protector would exceed his authority if he would turn against the very reason for his existence.2 The Committee also warned that it would be a mistake to assume that progressive rates would result in higher tax revenues. The number of well-to-do citizens who would effectively pay the highest rates was much smaller than assumed. Taxes that are borne equally would have the largest proceeds, while taxes that are contributed by the few could only result in relatively little additional income for the Treasury. Furthermore, the Committee considered the economic consequences of progressive income taxation: entrepreneurs would be discouraged from taking risks and generating employment; merchants would not be able to continue their trade on the same footing; and rentiers would reduce their expenditures at the expense of smaller tradesmen and the common workers. Also, the wealthier citizens might be tempted to leave the country, with all the economic consequences that one could expect. On the other hand, the Committee argued that tax differentiation could be justified as a means of encouraging growth by removing obstacles to enterprise and ‘active’ capital. In fact, debates until the end of the nineteenth century were more concerned with the intersectoral incidence of taxation between industry and agriculture or producers and rentiers than with the interpersonal incidence of taxation.3 Several progressive income taxes were in fact levied in the early years of the Batavian Republic, when the revolutionary Government was under constant threat of state bankruptcy, but these taxes were shortlived, the negative consequences obvious, and in the first years of the nineteenth century, tax reforms became unavoidable.

II. THE NINETEENTH-CENTURY DEBATE ON TAX REFORM

Eventually, in 1805–06, the Dutch Finance Minister, Alexander Gogel, managed to implement a new tax system for the new state. This system was partly based on the excise taxes and direct consumption taxes of the individual provinces in the former Dutch Republic, but the new patent tax—in fact a payment for a licence to conduct a profession relied on the

2 3

Eg P Leroy-Beaulieu, Traité de la science des finances (Paris, 1877) 135. Cf MJ Daunton, Trusting Leviathan (Cambridge, 2001) 140.

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earlier French example. Gogel’s tax system remained the basis for taxation in the Netherlands up to the end of the nineteenth century. Consequently, the pace of tax reform severely lagged behind social and economic changes over the nineteenth century. In the early nineteenth century, the Dutch economy depended upon (colonial) trade, foreign investment, and agriculture. That was an insufficient foundation for economic growth: GDP per capita hardly increased between 1820 and 1860. It would take until the industrialisation in the 1870s before developments resulted in more prosperity and social change. Issues such as trade union organisation, general franchise and tax reform all developed in the latter decades of the nineteenth century: these were different aspects of the same process of modernisation of the Dutch economy and society. Gogel’s early nineteenth-century tax system had different elements that could be considered as partial approaches to taxing income, but each of them had its flaws: –

–

–

the licence tax (patent) covered income from business and employment. It used a presumptive approach: income from different types of business and employment was estimated rather than measured. The main problem of the tax was that it proved very impractical to connect estimates to each and every kind of business and employment, especially as the developing economy seemed to generate activities that could not be classified unarbitrarily. More ‘modern’ types of business and employment escaped from the ‘equall taxation’; the land tax aimed at income generated by agriculture. Again, a presumptive approach was used, which in itself may not be a weak starting point but in respect to varying regional effects of economic modernisation the assessment should have been made using modern value estimates, which proved to be difficult; income from government bonds and pensions was untaxed, which fact was in contradiction with ‘equall taxation’ as well.

Table 1.1 shows the main data on the Dutch tax system for the second half of the nineteenth century.4

4 Tax revenue estimates for the 1820s and 1830s include Belgium, and therefore cannot be compared with the figures for 1840 and onwards. In GDP terms, tax revenues are at their top in 1850; this is caused by a decline in GDP between 1840 and 1850 (and it shows that the tax system was insensitive to business cycle effects).

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Table 1.1: Main tax revenues 1850–90 in % GDP

1840 1850 1860 1870 1880 1890

Licence tax

Land tax

Personal tax

Import duties

Excise tax

Stamp and registration duties

0.3 0.5 0.4 0.4 0.4 0.4

1.5 1.8 1.4 1.1 1.0 1.0

0.8 1.1 1.0 0.9 0.9 0.9

0.7 0.9 0.7 0.5 0.4 0.5

2.6 3.6 2.4 3.0 3.5 3.5

0.9 1.1 1.2 1.0 1.3 1.0

Criticisms of this tax system were emerging from the 1840s onwards, and took two different lines. The first issue was the sectoral distribution of tax burdens. The tax system as a whole was perceived by commentators virtually to exempt portfolio investors and to tax economic activity in an arbitrary and discriminatory way. The second issue, which gained in weight over the last decades of the century, concerned inter-personal distribution. Notwithstanding the attempts of Minister Gogel in the early nineteenth century to relieve the lower income groups from taxes on consumer commodities, a substantial part of tax revenues was still generated by excise on commodities such as meat, soap and alcoholic beverages and also by import duties. These taxes were perceived as burdensome for the lower classes in particular, which connected the tax reform debate to the emerging discussions on social justice.

A. The Academic Debate on Tax Reform in the Second Part of the Nineteenth Century Nicolaas Pierson (1839–1909) played a pre-eminent role in creating adequate political support for progressive income taxation. Pierson, a conservative liberal in politics, was the Dutch Finance Minister in the last decade of the nineteenth century. In his early years, his predecessor as president of the Dutch central bank strongly advised Pierson not to get involved with tax issues, as he believed these could easily overwhelm him. The young scholar and banker, however, ignored the advice, and became an outstanding tax scholar and eventually the Finance Minister who introduced a progressive income tax. In an article from 1881 he referred to Gogel’s 1805 explanatory memorandum, referring to his demand to take the relationships between the individual members of society into account, and the nature of their properties and incomes and their relative faculties

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to carry the burdens. ‘One could almost say’, Pierson commented, ‘that what has to be done in finance, is the consequent implementation of the principles Gogel expressed, roughly continuing the policy of the system of 1805’.5 In his Principles of Political Economics of 1875, Pierson shows the influence of the Edinburgh school, when he argues that the relative wealth of the citizens after taxes should be equal to their relative wealth before taxes.6 In his later publications we find a slightly modified view. In 1879 he analysed the possibilities for taxation according to wealth. Equality for all citizens in law, he says, is one of the prime principles of the modern state. Then why do we leave this principle in taxation, by charging the wealthy more than the impecunious? Perhaps consumption taxes should be the nucleus of taxation, as proposed by Hobbes; this would probably be the least arbitrary.7 In Leviathan Hobbes favoured taxation of consumption, since the equality of imposition consisteth rather in the equality of that which is consumed, than of the riches of the persons that consume the same.8

These words have often been quoted and repeated in other terms, but they do not indicate how income should be taxed progressively. On the contrary, these words indicate that taxation should be proportional to consumption. Also, the underlying benefit theory—that one should pay for the protection that allows the undisturbed enjoyment of property and income—does not support a tax according to wealth, Pierson concludes. The same goes for the closely related theory of the citizen and the state having a kind of a limited partnership. Vocke in 1868 established that the state is an organisation of the people on moral, rational and economic grounds. Everything a member of the state possesses would be the result of this partnership, and hence the state would have the fullest competency to use the wealth of the nation for its own preservation and the achievement of its goals.9 This does not indicate how wealth should be taxed either. For an answer, Pierson then turned to John Stuart Mill, the author who had found the basis for the demand for equality in the maxim that no one

5

In the journal De Gids, October 1881 at 28. NG Pierson, Grondbeginselen der staathuishoudkunde (Haarlem, 1886) 310. 7 See Pierson, above n 6.at 594. 8 Th Hobbes, Leviathan (1660) at ch 30 available from the library at: http://oregonstate. edu/. A similar position Pierson found in W Petty, A Treatise of Taxes and Contributions (first published 1662) at ch 15.1–2: ‘men should contribute To the Publick Charge but according to the share and interest they have in the Publick Peace; that is, according to their Estates or Riches: now there are two sorts of Riches, one actual, and the other potential. A man is actually and truly rich according to what he eateth, drinketh, weareth, or any other way really and actually enjoyeth…every man ought to contribute according to what he taketh to himself, and actually enjoyeth’. 9 W.Vocke, Zeitschrift für die gesammte Staatswissenschaft (1868) 57–8. 6

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should be inconvenienced more than his fellow citizen. Pierson pictured the desperation of a Finance Minister, who lived up to this criterion. If one contributor works five, and another 10 hours a day, while each pays a proportionate tax of 10 per cent, each day the first one would work only half an hour for the Treasury while the other would contribute a full hour’s work. Would this be equality of convenience? What else would the idea of ‘inconvenience’ be but a riddle, Pierson complains: Mill names us the land where to steer to, but he does not provide a map to find it or tell us how to reach the shore.10

Similarly, Pierson was not satisfied with the French economist LeroyBeaulieu’s defence of proportional taxation. The presumption that all citizens participate in the advantages of the Government in proportion to their income, and hence that they should pay in proportion to that income, might indeed protect the citizens from fiscal oppression. But the objection that the principle of proportionality is the only protection from arbitrariness reminds Pierson of objections against the infallibility of the Pope: one cannot prove it but where would we be without it? And why would one who earns twice as much as someone else, pay exactly double the amount of tax? What else then, Pierson asks, is Leroy-Beaulieu’s principle of proportionality but a naïve hypothesis that is only supported by the convention of the preceding centuries? The point Pierson wants to make is that the preceding tax scholars and the authors of his time were caught in the dilemma that the tax burden should be distributed equally, but that taxation according to wealth per se (Pierson believed) deviates from the principle of equality. If the equality principle would be upheld strictly, the costs of government would be simply distributed equally among the members of the state. This would be untenable for the lower classes, and also impracticable, but not unjust. The solution to the dilemma should be the common interest, the old rule Salus populi suprema lex esto. If the burdens are not divided according to individual means, the economic consequences would be dramatic and the political consequence (uproar) would be unacceptable. If progressive taxation best serves the common interest, fine. But some moderation should be observed, as the common interest would not be served by driving the wealthy out of the country.11 It is clear that Pierson took a wider point of view than that of tax neutrality in the narrow sense; but he never abandoned the idiom of his age, which centred upon the concept of declining utility of income. In 1881 Pierson wrote that the taxes should be progressive, not to the infinite, but up to a certain level. The application of the progressive principle is 10 11

See above n 7. NG Pierson, ‘Belasting naar den welstand’ in De Gids 1879, II, at 1–24.

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difficult, he admits, and a certain arbitrariness can never be avoided. But the principle cannot be used to justify a 100 per cent top rate, since the marginal value of income will never be zero. Earlier writers, such as De Puynode and Guyot in France or Treub in the Netherlands, had argued that utility stops declining after a certain level of income.12 Pierson accepted a moderate progression, not just in the income tax but of all taxes together; the moderation would mitigate the inherent arbitrariness. Seven years later, however, he expressed his strong concerns about progression. He found there is a ‘complicated mathematical problem’ in the theory, meaning the consequences of the sacrifice theory and the arbitrary choices that come along in practice.13 This mathematical issue was further explored by AJ Cohen Stuart (1855–1921). He was educated in the exact sciences and he could combine his knowledge from that education with his interests for taxation. The mathematical problem Pierson had referred to was taken up by the author as a challenge for a legal dissertation presented in 1889. The starting point is the assumption that income tax progression according to the rule of equal proportional sacrifice requires that the marginal utility of income declines. This assumption, the young doctor explains, was firmly rooted in the economic literature of the time, to the point of almost becoming an axioma. The decline of the utility curve being unknown, any specific proposals for scales of progression could only be qualified as unfounded. Cohen Stuart presented carefully constructed tables indicating that the arguments hitherto used for moderated progressivity could be turned into a defence of proportional, or of regressive, as well as of progressive taxation. Eventually he concluded that rate progression is acceptable, even under a substantial uncertainty about the decline of the utility curve. However, given the uncertainty, such progression could only be very moderate. This hardly seems to be a world-shaking conclusion. In fact the study seems to present a scientific translation of the intuitive notion expressed by Adam Smith, namely that it would not be very unreasonable for the rich to contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion. What Cohen Stuart’s study did show was that the idea of rate progressivity (whatever its specific form) cannot be founded mathematically.14

12 WPJ Bok, De belastingen in het Nederlandsche Parlement van 1848–1888, inleiding, de Nederlandsche belastingen en hare hervorming, in het bijzonder met het oog op de invoering eener Rijks-Inkomstenbelasting, diss Amsterdam (Haarlem, 1888)179 refers to differences in social status of the individuals in question, that apparently should be taken into account. 13 NG Pierson, ‘Belastinghervorming’ in De Gids, October 1881, at 5–6; ‘Nieuwe litteratuur over belastingen’ in De Gids, February 1888, at 304–5; Bok, above n 12, at 174–5. 14 AJ Cohen Stuart, Bijdrage tot de theorie der progressieve inkomstenbelasting (diss University of Amsterdam 1889) (published Nijhoff, Amsterdam).

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Behind the mathematical problems of utility curves lay an evident question of social policy: should the middle classes bear the main burden of progressivity? It is interesting to see how mathematics interacted with politics in the thinking about tax progressivity. The idea that ‘declining utility’ prescribed a top tax rate of 99 or 100 per cent was not politically feasible, yet there was something mathematically inevitable to it. A point considered relevant at the time was, that science and culture depend on the existence of a wealthy and benevolent class of citizens. Schäffle had previously suggested that this would be a reason for more modest progressivity. In the eyes of the modern reader this point may be difficult to understand. In the nineteenth century, however, private initiatives were considered as the leading stimulus for scientific projects and commissions to artists and architects, just as private initiatives were considered to boost the market economy in general. A reduction of the net income of the wealthier classes would reduce consumption and therefore leave craftsmen, domestic personnel and many middle income earners unemployed. The case against steep-rate progressivity therefore seemed to rest on an economic argument concerning incentives and growth. The attorney and later Prime Minister, PWA Cort van der Linden (1846–1935), was not impressed by this objection to steep progressivity. He agreed that the argument holds if good fortune strikes only the most deserving. And yes, in addition, if the state does not have a say in the distribution of goods and powers. His acceptance of the idea that the state should redistribute wealth,15 an idea that he put forward with reference to John Stuart Mill, was not exactly communis opinio. The daily reality, however, proved in his opinion that the existing distribution of property and income was increasingly difficult to maintain. In the nineteenth century differences in income and wealth had sharply increased: The more than proportionate ability to pay of the larger incomes catches the eye as so obvious, that without a certain impudence one cannot maintain a position that violates the facts.16

This would be a call for redistributional taxation. The author recalls the strong words of Proudhon and Leroy-Beaulieu, who had argued that the pyramidical distribution of wealth left too few high income earners at the top to reach an effective redistribution of wealth by progressive taxation. Referring to Leroy-Beaulieu’s data on the incomes in Prussia, he agrees that the major part of national income is earned by the lower classes with very moderate incomes. But the conclusion is incorrect that there is no room for redistribution in the absence of a large number of wealthy contributors:

15 PWA Cort van der Linden, Leerboek der financiën, de theorie der belastingen (-Gravenhage, 1887) 95. 16 Van der Linden, above n 15, at 71–4.

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rate progressivity should simply be steep enough. Cort van der Linden admits a 100 per cent rate would be a bridge too far. Also, the author admits that individual utility curves will not be identical. He concludes there should always be a limit to progression, and progressive taxation should only address the ability to pay. The outcome should be moderate progression, while there is still a role for additional consumption taxes. This proves the liberal statesman to be a man of practical opinions, but leaves his reader with the uncomfortable feeling that the conflict between theory and practice remains unsolved: this cannot be avoided, according to Cort van der Linden. A compromise in tax legislation is compulsory because the legislator has to weigh principles of justice, economics and finance, the latter including the necessity of supplying the Treasury with a budget for the expenditures of the state. The three principles however will hardly provide clear-cut answers, as they will easily conflict in practice. For this reason he expected little security from the highest principles drafted by authors like McCulloch, Wagner, Stein or Schäffle. McCulloch believed the best tax is distinguished not by most nearly proportioning to the means of individuals, but by ease of assessment and collection, and if it is most conducive, all things considered, to the public interest. ‘Excellent! But what is this salus populi?’, Cort van der Linden comments. Schäffle considered legal principles like universality and ability to pay as consequences of economic principles. This is correct, in the Dutch commentator’s opinion, if the state is entitled to command all private households as much as to control the income of the state. The prime position of financial political principles, in Wagner’s studies, is also criticised: why would financial policy override the principle of justice in taxation? The task of the tax legislator is to find the optimum balance.17 Cort van der Linden was succeeded by MWF Treub (1858–1931) as Professor of Political Economy and Statistics at the University of Amsterdam, who later became Minister of Finance in his turn. In his early career, Treub obtained a doctorate in law by presenting a thesis on the history of taxes. In the same year, 1885, Treub published another book dealing with the period up to modern times, and in which he offered proposals for new tax legislation. In this volume special interest was paid to the progressive income tax. The theory of decreasing marginal utility is explained, but without the reservations that had been so amply discussed in the preceding fiscal literature. Referring to Schäffle, he argues that income should be approached not by a single income tax, but by several taxes which together should levy a just part of the earned income: part of these to be based on presumed or actual income as can be determined at source, and part of these depending on public displays of consumption. Treub states that

17

Van der Linden, above n 15, at 58–62, 103–4.

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moderation should be the key, and he quotes Paul Leroy-Beaulieu who had remarked: ‘in special instances each tax limps due to inequities. For this reason each tax, whatever its theoretical merits, should be moderate’. The Dutch author was known for his left-wing liberal ideas, but progression as a tool for income redistribution is not advocated in his book. In his inaugural address at Amsterdam University he underlined that political economy should advance the welfare of the entire community, and not exclusively the interests of the rich. But individual responsibility is also underlined: ‘a strong society can exist only, when its members will be urged to develop their own strength as much as possible’.18

B. Introducing Income Taxation: the 1890s At the end of the nineteenth century, the tax reform debate became part of a broader debate on social reform. As the Dutch author De Clercq put it in 1891 in an essay on the income tax: ‘With a progressive income tax, after all, and the universal suffrage, nothing can prevent us from expropriating the rich in a legal way.’19 The growing support for socialist ideas among the working classes and the extension of the number of citizens entitled to vote must have had an impact on the policy of the ruling class. But outside the circle of the labour movements, income redistribution by means of progressive taxation was still considered fundamentally wrong.20 A milestone in the history of progressive income taxation in the Netherlands was the twin income taxes introduced by Nicolaas Pierson in the early 1890s. Although authoritative authors still upheld that the direct consumption taxes on personnel, houses etc as included in Gogel’s legislation were ‘infinitely better than any income tax ever was or ever will be’,21 in 1891, when De Clercq wrote his essay, he could state that the discussion at that time was focused more on the question of whether such a tax should be progressive or proportional than on the issue whether it should be introduced at all. A major problem at the time was how to tax income from movable property. One of the reasons was that a large part of such property consisted of pension payments from government bonds, and any 18 MWF Treub, Ontwikkeling en verband van de Rijks-, provinciale en gemeentebelastingen in Nederland (Leiden, 1885) 553. 19 D de Clercq, Glasgow en hare gemeente-organisatie, een voorbeeld van praktisch socialisme met eene beschouwing over inkomsten- of grondrente belasting (Amsterdam, 1891) 23. The author had his doubts about the income tax, however, and proposed a tax on rent similar to the proposals of Henry George. 20 FHM Grapperhaus, Fiscaal beleid in Nederland van 1800 tot na 2000 (Deventer, 1997) 61–2. 21 Buijs in Staathuishoudkundig Jaarboek 1882 Verslag at LX, approvingly quoted in JC Bloem, Een woord over de middelen tot herstel van het evenwicht tusschen ’s Rijks Inkomsten en Uitgaven (The Hague, 1883) 6.

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tax on such payments seemed to imply that the government willingly defaulted on its existing obligations. A proposal for a 0.75 per cent levy on the capital value of all properties and 5 per cent of various non-profit income had failed in 1848. New proposals were rejected in 1850 and again in 1871. Fresh attempts would follow at shorter intervals, but were rejected for various reasons. Clearly it was difficult to compromise between the different ideas of equitable taxation. The political problem of not taxing rentiers became socially difficult to explain, especially after 1887 when the constitution had been amended and the number of voters had been doubled. It became increasingly clear that income from movable property could not be exempted much longer. In 1795 and in 1848, pressing budgetary needs had prevented a full implementation of the commonly accepted idea that the poorer classes should be relieved of the unequally pressing indirect taxes on consumer necessities: in the 1890s conditions had much improved. Minister Pierson admonished the conservative commentators who may have viewed the idea of progressive taxation with mistrust that it is always difficult to notice inequities to which society has become familiar. He compared this with his own experience during a visit to the United States: Something over 33 years ago I stayed in the southern states of North-America. I could observe how the most kind and God fearing people accepted slavery without any objection. They went to an auction of slaves, like we go to an auction of houses, to see what was occurring. They were used to this. And likewise we are used to the inequities of our tax system; we do not notice them anymore. Still, they exist and we should take them into account.22

After the elections of 1891 Pierson found an opening for a new income tax proposal. In fact, his proposal consisted of two parts: separate rules for capital income (1892) and employment income (1893). The aim was, however, to tax all income by a ‘dual’ income tax. Both taxes had progressive rates (up to 2 per cent for capital income and 3.2 per cent for employment income), with basic exemptions. The employment income tax included wages, pensions and annuities, income from self-employment and also income of legal persons. The two systems of income taxation were not, in fact, completely separate: •

taxpayers with high employment income were taxed more heavily by the capital income tax—they were not allowed the basic exemption in the latter tax; at the same time, those with a high taxable net wealth were taxed at the top tax rate over the full amount of their employment income23;

•

22

Handelingen Tweede Kamer 1891-–92, at 1161. This is the Dutch Hansard. A reduced basic exemption in the employment tax was available at lower levels of taxable net wealth. 23

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on the other hand, those who were not taxed by the capital income tax because of the basic exemption, were imputed an additional employment income of 4 per cent of their net wealth; to the extent that a taxpayer used his capital in the acquisition of employment income, he could deduct 4 per cent of the equity.24

This quasi-analytical approach of the different sources of income was objectionable to those who favoured a graduated rate; personal ability to pay can only be determined if all sources of income are added and relevant costs and expenses deducted. In 1890 Treub, however, had described an analytical approach that should still take into account the ability to pay, by differentiating between income from capital, business, and labour. There could be a graduated rate for each category, and the fact that income from capital is most durable, business income less durable and income from labour not durable at all, could be compensated by deductions for business income and even a larger deduction for labour income. Heynsius, in his comments on Pierson’s split income tax, believed that Treub’s idea was not feasible in practice. One of the major problems the tax legislator had to cope with was the primitive state of accountancy systems at the time. This, Heynsius argued, would also be a problem for the income tax proposed by Cort van der Linden: whether the highly learned professor had ever tried to calculate the income of a farmer was his question.25 Pierson had to come up with a solution. The problem was most obvious with respect to income from property. Pierson’s answer was the taxation of presumed income, instead of taxing the actual income. Pierson believed each individual taxpayer should reasonably be able to achieve an income of 4 per cent from his capital investments over a longer period of time. This income would be taxed progressively at a rate starting at 2.5 per cent rising to 3.75 per cent. Effectively this would equal a tax on net wealth (in excess of a basic exemption) of 1 to 1.5 pro mille. The tax therefore had a double progression, resulting from the exemption and from the graduation of the rate. This weak progression raised a lot of discussion. Heynsius wrote that a steeper progression rate might have been preferable, but he admits that this rate in the end would only be a matter of one’s subjective opinion.26 The progression in any case was not intended to redistribute income. The progression was only to fill the budgetary gap caused by the exemption for smaller fortunes; the tax was not due on individual savings up to 13,000

24 A specific case was deductible rent on real estate. If the owner used it in the course of his own business or trade, the deduction was 7% of the economic value (instead of 4% for financial equity). 25 AHJ Heynsius, De voorgestelde belasting op de inkomsten uit vermogen (Amsterdam, 1892) 8–9, 17. 26 Heynsius, above n 25, at 17.

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guilders.27 Consequently, with the 4 per cent presumed income, this would be a personal tax allowance of 520 guilders. Shortly after the capital income tax, Pierson proposed a tax on income from employment and business, also with a weak progression up to 3.2 per cent.28 The introduction of these taxes was only part of a larger tax reform. The excise on distilleries was increased, the excise on soap was abolished and the excise on salt reduced, as well as duties for mortgages and registrations. The entire reform should be neutral for budgetary purposes, but it is clear that the new taxes would approach the ability to pay better than the situation before 1893. Still, Pierson’s purpose was not to make the tax system as a whole progressive. The rate graduation should only compensate for the degressive effect of the indirect taxes.29 It was the first proposal, on capital income taxation, that raised the most fundamental discussions in Parliament on tax rate progressivity. The Liberal party, the ruling political party supporting Pierson, favoured a progressive property or income tax. This party felt sympathetic towards the intention to have at least a partial shift of the tax burden from the poor to the wealthier classes. Discussions in Parliament touched equally upon issues of practice and theory. From a practical and an economic point of view, it was argued by some representatives that the tax burden should remain with the lower income classes. They believed that that entrepreneurs’ wealth should be cherished to stimulate the economy and to create jobs for less fortune labourers. The argument was rejected by others: if the labouring classes could spend more, as a consequence of the redistributional effect of Pierson’s proposed reforms, this would fuel the economy. This brings us back to the principle of tax progressity, which some parliamentarians saw as a Socialist principle, aimed at the equalisation of property. One opponent of progressivity worded the feelings in his political circle as he said: Sometimes there are issues in the air that one cannot turn about, not even if one does not agree with them. This is the case with progressive taxation and a broader suffrage, I believe. One can fight them, but they will become reality anyway.30

The flaws in the theory of progressive taxation were duly noted by other Members of Parliament also. Had not the Minister himself admitted ‘the

27 This amount of capital was probably sufficient at the time to allow a modest living. Counting the 4% presumed income, this would be a personal tax allowance of 520 guilders. 28 Handelingen Tweede Kamer 1891-–92 1118. In comparison, the minimum of subsistence, which would be exempt from taxation, was calculated at 400 guilders, while an income of 200 guilders was not unusual for many labourer families: Handelingen Tweede Kamer 1891–92 1143. 29 Handelingen Tweede Kamer 1891–92 Memorie van Antwoord at 51. 30 Ibid 1240.

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progression theory has made a stormy entrance in science as being of paramount importance, but nowadays no scientist dares promoting the theory any longer?’31 This was acknowledged on both sides of the political spectrum. Even the left-wing politicians could agree, but they saw no reason to change their desire to implement the theory anyway. The amendments filed included a wide range of progressive rate proposals, in itself already an indication of the intrinsically arbitrary outcomes of the theory in the absence of a mathematical fundament. But why should there be a mathematical fundament to the progressive rate, one representative asked. What is the mathematical fundament for the 63 guilders excise on liquor? The choice of rates was recognised as a question of politics rather than economic theory. Several representatives urged the Minister to increase the progressivity. Why limit the progressivity at just a few per cent? Others questioned this plea for higher rates. Where should one stop? At the level of pure confiscation?32 The income tax should not be an envy tax, it was argued, not a tax imposed ‘out of mere hate, out of envy for those who have been privileged by fortune’. A more moderate comment, but materially similar, argued that: it has appeared to me as one of the worst characteristics of an unhealthy democracy, if the majority of the voters would freely dispose of the purse of a small minority, if one would engage into high expenditures on account of the State, to please the crowd, knowing that the cost of these expenditures would not be felt by the masses. May the Netherlands always be preserved from such a phenomenon.

Last but not least, there was the issue of international tax competition. The wealth income tax was by some viewed as a premium to leave the country. One representative calculated that with a realistic return of 3.5 per cent the tax would be 5.63 per cent of the actual income, which would be twice the rate that was levied, for example, in England at the time.33 The Minister opened his reply to the comments on the progressive rates by saying that he had drafted the relevant article with much hesitation. He felt that the tax should be progressive. Initially however he had feared that the opposition against progressive taxation would be fierce. Much to his surprise, the majority of the representatives and other commentators had not objected to the progressive principle, but to the moderation with which it was applied. Also, the objections came not only from commentators who would not have to pay the property tax, but also from inhabitants of the most luxurious neighbourhoods in the Netherlands, who could accept an

31 32 33

Ibid 1240. Ibid 1102. Ibid 1109–29.

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even stronger progression than the minister had proposed. This at least covered the concerns of conservative representatives for adopting an envy tax or at least for a tax that would not be democratically legitimised because the constituents of the proponents in parliament would not be liable for the tax. Pierson summarised his position: the taxes must be distributed according to the standard of the so-called free income. That is the income above the minimum of subsistence. The combination of taxes must be directed in such way, that this aim can be effected. For that purpose we need progression in the income tax. Progression in this tax is the means to achieve proportionality in the sense just referred to.

To him, moderation in rate progressivity was not only the answer to the problem that all theories on progressive taxation seemed defective, but also necessary to avoid tax evasion and tax avoidance; why would a Dutchman returning rich from the colonies choose his domicile in the Netherlands, if he could avoid the progressive property tax by settling elsewhere? To Pierson, the rejection of the pleas for steeper progression was a matter ‘of plain common sense’.34

III. THE HARD PRACTICE OF PROGRESSIVE INCOME TAXATION (1892–1940)

A. Pierson’s Income Taxes of 1892–93 By modern standards, the employment and capital income taxes were extremely simple, each of them covering just a few pages of substantive rules.35 The employment income tax summed up the sources from which taxable income can flow to a taxpayer, such as a business, a wage contract, or independent labour. The tax made hardly any further distinction in the tax treatment of these sources. In all cases, taxable income consisted of the pure gains after deduction of costs. Limitations on deductions did, however, occur. Expenses made on carriages, if also used for private purposes, were only deductible for the half. The law did provide for special treatment of several types of income and specific sectors of commerce and industry, for example pensions and annuities were taxed at 50 per cent of their amount. Most of the special rules were meant to continue a favourable tax treatment accorded by the licence tax. The 1892–93 dual income tax was hardly a success in terms of revenue, though the number of taxpayers did increase over the years. In 1894, the 34 35

Ibid 1245–47. The larger part of both tax codes deals with issues of administration and review.

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total income tax revenue equalled 0.8 per cent of GDP. In 1914, income tax revenue still stood at 0.9 per cent of GDP. In light of the progressive rate structures of the dual income tax, this was indeed a poor performance, as GDP had roughly doubled in 20 years. The reason was that the capital income tax was not very effective, which also affected the functioning of the employment income tax because both systems were intertwined. The employment income tax used a basic exemption of 650 guilders, which was adequate to exempt a large majority of employees from the tax. The top rate of 3.2 per cent was reached at an annual income of 8,200 guilders. In 1914, a total number of 4,400 people actually paid that top rate. Most of them did so because their net wealth (taxable by the capital income tax) exceeded 200,000 guilders, which meant that their full employment income was taxable at the 3.2 per cent rate. Only a few hundred people paid the 3.2 per cent rate because of high income from employment. This means that the rate progressivity of the employment income tax depended heavily on the registration of (high) net wealth. This registration was evidently of poor quality. An important explanation can be found in the weak administrative basis of the tax. If a taxpayer failed to file a tax return, taxable income would be assessed, but there was no penalty for false reporting. Also, there was no legal provision for additional tax assessment. For practical purposes, both parts of the dual income tax had been assigned to different departments of the tax administration. The department that had to implement the capital income tax was better-skilled, and more familiar with taxes applicable to high-income earners (like estate and inheritance taxes), while the department that had to collect the employment income tax was used to digging into the books of ordinary shopkeepers. The co-operation between both departments was not close. As the Government’s statististical bureau started in 1894 to collect and publish income tax data, it is possible to get a fairly adequate idea of the functioning of both taxes. It appears that especially the capital income tax never worked properly. In the 20 years between 1894 and 1913, Dutch GDP roughly doubled. Progressive taxes usually generate a growth dividend: a 1 per cent increase in GDP leads to a more than 1 percent increase in income tax revenue. With Pierson’s taxes, however, this never happened. The employment tax revenue increased by 85 per cent (slightly less than GDP growth), the capital income tax by a shallow 45 per cent. To be sure, the total number of taxpayers doubled, but the growth concentrated in the range of lower-income taxpayers (taxable by the employment income tax, but not by the capital income tax). The largest increase in taxpayers was people with taxable incomes just exceeding the basic exemption. In these cases, the tax due must hardly have outweighed the administrative and compliance costs. The number of taxpayers subject to the capital income tax

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increased at a far slower pace. The average net wealth per taxpayer also increased slowly, as did the capital income tax revenue. It seems that the tax administration was unable to get access to the rapidly increasing private prosperity. The pillar of Pierson’s income tax system was the group of taxpayers assessable under both the employment and the capital income tax. Here, the effect of increasing prosperity did become visible, in terms of increases in average income and tax burdens. The growth of this group of taxpayers must have been affected adversely by the weak performance of the capital income tax.

B. The Income Tax of 1914 Though attempts had been made to improve the effectiveness of the capital income tax,36 in 1914 it was concluded that dual income taxation did not work. The new income tax of 1914 (in force from May 1, 1915) taxed all income from employment and capital. The capital income tax was continued as a net wealth tax at a much lower rate. The new income tax law still covered only six pages of text, but it was more elaborate that its predecessors. It mentioned four categories of income: 1 2 3 4

immovable property; movable property; business and employment; and annuities and pension benefits.

Following the German source concept, capital gains on private investments were not taxable. While employment included labour ‘of any nature’, non-business profits made by ‘pure speculation’ were explicitly exempted. A second element that was borrowed from the Prussian income tax was that taxable income was not actually measured but estimated on the basis of last year’s income. For that purpose, only a taxpayer’s ‘sources of income’ as they existed at the start of the taxable period were taken into account. One necessary exception to this rule of estimation based on the past was income from incidental labour, which could of course only be taxed on a realisation basis. The rates of this new income tax were slightly increased, compared with the dual income tax. The impact on tax revenues was significant. Taking the new income tax and the net wealth tax together, tax revenue was increased by some 50 per cent in a single year. It is interesting to see how this tax reform increased the effective progressivity of income taxation. In 36 By creating a legal basis for additional tax assessment, as a response to widespread under-reporting of net wealth. A legal penalty for under-reporting was only introduced in the 1920s.

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fact, all additional tax revenue was generated by high-income taxpayers. This steeper progressivity was a result of two factors of roughly equal weight37: •

•

wealthy taxpayers were now taxed on their true investment incomes, rather than on a presumptive 4 per cent; income tax assessment was now concentrated with a single department of the tax administration. As a result, taxable incomes of the wealthiest taxpayers increased by some 50 per cent on average in a single year; higher tax rates and steeper progression (with a top tax rate of 5 per cent, only to be reached at a very high level of income of 20,000 guilders) made high income groups pay more tax.

The First World War (in which the Netherlands remained neutral) required that the full revenue potential of this new income tax was put to the test with ‘temporary’ increases in rates. These increases were consolidated in 1919. The number of scales was then augmented from 4 to 15, and the top tax rate increased to 16 per cent. It must be added that this top rate was even more symbolic than the top 5 per cent rate of 1914, as it was only applicable to incomes in excess of 70,000 guilders. The number of taxpayers involved must have been insignificant. At lower levels of income the rates were also increased. At the same time, the basic exemption was raised for the first time since 189238 —as it happened, it was also the last time until 1941. In a few years’ time, income tax revenue had tripled, and the average tax burden increased from 1.9 per cent of taxable income (1915–16) to 3.6 per cent (1919–20). Roughly 70 per cent of the tax revenue increase can be attributed to higher tax rates. The remaining increase stems from economic growth and the growing numbers of taxpayers—approaching 1 million at the beginning of the 1920s. Compared with the extensive debates on tax rate progressivity in the late nineteenth century, the political resistance against higher and more progressive income tax rates had become surprisingly weak. The idea of progressive income taxation had become accepted fairly generally within a few decades. Basically, the income tax was still a simple piece of legislation. But the first signs of broader socio-economic use were becoming visible. In the legislative process leading to the 1914 tax reform, Parliament had already shown interest in the development of a system of deductions for dependent

37 The revenue effect of the increase of tax rates has been determined by estimating the revenue of the new income tax as if the tax rates had not been increased. Available data from the Government Statistical Yearbook are sufficiently specific to allow for such a calculation (tax payments and taxable income are reported for about 10 classes of income). 38 From 650 to 800 guilders.

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children. The 1914 text of the law allowed no deduction for the costs of raising children, but did allow a standard deduction for every dependent minor child. With the 1919 tax rate increases came a more elaborate system of child deductions. Its design was an interesting compromise between those who wanted the state to pursue social policies (if necessary, also through the tax system) and those who stuck to the belief that the state should refrain from getting involved in the existing socio-economic order. Every taxpayer (still not including most blue collar workers) would be entitled to a standard deduction for his children, depending on their age, but also on his level of income—the higher his income, the higher his deduction. The idea behind this design was that people with higher incomes will usually spend more money on the education of their children—a fact of life that the tax legislator should accommodate. The system of income estimation was a fundamental weakness of the 1914 income tax. It was supposed to make tax administration easier, and to ensure that taxpayers would know their tax liabilities in advance. As such, it was an alternative to withholding tax on, for example, wages and dividends, which was at the time believed to be too difficult. But in fact, the result often was that one’s taxable income reflected neither last year’s, nor the current year’s true income. The estimation approach also created evident tax planning opportunities. The weakness of the system became more visible as tax rates increased. Though the national tax rates were even reduced in the late 1920s,39 municipalities eagerly applied supplementary taxes. As a result, the combined top income tax rate in the larger cities reached a level of 50 per cent. Reducing taxable income became a profitable activity. A separate fundamental weakness of the tax system was that legal persons were not included and no corporation income tax was adopted: only profit distributions were taxed at source. Business incorporation therefore became a major tax planning device, and the combination with personal income estimation (discussed below) opened opportunities for avoiding tax altogether.

C. Running the Tax System: the Roles of the Legislator and the Supreme Court From 1914 onward, taxpayers could submit their disputes with the tax administration to Review Councils, which specialised in direct tax matters, with a right of appeal to the Supreme Court. The Supreme Court’s role in 39

But a national defence tax, in force until 1930, put an additional tax on high incomes.

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tax matters was (and is) limited to interpretation of the law and legal principles40; it does not reconsider the facts of the case. The role of the Supreme Court in tax matters can be viewed from two angles. First, given the simple nature of the Income Tax Act 1914 (ITA 1914), important elements of substantive income tax law had to be developed by the Supreme Court. The court had to operate as a quasilegislator. Second, the Dutch income tax system seems to have suffered extensive tax avoidance after 1919. One indicator is that income tax revenues steadily declined in GDP terms. After a top of nearly 7 per cent GDP in 1920, not much more than 3 per cent remained 10 years later. The role of the Supreme Court was here to clarify the borders between use and abuse of the law. The role of the Supreme Court in developing the idea of ‘income taxation’ has been important. No full discussion of that role is undertaken here; but some of the most important contributions will be mentioned.

D. Income: Conditions for Taxability The ITA 1914 stipulates four categories of income, which include a number of sources such as: exploitation of immovable and movable property, and a business, employment, other forms of labour (such as providing services and the management of one’s portfolio investments) and annuities. The Supreme Court illuminated under which conditions such sources are deemed to exist. The court’s first requirement is that there is participation in economic life. This excludes income generated within the private (family) circle, as in the case that the Supreme Court decided in 1923.41 In that case, a single female taxpayer had imputed income because she shared the costs of her household with a nephew who lodged with her. The Supreme Court decided that this kind of ‘saving on costs’ in the private sphere was not included in any of the sources of the law. The criterion of participation in economic life should not be identified with voluntary market exchanges: criminal and illegal activities of any kind can be sources of income.42 The second requirement for a source is that it can reasonably be expected to generate net gains. The classic example is the consul-general case.43 The taxpayer in this case claimed deduction of costs for an 40 The Dutch Supreme Court cannot test laws against the Constitution, but it can apply principles (of sufficiently specific nature) embedded in international treaties to which the Netherlands are bound. 41 Supreme Court, Beslissingen in Belastingzaken, (Amsterdam) B. 3307, 31 October 1923. 42 Ibid B. 4481, 13 March 1929. 43 Ibid B. 4857, 26 November 1930.

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honorary function that would never generate positive net results. The court ruled that under such a condition, there was no source of income. Additionally, the Supreme Court’s older case law requires that acquisition of income be intended. On this ground, incidental labour performed for friends out of kindness, was not considered a source of income, and any unintended reward remained tax-free. In the classic case,44 a taxpayer had advised his brother on the minimum price to be asked for some real estate; he had not intended to share in the profits. The Supreme Court ruled that such advice could qualify as a source of income (non-contract labour), but that in this case—the provision of good counsel among brothers without any intention to receive a reward—no source of income existed. The German concept of source puts some emphasis on periodicity (especially in the work of Adolph Wagner): only a repeated flow of revenues can constitute a source of income. In the Dutch case law, this criterion has not been adopted. According to the Supreme Court, a source of income must, generally speaking, be able to generate revenues repeatedly, but this criterion should be applied to the source, and not to each separate type of income from a source.45 In the field of income from labour, the idea of periodicity has never been relevant, as the law specifically declared revenues from incidental labour to be taxable. Important conceptual questions which were decided in case law include the concept of business (or enterprise), and the minimum amount of labour that can qualify as a source in the absence of an employment contract. In 192946 the Supreme Court decided that legal acts consisting only of the disposal of (non-business) assets could not in themselves qualify as labour, implying that any positive results would be tax-free speculative gains. It has since become an accepted rule (now embodied in the law) that ‘normal management’ of one’s own portfolio does not give rise to income from labour. The consequence is that any capital gains resulting from this normal management are tax-free. Business capital gains, however, are taxable. The ITA 1914 provided a broad and general concept of taxable business profits, and mentioned an array of deductible costs and expenses. In the early years of the law, the Supreme Court had some difficulty in defining business profits in terms of source. The law considered any gain resulting from the business as business profits. In 1921, the Supreme Court decided that this included gains on the sale of business assets, on the condition that the sale was part of the

44

Ibid B. 5365, 25 January 25 1933. Ibid B. 4533, 26 June 1929. The case concerned incidental revenue from letting real estate (the tenant had made improvements at his own expense). Though this type of revenue was incidental, the source (the real estate) was apt to generate repeated flows of (rental) income. 46 Ibid B 4501, 24 April 1929. 45

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normal conduct of the enterprise.47 That is to say, the court held that profits are not always causally connected to the source business—selling redundant investments could well be tax-free. Ten years later, the court changed its mind: all gains (and losses) on the sale of business assets are taxable unconditionally.48 From that time on, the situation has been that capital gains are taxable when allocable to a business, but tax-free in other cases.

E. When are Business Profits Taxable? The ITA 1914 provided little guidance as to the timing of business profits and costs, ie the question of in which taxable year profits have to be reported and costs and expenses can be deducted. It referred to ‘sound business practice’ but only with respect to depreciation of business assets and valuation of claims. The Supreme Court has extended the application of this criterion. According to the court, a taxpayer is free to adopt any method of calculation of yearly profits that is in agreement with sound business practice. Very generally speaking, this means that revenues must ultimately be included in taxable income upon realisation (such as the moment of conclusion of a contract, but more usually the delivery of goods); costs should be matched to the revenues concerned. Sound business practice allows considerable flexibility with respect to entrepreneurial uncertainty; costs can be taken into account on the basis of reasonable expectation rather than realisation. The court’s wide application of the criteria of sound business practice was codified after the Second World War, and is still the basis for the calculation of yearly taxable profits. There is a tendency, however, to limit the freedom of taxpayers in this respect, because the rules of sound business practice allow them considerable opportunities for postponement of tax.

F. Which Expenses Qualify as Deductible Costs of Labour? The ITA 1914 pointed out that the revenue stemming from a source should be reduced with costs of acquisition, collection and maintenance of that revenue. For income from business and employment, these costs included the costs made to carry on the business or to perform the job. We may safely assume that the inflow of new taxpayers around 1920 consisted primarily of white-collar employees. It does not come as a surprise that issues concerning taxation of labour income came to the fore in the 47 48

Among other cases: Ibid B. 2727, 9 February1921. Ibid B. 5044, 23 September 1931.

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Supreme Court’s case law. Two types of costs have generated a considerable amount of case law from the 1920s onwards: 1

deduction of the costs of a study at home. The Supreme Court’s strict interpretation of the law was that such costs could only be deductible if they were inevitably required by the nature of the job; deduction of travelling expenses between the place of residence and the place of work. Again, the Supreme Court held that such costs were non-deductible, unless these were unavoidable to perform the job. This could be the case when a taxpayer had two jobs in different places, or when his wife and he worked in different places.

2

On these issues, the legislator later took a much more liberal stand (at least until the tax reform of 1990). As a result, costs of studies and travel expenses became major tax expenditures after 1945. The limitation (and eventual abolition) of these deductions has been a major problem in Dutch tax policy in the late twentieth century. In comparison, the Supreme Court of the Interbellum proved well able to resist increasing social pressure by employees to broaden the concept of deductible costs of employment. A final example is labour union contributions. The Supreme Court ruled that these contributions were inevitable costs of employment only in closedshop sectors (such as typographists, where union membership was required to obtain a job)49. It took a Cabinet implementing order (1926) to include all labour union contributions under the concept of deductible costs.

G. The Supreme Court and Tax Planning When tax rates increased after the First World War, a growing number of income tax planning cases was brought before the Supreme Court. The court developed several approaches to these cases. One approach was to ignore a fictitious legal act (sham) for tax purposes. A second approach was (re)qualification of legal acts and transactions for tax purposes. But the court also came to accept the fraus legis doctrine in tax matters, which allowed it to adjust the tax consequences of legal acts and transactions. A popular sham in the 1920s was the invalid incorporation of enterprises. The Dutch commercial law at the time did not know the private limited liability company, and to establish a public limited company, it required at least two participants. In response, taxpayers wanting to incorporate their business for tax purposes tried to do so with some help of

49

Ibid B. 3397, 9 April 1924.

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other persons, whose participation was in fact fictitious. The Supreme Court did not hesitate to decide that in these cases, the act of incorporation was not relevant for tax purposes.50 As to the characterisation of legal acts and transactions for tax purposes, the Supreme Court initially showed some hesitation. An obvious case of tax planning came up in 1922. The case concerned a life insurance policy contract of considerable value (160,000 guilders payable after 15 years or upon earlier death). Payments to such an insurance contract were not deductible for tax. The insured person had, however, created deductible interest payments by borrowing the capital to be deposited (100,000 guilders) from the insurance company. The tax inspector, stressing that such connected transactions were becoming more and more popular, claimed that in fact the interest payments should be considered as insurance premiums. In a case like this, the modern Supreme Court would probably decide to qualify the interest payments as premiums for tax purposes. But the Court of 192251 did not. It did admit that sham transactions could be ignored for tax purposes. However, it agreed with the Review Council that in this case, even if tax saving had been the aim, two separate legal transactions had indeed taken place. Therefore, interest deduction could not been denied. In 1925, the legislator moved against large-scale tax avoidance by adopting ‘proper taxation rules’. Under these rules, legal acts and transactions could, with specific conditions, be ignored if these transactions were caused by tax considerations. In their design, the proper taxation rules were specifically aimed at a common technique of tax avoidance under the income estimation rules of the ITA 1914. Income was estimated by looking at last year’s income from sources extant at the beginning of the taxable year. Under that rule, it could be attractive to have a source of income ‘disappear’ just before that date. Take, for example, a business which generates net profits of 1,000 guilders in Year 1, and 10,000 guilders in Year 2. Taxable profits in Year 2 would just be 1,000 guilders, but taxable income in Year 3 would be 10,000. A popular way to avoid that, was to incorporate the business before the end of Year 2, while using any excess funds as private income. At the beginning of Year 3, there would be no ‘business’ source, but instead, a ‘shares’ source with no short-run expectation of profit distributions (and as there was no corporate income tax, profit retention had no tax consequences). Therefore, taxable income for Year 3 would be low or zero. It was this type of tax-inspired legal transaction that the proper taxation rules addressed.

50 51

Ibid B. 4165, 30 November 1927 seems to be the first case. Ibid B.2924, 15 April 1922.

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At the same time, the Supreme Court accepted the relevance of the fraus legis concept in tax matters. It did so for the first time in 1926, in a case concerning inheritance tax. In this case, the testator had attempted to keep a right of usufruct outside of the scope of inheritance taxation: the normal condition that this right would terminate at his death was replaced by the very unusual condition that it would do so three days before his death. The Supreme Court ruled that the legal circumstances created by the parties involved were so close to the circumstances that the legislator had intended to tax, that the purpose of the law would be frustrated if this fraudulent use of the law was accepted. This approach was criticised at the time, but has become accepted since. The ‘proper taxation rules’ introduced in 1925, however, have not been applied again since the 1980s.

H. The Idea of Income Taxation at Stake? The Depression plunged the Dutch public finances into crisis. A turnover tax was introduced in 1933 and import duties were raised. But it was obvious that personal income tax was in need of reform. The problems of the income tax can be summarised in two points: 1

2

the technique of income estimation was an evident failure. It had been used as an alternative to withholding techniques, but many employers and employees would prefer a wage withholding tax. Indeed, large enterprises had started to withhold income tax on the wages of their higher-paid workers; a second evident problem was the lack of a tax on corporate profits. This put a high tax premium on incorporation of businesses. To illustrate the point: the number of corporations doubled between 1915 and 1934. In 1915, two-thirds of these corporations made no taxable distributions, in 1934, three-quarters of them did not.

The problems were aggravated by high tax rates, caused primarily by increasing municipal supplementary rates. At the end of the 1930s, the Government appointed a committee of tax experts to study the remedies to these problems. It made a proposal for a simplified system of revenue taxation, which was subsequently worked out in draft legislation and submitted to parliament. The idea was to tax different types of gross revenues (wages, rents, business profits and interest), all at the rate of 2 per cent. There would be a separate tax on corporate profits, at a rate of 8 per cent. The ITA 1914 would not be abolished, but remain to serve as a progressive tax on high incomes. In a sense, this meant that the ITA 1914 was declared an incurable case.

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The explanatory memorandum pointed out that this system of taxes could well take account of taxpayers’ personal circumstances, by a number of measures: 1 2 3

workers would be entitled to reclaim wage tax to the amount of their labour-related expenses (an early kind of tax credit); child deductions would be replaced by direct payment of child benefits; and taxation and deduction of interest were simulated by an intelligent device: the payer would deduct 2 per cent by way of withholding tax, but would be allowed to keep that amount himself; the payee faced no further tax.52

There was no proposal to simulate the basic income tax threshold by some kind of general tax credit. Therefore, some opponents of the plan argued that it would increase the tax burden on low incomes using a deceptive collection technique. The proposal was, however, aimed at keeping progressivity in the tax system at large, for example by reduction of excises, and of course by the adoption of an 8 per cent tax on corporate profits. But apparently, this analysis was too sophisticated to convince Parliament. No tax reform passed until the outbreak of the Second World War, though a system of wage withholding taxation was being studied and developed by the Ministry of Finance. Also, a corporate income tax was prepared. More conventional measures were in fact adopted, in the first year of the war, during German occupation. A wage withholding tax, a new personal income tax (based on realised rather than estimated income) and a profits tax were all introduced in 1941–42. This in fact laid the foundation for the post-war Dutch income tax system. The adoption of the wage withholding tax was a big success in terms of revenue and the number of taxpayers. It showed how ineffective the ITA 1914 had been. The wage withholding technique not only made it possible to tax lower-income workers (which resulted in an additional 1.2 million taxpayers). There was also a considerable increase (35 per cent) in the number of wealthier taxpayers, which indicates the scale of tax avoidance in the 1930s. Given the unreliability of income data, it is not possible to estimate the changes in tax burdens between 1940–41 and 1942. Tax payments evidently increased sharply. This increase was partly due to the integration of municipal levies in the national tax rates; to an unknown extent, tax revenues were spurred by anti-avoidance rules during the transition from the ITA 1914 to the new taxes. In the meantime, the Dutch refugee cabinet established in London adopted its own income tax. It is a rare example of 52 The apparent underlying idea was that a tax of 2% on interest receipts combined with deduction of interest payments at the same rate leads to a revenue of zero; to leave interest untaxed would, however ,create economic distortions.

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a purely extraterritorial tax. Subject to the tax were all Dutch nationals not living in the Netherlands (and other Nazi-occupied territory), they were taxable on all income not derived from the Netherlands (and other occupied territory). Taxable income was defined in a single article of not much more than a hundred words—a striking hyperbole of pre-war legislative carelessness with respect to the concept of income. As in the 1914 tax, income was to be estimated in advance. Perhaps as an echo of the simplified system discussed in the late 1930s, the rate was a flat 5 per cent (for those who paid normal income tax in another country) or 20 per cent (for others).53 But the only article that had practical meaning (and revenue impact) stipulated that wages paid by the Dutch (London-based) government were to be taxed at source.

IV. MAJOR TRENDS IN POST-WAR PROGRESSIVE INCOME TAXATION

The post-war era started with top income tax rates of up to 75 per cent. The most recent tax reform (the ITA 2001) uses a 52 per cent top rate and a flat-rate presumptive portfolio income tax. There is significant political support for a general flat-rate tax. What happened to the idea of tax rate progressivity? Any attempt to answer that question thoroughly would require a full paper to itself. In the present paper, the only intention is to show some basic continuities and changes in comparison with the income taxes of 1892–93 and 1914. The discussion focuses on the question of how the development of the Welfare State, and the increasing complexity and instrumental use of income taxation, affected the debate on tax rate progressivity.

A. The Development of the Welfare State The post-war development of the Welfare State influenced the personal income tax in several ways: 1. the income tax became a major source of state revenue (at roughly 10 per cent of GDP, compared with 1 per cent in the early years of income taxation). In particular, the use of (wage) withholding techniques allowed the inclusion of lower-paid workers in the income tax. These techniques also offered the financial foundation for an extensive system of social security; 2. the income tax became an important vehicle for social and economic 53

There also was a basic exemption of £100 or US$400.

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policy, starting with investment incentives in the early 1950s. Extensive ‘fiscal welfare’ schemes for, inter alia, dependent children, pensioners and disabled originated in the 1960s. In the ITA 2001, most of these social policy issues are being dealt with by way of a tax credit system (of rapidly increasing complexity, and with the compliance and take-up problems that are well-known in other countries). More generally, the focus of income tax policy has shifted from issues of sectoral tax burden distribution (dominant in the nineteenth century) to issues of household purchasing power and personal income distribution. Around 1975, the income tax was even considered an important instrument in reducing income inequality; 3. social security financing has crowded out income taxation especially at lower levels of income where income tax and social security contributions have been compounded in one tax rate (since 1990). Currently the lowest tax rates (at about 35 per cent) consist almost fully of social contributions. In a sense, paying income tax is again the privilege of high-income earners; and 4. at the same time, however, the income tax base has been eroded by deductibility of (earnings-related) pension contributions. This explains to some extent54 why the Dutch income tax has high rates (between 42 and 52 percent for most taxpayers) compared to its revenues. Adding up these developments, it is clear that the role of personal income tax in society has undergone considerable change. For sure, the tax has always been connected to issues of personal income distribution. But the amount of instruments available to the government to redistribute income and welfare has increased, as have the difficulties in co-ordinating these instruments. Income tax rate progressivity has become far less important as a sign of public involvement with differences in income.

B. Issues of Complexity, Compliance and Effectiveness Such issues are closely connected to the changes in the role of income taxation in society. As we saw in the previous section of this paper, the idea of a much simpler type of income taxation was developed in the 1930s. It was a response to the low effectiveness of the ITA 1914, both in taxing the rich, and in generating adequate revenues. Apart from the income estimation rules,55 the ITA 1914 was a simple piece of law. It had no special 54

The other explanation is the extensive use of mortgage interest deductibility. Which had become much elaborated in response to the wide array of economic decisions that could affect the actual estimation; the ‘human capital’ developed in devising and applying these rules became completely obsolete with the introduction of wage withholding taxation. 55

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incentives for businesses, pensioners or whatever. The broad use of income taxation for social and economic policy is typical for the post-1945 period. With it came political involvement with the concept of taxable income, especially in the field of deductible costs. The trend has been to define ever more precisely the specific business and employment costs that can be deducted. In the case of wage income, no costs can be deducted under the ITA 2001. On the other hand, work incentives have been developed for both employees and self-employment. From the 1970s onwards, academic analysis and debate tended to be sceptical about the effectiveness of high and progressive income tax rates. Looking at the statistics, it appeared that much of the rate progression was undone by the use of deductions. Taxpayers became more conscious about tax planning opportunities. What helped was the development of a tax planning industry. Its development had started in the 1920s and 1930s, but its expansion took effect from the 1960s onwards. At that time, tax law became an academic discipline with a specialised curriculum starting at undergraduate level. Tax planning became something of a national entertainment in the field of portfolio investment, where the existing concepts (no tax on non-business capital gains, full deductibility of interest paid) simply did not work any more. These developments demonstrate the difficulties of adapting a basically nineteenth-century institution to a twenty-first-century environment. The idea of tax rate progressivity as it was developed in the nineteenth century, never took into full account the intrinsic weaknesses of the concept of income. The consecutive tax reforms of 1990 and 2001 have attempted to increase the tax base while reducing the tax rates and especially the top income tax rate. The 1941 level of 75 per cent was continued after 1945 (albeit reduced to 72 per cent) until 1990 when it was reduced to 60 per cent, and 52 per cent in 2001. The actual tax rate progression has become modest.56 For portfolio investment income, the idea of rate progression has already been abandoned.57 This demise of tax rate progressivity over the course of a full century evidently reflects important changes in the economic and political environment of tax policy. But it also shows how long it may take to put new ideas in taxation to the test.

56 Over the first €17,000, the tax rate (including social security contributions) is 34%; over the next €35,000, the tax rate increases from 41% to 42%; income in excess of €52,000 is taxed at 52%. 57 H Vording and A Lubbers, ‘The Netherlands Presumptive Income Tax on Portfolio Investment: Background, Aims and Effects’ (2006) 60 Bulletin for International Taxation 327.

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C. Future Developments In this paper we presented a brief overview of the thinking on personal income taxation in the Netherlands over the last two centuries. Unavoidably, such an overview, primarily describing developments in the history of tax law, has the unsatisfactory consequence that it is open ended. The ITA 2001 presents the finale, but that finale is by definition no more than an intermediary stage. Income tax has become an indispensable tool in the hand of the tax legislator, but on the other hand, tax progression has been weakened substantially in the Netherlands. The rhetoric with respect to tax progressivity has also altered in several ways. The nineteenth-century debate on tax rate progression was highly academic in nature. The idea of progressivity up to a 100 per cent rate found its limit in an image of a class society—wealthy people were needed to sustain culture and economic progress. The debate was perhaps more heated than justified by the very modest tax rates adopted at the end of the century. In the early twentieth century, however, a steep progression (with combined effective rates exceeding 50 per cent) was achieved without much further discussion. In practice the administrative basis of the tax remained weak. Only a combination of tax measures taken after 1940 made it feasible to increase the top income tax rate to more than 70 per cent. It remained at that level until the 1980s. The obvious reduction in tax rate progressivity in the income tax reforms of 1990 and 2001 should primarily be seen as a pragmatic policy response to tax avoidance. It seems that an era of progressive taxation has passed, and a move towards a flat rate income tax is only a matter of time.

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2 A History of Progressive Tax in Australia CYNTHIA COLEMAN AND MARGARET MCKERCHAR

ABSTRACT Australia was first settled as a series of colonies and became a Federation in 1901. Federal Parliament was given a general power to impose tax under s 51(ii) of the Constitution, but this power was concurrent with that of the States’ taxing power. The Income Tax Assessment Act 1915 (Cth) was enacted to assist in funding the cost of Australia’s involvement in the First World War. The 1915 Act contained progressive rates ranging from 1.25 per cent to 25 per cent. It was not until after the Second World War that the Federal Government took exclusive control of income tax. Subsequent federal legislation, including the current Income Tax Assessment Act 1936 (Cth) (ITAA 1936) and Income Tax Assessment Act 1997 (Cth), has maintained progressive rates for personal income tax. Companies have always been taxed at a flat rate. This paper looks at the history of progressive rates in Australia. It considers previous work by Smith which charts the degree of personal income tax progressivity since the first Federal Act and analyses the effect of relevant political and sociological factors. In the 1970s there was widespread tax avoidance in response to a lack of indexation combined with high marginal rates applying at low thresholds. As a result there was widespread community acceptance of artificial schemes. The Federal Government in the 1980s reduced both the rates and the threshold at which they applied, but, in the 1990s, mass-marketed tax avoidance schemes proliferated in response to the high rates imposed on taxpayers subject to the withholding collection system, and the effect of ‘bracket creep’. In 2006, bodies such as the Institute of Chartered Accountants lobbied for a reform (and lowering) of the current rates, on the grounds that they act as a disincentive to productivity and an incentive to participate where possible in * Figures 2.1−2.4 (pp 49−52) first published in Smith, J ‘Progressivity of the Commonwealth Income Tax 1917−1997’ (2001) 3 Australian Economic Review No 34. Copyright © 2001, Julie Smith. Reproduced with permission of Blackwell Publishing Ltd.

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the cash economy. The current Conservative Government has lowered rates and raised thresholds in the last three Budgets. Most commentators acknowledge that although indexation of marginal rates would solve the problem, this solution is politically naïve as it is too expensive for governments and does not give them the political capital which is generated by a tax cut. The current Conservative Government has been in power for 10 years and has concentrated on introducing many tax expenditures targeted at families with children. The 2006 May Federal Budget also introduced major changes to superannuation. These changes further affect the progressivity of the tax system.

I. INTRODUCTION

W

HEN AUSTRALIA BECAME a Federation in 1901 the Federal Government was given concurrent powers to tax income. The first Federal income tax legislation was enacted in 1915 to assist in funding the First World War. Australia had a progressive tax system from the outset. The general concept of progressivity means that as a taxpayer’s income increases, their average tax rate rises. After the Second World War the Federal Government assumed total control over taxation. This has caused problems because the States are responsible for many high-cost areas such as roads, education and health. The recent trend has been for the Commonwealth to contribute to these costs. In 2000, when Australia introduced a Goods and Services Tax, the revenue was given to the States, but this has not solved the problem of vertical/fiscal imbalance. Until the Second World War taxpayers paid income tax at both a State and a Federal level.1 Research by Smith, using global tax progressivity measures, charts the progressivity of the Commonwealth personal income tax from 1917 to 1997. While acknowledging the deficiency of some of the available data, Smith concludes that there was a decline in progressivity during the Depression, which was predictable, and a further post-war decline, due to a lack of proactive policy at a time when there was high inflation and real income growth. She does not investigate the political and social factors involved in tax policy formulation. In the last 10 years the current Conservative Government has concentrated on tax expenditure measures in conjunction with lowering rates and this has led to a lessening of progressivity.

1 J Smith, ‘Progressivity of the Commonwealth Personal Income Tax, 1917–1997’ (2001) 34(3) Australian Economic Review 263.

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II. ISSUES IN TAX PROGRESSIVITY

The issue of tax progressivity deals with the allocation of the tax burden. There are two policy issues involved for a Government which is determining the level of taxation it wishes to impose: the ‘benefit’ principle and the ‘ability-to-pay’ principle.2 The ‘benefit’ principle treats government services as being bought by the taxes paid by its citizens. It is hard to allocate benefits at an individual level. Taxpayers who are conscientious objectors resent money spent on defence. One of the arguments in favour of introducing charges for higher education in Australia is that, historically, those who attend university usually earn more than those who don’t but because all taxpayers pay for education, its cost is an imposition on those who never attend. This argument applies to all public goods. Qualitative research has consistently demonstrated that in Australia taxpayers have a very personal attitude towards the tax system and use their personal views to justify tax evasion, particularly participation in the cash economy.3 The ‘benefit’ principle is based on the concept of fairness which is decided by governments at the budget level. The other policy principle, ability to pay, is also based on the concept of fairness. Both principles were recognised by Adam Smith in the dictum: The subjects of every state ought to contribute toward the support of government as nearly as possible, in proportion to the revenue which they respectively enjoy under the protection of the state.4

Tax policy-makers juggle the trade-off between the social benefit of post-tax income equalisation in order to fund public goods and the cost caused by the disincentive of high marginal tax rates imposed under a system of redistribution. Australia has always had progressive rates but not all research into the progressivity of the system as a whole has taken adequate account of tax expenditures. During certain periods, such as the seventies, eighties and nineties, high marginal rates imposed at low thresholds led to widespread evasion and the creation of artificial schemes. III. GLOBAL MEASURES OF TAX PROGRESSIVITY

Taxes are progressive, proportional or regressive. It is easy to identify a tax type, but more difficult to measure tax progressivity. There are several 2

J Slemrod, Tax Progressivity and Income Inequality (Cambridge, 1994) ch 1. R Musgrave, ‘Progressive taxation, equity, and tax design ‘in Slemrod, above n 2, at 349; and C Coleman and M Wilkins, ‘How do you want to play-honest? Research into motivations for taxpayer compliance’ in M Walpole and C Evans, Tax Administration in the 21st Century (Prospect, 2000). 4 A Smith, The Wealth of Nations (1776) (E Cannon ed). (1904) vol 2; R Putnam in Musgrave, above n 2, at 344. 3

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different measures which are used to measure tax progressivity, and different results are obtained depending on which measure is used.5 Global tax progressivity indices are used to measure the overall progressivity of a tax system. The data consists of combining the rate structure of the tax system as well as the distribution of income and income earners. Aggregate Tax Redistribution measures regard the tax progressivity of a tax system as being based on how much the distribution of the tax burden is transferred from proportional taxation to lower income earners. They are based on normal concentration curves. When this method is used the level of progressivity does not vary according to the tax rate structure. Two of the main methods used in this way are the ‘K’ index and the ‘S’ index. The ‘K’ index compares the Gini co-efficient for before tax income with a ‘concentration curve of taxes’.6 The Gini co-efficient is a statistic which measures the degree of expenditure in a population. It ranges from a minimal value of zero, which regards all individual taxpayers as equal to a theoretical maximum of one. A progressive tax has a value between zero and one; a proportional tax has a value of zero; and a regressive tax has a negative value. The K index has a value of -2 and 1. The Suits index, ‘S’, measures a regressive tax between -1 and 0 and a progressive tax between 0 and 1. This index uses income shares rather than population in its weighting. Smith7 notes that it compares the concentration curve of taxes in relation to incomes with a curve developed from a proportional distribution of the tax burden. Aggregate Income Redistribution measures use relative concentration curves. The measure used measures tax progressivity on the basis of how much the tax system reduces after tax income inequality. The most used index was developed by Musgrave and Thin (the M–T index).8 It uses a Gini (Lorenz) co-efficient to measure and compare the concentration of after-tax incomes with that of pre-tax incomes. The index is weighted by income and population shares. The M–T ratio of a progressive tax is greater than one and if the index rises this indicates an increase in tax progressivity. All these indices measure different things, so they produce different results when a country introduces changes in its tax system. The M–T index will rise when tax revenue increases even if there has been no change 5 T Alchin, ‘An analysis of structural progressivity of income taxation’ (1983) Economic Research Bulletin No. 16, Department of Economics, University of Wollongong, Australia; and Smith, above n 1, at 265 ff. 6 Ibid citing N Kakwani, ‘Application of Lorenz curves in economic analysis’ (1977) 45 Econometrics 7197; and ‘Measurement of tax progressivity: an international comparison’ (1977) 87 Economic Journal 71. 7 D Suits, ‘Measurement of tax progressivity’ (1977) 67 American Economic Review747, discussed in Smith, above n 1, at 265. 8 R Musgrave and T Thin, (1986) ‘Income Tax Progression 1929–48’ in Public Finance in a Democratic Society: Collected Papers of Richard A. Musgrave (RA Musgrave ed) (New York, 1986), discussed in Smith, above n 1.

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in rates. The S and K indices will rise when the average tax rate increases with income, even if the post-tax revenue is not changed. One advantage of the M–T index is that it can measure changes which are not revenueneutral, and which show changes in the incidence of tax. Various measures have been used to investigate tax progressivity in Australia, but the only comprehensive one has been undertaken by Smith, using the statistics published in the Commissioner of Taxation’s Annual Report. Those reports show the taxable income of individual taxpayers, the amount of tax paid and the type of income, for example after 1985, capital gains.

IV. HISTORICAL DEVELOPMENT OF PERSONAL INCOME TAX IN AUSTRALIA

Prior to examining these statistics, the paper examines the political and social factors in Australia during the relevant period. Australia was settled as a series of colonies and became a nation on 1 January 1901. The important issues prior to Federation which remained entrenched in Australian politics were: the ‘White Australia’ policy; judicially enforced needs-based wage fixing; high protective tariffs for the manufacturing industry; revenue equalisation between the States; and establishing a central economic and development role for the Commonwealth.9 The fiscal relationship between the Federal and State Governments has remained a problem. The New South Wales Government commissioned a report on this issue. It was published in May 2006.10 The Australian Constitution contains three main provisions dealing with taxation. Section 51(ii), dealing with concurrent powers, gives the Federal Parliament power to make laws: for the peace, order, and good government of the Commonwealth with respect to…taxation, but so as not to discriminate between States or parts of States.

Section 90 of the Constitution states: On the imposition of uniform duties of customs, the power of the parliament to impose duties of customs and of excise, and to grant bounties on the production or export of goods, shall be exclusive.

Section 55 of the Constitution states: Laws imposing taxation shall deal only with the imposition of taxation, and any provision therein dealing with any other matter shall be of no effect. 9 R Eccleston, ‘The Thirty Year Problem: The Politics of Australian Tax Reform’ in Australian Tax Research Foundation, Research Study 42 (2004) at 37. 10 N Warren, Benchmarking Australia’s Intergovernmental Fiscal Arrangements—Final Report. (2006) (Warren Report).

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The rest of the section deals with similar limits regarding the imposition of customs and excise duties. The purpose of s 55 is to prevent the tacking of unrelated non-taxation matters on to taxation Bills which the Senate is unable to amend under s 53 of the Constitution. This has meant that Parliament enacts separate assessment and rating Acts, which is very convenient because the rating Acts are amended regularly. Whenever a new tax is imposed, such as the Fringe Benefits Tax Act in 1986, there is an inevitable constitutional challenge mounted by some or all of the States. Section 99 of the Constitution states: The Commonwealth shall not, by any law or regulation of trade, commerce of revenue, give preference to one State or any part thereof over another State or any part thereof.

Section 114 provides that neither the States nor the Commonwealth shall impose tax on any property belonging to the other without the other’s permission. Section 117 provides that residents in any State shall not be subject to any disability or discrimination which they would not be subject to if they lived in another State. V. FEDERAL INCOME TAX LEGISLATION AND COMMISSIONS OF INQUIRY

As a result of the welfare measures offered by the Government, Commonwealth expenditure exceeded revenue and the first Federal Income Tax Assessment Act was enacted in 1915 to assist in funding the First World War.11 The States continued to impose income tax. The Federal Act was modelled on the State legislation and was intended to tax ‘surplus wealth’. It imposed tax on income from personal exertion at progressive rates from 1.25 per cent up to approximately 13 per cent for amounts below £7,600 and 25 per cent thereafter. Income from property was taxed at 25 per cent for amounts over £6,500 and income from companies at a flat rate of 7.5 per cent. The post-war welfare measures meant that the Federal Government needed the revenue to fund its programmes. The First Royal Commission on Taxation (W Kerr, Chair) was established in 1920 to inquire into, inter alia: • • • •

the equitable distribution of the burdens of taxation; the harmonisation of Commonwealth and State taxation; special rules for primary producers; simplification of the duties of taxpayers for returns and appeals; and

11 For a detailed analysis, see P Harris, ‘Metamorphosis of the Australasian Income Tax: 1866 to 1922’ Australian Tax Research Foundation. Research Study Number 37.

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general recommendations for reform of the tax system so it had a sound basis and was equitable.

As a result of this the 1915 Commonwealth Act was repealed and replaced by the Income Tax Assessment Act 1922.

VI. THE 1930s

The Depression caused the next crisis for Australia. State and Commonwealth debt combined increased ten-fold from October 1929 to December 1930.12 The Premiers’ Conference in 1930 agreed that the all six State Governments and the Commonwealth would co-ordinate public finance. The Commonwealth Bank, which was Government owned, would control credit. In the Depression in 1930 the Commonwealth introduced a Wholesale Sales Tax at a rate of 2.5 per cent. It also had progressive rates which rose to 6 per cent in 1931. For the first time, income taxes were being imposed on average wage earners. The Pay-As You-Earn (PAYE) withholding system was introduced in order to make the tax less visible. In 1932 the second Royal Commission on Taxation (D Ferguson, Chair) was established to investigate standardising and simplifying the tax laws as the State/Commonwealth laws interacted. It recommended uniform taxation and led directly to the enactment of the Income Tax Assessment Act 1936 (Cth). The Grants Commission was also established. Its function was to assist in equalising the revenue between States when the Commonwealth distributed its funds. An ongoing problem in Australia is the fact that the more populous and wealthy States, such as New South Wales and Victoria, resent subsidising smaller States such as Tasmania. When the Goods and Services Tax was introduced on 1 July 2000, to gain support for it the Commonwealth said that all the revenue from it was to be given to the States. The Commonwealth has refused to count the revenue from the tax as part of its revenue, which can distort tax statistics, and the States are still fighting over losing ‘their’ revenue to subsidise other States.

VII. THE 1940s

When the Second World War broke out, for the first time Australia faced the threat of invasion. The Japanese bombed Darwin and three Japanese submarines were chased out of Sydney Harbour. Defence spending increased. The Government appointed a Special Committee on Uniform 12 R Matthews and W Jay, Federal Finance: Intergovernmental relations in Australia since Federation (Melbourne, 1972), discussed in Eccleston, above n 9 at 35.

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Taxation which recommended that the Federal Government had the constitutional power (s 51(vi) defence) to take exclusive control over income tax. Under s 96 the Government made compensating grants to the States. In 1942 the Commonwealth passed four Acts which transferred exclusive power to raise income tax to it: 1 2 3 4

the States Grants (Income Tax Reimbursement) Act 1942, which granted payments to the States if they refrained from levying income tax; the Income Tax (War Arrangements) Act 1942, which transferred State tax officers to the Commonwealth; the Income Tax Assessment Act 1942, which gave priority to the Federal income tax over that of the States; and the Income Tax Act 1942 which imposed tax rates which were the equivalent of a combination of the previous Commonwealth and State rates. The highest marginal rate was 90 per cent so it was not practical for a State to levy its own income tax.

The constitutional validity of these arrangements was challenged in what are known as the two Uniform Tax Cases: South Australia v Commonwealth (1942) 65 CLR 373 and Victoria v Commonwealth (1957) 99 CLR 575. In the first case the High Court upheld the validity of all four Acts and in the second case a majority rejected the validity of the Act which required taxpayers to pay Federal income tax before they paid State income tax.

VIII. THE 1950s

In the 1950s Australia exported a range of commodities, protected its manufacturing base with high tariffs and enjoyed strong economic prosperity and political stability. This was similar to the world trend except that Australian industries remained insulated from international competition. Treasury dominated tax policy-making and did not engage with other stakeholders in the system. This trend has continued to the present.13 In the fifties there was virtually no tax policy, and the Government made changes through the annual Budget. Income tax became the main source of revenue for the Government. Because of the general prosperity, ‘bracket creep’ meant that the Government collected increasing revenue without the necessity of raising tax rates. The tax burden shifted from the wealthy to ordinary Australians who had less capacity to pay. The terms of reference of the Spooner Committee included simplification of the tax legislation, 13 Eccleston, above n 9 at 42–3 and M Dirkis, ‘Observations on the development of Australia’s Income Tax Policy and Income Tax Law’ (2002) 46 Bulletin of the International Bureau of Fiscal Documentation 522.

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simplification of tax returns and other forms, and identifying anomalies in the law so that they could be removed in order to achieve an adequate and equitable basis of taxation. As a result of its recommendations, the Menzies Government introduced a stepped-rate system, combined the separate levies of income tax and the social services contribution, and reintroduced concessional deductions for dependants, educational expenses for children under 21 who were in full-time education, medical expenses and superannuation, and abolished the differential rates for income from property. The Federal Land Tax was repealed. Groenewegen described the approach to tax policy as one of ‘benign neglect’.14 IX. THE 1960s

In 1959 the Commonwealth Committee on Taxation was appointed under the guidance of Sir George Ligertwood specifically to advise on tax avoidance issues. In the 1960s professional taxpayers who were earning high incomes began to avoid tax. Typical strategies involved converting what would be taxable income into untaxed capital gains or assisting private companies to rearrange their structure so that they qualified as public companies under the Act. This meant that they avoided the Division 7 undistributed profits tax which only applied to private companies. The approach of the Australian judiciary followed the Duke of Westminster15 doctrine and the court held that s 260 (Australia’s general anti-avoidance section) did not apply. Alienation of income was also practised, at times through the use of interposed entities and service trusts. Some specific anti-avoidance legislation was introduced to prevent it.16 By the late sixties, inflation was becoming a problem. In 1964 the Downing Inquiry17 investigated the overall equity of the tax system. Rising prices and ‘bracket creep’ meant that the burden of tax was falling more on ordinary workers which eroded the progressivity of the tax system. The Report commented18: The substantial degree of progression of tax paid in relation to taxable income is significantly abated by erosion of the income tax base, and by avoidance and evasion of tax liability, all of which favour high income groups relatively to lower income groups. 14 P Groenewegen, ‘Progressive personal income tax—a historical perspective’, Working Paper no 120, Department of Economics, University of Sydney (1988). 15 Duke of Westminster v CIR [1936] AC 1 at 19–20 per Lord Tomlin: ‘Every man is entitled to order his affairs so that the tax attaching under the appropriate acts is less than it otherwise would be.’ 16 Income Tax Assessment Act 1936 (Cth), s 102B. 17 R Downing, H Arndt, A Boxer and R Matthews, Taxation in Australia: Agenda for Reform (Melbourne, 1964). 18 Ibid 171.

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The tax base was narrow because there was no effective tax on capital gains or fringe benefits. This increased the incentive for non-PAYE taxpayers to avoid.19 Tax planning strategies and artificial schemes were discussed and marketed in the financial press. The taxpayer population became less compliant and enforcement was more difficult for the Australian Taxation Office because income tax had become a mass tax. The Government continued to rely heavily on personal income tax. There was minimal Government or legislative response to the recommendations of the Ligertwood Committee and none to those of the Downing Inquiry. X. THE 1970s—THE ASPREY REPORT

By the seventies, inflation had pushed too many income earners into higher marginal tax rate brackets. In 1972 the McMahon Government set up the Taxation Review Committee, chaired by Justice Asprey, to undertake a comprehensive review of the tax system. It was the first such review since the 1934 Royal Commission on Taxation (the Ferguson Commission). It was appointed to provide the Government with independent and objective policy advice. Its task was to provide recommendations in relation to tax reform which had due regard for: The need to ensure a flow of revenue sufficient to meet the requirements of the Commonwealth … the effects upon the economic and efficient use of resources of Australia … the desirability that there is a fair distribution of the burden of taxation, and to ensure that revenue is raised by means that are not unduly complex.

In its Final Report,20 Chapter Four discussed the problem of progressivity. The Committee noted that Australia was committed to the concept of progressivity even though it was a deterrent to saving. The Committee reviewed all the available statistical sources (the annual Taxation Statistics supplied by the Commissioner of Taxation, the Australian Survey of Consumer Expenditure and Finances and an Income Distribution survey conducted by the Australian Bureau of Statistics) and concluded that, although useful, they all had limitations. The Committee noted at 4.36 that Australian society was very homogeneous, both economically and socially. As a country with a very high standard of living, commentators notice that it has a tendency to overvalue material wellbeing. Most Australians are self-reliant, tolerant and individualistic, but have no concept of an exact social or income scale on which they identify their own place. Nevertheless there is widespread 19

Eccleston, above n 9, at 53. Taxation Review Committee Full Report (1975) Australian Government Publishing Service. 20

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acceptance of the concept of progressivity and social service payments for those in extreme poverty. Chapter Six dealt with inflation and noted that average wage earners were close to paying tax at a marginal rate of 50 per cent. The Committee recommended: •

Lower and simplify the income tax scale and extend the direct and indirect tax base by introducing a Capital Gains Tax and a Value Added Tax (para 28.12–28). Replace the classical system of company taxation with a partial imputation system (para 28.18). Eventually introduce capital gains tax by including it partly within the income tax base (para 28.25). Integrate State and Federal gift and death duties into a national capital transfer tax system (para 28.26). Abolish Wholesale Sales Tax and replace it with a broad-based single-rate consumption tax (value added tax model) to finance reductions in personal income tax.

• • • •

None of the committee’s recommendations were followed at the time but, 30 years later, they have all been implemented. In 1974 inflation had become an even bigger problem, both economically and politically. The Whitlam Government appointed a specialist committee to investigate it. The Matthews Inquiry—Inquiry into Taxation and Inflation (1975) had very precise terms of reference. Its task was to examine the effects of rapid inflation on taxation paid by persons, and in particular: •

to examine methods which could be used to apply indexation to the personal income tax system; to assess the relative merits of: – effectiveness in providing an up-to-date adjustment for price increases; and – the issue of practicability of implementation.

•

The Report recommended that the income tax brackets and the threshold limits for rebates be indexed to the rate of inflation. This meant that the burden of tax would remain constant although prices continued to rise. The Treasury was opposed to the concept of indexation, on the ground that it was too expensive.21 In 1976 the Fraser Government implemented indexation. It was modified in 1977 and abolished in 1982. In the seventies, tax avoidance in Australia became widespread. There was community acceptance and promoters of mass-marketed schemes were

21

Eccleston, above n 9, at 66.

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praised in the press. Marginal rates were high and thresholds were low. Public acceptance waned when the problem was exposed in the Costigan Report22 and PAYE taxpayers realised they were paying more tax because wealthy people were not paying their share. Technological change meant that capital was more mobile and transfer pricing and the use of international tax havens increased. The Australian High Court, under Chief Justice Barwick, interpreted tax legislation in a narrow literal manner. Barwick CJ had practised during the second World War and his biographer traces his literalistic approach to legislation to the fact at that time his clients were interested in methods of by-passing the war time regulations and continuing to run their businesses as profitably as possible23: Tax laws could be construed in highly technical terms, without regard for the purpose they were designed to serve. It was not a lawyer’s concern if the state was left without wartime powers, nor was it a lawyer’s worry that the rich might avoid contributing to the revenue.24

XI. THE 1980s TO 2006

In the mid-eighties the Federal Government (under Hawke) linked wages, taxes and social security measures. A tax summit was held and a comprehensive inquiry was undertaken into the tax system. It was primarily undertaken by Treasury but community input was taken into account. The Draft White Paper—Reform of the Australian Tax System (RATS) was issued.25 The Paper noted (at page 3) that one of the major problems with the tax system was that the reliance on personal income tax had grown while other sources of revenue (company tax, customs and excise duties) had declined. Special concessions, tax avoidance and evasion had played a part. The increased reliance on personal taxes had impacted heavily on taxpayers earning relatively moderate incomes. The Report then reviewed the following changes which had occurred between 1954–55 and 1984–85: •

•

the marginal rate of tax for a taxpayer on average earnings had increased from 19 per cent to 46 per cent while the average rate had risen from 10 per cent to 25 per cent; 2.1 million taxpayers, equivalent to around 39 per cent of all full-time employed persons, now faced a marginal rate of 46 per cent or more, compared with approximately 1 per cent 30 years previously;

22 F Costigan, QC, Royal Commission on the activities of the Federated Ship Painters and Dockers Union: Final Report (Canberra 1984). 23 D Marr, Barwick (Sydney, 1980; reprinted 2005) 33. 24 Ibid 227–8. 25 Reform of the Australian Tax System—Draft White Paper (Canberra. 2005).

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•

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the top marginal rate (60 per cent) was cutting in at only 1.6 times average yearly earnings whereas in 1954–55 the top rate (66.7 per cent) cut in at income levels approximately 18 times average yearly earnings; the present-day equivalent of the 1954–55 income level at which the top marginal rate applied would be about $400,000, compared with the $35,000 level at which it currently cut in; and income tax assessed to individuals earning more than 1.6 times average yearly earnings ($35,000) accounted for over half of total tax attributable to individuals in 1954–55, the current comparable upper income ranges now account for only around 20 per cent.

RATS’ major recommendations included: •

•

•

the introduction of a comprehensive capital gains tax. It commenced on 20 September 1985 and ‘grandfathering’ was used. It was imposed on the post-inflation gain so that capital was still more attractive than income; introduction of a full dividend imputation system from 1 July 1986. At the time of introduction the company rate and the maximum personal rate were the same; introduction of Fringe Benefits Tax from 1 July 1986. For administrative efficiency it was imposed on employers.

A major priority was to reduce the high marginal rates paid by salary and wage earners. They earned two-thirds of national income, but paid 80 per cent of income taxes. Rates were lowered, foreign tax credits were introduced which taxed the overseas income of Australian residents for the first time. Gold mining income was taxed for the first time, and superannuation concessions were curtailed. In 1993 in the Federal election the Leader of the Opposition (Hewson) proposed introducing a Goods and Services Tax into Australia. The public rejected the concept. In 1998 the Federal Government (under Howard) announced a comprehensive Review of Business Taxation (Ralph). It was called A New Tax System (ANTS) not a new tax.26 It introduced a Goods and Services Tax (GST) at a flat rate of 10 per cent from 1 July 2000. It was meant to constitute a total package, but various proposals were abandoned. Capital gains tax concessions were introduced—if taxpayers hold an asset for one year they receive a 50 per cent discount. The cuts to the marginal rates were eroded within three years because of the combined effect of ‘bracket creep’ and the GST. The Government has reduced marginal rates and raised thresholds regularly in the annual Budget in

26 Review of Business Taxation, A Strong Foundation (Canberra, 1998); and A Tax System Redesigned (Canberra, 1999).

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order to prevent too many wage and salary earners from being in the top bracket. Periodically, the issue of indexation of marginal rates arises.27 In addition the Government has a strong commitment to tax expenditure measures. There are items such as Family Tax Benefit A, Family Tax Benefit B and the baby bonus. The word ‘welfare’ is not mentioned. In the May 2006 Budget, the tax on superannuation payments was abolished for those who receive them after age 60. This is a measure which favours the wealthy. These measures are tending to reduce progressivity in the tax system.

XII. STATISTICAL ANALYSIS

Smith28 reviewed early work undertaken in Australia on personal income tax, using the standard global tax indices. Her paper used the annual statistics published by the commissioner of Taxation since 1916–17. The data comprises the taxable income of taxpayers and the amount of tax paid, which is delineated by grade of income for individual taxpayers. The paper recognised various weaknesses in the statistics: •

• •

• • • •

Some households have two income earners, so the redistributive impact of taxation on individuals may differ from that on households. In Australia there has been a trend for more married women to work, often part-time if they have children. This is partly a result of more women receiving higher education, and partly a result of high rates and the cost of housing. The statistics only include taxpayers who file returns. The proportion of earners who are taxpayers can fluctuate. The statistics do not include leakage because of evasion or avoidance. The amount of income lost through participation in ‘Bottom of the Harbour Schemes’ in the eighties was estimated in the Costigan Report as being over 4 billion dollars. Taxable income changes depending on tax expenditures, social security payments and deductions available. Until 1947–48 the data was grouped using taxable income categories and after that date it used ‘actual’ (gross) income. The data for 1915–16 is not reliable because it was incomplete. Some data from the Second World War is incomplete, some assessments were ‘delayed’, and the tax-exempt income of servicemen is not included.

27 M Fraser in Australian Financial Review 26 April 2005 at 69: ‘Bring back indexation’. Countered by AN Maiden who alleges that there was no need for the Fraser Government to repeal it. 28 Above n 1.

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Until 1921–22, statistics did not separate personal taxpayers from company taxpayers. From 1940 to 1941, a War Tax was imposed on all income above £156 and the statistics do not report details of its distribution. From 1986, Capital Gains Tax is included in individual income tax statistics, but Fringe Benefits Tax is not, because it was levied on employers.

XIII. RESULTS

Smith measured personal income tax progressivity in Australia for the income years 1916–17 to 1996–97 by calculating the three indices discussed previously. She used the taxation statistics published by the Australian Taxation Office. Figure 2.1: Global tax progressivity indices, Australia, 1916–17 to 1996–97

Source: Derived from Australian Taxation Office, Taxation Statistics (Canberra, various years)

Tax progressivity peaked in 1941–42 and 1950–51 on all measures. There were rising average rates and a steepening taxation scale. The data shows: • •

Progressivity in Australia has been relatively stable before the Second World War and since the late seventies. During the Depression and the Second World War there were sharp fluctuations in progressivity.

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Cynthia Coleman and Margaret McKerchar There was a peak in progressivity in the early fifties on the K or S indices and a strong decline until the late seventies. The M–T index peaked in the early fifties, mid-seventies and mideighties. Smith notes this is an ambiguous trend.

Figure 2.2: Lorenz Curves for S Index of Tax Progressivity, Australia, Selected Years 1916–17 to 1995–96

Source: Derived from Australian Taxation Office, Taxation Statistics (Canberra, various years)

Figure 2 shows the Lorenz curves associated with estimates of the S index. There is a consistent shift outwards which shows a decline in measured progressivity during the period. There is a decline in progressivity between 1995–96 and 1938–39, 1942–43 or 1951–52 and the higher progressivity in 1938–39 or 1951–52 than in 1942–43. In 1942 State taxes were subsumed into Federal income tax and this reduced progressivity because State taxes at that time were less progressive. Where the curves cross, the rankings under the S index are more ambiguous. The change observed between 1995–96 and 1979–80 is affected by the weight placed on the higher taxes paid by taxpayers in the highest income brackets, as against the lesser progressivity of the rest of the

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income range. Smith notes that comparisons of progressivity ranking between 1916–17 and 1942–43, 1959–60 or 1979–80 produce ambiguous results. Figure 2.3: Average Tax Rates on Taxable Income, Australia, 1916–17 to 1996–97

Source: Derived from Australian Taxation Office, Taxation Statistics (Canberra, various years)

When the movements in the indices in Figure 2 are compared with the average tax rates in Figure 3, they reflect the social conditions and tax changes discussed when considering the data limitations. The M–T index is dominated by the changes in structural progression of the early decades of the income tax when it moves closely with the other two indices. The M–T index changes little in the Depression, although revenue increased during that time, whereas the S and K indices record falls in progressivity. Social and legislative changes can create changes in progressivity measures. In 1942–43 many more taxpayers became subject to income tax, in order to raise revenue for the Second World War. Before that war the taxpayer proportion of the population rose from 5 per cent to 10 per cent, to about 50 per cent in 1947 and 60 per cent in the early fifties. Figure 2 shows the alteration in the income distribution characteristics of the taxpayer population. There is inadequate data adequately to deal with the changes in the proportion of incomes caught under income tax legislation. The income distribution surveys do not adjust for incomes which are excluded. If they were included this could increase progressivity because non-taxpaying people comprise a greater share of the income

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Figure 2.4: Taxpayer–Population Ratios

Source: Derived from Australian Taxation Office, Taxation Statistics (Canberra, various years) and W Vamplew, Australians: Historical Statistics (Sydney, 1987)

earning population than their share of aggregate income and their nil tax share. These taxpayers are assumed to have equal incomes. The indices demonstrate that personal income tax in Australia has remained reasonably progressive over a sustained period. Any marked declines can be explained by social conditions which caused governments to change tax legislation in order to raise more revenue. This happened during the Depression when both States and the Federal Government either raised rates or lowered thresholds in order to fund social programmes such as unemployment benefits. XIV. CONCLUSION

The current Commissioner of Taxation, Michael D’Ascenzo, has consistently stated that, overall, the taxpayer population is compliant. The Australian Taxation Office is subject to endless audits. The Inspector General of Taxation, David Vos, stated at the eighth International Conference on Tax Administration in April 2006 (Sydney) that in 2005 53 different bodies investigated various aspects of ATO administration. After the Second World War, income tax in Australia changed from a ‘class tax’ to a ‘mass tax’. Tax avoidance measures became more widespread from the late fifties. The Menzies Government in the fifties introduced many social measures such as deductibility for a lot of items incurred in a family household, for example, education expenses of children under the age of

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21. ‘Bracket creep’ became a problem and tax avoidance became much more widespread from the seventies onwards. Both have remained a problem. The introduction of the Goods and Services Tax has exacerbated the problem.29 To counter its effect the Howard Government has consistently lowered rates and increased family support measures.30 The Government has been targeting two-income families earning $65,000–$85,000. Table 1: Global tax progressivity indices, Australia, 1916–17 to 1996–97 Year 1916–17 1917–18 1918–1931 1920–21 1921–22 1922–23 1923–24

M-T 1.017 1.028 1.027 1.028 1.021 1.022 1.018

K 0.173 0.204 0.208 0.227 0.201 0.203 0.170

S 0.392 0.421 0.425 0.431 0.456 0.458 0.416

1924–25

1.016

0.171

0.397

1925–26

1.016

0.173

0.402

1926–27

1.015

0.178

0.400

1927–28

1.015

0.186

0.409

1928–29

1.019

0.197

0.437

1929–30

1.023

0.153

0.350

1930–31

1.016

0.158

0.306

1931–32

1.027

0.205

0.431

1932–33

1.021

0.207

0.443

1933–34

1.013

0.203

0.427

1934–35

1.012

0.208

0.449

1935–36

1.009

0.195

0.443

1936–37

1.009

0.205

0.459

1937–38

1.010

0.215

0.483

1938–39

1.014

0.216

0.475

1939–40

1.060

0.205

0.380

1940–41

1.131

0.313

0.463

1941–42

1.224

0.399

0.471

1942–43

1.258

0.287

0.342

29 N Warren, A Harding and R Lloyd, ‘GST and the Changing Incidence of Australian Taxes: 1994–95–2001–02’ (2005) 3(1) E-journal of Tax Research 114. 30 G Megalongenis, ‘Babies and Bracket Creep’ Weekend Australian, April 1–2 2006. 31 Taxation statistics were not available for the income year 1919–20.

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Year 1944–4532 1945–46 1946–47 1947–48 1948–49 1949–50 1950–51 1951–52 1952–53

M-T 1.231 1.221 1.179 1.138 1.129 1.122 1.228 1.216 1.192

K 0.271 0.335 0.289 0.300 0.325 0.357 0.381 0.329 0.319

S 0.321 0.402 0.344 0.377 0.412 0.464 0.497 0.404 0.387

1953–54

1.192

0.319

0.386

1954–55

1.144

0.309

0.372

1955–56

1.140

0.296

0.357

1956–57

1.147

0.299

0.362

1957–58

1.139

0.287

0.342

1958–59

1.137

0.280

0.333

1959–60

1.129

0.271

0.324

1960–61

1.136

0.268

0.315

1961–62

1.128

0.265

0.312

1962–63

1.128

0.260

0.311

1963–64

1.148

0.263

0.308

1964–65

1.158

0.250

0.317

1965–66

1.163

0.244

0.284

1966–67

1.166

0.238

0.277

1967–68

1.172

0.237

0.274

1968–69

1.170

0.226

0.261

1969–70

1.177

0.221

0.257

1970–71

1.161

0.214

0.251

1971–72

1.171

0.212

0.240

1972–73

1.191

0.213

0.240

1973–74

1.202

0.201

0.226

1974–75

1.265

0.244

0.275

1975–76

1.229

0.195

0.214

1976–77

1.242

0.187

0.203

32 To avoid levying two years of taxation on the same year of income with the introduction of PAYE in 1943–44, income tax was substantially remitted for that year. The estimate of tax progressity for the 1943–44 income year has therefore been omitted from this table.

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A History of Progressive Tax in Australia

Year 1977–78 1978–79 1979–80 1980–81 1981–82 1982–83 1983–84 1984–85 1985–86 1986–87 1987–88 1988–89 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97

M-T 1.220 1.210 1.208 1.198 1.200 1.199 1.207 1.224 1.243 1.246 1.187 1.156 1.192 1.188 1.186 1.181 1.182 1.171 1.182 1.174

K 0.186 0.172 0.167 0.164 0.163 0.169 0.166 0.177 0.187 0.187 0.166 0.146 0.178 0.179 0.183 0.178 0.179 0.171 0.176 0.168

55

S 0.199 0.181 0.181 0.176 0.176 0.185 0.182 0.196 0.208 0.209 0.178 0.148 0.193 0.195 0.198 0.192 0.191 0.183 0.187 0.179

Tax progressivity in Australia has been consistent. Changes can easily be explained by historical circumstances such as the Depression, social measures introduced by the Federal Government of the day and political circumstances when governments lower rates to mitigate ‘bracket creep’ and offer tax expenditure measures.

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3 Tax Reform in Early Twentieth-Century France The Politics and Techniques of Redistribution NICOLAS DELALANDE

ABSTRACT The aim of this article is to focus on the French experience of tax reform in the early twentieth century. France was the first European nation to introduce universal manhood franchise in 1848. The Third Republic (1870−1940) founded a democratic regime in which the labour movement played a major role at the end of the nineteenth century. Yet it was also in this country that resistance to progressive taxation succeeded in postponing the vote for a personal and graduated income tax until the eve of World War I. More than 200 income tax projects were discussed in Parliament between 1848 and 1914 before the law of 15 July 1914 was passed. How can we explain such a long resistance? How did it affect the French attitude towards redistribution? What are the social and political factors that shaped the French fiscal system and gave it its distinctive features in the interwar years? This chapter argues that social and political mobilisation against income tax before World War I accounts for the low level of redistribution in the interwar period. The whole process seems to have taken its impetus in this country exactly forty years ago with Lloyd George’s budget for 1909–1910, which, in introducing progressive taxation, abandoned the idea that for taxation purposes, equality implies proportionality. (Bertrand de Jouvenel, The Ethics of Redistribution (Cambridge, 1952) 5)

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Nicolas Delalande I. INTRODUCTION: FRANCE AND TAX REFORM IN AN INTERNATIONAL CONTEXT

I

N A LECTURE he gave at Oxford in 1949, the French liberal philosopher Bertrand de Jouvenel presented the introduction of progressive taxation in Britain in 1909 as the turning point of the history of state intervention in income distribution. He emphasised the fact that the process of redistribution spread all over Europe in the early twentieth century. Progression was introduced in the tax legislation of most industrialised countries (Britain, Germany, Italy, France and the United States) between the 1890s and the 1910s.1 Tax historians have lately underlined the common pattern of fiscal reform and the role of international exchanges of ideas and policies about taxation in this period.2 There is a lot of evidence for the notion of an international movement towards redistributive tax policies occurring on the eve of the twentieth century, however, it should be noted that national tax systems have always relied on particular views about the form and level of income redistribution. The politics and techniques of taxation are the results of distinctive political, economic, social and cultural histories. Moreover, economic and social historians have shown that the effects of graduation were sometimes overestimated by contemporary observers such as de Jouvenel. The efficiency of progressive taxation on income and capital depended on various elements (tax bases, tax allowances, tax rates and assessment techniques, for instance). The aim of this paper is to focus on the French experience of tax reform in the early twentieth century. France was the first European nation to introduce universal human franchise in 1848. The Third Republic (1870– 1940) founded a democratic regime in which the labour movement played a major role at the end of the nineteenth century. Yet, it was also in this country that resistance to progressive taxation succeeded in postponing the vote of a personal and graduated income tax until the eve of the First World War. More than 200 income tax proposals were discussed in Parliament between 1848 and 1914 before the law of 15 July 1914 was passed. How can we explain such a long period of resistance? How did it

1 M Daunton, Trusting Leviathan. The Politics of Taxation in Britain, 1799–1914 (Cambridge , 2001); P-C Witt (ed), Wealth and Taxation in Central Europe: the History and Sociology of Public Finance (New York, 1987); P Favilli, Il labirinto della grande riforma: socialismo e questione tributaria nell’Italia liberale (Milan, 1990); G Ardant, Histoire de l’impôt. Vol 2 (Paris, 1972); R Stanley, Dimensions of the Law in the Service of Order: Origins of the Federal Income Tax, 1861–1913 (Oxford, 1993); Y Kotsonis, ‘“No Place to Go”: Taxation and State Transformation in Late Imperial and Early Soviet Russia’, (2004) 76 Journal of Modern History 531. 2 We refer here to the conference organised by Florian Schui and Holger Nehring on ‘the transfer of ideas about taxation since 1750’ at Cambridge University and CRASSH in September 2005 (Global Debates about Taxation (London, 2007)).

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affect the French attitude towards redistribution? What are the social and political factors that shaped the French fiscal system and gave it its distinctive features in the interwar years? This paper will be divided in three parts. First, it will give a presentation of the nineteenth-century French tax system and focus on the role of political economy in taxation debates. Second, it will highlight the institutional and political context in which calls for tax reform flourished at the beginning of the twentieth century. Lastly, it will provide an analysis of the distinctive features of French redistributive policies in the immediate post-war period.

II. ‘FAIR TAXATION’ UNDER THE THIRD REPUBLIC: PROPORTIONALITY VERSUS PROGRESSION

A. The Nineteenth-Century Tax System: the Liberal Prejudice in Favour of Indirect Taxation The French fiscal system was under widespread criticism at the end of the nineteenth century. It was usually seen as ‘regressive’ and unfair because indirect taxation was much more developed than direct taxation. In 1900, direct taxes accounted for only 20 per cent of total tax revenue, whereas excise duties and customs duties provided for more than 50 per cent of total tax revenue (see Table 3.1). Thus the fiscal burden fell mainly on poor classes and was distributed very unequally. Such an imbalance between indirect and direct taxes had its origins in the first years of the nineteenth century. The French Revolutionaries had abolished all the direct and indirect taxes of the Ancien Regime in 1789–90. The four direct taxes they created (the ‘quatre vieilles’: see below) provided very low revenue yields and were unable to cover the charges of protracted war against Europe. Napoleon thus reintroduced indirect taxes on wine, beer, spirituous liquors and salt and re-created monopolies (tobacco) at the beginning of the nineteenth century. The share of indirect taxes in total state revenues grew steadily in the following decades. In 1848, the Second Republic (1848–52) contemplated abolishing the ‘impôt des boissons’, one of the most unpopular taxes of the time with the hated ‘octroi’, but political conflicts between Republicans led to the withdrawal of the reform. The Government thus decided on an increase in direct taxes by 45 per cent to solve the financial crisis, which triggered off massive tax revolts in Southern France.3 The unpopularity of the Second Republic’s tax policy gave Louis-Napoleon 3 R Gossez, ‘La résistance à l’impôt. Les quarante cinq centimes’ (1953) XV Etudes. Bibliothèque de la Révolution de 1848 89.

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Bonaparte the opportunity to win peasants’ support and to overthrow the Republic on 2 December 1851. Hence, when the Republicans returned to power in 1870, they preferred to resort to indirect taxes and loans to finance budget deficits (France had to pay a war indemnity of 5 billion marks to the German Empire) rather than increase direct taxes or create new ones. Adolphe Thiers and conservative Republicans introduced a new tax on matches and raised customs duties on colonial goods (coffee, tea and cocoa). Protectionism was then reinforced in the 1880s. Though criticised, indirect taxes were praised by some economists and politicians who saw them as the best fiscal tools to fund government with the minimum of irritation for taxpayers. To liberal minds, ‘fiscal anaesthesia’ (the idea that the taxpayer should not be aware of what he pays) was supposed to improve tax compliance. However, indirect taxes unleashed consumers’ protest and could not be increased indefinitely. The yield and the elasticity of direct taxes were particularly low and inefficient. The ‘quatre vieilles’ (the land tax; the personal and movable property tax; the business tax; and the door and window tax), created between 1790 and 1798, were all real taxes, assessed through external indicators. Ascertainment of the taxpayer’s actual personal income never existed before the introduction of the income tax in 1914. This tax system was intended to protect the integrity of the private sphere (the door and window tax embodied the ‘ideal tax’, assessed without any contact between tax administrators and taxpayers). To ‘tax things, not men’ was the usual liberal credo of the time. Achieving equality of treatment between taxpayers implied proportional taxes. As DE Schremmer writes, this fiscal system ‘conforms especially well with the liberal principles of generality and equality’.4 But at the end of the nineteenth century, these taxes were backward-looking, given the economic and social changes brought by the Industrial Revolution. The land tax continued to be the cornerstone of the French fiscal system, whereas business activities played an ever-increasing role in the economy.

4 DE Schremmer, ‘Taxation and Public Finance: Britain, France and Germany’ in P Mathias and S Pollard (eds), The Cambridge Economic History of Europe, viii, The Industrial Economies: The Development of Economic and Social Policies( Cambridge, 1989) 374.

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Table 3.1: Tax revenues in 1900, 1913 and 1923 (as percentage of total tax revenues)5 1900 20% 2% 32% 0% 17% 21% 7% 1% 100%

Direct taxes Tax on the income of securities Excise duties Turnover tax Customs duties Registration taxes Stamp duties Other tax revenues Total

1913 18% 4% 25% 0% 22% 23% 7% 1% 100%

1923 24% 6% 19% 16% 11% 18% 4% 2% 100%

Some Republicans of the Left, led by Léon Gambetta, promised a comprehensive tax reform in the early 1870s. In 1869, one year before the demise of the Second Empire, Gambetta included the income tax in his political platform (the ‘programme de Belleville’). Republicans created a new tax on the income from securities, levied at source at a rate of 3 per cent in 1872, but the prospect of the introduction of a comprehensive income tax soon vanished. Personal and progressive taxation aroused too much political and social conflict while the Republic’s foundations were still weak. Hence, Gambetta abandoned his support to progressive taxation and adopted a much more traditional approach. As in 1848, the parliamentary debates of 1871–72 showed that progression was still seen as the symbol of social revolution. In a famous statement, Adolphe Thiers, the leader of conservative Republicans and of the repression against the Commune, described progressive taxation as the road to ‘social discord’. Himself the author of a book on property, he perfectly voiced the dominant views of political economy about taxation at that time.6

B. Political Economy and Taxation: the Weakening of the Liberal Consensus against Progression Whereas progression had been part and parcel of French intellectual history since the eighteenth century,7 the leading economists of the 1870s 5

Statistiques et études financières, supplément n 175, July 1963. On Thiers’ views about taxation, see R Schnerb, ‘La politique fiscale de Thiers’ in J Bouvier and J Wolff (ed), Deux siècles de fiscalité française, XIXe-XXe siècles. Histoire, économie, politique (Paris, 1973). 7 See J-P Gross, ‘Progressive Taxation and Social Justice in Eighteenth-Century France’ (1993) 140 Past and Present 79. 6

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and 1880s viewed it as a Socialist threat undermining the liberal Republican consensus. Léon Say, the grandson of Jean-Baptiste Say and a famous professor of political economy at the Ecole libre des sciences politiques, Minister of Finance several times between 1872 and 1882, fought against the proponents of progression in Parliament and during public conferences. The lectures he gave at the Ecole libre in 1886 were significantly entitled ‘Democratic solutions to the tax question’ and devoted hundred of pages to warning against the alleged dangers of graduation.8 Say argued that because of universal franchise and the rise of the labour movement, democracy ran the risk of sinking into demagoguery. The possibility of the majority of the poor taxing the minority of the wealthy was clearly identified as the most dangerous menace to ‘bourgeois politics’. Paul Leroy-Beaulieu, a professor at the prestigious Collège de France, joined Say and other liberal economists (G de Molinari, Frédéric Passy and Alfred Neymarck) in criticising state expansion.9 All these economists gathered in the Société d’économie politique, founded in 1842, whose periodical, the Journal des économistes, was the only publication in the field of political economy in France until the late 1880s.10 There was no place for intellectual dissent in this club of liberals. For instance, the Société d’économie politique organised a debate in 1895 about the ‘advantages and drawbacks of living conditions inequality’. Almost all the speakers shared the Spencerian theory according to which inequality is the condition and retribution of economic success, except one, René Worms, who was judged a ‘Socialist’ because he emphasised the social origins of inequalities and the role of taxation to correct them.11 The domination of liberal economics eroded in the 1890s. Political economy entered universities in 1878 and was taught in Law Faculties. New economists appeared whose ideas on taxation were different from those of liberal thinkers. The arrival of a new generation, more professional than the previous one, made it possible to discuss the merits and the risks of progressive taxation. A new periodical, the Revue d’économie politique, was launched in 1887 to offset the intellectual influence of the Journal des économistes. Charles Gide, Paul Cauwès and Gaston Jèze promoted new themes and new methods of research. Their approach to taxation broke with the nineteenth-century tradition. Contrary to liberal economists, they admitted that the system of the ‘quatre vieilles’ and the

8 L Say, Les solutions démocratiques de la question des impôts: conférences faites à l’Ecole libre des Sciences Politiques (Paris, 1886). 9 On Leroy-Beaulieu’s intellectual and political positions, see S Gemie, ‘Politics, Morality and the Bourgeoisie: the Work of Paul Leroy-Beaulieu (1843–1916)’ (1992) 27 Journal of Contemporary History 345. 10 For a comprehensive presentation of political economy in France, see L Le Van-Lemesle, Le Juste et le Riche. L’enseignement de l’économie politique, 1815–1950 (Paris, 2004). 11 ‘Société d’économie politique: séance du 5 juin’, Journal des économistes, June 1895.

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crushing weight of indirect taxes were in complete contradiction with the French Revolution’s tax ideals. Progression could thus be justified as a necessary tool to counterbalance the regressive incidence of excise duties. The interpretation of the legacy of the French Revolution was at the centre of all economic and political debates. Article 13 of the Déclaration des Droits de l’Homme et du Citoyen (‘every citizen must contribute to public spending in proportion to its capacities’) was the source of endless disputes. For conservative Republicans, it prohibited progressive and personal taxation as arbitrary measures typical of the Ancien Régime. The intellectual conflict opposed two definitions of taxation. The first was the ‘benefit approach’ according to which the taxpayer pays for the benefit received from the state. Some argued at the time that since the poor received more social relief from the state, regressive taxation had logical foundations. The second definition emphasised the notion of ‘ability to pay’ and equality of sacrifice. The French economists defending progression found intellectual justifications in the work of foreign economists such as Edwin Seligman, Francis Edgeworth or Alfred Marshall. Seligman’s essays on progressive taxation and on the incidence of taxation were translated into French in 1909 while political conflict over the income tax reached its climax.12 However, marginal economics was underdeveloped in French political economy and most of the debates focused on the tax reforms introduced in foreign countries. The Prussian Einkommensteuer often served as a scapegoat for opponents to the income tax. The German Empire was criticised for its authoritarianism and personal and progressive taxation presented as the symbol for the lack of civil liberties. Yves Guyot, the editor of the Journal des économistes in the 1890s and 1900s and a proponent of proportional and real taxation, castigated German political economy for being enslaved to the state’s needs.13 French liberals were less comfortable when it came to the British income tax. On the one hand, as free traders, they praised British politicians for having abolished customs duties. But, on the other hand, they could not accept the principle of Peel and Gladstone’s income tax, still less the introduction of differentiation and graduation by Lloyd George in 1907 and 1909. The impression that France was lagging behind in terms of fiscal innovation became blatant in the 1900s. Equating progression with confiscation was no longer universally accepted among French economists. In 1911, M Aguiléra wrote an article in the Revue d’économie politique

12 ERA Seligman, L’impôt progressif en théorie et en pratique (tr by Ant Marcaggi) (Paris, 1909); Théorie de la répercussion et de l’incidence de l’impôt (tr by L Suret) (Paris, 1910). 13 Y Guyot, ‘La banqueroute du socialisme de la chaire’ (1907) Journal des économistes, May 161.

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summarising the dominant thought on progression.14 He remarked that even Social Catholics pronounced themselves in favour of a graduated income tax. Progressive taxation could be used to promote social reform while reinforcing private property. Differentiation between productive and unproductive sectors made it possible to implement tax reform without slowing down economic activity. The idea that progressive taxation would lead to ever-increasing tax rates was debunked on the ground that Parliament had no interest in fostering social conflict. After 40 years of intense intellectual debates, the virtues of a cautious use of graduation had convinced many economists, state officials and politicians. As Martin Daunton writes on the relationship between political economy and policy, the language of economics could provide post hoc justification and theory…the issue is therefore how the ideas of political economy enter into a more general political culture.15

That will be subject of the next section.

III. PROGRESSIVE TAXATION ON THE POLITICAL AGENDA: SOCIAL POLICIES, WAR FINANCE AND TAX REFORM

A. Fiscal Pressures: Social Policies and War Finance The growing pressure of the labour movement forced Republican leaders to find new ways of solving the ‘social question’. Private charity appeared to be no longer able to alleviate the economic and social consequences of industrialisation, although some of the liberal Republicans tried to promote social reform by creating private institutions such as the Musée Social. Several laws were adopted to improve workers’ living and working conditions at the turn of the twentieth century. The first insurance law on work injuries was voted in 1898 and granted employees the right to receive compensation for accidents at work. A law of 1905 increased municipal authorities and state financial participation in poor relief. In 1910, a law on workers’ and peasants’ pensions was passed. This legislation was the result of the widening audience of Radical and Socialist parties after the Dreyfus Affair. Left Republicans won General Elections in 1902 and 1906 (however, Socialists did not take part in governments, to conform with the Second International’s instructions). The rise of social spending (though

14 M Aguiléra, ‘L’équité et les limites de l’impôt progressif’ (1911) Revue d’économie politique 508. 15 Daunton, above n 1, at 138.

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limited in comparison with that in other European countries16) gave new legitimacy to demands for tax reform. The Socialists, led by Jean Jaurès (1859–1914), ceased to consider taxation as a secondary and transitory tool for revolution, and began fully to support the campaign for a progressive and general income tax. Emile Chatelain, a Socialist thinker, wrote in the Revue socialiste in February 1909 that ‘the income tax is the key to all social reforms’. Evoking the British example, he advocated the financing of a workers’ pension scheme through taxation rather than through payroll taxes.17 Similarly, the radical deputy Jean-Félix Javal (1871–1915) called for a levy on capital to finance pensions. The very notion of democracy as ‘cheap government’, deeply embedded in the liberal dogma of early Republicans, vanished. As Jean Jaurès stated in a famous speech in favour of income taxation, ‘the advantage of democracies is not to spend less, but to spend in a better way’, for those who really need it.18 The other structural reason pushing for tax reform came from international and military tensions. The idea of a ‘small state’ could no longer be defended, even by conservative Republicans, in the context of Imperial Germany’s military and naval expansion. France had already adopted universal conscription in 1889 to prepare itself for the Revanche. Colonial conquests in Asia and Africa also required heavy expenditure. In 1913, Parliament passed legislation that extended conscription from two to three years. It put dramatic strains on France’s public finance. According to Niall Ferguson’s figures, France’s military effort was one of the strongest in Europe (30 per cent of French public spending went on defence).19 However, the Republic lacked the tax tools to cover its spending. Indebtedness grew at a steady pace (it represented 85 per cent of GNP in 1913, while England’s public debt amounted to a mere 27 per cent of GNP and Germany’s 40 per cent). The rise of social spending and the European arms race provided proponents of income taxation with solid arguments. The adoption of the three-year law in 1913 paved the way for a strategic compromise between Radicals and Socialists on the one hand and conservative Republicans on the other. The Socialists rejected the three-year law but approved of the income tax Bill that had been voted by the Chambre des députés in 1909 and since then left aside by the Senate. Conversely, many conservative Republicans supported the extension of conscription but resented any income tax legislation. In 1913, Joseph

16 PV Lindert, ‘The Rise of Social Spending, 1880–1930’ (1994) 31 Explorations in Economic History 1. 17 E Chatelain, ‘Les risques des ouvriers et l’impôt’ (1909) Revue socialiste, February 145. 18 Chambre des Députés, Journal Officiel. Débats parlementaires, 10 July 1894 1237. 19 N Ferguson, ‘Public Finance and National Security: the Domestic Origins of the First World War Revisited’ (1994) 142 Past and Present 162.

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Caillaux, the Minister of Finance, publicised a proposal on a capital tax, which immediately frightened liberal Republicans. Conservative politicians became aware that the income tax could be the lesser of two evils provided that graduation and compulsory declaration of revenues should be strictly limited. Socialists and Radicals could promote income taxation as a tool for social justice, whereas conservative Republicans had to put up with the idea that income taxation was the only means of financing increasing budgets.

B. Political and Social Resistance to Progressive Taxation: the ‘Bourgeois Politics’ of Tax Reform However, the case for a personal and graduated income tax had to overcome many institutional and social obstacles before entering legislation. As Sven Steinmo emphasises in his comparative study of tax policymaking, the distribution of power and institutional arrangements are key factors for understanding the pace of reform.20 The Chambre des Députés voted several income taxation Bills from 1896 onwards which were continuously rejected by the upper Chamber, the Senate. Indeed, the Constitutional Laws of 1875, which served as a Constitution for the Third Republic, were the result of a compromise between moderate royalists, the orléanistes, and conservative Republicans. They attributed extended financial power to the Senate, so that no legislation could be passed without the upper Chamber’s agreement. The indirect ballot system used to elect Senators entailed overrepresentation of conservative and rural interests. As in Britain, the question of progressive taxation provoked repeated clashes between the lower Chamber and the Senate. Adopted in 1895 by Deputies, the reform of inheritance duties introducing graduation was finally voted by Senators in 1901. The Senate’s power of veto, used many times to reject women’s right to vote and workers’ pensions, reached its climax in tax policy. Resistance to personal and progressive taxation was not only political and institutional, it also nurtured social and economic protest from various interest groups of ‘civil society’. At no other moment in French contemporary history was public opinion so captivated by taxation matters. Several leagues were created to campaign against income tax proposals and fight against so-called ‘Socialism’.21 In 1896, a parliamentary inquiry showed that almost every one of the Chambres du Commerce (the regional 20 S Steinmo, Taxation and Democracy. Swedish, British and American Approaches to Financing the Modern State (New Haven and London, 1993). 21 See G Le Béguec, ‘Le moment de l’alerte fiscale: la ligue des contribuables’ in P Guillaume (ed), Regards sur les classes moyennes (Talence, 1995).

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representative bodies of merchants and manufacturers) opposed Léon Bourgeois and Paul Doumer’s proposal of a graduated income tax.22 Jules Roche, a former Minister of Commerce in the early 1890s and a conservative Republican deputy in the lower Chamber, founded the Ligue des contribuables (the ‘Taxpayers’ League’) in 1899. The same year, the Ligue contre l’impôt sur le revenu et l’inquisition fiscale was launched by Joseph Kergall a regular contributor to the Journal des Economistes. These two new organisations claimed to speak on behalf of the ‘taxpayer’ and to defend small shopkeepers, craftsmen and peasants. Opposition to income taxation prepared the ground for a wider middle-class protest, culminating in the years 1907–14.23 The leagues intensified their mobilisation when Joseph Caillaux presented his new proposal for an income tax in 1907. The Comité central d’étude et de défense fiscale, a branch of the Association de défense des classes moyennes, organised public conferences and distributed thousands of posters and postcards to denounce personal taxation and income declaration as infringements on individual liberty and privacy, while condemning graduation for breaking with the principle of equality. They also rejected the idea of differentiation between earned and unearned incomes, arguing that it would foster social conflict and injustice. The fear of ‘fiscal inquisition’ was actually used by the upper classes to present resistance to income taxation as a mass protest against the state, whereas all proposals were designed to apply to a very small proportion of taxpayers. The links between these supposedly grassroots movements and high politics were obvious, since the Comité central d’étude et de défense fiscale had close connections with economists, manufacturers and political leaders such as Jules Roche, Raymond Poincaré or Paul Deschanel.

IV. THE DISTINCTIVE FEATURES OF FRENCH FISCAL REDISTRIBUTION: AN ANALYSIS

A. The Foundation of a New Tax System: the Inheritance Tax (1901) and the Income Tax (1914–17) In spite of all these institutional and social constraints, the French tax legislation underwent a major change before and during the First World War. The name of Joseph Caillaux (1863–1944), the radical Minister of Finance in 1899–1902, 1906–09 and 1913–14, is always associated with 22

Archives Nationales, C5550, Doumer’s proposal. The birth of middle-class protest in contemporary France is treated by J Ruhlmann in Ni bourgeois ni prolétaires. La défense des classes moyennes en France au XXe siècle (Paris, 2001). 23

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the remaking of the French ‘fiscal constitution’.24 The son of a conservative Republican who had exercised ministerial responsibilities in the 1870s, Caillaux was a brilliant member of the Inspection des Finances, one of the highest grand corps of French public service. As a public servant and a Radical, he was concerned about the state’s role in promoting social reforms. Contrary to most of the liberal economists and finance experts of the time, he saw progressive taxation as a modern, fair and productive principle, although he changed his mind between 1901 and 1907, from a cautious position to an adamant defence of graduation. The archives of the Ministry of Finance show that he benefited from a comprehensive knowledge of foreign legislation on tax reform through administrative reports and inquiries. Many other public servants shared his conviction that France’s fiscal system could not keep on lagging behind those of other industrial nations. Caillaux was partly responsible for the first introduction of graduation in French tax legislation. Indeed, the reform of the inheritance tax in 1901 marked the entry into a new fiscal era. This tax had been created in 1799 and had remained unchanged since then. It was a purely proportional tax, but the tax rate was graduated according to kinship ties (inheritors in direct line paid less in taxes than non-lineals). The yield of the tax was low (it accounted for 8 per cent of total tax revenue in 1900, while in Britain death duties were 14 per cent of the tax revenue of central government in 190125) and its reform was proposed in 1894 by the Minister of Finance Raymond Poincaré, a conservative Republican. The goal of the reform was to introduce graduation (top rates would not exceed 2 per cent) to make up for the loss of revenue caused by the possibility given to inheritors to deduct debts from received assets. Though limited, this proposal was refused by the Senate because even a small degree of graduation was seen as a ‘concession to spoliative doctrines’.26 The Bill was blocked until 1901, when Caillaux finally succeeded in overcoming the Senate’s opposition in February. People inheriting more than 1 million Francs were taxed at a rate of 2.5 per cent. The top tax rate was then increased, but it never exceeded 6.5 per cent before the First World War. Income taxation really occupied the forefront of political debates after the electoral success of Radicals and Socialists in 1906. Clemenceau, the historical leader of radicalism, took the presidency of a government in which Caillaux returned to the Ministry of Finance. The income tax had

24 For a biography, see J-C Allain, Joseph Caillaux. Vo. 1: Le défi victorieux (1863–1914) (Paris, 1978). 25 Daunton, Trusting Leviathan, above n 1, at 225. 26 Ch Bodin, ‘La réforme des droits de succession et la notion de l’impôt progressif’ (1894) Revue d’économie politique 951.

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been at the centre of the electoral competition.27 Caillaux presented a proposal for a new system of direct taxes in 1907. It consisted in the abolition of the four existing direct taxes (the ‘quatre vieilles’), which had to be replaced by a new system combining partial income taxes divided into eight schedules and a general comprehensive income tax. This project was adopted by the Chambre des Députés on 9 March 1909, but the Senate opposed it until 1914. The coming of war urged politicians to find a solution to funding military expenditure, so that a compromise was attained to vote the law creating the general and progressive income tax on 15 July 1914. The Conservatives brought substantial modifications to the initial project. Income declaration became optional (taxpayers could choose to be taxed by administrative assessment) and the high marginal rate amounted to a mere 2 per cent. Incomes below 5,000 francs were fully exempted. The general income tax was first applied in 1916 on the incomes of the previous year (1915). Top tax rates were then increased to reach 10 per cent in 1917 and 20 per cent in 1918. The new system was completed when Parliament adopted the law creating partial income taxes on 31 July 1917. The building tax, the land tax and the tax on income from securities had been restructured in 1914. Five new schedules were created to tax incomes from business, agricultural incomes, earned incomes (wages), incomes from professions and some particular revenues from capital which were not hit by the traditional tax on income from securities.28 The major innovative feature of this system was that it introduced differentiation between incomes from land, capital and labour. Tax rates varied for each schedule, but they were all proportional. Rates ranged from 3.75 per cent for agricultural and earned incomes to 4.50 per cent for business incomes. Methods of assessment relied mainly on objective indicators.

B. What Kind of Fiscal Redistribution? The Limited Impact of Tax Reform How did this fiscal transformation affect income redistribution?29 The first noticeable element was that the French general income tax fell on a small number of taxpayers. Only 4.6 per cent of French households paid the 27 For a detailed account, see M Frajerman and D Winock, Le vote de l’impôt sur le revenu, 1907–1914, Publications de l’AUDIR (Paris, 1973). 28 The whole system is presented in detail in DE Schremmer, ‘Taxation and Public Finance: Britain, France and Germany’ in P. Mathias and S Pollard (eds), The Cambridge Economic History of Europe, viii, The Industrial Economies: The Development of Economic and Social Policies (Cambridge, 1989) 391–7. 29 The impact of taxation on income inequalities has been studied in depth by T Piketty in Les hauts revenus en France au XXe siècle. Inégalités et redistribution (Paris, 2001).

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general income tax in 1918, and this figure rose to only 12–13 per cent in the interwar period. The general and progressive income tax targeted a small part of the largest fortunes. Workers and the middle classes benefited from relatively high exemption thresholds (5,000 francs in 1916, 6,000 francs in 1919 and 7,000 francs in 1922). Deductions for married couples (2,000 francs) and for family charges (children and aged relatives) greatly reduced the number of liable persons. As a consequence, the yield of the general income tax was rapidly disappointing (it represented 10 per cent of total tax revenues in 1923 and 1 per cent of GDP). The law of 25 June 1920 increased nominal tax rates to 50 per cent, but effective rates paid by the upper centile (ie the 0.01 per cent richest) never exceeded 30 per cent in the 1920s and 1930s. Moreover, taxpayers had the right to deduct from their income liable to the general income tax the sum they had paid for all the direct taxes the previous year. The new system of partial income taxes induced a redistribution of the fiscal burden between economic sectors. Those who opposed differentiation before the First World War warned against the rise of sectional interests and social conflict. Fiscal inequalities between schedules were indeed the subject of harsh political conflicts in the 1920s. As Charles S Maier argues, the post-war era marked a significant transformation of European states, with the development of corporatist organisations.30 Merchants and manufacturers protested against the increasing share they had to pay in the new system. As Table 3.2 shows, taxation of business incomes accounted for a third of direct tax revenue in 1928. The creation of a turnover tax in 1920 to compensate for the low yields of new income taxes aroused further complaints from business organisations. Agricultural incomes were taxed very lightly, although agriculture still represented a third of national product in the 1920s. The imperfection of farmers’ accounting practice made assessment of taxable incomes particularly difficult, so that the tax administration was forced to use average values and estimates. As for the schedule on incomes from professions, it was renamed in the 1920s the ‘voluntary tax’ because tax control was almost impossible.31

30 CS Maier, Recasting Bourgeois Europe: Stabilization in France, Germany and Italy in the Decade After World War I (Princeton, 1975). 31 P Allard, Les bons contribuables sont-ils des poires? Contre les déserteurs de l’impôt. Comment on fraude le fisc (Paris, 1929) 192.

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Table 3.2: Direct taxes revenues in 1918, 1923 and 1928 1918

1923

1928

in MF

% of direct taxes

in MF

% of direct taxes

21

1923

34

2308

17

219

13

500

9

1638

12

109

6

1551

27

4068

30

1

0,1

30

0,5

202

1,5

36

2

221

4

832

6

Incomes from professions

3

0,2

69

1,2

164

1,2

Incomes from securities

253

15

1165

20

3542

26

Taxes on war profits

591

35

—

—

—

—

in MF

% of direct taxes

General income tax

363

Land tax Incomes from business Agricultural incomes Earned incomes

Total direct taxes

1713

5698

13478

The implementation of income taxation did not alter the nineteenthcentury pattern between direct and indirect taxes. The narrowness of the tax base and the impossibility of generalising tax declarations maintained the share of direct taxes at around 25 per cent of total tax revenues, which was not so different from the pre-war situation. Excise duties, far from being abolished, were consolidated through the creation of the turnover tax in 1920. The weight of indirect taxes and the effects of inflation in the early 1920s triggered workers’ anger at expensive bread. To a certain extent, the reform of the French tax system failed to achieve the two goals it was supposed to aim at: financial productivity and social justice. Income taxation proved inadequate to cover the cost of war. The last distinctive feature of the French fiscal system after the First World War was its bias in favour of large families. The law of 1914 created family allowances (2,000 francs for married couples and 1,000 francs for each additional child). Tax cuts were also granted according to family charges (a married couple with three children benefited from a tax reduction of 20 per cent). The situation of single men and women worsened when the law of 25 June 1920 imposed on them a tax surcharge of 25 per cent (10 per cent for unmarried couples). Tax policy was thus

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Figure 3.1: Direct taxes as percentage of total tax revenues, 1900–30

greatly influenced by pro-natalism considerations.32 The use of taxation to define the nature of the family has since then been a constant aspect of fiscal redistribution in France.

V. CONCLUSION: TAX REFORM AND CONSENT TO TAXATION

In conclusion, the effects of progressive taxation on income distribution were still limited in the interwar years. The introduction of a personal and graduated income tax and of partial income taxes represented a major philosophical and technical change in taxation policies, however, they started to play a real redistributive role only after the Second World War, when the income tax applied to a majority of taxpayers. The legitimacy of the tax system was as contentious in the 1920s as it had been before the First World Wa. The principle of progression had been accepted, however, the state lacked the administrative techniques to implement the new tax system successfully. Politicians were unable to find a consensus between competing interests (agriculture, business, labour and familialism) on the form and level of redistribution, whereas tax reform aimed at fair taxation, fiscal inequalities and tax evasion rose in the 1920s and 1930s and weakened consent to taxation and the authority of the state.

32 It was also true of social policies: see He Chapman, ‘French Democracy and the Welfare State’ in G Reid Andrews and H Chapman (eds), The Social Construction of Democracy (1870–1990) (New York, 1995) 291.

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4 Traditions of Wealth Taxation in Germany ANDREAS THIER

ABSTRACT In 1995 the German Federal Constitutional Court had to decide whether, and under what conditions, the taxation of wealth is constitutionally allowed. The court accepted the wealth tax in principle. The judges made clear, however, that a wealth tax can be constitutional only as a sort of profit tax (Ertragsteuer). In this view, a wealth tax can levy only elements of wealth, which are at least potentially able to yield a return. As a consequence, assets which yield no return, can not be subject to a wealth tax. In a dissenting vote, ErnstWolfgang Böckenförde formulated another concept of wealth taxation. In his opinion wealth is only an indicator of the ability to pay taxes in general. Therefore a wealth tax can also levy against assets which do not produce a yield. Both the majority opinion and Böckenförde alleged in support of their argument the tradition of wealth taxation in Germany. In fact, both arguments can be related to a specific tradition of wealth taxation: the majority opinion represents a tradition which is often referred to as fundus theory, while the dissenting vote can be assigned to the so-called wealth possession theory. A crucial point in both concepts is the history of the Prussian Ergäzungssteuer (Supplementary Tax) 1893, which is seen as a historical principle reference for both concepts. This chapter addresses both traditions. It will discuss whether, and to what extent, a specific traditional element of wealth taxation can be found in German tax history. It is argued, first, that during the Early Modern Period the concept of a profit tax was dominant, even though from time to time the idea of a levy on wealth itself emerged. The second section shows that during the ninteenth century both concepts were formulated as more or less complex opposing theories. The third section discusses the emergence of the Prussian Supplementary Tax in detail and shows that the legislative drafting of this tax was influenced by both concepts.

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Andreas Thier I. INTRODUCTION

I

N 1995 THE GERMAN Federal Constitutional Court had to decide whether, and if so under what conditions, the taxation of wealth is constitutionally allowed.1 The court accepted a wealth tax in principle. The judges made clear, however, that a wealth tax can be constitutional only as a sort of profit tax (Ertragsteuer). In this view, a wealth tax can be levied against elements of wealth which at least have the potential to yield a return. As a consequence, assets which yield no return cannot be subject to a wealth tax.2 In a dissenting vote, Ernst-Wolfgang Böckenförde created another concept of wealth taxation. In his view, wealth is only an indicator for the ability to pay taxes in general. Therefore Böckenförde claimed that a wealth tax can cover also assets without any yield.3 Both sides, the majority opinion and Böckenförde, alleged in support of their argument the tradition of wealth taxation in Germany. The majority opinion highlighted the historical importance of a wealth tax. The majority also argued that modern wealth taxation sets forth a concept of a supplementary taxation of unearned, funded (fundiert) income.4 On this point the majority disagreed with an argument in a decision of the Federal Constitutional Court of 1976: here, the court had stated that wealth taxation is a tax traditionally independent of wealth returns.5 Böckenförde stressed a similar point to that made in the decision of 1976. In his view there was also a strong tradition of wealth tax legislation creating a tax burden also upon assets which generate no return.6 Both arguments can be related to a specific tradition of wealth taxation. The majority opinion represents a concept which is often referred to as ‘fundus’ theory, while the dissenting vote can be assigned to the so-called ‘wealth possession’ theory.7 For the fundus theory, wealth taxation can only apply to the potential returns from wealth. To give a tapered example

1 Federal Constitutional Court, decision from 22 June 1995, in: Entscheidungen des Bundesverfassungsgerichts vol 93 121 et seq (hereinafter cited as: BverfGE 93, 121); for the constitutional framework and the consequences of the decision for the constitutional law doctrine see the survey in: K Vogel, C Waldhoff, Bonner Kommentar zum Grundgesetz 81. delivery (1997) Vorb. zu Art. 104a–115, n 532–47; N Vieten, Die verfassungsrechtliche Zulässigkeit der Wiedereinführung einer Vermögensteuer. Zugleich eine Untersuchung des Halbteilungsbeschlusses des Bundesverfassungsgerichts (Frankfurt, 2005) (= Kölner Schriften zu Recht und Staat, Bd 25), passim. 2 BVerfGE 93, 121, 140 et seq. 3 BVerfGE 93, 121, 149, 158 et seq. 4 BVerfGE 93, 121, 134 et seq, 139. 5 Federal Constitutional Court, decision from 27 October 1975, in: Neue Juristische Wochenschrift 1976, 101. 6 BVerfGE 93, 121, 158 et seq. 7 For a short survey, see T Herzog, Funktion und Verfassungsmässigkeit der Vermögenssteuer,(Basle and Frankfurt, 1985) (= Basler Studien zur Rechtswissenschaft, Bd 14), 32–45; for a deeper discussion, see F Helmert, ‘Die Rechtfertigung der Vermögensteuer’ (1987) 69

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for this point of view, assets consisting only of canvases might not be subject to wealth taxation. For the wealth possession theory, however, wealth itself is an indicator of the ability to pay taxes; therefore, here, it would make no difference if the assets consisted of shares or pictures. Those concepts and their traditions will be discussed in this essay. It will be argued that elements of both concepts can be found in the German history of taxation. But even though the continuity of both theories can be traced back to the early modern period, objectives and reasons of wealth taxation changed, at least in part. As will be argued in a first section (section II below), wealth taxation during the sixteenth to the eighteenth centuries was based mainly on a concept of profit taxation. This situation changed in the nineteenth century, as will be demonstrated in a second section (section III below). With the rising importance of income tax, wealth taxes were now perceived either as an instrument for the burdening of incomes generated by assets or as one for reducing social inequalities by means of tax legislation. Both concepts were often combined. In a third section (section IV below), the legislative reception of such ideas will be addressed. The discussion will focus on the Prussian Supplementary tax of 1893, where both concepts were combined and laid the ground for the further development of wealth taxation in Germany. It will be argued that—contrary to the argument of the Federal Constitutional Court—since 1892–93 both concepts of wealth taxation have been influential in the tax legislation.

II. ELEMENTS OF WEALTH TAXATION IN MIDDLE EUROPE DURING THE EARLY MODERN PERIOD

Wealth taxation in middle Europe had its origins in the medieval levies, mostly called Bede or Schoß (fold).8 These taxes emerged in about the

Finanz-Rundschau 615–17; see also K Oechsle, ‘Hundert Jahre Vermögensteuergesetze in Deutschland. Zur Geschichte und Begründungsproblematik der modernen Vermögensteuer’ (1993) Betriebsberater 1369–75, 1370 et seq. 8 For a short survey, see W Schomburg, Lexikon der deutschen Steuer- und Zollgeschichte. Von den Anfängen bis 1806 (Munich, 1992), sv ‘Schoss’, 338 et seq; A Thier, Art ‘Bede’ in A Cordes, H Lück, D Werkmüller unter philologischer Mitarbeit von R SchmidtWiegand (eds), Handwörterbuch zur Deutschen Rechtsgeschichte, Handwörterbuch zur deutschen Rechtsgeschichte, 3 fasc: (2nd edn, Bayern, – Berlin, 2005) cols 494–6. Regarding the situation of public finance in middle Europe during the Early Modern Time in general: V Press, ‘Finanzielle Grundlagen territorialer Verwaltung um 1500 (14–17 Jahrhundert)’ in Die Verwaltung und ihre Ressourcen. Untersuchungen zu ihrer Wechselwirkung. Tagung der Vereinigung für Verfassungsgeschichte in Hofgeismar 13. 3.–15. 3. 1989 (Berlin, 1991) (= Beihefte zu ‘Der Staat’, H. 9), 1–29, 2 (with reference to taxation) and passim; see also E Isenmann, ‘The Holy Roman Empire’ in R Bonney (ed), The Rise of the Fiscal State, c.

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twelfth century in the cities and territories.9 The basis of assessment was often provided by a self-declaration of the total value of all assets, confirmed on oath.10 While this procedure dominated in the cities especially in about the fifteenth century, land registers also came to exist in rural areas. In these registers, often called Bederegister or Schossregister, the size of the taxed estates was listed. In most cases so called Hufe (hooves) were used as a measurement. Thus in some cases reformed taxes on landed property were also named Hufenschoss as, for example, in Brandenburg-Prussia, where such a tax has been found since the sixteenth century. Taxes such as the Hufenschoss reflected the tendency for a type of wealth taxation which could be found in most regions of the Old Empire from the sixteenth to the eighteenth centuries.11 For a long period, the subject of taxation was not the wealth itself, but single assets such as landed property or cattle. At the same time, the possible yield became the defining factor for the value of taxable assets, while the market value of taxable assets lost its importance.12 So taxation shifted to what would be called, in modern terms, a tax on profit. This may be demonstrated by an example of a tax in Salzburg. The so-called Rusticalsteuer, created in 1620, included as taxable objects landed property, cattle, moveable property used for the domestic economy, and all outstanding accounts. The basis of assessment was provided by the market value of the landed property and an estimate of the value of the other assets. This tax—a rate of 1.125 per cent of the total wealth—was reformed in 1778. At that time the Rusticalsteuer taxed mainly real estates. The most important innovation was the introduction of a land register which contained detailed data mainly about the location of the property, the type of land use and, where relevant, the extent of cattle rearing. The taxable value of the estate was now calculated by a combination of the market value, the value of the

1200–1815 (Oxford, 1999) 243–80, in particular 248–51 (referring to the early forms of taxation) and R Bonney, ‘Revenues’, in: Id (ed), Economic Systems and State Finance (Oxford, 1995) 421–505, 472–88. 9 KS Bader and G Dilcher, Deutsche Rechtsgeschichte. Land und Stadt—Bürger und Bauer im Alten Europa (Berlin/Heidelberg/New York, 1999) 443. 10 A Erler, Bürgerrecht und Steuerpflicht im mittelalterlichen Städtewesen. Mit besonderer Untersuchung des Steuereides (2nd. edn, Frankfurt, 1963) passim. 11 Short survey on the tax systems in the Holy Roman Empire during the sixteenth century: W Schulze, ‘The Emergence and Consolidation of the “Tax State” I: The Sixteenth Century’ in R Bonney (ed), Economic Systems and State Finance (Oxford, 1995) 261–79, 268–73. In particular, for the strongly wealth-based Gemeinen Pfennig, an imperial tax established in 1495, see E Isenmann, ‘Reichsfinanzen und Reichssteuern im 15. Jahrhundert’ in (1980) 7 Zeitschrift für Historische Forschung 1–76, 129–218at 195–8, and in further detail P Schmid, Der Gemeine Pfennig von 1495 (Göttingen 1989) (= Schriftenreihe der Historischen Kommission bei der Bayerischen Akademie der Wissenschaften, Bd 34) 181–8 (regarding the element of wealth taxation) and passim. 12 For a general survey, see A Thier and C Waldhoff, Art. ‘Tax Law’ in SN Katz (ed), Encyclopedia of Legal History (forthcoming).

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cattle, the costs of cattle-rearing and the geographic location of the estate. Therefore the taxable value of landed property was also determined by the earning capacity of the estate.13 This focus on the potential return of wealth as the basis of assessment for wealth taxation corresponds to similar demands of contemporary14 tax science. Having arisen in particular as part of the newly emerged political science15 in the middle of the sixteenth century,16 from the seventeenth century the cameralistics debated the elements of and reasons for both the existing, and an ideal, taxation.17 In these interpretations taxation based on wealth was dominant. That had its rationale in the idea that wealth would be the best measure of the extent of the duty: Theodor Ludwig Lau,18 for example, demanded in 1719 that ‘taxes should be levied on those, who can give…them without complaint or greater reduction of their assets’19; nearly a century before, in 1631, David Mevius20 had stated as a

13 C Dirninger, ‘Das Steuer- und Abgabensystem im Erzstift Salzburg im 18. Jahrhundert’ in E Schremmer (ed), Steuern, Abgaben und Dienste vom Mittelalter bis zur Gegenwart (Stuttgart, 1994) (= Vierteljahresschrift für Sozial- und Wirtschaftsgeschichte, Beihefte, n 114) 109–45, 127 et seq. Similar notions of the development of wealth taxation in K Schmuki, Steuern und Staatsfinanzen. Die bürgerliche Vermögenssteuer in Schaffhausen im 16. und 17. Jahrhundert (Zürich, 1988) 122, with reference to the cities in the South-west of the Holy Roman Empire. Against that background it is of special interest that in some cities like Schaffhausen every asset was covered by the wealth tax, levied in this town. 14 For a general survey on the debate on taxation, its legitimacy and its shape during the late Middle Ages and the fifteenth century, see E Isenmann, ‘Medieval and Renaissance Theories of State Finance’ in R Bonney (ed), Economic Systems and State Finance (Oxford, 1995) 21–52 (particularly with regard to the idea of property and wealth taxation: ibid 46 et seq). 15 M Stolleis, Geschichte des Öffentlichen Rechts vol 1: Reichspublizistik und Policeywissenschaft 1600–1800 (Munich, 1988) 80–90. 16 J Jenetzky, System und Entwicklung des materiellen Steuerrechts in der wissenschaftlichen Literatur des Kameralismus von 1680–1840, dargestellt anhand der gedruckten zeitgenössischen Quellen (Berlin, 1978) (= Schriften zum Steuerrecht, Bd 17); H Schulz, Das System und die Prinzipien der Einkünfte im werdenden Staat der Neuzeit, dargestellt anhand kameralwissenschaftlicher Literatur (1600–1835) (Berlin, 1982) (= Schriften zum Öffentlichen Recht, Bd 421); M Stolleis, Pecunia nervus rerum. Zur Staatsfinanzierung der frühen Neuzeit (Frankfurt, 1983); essentially A Schwennicke, ‘Ohne Steuer kein Staat’: Zur Entwicklung und politischen Funktion des Steuerrechts in den Territorien des Heiligen Römischen Reiches (1500–1800) (Frankfurt, 1996) (= Ius commune, Sonderhefte, Studien zur Europäischen Rechtsgeschichte 90). 17 Jenetzky, System und Entwicklung, above n 16, at 100 et seq; Schwennicke, ‘Ohne Steuer kein Staat’’, above n 16, at 167–73. 18 M Pott, ‘Einleitung’ in M Pott (ed), Theodor Ludwig Lau (1670–1740) (Stuttgart-Bad Cannstatt, 1992) (= Philosophische Clandestina der deutschen Aufklärung I/1) 9–54 at 16–30. 19 Theodor Ludwig Lau, Aufrichtiger Vorschlag von glücklicher, vorteilhafftiger, beständiger Einrichtung der Intraden und Einkünftem der Souverainen und ihrer Unterthanen, in welchem von Policey- und Cammer-Negocien und Steuer-Sachen gehandelt wird (Frankfurt, 1719; repr Frankfurt, 1969) 317:‘Die Steuren [sic], von den jenigen zu nehmen, die solche ohne Beschwerde und grosse Verminderung ihrer Haabseligkeiten [sic]…geben können’. 20 W Buchholz, Art ‘Mevius, David’ in Neue Deutsche Biographie XXI (Berlin, 2003) 281–3.

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general principle that whoever owns more should pay more, and whoever owns nothing should not be taxed.21 The background to demands was apparently an ideal of harmony of taxation, justice and social peace. Matthaeus Wesenbeck Junior, for example, stated in 1645: Justice orders this harmony that he, who accumulates more in his (private) hands, shall also give more for the public.22

Obviously, such statements were inspired by elements of the sixteenth- and seventeenth-century Aristotelian renaissance in the political science and its concepts of a good policy (gute Polizei).23 But this matter24 cannot be discussed here. More important in the present context is another point: as is suggested in Wesenbeck’s statement, for most authors wealth was only an indicator of the size of the revenues of its owner. The differences in those revenues gave reason for the differences in the size of tax liability.25 As a consequence of this thought, a tax on income would have been the best solution. But, at that period, income tax was widely unknown.26 For the authors of this period capitation was the only alternative. But this tax was generally disapproved of, as it caused heavy disadvantages for the poor. Caspar Klock27 spoke in 1651 of a ‘servitus. . . durissima et inqiuissima’, as though the poor man had to pay the same amount of tax as the rich one.28 So only wealth was left at the centre of the taxation order,

21 D Mevius, ‘De contributionibus. Disputatio juridico–politica, Greifswald 1631’, conclusio XVIII, fol. 39r: ‘qui plus habet plus solvat qui nihil possidet exactioni non subjaceat’, quoted from Schwennicke, ‘Ohne Steuer kein Staat’ , above n 16, at 169 et seq, n 282. 22 Matthäus Wesenbeck (junior), Cynosura liturgica de subsidiis necessitati publicae ferendis Sive duodecas harmonicae justitiae, de publicis imprimis extraordinariis contributionibus, secundum theologica, juridica, politica et historica principia proportionabiliter instituendis (Frankfurt, 1645), conclusio IX, n 3, p 135, quoted from Schwennicke, ‘Ohne Steuer kein Staat’, above n 16, at 168, n 277: ‘Iustitia haec harmonica imperat, ut plus adiiciat in publicum, qui plus adiicit lucro privato.’ 23 For a survey, see: Stolleis, Geschichte, above n 15, at 334–93; in more detail, see T Simon, ‘Gute Policey’. Ordnungsleitbilder und Zielvorstellungen politischen Handelns in der Frühen Neuzeit (Frankfurt, 2004) (= Studien zur europäischen Rechtsgeschichte, Bd 170) 15167; see also Stolleis, Pecunia nervus rerum, above, n 16, at 101–3. 24 For the relationship between taxation and the elements of a good policy, see in further detail Simon, ‘Gute Policey’ , above n 23, at 297–303, with further reference. 25 See, eg, Lau, Aufrichtiger Vorschlag, above n 19, at 317: ‘Therefore they [namely the taxes]…should be established by the quantity of the annual revenues, because, who owns much, shall contribute much, who owns only little, shall contribute little (Daher sie [scil. die Steuern] …nach der Quantität jährlicher Einkünften [sic] einzurichten; weil, wer viel hat, viel beytragen, wer wenig hat, wenig contribuieren soll…).’ 26 Jenetzky, System und Entwicklung, above n 16, at 192–7, 200–4; Schulz, Das System und die Prinzipien, above n 16, at 135 et seq, 379 et seq. 27 E Dittrich, Art. ‘Klocke’ in Neue Deutsche Biographie vol 12 (Berlin, 1980) 102 et seq; Stolleis, Pecunia nervus rerum, above n 16, at 90 et seq. 28 C Klock, Tractatus de aerario, sive censu, per honesta media absque divexatione populi licite conficiendo (2nd edn, Nuremberg, 1671) vol 2, cap 79, n 42, p 788; see also Schwennicke, ‘Ohne Steuer kein Staat’, above n 16 172, n 291 with a slightly different reading of this quote.

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which had to be sized secundum vires cuiusque patrimonii, as it was often stated, especially in the seventeenth century.29 In order to cover these vires of wealth, this potential, most authors demanded that the capacity to earn wealth should form the measure of taxes. Therefore assets could be taxable only if they were able to bring a return, or at least a benefit. In 1721, for example, it was stated that taxes and tributes should only be given because of the usability and the income of every taxable piece and that no one should pay taxes, if he has no use and benefit of a piece.30 Concretely, this principle meant also that so-called praedia sterilia or pecunia otiosa could not be taxable assets. Actually, some authors denied the taxability of such items.31 That meant also the denial of every form of taxation of the wealth substance.32 So it could be said that in this concepts the taxation of wealth tended to be a form of a profit taxation, which came near to the fundus theory. On the whole, these ideas prevailed until the end of the Old Empire, even though the rise of the idea of an income tax began during the eighteenth century.33 At the same time, taxation (and thus also the taxation of wealth) was sometimes seen as an instrument for the governmental regulation of social and also economical behaviour.34 At that point taxation definitely became an instrument of the ‘good policey’ as well: Georg Heinrich Zincke (1692–1768),35 for example, stated that

29 See C Klock, Dissertatio theorico-practica de contributionibus hodie, ut plurimum in Germania usitatis (Basle, 1608), conclusio 52, fol. 15r: per aes et libram, id est secundum vires patrimonii cuiusque; quoted from Schwennicke, ‘Ohne Steuer kein Staat’, above n 16, at 169 et seq, n 282. 30 JD Eulner, Practische Vorschläge welcher gestalt Steuer und Contribution zum Nutzen eines Landesherrn und ohne Nachtheil der Unterthanen nach Anleitung der Reichs-Abschiede einzurichten seyn,(2nd edn, Marburg, 1741) § 88, pp 91 et seq (see also Schwennicke, ‘Ohne Steuer kein Staat’ , above n 16, at n 286, 171 with a slightly different reading): Eulner demanded that ‘Steuren und Tributen nur von der Nutzbarkeit und Einkommen eines jeden steuerbaren Stücks gegeben werden müssen und dass niemand Collectis solvendis obstrict seye, er habe dann Nutzen und Genuss von einem Dinge’. 31 Schulz, Das System und die Prinzipien, above n 16, at 363–65, Schwennicke, ‘Ohne Steuer kein Staat’ , above n 16, at 171. 32 See, eg, the demand of I Hübner, Abhandlung von der unentbehrlichen Nothwendigkeit der sämmtlichen Kammeralwissenschaften in einem weisen Staate (Burghausen, 1777) 28, that taxes ‘must be required only from the uses, but not from wealth in its substance’ (nur von den Nutzungen, nicht aber von dem Substanzvermögen…begehrt werden dürfen); quoted from Schulz, Das System und die Prinzipien , above n 16, at 361. 33 Schwennicke, ‘Ohne Steuer kein Staat’ , above n 16, at 337–43. 34 Schulz, Das System und die Prinzipien, above n 16, at 383–9; Schwennicke, ‘Ohne Steuer kein Staat’, above n 16, at 329 et seq; Simon, ‘Gute Policey’, above n 23, at 559–62. A Tautscher, ‘Die Steuer als Gestaltungsmittel der Volkswirtschaft bei den Merkantilisten’ in (1943) 9 Finanzarchiv, NS 303–37, 313–35. 35 P Zimmermann, Art ‘Zincke, Georg Heinrich’ in Allgemeine Deutsche Biographie vol 45 (Leipzig, 1900) 313–15.

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by a duty…a polic(e)y evil could be regulated or a convenient reason of polic(e)y, the thriving of the alimental class as whole or of a single species of the alimental craft…(could be) stimulated.36

In the long run such ideas resulted in the idea of luxury taxes which, as might be said, fiscalised the tradition of the early modern ban on luxuries.37 In another direction ran the idea of using a wealth tax in order to reduce inequalities of wealth, in other words redistributing wealth by means of taxation.38

III. WEALTH TAXATION AND TAX ABILITY IN THE GERMAN DEBATES OF THE NINETEENTH CENTURY

During the nineteenth century the tax system in German states underwent a fundamental change39: income tax became the basis of the tax order. In Prussia,40 for example, in 1820 the so called Klassensteuer (class tax) was introduced,41 which was transformed into the Klassen- und klassifizierte 36 GH Zincke, Anfangsgründe der Cameralwissenschaft, worinnen dessen Grundriss weiter ausgeführet und verbessert wird vol 2 (Leipzig, 1755) § 661 f, 804: ‘dass mittelst der Abgaben einem…Policey-Uebel gesteuert, oder ein angenehmer Zwecl der Policey, nämlich der Flor der Nahrungs insgemein, oder einer Art der Nahrungsgewerbe…befördert wird’. 37 Stolleis, Pecunia nervus rerum, above n 16, at 57–61. 38 JW von der Lith, Neue vollständig erwiesene Abhandlung von denen Steuern und deren vorteilhafter Einrichtung in einem Lande, nach den Grundsätzen einer wahren, die Verbesserung der macht eines Regenten und die Glückseligkeit seiner Unterthanen wirkenden Staatskunst (Ulm, 1766) 21: ‘A wise prince will… use taxes for the purpose that he lowers the inequality of the wealth of his subjects’ (Ein weiser Regent wird…die Steuern darzu anwenden, um die…Ungleichheit des Vermögens seiner Unterthanen zu vermindern). See also Schwennicke, ‘Ohne Steuer kein Staat’, above n 16, at 329, and Tautscher, Die Steuer als Gestaltungsmittel, above n 34, at 324. 39 For a survey, see: H-P Ullmann, Der deutsche Steuerstaat. Geschichte der öffentlichen Finanzen(Munich, 2005) 43–7; in further detail: M Spoerer, Steuerlast, Steuerinzidenz und Steuerwettberwerb. Verteilungswirkungen der Besteuerung in Preussen und Württemberg (1815–1913) (Berlin, 2004) (= Jahrbuch für Wirtschaftsgeschichte, supplement 6); E Schremmer, Steuern und Staatsfinanzen während der Industrialisierung in Europa. England, Frankreich, Preussen und das Deutsche Reich 1800 bis 1914 (Berlin/Vienna, 1994); see also R Siegert, Steuerpolitik und Gesellschaft. Vergleichende Untersuchungen zu Preussen und Baden 1815–1848 (Berlin, 2001) (= Schriften zur Wirtschafts- und Sozialgeschichte 63). 40 P Greim-Kuczewski, Die preußische Klassen- und Einkommensteuergesetzgebung im 19. Jahrhundert. Eine Untersuchung über die Entwicklungsgeschichte der formellen Veranlagungsvorschriften (Cologne, 1990) (= Reihe: Wirtschafts- und Rechtsgeschichte Bd 18); P Linzbach, Der Werdegang der preußischen Einkommensteuer unter besonderer Berücksichtigung ihrer kausalen Entwicklungsfaktoren, ein Beitrag zur Durchsetzbarkeit der Einkommensteuer (Frankfurt/ Berne/ New York/ Nancy, 1984) (= Europäische Hochschulschriften, Reihe V: Betriebswirtschaftslehre, Bd 503); A Thier, Steuergesetzgebung und Verfassung in der konstitutionellen Monarchie. Staatssteuerreformen in Preußen 1871–1893 (Frankfurt, 1999) (= Studien zur Europäischen Rechtsgeschichte 119) 35–71 (for the period up to 1871). 41 Gesetz wegen Einführung einer Klassensteuer, 30. 5. 1820, Gesetzessammlung für die Königlichen Preussischen Staaten (hereinafter cited as GS) (1820) 140; E von Beckerath, Die

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Einkommensteuer (class- and classified income tax) in 1851.42 Against the background of such developments, the wealth tax lost ground. This process was reflected in a shift of the majority opinion in economics at the end of the eighteenth century which voted against the wealth taxation and for income and pure profit taxes.43 In the first two-thirds of the nineteenth century the taxation of wealth was not an issue for the legislators and the broad majority of economists or jurists.44 The Industrial Revolution and the emergence of the social question, however, changed the situation in the last third of the nineteenth century. During the 1870s, the idea of government-regulated social reform arose, by means of which social tensions would be reduced.45 This concept gained influence in the taxation debate too.46 Even though most authors objected to the idea that tax legislation should be used as a main lever of social reform, as Adolf Held47 stated in 1873,48 social differences should be taken into account.49 This approach was also based on the rise of a principle, which had among other things, its roots in the early modern demand for harmony and equality of taxation.50 But instead of the more abstract postulates of the cameralistics, from the middle of the nineteenth century

preußische Klassensteuer und die Geschichte ihrer Reform bis 1851 (München/Leipzig, 1912; repr Bad Feilnbach, 1990) (= Staats- und Socialwissenschaftliche Forschungen, fasc. 163). 42 Gesetz, betreffend die Einführung einer Klassen- und klassifizierten Einkommensteuer, 1. 5. 1851, GS 1851, 193; Beckerath, Die preußische Klassensteuer, above n 41, at 82–5; H Teschemacher, Die Einkommensteuer und die Revolution in Preußen, eine finanzwissenschaftliche und allgemeingeschichtliche Studie über das preußische Einkommensteuerprojekt von 1847 (Tübingen, 1912) 68 et seq and passim. 43 K Oechsle, Die steuerlichen Grundrechte in der jüngeren deutschen Verfassungsgeschichte. Zugleich eine Untersuchung über das historische Verhältnis von Steuerverfassungsrecht und Finanzwissenschaft (Berlin, 1993) (= Tübinger Schriften zum Staats- und Verwaltungsrecht vol 20). 44 P Bechstein, Die Rechtfertigung von Einzelsteuern unter besonderer Berücksichtigung der verfassungsrechtlichen Anforderungen, dargestellt am Beispiel der Vermögensteuer (Tübingen, 1997) 8–15. 45 R vom Bruch, Bürgerliche Sozialreform im deutschen Kaiserreich in id (ed), ‘Weder Kommunismus noch Kapitalismus’, Bürgerliche Sozialreform in Deutschland vom Vormärz bis zur Ära Adenauer (Munich, 1985) 61–179, passim. 46 FK Mann, Steuerpolitische Ideale. Vergleichende Studien zur Geschichte der ökonomischen und politischen Ideen und ihres Wirkens in der öffentlichen Meinung 1600–1935 (Jena, 1937) (= Finanzwissenschaftliche Forschungen fasc. 5) 316–24; Oechsle, Die steuerlichen Grundrechte, n 43), at 92–105; Thier, Steuergesetzgebung und Verfassung, above n 40, at 273–99. 47 G Stavenhagen, Art ‘Held, Adolf’ in Neue Deutsche Biographie vol 8 (Berlin, 1969) 461 et seq. 48 A Held, Die Einkommensteuer. Finanzwissenschaftliche Studien zur Reform der directen Steuern in Deutschland (Bonn, 1872) 143: It could not be claimed that die Steuergesetzgebung ein Haupthebel der socialen Reform…werde. 49 Thier, Steuergesetzgebung und Verfassung, above n 40), at 285–91. 50 Above n 22.

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German economists stressed the ‘ability-to-pay’ principle.51 As a consequence, it was often argued that, as Adolf Held put it in 1873, ‘the rich pay too little’.52 Statements like this one referred to numeerous problems of the existing tax order, for example the procedure of tax assessment53 or the privileges for capital gains.54 In the context of the discussion about tax reform which would fix those problems, the wealth taxation as a supplement to the income taxation often had a revival. Some economists now argued that the distinction between earned income and unearned, funded income should result in different tax rates or in an additional taxation of funded income beside the general income tax.55 The background to this concept was the idea that unearned income had its origins not in personal achievements and labour but in the pure existence of wealth independent from personal activities. In that case the personal forces (would) remain completely at disposal, as Friedrich Neumann (1835–1910)56 put it.57 In that argument the taxation of wealth had its rationale in the special form of yield resulting from the possession of assets. But even though this idea came near to the fundus theory, it did not exclude another argument, which focused on the possession of wealth itself. This becomes clear particularly in the case of Friedrich Neumann: in order to give reasons for a wealth tax he stressed the point that the ability to pay taxes depended not only on assets with a possible yield but on the value of the wealth as a whole: 51 D Pohmer and G Jurke, ‘Zur Geschichte und Bedeutung des Leistungsfähigkeitsprinzips unter besonderer Berücksichtigung der Beiträge im Finanzarchivs und der Entwicklung der deutschen Einkommensbesteuerung’ in(1984) 42 Finanzarchiv NS 445– at 450–3. 52 A Held, ‘Gutachten über die Steuerfrage’ in Die Personalbesteuerung. Gutachten auf Veranlassung der Eisenacher Versammlung zur Besprechung der socialen Frage (Leipzig, 1873; repr Vaduz, 1988) (= Schriften des Vereins für Socialpolitik vol 3) 23–38, 26: Nicht, daß die Armen zuviel, sondern daß die Reichen zu wenig zahlen, das ist sociale Uebel, an dem wir im Gebiete des Steuerwesens laboriren. For similiar statements see Thier, Steuergesetzgebung und Verfassung, above n 40, at 289. 53 For a detailed discussion based on the Prussian example, see Greim-Kuczewski, Die preußische Klassen- und Einkommensteuergesetzgebung, above n 4040, at 146 et seq, 164–6, and Thier, Steuergesetzgebung und Verfassung, above n 4040), at 63–7. See also H Spenkuch, Das Preußische Herrenhaus. Adel und Bürgertum in der Ersten Kammer des Landtages 1854–1918 (Düsseldorf, 1998) (= Beiträge zur Geschichte des Parlamentarismus und der politischen Parteien vol 110) 248–51. For a fascinating background analysis of the infamous practices of tax assessment in the east Elbian regions, see now P Wagner, Bauern, Junker und Beamte. Lokale Herrschaft und Partizipation im Ostelbien des 19. Jahrhunderts (Göttingen, 2005) (= Moderne Zeit vol 9) 560–2. 54 Schremmer, Steuern und Staatsfinanzen, above n 3939) 147, 196 et seq; Thier, Steuergesetzgebung und Verfassung, above n 40, 67. 55 Bechstein, Die Rechtfertigung von Einzelsteuern, above n 44) 15–24; Thier, Steuergesetzgebung und Verfassung, above n 40) 290–9. 56 W Kosch and E Kuri, Biographisches Staatshandbuch. Lexikon der Politik, Presse und Publizistik, vol 2 (Berne/Munich, 1963) 915. 57 Fr J Neumann, Die progressive Einkommensteuer im Staats- und Gemeindehaushalt. Gutachten über Personalbesteuerung (Leipzig, 1874) (= Schriften des Vereins für Socialpolitik vol 8) 178: ‘Die persönlichen Kräfte’ would ‘ganz zur Disposition bleiben!’.

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Whoever…leaves essential parts of his assets unused or uses them for luxury items…,which bring him only pleasure but no revenue, is in principle no less able to pay than if he were to allow his …capital to ‘work’.58

As a consequence this concept made it possible (at least in theory) to achieve a taxation of the substance of wealth: if taxable wealth produced no income, the tax debt had to be paid from the substance of the wealth itself. It therefore also prepared the way for a redistribution of wealth by means of taxation. This later so-called ‘possession’ theory of wealth also found its followers, even though it remained highly controversial in the debate among economists.59 Its attraction for economists might be explained by the widespread ideal of a strong monarchic state, which could give the economic and social order new stability by intervention.60 In any case, the ‘possession’ theory and the fundus theory should make their way into the tax legislation process.

IV. WEALTH TAXATION AND THE PRUSSIAN SUPPLEMENTARY TAX OF 1893

In 1890 Johannes Miquel,61 the Prussian Minister of Finance, started a great reorganisation of the Prussian tax system.62 As a first step, he complied closely with an old parliamentary demand and introduced a new income tax in 1890–91.63 As a second step, Miquel reorganised financial relations between the Prussian state and its municipalities: property taxes (in particular the property tax and the trade tax) which were originally 58 Neumann, Die progessive Einkommensteuer, above n57) 186: ‘Wer bedeutende Teile seines Vermögens ungenutzt lässt oder zu Luxusanlagen… verwendet, von denen er Genuß, aber nicht Einkommen hat, der ist an sich nicht minder leistungsfähig, als wenn er sein… Capital arbeiten ließe.’ 59 Bechstein, Die Rechtfertigung von Einzelsteuern , above n44) 19–24. 60 Typical for this position were demands for a ‘social tax reform’ (C Frantz, Die soziale Steuerreform als die conditio sine qua, wenn der sozialen Revolution vorgebeugt werden soll (Mainz, 1881; repr Aalen, 1972) or a ‘state socialism’ (A Wagner, ‘Finanzwissenschaft und Staatssozialismus, mit einer Einleitung über Stein’s und Roscher’s Finanzwissenschaft’ in Zeitschrift für die gesamte Staatswissenschaft 43 (1887, repr 1977) 35–-122), using taxation to regulate ‘the distribution of the revenue and the wealth of the civil economies’ (Verteilung des Einkommens und Vermögens der Privatwirtschaften) Wagner, ibid 117. 61 R Aldenhoff, Art ‘Miquel’ in Neue Deutsche Biographie vol 17 (Berlin, 1994) 553 et seq; H Herzfeld and J von Miquel, sein Anteil am Ausbau des Deutschen Reiches bis zur Jahrhundertwende, vol. 1–2 (Detmold, 1938). 62 Thier, Steuergesetzgebung und Verfassung, above n 40, at 432–642. A Thier, ‘Die Gesetzgebungsverfassung der deutschen konstitutionellen Monarchie als bewegliches System: Preußische Steuergesetzgebung 1879–1893’, in B Holtz and H Spenkuch (eds), Preußens Weg in die politische Moderne: Verfassung – Verwaltung—politische Kultur zwischen Reform und Reformblockade (Berlin, 2001) (= Berlin-Brandenburgische Akademie der Wissenschaften, Berichte und Abhandlungen, Sonderband 7) 285–320 at 308–19. 63 Einkommensteuergesetz, 24. 6. 1891, GS 1891, 175.

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allocated to the state, were transferred to the municipalities in 1892–93.64 As this transfer would result in a diminution of state revenue, Miquel had to create a substitute. Hence he ordered the drafting of a new state levy.65 This new tax should complete the new order of state taxation with income tax as its core. In order to highlight the position of the new tax alongside income tax, the Finance Ministry named it supplementary tax.66 At the same time, the supplementary tax was also to meet another old postulate of the Parliament in Prussia: a Prussian wealth tax should be established. In the session 1882–83 the Prussian House of Representatives (and also members of the Finance Ministry67) had demanded a ‘higher taxation of income by capital wealth either as part of an income tax or in another way’.68 Actually, Miquel also pursued the same idea. In a memorandum, delivered together with the Bills for the session 1892–1893, he stated that the new levy should establish a special application to income, based on the possession of wealth.69 In particular, this statement seems to indicate Miquel’s commitment to the fundus theory. The new tax should apparently establish a tax burden especially on funded income. In fact this statement and similar quotes70 have often been highlighted in discussions about Modern German tax history.71 In particular, the majority opinion of the Federal Constitutional Court in the decision of 1995 argued in this direction. In the majority argument the Prussian supplementary tax formed important evidence for the suggested strong impact of the fundus theory in

64

Gesetz wegen Aufhebung direkter Staatssteuern, 14. 7. 1893, GS 1893, 119. The drafting process had already started in 1891: see Thier, Steuergesetzgebung und Verfassung, above n 40, at 594 et seq, n 611. 66 For the origins of this name, see Herzfeld, Miquel II , above n 61, at 263. 67 Since 1879 there had been an intensive debate inside the Prussian Finance Ministry on the structures of a future tax reform, which should encompass also the introduction of a capital gains tax: Thier, Steuergesetzgebung und Verfassung, above n 40, at 306–19. 68 Stenographische Berichte des preußischen Hauses der Abgeordneten (hereinafter cited as ‘Sten Ber prHdA’ and the numbers of the session, combined with the years of the session period) XV/1 1882/83, Anlagen II, nr 91, pp 1063–74, at 1074 (draft of the parliamentary committee, which was later adopted by the parliamentary plenary session). For the background of this demand, see Thier, Steuergesetzgebung und Verfassung, above n 40, at 353–72. 69 Sten Ber prHdA XVII/5, 1892/93, Anlagen II, nr 8, pp 913–1015, 931. 70 See in particular the Bill on the supplementary tax, Sten Ber prHdA XVII/5, 1892/93, Anlagen II, nr 6, pp 509–36, at 519, where the Ministry had stated that the new tax should establish ‘the distinction…of the funded and the not funded income’ (die Unterscheidung des fundierten und des nicht fundierten Einkommens); see also ibid 522, where the supplementary tax is legitimated by the ‘higher tax strength’, which would result from the ‘funded on wealth possession based income compared to the labour income’ (die höhere Steuerkraft, resulting from the fundirten [sic], auf Vermögensbesitz gegründeten im Vergleiche zu dem Arbeitseinkommen). 71 See, for example, D Dziadkowski, ‘Zur Vermögensteuerentlastung des Betriebsvermögens. 90 Jahre Preußische Ergänzungssteuer’ in (1983) Betriebsberater at 2193–6 at 2193 et seq; M Horn, ‘Die Vermögensteuer—ein steuerliches Relikt aus dem 19. Jahrhundert’, in (1978) 55 Steuer und Wirtschaft 56 et seq. 65

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the tradition of wealth taxation.72 But this argument is not quite correct as the drafting materials make clear. For Miquel and the officials of his Ministry, the supplementary tax was based both on the idea of a special taxation of funded income and—at the same time—the special capacity of the wealthy to pay tax. This becomes clear in particular in the introductory remarks of the memorandum concerning the second step of the Prussian tax reform. Here, the supplementary tax was assigned a threefold task: it should, as just mentioned, cover the funded income; it should form a supplement, ‘where the shape of the income tax does not suffice for an appropriate coverage of elements with a special ability (to pay taxes)’; finally it should strengthen the financial position of the state.73 Here, the possession of wealth gave—beside the special structure of funded income— another reason for the introduction of the supplementary tax. In the (often neglected) parliamentary debate, both elements were also present. A member of the Centre party, for example, argued explicitly that the ability to pay taxes could be judged ‘not by the wealth, but (only) by the revenue deriving from the wealth’.74 On the other hand, a member of the German-Conservative party described this ability as the ‘possibility of delivering so and so much to tax from someone’s wealth’,75 thus focusing again on wealth as a crucial element for tax liability. Against this background it should become clear that the Prussian supplementary tax combined elements of the fundus theory and elements of the possession of wealth concept.76 However, the question remains whether the supplementary tax also adopted the possession of wealth concept in its concrete rules. In fact the tax law also covered assets, which, as was stated in the draft, were used by their owner only as the ‘means for the heightening of the enjoyment of life’.77 On that point Miquel had clearly stated within the Prussian State Ministry that it would be impossible to ‘leave the tax-strong 72 BVerfGE 93, 121, 139: ‘Die geltende Vermögensteuer führt die mit dem preußischen Ergänzungsgesetz geschaffene Konzeption einer ergänzenden Besteuerung des fundierten Einkommens fort’. 73 Sten Ber prHdA XVII/5, 1892/93, Anlagen II, nr 6, pp 509–536, 519: the supplementary tax should ‘ferner ergänzend eintreten, wo die Form der Einkommensteuer behufs angemessener Erfassung leistungsfähiger Elemente nicht ausreicht, sie soll endlich die Finanzgebahrung des Staates stärken, ihr eine sichere Grundlage geben’. 74 Member of the Prussian chamber of deputies, Fuchs, in Sten Ber prHdA XVII/5, 1892/93, Verhandlungen I, 8th plenary session, 24.11.1892, pp 198–200, 199: ‘nicht nach dem Vermögen, sondern (nur) nach dem Einkommen aus dem Vermögen’. 75 Member of the Prussian chamber of deputies, Philipp of Bismarck, in Sten Ber prHdA XVII/5, 1892/93, Verhandlungen III, 62nd plenary session, 17.4.1893, 1826–29, 1828: ‘die Möglichkeit, von seinem Vermögen so und so viel zur Steuer abzugeben’. 76 On the same line, see Bechstein, Die Rechtfertigung von Einzelsteuern, above n44, at 25–8; see also E Raths, Bedeutung und Rechtfertigung der Vermögensteuer in historischer und heutiger Sicht (Zürich, 1977) (= Wirtschaftswissenschaftliches Institut der Universität Zürich, series B, nr 3), 126. 77 Sten Ber prHdA XVII/5, 1892/93, Anlagen II, nr 8, pp 913–1015, 932: ‘als Mittel zur Erhöhung des Lebensgenusses’.

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assets of the richest elements (ie the citizens) tax free’.78 Even though it was proposed during the ministerial drafting process of the supplementary tax Bill that only the usable wealth, by its nature dedicated to production,79 would be taxable, in the end tax was also levied on assets producing no yield. Only elements of the moveable ‘wealth in use’ (Gebrauchsvermögen) were excluded from the tax.80 So, the strongly stressed opposition of the fundus theory and the theory of ‘wealth possession’81 vanished in the legislative process. The Prussian supplementary tax adopted both concepts, even though the idea of wealth possession had a little stronger impact, as the taxation of assets without possible yield demonstrates. With regard to the controversy of the 1995 decision of the Federal Constitutional Court it could be said that the minority opinion comes a little bit closer to the historical evolution of the German wealth taxation. This tradition was continued in the further development of German tax legislation, which, unfortunately, cannot be discussed in further detail here.82 The following points, however, are of special importance: the legislation of individual states in the second German empire adopted the combination of fundus and wealth possession theory, which had characterised the Prussian supplementary tax.83 The imperial wealth tax introduced in 192284 was characterised as an additional income tax for funded income.85 The majority opinion of the 1995 decision argued therefore that this tax would also be a form of special profit tax.86 But this interpretation can not explain why the wealth tax of 1922 also covered jewellery and

78 Miquel, Memorandum about the continuation and finishing of the reform of the direct state taxes and the municipality taxes, 25.5.1892 in Geheimes Staatsarchiv Preussischer Kulturbesitz, I HA Rep 151 HB, Nr 1727, fol 121r–143v, 131r. 79 Draft: principles for the issuing of a supplementary tax law (August 1892) in Geheimes Staatsarchiv Preussischer Kulturbesitz, I HA Rep 151 HB, Nr 1728, fol 18r==20r, 18v: ‘nur das nutzbare, nach seiner Natur zur Produktion bestimmte Vermögen’. 80 For a detailed discussion of the provisions of the supplementary tax Bill, see Thier, Steuergesetzgebung und Verfassung, above n 40, at 601–3. 81 F Helmert, ‘Die Rechtfertigung der Vermögensteuer’ in (1987) 69 Finanzrundschau 615–17. 82 For an excellent survey, see Ullmann, Der deutsche Steuerstaat, above n39, at 72–80, 101–5, 108–10, 114–16, 149–66, 180–3, 192, 202, 207 et seq, 217 et seq, 220–2. Regarding the wealth tax legislation in particular, see Bechstein, Die Rechtfertigung von Einzelsteuern, above n 44 at 30–43. 83 Bechstein, Die Rechtfertigung von Einzelsteuern, above n 44, at 30–2. 84 Vermögensteuergesetz, 8.4.1922, Reichsgesetzblatt I, 335. 85 P Jacobi, ‘Über Sinn und Unsinn der Vermögensteuer, oder: Ist eine eigenständige Vermögensteuer neben der Einkommensteuer zu rechtfertigen’ in (1987) 69 Finanzrundschau 413–19, 414; see also Bechstein, Die Rechtfertigung von Einzelsteuern, above n 44, at 36. 86 BVerfGE 93, 121, 139: The wealth tax of 1922 would have found ‘ihre Begrenzung im Merkmal der Sollertragsteuer…’.

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other luxury goods,87 ie assets which could generate no potential yield. These provisions only make sense against the background of the idea of wealth possession. Hence it seems that the legislators of 1922 once again combined both ideas. The wealth tax law of 197488 was unambiguous in that point: it also covered luxury goods.89 This rule was explained with reference to the idea of wealth possession: Wealth itself…forms an ability to pay…,which is also of relevance for taxation …Therefore also assets without a future yield, e.g. art collections or jewelry, remain subjected to taxation.90

V. CONCLUSION

The historical interpretation of the law has mostly a weak position in the German discourse on constitutional law91 and tax law. Sometimes, however, it appears as though traditions of ruling principles establish a certain historical a priori status in the debate. Such a situation, when historia becomes not only magistra but also jurisconsulta, emerges apparently in the case of wealth taxation. As a matter of fact, such a focus on historical continuities with dogmatic intention can make much sense. Modern civil law, for example, is deeply rooted in the European legal tradition. The rules and principles of contracts, property or damage are rarely understood

87 Cf in particular § 9 nrs 7–8 of the Vermögensteuergesetz 1922, where Gegenstände aus edlem Metall, Schmuck und Luxusgegenstände as well as Kunstgegenstände und Sammlungen were declared as taxable assets. 88 Vermögensteuerreformgesetz, 17.4.1974, Bundesgesetzblatt I 1974, 949. 89 Cf § 4 section 1 Vermögensteuergesetz in connection with § 110 section 1, nrs 10, 11 with similar provisions as in the law of 1922 (above n 87). 90 Bundestagsdrucksache VI/3418, p 51 in Verhandlungen des Deutschen Bundestages, Anlagen zu den stenographischen Berichten vol 161: ‘(dass) das Vermögen an sich…bereits eine steuerlich relevante Leistungsfähigkeit des Steuerpflichtigen darstellt…Deshalb bleibt auch künftig ertragloses Vermögen, z. B. Kunstsammlungen oder Schmuckgegenstände, der Besteuerung unterworfen’. For this approach see already the statement of the scientific council at the Federal Ministry of Finance, ‘Gutachten zur Reform der direkten Steuern (Einkommensteuer, Körperschaftssteuer, Vermögensteuer und Erbschaftsteuer) in der Bundesrepublik Deutschland (11.2.1967)’ in Wissenschaftlicher Beirat beim Bundesministerium der Finanzen, Entschließungen, Stellungnahmen und Gutachten von 1949 bis 1973 nr 27, pp 326–400, 373, where the council referred to the ‘durch Vermögensbesitz erhöhten Leistungsfähigkeit’ regarding the taxation of assets without yield, see ibid 376 et seq; as survey to the modern debate about the legitimacy of wealth taxation, see Bechstein, Die Rechtfertigung von Einzelsteuern, above n 44, at 52–89, and Raths, Bedeutung und Rechtfertigung der Vermögensteuer, above n 76, at 135–47. 91 For the importance of the historical interpretation of constitutional law, see C Starck, ‘Die Verfassungsauslegung’ in J Isensee and P Kirchof (eds), Handbuch des Staatsrechts der Bundesrepublik Deutschland vol 7 (Heidelberg, 1992) § 164 nrs 57–60; see also R Stettner, ‘Commentary on Art. 70 GG’ in H Dreier (ed), Grundgesetzkommentar (2nd edn, Tübingen, 2007) n 29–31.

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if their underlying Roman and canon law traditions are not considered.92 But in the area of tax law the changes in constitutional and also international public law have produced some profound breaks in the lines of tradition.93 The rise of fundamental rights and of a strong constitutional jurisdiction have fundamentally changed the framework of tax legislation in Germany. Nevertheless, as the example of wealth taxation might demonstrate, some traditions of tax legislation have maintained their stability and thus their importance for our understanding of the modern tax law system.

92 See, in particular, for this perspective the studies of Reinhard Zimmermann, ‘Das römisch-kanonische ius commune als Grundlage europäischer Rechtseinheit’ in Juristenzeitung 1992 8–20; and ‘Heard melodies are sweet, but those unheard are sweeter . . .’ Condicio tacita, implied condition, und die Fortbildung des europäischen Vertragsrechts’ in (1993) 193 Archiv für civilistische Praxis 121–73. 93 For an argument in that respect regarding the constitutional order of taxation in Germany, see C Waldhoff, Verfassungsrechtliche Vorgaben für die Steuergesetzgebung im Vergleich Deutschland—Schweiz (Munich, 1997) (= Münchener Universitätsschriften, Reihe der Juristischen Fakultät, Bd 121) 102–4.

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5 Tax Transfers: Britain and its Empire, 1848–1914* MARTIN DAUNTON ABSTRACT In a footnote to their influential two-volume account of British Imperialism, Peter Cain and Tony Hopkins comment that ‘taxation in Africa remains a neglected subject’, despite the fact that colonial officials had to wrestle with the problem of extracting revenue in the absence of an existing tax base.1 In India, there was a pre-existing tax base, but it was not necessarily one that British rulers saw as appropriate or sustainable. They pondered how it should be reformed in order to ensure that the Raj secured as much revenue as possible, while also ensuring political stability and encouraging economic growth. Similarly, decisions on the shape of taxation in the new white-settler colonies had major implications for the nature of society, the distribution of income and wealth, the allocation of land, and the provision of welfare. In each case, taxation was linked with normative assumptions about the most desirable social and economic structure—the nature of land ownership, the distribution of income and wealth, and the limits of the market—and with calculations of political stability and order. Most writing on imperial taxation deals with the issue of the burden of imperial finance on Britain, and the vexed question of whether the result was to increase domestic taxes above the level in other European countries.2 Surprisingly little has been written about the taxation of the British empire, * A version of this chapter appeared in H Nehring and F Schui (eds) Global Debates about Taxation (Basingstoke, 2007) 137−57. 1 PJ Cain and AG Hopkins, British Imperialism: Crisis and Deconstruction, 1914–1990 (Harlow, 1993) 205. But see T Garba, ‘Taxation in some Hausa emirates, 1880–1939’ (PhD thesis, University of Birmingham 1986); the issue does appear in many more general books but there is no systematic study. 2 For this debate, see LE Davis and R Huttenback, Mammon and the Pursuit of Empire: The Economics of British Imperialism (abridged edition, Cambridge, 1988); P O’Brien, ‘The costs and benefits of British imperialism, 1846–1914’ (1988) 120 Past and Present; P Kennedy, ‘The costs and benefits of British imperialism, 1846–1914’(1989) 125 Past and Present.

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not from the point of view of the burdens on Britain but from the point of view of the colonies, and the decisions about the mode of extraction of revenue. The issues are connected, for the greater the success of securing revenues within the colonies, the greater the ability to reduce transfers of funds from the metropole, or even to reduce domestic taxation at the expense of contributions from the empire. The British Government had a well-developed sense of how to extract revenues within the metropole, and a clear sense of how its commitment to fairness and equity, to transparency in accounts, and to involvement of taxpayers in collection all contributed to a sense of legitimacy. How far were these approaches to taxation adopted within the empire to secure compliance and to minimise conflict, or did other considerations apply? Rather than adopting domestic assumptions about taxation as a means of securing revenue with the minimum of disturbance to the status quo, did the imperial authorities seek to use taxation as an instrument to force colonial society into a new shape and, if so, what determined the choice? Was it to mimic the social structure of the metropole or to depart from it in some respects? In other words, is the crucial consideration the transfer of ideas about taxation, or the transfer of assumptions about the social and economic structure, with taxes as one method of shaping the changes? Was the aim convergence between Britain and the colonies, pragmatic divergence to meet circumstances and to serve metropolitan needs, or principled divergence to avoid some of the less desirable features of metropolitan society?

I. METROPOLE AND COLONIES

I

N TRUSTING LEVIATHAN, I argued that the British state experienced a loss of legitimacy in fiscal extraction after the Napoleonic wars when government spending reached 23 per cent of GNP. The reconstruction of legitimacy was a difficult and lengthy process, and was linked with a fall in government spending to a trough of around 8 per cent by the end of the century. The fiscal military state was contained, not only through domestic processes as a result of stressing equity, using accounting techniques to show that taxes were used efficiently and for the intended purpose, and ensuring a high level of voluntary compliance.3 The fiscalmilitary state was also exported, as CA Bayly has argued. In 1831, Archibald Alison commented that the Whigs were upsetting society and politics by reducing taxation on the great cities and industrialists in Britain and passing the fiscal burdens to the colonies. This might sound like spurious special pleading, but Bayly remarks that ‘the Indian peasant bore

3 M Daunton, Trusting Leviathan: The Politics of Taxation in Britain, 1799–1914 (Cambridge, 2001) 63–76

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a heavy part of the costs of Britain’s world role which the British people were not prepared to bear’, allowing the British state at home to ‘disarm and civilianise itself’.4 The extraction of more revenue from the empire ran counter to the model adopted in the metropole. Domestic compliance and legitimacy were crucial; in the empire, more draconian policies were possible. The empire allowed Britain to escape the problems of 1848 in continental Europe, for distant colonies were used to ease burdens at home, both by paying taxes and bearing the costs of adjustment to free trade which contributed to domestic prosperity. The risks were high, and the problems faced by Paris and other continental European cities in 1848 were experienced in riots, civil disobedience or fiscal crisis in Montreal, New South Wales, Tasmania, Ceylon, Punjab, the Orange River and Cape. There was no fiscal revolt in Britain in 1848 but there was serious discontent in the empire.5 What lay behind the contrasting experiences of metropole and colonies in 1848? At home, the Whigs wished to hold down taxes on the middle classes while spending more money on defence against France. One solution was to cut defence expenditure on the colonies by replacing garrisons with local forces; another was to displace the tax burden, for example by cutting sugar duties so that the domestic working class had a cheap commodity, at the expense of colonial planters. Such policies secured the desired effect at home and triggered discontent in the colonies, where free trade eroded incomes and made payment of taxes more difficult. The worst experience was in Ceylon, where the costs of the army were to be met by a land tax and new indirect taxes. The planters succeeded in blocking the land tax so that more of the tax burden fell on indirect taxes, resulting in an uprising by the peasantry. The attempt to shift the burden of taxation from the metropole to the colonies was problematic.6 In this paper, I wish to sketch the outcomes after 1848, in three different circumstances: settler colonies such as Australia and New Zealand with elected assemblies and a degree of political autonomy; colonies with large populations and existing systems of revenue extraction such as India; and colonies with large populations without a developed tax system where methods of extraction were developed virtually de novo, above all in

4 A Alison, ‘On the financial measures of the reformed parliament, No. 1. The Whig budget’ (1831) 29 Blackwood’s Edinburgh Magazine 975, quoted in A Gambles, ‘Rethinking the politics of protection: Conservatism and the corn laws, 1830–52’ (1998) 113 English Historical Review 946; CA Bayly, ‘Returning the British to south Asian history: the limits of colonial hegemony’ (1994) ns 17 South Asia 16, 18–19 and ‘The British military fiscal-state and indigenous resistance: India, 1750–1820’ in L Stone (ed), An Imperial State at War: Britain from 1689–1815 (London, 1994). 5 M Taylor, ‘The 1848 revolutions and the British empire’ (2000) 166 Past and Present 146. 6 Taylor, above n 5, at 159–60, 164–5.

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Africa. Clearly, the political calculations were very different in each case, and so were the economies of each region and the ability to extract revenue. In each case, the debate over taxation was clearly connected with other issues: the nature of land ownership and tenure, and the form of the labour market. These societies were predominantly agricultural, and the most obvious way of extracting revenue was by taxing land—a commonplace in preindustrial societies in Europe. Schumpeter’s notion of a shift from the domain state to the tax state applies to the empire as well as to Europe: a domain state lives on revenues of Crown estates, and goods and services from dependants. In a tax state, revenue comes from taxes—and this means a conflict with other claims on the surplus (rent, profits of the farmers). Would the result be an alliance of the Crown with the landlords to their mutual benefit against the peasant; or of the Crown with the peasant against the landlords?7 Whether the tax state complemented the rise of great estates or opposed it depended on a strategic choice about the most effective way of extracting revenue and securing political stability. It also reflected normative assumptions about the most effective way of stimulating economic growth. Would growth be encouraged by large estates able to invest in agricultural improvement, co-operating with tenant farmers who were freed of the need to purchase land and so able to use their own assets for more animals, fertilisers and tools? Or would growth be stimulated by small owner-occupying farmers who were freed of the necessity to support large landowners? These issues were debated in nineteenth-century Britain, and had a complex political history. Small farms and a free trade in land were associated with radical critics of parasitical and exploitative aristocrats who had ‘stolen’ the land from small yeomen farmers and peasants through a misappropriation of state power. In the radicals’ view, the large estates should be dissolved in turn through state power, most particularly taxation. They applauded small peasant proprietorship as socially just, dissolving the problems of poverty of the landless poor and deference to aristocratic power. But would such a system of land ownership be economically efficient? The dominant view in the nineteenth century was

7 J Schumpeter, ‘The crisis of the tax state’ in AT Peacock, R Turvey, WF Stolper and E Henderson (eds), International Economic Papers, no 4 (London and New York, 1954); for a more recent development of his ideas, see R Bonney and WM Ormrod, ‘Introduction: crises, revolutions and self-sustained growth: towards a conceptual model of change in fiscal history’ in WM Ormrod, MM Bonney and RJ Bonney (eds), Crises, Revolutions and Self-Sustained Growth: Essays in European Fiscal History, 1130–1830 (Stamford, 1999). For a controversial account of the interplay between rents and taxes and agrarian social structure, see R Brenner, ‘Agrarian class structure and economic development in pre-industrial Europe’ (1976) 70 Past and Present 30.

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that the divide between landowners, tenants and labourers was economically rational and efficient. At the end of the nineteenth century, more doubts were appearing as British agriculture failed to adapt to change— and some Conservatives realised that small yeomen farmers had another attraction, as a bulwark of property owners against socialism.8 These British—and particularly Irish—debates influenced policy in the colonies, and the debates in the colonies in turn fed into British debates which drew on Australasian reforms of land registration and land taxation.9 The structure of land ownership also connected with the labour market. A concentrated pattern of land ownership with large tenant farmers entailed a class of landless labourers with implications for welfare provision to cover seasonal unemployment. By contrast, small owner-occupied farms drew on family labour, sometimes reallocating surplus members among each other as part of the lifecycle. Families might opt to use the farm to support their members rather than to maximise output for the market; even if they did adopt a highly commercial attitude, the welfare implications were different, for the farm provided an asset in old age. There were advantages and disadvantages of each system. Landless labourers might become a threat to social stability, or they might provide a flexible source of labour for capitalist farming. Small family farms might offer stability, but their owners might lack the necessary capital and knowledge to develop colonial agriculture, and especially export crops. The issue was particularly significant in Africa: how could a noncommercialised system of hunting, pastoralism and subsistence cultivation be turned into commercial agriculture, and how could men be induced to work for wages on plantations or capitalistic farms, and in mines? The outcome depended on the definition of land rights and the imposition of taxation. Should capitalistic farming be encouraged by exempting this sector from taxes; and could the creation of a workforce be stimulated by taxation of Africans so that they needed to work for wages in order to pay? How would the taxes be collected: through bureaucracies (with the danger of a loss of consent in return for higher yields) or by devolving to the taxpayers or indigenous peoples (with the possibility of securing

8 FML Thompson, ‘Changing perceptions of land tenures in Britain, 1750–1914’ in D Winch and PK O’Brien (eds), The Political Economy of British Historical Experience, 1688–1914 (Oxford, 2002); see also A Offer, The First World War: An Agrarian Interpretation (Oxford, 1989) ch X. 9 A good example is the system of land registration designed to create a free market in land which was implemented in South Australia in 1858, often (and inaccurately) named after one of its advocates, Robert Torrens, who attempted to introduce the reform in England. The issue is discussed in the thesis of Edmund Rogers (University of Cambridge, 2009). See also A Offer, Property and Politics, 1870–1914: Landownership, Law, Ideology and Urban Development in England (Cambridge, 1981) 33.

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consent at the expense of yield)? The success or difficulties of securing tax revenues affected the ability to raise loans for investment in the infrastructure, and to make a transition to a fiscal state which combined tax revenues and large-scale borrowing at low interest rates and without the threat of default. The tax authorities needed to have an eye to resistance from the taxpayers, and also to the bond market in London which carefully assessed the risk of lending—and the payment of interest to bondholders outside the society had the potential for political resentment on the part of taxpayers. The colonial officials and metropolitan politicians implementing taxes in India and Africa, and the legislative assemblies of settlers in Australasia, were aware of the fiscal assumptions and approaches of Britain, and were often experienced in both metropole and colonies. For example, James Wilson, a free trader, founder of The Economist, and Liberal MP, served as secretary of the India Board of Control where he was responsible for finance and revenue, before becoming financial secretary of the (British) Treasury, and then in 1859 financial member of the Council in India—in effect, Chancellor of the Exchequer for India. He had the difficult task of resolving the financial crisis created by the Indian mutiny, seeking to use the insights of Cobdenite political economy in the sub-continent.10 The link with the ‘Manchester school’ was direct and controversial. Similarly, Gladstonian finance and India were linked by Stafford Northcote and his son Henry. Stafford was secretary to Gladstone, Secretary of State for India, and Chancellor of the Exchequer from 1874 to 1880. Henry served as his father’s secretary at the Treasury and in 1900 became Governor of Bombay where he launched a programme of reform of the land revenue, before he moved to Australia as Governor-General in 1903.11 Alfred Milner was secretary to George Goschen, the Chancellor, moving to be Director-General of Accounts and Under-Secretary of Finance in Egypt, returning to Britain as Chairman of the Inland Revenue before returning to the colonies as Governor of the Cape and High Commissioner of South Africa, and eventually Colonial Secretary.12 Matthew Nathan provided another link, moving from his initial career in the Royal Engineers to colonial administration in Sierra Leone in the aftermath of a tax revolt; in 1911, he became Chairman of the Board of Inland Revenue, returning to colonial service as Governor-General of Queensland in 1920–25.13 Personal careers, quite apart from the writings of political economists, linked

10 11 12 13

Entry in Oxford Dictionary of National Biography. Entries in Oxford Dictionary of National Biography. Entry in Oxford Dictionary of National Biography. Entry in Oxford Dictionary of National Biography.

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domestic and imperial taxation. But were ideas transferred from one locale to another, or did circumstances dictate different approaches and techniques of fiscal extraction?

II. SETTLER COLONIES

What was the connection between land and taxes in the white-settler colonies? The existence of large amounts of public land meant that they had some features of a domain state able to raise revenue from its lease or sale—which posed the question of what system of tenure should be adopted. If ownership or occupation of land was widespread, some of the costs of welfare could be reduced by passing the burden to the family farm. Small farms might be viewed as a source of stability, creating a society of property owners and escaping the extremes of landed aristocrats and landless labourers. But reliance on small family farms also had certain disadvantages in sacrificing economies of scale and, in the case of owneroccupation, foregoing the ability to share risk and investment between tenant and landholder. They might be seen as a route to inefficiency, leading to a misuse of resources by settlers who lacked capital or knowledge to use the land to good effect. These issues were debated and contested both in Britain and in the settler colonies of Australia and New Zealand—leaving aside further major topic of the rights of indigenous peoples.14 The development of white-settler colonies required large-scale investment in public works such as roads, railways, and ports which exceeded their tax income in any year. As with the fiscal-military state, ‘lumpy’ investment required loans, supported by the certainty of a flow of income to pay interest, and confidence that the government would not default. The result was a similar debate over the costs and benefits of loans in the white-settler colonies as in the fiscal-military state. After the defeat of the French in 1815, the high costs of funding the war-time debt led to a radical attack on the fiscal system, for the removal of the income tax in 1816 and the failure to revise the land tax since the 1690s meant that much of the tax burden fell on workers and producers through customs and excise duties, with the benefits taken by aristocrats and rentiers. The removal of this perception of inequity and misuse of political power was a major task

14 See, for example, the contentious work of H Reynolds, The Law of the Land (Ringwood, Vic, 1987) and, for a more sophisticated analysis, PG McHugh, Aboriginal Societies and the Common Law: A History of Sovereignty, Status and Self-Determination (Oxford, 2004). The older study by SH Roberts, The Squatting Age: Australia, 1835–47 (Melbourne, 1935) retains its interest.

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of politicians in the 1830s and 1840s.15 Similarly, in a settler society, public works might lead to higher land prices, with the benefits taken by large ‘squatters’ or the colonial gentry, and the wider population paying taxes to service the debt which was largely held outside the colony. The recipients might see British investment in the white-settler colonies as the provision of a scarce resource on reasonable terms, or as an exploitative and imperialistic drain on their economies. The political situation varied according to the institutional systems and social structures of the debtors, and changed over time. In Australia before the First World War, for example, government loans were in the hands of representative bodies and most non-governmental loans went to Australian-owned and -operated concerns. Consequently, capital imports were for the most part unproblematic, compared with the situation in Argentina, a settler economy outside the empire. There, most of the loans were to companies registered in Britain with British directors, and there was direct competition between British and Argentinean concerns or a sense that outside capitalists were extracting income.16 The backlash against global capital flows become more intense after the First World War, when the price of primary products fell sharply, placing strains on the balance of payments and on domestic prosperity: even in Australia, there was growing resentment at the costs of loans, and in Argentina there was a nationalistic backlash against British interests. Taxation was therefore intimately connected with issues of land ownership in terms of both welfare provision and investment in the infrastructure. One outcome was an interest in land taxation, not just to secure revenue but also to shape the social structure. A tax on land is administratively convenient, for it is visible, an obvious taxable entity in societies where it was difficult to measure incomes. It was usually a major element in taxation in agrarian societies, without any ulterior motive beyond securing revenue for the state. But a land tax could also have a wider ambition that went beyond revenue considerations to a desire to shape the structure of settler society. Land taxation appealed to opponents of large holdings as a device to break them up for small farmers. For example, the proposed land tax in New South Wales in 1860 was linked with the ambition of stopping the emergence of large estates when public lands were thrown open for sale. Of course, land taxation was opposed by advocates of large land holdings, and was not welcome to many others 15 See PK O’Brien, ‘The political economy of British taxation, 1660–1815’ (1988) 41 Economic History Review 1; P Harling and P Mandler, ‘From “fiscal-military” state to laissez-faire state, 1760–1850’ (1993) 32 Journal of British Studies 44. 16 LE Davis and RE Gallman, Evolving Financial Markets and International Capital Flow: Britain, The Americas and Australia, 1865–1914 (Cambridge, 2001) 817–19, 822–5; see also D Denoon, Settler Capitalism: The Dynamics of Dependent Development in the Southern Hemisphere (Oxford, 1983).

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who feared a wider radical attack on property and wealth. A further concern was whether it was fair to impose a tax on land rather than on other forms of property and income from trade and industry. These debates could have a variety of outcomes and the form taken by taxation was central to debates over the nature of settler societies, and to their ability to extract revenue. New Zealand provides one case study of the debates over taxation and land in white-settler societies.17 Initial attempts to introduce an income tax modelled on British precedent did not succeed, and attention turned to a land tax based on the unimproved value of land and not (as in the British income tax) its annual value. Underlying the tax was the assumption that while landowners were not paying their fair share of taxes, they were taking the benefits of public works. Whether the law would pass was doubtful, given the influence of the landed gentry in the upper house, and progress was delayed. Victoria set a precedent in 1877, introducing the first land tax in Australia with the intention of breaking up large estates above 640 acres. New Zealand followed in 1878–79, when John Ballance, the Colonial Treasurer, introduced a land tax. However, Ballance diverged from Victoria, for New Zealand had incurred larger loans, especially during the premiership of Julius Vogel, and the land tax applied to all land and not just extensive holdings. Income from personal exertion (that is, salaries, professional fees or the profits of trade and industry) was untaxed, going further than the advocates of differentiation in Britain in the 1850s and 1860s. They argued that ‘unearned’ income from land or bonds continued regardless of the health or age of the owner, and left an asset to support dependents. ‘Earned’ or ‘industrious’ income from salaries and profits depended on the health and age of the individual, and ceased without leaving an income for dependants. As a result, part of the earned income needed to be saved and should therefore be encouraged by a lower rate of tax. Gladstone refused to accept the case for differentiation, on the ground that it would turn the income tax into a source of conflict between different forms of income and property, rather than integrating classes in a common endeavour. At most, he allowed a tax break on the actual sums paid into life insurance policies to provide support for retirement and dependants.18 By contrast, the New Zealand tax of 1879 did not tax income from employment at all, whereas landed property was taxed even if it produced no income.

17 These comments largely rely on PA Harris, Metamorphosis of the Australasian Income Tax, 1866–1922 (Canberra, 2002). 18 On this debate, see HCG Matthew, ‘Disraeli, Gladstone and the politics of midVictorian budgets’ (1979) 22 Historical Journal 615 and M Zimmeck, ‘Gladstone holds his own: the origins of income tax relief for life insurance purposes’(1985) 58 Bulletin of the Institute of Historical Research 167.

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Ballance advocated denser land settlement by smaller farms and land nationalisation, and in 1885 he introduced a Land Act in order to encourage settlement by offering leases of small holdings of Crown land and by making government loans available. He believed that large pastoral farms blocked economic progress and prevented access to land by new settlers; unlike many contemporaries, he did not argue that the Maoris should surrender their land in order to encourage settlement. In the election of 1890, he campaigned for radical land reform, arguing for a tax on the ‘unearned increment’, and advocating the programme of Henry George as a means of ‘bursting up the great estates’. The election brought Ballance to power as both Premier and Colonial Treasurer, and he worked with John MacKenzie, the Minister of Lands from 1891 to 1900, to implement his proposals. In 1891, the Liberal Government replaced the existing property tax with a progressive land tax and a progressive income tax. In 1892, further legislation led to government purchase of land from large estates for settlement, with the threat of compulsion against those who did not sell voluntarily. Between 1892 and 1912, the Government purchased 223 estates and settled 7,000 farmers on the land.19 The tax system was both an instrument for creating a particular social structure by breaking up large estates, and a means of funding other social policies—not least non-contributory pensions in 1898. The Liberals wished to spread land ownership more widely, and to create a more open society with higher levels of social mobility.20 The New Zealand tax system became a model for the colonies in response to the depression of 1890s. What were the drivers in the debates in New Zealand and the Australian colonies? First, the cost of public works meant that there was a need to raise revenue for loans for roads and railways, and also to fund the costs of land settlement. Second, the desire to break up large estates and to differentiate against those who did not live by their own exertions, was a major concern of Liberal politics. Third, the depression of the 1890s created difficulties in the settler societies. Finally, there was the issue of welfare. Financial pressure meant that public authorities tried to pass more of the cost of support from the poor law to family members by widening the definition of family responsibilities, which led to concern that family farms were overloaded with responsibilities. An alternative form of taxfunded welfare emerged.21 The policies adopted by Liberals in New

19 See his collection of essays A National Land Policy Based on the Principle of State Ownership (Wellington1887); T McIvor, ‘John Ballance (1839–1893)’, Oxford Dictionary of National Biography; T McIvor, The Rainmaker: A Biography of John Ballance (Auckland, 1989); D Hamer. The New Zealand Liberals: The Years of Power (Auckland, 1988). 20 For the policies of Richard Seddon, see Hamer, above n 19; also ‘ Richard John Seddon (1845–1906)’, ODNB. 21 D Thomson, A World Without Welfare: New Zealand’s Colonial Experiment (Auckland, 1998).

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Zealand exceeded the limits of acceptable taxation in the metropole, where the income tax was still flat rate and undifferentiated. Colonial ideas on taxation returned to Britain. Old age pensions were the most obvious area of interest in Britain, and there was also considerable debate over the use of arbitration in labour disputes. The British Liberal Government moved to differentiation and progression in the income tax, and to the use of a land tax to attack large estates, as a free trade response to Conservative support for tariff reform.

III. INDIA

In the case of India, the British faced an existing system of land tenure and fiscal extraction, with a large indigenous population without formal political rights in shaping policy. The key problem was how to move from a complex hierarchy of rights where proprietorship and revenue extraction were overlapping and multiple. The solution reflected assumptions about the most desirable pattern of land ownership and understandings of the course of growth, both of which were influenced by English precedents, mediated by administrative and political expediency in India. The permanent settlement in Bengal in 1793 offered one solution. The zamindars had a clearer right of ownership that was linked with collection of revenue for the Government. Payments were fixed and failure to pay meant loss of proprietorship. An alliance was created between the East India Company and zamindars against peasants, so creating intermediaries to contain revolt against taxation. The zamindars might be seen as equivalent to large aristocratic landowners in England, who would encourage agricultural development and provide a force for stability in rural society. Of course, the English land tax was itself a form of ‘permanent settlement’, for it was fixed in the 1690s and formed a decreasing proportion of income from the land as rents rose in the later eighteenth century. By analogy, the zamindars might react in the same way as large English landlords, investing their profits in order to encourage growth and prosperity. However, the permanent settlement also had a serious disadvantage: the East India Company and later the Crown did not share in the profits of agriculture as the value of land rose, and taxes had to be imposed on other groups in society which might be viewed as inequitable and a source of political controversy. In other words, land tenure and the tax system were linked with visions of growth based on a particular view of the English agricultural revolution and the benefits of great estates—or of their drawbacks. English landowners were criticised by radicals as parasites, expropriating common land, increasing rent levels and ignoring their social obligations. Similarly, the zamindars were open to criticism for extracting more rent without reinvesting and without fulfilling their

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obligations to maintain water supplies and other communal services. The outcome in the North West Provinces in 1833 was a temporary settlement which allowed renegotiation of the Government’s claim to revenue, so ensuring that revenue rose in line with rising rents and land values, or according to the needs of the Government. However, the temporary settlement also created practical problems, for renegotiation led to tensions and involved closer Company or Crown involvement in fiscal extraction. Hence the British Government in India shifted back to the use of permanent settlement, on the ground that it led to growth and minimised resistance. Not everyone agreed that the use of settlement was desirable, and not least James Mill who was responsible for the revenue letters from the Board of Control in London to the Government of India. He followed other political economists—and above all Ricardo and Malthus—in arguing that rent was an unearned income from land, offering the best source of revenue without distorting the allocation of labour and capital. Mill therefore argued that in districts not covered by the permanent settlement, taxation should be based on the share of rent in the total produce of land. By levying a tax direct on the cultivator, exploitative middlemen could be removed, and by varying the tax by the quality of land, the unearned surplus or Ricardian rent produced by superior land could be removed. The task was entrusted to RK Pringle, a student of Malthus, who set to work recording the extent of each holding, its quality, and estimating the net produce left after all costs had been met, including a reasonable return to family labour and capital; the Government should then claim 55 per cent as its share. This scheme was implemented in 1828, without success, for the collection of data was flawed, and the revenue demand was too high. The solution was to adjust Pringle’s approach, without abandoning the search for Ricardian rent. Of course, the ideas of economists and theoreticians in London collided with practicalities on the ground, where administrators were obliged to follow local custom and to be concerned with social order. However, it would be wrong to deny that the ideas had some impact, despite the constraints on action.22 The adjustment formed the basis of the ryotwari system which asserted the rights of cultivators or peasants (ryots)who paid taxes direct to the Government. From 1835, the Bombay Survey and Settlement evolved as a means of preventing exploitation of cultivators by tax farmers, and encouraging increases in productivity and efficiency through incentives to

22 E Stokes, The English Utilitarians and India (Oxford, 1959) 93–102; MB McAlpin, Subject to Famine: Food Crises and Economic Change in Western India, 1860–1920 (Princeton, 1983) 108–9. For a denial of the importance of Ricardian rent in practice, see M Mann, ‘A permanent settlement for the Ceded and Conquered provinces: revenue administration in north India, 1801–33’ (1995) 32 India Economic and Social History Review 219.

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the cultivators to accumulate capital and increase their revenues. The land was surveyed to establish occupation and soil quality; and rather than make unrealistic calculations of the amount of net produce, payments were assessed according to the condition of the occupier and the amount paid from the area in the past. The ryot would then be assured the payment of the same amount for a defined period before a new settlement—a highly complex and time-consuming exercise—was implemented. In theory, all land belonged to the state, but so long as the ryot paid tax to the Government, he had security of tenure and could sell and bequeath the land. The amount of tax varied with the quality of land, so that inefficient ryots would be encouraged either to improve their techniques in order to pay the tax, or to transfer their holdings to someone who could. The Bombay Revenue and Settlement therefore rested on a particular vision of the connection between tenure and economic growth.23 Whether the system had the desired effect is another matter, for, contrary to the intentions of the reformers, the tax might act as a disincentive by imposing a high charge on the cultivator; and the intrusion of tax collectors might generate tension. Perhaps the tax system was securing revenue at the expense of growth. In 1901, the Famine Commission complained that the proponents of the ryotwari system expected the accumulation of agricultural capital: but their plans did not promote thrift, nor did they conduce to the independence of the ryot. They looked for the capitalist cultivator; and we find the sowkar’s serf.24

Many Indian nationalists complained that the burden of the land revenue rose as a proportion of output over time, with serious economic consequences. Reality is different, particularly when the amount of land tax collected per acre is compared with the amount of output sold to pay the tax. In the Bombay Presidency, the nominal tax per acre was reduced in the initial settlement and continued to fall during its term; although the amount was increased at resettlement, it remained lower than before the initial settlement. Changes in prices meant that the tax demand varied in real terms as a proportion of income: prices rose over this period, so the real value of the tax declined to a greater extent.25 Certainly, the land tax remained the major source of government revenue, but it did decline as a proportion of net revenue, from 52.8 per cent in 1865 to 48.1 per cent in 1895 and 40.1 per cent in 1910.26 The decline accelerated after the war, as a result of political protest such as the Bardoli campaign in the Bombay

23

McAlpin, above n 22, at 110–13. Quoted in AK Bagchi, ‘Land tax, property rights and peasant insecurity in colonial India’ (1990) 20 Journal of Peasant Studies 40. 25 McAlpin, above n 22, at 198–202. 26 PJ Thomas, The Growth of Federal Finance in India (Madras, 1939) 500. 24

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Presidency against reassessment of the land settlement that led to refusal to pay. The collection of land revenues collided with constitutional reform, for the tax was the responsibility of the executive rather than the representative legislative councils.27 The declining contribution of the land tax meant that the Government of India had to turn to other sources of revenue. At the time of the transfer of power from the Company to the Crown in 1858, the major sources of revenue were the monopolies on opium and salt. Not surprisingly, James Wilson’s Cobdenite principles were offended, and he aimed to bring Indian finances in line with the principles adumbrated by Peel in 1842 and Gladstone in 1853. They had been anxious that taxes should not divide classes and interests but serve to create a sense of common interest by reducing indirect taxes and allowing the poor to share in the consumption of goods. Hence, in his first Budget, in 1860, Wilson urged that ‘All taxation must be based on the postulate of perfect equality and justice between the different classes of the community’. Furthermore, ‘taxation must be in accordance with sound commercial and financial principles’— that is, the level should not distort or reduce trade and production.28 He aimed to introduce free trade and an income tax to India. How successful was he in achieving this ambition of importing the principles of metropolitan equity in taxation to the Raj? The income tax was only a small part of net revenue: in 1865 it amounted to 2.1 per cent, in 1895 to 3.9 per cent, and in 1910 3.7 per cent. The tax was initially introduced in 1860 as a temporary measure to pay for the costs of the mutiny, and most members of the council felt it should expire in 1865. Although the Viceroy, John Lawrence, had his doubts, the Finance Member, Charles Trevelyan, allowed it to end in the face of strong opposition from both zamindars (who claimed exemption as a result of the permanent settlement), and the British community. Trevelyan’s choice had more in common with 1816, when the income tax was allowed to expire after the Napoleonic wars, than with 1842 when it was reintroduced and linked with free trade. Instead, Trevelyan proposed export duties: since he could not have both an income tax and free trade, he was prepared to sacrifice the former at the expense of the latter. However, the Government in London did not permit the export duties. Instead, licence and certificate taxes were introduced in 1867 and 1868, amounting in effect to a form of income tax. Wilson’s proposals for equity and balance were sacrificed. Although the income tax was reintroduced in 1870, it was again abandoned in 1873 as a result of strong opposition

27 N Charlesworth, ‘The problem of government finance in British India: taxation, borrowing and the allocation of resources in the inter-war period’ (1984) 19 Modern Asian Studies 522–3. 28 Thomas, above n 26, at 121.

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from both Indians and British civilians, despite the concern of administrators that rich Indians were exploiting the mass of the population.29 The costs of government were rising in the later nineteenth century as a result of the depreciation of the rupee, military spending, and investment in economic development. Indirect taxes became more important and changed in character. The revenue from opium fell as a proportion of net revenue, as a result of changing judgements about the morality of the trade and Chinese hostility to imports. The importance of the salt monopoly initially rose but then fell as a result of political protests. In 1865, opium was 19.7 per cent and salt 14.6 per cent of net revenue; by 1895 the figures were 10.8 and 18.1 per cent; and in 1910 14.6 and 6.5 per cent. Meanwhile, customs revenue rose from 5.7 per cent of net revenue in 1865 to 10.5 per cent in 1895 and 14.9 per cent in 1910, and excise duties from 5.1 to 12.0 per cent and 15.4 per cent.30 In 1865, the aim was to introduce export duties that would ensure that India remained open to British goods; obviously, the Indian business community preferred import duties—a policy not acceptable in London or Lancashire.31 As the financial situation become more pressing with the rising fiscal pressure of the later nineteenth century, import duties became more appealing to the British authorities in India and were introduced in 1894. However, they were strongly opposed in Lancashire which saw a serious threat to its markets from tariffs and the deterioration in the exchange rate of the rupee. The solution was to impose an excise duty on Indian cloth as a counterpart to the import duty, to ensure that the market was not distorted.32 When India was granted fiscal autonomy after the First World War, the share of customs duties rose still further, reaching 39.9 per cent of net revenue in 1930 as the land tax declined to 22.7 per cent. By then, opium and salt had declined to 1.6 and 4.9 per cent, and excise to 12.7 per cent. There was a fundamental shift to customs duties, continuing the pre-war trend.33 This is not surprising,

29 M Naidis, ‘A note on Sir John Lawrence and the income tax’ (1960) 80 Bengal Past and Present 78–82; S Chandra, ‘The income tax (1860–1873): a study in basic contradictions’ (1966) 3 Indian Economic and Social History Review 163–8; I Klein, ‘Wilson v Trevelyan: finance and modernization in India after 1857’ (1970) 7 Indian Economic and Social History 179. 30 Figures are from Thomas, above n 26, at 500. 31 Naidis, above n 29, at 78. 32 AW Silver, Manchester Men and Indian Cotton, 1847–72 (Manchester, 1966); P Harnetty, ‘Lancashire and the Indian cotton duties, 1859–62’ (1965) 18 Economic History Review 333 and ‘The Indian cotton duties controversy, 1894–6’ (1962) 77 English Historical Review 684; I Klein, ‘English free traders and Indian tariffs, 1874–1896’ (1971) 5 Modern Asian Studies 251 and ‘Politics and public opinion in Lytton’s tariff policy’ (1967) 45 Journal of Indian History 465; C Dewey, ‘The end of the imperialism of free trade: the eclipse of the Lancashire lobby and the concession of fiscal autonomy to India’ in C Dewey and AG Hopkins (eds), The Imperial Impact: Studies in the Economic History of Africa and India (London, 1978). 33 Thomas, above n 26, at 501.

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given the political calculations of rising nationalist pressure. An increase in taxation led to a demand for wider political participation—and, in the words of Peter Robb, ‘resistance to British rule was fuelled by attempts to extend the amount and scope of taxation’.34 The transfer of British conceptions of taxation to India was therefore highly constrained. In the case of land taxation, different assumptions about the connection between land tenure and economic growth were in conflict, as a result of ideological differences within Britain and the dictates of administrative expediency on the ground. Similarly, metropolitan principles of free trade and equity collided with political realities in India, forcing a shift towards indirect taxes and particularly customs duties which were anathaema at home.

IV. AFRICA

Africa posed different problems from India, for there was no pre-existing revenue system (or at least, not one recognised by the British authorities) and no commercialised agriculture or land tenure on the lines understood by the British. There were two broad outcomes, with various intermediary forms of tenure and agriculture. At one extreme, there was reliance on small farms and African cultivators, with land held directly by the farmers or on trust by the Crown. This pattern was found in Uganda and West Africa, where there was little large-scale European production except in mining, and the imperial authorities encouraged peasant production, even by means of coercing cotton planting. At the other extreme, white settlers operated large farms and metropolitan companies ran plantations, with a large amount of land alienated from the Africans on the assumption that it was not properly utilised. This pattern applied most obviously in South Africa. Other parts of Africa fell somewhere between the two extremes: in Kenya, for example, white settlers relied on indigenous labour but there were no large-scale capitalist land concerns; in central and southern Africa large farms and plantations co-existed with African cultivators. The outcome varied according to three factors: chronology, with land more likely to be alienated in the early stages of colonisation; geography, with more alienation where the climate was more attractive for European settlement; and self-government, for alienation was easier where white settlers had more control over the political process.35 34 PG Robb, Ancient Rights and Future Comfort: Bihar, the Bengal Tenancy Act of 1885, and British Rule in India (Richmond, 1997). 35 DK Fieldhouse, ‘The economic exploitation of Africa: some British and French comparisons’ in P Gifford and WR Louis (eds), France and Britain in Africa and: Imperial Rivalry and Colonial Rule (New Haven and London, 1971).

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In all cases, the colonial rulers had to establish some way of raising revenue in order to pay for administration and long-term economic development, of encouraging Africans to grow crops for the market, or of securing a workforce for European farms, mines and plantations. The colonial authorities or the local assemblies used a number of techniques to encourage commercialisation and the emergence of a wage labour force. One was to demand specified periods of work from Africans, which was unusual except in Kenya and Uganda, and even there it did not last long. A second and more common approach was to place pressure on chiefs to provide ‘volunteers’ to European enterprises or to grow particular crops. However, this technique declined in the face of hostility from the metropolitan authorities. Much more common were three other approaches: land policy to create a waged workforce on the reserves, as in southern and central Africa; contracts, sometimes with penal sanctions, in South and east Africa; and taxation to encourage the growth of commercial crops and waged labour.36 Above all, the imperial power relied on the ‘hut tax’. Initially, there was some concern about the implications of the hut tax. In 1855, George Grey, the Governor of the Cape, explained his policy on taxation to the second session of the colonial parliament. More revenue was needed to cover authorised expenditure, and Grey argued that the solution was indirect taxes, given the difficulties of collecting a direct tax in a country with a highly dispersed population, and ‘barbarous or semibarbarous tribes’ who could not easily be induced to pay. Indirect tax would be paid without knowing it, and would in effect be voluntary; and the yield would increase as the natives were raised in the social scale and used more goods.37 Indeed, the authorities might even decline payment of the hut tax, for it was closely linked to rights to land. In 1855, the special commissioner on the eastern Cape was concerned about the influx of population, and refused to accept payment of the hut tax on the ground that there was no room for the incomers who took the receipt of the tax as a claim to land—a position endorsed by the Prime Minister, Lord John Russell.38 However, Grey’s confidence in indirect taxes was misplaced. Could revenue rise sufficiently unless Africans were forced into a commercialised and monetised economy that produced taxable goods and income to meet tax liabilities? And could crops be grown for the market, or mines

36

Fieldhouse, above n 3, at 620–2. Cape of Good Hope: Further Papers Relative to the State of the Kaffir Tribes, ‘Governor’s address to the Legislative Council and the House of Assembly, at the opening of the second session of the Colonial Parliament’ 524. 38 Cape of Good Hope: Further Papers Relative to the State of the Kaffir Tribes, ‘Report of special commissioner, appointed to inquire into the present state of the Fingoe locations on the Eastern Frontier, especially in the division of Victoria, Fort Beaufort, and Queen’s Town, and the location of the Zitzikama’, W Calderwood, 22 Jan 1855 at 505; ‘Copy of a despatch from the Right Hon. Lord John Russell to Governor Sir George Grey’ 26 May 1855 at 533. 37

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developed, unless a waged labour force was created? Such considerations led to an increasing reliance on the hut tax as a means of forcing economic and social change. Of course, there were many other reasons for migration—a traditional response to dry seasons, ecological disasters caused by disease and famine, or a collapse of the pre-colonial social system—but taxation was certainly one force for change.39 The use of the hut tax to create a labour force was most explicit in South Africa, where the policy of Cecil Rhodes was encapsulated in the Glen Grey Act of 1894. Land was divided into smallholdings in order to replace communal property with individual plots. Of course, there was a danger that Africans would remain on their smallholdings, so competing with white farmers in product markets and refusing to provide a waged workforce. But Rhodes was confident that the process of subdivision of holdings would soon force men into the labour market. As he pointed out every black man cannot have three acres and a cow…It must be brought home to them that in future nine-tenths of them will have to spend their lives in daily labour, in physical labour, in manual work.

The process of economic and social transformation would be encouraged by a hut tax of ten shillings on men who had not worked for wages for three months.40 South Africa was extreme in the transformation of land rights. In Nyasaland, the approach was somewhat more cautious. The Administrator, Harry Johnston, was initially in the pay of Rhodes who wished to create landless labourers to work on large plantations. Instead, Johnston opted to grant land to the Africans and to rely on the hut tax to create waged labour and, above all, commercialised cultivation. In 1901, the full rate of hut tax was 6s, but this was reduced to 3s on condition that the taxpayer worked for a European for a month; in 1911, the rate was raised to 8s, with a lower rate of 4s for men who worked for a European or sold rice, tobacco or cotton to a European. The local colonial officer approved the list of Europeans for whom the Africans could work and with whom they could trade. Although this system was open to exploitation, small African cultivators did have some independence, for they could raise money to pay the tax through their own economic activities and could avoid sinking into waged labour and dependence as further south.41 The appeal of the tax was obvious: huts are visible and easily counted, and were known to the chiefs who could be co-opted into assessing and 39 M Wright, ‘East Africa, 1870–1905’ in R Oliver and GN Sanderson (eds), The Cambridge History of Africa, VI, From 1870 to 1905 (Cambridge, 1985). 40 S Marks, ‘Southern and central Africa, 1886–1910’ in Oliver and Sanderson (eds), above n 39. 41 L White, Magomero: Portrait of an African Village (Cambridge, 1987) 85–90; Baker, ‘Tax collection’, 49–50, 52, 53; Marks, above n 40, at 456; AJ Hanna, The Beginnings of

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collecting the taxes. In Nyasaland, for example, the chiefs received a commission of 10 per cent, and they might well be more effective than direct collection by officials, at least in the initial stages. Subsequently, collection in Nyasaland was transferred to officials.42 Not surprisingly, officials with an eye to the legitimacy of the tax in the opinion of missionaries, bodies such as the Aborigines Protection Society, and wary civil servants in London who feared disorder, stressed the ease of collection and high level of compliance. ‘The settled population may fairly be said to discharge its tax liabilities almost to the last shilling with little or no pressure’, it was reported from Nyasaland in 1910.43 In fact, reality was somewhat different from the comforting picture of contented Africans willingly paying for protection by a beneficent British administration. Collection of the hut tax could be carried out with a degree of brutality and force. In Nyasaland and Kenya, for example, collection was enforced by destroying or forfeiting huts, seizing wives or imprisoning defaulters.44 The system was open to abuse by farmers and traders who failed to record work or sales, so that Africans were forced to supply more labour or goods than legally necessary. The wage rate or price of goods set by the tax system might diverge from the market rate in order to encourage more waged labour and production.45 Further, the assessment of the tax might collide with local customs. In Swaziland, for example, a tax of £2 was imposed on males, and an additional £2 on each wife after the first—an imposition that was deeply resented.46 The tax system was in any case highly regressive. The hut tax fell on Africans whereas European settlers and companies paid little or nothing. European incomes were usually not taxed, and in some cases export duties were levied on African and not European production. As a result, African farmers paid a much higher proportion of their income in taxes, an effective transfer from poor to rich so that Africans paid for the infrastructure and labour needed by colonial enterprises. The Labour Commission in Kenya in 1927 estimated that

Nyasaland and North-Eastern Rhodesia, 1859–95 (Oxford, 1956) 241–4; RI Rotberg, The Rise of Nationalism in Central Africa: The Making of Malawi and Zambia, 1873–1964 (Cambridge, Mass, 1966), 40, 41–3, 46–7. 42 C Baker, ‘Tax collection in Malawi: an administrative history, 1891–1972’ (1975) 8 International Journal of African Historical Studies 40–5, 55–7. 43 Baker, above n 42, at 46–47. 44 Baker, above n 42, at 47–9; Marks, above n 40, at 456; RD Wolff, The Economics of Colonialism: Britain and Kenya, 1870–1930 (New Haven and London, 1974) 117. 45 Rotberg, above n 41, at 33–4. 46 DH Gillis, The Kingdom of Swaziland: Studies in Political History (Westport, Conn and London, 1999) 136.

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direct taxes were about 30 per cent of the earnings of an African family on a reserve, before taking account of indirect taxes.47 In John Lonsdale’s words, taxation which was levied on all made it possible for public expenditure to subsidise the few, to make them more attractive to outside investors.48

Not surprisingly, the hut tax and its wider implications for social and economic structures led to periodic resistance, and ‘officials feared rebellion as much as they desired taxation’.49 One of the first, and most serious, rebellions was the ‘hut tax war’ in Sierra Leone in 1898.50 The experience meant that the British administration was cautious about imposing direct taxation or challenging the chiefs’ control of land in Nigeria and the Gold Coast, where capitalist agriculture on plantations or larger African farms failed to materialise. In Nigeria, the emirs in the Islamic north of the colony collected taxes and retained power as native administration, with part of the tax revenue handed over to ‘native treasuries’ and the remainder passed to the Crown. By giving them security and relying on ‘indirect rule’, the Governor, Frederick Lugard, hoped that they would be bound to the British state and turn to cultivation in place of slavery and warfare. As John Lonsdale remarks, the British authorities conceded defeat and called it principle. It enshrined the nebulous concept of communal land tenure under tribal authority, in order to hide the nakedness of British weakness and ignorance.51

In South Africa, the authorities were more robust and powerful. The Zulu rebelled against the hut tax in 1896, and the imposition of a further £1 poll tax on adult males triggered armed revolt in 1907 that led to the death of between 1,000 and 4,000 Africans, and the imprisonment of 7,000.52 At the Colonial Office, Churchill criticised the ‘disgusting butchery of natives’ that made the colony ‘the hooligan of the British empire’.53 An approach to

47 See the case study of one colony by V Jamal, ‘Taxation and inequality in Uganda, 1900–1964’ (1978) 38 Journal of Economic History 418–28; also Wolff, Economics of Colonialism,- 118–19; Fieldhouse, above n 35, at 614–15. 48 J Lonsdale, ‘The conquest state of Kenya’ in JA de Moor and HL Wessling (eds), Imperialism and War: Essays on Colonial Wars in Asia and Africa (Leiden, 1989) 88. 49 J Lonsdale, ‘The European scramble and conquest in African history’ in Oliver and Londsale (eds), Cambridge History of Africa, VI 752. 50 L Denzer and M Crowder, ‘Bai Bureh and the Sierra Leone hut tax war of 1898’ in RI Rotberg and AA Mazrui (eds), Protest and Power in Black Africa (New York, 1970); A Abraham, ‘Nyagua, the British and the hut tax war’(1972) 5 International Journal of African Historical Studies 94 and ‘Bai Bureh, the British and the hut tax war’ (1974) 7 International Journal of African Historical Studies 99. 51 Lonsdale, above n 49, at 744, 761, 764–5. 52 Marks, above n 40, at 457; S Marks, ‘The Zulu disturbances in Natal’ in Rotberg and Mazui (eds), Protest and Power. 53 Marks, above n 40, at xx.

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disturbances that would not have caused too much concern a decade earlier was now unacceptable. But the British Government did little to remove the underlying grievances in South Africa where land was alienated, men forced into the labour market on unfavourable terms and the fiscal system highly regressive. The relationship between land and taxes in Africa was therefore variable, from the survival of African proprietorship and administration in Nigeria to the loss of land and proletarianisation in South Africa. Taxes were linked with a desire to create a more commercialised and capitalistic society by different means, varying from inducing African cultivators to produce for the market to forcing them into waged labour on large plantations or mines. Taxation was used not only to produce revenue for development and administration, but as a lever to shift the structure of society. Unlike in Britain, the administrators showed little concern for balance and equity in the tax system: it was biased between groups, as a deliberate act of policy. British precedents offered little or nothing to the fiscal administration of Africa, and neither did precedents elsewhere in the empire. The aim was to create a commercialised society producing for export markets, and in the process stratagems were used to raise revenue that led to resistance and a lack of legitimacy. African nationalists were placed in a difficult position, for opposition to taxation was central to their campaigns; the problem was that opposition to the tax system imposed by the British as lacking in legitimacy and consent also weakened the Africa state.

V. CONCLUSION

The transfer of ideas about taxation within the British empire was varied and complicated. In most cases, the transfer did not entail a direct application of the British fiscal system to the colonies, unlike in the French empire where the metropolitan cadastral survey was adopted. Even in the white-settler colonies, the application of the income tax diverged from the metropole, reflecting local concerns over the stimulation of earned income and the desire to contain large landed estates. The income tax took on a more radical edge than in Britain, pre-empting the policies adopted by the Liberal Government after 1906. Similarly, fiscal policies in India rested on a different connection between direct and indirect taxes than in Britain, with a shift towards customs duties in order to resolve the problems of raising revenue caused by the difficulties of imposing an income tax and the lack of buoyancy in the land revenue. In the white-settler colonies, India and Africa, debates over taxation were more concerned with the nature of land tenure and assumptions about the generation of economic growth than with the application of British terms of equity and balance in

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the fiscal system. Further, the debates over land tenure did not rest on the imposition of a single norm based on the dominant tripartite structure found in Britain, of large landowners, tenant farmers and landless labourers. This did apply to the zamindars of India, and the belief that they would stimulate economic growth much as the great aristocratic landowners of Britain during the agricultural revolution. But the assumption was contested on ideological grounds (as in India by James Mill or in New Zealand by John Ballance) as well as on purely practical grounds, as in Nigeria. The outcome also shaped the capacity of the colonial state, its ability to fund long-term development, secure loans on favourable terms and pay for welfare and the social infrastructure. Should taxes be used to pay for welfare within the colonies, and in particular should the English poor law be adopted in the white-settler societies? Might money be better spent on education, as in Scotland? How should the disasters of famine and devastation of cattle by disease be dealt with in India and Africa? How much should be spent on defence, and how much transferred to Britain to pay for the empire, or transferred from Britain to stimulate development? These issues remained open as long as the empire survived.

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6 The Impôts Arabes: French Imperialism and Land Taxation in Colonial Algeria, 1830–1919 DAVID TODD

ABSTRACT Taxation is a major instrument of imperial domination and for transforming colonised societies. As the French conquered Algeria between 1830 and 1850, they first opted for maintaining the direct Koranic taxes on land and cattle put in place under Turkish rule or more recently introduced by Abd al-Qadir, the leader of indigenous resistance to the French after 1832. Such taxes or impôts arabes were initially construed as tributes and their payment as recognition of French rule by indigenous tribes. Thanks to agricultural growth and administrative rationalisation after 1850, the impôts arabes became one of the colony’s main sources of revenue. Yet French administrators were dissatisfied by the enduring diversity of taxation regimes, which was often grounded in religious or ethnic differences: Kabyles enjoyed a privileged fiscal status, while French and other European settlers were exempted from direct taxes on land and cattle. Under the Second Napoleonic Empire (1852–1870), drawing on physiocratic theories and memories of the fiscal reforms introduced by the Constituent Assembly in 1791, French administrators sought to replace the impôts arabes by a single and universal land tax on the metropolitan model. Technical difficulties such as the problems posed by the constitution of an Algerian cadastre, the stringent opposition of European settlers to the abolition of their privileges, and the catastrophic famine of 1866–1868, brought efforts at reform to a halt. More sympathetic than the previous regime to European settlers and despite the growing inefficiency of the impôts arabes, the Third Republic proclaimed in 1870 waited until the aftermath of the First World War to introduce a uniform regime of direct taxation in Algeria.

Taxation in the European colonial empires of the nineteenth century remains an under-researched topic. Yet taxes were one of the principal tools of colonial governance. Colonial authorities used them to fund, at

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least in part, the costs of imperial rule, but also, perhaps more importantly, to reshape colonial societies in accordance with metropolitan economic values and commercial needs. Considering the question of taxation in the British Empire, Daunton remarked that Britain exported the ‘fiscal-military state’ to its colonial possessions while keeping it contained at home after 1815.1 This essay on land taxation in colonial Algeria argues that a parallel may be drawn in the case of French imperialism, with the proviso that France in the nineteenth century tended to export its own bureaucratic, privilege-based and less efficient model of fiscal extraction under the Ancien Régime.2 Land taxation was one of the most important aspects of colonial fiscal regimes. In the eyes of colonisers, indigenous consent to taxes on land signified acceptance of a new territorial sovereignty. Furthermore, most colonial economies remained predominantly agricultural, making land the main component of the tax base and land taxation the main tool of socio–economic transformation at the disposal of colonial administrators. In the case of the French empire, these two factors were reinforced by the influence of France’s intellectual, political and fiscal history since 1750: Enlightenment intellectuals, especially the Physiocratic movement, had clamoured for the rationalisation of land taxation, and in 1790 the Constituent Assembly had replaced the vast array of taxes and dues on land under the Ancien Régime by a single contribution foncière or impôt foncier (land tax). The new tax confirmed the property rights of millions of small landholders and continued, in nineteenth-century France, to symbolise the abolition of agrarian feudal relations.3 During the Napoleonic period, French armies had spread the contribution foncière in several annexed or occupied parts of Western Europe. French administrators attempted to do likewise in colonial territories, beginning with Algeria, France’s first overseas colony in the nineteenth century. After adopting and rationalizing existing proportional taxes on land produce, collectively designated as the impôts arabes (Arab taxes), they endeavoured to transform them into a single quota land tax on the model of the metropolitan impôt foncier. They hoped that the new tax,

1 M Daunton, ‘Tax transfers: Britain and its Empire, 1848–1914’ in H Nehring and F Schui (eds), Global debates about taxation (Basingstoke, 2007); on the British ‘fiscal-military’ state and its decline in Britain after 1815, see M Daunton, Trusting Leviathan: the politics of taxation in Britain, 1799–1914 (Cambridge, 2001) 32–57. 2 On the contrast between the British and French models of fiscal extraction in the eighteenth century, see P Mathias and PK O’Brien, ‘Taxation in Britain and France, 1715–1810: a comparison of the social and economic incidence of taxes collected for the central government’ (1976) 5 Journal of European Economic History 601; see also R Bonney, ‘What’s new about the new French fiscal history?’ (1998) 70 Journal of Modern History 639. 3 There are few recent works on land taxation in nineteenth-century France; the best available study remains R Schnerb, ‘Techniques fiscales et partis pris sociaux: l’impôt foncier en France depuis la Révolution’ (1938) 10 Annales d’histoire économique et sociale 116.

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combined with the replacement of collective tribal property by small individual landholdings, would encourage agricultural growth and facilitate the ‘assimilation’ of Algeria by France. This effort failed in the face of radical opposition from European settlers, who were exempted from the impôts arabes and wished to preserve their fiscal privileges. The desire to transpose the French fiscal revolution across the Mediterranean paradoxically resulted in the perpetuation until 1919 of a differential system of land taxation, based on ethno–religious distinctions between Christian Europeans, Kabyles, Arabs and indigenous Jews. The essay first examines the creation of the impôts arabes, inspired by traditional Koranic taxes and construed as a political tribute, between 1830 and 1850. It then studies the administration’s push for reform of land taxation and its limited results between 1850 and 1867. Lastly, it analyses the abandonment of reform and its consequences after 1867.

I. THE CREATION OF THE IMPÔTS ARABES (1830–50)

The French faced major difficulties in trying to establish a regular system of land taxation in Algeria. By the time French forces captured Algiers in 1830, France had lost most of its earlier colonial possessions in America, Africa and Asia. Save for a brief attempt to reform the Egyptian tax system between 1798 and 1801, French administrators had little if any experience of levying taxes in non-European societies.4 Moreover, the conquest of Algeria was a drawn-out process. Warfare in Arab-speaking regions lasted until 1847, while Berber-speaking Kabylia was only subjugated in 1857. Such conditions further hindered the definition and implementation of new fiscal rules. Yet the single most serious obstacle to the levying of regular taxes on land was the loose character of state structures before the conquest. The Deylik of Algiers was nominally a province of the Ottoman Empire, but the Dey’s writ barely ran beyond the immediate vicinity of the capital. Algeria remained a pre-modern society, dominated by warlords, chieftains and marabouts.5 Using Joseph Schumpeter’s distinction between the ‘demesne state’ (where the sovereign’s revenue mainly originates from its demesne) and the ‘tax state’ (where the sovereign levies regular taxes), the Deylik still

4 MM El-Sorougy, ‘The tax system in Egypt during the French expedition (1798–1801)’ (1972–74) 11 Rivista italiana di studi napoleonici 67. 5 J Thobie et al, Histoire de la France coloniale (2 vols, Paris, 1991), vol I 327–40, 355–64; P Pluchon, Histoire de la colonisation française (2 vols, Paris, 1991), vol II 21–34; C-R Ageron and C-A Julien, Histoire de l’Algérie contemporaine, 1830–1954 (2 vols, Paris, 1964–79), vol I 1–20.

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appeared much closer to the former.6 A French commission of inquiry set up immediately after the capture of Algiers found that the Dey’s private income (1.5 million francs) was more than twice as large as the Government’s revenue (700,000 francs).7 French authorities established a few indirect taxes in the towns brought under effective French rule (Algiers, Oran, Bône). Yet, between 1834 and 1839, revenue stagnated at approximately 2 million francs, while expenditure rose from 18 to 38 million francs.8 The Duc de Rovigo, Governor-General of French North Africa, admitted in 1832 that only a regular direct tax or tribute paid by all parts of the Deylik would ‘consolidate and sanction … our presence in the country’. But the enforcement of such a tax, he warned the French Government, would require protracted military operations and a larger force than he had at his disposal.9 French authorities wished to create a new tax to reduce the colony’s fiscal deficit, but also to ascertain indigenous consent to French rule. A parliamentary Commission d’Afrique, which visited Algeria in 1833, concluded that France ought to establish some ‘tributes’ and ‘exact them by force, in every place that force can reach’. Collection costs were likely to be higher than the yield, one member of the commission admitted, but the main aim of the tax should be ‘to organize collection and accustom indigenous inhabitants to it’. Payment of the tax or tribute, another member explained, should be interpreted as recognition of French authority: It is above all necessary to dispel the notion that we are powerless and prove that we are the masters … Then, but only then, the Arabs will believe that this civilization, which we praise to them, may be worth something, and that the harm we do not do to them is evidence of our sense of justice rather than of our weakness … we must, thanks to a tribute, obtain the recognition of our sovereignty, prove that we are strong, create friends that we can reward with privileges and pecuniary advantages, and enemies that we can punish and hand over to the hatred and fondness for plundering of our friends.

The Commission d’Afrique postponed the establishment of a regular land tax until after the conquest was complete. Meanwhile, ‘the army’ would serve as ‘tax collector’.10 But how should the new tax or tribute be assessed? The French decided to maintain the fiscal innovations recently introduced by two powerful 6 JA Schumpeter, ‘The crisis of the tax state’ in AT Peacock, R Turvey, WF Stolper and E Henderson (eds), International economic papers, n 4 (London and New York, 1954) 5. 7 E de Salle and R Vincent, ‘Les finances d’Alger’ (1832) 36 Revue de Paris 130. 8 See the study of Algerian finances published for the hundredth anniversary of the French conquest: M Douël, Un siècle de finances coloniales (Paris, 1930) 18, 33–60, 89. 9 Duc de Rovigo to the Minister of War, 24 September 1832, Vincennes, Service Historique de l’Armée de Terre (SHAT), 1 H 17/3. 10 Procès-verbaux et rapport de la commission nommée par le roi (Paris, 1834) 147–65; see also Procès-verbaux et rapports de la commission d’Afrique (Paris, 1834) 501–10.

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warlords: Ahmed, Bey of the Constantine province (eastern Algeria), who had been asserting his independence from Algiers since the early 1820s, and Abd al-Qadir, son of a marabout, who established a new Emirate in the Oran and Algiers provinces (western and central Algeria) after the collapse of the Deylik and declared jihad on the French in 1832. Ahmed resisted the French until the fall of Constantine in 1837, while Abd al-Qadir fought the invaders until his capture in 1847. Both thoroughly overhauled taxation in their respective territories, partly in order to mobilise resources and meet the French military challenge.11 Ahmed Bey replaced the djabri, an arbitrary tax on harvests paid in kind to the Dey, by several dues payable in cash on the land, notably the hokor, a rental fee on his estates and the land owned collectively by tribes. He also continued to levy the achour, a traditional tax in kind on grain harvests.12 After the capture of Constantine, French functionaries compared Ahmed’s reforms favourably with the fiscal organisation of the former Deylik, and estimated the annual yield of his direct taxes payable in cash at 1.25 million francs. But they found fault with Ahmed’s systems of assessment and collection of the achour, which still relied on the traditional hierarchy of kaids, kalifs, aghas and sheiks acting under the loose supervision of a few kaids el-achour. Due to the laxity of assessment and large-scale embezzlement, the actual proceeds of the achour amounted in the French estimate to no more than 2 per cent of grain harvests, although achour literally meant a ‘tenth’.13 Abd al-Qadir carried out a more comprehensive fiscal reform, which enabled him to raise a substantial army and inflict several military setbacks on the French until the mid-1840s. The Emir instituted two assessed taxes: the achour on harvests, and the zekkat (‘alms’) on cattle and handicrafts. Both taxes were paid in kind at a rate of approximately one-tenth of gross income.14 The grain of the achour served as a reserve for the tribes and the army’s supplies, while the proceeds of the zekkat were auctioned to provide the Emir with cash. The success of Abd al-Qadir’s reform also relied on a marked improvement in assessment and collection methods. He appointed agents answerable to himself only (kedjas or khalafs), who conducted annual censuses and collected the proceeds of the achour and the zekkat,

11 A Temini, Le Beylik de Constantine et Hâdj Ahmed Bey, 1830–1837 (Tunis, 1978); B Etienne, Abdelkader: isthmes des isthmes (Paris, 1994) 115–212. 12 F Moussaoui El-Kechaï, ‘Le système fiscal dans le rural du Beylik de Constantine durant la fin de la période ottomane (1771–1837)’ (1995) 79–80 Revue d’histoire maghrébine 463. 13 See memoranda ‘Sur les ressources financières de la province de Constantine’, 27 March 1838 1–3, and ‘Résumé des recherches sur l’impôt particulièrement dans le Tell oriential et dans le Tell occidental’ (1841) 18–19, 61–3, in Aix-en-Provence, Centre des Archives d’Outre-Mer (CAOM), F 80 933. 14 The achour’s rate was 10% of the harvest and the zekkat’s 1 sheep out of 100, 1 ox or cow of 30 and 1 camel out of 40.

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weakening the authority of traditional chieftains in the process.15 The fiscal dimension of Abd al-Qadir’s state-building enterprise made a powerful impression on French officials, including Alexis de Tocqueville, who noted during his visit to Algeria in 1841 that the Emir levied annually the equivalent of 3 million francs in the province of Oran alone.16 According to the testimonies of Tocqueville and other French officials, the high level of consent secured by Abd al-Qadir for the new taxes owed a lot to their religious basis in the Koran and the holy character of the cause they served to finance—the war against French ‘infidels’.17 A protracted debate in France over the desirable level of French presence in Algeria delayed the implementation of the Commission d’Afrique’s fiscal recommendations. The Government eventually warmed to the project of colonisation and increased troop levels from 42,000 men in 1837 to 108,000 in 1846, with a view to occupying and administering the entire Tell (the northern, non-desert part of Algeria).18 As predicted by the Commission, the exaction of tributes, under the form of the taxes established by Ahmed Bey and Abd al-Qadir, primarily served to ensure the recognition of French sovereignty. The French harboured some misgivings about the imperfections and the religious inspiration of the hokor, achour and zekkat. But they found it more expedient to leave these taxes in place and rely on military force to collect them. In the former Beylik of Constantine, the proceeds or monetary equivalent of the hokor and achour collected by the French rose from less than 100,000 francs in 1838 to 1.9 million francs in 1844.19 Consent to taxation chiefly relied on fear of military coercion. In 1841, for example, Général Négrier, commander of the Constantine province, led an expedition to punish several tribes that had failed to pay taxes the previous year. In particular, he wished ‘to strike a great blow’ against the powerful Smouls, ‘which would serve as an example to the province’s other tribes’. When the Smouls’ leaders implored his ‘forgiveness’, Négrier renounced plundering their territory, but he took several ‘hostages’ as he collected 29,000 francs in arrear taxes and a fine of 11,000 francs. He took again

15 A Warnier, ‘Résumé des recherches’ 14–27, and ‘Notice sur les impôts & leur mode de perception sous la domination de l’Emir El-hadj Abd-el-Kader’, 10 July 1842, CAOM, F 80 933. 16 A de Tocqueville, ‘Notes du voyage en Algérie de 1841’ in A de Tocqueville, Sur l’Algérie, (ed S Luste Boulbina) (Paris, 2003) 61–96, at 66; Tocqueville reiterated his admiration for Abd al-Qadir’s fiscal and military achievements in his unpublished ‘Travail sur l’Algérie’ (1841), in Sur l’Algérie 97–177, at 106–7. 17 P Fournier, ‘L’état d’Abd-el-Kader et sa puissance en 1841 d’après un rapport du sous-intendant militaire Massot’ (1967) 14 Revue d’histoire moderne et contemporaine 123. 18 Julien and Algeron, Histoire de l’Algérie contemporaine, above n 5, vol. I 107–63, 270. 19 ‘Note sur les impôts dans la province de Constantine’ [1839] 1–5, CAOM, F 80 933; Ministère de la Guerre, Tableau de la situation des établissements français dans l’Algérie en 1844–1845 (Paris, 1846) 294–5.

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some hostages in the neighbouring Segnias tribe to ensure the payment of 4,000 francs in arrear taxes. ‘These acts of firmness’, Négrier concluded in a report at the end of the year, ‘made the impression that I expected. They threw in the populations a sentiment of fear that has [since] kept them to their obligations’.20 Several years and more punitive expeditions proved necessary before consent became permanent. In July 1841, Négrier sent 55 cavalrymen to punish the Mouyas who refused to lend themselves to an assessment operation. The squadron burnt down the Mouyas’ shacks, destroyed their harvests and brought 500 heads of cattle back to Constantine, to be returned to the tribe after the payment of taxes. As soon as troops were wanting in a district, an officer in Bône complained in September 1842, tribes became ‘recalcitrant’ with regard to the collection of taxes. In January 1843, Négrier’s interim successor at the head of the Constantine province reported that despite Négrier’s expedition in 1841, the Segnias still owed 5,000 francs in taxes and that he would be ‘obliged to go and chastise them in the summertime unless [he could] before then get hold of an influential chief [as hostage]’.21 The exaction of tributes in the Oran and Algiers provinces proved even more difficult than in Constantine. Abd al-Qadir enjoyed widespread support until the mid-1840s and French officials doubted whether Arab tribes would consent to pay taxes established to finance jihad against France. But in 1841, French authorities began to levy both the achour and the zekkat, limiting the latter to cattle.22 The monetary equivalents of payments, amounting in 1842 to 18,000 francs in Oran and 341,000 francs in Algiers, respectively rose in 1844 to 710,000 and 619,000.23 As in Constantine, the army played the role of tax collector and several punitive expeditions were necessary to secure consent. In Oran, for example, Général Bedeau in October 1842 had 1,000 cavalrymen live on the land of the Oulhassas tribe for six days, and he took eight hostages to enforce payment of the achour.24 French officials in Algeria hailed with satisfaction the growing yield of what they began to call the impôts arabes in the three provinces: 1.9 million francs in 1843, and 3.2 million in 1844. Although such sums 20 Général Négrier, ‘Rapport sur la province de Constantine’, 31 December 1841, SHAT, 1 H 79/3. 21 Général Randon, ‘Rapport sur la perception de l’impôt en 1842 [dans la subdivision de Bône]’, 4 September 1842, SHAT, 1 H 86/3; interim commander of the Constantine province to the Minister of War, 4 January 1843, SHAT, 1 H 88/3. 22 ‘Résumé des recherches’, above n 13, at 112–13; ‘Instruction sommaire sur l’assiette de l’impôt’ 1–3; CAOM, F 80 933. 23 Tableau de la situation des établissements français dans l’Algérie en 1843–1844 (Paris, 1845), at 304–5, and Tableau en 1844–1845, above n 19, at 294–5. 24 Général Bedeau to the Governor General of Algeria, 3 November 1842, SHAT, 1 H 87/2.

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represented only a small fraction of French public expenditure in Algeria (78 million francs in 1844), they sanctioned the recognition of French sovereignty.25 The Algiers Director of Finance described the rise of yields as reflecting the progress of ‘pacification’ and called the impôts arabes ‘the most reliable thermometer of our policy and domination’.26 The lax definition of assessment and collection rules, however, provoked unease among officials in Paris. On 17 January 1845, an ordinance on Algerian finances called for their urgent ‘regularization’. Despite reiterated orders in subsequent months to issue a text that would provide a rigorous definition of the taxes, Maréchal Bugeaud, Governor-General of Algeria from 1841 to 1847, refused to comply. He explained that such regularisation was impossible, because the impôts arabes were essentially an instrument of conquest: Politics above all are opposed to the bounding of the impôt arabe by immutable rules as in France. A multitude of circumstances and facts require opportune modifications. Thus for instance: you are threatened by an invasion from Abd al-Qadir in a land already intensely worked up by his emissaries. It is not expedient to be rigorous, to increase the tax, even though some new statistical information suggests that it should be increased. This is what we did during the last crisis. Other tribes having remained loyal to us and suffered from misfortunes as a result of this loyalty, we had to ask for less in order to compensate a little for their losses and reward them for their commitment to our cause.27

As predicted by Bugeaud, a metropolitan-like codification of the impôts arabes proved impossible. Until their abolition in 1919, the taxes were levied on the flimsy legal basis of the ordinance of 17 January 1845, the same that called for their ‘regularization’. But as armed resistance to French rule subsided from the mid-1840s onwards, colonial authorities strove to rationalise tax assessment and collection procedures. Changes included the supervision of both operations by French officers, a reduction in the role and emoluments of indigenous chiefs, the partial homogenisation of the tax base and tax rates within each province, the issuance of tax notices for indigenous taxpayers, and the payment of taxes in cash. Rationalisation pursued three complementary objectives: the establishment of consent on trust and administrative accountability rather than fear of military coercion; the transformation of the impôts arabes into a substantial source of revenue; and the development of commercial exchanges in Algerian society.

25 Tableau en 1844–1845, above n 19, at 294–5; Douël, Un siècle de finances coloniales, above n 8, at 141. 26 The Algiers Director of Finance to the Minister of War, 5 September 1843, CAOM, F 80 934. 27 Maréchal Bugeaud to the Minister of War, 21 October 1846, CAOM, F 80 933.

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This policy of rationalisation was first implemented in Constantine under the impulse of the Duc d’Aumale, a son of King Louis-Philippe (1830–48) and commander of the province between 1844 and 1847. On taxation, as on other aspects of Algerian affairs, Aumale followed the recommendations of his friend and adviser, Ismayl Urbain. A mulatto born in Guyana in 1812, Urbain had grown up in Marseilles and converted to Islam while he visited Egypt in the mid-1830s. In 1837, he settled in Algeria and became a translator in the French administration. He would later assert himself as a leading figure of the arabophile party, which advocated the reconciliation of European and indigenous interests in Algeria. A former disciple of the Saint-Simonian school, Urbain believed that colonisation should consist in economic development, thanks to European investments and the spread of capitalist habits among indigenous inhabitants rather than cultural assimilation.28 Writing from Constantine to a Parisian correspondent in January 1844, Urbain expressed his belief that ‘the question of taxation in Africa’ had ‘financial’ as well as political importance: ‘once the tribes are subjugated, we can hopefully achieve more accurate estimates of the components of their wealth and through a more extended and more equitable distribution [of the tax burden] increase revenue for the treasury’. Yet he advocated a policy of incremental improvement, based on ‘a wise consideration’ for ‘old customs’: ‘Improvements…will have to be successive [and] will be a gradual, prudent and perhaps even slow progress towards a state of regularity.’ For the moment, he propounded two main innovations in the Constantine province: the obligation for sheiks to draw up annual registers, which would indicate the area cultivated by each labourer; and the control of these registers by French officers with a sufficient knowledge of topography and Arab agriculture.29 Aumale successfully implemented the changes recommended by Urbain. Ahmed Bey’s kaids el-achour were abolished and French officers from the bureaux arabes, a branch of the military administration in charge of indigenous affairs, verified instead the assessments made by sheiks and collected the proceeds of the hokor and achour. In addition, Aumale significantly reduced the part played by indigenous officials. To prevent sheiks and others from embezzling money, public letters indicating the amount due by each cultivator were sent to all villages, and their share in tax proceeds was reduced from one-third to one-fifth (and later to one-tenth). Aumale also harmonised the rates of the hokor and achour per djebda—a land unit literally meaning ‘plough’ and varying from 8 to 15

28 M Levallois, La genèse de l’Algérie franco-musulmane : Ismayl Urbain, 1837–1848 (Paris, 1999); and Ismayl Urbain (1812–1884): une autre conquête de l’Algérie (Paris, 2001). 29 Urbain to Fellman, Director of Algerian Affairs at the Ministry of War, 23 January 1844, SHAT, 1 H 94/3.

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ha.30 The commander of the Constantine province acknowledged that a lot remained to be done, but he proudly described the new system as ‘rational’ and ‘general and easy to implement’. The increased role of French officials and the collection of statistics permitted a better control of assessments, while consent no longer relied on ‘the terror caused by the approach of our bayonets’.31 Following his enlightened administration of Constantine, Aumale became Governor-General of Algeria in 1847, shortly before the 1848 Revolution swept away the July Monarchy (1830–48) and forced him into exile. Also in 1847, Urbain was appointed political adviser for Algerian affairs at the Ministry of War in Paris, a position which he retained until 1860. Few documents are available on taxation in Oran and Algiers between 1845 and 1850, but later descriptions suggest that similar efforts were made in these provinces to supervise more closely and rationalise assessment and collection procedures. The Second Republic (1848–52) pursued the previous regime’s policy of gradual improvement. In particular, the decree of 11 March 1850 prescribed the payment of all the impôts arabes in cash. In Constantine, the achour became a uniform fixed due per djebda, while in Oran and Algiers, military authorities annually determined in each district the rates of the achour and zekkat per djebda. Payment of the impôts arabes in cash met with little resistance, further facilitating tax collection. Together with the repeal of restrictions on imports of Algerian agricultural products by the customs law of 11 January 1851, the measure also encouraged indigenous producers to commercialize their products.32 Rationalisation, commercialisation and the end of warfare led to a rapid increase in the yield of the impôts arabes after 1850 (see Figure 6.1). By 1856, the taxes’ gross yield represented 50.5 per cent of all public revenue raised in Algeria by the French state and provincial authorities.33 Taking into consideration the initial difficulties faced by the French, the pragmatic transformation of Ahmed Bey and Abd al-Qadir’s religious taxes in kind into regular taxes payable in cash appears as a significant success. The new impôts arabes not only sanctioned the establishment of French sovereignty in Algeria; they also became, in less than 15 years, the colony’s main source of revenue. These achievements nevertheless failed to satisfy French administrators, who strove under the Second Empire (1852–70) to transform the impôts arabes into a metropolitan-style land tax. 30 The djebda designated the surface that could be tilled by one plough every year. It therefore tended to be larger in plains than in hilly or mountainous regions. 31 Duc d’Aumale to Général Bugeaud, ‘Sur la perception de l’impôt’, 7 August 1844, CAOM, F 80 934. 32 Douël, Un siècle de finances coloniales, above n 8, at 233–5. 33 Tableau de la situation des établissements français dans l’Algérie en 1856–1858 (Paris, 1859), at 1095; Statistique financière 1 (1900) 4–5.

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Figure 6.1: Net yield of the impôts arabes, 1838–1900

Sources: my calculations, based on Tableau de la situation des établissements français dans l’Algérie (Paris, 1839–68), Statistique générale de l’Algérie de 1867 à 1872 (Algiers, 1874) and Statistique financière de l’Algérie 1 (1900) II. ATTEMPTS AT REFORM (1851–67)

The impulse to reform Algerian land taxation taxes along metropolitan lines was rooted in France’s fiscal history. The impôt foncier was one of the French Revolution’s main fiscal legacies. Despite its limitations and rigidity, French administrators still credited it with significant achievements, notably the replacement of the Ancien Régime’s various taxes on land produce by a single, more just and efficient, land tax. Construing the impôts arabes as a remnant of Algerian ‘feudality’, they wished to transpose the fiscal and social consequences of the Revolution across the Mediterranean. This policy of fiscal assimilation received the wholehearted support of Napoleon III, who was intent on increasing the productivity of indigenous farmers. A single and rational land tax had been a pet project of the Physiocratic School in the eighteenth century. Agriculture being the only original source of wealth, the Physiocrats argued, taxation should bear almost exclusively on the ‘net product’ of the land. They therefore placed a special emphasis on the rationalisation of land taxation, characterised under the Ancien Régime by a motley and regionally uneven array of taxes (taille, vingtième, tithe, feudal dues etc.). Quesnay and most leading Physiocrats favoured a land tax proportional to leases—the best approximation of the net product, in their opinion. Other thinkers influenced by Physiocracy, including the reformist Minister Anne-Robert-Jacques Turgot, subscribed to the project of a rationalised land tax, but viewed proportional taxes assessed by the administration with suspicion, as assessment was often

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arbitrary and evasion easier for influential tax-payers. These critics rejected an impôt de quotité (proportional tax) in favour of an impôt de repartition (quota tax), whereby the state would determine for several years the quota or quantity of revenue that it wished to raise through the land tax, while local assemblies would distribute the quota between provinces, districts, parishes, and individual taxpayers—hence the name of ‘répartition’ (distribution).34 The Constituent Assembly opted for the quota land tax when it created the contribution foncière in 1790, and it instructed local assemblies to distribute the quota proportionally to each plot’s productive capacity. According to its defenders, the system of the quota would be advantageous both to the state, which could count on a predetermined and stable source of revenue, and to taxpayers, who could ensure through their local representatives that the quota would be equitably distributed. Distribution by local assemblies, it was hoped, would also reduce collection costs and strengthen consent. Moreover, its advocates argued that a quota land tax would spur agricultural growth, through the taxation of uncultivated land and a de facto tax exemption on marginal increases in output (until the next revision of the quota distribution). In 1807, to facilitate the distribution of the quota, Napoleon determined the constitution of a cadastral land survey of the entire French territory by expert geometers.35 The implementation of the impôt foncier has often been described as a relative failure. Distribution provoked interminable disputes and was confined, after 1821, to the municipal level: the land tax became a fixed lump sum paid by each department, regardless of economic change, while redistribution by municipal councils altered little the tax bearing on each plot of land over time. The cadastre was only completed in 1846, and it was never used to modify the quota’s distribution at the national and departmental levels. As a result, the share of the land tax in public revenue steadily declined. Yet many Frenchmen, at least until the 1870s, continued to view the impôt foncier as a successful fiscal innovation. The new land tax remained France’s most productive direct tax until the First World War, and its fixity allegedly encouraged agricultural improvement. Above all, it was seen as guaranteeing the post-revolutionary rural order, sanctioning the abolition of ‘feudality’ and, together with the cadastre, entrenching the French small peasantry’s property rights.36

34 G Weulersse, Le mouvement physiocratique en France, 1754–1770 (2 vols, Paris, 1910, repr 1968), vol I 268–72, 468–73; and La physiocratie sous les ministères de Turgot et de Necker, 1774–1781 (Paris, 1950) 62–78. 35 M Marion, Histoire financière de la France depuis 1715 (6 vols, Paris, 1927–28), vol II 179–94, and vol III 255–61, 308–14. 36 Schnerb, ‘Techniques fiscales’, above n 3, at 120–2, 127–31; J Bouvier, ‘Sur “l’immobilisme” du système fiscal français au XIXe siècle’ (1972) 50 Revue d’histoire économique et sociale 50 483.

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During the revolutionary and Napoleonic period, the propensity of French armies to export the impôt foncier in Western Europe illustrated this belief in the capacity of the new tax to transform economic and social relations along liberal-capitalist lines.37 French administrators in Algeria were animated, to some extent, by the same ambition. Equating the hokor, achour, zekkat and other tributes with the Ancien Régime’s direct taxes, they wished to replace them by a single quota land tax. Such a fiscal revolution, they hoped, would help transform indigenous Algeria in a society of small independent farmers, comparable to post-revolutionary rural France. This project was the fiscal dimension of France’s design to ‘assimilate’ rather than merely govern its North African possessions—a design that had entered a crucial stage in 1848 with the creation of the Oran, Algiers and Constantine départements, although larges swathes of Algerian territory remained under the authority of military governors until the 1870s. The drive for fiscal reform reached its apex under the reign of Napoleon III. Ismayl Urbain’s influence grew, and he persuaded the Emperor to pursue a policy aiming to reconcile economic modernisation with respect for the rights of Muslim Algerians.38 In 1861, Urbain became rapporteur at the Algiers Conseil de Gouvernement (the Algerian equivalent of the Paris Conseil d’Etat). He also exposed his views on the colony’s economic and political future in two influential pamphlets, L’Algérie pour les Algériens (1860) and L’Algérie française, indigènes et immigrants (1862). Urbain argued that France should encourage European investment in Algerian industrial ventures, railways and mines, but that it should promote indigenous agriculture rather than facilitate land expropriation in favour of European settlers. The pamphlets were well received in France, and Urbain wrote to a friend: Ideas are improving. I am more and more convinced that an economic revolution will soon be possible. Only the imbeciles…do not understand yet that the immigrant must mostly be a capitalist, a director, an initiator through intelligence

rather than rob indigenous Algerians of their land.39 Napoleon III’s arabophile policy culminated with the Senatus-Consulte of 22 April 1863, which stopped the confiscation of indigenous tribal land and prescribed its transformation into private property divided up amongst indigenous farmers. During his official visit to Algeria in 1865, the 37 On the implementation of the impôt foncier in Italy and Western Germany, see M Samland, ‘Déchiffrer “l’égalité devant l’impôt”. Pour une radiographie de la réforme de la contribution foncière (1789–1834)’ (1992) 7 Histoire et mesure 313. 38 A Rey-Goldzeiguer, Le royaume arabe : la politique algérienne de Napoléon III, 1861–1870 (Algiers, 1977). 39 Urbain to Frédéric Lacroix, 10 June 1862, CAOM, 1 X 3.

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Emperor chose Urbain as his personal interpreter and, on his return to Paris, published a Lettre sur la politique de la France en Algérie (1865). The pamphlet drew heavily on Urbain’s ideas, including his criticisms against the impôts arabes: Napoleon III accused the taxes of having ‘the double disadvantage of exceeding the tax-paying capacity of the [indigenous] population and upsetting the very principle of agricultural development’, and proposed to replace them by a single quota land tax on the metropolitan model.40 The French administrators’ belief in the socio–economic virtues of the impôt foncier, abetted by Urbain and Napoleon III’s desire to improve the condition of indigenous farmers, led to four major attempts to overhaul the impôts arabes between 1852 and 1867. The first project was elaborated in 1852 by a commission of officers from the bureaux arabes; the second in 1859 by a commission of six Paris and Algiers civil servants (including Urbain); and the third in 1861 by a commission of 12 civil and military administrators in Algeria—the latter commission’s conclusions were endorsed by a report from the Conseil de Gouvernement drawn up by Urbain.41 The fourth was conducted from Paris between 1864 and 1867, by the imperial Government. The four projects were grounded in the same diagnosis: the burden of land taxation was unfairly distributed, between European and indigenous farmers as well as among indigenous farmers; and proportional taxation acted as a disincentive for agricultural improvement. As a remedy, all four projects recommended the replacement of the impôts arabes by a single quota land tax and its gradual application to European settlers. Advocates of reform underlined the heterogeneity of taxation on indigenous land property. A stark contrast persisted between Constantine, subjected to the hokor and achour, and Algiers and Oran, subjected to a different type of achour and the zekkat. Constantine was the richest province per capita but, due to the absence of taxation on cattle, fiscal pressure was lower than in Algiers and Oran: in 1851, the commission of the bureaux arabes estimated the average tax burden at slightly under 20 francs ‘per tent’ in Constantine and at more than 25 francs in Oran. There also remained significant discrepancies within each province, often stemming from the variable character of the djebda—the more uneven the terrain, the smaller the djebda and therefore the higher taxation relative to the cultivated surface.42 Internal discrepancies were acute in Constantine, 40 Napoléon III, Lettre sur la politique de la France en Algérie (Paris, 1865) 25–8, 38; for Urbain’s views on taxation, see his pseudonymous pamphlets G Voisin, L’Algérie pour les Algériens (Paris, 1860, new ed 2000) 82–7, and L’Algérie française, indigènes et immigrants (Paris, 1862, new ed 2002) 97. 41 Minutes of the Conseil de Gouvernement, 25 September 1861, CAOM, 3 F 42, fols 86–8. 42 See above n 31, at 9.

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where land owned privately (melk properties) was exempted from the hokor. Within this province, the average tax burden varied from 11 francs per tent in the richest sub-division (Constantine) to 29 francs in the poorest (Bône).43 Heterogeneity also resulted from the multiplicity of exceptional tax regimes, used instead of the hokor, achour and zekkat for tribes outside the reach of direct French rule. In Constantine, tribes living in the Sahel or the desert were subjected to three different types of lezma (‘obligation’), which were either fixed tributes or assessed taxes based on palm trees or livestock. In Algiers, tribes from the desert paid the eussa, a tax on grain transactions, while in Oran, the Douair and Smelah tribes, in return for their contribution in auxiliary cavalry to the French army, were subjected to the hak-el-chabir, an advantageous fixed due per djebda and per head of cattle. The conquest of Kabylia in 1857 further increased heterogeneity, with the creation of two new types of lezma: the one a poll tax on each pubescent male in Great Kabylia (Algiers province), and the other a tax based on the number of households and distributed between tax-payers by councils of notables in Lesser Kabylia (Constantine province).44 In addition, exemptions from the impôts arabes were granted to certain categories of individuals who served colonial authorities such as spahis (native elite cavalry) or indigenous soldiers wounded in action.45 Indigenous officials in charge of tax-collection were also, in practice, exempted, their more extended fiscal privileges and more stable position than under Turkish rule enabling them to become a new sort of Algerian ‘nobility’.46 However, the main fiscal inequity remained the exemption of Europeans from land taxation. The legal ground for this exemption was vague. It was not French nationality, since other European settlers, who made up approximately half of the European population in Algeria until the 1880s, were also exempted. It was not religion either, since indigenous Jews were also subjected to the impôts arabes. Unsuccessful attempts at codification of the impôts arabes merely described the exemption of Europeans as an incentive for colonisation, or as a compensation for the frugal lifestyle of indigenous inhabitants, who therefore paid less than settlers in indirect

43

‘Projet de décret sur les impôts arabes – Rapport’, c. 1851, 5–6, CAOM, F 80 1822. ‘Projet de décret’, c. 1851, at 4–7, CAOM, F 80 1822; Procès-verbaux de la commission institué à l’effet de préparer La substitution de la contribution foncière aux impôts arabes (Algiers, 1862) 20–2; see also Commission d’études de l’impôt arabe (Algiers, 1893) 31–6, 173–80. 45 On the exemption of Spahis, see administration des contributions directes to the General commanding the Algiers province, 12 July 1873, CAOM, 1 I 141/2; on the exemption of wounded indigenous soldiers, see Governor General of Algeria to the Generals commanding the provinces of Oran, Algiers and Constantine, 4 March 1850, CAOM, F 80 936. 46 P Von Sivers, ‘Les plaisirs du collectionneur: capitalisme fiscal et chefs indigènes en Algérie (1840–1860)’ (1980) 35 Annales: économies, sociétés, civilisations 679. 44

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taxes. Several civil servants nevertheless remained uncomfortable with this exemption. A member of the commission of 1861, the director of the domaines in Constantine, declared that the present fiscal situation of Algeria resembled ‘the one that prevailed in France in 1789’: it was characterised by ‘a land tax that spare[d] the properties of Europeans . . . just as the taille used to spare the properties of churchmen, noblemen and bourgeois from free cities’.47 The variety of land-taxation regimes was indeed reminiscent of the Ancien Régime, except that fiscal status was implicitly based on ethno– religious categories rather than membership of an estate: Christian Europeans were exempted; Kabyles, often described by the French as more amenable to civilisation than Arabs, benefited from a level of per capita taxation approximately two-thirds lower than other indigenous inhabitants; and Arabs and Jews were subjected to the hokor, achour and zekkat.48 Legal intricacies resulting from the diversity of statuses also recalled the Ancien Régime. One of the most enduring difficulties was the case of indigenous farmers who exploited European-owned land. The frequent absence of individual property rights in Arab tribes made it difficult to determine whether it was the proprietor or the cultivator of a plot who owed the impôts arabes. In 1849, the Algiers Conseil de Gouvernment ruled that indigenous farmers cultivating European properties ought to pay the taxes unless they were sharecroppers living with Europeans. But, in 1858, the French Government, giving in to the pressure of European large landowners, issued a decree that reversed the decision. The contentious issue would only be settled in 1872, when another decree would restore the situation prevailing between 1849 and 1858.49 Rationalisation and extension of the impôts arabes to privileged categories of the population may have sufficed to reduce heterogeneity. But advocates of reform criticised the taxes on grounds of fiscal efficiency as well as equity. The uneven distribution of the tax burden itself, they argued, tended to reduce yields by sparing many rich farmers, including European settlers. The annual frequency of vexatious assessments, several added, tended to erode consent and might provoke tax revolts. Advocates of reform also denounced the sharp annual variations in revenue due to the sensitivity of the tax base to climatic events or epizootics. Perhaps the most common criticism was the conviction that proportionality of the impôts arabes in Algiers and Oran discouraged the growth of agricultural productivity: uncultivated land was left untaxed and taxation captured too large a

47

Procès-verbaux (1862), above n 10, at 76. On the French perception of the Kabyles, see PME Lorcin, Imperial identities: stereotyping, prejudice and race in colonial Algeria (London, 1995) 146–69. 49 Governor General to the General commanding the province of Algiers, 17 April 1852, CAOM, 1 I 141; ‘Note’, 30 June 1874, CAOM, F 80 1823. 48

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share of output gains. According to the President of the Commission of 1861, an inspecteur general des finances, only a quota land tax would ‘goad…landowners on the path of improvements aiming at an increase in agricultural products’.50 The solution, the advocates of reform concurred, lay in the refashioning of land taxation on the model of the metropolitan impôt foncier. Such a project also tallied with the French design to transform Algeria in an integral part of France. According to the Commission of 1851, reform of land taxation would ‘further reduce the distance, through administrative assimilation, between the conquered land and the motherland’. The Commission of 1859 wished not only ‘to substitute law to arbitrary rule and equality to privilege’ but also to create ‘contact points’ between land taxation in Algeria and the impôt foncier, which would ‘later facilitate the work of assimilation’.51 Reform, the Commission of 1861 argued, would be ‘a great step towards assimilation’.52 Yet two obstacles rendered the immediate implementation of the metropolitan land tax in Algeria impossible: the prevalence of collective property among Arab tribes, and the absence of reliable estimates of each property’s productive capacity. The four projects therefore proposed transitory formulae, until the adoption of private property and the completion of an Algerian cadastre. The Commission of 1851 proposed the creation of a new unique tax, the gherama or impôt sur les revenus fonciers (land-income tax) on all agricultural products (grain, cattle, but also olives, figs, dates etc.). The gherama would be a quota land tax with a quota fixed for three years and individual contributions based on estimates of average land produce; a fixed lezma would be levied in tribes where such an estimate was not available yet.53 The Commission of 1859 put forward a three-tier project with a quota land tax based on the assessed value of land properties in territories under civilian administration, a proportional land-income tax similar to the project of gherama in military territories, and a fixed lezma in tribes where assessment operations were impossible. Tribes would accede from the second or the third to a superior tier as civilian territories expanded and as assessment became possible, while European properties would eventually be subjected to the same tax as indigenous properties in the first tier.54

50

Procès-verbaux (1862), above n 10, at 42–3. ‘Projet de décret’, c. 1851, at 4; Ministry of Algeria, report on the reform of the impôts arabes, March 1859, CAOM, F 80 1822. 52 Procès-verbaux (1862), above n 10, at 92. 53 ‘Projet de décret’, c. 1851, at 9–17, CAOM, F 80 1822. 54 ‘Rapport de la commission chargée d’examiner un projet de réforme de l’impôt arabe’, 25 November 1859, and project of arrêté on ‘assiette et le recouvrement des impôts perçus sur les indigènes en Algérie’ [1859], CAOM, F80 1822 51

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The Commission of 1861 opted for a land tax with a contingent fixed for 10 years and determined by the average proceeds of the impôts arabes in the past five years. The tax would be applied immediately to indigenous properties in civilian territories, to European properties from 1870 onward, and gradually in military territories as private property replaced collective ownership. Municipal councils in civilian territories and djemâas (councils of notables) in military territories would oversee the distribution of the tax burden at a local level.55 The project personally supported by Napoleon III was the most ambitious. In 1864, an imperial decree determined the constitution of an Algerian cadastre. The land survey would permit the establishment of matrices foncières (bases for the land tax) similar to those used in metropolitan France. The decree also invoked ‘the equality of all before taxes’ to signify that the land tax would be applied to European as well as indigenous properties.56 Between 1865 and 1867, the imperial Government elaborated plans for a land tax based on the cadastre in civilian territories, combined with a transitional quota land tax based on past tax receipts in military territories.57 Reform enjoyed strong support within the administration. Général Randon, Governor-General of Algeria between 1851 and 1858, firmly endorsed the project of the bureaux arabes: ‘This great principle [of assimilation], which regulates our general conduct in the administration of the colony, must no longer be kept out of sight in the special question of the impôt arabe.’58 The Conseil Supérieur de l’Algérie, a legislative body constituted in the majority by civil servants, approved the project elaborated by the Commission of 1861, and the reporter of the Conseil asserted: The superiority of the contribution foncière over the tithe, for which it was substituted by our great Constituent Assembly, cannot be contested. The tithe is the tax of primitive peoples; the impôt foncier, by contrast, is adopted by the peoples engaged on the path of civilization. The progress achieved in France was so celebrated, so conspicuous that we have seen most European states imitate our example.59

55

Procès-verbaux (1862), above n 10, at 108–14, 126–7, 137. Governor General to the Minister of War, 22 May 1864, ‘Rapport à l’Empereur, approuvé le 2 juillet 1864’, and ‘Note sur l’établissement de l’impôt foncier en Algérie’, c. 1865, CAOM, F 80 1823. 57 ‘Rapport sur la lettre impériale’ and ‘projet d’arrêté’, c. 1866, CAOM, 1 I 141/1; see also later descriptions of the project in ‘Situation des travaux du cadastre’, 1869, ‘Note sur le régime financier de l’Algérie’, 17 June 1869, and ‘Transformation des impôts arabes en un impôt unique’, c. 1869, SHAT, 1 H 238. 58 Général Randon, 1853, cited in minutes of the Conseil de Gouvernement, 23 January 1885, CAOM, 3 F 102, fols 109–10. 59 Minutes of the Conseil Supérieur de l’Algérie, 11 and 17 October 1862, CAOM, 2 F 1, fols 45–7. 56

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None of the four projects, however, was eventually implemented, and only minor adjustments were carried out. In 1855, civilian and military local authorities were authorised to levy centimes aditionnels (additional cents) on the hokor, achour and zekkat to finance public works, a mechanism similar to the additional cents on the impôt foncier levied by metropolitan departments. In 1858, the zekkat was extended to the Constantine province, and the rate of the hokor slashed by a third to compensate the resulting increase in fiscal pressure. In 1862, the rates of the achour were harmonised within the provinces of Oran and Algiers, and in 1867 between the three provinces. In 1863, a uniform rate of the zekkat was adopted throughout the colony. In civilian territories, the surveillance of assessment and collection was transferred from the bureaux arabes to a new administration des contributions directes.60 Unfavourable circumstances contributed to the failure of reform. The mobilisation of a large fraction of French forces in Algeria for the Crimean War (1853–56) led to the indefinite postponement of the proposals put forward by the Commission of 1851. The project of 1859 was elaborated under the auspices of a new Ministry of Algeria created in 1858, and was abandoned after the abolition of the Ministry in 1860. The SenatusConsulte of 22 April 1863 rendered obsolete the proposals of the Commission of 1861. The attempt at reform sponsored by Napoleon III coincided with a series of poor harvests and epizootics. Yet each attempt also met with a more decisive factor: the determined opposition of European settlers, who feared the loss of their fiscal privileges and who enjoyed the support of liberals and republicans in metropolitan France. The advent of the Third Republic in 1871 would result in the definitive abandonment of reform.

III. THE FAILURE OF REFORM AND ITS CONSEQUENCES (1867–1919)

Since the 1830s, ‘assimilation’ had served to justify the settlement of Europeans in Algeria. Daily interactions with Europeans, it was argued, would spread civilised mœurs and more advanced farming techniques. Yet it was European settlers who foiled fiscal assimilation. In their efforts to thwart reform, they received the support of the left, supposedly the guardian of the French Revolution’s ideals. Settlers and Republicans narrowly reinterpreted fiscal assimilation as the supervision of assessment and collection operations by civilian functionaries rather than officers from the bureaux arabes. The irregularity of the tax base, proportionality and 60 Procès-verbaux (1862), above n 10, at 15; Etude sur les impôts arabes (Algiers, 1879) 19–24.

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exceptional tax regimes were left untouched because a more comprehensive reform would have called into question the exemption of European settlers. The ensuing fossilisation of the impôts arabes contributed to the failure of political assimilation and to the colony’s enduring financial difficulties. European settlers paid lip service to the necessity of fiscal reform and the virtues of the impôt foncier, but their proposals radically differed from those put forward by the administration. Re-appropriating the rhetoric of assimilation, they demanded that French civilian functionaries replace indigenous officials and French officers to conduct assessment and collection operations. Such a change, they claimed, would reduce corruption and significantly increase tax yields. In reality, they wished to curtail the army’s influence in the colony and the authority of indigenous officials, whom they perceived as the Bonapartist army’s clients. Their claims also diverted public opinion from the other problems posed by the impôts arabes. Already in 1858, a settlers’ spokesman, Clément Duvernois, accused ‘Arab lords’, with the complicity of the bureaux arabes, of pocketing 8–10 million francs in taxes owed to the French state. In 1865, Auguste Warnier, a leading figure of the arabophobe party, put embezzlement by indigenous officials and French officers at an extravagant 48 million francs.61 Metropolitan liberals and republicans echoed these representations. They opposed the Emperor’s arabophile policy because they suspected him of scheming to use the unenlightened Arab masses as a new prop of his regime, just as he had manipulated the French rural masses in order to seize power in 1851. They also empathised with French settlers, who were often political exiles and had turned the colony into an anti-Bonapartist stronghold. At the plebiscite organized by Napoleon III to bolster his legitimacy in 1870, the ‘no’ vote reached 54 per cent among the Algerian electorate (composed exclusively of French settlers), against only 17.6 per cent in metropolitan France.62 Liberals and Republicans were therefore not inclined to support fiscal reform in Algeria and preferred to denounce the ‘feudal’ organisation of tax collection as the main flaw of the impôts arabes. In May 1864, at the Corps Législatif, a liberal deputy called indigenous officials who collected taxes ‘professional thieves’ and asserted that the root of the problem lay in Muslim moeurs, and you will not only find it in Algeria, you will find it in Turkey, you will find in Persia, you will find in Syria … and in all Muslim countries. These moeurs are a hundred years behind the times.

61 C Duvernois, L’Algérie. Ce qu’elle est. Ce qu’elle doit être (1858) 149–86; A Warnier, L’Algérie devant l’empereur (Paris, 1865) 9, 24–6, 42. 62 Ageron and Julien, Histoire de l’Algérie contemporaine, above n 5, vol. I, at 446.

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Concurring with his colleague, a Republican deputy accused the Second Empire of ‘[having] resuscitated in Africa the system, which apparently seemed done away with, of the fermiers généraux … for the benefit of the kaid’.63 As mentioned above, a severe agricultural crisis also stalled Napoleon III’s project of fiscal reform—between 1865 and 1868, a combination of dry weather, swarms of locusts and epizootics resulted in a dramatic fall of the agricultural output and one of the worst famines in Algerian history. Estimates range from 400,000 to 1 million deaths, representing between 15 and 40 per cent of the indigenous population. Several historians have pointed to the increasingly commercial character of Algerian agriculture as one of the famine’s main causes. The rise of agricultural exports and the more frequent use of cash—encouraged by the payment of the impôts arabes in cash—had led to the depletion of traditional reserves of foodstuffs, and left tribes unprepared for the shortfalls of the late 1860s.64 A secondary consequence of the famine was a major financial crisis. Since 1845, the impôts arabes had become the main fiscal resource of the Oran, Algiers and Constantine départements.65 Lower agricultural yields and measures of tax relief granted by the military administration resulted in a decline of the proceeds of the impôts arabes from 13 million francs in 1863 to 7.5 million in 1868, leaving the three Algerian départements almost bankrupt.66 Agricultural crisis and the collapse of local finances might have compounded the case for land taxation reform along the lines desired by the administration and the Emperor. Yet imperial authority was weakening in the late 1860s, both in metropolitan France and in Algeria.67 In this context, crisis strengthened the hand of European settlers, who blamed the famine on the arabophile policy of the Emperor and financial difficulties on the corruption of indigenous officials and military officers charged with the levying of taxes. Settlers who testified at the 1868 inquiry on the state of Algerian agriculture rejected the creation of a universal land tax and demanded instead the abolition of ‘the feudal and theocratic links’ that bound indigenous farmers with tribal chiefs and officers from the bureaux

63 Annales du Sénat et du Corps Législatif. Session de 1864, (8 vols, Paris, 1865), vol VII 236–8, 266–77. 64 D Sari, Le désastre démographique (Algiers, 1982). 65 The share of the proceeds of the impôts arabes granted to the départements had gradually risen from one-tenth in 1845 to five-tenths in 1862 and was again increased to six-tenths in 1868; see ‘Note sur le régime financier de l’Algérie’, 17 June 1869, SHAT, 1 H 238, file 11, and ‘Note sur la situation financière des budgets provinciaux de l’Algérie’, May 1869, CAOM, F 80 1823. 66 Tableau de la situation des établissements français dans l’Algérie en 1863 (Paris, 1864), at 88–105; Statistique générale de l’Algérie de 1868 à 1872 (Algiers, 1874) 208–9. 67 R Price, The French Second Empire: an anatomy of political power (Cambridge, 2001) 290–317, 344–401.

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arabes. The Cahiers Algériens, modelled on the 1789 cahiers de doléances and drafted by a group of arabophobes led by Warnier in 1870, advocated the adoption of the metropolitan land tax in order to destroy ‘Muslim communism’, but combined with at least a 20-year exemption on European properties.68 The Third Republic, proclaimed in the wake of France’s defeat against Prussia (1870–1871), satisfied most of the settlers’ claims with regard to land property and taxation. In August 1871, a decree established a new service of recenseurs (later répartiteurs) who replaced officers from the bureaux arabes for the assessment of the hokor, achour and zekkat. In July 1873, a law relaxed restrictions on the confiscation and the buying of indigenous land, and the same year, cadastre operations were suspended, after only a tenth of the Tell had been surveyed. Furthermore, the Third Republic granted full political rights to French citizens in Algeria. Algerian deputies in Paris and the elected Conseils généraux of Oran, Algiers and Constantine would thereafter possess sufficient political influence to stymie further attempts to abolish the settlers’ fiscal privileges. When the National Assembly, dominated in 1874 by moderate royalists, renewed proposals to establish the impôt foncier in civilian territories and a quota land tax in military territories, the Algerian Conseil généraux loudly protested, and the project was abandoned after the republicans returned to power in 1876.69 The new Republican regime nevertheless altered the ethno-religious dimension of land taxation by exempting indigenous Jews from the impôts arabes. Since the 1860s, Algerian Jews had repeatedly protested against their subjection to Muslim religious taxes.70 After the provisional Republican Government collectively granted them French citizenship (Décret Crémieux of 24 October 1870), the Conseil d’Etat ruled that they no longer ought to pay the hokor, achour and zekkat.71 Yet colonial authorities continued to require payment from naturalised Jews until 1884. The reluctance of the administration was partly grounded in anti-Semitism. If ‘indigenous Jews’ were exempted, an officer in the Algiers province wrote to his superior in 1873, their propensity to ‘usury’ would enable them to ‘become the proprietors of the entire Algerian soil, at the expense of

68 Enquête agricole (Algiers, 1870), esp. p 216; A Warnier et al, Cahiers algériens (Algiers, 1870) 47–54. 69 ‘Impôts arabes—Transformation—Notes diverses’ [1874], in CAOM, F 80 1822; L Tellier, ‘Etablissement de l’impôt direct en Algérie’, 14 July 1874; ‘Rapport présenté au Conseil d’Etat’, 16 March 1875; Minister of Finance to Conseil d’Etat, 5 January 1876, in CAOM, F 80 1823. 70 Procès-verbaux (1862), above n 10, at 76; Enquête agricole, above n 58, at 276; see also requests for exemption by indigenous Jews to the Conseil d’Etat, for instance Abrahamel-Canoni, Salomon Sarfati, Maklouf-ben-Oliel et al, 13 August 1863, and Fredja Touboul, 26 July 1866, CAOM, F 80 117. 71 Decision ‘Kalfallah Assoun’, 28 November 1879, cited in L-M Trousset, Les impôts arabes en Algérie (Algiers, 1922) 42–3.

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Christians as well as Muslims’.72 But since 1865, indigenous Algerians had conditional access to French citizenship (provided in particular that they renounce Jewish or Muslim civil law), and the administration also feared that an automatic exemption would incite Muslims to request ‘a sort of en masse naturalization, which would dry up the source of the impôts arabes, although they are almost the only resource of local budgets’.73 The same fear was echoed, a few years later, by a colonist’s pamphlet on Les indigènes algériens et l’impôt arabe (1882).74 Such reticence suggests that fiscal privileges in Algeria were a significant hindrance to the extension of French citizenship: between 1865 and 1915, only 2,396 indigenous Muslims were naturalised.75 New commissions were appointed in 1884 and 1892 to study a possible replacement of the impôts arabes by an impôt foncier applicable to all communities. But in 1885, the Conseil de Gouvernement rejected the first project as impractical and politically unwise.76 The commission of 1892, for its part, only recommended minor changes in assessment procedures, and concluded that ‘the hour of [fiscal] assimilation has not yet struck’. ‘When dealing with a people immobile in its disdainful ignorance, in its beliefs, in its fatalistic and contemplative theories which it holds from religion and atavism’, the commission’s report added, ‘copying what [was] being done in France’ was ‘dangerous and chimerical’.77 Several pamphlets by settlers in the 1890s openly repudiated ‘fiscal assimilation’ as incompatible with an efficient system of colonisation, and argued that different kinds of taxes should apply to different ‘races’.78 In 1892, a committee of the metropolitan Senate regretted the persistence of ‘personal privileges grounded in certain origins’ and ‘distinctions of race’ with regard to taxation in Algeria, but admitted that metropolitan taxes only suited ‘the European lifestyle’.79 To remedy the financial crisis of the Algerian départements, the Third Republic merely increased the rates of the achour and zekkat (in 1874, 1877 and 1886), and the amount of the lezma in Great and Lesser Kabylia (in 1886). The net yield of the impôts arabes temporarily recovered, from 8 million francs in 1871 to 13 million in 1879 and 15 million in 1887. This

72 General commanding the Médéa subdivision to the General commanding the Algiers division, 8 August 1873, CAOM, 1 I 141. 73 ‘Impôts arabes—Projet de transformation’ [1872] 12–13, CAOM, F 80 1822. 74 C Bazille, Les indigènes algériens (israélites et musulmans) et l’impôt arabe (Paris, 1882). 75 P Weil, Qu’est ce qu’un Français (Paris, 2004) 225–43. 76 Minutes of the Conseil de Gouvernement, 23 January 1885, CAOM, 3 F 102, fols 102–49 77 Commission d’études, above n 44, at 308. 78 F Desoliers, De l’assimilation fiscale en Algérie (Algiers, 1895); L Bonzom, Du régime fiscal en Algérie (Paris, 1899). 79 Du régime fiscal de l’Algérie (Paris, 1892).

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has led Charles-Robert Ageron, the historian of colonial Algeria, to denounce ‘a massive increase’ in the tax burden on indigenous Algerians under the Third Republic.80 But the net yield of the impôts arabes after 1870 was not significantly higher than under the Second Empire (13 million francs in 1863). Furthermore, it soon resumed its downward trend, reaching 12.5 million in 1893 and 11.5 million in 1899. Given the rapid increase in indigenous population after 1875, the net yield per capita even declined from 5.70 francs in 1876 to 3.60 francs in 1891.81 And by 1906, the gross yield of the impôts arabes only represented 15 per cent of the colony’s revenue, against more than 50 per cent in the 1850s.82 French land taxation policy in Algeria did not therefore only fail politically, inasmuch as ‘assimilation’ was abandoned, but also financially. From the standpoint of public finances, the Algerian venture as a whole was never a profitable one for the French. Net annual transfers (French public expenditure in Algeria minus revenue extracted from the colony) declined from an average of 80 million francs per annum in the 1840s to 65 million per annum between 1851 and 1880, before rising again to more than 80 million per annum between 1881 and 1900. Such a level of transfer represented between 0.4 and 0.7 per cent of the French GDP between 1830 and 1900, an effort comparable to the level of French aid to the developing world today. The main cause of this structural deficit probably lay in the level of expenditure. Despite imperial expansion in Indochina, Tunisia, Sub-Saharan Africa and Madagascar, public expenditure in Algeria still represented more than 50 per cent of all French colonial expenditure in 1900.83 But the decreasing yield of the impôts arabes contributed to the worsening of the Algerian fiscal deficit after 1870, and the causes of this decline were representative of the French financial problem in Algeria. The decrease in yields partly reflected the growth of activities other than agriculture and the worldwide fall of agricultural prices in the late nineteenth century, proving the impôts arabes to be a poor fiscal ‘handle’ on Algerian economic development.84 Yet Algeria remained a predominantly agricultural economy well into the twentieth century, and a sharp increase in the level of metropolitan and Algerian agricultural protection in 80

CR Ageron, Les Algériens musulmans et la France, (2 vols, Paris, 1968), vol I 253–65. Statistique financière de l’Algérie 1 (1900), Statistique générale de l’Algérie en 1885– 1887 (Algiers, 1889) 6, and Statistique générale de l’Algérie en 1891–1893 (Algiers, 1894) 7–8. 82 My calculation, based on Statistique financière de l’Algérie 2 (1906) 8–9, 18–19. 83 F Bobrie, ‘Finances publiques et conquête coloniale: le coût budgétaire de l’expansion française entre 1850 et 1913’, Annales: économies, sociétés, civilisations 31 (1976) 1225, at 1231; see also F Crouzet and J-P Dormois, ‘The Significance of the French Colonial Empire for French Economic Development (1815–1960)’, Revista de historia economica 15 (1998) 323, at 324–7. 84 Ageron, Les Algériens musulmans, above n 80, vol II 724. 81

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1892 (Méline tariff) did not put an end to the decline in tax yields. Two other factors, directly related to the failure of land taxation reform, probably played a more important part: the acquisition of indigenous land by European settlers, who remained exempted from the hokor, achour and zekkat; and the poor performance of civilian functionaries in assessing and levying the same taxes, while civilian territories expanded at a rapid pace from 1871 onwards. There is little available data about the first factor. But numerous testimonies confirm that contrary to the claims of European settlers, who predicted an increase in tax receipts as the civilian administration took over from the military, répartiteurs and civilian tax collectors proved far less efficient than officers from the bureaux arabes. First, while before 1870 military officers could rely on the help of numerous indigenous agents, each répartiteur, with the assistance of a single translator, had to estimate the taxpaying capacity of ‘7,000 or 8,000 fellahs spread over an area of 150,000 to 200,000 hectares’; even the commission of 1892 (hostile to the military administration) admitted that répartiteurs were frequently obliged to underestimate land produce.85 Second, whereas military officers could resort to arbitrary fines or imprisonment in order to exact payment, civilian agents could only seize personal goods after a long judicial procedure.86 As a result, according to Auguste Vital, a friend of Ismayl Urbain residing in Constantine, the proportion of unpaid tax bills rose from less than 1 per cent in military territory to between 25 and 30 per cent in civilian territory.87 Fiscal assimilation limited to formalities—rather than the redefinition of the tax base along metropolitan lines—proved an unmitigated failure. Awareness of this failure was manifest in the land taxation policies pursued by the French in colonies acquired after Algeria. In Indochina and Tunisia, they rationalised the existing systems of land taxation and extended them to European settlers.88 The case of Morocco, which only became a French protectorate in 1911, is particularly interesting. Between 1881 and 1901, under the pressure of growing European influence and economic penetration, the Moroccan administration carried out a considerable overhaul of land taxation, partly inspired by the French experience in Algeria but designed to prevent the fiscal exemption of European

85

Commission d’études, above n 44, at 15–16. ‘Note’ by the directeur des contributions in Algiers, 13 April 1869; ‘Note sur l’Algérie’, April 1870 23–4, SHAT, 1 H 230; see also the similar conclusions of a report from 1879, cited in Ageron, Les Algériens musulmans, above n 80, vol. I 160. 87 Vital à Urbain, 30 April 1872, in Correspondance du docteur A. Vital avec I. Urbain (1845–1874) ed by A.Nouschi (Algiers, 1958) 359; see also Vital à Urbain, 10 July 1872 366–8. 88 H Guermeur, Le régime fiscal de l’Indochine (Hanoi, 1909) 83–9; N Dougui, ‘La politique fiscale du protectorat français en Tunisie (1884–1939)’, (1996) 81–82 Revue d’histoire maghrébine 183. 86

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landowners: in particular, they replaced religious taxes on land produce by a single tax payable in specie and applicable to all landowners, the tertib or ‘regulation’. The Moroccan Sultan lacked the authority to implement the reforms, and Europeans continued to evade payment. But the French administration confirmed the tertib, and its first piece of fiscal legislation in 1913 was to ensure its application to European settlers.89 In Algeria, the impôts arabes were only abolished in the wake of the First World War, partly in recognition of the indigenous Algerian contribution to the French war effort (180,000 indigenous Algerian soldiers and 200,000 workers). On 1 January 1918, a land tax on the model of the now proportional impôt foncier was introduced at a 4 per cent rate on European properties; and the following year, it was extended to indigenous properties in replacement of the impôts arabes, making Algeria one of the last French colonies to adopt uniform direct taxation regardless (at least in principle) of ethnicity or religion.90 French land taxation policy in Algeria met with some initial successes. Between 1840 and 1860, French administrators pragmatically confirmed and gradually rationalised the main taxes established by Abd al-Qadir and Ahmed Bey, using them to obtain the recognition of French sovereignty by indigenous Algerians and to encourage the commercialisation of Algerian society. But the project to replace them with the metropolitan impôt foncier failed, due to technical obstacles and, more decisively, the enduring opposition of European settlers to the abolition of their fiscal privileges. The stalling of reform aggravated the structural deficit of the Algerian colony and defeated French ambitions to export overseas the fiscal dimension of the 1789 Revolution. The vexed question of the impôts arabes was therefore a significant episode in the history of French colonial finances and contributed to the abandonment of ‘assimilation’ as the goal of French imperialism after 1860.

89 G Cattenoz, La fiscalité marocaine (Paris, 1927) 13–21, 73–95; A. El Kesri, ‘La fiscalité marocaine du protectorat à l’indépendance : étude d’un immobilisme’ (unpublished dissertation, University of Paris XII 1979) 54–64, 119–20, 164–70. 90 Trousset, Les impôts arabes en Algérie, above n 71, at 88–93; Douël, Un siècle de finances coloniales, above n 8, at 639, 651–2.

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7 We of the ‘Never Ever’: The History of the Introduction of a Goods and Services Tax in Australia from 1970 to 2005 KATHRYN JAMES

ABSTRACT Value added tax (VAT) has become one of the most pervasive tax instruments across the developed and, increasingly, the developing world. However, despite broad-based consumption tax reform dominating the Australian taxation agenda from the 1970s onwards, Australia did not introduce VAT until 1999 with the enactment of the A New Tax System (Goods and Services Tax) Act 1999. This article analyses the protracted and controversial history of the introduction of an Australian VAT from 1970 to 2005. It concludes by considering how politics can help explain both this specific history and tax reform outcomes more broadly.

I. INTRODUCTION

V

AT HAS BECOME one of the most pervasive tax instruments across the developed and, increasingly, the developing world.1 In this sense, it offers an archetypal example of what the public policy literature variously describes as ‘policy transfer’ or ‘policy convergence’. At

1 C Webber and A Wildavsky, A History of Taxation and Expenditure in the Western World (New York, 1986) 547–8; OECD, Consumption Tax Trends (Paris, 1993); J Kato, Regressive Taxation and the Welfare State: Path Dependence and Policy Diffusion (Cambridge, 2003) 25.

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their broadest, these terms denote the phenomenon whereby policy instruments are becoming progressively similar across advanced (and advancing) industrial states.2 Despite broad-based consumption tax reform dominating the Australian taxation agenda for the better part of three decades, by 2000 Australia was one of only two OECD countries which had not introduced a VAT (or goods and services tax (GST)).3 While Australia was certainly not alone in resisting this policy convergence,4 few can boast the intensity, duration and profile of the Australian effort. VAT debuted on the official reform agenda in 1974 and 1975 with the Reports of the Taxation Review Committee (the Asprey Committee) which recommended the introduction of a value added style tax.5 The recommendation failed to attract government support for the remainder of the decade, despite its later promotion by, then Treasurer of the conservative coalition government, John Howard. The second attempt crossed the partisan divide, with the Labor Government’s 1985 Draft White Paper recommending a retail sales tax (RST).6 The proposal was scuttled four weeks later at the 1985 National Tax Summit. In 1993, a 15 per cent GST was promoted by coalition opposition leader, John Hewson, as the centrepiece of the Fightback! election package.7 The package, designed to

2 The public policy literature variously describes the process as ‘policy transfer’, ‘policy diffusion’ or ‘policy convergence’. This can occur either voluntarily or coercively through mimicry, deliberate replication or forced adoption but is often attributed to the shared pressures and underlying requirements of advanced industrial economies in a global economy: RK Osgood, ‘The Convergence of the Taxation Systems of the Developed Nations’ (1992) 25 Cornell ILJ 339; H Wilensky, Rich Democracies: Political Economy, Public Policy and Performance (Berkeley, CA, 2002); R Eccleston, ‘Recycling Tax Policy? Path Dependency, Policy Transfer, Innovation and Australian Tax Policy – Insights from the Public Policy Literature’ (paper delivered to the Australasian Taxation Teachers Association Conference, Melbourne University Law School, 31 January 2006). 3 The other being the United States where retail sales tax is levied at the state and local level: OECD, Consumption Tax Trends: VAT/GST and Excise Rates, Trends and Administration Issues (2004 edn., Paris, 2005) 20. 4 For example, see the controversies surrounding GST reform in Japan and Canada (the latter precipitating a minor constitutional crisis and contributing to the demise of the Progressive Conservative Party): See N Brooks, The Canadian Goods and Services Tax: History, Policy, and Politics (Sydney, 1992); S Blount, ‘The politics of taxation: the introduction of the GST into New Zealand, Canada, Japan and Australia’ (2001) 16(4) Australian Tax Forum 439. 5 The Committee is commonly referred to as the Asprey Committee, after its chair, New South Wales Supreme Court Justice, Kenneth Asprey. Further references will be made to the ‘Asprey Committee’ and to the ‘Asprey Reports’ when referring to the Committee’s reports: Taxation Review Committee (Asprey), Commonwealth of Australia Parliament, Preliminary Report (Canberra, 1974), Taxation Review Committee (Asprey), Commonwealth of Australia Parliament, Full Report, (Canberra, 1975). 6 Treasury, Commonwealth of Australia, Reform of the Australian tax system: Draft White Paper (Canberra, 1985). 7 Liberal Party of Australia, Fightback! It’s your Australia: the way to rebuild and reward Australia (Canberra, 1991); Liberal Party of Australia, Fightback! the Liberal and

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return the conservative coalition to office after 13 years in opposition, virtually single-handedly caused the loss of the ‘unlosable’ election. The fall-out from this electoral disaster prompted the then leader of the opposition, John Howard, to issue a ‘never ever’ declaration in 1995 that hailed the death of the GST as Liberal-National coalition policy.8 However, like Lazarus rising from the dead, less than three years later, a 10 per cent GST was proposed as the core component of the, by then incumbent, Howard conservative government’s 1998 election tax reform package. The package, unassumingly entitled, A New Tax System (ANTS) promised, as the name implied, ‘not a new tax’, but ‘a new tax system’.9 On 3 October 1998, the Government was narrowly returned to office enabling it to negotiate passage of the legislation through the Australian Senate on 28 June 1999.10 On 8 July 1999, the Commonwealth Parliament of Australia enacted A New Tax System (Goods and Services) Act 1999 (Cth), which heralded the introduction of a GST into the Australian tax system after more than 25 years of reform efforts. Central to this tale is Howard’s ‘never ever’ declaration which gives rise to its literary parallel—the ‘never never’. The ‘never never’ occupies a central role in Australian mythology—as the metaphor for the inimitable Australian outback famously captured in Jeannie Gunn’s We of the Never Never, where the author describes how she overcomes the hostility and resistance of the ‘never never’ eventually to find acceptance.11 However, ‘never never’ has other connotations—it can also signify a fantasy or utopia promised in the place of a real benefit.12 Depending on the perspective of the reader, this might be an equally appropriate metaphor for the history of the Australian GST. An analysis of the history of the Australian GST offers the opportunity to develop a framework from which to further our understanding of the complex web of factors that combine to guide the tax reform process. To this effect, the history of Australia’s GST will be divided into four parts reflecting the four major phases of the reform effort from 1970 to 2005, which broadly centre on the following events:

National Parties’ plan to rebuild and reward Australia (Canberra, 1991); Liberal Party of Australia, Fightback! Fairness And Jobs (Canberra, 1992). 8 M Grattan, ‘Howard Bans GST “Forever”’, 3 May 1995, The Age, 5; I McAllister and C Bean, ‘Electoral politics of economic reform in Australia: the 1998 Election’ (2000) 35(3) Australian Journal of Political Science 383 at 388. 9 Treasury, Commonwealth of Australia, Tax Reform: not a new tax, a new tax system (Canberra, 1998) (circulated by Peter Costello, Treasurer of the Commonwealth of Australia). 10 Taking effect on 1 July 2000. 11 J Gunn, We of the Never Never (Richmond, 1908). 12 Such a reading is reminiscent of ‘never land’ or ‘never never land’ in JM Barrie’s famous novel Peter Pan (London, 1928).

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Kathryn James 1974–75: Asprey Committee Reports; 1985: Draft White Paper and National Taxation Summit; 1993: Fightback! election campaign; 1998: election campaign—A New Tax System (2000).

The chapter concludes by considering the potential for further research to explain the trajectory of tax reform. As the introduction of a GST into the Australian legal system is as much a story of recent Australian political history as it is an exegesis in the Australian taxation policy process, it is worth prefacing this analysis with some historical context.

II. POLITICAL CULTURE, TAX HISTORY AND THE NATURE OF THE WELFARE STATE

A. Political Institutions The Australian federal state functions according to the rules prescribed by the written Constitution, which gave rise to the Federation in 1901.13 The federal Parliament is bicameral. The lower house, the House of Representatives, is strongly majoritarian and adversarial. Two major political groupings have overwhelmingly dominated the lower house—the Conservatives (the current incarnation being the Liberal and National coalition) and the Labor Party (ALP). In contrast, the upper house, the Senate, primarily owing to its proportional representation, has evolved to become a powerful house of review with few governments holding a Senate majority over the reform period.14 The centre–left party, the Democrats, has held the Senate balance of power at various times since its formation in 1977 and has consequently played an important role in recent political history. In the Westminster tradition, the Executive is drawn from the party controlling the majority of the House of Representatives. As a constitutional monarchy, the Queen,15 represented by the Governor-General, is the head of state. However, the Prime Minister, who in the parliamentary tradition leads the majority of members in the House of Representatives, is

13 Commonwealth of Australia Constitution Act 1900 – hereafter referred to as the ‘Constitution’. 14 Since 1972 the Government has controlled the Senate on only three occasions for a total period of approximately six years – twice by the Fraser Coalition Government and later by the Howard Coalition Government. 15 Queen of the United Kingdom, who is also the Queen of Australia.

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the head of government. Economic policy, including tax policy, has remained the predominant domain of Treasury.16

B. Tax History The history of Australian taxation policy broadly resembles the major trends of taxation in Western democracies.17 That is, over the course of the twentieth century the tax base has evolved from a primary reliance on indirect consumption taxes (mainly customs duties) to mass direct progressive income taxation to fund war efforts and the post-war welfare state.18 However, since the worldwide economic shocks from the 1970s oil crises, attempts to shift the emphasis from income tax to a greater reliance on consumption taxation in Australia have ensued. The reasons for this shift are as numerous as they are contested. The shift has in part resulted from the simultaneous decline of the Keynesian consensus and the influence of neo-classical economic rationalism. Moreover, the trend was further fuelled by a growing body of literature claiming adverse labour force participation from high marginal tax rates and by admissions by tax reformers of their failure to fix the income tax base. This provided advocates of consumption tax reform with two key lines of attack: first, the progressive system might not be as progressive as claimed (although this ignored the overwhelming evidence to the contrary); secondly, a consumption tax might catch some who slipped through the inadequate income tax net.19 As with other industrialised democracies, Australia relies on a small number of taxes to generate revenue, with most revenue derived from income and consumption taxation.20 The Federal Government dominates 16 Tax policy is also influenced by the Ministry of Finance and the Department of Prime Minister and Cabinet (DPMC) and the revenue collection authority – the Australian Tax Office. This unique division between Treasury and Finance was introduced by Prime Minister Fraser in 1976 in order to break Treasury’s monopoly on economic advice: C Sandford, Successful Tax Reform: Lessons from an Analysis of Tax Reform in Six Countries (Bath, 1993) 84; A Fenna, Australian Public Policy (2nd edn., Frenchs Forest, NSW, 2004) 263. 17 See S Steinmo, ‘The evolution of policy ideas: tax policy in the 20th century’ (2003) 5(2) British Journal of Politics and International Relations 206. 18 See generally JP Smith, Taxing Popularity: The Story of Taxation in Australia (revised edn, Canberra, 2004); R Eccleston, The Thirty Year Problem: The Politics of Australian Tax Reform (Sydney, 2004); Fenna, above n 16, at ch 11; S Reinhardt and Steel, ‘A brief history of Australia’s tax system’ (2006) Economic Roundup 1. 19 For a general discussion of these broader trends, see: J Slemrod (ed), Tax progressivity and income inequality (Cambridge, 1994); Brooks, above n 4, at 107–14, 163–9. 20 From 1965 to 2000 income tax receipts constituted between 11.8 and 18.1% of GDP (or approximately 50–60% of total tax revenue), while consumption tax receipts (including customs and excise duties and the WST) constituted between 7.6 and 9.9% of GDP (or approximately 30–35% of total tax revenue): OECD, Revenue Statistics: 1965–2004 (Paris, 2005) 107–8.

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the raising of taxation revenue. This is largely the result of a series of constitutional decisions by the High Court which have effectively given the Commonwealth exclusive de facto power to levy income and exclusive de jure power to levy sales taxes.21 These taxes overwhelmingly contribute the vast bulk of Australia’s revenue. The resulting legacy is ‘vertical fiscal imbalance’ whereby revenue-poor states bear half the burden of public expenditure and are therefore left dependent on the largesse of the Commonwealth, which collects approximately 80 per cent of Government revenue.22 The revenue consequences of the imbalance are borne out in tax politics, with citizens remaining ‘blind to the inconsistency of demanding better state Government services while resisting higher Commonwealth taxes’.23 From 1930 to 2000, a wholesale sales tax (WST) formed a major part of the indirect tax base. Initially introduced in 1930 to offset declining customs revenue yields resulting from the economic Depression, the schedular tax was levied at the wholesale level on a narrow base of goods.24 The ad hoc approach to the WST’s introduction continued until its demise in 2000, by which time the WST had endured sporadic alterations, increases and exemptions resulting in increased complexity, inefficiency and regressivity. By the late twentieth century, the WST was an easy target for those who advocated broad-based consumption tax reform.

C. Social Trends and Spending Although Australians enjoy a relatively high standard of living, in keeping with the modern capitalist trend, there is marked inequality between rich and poor.25 By OECD standards, Australia is a low-tax and low-spending 21 The concurrent taxing power between the Commonwealth and States under s 51(ii) of the Constitution has been severely circumscribed by two key lines of High Court decisions. First, in 1942 the Commonwealth, in order to meet its wartime revenue needs, successfully made grants of financial assistance to the States under s 96 conditional on the States abandoning their income taxes. This resulted in the Commonwealth’s monopolisation of income tax: State of South Australia v Commonwealth (Uniform Tax case (No 1)) (1942) 65 CLR 373; Victoria & New South Wales v Commonwealth (Uniform Tax case (No 2)) (1957) 99 CLR 575. Second, the High Court’s expansive interpretation of the Commonwealth’s exclusive power to impose customs and excise duties under s 90 of the Constitution has effectively excluded the States’ levying sales tax: See Ha & Lim v New South Wales (1997) 189 CLR 465; Capital Duplicators Pty Ltd v Australian Capital Territory (No 2) (1993) 178 CLR 561. 22 Fenna, above n 16, at 173. 23 See Smith, above n 18, at 154. 24 This was due to the Scullin Labor Government’s concern to maintain progression in the tax system by taxing luxury goods: Eccleston, above n 18, at 35. 25 ABS, ‘Income Distribution: Trends in earnings distribution’ 4102.0—Australian Social Trends (2000): in the first major study of wealth distribution in Australia since 1915, wealth was found to be much more unevenly distributed than income. It was estimated that in 2002,

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state.26 Tax revenue has hovered around 25–30 per cent of GDP from 1965 to 2004, placing it consistently about 5 per cent below the OECD average.27 D. Australian Political Culture Perhaps as a reflection of its geographic isolation, the tradition of Australian public policy has been isolationist or, as one commentator argues: ‘Australia has tended to insulate itself from the rest of the world to an abnormal degree.’28 Twentieth-century examples of this trend include the White Australia Policy’s migration restrictions, tariff protection for domestic industries and centralised wage-fixing.29 While these policies have been phased out to varying degrees, the approach continues to inform Australian public policy. Although efforts to divine national cultural norms are fraught with difficulty, there is, at least in much political discourse, an emphasis on a ‘fair go’. Of course, as with most norms or values the content of the notion is subject to endless political manipulation. Increasingly, however, the use of the term ‘fair go’ in political discourse connotes fairness of opportunity (for some) rather than fairness of outcome (for all).30 Whether influenced by this isolationist tendency or otherwise, commentators have remarked upon the conservatism31 of the Australian electorate as evidenced by a reticence for change, particularly evident at constitutional referenda.32 Moreover, the electorate’s scepticism of self-interested elites and a growing embrace of populism33 have recently been prominently demonstrated by the parliamentary success in the late 1990s of the 45% of Australia’s net wealth was held by the richest 10% of Australians while the bottom half of the population held just 8.8%: B Headey, D Warren and G Harding, Families, Incomes and Jobs: A Statistical Report of the HILDA Survey (Melbourne, 2006). 26 D Warburton and P Hendy, International Comparisons of Australia’s Taxes, (Canberra, 2006) xv. 27 OECD, Revenue Statistics: 1965–2004 (Paris, 2005) 67–9. 28 See Fenna, above n 16, at 28. 29 See Fenna, above n 16, at 216–18; See Eccleston, .above n 18, at ch. 2. 30 Some formal political efforts to capture the notion of a ‘fair go’ include the legislative insertion of a ‘fair go all around’ in s 635 of the Workplace Relations Act 1996 (relating to termination of employment). In 1999, Prime Minister Howard (among others) put forward various proposals for a preamble to amend the Constitution. The initial proposal read: ‘We value excellence as well as fairness, independence as dearly as mateship.’ The final proposal (rejected by referendum in 1999) read: ‘We the Australian people commit ourselves to this Constitution…supportive of achievement as well as equality of opportunity for all’ (emphasis added): Constitution Alteration (Preamble) Bill 1999; D Gough, ‘Australians value a “fair go” highest’, The Sunday Age, 12 November 2006 at 6. 31 ‘Introduction and Summary’ in B Tran-Nam (ed), Tax Reform and the GST: An International Perspective (St Leonards, 1998) 4; See Fenna, above n 16, at 53. 32 Only eight of 44 proposals to amend the Constitution have been carried. 33 See Fenna, above n 16, at 57.

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xenophobic One Nation party and its subsequent impact on mainstream government policy.34 This ‘strong populist streak’ extends to tax policy and, when combined with an adversarial two party political system, makes ‘it exceedingly difficult to pass tax legislation without first demonstrating … considerable popular support in the community’.35

E. Economy By OECD standards, Australia has a small domestic economy. A large amount of Australia’s export revenue comes from primary resources and agriculture.36 Its population of 21 million people37 means there is not a large home market to support domestic industries, thus making Australia heavily export-dependent and vulnerable to external market trends. Following the relative stability of the post-war years, the Australian economy experienced the cyclic instability of most Western industrialised economies after the 1970s oil crises.38 Table 7.1 shows the key macroeconomic indicators over this period. Consistent with global trends, the economy suffered three recessions (in 1974, 1982 and 1991)39 followed by corresponding periods of expansion.40 The economy underwent high inflationary periods in the mid-1970s and early and late 1980s. Unemployment has become a permanent feature of the macroeconomic landscape, growing from a stable average of 1–2 per cent in the early 1970s to 5–6 per cent by the end of the decade and peaking at approximately 10 per cent in the early 1980s and 1990s. The structure of the Australian economy and the exponential growth in foreign debt led to, the then Treasurer, Paul Keating’s infamous warning in 1985 that Australia was in danger of 34 For example, following the Tampa Crisis (where the Australian Government refused permission for the Norwegian cargo vessel the MV Tampa to dock following the ship’s rescue of 460 asylum seekers) the 2001 Federal Election campaign was dominated by the issue of border protection whereby John Howard campaigned on the slogan ‘we decide who comes into this country and the circumstances in which they come’: see D Marr and M Wilkinson, Dark Victory (Crow’s Nest, NSW, 2003). 35 PD Groenewegen, Australian Taxation Policy (2nd edn, Melbourne, 1987) at 171. 36 See Fenna, above n 16, at 26. 37 Estimated at 21,838,520 as of 8 July 2009: ABS, ‘Population Clock’, available at: http://www.abs.gov.au/ausstats/ 38 Australia’s ability to supply its own domestic oil market insulated it from the direct impact of the worldwide rise in crude oil prices, however, it suffered from the effects of the global economic downturn and later experienced the full effects when in the 1977–78 Budget domestic oil prices were brought into parity with world oil prices: Treasury, Commonwealth of Australia, Annual Report 2000–2001 (Treasury 2001). 39 A mini-recession may also have occurred in 1977, however, the Reserve Bank of Australia (RBA) argues it might better be regarded as a ‘pause’ in the late 1970s recovery: Reserve Bank of Australia, Semi-Annual Statement on Monetary Policy (Canberra, 1997) 4. 40 See Fenna, above n 16, at 245.

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becoming a ‘Banana Republic’.41 However, following the recovery from the 1991 recession, the Australian economy has experienced strong growth, declining unemployment and low inflation.42

Table 7.1: Key macroeconomic indicators43 1950s

1960s

1970s

1980s

1990s

Real GDP growth

4.2

5.3

3.5

3.3

3.5

Per capita GDP growth

1.8

3.3

1.8

1.7

2.3

CPI inflation

6.1

2.5

10.1

8.3

2.3

Unemployment rate

2.2

2.2

4.2

7.6

8.9

−2.2

−3.0

−1.8

−4.7

−4.4

Current account deficit (percentage GDP)44

The bipartisan policy response to the volatile economic conditions has been one of financial deregulation,45 tariff reduction, privatisation, agreement-based industrial relations reform, targeted low inflationary policies46 and the maintenance of government budget surpluses. With economic uncertainty translated into electoral volatility and with political success increasingly dependent on economic indicators, taxation, which is viewed as a key tool of macroeconomic management, has been fiercely contested.47 Nowhere has this been more evident in Australia, than in the attempts to introduce a broad-based consumption tax. 41 That is, an insolvent resource-based economy dependent on the goodwill of overseas lenders. Australia’s current account deficit rose from an average of 2.75% of GDP between 1959 and 1984 to an average of 4.75% of GDP from 1985 to 2005; net foreign liabilities rose from 6% of GDP in June 1981 to about 30% of GDP in the mid-1980s and is currently at 51.3% of GDP: See Fenna, above n 16, at 208; Australian Bureau of Statistics, 5302.0— Balance of Payments and International Investment Position, Australia, March quarter 2006 (Canberra, 2006). 42 Unemployment fell from 10.5% in 1992 and is currently around 5%; growth has averaged approximately 3.5%; the average CPI rate has been 2.5% per annum. Nevertheless, foreign debt levels remain high: see Fenna, above n 16, at 245. 43 D Gruen and G Stevens, Australian Macroeconomic Performance and Policies in the 1990s (Research Paper) (Canberra, 2000) at 33. 44 Excludes Reserve Bank of Australia gold transactions. 45 Ushered in by the December 1983 floating of the Australian dollar. 46 The macroeconomic policy response has been one of ‘fight-inflation-first’, with monetary policy deliberately targeted at keeping the underlying inflation rate within a band of 2–4%: See Fenna, above n 16, at 266. 47 Studies show that voters use a combination of macro and micro economic factors in deciding how to vote. Following the economic instability of the 1970s, Australians’ voting behaviour has been influenced by perceptions of economic insecurity: see McAllister and Bean, above n 8, at 392.

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A. Phase 1—the 1970s and the Asprey Committee The Asprey Reports marked the first official endorsement of a broad-based consumption tax in Australia.48 The Asprey Committee conducted what was, and arguably still is, the most comprehensive review of the Australian taxation system.49 From its announcement on 11 April 1972, the Asprey Committee was destined to be used as a political pawn. It was an uncertain election year where the conservative Coalition Government, led by Prime Minister William McMahon, was faced with the very real prospect of electoral defeat. The Committee’s announcement was precipitated by growing criticisms of the systemic inefficiency and inadequacy of the Australian taxation system. In particular, inflation-induced bracket creep was said to be increasing the tax burden on low-middle income earners and encouraging the tax avoidance activities of high wealth and income taxpayers.50 Groenewegen attributes the review to a strategic political response to deflect criticism by allowing ‘softer tax reform options to be exercised [early]…and the more difficult problems to be postponed until the Committee reported’.51 The strategy entailed a cynical, albeit unspoken, acknowledgement of the many and varied means to ‘snow’ a report.52 However, it failed to prevent the Gough Whitlam led ALP from assuming office after 23 years in opposition. Despite the Whitlam Government maintaining its rhetorical support for the Asprey Committee, the calamitous economic and political events culminating in the Government’s extraordinary demise in the constitutional crisis of November 1975 ensured the rhetoric was never translated into reform.53

48 The Asprey Committee produced both a Preliminary Report on 1 June 1974 and a Full Report on 31 January 1975: Taxation Review Committee (Asprey), Commonwealth of Australia Parliament, Preliminary Report (Canberra, 1974) (Asprey Preliminary Report); Taxation Review Committee (Asprey) Commonwealth of Australia Parliament, Full Report (Canberra, 1975) (Asprey Full Report); Prior to Asprey the (non-government) Downing Report rejected a broad-based consumption tax on equity grounds: RI Downing and Social Science Research Council of Australia, Taxation in Australia: agenda for reform (Melbourne, 1964) 173. 49 The Asprey Committee received 605 submissions: 21 papers prepared by Treasury and the ATO (only 13 were published) and commissioned and/or considered nine studies: See Asprey (1975), above n 48. 50 PD Groenewegen, Everyone’s guide to taxation in Australia (Sydney, 1985) at 46–7. 51 Groenewegen, above n 50, at 137–8. 52 Groenewegen, above n 50. 53 The 1975 crisis arose from the Senate blocking the Government’s supply Bills, which led to the sacking of the Whitlam Government by the then Governor-General, Sir John Kerr,

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B. Content of the Asprey Reports The central recommendation of the Asprey Reports was that ‘the weight of taxation should be shifted towards the taxation of goods and services and away from the taxation of income’.54 To facilitate this shift in the tax mix, the reports recommended the introduction a broad-based value added tax and the abolition of the existing WST.55 The reports painstakingly developed the template used for much subsequent tax reform discourse: first, diagnose a ‘crisis’ in the Australian tax system56; second, thoroughly analyse and assess the broader normative criteria of equity, simplicity and efficiency57; third, wrestle the competing gravitational pulls of equity against efficiency and simplicity while addressing the failed realisation of progressivity58; and finally, prescribe reform.59 In this case, the Asprey Reports erred on the side of simplicity and efficiency through shifting the tax base towards consumption. However, they sought to facilitate fairness through both broadening the income tax base to include capital gains and by alleviating regressivity through appropriate transfer provisions and tax exemptions.

C. Reception of Asprey Reports The reaction to the Asprey Reports ranged from open hostility to dismissal. The financial press declared ‘Asprey Tax Flop’60 and derided the largely ‘academic tract’ as a ‘lawyers’ goldmine’.61 Academic reviews

on 11 November 1975 and the calling of a double dissolution election: See J Richardson, Resolving Deadlocks in the Australian Parliament: Research Paper 9 (2000–01) (Canberra, 2000). 54 See Asprey (1975), above n 48, at 530. 55 Specific proposals in relation to income tax included the compression and reduction of tax rate scales (especially in the lower ranges to offset the impact of a broad-based consumption tax) offset by base-broadening measures. Other recommendations included: the integration of federal and state death and gift duties; replacement of the classical system of company taxation with partial imputation; rejection of a wealth tax; discussion of the possible introduction of a family tax unit; and measures to combat tax avoidance: See Asprey (1975), above n 48, at ch 28. 56 See Asprey (1975), above n 48, at ch 2. 57 See Asprey (1975), above n 48, at chs 3–5. 58 See Asprey (1975), above n 48. 59 See Asprey (1975), above n 48, at ch. 28. 60 R Haupt, ‘Asprey Tax Flop’, Australian Financial Review, 6 June 1974, 1. 61 Editorial, ‘The persuasive Mathews Report’ Australian Financial Review, 30 May 1975, 2.

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impugned the economic credentials of the Asprey Reports and criticised the lack of workable policy recommendations.62 While the initial government response was to either ignore or contradict the recommendations of the Asprey Preliminary Report,63 the Full Report would later provide a useful political asset. On 26 May 1975, the Whitlam Government released the high profile report of the Mathews Committee on Taxation and Inflation.64 A near-unanimous call was made for the implementation of the report’s central recommendation—to index income tax scales and rebates to the rate of inflation.65 However, the Government, increasingly reliant on the increased taxation revenue provided by spiralling inflation in order to support its growing expenditure, lacked the political will or capacity to make such a change.66 The Asprey Full Report, which the Government had ignored since its completion in January 1975 and intended to swamp with the general August Budget papers, became a piece of political capital because it queried the need for indexation of income tax rates. Consistent with Prime Minister Whitlam’s preference, it suggested the Government retain its discretionary power to make tax cuts to adjust for inflation.67 Therefore, one day after the release of the

62 For example, see AR Prest, ‘The Australian Tax System Reviewed’ (1975) 51(136) Economic Record 576 who, while broadly supportive of the Committee’s approach, concluded that the report lacked the ‘deeper subtleties of tax analysis’ and expressed concern that the Committee ‘may have been a little too closely tied to the apron strings of a Treasury’; RH Wallace, ‘Taxation Reform: But what is the agenda?’ (1975) 51(136) Economic Record 564. These criticisms were fuelled by the resignation of the Committee’s sole economist, David Bensusan-Butt, on 1 June 1974—who was later revealed to be wholly unsatisfied with the direction of the Asprey Committee especially regarding its broad terms of reference and the obstructive and manipulative role played by the Australian Treasury: see Eccleston, above n 18, at 62. 63 For example, despite Treasurer Frank Crean specifically requesting the Preliminary Report for the August 1974 Budget, the Budget proposals ran counter to many of the recommendations in the report concerning personal income tax, other recommendations were simply ignored: S Simson, ‘Government ignores Asprey Report’ Australian Financial Review, 18 September 1974 at 7. 64 Reflecting the perceived urgency of the issue, the Mathews Committee was established on 12 November 1974 and reported just six months later in May 1974: Committee of Inquiry into Inflation and Taxation (Mathews Committee) Commonwealth of Australia, Inflation and taxation: report of Committee of Inquiry into Inflation and Taxation, May 1975 (Canberra, 1975). 65 Mathews, above n 64, at ix–x; PD Groenewegen, Australian taxation policy: survey 1965–1980 (Sydney, 1981) at 31–2; R Haupt, ‘Radical Blueprint for Tax Reform’ Australian Financial Review 27 May 1975 at 1, 8, 10, 12 and 16; ‘Only tax reform can save the economic system’ Australian Financial Review, 27 May 1975 (edited extracts of Mathews Report) at 2–3, 5. 66 Inflation caused total taxation revenue to increase from $8,507 million in 1970 to $21,121 million in 1975, finishing at $39,878 million in 1980 despite official rates remaining relatively constant: See Fenna, above n 16, at 261. 67 See Asprey (1975), above n 48, at ch. 6.

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Mathews Report, the Government finally tabled the Asprey Full Report on May 27, 1975, effectively to ‘trump’ the Mathews Report.68

D. Three Strikes and Out—Attempts at Consumption Tax Reform throughout the 1970s The political upheaval surrounding the dismissal of the Whitlam Government on 11 November 1975 prevented any attempts at serious taxation reform. However, with the subsequent election of the Fraser conservative coalition Government and appointment of a pro-consumption tax Treasurer, John Howard, the issue of broad-based consumption tax reform soon returned to the agenda. Howard made three unsuccessful attempts to broaden the consumption tax base to make room for income tax cuts. The first attempt in 1978 to introduce a retail sales tax (RST)69 was effectively thwarted by a fierce campaign instigated by the Retail Traders Association (RTA) that attracted substantial media coverage and resulted in over 45,000 letters sent to federal Members of Parliament.70 The campaign set a precedent for political strategies designed to scare and mobilise opposition to broadbased consumption tax reform. The second attempt was motivated by political opportunism and came after the Fraser Government’s third successive election victory on 18 October 1980. For six months the Government possessed that rare political commodity—control of the Senate. Howard requested the Treasury to evaluate preferred methods to expand the consumption tax base.71 Cabinet later ostensibly abandoned reform plans because of ‘inflationary’ concerns.72 However, the reform push had already effectively fallen victim to the demands of the 1980 Queensland State election campaign where Prime Minister Malcolm Fraser publicly abandoned consumption tax 68 B Toohey, ‘Tax Reform Deluge: Asprey Report tabled to trump Mathews Committee’ Australian Financial Review, 28 May 1975 1; Cf Groenewegen64, above n 65, at 26 who suggests that the simultaneous release of the Asprey Report alongside the Mathews report ‘totally and intentionally destroyed any immediate impact it [the Asprey Report] may have had’. This comment suggests one of two possibilities: first, the focus of the simultaneous release was to dampen the reception of the Asprey Final Report (the press reports at the time suggest otherwise); or, alternatively, it suggests a successful strategy to ‘snow’ both reports. 69 A committee of interested groups was established in August 1978 by the ATO to discuss reform options. The ATO favoured an RST due to its administrative ease and greater revenue-raising capacity over a WST: see Groenewegen (1985), fn.49 at 242–243. 70 See Groenewegen, above n 50, at 242. 71 The methods under consideration included a VAT, an RST or an extension of the WST: see Sandford, above n 16, at 90. 72 Commonwealth of Australia, Parliamentary Debates, House of Representatives, 24 February 1981, Hansard (John Howard).

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reform to aid the election of his state counterparts.73 Fraser’s stance was buttressed by the revenue windfall resulting from the crude oil excise and import parity pricing which more than doubled Commonwealth excise tax revenues in less than four years.74 Finally, Treasurer Howard resorted to reform by stealth by attempting to extend the WST in the August 1981 Federal Budget despite his public abandonment of such an approach in March. The reforms were later twice defeated in the Senate.75 The failed reform efforts led Groenewegen to conclude that by ‘the end of 1982 it almost seemed that the only way to increase Australian consumption taxation was the inequitable and inefficient raising of sales tax rates’.76

IV. PHASE 2—THE 1980S DRAFT WHITE PAPER AND NATIONAL TAXATION SUMMIT

A. Step 1—the Path to the Summit After seven years, the Fraser Government suffered the electoral fall out from an economy in recession with continuing high inflation and high unemployment rates, increasing industrial unrest and severe drought in the eastern states.77 In a spectacular misreading of the electoral mood, Prime Minister Fraser called an early double dissolution election on 3 February 1983.78 On 5 March 1983, the Bob Hawke-led ALP was swept to power with a majority of 25 seats. Following his election victory, Hawke was quick to establish his style of consensus-based policy-making. The key component of his macroeconomic approach was the successful negotiation and signing of the Prices and Income Accord (the Accord) with the Australian Council of Trade Unions (ACTU). The Accord was essentially an attempt at corporatist economic policy-making aimed at achieving non-inflationary growth. In 73

See Groenewegen, above n 50, at 242. See Smith, above n 18, at 116; See Sandford, above n 16, at 90. 75 See Groenewegen, above n 50, at 243. 76 See Groenewegen., above n 50, at 245. 77 In the late 1970s Australia’s current account deficit steadily worsened and reached 5.5% GDP in 1981–82, Australia’s average annual growth during the Fraser years averaged 2%, while unemployment had risen to approximately 10% in 1983; the economy experienced recession from 1982 to 1983: see Fenna, above n 16, at 208. 78 The move to call an early election appeared to be motivated by the desire to contest an election against the former ALP leader Bill Hayden, who was electorally unpopular (and also motivated by an unexpected Coalition by-election victory). However, timing went against Fraser when the popular Bob Hawke was elected ALP leader on the same day Fraser called the election: B Hawke, The Hawke Memoirs (Port Melbourne, 1994). 74

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essence, unions agreed to exercise wage restraint in exchange for government assurances for the maintenance of real wages through wage indexation, tax relief and the provision of universal public health services such as Medicare.79 In other words, the Accord was an effective political tool to dampen wages growth. Critically, however, this exercise in corporatism left out one key stakeholder—business. In response, business re-assessed and redeveloped its lobbying capacity with the formation of groups such as the Business Council of Australia (BCA) in 1983.80 Tax reform dominated the next election campaign in December 1984. The reform agenda was in part reignited by the economic recession and the public exposure of rampant tax avoidance and evasion by the Costigan Royal Commission.81 These activities were facilitated by both bureaucratic incompetence and the narrow literalist interpretative approach of the High Court to taxation legislation which encouraged the pursuit of form over substance.82 The annual revenue losses attributed to avoidance and evasion were estimated to exceed A$7 billion.83 Meanwhile, the over-reliance on personal income tax coupled with the phenomenon of bracket creep was again leaving middle income PAYE taxpayers to shoulder an increasing share of the tax burden. By the early 1980s politicians and commentators alike viewed the decline in tax morality as destroying the Australian tax system.84 Both the Treasurer, Paul Keating, and Shadow Treasurer, John Howard, acknowledged the worrying state of fiscal affairs in March 1984.

79 The Prices and Income Accord lasted from 1983 to 1997 and was re-negotiated eight times during this period. The Accord also introduced superannuation benefits for most workers: see Fenna, above n 16, at 271. 80 The BCA is an association of chief executives from Australia’s largest corporations: see www.bca.com.au 81 Originally designed to investigate criminal activities in the Painter and Dockers Union, the Commission uncovered criminal tax avoidance activities undertaken by the union on behalf of some of the country’s most wealthy and high profile elite in what became known colloquially as the ‘bottom of the harbour’ schemes (a practice of stripping a company of its profits, assets and records in order to avoid its tax liabilities): Royal Commission on the Activities of the Federated Ship Painters and Dockers Union (Commissioner Frank Costigan), Interim report No 4 (Canberra, 1982). 82 The Costigan Report revealed the earliest detection by the ATO of such a scheme in 1973 and the abandonment of the prosecution in 1979: see Costigan, above n 81; P Grabosky, Wayward governance: illegality and its control in the public sector (Canberra, 1989) 143–59; for some examples of the High Court approach, see: FCT v Westraders Pty Ltd (1980) 144 CLR 55; Curran v. Federal Commissioner of Taxation (1974) 131 CLR 409; Slutzkin v Federal Commissioner of Taxation (1977) 140 CLR 314; Cridland v Federal Commissioner of Taxation (1977) 140 CLR 330. 83 Treasury, Commonwealth of Australia, Reform of the Australian tax system: Draft White Paper (Canberra, 1985) 1. 84 J Howard, ‘Taxation Reform’ (1984) 1(1) Australian Tax Forum 8; Groenewegen, above n 50, at 72; J Head, Monash University Centre of Policy Studies and Australian Tax Research Foundation, Taxation issues of the 1980s: papers presented at a conference (Sydney, 1983) 15.

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However, only Howard publicly declared his long-standing support for broad-based consumption taxation as a remedy for these fiscal woes.85 Nevertheless the conservative opposition campaigned on the negative and reactionary slogan of: ‘No wealth taxes, no estate duties and no capital gains tax’.86 The belief abounded in the ALP that the 1980 election was lost because of community suspicion regarding the ALP introducing a capital gains tax (CGT).87 The Prime Minister was therefore placed in the unenviable position of needing to acknowledge the need for tax reform without committing electoral suicide. Hawke’s response was to utter an allegedly impromptu remark during a campaign radio interview, which committed an ALP Government to holding a tax summit.88 With Hawke only willing to make a pre-election commitment to the process of tax reform, the formal announcement of that process in October 1984 took on increased significance.89 It was to begin in 1985 with a comprehensive review of the Australian tax system followed by the convening of a National Taxation Summit, with both working towards introducing a tax reform package by the end of the year. The process was largely shaped by the need to gain the support of the party holding the balance of power in the Senate, the Australian Democrats, and the impetus to act quickly in the three-year electoral term to prevent the inevitable transitional issues costing votes at the next election. Hawke committed to nine guiding principles that would fundamentally influence the fate of subsequent reform proposals.90 Two proved particularly critical. Principle 7 essentially required any indirect tax to be acceptable to unions (in order to maintain the Accord) and Principle 9 required widespread support from community groups at the National Tax Summit.91

85 See Howard, above n 84, at 12; P Keating, ‘The Government’s Taxation Objectives’ (1984) 1(1) Australian Tax Forum 2. 86 See Sandford, above n 16, at 91. 87 This was prompted by a comment by the Shadow Finance Minister indicating that the ALP may consider a CGT: see Sandford, above n 16, at 91. 88 Although this is the widespread understanding, Andrew McCathie suggests the idea of holding the Summit ‘had in fact been around for some time and the press travelling with the Prime Minister had been waiting for several days for Mr Hawke to announce it’: ‘Render unto Caesar: Your Guide to who’s at the Tax Summit’, Australian Financial Review, 28 June 1985 33. 89 Commonwealth of Australia, Prime Minister (Bob Hawke), ‘Government Taxation Policy Statement’ 31 October 1984; G Hywood, ‘Hawke To Shed Light On Form Of Tax Review’, Australian Financial Review, 29 October 1984 3. 90 Bob Hawke, ALP Policy Speech, 13 November 1984. 91 Principle 7 read: ‘if any reform package which includes changes in indirect taxes is contemplated, it must be acceptable to various groups in the Australian community whose response will determine whether we can maintain moderation in wage movements’: Treasury, Commonwealth of Australia, Reform of the Australian tax system: Draft White Paper (Canberra, 1985) (hereinafter ‘DWP’) 2.

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In contrast to McMahon over a decade earlier, the tactic of deferring substance with procedure worked. The Hawke Government was returned to power, albeit with a reduced majority, on 1 December 1984.

B. Step 2—the Agenda In compliance with the tight agenda, Treasury released the Reform of the Australian Tax System: Draft White Paper on 4 June 1985—one month prior to the Summit. The Draft White Paper dutifully adhered to the Asprey formula for tax reform discourse: •

diagnose crisis: The tax system was ‘unduly complex’, ‘unfair’, distortionary and structurally flawed with a narrow base subject to increased avoidance and evasion92; faithfully recite the key tax reform criteria of equity, efficiency and simplicity; acknowledge the need to reconcile the inevitable conflicts between the criteria; and most importantly, prescribe reform.

• • •

The Draft White Paper canvassed three alternatives for reform.93 Option A essentially consisted of broadening the direct tax base; Option B consisted of Option A but with additional measures to broaden the indirect base through the introduction of a 5 per cent RST and levying the existing WST at 10 per cent on selected goods; and the Government-preferred Option C which entailed Option A base-broadening plus a shift in the tax mix from income to consumption with the introduction of an RST of 12.5 per cent (replacing the WST). Treasury predicted the revenue gains would allow a 30 per cent reduction in income tax rates and additional compensation measures for low income earners and pensioners.94

C. Step 3—the Ascent From the outset, Treasurer Paul Keating became a zealous ‘unswerving advocate’95 for Option C, utilising everything from ‘sick bags’ to ‘vacuum 92

DWP, above n 91, at 1. DWP, above n 91, at ch 22. 94 Proposals to extend the direct base included a tax on realised capital gains, fringe benefits, the removal or reduction of specific concessions such as negative gearing and film industry concessions: DWP, above n 91, at 242–55. 95 G Hywood, ‘Power Politics and the Summit’, Australian Financial Review, 28 June 1985 1. 93

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cleaners’ to sell his ‘blue-print for action’.96 Hawke, in contrast, adopted the less forthright role of ‘conciliator’ whose commitment to Option C appeared to waiver.97 However, in the four-week lead up to the Summit, the challenges quickly became apparent. Opposition to Option C was expressed not just from the usual suspects of unions, business and welfare groups, but also within the Government itself, with both Cabinet and the bureaucracy bitterly divided on the issue.98

D. Step 4—the Summit The Prime Minister’s opening address to the 160 Summit participants99 called for the ‘tempering of narrower, short term sectional interests with a sense of a wider, longer term national interest’.100 However, the Summit quickly degenerated into pluralist dysfunction with speaker after speaker rejecting the Government’s proposal largely on sectional grounds. By the end of day one Keating condemned the ‘divided, sectional and too uncompromising’ approach of the Summit participants.101 Over the course of the Summit, business declared their support for a consumption tax but firmly opposed the expansion of the direct tax base.102 Welfare groups (including the peak welfare body ACOSS (the Australian Council of Social Service)) and, critically, the ACTU were generally supportive of the expansion of the direct tax base, but opposed a consumption tax on equity grounds. An Editorial in the Australian Financial Review aptly summarised the state of affairs: ‘[e]veryone complains about Option C, but no one 96 P Keating, ‘Address by the Treasurer, the Hon Paul Keating, to the National Press Club’ 5 June 1985 (Treasury Press Releases No 61); A McCathie, ‘Keating uses an air sickness bag: But only to explain details of his plan’, Australian Financial Review, 21 June 1985 8. 97 G Hywood, ‘Power Politics and the Summit’, Australian Financial Review, 28 June 1985 1; G Hywood, ‘Hawke Clear Way for Retreat from Option C’, Australian Financial Review, 26 June 1985 8. 98 Keating overcame opposition from the Left and Centre Left factions to gain Cabinet endorsement of Option C. In part reflecting the Cabinet division, Treasury overcame opposition from the Department of Finance and the Department of Prime Minister and Cabinet in favour of Option C: G Hywood, ‘Power Politics and the Summit’, Australian Financial Review, 28 June 1985 1; A McCathie, ‘Render unto Caesar: Your Guide to Who’s at the Tax Summit’ Australian Financial Review, 28 June 1985 33. 99 Among the 160 invited participants assembled to discuss were State premiers, 28 trade union representatives, 38 business and professional associations, 25 community and welfare groups and 14 tax practitioners, tax associations and academics. The Opposition was invited but did not attend: See Sandford, above n 16, at 94. 100 Commonwealth of Australia, National Taxation Summit: Record of Proceedings (Summit held from Monday July 1 to Thursday July 4, 1985, Parliament House, Canberra) (hereinafter ‘NTS’) at 3. 101 NTS, above n 100, at 55. 102 NTS, above n 100, at 118–19, 166.

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comes up with anything better’.103 The situation only worsened for the Government: the release of an opinion poll on day two showed a slump in the Government’s electoral support104; on day three, Summit participants expressed their overwhelming opposition to a consumption tax.105 In response, Hawke negotiated a compromise deal with the ACTU which effectively mirrored the ACTU’s preferred position of Option A with a selective tax on services. Keating, the main advocate of a consumption tax, was not party to the negotiations which he had earlier declared would ‘cut out the heart of the package’.106

E. Step 5—the Decline The post-Summit evaluation was brutal. The press reports declared ‘Option C Sinks, Summit Ends with a Whimper’.107 Commentators spoke of a ‘final humiliation’, embarrassing back-downs and an ‘[a]brupt end to reform dalliance’.108 The overwhelming resemblance between the compromised package and the ACTU’s preferred position fuelled Opposition claims of the Government’s ‘absolute domination’ by the ACTU.109 Eventually, the Summit compromise was abandoned as ‘unworkable, impracticable and inconsistent with the basic objectives of tax reform’.110 In its place Keating declared in September 1985 ‘the most far-reaching reform of the Australian tax system to be undertaken by a Government in living memory’.111 The reforms essentially consisted of a watered-down capital gains tax, a fringe benefits tax and some base broadening for the 103

‘The Curious Case of Option C’, Australian Financial Review, 2 July 1985 1. A Morgan Gallup poll showed public approval of the Government at 41%—eight points below the Opposition at 49% and for the first time Opposition leader Andrew Peacock was considered more popular than Bob Hawke: G Hywood, ‘As Summiteering Gives Way to Bargaining, A Compromise is On, Says Hawke’, Australian Financial Review, 3 July 1985 1; G Hywood, ‘Keating’s Brave Defeat: A Comprehensive Retreat on Reform’, Australian Financial Review, 5 July 1975 1. 105 Opposition included four key Cabinet Ministers initially opposed to the GST; business groups were among the only supporters of a broad-based consumption tax: P Bowers, ‘Hawke had no choice but to opt for damage control’ Sydney Morning Herald, 6 July 1985 1. 106 NTS, above n 100, at 181. 107 A McCathie, ‘Option C Sinks, Summit Ends With A Whimper’, Australian Financial Review, 5 July 1985 3. 108 A McCathie, ‘Abrupt End to Reform Dalliance’, Australian Financial Review, 14 August 1985 3. 109 G Hywood, ‘Keating’s Brave Defeat: A Comprehensive Retreat on Reform’, Australian Financial Review, 5 July 1975 1. 110 Specifically, the selective services tax was abandoned: P Keating, ‘Indirect Tax Measures’ (Press Release No 181, 13 August 1985). 111 P Keating, Reform of the Australian Taxation System: Statement by the Treasurer (Press Release) (Canberra, 19 September 1985). 104

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WST.112 Although arguably correct, Keating’s declaration only served to highlight the deficit between expectation and delivery; how the ‘possibility of a much more dramatic reform ha[d] evaporated’.113 More fundamentally, however, minus the revenue-raising capacity of a broad-based consumption tax, the Government’s reforms lost revenue neutrality and would later compound a deficit-ridden budget by the end of the 1980s.

V. PHASE 3—FIGHTBACK! AND THE 1993 FEDERAL ELECTION

A. Round 1—the Lead-up The political power of taxation reform was demonstrated with devastating effect during the 1993 federal election campaign. After almost a decade in office, the ALP was plagued by leadership tensions between Prime Minister Hawke and Treasurer Keating, and was presiding over an economy in deep recession since 1991 with interest rates up to 17 per cent, unemployment at 11 per cent, an A$11.6 billion budget deficit and record levels of foreign debt.114 The conservative coalition reinvented itself with the election in April 1990 of a new and popular leader, John Hewson, a professional market economist and relative political novice. The conservative coalition looked poised for election victory. However, rather than watch a government unravel, Hewson pursued a radical political and economic agenda. In October 1990, Hewson embarked on a clandestine process of policy development, relying almost exclusively on a private economics consulting

112 The reforms occurred in two stages: Stage 1 included imputation for corporate and shareholder tax, reforms to tax administration, a reduction in income tax rate scales, a reduction in the top marginal rate from 60% to 49% (in alignment with the company tax rate); the second stage occurred in May 1988 and mostly consisted of company tax reform measures including a reduction of the company tax rate from 49% to 39% (thereby undermining the tax symmetry established in the 1985 reforms): P Keating, ‘Reform of the Australian Taxation System’ (Statement by the Treasurer: Canberra, 19 September 1985); see Sandford, above n 16, at 79–80. 113 ‘A Hollow Victory’, Australian Financial Review, 14 August 1985 12. 114 The budget surplus of A$6.6 billion in 1989–90 had morphed into an A$11.6 billion deficit by 1991–92. Almost half of the A$18 billion turnaround was said to result from diminished tax receipts and increased social spending produced by the economic downturn; Australia’s foreign debt was at record levels at 45% GDP in 1992, with a current account deficit surging from 2% GDP to a critical level of 5% of GDP; monetary policy set interest rates at 17% to dampen the extraordinary economic growth of the late 1980s: see Fenna, above n 16, at 207–8.

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firm, Access Economics,115 rather than seeking input from his own Shadow Cabinet.116

B. Round 2—the Release of Fightback! In November 1991, Hewson released Fightback!, a comprehensive 650page neo-liberal economic manifesto. Its central component was a 15 per cent GST, levied on a broad base, including food, with minimal exclusions.117 The resulting revenue would facilitate the abolition of a number of indirect taxes (including the WST) and provide for a 30 per cent reduction in income taxation.118 In short, the tax reforms aimed to shift the tax mix from income to consumption.

C. Round 3—Mobilisation Despite an initially favourable reception, the release of 650 pages of major tax reform halfway through an election term, enabled opposition to mobilise.119 Keating succeeded Hawke as Prime Minister on 19 December 1991, and harnessed all the political lessons of 1985 to launch a partisan political assault on the centrepiece of Fightback!—the GST. On 26 February 1992, Keating released the Government’s formal policy response entitled One Nation. The package was politically savvy yet fiscally irresponsible with a promise to match Fightback!’s proposed personal 115 Access Economics was established in 1988 by two senior ex-Commonwealth Treasury officials, who marketed the firm as aiming to ‘provide private sector clients with the quality of economic information and policy advice given confidentially to Government Ministers’. Hewson was therefore able to gain knowledge of the Treasury approach to policy-making, thus indirectly continuing the impact of Treasury’s support for a consumption tax: see www.accesseconomics.com.au 116 Shadow Cabinet reportedly was only shown a 10-page proposal with an 8% GST before public release: see Eccleston, above n 18, at 105. 117 Zero-rated exclusions included: health and education services, non-commercial government activities, sales of businesses as ‘going concerns’, welfare religious and charitable institutions, exports. Residential rents, building construction, financial services, gambling and lottery were exempt from the GST but input taxed. 118 Fightback! promised that 95% of taxpayers would face a marginal rate of 30% or less—although the greatest reductions were for high-income taxpayers; significant cuts were also proposed for CGT and Fringe Benefits Tax (FBT): Liberal Party of Australia, Fightback! It’s your Australia: the way to rebuild and reward Australia (Canberra, 1991) at 2. 119 A Saulwick Herald poll showed an 8% gain in Coalition support over one month and 22% higher public support than for Labor: P McIntosh, ‘Coalition Support Surges After Package’, Sydney Morning Herald, 27 November 1991 4; commentators lauded the ‘vision’ and ‘leadership’ offered by the package, even if disagreeing on the detail: R Gottliebsen, ‘Finding a Way Out of the Mess’, Business Review Weekly, 29 November 1991 6; M Grattan, ‘GST Numbers Game —A Matter of Leadership’, The Age, 23 November 1991 2.

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income tax cuts without a GST.120 The strategy, however, paid immediate dividends, with public support for the Government rising 6 per cent following its release.121 The advantages of incumbency were demonstrated by a stream of Treasury reports discrediting Fightback! by locating $4 billion funding short falls or predicting that four out of five taxpayers would be worse off under the package.122 Expert economic analysis further fuelled the uncertainty by questioning the underlying economic assumptions, economic modelling and distributional impacts of the Fightback! package.123 Indeed, the academic response was uncharacteristically interventionist and highprofile attracting substantial media coverage, which, in particular, highlighted the political disaster following the Canadian introduction of a GST.124 Keating was able to capitalise on growing opposition to Fightback! from the unions, the church and welfare groups.125 While business was overwhelmingly supportive of Fightback!, Keating was able to exploit the occasional vocal fractious departure, most notably from the tourism industry.126 In contrast, Hewson’s combative approach alienated most opponents and even his own core support base. With public support declining throughout 1992,127 Hewson capitulated to pressure from both inside and outside his party and compromised with

120

P Keating, ‘One Nation’ (Statement by the Prime Minister, Canberra, 26 February

1992). 121

See Eccleston, above 18, at 108. T Colebatch, ‘GST “hole” Now $4b—Tax Office’, The Age, 17 December 1991 10; P Cleary, ‘No Jobs with Tax: Treasury’, Sydney Morning Herald, 5 March 1992 6. 123 T Colebatch, ‘GST Would Hurt Poor Families, Say Economists’, The Age, 25 February 1992 6. 124 The contrast to the usual measured post facto academic analysis was prompted by a tax research body sponsoring a research project with Australian and international experts that carefully examined the entire Fightback! package, including the GST. While different academic writers were both critical and supportive of each element of the package, it was the GST that attracted most media attention, with the further publication of a monograph on a key paper by Brooks on the Canadian GST stimulating much debate in the popular press: J Head (ed), Fightback! an economic assessment: papers from a conference organised by the Public Sector Management Institute, Monash University (Sydney, 1993); see Brooks, above n 4. 125 Opponents included those groups in 1985 who opposed consumption tax reform on welfare and equity grounds including the ACTU and ACOSS (however, ACOSS also voiced opposition to the Government’s One Nation package for failing to provide adequate tax relief for disadvantaged low income groups) along with an unprecedented intervention by church groups (specifically the Catholic Social Welfare Commission) who opposed a GST on ‘basic life-sustaining goods such as food’. 126 A poll of Australia’s top 1,000 chief executives revealed overwhelming support for the GST and associated tax changes: D Uren, ‘Editor’s Note’, Business Review Weekly, 11 December 1992 10. 127 By November 1992, the ALP Government had surpassed the Opposition for the first time since the March 1990 election. Specific concern also arose following an unexpected by-election win on 11 April 1992 by an independent anti-GST candidate, P Cleary: P 122

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the release of Fightback!II on 18 December 1992. The emphasis this time was on Fightback! Fairness and Jobs, with the major concession being the exemption of food and childcare from the GST.128 However, the perverse effect of the compromise was that it undercut Hewson’s key political asset—his resolute commitment to reform. Few commentators characterised it as anything other than a ‘backflip’, ‘cave in’ or ‘descent into populism’.129 Keating capitalised on the sustained opposition to a GST130 with a shrewd political declaration in November 1992 that an ALP opposition would not oppose a GST in the Senate. Given Hewson’s insuperable commitment to the GST typified in his declaration that ‘[i]f we can’t win with the GST then we don’t deserve to govern’,131 the ‘referendum’132 was declared. Voters were presented with a clear choice: a vote for the coalition was a vote for the GST.133 D. Round 4—Let the Fight Begin With the declaration of a federal election on 8 February 1993, the inordinately long informal campaigning gave way to formal electioneering. The GST dominated the election campaign and ‘it was the GST that proved to be the most electorally damaging’.134 The Government orchestrated an effective and some would say ‘masterful’ scare campaign135 with advertisements playing on the electorate’s uncertainty and reticence to change. This Hartcher, ‘Opposition Fears GST Cost Votes’, Sydney Morning Herald, 14 April 1992 3; T Dodd, ‘Coalition will turn to crime in bid to sell Fightback! package’, Australian Financial Review, 29 May 1992 7; M Gordon, ‘Libs’ GST: On Sale Again’, Sunday Age, 19 April 1992 1; P Hartcher, ‘Opposition Fears GST Cost Votes’, Sydney Morning Herald, 14 April 1992 3. 128 Emphasis added. In addition, some of the harsher edges of the package were softened, such as the abolition of a strict nine-month time limit on unemployment benefits and the postponement of the A$4 billion cut in public-sector spending. However, the industrial relations reform and a commitment to zero tariffs remained intact: Liberal Party of Australia, Fightback! Fairness And Jobs (Canberra, 1992); M Stutchbury, ‘Dr John Backflip Begs Questions of his Economic Blueprint’, Australian Financial Review, 21 December 1992 7. 129 Stutchbury, above n 128; M Millett, ‘Hewson Caves in on GST’, Sydney Morning Herald, 9 December 1992 1; Walsh quoted in Eccleston, above n 18, at 115. 130 Despite Liberal Party claims to the contrary, polls indicated public support for the Coalition and Hewson had declined following Fightback!II: T Burton, ‘Opposition Support Down Since Fightback II: Poll’, Australian Financial Review, 25 January 1993 3. 131 P Kelly, ‘The Politics of Economic Change in Australia in the 1980s and 1990s’ (speech delivered at the Reserve Bank of Australia: The Australian Economy in the 1990s, HC Coombs Centre for Financial Studies, Kirribilli, 24–25 July 2000). 132 Although popularly labelled a ‘referendum’, the election more accurately resembled a plebiscite rather than a formal referendum governed by the Australian Constitution. 133 ‘Keating Goes For Broke’, Sydney Morning Herald, 7 November 1992 26. 134 See McAllister and Bean, above n 8, at 388. 135 N Brooks, ‘Lessons for Australia from the Canadian Experience with the GST: Don’t Do It!’ in B Tran-Nam (ed), Tax Reform and the GST: An International Perspective (St Leonards, 1998) 112.

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was evidenced by Keating’s declaration that: ‘If you don’t understand the GST, don’t vote for it. And if you do understand it, I know you will never vote for it.’136 The ALP campaign was supplemented by an estimated A$2 million union push against the GST.137 In contrast, Hewson’s campaign performance was clumsy and awkward, as epitomised by an infamous television interview where he appeared at a loss to explain how the GST would apply to a birthday cake.138 Not even an advertising campaign in support of the GST by peak business groups, under the banner ‘Australians for Tax Reform’, could save Hewson.139 As Kelly argues, ‘in the hands of a skilled practitioner’ the GST ‘could have been marketed’.140 Hewson, however, was a ‘wretched salesman’.141

E. Round 5—the “Sweetest Victory” On 13 March 1993, the ALP was returned to office with a 1.5 per cent swing towards the ALP in the two-party preferred vote.142 Hewson was left to lament the loss of the seemingly ‘unlosable’ election, a loss specifically attributed to the GST.143

VI. PHASE 4—1998–2000: THE DAWNING OF A NEW TAX SYSTEM

A. Background Following the 1993 election, it quickly became apparent that One Nation’s predicted growth forecasts would not be borne out. In fact, the economy was still suffering the effects of the recession with a budget deficit approaching A$16 billion for 1996–97 exacerbated by the low inflation environment which limited revenue growth. Consequently, the Government was forced to abandon honouring the full component of its promised 136

See Brooks (1998), above n 135. J Brown, ‘The Tax Debate, Pressure groups and the 1998 Federal election’ (1999) 18 Policy, Organisation and Society 75; J Harrison and M Stretton, The GST Debate (Originally published as The GST Debate—A Chronology: Background Paper No. 1 1997–1998; Updated by Marilyn Stretton to February 1999) (Canberra, 1999). 138 The interview was conducted by Mike Willessee and broadcast on Channel 9 prime-time current affairs programme A Current Affair. 139 The campaign was instigated by peak business groups—BCA and the Australian Chamber of Commerce and Industry (ACCI). 140 See Kelly, above n 131. 141 L Carlyon, ‘Carlyon’, Business Review Weekly, 27 November 1992 15. 142 The victory was narrow, with the outcome being determined by 1,500 votes across eight marginal seats: see Brooks.134, above n 135, at 113. 143 See Bean and McAllister, above n 8, at 388. 137

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tax cuts, and ratcheted up WST and excise revenue by $3 billion. The ironic legacy of the 1993 election outcome was that the Government’s continued ‘piecemeal reform in 1993 resulted in consumption tax increases which were more regressive than the reformed Fightback! GST’.144 After a period of instability following the 1993 electoral defeat, the Conservatives looked back to their political past in order to salvage their future, and re-elected John Howard as leader in January 1995. Political pragmatism forced Howard publicly to abandon his career-long commitment to consumption tax reform when, in order to quell electorally damaging speculation as to the resurrection of the GST, he declared, ‘[t]here’s no way the GST will be part of our policy. It’s dead. Never ever. It’s dead’.145 In stark contrast to Hewson, Howard remained a ‘small target’ in the 1996 federal election campaign preferring to focus on the Government’s weaknesses in order to bring about electoral defeat.146 This approach necessitated public assurance that the coalition would not introduce or increase taxes. The strategy proved successful, with the coalition securing office on 2 March 1996 with a large majority.147

B. The Push for Reform The Howard Government’s first term in office was marred by political instability. Within a week of victory, Treasurer Peter Costello revealed projected estimated budget deficits of A$4.9 billion in 1996–97, extending to A$7.6 billion the following year. Significantly, the root cause of the estimated deficit was an A$5 billion revenue shortfall due to the low inflation environment. In order to return the budget into surplus, the Treasurer announced drastic expenditure reductions of A$4 billion over two years.148 In doing so, the Government controversially abandoned an estimated A$12 billion or 25 ‘non-core’ election promises.149

144

See Smith, above n 18, at 148. Howard was forced to make the declaration following a response to a question at a business lunch where he said that the 1993 election had been a referendum on the GST and there was ‘no way’ that it could be policy for the next election. But ‘what happens in the future I don’t know’: M Grattan, ‘Howard Bans GST “forever”’, The Age, 3 May 1995 5; see McAllister and Bean, above n 8, at 388. 146 See Eccleston, above n 18,at 125. 147 A 6.25% nationwide swing towards the Coalition secured a 46-seat majority in the House of Representatives: see Eccleston, above n 18, at 126. 148 See Eccleston, above n 18, at 127. 149 L Tingle, ‘Pledges Kept, Says Howard’, The Age, 22 August 1996 7. 145

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In response to the egregious economic and political situation, interest groups mobilised and began to clamour for indirect tax reform.150 With Fightback! firmly etched in the political memory, however, neither the Government nor the opposition possessed the political will or capacity to embark upon any radical indirect tax reform. Filling the vacuum created by political inaction was the development of an ‘unholy’151 alliance between the peak business association, the Australian Chamber of Commerce and Industry (ACCI), and peak welfare body, ACOSS.152 Despite, previously advocating opposing positions on consumption tax reform, convinced of the need to build tax reform consensus, ACCI Chief Graeme Samuel approached ACOSS President Robert Fitzgerald in April 1996.153 The resulting ‘alliance’ convened a National Tax Summit attended by over 200 representatives (excluding politicians) where support was articulated for a broad-based consumption tax.154 Critically ACOSS’ support was contingent on there being no shift in the tax mix, no undermining of progressivity and there being adequate revenue to support the poor.155 The Summit gave rise to a Tax Reform Forum to maintain ongoing reform dialogue.156 In promotion of the reform agenda, business groups established the Business Coalition for Tax Reform (BCTR) which, on 11 June 1998, launched a A$5 million public advertising campaign under the populist banner of ‘Australians for a fairer tax system’.157 Whether directly or indirectly resulting from the ACOSS/ACCI campaign, public support for the GST peaked in 1997, with supporters almost doubling the number of opponents.158 Sensing the mood for change,

150 Groups ranged from business representatives, conservative State Premiers, the National Commission of Audit Office, The Productivity Commission: see Harrison and Stretton, above n 137. 151 R Krever, ‘The Political Economy of the GST: A Comment on Professor Brooks’ Paper’ in Tran-Nam, above n 135, at 144. 152 Both groups were peak representatives for their constituencies: for ACCI this included over 350,000 businesses; for ACOSS this included over 11,000 organisations seeking to represent the low income and disadvantaged on social and economic policy matters: see Brown, above n 137, at 80–81. 153 See Eccleston, above n 18, at 130. 154 The ACTU and BCA were invited but did not participate in the Summit (however, the BCA later joined the Tax Reform Forum): see Brown, above n 137, at 82. 155 ACOSS, Tax Reform Pack (Strawberry Hills, NSW, 1997). 156 The forum maintained dialogue through a monthly roundtable discussion between business and welfare groups (namely ACCI, BCA and ACOSS) and continued until 1998: Brown, above n 137, at 83. 157 J Warhurst, J Brown and R Higgins, ‘Tax Groupings: The Group Politics of Taxation Reform’ in M Simms and J Warhurst (eds), Howard’s Agenda: The 1998 Australian Election (St Lucia, 2000) 170. 158 In 1996 some polls showed supporters at 56% to opponents at 37% and in 1997 59% to 31%: S Blount, ‘Public Opinion and Tax Aversion in Australia’ (2000) 36(3) Journal of Sociology 275 at 279.

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Howard hoped to use his career-long commitment to broad-based consumption tax reform to salvage his declining credibility on a range of economic, political and social issues. On 18 May 1997, Prime Minister Howard indicated he would seek a mandate for tax reform at the next election.159 Over the next year, a parallel process of policy development occurred. In order to avoid the development mistakes of Fightback! and create at least the appearance of consultation, a Tax Consultative Task Force was established and received 600 public submissions.160 The report was handed to the Treasurer in February 1998 but was never publicly released. However, the real policy development occurred within the Taxation Task Force. This Task Force consisted of a select group of elite bureaucrats from the Treasury, ATO and Department of Prime Minister and Cabinet who consulted almost exclusively with senior Government Ministers.161 While business was consulted on an ad hoc basis, ACOSS was excluded, leading Fitzgerald to declare that ‘there is no real consultation, everything is being done behind closed doors’.162 Two external factors strengthened the Government’s position. First, the High Court ruled on 5 August 1997 that the levying of State ‘franchise fees’ was unconstitutional.163 The states effectively lost approximately A$5 billion or 17 per cent of their revenue.164 Although the consequences were mitigated by a Federal Government ‘rescue package’,165 the Government was quick to seize on the ‘opportunity of the decade’166 to reform the tax system. On 13 August 1997, the Government released its guiding principles for tax reform which consisted of the need for revenue neutrality, a substantial reduction in income taxation, consideration of broad-based indirect taxation with compensation and the need to address

159 Howard was seen as being weak on the rise of the One Nation party and a series of Government scandals relating to MPs’ travel ‘rorts’. Announced during an interview on the Channel 7 television Current Affairs programme Face to Face: see Brown, above n 137, at 84. 160 See Eccleston, above n 18, at 134. 161 Ibid. 162 S Neighbour, Never say never (Four Corners broadcast by the Australian Broadcasting Corporation: 18 May 1998); Eccleston, above n 18, at 134. 163 Ha & Lim v New South Wales (1997) 189 CLR 465: the High Court ruled that franchise fees levied by states on tobacco (and by implication petrol and alcohol) were excise duties which could only be exclusively levied by the Commonwealth under the Constitution, s 90. 164 See Brown, above n 137, at 85–6. 165 The Commonwealth Government effectively secured state government revenue through retrospective legislation allowing the Commonwealth to collect excise revenue to distribute to the states. The warning had already been sounded following the High Court decision of Capital Duplicators Pty Ltd v Australian Capital Territory (No 2) (1993) 178 CLR 561: see Smith above n 18, at 150. 166 Treasurer Costello quoted in Brown, above n 137, at 86.

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Commonwealth–State fiscal relations.167 Second, the Government was assisted by the relative stability of the Australian economy, with low inflation, falling unemployment and forecast budget surpluses in the face of the Asian economic crisis of 1997–98. This enabled the Howard Government to label tax reform as an integral part of their demonstrably successful macro-economic management approach. On 16 August 1998, the Government released the much anticipated A New Tax System (ANTS) package featuring a GST levied at 10 per cent on a broad range of goods and services, including food. An estimated $27.2 billion in GST revenue and a government surplus forecast at $14.6 billion for 2000–01 allowed for the abolition of a range of indirect taxes and for personal income tax cuts squarely targeted at middle income earners totalling A$13 billion per annum.168 Borrowing loosely from the Asprey template, the package diagnosed the critical state of the existing tax system as ‘out of date, unfair, internationally uncompetitive, ineffective and unnecessarily complex’.169 ANTS would address this by providing economic security, consistency, simplicity and incentive (the latter equated with fairness through providing ‘greater reward for effort’).170 Learning from history and reflecting the conventional wisdom in the tax politics literature,171 the prescription attempted to offer something for everyone—from the states, to business and ‘deserving’ individuals.172 It offered a series of interdependent tax and non-tax related reforms as part of a broader ‘policy framework for securing Australia’s economic future’.173 Crucially, the public was given much less detail (the 208 page package was one third of Fightback!’s size) and much less time to respond, with an election called within two weeks of the release on 30 August 1998 for 3 October 1998.

C. Electioneering Having set the parameters, Howard sought the elusive mandate of the Australian people for broad-based consumption tax reform. The need for

167 Treasury, Commonwealth of Australia, Tax reform: not a new tax, a new tax system: the Howard Government’s plan for a new tax system (Canberra, 1998) at 14 (ANTS). 168 See ANTS, above n 167. 169 See ANTS, above n 167, at 5. 170 See ANTS, above n 167, at 15. 171 See Sandford, above n 16, at 201–5; AR Prest, ‘The Political Economy of Tax Reform’ (1972) (37) Economic Papers 11. 172 ANTS, above n 167, at 14. 173 ANTS, above n 167, at iii.

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the public mandate was sharpened by Howard’s ‘never ever’ declaration. The election campaign was closely contested and dominated by the issue of taxation reform.174 The coalition campaigned on tax reform as symbolic of vision, leadership and a necessary component of the sound economic management which had guided Australia’s economic success in the face of crisis. In contrast, the major feature of the ALP’s tax package, under the leadership of Kim Beazley, was the absence of a GST.175 Beyond the characteristic support of unions, the response of the press, business and welfare groups to the ALP package was scathing.176 The ALP’s failure to address substantive tax reform was used by the Government to distinguish a government of the future from an opposition trapped in an economically and politically untenable past as encapsulated by the slogan: ‘Don’t go back to Labor: Australia Can’t Afford It.’177 The Government’s campaign was bolstered by incumbency with Treasury keeping a clandestine grip on the modelling and effects of the ANTS package and with the use of an unprecedented A$15 million of public funding allocated to advertising the need for tax reform.178 On 3 October 1998, the coalition returned to office with a 13-seat majority in the House of Representatives.179 Crucially for the Government, the campaign had convinced the electorate of the need for tax reform.180 Unlike 1993, the GST brought the Howard Government a slight electoral advantage.181 However, despite regaining government, the coalition lost the two-party preferred vote 49 per cent to 51 per cent and would still require the support of at least two non-government senators in order to gain passage through the Senate.182

174 Overall, two-thirds of voters saw some aspect of taxation as the most important issue in campaign with 42% of voters nominating the GST as the most important issue: McAllister and Bean, above n 8, at 390–1. 175 In addition, the ALP package offered targeted income tax credits favouring low- and middle-income earners, direct tax base broadening and a crackdown on avoidance and evasion: see Eccleston, above, n 18, at 141. 176 ACOSS President Michael Raper labelled the ALP package ‘fair enough, but not good enough’ and stated ‘ACOSS does not accept Labor’s argument that the tax system is not “broken”. We believe it is in such disrepair that it needs comprehensive rebuilding not just patching up’: ACOSS, Media Release, 3 September 1998. 177 J Warhurst, ‘Tax Attacks: The 1998 Australian Election Campaign’ in M Simms and J Warhurst (eds), Howard’s Agenda: The 1998 Australian Election (St Lucia, 2000) at 3. 178 Brown, above n 137, at 94. 179 Warhurst, above n 177, at 8. 180 Lynton Crosby, Federal Director Liberal Party, attributed the Coalition victory to a belief in the community that tax reform was needed and that the ALP could not deliver it, a claim not expressly refuted by, then ALP Assistant National Secretary, Candy Broad: M Simms and J Warhurst. ‘Editors’ Introduction: The Nature and Scope of Howard’s Victory’ in Simms and Warhurst, above n 177, at xvii. 181 See McAllister and Bean, above n 8, at 398. 182 Ibid.

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D. The Translation of a Tenuous Mandate into Reform The fragility of the mandate combined with declining public support for a GST forced the Government into compromise. The first compromise consisted of the establishment of the Senate Select Committee on the GST whose investigations and reports highlighted some of the negative distributional consequences of the Government’s package which had been suppressed during the election campaign.183 More critically, however, following a failure to secure the support of one key independent senator, the Government was forced to negotiate with the Australian Democrats led by Meg Lees. Contrary to popular understanding, the Democrats had not specifically opposed a GST but had opposed its application to food and expressed significant concerns over the equitable impact of the ANTS package. After a protracted and controversial period of negotiation, a compromise was announced on 28 May 1999 whereby basic food would be zero-rated at a cost of approximately A$3.09 billion and increased compensation for low income earners provided at a cost of A$2.85 billion over four years.184 The compromise enabled the subsequent enactment of the ANTS legislation on 8 July 1999.

VII. POSTSCRIPT

Consistent with the implementation of major legislative reform, the ANTS package experienced various transitional problems and was subject to numerous amendments.185 However, unlike its Conservative Canadian counterparts, the Howard Government was largely spared the electoral consequences of introducing a GST. In its place, the electoral sword fell squarely on the Australian Democrats who, despite deposing Meg Lees for her role in passing the ANTS package, have been decimated – losing all their senators in subsequent federal elections.186

183 Commonwealth of Australia, Senate, Report of the inquiry into the GST and a new tax system, (Canberra, 1999). 184 Other concessions related to the environment; reduced tax cuts for people earning above A$50,000 a year and, in particular, above A$60,000; more generous compensation for pensions, allowances and benefits worth an extra A$730 million; further GST exemptions in health and education; a delay and deferment in the abolition of State taxes: P Kelly, ‘Over the Line’, The Australian, 29 May 1999 21. 185 A New Tax System (Goods and Services Tax) Act 1999 has been the subject of multiple legislative amendments since its enactment—many occurring between the date of enactment on 8 July 1999 and the date of operation on 1 July 2000. 186 While the demise of the Democrats is not solely attributable to the GST, this was a major catalyst for the unravelling.

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While the legal implications of the ANTS package are yet to be fully tested before the appellate courts,187 a pattern in the broader distributional consequences of the ANTS package and subsequent reforms began to show progressivity in decline. This was partly indicated by a corresponding shift in the tax mix following the introduction of ANTS. The relative share of income tax revenue as a percentage of the total Commonwealth taxation revenue fell from 77 per cent to 71 per cent from 1999–2000 to 2004–05, matched by a corresponding rise in consumption tax revenue from 22 per cent to 28 per cent over the same period.188 The GST did not turn out to be the promised salve of Commonwealthstate fiscal relations. Although the Commonwealth government continued to label the GST a state tax, with the Commonwealth administering, collecting and controlling the distribution of GST revenue to the states, it is a state tax in name alone.189 The failure of the GST to remedy Commonwealth and state fiscal relations has been evidenced by the continued annual jousting between the Commonwealth and state treasurers over the distribution of revenue. In fact, these continued controversies prompted the former Commonwealth Treasurer, Peter Costello, to admit that the opportunity to remedy fiscal relations through the GST had been missed.190 The revenue yield of the GST exceeded initial expectations. GST revenue steadily increased from A$23,854 billion in 2000–01 to A$35,473 billion in 2004–05.191 The substantial revenue gains, in part, enabled the Howard Government to repeatedly cut income tax rates mostly in favour of high income earners.192 In contrast, the interaction of the tax system and increasingly restrictive welfare provisions left unemployed and low income 187 In 2008 the first decision by the High Court of Australia on the A New Tax System (Goods and Services Tax) Act 1999 (Cth) ruled in favour of the Commissioner of Taxation by holding that the respondent was liable to pay GST on a deposit that had been forfeited upon the termination of a contract for the sale of land. The court ruled that a taxable supply was made upon entry into the contract of sale and the forfeited deposit was consideration for supply within the meaning of the Act: see Commissioner of Taxation v Reliance Carpet Co Pty Ltd (2008) 236 CLR 342. 188 Australian Bureau of Statistics, 5506.0—Taxation Revenue, Australia, 2004–05 (Canberra, 2006). The increase in income tax revenue for 2004–05 is attributed to stronger income growth and profitability—in part a reflection of the Australian ‘resource boom’. 189 See Smith, above n 18, at 152. 190 Channel 9, ‘Treasurer Peter Costello interviewed by Laurie Oakes: Federal-state relations, tax’ Sunday, 2 July 2006, available at: www.treasurer.gov.au/tsr/content/transcripts/ 2006/098.asp at 30 November 2006. 191 Australian Bureau of Statistics, 5506.0—Taxation Revenue, Australia, 2004–05 (Canberra, 2006) 9. 192 For example, the top marginal rate has decreased from 47% in 1999/2000 to 45% in 2006 while the threshold has dramatically increased from $50,000 to $150,000. In contrast, tax relief for low- to middle-income earners has been less generous: Treasury, Commonwealth of Australia, Pocket Guide to the Australian Tax System (2006) 6. This conforms to the trend identified by Steinmo in five countries where effective tax rates declined for the very rich, were maintained for the middle class and went up as a percentage of income for the very poor: see Steinmo, above n 17, at 232.

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earners facing effective marginal tax rates of up to 78 per cent.193 Ironically, not only did the broader legislative reforms undermine any gains for welfare and low income earners in the compromised ANTS package, but they bore a striking resemblance to the stark neo-liberal economic agenda the electorate so comprehensively rejected in the Fightback! package 13 years earlier.

VIII. ANALYSING REFORM

As with all political change, there is unlikely to be a single answer that fully accounts for the complex web of factors that guide the tax reform process. However, the history of the Australian GST provides fertile ground for testing political theory. In a seminal article on the study of public policy, Richard Simeon proposed a comprehensive framework by which to analyse policy outcomes.194 In contrast to other ad hoc approaches which seek to attribute reform outcomes to one or two independent variables, Simeon’s framework encompasses the major normative approaches across a range of political, legal and social science disciplines. The approaches broadly converge on five principal themes: environment, power, ideas, institutions and processes.195 While most analyses of tax reform address one or two of these themes, few address them all.196 While a full examination of the approaches is beyond the scope of this chapter, some initial observations on the themes will demonstrate the potential for future research to further our understanding of the tax policy process and tax reform outcomes more generally.

A. Environment Some commentators argue that policy outcomes are largely determined by socio-economic, technological and physical environmental factors at both the national and international level.197 Therefore one could attribute the Australian GST reforms to the unstable domestic and global economic climate of the past 30 years. Each major reform effort was precipitated by 193 ACOSS, Taxation in Australia: Home Truths and International Comparison (Information Paper 347) (Strawberry Hills, NSW, 2003) 25. 194 R Simeon, ‘Studying Public Policy’ (1976) 9(4) Canadian Journal of Political Science 548. 195 See Simeon, above n 194, at 566. 196 See Blount, above n 4; Brown, above n 137; Smith, above n 18; and Eccleston, above n 18, who has offered the most comprehensive account through a broadly institutionalist framework. 197 R Jackson and D Jackson, Politics in Canada: culture, institutions, behaviour and public policy (3rd edn, Scarborough, Ontario, 1994) 560–2; Sandford, above n 16, at 228–9.

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a domestic economic recession (in 1974, 1982 and 1991) prompted by worldwide recessions. The only major reforms implemented throughout the period in 1985 and 1998 followed periods of recovery. However, to what extent did the economic environment drive or inhibit reform? While one might, for example, point to the increase in global trade as necessitating a neutral tax on exports this factor alone cannot explain why the GST was the tax instrument of choice or why it was so fiercely promoted and contested over such a sustained period. B. Power Some theorists argue that patterns of public policy will reflect the distribution of power within society. However, different theorists differ over how power is to be conceptualised, identified and measured. Pluralist approaches see power as widely dispersed among groups as evidenced by their influence on a broad range of policy outcomes.198 A look at the role of participants in the Australian GST reform process initially fits well with Dahl’s pluralist ‘polyarchy’ model.199 This can be seen from the way interest groups shaped policy outcomes with their resistance to broadbased consumption tax reform at the National Tax Summit in 1985 and the later promotion of a broad-based consumption tax by ACCI and ACOSS in 1996. However, while many attribute the ACOSS/ACCI alliance as a key factor in resurrecting the GST,200 few have sought to explain why, within a decade, ACOSS both reversed its entrenched opposition to a broad-based consumption tax and contradicted the position of welfare groups in other jurisdictions.201 In contrast, Elite202 and neo-Marxist203 scholars see power as highly concentrated amongst an elite or a class. While ostensibly losing from the 1985 Summit compromise, business groups were the net beneficiaries of 198 For the classic exposition of the pluralist approach, see: R Dahl, Who governs? Democracy and power in an American city (New Haven, 1961). 199 R Dahl, A Preface to Democratic Theory (Chicago, 1956). 200 See Brown, above n 137. 201 For example, welfare groups in Canada remained firmly opposed to a GST: see Brooks, above n 4, at 2; Krever, above n 151, at 144. 202 CW Mills, The Power Elite (New York, 1956); F Hunter, Community Power Structure: A Study of Decision Makers (Chapel Hill, 1953); GW Domhoff, The Four Networks Theory of Power: A Theoretical Home for Power Structure Research (April 2005) Who Rules America?, http://sociology.ucsc.edu/whorulesamerica/theory/four_networks.html at 24 March 2006. 203 See R Miliband, The State in Capitalist Society (London, 1969) whose instrumental approach views public policy outcomes as serving the interests of capitalist classes because of their occupation of positions of power; cf N Poulantzas, Political Power and Social Classes (London, 1973) who advocates a structural–functionalist approach whereby the state exists in order to maintain the political and social structures necessary for the maintenance of capitalist economies for the benefit of the capitalist class.

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the macroeconomic reforms implemented throughout the 1980s and 1990s where policies such as the Accord effectively suppressed wages.204 While these reforms may have contributed to record profitability they have also exacerbated the growing disparity between rich and poor. However, this does not necessarily explain why business groups, such as ACCI, perceived the support of welfare groups, such as ACOSS, as critical to the implementation of a GST.

C. Ideas Many theorists have focused on the role of ideas in shaping policy outcomes, but few seriously engage with the difficult causal and definitional issues such as why specific ideas get translated into policy outcomes and what is meant by the term ‘idea’ and the related concepts of ‘culture’, ‘value’ or ‘ideology’. A preliminary examination of the role of culture and ideology in the Australian GST reforms will begin to explore these issues.205 From one perspective, the history of the GST reforms might be attributable to a certain Australian political culture, such as its isolationism, its embrace of a ‘fair go’, or its electoral conservatism and scepticism of political elites.206 However, culture is neither unitary nor immutable and sweeping cultural explanations offer very little in explaining the sudden turnaround from ‘never ever’ in 1995 to the legislative introduction of ANTS in 1999. Alternatively, attempts have also been made to attribute tax policy outcomes to specific ideologies. Put crudely, one might expect parties associated with the Left to embrace more progressive modes of taxation while those on the Right to favour more regressive taxes.207 However, the bipartisan embrace of broad-based consumption tax in Australia from the early 1980s contradicts this hypothesis. Perhaps the more pertinent question is: what caused the bipartisan embrace? To answer this we might locate the global shift towards consumption taxes within the global shift in dominant economic thought over the twentieth century. 204 Additional reforms included deregulation of the labour and monetary markets and the slashing of corporate tax rates: see R Eccleston, ‘The Significance of Business Interest Association in Economic Policy Reform: The Case of Australian Taxation Policy’ (2000) 2(3) Business and Politics 309. 205 M Weber, The Protestant ethic and the spirit of capitalism (2nd edn, London, 1976); Steinmo, above n 17, at 207; A Giddens, Sociology (5th edn, Cambridge, 2006) at 670–3; contrast K Marx and F Engels, Collected Works vols 3 and 5 (London, 1975). 206 BG Peters, The Politics of Taxation: A Comparative Perspective (Cambridge Mass, 1991) 5; V Thuronyi, Comparative Tax Law (The Hague, 2003) 3; see Sandford, above n 16, at 228. 207 See Peters, above n 206, at 9.

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D. Institutions A brief survey of the history of the Australian GST highlights the impact of a number of key executive, legislative and judicial institutions on tax policy outcomes.208 This includes the adversarial two party political system, which contributed to the transformation of Keating from zealous advocate of broad-based consumption tax reform in 1985 to vociferous opponent in 1993; the vertical fiscal imbalance of the Australian federal state; the role of the Senate as a house of review; and finally, the three-year electoral cycle which has ensured that no government has successfully sought major tax reform outside its first year of office. E. Processes Some theorists focus on the manner in which reform processes influence reform outcomes. While public choice theorists attempt to model these outcomes,209 this chapter will briefly consider a different approach where commentators have sought to pragmatically explore the impact of specific procedures on policy outcomes. The Hewson and Howard GST experiments verify much of the conventional thinking in the tax politics literature: first, the political need to avoid detailed and drastic tax policy proposals long before an election campaign; secondly the importance of an interdependent package whereby losses are offset by clear gains; thirdly, the importance of presenting at least an appearance of consultation; and finally, the importance of the political sell for tax policy specifically by individual leaders and increasingly through media campaigning where what is left unsaid is equally, if not more, significant than what is said.210 IX. FUTURE DIRECTIONS

This preliminary analysis deliberately raises more questions than it answers. However, in doing so it highlights the potential for an historical, 208 Although definitions of institutions vary markedly, this analysis will focus on institutions as the formal political structures of the state, such as Parliament, in the policy process: See Peters, above n 206, at 15. 209 Public choice theory is the ‘economic study’ of ‘non-market’ public decision-making: see Jackson and Jackson, above n 197, at 564; see, for example, JM Buchanan and G Tullock, The Calculus of Consent, Logical Foundations of Constitutional Democracy (Ann Arbor, 1962). 210 See Sandford, above n 16, at 209–21; AR Prest, ‘The Political Economy of Tax Reform’ (1972) (37) Economic Papers 11; BJ Arnold, ‘The Process of Tax Policy Formulation in Australia, Canada and New Zealand’ (1990) 7(4) ATF 379; Groenewegen, above n 35, at 168–74.

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inter-disciplinary and multi-faceted approach to analysing tax reform. Such an approach not only offers the potential for comprehensive analysis of other reform initiatives but, in its application to the Australian GST, might help the reader to determine whether the appropriate metaphor is the ‘never never’ of Jeannie Gunn’s relenting outback or the Peter Pan utopia of false hope.

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8 Privy Council Tax Cases— A Ton of Fun PHILIP RIDD

ABSTRACT This chapter surveys the 100 cases decided by the Judicial Committee of the Privy Council between 1921 and 1975 and reported in Annotated Tax Cases. Some 11 of the cases are not reported elsewhere in the main series of law reports. The chapter puts the cases into their relevant and varied legislative backgrounds and jurisdictions. A few of the cases may be familiar through citation in modern UK or other cases but many others will not and some clearly invite interested study either for themselves or for their legislative background. The Privy Council upheld the court below in 63.8 per cent of the cases and reversed in 36.2per cent; the significance of these figures is examined.

I. SCOPE AND PURPOSE

T

HIS PAPER CONCERNS the 100 tax cases decided by the Judicial Committee of the Privy Council and reported in the series of law reports initially called Accountant’s Tax Cases but more generally known by its later name of Annotated Tax Cases (‘ATC’), a series published from 1921 to 1975. ATC includes many cases which were not reported in the main series of law reports—that is to say, the Law Reports, the Weekly Law Reports and the All England Reports—and equivalents in Scotland and Northern Ireland—but in fact only 11 out of the 100 were not reported in the main series. Those 11 cases will be examined at some length. The other 89 cases will be covered more briefly. The purposes of the paper are (a) to draw attention to, and stimulate interest in, those cases which have fallen into desuetude; (b) to remind readers of some cases which, though still alive in terms of mention in footnotes in authoritative books about tax, are not well known or remembered; and (c) to see to what extent the Privy Council was in

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agreement with, or was not in agreement with, the courts of the jurisdictions from which the cases came. The paper does not attempt a full study of all Privy Council tax cases. There were many such cases before ATC was started in 1921; there have been many since ATC ceased to be produced in 1975; what is more, the coverage by ATC of 1921–75 was far from comprehensive and, as it cannot be said that the omissions were only cases of negligible interest, the 100 cases under examination do not represent a coherent, rational, whole. The paper can, therefore, be no more than a preliminary to a comprehensive study. Most of the 100 cases concerned income tax, but some were on death duties and stamp duties, and, for anyone who has a fascination with that aspect of land law represented by the Latin expression usque ad coelum et ad inferos (or a sadistic desire that valuers should be confronted with problems beset with intractable difficulties), there is the bonus of an Australian rating case. Section II of the paper will consider matters of general background. Section III will examine the 11 cases not reported in the main series of law reports : those 11 case all concern income tax, and they will be presented in chronological order. Section IV will cover four cases which did not turn on points of taxation. Section V will cover the other 85 cases, and they will be presented tax by tax, and with the income tax cases divided under several headings. Section VI will consider the extent to which local courts found themselves overruled in London.

II. BACKGROUND

The Privy Council is, of course, a truly ancient body which provides a rich source of study for anyone interested in any period of history from the early Middle Ages onwards. Furthermore, as the Privy Council was at work in the judicial field, as well as in others, the law researcher has several hundreds of years of history at his disposal. 1833 is, however, a year of particular importance because, under the special influence of Lord Brougham, major reform took place. The embodiment of that reform is the Judicial Committee Act of that year, which set up the Judicial Committee of the Privy Council in, despite intervening legislation, much the form that we know today. The two most significant changes since 1833 have been the reduction of the quorum from four to three (in 1843) and the relaxation which enabled reasoned dissent to be expressed (in 1966). Among other articles about the work of the Judicial Committee, two are especially worthy of mention. Both were transcripts of addresses or lectures delivered in Cambridge by members of the Judicial Committee, and both were published in the Cambridge Law Journal. The address delivered by Viscount Haldane of Cloan in 1921 is in volume 1 at pages 143–55, and the lecture given by Sir George Rankin in 1938 is in volume 7

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at pages 2–22. Lord Haldane’s address is conspicuous for its acceptance of the importance of the law, practices, customs, and so on, of the particular locality from which an appeal emerges—or, to put much the same point another way, the need for the Privy Council to be on guard against achieving the undesirable result of imposing principles of English law where they do not fit. An example which Lord Haldane gave related to the Gold Coast of West Africa, as Ghana then was, and it was determined that English property law should not displace, or be grafted onto, the locally established principles of tribal ownership. And, on the bold assumption that the citizens of the Gold Coast were familiar with pre-1925 English property law, it may be taken that the verdict was greeting with a rousing cheer by the whole populace, except perhaps the lawyers. Lord Haldane thought that ‘the real work of the Committee is that of assisting in holding the empire together’. With notable foresight, he shrewdly remarked that in his view ‘it is a disappearing body’. For present purposes the observations of Lord Haldane and of Sir George Rankin are conspicuous for the fact that they do not make any mention of the sizeable body of tax cases which came before the Judicial Committee. To a large extent that is easy to understand. Wrangles between taxpayers and fiscal authorities often have no general importance; sometimes they involve principles of significance in the workings of tax systems, or important points of non-tax law; only rarely, though, do tax cases have huge constitutional significance. But, as was recognised, the Judicial Committee was engaged in resolving tensions as between provinces or states and federal government, which were lively issues particularly for Canada and Australia, and jurisdiction to tax would have been one of the more important tensions. Those matters belonged almost exclusively to the nineteenth century, but an exception is the first case in Section IV below, Shell Company of Australia Ltd v Federal Commissioner of Taxation, in which it was contended that an Act of the Commonwealth Parliament infringed the Constitution of Australia. In the 1921–75 period the subjectmatter which came before the Judicial Committee in relation to taxes tended to be disputes relating to tax legislation which was closely similar to UK tax legislation, and probably the only important exception was the class of case which related to general anti-avoidance provisions which operated in Australia and New Zealand, for which there was no UK equivalent (except in legislation relating to excess profits taxation—but that legislation had scarcely engaged judicial attention). From here on the ‘Privy Council’ will be used as shorthand for the ‘Judicial Committee of the Privy Council’.

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III. THE ELEVEN CASES REPORTED IN ATC BUT NOT IN THE MAIN LAW REPORTS SERIES

A. Commissioner of Taxes (Bombay) v Western India Turf Club Ltd1 The issue in this case was whether a company, which had succeeded to the business of an unincorporated association, and which was liable to super-tax in its first year in respect of the unincorporated association’s profits of the previous year, was liable at the rate applicable to a company or at the rate applicable to an unincorporated association. The company was incorporated on 1 April 1925 as a company limited by guarantee, and it took over the assets, effects and liabilities of the Western India Turf Club, an unincorporated members’ club. It was common ground that for the year 1925–26 the company was liable, under ss 26, 55 and 58 of the Indian Income Tax Act No XI of 1922, to super-tax in respect of the club’s profits in the previous year of Rs 15,03,522. Section 55 referred to payment at the rate or rates laid down for a particular year. For 1925–26 the rates were laid down by the Finance Act No XIII of 1925, and, while a flat rate (one anna in the rupee) applied to companies, some of the rates applicable to others, including associations, were on a rising scale. The Commissioner of Taxes made an assessment on the footing that the rising scale applied. The Assistant Commissioner confirmed the assessment, but the High Court in Bombay, allowing the company’s appeal, held that the flat rate applied. The Privy Council (The Lord Chancellor, Lord Buckmaster, Lord Carson, Lord Darling, and Lord Warrington) dismissed the Commissioner’s appeal. The judgment is short, and the reasoning comprised a single paragraph, viz: The argument which has been used in favour of the appeal seems to involve the fallacy that liability to tax attached to the income in the previous year. That is not so. No liability attached to the income of this company until the passing of the Act of 1925, and it was then to be taxed at the rate appropriate to a company.

B. Commissioner of Income Tax, Bombay Presidency v Ahmedabad New Cotton Mills Co Ltd2 The issue in this case was whether, when there is a correction to an undervaluation of a company’s closing stock, the company is entitled to a corresponding correction in the value of its opening stock. 1 2

(1927) 6 ATC 1080. (1929) 8 ATC 575.

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The taxpayer company, merchants and manufacturers, held stocks of cotton, yarn, cloth, waste and coal. In its accounts for the year ended 31 December 1925 closing stock was credited at a figure lower than both cost and market value. The company was initially assessed to income tax on income of Rs 2,49,142. Once the income-tax officer had learned of the undervaluation, a further assessment was raised. The company appealed, accepting that the closing stock was undervalued, but contending that the opening stock had also been undervalued and that an adjustment should be made for this, It appears that the accounts for the previous years, possibly for as many as 10 years, had explicitly stated that the valuations were ‘under cost’ or ‘under market value’. The company said that the regular practice of undervaluation was a safeguard against market fluctuations and in order to create a special reserve for the equalisation of dividends, but that explanation was not accepted. The Assistant Commissioner confirmed the assessments and the Commissioner declined to interfere. The High Court of Judicature at Bombay allowed the company’s appeal, and its decision was upheld by the Privy Council (Lord Buckmaster, Lord Dunedin and Lord Tomlin, Sir George Lowndes and Sir Binod Mitter). The judgment of the Privy Council was very short. The question was one which, it was considered, should answer itself. Both valuations required to be adjusted, as otherwise the ascertained profit would not be ‘the real one’. C. Commissioner of Income Tax, Bombay Presidency v The Bombay Trust Corporation Ltd, as Agent of the Hongkong Trust Corporation Ltd3 The issue in this case was whether a company, resident in British India, was assessable as agent of a non-resident company from a business connection in British India. The facts are set out at length in the report’s headnote, but the shorter version in the Privy Council’s judgment suffices. Bombay Trust Corporation Ltd was stated to have its office in Bombay. Hongkong Trust Corporation Ltd. was stated to have been incorporated in Hong Kong. Implicit in those statements is that the Bombay company was resident in British India, but the Hong Kong company was not. The Hong Kong company lent money from time to time on deposit to the Bombay company at the rate of 5.25 per cent., and the Bombay company duly paid interest at that rate on the money deposited. Section 40 of the Indian Income Tax Act 1922 was a general provision enabling assessment of, among others, the agent of a person resident out of 3

(1929) 8 ATC 582.

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British India if the agent was in receipt of profits or gains of the non-resident. Section 42 deemed to be income accruing or arising within British India the profits or gains of a non-resident through or from any business connection or property in British India, and provided that any agent shall be deemed to be, for all purposes of the Act, the assessee in respect of such income. Section 43 enabled the Income Tax Officer, where a person was employed by or on behalf of a non-resident, or had any business connection with a non-resident, to serve a notice, stating his intention to treat that person as the agent of a non-resident person. Such a notice was served on the Bombay company in relation to the Hong Kong company. The Bombay company appealed against income tax assessments relating to the years ended 31 March 1925 and 1926, on grounds that it was not assessable. The Assistant Commissioner held the Bombay company to be assessable, but the High Court allowed the company’s appeal. The High Court considered that ss 40, 42 and 43 must be read together, and, while the Bombay company was agent of the Hong Kong company within s 43, in ss 42 and 43 the term ‘agent’ was used in the same sense as in s 40, ie as a person in receipt of the profits. The Privy Council (Lord Buckmaster, Lord Dunedin and Lord Tomlin, Sir George Lowndes and Sir Binod Mitter) allowed the appeal of the Commissioner of Income Tax. The Privy Council was unable to accept the High Court’s view of the linkage of the statutory provisions, but considered s 43 to be self-standing. As that provision clearly applied, with the consequence that the Bombay company became deemed to be the agent of the Hong Kong company for all purposes of the Act, it made the Bombay company an agent within s 42, irrespective of the fact that it was not in receipt of the relevant profits, and assessable accordingly. D. Trustees Corporation (India) Ltd v Commissioner of Income Tax, Bombay Presidency4 The issue in this case was whether the appellant company (‘TCI’) had made a loss on certain shares. The shares in TCI, an Indian company, were, except for two shares held by nominee subscribers, owned by two English companies, which each held a substantial shareholding in Burma Corporation (India) Ltd. In 1920 agreements were made by which TCI was to buy those shares (or substituted shares if the Burma Corporation was restructured, as in the event it was) in consideration of issue of a large block of TCI’s own shares credited as fully paid, and those agreements were ‘duly filed’. Further 4

(1930) 9 ATC 260.

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agreements made on the same occasion, which were not intended to be filed and were not filed, were described by the Privy Council as containing the ‘real transaction’. After referring to a further composite agreement in 1923, made necessary by a failure to deliver the shares in accordance with the 1920 agreements, the Privy Council stated the result to be that ‘the agreements left the English companies with, in effect, the same dominion over the shares as they enjoyed before their so-called sale’. The English companies, with TCI’s consent, sold the shares in the Burma Corporation in 1924, by which time their value was much lower than it had been in 1920. TCI eventually received a sum which was well below the par value of its shares as issued to the English companies, and it claimed to have made a loss on the footing that the Commissioner of Income Tax was bound in law to take as the price paid for the Burma Corporation shares the nominal value of the shares allotted by TCI in payment for them. The senior taxing officer concluded that the loss was a capital loss, not a revenue loss. But the Commissioner of Income Tax did not accept that a loss had been made at all, holding that the whole scheme was, as a simple purchase and sale of shares, illusory. The proceedings seem to have become rather complicated after that, but in the result the High Court dismissed TCI’s appeal. The Privy Council (Lord Blanesburgh, Lord Warrington of Clyffe and Sir Charles Sargant) upheld the High Court’s decision. The Privy Council noted that in the actual result the TCI shares had been issued at a discount, and the amount of that discount represented the loss which TCI claimed to have sustained, but that view was founded on the assumption that the shares were held by the English companies on a fully paid basis, ie the English companies were free from liability for calls or otherwise. But that assumption was held to be false, on the authority of Moseley v Koffyfontein Mines Ltd5 , which had established the principle that ‘if an arrangement for the issue of shares is such that in the course of its due working out there is as much as a possibility that in the result the shares will have been issued at a discount, then the issue of the shares as fully paid cannot be justified’. That there had been such a possibility was proved by the very fact that it had materialised. The appeal therefore failed on that ground. Observing that, while this point had been foreshadowed by the learned Commissioner, neither in the High Court nor in the arguments before the Board, had the case been dealt with so simply, the Privy Council proceeded ‘to consider its further aspects’, and did so at some length. The principal point was that TCI relied on In re Wragg6 as authority for the proposition that the Commissioner was bound by the nominal value of the shares

5 6

[1904] 2 Ch 108. [1897] 1 Ch 796.

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issued, but the Privy Council considered that In re Wragg was to be distinguished in consequence of the Commissioner’s conclusion of fact that the transaction, regarded as a purchase and sale, was illusory, a conclusion supported by ample material. In any event the Privy Council did not regard In re Wragg as in point. E. Pondicherry Railway Co. Ltd v Commissioner of Income Tax, Madras7 The issues in this case were whether the appellant company (‘PR’), not being resident in India, was liable to income tax in respect of certain receipts and, if so, whether a deduction was permissible in respect of a liability to share the profits. The material facts, which were complex, relate to the running of a railway in French India, from the landing pier at Pondicherry to a junction with the South Indian railway at the frontier of French territory. PR, a company resident in England, had, in 1878, acquired from the French colony of India the right to construct and work this railway line. Under the concession PR had to pay half of the net profits of the railway, to be calculated under deduction of specified outgoings, to the French Colonial Government. In accordance with a power in the terms of the concession, PR made an agreement in 1879 with the South Indian Railway Co. Ltd (‘SIR’), by which SIR undertook to work, manage and maintain the Pondicherry railway. SIR was entitled to retain out of the receipts a sum in respect of working expenses calculated under a specified formula, and, after that deduction, SIR had to pay the receipts every six months to PR in India in rupees. A single individual, Mr. Rothera (previously Mr. Scott), operating in Trinchinopoly, acted as agent for both PR and SIR, received the moneys payable by SIR, prepared the accounts, and remitted the shares of profits to the French Colonial Government in Pondicherry and to PR in London. Mr. Rothera, as agent of PR, was assessed to income tax and super-tax, under the Indian Income Tax Act 1922, for 1925–26 and 1926–27. On appeal, liability was denied and, if that were to fail, a deduction was sought in respect of the payments to SIR. The assessments were confirmed, first by the Assistant Commissioner, and then by the Commissioner of Income Tax, whose decision was upheld by a majority in the High Court. The Privy Council (Lord Macmillan, Lord Salvesen and Sir George Lowndes) dismissed PR’s appeal. The Privy Council found it necessary to deal with only two questions. Under s 4(1) liability arose in respect of income, profits or gains, received 7

(1931) 10 ATC 365.

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in British India. PR contended that Mr. Rothera was not its agent to receive payments on its behalf from SIR, but was merely its agent for transmission to London. The Privy Council held that the facts did not support this contention, and described in detail the aspects of Mr Rothera’s activities which exceeded those ascribed to him in the contention, including the comment: ‘He is instructed from London to ‘pay over to the French authorities’ their moiety. How he can obey this instruction and pay over what, on the appellant’s submission, he has not received requires for its appreciation a metaphysical subtlety remote from the prosaic realm of income-tax law.’ The second issue dealt with was the deduction issue. The payment to the French authorities was a payment out of profits, not a payment made to earn profits. Whilst cautioning about the use of English authorities in Indian income tax cases, the Privy Council referred to the relevant principle as stated by Lord Halsbury LC in Gresham Life Assurance Society v Styles.8

F. Dinshaw v Commissioner of Income Tax, Bombay Presidency9 The issue in this case was whether a debt owed by a company might be regarded as bad or irrecoverable even though the company was still a going concern. The taxpayer was a partner of HF Commissariat & Co, who, as agents for Assur Veerjee Mills Ltd, had entered into promissory notes or bonds which amounted to guarantees in respect of advances made to the company by banks. On the banks recalling the loans to some extent, the company was unable to pay and the firm was obliged to honour its guarantee. For 1928–29 the taxpayer’s share of the firm’s payments was Rs 1,73,500, and for 1929–30 (the preceding year basis of assessment being applicable) he claimed that that sum was deductible for income tax purposes as a bad debt incurred in the ordinary course of business. The income-tax officer rejected the claim on the grounds that the sum could not be regarded as a bad debt incurred in the ordinary course of business and should be treated as a debt of a capital nature. The Assistant Commissioner rejected an appeal but on different grounds, namely that the debt could not be regarded as a bad debt as long as the company was a going concern. The Commissioner upheld that decision, and so did the High Court. The Privy Council (Lord Tomlin, Lord Russell of Killowen, Lord Macmillan, Sir Lancelot Sanderson and Sir Shardi Lal) allowed the taxpayer’s appeal. 8 9

[1892] AC 309, 315. (1934) 13 ATC 284.

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The judgment of the Privy Council was very short. It was held that there was no principle or authority to support the High Court’s decision, and whether a debt is wholly or partly, and to what extent, bad or irrecoverable is a question of fact to be decided upon consideration of the relevant facts of the particular case.

G. Commissioner of Income Tax, Bihar and Orissa v Maharajahdhiraj of Darbhanga10 As will appear, there were several issues in this case relating to the computation of income from a moneylending activity, and there was a separate issue as to whether a payment to a landlord was a capital (non-deductible) payment or an income (deductible) payment in respect of a colliery business. The facts, issues and points of decision will be set out in five segments. Three paragraphs of the Privy Council judgment have been omitted as not worthy of coverage. (a) Prior to his death in 1929 the taxpayer engaged in moneylending, though not as a business. He maintained both a deposit register and an interest register. Payments by debtors were recorded in the deposit register, but initially without an allocation between principal and interest. Subsequently, if and when such an allocation was made, a corresponding entry for the amount of interest was made in the interest register. The allocation was not necessarily made in the year of receipt, but it might be made in a later year. Accounts were drawn up to 30 September in each year. Tax was chargeable on a preceding year basis, so the accounts to 30 September 1924 were the basis for the 1925–26 assessment. On previous occasions the taxpayer had produced his interest register, but not his deposit register. With the 1924 accounts the deposit register was also produced. The income tax officer was therefore enabled to calculate the true amount of interest received over several years. The same occurred with the 1925 accounts, though the income tax officer made due adjustments for amounts which now appeared in the interest register but which he had taken into account in the previous year’s calculation. These facts gave rise to an issue relating to the 1926–27 assessment. The taxpayer challenged the income tax officer’s method of computing his income, but the challenge failed before the High Court of Judicature at Patna and before the Privy Council (Lord Macmillan, Sir George Lowndes and Sir Dinshah Mulla). Section 13 of the Indian 10

(1933) 14 ATC 542.

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Income Tax Act 1922 provided that, where a taxpayer’s method of account was such that, in the opinion of the income tax officer, the income could not properly be deduced therefrom, the computation should be on such basis and in such manner as the income tax officer might determine. That provision plainly applied. Further, the method actually adopted by the income tax officer was not considered to be wrong, even in so far as the result included ‘sums carried by the assessee to income account in that year out of the receipts of previous years which have been held in suspense and no part of which has previously been returned as income’. (b) In the year in issue one particular debtor made two payments, the second of which, Rs 2,78,000, gave rise to an issue. The income tax officer treated it as interest, though the taxpayer has appropriated only part of it (Rs 18,816) to interest. The High Court upheld the income tax officer’s decision, but limited to Rs 2,71,190. That was the figure of the accumulated interest liability of the debtor which, after allowing a deduction for the sum of Rs 38,091 taxed as interest in the previous year, remained untaxed. The Privy Council agreed with the High Court. Where no appropriation between capital and interest was made by either debtor or creditor, the presumption was that the payment was attributable in the first instance towards the outstanding interest : Venkatradi Appa Row v Parthasarathi Appa Row11, and, while that presumption operated primarily between debtor and creditor, the income tax officer was considered to have been entitled to apply it in the circumstances. (c) In the year in issue the taxpayer also received income from the purchase of property under mortgage decrees. The taxpayer did not return any income from this source, but later admitted realisation of Rs 4,364. The income tax officer increased the amount to Rs 1,04,364. In the light of the history of previous years, the assessment was upheld. The Privy Council noted that the taxpayer should, if he wished to displace the assessment, have adduced evidence of the correct figures, but he had made no attempt to do so. (d) In the year in issue the taxpayer made an arrangement with one debtor by which, in satisfaction of a debt of Rs 38,09,571 (principal of 32 lacs and interest of Rs 6,09,571) the debtor transferred several items of property to the aggregate value of Rs 38,09,569. Of that figure Rs 20,74,973 related to assets which were equivalent to cash, but the balance, Rs 17,34,596 were promissory notes given by the debtor. The Commissioner took the view that for tax purposes the interest should come into account. On this point the taxpayer succeeded before the

11

(1921) 48 IA 150, 153.

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High Court and the Privy Council. Where a liability to pay interest was satisfied by a payment in kind, the receipt was taxable only if it was ‘the equivalent of cash—or, in other words, money’s worth’: Californian Copper Syndicate v Harris12, Scottish and Canadian General Investment Co v Easson.13 The figure of Rs 17,34,596 was, therefore, not taxable income. As to the Rs 20,74,973 the position as between debtor and creditor was that the taxpayer might up to the last moment appropriate it to capital account (Cory Bros & Co v Owners of the ‘Mecca’,14), and the taxpayer was entitled to appropriate payments as between capital and interest in the manner least disadvantageous to himself: Smith v Law Guarantee and Trust Society Ltd.15 (e) The items valued at Rs 38,09,569 included a colliery valued at Rs 7,37,339. The debtor represented it to be free from encumbrances, but it transpired that there were arrears of fixed or dead rent due to a superior landlord of Rs 67,872. The taxpayer duly paid that sum, but his claim for a deduction for tax purposes was refused by the Commissioner. The High Court allowed the taxpayer’s appeal, holding that the payment might properly be considered as rent, deductible under s 10(2) of the 1922 Act. The Privy Council disagreed, holding that it was a sum paid by the taxpayer in order to get possession of the colliery, not a sum expended by him in the carrying on of the colliery. In any event it was in respect of a period of occupation when the taxpayer was not the occupier, so it cannot have been rent vis à vis the taxpayer.

H. Commissioner of Income Tax, Madras v PRAL Muthukuruppan Chettiar16 The issue in this case was whether a share of profits paid to an outgoing partner was a capital receipt and therefore not assessable to income tax. The taxpayer was one of three members of a partnership whose business, conducted in Colombo, was money-lending. Following the taxpayer’s retirement from the business on 31 July 1930, the other partners remitted to him in India a sum which included Rs 38,305 due to him as interest on capital. That sum was included in an income tax assessment for 1931–32. The Assistant Commissioner, and in turn the Commissioner, upheld the assessment in that respect, but the High Court decided in favour 12 13 14 15 16

(1904) (1922) [1897] [1904] (1935)

6 F 894; 5 TC 159. SC 242; 8 TC 265. AC 286. 2 Ch 569. 14 ATC 368.

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of the taxpayer, applying Commissioners of Inland Revenue v Burrell,17 as followed in Commissioner of Income Tax, Madras v Siddha Gowder and Sons.18 The Privy Council (Lord Atkin, Sir John Wallis and Sir Shardi Lal) allowed the Commissioner’s appeal. The judgment of the Privy Council is very short. Commissioners of Inland Revenue v Burrell was distinguished, because it related to receipt by a shareholder of his share of the assets of a company upon a winding-up, and, as shareholders do not, during continuance of a company, have a right to the profits (unless a dividend is declared), a distribution by a liquidator cannot be reconstructed into a division of capital and profits. By contrast, a partner does, pre-dissolution, have a right to profits, and those profits cannot alter their character by dissolution. The Privy Council dismissed a contention that the Commissioner had taken the contrary line in a previous case, and was therefore blowing hot and cold in successive cases. That was held to be ‘a privilege not confined to Commissioners of Income Tax and its exercise cannot influence judicial determination of the law’.

J. Commissioner of Income Tax, Madras v Fletcher19 The issue in this case was whether a sum paid to an employee on his retirement was liable to Indian income tax. The taxpayer was an employee of the Buckingham & Carnatic Co Ltd, an Indian company. On his retirement in 1933 he received Rs 36,794 paid out of ‘The Officers’ Retiring Fund’. That fund was constituted and managed under a set of rules, as follows. The fund was to be in receipt of all bonuses ‘which the company may from time to time allot’ to its credit; bonuses would be apportioned between officers of the company in proportion to their salaries; the officers had no claim on the fund during their employment; if an officer died during employment, payment would be due out of the fund to his legal representative; subject to completion of a specified number of years of service with the company, an officer would, on retirement, receive his share of the fund; finally, the directors had a wide discretionary power to decide who was eligible to benefit, to alter the rules, and on all other matters in connection with the fund. Income tax was deducted from the payment, and the taxpayer claimed a refund. In the High Court, Madras, a majority held in the taxpayer’s favour. The Privy Council (Lord Maugham, Sir Lancelot Sanderson and Sir George Lowndes) dismissed the Commissioner’s appeal. 17 18 19

(1924) 9 TC 27. ILR 55 Madras 818. (1937) 16 ATC 213.

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In its judgment, delivered by Sir George Lowndes, the Privy Council declined to consider UK tax law, and in particular Henry v Foster.20 UK and Indian tax law differed widely. The crucial issue was whether the sum received was to be characterised as deferred income, as had been the minority view in the Madras court. The incident that the company had a discretion how much, if anything, to pay into the fund each year was alone sufficient to negative the idea that allotments were part of an officer’s current salary. Other features of the rules reinforced that conclusion, and established that the sum paid was not ‘income’. As one of the majority judges in the Madras court had held, the payment was just as much a capital receipt as would be a lump sum paid out of a provident fund on an employee’s retirement. It is worth noting that Counsel for the Commissioner conceded that, where a sum was paid to the legal representative of a deceased employee, that sum would not be taxable.

K. d’Aguiar v Guyana Commissioner of Inland Revenue21 The issues in this case were whether certain covenanted payments were exempt from income tax by reason of the recipient being an organisation of a public character or by reason of it being a body whose objects were wholly charitable. In 1961 the taxpayer covenanted to make annual payments of $4,200 for each of three years to the Citizen’s Advice and Aid Service of Georgetown, Guiana. The objects of that Service, as summarised in the headnote, were ‘to assist those in need, encourage thrift, promote adult education and technical training, help the citizen to benefit from State services, and generally to do anything to assist the citizen’. Under s 53(3) Income Tax Ordinance, Cap 299, an annual payment remained the chargeable income of a taxpayer ‘unless the income has been transferred, assigned or otherwise disposed of for a period exceeding two years or for the remainder of his life to or for the benefit of any ecclesiastical, charitable or educational institution, organisation or endowment of a public character within British Guiana’.. By a separate provision the English law of charities was designated to apply to Guyana. The taxpayer’s claim for exemption (for the year of assessment 1962) failed at all stages, viz the Supreme Court of British Guiana, the Supreme Court of Judicature of Guyana, and the Privy Council (Lord Hodson, Lord Donovan and Lord Wilberforce). 20 21

(1932) 16 TC 605. (1970) 49 ATC 33.

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The taxpayer’s first argument was that s 53(3) should be so interpreted that the words ‘of a public character’ qualified only ‘endowment’, and not ‘institution, organisation or endowment’, so that payments to an endowment of a public character were deductible even if the endowment was not charitable. The Privy Council held that the words were not susceptible of the construction advanced. On the issue whether or not the purposes of the Service were charitable, the Privy Council first examined whether the case ‘can be considered as favoured by existing decisions’. The nearest cases in relevance were found to be Williams’s Trustees v CIR22 and CIR v Baddeley,23 and they were against the taxpayer. The Privy Council then examined two special sets of decisions. The first (In re Wedgwood24 and In re Cranston25) related to trusts for animals, but the promotion of kindness of man to man, as opposed to man to animals, was ruled out of the charitable sphere by previous authorities dealing with ‘philanthropic’ and ‘benevolent’ purposes. The second set of special cases were such as In re Smith26 (‘unto my country England’), and gifts for the benefit of the inhabitants of a locality, but they did not apply where the purpose of a trust was specifically expressed. Finally, therefore, the Privy Council examined the stated objects of the Service, and agreed with Chief Justice Luckhoo that many were widely outside any conception of the legally charitable. The Privy Council prefaced the reasoning with acceptance of the point that the community in Guyana was different in composition and development to that of England, and that this should be taken into account.

L. Ceylon Commissioner of Inland Revenue v Rajaratnam27 The issue in this case was whether sums paid under deeds of covenant were deductible in computing the taxpayer’s income. On 1 February 1958 the taxpayer executed two deeds of covenant, one in favour of each of his two brothers. Under each covenant he was to pay to the named brother Rs 1,500 annually for seven years (or, if shorter, during his, the taxpayer’s, lifetime). The covenants were made in consideration of natural love and affection. The deeds were charged to stamp duty under s 26 of the Stamps Ordinance 1909, which included annuities by covenant. Payments for 1957–58 were included in the brothers’ income, and they paid tax on the receipts. The taxpayer made a claim for deduction 22 23 24 25 26 27

[1947] [1955] [1915] [1898] [1932] (1971)

AC 447. AC 472. 1 Ch 113. IR 431. 1 Ch 153. 50 ATC 441.

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on the footing that the payments were of annuities, and under s 15(1)(g) of the Income Tax Ordinance 1932 (as amended), ‘any annuity, ground-rent or royalty’ was deductible. The claim was disallowed. On appeal the Deputy Commissioner held that for UK tax purposes the payments would be regarded as ‘other annual payments’, not as ‘annuities’, and, as the Ceylon provision did not refer to ‘or annual payments (contrast s 169 of the Income Tax Act 1952), the payments were not deductible. The Board of Review dismissed the taxpayer’s appeal, giving different reasons, which the Commissioner did not seek to support in his arguments on appeal. The Supreme Court of Ceylon allowed the taxpayer’s appeal, holding that the right to receive recurring annual payments, which were income in the hands of the payee, could properly be described as an ‘annuity’, even though the payee had not acquired the right by purchasing it for a capital sum, and there was no warrant for a more limited meaning. The Privy Council (Lord Cross of Chelsea, Lord Hodson, Lord Kilbrandon, Sir Frederic Sellers and Sir Benjamin Ormerod) dismissed the Commissioner’s appeal. The Privy Council agreed with the reasoning of the Supreme Court of Ceylon. The submission that “annuity” meant only a purchased annuity relied on observations of Watson B in Foley v Fletcher,28 but those observations were considered limited to the context of distinguishing between a purchased annuity and a sale of property by instalments. The Privy Council considered that the taxpayer’s payments could fairly be described as annuities, and that that view received support from s 26 of the Stamps Ordinance 1909.

IV. THE CASES WHICH DID NOT TURN ON POINTS OF TAXATION

The main case under this heading is Shell Company of Australia Ltd v Federal Commissioner of Taxation.29 The taxpayer company alleged that an Act of the Commonwealth Parliament infringed the Constitution of Australia. The taxpayer company, previously called British Imperial Oil Co Ltd, incorporated in Great Britain, carried on business in Australia, selling oil, petrol and petroleum products. The Commissioner made assessments to tax on the company in reliance on s 28 of the (Federal) Income Tax Assessment Act 1922–1924, which provided for an assessment on a percentage of the total profits of business carried on in Australia but controlled by persons resident outside Australia. 28 29

(1858) 3 H & N 769. [1931] AC 275.

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In relation to an assessment for the financial year 1922–23, the company contended that the assessment was invalid on the grounds that the Board of Appeal created by the Act of 1922 was a court exercising part of the judicial power of the Commonwealth but, as its members were appointed for a period of seven years, it was contrary to ss 71 and 72 of the Constitution of Australia, by which a duly appointed justice could be removed only on an address from both Houses of Parliament. That contention was successful in the High Court of Australia30 which applied Waterside Workers’ Federation of Australia v JW Alexander Ltd.31 In relation to an assessment for the financial year 1923–24 the company took the same line. Meanwhile Parliament enacted the Income Tax Assessment Act 1925, by which the Board of Appeal was abrogated and was replaced by a Board of Review. Under the revised legislation a taxpayer, who was dissatisfied with a decision of the Commissioner, had a choice : he could request the Commissioner either to refer his decision for review by the Board of Review or to treat his objections as an appeal and to forward it either to the High Court or to the Supreme Court of the State. The Commissioner put the company to this choice, and the company requested forwarding to the Supreme Court of Victoria. Nevertheless the company maintained its initial line, and the High Court of Australia (Isaacs, Higgins, Gavan Duffy, Rich and Starke JJ, Knox CJ dissenting) held that the Board of Review was an administrative or executive tribunal and that no objection could be taken to the limited tenure of office of its members. The issue proceeded to the Privy Council. The importance of the case is perhaps demonstrated by the fact that five members sat, headed by the Lord Chancellor. They were Lord Sankey LC, Viscount Dunedin, Lord Blanesburgh, Lord Russell of Killowen and Chief Justice Anglin. But a more convincing demonstration is afforded by the representation of the parties. The company’s counsel were WA Greene KC, Gavin Simonds KC and Andrewes Uthwatt, while the Commissioner’s Counsel were Sir John Simon KC and Somervell KC. In due season those individuals transmogrified into Lord Greene MR, Viscount Simonds, Lord Uthwatt, Viscount Simon, and Lord Somervell of Harrow. A short way out was available in the sense that the company had to establish that there was some inseparable connection between the charging provision (s 28) and the provisions which created the Board of Review. As the company had exercised its option to have its appeal go to what was incontestably a properly constituted court, the lawfulness or otherwise of the Board of Review appeared to be an immaterial happenstance. The

30 31

35 CLR 422. (1918) 25 CLR 434.

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Privy Council noted this issue, but chose to confront the issue whether the Board of Review was constitutionally satisfactory. The Privy Council was not too shy to observe that the Federal Legislature must be taken to have set itself to get over the difficulties created by the High Court decision in relation to the company’s 1922–23 appeal, and to notice that the changes had reflected suggestions made by the Judges who took part in that decision. But Counsel for the company had submitted that the Board of Review was, in effect, in just the same position as the old Board of Appeal, and that the legislation was camouflage. It was on this point that the Privy Council, in agreement with the majority in the High Court of Australia, held that the company’s case failed. The Privy Council noted the differences between the old and the new body, as analysed in the judgments of Isaacs J and Starke J. In addition the Privy Council noted the distinction that the orders of the Board of Review, unlike those of the Board of Appeal, were not stated to be conclusive for any purpose whatsoever. It was further noted that the authorities clearly showed that there are tribunals with many of the trappings of a court which, nevertheless, are not courts in the strict sense of exercising judicial power. Isaacs J’s remark, that the Board of Review had been assimilated to the Commissioner, rather than to the Court, had already been noted. The ratio of the judgment has its origin in the paragraph which read: Their Lordships are of opinion that it is not impossible under the Australian Constitution for Parliament to provide that the fixing of assessments shall rest with an administrative officer, subject to review, if the taxpayer prefers, either by another administrative body, or by a Court strictly so called, or, to put it more briefly, to say to the taxpayer ‘If you want to have the assessment reviewed judicially, go to the Court. If you want to have it reviewed by business men, go to the Board of Review’.

With the benefit of further citations from the judgment of Isaacs J, the Privy Council concluded that the Board of Review was not exercising judicial powers. Agreement was expressed with the following remark of Isaacs J: ‘unless…it becomes clear beyond reasonable doubt that the legislation in question transgresses the limits laid down by the organic law of the Constitution, it must be allowed to stand as the true expression of the national will’. That was sufficient to conclude the case. It was unnecessary to address an issue whether ss 71 and 72 of the Constitution of Australia were not more limited in effect than as advanced in the company’s argument, ie a contention that they did not go so far as to insist on appointment of Judges for life, but merely provided for a special method of removal during the course of their tenure. All the same, the Privy Council gave a strong indication that the Commissioner would not have succeeded on that issue.

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The judgment does not elucidate the grounds upon which Knox CJ parted company from his brethren in the High Court of Australia. On the other hand the judgment is unusual for containing so much citation from the reasoning in the Court below. This might be a sign of special tenderness, deference or diplomacy, as the issue was a constitutional one. But it might just have been the style of Lord Sankey LC, who delivered the judgment. Or it might be happenstance. It is a possible criticism of the decision that the lines of demarcation seem to be technical and insubstantial. Nothing appears to contradict the assertion by counsel for the company that that the Board of Review was, in effect, in just the same position as the old Board of Appeal. All the same the company’s case lacked merit in that it was not obliged to encounter the Board of Review and had taken steps to ensure that it would not do so. The second case, Vincenzini v Regional Commissioner of Income Tax,32 concerned court procedure. The appellant taxpayer failed to lodge in time documents required to accompany his memorandum of appeal to the Supreme Court of Kenya, but he remedied the default later. It was held that his appeal was not to be struck out. The third and fourth cases involve the same taxpayer, Mr Ranaweera, a gentleman who owned considerable landed property in Ceylon and had a large income. In Ranaweera v Wickramasinghe33 he petitioned the Supreme Court for an order to quash a decision of the Commissioner on grounds that a decision to impose a penalty was an exercise of judicial power and the Commissioner was not a judicial officer duly appointed by the Judicial Service Commission, so that he lacked jurisdiction. The Privy Council held that the Commissioner was performing administrative duties, albeit that he must act judicially in exercising his power. Unusually the judgment refers to US authorities—also the Shell (1931) case described above—but only in a general survey. In Ranaweera v Ramachandran34 the contention was that a Board of Review decision (upholding a penalty) should be quashed because either (1) its members were exercising judicial powers, but could not properly do so as they had not been appointed by the Judicial Service Commission, or (2) they were not validly appointed because, as ‘public officers’, they should have been appointed by the Public Service Commission, and not by the Minister of Finance. On (1), the Privy Council held that the Board’s functions were administrative, though judicial qualities were called for in their performance. Dicta in CIR v Sneath35 were found helpful, and the remark of Megarry J in Slaney v

32 33 34 35

[1963] [1970] [1970] (1932)

AC 459 ; 42 ATC 49. AC 951; 48 ATC 518. AC 562; 48 ATC 523. 2 KB 362.

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Keane,36 to the effect that Commissioners no longer had administrative functions following the Income Tax Management Act 1964, was doubted. On (2), it was held that members of the Board were like independent arbitrators and that the language of s 3 of the Constitution was inapt to describe members of the Board having regard to the duties they had to perform. Lord Diplock was dubitans on (1) and dissented on (2).

V. THE OTHER CASES WHICH TURNED ON POINTS OF TAXATION

A. Income Tax i. General Statutory Exemption In United Towns Electric Co Ltd v Attorney-General for Newfoundland37 the question was whether statutory exemptions of the appellant company from taxation were confined to local taxation and did not include income tax. The question derived from a statutory provision of 1902 which had made the company liable for water rates but otherwise exempted it from taxation. The respondent relied on the ejusdem generis rule of construction. The Privy Council held that mention of one species goes not create a genus, and more generally that there was no ground for limiting the general and ordinary meaning of the term ‘taxation’. ii. Charity In Tribune Press, Lahore (Trustees) v Income Tax Commissioner, Punjab, Lahore38 the question was whether a trust to keep up the liberal policy of a newspaper was for the advancement of an ‘object of general public utility’ within an exemption provision, namely s 4(3)(i) of the Indian Income Tax Act 1922. The main issue related to the thorny topic of political objects, on which there was a series of English authorities. In the result it was held to be beyond doubt that the testator’s purpose was ‘to benefit the people of Upper India by providing them with an English newspaper—the dissemination of news and the ventilation of opinion upon all matters of public interest’, so it had not been made out that a political purpose was the dominant purpose of the trust. In Caffoor v Commisssioner of Income Tax, Colombo39 it was held that a trust, the purposes of which related to education and to the relief of 36 37 38 39

[1970] [1939] [1939] [1961]

Ch 243. 1 All ER 423; 18 ATC 294. 3 All ER 469; 18 ATC 243. AC 584; 40 ATC 93.

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poverty, was not an ‘institution of a public character established solely for charitable purposes’ by reason a provision in the trust which gave priority to family members. On a preliminary point it was held that a decision of the Board of Review for an earlier year did not operate as an estoppel per rem judicatam, because in a tax appeal the dispute is about the amount of the assessable income for the year in question. iii. Liability as Agent Commissioner of Income Tax, Bombay Presidency and Aden v Bombay Trust Corporation Ltd40 was a follow-up to the case reported at (1929) 8 ATC 582, in which the taxpayer company had been held liable as agent in respect of tax on interest paid to the Hong Kong Trust Corporation Ltd. The present case concerned the year of assessment 1928–29, and related to any interest paid in 1927. The taxpayer company’s books did not record any such interest, but indicated, to the contrary, that the Hong Kong company had been paid off in 1926. The Commissioner, conscious that the companies, and their bankers, were closely associated, their shares being held almost exclusively by one family, sought to uphold an assessment on the taxpayer company, but the attempt failed because there was no evidence to suggest that interest accrued or arose in 1927, contrary to what was recorded in the taxpayer company’s books. In Trinidad Lake Asphalt Operating Co Ltd v Commissioners of Income Tax for Trinidad and Tobago41 it was held that where a company paid a dividend by means of cancelling a debt owed to it by the shareholder concerned, there was ‘transmission’ of ‘revenue’ within s 30 of the Income Tax Ordinance 1940 (Trinidad and Tobago), rendering the payer company liable to tax as agent for the non-resident shareholder. iv. Mutuality In English & Scottish Joint Co-Operative Wholesale Society Ltd v Assam Agricultural Income Tax Commissioner42 the company, incorporated under the Industrial Provident Societies Act 1893, grew and manufactured tea in Assam, and sold it to its two members, exporting it to England and Scotland. The company was funded by advances made by the two members, and its rules provided for the application of net profits. It was held that the mutuality principle applied only to arrangements which precluded the possibility of the making of profits, as, for example, where a 40 41 42

[1936] 2 All ER 1679; 15 ATC 441. [1945] AC 1; 23 ATC 274. [1948] 2 All ER 395; 27 ATC 332.

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common fund is set up as the vehicle by which to share losses, and the present case involved no such arrangements. In Doctor’s Cave Bathing Club (Fletcher) v Jamaica Commissioner of Income Tax43 the main issue was whether the appellant club was exempt from Jamaican income tax on the mutuality principle or was chargeable in respect of a trading profit of £472 on gross receipts of £1,720—the year in issue was not specified in the report, but was evidently later than 1963. The club, a members’ club, owned a bathing beach at Montego Bay. Its financial arrangements changed in 1956 and in 1963. At all times there were ordinary members, paying subscriptions, and paying visitors, but the case relates to hotel guests. Up to 1956 hotel guests bought visitors’ tickets at their hotels, the hotels having acquired blocks of tickets. From 1956 the club had a class of members, called ‘hotel members’, each hotel paying 2s per head in respect of the audited number of guests in the hotel over a specified period. The change in 1963 apparently followed a ruling, adverse to the club, by the Income Tax Appeal Board. The hotel members were given a right to vote and they were to pay a subscription of £1 10s, in addition to the sums in respect of the audited guest count. In fact there were three or four hotel members. The Privy Council concluded that, in deciding where the relationship of mutuality ends and that of trading begins, no single criterion is likely to be decisive. The judgment therefore addressed the appeal by close reference to its own facts, and in two ways. First, it was said that: if mutuality is to have any meaning, there must be a reasonable relationship, contemplated or in result, between what a member contributes and what, with due allowance for interim benefits of enjoyment, he may expect or be entitled to draw from the fund—between his liabilities and his rights.

In terms of interest in the club’s surpluses, having regard to the amount of their contributions, ordinary members had an overwhelmingly greater interest than hotel members. The second approach was to recognise that pre-1956 the club was clearly trading in the same way as found in Carlisle & Silloth Golf Club v Smith,44 to agree with the Appeal Board decision in 1963, to the effect that the 1956 changes had not altered that position, and then to conclude that the 1963 changes could not be held to have changed the position without ‘distortion, if not a mockery, of the mutuality principle’. The decision in favour of the Commissioner on those grounds made it unnecessary for the Privy Council to address an alternative contention,

43 44

[1972] AC 414; 50 ATC 368. [1913] 3 KB 75; 6 TC 45.

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based on s 10(1) of the Income Tax Law 1954 (No 59), that the Commissioner was entitled to disregard the 1963 changes as an ‘artificial or fictitious’ transaction.

v. Trading In Minister of Finance v Smith45 the issue was whether the taxpayer was liable to income tax on his profits from illicit traffic in liquor, and the Privy Council held that he was, there being no valid reason for a restrictive construction of the relevant provision of the Canadian Income War Tax Act 1917. Speldewinde (Commissioner of Income Tax) v Peiris46 concerned s 11(1) of the Income Tax Ordinance of Ceylon 1938 which provided a general rule of assessment on a preceding year basis, but later sub-sections of which provided special rules. Section 11(6) dealt with the position where ‘a person…ceases to carry on…business…in Ceylon’. Mrs Peiris, who ran an agricultural business, died on 23 October 1951. The Commissioner took the view that s 11(6) applied. The Privy Council held that that was correct, and that neither the language nor the context justified a conclusion that cessation by reason of death was not within the compass of that provision. Iswera v Commissioner of Inland Revenue47 is a well-known case on trading, or, more precisely, on an ‘adventure and concern in the nature of trade’ (s 2 of the Income Tax Ordinance 1956 of Ceylon). In 1951 the taxpayer wished to move within Colombo to reside nearer the school which four of her five daughters were attending. She tried to buy part of a nearby building site, but the vendor would only sell the site as a whole. The taxpayer bought it for Rs 450,000, though under the agreement she was bound to reconvey a site of 60 perches to the vendor. On paying the deposit the taxpayer caused a plan for development of the site to be prepared. This showed 12 building plots and provision for roads. She found purchasers for nine plots and kept two for her own house, the twelfth being the one for reconveyance to the vendor. The financial result was that the taxpayer was out of pocket to the measure of Rs 15,275, but retained land the market value of which was Rs 87,040. She was assessed to income tax on the difference, viz. $71,765, though it was later agreed, without prejudice as to liability, that the net profit was Rs 66,331. The Board of Review dismissed the taxpayer’s appeal, finding that her ‘dominant motivation’ was to make a profit. The Court of Appeal held

45 46 47

[1927] AC 193; 5 ATC 621. [1958] AC 1; 36 ATC 236. [1965] 1 WLR 663; 44 ATC 157.

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that the Board had applied the relevant legal principles correctly. The Privy Council upheld that decision. The judgment, delivered by Lord Reid, includes the much-cited passage: If, in order to get what he wants, the taxpayer has to embark on an adventure which has all the characteristics of trading, his purpose or object alone cannot prevail over what he in fact does. But if his acts are equivocal his purpose or object may be a very material factor when weighing the total effect of all the circumstances.

vi. Whether any Income Received In St Lucia Usines and Estates Co Ltd v Colonial Treasurer of St Lucia48 the issue was whether the taxpayer was liable to income tax for 1921 because, although it had ceased both to trade and to be resident in St Lucia, it was entitled to receive a sum of interest which, in the event, had not been paid. If the company was liable for 1921, the measure of liability would have been its income for the year ended 30 September 1920, but the company was liable only if it had ‘income arising or accruing’ in 1921, and the Privy Council held that that phrase denoted that ‘there must be a coming in to satisfy the word “income”’—which there had not. In Doughty v Commissioner of Taxes49 the issue was whether, on a partnership business being transferred to a limited company, an increase in the stated balance sheet value of the stock in trade was an assessable profit. In 1920 the taxpayer and Mr Arthur George, general merchants and drapers, converted their partnership into a limited company, and they subscribed the memorandum of association for all the 175,000 £1 shares in the company, of which 76,000 were allotted to them. The capital account of the partnership stood at considerably less than £76,000, so some accounting adjustments were necessary, and one was to alter the value of the stock in hand from some £43,358 to £58,383, an increase of £15,025. The claim by the Commissioner of Taxes that this last amount was a taxable profit was rejected. It was held that if the transaction were a sale, then there was no separate sale of the stock in hand, and if the transaction were not a sale, the partners made no money by an alteration in the stock value. In Holden v Inland Revenue Commissioner; Menneer v Inland Revenue Commisioner50 each taxpayer, entitled to sterling funds in the UK, arranged through brokers for securities to be bought with funds and for the securities immediately to be sold for New Zealand currency, and by 48 49 50

[1924] AC 508 ; 4 ATC 112. [1927] AC 327; 6 ATC 417. [1974] AC 868; 53 ATC 175.

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this well recognised method of transferring sterling funds, the return was better than that at the official exchange rate. The issue was whether or not the measure of that success was a taxable profit. The taxpayers’ argument, that the property had not been acquired for the purpose of selling, received short shrift, because that was the essence of the matter, it making no difference that the wider objective of transmitting funds from the UK to New Zealand was achieved. The big issue was whether profits or gains had been made. That depended on whether the purchase price measured in New Zealand currency was to be ascertained at the official rate. The Privy Council held that, where there were two recognised methods of transferring sterling funds, the funds had to be valued for what they were worth in the better market, and that led to the conclusion that there were no profits or gains.

vii. Whether Receipt Income or Capital The background to Commissioner of Taxes v British Australian Wool Realization Association Ltd. (in liquidation)51 was that there was a vast surplus of wool at the end of the First World War, during which the whole annual Australian wool clip had been acquired by the UK Government under an inter-Government arrangement for equal sharing of any profits. The taxpayer company was incorporated in Victoria in 1921 to manage and control the sale of the wool in accordance with the inter-Government agreement. The wool was sold between 1921 and 1924 by contracts made and executed outside Australia. Liquidation of the company followed, and over £4 million was available for distribution. The company also earned a commission in respect of sales on behalf of the Imperial Government. Further, the Commonwealth Government paid over to the company some £18,000, the proceeds of an agreement which that Government had with Wool Combing and Spinning Co Ltd. The issues in this case were several. The first was whether a surplus on sale of wool was (a) an income or capital receipt, and (b) if income, was ‘earned in or derived in or from Victoria’. The Privy Council held the receipt to be capital, placing much emphasis on the proposition that ‘the realization by the Association was primarily always a matter of State, and never, in any sense, commercial’. The conclusion was that ‘the Association’s interest in the wool always was fixed capital and never was circulating capital’. Its function was simply to realise a capital asset and distribute the proceeds. It was mere realisation, not trading. The second issue was whether commissions received on the sale of wool were profits ‘earned in or derived in or from Victoria’, but it was held that 51

[1931] AC 224; 9 ATC 449.

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no part of the profit-earning operations of the company was carried out in Victoria, and no part of ‘its so-called profits’ was earned in or derived in or from Victoria. The third issue was whether the sums received for distribution (£138,000) (a) represented a profit earned, and (b) if so, were ‘earned in or derived in or from Victoria’. On this, too, the company succeeded. It was held that the company was simply a medium for distribution from the Government to the suppliers. Finally, the Commissioner sought to rely on a new argument by reference to an amendment provision in the Income Tax Acts Amendment Act 1923. This was ruled out. The Privy Council said that it was only ‘under exceptional circumstances’ that they would admit an argument on which they did not have the benefit or assistance of the views of the courts below, and ‘these exceptional circumstances do not exist here’. No criteria of what might be ‘exceptional circumstances’ were vouchsafed. The Commissioner had no more success in the second ‘war and wool’ case. This was Commissioner of Taxes v Union Trustee Company of Australia Ltd.52 The issue in this case was whether certain sums received by a shareholder were liable to Queensland income tax. Arthur Herbert Whittingham, a sheep grazier and wool grower in Queensland, owned 10,781 shares in British Australian Wool Realization Association Ltd. which was the subject of the preceding case. The receipt of those shares in 1921 was treated as income, at the then market value of 12s 6d per share. In 1923 and 1924 the company made capital distributions which totalled 19s per share. The Commissioner treated 6s 6d per share as the taxpayer’s income, but this was contested by the taxpayer (and, after his death, his executor). The background to the first issue was that the general scheme of the Queensland Income Tax Act 1924 was to base liability to tax on the source of the income, not the residence of the taxpayer, and the power to tax property was limited to property in Queensland—although a gain was taxable as a profit arising from the sale of ‘any personal property whatsoever’ within s 10(2) of the Act, that provision was considered, as determined in a previous Australian case, to be confined to personal property situate in Queensland. The company’s profits were not, however, from a source in Queensland, and the Commissioner was not understood ‘seriously to dispute this conclusion’. The Commissioner relied principally on extensions to s 10 introduced in 1926 with retrospective effect. The new s 10(2)(b) specifically related to moneys received from a company which had issued certificates or shares to a person who had had dealings with it with respect to goods produced in Queensland. But the

52

[1931] AC 258; 9 ATC 467.

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provision did not expressly say that it was to apply even where the company concerned did not carry on business, or possess assets, or derive profits from sources, in Queensland, and the first issue was taken to be whether some such words should be read in by necessary implication. The Privy Council observed: It would be affectation to doubt that the Association was directly in the view of the draftsman of these new provisions and it is not less probable that the [taxpayer’s] shares therein and the sums received by him in respect thereof were just the kind of receipts which the draftsman was intent to capture for taxation if he could. But the intentions or desires of a draftsman are of no importance in such matters. The question is whether the Legislature has accepted and made itself responsible for words which have that effect.

The Privy Council’s conclusion was that such words could not be implied without destroying entirely the structure of the Act. It was noted that that conclusion made it unnecessary to consider the ‘very serious question as to its validity’ which would have arisen if the Queensland legislature had done what the Commissioner said it had done. There remained the Commissioner’s alternative contention that the gain was a profit of the taxpayer’s business as a sheep breeder and wool grower. That failed because ‘so soon as income tax assessed upon the shares at their then value had been paid, these shares ceased in the [taxpayer’s] hands to be other than a form of property with its own incidence to tax, if any there was attached to it’. The decision is debatable. The question, whether words should be implied to widen the scope of a provision which is the amended form of a provision into which words were implied to limit its scope, is not necessarily a profitable question. That proposition might be put another way and more closely related to the subject-matter of the case. If all questions of implication were left aside, then s 10 would have had the effect for which the Commissioner contended; so the question would then arise whether the words should be confined by a process of implication to have the contrary result; and it would scarcely be comfortable to favour implication if the effect would be to render the provision nugatory. Australia (Commonwealth) Commissioner of Taxation v Squatting Investment Co Ltd53 was another ‘war and wool’ case, but relating to the Second World War, and, curiously, the cases in relation to the First World War were not mentioned in the judgment. The underlying facts are similar—purchase by the UK Government of the whole Australian wool clip for several years. In late 1949 the taxpayer company, wool growers, received £22,851, an interim distribution by the Wool Realisation Commission pursuant to the Wool Realisation (Distribution of Profits) Act 53

[1954] 1 All ER 349; 33 ATC 38.

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1948. This was held to be a trade receipt, being ‘an additional payment voluntarily made to the [taxpayer company] for wool supplied for appraisement or, if the compulsory acquisition can properly be described as a sale, a voluntary addition made by the Commonwealth to the purchase price of the wool’—‘they supplied the wool in the course of their trade and this further payment was made to them because they supplied it’. In Minister of National Revenue v Spooner54 the issue was whether a sum paid by a purchaser of land to the vendor, being 10 per cent of the gross proceeds of the sale of oil extracted by the purchaser from the land, was a capital or an income receipt. In 1925 the taxpayer, Catherine Spooner, who owned the freehold of a ranch in Alberta, sold 20 acres of the land to Vulcan Oils Ltd., in consideration of a cash sum, some shares in the company, and ‘ten per cent. of all the petroleum, natural gas and oil produced and saved from the said lands free of costs’. In 1926 the company struck oil, and in 1927 the company paid $9,570 to the taxpayer, being 10 per cent of the gross proceeds from the sale of oil. In the Exchequer Court Audette J agreed with the Minister’s argument that the 10 per cent royalty was ‘a reservation operating as an exception out of the demise…of the profits derived from the working and development of this land’, so that the oil was not sold, but only the right to search for oil. The Supreme Court of Canada disagreed, and the Minister’s appeal to the Privy Council was unsuccessful. After reciting Audette J’s reasoning, the Privy Council commented: But this is not really so. The agreement provides for a sale to the company of all the [taxpayer’s] right, title and interest in the land, which includes the right to any oil which it may contain.

That would appear to be a finding of law conclusive of the matter. But the Privy Council went on, with references to Jones v CIR55 and CIR v Marine Steam Turbine Co,56 to find the issue finely balanced, and decided to agree with the Supreme Court of Canada on the basis ‘that it was for the Minister to displace [the Supreme Court’s] view as being manifestly wrong. In their Lordships’ opinion he has failed to do so’. The law reporter faithfully included ‘Onus on appellant Minister’ in the report’s catchwords. It is startling that so eminent a court should muddle an issue of law with a concept about proof. In R v British Columbia Fir and Cedar Lumber Co Ltd57 the full amount of an insurance receipt was held to be taxable income in British Columbia. Following a fire at its premises, the taxpayer company was paid various

54 55 56 57

[1933] [1920] [1920] [1932]

AC 684; 13 ATC 397. 1 KB 711. 1 KB 193. All ER 147; 15 ATC 624.

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sums under an insurance policy, including $43,000 for loss of net profits over 215 days. The company’s accounts included only a part of that sum as an income receipt, the balance being regarded as in excess of the loss sustained because the rebuilding of the plant had taken a less number of days than had been allowed for by the adjusters. The full receipt was held to be ‘income’ within the taxing provisions, and analysis showed that it was a revenue receipt. In Punjab Co-Operative Bank Ltd, Amritsar v Commissioner of Income Tax, Lahore58 it was held that realisation by a bank of some of its securities in order to meet withdrawals by depositors is a normal step in carrying on the banking business, and the amount realised on the sale of its securities over their cost price is therefore taxable as part of the profits of the business of the bank under the Indian Income Tax Act 1922. In Liquidator, Rhodesia Metals Ltd v Commissioner of Taxes59 the taxpayer company was incorporated in England on 30 November 1935 and Sir Edmund Davis was a large shareholder. On 12 December 1935 Sir Edmund sold to the company for £5,000 a number of mining claims in Southern Rhodesia to which he was entitled. The company spent about £2,000 in developing the claims. The whole undertaking of the company was sold on 3 March 1936 for £152,000 to another company of which Sir Edmund was a large shareholder. An assessment was raised under the War Taxation and Excess Profits Duty Ordinance of Southern Rhodesia, No 20 of 1918. The receipt was held to be income, not capital, because the business of the company was to develop and sell the claims by way of a scheme of profit-making. Further, the income was from a source in Rhodesia, namely the mining claims. Authorities were not regarded as helpful because the Rhodesian legislation different from that of the U.K. and, semble, other countries. McLelland v Commissioner of Taxation of the Commonwealth of Australia60 was a case on whether a receipt was capital or income. The taxpayer and her brother inherited land. She wanted to keep it, but he wanted to sell. So she bought him out, but, in order to do so, she had to sell part of the land. The Privy Council held that the proceeds of sale were a capital receipt, because the acquisition of the land was by bounty, and not for the purpose of profit-making, and there was no ‘profit-making undertaking or scheme’ within the relevant statutory provision.

58 59 60

[1940] AC 1055; 19 ATC 533. [1940] AC 774; 19 ATC 472. [1971] 1 WLR 191 ; 49 ATC 300.

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viii. Tax on Distributions In Commissioner of Income Tax, Bengal v Mercantile Bank of India Ltd61 it was held that shareholders did not receive taxable income when investment companies capitalised accumulated undistributed profits and issued to the shareholders bonus debentures which were subsequently redeemed. This arose from the death in 1928 of Sir David Yule, whose large estate included holdings in the 20 companies with which the case was concerned. The scheme was to enable the trustees to pay duties in both the UK and India. But the personal motive or purpose of the shareholders was declared irrelevant if the company had in fact capitalised its accumulated profits. That point had emerged in CIR v. Fisher’s Executors [1926] AC 395, and that case and CIR v Blott62 were House of Lords authorities conclusively in favour of the taxpayer trustees. The Commissioner’s argument relied on Swan Brewery Co Ltd v The King,63 but that case concerned a Western Australian provision which contained a special definition of dividend. The Privy Council found the UK and Indian law to be the same, but the Western Australian terminology to be different, so that the Swan Brewery case was to be distinguished and CIR v Blott should be applied in relation to India—thus, views that Blott and Swan Brewery were inconsistent with each other did not require adjudication. In Nicholas v Commissioner of Taxes of the State of Victoria64 receipt of 210,000 shares in a company was held to be a dividend, profit or bonus credited to the taxpayer from the profits of a company within the Unemployment Relief Tax (Assessment) Act 1933 and the Income Tax Act 1935 (of Victoria). Australian Mutual Provident Society v Commissioner of Inland Revenue65 was about taxation of a life insurance business under s 149 of the Land and Income Tax Act 1954, by sub-s (2) of which an allotment of surplus funds by way of reversionary bonuses or otherwise was, after deduction of any income exempt from taxation by virtue of s 86 or otherwise howsoever, deemed to be profits of the company for the year. The first issue related to an allotment of £1,736,492 to fund reversionary bonuses of a face value of £2,929,285. On second thoughts, the company applied a different method of calculation and, for bonuses of the same face value, that method showed a cash value of £1,393,619 rather than £1,736,492. But the higher of those two cash value figures was held to be the correct one because, on the plain words of the Act, the

61 62 63 64 65

[1936] [1921] [1914] [1940] [1962]

AC 478; 15 ATC 337. 2 AC 171. AC 231. AC 744; 19 ATC 527. AC 135; 40 ATC 406.

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Commissioner was not concerned with the allotment or declaration of a particular bonus but with the allotment of surplus funds, and there was evidence to support the finding of fact that £1,736,492 was the amount actually allotted. The second question related to the deduction of exempt income, and concerned dividends received, which had variously borne New Zealand and foreign taxes. It was held that section 149 was limited to exemption from New Zealand tax. Finally there was a question whether income from Australian companies’ shares had been derived from business carried on in New Zealand, but the evidence had not established that it had. Government of the Federation of Malaya v Rimau Omnibus Co Ltd of Ipoh66 involved an action by the Government to recover $7,793, which was the amount by which the tax referable to a dividend paid by the taxpayer company exceeded the company’s tax liability for the year of assessment concerned. The company adduced a technical argument that the provision which provided for recovery by the Government misfired, but the argument failed because it would render the scheme of the provision neither sensible nor intelligible, and in any event the opening words of the relevant sub-s (6), viz. ‘for the purposes of this section’, showed that it applied throughout the section. An alternative contention that the provision, which came into effect on 1 January 1956, did not apply to past dividends failed on the wording, viz ‘has been paid’. In Bicber Ltd (in voluntary liquidation) v Commissioner of Income Tax67 it was held that a dividend is taxable even though paid out of capital profits of the paying company. The Privy Council followed three previous cases: In re Bates,68 Hill v Permanent Trustee Company of New South Wales Ltd69 and CIR v Reid’s Trustees,70 in all of which it had been reasoned that a limited company, not in liquidation, could make a payment by way of return of capital only as a step in an authorised reduction of capital, so that any other payment was income in the hands of a shareholder. In Sim Lim Investments Ltd v Attorney-General, Singapore71 the taxpayer company’s wholly-owned subsidiary, Sim Lim Co Ltd, declared and paid on 6 March 1965 a dividend. By s 35(7A) of the Income Tax Ordinance the preceding year basis of computation applied, so that the dividend formed part of the taxpayer’s income for the year of assessment

66 67 68 69 70 71

[1962] [1962] [1928] [1930] [1949] [1970]

1 WLR 1429; 41 ATC 320. 1 WLR 897; 41 ATC 262. Ch 682. AC 720. AC 361. AC 923; 48 ATC 596.

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ended 31 December 1966. The company argued that under sound accountancy practice, as between a wholly-owned subsidiary and its parent, a dividend is properly to be regarded as income for the year the profits of which it represented. It was held that s 35(7A) could only be construed to mean that income from a dividend does not accrue until it has been declared and at least become payable. In Woodend (KV Ceylon) Rubber and Tea Co Ltd v Commissioner of Income Tax72 the company’s contention was that to some extent radical changes in 1959 to Ceylon’s system of taxation were in breach of 1950 legislation which gave effect to a double taxation agreement of 1950 between the UK and Ceylon. The submission related to an additional 33.33 per cent (additional to 45 per cent) which applied when dividends were distributed. The company alleged that this was a ‘tax in lieu of the taxation of dividends, or any tax in the nature of an undistributed profits tax on undistributed profits of the company’. That failed because (a) dividends were not the subject of the extra tax, but the condition of it being levied, and (b) the tax was not on remittances but on the company’s income, whether distributed or not. A separate argument was that the additional tax was ‘higher or more burdensome’ than the taxation to which resident companies were subjected, but that was demonstrated by figure-work to be wrong. Finally it was argued that the 33.33 per cent charge was precluded by the 1950 legislation as ‘other taxation’. The Supreme Court of Ceylon held that it was income tax, and therefore not ‘other taxation’. The Privy Council did not favour that reasoning, but held that the 1959 Act could not be construed as referring only to non-resident companies exclusive of those to which the 1950 legislation applied, and that the 1950 Act could not prevail over the 1959 Act. In Guiana Industrial and Commercial Investments Ltd v Guyana Commissioner of Inland Revenue73 the Guyana Revenue was successful in its attempt to recover from the recipient of a dividend the difference between the amount of tax ($32,727) deducted at source on the payment of the dividend and the appropriate proportion ($1,899) of the payer’s liability to tax ($23,745). The Guyanese system include a provision which ran: Provided that where tax is not paid or payable by the company on the whole income out of which the dividend is paid the deduction shall be restricted to that portion of the dividend which is paid out of income on which tax is paid or payable by the company.

72 73

[1971] AC 321; 49 ATC 130. [1971] 1 WLR 288; 50 ATC 1.

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The Privy Council held that that proviso applied, both on a literal construction and in view of the whole design of the context in which it appeared. ix. Close Companies There were several cases about provisions by which to some extent the undistributed income of certain companies might be deemed to have been distributed to the shareholders. Commissioner of Income Tax v Bjordal74 concerned a proviso in the Uganda legislation by which, in respect of a company which was deemed to be one in which ‘the public are substantially interested’, an order could not be made to deem undistributed income to have been distributed. The shareholdings in Bjordal Mines Ltd were such that the taxpayer held 73.96 per cent of the voting power, his brother (and fellow director) held 25.99 per cent, and five other persons together held 0.04 per cent. The brother had bought his shares from the taxpayer for full value, but he was not alleged to be the taxpayer’s nominee, nor to have been acting in concert with the taxpayer as a shareholder or as a director. The proviso would apply if the controlling interest was held by the taxpayer alone, but not if it were held by him and his brother together because in that event the brother would be disqualified from being a member of ‘the public’. In adopting 51 per cent of the voting power as the test for a controlling interest, the Privy Council noted that that would enable general control, and were not persuaded by the Commissioner’s argument that the limitations on that ability should direct attention to 75 per cent. Commissioner of Income Tax v Williamson Diamonds Ltd75 related to a Tanganyikan provision (s 21(1) of the Income Tax (Consolidation) Ordinance 1950). The Commissioner directed a deemed distribution of £22,896, being 60 per cent of the company’s total income for the year ended 31 December 1950. The company’s ground of appeal was that the Commissioner had failed to have ‘regard to losses previously incurred by the company’ within s 21(1), in terms of capital losses sustained. The Commissioner argued that capital losses were not within the scope of s 21(1), because s 2 defined ‘loss’ as meaning, unless the context otherwise required, a loss computed in like manner as profits, ie an income loss. The affair turned out to be a damp squib because the company failed to establish that it had sustained a loss of any kind. The Privy Council nevertheless went on to consider the point of principle and considered that, while the Commissioner’s argument about the specific reference in s 21(1) to losses was correct, the judgment to be formed under that provision 74 75

[1955] AC 309; 34 ATC 18. [1958] AC 41; 36 ATC 233.

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(whether payment of a dividend, or a larger dividend than that declared, would be unreasonable) had to take into account all the circumstances, so that capital losses would enter the picture by that route. In Houry v Commissioner of Income Tax76 the deemed distribution provision was in the East African Income Tax (Management) Act (s 22). The Act also had a provision (s 24) by which, in relation to certain settlements, income paid to or for the benefit of a child of the settlor was to be treated as the settlor’s income. Did the latter section cover deemed income of a child by operation of the former section? The Privy Council held in the negative. The provisions were held to be independent, incapable of harmonisation. Crucially, s 22 specifically directed that the appropriate portion of the deemed distribution ‘shall be included in the total income of such shareholder for the purposes of this Act’, and s 24 directed that income which it attributed to the settlor was not, for the purposes of the Act, ‘the income of any other person’. In Inland Revenue Commissioner v Associated Motorists Petrol Co Ltd77 the taxpayer company, incorporated in New Zealand, held half of the shares of a company incorporated and resident in the Bahama islands and deriving no income from New Zealand, and so not subject to New Zealand income tax. The other half of the shares was owned by a Gulf Oil subsidiary. The Commissioner assessed the company to income tax for 1960–65 on the basis that the Bahamian company was a ‘proprietary company’, ie under the control of not more than four persons, so that the shareholders were assessable on its income under s 138 of the Land and Income Tax Act 1954. The conclusion was, though, that that provision was impossible to apply to a company which had no income assessable for tax, no taxable income, and therefore no total income within the meaning of the provision. x. Deductible Expenditure In Aspro Ltd v Commissioner of Taxes78 the issue was whether the Commissioner had wrongly restricted the deduction of the remuneration of the directors of a New Zealand subsidiary of an Australian company. It was held that that, where a company duly awarded remuneration for services, and it was admitted that services had indeed been rendered, that was not alone sufficient to exclude inquiry by the Commissioner, and that the company had failed to produce evidence to disentitle magistrate from concluding that only part of the voted remuneration had been exclusively incurred in the production of the company’s assessable income. 76 77 78

[1960] AC 36; 38 ATC 328. [1971] AC 784; 49 ATC 295. [1932] AC 683; 11 ATC 397.

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In Tata Hydro-Electric Agencies Ltd., Bombay v Commissioner of Income Tax, Bombay Presidency and Aden79 it was held that the taxpayer company, managing agents of electric power companies, was not entitled to a revenue deduction in respect of amounts paid to certain third parties under agreements made with the company from which the taxpayer company had, by assignment, acquired the agency, because the payments were not made for the purpose of earning profits in the conduct of the agency business, but in fulfilment of the terms on which the company had purchased the business. In Indian Radio and Cable Communication Co Ltd v Income Tax Commissioner, Bombay Presidency and Aden80 the issue was whether a payment made to a company, from which the taxpayer had acquired a business, was deductible expenditure as being in the nature of rent. The sum in question was half of the taxpayer company’s net profits. The Privy Council carefully avoided making any sweeping statement of principle or relying on previous authority (eg the Pondicherry case above), but held that there was no sufficient ground for holding that the sum in question was of the nature of rent. In the acquisition agreement it was not described as rent, nor were there included several of the clauses which a lease of plant would naturally contain. The sum payable might be small, or great, or nothing—a most unusual feature in the case of rent. The sum was payable in respect of several advantages, not all of which were of a temporary character. The agreement was more like one for a joint venture than one for a lease. In Income Tax Commissioner, Bihar and Orissa v Maharajahdhiraj Sir Rameshwar Singh of Darbhanga81 costs incurred in litigation were held to be a deductible expense of the business of a moneylender, because, contrary to the Commissioner’s submission, the litigation was connected with the moneylending business. In Minister of National Revenue v Wright’s Canadian Ropes Ltd82 the taxpayer company successfully appealed against a decision of the Minister of National Revenue who, exercising a discretion given to him by s 6(2) of the Income War Tax Act and Excess Profits Tax Act of the Dominion of Canada, disallowed certain commissions paid by the taxpayer company to an English company in the years 1940–42 as an expense ‘in excess of what is reasonable or normal’. It was held that there was no evidence of the material before the Minister, that the courts could not assume that he had before him sufficient facts to support his determination, that the only inference that could be made was that he had had no other material before

79 80 81 82

[1937] [1937] [1942] [1947]

AC 685; 16 ATC 3 All ER 709; 16 1 All ER 362; 20 AC 109; 26 ATC

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him than that in the documents before the court. Those documents were considered to have contained no material to justify the disallowance. In Mohanlal Hargovind of Jubbulpore, Messrs v Commissioner of Income Tax, Central Provinces and Berar, Nagpur83 it was held that the taxpayers, cigarette manufacturers, were entitled to a revenue deduction in respect of the costs related to the acquiring of tendu leaves which formed part of the cigarettes. The Commissioner’s argument, that the costs were of a capital nature, hinged on the taxpayers having acquired an interest in the land or the trees, but it was held that they had no more than a right to pick and carry away the tendu leaves. In Ralli Estates Ltd v Commissioner of Income Tax84 a ‘royalty’ of £174,600, payable, together with a premium of £311,000, under an agreement for leases of sisal estates in Tanganyika, was held to be capital expenditure because it was not a true royalty but part of the purchase price, as demonstrated in one of the contemporaneous documents which stated the ‘total net capital value’ of the estates as £485,600. In Commissioner of Inland Revenue v Four Seas Co Ltd85 a company was held unable to set off against the profits of a firm, of which it was one of the two partners, a loss sustained in trade conducted on its own account, because the legislation on Hong Kong business profits tax was in terms which required a partnership to be treated as an entity for tax purposes and only losses incurred by the partnership could be set against its profits. In Commissioner of Inland Revenue v Appuhamy86 it was held that a deduction from the profits of a business was not due in respect of the costs of litigation paid by the proprietor to defend a claim that he was not the sole proprietor, because the expenses related to an issue whose outcome would not have affected the profits of the business one way or the other, but would have affected only the respondent’s share as owner of them, and they could not be said to have been expended in the production of the profits of the business. In Commissioner of Taxes v Nchanga Consolidated Copper Mines Ltd87 it was held that a payment of £1,384,569 was income, not capital, expenditure. The taxpayer company was one of three companies which, while independent of each other, together operated a copper mining business comprising three mines. Following a steep fall in the price of copper, it was agreed that one company should cease production for a year, the other two companies to pay a sum of compensation, and the

83 84 85 86 87

[1949] [1961] [1962] [1963] [1964]

AC 521; 28 ATC 287. 1 WLR 329; 40 ATC 9. AC 161; 40 ATC 419. AC 127; 41 ATC 317. AC 948; 43 ATC 20.

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£1,384,569 was the share of that compensation which the taxpayer company had to bear. The Privy Council considered that that expenditure had ‘no true analogy with expenditure for the purposes of acquiring a business or the benefit of a long-term or “enduring” contract’, but it did ‘bear a fair comparison with a monetary levy on the production of a given year’, and ‘its true analogy is with an operating cost’. Commercial ties, whether of public houses or fuel service stations, have given rise to much tax litigation. B P Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia88 concerned payments of a ‘development allowance’ to retailers for the improvement of service stations. The Privy Council held that the solution to the problem was not to be found by any rigid test or description, but, on a balance of all the relevant considerations, the scales appeared to incline in favour of the expenditure being revenue and not capital outgoings. In Mobil Oil Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia89 the tie arrangements were different, but the result was the same. There was, however, a separate, and logically prior, issue. The Commissioner raised an argument that the contracts fell within the general anti-avoidance provision, s 260 of the Income Tax and Social Services Contribution Assessment Act 1936–60. Interestingly, the headnote records the Commissioner as contending ‘that the agreements were not real transactions but a sham’, though there is nothing to that effect in the relevant part of the note of the argument. But the s 260 argument failed because ‘the transaction was capable of explanation by reference to an ordinary sensible business arrangement’—Newton v Commissioner of Taxation of the Commonwealth of Australia90 was mentioned with tacit approval. In Reynolds v Commissioner of Income Tax91 it was held that no deduction could be made, in respect of payments made under a deed of covenant made by a married woman in favour of her children, in computing her husband’s income tax liability in Trinidad and Tobago. In Commissioner of Inland Revenue v Mutual Investment Co Ltd92 a company, whose income comprised dividends and loan interest, sought deduction of all of its expenditure, not just the expenditure referable to the loan interest, but it was held that dividends were taxable under a distinct provision in the Hong Kong code, and the section which permitted expenditure to be deducted applied only to the loan interest income.

88 89 90 91 92

[1966] [1966] [1958] [1967] [1967]

AC 224; 44 ATC 312. AC 275; 44 ATC 323. AC 450; 37 ATC 245. 1 AC 1; 44 ATC 491. 1 AC 587; 45 ATC 359.

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In Commissioner of Income Tax v Hanover Agencies Ltd93 the taxpayer company, whose business was the letting of seven premises, succeeded in a claim for a wear and tear allowance in respect of one of the buildings for the purposes of Jamaican income tax, because the company’s profits were, for tax purposes, profits of a business, not rents, and the buildings were ‘used’ for the purposes of the business as ‘used’ should not be restricted to mean ‘occupied’. In Borneo Airways Ltd, Kuching v Commissioner of Inland Revenue, Kuching,94 which concerned Sarawak corporation profits tax, companies resident in, and centrally controlled and managed in, Sarawak were held unable to set off, against their profits, losses incurred by their branches in Sabah and Brunei. The statutory provision in issue clearly limited set off only to losses ‘attributable to activities in Sarawak’, and control and management was not relevantly an activity in Sarawak In Inland Revenue Commissioner v Europa Oil (NZ) Ltd95 expenditure under complex commercial contracts relating to gasoline was held not to be deductible because it had been incurred partly in order to produce a return to the taxpayer company through another company, of which it was a 50 per cent shareholder. By a majority, the Privy Council concluded that the various contracts involved interdependence of obligations and benefits, and represented one contractual whole, and that achieving the benefit through the other company was a purpose of the taxpayer company, not some irrelevant collateral benefit. The majority did not need to, and did not, rule on the Commissioner’s alternative contention based on a general anti-avoidance contention, but the dissenters disagreed with the Commissioner’s argument. In Guiana Industrial and Commercial Investments Ltd. v. Guyana Commissioner of Inland Revenue (No 2)96 the issue was whether a liability to income tax was a debt owed by the appellant company on 30 November 1961, though it had not yet been assessed and it was payable only within 30 days after the date of assessment. The Latin tag debitum in praesenti, solvendum in futuro was much in play as substantiating that there was a present debt on 30 November 1961, but the Privy Council decided that the case turned on the proper construction of ‘debts owed by him on that date’, and concluded that it was impossible accurately to assert that on 30 November 1961 the company owed a debt for the year of assessment 1962.

93 94 95 96

[1967] [1970] [1971] [1971]

1 AC 681; 48 ATC 529. AC 929; 48 ATC 598. AC 360; 49 ATC 282. AC 841; 50 ATC 197.

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xi. Computation Generally In Payne v Deputy Federal Commissioner of Taxation97 it was held that the amount of interest on British stock received in London should be included in an Australian income tax assessment, not in terms of the number of pounds sterling received, but in terms of the greater number produced by application of the exchange rate between English and Australian pounds, as the currency dealt with in the provisions of the Australian Income Tax Acts was Australian currency. In Attorney-General of Ceylon v Mackie98 the issue was the value of shares in a company on the death in 1940 of a director/shareholder. The company sold rubber. Results had been inconsistent and there was no steady trend. In the result the Supreme Court of Ceylon held that the value should not be based on any figure higher than the value of the tangible assets of the company, and the Privy Council declined to upset that conclusion. In Minister of National Revenue v Anaconda American Brass Ltd99 the issue was how to value closing stock for the purpose of ascertaining the profits of a trade. Over many years the taxpayer company bought various metals as raw material from which to manufacture various metal products, but it did not keep records which would show which of the purchased metals had been used for manufacture and which had not, so it was impossible at the year end to ascribe cost prices to the stock on hand. The company sought to resolve the difficulty by applying the LIFO (‘last in, first out’) method, but the Minister favoured the FIFO (‘first in, first out’) method. The company’s case was supported by expert accountancy evidence, but nevertheless did not succeed. The Privy Council did not question that LIFO might be more appropriate for the corporate purposes of a trading company, but noted that those purposes might well differ from the fiscal objective, namely ascertaining annual profits, and therefore preferred the Canadian Minister’s case, which was that the FIFO method ‘attains more nearly the result postulated by Lord Loreburn LC in Sun Insurance Office v.Clark [1912] AC 443, 454 “that the true gains are to be ascertained as nearly as it can be done”’.

xii. Employment Commissioner of Income Tax, Colombo v Sutherland (Executrix of the Estate of RW Sutherland, decd100 was a case which eventually turned on its 97 98 99 100

[1936] [1952] [1956] [1952]

AC 497; 15 ATC 345. 2 All ER 775; 31 ATC 435. AC 85; 34 ATC 330. AC 469; 31 ATC 419.

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facts. A payment made following an employee’s death was held to be an ex gratia payment to the widow personally, rather than something which was due to her husband’s estate on his death—and on that footing it was not taxable. In Ashenheim v Commissioner of Income Tax101 the issue was whether the salary of Jamaica’s ambassador to the USA was taxable to Jamaican income tax for 1963. This turned on construction of s 5 of the Income Tax Law 1954, as amended. The taxpayer’s argument was (i) that s 5(c) was applicable to the exclusion of s 5(a) and (b), or (ii) that ‘employment’ used in those sub-sections meant self-employment. The taxpayer was held, though the holder of an office, to be in the employment of the Crown, and his salary was held to be taxable under s 5(b)(iii). In Comptroller of Inland Revenue v Knight102 the Privy Council held that a redundancy payment to an employed surveyor was not taxable: like a payment made under an express bargain between employer and employee as consideration for abrogation of a service agreement, it was not paid ‘in respect of his employment’. Chibbett v Joseph Robinson & Sons103 was approved. In Heywood v Malaysia Comptroller-General of Inland Revenue104 the issue was whether a sum paid to an employee on cessation of employment was taxable under the Malaysia Income Tax Act 1967. The taxpayer, a planter, was in employment, under successive agreements, with the same employer, from 1951 to 1968, when his employers sent him a letter which gave him three months’ notice of termination of his employment, and which stated ‘as compensation for loss of employment you have been accorded a sum of $32,000 ex gratia’. That sum had been calculated under a scheme for compensating employees for loss of employment in consequence of amalgamations. Under the scheme the calculation was to be by reference to age and years of service, but the scale was such that there was a peak in the age range 37–45 and, by age 55, the age of retirement, there was a decline down to nil. The taxpayer was 41 when his employment was terminated. He contended that the payment was not employment income, but compensation for loss of employment, in which case the amount would be below the taxation threshold. The Privy Council noted that the compensation scale cannot have reflected deferred remuneration because, if that had been its purpose, the maximum would have been at the age of retirement, 55, and the result was that the scheme was for compensation for loss of future employment. Moreover, the employee’s contractual terms were such as to provide ‘a clear expectation of employment until he

101 102 103 104

[1973] [1973] (1924) [1975]

AC 1; 51 ATC 196. AC 428; 51 ATC 203. 9 TC 48. AC 229; 53 ATC 280.

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reached [55]’. Thus it had clearly been established that the payment was compensation for loss of employment.

xiii. Settlements In Naranjee v Commissioner of Income Tax105 a settlement was held not to be ‘revocable’ within a Tanganyikan statutory deeming provision which brought in any settlement where the settlor was able to have access, by borrowing or otherwise, to any of the trust income or assets. The Privy Council concluded that the provision referred to access in a personal or private capacity, so that it was not satisfied by the circumstance that the settlor was one of the trustees who might invest trust moneys in, or make loans to, companies in which the settlor was interested.

xiv. Machinery of Taxation In Rhodesia Railways Ltd v Resident Commissioner and Treasurer, Bechuanaland Protectorate106 a time-bar was held inapplicable to preclude the giving of relief from Bechuanaland income tax in respect of UK income tax. The statutory provision in issue was held to apply only to cases of overpayment, not to situations involving of relief by way of repayment of what had originally been properly paid. Gamini Bus Co Ltd v Commissioner of Income Tax, Colombo107 was a back duty case. The Commissioner, dissatisfied with the company’s tax returns for 1943–44 to 1946–47, made estimated assessments to income tax in figures higher than the declared profits, relying on a comparison with the assessed profits of seven other bus companies, a method to which the appellant company objected. It was held that that method was a proper guide, that there was no breach of the principle of confidentiality because no names were given in the document which set out the comparison, and that use of it in the appeal proceedings did not involve a breach of the principles of fair play or natural justice. Apparently it was said that bus companies normally understate profits, and the Privy Council thought fit to stress that, although it had not happened in the present case, habitual understatement could not itself go to prove understatement in a particular case. Mandavia v Commissioner of Income Tax108 concerned the machinery of assessment in the East African Income Tax (Management) Act 1952. It 105 106 107 108

[1964] [1933] [1952] [1959]

AC AC AC AC

1238; 43 ATC 147. 362; 12 ATC 219. 571; 31 ATC 467. 114; 37 ATC 384.

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was held that, while time was running for the taxpayer to respond to a request for tax returns, the Commissioner was unable to invoke the facility to make estimated assessments. In Argosy Co Ltd v Guyana Commissioner of Inland Revenue109 the issue was whether an estimated assessment to income tax (profits of $25,000) had been properly raised in circumstances in which the books of account of a company in liquidation were destroyed by fire in a riot, so the liquidator was unable to submit a return. The company had not been profitable in recent years, though one section had been improving. The case might have gone the Commissioner’s way, but the Privy Council focused on the company’s carry-forward losses of $62,344 and held that, in view of them, the Commissioner could not reasonably have formed the opinion that the company was liable to income tax for 1962.

xv. Anti-Avoidance In Newton v Commissioner of Taxation of the Commonwealth of Australia110 a general anti-avoidance provision (s 260 of the Income Tax and Social Services Contribution Assessment Act 1936–51) was held applicable to a string of transactions which were undertaken in December 1949 in relation to the profits of three successful private companies which were about to attract 75 per cent tax because, if they were not distributed, a statutory deemed distribution would occur. The Privy Council concluded: (1) that s 260 was not to be regarded as being of no effect at all; (2) that s 260 was not limited to applying only to an arrangement which sought to displace a liability which had already come home to a taxpayer, and indeed would on that basis have no effect at all; (3) that s 260 applied to an arrangement in relation to which the overt acts of implementation showed that it had been implemented in that particular way to avoid tax—so that it would not apply to transactions ‘capable of explanation by reference to ordinary business or family dealing’; (4) that s 260 is worded to apply where one of the purposes or effects of an arrangement (not the sole purpose) is to avoid liability for tax; and (5) that, where s 260 applies, the Commissioner cannot avoid or ignore the transactions altogether, but can do so so far as they have the purpose or effect of avoiding tax—or, as Fullagar J had put it, s 260 ‘entitles the Commissioner to look at the end result and to ignore all the steps which were taken in pursuance of the avoided arrangement’. 109 110

[1971] 1 WLR 514; 50 ATC 49. [1958] AC 450; 37 ATC 245.

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On the facts, the Commissioner was held entitled to regard £1,764,136 as income derived by the shareholders from the shares—£1,661,722 had reached their hands and, while the balance (£102,414) had accrued to a company controlled by a consulting accountant and involved in the scheme, the position was the same as if the shareholders had received it and had then paid it to that company as remuneration for services. In Peate v Commissioner of Taxation of the Commonwealth of Australia111 a general anti-avoidance provision was held to catch a scheme by which a doctors’ partnership ceased and was replaced by an arrangement involving a company and several family companies. In Mangin v Inland Revenue Commissioner112 a New Zealand general anti-avoidance provision was held to catch a scheme by which a farmer created ‘paddock trusts’ under which he became an employee of the trustees and the farming profit came to him (and his family) via the trusts. In Ashton and Wheelans v New Zealand Commissioner of Inland Revenue113 the general anti-avoidance provision in s 108 of the Land and Income Tax Act 1954 was held to apply to certain transactions relating to the financing of a partnership, the effect of which was that some of the partnership income accrued to family trusts made by the appellants, two of the partners. In fact much of the money in the trusts’ bank accounts found its way into the pockets of the appellants. Evidence was given that the purpose of the trusts was to secure that, in the event of the death of one appellant, his share of the partnership income would be received by his family. The judge at first instance held that to be the ‘predominant purpose’, but the Court of Appeal held that motive was irrelevant, and that the test to be applied in relation to s 108 was objective, the purpose of a transaction to be determined by what the transaction effects. The Privy Council agreed and, as counsel for the appellants stated in his opening that he would not dispute that one of the purposes and effects of the arrangements made by the appellants was to avoid the incidence of tax, that was decisive because: ‘If that was, as in their Lordships’ view it clearly was, one purpose and one effect of the arrangements, it matters not what other purposes or effects it might have; section 108 applies.’

B. Stamp Duties In Hotung v Collector of Stamp Revenue114 it was held that stamp duty was payable on the full amount of a price payable by a down payment and 111 112 113 114

[1967] [1971] [1975] [1965]

1 AC 308; 45 ATC 193. AC 739; 49 ATC 272. 1 WLR 1615; 54 ATC 277. AC 766; 44 ATC 57.

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twenty-three annual instalments, not on the value at the date of conveyance of the amount of the down payment and the value of the deferred amounts. While s 5 of the Stamp Ordinance of Hong Kong directed that stamp duty was to be calculated on the ‘amount or value of the consideration on the day of the date of the instrument’, ‘value’ was held to be the basis of measurement only for the cases indicated in ss 34–36 of the Ordinance, none of which applied in the present case. In Broken Hill Proprietary Co Ltd v Valuer-General115 the dispute involved the Stamp Duties Act 1920 (as amended), though it did not directly involve a tax liability. In 1960 the appellant company sold to the second appellant company (its wholly owned subsidiary) land, and the steel works on it, for the unencumbered value of it within the meaning of the Stamp Duties Act 1920, and application was made to the ValuerGeneral to determine that value. His valuation was $100 million, but the appellant companies considered that the right value was some $27 million. They reached that figure in reliance on provisions in the Valuation of Land Act 1916–59 of New South Wales, particularly s 5(2) by which certain plant and machinery was not to be included in the valuation. The Valuer-General successfully contended that his valuation was to be made under Part VI of the Act, particularly s 70, which dealt with valuations for stamp and death duties, and he argued that the statutory formulae for rating purposes in the earlier part of the Act had no application. The Privy Council found the Act ambiguous, and held that, in the absence of clear words, it would not be right to apply rating principles to areas not concerned with rating, especially as to do so would produce anomalous results.

C. Death Duties In Commissioner of Stamps, Straits Settlements v Oei Tjong Swan116 it was held that Straits Settlements estate duty applied to movable property situate outside the Straits Settlements of a person who died domiciled in the Straits Settlements. The executors’ argument on territoriality failed because, as determined in Blackwood v The Queen,117 the law of nations contained nothing to prevent a government from taxing its own subjects on the basis of their foreign possessions. The Privy Council concluded that the statutory provisions specifically contemplated that estate duty applied to property situate outside the colony. 115 116 117

[1970] AC 627; 48 ATC 193. [1933] AC 378; 12 ATC 603. (1882) 8 App Cas 82.

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Armstrong v Estate Duty Commissioner118 involved a Hong Kong provision which conferred exemption of property on the death of the second spouse if estate duty had been paid on the death of the first spouse and if the property was settled property of which the second spouse had not been competent to dispose. Settled property was defined by s 25(2) by words which included ‘any property…[which] stands for the time being limited to or in trust for any persons by way of succession’. The exemption was claimed in respect of an annuity which had been payable to the deceased under the will of her husband, but it was held that the exemption did not apply, because there was no ‘definite property’ which stood in trust for the widow and then for residuary legatees in succession. Commissioner of Stamp Duties of New South Wales v Way119 concerned a claim for New South Wales estate duty in relation to a charitable trust effected by a settlement made in 1928 by Sir Robert Gillespie who died in 1945. Section 102 of the New South Wales Stamp Duties Act 1920–49 contained detailed provisions about settlements. In the result the Commissioner’s claim relied on two clauses in the trust instrument. The first clause conferred an absolute discretion on the trustees as to the application and appropriation of the trust fund, but provided that during his lifetime the settlor’s direction and approval was required. The Commissioner’s argument was that the effect of this clause was that a new trust would arise on the settlor’s death. The argument failed because no change of beneficiaries was involved. The second clause relied on was one under which the settlor had power to require the trustees to acquire property from him by purchase or exchange at a sum at least 5 per cent below its value. The Commissioner’s argument was that this reserved to the settlor an interest in or benefit out of or connected with the trust property or a right to reclaim or restore it to himself. The argument failed because the power was held to be a fiduciary power, and in any event was not such a power as to give the settlor any hold over the trust funds. In Oakes v Commissioner of Stamp Duties of New South Wales120 the issue was whether, for the purposes of New South Wales death duty, the estate of the deceased should include the whole, or only one-fifth, of the value of the property of a trust which the deceased had established in 1924 and by which, subject to various provisions, the trust property (a grazing property) was held for the deceased and his four children as tenants in common in equal shares. Under a provision in the deed the deceased received remuneration for managing the grazing property. It was held that, by reason of that remuneration, he had not been excluded from benefit

118 119 120

[1937] AC 885; 16 ATC 473. [1952] 1 All ER 198; 30 ATC 385. 1954] AC 57; 32 ATC 476.

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from the subject of the gift, it being impossible to conclude that the right to remuneration was property which had been reserved out of, and therefore did not form part of, the gift. In Commissioner of Stamp Duties of New South Wales v Pearse121 there were two distinct issues. One was whether, in relation to valuing shares for the purposes of death duty, the mode of valuation was an issue exclusively for the Commissioner, and not one on which, under the appeal procedures, the court had jurisdiction to interfere. The second was whether the amount of the professional charges of a solicitor, payable under a standard provision in the will, were to be regarded as property which passed to the solicitor under the will or as payable out of the property which had passed under the will to the deceased’s widow, the former involving a higher rate of duty than the latter. The executors succeeded on the first issue, but the Commissioner succeeded on the second. In Perpetual Executors and Trustees Association of Australia Ltd v Commissioner of Taxes of the Commonwealth of Australia122 the issue was whether the value of a deceased’s interest in the goodwill of the partnership came in for estate duty under a deeming provision in circumstances in which the surviving partners had an option to buy out the deceased’s share without the purchase price including anything in respect of the goodwill. It was held that the interest came in under another provision as ‘personal property wherever situate’, so that there was no room for the deeming provision to operate. In Rice v Commissioner of Stamp Duties, Fiji123 a husband assigned to his wife absolutely a policy of life insurance on his life for £1,000, together with all accrued and future bonuses, it being his intention to continue paying the premiums to keep the policy alive. For the purposes of gift duty under the Death and Gifts Duties Ordinance of Fiji the Commissioner took the view that the policy represented an interest affected by a contingency. It was held that, while there was uncertainty how much, if anything, would be paid out under the policy, the taxpayer’s wife’s interest was absolute, and not subject to any contingency. Ward v Commissioner of Inland Revenue124 concerned an event in 1932 by which the deceased transferred real property in New Zealand to his four sons for full consideration in the form of annuities payable to himself and his wife for life. On his death in 1949 the Commissioner claimed that under section 5 of the Death Duties Act 1921 the value of the real property should be included in the deceased’s estate. The Privy Council left several points of dispute open because it was considered that the transfer exactly

121 122 123 124

[1954] [1954] [1954] [1956]

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91; 32 ATC 483. 114; 35 ATC 215. 216; 33 ATC 228. 391; 35 ATC 41.

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answered the description of a ‘disposition of property…which is accompanied by…a contract for any benefit to the deceased for the term of his life’. This followed from the ordinary meaning of the word ‘disposition’. There was held to be no basis for excluding commercial bargains for full consideration. The case was considered to come exactly within the words of the statute, so considerations of possible hardship could not affect the decision. In Commissioner of Stamp Duties v New Zealand Insurance Co Ltd125 the issue was whether a liability to pay part of an annuity was within a class of debts prohibited from deduction for estate duty purposes under a provision which directed that no allowance should be made ‘for contingent debts or any other debts the amount of which is, in the opinion of the commissioner, incapable of estimation’. The Privy Council avoided resolving the issue whether or not the debt was a ‘contingent debt’, because it favoured the administrator’s submission that the provision was limited to debts the amounts of which were (in the Commissioner’s view) incapable of estimation, ie it did not automatically cover all contingent debts. It was further decided that, having regard to the known practice of the valuation of life annuities on actuarial principles, the Commissioner ‘must have been acting under some misapprehension of the applicable law when he committed himself to the’ view that the particular debt was incapable of estimation. In Commissioner of Stamp Duties of New South Wales v Permanent Trustee Co. of New South Wales,126 a case on s 102 of the New South Wales Stamp Duties Act 1920–49, it was held that the deceased’s daughter did not have exclusive possession and enjoyment of trust property because the deceased had been in receipt of benefits in the form of interest-free loans. In Chick v Commissioner of Stamp Duties,127 another case on s 102(2)(d) of the New South Wales Stamp Duties Act 1920–56, the issue was whether or not property, which had been the subject of a gift, had been ‘retained to the entire exclusion of’ the deceased. The property, a farm, was one of three farming properties, the business of which was conducted by the deceased and his sons. Self-evidently the fact was that the father had not been excluded from the property, and that was sufficient to dispose of the matter, because the Privy Council declined to place any gloss on the plain words of the legislation. In Commissioner of Estate and Succession Duties (Barbados) v Bowring128 it was held that, for the purposes of Barbadian death duties, the

125 126 127 128

[1956] [1956] [1958] [1962]

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284; 512; 435; 171;

35 35 37 39

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deceased had not been ‘competent to dispose’ of trust property by reason of a power, subject to the consent of the trustees, to revoke the trust. The Privy Council considered that the trustees had a restraining power which amounted to a fetter on the settlor’s right to revoke the trust, and that the settlor did not have ‘a way to make the property her own, since the trustees were empowered to block that way’. In Commissioner of Stamp Duties (Queensland) v Livingston129 the taxes concerned were Queensland succession duty and administration duty, broadly equivalent to the long-repealed UK succession duty and probate duty. The deceased had been given, under the will of her first husband, one-third of his estate. At the time of her death, the residue of that estate had not been ascertained and the final balances due to the residuary legatees had not been determined. The issue relating to succession duty was whether the deceased was entitled to a beneficial interest in the property which comprised the first husband’s estate. It was held that she was not so entitled because, as a residuary legatee of an unadministered estate, what she had was no more than a chose in action, a right to have the estate properly administered. The claim for administration duty failed for what was much the same reason. Commissioner of Stamp Duties v Atwill130 concerned s 102 of the Stamp Duties Act 1920 of New South Wales, by which the estate of a deceased was deemed to include all property which the deceased has disposed of by a settlement containing any trust in respect of that property to take effect after his death…Provided that the property to be included in the estate of the deceased shall be the property which at the time of his death is subject to such trust.

The executors produced a bold contention that the property there mentioned was not the whole of the trust property, but only so much of the property originally settled as still remained property of the trust. The Privy Council did not favour that construction, noting that it would open ‘a very large gate for avoidance’, and that ‘it cannot have been the intention of the legislature so to provide’. In Falkiner v Commissioner of Stamp Duties131 the same point arose as in Atwill, but an additional issue was whether a trust for next of kin was capable of taking effect on the settlor’s death within the meaning of s 102, and it was held that it was.

129 130 131

[1965] AC 694; 43 ATC 325. [1973] AC 558; 51 ATC 321. [1973] AC 565; 51 ATC 325.

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D. Rating New South Wales Railway Commissioner, Sydney City Council, and Wynyard Holdings Ltd v New South Wales Valuer-General132 concerned rating liability under New South Wales legislation of an area in Sydney which included an office block and an hotel. There were complications such that the leaseholder, Wynyard Holdings Ltd, was not the lessee of a straightforward block of land, in the sense of a defined surface area of land together with all of what was above and below that surface—in effect, the lessee had a block which was punctuated with gaps, and the question arose as to how, if at all, the lessee’s liability to rates was to be measured? The Commissioner for Railways and the Sydney City Council contended that the demised premises should be valued as a whole. The Valuer-General had not done this, but had proceeded by reference to various strata, and had done so in a way which omitted twelve areas of space (‘land islands’) within the total area of the demised premises. The lessee went for broke and contended that its premises could not be valued at all, on the grounds that nothing could be valued as land except land in the strict sense, ie land defined only by vertical boundaries, usque ad coelum et ad inferos. The absence of any relevant statutory definition of the term ‘land’ as used in the New South Wales rating legislation, led to the Privy Council considering the lessee’s contention at some length, as follows: It is well known that this brocard [usque ad coelum et ad inferos] cannot be traced in the Digest or elsewhere in Roman law. The first recognised appearance is in the thirteenth-century gloss of the Bolognese Accursius upon Digest VIII. 2.1. It appears there in the form ‘cuius est solum esse debet usque ad coelum’: (compare in the law of Scotland, Stair’s Institutions II. 7.7). In the form of a maxim, it only has authority at common law in so far as it has been adopted by decisions of equivalent authority. The earliest recognition appears to be recorded in Bury v Pope (1588) Cro. Eliz. 118, where reference is made to its use Temp. Edward I in the form ‘cuius est solum eius est summitas usque ad coelum’, but the context of this statement in the reign of Edward I has not been identified. Coke upon Littleton, 4a contains an uncritical adoption of this maxim, supported by some references (incorrect) to Year Books. He is followed by Blackstone : ‘Land hath also, in its legal signification, an indefinite extent upward as well as downward. Cuius est solum eius est summitas usque ad coelum…therefore no man may erect any building or the like to overhang another’s land…So that the word “land” is not only the face of the earth but everything under it or over it’. Commentaries II c.2 p.18.

132

[1974] AC 328; 52 ATC 1

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There are a number of examples of its use in judgments of the nineteenth century, by which time mineral values had drawn attention to downwards extent as well as, or more than, extent upwards. But its use, whether with reference to mineral rights or trespass in the air space by projections, animals or wires, is imprecise, and it is mainly serviceable as dispensing with analysis : Pickering v Rudd (1815) 4 Campbell 219, Ellis v Loftus Iron Co (1874) LR 10 CP 10. In none of these cases is there an authoritative pronouncement that ‘land’ means the whole of the space from the centre of the earth to the heavens; so sweeping, unscientific and unpractical a doctrine is unlikely to appeal to the common law mind. At most the maxim is used as a statement, imprecise enough, of the extent of the rights, prima facie, of owners of land: Lord Justice Bowen was concerned with these rights when, in a case dealing with rights of support, he said: ‘Prima facie the owner of the land has everything under the sky down to the centre of the earth’ (Pountney v Clayton (1883) 11 QBD 820, at page 838). Two cases may have some bearing upon the present in so far as they relate to layers. In Electric Telegraph Co v Overseers of Salford (1855) 11 Exchequer 181, it was decided—with reference to the English test of rateability, i.e. occupation—that the company owning telegraph wires was in occupation of the air space through which the wires passed. Baron Martin said: ‘The simple question is whether the facts stated show that the company has the exclusive occupation of what the law calls land’ and concluded that it had. So a layer horizontally defined above the surface, was held to be land and capable of being rated. In Corbett v Hill (1870) LR 9 Equity 671 the plaintiff, who owned a room projecting over the defendant’s land, was held to own only ‘such a portion…carved out of the freehold as is included between the ceiling of the room at the top and the floor at the bottom’. The defendant was held to own everything below and above. This is a clear recognition of ownership of a layer or, as it would now be called in New South Wales, a stratum. The same conception is reflected in the High Court judgments in Borough of Glebe v Lukey (Australian Gaslight Co) [1904] 1 CLR 158, and in North Shore Gas Co Ltd v Commissioner of Stamp Duties (N.S.W.) (1940) 63 CLR 52, Mr Justice Dixon at page 70. These authorities suggest that in the rating and valuation legislation of New South Wales, before references to strata were introduced, ‘land’ had an indefinite significance; it was not limited to the surface, or, more importantly, to spaces having a direct connection with the surface.

The lessee’s contention, that it escaped rating, therefore failed and, aside from a procedural point, the remaining issue related to the fundamental difference in the approach to valuation as previously described. The Privy Council held that, in deciding what parcels were to be valued, the Valuer-General must have regard to the geographical, functional and structural unity or otherwise of the subject-matter, and that the mere

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presence of strata did not mean that any site should not be valued as a whole. On the facts the conclusion was that there were no conditions existing such as to justify fragmentation into strata and a residue of land. Two side-points are as follows. First, Lord Wilberforce noted a comment by the first instance judge that the Valuer-General’s contentions would give rise to problems of valuation which were highly complex, abstruse and at points almost impossible to resolve, and Lord Wilberforce commented ‘if that is so, this will not be the first time that valuers have been faced with intractable difficulties’. Second, it is a delight to note that the 1961 legislation’s definition of ‘stratum’ ended ‘and “strata” is the plural of stratum’.

VI. THE EXTENT TO WHICH THE PRIVY COUNCIL MADE A DIFFERENCE

While most cases involve a clear win for the taxing authority or for the taxpayer, and the decision of the court below is upheld or reversed, a few cases are not so straightforward. For present purposes only three of the hundred cases are not clear cut. In Commissioner of Income Tax, Bihar and Orissa v Maharajahdhiraj of Darbhanga (1933) the Commissioner sustained victory on three points, continued to lose the fourth, but triumphed anew on the fifthwhich explains why ‘.8’ and ‘.2’ come into what follows. In Commissioner of Stamp Duties of New South Wales v Pearse there were two issues, and the Commissioner lost one throughout, while the taxpayer lost the other throughout. As to New South Wales Railway Commissioner, Sydney City Council, and Wynyard Holdings Ltd v New South Wales Valuer-General, the simple line will be taken that the lessee continued to lose. Analysis shows that the decision of the immediate court below was upheld as to 63.8 per cent and reversed as to 36.2 per cent. Viewed on a region/country by region/country basis, the results are not dramatically different. Among those regions/countries which were involved in a significant number of cases—taking 10 or more as ‘significant’—only the courts of Africa, at 40 per cent, fell short of the overall 63.8 per cent in terms of being upheld, and only the courts of Sri Lanka (then Ceylon) can rejoice in being upheld in over 80 per cent of their decisions (82 per cent). The largest number of cases (22) came from Australia. In all of the earliest eight of those cases the Australian courts were upheld, but the later 14 were split equally. Of the 36.2 reversals, 19 were reversed to the advantage of the taxpayer, and 17.2 to the advantage of the taxing authority. Overall, the taxing authority was successful to the measure of 60.3 per cent and the taxpayer 39.7 per cent.

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It is no surprise that this statistical analysis produces no surprises. The reversal rate of 36.2 per cent might, at a simple level, suggest that the Privy Council earned its keep.

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9 The History of the United Kingdom’s First Comprehensive Double Taxation Agreement JOHN F AVERY JONES *

ABSTRACT For some time the United Kingdom failed to make any tax treaties because of its strong objections to source taxation by the other state. This chapter considers the reasons for that objection and the compromise in that attitude that finally made a tax treaty with the United States possible in 1945—when war levels of taxation meant that lack of any double taxation relief outside the Empire had become extremely serious. The chapter draws on information in the Public Record Office about the negotiations which led to the conclusion of the treaty. The US/UK treaty is remarkable in tax treaty history for the number of items that are to be found for the first time ever in that treaty and which became our (and in some cases everyone’s) treaty practice.

I. THE UNITED KINGDOM APPROACH

I

N MAY 1930 Sir Percy Thompson KBE, CB, Deputy Chairman of the Board of Inland Revenue, proposed a bold resolution to the Fiscal Committee of the League of Nations during the Committee’s consideration of the problems of double taxation: That the prevalent view that an undesirable economic result, viz., the creation of an artificial barrier which impedes the free flow of capital into the channels in which it can be most usefully and profitably employed, is produced by double * The author is grateful to Mr Sanford H Goldberg for providing him with US material.

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taxation is fallacious: that origin taxation is solely responsible for this undesirable economic result which would remain unaffected if all taxes based on residence were everywhere abolished and in consequence double taxation ceased to exist.1

The proposal that barriers to the free flow of capital internationally would be prevented if the residence state only, and not the source state, taxed the income, might even be described as foolish rather than bold.2 Not only was it contrary to everything that the Fiscal Committee had been doing since 1923 at meetings that Sir Percy had attended3 (which was to determine those items of income that could be taxed at source) but it was also the exact opposite of almost every tax system of the countries represented, which then taxed income at source only.4 The members of the committee did their best to postpone a vote on it. The minutes record: ‘After discussion, the Fiscal Committee has decided to adjourn the decision on this question until its next session.’ At the next session in May–June 1931, the resolution, slightly redrafted, was again discussed and the minutes record: The Committee noted the very interesting explanations furnished by Sir Percy Thompson. It considered that the question as expounded presented, in addition to a highly practical side, other aspects which fell rather within the field of theoretical economics. The Committee therefore thought it necessary that fuller preparation should be made for the discussion than was possible at the time. Sir Percy Thompson was accordingly requested to be good enough to submit to his colleagues a written statement5 setting forth the reasons which he had already

1 League of Nations Fiscal Committee, Report to the Council on the Work of the Second Session of the Committee, May 1930 (Document C340.M140.1930.II); Legislative History of US Tax Conventions vol.4 at 4211, available at: http://setis.library.usyd.edu.au/-oztexts/ parsons.html 2 There is reference in a document in the National Archives, Public Record Office (TNA:PRO), IR40/7463, that Sir Percy had sent a memorandum to the Chancellor (Churchill) in September 1928 prior to a meeting in October 1928 in Geneva (which would be the meeting at which the 1928 drafts, see text below at n 53, were approved) proposing this solution, and the Chancellor had approved his approach. In January 1930 an Inland Revenue internal committee made a report proposing double taxation relief on the lines of the treaty with Ireland, complete with a draft treaty (IR40/4680), and so the timing of Sir Percy’s resolution may have been prompted by adoption of that report as UK policy. 3 He attended all the meetings of technical experts from 1923 onwards (except for the fourth and fifth sessions in October 1924 and February 1925, while he was sitting on a Commission in India and Mr GB Canny replaced him and signed the 1925 report), and he participated in the Reports of 1927 (prepared in 1926–27), 1928, 1929, 1930, 1931 and 1933. There are some records of these meetings in TNA:PRO IR40/3419. 4 Apart from the United Kingdom, the United States and Germany, all of which had income taxes, the only taxes imposed by states represented on the fiscal committee were impersonal taxes charged only on a source basis, see text below at n 19 for more about such taxes. 5 The author has not found such a written statement by Sir Percy.

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given them verbally, to enable the members of the Committee to go more fully into the matter and be ready to discuss it at a later session.6

One senses that the discussion damned the proposed resolution with faint praise and another excuse was found for putting off the discussion once again. Unfortunately for Sir Percy, there was no meeting in 1932.7 By the time of the 1933 meeting there were more pressing and down-to-earth matters in the form of the results of Mitchell B Carroll’s8 enquiry into the apportionment of profits in 27 countries and a preparation of a draft convention on the subject. Sir Percy’s resolution had been forgotten about as nothing was recorded in the minutes, and that was the last meeting that Sir Percy attended before his retirement in 1935.9 This article traces the origins of the UK attitude that led to the proposed resolution; at first sight a strange attitude for the United Kingdom to take when it had relied heavily on deduction of tax at source on almost all types of income10 since Addington’s 1803 tax. One might be forgiven for thinking that, in terms of ease of tax collection, withholding tax from non-residents was even more important than doing so from residents. The answer is that as an exporter of capital we stood to lose by giving relief for foreign taxes. The consequence of this attitude was that, with the exception of Ireland,11 nobody made any comprehensive tax treaties with us before the end of the Second World War. By then, there were some 54 treaties, mainly with European countries.12 The United States had made

6 Fiscal Committee, Report to the Council on the Work of the Third Session of the Committee, June 1931 Section XI; Legislative History at 4231–2. 7 The author is grateful to Mr Stefano Simontacchi for checking this in the League of Nations archives in Geneva. The 1932 meeting was postponed until 1933 ‘for reasons of economy’. The Fiscal Committee had a three-year life that was due to expire in 1932; it had to be extended to 1933. 8 Mitchell B Carroll (1898–1987), as Chief of the Tax Section at the Department of Commerce with Thomas S Adams (see below n 31), attended all the League of Nations meetings from 1926 to 1946, becoming chairman in 1938. He had an interesting background including not only degrees from George Washington University in Washington DC and the Johns Hopkins University in Baltimore, but also from universities in Paris and Bonn, which made him the ideal person to make such a survey. He was President of the International Fiscal Association from 1939 to 1971 and attended their conferences up to the New York conference in 1986. 9 He signed the Board of Inland Revenue’s annual report for 1934 in February 1935 but not the report for 1935 in February 1936, so he must have retired between these two dates. 10 In 1930 deduction of tax at source applied to rents under leases (it was restricted to leases of more than 50 years by the Finance Act (FA) 1940), rentcharges, etc, dividends, yearly interest (including foreign dividends and interest paid by a UK paying agent), annuities, annual payments, patent royalties, mining royalties, copyright royalties paid to non-residents only, maintenance (alimony) (small maintenance payments were excepted in 1944), employment income and pensions from public offices only (deduction of tax from other employment income and pensions started in 1943). 11 See below n 45. 12 The number of income tax treaties existing before the US–UK treaty to which each country was party was: Austria 8, Belgium 6, Canada 1, Czechoslovakia 6, Danzig 1,

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three treaties with European countries,13 plus one with Canada (1942). We shall trace the change of attitude that made a treaty with the United States possible in 1945, leading to an avalanche of treaties with other countries. The United Kingdom’s attitude against source taxation internationally had originally received support in the 1923 report for the League of Nations by the four wise men,14 which was actually written by only two of them, Professor Seligman (United States) and Sir Josiah (later Lord) Stamp (United Kingdom).15 Consequently it was unrepresentative of mainland European tax thinking. The third, Professor Bruins (the Netherlands) largely agreed with them. The fourth, Senator (later President) Einaudi (Italy) never made any contribution,16 which Professor Seligman later regretted as Italy was the only one of the three countries represented that was a net importer of capital.17 The taxes in mainland Europe18 which were the background to the Report were impersonal taxes (impôts réels: a series of separate taxes imposed on different types of income on a source

Denmark 5, Finland, 3, France 10, Germany 17, Hungary 5, Iceland 3, Ireland 1, Italy 7, Liechtenstein 1, Luxembourg 2, Netherlands 5, Poland 4, Romania 2, Saar 2, Sweden 8, Switzerland 3, Tunis 1, United Kingdom 1 (Ireland), United States 4 (Canada, France (2) and Sweden), Yugoslavia 2. (Because this counts countries separately, the total number of treaties is half the total of these numbers, namely 54.) The author is indebted to Professor Richard Vann for this list, who points out that the list in the three volumes of the League of Nations tax treaties is incomplete. Mitchell B Carroll gave a figure of around 60 treaties in evidence to the US Senate Foreign Relations Committee on behalf of the National Foreign Trade Council in 1945 in relation to the US–UK treaty, which suggests the existence of some other treaties: SI Roberts (ed), Legislative History of United States Tax Conventions, Roberts & Holland Collection (Buffalo, NY, 1993) vol.20 at 2609. 13 With France (1932, 1939) and Sweden (1939). 14 Report on Double Taxation, Submitted to the Financial Committee, 5 April 1923 (Document EFS73.F19) (hereinafter ‘1923 Report’); Legislative History of US Tax Conventions, above n 1, at 4005. 15 Member of the Board of Inland Revenue until 1919, when he became secretary and director of Nobel Industries Ltd from which Imperial Chemical Industries (ICI plc) later developed; and a member of the 1920 Royal Commission on Taxation. 16 MJ Graetz and MM O’Hear, ‘The “Original Intent” of US International Taxation’ 46 Duke LJ 1021 at 1075. 17 Graetz and O’Hear, above n 16, at fn 225. In 1924 US investments abroad were $15.1 billion and foreign investments in the US were $3.9 billion (Broadberry and Harrison (eds), The Economics of World War I (Cambridge, 2005), Table 10.9 at 335). At the end of 1918–19 UK Government borrowing on capital account was £1,365 million (75% from the US), and overseas loans were £1,741million (at 221). The Netherlands were neutral during the war and Amsterdam became an important international centre of finance in Europe after the war (at 151). Italy had been a net borrower for a long time and raised a further £50 million in London pursuant to the Treaty of London (1915) (at 281, 299). For the figures for investment between the US and the UK at the time of the US–UK treaty (1945), see fn 250. 18 We also recommended this type of tax for the Colonies following the Report of an Inter-departmental Committee on Income Tax (Cmd.1788, 1922. The tax was based on income ‘accruing in, derived from, or received in’ the colony, which seems to be a combination of impersonal tax and the remittance basis; it did not require any determination of the taxpayer’s residence. Many Privy Council cases on source derive from these colonial taxes: see M Littlewood, ‘The Privy Council, the Source of Income and Stare Decisis’ [2004] BTR 121.

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basis, such as a tax on land, a tax on business profits, etc).19 The distinction was that impersonal taxes were charged on income regardless of the recipient, whilst personal taxes (income tax) depended on the status of the recipient, particularly on his residence.20 More relevantly, personal taxes were on total income21: impersonal taxes were on limited types of income.22 Income tax was dealt with in the final section of the report after death duties and property taxes which demonstrates its lack of importance. In relation to ‘the income tax proper in its developed form, as found in Great Britain, the United States and the German Empire’,23 the four economists started by recognising that ‘the method of classification and 19 It has been suggested that such taxes are the only ones compatible with the EU treaty and so history may soon go full circle with their reintroduction (while it could equally well be argued that Sir Percy’s proposal would be equally compatible with EU law—see MJ Graetz and AC Warren, ‘Income Tax Discrimination and the Political and Economic Integration of Europe’ 115 Yale LJ 1186 at 1218—such a solution would have no more chance of success now than it did then). 20 Italy–Germany (1925) [references in this form are to tax treaties] defined each as follows: ‘For the purpose of this Convention the taxes levied on specific taxable objects and on the basis of their economic relation to the territory of a State, are regarded as impersonal taxes. As personal taxes are considered those direct taxes which are imposed on the aggregate taxable objects—income or capital—with regard to the taxpayer to whom they belong and on the basis of the nationality, domicile or residence of such person.’ Another distinction is that impersonal taxes are generally levied at proportional rates, and personal taxes at progressive rates. 21 Even income taxes were levied on a list of taxable items: Germany had a list of eight items in 1933 of which income from agriculture, commerce, independent professions, wages and income from capital are similar to the Model (MB Carroll, Taxation of Foreign and National Enterprises (Geneva, 1932) vol.1, (1933), vols 2 and 3) (hereinafter ‘LoN National Reports’) vol 1 at 104); the Netherlands, four categories: from real property, movable capital, industry and labour, annuities and pensions (vol 2 at 341), which contain some similarities to the Model; the United Kingdom had a schedular system without any close connection between the content of the schedules and the Model’s categories (vol 1 at 169; and see above n 20); and the US taxed all income unless exempted (vol 1 at 203). 22 By the time of the LoN National Reports, in 1932 and 1933 the impersonal taxes were—in Belgium: tax on land and buildings, tax on movable capital, tax on professional income (Taxation of Foreign and National Enterprises vol 2, above n 21, at 50); France: tax on the income from buildings, tax on the income from land, tax on movable capital, proportional charge on mines, tax on industrial profits, tax on agricultural profits, tax on salaries, wages, pensions and annuities, tax on profits from non-commercial occupations (vol 1 at 59); Italy: tax on land, tax on buildings, tax on movable wealth, tax on agricultural income (in addition to an income tax on individuals only introduced in 1923 with the rates being fixed in 1925, and a tax on bachelors introduced in 1926) (Taxation of Foreign and National Enterprises vol 2, above n 21, at 256); Japan: land tax, business profits tax and capital interest tax (in addition to income tax) (Taxation of Foreign and National Enterprises vol 3, above n 21, at 76); the Netherlands: tax on land and buildings, and on dividends and tantièmes (Taxation of Foreign and National Enterprises vol 2, above n 21, at 332), as well as an income tax; Switzerland had a combination of income taxes and impersonal taxes, seven Cantons then having an income tax and a property tax, and the remainder having various impersonal taxes (Taxation of Foreign and National Enterprises vol.2, above n 21, at 417). 23 And also to the part of the French tax known as the complementary tax, or impôt global, and the Italian tax contemplated by a law of 1919 which had recently been postponed (it was reintroduced in 1923 with the rates of tax fixed in 1925). Income tax also existed at the time in Australia and Canada.

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assignment of sources’ (ie what later happened in tax treaties) was in theory the soundest but was virtually impossible in economic theory and would be equally impossible in practice. Their main theoretical concern was: that the economic conception of income is so complex and that of the legal and statutory definitions of income by different countries are so diverse24 that the problem of double taxation is much more seriously complicated for this class of taxes than for any other.25

Such problems did not arise when impersonal taxes were imposed at source by only one country; the residence state did not tax if it were not also the source state. The four economists posed such questions as: was the return from ownership of a farm a business profit or a return on the investment in the form of rent? Or if the farm were owned by a company which had other forms of income, what was the nature of the dividends? This may seem a strange concern since Sir Josiah Stamp was familiar with the UK schedular system that had to solve such problems. Perhaps their real concern was that the taxpayer could easily avoid source taxation by interposing or removing a corporation.26 Instead they concluded in favour of exemption by the source state: To sum up: (1) On the subject of income taxation in its developed form, the reciprocal exemption of the non-resident under method 2 [exemption by the source state]27 is the most desirable method of avoiding the evils of double taxation and should be adopted wherever countries feel in a position to do so.28

24 It should be pointed out that this problem was solved by the US–UK treaty (1945) by what is now Art 3(2) of the Model, that undefined terms have the meaning in the tax law (effectively in the source state) unless the context otherwise requires. 25 1923 Report, Section III, April 1923, Legislative History of US Tax Conventions, above n 1, at 4049. 26 1923 Report, Part III, Section III, Legislative History of US Tax Conventions, above n 1, at 4049. They had pointed out at 4045 that if a state exempted interest on securities but not mortgage interest, a borrower would find it easier to borrow in the form of general debentures rather than a charge on the land; and at 4053 that it was undesirable that tax charges could easily be avoided by the interposition or removal of a corporation, which was in the taxpayer’s hands. This problem became more serious later with hybrid entities and securities, and has been dealt with in the United Kingdom by provisions directed at tax arbitrage in F(No 2)A 2005, ss 24–31. 27 Set out in full, Method 2 was: ‘that the country of origin should exempt all non-residents from taxation imposed on income drawn from sources within its borders, recognises the theoretical fact that the country wanting the money cannot successfully “tax the foreigner”; it can only shut him out. It would have the effect of increasing the flow of capital from abroad and the development of less-favoured regions. This may be called the method of exemption for income going abroad’. Report, Part III, Section I, at 4046. 28 1923 Report, Part III, Conclusion, Legislative History of US Tax Conventions, above n 12, at 4055.

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The last phrase recognised that this method was suitable only when the two states had an approximately equal level of investment in each other.29 Where this was not the case the obvious problems between a debtor and a creditor state could be overcome not at the level of the taxpayer but by compensating payments between the two states.30 This conclusion supported the UK view, hardly surprisingly as the main authors were from the United States and the United Kingdom. So, with hindsight, it can be seen that in this respect the four economists played no part in influencing the evolution of tax treaties in Europe, and thereafter worldwide. One of the reasons was that the person who had the most influence over the subsequent development of US international taxation, Professor Thomas S Adams,31 the inventor of the US foreign tax credit in 1919, had entirely different views on source taxation from those of Professor Seligman.32 At the same time as the 1923 Report the private sector in the United Kingdom was arguing for residence-only taxation in another forum, the

29 The 1923 Report also pointed out that, in relation to interest, the borrowing state often has to exempt the interest from tax (as had Australia, New Zealand, France and Brazil on loans raised in the British money market, and the United Kingdom in relation to Government securities owned by non-domiciled and non-ordinarily resident investors) Part III, Section I, Legislative History of US Tax Conventions, above n 1, at 4044, or increase the rate of interest so that the tax is not suffered by the lender (Section III, at 4052). 30 1923 Report, Part III, Section III, Legislative History of US Tax Conventions, above n 1, at 4054. This method has surfaced again recently in the form of compensation payments in the EU Savings Directive (2003/48/EU of 3 June 2003), Art 12 under which states levying a withholding tax retain 25% and pay 75% to the beneficial owner’s state. 31 Thomas S Adams was a Professor at Yale who was appointed by President Wilson as tax adviser to the Treasury Department from 1917 to 1923, and from then until his death in 1933 was the key spokesman for the US in the international tax treaty movement having considerable influence under both Democratic and Republican regimes: see Graetz and O’Hear, above n 16, generally. Brownlee in Federal Taxation in America (2nd edn, Cambridge, 2004) at 247 describes him as the most important economist in the Treasury between 1917 and 1933. He was responsible for proposing the foreign tax credit in 1918 and source rules in 1921 which moved away from taxing business income in the country of sale (at 1054–59). His views were therefore very different from Prof Seligman, the US member of the four League of Nations economists. He and Mitchell B Carroll were members of the League of Nations committee of technical experts appointed in 1926 (1927 Report, Legislative History of US Tax Conventions, above n 1, at 4120). It is interesting that recently the US seems to be moving towards the British view, see the preference for residence taxation in the 1977 blueprints for Basic Tax Reform and a 1996 Treasury report arguing that source taxation was being rendered obsolete by electronic commerce, quoted in Graetz and O’Hear, above n 16, at 1034–35. An even greater indication of change is the absence of withholding tax on direct dividends on 80% shareholdings, and dividends paid to pension funds agreed with the United Kingdom in the 2001 treaty. 32 Graetz and O’Hear, above n 16, at 1075 compare them in this way: ‘Adams—a man who held both academic and governmental posts throughout his life—was pragmatic, instinctual, sensitive to political and administrative constraints, and usually oriented toward the technical aspects of a problem. In sharp contrast, Seligman—a lifelong academic—was a grand systematic thinker. Seligman did not ignore political and administrative constraints, but he preferred to focus on the big picture and avoid problems for which theory seemed inadequate.‘

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International Chamber of Commerce, which had taken the lead in discussions on double taxation. The United Kingdom representative had a harder struggle in that forum because the US representative was Professor Adams who took a leading part in proposing that forum’s resolutions. The UK opposition, however, prevented adoption of the Chamber’s proposed resolutions in 1923.33 The Resolution adopted in 1924 was: In order to avoid double taxation, the best means would be to accept residence as a basis of the tax on income. They recognise, however, that the application of this principle could not be expected completely to preclude all taxation according to its origin of income derived from landed property or even from commercial or industrial income. In all cases, without exception, where taxation according to origin cannot be avoided, the Committee consider that a distinction must be made between taxes affecting income at its origin and those which affect the taxpayer by reason of his residence and are charged on his entire income.34

The UK influence can be seen in the first sentence coupled with the compromise in the remainder. The next event at the League of Nations was a report in 1925 from a small committee of technical experts, comprising, in contrast to three out of the four economists, mainly countries that were net importers of capital35 and also had impersonal taxes. They acknowledged the influence of the work of the International Chamber of Commerce which had sent a delegation to one of their meetings in 1924.36 The committee also considered all the treaties that had recently been made, mainly between the newly-independent states arising after the First World War from the break-up of the Austro–Hungarian empire: Austria, Czechoslovakia, Hungary, Romania, Poland and the Kingdom of the Serbs, Croats and Slovenes (later Yugoslavia).37 The report concluded by settling the following 33

Graetz and O’Hear, above n 16, at 1069. Quoted in ‘Double Taxation and Tax Evasion’, Report and Resolutions submitted by the Technical Experts to the Financial Committee, February 7, 1925 (Document F212) (the 1925 Report), Legislative History of US Tax Conventions, above n 12, at 4068; and see TNA: PRO IR40/2790 for correspondence between the International Chamber of Commerce and the Revenue. 35 The countries represented were Belgium, Czechoslovakia, France, Great Britain (the author has left such references in League of Nations material but strictly it should be the United Kingdom), Italy, the Netherlands and Switzerland. All, except Great Britain and the Netherlands, were net importers of capital; and all, except Great Britain, had impersonal taxes. 36 1925 Report at 8; Legislative History of US Tax Conventions, above n 12, at 4068. 37 Of treaties made since the First World War, the committee lists: Germany–Austria (1922), Germany–Czechoslovakia (1921), Austria–Czechoslovakia (1921), Hungary– Rumania (1923) (which the author has not been able to trace and may relate only to administrative assistance), Hungary–Czechoslovakia (1922), Germany–six Swiss Cantons (1923) (dealing only with employment income), Italy–Austria–Hungary–Poland–Romania– Kingdom of the Serbs, Croats and Slovenes (1922, potentially the first multilateral treaty but 34

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approved list of source taxation (by necessity) for impersonal taxes: immovable property (including mortgages), industrial, commercial, or agricultural income (where there is a permanent establishment), shipping (exclusive taxation in the state of the real centre of management subject to reciprocity), directors’ fees (at the state where the company has its fiscal domicile), earned income (where the employment was carried out, subject to the right to have special provisions for frontier workers), interest and dividends (the state where the debtor was domiciled).38 This list is not surprising as it is the same as that contained in the existing treaties that they considered.39 The committee concluded that for personal taxes, on the other hand, there would be no source taxation, except possibly for income from immovable property and permanent establishments (but not to include dividends). This followed the International Chamber of Commerce’s resolution and the Italy-Czechoslovakia treaty (1924), the only treaty then making the distinction between personal and impersonal income.40 Although the report said the committee had profited from the 1923 report of the four economists,41 it was clearly not a major influence outside the field of personal taxes. The Committee emphasised that the division between impersonal and personal taxes was ‘made on purely practical purposes and no inference in regard to economic theory should be drawn from this fact’.42 The

only ever in force between Austria and Italy), Czechoslovakia–Italy (1924, the only treaty then making a distinction between personal and impersonal income, the provisions of which are summarised in the Report): Legislative History of US Tax Conventions, fn 1 at 4072. Although not listed, there was also Germany–Hungary (1923). The above states continued to be the driving force in treaty making during the 1920s. Further treaties made during the 1920s included: Austria–Liechtenstein (1928), Austria–Switzerland (1927), Czechoslovakia– Poland (1925), Danzig–Poland (1924, 1929) [Danzig was a free city administered by the League of Nations], Denmark–Germany (1928), Denmark–Iceland (1927), Germany–Italy (1925), Germany–Poland (1923) provisional agreement pending negotiations and 1922 administrative assistance treaty, Germany–Sweden (1928), Germany–Switzerland (1929) on taxation of power plants on the Rhine, Hungary–Italy (1925), Hungary–Poland (1928), Hungary–Kingdom of the Serbs, Croats and Slovenes (1928), Ireland–UK (1926). 38 1925 Report at 31, Text of the Resolutions, Legislative History of US Tax Conventions, above n 12, at 4091. 39 A few of the treaties in the list above n 38 did not contain shipping provisions, no doubt for geographical reasons, although some contain a statement that this would be dealt with in a separate treaty; and three of them did not contain a directors’ fees article. 40 1925 Report at 12, Legislative History of US Tax Conventions, above, n 12, at 4072. Czechoslovakia–Italy (1924) (and some, but not all, later treaties making the distinction between personal and impersonal taxes: see fn 51) permitted personal taxation at source of immovable property, mortgages, industry or trade, and work and the inclusion of this last item is therefore wider than the 1925 Report. 41 42 1923 Report, Legislative History of US Tax Conventions, above n 12, at 4069. 42 1925 Report at 15, Legislative History of US Tax Conventions, above n 12, at 4075. Sir Percy Thompson (see above n 3) was quoted as saying that any such classification ‘would become positively dangerous if any attempt was made, from the mere difference of nomenclature, to draw conclusions as to the different economic effects of these taxes’. Professor Adams was also critical of the distinction: Graetz and O’Hear, above n 16, at 316.

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distinction between these taxes was a potential problem for both the United States and the United Kingdom43: the United States feared that if its tax was classified as impersonal they would lose the right to tax some income at source; and the United Kingdom feared the competitive disadvantage caused by UK tax in the residence state in addition to that paid by competitors in the source state for which only a deduction was given for taxes outside the dominions at the time, while competitors enjoyed exemption in their residence state. One may wonder why the UK delegate, Sir Percy Thompson, signed the report; the answer may have been that at that stage it was theoretical and the problems of bilateral treaty negotiation had not yet been encountered. Turning the report into a model treaty was the task of a further-enlarged committee of experts meeting from 1926 including the United States, represented by none other than Professor Adams assisted by Mitchell B Carroll.44 It should be mentioned that 1926 was also the year of the United Kingdom’s only treaty, based on Sir Percy’s principle of residence-only taxation, that with Ireland.45 Most mainland European countries had only impersonal taxes and they had taken the lead in making treaties that

43 As the 1925 Report notes, the schedules of the British income tax were divisions under which income is classified for computational purposes, whereas the French impôt schédulaire (schedular tax—the Report said that there was no more than an etymological connection between the two expressions) on immovable property had no connection with the part of the general income tax that applied to immovable property (Legislative History of US Tax Conventions, above n 12, at 4075); the four economists had made the same point, at 4030. Sir Josiah Stamp had said in 1919 that up to 14 years earlier the UK tax had been a tax in rem (The Fundamental Principles of Taxation in the light of Modern Developments (1923) at 17); this is presumably a reference to the introduction of earned income relief by FA 1907, s.19 subject to a maximum earned income of £2,000, which had to be claimed in a return. It seems clear that the Committee classified the British tax as a personal tax. The United States had the same problem: Graetz and O’Hear, above n 16, at 246, 249. 44 The countries represented were Argentina, Belgium, Czechoslovakia, France, Germany, Great Britain, Italy, the Netherlands, Poland, Switzerland, the United States and Venezuela (compare with above n 35): Report presented by the Committee of Technical Experts, April 1927 (Document C216.M85.1927.II) (1927 Report), Legislative History of US Tax Conventions, above n 12, at 4120. 45 Agreement of April 14, 1926, reproduced as ITA 1952, sch 18 (and later ICTA 1970, sch 12) under which: ‘Any person who proves to the satisfaction of the Commissioners of Inland Revenue that for any year he is resident in the Irish Free State and is not resident in Great Britain or Northern Ireland shall be entitled to exemption from British income tax for that year in respect of all property situate and all profits or gains arising in Great Britain or Northern Ireland and to exemption from British super-tax for that year’ and similarly for residents of Great Britain or Northern Ireland. The Agreement had effect only if and so long as legislation confirming it was in force both in Great Britain and Northern Ireland and in the Irish Free State. There were subsequent agreements of 25 April 1928, 4 April 1959 and 23 June 23 1960 not affecting the principle of the first agreement. The decision in Collco Dealings Ltd v IRC (1961) 39 TC 509 was on this treaty, to the effect that the taxpayer was ‘entitled under any enactment to an exemption from income tax’ on the basis that the treaty exemption was by virtue of the enactment giving effect to the treaty, and so was caught by dividend stripping legislation. The treaty relief was preserved when unilateral relief was introduced in 1950. The treaty was replaced by one in OECD Model form in 1976. Between

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provided for source taxation of the list approved in the 1925 Report and often other types of income, although, unlike the report, mostly without making any distinction between personal and impersonal taxes.46 The United States and the United Kingdom were out of line on two counts: they were net exporters of capital and they had income taxes (personal taxes) rather than impersonal taxes. The differences of view between the United States and the United Kingdom on the one hand, and the rest of the countries represented on the other hand, can be seen by comparing the treatment of other types of income than those for which source taxation of impersonal taxes had been agreed in 1925 (in particular dividends, interest and private pensions). The 1927 draft produced by the Committee provided for impersonal taxation at source of dividends and all pensions, but not interest, and contained no provisions for taxing personal taxes on a source basis. This clearly shows UK influence in relation to both interest and personal taxes.47 This compromise cannot have received general acceptance48 because by the following year, 1928, the Committee prepared three alternative drafts, thus demonstrating the lack of agreement.49 The first, draft 1a, provided for impersonal taxation at source of dividends, interest and all pensions (in addition to the previous list).50 This draft contained no provisions for personal taxation at source, in accordance with the 1925 report. Italy, in particular, made a number of treaties with other countries in this form.51 The second, draft 1b, prepared by the US 1923 and 1926, dominion income tax relief (see below, n132) was incorporated by reference and applied by the UK to Irish tax and Ireland gave relief for the balance. 46 Italy was the exception: see below, n 51. 47 1927 Report, draft convention Arts 3, 4 and 8, Legislative History of US Tax Conventions, above n 12, at 4124–5. Any source taxation was refunded on production of proper evidence. 48 It is recorded in Professor Adams’ papers (quoted in Graetz and O’Hear, above n 16, at fn 264) that ‘the Belgian expert accused the British expert [Sir Percy Thompson] of putting his nation’s economic interests ahead of the general interests, and claimed that the British position would reduce debtor nations to “economic servitude”’. Sir Percy cannot have been a popular member of the committee. 49 Report presented to the General Meeting of Government Experts, October 1928 (Document C562.M178.1928.II) (1928 Report), Legislative History of US Tax Conventions, above n 12, at 4155. The Report states under the heading ‘General Considerations’ that the 1927 draft was aimed at countries which levied impersonal taxes and a personal general tax, but could also be used where there was a personal tax in the residence state and schedular taxes in the source state. The Report explained that the two new drafts were for use between countries in which taxation by reference to domicile predominates, and the second to relations between countries possessing different fiscal systems. Legislative History of US Tax Conventions, above n 1, at 4161. 50 1928 Report, draft 1a, arts 3, 4 and 8, Legislative History of US Tax Conventions, above n 12, at 4162. 51 Italian treaties with: Belgium (1931), France (1932), Czechoslovakia (1924), Germany (1925), Hungary (1925) (although the last three had source taxation of personal income for four types of income). The same is also found in Hungary–Poland (1928), Hungary–Romania (1932) and Hungary–Kingdom of the Serbs, Croats and Slovenes (1928), all of which permitted some source taxation with personal taxation.

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and UK representatives, included source taxation of public (but not private)52 pensions and no source taxation of dividends, interest or royalties; it made no distinction between personal and impersonal taxes, thus moving away in part from the view of the four economists by allowing some source taxation in personal taxation, reflecting US influence.53 There was no support for such a draft in later treaties although much of it, though not the absence of source taxation of dividends, would later be found in the US–UK treaty (1945) discussed below. The third, draft 1c, was basically the same as draft 1a as it applied to source taxation of impersonal taxes. It envisaged the possibility of reduced withholding taxes on interest and dividends but, more importantly, did not make any distinction between personal and impersonal taxes, so that the same taxation at source that applied to impersonal taxes was applied to income tax, contrary to the conclusions of the four economists and the 1925 report. This aspect was highly significant because it was draft 1c that became the model for the future so continuing the European tradition of making no distinction in treaties between personal and impersonal taxes. This failure to distinguish may have been because European countries only had impersonal taxes; it was some time before reduced withholding taxes were actually adopted in treaties.54 The impression given by these three drafts is that not only were the United States and the United Kingdom isolated from the rest, but there were substantial differences of view between the United States and the United Kingdom. The 1928 draft 1b demonstrates a compromise between the United States in the person of Professor Adams, who was a strong proponent of source taxation, and Sir Percy Thompson, who held the opposite view equally strongly. The United Kingdom succeeded in preventing source taxation on dividends55 and interest which they regarded as the 52 There were cases of this being agreed later by other states, for example Belgium– Germany (1938), Belgium–Netherlands (1933), France–Sweden (1936) (both public and private pensions) and France–Switzerland (1937). 53 The form of 1928 Report draft 1b was that in art 1 in principle income was taxable in the residence state subject to exceptions in art 2 for income from immovable property, industrial, commercial or agricultural income, directors’ fees, salaries and wages, and public pensions. Double taxation in respect of art 2 income was relieved by credit which was the US law (art 3), Legislative History of US Tax Conventions, above n 12, at 4170. It is interesting that a nil rate of withholding tax on interest and royalties is now contained in the 1996 US Model treaty. 54 This is found in US–Sweden (1939) (dividends) but is otherwise unknown in 1930s treaties. Belgium–France (1931) limited the residence state tax on transferable securities to 12%. 55 We must have interpreted this as meaning that we could still collect the tax from the company and that we did not tax on the dividend itself (there was no schedule taxing dividends before 1965). The 1925 Report (Legislative History of US Tax Conventions, above n 12, at 4075) acknowledged that although tax on dividends was collected from the company it was tax at the source, although a personal tax, while in other European countries a tax on dividends was an impersonal tax. While historically this may have been how tax on dividends

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most important,56 and the United States obtained source taxation of permanent establishments, directors’ fees, employment income and public pensions. The United States included their foreign tax credit. This may not have been that much of a problem for the United Kingdom in the circumstances since we had a type of foreign tax credit from 1916 (limited to the Dominions) which was not limited to the residence state giving credit for the source state tax.57 The differences between the United States and the United Kingdom will be seen more clearly later when the 1945 treaty is discussed. It was at this point in the history (1930) that Sir Percy Thompson proposed the resolution quoted at the beginning of this article. It was a stand taken on a point of principle, one that suited the United Kingdom as a large exporter of capital because, if tax were charged at source for every pound of withholding tax we collected on income of non-residents, we lost a greater amount by giving credit for the tax that the other state collected from income of our residents. Since deduction at source was the foundation of Addington’s income tax and has obvious benefits when taxing non-residents, it is difficult to see any other justification for the United Kingdom’s attitude. The United States was also a capital exporting country but Professor Adams did not agree with the United Kingdom about source taxation. He realised the advantage of the secondary effect of giving the other state tax revenue that could be spent on repaying far larger US government debts58 or buying US goods.59 He was also more of a pragmatist who saw the need to make treaties.60 He also objected to the absence of interest withholding tax on foreign government debt.61 Our was regarded (see Gilbertson v Fergusson (1881) 1 TC 501), it was later accepted that the company paid tax on its own behalf and not on behalf of its shareholders, as confirmed by the cases cited below n 68. If the logic of the statement in the Report is followed we would have to refund the tax paid by the company if there was no source taxation of dividends. We cannot have thought this or we would not have pressed for the absence of source tax. 56 See below n 72 for the difference between the focus of the two countries in this respect and the possible reasons for it. 57 See below n 132 for more details. 58 The US was owed $11 billion by allied governments for First World War loans and the United States made a substantial loan to Germany in 1924 (Graetz and O’Hear, above n 16, at 1051, text at fn 123, and see fn 124). Source taxation would not have been an issue for government-to-government debts because of sovereign immunity. UK overseas borrowing on capital account by the government during the war amounted to £1,365 million by the end of 1918–19, with 75% coming from the US (Broadberry and Harrison, above n 17, at 221. Their figure for US advances to allies was $9,455 million (at 23)). 59 Graetz and O’Hear, above n 16, at 1072. 60 See above n .32. 61 ‘It would be disastrous for Europe to be flooded with securities entirely exempt from taxation, as was the case in the US’: quoted in Graetz and O’Hear, above n 16, at 307. The US issued tax-exempt bonds which were widely taken up by high-rate taxpayers. This is a different point since the absence of withholding tax on foreign government bonds did not affect their taxability in the residence state, and so this was really an argument about discouraging tax evasion. See text below at n 115 in relation to the US–UK treaty.

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attitude was clear, as everyone now knew from the proposed resolution, and in consequence, apart from Ireland, which was obviously a special case, nobody else made a comprehensive tax treaty with us before the Second World War. Before turning to the negotiations with the United States we should mention the League of Nations Mexico draft of 194362 which arose out of a regional conference attended (because of the War) only by the United States, Canada and Latin American countries.63 Not surprisingly, this Model emphasised source taxation. Although it was the then latest model it seems to have had extremely limited influence on the US–UK treaty. The London draft of 1946 restored the balance somewhat, but this was subsequent to the US–UK treaty.

II. THE US–UK 1945 TREATY

We can now leave aside the United Kingdom’s differences of view with the rest of the world and concentrate on the differences between the United States and the United Kingdom. Both were capital exporting countries although at the time the United Kingdom had twice the amount of investment into the United States than there was in the opposite direction.64 Hence, assuming that income flows mirrored the amount of investment, if the United States charged a withholding tax on a particular type of income we stood to lose twice the amount of tax we collected on payments of that type to the United States by giving credit65 for the US tax on payments from the United States, this explains our attitude to source taxes. We need first to remind ourselves of the UK tax system at the time. A company paid income tax (plus profits tax, then called national defence contribution)66 on its profits. Dividends were paid out of taxed profits and so it looked as if standard rate tax (then 50 per cent) had been deducted 62 Legislative History of US Tax Conventions, above n 12, at 4378, with the London draft on facing pages. 63 Argentina, Bolivia, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay and Venezuela. 64 See text below at n 250. 65 Which we did not give for US tax at the time, but we knew that we would have to accept credit: see text below at n 140. 66 This is the position after 1947; for simplicity, excess profits tax, then 100%, as a war-time tax which was abolished in 1946 with effect from 1947, will be ignored in this article, although the treaty applied to it. From 1939 companies paid the higher of excess profits tax and national defence contribution (which became profits tax). Profits tax was at a higher rate on distributed profits (12.5%) than undistributed profits (5%), to encourage reinvestment but, as the 1955 Royal Commission pointed out, it merely encouraged retention (Cmd 9474 para 536). This differential rate was abolished in 1958, following a recommendation of the Royal Commission.

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from the dividends. Interest and patent67 royalties were paid under deduction of tax but were not deductible in computing profits: the payer obtained relief by deducting and retaining the tax. Both of these caused problems for the United States because the shareholder, or recipient of the interest or patent royalty, had not himself paid the tax and so did not qualify for foreign tax credit relief in the United States.68 In the United Kingdom the only relief for foreign tax outside the dominions, including, therefore, US tax, was to deduct it. This was extremely serious for taxpayers with the combined effect of the UK standard rate of 50 per cent plus 5 per cent national defence contribution, which was exacerbated by the lack of capital allowances on plant and machinery (until the Income Tax Act 1945 which took effect from 1946 to 1947) and US corporate rates of 40 per cent. Mitchell B Carroll pointed this out to the Senate Foreign Relations Committee on behalf of the National Foreign Trade Council, comprising US companies involved in foreign trade, which consequently strongly supported the treaty.69 The Council submitted an excellent memorandum to the Committee containing many practical points of difficulty that US companies had in their tax relations with the United Kingdom. The burden and rates of tax in the United Kingdom had risen significantly during the War70 and it seems surprising that both countries were not pressing for a treaty earlier. By the time negotiations commenced in 1944 the United States had made treaties with France (1932 and 1939),71 Sweden (1939) and Canada (1942), so evidencing an emerging US treaty policy. Their initial negotiating position was a draft based on the US–Canada treaty.72 To us the reduced rate of withholding tax given to Canada was not the international norm that we now accept, but was regarded as a discrimination against us. The idea of the United Kingdom being treated worse than Canada must

67

And copyright royalties (except film) paid abroad. Biddle v Commissioner 302 US 573; Irving Air Chute Inc v Commissioner 1 TC 880 [US case reference] affd 1/43 Fed 2d (d) 266 (certiorari denied). We had come to the same conclusion for dividends—that a company paid tax on its income on its own behalf and not on behalf of its shareholders: see Cull v IRC (1939) 22 TC 603 (UK company), and Canadian Eagle Oil Co Ltd v The King (1945) 27 TC 205 (UK shareholder in Canadian company receiving UK taxed income, reversing Gilbertson v Fergusson (1881) 1 TC 501); for interest and royalties ITA 1918, All Sched Rules r 19 (later ICTA 1988, s.348(1)(d), now ITTOIA 2005, s.686) deemed the recipient to have paid the tax. A US company holding 50% of a UK company was entitled to underlying tax relief, so the problem did not arise for such companies: Legislative History of United States Tax Conventions, above n 12, at 2613. 69 Legislative History of United States Tax Conventions, above n 12, at 2608, 2610. 70 The standard rate of income tax in 1938–39 was 27.5% (5s 6d in the pound) and in 1945–46 was 50% (10s in the pound), although it reduced to 45% (9s in the pound) in 1946–47. The burden of taxation had risen from 25.2% of national income in 1938 to 44.7% in 1944 (M Daunton, Just Taxes (Cambridge, 2002) 176). 71 Although not effective until after the War. 72 Note to the Chancellor (John Anderson), 19 May 1944: TNA: PRO IR63/167 at 488. 68

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have been very shocking. In any case we did not believe in withholding tax at all, as Sir Percy Thompson’s draft resolution at the League of Nations had shown. Although not expressed as such, our negotiating position was effectively the League of Nations 1928 draft 1b; the next generation of civil servants were set to repeat the battle between Sir Percy and Professor Adams. The difference in approach in the two countries is noteworthy: we were far more interested in the treatment of dividends than business income; and the opposite applied in the United States.73 Perhaps this was conditioned by the respective tax systems: the United States taxed companies as such; the United Kingdom effectively collected tax from companies on behalf of the shareholders (except for profits tax). There is a surprising amount of information in the public domain74 about our negotiating stance, through memoranda to the Chancellor from the Revenue,75 although they deal with relatively high-level points so some

73 Graetz and O’Hear, above n 16, at 1087. The same difference in view can be seen in relation to the League of Nations 1928 draft 1b: see above n 55. In 1925 the US rate of tax on corporations was 13.5% compared with 5% for individuals. Interestingly, Sir Josiah Stamp (one of the League of Nations’ four economists: see above n 14) had recommended a corporation tax to a Select Committee in 1920 (see MJ Daunton, ‘How to Pay for the War: State, Society and Taxation in Britain, 1917–24’, The English Historical Review (vol 111, no 443) 882 at 898 and 914). 74 Although documents relating to treaty negotiations are not disclosed by the National Archives Public Record Office for 75 years, quite a lot of documents comprising briefing to the Chancellor of the Exchequer and communications between the Board and the negotiators are contained in the documents relating to the Finance Bill 1945 which contained a clause giving effect to the US treaty. The author’s reason for not pointing out this error to the PRO is that there have been two subsequent income tax treaties, and one subsequent inheritance tax treaty, so no question of national interest can still be involved. Lapse of time is also recognised by the courts as overriding public interest immunity. In addition, the documents had already been available to the public for 30 years when the author found them. Thus the major issues can be seen but there will be others that will not emerge until 2020. 75 TNA: PRO IR63/167. Note to the Chancellor (John Anderson), 19 May 1944 at 488; with accompanying note of 22 May 1944 at 503; meeting with the Chancellor, 25 July 1944 at 514; letter to ‘Padmore’ (the Chancellor’s private secretary), 31 August 1944 at 517; memorandum to the Chancellor, 24 October 1944, commenting on a memorandum from various companies at 524; meeting with the Chancellor, 8 November 1944 before further negotiations at 533; telegram from Washington to the Chancellor’s private secretary, 30 November 1944 at 534; reply, 8 December 1944 at 41; further telegram, 9 December 1944 at 542, and 12 December 1944 at 43; reply, 13 December 1944 at 544; draft report to the Chancellor (9 pp), 22 December 1944 at 546; memorandum by the Chancellor, 1 January 1945 at 557; note to the Chancellor on exchange of information, 10 March 1945 at 561; letter to the Chancellor’s private secretary, 21 March 1945 at 563, and 9 April 1945 at 568, commenting on the Memorandum by the Minister for Information; note of meeting on 10 April 1945 between the Chancellor and representatives of the Clearing Bankers Committee and the Accepting Houses Association at 572; note of discussions on 18 January 1945 between the Inland Revenue and the Dominions Office, the Colonial Office and the Treasury on double taxation and the colonies; note to the Chancellor, 1 June 1945 on taxation provisions of commercial treaties relating to personal allowances to non-residents at 583. There is little of note about the treaty in Hansard.

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of the detail is not covered.76 The surprising point to the writer is the extent to which the Chancellor was informed of negotiations. On the US side there is a lot of published material presented to the Senate Foreign Relations Committee77 mainly about the detail of the treaty but to some extent emphasising the benefits to the United States, some of which may have been stated more for the benefit of the Committee rather than how the United Kingdom viewed them. There were written memoranda from the Joint committee on Internal Revenue Taxation, the Treasury Department, the National Economists and Statistics Unit of the Department of Commerce and the National Foreign Trade Council. Oral evidence was given by Mitchell B Carroll, Franklin Cole (an economic consultant), the American Bar Association, Eldon King (Special Deputy Commissioner, Bureau of Internal Revenue and the US chief negotiator) and Colin Stam (Chief of Staff, Joint Committee on Internal Revenue Taxation). A good picture can therefore be obtained by combining the sources in the two countries. The first note on the Revenue’s file (apart from an internal note about double taxation of 4 April 1944) is dated 19 May 1944. It mentions that discussion had started on 25 April 1944 with the United States working from the treaty they had agreed with Canada, although it appears from US material that there had been exploratory talks as early as 1937.78 The Revenue’s first note to the Chancellor of 19 May 1944 was not optimistic: although the United States were pressing for action, ‘the most that can be hoped for is that there should be a continuance of the discussions, directed

76 One such issue on which there is no information at present that particularly interests me is the origin of Art II(3) (now Art 3(2) of the OECD Model) which was first used in this treaty: ‘In the application of the provisions of the present Convention by one of the Contracting Parties any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that Contracting Party relating to the taxes which are the subject of the present Convention.’ US–Canada (1942) by contrast had contained definitions of (in addition to dividends and interest) rentals and royalties, pensions, life annuities, engaged in trade or business, office or place of business, and subsidiary corporation. This provision prevented the need for further expansion of definitions in treaties. 77 Leading to Senate Executive Report No 6, 79th Cong, 1st Sess, 3 July 1945 and Senate Floor Debate and Action, 12 July 1945, 91 Cong Rec 7448, followed by further debates in 1946 leading to Senate Executive Report No 4, 79th Cong, 2d Sess, 10 May 1946 and Senate Floor Debate and Action, 1 June 1946, 92 Cong Rec 6108–6110. Legislative History of United States Tax Conventions, above n 12, at 2604 onwards. 78 Eldon B King, Special Deputy Commissioner, Bureau of Internal Revenue, told the Senate Foreign Relations Committee that there had been a preliminary exploration in 1937 at which the UK secrecy and the US extraterritorial taxation had been identified as the major obstacles to a treaty: Legislative History of United States Tax Conventions, above n 12, at 2622. In the United Kingdom there are some earlier memoranda in TNA:PRO IR40/7463 on whether there was a need for tax treaties and whether to negotiate with the United States, and the British Chamber of Commerce in the United States were pressing for action in 1938 (IR40/6156). There was even a suggestion made by an MP as early as 1927 that the Revenue should negotiate (IR40/3306).

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to working out certain primary principles’. This cautious attitude was understandable. This was the first comprehensive treaty that the Revenue had negotiated, and they knew that they would be creating a precedent. In fact, the treaty was signed almost exactly a year after negotiations began, on 16 April 1945, the last possible date to ensure publication on Budget day, 24 April 1945.79 An interesting feature is the recognition by the UK Revenue of the work of the International Chamber of Commerce, to which reference has already been made and which the Revenue referred to as ‘an admirable memorandum’. They suggested to the Chancellor that the Chamber should be invited to nominate representatives to keep in touch with the Revenue during negotiations on a confidential basis, which was well in advance of the time.80 The treaty applied comprehensively in the United Kingdom to income tax (including surtax), excess profits tax81 and national defence contribution (which became profits tax in 1947).82 A separate treaty relating to estate duty was negotiated at the same time. The major issues in this negotiation were dividends and interest, double taxation relief and, perhaps surprisingly, exchange of information; these will be dealt with first.

III. DIVIDENDS

We would now categorise this as a treaty between a state (the United States) with a classical corporation tax system, and one (the United Kingdom) with a full imputation system (except for profits tax) where the company was charged to income tax and dividends were treated as income that had already been charged to income tax. The US–Canada treaty, from which basis the United States were working, was a treaty between two countries both with classical corporation tax systems, and so was of 79 Letter to the Chancellor’s private secretary, 9 April 1945: TNA: PRO IR63/167 at 568. In fact, because of the election the original Bill was withdrawn on 29 May 1945 and the legislation was passed in an autumn Bill, F(No 2)A 1945, passed on 20 December 1945. This Act contains additional provisions from the original Bill in order to achieve retroactivity of the treaty (s 51(6)). The treaty was approved by Order in Council on 2 August 1946 as the Double Taxation Relief (Taxes on Income) (USA) Order 1946 (SR & O 1946 No 1327). An estate duty treaty was made at the same time; see the heading ‘Estate duty treaty’. 80 Note to the Chancellor, 19 May 1944: TNA:PRO IR63/167 at 492. 81 See above n 66. 82 The application of the non-discrimination article (see the heading ‘Nondiscrimination’) to ‘taxes of every kind or description, whether national, federal, state, provincial or municipal’ is not within the (later-drafted) enabling legislation in F(No2)A 1945, s 51, which, like the rest of the treaty, was restricted to ‘income tax, excess profits tax or the national defence contribution and any taxes of a similar character imposed by the laws of that territory’. The same problem applied to the treaty’s application to UK taxes of a substantially similar character imposed subsequently.

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limited assistance in this situation. The Revenue’s note, which was made before negotiations began, recognised that: it is difficult to see any method of reconciling the two systems and practical considerations would point to the adoption of the allowance of tax against tax formula..83

This was far removed from their negotiating stance. We started from the extreme Sir Percy Thompson position which had succeeded against Professor Adams in the League of Nations 1928 draft 1b of wanting a nil rate of withholding tax on dividends, interest and royalties from the United States in return for our merely giving up surtax on the same types of income. No doubt the United States realised this was not much of a concession as we could not collect anyway, but we had nothing else to concede, at least so far as dividends were concerned.84 But the tax treaty world had moved on since 1928 and their latest treaty with Canada had a 15 per cent rate of withholding tax. The United States must have been keen for us to reduce our tax because they did not give credit for any of it, but that was not really an option for dividends with a full imputation system. We had a fall-back position of allowing the United States a withholding tax of 6 per cent, which was the minimum internal rate of tax on which there were surtaxes of 13–82 per cent. One suspects that we never put this forward.85 The United States had a 30 per cent withholding tax rate, which they had reduced by treaty to 10 per cent for Sweden (which we were told was unlikely to last and could not be considered as a precedent) and 15 per cent for Canada, which the United States regarded as the lowest rate to which Congress would agree.86 Our position was out of the question to the United States but we persisted in it, finally after eight months’ negotiations we reserved the position for political agreement and recorded this in writing to the leader of the US delegation.87 The Revenue explained to the Chancellor that ‘I felt that an official agreement on such a proposal would be tantamount to committing His Majesty’s Government’.88 The note to the Chancellor, however, recommended acceptance.

83 Note by Board of Inland Revenue on Double Taxation re pending discussions with United States: TNA: PRO IR63/167 at 486–7. 84 Note to the Chancellor, 19 May 1944:TNA:PRO IR63/167 at 490; note of 19 May 1944: TNA:PRO IR63/167 at 501. 85 Letter to ‘Padmore’ [the Chancellor’s Private Secretary], 31 August 1944: TNA:PRO IR63/167 at 517. 86 Memorandum by the Chancellor, 1 January 1945: TNA:PRO IR63/167 at 559. 87 Letter to Eldon P King, Deputy Commissioner of Internal Revenue, 14 December 1944: TNA:PRO IR63/167 at 545. 88 Draft note to the Chancellor, 22 December 1944: TNA:PRO IR63/167 at 551.

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Thus we finally lost the re-run of the 1928 arguments and accepted the offer of 15 per cent withholding tax on dividends89 paid from the United States.90 In return we merely gave up surtax on dividends paid from the United Kingdom: so we obtained a good bargain. The reduction in withholding tax was conditional on the dividend being subject to tax91 in the residence state and the recipient not having a permanent establishment in the source state. The 15 per cent US withholding tax was actually a good compromise giving near equality in the result between the UK standard rate of 50 per cent and the US corporation tax of 40 per cent plus 15 per cent withholding tax on the remaining 60 per cent, totalling 49 per cent.92 This change resulted in a notional deduction of tax at the standard rate from the whole of the dividends in the United Kingdom. Previously where Dominion Income Tax relief applied the UK tax was deducted from the net after double taxation relief.93 The new system resulted in the introduction of the ‘net UK rate’, ensuring that repayments of tax deducted from dividends were restricted to the UK tax actually paid.94 A 5 per cent rate of withholding tax on dividends was agreed for direct investment (defined as dividends paid to a company owning the high figure of 95 per cent of the voting power)95 subject to two qualifications: first, that not more than 25 per cent of the paying company’s income was from dividends and interest (except from subsidiaries), and, second, that the 89 ‘Dividend’ was undefined and so by Art II(3) took the internal tax law meaning. Dividends were later defined by the 1966 Protocol; interest remained undefined. 90 The Double Taxation Relief (Taxes on Income) (USA) Regulations 1946, (SI 1946 No 1331) provided for paying agents to deduct the balance of the standard rate over 15% from US dividends. 91 This was to be replaced by a beneficial ownership requirement in the 1966 Protocol, the first treaty to do so in relation to income, as opposed to assets: see below n 109. At the same time, a remittance article was introduced denying the treaty benefit for unremitted income taxable on the remittance basis, thus preserving in this respect the subject-to-tax provision and applying the restriction to other kinds of income. 92 Memorandum by the Chancellor, 1 January 1945: TNA:PRO IR63/167 at 559. This comparison, however, ignores that the company paid an additional 12.5% profits tax on distributed profits. It is mentioned in TNA:PRO IR40/9940 that consideration was given to a sliding rate of withholding tax, but it was decided to have a fixed 15%. The National Foreign Trade Council Memorandum to the Senate Foreign Relations Committee (Legislative History of United States Tax Conventions, above n 12, at 2613) exaggerates the US tax by adding the 30% withholding tax to the 40% cent corporate tax, making 70%, whereas the 30% is on the remaining 60% after corporate tax. 93 This had the odd result that surtax payers grossed up the dividend by the UK tax only, which resulted in a smaller gross amount than if there had been no relief for foreign tax. Because of the higher UK tax charge before credit, a Budget Resolution was required: TNA:PRO IR63/168 at 27. 94 F(No 2)A 1945, s 52. This had been put forward by the International Chamber of Commerce as an alternative to its preferred position of the continuation of the Dominion Income Tax Relief system: TNA:PRO IR63/167 at 594. 95 At the time this was unconnected with underlying tax relief because such relief applied to everyone regardless of the size of the holding.

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relationship between the two corporations had not been arranged or maintained primarily with the intention of securing such reduced rate, a formula which had been used by the United States in their treaty with Canada.96 We would later adopt a variation on this formula in all our treaties. Shortly afterwards, we agreed a nil rate of withholding tax on dividends on direct investments97 in our treaties with Canada (1946), South Africa (1947) and Australia (1947), and on all dividends in our treaty with New Zealand (1947) and the same in all the colonial treaties.98 We had agreed during negotiations to a definition of residence for withholding tax purposes of a company ‘created or organised’ under the law of one of the states,99 although this was not carried through in the drafting because the dividends, interest and royalties articles depended on income from sources in the United Kingdom.100 ‘United Kingdom corporation’ is a defined expression meaning one created101 under the laws of the United Kingdom but this is used only in three places: the exemption for shipping and aircraft (where resident would have been more appropriate from our point of view)102; exemption from the US personal holding company provisions103; and in the infamous Art XV, then applying in one direction exempting from US tax dividends and interest paid by a United Kingdom corporation except where the recipient was a US citizen, US resident or a US corporation. This was designed to prevent the United States charging its secondary withholding tax on dividends if 50 per cent or more if the income had been earned in the United States. In practice it was impossible for them to find out what proportion of income arose in the United States.104 A similar provision is found in the US–Canada treaty. The 96

That treaty had a 5% withholding tax on dividends from subsidiaries. Unless more than 25% (Canada), or 50% (Australia), of the income was from dividends and interest (except from wholly owned subsidiaries). 98 Other early treaties with a nil rate on dividends on direct investments included Sweden (1949), Denmark (1950), Norway (1951), Finland (1953) and Belgium (1954). Subsequently, 5% became the norm for dividends on direct investments until the 2001 US–UK treaty reverted to a nil rate for holdings of 80% of the voting power. 99 Telegram from Washington to the Foreign Office, 30 November 1944: TNA:PRO IR63/167 at 534, commented upon by Sir CH Wakely, 6 December 1944 at 538. 100 It did apply to dividends from US corporations paid to UK residents; the converse case applied to dividends with a UK source paid to US residents. For both states the treaty provision interest and royalties depended on having a source in the state. 101 The equivalent definition of a US corporation used the words created or organised (see below n 233), presumably because this was their internal law expression. 102 See below n 210. 103 Art XVI (also found in US–Canada (1942). Legislative History of United States Tax Conventions, fn 12 at 2591. A UK corporation was exempt if more than 50% of the voting power was in the hands of UK residents. It was thought unlikely that US persons would give up control of a company in order to avoid the tax, particularly as the company would be liable to surtax directions which could theoretically be collected from the US persons, Legislative History of United States Tax Conventions, above n 12, at 2663. The exemption applied retrospectively to years after 1935 (Art XVII). 104 The exemption also applied retrospectively to years after 1935 (Art XVII). 97

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drafting failed to deal with dividends attributable to a permanent establishment in the United States where exemption was clearly inappropriate; this would be the subject of much litigation in its later reciprocal form adopted by the 1966 Protocol.105 For all other provisions company residence in the United Kingdom was defined in accordance with our case law: ‘A corporation is to be regarded as resident in the United Kingdom if its business is managed and controlled in the United Kingdom.’106 A US corporation was excluded from the definition of resident of the United Kingdom. The dividend article was obviously a critical provision which was made subject to the Chancellor’s approval. This is demonstrated by the unusual power to terminate the dividend article separately from the rest of the treaty by notice before 30 June in any year starting in 1946 to end on the following 1 January in the United States and 6 April in the United Kingdom, so that it had only a minimum life of two years.107 It was in fact later terminated by the United States who gave notice on 30 June 1965 when we introduced corporation tax. Interestingly, our memorandum outlining proposals to be communicated to US representatives mentioned that ‘regard is to be had, of course, to the position of the beneficial owner of the shares etc where the nominal shareholder etc is not the beneficial owner’.108 Nothing was said about beneficial ownership in this treaty but the first reference in any tax treaty to beneficial ownership of income109 would be in the 1966 Protocol to this treaty.

105 TNA: PRO IR63/167 at 500. For cases on this treaty article, see Strathalmond v IRC 48 TC 537; Avery Jones v IRC (1976) 51 TC 443; IRC v Exxon Corp [1982] STC 356; IRC v Commerzbank and IRC v Banco do Brasil [1990] STC 285. Similar provisions in other US treaties were considered in Germany in BFH, 9 October 1985, (1986) 26 European Taxation 120, and in the US in Great-West Life Assurance Co v US 49 AFTR 2d 82–1319, 82–1 USTC 9374. 106 Art II(1)(g). 107 The whole treaty could be terminated by the same notice but starting in 1947. It had been proposed in negotiations that it should have a minimum life of five years (Memorandum by the Chancellor, 1 January 1945 TNA: PRO IR63/167 at 560) and so this was effectively reduced to three years. The withholding tax article in US–Canada could be separately terminated after three years if either state imposed a higher rate. 108 TNA: PRO IR63/167 at 510. The ‘etc’ shows that the statement was intended to include interest and royalties. 109 The expression was used in relation to assets in the contemporaneous estate tax treaty: ‘Shares or stock in a corporation other than a municipal or governmental corporation (including shares or stock held by a nominee where the beneficial ownership is evidenced by scrip certificates or otherwise) shall be deemed to be situated at the place in or under the laws of which such corporation was created or organised’: Art III(2)(d). The first treaty use in relation to assets was in US–Canada (1942): see below n 177. The expression was later used in UK income tax treaties relating to shareholdings in UK–Australia (1946) (dividends paid by a 100% subsidiary), UK–Ireland (1949) (dividends paid by a 75% subsidiary); UK–Denmark (1950) (ditto for 50% subsidiary); UK–Switzerland (1954) (ditto 10% holding); UK–Japan (1962) (ditto 50% holding).

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An exclusion from the dividend article for trust income was discussed but was not included.110 It was not necessary, so far as the United Kingdom was concerned. It would become necessary after enactment of the Finance Act 1973 provisions turned distributions from discretionary trusts into a separate source of income that would otherwise fall into the ‘other income’ article, thus preventing any source taxation. An exclusion for trust income is now included in all our treaties.

IV. INTEREST

Most sources of UK income, including interest, annuities and other annual payments, were subject to deduction at source for both residents and non-residents. We therefore viewed the US withholding tax on nonresidents only as discriminatory and pressed for a nil rate of withholding tax on interest. The United States had achieved retention of the full internal law withholding tax on interest in its treaties with France (1939) and Sweden (1939), and a reduced 15 per cent with Canada (1942), and so the United Kingdom’s prospects of achieving a nil rate must have been slim. Our bargaining counter was that we were already exempting interest on government securities,111 which is how the United States presented it to the Senate Foreign Relations Committee.112 From interest other than on government securities we were deducting tax at 50 per cent on payments to non-residents, while the United States were deducting it at 30 per cent, so that elimination of our tax doubled the income paid to US persons. There is, however, nothing in the papers to show that we realised the strength of our position on this point. The Revenue’s note to the Chancellor after initial negotiations noted that the United States had reserved their position 110 TNA:PRO IR63/167 at 534. The effect of the distinction between Archer-Shee v Baker 11 TC 749 (where dividends flowing to a life tenant of an English law trust preserved their character as dividends, with the result that the remittance basis did not apply since it had been ended by FA 1914, s 5 for foreign securities, stocks, shares and rents) and Garland v Archer-Shee 15 TC 693 (that the opposite was the case under a New York law trust, with the result that the remittance basis still applied as the income was foreign trust income, not from securities, stocks, shares and rents) had been abolished for UK domiciled persons by FA 1940, s 19 which removed the remittance basis from all foreign income other than trading, pension and employment income. No special provision dealing with dividends paid from trusts was therefore necessary in the United Kingdom. 111 This exemption was initially introduced in 1915, that during the First World War and for one year after, the Treasury had the power to issue securities, free of both income and capital taxes when in the beneficial ownership of persons not ordinarily resident in the UK and not domiciled F(No 2)A 1915, s 47 (the non-domiciled condition was repealed by FA 1916, s 44); ITA 1918, s 46; ITA 1952, s 195; ICTA 1970, s 99; ICTA 1988, s 47, repealed FA 1996. By FA 1916, s 63 the relief for securities issued free of tax to non-ordinarily residents was extended to securities issued in the United States by local authorities in the United Kingdom held by non-domiciled persons or non-ordinarily resident British subjects. 112 Legislative History of United States Tax Conventions, above n 12, at 2627.

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for consideration by their Government.113 Lord Keynes, who then had an honorary position at the Treasury, thought that the Revenue’s position was ‘very dangerous indeed’, arguing that it would lead to tax evasion by individuals, leading to very high amounts of dollar debt, and thin capitalisation by companies.114 In the United States, Professor Adams had for the same reason argued in the League of Nations committees against foreign government bonds issued free of withholding tax.115 At the time our holdings of US government securities were small and obtaining such relief was not so important.116 In this respect, our persistence paid off and we achieved our 1928 position of a nil rate of withholding tax on all interest117 that was subject to tax in the residence state. This also eliminated the problem where the United States did not give credit for the UK tax at source because the tax had not been paid by the recipient; under the UK system the tax was deducted and retained by the payer.118 Because the treaty had retrospective effect and the US tax had previously been deducted, a Budget Resolution was required to bring the tax deducted into charge.119 An exception was made for interest paid by a US subsidiary to its UK parent (holding more than 50 per cent of the voting power) and vice versa so that the full rate of withholding tax applied in such a case. The logic from the UK point of view seems to have been that a subsidiary was more like a branch than an investment,120 and, from the US point of view, that it was necessary to prevent thin capitalisation.121 A nil rate of withholding tax on interest became the norm in our early treaties.122

113

Note of 19 May 1944 TNA:PRO IR63/167 at 489. Note of 28 August 1944 TNA:PRO IR63/167 at 521. 115 Graetz and O’Hear, above n 16, at fn.307. 116 In 1943 fiduciary (presumably meaning interest) income paid from the United States to the United Kingdom was $4 million, which excludes interest paid to the UK Government (Data from the International Economists and Statistical Unit of the Department of Commerce presented to the Senate Foreign Relations Committee in connection with this treaty: see below text at n 249). 117 This was subject to the recipient not being not engaged in trade or business in the other state, which is a US internal law expression, but which was defined in the treaty to mean not having a permanent establishment there (Art II(2)). 118 Since companies paid income tax this rule then applied equally to companies. 119 TNA:PRO IR63/168 at 26. 120 TNA:PRO IR63/167 at 486. The same thinking would later be seen in the original disallowance for corporation tax of such interest as a deduction (FA 1965, sch 11 para 1(1)(d)(iv), later TA 1970, s 233(2)(d)(iv); ICTA 1988, s 209(2)(e)(iv), repealed by FA 1995, s 87(2)). 121 Legislative History of United States Tax Conventions, above n 12, at 2659. We included a similar provision in early treaties with Denmark (1950) and Finland (1953). 122 South Africa (1947), Sweden (1949), Denmark (1950), Netherlands (1950), France (1951), Norway (1951), Finland (1953), Greece (1954), Belgium (1954), Switzerland (1955) and Germany (1955). Colonial treaties did not have an interest article (apart from a false start with Southern Rhodesia (1946) which lasted only until 1956). 114

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The result of a 15 per cent withholding tax on dividends and a nil rate on interest seems a strange combination since the source state collects company tax in addition on dividends and no such tax on interest as it is deductible. This treaty may have influenced the OECD Model’s equally illogical 15 per cent on dividends, 10 per cent on interest and nil rate on royalties, deriving originally from the OEEC Fourth Report (1961).

V. ROYALTIES

Exactly the same treatment as applied to interest was achieved for royalties, so that they were exempt from withholding tax as long as they were subject to tax in the residence state and the resident did not carry on trade or business in the source state through a permanent establishment.123 This must have been less of a problem for us to achieve as the United States had agreed the same in their treaties with France (1939) and Sweden (1939), though not with Canada, perhaps because Canada, as an importer of technology from the United States, wanted to retain a 15 per cent rate. Again the nil rate avoided the credit problem in the United States on patent and copyright royalties paid under deduction of UK tax.124 A nil rate of withholding tax on royalties was the norm in all our early treaties. Film royalties were the biggest issue for us. We had the worst of all possible worlds: we did not levy any withholding tax under internal law on film royalties paid to the United States, but they imposed 30 per cent for which we gave only a deduction. This treaty is the first treaty to include film rentals within the definition of royalties, thus exempting them from withholding tax. Mining royalties together with rent from real property were dealt with in another article.125 This reduced the tax rate from the US internal law 30 per cent rate to 15 per cent but with an option to be taxed as if carrying on trade through a permanent establishment on a net basis, and merely exempting them from surtax in the United Kingdom. This option permitted 123 This had a ‘force of attraction’ effect, then existing in US law, so that the exemption was lost even though the royalties were not connected with the permanent establishment: ‘If it is so engaged [in trade or business in the United States through a permanent establishment situated therein], United States tax may be imposed upon the entire income of such enterprise from sources within the United States to permanent establishment profits’ (and vice versa). This rule was changed for royalties by a 1958 Protocol so that the withholding tax exemption applied so long as the royalties were not ‘directly associated with the business carried on through that permanent establishment’. The United States abolished the ‘force of attraction’ principle in 1966. 124 Legislative History of United States Tax Conventions, above n 12, at 2659. 125 Art IX. The provision became reciprocal by the 1966 Protocol. We also agreed a 15% rate with Canada (1946) but limiting source tax on real property income was an unusual treaty provision. Contrast the estate duty treaty referring to immovable, rather than real, property: see below n 271.

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continued deduction of income tax at the standard rate,126 which seems to have been a favourable bargain made by the United Kingdom: in the previous US treaties, full source tax had been payable on these. The US tax of 15 per cent on the gross rent was intended by the United States to equate to the UK 50 per cent tax on the net rent.127

VI. DOUBLE TAXATION RELIEF

Both the United States and the United Kingdom started relieving double taxation by deducting the foreign tax.128 The United States, at the instigation of Professor Adams, adopted the foreign tax credit in 1919129 and the United Kingdom did so in 1916 on a limited and temporary basis: this became permanent in 1920. The United States credit applied to countries worldwide and was originally a full credit130 not limited to the US tax on the same profit at a time when foreign taxes were generally higher131; the change to an ordinary credit was made in the US Revenue Act of 1921. The United Kingdom ordinary credit applied only to income tax and excess profits tax in the Dominions and then only up to half the UK tax rate132; it was hoped that the Dominions would relieve any excess,133 but only India and (in part) Australia did so.134 Dominion Income Tax relief was also odd as it required the source state to provide 126 See FA 1934, s 21 for the deduction of tax on mining royalties. The surtax exemption applied to a US resident who was subject to tax there and not carrying on trade or business in the United Kingdom through a permanent establishment. 127 Although the UK tax charge on rent under sch A was traditionally based on the annual value rather than the actual rent, a charge was introduced in FA 1940, ss 13–18 on ‘excess rents’ (including mineral royalties) above the annual value, so that effectively the actual rent was taxed by the time of the treaty. 128 United States: Graetz and O’Hear, fn 16 at 1041, text at fn 83; United Kingdom: FA 1920, s 27. The United States gave a deduction for UK taxes paid on US income of a UK company: Welch v St Helens Petroleum Co 18 Fed (2d) 631, in Legislative History of United States Tax Conventions, above n 12, at 2643, expressing concern that the company was entitled to a deduction and the shareholder was entitled to a credit for the same tax. 129 By the misleadingly named Revenue Act 1918, which was in fact enacted in 1919 after the War: see Graetz and O’Hear, above n 16, at fn 105. 130 See the OECD Model, Art 23 Comm para 15 for the difference between full and ordinary credit. 131 Graetz and O’Hear, above n 16, at 1055 who record that in 1921 the lowest US rate was 10% and the standard UK rate was 30%. 132 Started as Colonial Income Tax Relief by FA 1916, s 43; extended to Colonial excess profits duty by FA 1917, s 23; consolidated as ITA 1918, s 55; extended to Protectorates by FA 1919, s 20; made permanent as Dominion Income Tax Relief by FA 1920, s 27. See R Willis, ‘Great Britain’s Part in the Development of Double Taxation Relief’ [1965] BTR 270. 133 For example, if the UK rate was 25% and the Dominion rate 15%, we gave relief for 12.5%, and we hoped that the Dominion would give relief for the other 2.5%. 134 See Willis, above n 132, at 274. Australia had an exemption system and originally saw no need to give further relief. Ireland, to which the same relief applied between 1923 and 1926 (see above n .45) also gave relief.

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relief for the residence state tax as well as the other way round.135 Outside the Dominions, and therefore the rule that applied to the United States, the 1920 Royal Commission saw no reason for giving any relief: giving up UK tax for the good of the Empire was one thing, but the logic did not apply elsewhere.136 Therefore at the time of the negotiations only a deduction137 was given for US tax, while the United States had been giving credit for foreign tax for 25 years. The United States naturally wanted us to adopt a similar tax credit to theirs, in the same way as they had persuaded Canada to do so in their treaty; this must have been easier as Canada had given credit on a reciprocal basis from 1919. We thought that US credit relief as amended by the treaty to make it applicable to the United Kingdom deduct and retain system might be good for exports to the United States. We did not want to encourage too much investment from the United States into the United Kingdom, a concern to us between the Wars, but we realised that what relief the United States gave was outside our control.138 The type of relief to which we were prepared to agree in the treaty was considered by the Revenue from first principles before negotiations began.139 Interestingly, the Revenue’s note recognised that credit relief on the lines established by the United States was the only way of coming to an agreement with the United States. Their first note to the Chancellor said it was the only practical solution because all foreign countries were ‘origin’ in US taxation philosophy.140 This did not stop us from arguing vigorously against tax at source during negotiations but it shows that the Revenue had already

135 In addition to relief given to residents on income taxed in the source state, relief was also given by the United Kingdom on UK source income that was taxed in the hands of a Dominion resident. Tax at the reduced UK rate was deducted from dividends which meant that for surtax they were grossed up to a smaller figure than domestic income. Relief was also given on preference dividends although the tax was borne by the ordinary shareholders. Both of these aspects were changed in F(N. 2)A 1945. 136 Cmd 615, para 83. Relief on the same lines as in the United States had been urged on the Commission in evidence by members of the Singer family resident in the United Kingdom whose father was the inventor of the Singer sewing machine, and their counsel, George Edwardes Jones, whose evidence gives a detailed account of US tax at the time: see Minutes of Evidence, 2 July 1919 at 255 onwards. 137 So far as trading profits were concerned, much later (in 1952), the House of Lords held in IRC v Dowdall O’Mahoney & Co Ltd 33 TC 259 that in computing excess profits tax on the profits of a UK branch of an Irish company Irish taxes on the branch profits were not deductible. Deduction for non-creditable foreign taxes was restored as a pre-consolidation (TA 1970) amendment by FA 1969, sch 20, para 7 (now ICTA 1988, s 811), but deduction by concession had applied in the meantime. 138 Memorandum of 22 May 1944: TNA:PRO IR63/167 at 503. 139 Inland Revenue memorandum, 4 April 1944: TNA:PRO IR63/167 at 482. 140 Note on double taxation re pending discussion with US, 4 April 1944: TNA:PRO IR63/167 at 486; Note to the Chancellor, 19 May 1944 (at 489). The exemption or credit provisions in the League of Nations Mexico 1943 draft convention were referred to (at 485). Exemption had been recommended to the Revenue by Unilever but ‘the discrimination in favour of the trader who operates abroad as compared with the trader who operates at home

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decided to compromise Sir Percy Thompson’s strict approach of no source tax.141 The United States were therefore able to present the treaty to the Senate Foreign Relations Committee as achieving a major change: the United Kingdom accepting the foreign tax credit.142 One matter was made clear by the Chancellor: there could be no question of discretionary relief.143 The US relief was given by reference to a statutory provision, and our credit had to be by reference to provisions to be enacted in the future, in fact in the Finance (No 2) Act 1945. That act also contained the enabling power to give effect to treaties which is now contained in s 788 of the ICTA 1988. The new relief code applied to income tax and excess profits tax (including National Defence Contribution, which was renamed profits tax)144 when a treaty so provided145 on the more normal basis of the residence state giving relief for source state taxes.146 The treaty provided: (1) Subject to Section 131 of the United States Internal Revenue Code as in effect on the first day of January, 1945, United Kingdom tax shall be allowed as a credit against United States tax. (2) Subject to such provisions (which shall not affect the general principle hereof) as may be enacted in the United Kingdom, United States tax147 payable148 in

seems conclusive against its adoption’ (at 485). The Revenue’s internal committee had come to the same conclusion in 1930 (TNA: PRO IR40/4680). 141 See the quotation at fn 2. 142 Legislative History of United States Tax Conventions, above n 12, at 2625. 143 Note of meeting on 1 June 1945 with the Chancellor TNA:PRO IR63/167 at 506. This was a live issue since the League of Nations 1943 Mexico draft convention provided (and the London draft would subsequently provide) for consultations between the competent authorities ‘with a view to reaching an agreement for an equitable avoidance of double taxation’. The 2001 US–UK treaty would be the first (apart from one treaty where it was obviously included by mistake) UK treaty enabling the Revenue to consult with the other competent authority for the elimination of double taxation in cases not covered by the treaty (Art 25(3) second sentence of the OECD Model), which had previously been thought to be something to which Parliament would not agree. 144 Hence the words still found in s 793(1)— ‘credit is to be allowed against any of the UK taxes.’—which puzzled the Special Commissioner in George Wimpey v Rolfe (1987) 62 TC 597. See the explanation suggested by Malcolm Gammie QC, counsel for the taxpayer, in Legal and General Assurance Society Ltd v Thomas [2005] STC (SCD) 350 at [17]. 145 Unilateral relief was not introduced until 1950 when we found that treaty negotiation was slower than anticipated. Dominion Income Tax Relief was abolished at the same time. Unilateral relief was originally limited to half the UK rate, or three-quarters when the tax was paid in a Commonwealth country. These limitations were removed in 1953. 146 Unlike Dominion Income Tax Relief: see above n 135. Unilateral relief initially differentiated between Commonwealth taxes, where the maximum credit was three-quarters of the UK tax (income tax and profits tax), and non-Commonwealth taxes, where the limit was half: FA 1950, s 36(2). This difference was introduced to give an incentive for treaty negotiations but was found not to be necessary and was repealed by FA 1953, s 26. See Double Taxation Relief for Companies, a discussion paper, Inland Revenue, March 1999, Annex 5, para.6. 147 US tax was defined in the treaty to mean federal tax; unilateral relief for state taxes was not given until 1961.

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respect of income from sources within the United States shall be allowed as a credit against any United Kingdom tax payable in respect of that income.149

The United States regarded their relief as establishing a ‘general principle’.150 This is presumably the origin of the expression ‘’which shall not affect the general principle hereof’: an expression first used in this treaty which was presumably intended to be a safeguard against our enacting a more limited relief.151 We continued to use these words in future treaties, and the United States later adopted them in their treaties, although with a slightly different sense.152 The treaty wording quoted above required the income to have a source within the United States to be eligible for credit. The treaty contained two source rules dealing with internal law problems about source. The first was that, if one gave ‘source’ its internal law meaning,153 profits attributed to a US permanent establishment are part of the UK resident’s sch D case I profits and not foreign source profits, with the result that there would be no credit relief for the US tax on the permanent establishment’s profits.154 The treaty corrects this by providing that: the profits so attributed [to the permanent establishment on an arm’s length basis] shall, subject to the law of such other Contracting Party, be deemed to be income from sources within the territory of such other Contracting Party.155

This was to become a deemed source rule applying to all types of income adopted in all our treaties from about 1967:

148 Greig v Ashton (1956) 36 TC 581 was decided on this provision and deals with the amount of credit where a refund of part of the US tax was made after devaluation of sterling. 149 Art XIII. 150 Note to the Chancellor, 19 May 1944: TNA:PRO IR63/167 at 489. 151 It seems, however, that in the United Kingdom the reference to the general principle has no effect in domestic law, as opposed to international law, since the treaty has effect by s 788(3), ‘subject to the provisions of this Part [of ICTA 1988]’, which contains the credit provisions, with the result that domestic law credit provisions have effect whether or not they affect the general principle of treaty relief. This is the same point as concerned the foreign tax credit for permanent establishments in Sun Life Assurance of Canada v Pearson [1984] STC 461, 516b Ch D (this point was not dealt with in the Court of Appeal). The position was the same when first enacted in F(No 2)A 1945. 152 In UK treaties the treaty relief is given ‘subject to the provisions of the law of the UK regarding the allowance as a credit against UK tax of tax payable in a territory outside the UK which shall not affect the general principle hereof’; US treaties provide for relief ‘in accordance with the provisions and subject to the limitations of the law of the US (as it may be amended from time to time without changing the general principle hereof)’. In the United Kingdom there is a general principle of treaty relief, while in United States the general principle only governs amendments to the law. 153 As required by Art II(3), subject to the context not otherwise requiring: see above n 76. 154 See JF Avery Jones, ‘Does the UK Give Credit for Tax on a Permanent Establishment Abroad?’ in H Alpert and K van Raad (eds), Essays on International Taxation in Honor of Sidney I Roberts (Deventer, 1993); and also in [1994] BTR 191. 155 Art III(3).

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For the purposes of the preceding paragraphs of this article [the double taxation relief article], profits, income and capital gains owned by a resident of a Contracting State which may be taxed in the other Contracting State in accordance with this Convention shall be deemed to arise from sources in that other Contracting State.156

It was first used by the United States in our next treaty with them (1975), by which time US treaties tended to define the source of about eight types of income. The United States moved away from including a general deemed source rule in the late 1980s. Inclusion of such a provision put an end to the proliferation of source rules in treaties.157 The second source rule in the treaty concerned personal (including professional) services and deemed the source to be where the services were performed, which was the US rule.158 In the United Kingdom this was the subject of considerable uncertainty because foreign employment income was then taxable under case V of sch D as a foreign possession without any statutory guidance about what made an employment foreign, although the treaty source rule applied only for credit purposes.159 This source rule was ahead of its time for the United Kingdom and would later be adopted as the charging rule in internal law in 1956 following a recommendation of the 1955 Royal Commission.160 As mentioned, relief for tax paid on UK dividends was an issue in the United States as the tax was not paid by the shareholder, as the US court had decided in Biddle.161 We managed to negotiate this reversal of this case:162

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UK–Luxembourg (1967), UK–Netherlands (1967). See JF Avery Jones, ‘Tax Treaty Problems Relating to Source’ (1998) 38 European Taxation 78; and also in [1998] BTR 222. 158 Art XIII(3). National Foreign Trade Council Memorandum: Legislative History of United States Tax Conventions, fn 12 at 2616. It does not deal with services performed on ships or aircraft, now dealt with by Art 15(3) of the OECD model. We included this for the first time in our treaty with Canada (1946). 159 The Royal Commission had described the current state of affairs as: ‘the Courts have had to treat each question as one of fact and to decide it according to the balance of what seem to be the relevant considerations. There is the nationality, domicile or residence of the employer. As the employer is normally a corporation, that test is likely to be somewhat artificial anyway. Then there is the country in which the contract of employment is made, which may or may not correspond with the national system of law by which it is to be governed. Thirdly, there is the country in which the moneys earned by the employment are paid, though it by no means follows that the whole salary will be paid in any one country. Lastly, there is the country in which the work is to be done: again two or more countries may be involved’: Cmd 9474 para 298. 160 They recommended that a place of performance rule be adopted, which it was by FA 1956, s 10. 161 See .above n 68. 162 Telegram from Washington to the Foreign Office, 30 November 1944: TNA: PRO IR63/167 at 535. 157

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For this purpose, the recipient of a dividend paid by a corporation which is a resident of the United Kingdom shall be deemed to have paid the United Kingdom income tax appropriate to such dividend if such recipient elects to include in his gross income for the purposes of United States tax the amount of such United Kingdom income tax.163

UK resident shareholders, even individuals, whatever the percentage holding, were equally entitled to credit for underlying tax on US dividends other than preference dividends. Since the only UK tax was both underlying tax and effectively withholding tax on the dividend this gave the same treatment as the US person enjoyed: Where such income is an ordinary dividend paid by a United States corporation, such credit shall take into account (in addition to any United States income tax deducted from or imposed on such dividend) the United States income tax imposed on such corporation in respect of its profits, and where it is a dividend paid on participating preference shares and representing both a dividend at the fixed rate to which the shares are entitled and an additional participation in profits, such tax on profits shall likewise be taken into account in so far as the dividend exceeds such fixed rate.164

Giving the United States a more favourable credit than Dominion Income Tax Relief meant that we had to offer the same for Dominion countries, as had been recognised by the Revenue before negotiations even started.165 Provision was made generally for treaties containing a general credit relief that initially ran alongside Dominion Relief.166 We were prepared to give personal allowances on a reciprocal basis. We had already agreed this with France in a treaty that had only been initialled before the War and was eventually contained in the 1947 UK–France treaty,167 but this was not included in the US treaty.

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Art XIII(1). Art XIII(2). The US rule required 50%: Legislative History of United States Tax Conventions, above n 12, at 2636. This was a feature of the credit relief regime enacted by F(No 2)A 1945 applying where a treaty so provided, which was appropriate to the then full imputation system for income tax, but which became inappropriate on the introduction of corporation tax in 1965 necessitating renegotiation of treaties and its removal from unilateral relief in 1966. UK–Myanmar (formerly Burma, 1950) is a surviving example of a treaty providing this. Underlying tax relief was given unilaterally for companies holding 50% in 1950, reduced to 25% for non-Commonwealth companies (with a relief applying from 1962 for holdings between 25 and 50% caused by local law restrictions), which can still be found in some treaties, eg UK–Germany (1964) although the more beneficial 10% that was introduced in internal law for all cases in 1971 applies. 165 Note of 4 April 1944: TNA:PRO IR63/167 at 486. 166 A hybrid solution is found in UK–South Africa (1947) where credit applies to a few items of income, such as business profits, but otherwise the law (Dominion Income Tax Relief) continued to apply, suggesting a failure to agree. 167 Note of 19 May 1944: TNA:PRO IR63/167 at 500, and see at 584 for the policy on this. 164

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John F Avery Jones VII. EXCHANGE OF INFORMATION

Exchange of information may seem a surprising item to be in the forefront of negotiations but the Revenue’s first note to the Chancellor of 19 May 1944 said that it was an issue to which the US representatives attached the greatest importance,168 for which the US initial draft had a very wide provision.169 A memorandum about exchange of information by the International Chamber of Commerce was referred to in the first note to the Chancellor. The Revenue’s first note to the Treasury of 22 May 1944 referred to the topic as ‘one which the Bank [of England] and the City have shown much anxiety [about] in the past’.170 Even exchange of information to establish arm’s-length pricing was then regarded as sensitive.171 One of the earliest notes says that the Revenue attributed the comparative smoothness of tax administration to the certainty of secrecy.172 It is certainly the topic on which there are the most memoranda to the Chancellor, who initially asked the Revenue to ‘proceed cautiously’.173 Everything else in the treaty seems to have been agreed by the end of 1944 but there are memoranda about exchange of information up to the last minute, ie 21 March 1945.174 The United States had details of all payments to people with UK addresses through their withholding tax mechanism, which applied only to payments to non-residents. They wanted the same in return, as in the US-Canada treaty by which each state provided the other with: The names and addresses of all persons whose addresses are within the [other state] and who derive from sources within the [reporting state] dividends, interest, rents, royalties, salaries, wages, pensions, annuities, or other fixed or

168 It was the topic dealt with first by Eldon P King, Deputy Special Commissioner of Internal Revenue to the Senate Foreign Relations Committee: Legislative History of United States Tax Conventions, above n 12, at 2622. 169 TNA: PRO IR63/167 at 491 and 498. The memorandum by the Chancellor of 1 January 1945 also stated that exchange of information ‘has always ranked as one of the most important elements in any Double Taxation Treaty entered into by the US’. We made it clear that we were not prepared to agree to an exchange of information treaty on its own: at 533 (we said the same to France: at 580). 170 Note to the Treasury, 22 May 1944: TNA:PRO IR63/167 at 504. 171 ‘The attitude of big business generally to the disclosure in relation to the assessment of branches or subsidiaries abroad of information relating to the profits etc of all the activities of the business.’: TNA:PRO IR63/167 at 491. 172 TNA:PRO IR63/167 at 498. 173 Note of meeting with the Chancellor, 25 July 1944: TNA:PRO IR63/167 at 515. The topic is referred to in notes at 491, 498, 503, 506, 512, 515, 519, 552, 560, 561–2,* 563, 564–6,* 569–70, 572–4 (meeting with representatives of the banks) and 575. (* indicates that this was the sole topic of the note.) 174 Letter to the Chancellor’s private secretary, 21 March 1945, enclosing an aide memoire on exchange of information: TNA: PRO IR63/167 at 563.

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determinable annual or periodical profits and income, showing the amount of such profits and income in the case of each addressee.175

In addition Canada provided information about176: (a) those with addresses outside Canada claiming through nominees, agents or custodians the reduced rate of tax that applied to all US income other than from trade or business; (b) those with addresses outside Canada deriving dividends from a Canadian corporation which derives more than 50 per cent of its income from the United States; and (c) those with addresses in the United States deriving income from non-resident owned Canadian investment corporations.177 The US treaties with France and Sweden were similar in effect. The problem for the United Kingdom was that deduction at source applied equally to residents and non-residents and so the Revenue did not have any information to exchange unless the treaty gave a reduction.178 Our position was that we would only give information necessary179 to the working of the treaty, to prevent fraud or avoidance, and facilities for obtaining information from public company share registers, which are open to the public.180 We were not prepared to obtain information that we did not require for our own tax purposes, a point that recurred much later over foreign sales corporations and which was resolved only in 2000 after the OECD pointed out that the only states requiring a domestic tax interest in order to obtain information from banks were Greece, Japan and the United Kingdom.181

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US–Canada (1942), Art XX(1), (2)(a). US–Canada (1942,) Art XX(2)(b), (c), (d). 177 Canadian corporations whose income was restricted to investment income which were owned by non-residents which were effectively taxed as non-resident corporations. This was the context of one of the references to beneficial ownership (of assets) in the treaty, which was the first treaty to use that expression, the other being the definition of subsidiary corporation. 178 It is interesting to note that the US originally applied deduction at source in the Civil War income tax and between 1913 and 1916 and gave it up in favour of information at the source as a result of pressure from corporations who were not paid for such work: see Brownlee, Federal Taxation in America (2nd edn, Cambridge and Washington DC, 2004) at 35, 112–13. 179 We changed the draft from ‘as will assist in’ to ‘necessary to’ preventing fraud and avoidance so as to limit the extent to which the US could ask for information: TNA: PRO IR63/167 at 562. The OECD Model Tax Convention changed ‘necessary’ to ‘foreseeably relevant’ [for carrying out the provisions of this Convention] in Art 26 in 2005. 180 TNA:PRO IR63/167 at 503. 181 Improving Access to Bank Information for Tax Purposes, (Paris, 2000) at para 86. FA 2000, s 146(3) permits the obtaining of information required by the treaty partner where the treaty contains a provision about the obtaining of information as in US–UK (2001), Art 27(2); UK–Canada (1978, 2003 Protocol), Art 24(3); UK–Australia (2003), Art 27(2); UK–New Zealand (1983, 2003 Protocol), Art.25(2). 176

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The article that was finally agreed was based on our draft of a very much simplified provision182 compared with that agreed by the United States with France, Canada and Sweden: (1) The taxation authorities of the Contracting Parties shall exchange such information (being information available under the respective taxation laws of the Contracting Parties) as is necessary for carrying out the provisions of the present Convention or for the prevention of fraud or the administration of statutory provisions against legal avoidance in relation to the taxes which are the subject of the present Convention. Any information so exchanged shall be treated as secret and shall not be disclosed to any person other than those concerned with the assessment and collection of the taxes which are the subject of the present Convention. No information shall be exchanged which would disclose any trade secret or trade process.183

This provision was limited to information necessary to carry out the treaty, that is information about reduced withholding taxes, which was information that we did have. The extension of information to combat fraud and avoidance was wanted by the United States and readily agreed to by us as we had also come up against difficulties with avoidance through the formation of foreign companies.184 In consequence the enabling legislation had to amend a provision that prevented the Revenue obtaining information from nominees about securities in the beneficial ownership of nonresidents; they would be entitled to obtain the information in relation to treaty-partner residents.185 The United States strongly pressed the question of mutual enforcement, to which they had agreed in their treaties with France (1939) and Sweden (1939), but that was a bridge too far for us, as it had been for Canada in its treaty with the United States (1942). The sensitivity of this issue had already been tested in Parliament which had refused to approve a proposal to enforce Dominion taxes in the Administration of Justice Bill 1926.186

182 Memorandum to the Chancellor, 10 March 1945: TNA:PRO IR63/167 at 562; aide memoire to the Chancellor, 21 March 1945, at 564. 183 Art XX. 184 TNA:PRO IR63/167 at 512, 519. The difficulty was in the operation of what is now Income Tax Act 2007 s 720 (at 565), originally enacted in 1936. There is no specific reference to avoidance in the equivalent provision in US–Canada (1942), US–Sweden (1939) or US–France (1939) treaties, although the information to be provided by Canada was in part presumably aimed at preventing avoidance. 185 FA 1939, s 18(5), amended by F(No 2)A 1945, s 55(2). Note to the Chancellor on the memorandum by the Minister of Information TNA:PRO IR63/167 at 569. A later concern that does not seem to have arisen at the time is whether the Revenue can obtain information that it does not need for its own purposes but the treaty partner wants. Later, the US would in relation to foreign sales corporations object to our not being able to do this. FA 2000 enabled us to obtain information for the benefit of treaty partners so long as the treaty provided for obtaining the information. 186 Note of 19 May 1944: TNA:PRO IR63/167 at 499; letter to the Chancellor’s private secretary, 31 August 1944 at 519. This proposal was put forward in connection with a

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We have still not agreed to mutual enforcement outside the EU but power to do so is included for the first time in the current Finance Bill.

VIII. OTHER ARTICLES

The other articles were less controversial. The following list shows how negotiations proceeded.

A. Permanent Establishment One might have expected more discussion of the principle of adopting the permanent establishment threshold for the first time but there is nothing in the UK papers about the definition187: one aspect of it was, however, considered by the Senate Foreign Relation Committee.188 It was certainly not regarded by us as an important topic. The only topics identified from the initial discussions were double taxation relief, shipping profits, interest on government loans and exchange of information.189 The memorandum of 20 July 1944 outlining matters to be communicated to US representatives mentions agencies.190 It accepts that we would have to give relief for tax on branch profits computed on arm’s-length principles, but makes no mention of the permanent establishment concept.191 Perhaps both sides recognised that this was already the international norm through the work proposed Finance Bill change that was not mentioned in Parliament in connection with this Bill and so far as the author knew was never introduced into a Finance Bill, to prevent avoidance of tax by becoming non-resident or non-domiciled: TNA: PRO IR40/7463. 187 See Willis, above n 132, at 278: ‘In the UK we perhaps looked rather sceptically at such a novel phrase as “permanent establishment,” and I think that our predecessors might be surprised to see the highly sophisticated definition which now appears in the model convention of the OECD’. 188 The Committee pointed out that a British resident dealing on US securities and commodities exchanges through a UK broker might be carrying on trade or business in the United States and be taxable but would not have a permanent establishment and so would not be taxable under the treaty. It was accepted that this was a theoretical problem because of the lack of information on such taxpayers in the absence of a treaty: ‘Thus there has been substituted for a theoretical and ineffective basis of taxation a more realistic and effective one.’ Legislative History of United States Tax Conventions, above n 12, at 2730. The absence of any UK tax for which they had to give credit in the reverse circumstances also benefited the United States. 189 Note on matters raised in the discussions, 19 May 1944: TNA:PRO IR63/167 at 493. 190 The United States agreed to our usual exemption for brokers and commission agents: draft report to the Chancellor, 22 December 1944: TNA: PRO IR63/167 at 547 (US law contained a similar exemption: Legislative History of United States Tax Conventions, fn 12 at 2611). US–France and US–Canada exclude both brokers and commission agents; US–Sweden excludes commission agents but not brokers. We made a number of earlier treaties made pursuant to FA 1930, s 17 limited to agency profits but not with the United States. 191 TNA:PRO IR63/167 at 509.

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of the League of Nations’ committees. The definition,192 which is substantially the same as the United States, Canadian and Swedish treaties, was rudimentary by today’s standards but all of its features are still found in the OECD Model: The term ‘permanent establishment’ when used with respect to an enterprise of one of the Contracting Parties means a branch, management, factory or other fixed place of business, but does not include an agency unless the agent has, and habitually exercises, a general authority to negotiate and conclude contracts on behalf of such enterprise or has a stock of merchandise from which he regularly fills orders on its behalf.193 An enterprise of one of the Contracting Parties shall not be deemed to have a permanent establishment in the territory of the other Contracting Party merely because it carries on business dealings in the territory of such other Contracting Party through a bona fide commission agent, broker or custodian acting in the ordinary course of his business as such. The fact that an enterprise of one of the Contracting Parties maintains in the territory of the other Contracting Party a fixed place of business exclusively for the purchase of goods or merchandise shall not of itself constitute such fixed place of business a permanent establishment of such enterprise.194 The fact that a corporation of one Contracting Party has a subsidiary corporation which is a corporation of the other Contracting Party or which is engaged in trade or business in the territory of such other Contracting Party (whether through a permanent establishment or otherwise) shall not of itself constitute that subsidiary corporation a permanent establishment of its parent corporation.195

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Art II(1)(l). This follows the wording of the treaty enabling legislation in FA 1930, s 17 providing for the exemption of agency profits except where the profits arise directly or indirectly through any branch or management in the United Kingdom, where the agent has and habitually exercises a general authority to negotiate and conclude contracts, or where the profits arise from the sale of goods from a stock in the United Kingdom. US–France (1939) and US–Canada (1942) also treated the existence of a stock of merchandise as a permanent establishment, as did the League of Nations Mexico and London drafts. On the other hand Belgium–Germany (1938), Hungary–Netherlands (1938) and Hungary–Switzerland (1942) excluded a stock of goods from constituting a PE, as would the OEEC First Report (1958). 194 Thus following our internal law: see above n 193. The Commentary to the 1927 League of Nations draft stated that ‘the Committee has not expressed an opinion on the point whether purchasing offices or sales offices are to be considered as places of business, this being a question of fact’. 195 This was, depending on how one understands the facts, the situation in Firestone Tyre & Rubber Co Ltd v Llewellin (1957) 37 TC 111, the assessments in which, as pointed out by R Vann, ‘Tax Treaties: the Secret Agent’s Secrets’ [2006] BTR 345 at 352, stopped on the entry into force of this treaty. Historically there were cases that were based on the subsidiary automatically being an agent of the parent: see Apthorpe v Peter Schoenhofen Brewing Co Ltd (1899) 4 TC 41 where a US subsidiary which had formerly carried on the trade continued merely to hold real property as required by local law: St Louis Breweries v Apthorpe (1898) 4 TC 111 where the UK company controlled the foreign subsidiary’s trade. The difference between shareholder control and control of the subsidiary’s trade does not seem to have been clearly understood by the UK parent company; the articles included power ‘’to manage the affairs or take over and carry on the business of any such American Company’. The US subsidiary in Bradbury v English Sewing Cotton Co Ltd (1923) 8 TC 481 had formerly been controlled in the United Kingdom (and had been found to be resident in American Thread Co 193

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There was case law in both countries excluding from tax profits from purchasing and so it is not surprising to find this in the treaty.196 The business profits article provided that if there was a permanent establishment in a state the entire profits from sources in the state could be taxed, thus accepting the US force of attraction principle.197 The industrial or commercial profits198 to be attributed to a permanent establishment were the profits which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm’s length with the enterprise of which it is a permanent establishment, the formula now in Art 7(2) of the OECD Model.199 This was only the second treaty to contain the formula, the first being the US–Canada treaty (1942). Profits tax could be assessed on the parent company on the profits of the group of companies (including non-resident subsidiaries),200 which, apart from providing for relief for losses, had particular benefits when there was a differential rate of profits tax between distributed and undistributed profits until 1958. The treaty provided that this rule was not affected by the treaty.201

B. Arm’s Length The United States had had an ‘arm’s length’ rule applying to associated companies in its internal law since 1924. The UK rule, dating from 1915, v Joyce (1913) 6 TC 1 and 163); it changed its residence in 1917. The separate trade of the foreign subsidiary was recognised in Bartholomay Brewing Co v Wyatt (1893) 3 TC 213 and Nobel Dynamite Trust Co v Wyatt (1893) 3 TC 224. The distinction between shareholder control and control of the trade is clearly made in Kodak Ltd v Clark (1903) 4 TC 549 concerning a UK company which owned 98% of the shares in the American Kodak Company; it was subsequently accepted where the foreign company (Deutsche Grammophon AG) was a 100% subsidiary of the UK company in Stanley v The Gramophone and Typewriter Co (1908) 5 TC 358. 196 ‘It would be most impolitic thus to tax those who come here as customers.’ Sulley v Att-Gen (1860) abstract in 2 TC 149 (misleadingly not in the index to that vol) per Cockburn CJ. The same provision is found in US–Canada (1942), US–France (1939) and US–Sweden (1939). The first use was in France–Belgium (1931). 197 Art III(1) and (2). The US abolished this principle in 1966 and a 1966 Protocol limited the charge to the profits directly or indirectly attributable to the permanent establishment. 198 Originally these were not defined but a definition was added in the 1966 Protocol. 199 We must have missed the point, subsequently covered by Art 7(3) of the OECD Model, that expenses incurred partly for the purpose of the head office and partly for the permanent establishment failed the ‘wholly and exclusively’ rule. This provision was added by the 1966 Protocol. 200 FA 1937, s 22; FA 1947, s 38. 201 Art III(2), last sentence. F(No 2)A 1945, sch 7, para 3 deemed all the profits to have been earned by the (UK resident) parent and therefore permits relief for foreign tax charged in the foreign subsidiaries, as an exception to the rule requiring UK residence for credit to be granted.

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applied only where there was foreign control otherwise than by a British subject (or British, Indian, Dominion or colonial firm or company)202 and operated by taxing the non-resident in the name of the resident; otherwise we relied on agency. The United States had used a provision on the following lines in its treaties with Canada (1942), France (1939) and Sweden (1939): Where an enterprise of one of the Contracting Parties, by reason of its participation in the management, control or capital of an enterprise of the other Contracting Party, makes with or imposes on the latter, in their commercial or financial relations, conditions different from those which would be made with an independent enterprise, any profits which would but for those conditions have accrued to one of the enterprises but by reason of those conditions have not so accrued, may be included in the profits of that enterprise and taxed accordingly.203

We thought that we had sufficiently provided for increasing the profits assessed to the arm’s length profits in internal law by the reference in, what is now, s 788(3)(c) of ICTA 1988204 and Art III(1) and (2). The US abolished this principle in 1966 and a 1966 Protocol limited the charge to the profits directly or indirectly attributable to the permanent establishment.

202

F(No 2)A 1915, s 31(3); ITA 1918, General Rule 7. The earliest treaty use is, however, by Sweden, which had introduced an ‘arm’s length’ rule into its internal law in 1928, in Sweden–Netherlands (1935) and Sweden–Hungary (1936). Both the League of Nations Mexico and London drafts had such a provision. 204 This gives effect to tax treaties in so far as they provide ‘for determining the income … to be attributed … to persons resident in the UK who have special relationships with persons not so resident’. IR63/168 at 152, note on cl 49(1): ‘It is, therefore, necessary to provide that the UK assessment may be levied on what would be the profit if branch and Head Office were independent concerns dealing at arm’s length.’ The original version (F(No2)A 1945, s 51(1)) had all the alternatives now in ICTA 1988, s 788(3) in one sentence and was perhaps clearer that this alternative applied where it did not result in relief: ‘the arrangements shall, notwithstanding anything in any enactment, have effect in relation to income tax, excess profits tax and the national defence contribution so far as they provide for relief from tax, or for charging the income arising from sources in the United Kingdom to persons not resident in the United Kingdom, determining the income to be attributed to such persons and their agencies, branches or establishments in the United Kingdom, or determining the income to be attributed to persons resident in the United Kingdom who have special relationships with persons not so resident’. Contrast the estate duty enabling legislation (‘so far as they provide for relief from estate duty, or for determining the place where any property is to be treated as being situated for the purposes of estate duty’: s 54) which envisaged the treaty imposing duty when the treaty moved the situs into the United Kingdom when the internal law situs was outside the United Kingdom (eg bearer shares in a UK company kept abroad): see below n 273. 203

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But doubts arose which were settled by the enactment of a new provision in 1951.205 Although the US–Canada treaty (1942) had a mutual agreement article by which the parties could consult to determine whether double taxation may be avoided in accordance with the terms of the treaty; this might have been useful in connection with this provision, but for some reason such an article was not included in this treaty. It was added by the 1966 Protocol.

C. Shipping and Air Transport We already had a shipping treaty with the United States dating from 1924,206 made under the 1923 enabling legislation: this was not controversial. The United States thought that extending the exemption to aircraft, as they had done in their treaties with Canada, Sweden and France, would benefit them more than the United Kingdom.207 Surprisingly, we agreed to an exemption in the United States drafted in terms of UK corporations (ie those created under UK law, rather than UK residents)208 for shipping and aircraft registered in the United Kingdom. In the initial negotiations we agreed to an exemption for companies resident in the United Kingdom, which was the rule in the earlier shipping treaty.209 The United States gave rise to the change by its insistence on taxing its nationals, including companies; so that if a US incorporated shipping company were resident in the United Kingdom, it was not prepared to exempt it.210 No examples of such a situation were known and so we agreed to the US position. The United States therefore agreed to exempt such profits of UK incorporated third-country resident companies, but denied exemption to third country incorporated but UK-resident companies.

205 Which became ICTA 1988, s 770; see now sch 28AA. See JDB Oliver, ‘Ship-money’ [1998] BTR 1 which quotes from the parliamentary debates that the Law Officers had advised in 1951 that the original provision (now ICTA 1988, s 788(3)(c)) (see above n 204) was insufficient for the purpose. 206 Exchange of Notes dated 11 August 1924, 18 November 1924, 26 November 1924, 15 January 1925, 13 February 1925, and 16 March 1925, SR & O 1924 No 1267. The enabling legislation was FA 1923, s 18, made as a result of the Report of the Imperial Shipping Committee: methods of assessment of shipping to income tax within the Empire (Cmd 1979, 1923). 207 Legislative History of United States Tax Conventions, fn 12 at 2626. 208 In addition to UK resident individuals who are not US citizens. 209 Note of 19 May 1944: TNA:PRO IR63/167 at 497. 210 Note of matters raised in the discussions of 19 May 1944 at 497. This point would have been cured by a saving clause, as had been included in US–Canada (1942) but there is no discussion of including one in the papers the author has seen.

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D. Non-Government Employment Income Employment income does not seem to have been regarded as particularly important. We were prepared to agree that tax was charged where the work was done.211 Income was exempt in the work state if performed there for less than 183 days for a resident of the other state. The 183-day rule was included in the proposals to be communicated to the US representatives, and so was, maybe, something we wanted.212 The article in the treaty is similar to the US–Canada and US–Sweden treaties,213 except that those treaties had a monetary limit to the exemption. These treaty provisions are similar to the present Art 15 of the OECD Model which permits taxation in the work state if the person was present for 183 days. The exemption in the Model, however, applies to work for a resident of anywhere other than the state in which the work was performed, rather than being limited to work for a resident of the other state. The article applied to personal, including professional, services, as had the League of Nations Mexico draft (and as would the London draft when it was finalised in the following year).214 Where the remittance basis applied, as it generally did to foreign employment income215 until 1974, there was no restriction on the source state exemption for unremitted income: this was introduced by the 1966 Protocol. Our memorandum outlining the proposals to be communicated to the US representatives states that the provision would include entertainers and this point does not seem to have been the subject of any further discussion recorded in the publicly available material.216 The treaty contained an exclusion from the employment article for public entertainers217 so that the internal law charge applied to them. The Senate considered this discriminatory against entertainers, which seems somewhat surprising since the 211 Memorandum by the Chancellor, 1 January 1945: TNA:PRO IR63/167 at 559. For our then law on the source of employment income, see above n 159. Rowlatt J’s dictum in Proctor v Ryall (1928) 14 TC 204, 214 that ‘the place of exercise governs’ was reversed by the courts but eventually reinstated by Parliament in 1956. 212 20 July 1944: TNA:PRO IR63/167 at 511. Employment income was in theory taxable in the United Kingdom, however short the visit. 213 US–France (1939) allowed taxation solely where the services were performed, but had a ‘fixed centre’ rule for professional services, which may be the origin of ‘fixed base’ in the former Art 14 of the Model (deleted in 2002). 214 These covered compensation for labour or personal services, including professions, all in the same article; the Commentary explains that the article covers both employments and professions: Art VII (Mexico); Art VI (London) (Document C88.M88.1946.IIA), see Legislative History of US Tax Conventions, above n 12, at 4343. Both included a 183-day rule. Earlier League of Nations drafts treated professions in the same way as businesses: 1928 Report draft 1a Art 5; 1b Art 2; 1c Art 3. 215 See above n 159 for the difficulty of determining whether employment income was foreign at that time. 216 TNA:PRO IR63/167 at 511. 217 ‘such as stage, motion picture or radio artists, musicians and athletes’: Art XI(3).

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United States had invented such a clause in the US–Sweden treaty (1939). They required the renegotiation of the provision; the United Kingdom agreed.218 It was deleted in a Protocol of 6 June 1946, so that the 183-day rule applied to entertainers. Both the treaty and the Protocol were approved at the same time in one Order in Council and so the exclusion never had effect. The provision was merely ahead of its time; it was adopted by the OECD in its 1963 Draft, and would become normal US treaty policy. Another feature of the treaty is that, as is always the case in US treaties, there is no directors’ fees article; the League of Nations 1928 draft 1b had provided for source taxation of directors’ fees at the real centre of management of the company. Although the United Kingdom taxed US directors of UK companies working in the United States,219 the United States did not succeed in persuading us to restrict taxability to duties performed in the United Kingdom.220 The United Kingdom moved to a place of performance test in 1956.

E. Government Employment Income The treaty provided that government service income paid by the US Government was exempt from UK tax except where the recipient was a British subject who was not also a citizen of the United States. This dealt with the problem that a US wife married to a British subject became a British subject221 and would accordingly be taxable on income from working in the US embassy in the United Kingdom. This exception gave her an exemption and was new to this treaty.222

218 Legislative History of United States Tax Conventions, above n 12, at 2723. An advantage of the change mentioned in Hansard, HC vol 425, col 1291 (17 July 1946) was that the United States could not tax earnings of UK stars who were in the United States for less than 183 days. 219 Before 1956 a non-resident director of a UK company, surprisingly even a private company, held a public office taxable under sch E (other employments were then taxable under sch D), performing all his duties outside the United Kingdom was deemed to hold a public office within the United Kingdom because the company was managed from the United Kingdom and he was entitled to attend board meetings in the United Kingdom. He was therefore taxable on the whole remuneration, an unusual example of a non-resident being taxed on work done outside the United Kingdom: McMillan v Guest (1942) 24 TC 190. 220 Legislative History of United States Tax Conventions, above n 12, at 2662. 221 US wives who before 1974 automatically took their UK husband’s domicile would be the subject of a special provision in the 1977 Protocol to the 1975 US–UK treaty (Art 4(4)), and repeated in the 2001 treaty. 222 Legislative History of United States Tax Conventions, above n 12, at 2660.

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F. Pensions The logic of our position against source tax also applied to pensions. Interestingly, the Chancellor had reservations about pensions because it might encourage retirement to the Channel Islands and those colonies with a low tax rate.223 Since the United States had agreed to waive its 30 per cent source tax on non-government pensions in their treaties with France (1939), Sweden (1939) and Canada (1942), there was presumably no difficulty in obtaining their agreement to such a provision. Where the remittance basis applied, which it generally did until 1974, there was no restriction on the source state exemption for unremitted income; this was introduced by the 1966 Protocol. Government pensions were taxable at source. The US treaties with Canada, France and Sweden also applied the pension provision to life annuities, and the UK treaty did the same, thereby eliminating the US 30 per cent rate on these.224

G. Capital Gains The United States had from the beginning regarded capital gains as a type of income, whereas we did not regard gains as income and so exempted them from tax. The probable reason for our different treatment of capital gains is that the distinction between income and capital had been developed in England in trust law concerning the entitlement of a life tenant of a landed estate. Income tax in the United Kingdom naturally adopted this existing distinction.225 We managed to obtain an exemption in the United States for gains of UK residents not having a permanent establishment in 223

TNA:PRO IR63/167 at 514. ‘The term “life annuity” means a stated sum payable periodically at stated times, during life or during a specified or ascertainable period of time, under an obligation to make the payments in consideration of money paid.’ The definition is similar in the other US treaties, except that the US–Canada included sums paid under a contributory retirement plan. Many older treaties applied the pension provision to life annuities but without defining them. 225 The distinction between capital gains and income in the United Kingdom was clearly established early in the development of tax law: see Att-Gen v London County Council, 4 TC 265 at 293 and Ryall v Hoare, 8 TC 521 at 525 without express reference to trust law, although trust law considerations were important in deciding that bonus shares were not income of the shareholder in IRC v Blott 8 TC 101. In the United States the trust law distinction between income and capital was much less important and in 1921 in a case which interestingly concerned a life interest trust, The Merchants’ Loan & Trust Co as Trustee of the Estate of Arthur Ryerson deceased v Smietanka 1 USTC 1124, the US Supreme Court decided that income for income tax purposes included capital gains, applying the same meaning of ‘income’ as had applied in the earlier Corporation Excise Act of 1909, which did not impose an income tax but which contained references to income. Trust law distinctions between income and capital were ignored since they depended on the terms of the trust instrument; and the Court said that British income tax decisions were on a statute so different that they 224

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the United States from the sale or exchange (the US internal law wording) of capital assets, which closely follows the US treaty with Sweden (1939), the first treaty to contain a general capital gains article.226 This exemption was initially regarded as controversial in the United States, although not for sound reasons.227

H. Professors and Teachers, and Students and Business Apprentices The exemption for professors and teachers visiting in the other state to teach for up to two years was new to this treaty. The exemption for visiting students and business apprentices, however, had been included in the US treaties with Canada, Sweden and France.228 These derived from a US request described in the memorandum outlining the proposals to be communicated to the US representatives as an educational concession with which we proposed to agree.229 It subsequently ceased to be US treaty policy to exempt professors and teachers.

J. Non-Discrimination A nationality non-discrimination provision applying only to residents of the state concerned and preventing ‘other or more burdensome’ taxation than on the state’s own nationals. This is the first occasion that these words are used and they are still found in the OECD Model.230 Nationality non-discrimination provisions on similar lines had been included in the US treaties with Canada, Sweden and France.231 Non-discrimination articles had not been included in the earlier League of Nations drafts until the Mexico draft in which the article was based on residence rather than were ‘‘quite without value’’ in the construction of the US income tax statute. The same interpretation was applied to capital gains of a corporation in Eldorado Coal and Mining Co v Mager 1 USTC 1127. 226 It was understood that this was to apply while we did not tax capital gains: TNA: PRO IR63/167 at 551. The provision became reciprocal in 1966 following our introduction of capital gains tax in 1965. 227 Legislative History of United States Tax Conventions, above n 12, at 2653, 2723 onwards: see above, n 188 for the reason why the objections were not sound. 228 The League of Nations Mexico and London drafts had such an exemption. 229 TNA:PRO IR63/167 at 491, 511. 230 See Woodend Rubber v IRC [1971] AC 321 at 332F for the meaning of this expression. 231 It is contained in the contemporaneous protocols to each of these treaties. US–Canada applied to ‘more burdensome’ taxes; US–France (1939) to ‘higher’ taxes, and US–Sweden to ‘other or higher’ taxes.

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nationality (as in the later London draft).232 For this purpose nationality was defined to include ‘persons, partnerships and associations deriving their status as such from, or created or organised under, the laws in force in any territory of the Contracting Parties’ words (in addition to ‘created or organised’ which were in US use)233 that would later find their way into the OECD Model.234 It would be interesting to know if the purported application of the article to ‘taxes of every kind or description, whether national, federal, state,235 provincial or municipal’ was something that we overlooked when drafting the enabling legislation, which is restricted to ‘income tax, excess profits tax or the national defence contribution’236 or whether we explained to the United States that it was something that we could not deliver. The absence of a non-discrimination article in the contemporaneous estate duty treaty suggests the former on the basis that the income tax treaty non-discrimination article covered estate duty so it was unnecessary to repeat a non-discrimination article in the estate duty treaty; but there is nothing in the publicly available material on this. The US material stated that the article had no effect as they did not discriminate between US citizens and British nationals residing in the United States.237 We did discriminate on such matters as the remittance basis for resident but non-ordinarily resident British subjects,238 but there is nothing in the papers to suggest that we gave this any thought.

K. Charities In an interesting suggestion that was well ahead of its time, the United States proposed that where a body was a charity under both US and UK law there should be reciprocal exemption, as had been included in the 232 Comparing a resident of the other state with a resident or national of the taxing state: Art XV (Mexico), XVI (London). The reference in those drafts is to ‘higher or other taxes’. 233 Note the contrast between the definitions in the treaty between ‘United States corporation’, meaning ‘a corporation, association or other like entity created or organised in or under the laws of the United States’; and ‘United Kingdom corporation’, meaning ‘any kind of juridical person created under the laws of the United Kingdom’. 234 The present form of article dates from the OEEC First Report (1958). 235 The inclusion of state taxes was a first for the United States: see National Foreign Trade Council memorandum, which points out that such provision is included in commercial and general relations treaties: Legislative History of United States Tax Conventions, above n 12, at 2617. An attempt to restrict states’ rights in relation to formulary apportionment would later be a major issue in the following (1975) US–UK treaty. 236 F(No 2)A 1945, s 51, now ICTA 1988, s 788: see above n 82. 237 Legislative History of United States Tax Conventions, above n 12, at 2665. 238 FA 1914, s 5 proviso, later ITA 1918 Case IV r 2; Case V r 3. Such a provision has little effect as most US persons will be non-domiciled and entitled to the remittance basis for a different reason.

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US–Canada treaty (1942). We were prepared to agree239 but for some reason this was not included. It was subsequently decided that UK tax relief for charities applied only to charities formed in the United Kingdom.240 L. Extension to Overseas Dependencies In a provision new to this treaty (and also contained in the contemporaneous estate duty treaty), either state could give notice extending the treaty to its: colonies, overseas territories, protectorates, or territories in respect of which it exercises a mandate,241 which impose taxes substantially similar in character to those which are the subject of the present Convention.

A later amendment made in 1955 enabled it to be extended with modifications and the quoted words became ‘territories for whose international relations it was responsible’. The extension had effect under the original treaty wording unless the other state gave notice that it did not accept the extension,242 but required positive acceptance under the revised wording. This was regarded as one of the significant features of the treaty from the Senate Foreign Relations Committee’s point of view. The State Department recommended to the President that the advice and consent of the Senate should be taken before the treaty was extended to any such dependency.243 Surprisingly, to our eyes today, the treaty was extended to 20 UK dependencies in 1959, some of which are territories with which the United States would not now contemplate making treaties.244 It is interesting that right from the beginning a stated objection to the treaty in the 239 Note of 19 May 1944: TNA:PRO IR63/167 at 511; Memorandum outlining the proposals to be communicated to the US representatives, 20 July 1944: TNA: PRO IR63/167 at 511. 240 The Camille and Henry Dreyfus Foundation Inc v IRC (1955) 36 TC 126, concerning a New York charitable foundation. 241 This wording did not apply to Canada, Australia or New Zealand, which were Dominions: Legislative History of United States Tax Conventions, above n 12, at 2665. 242 The United States said that this was the first instance of such a veto provision: Legislative History of United States Tax Conventions, above n 12, at 2628. Extension provisions were said to be commonly found in non-tax treaties such as consular, extradition and land tenure treaties, at 2632. 243 Legislative History of United States Tax Conventions, above, n 12, at 2652. 244 The territories were: Aden, Antigua, Barbados, British Honduras, Cyprus, Dominica, Falkland Islands, Gambia, Jamaica, Montserrat, Nigeria, Rhodesia and Nyasaland, St Christopher, Nevis and Anguilla, St Lucia, St Vincent, Seychelles, Sierra Leone, Trinidad and Tobago and the Virgin Islands. The extension excluded the articles on interest (except in the case of Rhodesia and Nyasaland), capital gains, and exemption from US accumulated earnings tax. The US Treasury announced in 1979 that it was investigating whether these extensions should be terminated to prevent use by taxpayers in third countries (Tax News Service, 30 September 1979). The extensions were terminated on 1 July 1982 with effect from

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United States was the possibility that it could be extended to low-tax territories and used to avoid US tax by non-resident aliens of the United States.245 The answer given to the objection was that it was an encouragement to increase US trade with such territories.246 Such a provision was adopted in subsequent US treaties247 and the United States later came to regret that they had not paid attention to the objection.

IX. THE ECONOMIC BASIS OF THE INCOME TAX TREATY

One of the most surprising features of the negotiations was that no estimate was ever given for the cost to the Exchequer of making the treaty. The Statistics and Intelligence unit of the Revenue had earlier produced an estimate of £0.5 million which might expand after the War to between £1 million and £2 million but they stated that the figure should not be relied upon except as a general idea of the order of magnitude.248 By contrast, on the American side, detailed statistics were presented by the International Economists and Statistical Unit of the Department of Commerce to the 1 January 1983, except for the extension to the British Virgin Islands which was terminated on 30 June 1982, with effect from 1 January 1983, and Antigua and Barbuda which gave notice to terminate on 26 February 1983, with effect from 26 August 1983 (US Treasury Department Press Release, 1 July 1982). Some of our early treaties with other countries were also extended to our dependencies, including Sweden (1949), Denmark (1950), Netherlands (1950), Norway (1951) and Switzerland (1955). 245 The objections are anonymous and were either made up by the Joint Committee on Taxation to give a balanced view, or were based on comments received from outside, Legislative History of United States Tax Conventions, above n 12, at 2607, 2619. 246 Legislative History of United States Tax Conventions, above, n 12, at 2594, 2642. While no doubt mainly aimed at UK dependencies, the National Foreign Trade Council memorandum pointed out that it would enable the treaty to be extended to Puerto Rico (Legislative History of United States Tax Conventions, above n 12, at 2617), but this was denied in the Technical Explanation at 2595 on the ground that its was autonomous in revenue matters, which seems unconvincing. 247 US–Netherlands (1948) was extended to the Netherlands Antilles; US–Belgium (1952) was extended to three dependencies: see Rosenbloom and Langbein, ‘United States Tax Treaty Policy: an Overview’ (1981) 19 Colum J. Transnat L 359 at 379. 248 Note on the cost of double taxation relief, 30 August 1944: TNA: PRO IR63/167 at 516. Taking the figures in this paragraph for income paid from the United States to the United Kingdom and assuming that income flows in the other direction were half, that half the dividends were paid to parent companies, that all the interest paid from the United Kingdom to the United States was on exempt gilts, (against the United Kingdom), that the ‘other income’ was all pe profits, and ignoring surtax, national defence contribution [profits tax] (incorrectly, because relief against profits tax was given first and any excess relief was deductible from the profit (FA 1947, sch 9, para 7(3)), resulting in a difficult calculation, see the 1955 Royal Commission (Cmd 9474) para 725) and excess profits tax, one can make a rough estimate that the United Kingdom lost withholding tax of £0.08 on royalties and gained £0.3 million through giving credit for less US tax than for which it had previously given a deduction, a net gain of £0.21 million (at an exchange rate of $4 = £1, the approximate rate before the 1949 devaluation of the pound). See fn.251 for an estimate of the cost to the United States.

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Senate Foreign Relations Committee of investment in each country by residents of the other.249 This showed investment from the United Kingdom to the United States of $2 billion (it had been $3 billion before the War), and from the United States to the United Kingdom of $1 billion, half by parent companies and half by the public. Income paid from the United States to the United Kingdom in 1943 is: dividends $22.5 million; fiduciary $4 million; royalties $2.7 million; and other income $2.8 million.250 No figure was, however, given to the Senate for the cost of the treaty.251 From the UK point of view most of the provisions of the treaty were considered to be neutral or favourable. There was already an exemption in the United Kingdom for government interest paid to non-residents, which covered the bulk of investment by non-residents in interest-bearing securities. Dividends still suffered tax at the standard rate, and surtax could not be enforced against non-residents. The film industry benefited from the exemption from the 30 per cent US withholding tax, for which there was previously only a deduction, and so would pay more UK tax. The principal cost was the change from deduction to credit for US tax which was contemplated as an aid for exports, the cost of which was regarded as inevitable.252 The Chancellor was, perhaps surprisingly, fobbed off by the Revenue with the remark that ‘the question of cost is really a secondary matter and the important issue is rather the principles on which the double taxation agreement should be founded’,253 as they recognised that the treaty would be the precedent for the future. One feels sure that today proper estimates are made of the cost of treaties before they are negotiated.

249

Legislative History of United States Tax Conventions, above n 12, at 2647. This excluded income of securities pledged to the FRC loan paid to the UK Government, which was free of US tax, of $8.7 million, and there were other Government holdings, and also UK companies taxed as resident foreign corporations (which included BATS and many investment trusts). 251 Assuming that income flows in the other direction were half, and that before the treaty the US gave a deduction for the UK tax deducted and retained on dividends, interest and royalties and that all royalties and pe profits were paid to companies paying US tax of 40% with the credit limited to that rate, and that individuals paid tax at 30%, one can make a rough estimate that the US lost withholding tax of $8.08 million and lost $3.3 8million on the change to credit (which was more of an internal law problem corrected by the treaty), total cost of $9.89 million (at an exchange rate of $4= £1). 252 Final report to the Chancellor, 21 March 1945: TNA:PRO IR63/167 at 567. The issue was complicated by the fact that excess profits tax was at 100% and so there was effectively no difference between credit and exemption: at 516. 253 Letter to the Chancellor’s private secretary, 31 August 1944: TNA:PRO IR63/167 at 519. 250

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John F Avery Jones X. ESTATE DUTY TREATY

At the same time the same team carried on negotiations for an estate duty treaty,254 thus demonstrating their versatility. As with the income tax treaty this followed a US–Canada treaty precedent rather than the work of the League of Nations.255 Double taxation of estate taxes was potentially a serious problem. We gave only a deduction for US estate tax256 (the only relief we gave unilaterally was a credit for tax charged on a situs basis in a British possession, which was, incidentally, the first example of credit in UK tax law).257 The United States did not give any relief at all for foreign estate taxes. Our negotiating position can be predicted from our income tax treaty position: taxation of personalty only in the country of the deceased’s domicile (we did not impose duty on foreign realty before 1962), although we recognised that this was a radical solution.258 The Chancellor thought that our proposals were sound in principle but he did not rule out examination of the wider possibility of avoiding duplication of charges.259 The US position was equally predictable: taxation primarily in the situs country with credit relief in the country of domicile or nationality.260 On this occasion we lost the argument, although we eventually achieved most of it in the subsequent capital transfer tax treaty with the United States in 1978261 in which the only situs charges are on land and permanent establishments of unincorporated businesses, but that was after

254 The Double Taxation Relief (Estate Duty) (USA) Order (1946 SR & O 1946 No 1351), which was signed on the same day as the income tax treaty, applying to estate duty in Great Britain and by Art IX separately to Northern Irish estate duty (with the possibility of separate termination); the author shall, for simplicity, continue to refer to the United Kingdom. At the time legacy duty (applying to estates of those domiciled in GB) and succession duty (applying to land in GB) also existed but were not covered by the treaty; they were less likely to apply to US persons. 255 The League of Nations had covered death duties in the 1923 Report and had developed estate tax models in 1927 (Legislative History of US Tax Conventions, above n 1, at 4133), 1928 (at 4176), and Mexico (at 4406), (and subsequently London (at 4407)). 256 FA 1894, s 7(4). 257 This had been introduced by FA 1894, s 20. Unilateral relief was not given for other countries’ death duties until 1962: FA 1962, s 29. 258 Letter to the Chancellor’s private secretary, 20 July 1944: TNA:PRO IR63/167 at 507; memorandum outlining the proposals to be communicated to US representatives, 20 July 1944, at 512. 259 Note of meeting on 20 July 1944: TNA:PRO IR63/167 at 514. 260 Letter to the Chancellor’s private secretary, 31 August 1944: TNA:PRO IR63/167 at 519. 261 Before that treaty, the 1945 treaty was applied to capital transfer tax by benevolent treaty override in FA 1975, sch 7, para 7(6) but excluding deemed domicile: see JF Avery Jones ‘Deemed Domicile Doesn’t Apply to Americans’ [1975] BTR 325.

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the OECD had produced a Model on these lines.262 We probably expected to lose because, in the memorandum outlining the proposals to be communicated to the US representatives, we noted that the laws of both countries were being reviewed to determine in what respect they differed with a view to agreeing common situs rules in cases of domicile in one or other state.263 This is exactly what happened as the main content of the treaty comprised 11 situs rules.264 The US rule for shares was that shares in a US company had a situs there and shares in a non-US company had a situs where the certificate was situated265; our situs rule was where the register, or bearer share, was situated, which could apply to third country incorporated companies.266 We harmonised on the same rule as for US companies. It was said that there was no revenue involved in the difference.267 For debts, the US situs rule was where the document was situated268; our rule was where the debtor was resident (or where the document was situated for a specialty debt). We harmonised on where the deceased was domiciled, which is closer to our rule. The United States exempted insurance policies of foreigners269; our rule was the situs was where the insurance company was situated (or where the policy was situated, if under seal). We harmonised on the country of the deceased’s domicile, which, assuming that was more likely to be where the policy was kept, was closer to their rule. This approach of settling conflicts of situs became the norm for our estate duty treaties,270 but later changed significantly under capital transfer tax and inheritance tax. We persuaded the United States to make the movable/immovable property distinction

262 The OECD 1966 draft permitted situs charges on immovable property, permanent establishments and ships, boats and aircraft only. The situs charge on ships, etc was dropped in the OECD 1983 draft. 263 TNA:PRO IR63/167 at 512. This was important not only to charging tax but for credit because it was recognised that there would be no credit unless the domicile state regarded the situs of the asset as being in the taxing state. 264 Art III. The net effect is shown in a useful table to a US Treasury technical memorandum in Legislative History of United States Tax Conventions, above n 12, at 2603, which shows the internal law charges and the effect of the treaty on them for US estate tax divided into US citizens domiciled in, and out, of the United States, non-citizens domiciled in the United States, the United Kingdom and elsewhere; and for estate duty those domiciled in the United States, the United Kingdom and elsewhere. 265 Legislative History of United States Tax Conventions, above, n 12, at 2597. 266 Referred to the Chancellor by telegram of 9 December 1944 TNA:PRO IR63/167 at 542 and agreed 13 December 1945 at 544. We had previously failed to reach agreement with South Africa over this problem as we did not want to give up our internal law charge on shares: draft report to the Chancellor, 22 December 1944 at 554. 267 Telegram from Washington, 9 December 1944: TNA:PRO IR63/167 at 542. 268 Legislative History of United States Tax Conventions, above n 12, at 2601. 269 Legislative History of United States Tax Conventions, above n 12, at 2600. 270 See estate duty treaties with: South Africa (1947, 1955), France (1963), Sweden (1961, 1965), Italy (1968), India (1956), Canada (1946), Netherlands (1950), Pakistan (1957), Switzerland (1957), Ceylon (1950).

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appropriate to conflicts of laws, rather than the internal law real/personal property distinction applying domestically in both countries.271 Interestingly, the existence of a Budget Resolution recognised that the effect of the treaty could, unusually, be to increase UK duty, for example by moving the situs into the United Kingdom.272 The enabling provision stated that estate duty treaties had effect so far as they provide for relief from estate duty, or for determining the place where any property is to be treated as being situated for the purposes of estate duty, the second of these recognising that the treaty might result in a charge rather than a relief.273 In addition to a normal credit relief, an interesting, and generous, form of relief for dual domicile cases (but not including a double charge caused by the US charge on the basis of nationality and the UK charge on the basis of domicile) in respect of property with a situs in neither state, or both states, was negotiated for the first time. Each state gave relief for a proportion of the lower of the two taxes corresponding to the proportion of tax payable in that state.274 This was generous in that it gave partial relief for taxes charged on total assets, not, as is usual, just for taxes charged on a situs basis. This formula eliminates the lower of the two taxes, leaving, as one expects with credit, the higher of the two. Many years later, in 1976,275 this same system was adopted for our generous unilateral relief for what is now inheritance tax where it is less suitable because the other state will almost certainly not give the same relief.

XI. CONCLUSION

It is strange in retrospect that Sir Percy Thompson and his successors did not do more in the 1930s to try to persuade states to eliminate or at least reduce their withholding taxes by treaty. It was certainly in our economic interests as a capital exporter to negotiate for such a result. The United States was the obvious country with which to start as it was one of the few countries with an income tax as opposed to impersonal taxes: the US tax system with its 30 per cent withholding tax but having a good credit relief for its own citizens and residents presented an obvious invitation to others to negotiate. But the initiative to negotiate the treaty clearly came from the US side. By the time negotiations started US taxpayers suffered our high 50 271 Legislative History of United States Tax Conventions, above n 12, at 2600. The income tax treaty provision was in terms of real property: see above n 125. 272 TNA:PRO IR63/168 p.30. The resolution also recognised that estate duty could be increased by the dual domicile credit (see next paragraph in the text) because the UK duty could be increased even though the total tax was decreased. 273 F(No 2)A 1945, s 54. 274 Art V(2). 275 FA 1976, s 125, now IHTA 1984, s 159.

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per cent standard rate coupled with our system of deducting and retaining tax that did not fit their foreign tax credit. From our point of view, the 30 per cent US withholding taxes for which we gave only a deduction must have been extremely onerous for UK taxpayers. The situation with estate tax and duty was even worse: both countries imposing situs charges on virtually everything; the United States giving no relief for our duty; and we giving only a deduction for their tax. One might have expected that both countries would be keen to conclude a treaty; certainly their taxpayers were. But the two treaties were not entered into lightly on the UK side, except perhaps from the economic point of view, as is demonstrated by the numerous communications with the Chancellor. We know that the United States started with the US-Canada treaty as their opening negotiating position. This treaty provides for 15 per cent withholding tax on dividends (5 per cent on dividends on direct investment), interest and royalties. We started with the Sir Percy attitude of wanting no withholding tax on any of these types of income, to which we had agreed with the United States in the League of Nations 1928 draft 1b.276 The result was that while we lost the argument on dividends, for which we merely gave up surtax which we could not collect, the absence of withholding taxes on everything else was the same as the 1928 draft. We did not therefore come out of the negotiations badly, as is demonstrated by the economics. By being willing at last to compromise Sir Percy’s extreme position on dividends we succeeded in making a treaty with the United States. Looking back it is surprising that we had been so concerned about having to give credit for reduced withholding taxes on dividends. The treaty was a significant turning point which immediately opened up the possibility of other treaties and shortly led to both countries entering into an avalanche of treaties.277 In many of these early treaties we negotiated no withholding tax on dividends on direct investments, nor on any interest and royalties,278 demonstrating that our fear that nobody would accept our view was exaggerated. The US–UK treaty is also remarkable for the number of items that were included there first and which became our (and in some cases everyone’s) treaty practice, and the history of this treaty explains how some of these 276 We seemed to accept the source taxation of immovable property, permanent establishments, directors’ fees, salaries and public pensions contained in 1928 draft 1b. 277 UK treaties with: Canada (1946), France (1947), South Africa (1947), Australia (1947), New Zealand (1947), Sweden (1949), Israel (1950), Denmark (1950), Netherlands (1950), Greece (1951), Norway (1951), Finland (1953), Greece (1954), Belgium (1954), Switzerland (1955), Germany (1955), (plus about 45 treaties with dependencies up to 1955). US treaties with: the Netherlands (1948), Denmark (1948), New Zealand (1948), Norway (1949), Ireland (1949), Greece (1950), Switzerland (1951), Finland (1952), Belgium (1952), South Africa (1952), Australia (1953), Germany (1954), Japan (1954), Italy (1955), Austria (1956), Pakistan (1957). 278 See above n 98 (and related text), n 122, and text following n 124.

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arose. These novel provisions included the future Article 3(2) of the OECD Model, a nil rate of withholding tax on interest, specific provision for film royalties, reference to beneficial ownership (of assets), special treatment for US wives in the government service article, a source rule for foreign employments, a source rule for permanent establishment profits (possibly the forerunner of a general deemed source rule), the professors and teachers exemption, the ‘general principle’ of treaty credit relief, the territorial extension provision, the definition of nationality for persons, partnerships and associations, preventing discrimination by charging ‘‘other or more burdensome’’ taxation, and applying the nondiscrimination article to state, provincial or municipal taxes, exchange of information to prevent fraud or avoidance; and in the estate duty treaty the double domicile relief. There were other features that, while not used for the first time in this treaty, became our standard treaty practice, such as the reduction in withholding tax on dividends on direct investment being conditional on the relationship not being arranged primarily to take advantage of the treaty provision that was later widened to cover all reductions in withholding tax. The treaty was a significant landmark not only in our success in making a comprehensive treaty at all but in its influence on many other treaties.

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10 The Rule in Gilbertson v Fergusson 140 Years of Relief for Underlying Tax JDB OLIVER

ABSTRACT Relief from double taxation in relation to UK tax paid on UK source profits by a non-resident company paying dividends to UK resident shareholders has been allowed in one form or another since 1863. Originally the relief was given under a rule which came to be known as the ‘rule in Gilbertson v Fergusson’ and which lasted for over 60 years. When that rule was overruled by the House of Lords in 1945, relief was thereafter given by a specific statutory provision. When that provision was repealed in 1965 on the demise of the then imputation system, the relief was continued with slight modification by a new statutory provision which continues to this day.

I. INTRODUCTION

C

URRENT UK LEGISLATION, dating back over 50 years to 1950,1 gives unilateral relief by way of credit for underlying tax suffered on foreign dividends received by UK corporate direct investors. This relief not only applies to foreign tax paid by the overseas company in its country of residence but extends to third country taxes and to any UK tax which has been paid by the overseas company on its profits. So, for example, where it has received income such as UK branch profits or UK source passive income the UK tax will be eligible for relief as underlying tax of the overseas company. It may seem curious that a foreign tax credit relief should incorporate relief for domestic tax; and indeed one might contrast, for example, the equivalent US foreign tax credit relief 1 FA 1950. Section 36 of and sch 6 to that Act seem to have been modelled on the earlier bilateral relief provisions as seen in F (No 2) A 1945, as amended by FA 1947, and in the US–UK treaty.

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provisions which, logically, do not give relief for US tax paid by a US-owned foreign corporation, because it is not foreign tax. Such, however, is the influence of history, as we shall see below. The principle on which this relief for UK tax is based can in fact be traced back 140 years, to a time long before the introduction of the UK unilateral foreign tax credit relief provisions. It began life in a tax case concerning the Imperial Ottoman Bank, reported as Gilbertson and others v Fergusson.2 A few years earlier, towards the close of 1862, the predecessor of the Imperial Ottoman Bank, the Ottoman Bank of London, which was a banking company established in London and carrying on business there with a branch in Constantinople, arranged to transfer its business to the Imperial Ottoman Bank, which was a Turkish corporation incorporated according to the laws of Turkey by a firman of the Sultan.3 Shares were issued to the shareholders of the Ottoman Bank of London and the remainder of the share capital was subscribed in Constantinople, Paris, London and other places. From 1863 onwards, the Imperial Ottoman Bank carried on business in Turkey and had a branch in London. It was not resident in the United Kingdom for tax purposes.4 Thus the position changed from a UK-resident company carrying on the business, including a branch in Turkey, to a non-resident company carrying on the business, with a branch in London. For the year 1874–75 the London agency made two returns of income tax, one being in respect of the profits of the bank and the other in respect of dividends of the bank (paid to the English shareholders). The profits of the bank were returned as £81,477 14s 8d, being the computation of the three-year average. An assessment was raised in that amount. The return in respect of dividends of the bank stated that: There were no … dividends … payable in respect of shares of the said Imperial Ottoman Bank … intrusted to the London Agency for payment to persons … in the United Kingdom, and payable by the said London Agency, for the year ending 5th April, 1875.

2 (1881) 1 TC 501. See also LR 5 Ex D 57; the report of the decision in the Exchequer Division is not reproduced in Tax Cases. 3 (1881) 1 TC 501at 503. 4 See Attorney General v Alexander (1874) LR 10 Ex 20, in which the Court of Exchequer had held that the bank was not resident in the UK. The grounds of that decision were, incidentally, misunderstood by the General Commissioners in the later residence case of The Cesena Sulphur Co Ltd. v Nicholson (1876) 1 TC 88 where they asserted, at 91, that in Attorney General v Alexander ’the Court…decided that the residence of a corporation must be regarded as the place of its incorporation’. But, as Huddleston B emphasises in the Court of Exchequer in Cesena, at 104, at least two of the judges had pointed out, in Attorney General v Alexander, that Constantinople, where the corporation was incorporated, was also the seat of business: see Cleasby B at 33 and Amphlett B at 34.

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This seems to have been based on an understanding that it was only to the extent that a remittance was received to fund the payment of the dividend that it fell within the paying agent provisions. The agents asserted that the relevant UK profits exceeded the amount of the dividends, no remittance was therefore received, and there should be a nil return.5 In other words, the dividend to the UK-resident shareholders should be treated as coming first out of any UK profits6 rather than being sourced on a proportional basis. The Special Commissioners made an assessment on the profits of the London branch, which was not objected to, since it was in the amount shown by the return. In addition, however, they assessed the agency on the full amount of the dividends, £98,322 10s, having at that point no information as to how much of the dividend could be said to have represented the UK branch profits, and leaving the paying agent to prove on appeal what amount should be deducted as representing UK profits.7 The case went to the Divisional Court of the Court of Exchequer who held (Kelly CB dissenting) that the assessment on dividends was based on the right principle, insofar as it assessed so much of the profits of the bank as was not shown on a return to arise from profits made in the UK.8 The statute9 made no reference to remittances but only to dividends ‘intrusted’ to the agents for payment.10 If, however, a portion only was earned in the UK, there being a single indivisible dividend, then they could claim to deduct in respect of that portion so that they should only be assessed in respect of the portion of the dividends representing profits arising outside the UK. The bank, by a proper return, could escape the effect to this extent, the court concluded. On appeal to the Court of Appeal the court unanimously affirmed the decision of the Divisional Court. Brett LJ put it thus: By the statute the Government are entitled to receive the income tax upon all the profits made in respect of the business carried on in England, and also beyond 5 In 1874–75 the amount of profits actually earned in England was £145,539 0s 2d, per Kelly CB: LR 5 Ex D 57 at 78. 6 This approach seems to have been the practice adopted from 1863 until 1874–75 when the present issue arose: an assessment was only raised on the paying agent for those earlier years to the extent that a remittance had to be made from abroad to cover the dividend paid to UK resident shareholders—see Kelly CB (1879) LR 5 Ex D 57 at 77. 7 (1881) 1 TC 501 at 508. Gilbertson, incidentally, was the senior of the nine English members of the management committee of the bank who were regarded as the agency carrying on the business in the UK on behalf of the bank and who were assessed in their capacity as the London agency of the bank and in their capacity as the paying agents of the dividend paid to the UK shareholders. 8 (1881) 1 TC 501 at 513. Kelly CB dissented. 9 Section 10 of the Act 16 & 17 Vict., c 34. 10 See Huddleston B: LR 5 Ex D 57 at 71. Kelly CB gave a dissenting judgment on this ground, holding that, since the UK profits sufficed to pay the dividend, no money had been intrusted to the agency.

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that on all dividends paid in England or in Turkey. Now it may be true that there are no specific words in this statute which point out that the Government are not to receive the tax twice over, but it would be so clearly unjust and obviously contrary to the statute that the Government should have the tax payable twice over by the same person in respect of the same thing, that I would say it was a necessary implication that that could not be right. …the order of the Divisional Court…points out the true principle, which is, that in respect of so much of the dividend as is payable out of the profits from the business carried on in England, the income tax is to be paid, not twice, but only once, but that the income tax is also to be paid in respect of so much of the dividend which is paid in England from the profits in Turkey. Whether it is properly worked out by the rule of three sum stated in the case I know not and do not care. That is a matter for an accountant more than for a court of law.11

Brett LJ added12: if part of the dividends in respect of which the income tax is payable is also in respect of profits earned from a business in England, the tax on that part would have to be paid twice over, which ought not to be; and as to that there should be a deduction. In respect, however, of so much of the dividends payable in England as is derived from profits from business carried on in Turkey, it is not paid twice over, and consequently as to that there ought not to be any deduction at all.

Bramwell LJ also points out that, as a matter of machinery, if income tax had not been deducted and accounted for by the paying agent on the proportion attributable to the Turkish profits ‘then each such shareholder would have had on his return to the Income Tax Commissioners to have charged himself in respect of the dividends received by him on which he had not paid tax’.13 The court did not attempt (see the quotation from Brett LJ, above) to specify how the amount of the dividend arising from or payable in respect of profits made in the UK was to be determined, contenting themselves with saying that the right principle was to assess ‘so much of the dividends

11 (1881) 1 TC 501 at 518. The ‘rule of three sum’ referred to was the calculation used in the alternative assessment of both branch profits and the dividend which was discharged by the Divisional Court. As described above, it calculated the amount representing the UK profits as being that proportion of the UK tax profits which the dividend paid to the UK-resident shareholders bore to the total dividend. This assumed a full distribution of the UK profits and did not attempt to calculate the overall percentage of profits which had been distributed and then apportion that percentage of UK profits between the dividends to resident and non-resident shareholders. 12 (1881) 1 TC 501 at 518. 13 (1881) 1 TC 501 at 521.

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intrusted to the committee for payment in the United Kingdom as is not shown by a proper return on the part of the bank, to arise from profits made in the United Kingdom’.14 Pausing at this point, one should recall the context that in the case of dividends paid by a resident company to its shareholders there was complete imputation. It may also have been a factor that the same persons were being assessed, first, as agents of the company and, second, as agents of the UK shareholders. Note that the rule made no distinction between portfolio and direct investors. Nevertheless the rule had been established and we next take notice of it in 1937 when an attempt was made (successfully) in Barnes v Hely Hutchinson15 to limit the scope of the rule. The taxpayer, a UK-resident individual, held preference shares in an Indian company which in turn held shares in two UK-resident companies. The Indian company received dividends from the UK companies which were paid out of profits which had borne UK income tax and such tax was deducted by the British companies from the dividends in question. The essential facts of the case thus differed in two respects from the facts in Gilbertson v Fergusson. First, the dividend was a preference dividend and not an ordinary dividend. Second, the UK tax had not been paid directly by the company paying the dividend but by the UK-resident companies in which it held shares.

II. TESTING THE SCOPE OF THE RULE

The City General Commissioners and the lower courts all followed the ‘rule in Gilbertson v Fergusson’, as it had come to be known by this time. The House of Lords, however, held that the taxpayer was correctly assessed on the full amount of the dividend. Lord Atkin states of the rule that: As far as the company had been taxed on its profits made in England it seems to me plain that the reasoning proceeded on the theory then prevailing that the company paid tax on behalf of its shareholders, a theory which as pointed out in Cull’s case16, no longer can be maintained. But it seems equally plain that the exception which the Courts were able to imply was based on this very ground – the injustice that would prevail if the tax were payable twice over by the same person on the same thing. Whatever the grounds of the decision, it has stood to the present day, and the Attorney-General did not seek to dispute its validity in facts such as those found in that case. There has been much legislation in Income 14

(1881) 1 TC 501 at 520 (Cotton LJ). 22 TC 655. 16 CIR v Cull 22 TC 603. The House of Lords’ judgment in Cull had been delivered on the same day—27 July 1939—as the House’s judgment in Barnes v Hely Hutchinson. Lord Atkin sat on both cases, as did Lords Russell of Killowen, Macmillan and Wright. 15

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Tax matters since the date of its decision, and this House would hesitate long in these circumstances before infringing a decision of such long standing and so often acted upon. But does the decision affect the present case?17

Lord Atkin goes on to point out that in the present case no UK tax has been paid directly by the foreign company and this distinction makes it difficult to apply the rule in the case of ordinary shareholders in the Indian company. But, even if the implied exception could be adopted for the ordinary shareholder, he was at a loss to see any reasons for applying it to the preference shareholder. The preference shareholder who receives his full dividend has suffered nothing directly or indirectly. Lord Wright, with whom Lords Russell and Macmillan concurred, did not think, for several reasons, that the analogy of dividends of an English company applied, and saw no sufficient ground in a case like this for relieving the taxpayer from what is expressed to be his liability under Case V.

III. A FRONTAL ATTACK

We now move forward again to Canadian Eagle Oil v The King which reached the House of Lords in 1945 where the decision in Gilbertson v Fergusson was finally overruled. As Lord Macmillan put it18: encouraged by a recent success in an affair of outposts (Barnes v HelyHutchinson, 22 T.C. 655), the Inland Revenue authorities have now in these appeals launched a full frontal attack on what is known as ‘the rule in Gilbertson v Fergusson’.

Canadian Eagle Oil Co Ltd was incorporated in Canada and was not resident in the United Kingdom. Its share capital comprised preference shares, participating preference shares and ordinary shares. Dividends were from time to time paid on all three classes. The company’s income included UK bank interest, on which it was directly assessed; interest on loans to UK-resident companies, on which tax was suffered by deduction; and dividends on shareholdings in UK companies. The company’s claims to apply the rule in relation to dividends on all three classes insofar as dividends to UK-resident shareholders were paid out of profits which had suffered UK tax by direct assessment or by deduction were accepted by the Revenue for all years up to 1931–32. For that year and later years the Revenue refused repayment in relation to the two classes of preference dividends, on the view, later to be upheld in Barnes v Hely-Hutchinson, that the rule applied only to ordinary dividends. Relief continued to be given on ordinary dividends up to and including 1938–39 but for 1939–40 17 18

(1939) 22 TC 655 at 672. Canadian Eagle Oil Co Ltd v R (1946) 27 TC 205 at 254.

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the Revenue restricted the relief to the part of the dividends represented by income which had been directly assessed, ie the bank interest. The company appealed against all of these restrictions on the repayment, relying on the rule. Viscount Simon concluded that the position taken in Gilbertson v Fergusson was demonstrably wrong. In CIR v Blott19 Viscount Cave had said: Plainly, a company paying income tax on its profits does not pay it as agent for its shareholders. It pays as a taxpayer, and if no dividend is declared the shareholders have no direct concern in the payment.

Lord Macmillan thought that: The so-called ‘rule in Gilbertson v Fergusson’ is open, in my opinion, to at least one insuperable objection. It is agreed that the relief which it gives is not relief against the whole tax exigible on the foreign dividends, but only to the extent of the proportion which that part of the foreign company’s income which has borne British tax bears to the total income of the foreign company, for the British shareholder’s dividend is only in part paid out of income which has borne tax. But how is this proportion to be ascertained? The foreign company doubtless has quite different rules for arriving at its total profits from the artificial rules which apply to the ascertainment of profits of a British company. One essential factor in the ascertainment of the extent of the relief under the rule in Gilbertson v Fergusson is thus entirely beyond any means of criticism and control on the part of the Revenue authorities. This seems to me a quite untenable position.20

Their Lordships also drew attention to the fact that if anyone was entitled to repayment it was the paying agent who had accounted for the tax on behalf of the shareholders and who would be accountable to the shareholders for the repayment received. It was not the company itself which was entitled to the repayment; and this by itself would have been enough to dispose of the case, though not the accompanying Selection Trust case where the appellant was the UK-resident shareholder who had received the dividends. Their Lordships pointed out that in Gilbertson v Fergusson the repayment was being claimed by Gilbertson in his capacity as paying agent acting for the shareholders and not as the agent carrying on the bank’s business in the United Kingdom.21

19

[1921] 2 AC 171. (1946) 27 TC 205 at 257. 21 See Viscount Simon (1946) TC 205 at 243, Lord Macmillan at 255 and Lord Simonds at 261. 20

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No sooner had the rule been abolished, however, than the relief (with some amendment) was promptly restored (for the year 1945–46 and subsequent years of assessment) by a specific statutory provision22 which, addressing Lord Macmillan’s concern, begins: Where on a claim made under this section, a person satisfies the Commissioners of Inland Revenue as respects an ordinary dividend paid to him and in respect of which he is chargeable to income tax by deduction or other wise for the year 1945–46 or any subsequent year of assessment, that— (a) it is a dividend paid by a body corporate not resident in the United Kingdom; and (b) the relevant profits of that body corporate included profits on which United Kingdom income tax has been paid by that body corporate, by deduction or otherwise, he shall be entitled to relief from the tax so chargeable on him in respect of the ‘appropriate fraction’ of the dividend.

The ‘appropriate fraction’ was defined as the fraction having as the numerator the gross amount of the relevant profits on which UK tax had been paid by deduction or otherwise and the denominator the said gross amount plus the gross amount of the relevant profits on which UK tax had not been paid. The term ‘relevant profits’ was defined in precisely the terms which were later to be considered in Owen v Southern Railway of Peru.23 Note that the relief applied to both direct and portfolio investors but was limited to ordinary dividends, thus excluding preference dividends and preserving in that respect the limitation imposed on the rule by the decision in Barnes v Hely Hutchinson.

V. CONTINUING SURVIVAL

This statutory provision, consolidated as s 201 of the Income Tax Act 1952, was repealed in 1965 (by s 97 of and sch 22 to FA 1965), with the ending of the imputation system of taxation of UK-resident companies. However, relief for UK tax as underlying tax was continued, with some changes, by the provisions of sch 16, parag 4 to FA 1965, consolidated as s 508 of ICTA 1970. The relief under the 1965 provision was broader than the rule and the statutory provision which immediately succeeded it, in that it applied to all dividends including preference dividends. The reason for this relaxation was that the relief was no longer available to portfolio investors but was limited to corporate direct investors possessing the 22 23

FA 1946, s 31,which, on consolidation in 1952, became Income Tax Act 1952, s 201. (1956) 36 TC 602.

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requisite control of voting power. Thus the relief was no longer available to individuals. A preference shareholder would be unlikely to possess the requisite voting control by reason of the preference shareholding alone but, if a company held ordinary shares controlling the necessary level of voting power, the company would qualify for the relief on any preference dividends as well as ordinary dividends. Section 26 of FA 1971 re-enacted this provision, taking in the existing extra-statutory concessions relating to credit for underlying tax. The resulting drafting in relation to UK and ‘third country’ tax is not always clear and was criticised in the later case of Memec.24 Further amendments to the statutory relief have been made, and some unmade, by more recent Finance Acts, by way of refinements to the calculation which were aimed to take care of certain difficulties first spotted by the House of Lords over 50 years earlier in Canadian Eagle Oil Co Ltd v R, first deeming the rate of underlying tax on a dividend from a UK-resident company to be the UK corporation tax rate—see the shortlived s 801(4A) of the Taxes Act 1980—and, second, capping credit for underlying tax. Yet the basic effect of the rule still survives in statutory form, drawing strength from the sheer common sense of it and gainsaying any objections from those who would say it is all a matter of economic double taxation as opposed to juridical double taxation, and misconceived on that account.

24

Memec plcv IRC (1998) 71 TC 77, at 101 (per Robert Walker J).

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11 Consent and Constitutionality in Nineteenth-Century English Taxation CHANTAL STEBBINGS 1

ABSTRACT Throughout the modern era of systematic direct taxation in England, beginning with the introduction of income tax in 1799, the invariable protest against the imposition of any new tax or system of taxation was that it was ‘unconstitutional’. This was particularly so when a tax breached certain accepted canons of taxation, notably that a tax should not be inquisitorial in its process, and that it should be administered locally by the taxpayers themselves. These canons of taxation were increasingly undermined in the nineteenth century, to strong public opposition. Taxpayers perceived them as aspects of the fundamental principle that a tax could only be levied with the consent of their representatives in Parliament. This gave the canons a certain formal legitimacy and considerable political influence. As a result legislators could not afford to ignore them, and they were given varying degrees of statutory expression. The conflict between the fiscal demands of modern government and the taxpayers’ demands for protection through the maintenance of the canons led to sustained tensions throughout the nineteenth century. American and French comparisons reveal the considerable importance of the canons in English taxation and thereby the essential character of the English system, and the impact of differing fiscal, constitutional, political and cultural conditions on the administration of taxes.

1 This research forms part of a wider project on the legal protection of taxpayers’ rights, 1780–1914, funded by the Leverhulme Trust, which support is gratefully acknowledged.

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N

O ONE LIKES to pay taxes. One of the few constants in the history of taxation is that a new tax or an increase in the rate or scope of an old one will almost invariably be met with disfavour and complaint by the taxpayers who are to be charged to it. Notions of public duty, shared responsibility and overall confidence in government, however, balanced such resentments and taxation in most cases was accepted with resignation as a necessary evil. By the dawn of the modern era of direct taxation in the nineteenth century this somewhat delicate balance was well on the way to becoming established.2 There existed, however, certain principles of taxation which, if a Government attempted to breach them, raised the strongest criticism and resentment among a significant proportion of the taxpaying public. So if the process of implementation of a tax was inquisitorial, or if it was administered by central government, it was regarded as having breached fundamental canons of taxation to the extent of unconstitutionality. These were only two of a number of such canons of taxation,3 but they were the two which were particularly valued in nineteenth-century England. Their breach provoked the most vehement outcry in Parliament, in the press and among taxpayers in public meetings, the most sustained popular resistance and the most equivocal response by the Government. They were canons which were not unknown in France and America at the same period, but reactions to their breach were sufficiently different as to throw the English attachment to them into the strongest relief. The object of this paper is to examine the reasons why these two canons were of such importance to the English, and through them to explore the legal and popular conceptions of the constitutionality of tax in the nineteenth century. It will be seen how such charges of unconstitutionality were justified as an absence of consent, how this influenced the legislative policies of nineteenth-century governments, and the impact of such legislative policies on the overall protection afforded to the English taxpayer. American and French comparisons are drawn to reveal the relative importance of the canons in English taxation and thereby the essential character of the English system, and the impact of differing fiscal, constitutional, political and cultural conditions on the administration of taxes.

2

See M Daunton, Trusting Leviathan (Cambridge, 2001) 6–27. Others were that direct taxes should be necessary, and that they should be voluntary. Both these canons were swiftly and effectively breached in the nineteenth century. Though it gave rise to intense opposition, that opposition was relatively brief and direct taxes which were not necessitated by a national emergency, and were compulsory, were ultimately accepted as part of the fiscal pattern. 3

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2. INQUISITORIAL AND CENTRALISED TAXATION

Inquisitorial machinery was one of the features which the English taxpayer found the most objectionable, and which he invariably condemned. It was generally believed that the machinery of taxation ought to be benign and trusting, that it should ask for the minimum amount of the most general information, which the taxing authorities should be prepared to accept at its face value with no further inquiry. Any entry into one’s house or property, any demand for a detailed statement of one’s financial affairs, any right vested in an administrative officer to inquire into them, and any examination on such matters, on oath or otherwise, were all regarded as unacceptable. The authors of all direct taxes faced a particular challenge in this respect. William Pitt and Robert Peel both had to adopt income taxation to meet urgent national demands, and both were acutely aware that to tax incomes and profits effectively and with any degree of accuracy the machinery of implementation had to be inquisitorial. In the debate on the repeal of the house and window taxes and whether they should be replaced by a property and income tax in 1833, Peel admitted that the latter would necessarily entail a ‘rigorous inquisition’, a ‘severe and unsparing scrutiny’ into men’s property.4 As the respected French economist, Henri Baudrillart, observed in 1871, with regard to income tax the state was either an inquisitor or a fool and there was no effective middle way.5 Pitt, Addington, Peel and Gladstone necessarily gave the bodies charged with the administration of the income tax varying degrees of inquisitorial power. The English tax system accordingly included a number of inquisitorial processes, which provided a fruitful source of taxpayer complaint. Taxpayers had to provide lists, declarations and sometimes detailed statements under the various assessed taxes and income tax statutes and endure visits by officials to inspect certain taxable property. If the assessing officials doubted the accuracy of a statement or if a taxpayer appealed they could make enquiries and demand further information. Witnesses could be examined on oath, and the taxpayer himself could be summoned to be examined or to swear to the truth of his statement, depending on the tax in question. Such processes were clearly inquisitorial. Of equal importance to the English taxpayer was the right to have his taxes administered in his community by lay commissioners representing him. He saw this as one of his major and original safeguards, with such local commissioners holding the balance between him and the Crown, ensuring the latter received no more and no less than was legally due. A tax administered by central government, and so breaching this principle of 4 5

Parliamentary Debates vol 17, ser 3, col 816, 30 April 1833 (HC). H Baudrillart, ‘L’impôt sur les Revenus’ (1871) 96 Revue des Deux Mondes 894 at

920.

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localism, was, like an inquisitorial tax, strongly condemned. This was so whether the tax was inquisitorial or not, but the horror of the former was intimately associated with the nature of the persons entrusted with its execution and it was significantly compounded if that was in the hands of central government. Just as direct taxes had to be inquisitorial to a degree if they were to be successful, so they had to be efficiently and uniformly administered. Localism, however, embodied independent, and therefore variable, action. Centralism, on the other hand, stood for uniformity and strong, focused control. Only the latter could provide the government with a uniform and efficient administration of taxes to provide the greatest yield of taxation and a steady and predicable flow of revenue to the Treasury. As the nineteenth century progressed, with its growing commercial complexity and sophistication, so the system of local administration by part time amateur laymen became increasingly inadequate. It was, said the Board of Inland Revenue in 1869, an ‘antiquated, cumbrous, and inefficient system’.6 So entrenched was the principle of localism in tax administration, both ideologically and practically, that there was no question of outright abolition, even though taxpayers themselves often complained about the shortcomings of the system. Accordingly the challenge was piecemeal, principally insidious though occasionally overt. Centralism grew almost unnoticed. The surveyor gradually but inexorably came to dominate the local commissioners, and therefore the administrative process itself, through his superior knowledge and expertise. The executive made numerous attempts to assume the duties of local bodies within the orthodox system. Occasionally the inadequacy of the local commissioners was formally addressed by legislation, notably by the introduction of the surveyor in the assessed taxes in the eighteenth century, the increase in the jurisdiction of the Special Commissioners in the mid nineteenth century and the many attempts in the early twentieth century to give assessing and collecting functions to Inland Revenue officials. Though the principle of localism was nevertheless retained almost entirely in theory, in practice the surveyor became the ‘pivotal figure’ in the income tax administration.7 Inquisitorial and centrally-administered taxes were not peculiar to England. In the nineteenth century both America and France showed both features at least to the same degree, and indeed sometimes exceeding it. In

6 ‘Twelfth Annual Report of the Commissioners of Inland Revenue’ House of Commons Parliamentary Papers (1869) (4049) xviii 607 at 635. See too ‘Sixth Annual Report of the Commissioners of Inland Revenue’ House of Commons Parliamentary Papers (1862) (3047) xxvii 327 at 344–5, 350; ‘Thirteenth Annual Report of the Commissioners of Inland Revenue,’ House of Commons Parliamentary Papers (1870) (82) xx 193 at 207; letter from a surveyor in The Times, 27 Jan 1873 p 12 col b 7 ‘Report of the Royal Commission on the Income Tax’, House of Commons Parliamentary Papers (1920) (615) xviii 97 para 375.

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France, the three principal direct taxes of the Ancien Régime, the taille, vingtièmes and capitation, and their administration by royal officials, the intendants,8 were strikingly inquisitorial. The main tax on land, the taille, was administered by commissioners who visited and reported on each parish, and gathered individual declarations as to their lands and all income, all in the context of publicity and penalties.9 Though the Revolutionary Government detested the inquisitorialism of the Ancien Régime and chose forms of taxation which kept it to a minimum, a degree of such process was inevitable because even visible property had to be both recorded and valued. In the nineteenth century the principal officials in the assessment of the direct taxes, the comptrolleurs, spent much of their year touring their district keeping the original tax registers up to date. To do this they had access to all official registered information on purchases and transfers of property, information on earlier assessments, and also visited the properties, gathered the views of the local assessors and interviewed taxpayers.10 France also experienced centralism in tax administration. In contrast to England’s relatively minor and piecemeal centralism, however, France’s was dominant. Under the Ancien Régime the unpopular intendants were powerful tools of centralised power, representing the state in every district in France in a very active and real sense, and effectively crushing local autonomy.11 And when Napoleon came to power, the administrative state he introduced was as highly centralised as Louis XIV’s had been.12 Paris was the source of all legislative power and effect and the system ensured that laws were implemented uniformly and obeyed throughout France. The département was the principal unit of administration, headed by the préfet who was the embodiment of central authority, answerable entirely to the minister in Paris and so totally loyal to the state. Indeed the préfet was as much a creature of central government as the old intendant. It was an uninterrupted chain of authority and command from the minister to the mayor.13 For the administration of direct taxation this took the form of a

8 In the pays d’éléctions: A de Tocqueville, The Ancien Régime and the French Revolution (tr Stuart Gilbert) (London, 1966) 64–6; Ma Marion, Dictionnaire des Institutions de la France aux xvii et xviii Siècles (1923 edn) (Paris, 1968) 293–9. In the pays d’états the king could levy taxes only through the provincial assemblies. 9 See J Brissaud, A History of French Public Law (South Hackensack, NJ, 1969) 497. 10 R Stourm, The Budget (tr Thaddeus Plazinski, ed WF McCaleb) (New York and London, 1917), 394–7. 11 See Brissaud, Public Law, above n 9, at 406–13. 12 See generally L Bergeron, France under Napoleon (tr RR Palmer) (Princeton, NJ, 1981) 37–51; A Forrest, The French Revolution (Oxford, 1995) 57–64. 13 J de Malafosse, Histoire des Institutions et des Régimes Politiques de la Révolution a la IVe République (Paris, 1975) 31–2; C Dupont-White, ‘L’Administration Locale en France et en Angleterre’ (1862) 38 Revue des Deux Monde, 289 at 291; see generally P Leroy-Beaulieu, L’Administration Locale en France et en Angleterre (Paris, 1873).

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hierarchy of salaried professional officials of central government from the directors in Paris, through the inspectors and comptrollers to the collectors.14 The principal taxes paid by Americans in the nineteenth century were state taxes on specific, visible property,15 and these, like those in England and in France, were inquisitorial to some degree. They involved an assessor calling at each house to obtain a statement or list, often under oath, setting out the taxpayer’s property, with a description and value.16 Land could be viewed, statements sworn to and witnesses examined.17 The federal Government was limited in its ability to raise direct taxes by the constitution18 but, just as Pitt had to explore all fiscal instruments to raise sufficient finance for the war against France, so did John Adams. Pitt looked to an income tax, Adams to a direct federal tax on property. This too was inquisitorial to an extent. Under the 1798 legislation taxing houses, land and slaves, owners had to deliver detailed returns of the situation, dimensions and building materials of their houses19 and similarly a tax of 1813 on gold, silverware, jewellery and watches required taxpayers to

14 See Stourm, The Budget, above n 10, at 393–421; see generally G Ellis, The Napoleonic Empire (Basingstoke and London, 1991) 26–35. 15 Most states taxed one or more of the following: land and buildings, farm stock, money, slaves, the stock in trade of merchants and personal property in general. Some imposed a poll tax and one a general income tax. See generally ‘Papers respecting the taxation of personal property in France, Germany, and the United States’ (1886) House of Commons Parliamentary Papers (4909) lii 851 at 866–7; ‘Reports as to the taxation of land and buildings in European countries and the United States of America’ (1890–91) House of Commons Parliamentary Papers (6209) lxxxiii 555; RT Ely, Taxation in American states and Cities (New York, 1888); S Benson, ‘A History of the General Property Tax’ in GCS Benson et al., The American Property Tax: its History, Administration, and Economic Impact (California, 1965). 16 For the process in Texas in the mid-nineteenth century, see the evidence of Ashbel Smith, secretary of state in Texas, in ‘Minutes of Evidence taken before the Select Committee on the Income and Property Tax’ (1852) House of Commons Parliamentary Papers (354) ix 1 at qq 2149, 2152 [hereafter ‘Minutes, 1852’]. See generally ‘Papers Respecting the Taxation of Personal Property in France, Germany, and the United States’ (1886) House of Commons Parliamentary Papers (4909) lii 851 at 865–9. 17 ‘Papers Bearing on Land Taxes and on Income Tax etc. in certain Foreign Countries, and on the Working of Taxation of Site Values in certain Cities of the United States and in British Colonies, together with Extracts relative to Land Taxation and Land Valuation from Reports of Royal Commissions and Parliamentary Committees’ (1909) House of Commons Parliamentary Papers lxxi (4750) 365 at 458 [hereafter ‘Papers Bearing on Land Taxes, 1909’]; ‘Reports as to the Taxation of Land and Buildings in European Countries and the United States of America’ (1890–91) House of Commons Parliamentary Papers (6209) lxxxiii 555 at 626–7. 18 And had traditionally preferred to rely on indirect taxation: H Carter Adams, ‘Taxation in the United States 1789–1816’ in HB Adams, Institutions and Economics, vol 2, (Baltimore, 1884). 19 Act of 9 July 1798, 5 Cong, 2 sess, ch 70 ss 8, 9; see too Act of 14 July 1798 5 Cong, 2 sess, ch 75.

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provide complete inventories of their property.20 The federal income tax of the Civil War depended on the written return of income by the taxpayer, on oath, which was checked by the assessor by investigation and who had the power to enter the taxpayer’s premises if no return was forthcoming.21 The question of centralism in tax administration in America was more complex since it could mean state or federal centralism. To implement the state taxes22 most states employed a system that involved a significant degree of centralism.23 The assessing and collecting officers were directly responsible to the town authorities and indirectly to county and state authorities, or else directly to the state authorities.24 They formed part of a clear hierarchy of local government officials, from the state fiscal officers of comptroller-general, the board of equalisation and the treasurer, through the auditors, boards of supervisors, assessors, collectors and treasurers of the counties, cities and towns. As such they were not entirely independent of the control of the central tax authority. The federal government at the end of the eighteenth century would ideally have used the state machinery to administer their direct taxes, but an enquiry by Oliver Wolcott in 1796 showed that the tax systems of the various states were ‘utterly discordant’ and could not be reconciled for use for federal purposes.25 Though Congress had to establish new machinery as there was none for federal taxes, it experimented with different systems. It was politically necessary to recognise the importance of localism, and all systems were composite in nature, incorporating elements of localism and centralism. In 1798 the preferred approach was to put the delicate valuation stage in the hands of centrally appointed commissioners using local assessors, while the subsequent assessment and collection were the responsibility of the existing officials of the federal internal revenue duties.26 For the federal direct tax

20 Act of 22 July 1813, 13 Cong, 1 sess, ch 16 (assessment and collection); Act of 2 Aug 1813, 13 Cong, 1 sess, ch 37 (apportionment). 21 Act of 1 July 1862, 37 Cong, 2 sess, ch 119 ss 6, 7, 9, 10, 11. The oath was introduced in 1864 by the Act of 30 June 1864, 38 Cong, 1 sess, ch 173 s 118. 22 In the state of New York these were three distinct taxes for three distinct purposes, collected at same time by the same machinery on the same basis of assessment: see the evidence of Dudley Selden of New York, sometime barrister and member of Congress: ‘Minutes, 1852’ q 1901. 23 The state property taxes differed, often considerably, in their detail, but most followed the same general principles of administration. See, for example, CJ Bullock, ‘The Taxation of Property and Income in Massachusetts’ (1916) 31 Quarterly Journal of Economics no 1, 1; Laws of the General Assembly of the Commonwealth of Pennsylvania (Harrisburg, 1885). 24 In West Virginia, for example, they were closely instructed and controlled by the state auditor and supervised in the process by the county court. See JS Miller, Laws of the State of West Virginia relating to Assessments, Taxes, Licenses, Collection of Taxes, Sales of Delinquent Lands and Forfeited Lands, in force in 1883, (Wheeling, 1883) para 5. 25 American State Papers: Finance, vol 1, 4 Cong, 1 sess, 413–41 at p 437 (13 Dec 1796). 26 The administrative system supporting the new tax was found in two Acts of July 1798. The Act of 9 July 1798, 5 Cong, 2 sess, ch 70 provided for the valuation of land and the

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of 1813 and the Civil War direct taxes of the 1860s a different approach was adopted, whereby each state was allocated its quota of the tax which it raised by its own machinery, with a federal bureaucratic structure acting as a default mechanism, and as the machinery for the Civil War income tax.27 The necessary central control was provided by the regulations of the Secretary of the Treasury and the supervision of a Commissioner of the Revenue.28 In that central office lay the origins of the Internal Revenue Service.29

3. POPULAR OBJECTIONS

In all three jurisdictions, therefore, in England, America and France, inquisitorial and centrally-administered taxes were known. Taxpayers and governments differed, however, in their responses and attitudes to these features. In England the dislike of inquisitorial processes was a general, even universal, feeling.30 Indeed Adam Smith’s denunciation of it as insupportable is well known.31 The house and hearth tax was condemned as ‘unjust in principle, oppressive in detail, inquisitorial and vexatious in its imposition and collection, and…susceptible of no modification which would take away its objectionable character’.32 The income tax was described as ‘odious’,33 ‘vexatious’,34 ‘arbitrary’,35 ‘immoral’,36 ‘cruel’,37

enumeration of slaves and the Act of 14 July 1798 5 Cong, 2 sess, ch 75 provided for the apportionment and collection of the tax on houses, land and slaves. 27 Act of 22 July 1813, 13 Cong, 1 sess, ch 16 (assessment and collection); Act of 2 Aug 1813, 13 Cong, 1 sess, ch 37 (apportionment); Act of 5 Aug 1861, 37 Cong, 1 sess, ch 45; Act of 1 July 1862, 37 Cong, 2 sess, ch 119; Act of 30 June 1864, 38 Cong, 1 sess, ch 173. 28 The officials acted under the binding regulations of the Secretary of the Treasury: see Act of 22 July 1813, 13 Cong, 1 sess, ch 16, s 4 ; Act of 5 Aug. 1861, 37 Cong, 1 sess, ch 45, s 12; Act of 1 July 1862, 37 Cong, 2 sess, ch 119, s 6; Act of 30 June 1864, 38 Con, 1 sess, ch 173, ss 8, 12. The office of Commissioner of the Revenue was created by the Act of 24 July 1813, 13 Cong, 1 sess, ch 22. See too Act of 5 Aug 1861, 37 Cong, 1 sess, ch 45, s 56; Act of 1 July 1862, 37 Cong, 2 sess, ch 119, s 1; Act of 30 June 1864, 38 Cong, 1 sess, ch 173, s 1. 29 See Act of 1 July 1862, 37 Cong, 2 sess, ch 119, s 89; Act of 30 June 30 1864, 38 Cong, 1 sess, ch 173. See, generally, L Doris (ed), The American Way in Taxation: Internal Revenue, 1862–1963 (New Jersey, 1963). 30 Parliamentary Debates, vol 62, ser 3, col 140, 8 April 1842 (HC) per Sir W Somerville. 31 A Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776) (Edwin Cannan ed, 1904; Chicago, 1976), Book V Chap II, Pt II 375–6. 32 Parliamentary Debates, vol 17, ser 3, col 764, 30 April 1833 (HC) per Sir John Keys. 33 Ibid, vol 61, ser 3, col 980, 21 March 1842 (HC) per Lord Dalmeny. 34 Ibid, col 1140, 23 March 1842 (HC) per Dr Bowring. 35 Ibid, vol 62, ser 3, col 130, 8 April 1842 (HC) per Mr P M Stewart. 36 Ibid, col 143 per Mr Sheil. 37 Ibid, col 1025, 22 April 1842, (HC) per Mr Wakley.

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‘harassing’,38 ‘mischievous’,39 ‘disgusting’,40 ‘demoralising’41 and ‘impolitic’.42 Its process was referred to as a ‘system of espionage’,43 as ‘nefarious machinery’44 and its personnel as ‘spies and informers’.45 Such emotive language reflected the strength of popular feeling: the term ‘inquisition’ suggested torture, the term ‘spies’ dishonest dealings.46 To cheers in the House of Commons in 1842 one member said that: [t]he evils of the Income-tax are so monstrous, that it is almost impossible to heighten them—they set hyperbole at defiance…an impost…which…is the most prejudicial to the interests, offensive to the feelings, abhorrent to the religious sentiments, and revolting to the moral sense of the English people.47

The objection to the income tax was not to the imposition itself but, in the words of ‘A Northern Freeholder’ in 1806, to ‘the disclosure of circumstances, which ought not to be disclosed at all’.48 In an age which valued individual independence and as such was concerned more with the machinery of tax than its substance, the objection was to the laying open of an honest man’s affairs to the gaze of his neighbours, friends, family, creditors and business colleagues. It was an abhorrent invasion of privacy which gratified either animosity or idle curiosity in those administering it49 and the disclosure of a man’s personal misfortunes to ‘a set of heartless functionaries’50 would lead to pain and humiliation.51 It was particularly resented by commercial men, since any disclosure of their financial affairs might impair their ability to attract credit and, ultimately, their livelihood. The reason for the particularly intense resentment felt by English taxpayers was said to lie in the national character.52 The general perception was that the English were particularly averse to interference and inquiry into their private affairs. At the end of the eighteenth century Charles Abbott maintained it was more pronounced in England than in any other country

38

Ibid, col 1032 per Mr Christie. Ibid. Ibid. 41 Ibid, col 1082, 25 April 1842 (HC) per Mr Hume. 42 Ibid. 43 Ibid, vol 61, ser 3, col 1272, 4 April 1842 (HC) per Mr Wallace, who had been a commissioner under the earlier income tax. 44 Ibid, vol 62, ser 3, col 694, 18 April 1842 (HC) per Mr T Duncombe. 45 Ibid vol 61, ser 3, col 1267, 4 April 1842 (HC) per Mr M Gibson. 46 Parliamentary History, vol 34, col 89, 14 Dec 1798 (HC) per Mr Simeon. 47 Parliamentary Debates, vol 62, ser 3, cols 152–3, 8 April 1842 (HC) per Richard Sheil. 48 Letter from ‘A Northern Freeholder’ on the Property Tax, 22 April 1806, Cobbett’s Political Register vol ix–x , 1806, at 752. 49 Parliamentary Debates, vol 62, ser 3, cols 406–7, 13 April 1842 (HC) per Mr O’Connell. 50 Ibid col 151, 8 April 1842 (HC) per Mr Sheil. 51 Ibid col 143. 52 Parliamentary Debates, vol 64, ser 3, col 30, 17 June 1842 (HL) per Lord Lansdowne. 39 40

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in Europe,53 and called it ‘a prejudice which universally existed’.54 The French Revolution had had a significant impact in this respect, as it had encouraged a measure of both national and personal insularity. The English reaction to centralised administration was just as strong and attempts at its introduction were invariably seen as vicious.55 Newspaper headlines such as ‘Hunting the Taxpayer: Safeguards to be Withdrawn’56 and ‘A Principle at Stake’57 were typical, and the Income Taxpayers’ Society was founded to protect the rights and liberties of English taxpayers in the face of such attacks.58 The French did not like inquisitorial taxes any more than the English. They hated any attempt to interfere with their personal liberty and privacy and were also sensitive to disclosure. Indeed, the French themselves believed they disliked inquisitorial taxes more than anyone else.59 It is true that French legislators tried to avoid it as far as possible. Even in the Ancien Régime, although the direct taxes were in theory based on both real and personal incomes, they were raised principally on the visible landed element with clear values in order to avoid the inquisitorial process necessary for the accurate levy of a tax on other income.60 This approach was continued after the Revolution, with its four new taxes being based on the objective and pre-determined value of property so that they could be ascertained without close inquiry or verification by central government.61 But when taxes were inquisitorial the reaction of the French was considerably more extreme than in England. When in 1841 the Government ordered a recensement, an updating of the basis of the taxes on houses, business premises, horses, servants, doors and windows, the reaction of the taxpaying public was extreme.62 The powers of entry and inspection given

53 Parliamentary History, vol 34, col 146, 31 Dec 1798. See too A Smith, Lectures on Justice, Police, Revenue and Arms (1763) (Edwin Cannan ed) (Oxford, 1896) 240. 54 The Times 1 Jan 1799. 55 So called in The Times, ‘A Principle at Stake’, 18 March 1920, p 17, col c. 56 Ibid 20 April 1921, p 11, col f. 57 Ibid 18 March 1920, p 17, col c. 58 Ibid, Leader, ‘Protection for the Taxpayer’, 28 July 1921, p 11 col e. 59 H Baudrillart, ‘L’impôt sur les Revenus’ above n 5 at 920. 60 The alternative was an arbitrary assessment, which was equally unacceptable. See R Stourm, Les Finances de l’Ancien Régime et de la Révolution, 2 vols, first published Paris, 1885 (New York, 1968), vol 1 238–44. 61 They were prélèvements indiciaires, namely taxes levied on the basis of visible property with a clear and pre-determined value. See B Brachet, Le Système Fiscal Francais (2nd edn, Paris, 1988) 43–4. The contribution foncière was a quota tax like the taille and like the American and English land taxes. The total sum to be raised was fixed by central government and it was shared out between the departments, districts and communes. The contribution personelle et mobilière on houses, horses, servants and carriages resembled the English assessed taxes: see Stourm, Finances vol 1, above n 60, at 245–56. For the patente, the tax on trade or commerce, see ibid, 275–94. 62 See F Ponteil, ‘Le Ministre des Finances Georges Humann et les Emeutes Antifiscales en 1841’ (1937) 179 Revue Historique 311.

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to the tax officials were described as ‘dures et inquisitoriales’ constituting an ‘effroyable invasion du fisc dans la commune’.63 All over France there were noisy and often violent demonstrations.64 Tax officials were attacked, stoned, pelted with fruit, and their houses burned.65 The refrain of a popular song, entitled ‘Dialogue between a Tax Inspector and a Taxpayer’ was ‘No, you will not enter!’.66 Nineteenth-century England never saw tax riots of this nature, even in the 1870s when resentment of income tax was at its height. The intense dislike of an inquisitorial tax was again revealed when the tax on commerce and industry, the patente,67 was reformed in 1844.68 An assessment of income and capital invested was unacceptable, raising ‘the seemingly everpresent Gallic stereotype of taxman as grand inquisitor’,69 and so it was accepted that it was to be assessed partly on the rental value of the business premises. The dislike of inquisitorial process and the desire for privacy endured as it did in England, and, according to an American commentator, was a major factor in the rejection of the French income tax of 188870 and one of the reasons why a general income tax was not implemented in France until 1917. The French, however, did not show the same dislike of centralism in tax administration as did the English. Public and official opinion showed a preference for it, liking the uniformity and control it provided,71 and regarded it as the best means of efficient local government. Central government saw localism as dangerous, as undermining the administrative unity achieved by the constitution and potentially leading to anarchy.72 Accordingly the demand for localism in French taxation was neither consistent nor strong, and when it was introduced taxpayers neither liked it nor particularly valued it.73 There had been a tradition of local involvement in the taille, with elected taxpayers taking it in turn to assess

63

Ibid 321. Ibid 322–4. Ibid 331–44. 66 Ibid 337. 67 It dated from 1798, and comprised a fixed charge based on the type of business and the size of the local population, and a charge based on the rent paid for the business premises. 68 RL Koepke, ‘The Loi des Patentes of 1844’ (1980) 11 French Historical Studies, no 3 398. 69 Ibid 412. 70 H Parker Willis, ‘Income Taxation in France’ (1895) 4 Journal of Political Economy no 1 37–53 at 52. 71 Koepke, ‘Loi des Patentes’, above n 68, at 414. 72 Ponteil, ‘Le Ministre des Finances’, above n 62, at 351–2. Throughout most of the nineteenth century France was in a state of political turmoil, moving from the Revolution to Consulate, Empire, Restoration, the July Monarchy, the Second Republic, the Second Empire and the Third Republic. Between 1789 and 1875 it issued 11 constitutions: see generally M Duverger, Le Système Politique Francais (Paris, 21st edn, 1996) 21–105. 73 Stourm, Finances, vol 1, above n 60, at 176. 64 65

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and collect it,74 but the system was corrupt and universally detested75 and had largely disappeared under the Ancien Régime. However, centralism was ideologically opposed to revolutionary principles and in taxation was contrary to the express provision of the constitution.76 The administration of tax by taxpayers themselves was regarded as a sacred trust, which the elected representatives of the people should not share with anyone else, and it was accordingly reintroduced for the new land tax from 1790.77 This venture into localism proved to be merely temporary, because Napoleon, unwilling to accept a large and growing deficit caused by the failure to collect the tax,78 introduced his highly centralised system. The element of local participation retained in his system was both limited and strictly controlled.79 The central tax officials acted with local officials and residents, the répartiteurs, in making the individual assessments.80 Localism was, therefore, not entirely rejected in France, and indeed had some popular support. Though the 1841 riots over the recensement were principally in opposition to an inquisitorial tax, they were also an expression of French localism and a resentment of the control of central government. Even those who acknowledged the need for the recensement could not approve of central revenue officials entering private homes.81 The reform of the patente in 1844 was equally revealing of French attitudes to localism, with some pressure to make the involvement of the mayor in the assessment of rental values of business premises compulsory, a demand rejected by a Government mindful of the potential disruption caused by an uncooperative mayor. It was left as a voluntary participation in the process,82 but was itself a concession to demands for a measure of localism in taxation. The desire for localism was also illustrated by a demand, though again unsuccessful, to have the prefect deciding any dispute between the government assessor and the mayor rather than an 74 de Tocqueville, The Ancien Régime, above n 8, at 66; Brissaud, Public Law, above n 9, at 446–7. 75 Stourm, Finances, vol 1, above n 60, at 92–5. 76 The constitution of 1793 provided that ‘Tous les citoyens ont le droit de concourir à l’établissement des contributions, d’en surveiller l’emploi, et de s’en faire rendre compte’ J Godechot (ed), Les Constitutions de la France depuis 1789 (Paris, 1970) 82. 77 Stourm, Finances, vol 1, above n 60, at 147–51. Collection was in the hands of persons who had successfully tendered for it. See ibid vol 1 157–8. The collection of tax by tender was essentially a private enterprise and as such bore a resemblance to the corrupt tax farmers of the Ancien Régime. 78 It had failed because it demanded too much of the unpaid elected officials: see M Marion, ‘Le Recouvrement des Impôts en 1790’ (1916) 121 Revue Historique 1 at 12–13; see generally PM Jones, The Peasantry in the French Revolution (Cambridge, 1988) 168–80. 79 Stourm, Finances, vol 1, above n 60, at 178–80; Stourm, The Budget, above n 10, at 395–6. 80 See ‘Papers respecting the Taxation of Personal Property in France, Germany, and the United States’ (1886) (4909) House of Commons Parliamentary Papers lii 851 at 854, 856. 81 Ponteil, ‘Le Ministre des Finances’ above n 62, at 324–8. 82 Koepke, ‘Loi des Patentes’, above n 68, at 413–4.

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agent of the Ministry of Finance. Though both were officials of central government, the prefect was at least in theory a representative of the locality. Whereas the English reaction to inquisitorial taxes was bitter and vocal, and that of the French was on occasion violent, that of the American taxpayer was more sanguine. It was not because they were indifferent to inquisitorial taxes. James Bayard observed in Congress in 1798: it was not so much the letter of a tax law which was offensive to the people, as the hand of the tax gatherer which compelled them to pay.83

Similarly in 1813, Charles Ingersoll remarked that the mode of collection was ‘an article of the utmost delicacy and importance. It is collection’, he said, ‘with all its domiciliary visits and examinations, that disgusts people more than the amount of their contributions’.84 A furniture tax in 1814 was called ‘an inquisition into private property’ and ‘vexatious’85 and an income tax in 1870 was said to be ‘at war with the right of a person to keep private and regulate his business affairs and financial matters’.86 The damage which could be caused to commercial men by the disclosure of their financial situation for the state property taxes was understood as it was in England,87 and when information under the Civil War income tax was disclosed there was sufficient public resistance to ensure that it was prohibited by later legislation. Nevertheless American taxpayers were more accepting of disclosure than the English, for two reasons. First, they were not subject to highly inquisitorial taxes. Their principal direct taxes for most of the nineteenth century were the state taxes, which were generally relatively non-inquisitorial property taxes similar to the English land tax, and as such more benign than the income tax which had been imposed in England so early on. Second, it was recognised that American taxpayers had a different attitude to the disclosure of their private financial affairs. They were generally less exercised by the matter of disclosure, probably because American society was considerably more democratic than that of England, and questions of appearances in society or commercial life were of less moment. The systems put in place for the administration of tax reflected this more accepting attitude since there was significantly more provision for the publication of personal tax information.88

83

Annals of Congress, 5 Cong, 2 sess, 1231, 5 Mar 1798. Ibid, 13 Cong, 1 sess, 367, 29 June 1813. 85 Ibid, 13 Cong, 3 sess, 456, 24 October 1814 per Mr Wright. 86 Congressional Globe, 41 Cong, 2 sess, 3993, 1 June 1870 per Mr McCarthy. 87 See the evidence of Colonel Benjamin P Johnson in ‘Minutes, 1852’, qq 2040; 2065–7. 88 Act of 9 July 1798, 5 Cong, 2 sess, ch 70 (federal direct tax on land slaves and houses); Miller, West Virginia, above n 24, at para 79 (state direct taxes); JA Hill, ‘The Civil War Income Tax’ (1894) 8 Quarterly Journal of Economics, no 4 416–52 at 436 (federal income tax). 84

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The American reaction to centralism was more complex than in England or France, primarily because of the constitutional framework of the country. The Americans felt a profound attachment towards their own particular state rather than the federal government. It was an attachment which led them to prefer state administration and institutions, indeed regarding their own assemblies much as the British regarded their own Parliament.89 The nature of the constitutional structure of the United States reflected this, since it provided that the states retained all powers that they chose not to assign to the federal government. This found fiscal expression in the dominance of state property taxation over federal taxation and the limitation of the federal government’s power to tax.90 It was, therefore, to a significant extent an institutionalised localism where local allegiances were recognised and the power of the central government strictly circumscribed. This constitutional provision tended to reduce potential tensions between localism and centralism since in theory there was no question of federal officers concerning themselves at all with state taxation. Nevertheless the American taxpayer resented federal taxes collected by federal officers. Their dislike was clearly revealed during the extensive debates in the early 1860s on the Civil War scheme of federal direct and income taxes.91 Indeed they had never liked this kind of centralism, objecting to British officials collecting the new import duties in America in 1767 and equally after independence objecting to the implementation of the hated whisky excise by federal officers. Roscoe Conkling found the ‘army of officers’ collecting the Civil War taxes an ‘obnoxious’ feature of the legislation,92 since it would deprive every State of the power to collect this tax by the mode known to its laws, out of all property taxable within its jurisdiction. It will supersede entirely the old-fashioned, economical system of laying and collecting taxes which our people are accustomed to and approve of, and puts in its place a system more unendurable than the tax itself.93

89 D Ramsay, The History of the American Revolution (ed LH Cohen) (Indianapolis: Liberty Classics, 1990) 18–19. 90 Article 1 of the federal constitution provided that ‘The Congress shall have power to lay and collect taxes, duties, imposts and excises, pay the debts and provide for the common defense and general welfare of the United States; but all duties, imposts and excises shall be uniform throughout the United States’; and that ‘No capitation, or other direct tax shall be laid, unless in proportion to the census’. For the ideological, political and pragmatic reasons for these provisions, see W Elliot Brownlee, Federal Taxation in America (2nd edn, Cambridge UKand Washington DC, 2004) 13–21. 91 See, generally, Charles F Dunbar, ‘The Direct Tax of 1861’ (1889) 3 Quarterly Journal of Economics, no 4 436; Hill, ‘Civil War Income Tax’ above n 88, at 416–52. 92 Congressional Globe, 37 Cong, 1 sess 247, 24 July 1861 per Roscoe Conkling. 93 Ibid, 25 July 1861 at 272.

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He wanted state administration rather than a ‘myriad of Federal emissaries’,94 a ‘mammoth machine’.95 As a result of this strength of feeling the federal government adopted a system whereby each state was given the option to raise its own quota of the direct tax by its own machinery and that federal officers would only be used if the state refused to do so.96 It still needed to establish a federal bureaucratic structure to act as a default system for the direct taxes and to administer the new income tax.97 It has been seen that it created a sensible and effective composite system.

4. CONSTITUTIONALITY

The reason why the English felt breaches of these canons so intensely was that they felt far more than mere natural dislike of an inquisitorial or a centrally-administered tax. French and American taxpayers resented those features of a tax, and while they complained about them, often strongly, on the whole they accepted them with relatively short-term opposition, much as the English had to accept involuntary and routine direct taxation. To the English, however, their breach was a breach of the constitution. Their criticism was invariably couched in terms of constitutionality. The inquisitorial nature of the excise was ‘hardly compatible with the temper of a free nation’,98 and that of the triple assessment was ‘not consistent with…the principles…of civil liberty’,99 ‘absolutely repugnant to the principles of a free constitution’100 and ‘contrary to the customs and prejudices of Englishmen, and repugnant to the principles of the constitution’.101 The triple assessment, being involuntary, even retrospective, was contrary ‘to every rational idea of liberty’.102 To many people even the mildly inquisitorial provisions of Pitt’s income tax of 1799 were frankly unconstitutional. Michael Taylor saw it as an invasion of the sacred right of private property. ‘It was upon the strength of that principle’, he famously said, that every man’s house was called his castle…but here a spy comes, not only into the House, but opens the bureau of every man, and becomes acquainted with his

94

Ibid at 285. Ibid at 286. 96 Act of 22 July 1813, 13 Cong, 1 sess, ch 16 (assessment and collection); Act of 2 Aug 1813, 13 Cong, 1 sess, ch 37 (apportionment). 97 Act of 5 Aug 1861, 37 Cong, 1 sess, ch 45 s 49. 98 W Blackstone, Commentaries on the Laws of England (ed E Christian) (15th edn, London, 1809) Book 1, ch 1 317. 99 Parliamentary History vol 33, col 1149, 3 Jan 1798 (HC) per Mr Nicholls. 100 Ibid col 1189, 4 Jan 1798 per Mr Hobhouse. 101 Ibid col 1302, 9 Jan 1798 (HL), Protest against the Assessed Taxes Bill. 102 Ibid col 1190, 4 Jan 1798 (HC) per Mr Hobhouse. 95

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most secret concerns. A man must show to this spy his bills, his notes, his bonds, and all his securities. This was monstrous.103

It undermined fundamental freedoms, ‘the principles of Magna Charta and the Bill of Rights; our ancient privileges; our birth-rights as Britons’.104 William Smith echoed the sentiment some years later when he described the income tax as ‘a conscription as vexatious and tyrannical upon property as the other was upon life and men’.105 Sir William Pulteney called it ‘a measure partaking of the spirit of absolute government’106 and Sir John Sinclair felt it was ‘infinitely preferable that we should lose some money, than run the risk of establishing principles abhorrent to that free constitution which this country has hitherto boasted of’.107 Thomas Jones said the inquisitorial power the tax involved was ‘not only unknown to the constitution, but totally subversive of it’.108 A letter from ‘A Northern Freeholder’ in 1806 is typical in its expression of resentment of the inquisitorial processes of the income tax. A taxpayer would be examined in a way which Englishmen in the days of our Alfred, and of William III could never dream that their descendants would be obliged to submit to, so long as they should be under the rule of a British prince, and governed by the ancient laws of the realm.109

When in 1816 it was debated whether the income tax should be repealed, Richard Preston described it as ‘the illegitimate offspring, the bastard of the constitution’.110 ‘Sooner than agree to oppression and unconstitutional taxation of this nature and extent’, he said, he would rather renounce his allegiance and leave the country than be ‘the slave of a tax gatherer at home’. The tax overturned ‘all those rights for which our ancestors bled’.111 Melodramatic maybe, but it illustrated the strength of feeling against the tax, and its perceived foundation in a breach of valued constitutional principles. Charles Buller, one of the most outspoken critics of the income tax, in 1842 insisted that it violated ‘the principles of freedom and the

103

Ibid vol 34, cols 90–1, 14 Dec 1798 ( HC) per Michael Taylor. Letter from ‘A Northern Freeholder’ on the Property Tax, 22 April 1806, Cobbett’s Political Register vol ix–x, 1806 at 752. 105 Parliamentary Debates vol 33, ser 1, col 437, 18 March 1816 (HC) per William Smith. 106 Parliamentary History vol 34, col 136, 27 Dec 1798 (HC) per Sir William Pulteney. 107 Ibid col 84, 14 Dec 1798 per Sir John Sinclair. 108 Parliamentary History vol 34, col 140, 22 Dec 1798 (HC) per Thomas Jones. 109 Letter from ‘A Northern Freeholder’ on the Property Tax, 22 April 1806, Cobbett’s Political Register vol ix–x, 1806 at 751. 110 Parliamentary Debates vol 33, ser 1, col 30, 7 March 1816 (HC) per Mr Preston. 111 Ibid. 104

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British constitution’112 and in the same vein Percy Smythe said it was ‘repugnant … [and] … inimical to the common practice of the Constitution’.113 In just the same way, whenever central government attempted to assume the duties of the local bodies and to take control of the administration of tax, resistance was intense and, of all the canons of taxation, was most consistently criticised on constitutional grounds. When Peel introduced the Special Commissioners to assess commercial income in some cases, Charles Buller observed that the tax was even more unconstitutional now that it included commissioners appointed by the Crown.114 When in 1883 there was an attempt to fill all vacancies in collectorships of commercial and employment income with government officials,115 the member for Manchester called it a ‘striking change, which really aimed at the alteration of…the Constitutional collection of the Income Tax’ and one that tended towards ‘compulsory centralization’.116 William Smith, recalling the words of Sir Robert Peel in 1842, observed that the constitutional principle of localism in tax administration was ‘a sound principle of human nature’.117 When the principle of local collection was again under threat in 1906, the profound implications of any changes in local administration were appreciated118 and The Times called assessment by independent local commissioners representing the taxpayer ‘the cardinal principle of income-tax assessment..119 Again in 1915 a similar proposal was opposed as undermining ‘the constitutional usage of this country’.120 The reason for the intense dislike of centralised tax administration lay in a powerful ideological allegiance to local interests. The English saw the right to assess and collect their own taxes in their own communities as a constitutional right.121 They had always valued local self-government, had a long tradition of it, and its institutions were perceived as enshrining their very liberties. The influence of localism was still immensely strong in the

112

Ibid vol 62, ser 3, col 1101, 22 April 1842 (HC) per Charles Buller. Ibid col 1039 per Percy S Smythe. 114 Ibid col 1001 per Charles Buller. 115 Ibid vol 279, ser 3, cols 488–506, 10 May 1883 (HC). See too BEV Sabine, ‘The General Commissioners’ (1968) British Tax Review 18 at 30–1. 116 Parliamentary Debates vol 279, ser 3, col 492, 10 May 1883 (HC) per John Slagg. 117 Ibid. col 501. A further attempt in 1887 failed: see The Times, Letters to the Editor, 15 Aug 1887, p 14 col a. 118 Parliamentary Debates vol 155, ser 4, cols 1476–7, 25 April 1906 (HC); ibid vol 158, cols 1146–8, 14 June 1906; ibid vol 163, cols 861–2, 30 Oct 1906. 119 The Times, Leader, ‘More Bureaucratic Finance’ 29 Oct 1915 p 9 col b, complaining about the increased power of the Inland Revenue in relation to the excess profits tax. See too The Times, 29 June 1927 p 17 col b. 120 Parliamentary Debates vol 76, ser 5, col 1101, 6 Dec 1915 (HC) per John Butcher. See too The Times, Letters to the Editor, 25 Oct 1915, p 9 col e. 121 See A Farnsworth, ‘The Income Tax Commissioners’ (1948) 64 Law Quarterly Review 372 at 388 where he calls it ‘a sacrosanct constitutional principle’. 113

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nineteenth century.122 The traditional local lay control of the administration of direct national taxes reflected the wider tradition of amateur participation in local government and the administration of justice. Locally-appointed laymen formed the cultural bedrock of both and, accordingly, of the administration of tax. In the sphere of tax this system of self-government was popularly called ‘self taxation’123 or ‘self assessment’. It was not just the veneration of traditional institutions which gave rise to a dislike of central administration124; it was the widespread distrust of central government itself. The excise had always been centrallyadministered and this had always exacerbated the intense popular dislike with which it was regarded.125 This distrust of state interference was particularly intense from the middle of the nineteenth century when there was a considerable increase in the intervention of the state in the individual’s private affairs in an attempt to address the social evils of the period.126 In the tax field, William Blackstone saw how the many executive officers administering various taxes127 had brought the authority of central government into every corner of the country and thereby giving it ‘an influence most amazingly extensive’. An encroaching state served to intensify the perception of the local administration of taxes by an impartial and independent body as an indispensable principle of taxpayer protection. This intense attachment to the local administration of tax was peculiarly English. Its system was undoubtedly sui generis, and its particular character is revealed when compared with France’s highly centralised structures and America’s composite system of local and central administration. When in the late nineteenth century the French began to feel their system of local government was oppressive, they took a lively interest in the English system, and showed a somewhat bemused128 though occasionally envious attitude to ‘self-government’.129 The English ideal of decentralisation, so

122

See D Fraser, The Evolution of the British Welfare State (London, 1973) 109. ‘Twelfth Annual Report of the Commissioners of Inland Revenue’ (1869) (4049) House of Commons Parliamentary Papers xviii 607 at 635. 124 For French comment upon this point, see Dupont-White, ‘L’Administration Locale en France’, above n 13, at 306. 125 It was equally unpopular in the United States: see DW Forsythe, Taxation and Political Change in the Young Nation 1781–1833 (New York, 1977) 38–51 for the failure of the unpopular whisky excise. 126 MW Thomas, ‘The Origins of Administrative Centralisation’ (1950) 3 Current Legal Problems 214. 127 He mentioned the Commissioners of Customs, of Excise, of the Stamps, the postmasters, the officers administering the salt duty, the surveyors of houses and windows, the receivers of the land-tax, the managers of lotteries and the commissioners of hackney-coaches: Blackstone, Commentaries, Book 1, above n 98, at 335. 128 P Leroy-Beaulieu, L’Administration Locale en France et en Angleterre (Paris, 1873) 55–9. 129 See T Zeldin, ‘English Ideals in French Politics during the Nineteenth Century’ (1959) 2 The Historical Journal no 1 40. 123

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strong in taxation, was impossible in France because there was, between the two countries, a fundamental difference in outlook because in France the dominant philosophy was one of centralisation.130 English selfgovernment was part of the fabric of life and engrained in society, having developed through usage over hundreds of years, and finding political acceptance and statutory expression. It depended on the unelected landowning resident Justice of the Peace undertaking public duties for no remuneration, motivated by feelings of public and social obligation and with a strong sense of independence. Furthermore, English local government had no clear hierarchy of counties, boroughs and parishes. In France there existed no local resident landowning aristocracy,131 no concept of unpaid amateurs carrying out a public service,132 and even the central officials who governed the localities in France had no local interests themselves.133 The system of local administration in England depended on a man’s birth or wealth, and did not sit comfortably, or indeed at all, with the ideals of the French Revolution. Independent localism did not, and could not, exist, and the hybrid system of English government could not be imposed in France.134 American state tax administration was in the English tradition,135 the process being in the hands of local lay untrained residents, men of respectability and usually of some property, though always remunerated.136 The key figures, the assessors,137 were generally elected annually in the northern states by the inhabitants and appointed by the state executive in the southern states. Election by popular vote of the inhabitants was an expression of localism which was not even seen in England. Furthermore, as in England, localism extended to the appeals as well as to the original assessments with aggrieved taxpayers appealing to a local body, consisting

130 Duc d’Ayen, ‘De La Constitution Anglaise et des Conditions du Gouvernement Représentatif’ (1862) 39 Revue des Deux Mondes 563 at 567. 131 Dupont-White, ‘L’Administration Locale en France’ above n 13, at 323; LeroyBeaulieu, L’Administration Locale, above n 128, at 17–21. See too H Taine, Notes on England (tr and with introduction by E Hyams, 1860–70) (London, 1957) 140–1, 162–3. 132 Dupont-White, ‘L’Administration Locale en France’, above n 13, at 300. 133 Duc d’Ayen, ‘De La Constitution Anglaise’, above n 130, at 585. 134 M Chevalier, ‘La Constitution de l’Angleterre’ (1867) 72 Revue des Deux Mondes 529 at 534. 135 In 1796 the Secretary of the Treasury, Oliver Wolcott, conducted an exhaustive survey of the nature of the taxes levied in the individual states and their administrative machinery, and his report provides an invaluable insight into the nature and machinery of these taxes: American State Papers: Finance vol 1, 4 Cong, 1 Sess, 413–41 (13 Dec 1796). 136 The assessors were remunerated at a fixed daily rate while in service or by a commission on the sums assessed. In New York in the mid-nineteenth century they earned one dollar and a quarter a day: the evidence of Colonel Benjamin P Johnson ‘Minutes, 1852’ at q 2287. 137 For the process of assessment in West Virginia at the end of the nineteenth century, see Miller, West Virginia, above n 24.

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of the Justices of the Peace, local freeholders, a county body138 or the assessors themselves.139 The English system was accepted as a model only to some extent, however, because the local assessors differed markedly in terms of independence. An American commentator in 1899, looking into the practical workings of the English income tax system on behalf of the Massachusetts Commission on Taxation, noted the contrast with the independence of the tax commissioners in England, and how they were neither responsible to any higher authority nor owing their offices to their fellow taxpayers, not being elected by them. It struck him forcibly that despite their being themselves property owners and taxpayers in the district for which they were appointed, they were not found to favour the taxpayer as against the Crown, and defended the rights of both.140 At a state level, therefore, the system of administration was an integrated one of localism and centralism. The condemnation of inquisitorial and centrally-administered taxes as unconstitutional had a legitimate basis. The principal and the clearest constitutional provision in English law concerning taxation was that of consent. It was a cardinal principle that a tax could only be levied with the consent of Parliament.141 It embodied the fundamental concept of the granting of subsidies to the Crown by Parliament, of a favour, a gift which Parliament could choose to make, or indeed to withhold. The principle was firmly established by the thirteenth century, a powerful instrument in restraining the demands of the Crown, and constantly reiterated until it was reaffirmed, at great cost in human life and suffering, by the Civil War of the seventeenth century. It had been tested in the great case of ship-money where though the judges ultimately found for the King on the facts, the fearless judgment of Sir George Croke for the plaintiff, John Hampden, proved in a scholarly and convincing way that the legality of tax had been founded on the basis of parliamentary consent since Magna

138

In West Virginia it was the county court: ibid para 94. For the board of appeal for the city of Philadelphia, see ‘Reports as to the Taxation of Land and Buildings in European countries and the United States of America’ (1890–91) (6209) House of Commons Parliamentary Papers lxxxiii 555 at 622. See too ‘Papers Bearing on Land Taxes, 1909’ 456. However, the Boards of Equalization, the bodies which ensured that taxpayers’ property was not assessed at a higher proportionate value than the other similar property on the roll, were centralised bodies of the executive government of the state: see the evidence of Colonel Benjamin P Johnson in ‘Minutes, 1852’ qq 1974–6, 1991–5; 2047; ‘Papers bearing on land taxes, 1909’ 457 140 JA Hill, ‘The English Income Tax, with Special Reference to Administration and Method of Assessment’ (1899) 4 Economic Studies nos 4–5, 278. 141 And was unchallenged after the fourteenth century: AL Brown, The Governance of Late Medieval England 1272–1461 (London, 1989) 224–5. See generally S Knox Mitchell, Taxation in Medieval England (ed S Painter) (New Haven, 1951) 156–235. 139

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Carta.142 It was ultimately confirmed in the Bill of Rights 1689143 which provided that ‘[L]evying money for or to the use of the Crown by pretence of prerogative without grant of Parliament … is illegal’.144 This, like all the rights laid down in the Bill of Rights, were ‘true, ancient and indubitable rights and liberties’ of the English people.145 Parliamentary authority, meaning the consent of Commons, Lords and Crown, came to be the exclusive legal basis of the right to tax and the liability to pay. Unlike America and France, this statement of the consensual basis of the right to tax was the sole unmistakably general constitutional provision on taxation. It was well known by the English people and it was widely believed, in England and elsewhere, that one of the great advantages of their constitution was the protection afforded to a taxpayer by the need for parliamentary consent to taxation.146 This requirement of consent derived from the subject’s right of private property, described by Blackstone as consisting of ‘the free use, enjoyment, and disposal of all his acquisitions, without any control or diminution, save only by the laws of the land’.147 The right to private property was highly valued by the Englishman and was prima facie inviolable, but necessarily inherent in it was the power in an individual to consent to parting with his property if he so chose. It was on this basis that taxation of the subject by the executive could be legitimate and not violate this fundamental liberty.148 The consent of the individual to paying tax was effected through Parliament, the theory being that each subject was present in Parliament through his representative and so that body could give its consent on his behalf.149 Taxation only by consent was a clear and unambiguous constitutional provision. Taxpayers’ consent to taxation was perceived as twofold: formal legal consent through the assent of the taxpayer’s representatives in Parliament ensured by a sophisticated parliamentary procedure for the enacting of

142

R. v Hampden (1637) 3 ST 825 at 1127–81. Described as one of the three ‘title-deeds of English political liberty’: E Boutmy, Studies in Constitutional Law (tr from 2nd French ed by EM Dicey) (London, 1891) 27. The others are Magna Carta 1215 and the Act of Settlement 1700. 144 Bill of Rights 1689 (1 Will & Mary sess 2 c 2) cl 4 of the declaration. See DW Williams, ‘Three Hundred Years On: Are our Tax Bills Right Yet’ (1989) British Tax Review 370. 145 Bill of Rights 1689 (1 Will & Mary sess 2 c 2) s 6. 146 J-L De Lolme, Constitution de L’Angleterre ou Etat du Gouvernement Anglois 2 vols. (London, 1785) vol 1 236. 147 Blackstone, Commentaries, Book 1, ch 1, above n 98, at 138. 148 See generally J Frecknall Hughes, ‘The Concept of Taxation and the Age of Enlightenment’, in John Tiley (ed), Studies in the History of Tax Law: Volume 2 (Oxford, Hart 2007), 256–65. 149 J Goldsworthy, The Sovereignty of Parliament (Oxford, 1999) 96–7. See generally Brown, Governance, above n 141, at 232–7; M Bacon, A New Abridgment of the Law, (ed H Gwillim) 7 vols (5th edn, London, 1798) vol vi, tit ‘Statute’ 365. 143

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money bills, and real consent. Real consent was the kind of consent which ensured compliance, and it embodied notions of voluntarism and of control. An involuntary tax in the sense of a tax that could not be avoided was itself often regarded as unconstitutional. Taxpayers believed that they should be able to choose whether or not they paid taxes, to modify their fiscal liability by their own personal behaviour, but this was one of the first canons of taxation to be breached at the end of the eighteenth century150 when it was understood that not to do so was economically unsustainable. But voluntarism was still valued in the sense that the English taxpayer persisted in regarding taxes as a gift to the government. Furthermore, he wanted to reinforce this notion of a voluntary gift by retaining an element of control over the taxing process. An inquisitorial or centrallyadministered tax would undermine this notion of real consent. Not only did an inquisitorial tax negate the notion of bounty, of a gift freely given, the compulsion to reveal the details of a person’s property was legitimately regarded as an infringement of the right of private property. The localist system of tax administration certainly gave emphasis to the consensual nature of taxation, in that it too promoted tax as a contribution, properly assessed by the taxpayers themselves and handed to the Crown voluntarily. Local administration ensured that taxpayers were part of the tax process, that they were to some extent taxing themselves, and that therefore their consent to being taxed was implicit. This control over taxation was of especial importance to them since not only was it part of the tradition of consensual taxation,151 it also provided an independent safeguard.152 As such the principle of localism was an expression of the very freedom which the English people had won in the constitutional conflict between them and their king in the seventeenth century. It lay at the heart of their constitutional liberties. It is in this context that English taxpayers regarded non-inquisitorial machinery and local administration as legitimate aspects of the right to consent to taxation and that their breach was accordingly unconstitutional. Their arguments were, therefore, arguably more than mere rhetoric.

150 Triple Assessment Act 1798 (38 Geo III c 16); Income Tax Act 1799 (39 Geo III c 13). See W Phillips, ‘The Real Objection to the Income Tax of 1799’ (1967) British Tax Review 177. 151 See generally C Brooks, ‘Public Finance and Political Stability’ (1974) 17 The Historical Journal no 2 281. 152 The Royal Commission on the Income Tax in 1920 famously described them as ‘a natural safeguard’: ‘Report of the Royal Commission on the Income Tax’ (1920) (615) House of Commons Parliamentary Papers xviii 97 para 344.

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5. LEGISLATIVE RESPONSES

Although the foundation of the canons in consent was firmer in the public mind than in law, the popular perception of an inquisitorial or centrallyadministered tax as unconstitutional had some formal legitimacy and considerable popular support. As such English governments could not afford to ignore it.153 As Lord Holland observed in the debate in the House of Lords on Pitt’s income tax in 1799, ‘[i]t was the business of a wise legislature to consult the prejudices as well as the interests of a nation, and to be as careful that the former should not be violated, as that the latter should not be injured’.154 Political leaders were aware that in the popular mind the issue of consent to taxation went far beyond the legal requirement of parliamentary consent, and that active consent to taxation by the public was essential. Taxes were invariably unpopular and could not effectively be levied without the real consent of the people. If there was significant opposition then avoidance, evasion and simple non-compliance would rise and the yield would suffer. Accordingly the popular attachment to the canons of taxation, in particular those of non-inquisitorial nature and localism, made adherence to them a powerful pacifier and therefore a political necessity. The constitutional provenance of the canons merely added to their political influence and few legislators in the nineteenth century felt able to undermine them. As a result governments were not only reluctant to breach them and to do so only when it was unavoidable, but also resolved to give positive legislative expression to them. Taxing legislation accordingly endeavoured to keep inquisitorial elements to the minimum, and to provide safeguards where inquisitorial process was unavoidable. William Pitt in particular had to compromise significantly on the inquisitorial character of his income tax in order to secure its passage through Parliament. First, he promised that the tax would be implemented by self-assessment, only requiring the taxpayer himself to declare a sum which represented not less than 10 per cent of his income.155 This bland and general declaration was to be taken on trust by the Inland Revenue, and only if the assessing commissioners were not satisfied could they issue a precept to demand the details of income, which would then be open to examination by both commissioners and the surveyor. This attempt to make a direct tax non-inquisitorial resulted in it being widely evaded and the tax a fiscal failure, but even Addington’s more searching return of income was mitigated in its effect by the division of a taxpayer’s income into separate sources returned to different officials.

153

Daunton, Trusting Leviathan, above n 2, at 180–204. Parliamentary History vol 34, col 187, 8 Jan 1799 (HL) per Lord Holland. 155 39 Geo III c 22 sch B no 8; Parliamentary History vol 34, col 7, 3 Dec 1798 (HC) per William Pitt. 154

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Second, Pitt would not compel a trader to produce his books before the commissioners.156 And lastly he provided that a taxpayer need not be examined on oath.157 A taxpayer appealing against an income tax assessment could only be required to answer questions in writing or could choose to appear in person before the commissioners, though in that case he was entitled to refuse to answer any question.158 Since it was evident that an inquisitorial procedure was to some extent necessary, the legislative expression of the canon requiring a noninquisitorial tax took the form of introducing provisions to ensure that the inquisitorial powers were not abused. All legislators surrounded their taxes with a raft of legislative provisions to this end. Provision was made to ensure that personal financial information remained, as far as possible, secret. Pitt promised that even the general declaration would be made, not to a government official, but to specially-appointed commissioners, who would be ‘persons of a respectable situation in life; as far as possible removed from any suspicion of partiality, or any kind of undue influence; men of integrity and independence’159: in other words, men who could be trusted. He reinforced that by imposing a system of oaths of secrecy,160 and made separate and even more generous privacy provisions for commercial taxpayers.161 As to local administration, governments were at first unambiguous in seeing it as a constitutional right and sought to give it explicit statutory form. This was not just a political decision to use a familiar system giving local autonomy and win the confidence of the taxpaying public. Fiscally, the orthodox view was that local knowledge, namely familiarity with local economic conditions, businesses, wages, properties and the situation of individual taxpayers was essential to arrive at a fair assessment of tax. The political reasoning behind the adoption of the principle of localism in England was not lost on an American commentator, who perceptively observed that the institution of local commissioners was intended to render the tax less obnoxious to the taxpayer by protecting him against the possible rapacity of the Government and furnishing a guarantee that the assessment would not be conducted in an inconsiderate or unduly rigorous manner.162

156 ‘Minutes, 1852’ qq. 1528, 1533. Though often appellants did bring them along to the hearing. See 43 Geo III c 122 s 148 (1803); 5 & 6 Vict c 35 s 120 (1842). 157 39 Geo III c 13 ss 16, 64 (1799); 43 Geo III c 122 s 151 (1803). 158 43 Geo III c 122 s 151. 159 Parliamentary History vol 34, col 6, 3 Dec 1798; 39 Geo III c 13, ss 11–21, ss 23–26; 39 Geo III, c 22 ss 3–12. This was to be ensured by property qualifications. 160 Parliamentary History vol 34, col 9, 3 Dec 1798. 161 See C Stebbings, ‘The Budget of 1798: Legislative Provision for Secrecy in Income Taxation’ (1998) British Tax Review 651. 162 Hill, ‘The English Income Tax’, above n 38, at 278.

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The strictest application of localism in tax administration left all administrative powers in the local institutions. Through their own subordinate officials the commissioners controlled the assessing of the tax, and supervised the collection process, and this system was adopted for all the major direct taxes of the nineteenth century. The land tax commissioners formed the purest example of localism in tax administration since virtually no interference from any official of the central government in the locality itself was permitted under the legislation. In income tax the ultimate legislative authority and control remained with the commissioners, though it has been seen that it was undermined in its execution and that theory and practice became severely dislocated. Peel maintained localism in tax administration on the expressed basis of constitutionalism.163 Furthermore, he saw the introduction of the Special Commissioners not so much as a breach of the principle of localism but as the support of the principle of a noninquisitorial tax by providing a choice to a taxpayer reluctant to expose his commercial affairs to local men.164 Throughout the modern era of systematic direct taxation in England, therefore, objections to taxes which breached the distinctive features of English taxation were routinely couched in terms of constitutionality. In none of the three jurisdictions under consideration were inquisitorial taxes accepted without complaint. It was a universal and natural reaction in a commercial society where property was of social and economic importance. But while the French disliked it on a human level and saw it as a legacy of fiscal abuses under the Ancien Régime165 and cultural and social conditions meant that the dislike was not so intense among Americans, the English saw it as an undermining of their fundamental freedoms. So too with the issue of localism, a feature closely bound up with the political structures of country. The French were not much interested in it and their political and social systems allowed only a limited and integrated localism, the Americans effectively side-stepped the issue but then used it or rejected it as it suited them, while the English perceived its breach to be utterly unconstitutional. Only the English looked for constitutional justification for their complaints and found it in their broadly stated principle of consent. This was 163 Parliamentary Debates vol 61, ser 3, col 912, 18 March 1842 (HC) per Sir Robert Peel; ibid vol 62, col 1385, 2 May 1842. 164 Ibid col 1384. 165 For the abuse of taxation as a factor in the French Revolution, see generally: N White, ‘The French Revolution and the Politics of Government Finance, 1770–1815’ (1995) 55 Journal of Economic History no 2 227 at 252; G Lefebvre, The French Revolution from its Origins to 1793 (tr E Moss Evanson) (London, 1965) 47–8; Jones, Peasantry, above n 78, at 37–42; RB Rose, ‘Tax Revolt and Popular Organization in Picardy 1789–1791’ (1969) Past and Present no 43, 92. See too A Forrest, The French Revolution (Oxford, 1995) 13–15; M Duverger, Eléments de Droit Public, (8th edn, Paris, 1977) 386. For a brief history of French taxation, see B Brachet, Le Système Fiscal Francais (2nd edn, Paris, 1988) 39–45.

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in contrast to France166 and America167 where although their authority for state taxation was equally founded on notions of popular consent and the sanctity of private property, not only were those principles not invariably expressed in their constitutions, their constitutions went further and included other express provisions as to taxation. Their constitutionality was more narrowly conceived, both popularly and legally. Those more precise and detailed constitutions directed the unconstitutionality of tax into recognised and specific channels. Having constitutions which were explicit and accessible, it was clearer to American and French taxpayers what was unconstitutional and what was not. The American challenges to the constitutionality of tax at the federal level in the nineteenth century accordingly concerned issues of apportionment among the states and the nature of direct taxation, for the constitution contained specific provisions

166 France lost the principle of popular consent to taxation in the fifteenth century, and the king levied taxes as of right: see M Wolfe, The Fiscal System of Renaissance France (New Haven and London, 1972) 35–52; P Dur, ‘The Right of Taxation in the Political Theory of the French Religious Wars’ (1945) 17 Journal of Modern History, no 4 289; Brissaud, Public Law, above n 9, at 490–2. The right was constantly reiterated, however: see J Flammermont, Remontrances du Parlement de Paris au xviii siècle, 3 vols (Paris1898) vol 3 404, 671; B Stone, The Parlement of Paris, 1774–1789 (Chapel Hill, 1981) 80–3; J Merrick, ‘Subjects and Citizens in the Remonstrances of the Parlement of Paris in the Eighteenth Century’ (1990) 51 Journal of the History of Ideas no 3 453; J Homer Read, ‘Constitutional Theories in France in the Seventeenth and Eighteenth Centuries’ (1906) 21 Political Science Quarterly no 4 639. Ultimately it was affirmed as a fundamental liberty in the Declaration of the Rights of Man and the Citizen in 1789, Art 14 of which stated that each citizen was entitled to establish, either personally or through his representatives, the necessity of any public contribution, to consent freely to it and to ensure its proper use and to determine its share, assessment, collection and duration. See S Caudal, ‘Article 14’ in G Conac, M Debene and G Teboul, La declaration des droits de l’homme et du citoyen de 1789 (Paris, 1993) 299–315. So, just as Frenchmen were citizens and not subjects, so their taxes became contributions, rather than impôts. It was reiterated, expressly or implicitly, in subsequent constitutions. See Godechot, Constitutions, above n 76, at 64–5 (constitution of 1791); ibid 84, 86 (constitution of 1793); ibid 134–6 (constitution of 1795); ibid 194 (constitution of 1804); ibid 222 (charter of 1814); ibid 266 (republican constitution of 1848); ibid 295, 316 (constitution of 1852). 167 The constitutions of each individual state in the American Union invariably provided that the citizens of the state could not be taxed without their consent. See, for example, ‘The Constitution of the State of Delaware’ in Delaware, The Laws of the State of Delaware, from the fourteenth day of October one thousand seven hundred, (New-castle, Delaware, 1797) Preamble and Art 1, s 8; ‘The Constitution or Frame of Government for the Commonwealth of Massachusetts’ in The Perpetual Laws of the Commonwealth of Massachusetts, from the establishment of its Constitution to the first session of the General Court, 1788’ (Worcester, Mass, 1788) Part I, Declaration of the Rights of the Inhabitants of the Commonwealth of Massachusetts, ss 1, 10, 23. The consent of the taxpayer to taxation was implicit in the constitution of the United States of 1787, of which Art 1 also explicitly laid down the guiding and fundamental principles of federal taxation, providing that direct taxes should be apportioned among the several states of the union, that the Congress should have the power to lay and collect taxes, that taxes should be uniform throughout the United States and that no capitation or other direct tax shall be laid unless in proportion to the census or enumeration.

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in those respects.168 Similarly French concerns as to the constitutionality of taxation tended to concentrate on issues of equality, for that was an expressed principle of profound importance to the French taxpayer.169 England, lacking the single-text written constitutions of France and America, had no one document which laid down the framework of rules of government or its fundamental values in relation to taxation. The constitution, which had evolved over hundreds of years, was instead contained in a small number of overtly constitutional documents, in a great many detailed rules in statutes and in case law, as well as governmental and parliamentary practices and usage.170 It was neither classified nor codified. The English taxpayer had no obvious practical way in which he could find out the basic constitutional principles governing taxation and so could not achieve a general view of it. Yet, despite the constitution, like the law, being essentially inaccessible to him, he felt he had a very clear idea of what was constitutional or unconstitutional about a tax. The one broad and expressed constitutional provision on consent was prominent, accessible, of immense popular significance and formed part of the national consciousness and identity. The principles of an unwritten constitution, in contrast with those of America and France, were arguably so flexible and uncertain, so lacking in visibility and precision, with only a few broad principles explicitly stated, that their understanding was based on tradition and usage. Indeed, William Blackstone had observed that the fundamental right of private property, of which consent to taxation was an expression,

168 B Ackerman, ‘Taxation and the Constitution’ (1999) 99 Columbia Law Review No 1, 1; R Blough, The Federal Taxing Process (New York, 1952) 195–7; MAS, ‘The Bearing of the Sixteenth Amendment on the Power of Congress to Tax Any Income Regardless of its Source’ (1920) 7 Virginia Law Review no 2 136; JH Riddle, ‘The Supreme Court’s Theory of a Direct Tax’ (1917) 15 Michigan Law Review no 7 566. The legality of both the income tax and the inheritance tax of the Civil War had been challenged unsuccessfully: Hylton v US 3 Dallas 171 (1796); Springer v US 102 US 586 (1880); Scholey v Rew, 23 Wallace (90 US) 331 (1874). The federal income tax of 1894 was successfully challenged in Pollock v Farmers’ Loan and Trust Company 157 US 429; 158 US 601 (1895) where the court held that the income tax was a direct tax, and that it was unconstitutional principally because it was a direct tax which had not been apportioned among the states according to population as the Constitution provided. As a result, America had to wait until 1913 to get its first income tax, and then only after the passing of the Sixteenth Amendment to the Constitution which gave Congress the power to impose an income tax regardless of the population of the state. 169 Declaration of the Rights of Man and of the Citizen, Art 13, made provision for equality in taxation. It provided that ‘Pour l’entretien de la force publique, et pour les dépenses d’administration, une contribution commune est indispensable; elle doit être également répartie entre tous les citoyens, en raison de leurs facultés’: Godechot, Constitutions, above n 76, at 35. See too ibid 36 (constitution of 1791); ibid 102, 134 (constitution of 1795); ibid 219 (charter of 1814); ibid 247 (charter of 1830); ibid, 264, 266 (republican constitution of 1848). 170 See generally E Boutmy, Studies in Constitutional Law (tr from French 2nd edn by EM Dicey) (London, 1891); RC van Caenegem, An Historical Introduction to Western Constitutional Law, (Cambridge, 1995).

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was ‘more generally talked of than thoroughly understood’.171 And so when the new income tax of 1799 was condemned as being unconstitutional, Charles Abbot, a distinguished lawyer and politician, observed that ‘[i]t was easy to assert this of any measure’. ‘It had a popular sound’, he said, ‘and was calculated to excite alarm’.172 He did not, he continued regret that the people of this country should be ready to take the alarm at the very idea of a measure being unconstitutional. It was right that they should be jealous of a constitution to which they owed so much happiness..173

The very breadth of the principle of consent and its prominence made it liable to wide and fluid popular interpretation and it was possible that English taxpayers condemned a tax as unconstitutional simply because they thought it was in some way harsh or unfair, it being the strongest condemnation they could find. But they did not entirely misunderstand the term ‘constitutional’ and confound it with expediency rather than legality.174 On the contrary, they showed an acute and subtle sense of constitutionality. Though they might struggle to articulate it in a coherent and systematic way, they had just as highly developed a sense of the constitution as did their American and French counterparts.

6. CONCLUSION

The English taxpayer’s view of an inquisitorial or centrally-administered tax as unconstitutional is revealing of his view of the scope of consent. It displayed a popular extra-statutory concept of consent which was significantly wider than parliamentary consent, important though that was, and was a powerful idea. Legal consent, the constitutional basis of taxation, had not been undermined because that had long been narrowed and limited to its express terms, namely parliamentary consent. What alarmed English taxpayers, and caused them to express their feelings in such emotive terms, was the perception that while parliamentary consent was unchallenged, any notion of true consent to a tax was being effectively crushed. The canons of taxation, those criteria of a good tax in a legal and political sense rather than an economic one, constituted a benchmark of conduct to remind legislators of optimum standards in tax. They were founded on consent, at least sufficiently so to explain their existence, their popular appeal and a degree of legitimacy. They were unwritten and not in themselves law other than the extent to which they were given statutory 171

Blackstone, Commentaries, Book 1, ch 1, above n 98, at 143. Parliamentary History vol 34, col 145, 31 Dec 1798, (HC) per Charles Abbot. 173 Ibid. 174 W Paley, ‘Moral and Political Philosophy’ in W Paley (1785, new edn 1825) The Works of William Paley vol 4, (E Paley ed) 7 vols (London, 1825) 372. 172

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expression, and so could be breached, but as they were indicators of what the public would find acceptable in a tax, governments did so at some political risk. They thus constituted a restraint on the power of the executive to tax, and as such, though voluntary, they formed an important element of taxpayer protection. While in giving the canons legislative expression governments were publicly acknowledging a connection with the principle of constitutional consent, they were driven by political motives rather than legal imperatives, and the taxpayer was correct in discerning that the breaches of the canons were of more real significance than their maintenance. Inquisitorial and increasingly centralised taxes had become the norm by the end of the century. And the canons were not the only instances in which real consent was undermined, for there was a wider movement to that effect. The Parliament Act 1911,175 whereby the House of Lords was taken entirely out of any influence in money bills, was regarded by many as a gross and overt undermining of the parliamentary protection, both formal and real, of the taxpayer. The growth of the party system and the lessening of the influence of the independent member were noted with equal concern. And when statutory force was given in 1913 to the practice of collecting tax on the basis of mere parliamentary resolutions before the Finance Act was passed,176 it appeared to many to mark the collapse of the formal constitutional protection of the taxpayer. These developments significantly reduced the legal protection hitherto enjoyed by the taxpaying public. The ancient safeguards, of which the canons of taxation formed an unwritten but important part, were undermined. A balance had to be struck between safeguarding the rights of the taxpayer and ensuring the Treasury collected its due taxes effectively. Increasingly though, it seemed to the taxpayer that the balance had swung towards the Government, and his essential protection in the constitutional requirement for his consent compromised.

175

Parliament Act 1911 (1 & 2 Geo V c 13). Provisional Collection of Taxes Act 1913 (3 Geo V c 3). The informal practice had been challenged in Bowles v Bank of England [1913] 1 Ch 57. 176

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12 The Role of Central Government in the Process of Determining Liability to Income Tax in England and Wales: 1842–1970 JOHN HN PEARCE

ABSTRACT This chapter examines the way in which the determination of liability to income tax in England and Wales moved from being a matter of local responsibility in 1842 to being part of the machinery of central government by the 1960s. The final stage was enacted by the Income Tax Management Act 1964 in provisions later consolidated in the Taxes Management Act 1970. Many of these changes had been sought by the Revenue Bill of 1921 and the chapter looks at the battle surrounding that Bill and its eventual loss. The chapter looks at many proposals for reform, some from Royal Commissions and some from Committees such as the Ritchie Committee of 1906. Income tax moves from being a flat rate tax to being a graduated tax and from being a class tax to being a mass tax. The tax also moved from being a locally administered tax to being a centrally administered tax. All three changes are traced to the first part of the twentieth century and the importance of the third is brought out.

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John HN Pearce I. THE INVESTIGATION TO BE CARRIED OUT

A. Preliminary—and the Point at which to End

O

LIVER CROMWELL IS recorded as referring to the ‘working of things from one period to another’1; and it is one such set of workings that I propose to investigate. The workings relate to the role of central government in the process of determining taxpayers’ liability to income tax in England and Wales. One reaction to this proposal may be to doubt whether there is anything to investigate. All that central government has to do, surely, is to require taxpayers to tell it if they have income. And, if they have, taxpayers may then be required to supply details, and to submit income tax returns to central government officials. And that is the point at which I end. In the Taxes Management Act 1970,2 as enacted, ss 7 and 8 deal with these matters.

B. The Point at which to Begin But that is not the point at which I must begin. On 11 March 1842, Sir Robert Peel proposed the re-introduction of income tax,3 but gave no details as to how the tax was to be administered. His omission to do so attracted comment4; and Peel provided details one week later.5 The machinery for the collection of the income tax was, in general, to be the same as that for the 1806 Act6; and a little later Peel went on to say that: the policy of the law hitherto has been with respect to the assessed taxes, and it was the principle with respect to the property-tax, not to make the collection depend upon the will of the Government, because it was thought more consistent with constitutional law, to entrust the amount to local parties, and that those who may have the confidence of their neighbours shall be employed for this purpose.7 1 WC Abbott (ed), The Writings and Speeches of Oliver Cromwell (Cambridge, Mass, 1945) vol 3 591. 2 1970 c 9. 3 Hansard, 3rd series, vol 61, 11 March 1842, cols 422–68. 4 See Hansard, 3rd series, vol 61, 15 March 1842, cols 594–7. 5 Hansard, 3rd series, vol 61, 18 March 1853, cols 910–2. 6 46 Geo. 3 c 65. 7 Hansard, 3rd series, vol 61, 18 March 1842, col 912. In The Times for 19 March 1842 (p 4, col b) this passage is reported rather differently, with Peel stating that ‘the policy of the law with respect to assessed taxes, as it was with regard to the property-tax, is not to make the collection of that tax depending on the mere will of the Government. It was thought more

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And Peel dealt with the role of central government by stating that– As far as the interference of the Government is concerned, the duty will be placed under the general superintendence of the office of Stamps and Taxes, and their officers, as far as they are available in all the duties connected with the mode in which the tax is to be levied.8

So, accordingly, under the Income Tax Act 1842,9 the administration of the income tax depended on individuals who acted locally. The Commissioners for the general purposes of the Income Tax (the ‘General Commissioners’) were at the summit of this local pyramid. But the legislation also envisaged that work would also be done by others subordinate to them: by Assessors, by the Clerks to the General Commissioners, by Additional Commissioners, and by Collectors. The interests of Central Government depended on the activities of the Surveyor of Taxes (later renamed the Inspector of Taxes). A good idea of how this machinery was supposed to work, in a simple case, for income assessed and charged to income tax under Schedule D10 at the beginning of the twentieth century, may be obtained from the Report of the Departmental Committee on Income Tax under the chairmanship of Charles Ritchie, the former Chancellor of the Exchequer, which reported in 1905,11 (the ‘Ritchie Committee’); and from the evidence presented to that Committee.12 Early in the income tax year, the General Commissioners appointed Assessors; and it was their duty to give the two kinds of notice for which the 1842 Act provided.

consistent with the principles of the constitution that parties locally known to those who were to be taxed should be employed—that those who had the confidence of their neighbours should be employed in its collection; and I propose to leave those provisions of the law untouched’. 8 Hansard, 3rd series, vol 61, 18 March 1842, cols 910–11. In The Times for 19 March 1842 (p 4, col b) Peel is reported as stating ‘I should propose, so far as the Government is concerned, to place the collection and general superintendence of the income-tax under the control of the offices of Stamps and Taxes, and their officers will be employed in the performance of all duties concerned with the levying of this tax’. 9 5 & 6 Vict. c 35. 10 A much fuller account, which most commendably deals with the intricacies of the machinery, is given in JF Avery Jones, ‘The Special Commissioners after 1842: from administrative to Judicial Tribunal’ [2005] British Tax Review 80, at 84–91. 11 Report of the Departmental Committee on Income Tax (Cd 2575, 1905) (subsequently cited as ‘Ritchie Committee Report’). I have derived great assistance from the account of ‘the present method of assessment’ given at iv–v (paras 4–13). 12 Appendix to the Report of the Departmental Committee on Income Tax with Minutes of Evidence taken before the Committee (Cd 2576, 1905) (subsequently cited as ‘Ritchie Committee evidence’). I have derived great assistance from the Memorandum of evidence submitted by Sir Thomas Hewitt, the Clerk to the General Commissioners for the City of London (at 30–1), and from the evidence given by W Gayler (Chief Inspector of Taxes) at 79–81.

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The first kind of notice, the ‘general notice’, was dealt with in s 47 of the 1842 Act, which provided in part that: the assessors … shall … cause general notices to be affixed on or near to the door of the church or chapel and market house or cross (if any) of the city, town, parish, or place for which such assessors act; … and such general notices shall, when the same shall be affixed as aforesaid, be deemed sufficient notice to all persons resident in such city, town, parish, or place, and the affixing of the same in manner aforesaid shall be deemed good service of such notice.

General notices were often called ‘church door notices’, for obvious reasons. The second kind of notice, the ‘particular notice’, was dealt with in s 48 of the 1842 Act, which provided in part that: the … assessors shall … give notice to every person chargeable to the said duties in respect of any property or profits situate or arising within the limits of the said places where such assessors shall act … requiring every such person to prepare and deliver, in manner directed by this Act, all such lists, declarations, and statements as they are respectively required to do.

The Assessor was under a duty to make a list of the persons on whom particular notices had been served.13 Taxpayers then completed their returns, and delivered them back to the Assessor. If the Assessor received a completed return with an amount of profits specified, the Assessor was to record that amount. If the Assessor did not receive such a return, he was to estimate the amount of profits made.14 The Assessor then delivered the returns received, and the documents prepared, to the General Commissioners. The next steps in the process, which involved the Clerk to the General Commissioners and the Additional Commissioners (a number of the General Commissioners appointed by the Commissioners themselves from among their own number), are described in the Ritchie Committee Report: 8.

From the List furnished by the Assessor, the Clerk to the General Commissioners prepares the Assessment, and enters up the Returns rendered by the tax-payers …

9.

The Assessment so prepared is delivered to the Surveyor of Taxes, who makes further application to such persons as have failed to make Returns: checks the correctness of the entries made in the Assessment; enquires as to the basis or sufficiency of the Returns in doubtful cases; discusses with the Assessor the liability of the several persons included in the assessment; enters the amount of assessable profit as ascertained from the accounts of

13 Section 57 of the 1842 Act, later consolidated as s 108(1) of the Income Tax Act 1918 (8 & 9 Geo 5 c 40). 14 See s 50 of the Taxes Management Act 1880 (43 & 44 Vict c 19) and Ritchie Committee evidence (p 80, Qs 30 and 31 (evidence of W Gayler)).

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Public Companies; and notes, for the information of the Additional Commissioners, any particulars of insufficient Returns, omissions, or undercharges, of which he may have knowledge. 10.

These Additional Commissioners are appointed by the General Commissioners. They fix the assessment, basing the decision upon:– (1) The amounts returned. (2) The estimates put forward by the Assessor or Surveyor. (3) The amounts shown by accounts produced to the Surveyor, or (4) Estimates which the Additional Commissioners themselves consider to be correct.

The meetings of Additional Commissioners are attended by the Surveyor.15

The Additional Commissioners then delivered the assessments that they had made to the General Commissioners: who … cause notices of charge to be issued to the persons assessed, giving the date of the meeting fixed to hear appeals, with instructions as to the course to be followed in the event of any objection to the charge. Such instructions require that Notice of Appeal be given to the Surveyor ten days before the date fixed for the hearing, and that accounts or other necessary evidence should be furnished to him before the date of the meeting. This evidence is examined by the Surveyor … At the appeal Meeting, the Surveyor attends on behalf of the Crown, and supports the Assessments made by the Additional Commissioners; the General Commissioners, after hearing the evidence, fix the liability; and the assessments are determined accordingly. From such determination of the Commissioners there is no appeal on questions of fact, but an appeal lies to the High Court on a question of law.16

C. Comments on the Structure Created This account of the income tax machinery prompts me to comment on the duty to start that machinery, on the role of the General Commissioners, and on the role of the Surveyors of Taxes. Under the 1842 Act, the duty to start the income tax machinery belonged to government: and, more specifically, to the local administration. The role of Assessors in serving general notices and particular notices was crucial.17 The duty to start the machinery did not belong to the taxpayer. 15

Ritchie Committee Report iv (paras 8–10). Ritchie Committee Report v (paras 11 and 12). 17 The Surveyor had power to serve a particular notice, but only if the Assessor had neglected to do so. (See s 57 of the 1842 Act, later consolidated as s 109 of the Income Tax Act 1918.) 16

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The role of the General Commissioners was more extensive than it is today. Such judicial authority as exists on this point dates from the twentieth century and not the nineteenth, and often relates to the Special Commissioners and not the General Commissioners. However, in R v Special Commissioners of Income Tax (ex parte Elmhirst),18 Lord Wright MR dealt with the role of the Commissioners by saying that: in making the assessment and in dealing with the appeals the Commissioners are exercising statutory authority and a statutory duty which they are bound to carry out. They are not in the position of judges deciding an issue between two particular parties. Their obligation is wider than that. It is to exercise their judgment on such material as comes before them, and to obtain any material which they think is necessary and which they think they ought to have, and on that material to make the assessment or the estimate which the law requires them to make. They are not deciding a case inter partes; they are assessing or estimating the amount on which, in the interests of the country at large, the taxpayer ought to be taxed.

On this basis, and at this period, the proceedings before the General Commissioners may be viewed as being of an inquisitorial and not of an adversarial nature.19 The role of the Surveyors of Taxes, by contrast, was of a subordinate nature.20 But, even so, there was much that the Surveyors could usefully 18 [1936] 1 KB 487; (1935) 20 TC 381 (CA). The quotation in the text is at 493 and 387 respectively. The Elmhirst case followed CIR v Sneath (1932) 17 TC 149, which was also concerned with the role of the Special Commissioners. In that case Romer LJ said ‘But the proceedings on the appeal are still merely directed towards ascertaining the income upon which the taxpayer is to be charged with Sur-tax for the particular year of assessment and the Special Commissioners may, if they think fit, increase the assessment made by them in the first instance. The appeal is merely another step, taken by the Commissioners, at the instance of the taxpayer, in the course of the discharge by them of their administrative duty of collecting the Sur-tax.’ (at 168). And Greer LJ said ‘I think the estimating authorities, even when an appeal is made to them, are not acting as judges deciding litigation between the subject and the Crown. They are merely in the position of valuers whose proceedings are regulated by statute to enable them to make an estimate of the income of the taxpayer for the particular year in question.’ (at 164). 19 ‘The term “inquisitorial” is one which is generally employed in the field of criminal procedure, to describe the civil law system whereby the judge himself has to inquire into the complaint, to ascertain the true facts and grounds of the dispute, and to apply the law. It is often distinguished from the accusatorial, or adversarial, system in which the function of the judge is to decide between the parties’ cases on the basis of the evidence put before him at the time of trial. Under an adversarial system, it is not the judge’s task to collect information; he relies on the parties to the dispute to put the evidence to him, and he makes his decision on the basis of that evidence. In the context of the appellant jurisdiction of the General Commissioners of Income Tax, and accordingly for the purposes of this article, the term ‘inquisitorial’ is used in the sense of inquiry beyond the evidence put to the tribunal.’: C Stebbings, ‘The General Commissioners of Income Tax: Assessors or Adjudicators?’ [1993] British Tax Review 52. The judicial authorities relevant for this issue are fully discussed in that article. 20 ‘[The] original conception of the Income Tax system was that the assessment and collection should be undertaken by local bodies of Commissioners and the local officials

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do. First, there was work that could be done in trying to obtain returns from taxpayers: for many returns were simply not submitted.21 The figures compiled for the purposes of the Select Committee on the Income and Property Tax of 1851–52 show that at least 40 per cent of Schedule D assessments in England and Wales made for the 1848–49 year of assessment were estimated.22 And, secondly, there was work that could be done in examining submitted returns. The 1885 version of the Inland Revenue’s Instructions to Surveyors of Taxes stated that: The Surveyor is himself to examine and compare all returns and statements of income with the assessments, and to rectify any errors he may discover either in respect of the amounts returned or the names of the persons assessed. The examination of the returns is regarded as most important work, and it must be made by the Surveyor himself.23

It is not easy to make a confident judgment about the overall level of taxpayer compliance in Victorian times. The position in Exeter in the early 1870s was undoubtedly unusual: but the Special Inspector sent by the Board of Inland Revenue to investigate the situation reported that of the 1,098 persons assessed to income tax under Schedule D, 305 (27.8 per cent) had made no returns at all. Another 571 (52.0 per cent) had returned insufficient amounts. Only 222 (20.2 per cent) had made returns satisfactory to the Board.24 Such evidence as there now is makes it very easy to formulate the working hypothesis that, as a result of a number of techniques ranging from ignoble ease at one end of the spectrum to

appointed by them, while the officers of the Board of Inland Revenue who watched the proceedings on behalf of the Crown had only limited powers of inspection and objection.’ Report of the Royal Commission on the Income Tax (Cmd 615, 1920) 83 (para 373). This Report is subsequently cited as ‘RC’. 21 In giving evidence to the Ritchie Committee in 1904, the Senior Special Commissioner, Mr Walter Gyles, stated that ‘I may say this from my experience, that I am quite sure the Revenue loses a great deal more money that it ought to receive in consequence of the absence of returns than in consequence of false returns. I am astonished to find the peculiar code of honour which is to be found all over the country. A man who would cut his arm off before he would deliberately write a false statement will wait until he is assessed, in the hope that the assessment will be wrong. And after he knows what he ought to pay on his profits he will say, “Oh, the Government officials have assessed me at £1,000; I know I make £2,000 profit, but that is their affair not mine.” And he will deliberately abstain from giving information which according to his return he is bound to give, and not consider that he is doing anything dishonourable or illegal.’ (Ritchie Committee evidence p 119 (Q 903).) 22 R Colley (ed), ‘Devizes Division Income Tax Assessments, 1842–1860’ (2002) 55 Wiltshire Record Society xvii. 23 Inland Revenue, General Instructions for the Tax-Surveying Branch of the Inland Revenue (England and Wales only) (1885) 35 (para 218). 24 See Fifteenth Report of the Commissioners of … Inland Revenue for the year ended 31st March 1872 (C 646, 1872) 52, and BEV Sabine, ‘The General Commissioners’ [1968] British Tax Review 18, at 29.

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outright fraud at the other, there was understatement of income for income tax purposes on a major scale in Victorian and Edwardian England.25

D. Further Comments During the nineteenth century, the rhetoric employed by Peel in 1842 was also found useful on later occasions. WH Smith, for example, quoted from Peel’s speech in 1883. A little earlier in his own speech, Smith had told the House of Commons that: He maintained that the principle on which the Income Tax was originally established was this—that there should be Commissioners representing the people who should appoint their own clerk, their own assessors, and their own collectors; and that, on the other hand, the Crown, the Chancellor of the Exchequer, and the Commissioners of Inland Revenue should have their surveyor and their inspector, to see that the Crown received no damage, and that the duties, as charged were realized. That was the principle of the Act originally, and it remained the principle of the Act still.26

Against this background, it is not surprising to find that, during the nineteenth century, few attempts were made to change the arrangements for assessing income tax to give a greater role to Central Government— and that those attempts were unsuccessful. In 1871 the Inland Revenue proposed that, while the General Commissioners should retain their appellate function, assessment and collection matters should be transferred to the Surveyors. But the Board felt that reform was only possible with the approval of the General Commissioners, whose opinions were accordingly canvassed. There was no consensus in favour of the proposal, and the Inland Revenue advised the Treasury not to proceed. And in 1887 the Government proposed granting power to the Board to transfer the functions of the Assessor to the Surveyor when a vacancy occurred, and to

25 On this see R Colley, ‘The Arabian Bird: A study of Income Tax Evasion in Mid-Victorian Britain’ [2001] British Tax Review 207; and S Matthews, ‘Self Assessment in Edwardian Manchester’ [1999] British Tax Review 298. The latter article considers two Surveyors’ Notebooks, covering the years from 1908 to 1911, giving details of 105 investigations, and relating to what was then Manchester 8 District. The conclusion drawn is that ‘The impression given by the notebooks is that understatement of income or profit was common. We do not know what percentage of returns was challenged but it is disappointing that of those that were checked, so many were found wanting. In their 105 investigations the Surveyors increased overall profits by about £3,176 or 15 per cent in the first notebook but by £6,655 or over 33 per cent in the second. That figure includes additional profits for earlier years settled informally.’ (ibid. at 299 and 307). 26 Hansard, 3rd series, vol 279, 10 May 1883, cols 499–500.

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abolish the position of Collector for Schedules D and E. There was a campaign against the proposal—and the proposal was abandoned.27 A pamphlet, published in 1906 and called ‘Administration of Income Tax’,28 concluded by saying that: It is therefore, perhaps, not extravagant to say that if the public once become alive to the fact that the real effect of Bills … is to interfere with, weaken, and ultimately break down the power and independence of the local Commissioners, their clerks, and other officials—who may not unreasonably be considered to be the Trustees of the public—any such Bills will be withdrawn. … By changing the present system so wisely devised by eminent statesmen in the past, and removing the buffer which the Commissioners represent, and were appointed to represent between the State and the Income Tax payer … it is felt that not only would considerable friction arise but loss would result to the State.

By 1970, however, the system in existence in 1906 had undergone great changes; and central government had acquired much more power. So, to return to the expression I used at the beginning: what was the working of things from one period to another? It is not a set of workings that may be presented in terms of a smooth development: for there is a major fault line associated with the withdrawal of the Revenue Bill of 1921. II. THE CARRYING OUT OF THE INVESTIGATION

A. 1900–20: the Existing System under Strain The Ritchie Committee reported in June 1905. It had been set up to ‘inquire into and report whether it is desirable to affect any alteration in the system of the income tax, as at present prescribed and administered’ under a number of heads, none of which referred explicitly to the machinery by which the tax was administered.29 Early on in its Report, the Ritchie Committee stated that: 27 For these episodes I have followed M Daunton, Trusting Leviathan: The Politics of Taxation in Britain, 1799–1914 (Cambridge, 2001) 195–7. 28 There is a copy of this pamphlet in PRO IR 74/20 and another in PRO T 171/120. The pamphlet is undated, but 1906 is referred to as ‘this year’ towards the end of the text. The pamphlet is also anonymous. But the copy in the Treasury file has the pencilled annotation ‘With the Cosmo Bonsor papers’. At the relevant time H Cosmo O Bonsor was the Chairman of the City of London General Commissioners. And passages in the pamphlet are strikingly similar to the written evidence presented by Copley Delisle Hewitt, the Clerk to the City of London Commissioners, to the 1919 Royal Commission. For that evidence, see Royal Commission on the Income Tax: Minutes of Evidence, 1920 pp. 1059–63 (paras 21,544– 21,578) (subsequently cited as ‘RC Minutes’). My present working hypothesis is that the pamphlet may be linked with the office of the Clerk to the City of London Commissioners. It may have been written by Sir Thomas Hewitt, by Copley Delisle Hewitt, or by both. 29 Ritchie Committee Report iii, xxv. The quotation in the text is from iii (para 2).

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we are glad to state that no very drastic alterations seem to us to be necessary in the administration of the Income Tax. Indeed, we desire to place on record our opinion that the tax appears, on the whole, to be levied with a minimum of friction and a maximum of result.

But was the situation as satisfactory as these words, taken on their own, suggest?30 Austen Chamberlain, the Chancellor of the Exchequer to whom the Ritchie Committee’s Report was presented, later told the House of Commons that ‘On the whole the Committee disappointed me by recommending so little change’.31 AM Scarff, an accountant with an extensive tax practice, was quite clear that the situation was not satisfactory.32 And, in 1901, GH Blunden, a Surveyor of Taxes, had stated in an article on ‘The Future of the Income Tax’, that: The organisation and machinery provided by the Income Tax Acts are almost wholly out of date and inadequate, and need to be completely overhauled and reconstructed. … The business has, in fact, entirely outgrown the machinery provided by the Income Tax Acts, and from sheer necessity the officers of the central government have had to take up the management of it. Although it is no part of their legal business, the bulk of the work of assessment and adjustment is performed or

30 As the Report had stated in para 1 that ‘The general principle and basis on which the tax is levied, was outside the scope of our reference’ it is arguable that the passage quoted does not give a general view of the working of the income tax machinery, but a view on the various specific topics that the Committee had been asked to investigate. 31 Hansard, 5th series, Commons, vol 53, 2 June 1913, col 675. In that same speech Austen Chamberlain went on to say that ‘I think you will have to consider very carefully before you change the system of having District Commissioners. I have got an idea for which I can give no very solid ground on the spur of the moment that the House has discussed and debated very seriously the question of District Commissioners more than once, and that a serious attempt has been made by individuals in the House to change the system. But when that has occurred, and when it has appeared likely that a change might take place, then a strong revolt has arisen against more paid officials interfering in our affairs, and against placing the taxpayers at their mercy, and although the District Commissioners may be unpopular so long as the present system exists, they begin to become popular when you propose to put others in their place. I do not say that it may not be the right thing to do, but I advise the Chancellor of the Exchequer [ie David Lloyd George] not to commit himself rashly to a change of that kind. It is necessary to have the support of public opinion in order to make the change successful.’ (ibid at cols 676–7). In the context of the Revenue Bill of 1921 these words may be considered to be very prescient. 32 AM Scarff, The Income Tax problem (1905) (a pamphlet). After quoting from the Ritchie Committee’s Report (see text), Scarff stated that ‘The minutes of the evidence upon which the Committee based their opinion have now been published, and it is evident that the Committee did not have witnesses before them who were competent to speak from an extensive experience of the working of the Income Tax Acts from the taxpayers’ point of view … [. From] the fact that the Committee consisted so largely of those who are engaged in the administration of the Acts it is perhaps not surprising that they should have come to the conclusion they did, a conclusion which I venture to say will not be endorsed by the great body of taxpayers who have more than sufficient cause to complain of the friction to which they have been subjected in the course of the extraction from them of the ‘maximum of result’ which seems to have afforded the Committee so much satisfaction.’ (at 8–9).

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directed by the surveyors, acting for, and in the name of, the Commissioners … There appears to be no longer any valid reason for the continuance of this state of things … It seems to need no arguing that there should be legislative recognition of the altered conditions, and that sufficient legal authority should be given to those who, from sheer necessity, must by hook or by crook carry on this vast and rapidly growing business.33

Blunden, therefore, thought that the existing machinery of the income tax was under strain in 1901; and the ‘obvious’ view is that this strain increased during the Edwardian period, and increased still further during the First World War.34 There was evidence to support the statement, made in 1920 in the Report of the Royal Commission on the Income Tax, that ‘an attempt by the General Commissioners to carry out the Income Tax Acts literally would result in a breakdown of the machinery.’35 ‘The Assessor’, the Board of Inland Revenue stated in May 1920, ‘has become the fifth wheel in the Coach’. In practice, the Assessors’ duties in connection with the making of assessments practically never extend beyond the issue of forms of return and the copying into assessment sheets of the figures shown in the returns. The examination of the returns and the determination of the rates of charge and reliefs due—all the work requiring knowledge of the law and practice—fall upon the Inspector.36

33 GH Blunden, ‘The future of the Income Tax’ (1901) 11 Economic Journal 157 at 164–5. 34 ‘[The] minute books of the Manchester Commissioners faithfully reflect the trend on a provincial scale. There is a continuous series of comments, almost amounting to complaints, on “the great increase of work” or “the immense and progressively mounting burden of running the division.”.’ Sabine, above n 24, at 35. 35 RC 76 (para 342). The Royal Commission continued: ‘It has naturally come to pass that many of the duties allotted to them [ie the General Commissioners] are, with their sanction, performed by the Inspector of Taxes.’ (ibid.) The Royal Commission also stated that: ‘Since the re-imposition of the tax in 1842 a great mass of new provisions has been added to the original scheme, the number of taxpayers has grown enormously, the complications of differentiation and graduation have been imposed on the old structure, allowances and reliefs have been multiplied, rates of duty have increased beyond all anticipation, and the Courts have formulated a great and growing body of Case law. Gradually—imperceptibly at first but in later years with increasing rapidity—the local bodies of Commissioners ceased to grapple with the ever increasing difficulties of administration, and tacitly allowed a large proportion of the work to be done by the Inspectors of Taxes, who, being whole-time officials, trained in Income Tax law and practice, and able to deal directly and without formality with the taxpayer, were better equipped to cope with the intricacies of the system than the unco-ordinated local bodies meeting occasionally in formal session.’ (RC p 83 (para 374)). 36 Leaflet issued by the Board of Inland Revenue, dated May 1920, headed ‘Assessment and Collection of Income Tax’ and marked ‘For Official use only’. There is a copy of this leaflet in PRO T 171/195. The Association of Tax Surveying Officers gave evidence to the 1919 Royal Commission that ‘The Assessor does not enquire into the adequacy of the income returned for assessment. If any profit and loss accounts are sent to him, either with the return or otherwise, he forwards them to the Surveyor for investigation without himself making any examination of them.’ See RC Minutes p 1273 (para 25,721). ‘The contention that the local

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There are also indications that Assessors were being ignored altogether. The Board of Inland Revenue also stated that: In almost all the large cases of assessment under Schedule D (Limited Companies, Statutory Companies, Corporations)—where the duty involved at 6s in the £ for a full year amounts to about £170,000,000—the Assessor is practically ignored. The taxpayer sends accounts direct to the Inspector on the eminently sensible ground that the knowledge and experience of the Inspector are necessary to the understanding of the accounts and to the task—often laborious and complicated—of computing the liability therefrom. The Inspector then himself furnishes the Commissioners with the amount of the liability which falls to be assessed.37

The Assessors in the City of London featured in special arrangements. In the City, in the 1917–18 year of assessment, there were 108,920 Schedule E assessments. Of these, the Assessors made 3,744; the remaining 105,176 (96.6 per cent) were made by the Surveyors. But, a little later, there was a change in the procedure. In the year 1919–20, when the Royal Commission had begun its sittings: The Clerk to the Commissioners instructed the Assessor to enter up the gross amount in every case, but on his attention being called to the inconvenience which would result it was arranged that the Surveyor should enter the amount in pencil and the Assessor should ink it in afterwards.

So, for the 1919–20 year of assessment, the Assessors entered 3,950 assessments in ink, and later inked over a further 136,550 entries (97.2 per cent of the total) made earlier in pencil in the Surveyors’ Offices.38 But this procedure supported an argument that it was the Assessors and not the Surveyors who were dealing with the situation.39 So far as the Clerks to the Commissioners were concerned, the Inland Revenue’s evidence to the 1919 Royal Commission was that the handing of the returns and the assessment books from one set of officials to another

bodies are in touch with the taxpayers by means of the Assessors is fantastic. Practically no taxpayer seeks advice from an Assessor; if he does, he is referred to the Inspector.’ The Accountant, 16 April 1921 453. 37 Ibid. 38 For this episode, see RC Minutes 1273 and 1285 (paras 25,721 and 25,911–25,935). The quotation in the text is at 1285 (para 25,914). 39 It seems that this practice was still being followed in the 1930s. In June 1946 James Callaghan told the House of Commons that ‘When I was in the City of London, employed in the Inland Revenue Department some 10 years ago, we had the services of assessors and it was most interesting. We who examined the taxpayers’ returns … were instructed that we were not to put in the figures which we adduced re the assessment in ink; we were to write them in pencil. We used to write them in pencil in order to conform to the law. When this had been done, a crowd of ancient gentlemen used to come across and insert in ink, over our pencilled figures, the precise amounts which we had entered, and we satisfied the due process of law accordingly. That was the value of the assessors to the taxpayer in the City of London in those days …’ Hansard, 5th series, Commons, vol 424, 24 June 1946, col 865.

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was ‘inherently wasteful and unbusinesslike’. If there was a delay in handing documents to the Surveyor, the time available for examining returns was ‘dangerously curtailed’. The Revenue therefore suggested that the clerical functions attached to the office of the Clerk to the General Commissioners should be transferred to the Surveyor, leaving the Clerk with ‘his primary role as the legal and general adviser of the General and Additional Commissioners’.40 So far as the Additional Commissioners were concerned, Sir Thomas Hewitt, the Clerk to the City of London Commissioners, gave evidence to the Ritchie Committee that the Additional Commissioners ‘go through every case above a certain amount’—implying that assessments below that amount were not necessarily considered.41 The 1919 Royal Commission was also given evidence of variations in practice. The Inland Revenue: called for statistics relating to the year 1917–18 in the case of 21 important and representative divisions throughout Great Britain … In those 21 divisions the total number of Schedule D assessments for the year 1917–18 was 317,000. In the case of one or two divisions no cases were considered by the Additional Commissioners, who simply contented themselves with formally signing the assessment books, but in the case of one division (a country division, which in practice is dealt with by two virtually separate bodies of Commissioners) the Commissioners for one side of the division considered every case, whilst the Commissioners for the other side of the division considered only 3 per cent. of the cases. In the case of no other division did the number of assessments considered exceed 10 per cent., whilst the average for the whole of the 21 divisions was less than 3 per cent., namely 8,600 assessments out of 317,000. Of

40 RC Minutes 1127–8 (paras 23,015–23). The quotations in the text are from paragraphs 23,015, 23,019 and 23,023. (Evidence given by A Binns, Deputy Chief Inspector of Taxes.) WW Thurgood, Surveyor at Bangor, North Wales, in 1903, found himself doing extra work on behalf of one of the Clerks to the Commissioners: ‘A new Clerk to Commissioners had recently been appointed [in Anglesey] and he was young and inexperienced. The Schedule A books for the Division were sent [to] him in the autumn for closing and the preparation of duplicates. About mid-November just as the return of the books was expected—for issue by 30th November, the Clerk to Commissioners was unexpectedly announced one afternoon with a number of big parcels. Instead of cheerfully announcing that his work was finished he collapsed into a chair and said, “Mr Surveyor I am desperately sorry to say I can do nothing more. I have been struggling all this time with one book and cannot manage it. I am completely exhausted and cannot go on. You can dismiss me or prosecute me or kick me out of the office or do anything you like to me, but I cannot finish the job. I am thoroughly ashamed of myself, but there it is, I am finished”. With that he departed leaving all the assessments and duplicates in a heap on the floor.’ Thurgood did the work in his spare time—and received a chicken at Christmas. [WW Thurgood], ‘Rambling Reflections’ (1935) 31 The Association of His Majesty’s Inspectors of Taxes: Quarterly Record 583–4. I owe this reference to the articles written by David Williams: see D Williams, ‘Masters of All They Surveyed: 1900–14’ [2004] The Quarterly Record of the Union of Senior Revenue Officials 106–28; ‘Masters of All They Surveyed 1900–14’ [1905] British Tax Review 142; and ‘Surveying Taxes, 1900–14’ [1905] British Tax Review 222–45. These articles give much information about Surveyors of Taxes in the years before the First World War. 41 Ritchie Committee evidence 31.

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the 8,600 cases considered by the Additional Commissioners, 8,000 were accepted as submitted by the Surveyor, 370 cases were decreased and 230 were increased. In addition, in the case of three out of the 21 divisions, assessments were made in 26 new cases on the initiative of the Additional Commissioners.42

The Surveyor was also active if the taxpayer appealed. The Ritchie Committee recorded that, in such a case, it was necessary for the taxpayer to notify the Surveyor: and that accounts or other necessary evidence in support of the objection should be furnished to him before the date of the meeting. This evidence is examined by Surveyor, who, in a large number of cases, interviews the appellant, and, as the result, the bulk of appeals are settled ‘out of Court’ the settlement arrived at being submitted to the General Commissioners for their approval.43

The evidence given by the Chief Inspector of Taxes to the 1919 Royal Commission included statistics as to how appeals were dealt with for the 1917–18 year of assessment in 22 Divisions throughout Great Britain. The General Commissioners heard 1,263 appeals; but the number of adjustments made by Surveyors, and accepted by the Commissioners, amounted to 66,533. If the two figures are combined, the adjustments made by Surveyors account for 98.1 per cent of the total.44

B. 1900–20: New Developments But not only did the first 20 years of the twentieth century see Surveyors of Taxes becoming very prominent within the income tax machinery, there were a number of new developments which, actually or potentially, worked in favour of central government. One development—at this stage of potential importance only—was that, as the concept of total income became relevant for more aspects of income

42 RC Minutes 1155 (para 23,465). The official giving evidence was A Binns, Deputy Chief Inspector of Taxes. 43 Ritchie Committee Report v (para 11). 44 Royal Commission on the Income Tax: Appendices … , 1920 31 (para 69). Philip Snowden assured the House of Commons in 1915 that ‘anybody who knows anything about the working of income tax laws knows that 99 per cent. of the disputes in regard to Income Tax … assessments are settled now by the Surveyor of Taxes … and I am sure that any Member who has any technical knowledge of this question … will agree that the surveyor of taxes, with his practical knowledge, his knowledge of the law, and his wide experience is a far better person to deal with this matter than the General Commissioners of Income Tax who know nothing about the income tax laws. As a matter of fact, the work with which the Commissioners are accredited is purely of nominal character. The real work is done by the Surveyor’: Hansard, 5th series, Commons, vol 76, 6 December 1915, cols 1126–7. On the basis of the statistic presented in the text, Snowden was exaggerating—to the extent of 0.9%.

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tax law,45 so the use of a return of total income increased. The 1919 Royal Commission was told that there were fewer than 15,000 taxpayers who, for one reason or another, did not need to provide a statement of total income.46 If the dealings between the Revenue authorities and the taxpayer should come to centre on one document, the statement of total income was already well placed to be that document. The role of the concept of ‘total income’ had grown with the introduction of super-tax by the Finance (1909–10) Act 1910;47 and, for my present purposes, that Act set an important precedent. The administrative provisions relating to super-tax contained no provision for the issue of general notices. Section 72(3) of the 1910 Act provided instead that ‘It shall be the duty of every person chargeable with the Super-Tax to give notice that he is chargeable to the Special Commissioners’. In this way, and in this particular context, the duty to start the income tax machinery was transferred from Government to the taxpayer. And, during the First World War, an extension of the powers of Surveyors of Taxes was made by s 28(3) of the Finance (No 2) Act 1915,48 which provided that:

45 On this, see JHN Pearce, ‘The Rise and Development of the Concept of “Total Income” in United Kingdom Income Tax Law: 1842–1952’ in J Tiley (ed), Studies in the History of Tax Law: Volume 2 (Oxford, Hart 2007) 87−117. 46 ‘… personal statements of total income are now rendered annually by almost every individual taxpayer.’ An individual whose income is wholly or partly earned renders a statement in order to claim the reduced rate of tax on his earned income, if his total income does not exceed £2,500. An individual whose income is wholly unearned renders a statement in order to claim the reduced rate of tax on his insured income, if his total income does not exceed £2,000. Every individual whose total income exceeds £2,500 is required to render a statement for the purposes of Super-tax. Thus the only individuals who need not render a statement of total income for one purpose or another are those whose final liability is represented by the standard rate of Income Tax (6s), namely, the relatively small class of persons (15,000 in number) whose total incomes lie between £2,000 and £2,500 and consist wholly of unearned income—and even here claims for the allowance of Income Tax in respect of Life Assurance premiums bring in a certain number of statements of total income, owing to the necessity for proving that the claimant’s income amounts to at least six times the amount of the premium.’ Royal Commission on the Income Tax: Appendices … 1920 7 (para 19). 47 10 Edw 7 c 8. 48 5 & 6 Geo 5 c 89. Section 28(3) of the 1915 Act (as enacted) had a difficult passage through the House of Commons. It was attacked at Committee Stage on the grounds that ‘The object of this Sub-section is, by a side-wind, to alter the procedure which has been in existence ever since the commencement of the Income Tax Acts, whereby there is a body of … Commissioners who stand as a buffer between the Income Tax payer and the Government.’ See Hansard, 5th series, Commons, vol 75, 26 October 1915, cols 112–53 at cols 133–4. The Chancellor of the Exchequer, Reginald McKenna, withdrew the clause as it then existed, returning at Report Stage, on 6 December 1915, with a new version to take account of the criticisms made. On that day, the clause was agreed, but Peel’s words in 1842 were quoted again, and the clause drew the comment that ‘if this House were in its normal condition, no

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The Commissioners of Inland Revenue may make regulations generally with respect to the assessment and collection of income tax under this Act in the case of weekly wage earners, and with respect to the procedure to be adopted for the purpose, and may in particular by those regulations in the case of those weekly wage earners, provide for the assessment of the tax by the surveyor of taxes.

Regulations appeared, and provided that: Quarterly assessments shall be made by the Surveyor of Taxes, who for this purpose may, in addition to the powers of a Surveyor of Taxes, exercise all the powers of an Assessor and of any Additional Commissioners or General Commissioners, except the power of hearing and determining an appeal.49

C. 1919–20: the Royal Commission After the First World War, a Royal Commission was constituted in 1919 ‘to inquire into the Income Tax (including Super-tax) of the United Kingdom’.50 The Commission reported the following year, and stated that: 328.

A considerable part of the evidence we have taken has been directed to the administrative side of our inquiry; we have given much time and thought to the possibility of improving the machinery by which the taxing statutes are put into force, and as a result it will be seen that we have several important recommendations to make in this connection …

329.

The primary object of good administration is to promote efficiency, which in Income Tax matters results in the smooth working of the machine in such a way as to produce the full measure of revenue with the minimum of irritation to the taxpayer and with the least possible inequity between one taxpayer and another …

330.

We are glad to be able to say that to the best of our belief … the practical administration of the Income Tax is in a highly efficient state … In short, the Income Tax is successfully administered.

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But we are bound to say that this smooth working of the machine has been rendered possible only by considerable deviations from the scheme of administration originally conceived by the founders of the tax. The Income Tax Act of 1842 … contemplated an almost purely local administration … The local representative of the Crown, corresponding to the Inspector of Taxes, had very little part in this scheme … Little by little, however, this plan has been departed from in practice under the pressure of circumstances, and every change has been in the direction of

Government whatever would have had the slightest chance of carrying a proposal doing away with the old Commissioners’. Hansard, 5th series, Commons, vol 76, 6 December 1915, cols 1101–2 and 1108. 49 SR & O 1916/202, reg 2. (See Statutory Rules and Orders [1916] vol i, 375.) 50 RC iii.

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making over to the Inspector of Taxes the exercise of powers that theoretically belong to the Local Commissioners and their officials. Without this gradual devolution to the Inspector the machinery of the tax would have been found to be hopelessly inadequate, and we might have had a very different report to make on this aspect of our subject. It will be found that many of the recommendations we have to make with regard to administration are directed towards recognizing and giving legal sanction to those practical developments in the working of the tax which have so largely contributed to its success, and removing those obstacles which, so long as they remain, act as a clog upon the wheels of the machine.51

So far as the local administration of the income tax was concerned, the Royal Commission recommended that: the office of Assessor should be abolished and the duties assigned to that official, more especially the duties of issuing and obtaining completed forms of return and of preparing lists and assessments, should devolve upon the Inspector of Taxes.52

Turning to the Clerks to the General Commissioners, the Royal Commission thought that it was evident: that time would be saved, and that the work as a whole would be better done, if the clerical duties which are now performed in the office of the Clerk to the Commissioners were transferred to the Inspector of Taxes.53

So far as the Additional Commissioners were concerned, the Royal Commission recorded the view that the Additional Commissioners were no longer necessary; but the Commission was ‘satisfied that it is of advantage to the country to have in every Income Tax Division the services of well-informed local persons of high character and standing for the purposes of assisting the officials in making correct Income Tax assessments’.54 The Royal Commission went on to recommend a role—but a significantly reduced role—for the Additional Commissioners. The recommendation was that the power to make income tax assessments under Schedule D should, in general, be transferred to the Inspectors of Taxes; but that the Additional Commissioners should be retained as an advisory body available for consultation in the case of any Schedule D assessment. The Additional Commissioners were also to be the authority for making Schedule D assessments in cases where the Inspector proposed to make an assessment in a sum that was greater than the amount returned for

51 52 53 54

RC RC RC RC

73–4 (paras 328–31). 86 (para 386). 82 (para 369). 78–9 (paras 353 and 355).

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assessment, the profits shown by the taxpayer’s accounts, or the amount of the assessment for the preceding year.55 So far as the General Commissioners themselves were concerned, the Royal Commission recommended that ‘the General Commissioners should continue to be the tribunal for hearing appeals in normal cases’56 But this role would be affected by a further recommendation relating to the settlement of appeals. The Royal Commission recommended that: where after notice of appeal has been given any necessary adjustment of an assessment is agreed upon between the taxpayer and the Inspector, the Inspector should have power to amend the assessment accordingly.57

If, as the Royal Commission recommended, the role of local officials in the administration of income tax was to be diminished, it followed that the role of Central Government would need to be increased. The Royal Commission fully accepted this proposition. After referring to developments in the administration of the tax, its Report stated that: The Inspector has thus become the pivotal figure in the Income Tax administration, and is indeed the personification of the present system to the majority of taxpayers who, following the directions on the official forms, consult him in regard to their returns, the adjustment of their assessments, and the repayment of any sums to which they may be entitled.58

The Report then referred to the recommendations made on administrative matters, and stated that: These recommendations are the result of a frank recognition of the part now played by the Inspector in the administration of the tax. They involve a considerable departure from the scheme contemplated by Peel … but between the system as it is to be found in the Income Tax Acts and the system as we have found it actually working from day to day throughout the country, there is such a wide divergence that we can almost say that our recommendations, in the main, do little more than propose to give legal sanction to the existing practice, and concentrate the work of local administration in the office of the Inspector, where in fact it is already largely performed.59

These recommendations must have been highly unwelcome to supporters of the local administration of income tax. But an article in The Accountant stated that: The Royal Commission has been very moderate in its recommendations for administrative reform. This is, no doubt, due in part to the guarded manner in

55 56 57 58 59

RC RC RC RC RC

79 (para 356). 77 (para 344). 127 (para 587). 83 (para 375). 83–4 (paras 376–7).

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which some of the official evidence was given. Apparently, there was a desire in official quarters that the condemnation of the system of local administration should come from sources other than official. Whatever may have been the motive for this policy, we think that it probably resulted in the members of the Royal Commission forming an opinion which, though highly unflattering to the present system, was less adverse than the facts warranted.60

D. 1921: the Revenue Bill The Report of the Royal Commission on the Income Tax is dated 11 March 1920;61 and the Chancellor of the Exchequer, Austen Chamberlain, gave his Budget Speech on 19 April of that year. In that Speech he said: [The] report of the recent Royal Commission marks an epoch in the history of the Income Tax in this country … It is my intention to submit to Parliament as early as possible a Bill to give effect to the recommendations of this Committee, but all the recommendations are not of equal importance, and not all of them carry the same measure of authority … Accordingly, subject to important exceptions, … I have decided that the general reform of the Income Tax is a matter which calls for a separate Bill. That Bill will be introduced as soon as possible.62

The recommendations relating to the administration of the income tax were not dealt with in the Finance Act 1920,63 and were, accordingly candidates for a later Revenue Bill. That Bill was prepared.64 Clauses 7–18 dealt with administration, and gave effect to recommendations of the Royal Commission. Clause 7 had the side-note ‘Abolition of office of assessor’, and sub-s (1) provided that: The office of assessor shall cease to exist, and all general and particular notices directed by the Income Tax Acts to be given by an assessor requiring persons to make returns shall be given by the surveyor …, and any such return shall be delivered to the surveyor.

Clause 8 had the side-note ‘Certain assessments to be made by surveyor’, and sub-s (1) of that clause provided that: (1) The following assessments shall be made by the surveyor– (a)

All assessments under Schedules A, B, and E; and

60 The proposals of the Royal Commission on the Income Tax with regard to Administration: The Accountant, 16 April 1921, 453. 61 RC 141. 62 Hansard, 5th series, Commons, vol 128, 19 April 1920, cols 91–3. 63 10 & 11 Geo 5 c 18. 64 Revenue Bill 1921 [Bill 60]. There was also an Explanatory Memorandum on the Bill (Cmd 1242, 1921).

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(b) Any assessment under Schedule D the amount of which– (i) does not exceed the amount returned for assessment; or (ii) is computed from accounts furnished by the taxpayer; or (iii) does not exceed the amount of the assessment made for the preceding year in respect of the same source of profits or income; and all the provisions of the Income Tax Acts which refer to the powers and authorities of assessors and commissioners in relation to the making of assessments and to assessments made or to be made by them shall be construed accordingly.

Clause 9 had the side-note ‘Provisions as to appeals, claims, and applications’, and sub-s (1) of that clause provided that: Where a person has given notice of an appeal under the Income Tax Acts, and before the appeal has been heard by the commissioners having jurisdiction in the matter, the surveyor, on proof to his satisfaction, agrees with that person as to any amendment which ought to be made in the assessment, the assessment shall be amended accordingly, and shall for all purposes be taken to have been originally made in its amended form.

And cl 11, which had the side-note ‘Preparation of assessment books, duplicates &c.’, had the effect of transferring clerical work from the office of the Clerk to the Commissioners to that of the Surveyor. On 22 February 1921 the Revenue Bill was still due to appear; but Austen Chamberlain was asked what he was going to do about it, and whether it would be taken on the Floor of the House. Chamberlain replied: No. I shall ask the House to send it upstairs. That is the only hope of passing it. If the House treats it as a contentious measure it will not be proceeded with.65

The Revenue Bill was introduced on 6 April 1921, and became the subject of a great deal of hostile criticism. ‘The proposals cut at the root of the principle of civilian control, and transfer the taxpayer to the soulless machinery of a Government Department.’66 It was the subject of a campaign in the Press;67 and it was also the subject of Resolutions passed by bodies of General Commissioners.68

65 Hansard, 5th series, Commons, vol 138, 22 February 1921, col 760. A little later he added that ‘the House must understand that if it is to be treated as a contentious measure, I cannot possibly hope to make progress with it this Session’. (ibid. col 761). 66 See The Accountant, 16 April 1921 455. 67 ‘That Bill …, the Revenue Bill … was put down for Second Reading. The night before the Second Reading was to come on nearly all the London evening papers contained articles attacking those provisions, and the following morning not merely the London papers, but the provincial Press, took up the same strain. By an alteration of the business of the House, the Revenue Bill did not come on for Second Reading that day. The agitation in the Press continued. Newspaper columns headed “Hunting the Taxpayer” were to be read, and attacks were made on the attempt of the bureaucracy to take away all the privileges of private people. In the end the Revenue Bill was withdrawn, and the newspapers who had conducted this agitation—which I think I am right in saying was entirely at the instigation of one rather able

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On 22 April 1921, The Times, which was opposed to the Bill, reported that Sir William Joynson-Hicks proposed to move, on the Second Reading: That this House declines to give a second reading to a Bill which increases the powers of Government officials and reduces the safeguards provided by the Constitution for the taxpayers of the country.

The Times continued: The Government’s intention to deprive the Income Tax Commissioners of their staffs and the taxpayers of the protection which the assessors afford them will, therefore, be raised as a capital issue when the measure first comes up for discussion. Members of Parliament who are taking up the taxpayers’ cause would be glad to be fortified by the opinions of chambers of commerce or other representative bodies of citizens in order that the full weight of public criticism may be brought to bear.69

Against this whole background, the Government drew the conclusion that: the provisions of those [administrative] Clauses would undoubtedly have excited very considerable controversy—so much so, indeed, that in view of the congested character of this Session it would have been impossible to pass the Bill. Accordingly, it was regretfully withdrawn.70

So the Revenue Bill 1921 was withdrawn.71 It was never reintroduced.72 Those opposed to Bills interfering with the existing system had scored their greatest, but last, victory.

gentleman in the City of London—congratulated themselves that their efforts on behalf of the taxpayers of the country had been successful, and that an anxious Government had withdrawn the Bill.’: Mr J S Holmes, speaking on the Second Reading of the Finance Bill, Hansard, 5th series, Commons, vol 142, 25 May 1921, col 181. There is a collection of press cuttings relating to the Bill in PRO IR 74/36. 68 Evidence of hostility from General Commissioners may be found in PRO IR 40/2622 and IR 74/36. To take one example, the General and Additional Commissioners for the Duchy of Lancaster argued that ‘The absence of any human barrier between the State officials and the tax payer, is contrary to all the principles of income tax administration which the public, through Parliament, have preserved in spite of numerous attacks in the past by the Revenue officials.’ (PRO IR 40/2622). 69 The Times, 22 April 1921, p 10 col g. 70 Sir Robert Horne, the Chancellor of the Exchequer, speaking on the Second Reading of the Finance Bill: Hansard, 5th series, Commons, vol 142, 25 May 1921, col 219. 71 For the withdrawal of the Bill, see Hansard, 5th series, Commons, vol 141, 4 May 1921, cols 1045 and 1188. 72 ‘The proceedings on that Bill were an absolute fiasco, because the Government were beaten by the Daily Mail and the General Commissioners for the City of London before they had uttered a single word in this House in defence of the proposals in the Bill. There has never been an occasion, as far as I know, to equal it.’ Douglas Houghton, speaking on the Second Reading of the Income Tax Management Bill on 12 February 1964, Hansard, 5th series, Commons, vol 689, 12 February 1964, cols 395–6.

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E. 1921—27 In these circumstances ‘the almost Gilbertian machinery with which we collect the income tax’73 continued in existence:74 and so, too, did the accompanying administrative problems. One problem that appeared in a slightly new guise was the multiplicity of documents issued to taxpayers. The Royal Commission’s Report had come forward with proposals for an integrated income tax calculation, and the Finance Act 1920 had implemented these proposals.75 Sections 17–22 of that Act introduced the present system of personal reliefs, but s 17(1) provided that those reliefs could only be claimed by: An individual who, in the manner prescribed by the Income Tax Acts, makes a claim in that behalf and who makes a return in the prescribed form of his total income … .

The tension accordingly continued between the returns prescribed in the original income tax legislation and the return of total income that had become important more recently. Against this background it is not surprising that a Committee was set up, with Mr Justice Rowlatt as Chairman (the ‘Rowlatt Committee’): To consider any simplifications which may be practicable under existing law in the return forms, claim forms, and notices of assessment issued in connection with income tax and super-tax, and to make recommendations in regard thereto.76

These limited terms of reference prevented the Committee from advocating major reforms;77 but the Rowlatt Committee’s Report nevertheless highlighted the point that the demand for taxpayers to provide information

73 This expression was used in 1942 by Mr G Benson, a Government backbencher. See Hansard, 5th series, Commons, vol 379, 13 May 1942, col 1811. 74 ‘I shall not weary the House by describing the appointment and swearing in of assessors who no longer assessed, of collectors who could no longer collect, and of general commissioners who had to be persuaded to make and allow assessments they never saw, but that is what has happened in Income Tax administration over these years. It is no wonder that two Royal Commissions paid tribute to the resourcefulness and skill with which the Inland Revenue improvised and circumvented to overcome the impedimenta of a century.” Douglas Houghton, speaking on the Second Reading of the Income Tax Management Bill on 12 February 1964, Hansard, 5th series, Commons, vol 689, 12 February 1964, col 398. 75 On this, see Pearce, above n 45, at 104−11. 76 Report of the Departmental Committee on the Simplification of Income Tax and Super-Tax Forms. (Cmd 2019, 1924) iii and 21 (subsequently cited as ‘Rowlatt Committee Report’). 77 At a preliminary meeting of the Committee ‘The Chairman drew attention in his opening remarks to the limited nature of the terms of Reference to the Committee and commented on the fact that the Committee had been appointed to investigate, not general questions arising on the Income Tax as a whole, but the simplification, within the existing law, of the forms at present in use.’ PRO IR 75/63 fo 17.

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about income could now be regarded as having two different sources.78 Against this background it is not surprising to find that: It was suggested … that the return for assessment and the return for total income might be merged. But there are two legal objections to this. In the first place, one is obligatory under penalty and the other is not. Secondly, the law requires two separate declarations.79

What could be done? A first possibility was creative administration. The Report recorded that: in the case of some payers of Super-Tax, it has been arranged that their return of total income for this purpose shall serve for their allowances. Still, even in their case, the form is delivered to them with each local demand for a return for assessment, though they are told upon the face of it that if they make a Super-Tax return that will suffice.80

A return made for the purposes of one tax (super-tax) and delivered to one body of officials (the Special Commissioners) was accordingly being passed on to a different body of officials (the Inland Revenue) who were then using that return as a substitute for another return required for a different tax (income tax) in a case where that other return was required to be delivered to another body of officials (the Assessors). A second possibility was to hope for better days, and here the Report noted: But so far as the issue of return forms is concerned, the system is that they are issued generally by untrained local officers who act for small areas, and are employed only to a limited extent in the work of computing actual liabilities and reliefs. While recognising that this is the system prescribed by existing law, we have been acutely aware throughout the whole course of our inquiry that it is a factor which checks simplification.81

On this analysis, the way forward was to enact new law.

78 On the one hand, where income was not deducted at the source ‘as in the case of trades or professions and of investments bearing interest or profits abroad, a return is required from the taxpayer in order to reveal to the Revenue Authorities the existence of this income. For this purpose “Particular Notices” under Section 100 and Schedule V of the Income Tax Act, 1918, have to be issued to him. These are the “Return Forms” which we are asked to consider.’ (Rowlatt Committee Report 5 (para 12)). On the other hand: ‘since by the Finance Act of 1920 a system of allowances has been introduced applicable to every case, a return of total income, taxed and untaxed, is practically always necessary. We say practically because it is not obligatory except in the sense that a taxpayer cannot, speaking generally, get his allowances without it.’ (Rowlatt Committee Report 6 (para 13)). 79 Rowlatt Committee Report 13 (para 46). 80 Rowlatt Committee Report 11 (para 35). 81 Rowlatt Committee Report 7–8 (paras 22 and 23).

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F. The Finance Act 1927 Winston Churchill, Chancellor of the Exchequer from 1924 to 1929, was most certainly not an admirer of an income tax system ‘so complicated and elaborate that very few tax payers can understand it’,82 and gave ‘directions . . .[for] considering in what respects the existing Income Tax and Super-Tax can be simplified’.83 A Departmental Committee charged with considering this question came to the conclusion that, if certain conditions were met, ‘a single return of total income annually, and the combination of Income Tax and Super-tax in a single tax, would become feasible’.84 The Committee also thought that: The proposal which we submit, whilst effecting a unification of the present Income Tax and Super-tax and a simplification of the returns, entails comparatively little disturbance of existing machinery. As a consequence it will be possible to work it without drastic interference with the powers and duties of the various bodies of local officers who are associated with the Inland Revenue Department in the administration of the Income Tax. Some modification of the existing statutory procedure will, however, be essential … In order to make effective arrangements to reduce to a minimum the number of return forms served, it will be necessary to transfer the issue of return forms from the Assessors, who work practically independently in their own localities, without co-ordination by any central authority, to the Inspectors, who are an organised body of Civil Servants, centrally controlled and co-ordinated.85

In forwarding the Report, the Chairman of the Board of Inland Revenue (Sir Richard Hopkins) submitted a lengthy memorandum of his own.86 The difficulties ahead might include: the reactions of the scheme on the system of local administration through Income Tax Commissioners. In earlier conversations with me I understood you to say that if the Committee found it necessary, in order to simplify the existing tangle, to propose that effect should be given to the Recommendations of the Royal Commission on the Income Tax for curtailment of the routine and administrative functions of the local Commissioners and their officers, you would be prepared to face the serious Parliamentary opposition to which these

82 PRO T 171/255 fos 109–10. On what follows, see also M Daunton, Just Taxes: The Politics of Taxation in Britain, 1914–1979 (Cambridge, 2002) 111–2. 83 Inland Revenue: Report of a Committee appointed to consider the Simplification of the Income Tax and Super-tax (October 1926) 1 (para 1). There is a copy of this Report in PRO T 171/255 fos 238–56. This Report also recommended that ‘a suitably constituted Committee … should be appointed … to draft the clauses of a Codifying Bill’ (see p 17 (para 58))—a recommendation that was followed by the setting up of the Codification Committee. 84 Ibid 5 (para 22). 85 Ibid 15 (paras 49 and 52). 86 PRO T 171/255 fos 222–37. Hopkins to Churchill 27 October 1926. The quotations in the text are at fos 231 and 232–3.

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proposals are known to give rise. The Committee have found it necessary to make such a proposal in one particular only.

The proposal relating to the Assessors was then described, and Sir Richard Hopkins continued: I have tried to form a judgment as to how much controversy would be roused by the removal from the Assessor of this purely routine duty. I find it very difficult to arrive at a conclusion. The matter is in its essence so trivial that it ought to pass without complaint; I think it quite possible, however, that it may be made the subject of gross misrepresentation and even possibly of mud-slinging similar to that which broke out at the time of the introduction of the Revenue Bill of 1921. The system of ‘one man one return’ could not be worked effectively unless the intervention of the Assessor is avoided, and I doubt whether the rest of the scheme without the advantages of the single return would be worth introducing.

Churchill was willing to go ahead87, and s 43(2) of the Finance Act 1927,88 as enacted, provided that: Any particular notice which under the provisions of the Income Tax Acts … may be given to any person requiring him to prepare and deliver any such lists, declarations, statements or returns as are required by the Income Tax Acts to be delivered … shall be given by the surveyor and not by the assessor, and any list, declaration, statement or return which the person to whom the notice is given is required to make shall be delivered to the surveyor.

The relevant clause of the Finance Bill attracted attention only at Report stage, when Sir John Marriott, a Conservative backbencher, declared: that in this Clause we have an exceedingly important principle of Income Tax administration at stake. The principal point at issue is this: Whether the payer of Income Tax is to be assessed and whether his tax is to be collected under the direction of local bodies of Commissioners—taxpayers like himself—or under the direction of a Government Department who are ultimately to receive the taxes.89

After referring to the Revenue Bill of 1921, and in particular to cl 7, with its proposed abolition of the office of assessor, Sir John Marriott continued:

87 With a view to making a pre-emptive strike against potential opposition to the scheme, the particulars of the alteration in the work of Assessors were explained in advance to Sir Henry Buckingham MP as Chairman of the Income Taxpayers’ Society and to Sir Henry Seymour-King as Chairman of the Commissioners of Income Tax (Schedule D) for the City of London. See PRO T 171/255 fos 342 and 364. 88 17 & 18 Geo 5 c 10. 89 Hansard, 5th Series, Commons, vol 209, 19 July 1927, col 359.

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the Clause which is under the consideration of the House tonight is in reality … an attempt to get by a side wind what it [i.e. the Inland Revenue] was not able to obtain by the Revenue Bill of 1921. [The] Clause … really represents … a subtle attempt to do by stealth what the Bill of 1921 attempted to do nakedly and unashamed.90

Churchill’s reply was on foreseeable lines: What is the principle of this simplification? It is the principle of one man, one return. We have heard of one man, one vote and now in another connection we have one man, one return—one return for Income Tax and Super-Tax in the course of a given year. If we are to achieve that object, it is absolutely necessary that the issue of the return form shall be undertaken by an organised body of people who are subject to a single control … Those conditions cannot possibly be satisfied by the parochial assessors who are the servants of some 700 different bodies of local commissioners acting for separate geographical divisions and working independently of their colleagues.91

The matter was pressed to a Division: the only occasion in the process I am investigating on which the House of Commons divided. The Government won by 223 to 9892; and s 43 of the Finance Act 1927 became law. Section 43(3) of the Finance Act 1927 provided in part that: the Commissioners [of Inland Revenue] shall have regard to the desirability of securing, as far as may be possible, that no person shall be required to make more than one return annually of the sources of his income and the amounts derived therefrom.

And s 44(1) of the Finance Act 1927 provided that– It shall be the duty of every individual who, for any year of assessment, is chargeable to income tax in respect of any part of his total income at a rate exceeding the standard rate to give notice that he is so chargeable to the Special Commissioners.

The duty placed upon the individual taxpayer to start the income tax machinery, which had existed for super-tax purposes, was accordingly reproduced for surtax purposes. James Grigg was Churchill’s Private Secretary; and recorded of the 1927 Budget that: As a side dish, Winston introduced an ambitious alteration in the structure of the Income Tax and Super Tax … The idea behind the change was to make it clear that Income Tax and Super Tax together made up one progressive impost which proceeded steadily and remorselessly from nil on the lowest incomes to very

90 91 92

Ibid cols 359–60. Ibid col 365. For the Division, see ibid cols 370–4.

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large figures on the highest, and to establish that it was the same body of income which was being taxed throughout. In keeping with such a conception he instituted the single return for all classes of income. Probably none of this was worth the administrative and legislative effort it absorbed.93

In the context of the process that I am investigating, however, I would be more positive: for I regard the legislation contained in the Finance Act 1927 as taking the decisive step in the transfer of power to central government. Once that legislation was in full force, the dealings between the individual taxpayer and the tax authorities centred on one key document, the individual’s tax return: and this document was issued by an officer acting on behalf of central government (which was new) and was returned to that same officer acting on behalf of central government (which was also new).

G. 1927–39 I am not aware of any further major developments in the period between 1927 and 1939. But the Report of the Income Tax Codification Committee, published in 1936, included the statement that: It hardly appears possible to rely on general notices for the purpose of the institution of proceedings against persons who fail to deliver returns; and we ascertained that, in practice, reliance is not placed upon them for this purpose. Proceedings for failure to make a return are not taken against a person unless a particular notice has been sent to him. For these reasons we propose that the general notices should be discontinued, and consequently the Bill omits all reference to them.94

Revenue officials noted that the Committee had proceeded in this way.95

H. 1939–45: the Second World War On the outbreak of the Second World War, the emergency legislation enacted included the Income Tax Procedure (Emergency Provisions) Act 1939.96 The statute was described in its long title as: 93

PJ Grigg, Prejudice and Judgment (London, 1948) 199. Income Tax Codification Committee: Report: Volume 1: Report and Appendices (Cmd 5131, 1936) 87 (para 154). For the Bill prepared by the Committee, see Income Tax Codification Committee: Report: vol 2: Draft of an Income Tax Bill (Cmd 5132, 1936). 95 PRO IR 76/43 contains such an indication. 96 2 & 3 Geo 6 c 99. 94

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An Act to make temporary provision for the performance by other Commissioners or persons of any of the functions of the General Commissioners, the Additional Commissioners, or the Assessor for any division, area or parish.

Section 1(1) of that Act provided that: The Commissioners of Inland Revenue may by order– (a)

…;

(b)

authorise all or any of the things which, but for the order, would fall to be done by the assessor for any specified parish to be done by the surveyor;

(c)

authorise all or any of the things which, but for the order, would fall to be done by or before the Additional Commissioners for any specified division or area, to be done by, or before the surveyor, either alone or acting in conjunction with one or more of those Commissioners;

These provisions gave opportunities to the Commissioners of Inland Revenue to extend the role of central government at the expense of local government (at any rate during the continuance of hostilities): but it seems that no order under this Act was ever made. The emergency that was the occasion of the passing of the Act was declared to be at an end on 1 February 194697; and the Act itself was repealed in 1950.98 Central government strengthened its position during the Second World War: but this was by enacting different legislation. The Inland Revenue consulted with representatives of the Clerks to Commissioners on what one Inland Revenue official described to another as ‘sundry proposals for easing and/or saving work … ’.99 As that same official had put the matter earlier, ‘The modern aim is, I think, to leave the Commissioners with only the very important job of hearing appeals against assessments’.100 The outcome was the tenth schedule to the Finance Act 1942,101 commended to the Commons on the basis that: As a result of this Schedule, such steps as can be cut out will be cut out by agreement with all the parties concerned. … The whole system under which Income Tax arises is very deeply rooted in our history, and it is not a thing which, in the middle of the war, one can uproot and replace by an entirely different system …

97 98 99 100 101

SR & O 1946/163. See the First Schedule to the Statute Law Revision Act 1950 (14 Geo 6 c 6). PRO IR 76/43. PRO IR 76/43. 5 & 6 Geo 6 c 21.

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We must ask the Committee to … accept the fact that this is the result of arrangement and agreement of all parties concerned and is an instalment towards the better collection and assessment … of the … Income Tax.102

The changes made by this schedule are nevertheless significant. Paragraph 1(1) and (2) provided that: (1)

The general notices … requiring the delivery of lists, declarations and statements shall not be given; but any question as to whether a person is liable to assessment in any parish shall be determined as if the foregoing provisions of this paragraph had not been passed and as if such a general notice as aforesaid had been duly given on the first day of the year of assessment.

(2)

It shall be the duty of every person who is chargeable to income tax for any year of assessment to give notice to the surveyor that he is so chargeable at or before the end of that year. Provided that no such notice need be given as respects any year for which he has delivered a statement of his profits and gains in accordance with the provisions of the Income Tax Acts.

Paragraph 1(1) sounded the death-knell of the general notice: by providing that the notice ‘shall not be given’, but that ‘any question as to whether a person is liable to assessment’ should be determined as if the notice had been given, para 1(1) ensured that the general notice had no further role to play in income tax administration.103 Paragraph 1(2) was also significant. The taxpayer’s duty to start the income tax machinery was now extended to the main body of income tax; and notice of chargeability was to be given to a representative of central government. The Second World War, like the First, also saw an increase in the powers of central government over income chargeable to income tax under Schedule E. The Income Tax (Employments) Act 1943,104 the first to contain enabling provisions for PAYE Regulations, permitted the Regulations to include provision ‘for the assessment and charge of tax by the surveyor in respect of emoluments to which this Act applies’; and also provided that ‘any such regulations shall have effect notwithstanding anything in the Income Tax Acts’.105 The Income Tax (Employments) Regulations 1944 accordingly provided that:

102 Hansard, 5th Series, Commons, vol 379, 14 May 1942, col 1986. The speaker was the Financial Secretary to the Treasury, Captain Crookshank. 103 ‘If I may for sake of example show the sort of thing involved in this Schedule, church-door notices are to be abolished. There is no useful purpose in these at all.’ Hansard, 5th series, Commons, vol 379, 5 May 1942, col 1300. The speaker was Captain Crookshank. 104 6 & 7 Geo 6 c 45. 105 See s 2(1) of that Act.

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Income tax in respect of emoluments shall be assessed and charged by the Inspector, who for that purpose may exercise all the powers of an assessor and of any commissioners as well as the powers of an Inspector.106

J. 1945–64 The period from 1945 to 1964 saw the completion of the development begun in 1927; and the later stages of this process were much less dramatic than the earlier ones.107 Section 62 of the Finance Act 1946108 provided for the abolition of assessors. Section 62(1) provided that: The Office of assessor for the purpose of income tax … shall cease to exist and the functions of the assessor under the Income Tax Acts … shall be exercised … by the surveyor or the collector, according as the Commissioners of Inland Revenue may direct.

The Inland Revenue’s ‘Notes on Clauses’ stated that: The separate office of Assessor is … obsolete and its removal is a further and small step in the reform of Income Tax administration, directed to concentrating in the hands of the Inland Revenue Department all the administrative work arising in assessment and collection of taxation … It is possible that the Clause will meet with some opposition. The abolition of the office of Assessor was one of the proposals of the Revenue Bill which was dropped owing to the opposition of local Commissioners, but a lot of water has flowed under the bridge since 1921.109

There was some grumbling during the Committee stage of the Finance Bill; but the relevant clause was agreed without a Division.110 A further step was taken in s 51 of the Finance Act 1949.111 Subsection (1) of that section was concerned with a number of imposts, including both income tax and surtax, and provided that: where … a person gives notice of appeal … and, before the appeal is determined … , the surveyor … and the appellant come to an agreement, whether in writing or otherwise, that the assessment or decision should be treated as upheld 106

SR & O 1944/251, reg 42(1). ‘It was a sacrosanct constitutional principle, for well over a century after the income tax was introduced into our fiscal system in 1799, that it should be administered by local commissioners and their officials the assessors and collectors; the recent transfer of this administration to officers of the Crown corresponds with a very real change in public opinion towards the central control of taxation.’ A Farnsworth, ‘The Income Tax Commissioners’ (1948) 64 Law Quarterly Review 372 at 388. 108 9 & 10 Geo 6 c 64. 109 Inland Revenue: Finance (No 2) Bill 1946 ‘Notes on Clauses’ 94–5. 110 Hansard, 5th series, Commons, vol 424, 24 June 1946, cols 862–7. 111 12 & 13 Geo 6 c 47. 107

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without variation, or as varied in a particular manner or as discharged or cancelled, the like consequences shall ensue for all purposes as would have ensued if, at the time when the agreement was come to, the Commissioners … had determined the appeal and had upheld the assessment or decision without variation, had varied it in that manner or had discharged it or cancelled it, as the case may be.

This provision accordingly enacted a recommendation of the 1919 Royal Commission that had been included in the 1921 Revenue Bill. The clause was agreed without a Division.112 Another Royal Commission was set up in 1951 to ‘inquire into the present system of taxation of profits and income’; and this Royal Commission dealt with matters of administration in its Third and Final Report, dated June 1955. This Report stated that: The striking thing is that the development of the income tax has involved a slow but continuous process of deviation from the original scheme of administration … Since 1920 [when the earlier Royal Commission, which had made the same point, had reported] the process has continued and today the position is that virtually all the executive work of tax administration is carried out by civil servants under the direction of the Board [of Inland Revenue].113

And the Report went on to say that: Our chief recommendation with regard to the making of assessments under the tax code is that … they should no longer be made by the local Commissioners (or, as the case may be, the Special Commissioners) and that, instead, the power should be exercised by officers of the Inland Revenue Department.114

A further small change was made in s 45 of the Finance Act 1960,115 which restated the obligation to give notice of chargeability to income tax or surtax. In the case of income tax, the notice was to be given to the inspector (which had been the case before); but, in the case of surtax, the

112 Hansard, 5th series, Commons, vol 467, 11 July 1949, cols 125–35. Selwyn Lloyd, the main speaker for the Opposition, began by observing that ‘This is not a very controversial matter, nor, I am afraid, is it a very interesting one’ (at col 126). In bringing forward this clause at this time, the Government was influenced by the fact that it had been necessary to obtain formal determination of settled appeals in connection with fixing the date for charging interest on unpaid tax and in connection with High Court proceedings for the recovery of tax. There were also a number of taxpayers who wished to take advantage of the fact that appeals settled by agreement had not been formally determined so as to claim the retrospective application of court decisions adverse to the Revenue. See Inland Revenue: Finance Bill 1949 ‘Notes on Clauses’ 135. 113 Final Report of the Royal Commission on the Taxation of Profits and Income (Cmd 9474, 1955) 281 (paras 940 and 941). 114 Ibid 282 (para 943). This recommendation was also made in the Seventh Report from the Estimates Committee (1960–61 Session) xi–xii (paras 24 and 25). 115 8 & 9 Eliz 2 c 44.

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notice was to be given either to the Special Commissioners (which had been the case before) or to the inspector (which was new).

K. The Income Tax Management Act 1964—and After The chief recommendation of the later Royal Commission’s 1955 Report was eventually enacted in the Income Tax Management Act 1964.116 In the House of Commons, a leading role was played by the principal spokesman for the Labour Opposition, Douglas Houghton, who had major connections with the Inland Revenue extending over many years. He told the Commons that: On the face of it, this is very dull stuff. Only those in the business know what an exciting and historic Bill this is. It ends out-of-date and cumbersome procedures and a long-standing and wasteful fiction in Income Tax administration.117

And again: I believe that the Bill is a landmark in tax administration. It is long, long overdue. A great deal that was in the Revenue Bill of 1920 has been integrated in what I would describe as reform by stealth—that is just pushing in a new Clause in the Finance Bill and achieving one little bit after another little bit. But there was such a big accumulation of reform needed that a separate Bill was required to complete the job. I am sure that the House is doing a good job tonight.’118

Section 5 of the 1964 Act gave effect to the recommendation of the later Royal Commission that responsibility for making assessments to income tax and surtax should be transferred to the Inland Revenue.119 Subsection (1) set out the basic rule that ‘all assessments to tax at the standard rate shall be made by an inspector’, and sub-s (2) the rule that ‘All assessments to surtax shall be made by the Board’. It followed that the office of Additional Commissioner was abolished, and that the Special Commissioners lost their assessing functions.

116 1964 c 37. The Financial Secretary to the Treasury, Alan Green, introduced this measure on the basis that ‘The Bill brings the law governing Income Tax machinery and procedures up to date. It should prove a useful contribution to the modernisation and simplification of the tax code, enabling worthwhile administrative changes to be made’. Hansard, 5th series, Commons, vol 689, 12 February 1964, col 387. 117 Hansard, 5th series, Commons, vol 689, 12 February 1964, col 395. 118 Hansard, 5th series, Commons, vol 692, 7 April 1964, col 942. 119 The Inland Revenue’s ‘Notes on Clauses’ described cl 5 (enacted as s 5) as ‘the most important in the Bill’. See Inland Revenue: Income Tax Management Bill 1964 ‘Notes on Clauses’ 21.

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Section 7 of the 1964 Act was described as providing ‘a single statutory base for the annual returns of income in general use, in place of the present amalgam of provisions’120; and sub-s (1) of that section provided that: Any person may be required by a notice given to him by an inspector or other officer of the Board to deliver to the officer within the time limited by the notice a return of his income, computed in accordance with the Income Tax Acts and specifying each separate source of income and the amount from each source.

A provision in these terms removed the option under which an individual chargeable to surtax could make a return of total income to the Special Commissioners. And finally, for present purposes, s 45 of the Finance Act 1960 was amended, so that, instead of a taxpayer giving notice of chargeability to surtax to the Special Commissioners, the taxpayer gave notice to the Board of Inland Revenue.121 So, speaking generally, the Income Tax Management Act 1964 took the law some way beyond—but not unrecognisably far beyond—the point to which the Revenue Bill of 1921 would have taken it.

III. CONCLUSION

Following the enactment of the Income Tax Management Act 1964, I consider it possible to regard the income tax machinery introduced by Peel as a thing of the past. In Peel’s time the duty to start the income tax machinery belonged to local government: but from 1965 a taxpayer who had not received a return was under a duty to notify the Inland Revenue. In Peel’s time returns were issued by, and returned to, the local Assessors: but in 1965 those returns were issued by, and returned to, the Inland Revenue. In Peel’s time assessments were made by the local Commissioners: but in 1965 assessments were made by the Inland Revenue. The General Commissioners continued to determine appeals, but an equivalent result was reached if a taxpayer settled his tax liability with a Revenue official. The machinery of the twentieth century income tax had finally shed its Victorian skin. There are also judicial dicta reflecting the changed position. In 1969, in Slaney (HM Inspector of Taxes) v Kean, Megarry J said that: It seems to me that today the Commissioners discharge functions which are essentially judicial in nature. Virtually all their administrative functions have now gone, and their basic functions are judicial.122 120

Inland Revenue: Income Tax Management Bill 1964 ‘Notes on Clauses’ 41. See Schedule 4 to the Income Tax Management Act 1964 and Pt I of the Table to that Schedule. 122 [1970] Ch 243, (1969) 45 TC 415. The quotation in the text is at 251 and 420 respectively. 121

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And, finally, in 1982, in Wicker v Fraser (HM Inspector of Taxes), counsel for the taxpayer argued that the General Commissioners should themselves have made various findings. But Goulding J said: It seems to me that his [Counsel’s] submission misconceives the function of appeal Commissioners. All the matters that he has spoken of would have much force if the appeal commissioners were an inquisitorial tribunal concerned to approach the primary facts de novo and to perform the same office as an officer initially making an assessment. But the Taxes Management Act 1970, does not give them that function.123

So counsel’s submission was rejected. The proceedings before the Commissioners were not of an inquisitorial nature. The legislation relating to the management of the income tax was consolidated in the Taxes Management Act 1970. In that Act as originally enacted, s 7 had the side-note ‘Notice of liability to income tax’. The section derived from s 45 of the Finance Act 1960, as amended by the Income Tax Management Act 1964; and the first two sub-sections of that section provided that: (1)

Every person who is chargeable to income tax for any year of assessment and who has not delivered a return of his profits and gains or his total income for that year in accordance with the provisions of the Income Tax Acts shall … give notice that he is so chargeable.

(2)

A notice under this section shall be given to the inspector or, in the case of an individual who is not chargeable to income tax other than surtax, either to the inspector or to the Board.

Section 8 of that Act had the side-note ‘Return of income’. The section derived from s 7 of the Income Tax Management Act 1964; and s 8(1) provided that: Any person may be required by a notice given to him by an inspector or other officer of the Board to deliver to the officer within the time limited by the notice a return of his income, computed in accordance with the Income Tax Acts and specifying each separate source of income and the amount from each source.

Central government, therefore, required taxpayers to tell it if they had income, and to deliver tax returns. These provisions, taken on their own, might strike someone coming new to the subject as predictable and pedestrian. But, less than 50 years earlier, the law had been very different.

123 (1982) 55 TC 641, 649. ‘Today the Commissioners’ role is to adjudicate rather than to assess.’ J Tiley, Revenue Law (5th edn, Oxford, 2005) 74. It may be argued, on the basis of dicta of Lord Donovan in Ranaweera v Ramachandran [1970] AC 962, 970, that the position is less clear cut than I have stated; but, in their turn, those dicta have been criticised. On this see further Stebbings, above n 19 and Avery Jones, above n 10, at 111–3.

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I have a final, and more general, reflection. Income tax today differs greatly from income tax as reintroduced by Peel. Income tax as reintroduced by Peel was essentially a flat-rate tax, but it is now a graduated tax.124 Income tax as reintroduced by Peel was a class tax, but it is now a mass tax.125 And income tax as reintroduced by Peel had an essentially local administration, but income tax today is centrally administered. And, in my opinion, the key events in all three processes took place in the first half of the twentieth century. It is that half-century, perhaps, that is the crucial half century in the history of the modern British income tax.

124

On this, see Pearce, above n 45. I take this nomenclature from CC Jones, ‘Bonds, Voluntarism and Taxation’ in Tiley (ed), above n 45, 428. 125

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13 Death and Taxes JOHN TILEY ABSTRACT As a preface to further work on the history on inheritance tax, this article provides a brief introduction to some of the repealed taxes on death. These taxes are not only part of our intellectual heritage but in the case of two of them, legacy duty (1780–1949) and succession duty (1853–1949), are useful reminders of some of the problems encountered if one has a donee-based tax on death. Current debates about donee-based taxes usually fail to make any mention of this past experience which is useful in indicating some of the problems which can arise. Mention will also be made of the duty usually known by its brief title as probate duty (1690–1894) but also covering administration and inventory.

T

ODAY’S INHERITANCE TAX (IHT), introduced in 1986, superseded capital transfer tax (CTT, 1974–86) which in its turn had superseded estate duty (1894–1974). Some of the features of today’s IHT can be traced back to estate duty, for example the potentially exempt transfer. Others can be traced back to CTT, not surprisingly since the primary inheritance tax legislation for the 1986 tax is technically the inheritance tax of 1984, renamed in 1986 and which had begun life as the consolidated Capital Transfer Tax Act of 1984. These features include not only the concept of the transfer of value but also the regime for discretionary trusts. Older readers of this review will recall that the discretionary trust regime of 1974 was much fiercer than today’s. All three have in common the characteristic that they are based on the circumstances of the donor as opposed to those of the donee.1 Our older taxes were more varied. These were, in order of creation: 1 For an effort to revive interest in donee-based taxes, see the Green Paper ‘Taxation of Capital on Death: A Possible Inheritance Tax in place of Estate Duty’ (Cmnd 4930. 1972); for one very different response based on a cumulative accessions tax, see CT Sandford, JRM Willis and DJ Ironside, An Accessions Tax (London, 1973).

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360 1 2 3 4 5 6 7

John Tiley probate/inventory/administration duty (1690–1894); legacy duty (1780–1949); succession duty (1853–1949); the (short-lived) account duty (1881–94); estate duty (1894–1974); settlement estate duty (1894–1914); and temporary estate duty (1889–94).

Of these, only legacy duty and succession duty were donee based and so it is on these that this chapter will concentrate. It will, however, be appropriate to say a brief word about the first tax mentioned, and a very brief word on the fourth. There is no doubting the role death taxes played in the nineteenth century and beyond. As Daunton points out: in 1871–75 death taxes raised 8.2 per cent of central government revenue while income taxes raised 10.3 per cent; the percentages for 1891–95 were 12.7 per cent and 17.2 per cent; and for 1910–14 they were 17 per cent and 27 per cent.2

I. SOURCES

First, however, a word about sources. The writer is conscious that the purpose of the present piece is to explore and to highlight rather than to provide that exhaustive account one always wishes to find time to do. In carrying out any such work one has to start with Martin Daunton’s magnificent historical works, Trusting Leviathan and Just Taxes.3 For more technical material one looks at the older editions of books on death duties such as Green, Hanson and Dymond (all written by people connected with the Estate Duty office) and the annual reports of Inland Revenue. These annual reports contain occasional, succinct and valuable, survey articles on the taxes.4 A particularly useful source was Norman’s Digest of Death Duties Alphabetically Arranged.5 Thanks to the recent distribution of books from the basement of Somerset House to some of our universities,6 the writer has also had the privilege of reading the Inland Revenue papers on the various Finance Bills without incurring the inconvenience of having to travel to the Public Record Office in Kew. He has also read the manual written for use in the Estate Duty Office and later published by HMSO in 1917. The first edition, prepared by Mr JA Gosset, had been published in two parts in 1881 and 1882, with updates to 1885 2 3 4 5 6

Trusting Leviathan (Cambridge, 2001) (‘TL’) 35 and 225. See TL, above n 2; Just Taxes (Cambridge, 2002) (‘JT’). Eg Thirteenth Report (new and revised edn of First Report). (3rd edn, London, 1912). Including Oxford, Cambridge and London.

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and 1890 respectively. The writer has not been able to track down the first edition and it is not clear whether it was ‘published’ as such; it is the nearest the old duties are to having their Beattie’s Elements of Estate Duty.7 The manual describes itself as ‘a first text book for new entrants to the office’. Clearly, much was expected of new entrants. The first footnote from chapter 2 ‘On the nature of the laws of England’ directs the new entrant that: [T]he legal classic of greatest present day value, at any rate in the work of the EDO, is the First Part of Coke on Littleton. A modern writer has written that no one would dare to enter the legal arena without fully digesting it.

The estate duty office itself was the subject of a report by the Committee on the Legacy and Succession Duty Office prepared for the Treasury in 1899; the office had an estate duty division but the office had not been renamed after 1894. Those wishing to study the work of the office including the various titles (and remuneration) of the different controllers and clerks are referred to that report.8. The Committee reported that there was no need to provide salaries to compete with private practice as the Civil Service offered a permanent engagement and a pension on retirement; the hours were not so long and holidays longer.9

II. PROBATE, ADMINISTRATION AND INVENTORY DUTY (1694) AND ACCOUNT DUTY (1881)

These were duties charged on the circumstances of the donor rather than the donee and both were repealed when estate duty was introduced in 1894. Until recently, probate duty was in force in Ontario and its validity was challenged—successfully—in Re Eurig’s Estate.10 The rates were modest: the first $50,000 was taxed at 0.5 per cent ($250), after which each $1,000 was taxed at 1.5 per cent which is the same as taxing each $100 at 0.15 per cent. So, on a $1 million estate, probate duty would have been $14,250 plus $250 or $14,500. As the duty was levied by a public body for a public purpose (the administration of justice), the Supreme Court of Canada held that it was a tax. It was a direct tax and so within the competence of the province but the majority said that, because a tax had to be passed by Parliament and not by the Lieutenant-Governor in Council, it was a direct tax on the estate; the executor would pay the tax and recoup it from the estate. The majority also held that it was not a 7 8 9 10

(8th edn, London,1974). (London, 1899). At 14. (1998) 165 DLR 4th 1.

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charge for a service (obtaining probate) because the procedures followed were exactly the same whatever the value of the estate. The UK Probate Office currently charges probate fees but these are very modest. They might have been drawn up with Re Eurig in mind; the maximum fee is £90, plus £1 per copy. Taking the figures in broad terms, in 2005 a grand total of around 299,000 grants were made; of these, 62,000 grants of probate were made on personal application and 137,000 by solicitors. Letters of administration with will annexed came to 13,500 and letters of administration simple (ie intestacy) to 87,000.11 For comparison, the Revenue say that IHT was paid on 34,000 deaths in 2005–06; so IHT is paid on about 10 per cent of estates.12 The original probate duty or, more fully, probate, administration and inventory duty, started in 1694 and ended in 1894.13 It raised regular and significant amounts of money. It was a charge on the grant of representation needed to establish devolution of property, for example personal property in the United Kingdom, and so was subject to a UK court’s jurisdiction. So the duty was charged on property in transit in the UK which belonged to a person domiciled abroad. Property of which the deceased was trustee was excluded. One should also recall that for much of the time real property devolved by title not by grant. Money belonging to the deceased which was secured on real estate was charged—but not profits from lighthouse tolls.14 One supposes that any attempt to reimpose probate duty in the UK would lead to avoidance: through gifts, donationes mortis causa and nominations and the use of property which does not need probate. Evasion would also be rife. As usual the people who would be liable would be the conscientious and those dying unexpectedly. As we shall see donationes mortis causa were subject to legacy duty.15 In the nineteenth century probate duty was avoided by giving property away before death and so account duty, sometimes called account stamp duty, was introduced in 1881; today it is principally remembered because of the fact that the estate duty rules in FA 1894, s 2(1)(c) legislate by reference to it. In 1884–85 the amount received from the probate duty came to £3.9 million while account duty yielded £31,500. These were significant amounts of money. In 1894 battleships of a new class, including the Hannibal and Mars, cost nearly £1

11 Department of Constitutional Affairs. For details of fees, see http://www.hmcourtsservice.gov.uk/cms/wills.htm. For details of numbers, see Department of Constitutional Affairs, Annual Report on Civil Judicial Statistics (Cm 2005, 6903) Table 5.10 (ch 5 deals with Family Matters). 12 Inland Revenue Statistics, Table 12.3: http://www.hmrc.gov.uk/stats/ [2006]. 13 FA 1894, s 1 and sch 1. 14 Norman’s Digest of Death Duties, above n 5, at 346. 15 36 Geo 3 c 52, s 7.

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million complete, ie fitted out.16 The yield from probate duty was greater than that from legacy and succession duties combined; in 1884–85 the amount received from legacy duty was £2.8 million and from succession duty £930,075.17 Originally, probate duty was a flat rate—10 shillings—and was paid by stamps not money; originally the stamp was on the grant itself but later on the Inland Revenue affidavit. Logically, matters were valued at the date of the grant, not the death. Later—perhaps prodded by the arguments of Adam Smith—it was made more proportionate, but the perverse effect was that smaller estates were taxed more heavily than larger ones and intestacy was taxed more heavily than testacy (until 1880).18 1859 saw the start of a graduated scale of probate duty when the value of personal estate exceeded £1 million. There were a few such (large) estates but not so many that substantial amounts of revenue resulted. As the Inland Revenue noted: apart from the reasonableness and justice of making these large estates pay more duty, the rapid increase in the value of the personal estates occasioned by the expansion of trade and enterprises renders it proper.19

III. LEGACY DUTY AND SUCCESSION DUTY

A. Rate Structure It is now time to turn to legacy duty and succession duty. Unlike most of the duties listed above, these are donee based, ie, in general, they taxed the property passing or transferred by reference to the circumstances of the recipient legatee or successor. Naturally this gave rise to many rules about valuation but it also enabled the rules to vary the total amount of tax according to the pattern of the donor’s bequests: the rate structure was doctrinally based in the correctness of leaving property to those to whom one was nearest in blood.20 We can see this very clearly by looking at Table 13.1 which is a slightly simplified table of the rates of tax for the years from 1815 until the repeals in 1949.21 16 Jane’s Fighting Ships of World War I 1919 (repr Military Press New York, 1990); the famous Dreadnought, completed in 1906, cost £1.8m (not fitted out). 17 Like legacy duty and succession duty, probate duty has a long overhang: in 1919–20 £12,594 and in 1928–29 £7,770 (excl Ireland). 18 Inland Revenue, 28th Annual Report. 19 Ibid. 20 This could also be part of the rules for donor-based taxes, as the exemptions and in particular, since 1974, the exemption for an estate passing to a spouse or, now, civil partner (IHTA 1984, s 18.) show. 21 The principal simplification is that the rate of succession duty (but not legacy duty) was increased in 1888: 51Vict c 8, s 21;. After FA 1894, s 1 the increase no longer applied if the estate were subject to estate duty or was remitted under FA 1894, s 15.

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Table 13.1: Tax rates, 1815–1949 1815

1909

1947

Widows and widowers

NIL

1%

2%

Children etc

1%

1%

2%

Brothers etc

3%

5%

10%

Uncles etc

5%

10%

20%

Great uncles etc

6%

10%

20%

Strangers

10%

10%

20%

This structure meant that the total burden of the taxes would, as those who like donee-based taxes wish, vary according to the pattern of distribution among the donees. As we shall see below, much learning was developed in deciding who the particular beneficiary might be and, since it was an attempt to tax the benefit received, when that benefit accrued and how its value should be determined. Attention, however, should be drawn to the two following points. The first is that while we shall return to the debate between donor- and donee-based taxes later as if it were a matter of choosing between them, this history already shows that one can have both systems of tax in force at the same time. The other is to note that that there was no exemption for charities, though the rate of tax on charities was not increased in 1947, so that it remained at 10 per cent not 20 per cent; hostility to charities was a feature of Gladstone’s outlook.22

B. 1949 Repeals As we have already seen, both duties were repealed in 1949. However, the story is a little more complex than that bald statement suggests, as is shown by the fact that the writer was told that the last legacy duty file was actually closed in this millennium not the last. The reason is that these two old duties were charged by reference to a death and that a succession occurring long after 1949 by reason of a will or document coming into force before 30 July 1949 could still trigger a charge to tax; hence the elaborate provisions in FA 1949.23 FA 1975 contains a provision headed ‘the final abolition of certain obsolete death duties’.24 This directed that no 22 Eg TL, above n 2, at 212: Daunton points out that Gladstone was particularly hostile to endowed charities as opposed to ‘voluntary’ charities. 23 FA 1949, ss 27–29 and the related Schedules. 24 FA 1975, s 50.

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person should be required to pay the tax and even amounts of outstanding duties were to cease to be due. However, any repayments could still be claimed. Some potential taxpayers with a timeless view of things seem not to have noticed. Visiting a cathedral in London in 2002, the writer’s attention was drawn to a leaflet issued by the Friends of the Cathedral. Inside he was invited to leave money to the Friends, the suggested clause noting kindly that the gift should be expressed to be ‘free of legacy duty’ which shows an otherwise unfashionable conservatism in some parts of the church. When we look at the Inland Revenue Parliamentary Papers for the Finance Bill 194925 we find classic civil service speak in support of the changes. Having three taxes on death—legacy duty, succession duty and estate duty—meant much duplication of work for the department and for executors and their professional advisers. Moreover, the two donee-based taxes were hard to defend ‘on modern standards’ since they were not related to taxable capacity but simply based on consanguinity. This ties in with another line of Revenue thinking which was that any relief should be given on the basis of dependency (ie need), not relationship (ie blood) However ‘modern’ that view might be, it is a very narrow view of what a family is and is perhaps now quite outmoded itself. The arguments in favour of an estate duty as opposed to an inheritance tax were predictably straightforward. There was much to be said in favour of either tax but in practice their hands were tied by the fact that the existing estate duty produced 90 per cent of the taxes on death and it was quite impossible to swap horses now.26 There would be a revenue cost since there would be a delay in collecting the inheritance tax as contrasted with the estate duty; estate duty was generally paid when obtaining probate, ie within a few months of the death, whereas the inheritance tax could only be collected when the administration was complete and it was known how much each person would receive. Interestingly, they noted that this had been the reason why Harcourt had preferred the estate duty concept in 1894. They added that the introduction of an inheritance tax would upset almost every existing will or settlement, for these documents would have been drawn on the basis that the major charge—estate duty—falls on the property before it is divided among the beneficiaries while the inheritance tax would fall on the property after division. Finally, and one senses the triumphant one behind the flourish: ‘the Estate Duty is a well proven instrument which is ready to hand while an Inheritance tax would have to be built up ab initio with all the problems that that would entail.’

25 26

Finance Bill 1949, cls 23–6 and 29 and 61 et seq. Ibid.

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It seems to the writer that this is all good sound stuff for 1949—but not totally convincing. However, one point did emerge from the papers which seemed to the writer to be of great importance and which relates back to the cathedral in 2002. This was that in most cases (two-thirds of the total), legacies and bequest were already left ‘free of duty’. This meant that the duties were actually paid out of the residue of the estate instead of by the individual beneficiaries. Where this was the case the legacy and succession duties simply acted as an additional estate duty. C. Yields We shall look at particular questions of yield later. However, some twentieth-century figures, taken from the annual reports of the Inland Revenue for the relevant years, will be useful at this stage: Table 13.2 shows how estate duty came to be the dominant source of death taxes, the percentages being those of the total taxes charged on death. Table 13.2: Estate duty 1913–14 Legacy duty Succession duty Estate duty

1938–39

1948–49

4.4 (16%) 0.909 (3.4%)

1928–29 (£, millions) 7.6 1.066

9.68 1.2

20.2 (10.1%) 2.9 (1.4%)

21.6 (80.6%)

81

66.00

177 (88.5%)

For comparison, in 1948–49 while the total death duties came to £200.1 million (gross), the Inland Revenue annual report tells us that income tax yielded £1,367 million and surtax £97.9 million. Having looked at the reasons for the 1949 repeal above, we should now observe that the Government made good its loss of tax by increasing the rates of estate duty.27 As the note to Butterworth’s Annotated Legislation observes, ‘plainly this is so but the substituted burden does not necessarily fall on the same shoulders’. This is right; both legacy duty and succession duty fell on the legatee (or other person receiving the legacy) or the successor. Some Inland Revenue annual reports comment on fluctuations in figures—sometimes what we would call the economic cycle or an event such as the prolonged and terrible agricultural depression. However, one could also have fluctuating returns because of fluctuating patterns of 27

FA 1949, s 28.

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estates; in 1865–66 one estate paid no less than £150,000 in legacy duty and succession duty and £42,000 in probate duty. 1866 saw a commercial panic; values went down and people could not pay—so there was a twofold effect. There were also fluctuating patterns of death which serve as a reminder of the hazards of diseases complacent modern folk dismiss as minor. The annual reports comment on the great measles epidemics for 1891 and 1892 and the influenza pandemic of 1919. The 1895–96 report comments on 1893–94, the year following the measles epidemics, as a ‘low death’ year.

D. Design Issues When looking at the taxes we find a number of issues which gave rise to difficult questions, some of law and others of policy. One was to define the basic concepts and to decide what was meant by a ‘legacy’ and what a ‘succession’ was. Another was to recognise that, having decided that both are accessions taxes charged by reference to the circumstances of the recipient, this would require one to be able to identify the actual recipient. A third was to decide what if any exemptions and reliefs there should be; as we have seen Gladstone did not favour an exemption for charities. A fourth was to take note of the number of taxes there might be on death and decide how they should interact: this was a particular problem in 1894 with the introduction of estate duty. A fifth was to decide the rate structure: these duties have differentiation by consanguinity not graduation, ie that the different rates are defined by reference to degrees of consanguinity—the more remote the degree, the higher the rate of tax. There were no elements of graduation in the rate structure (distinguish the accessions tax noted above)28 though the effect some of the smaller estate rules was to provide what used to be called ‘degressive’. A sixth was to have rules about collection and administration. A seventh was to address the problem of avoidance: the duties have rules on reservation of benefits.

IV. LEGACY DUTY

A. The Early History It is time to turn to the early and prime history of legacy duty, ie down to 1919. Legacy duty was introduced by Pitt’s Government in 1780, but the legislation was superseded by new legislation with amendments in 1796 28

See 1 above n 1.

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and it is this Act which is the legacy duty equivalent of the Finance Act 1894 for estate duty and the 1984 Inheritance Tax Act for inheritance tax, and remained so until the repeal of the duty in 1949.29 The 1796 Act was subject to some amendments but these were very few in comparison with modern times. The rates remained constant from 1815 until 1909 when Lloyd George’s increases took effect.30 The 1780 Act imposed a stamp duty which was charged not on the property itself but on the receipt for the property, being a charge on every skin or piece of vellum or parchment, or sheet or piece of paper upon which any receipt or discharge for any legacy [was written].31

This was to be changed in 1796 when the charge was imposed on the actual property. As the 1949 repealers noted, the 1780 duty was ineffective as receipts ceased to be given.32 In 1780 the rate of duty was 2s 6d (or 12.5p) if the legacy did not exceed £20; 5s (or 25p) for legacies between £20 and £100 and £1 if the legacies exceeded £100; there was no differentiation by category of beneficiary.33 In 1783 the rates were increased but with exemption for gifts to one’s spouse, children or grandchildren.34 In 1789 there was a further increase.35 1796 saw the start of the differential rates by degree of consanguinity. Gifts to spouses were exempt, as were gifts to lineal ancestors, since they did not appear in the chargeable categories. It was at this point that legacies of under £20 in amount were exempted.36 In accordance with one of the fundamental principles of legacy duty, one looked at the value at the time of receipt not date of death. So if the legacy carried accumulations of income and these brought the value of the legacy up to £20, it was not exempt. B. The 1796 Act It is time to rehearse some of the other rules in the 1796 Act. Many of these also became part of the succession duty rules after 1853 and some will be dealt with in a little more detail below. The present purpose is to indicate the scope and sophistication of the tax. The Act had 47 sections; s 1 repealed the older duties. Section 2 imposed the new duty on any legacy, specific, pecuniary or of any other description of £20 or more and 29

36 Geo 3 c 52 (1796). 45 Geo 3 c 28 (1805) and 55 Geo 3 c 184 Pt III (1815); FA 1910, s 58 (1909–10). 31 20 Geo 3 c 28, s 1: this formula goes back to the original Stamp Duty Act in 1694 (5 and 6 Gul and Mar c 21). 32 See above n 22. 33 20 Geo 3 c 28, s 1. 34 23 Geo 3 c 58. 35 29 Geo 3 c 51. 36 29 Geo 3 c 51, s 2. 30

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on any net residuary estate exceeding £100, whether the residue arose by testamentary disposition or intestacy. Section 2 also set out the rates of duty which, as with the 1815 list, varied according to the degrees of consanguinity and provided an exceptions for gifts to the deceased’s spouse. Sections 3–6 were administrative, s 6 dealing with duty not paid by the executors and when it was a debt to the Crown and when it was debt between the parties. Section 7 dealt with the concept of a legacy being a gift out of the personal estate of the deceased or charged on both real and personal unless satisfied out of real estate. The term also covered a donatio mortis causa. Section 8 began the treatment of annuities and stipulated how their values should be calculated. Section 12 used similar principles to deal with legacies to be paid to persons in succession (more will be said on this below but the important point was that there was an effort to tax the value of the annuity to the annuitant and not the value of the underlying property we are used to with IHT, CTT and estate duty). The liability rules were contained in ss 13 and 15. Section 14 exempted certain legacies to be enjoyed in kind. Section 16 dealt with joint legacies . Section 17 dealt with legacies subject to a condition and directed that they be treated as absolute bequests until it was known whether or not the condition would be satisfied.37 Section 18 dealt with legacies subject to a power of appointment; s 19 with money charged on personal estate but directed to be applied in the purchase of real estate; and s 20 with estates pour autre vie. Section 21 contained the very important exemption for money left to pay duty and directed that it was not to be treated as a legacy. Section 22, the longest section, with 51 lines, had rules on ascertaining duty when the asset had not yet been reduced to money. Section 23 dealt with duty on legacies satisfied in kind, ie not money; and s 24 with legatees refusing to accept the legacy with duty deducted at source. Of the other sections, s 44 allowed the Commissioners to reward informers. As noted above in connection with the £20 exemption, it was a fundamental principle of the tax that it was due at the time of payment delivery or other discharge of the legacy and not when the right to the legacy arose38; this was different from estate duty which concentrated on the date of the death. For legacy duty it followed that, if the property was not received, there could be no tax, so a mere appropriation by an executor of funds to pay a legacy did not trigger a liability to tax.39 Similarly, when there was change in the law it might take effect by reference to when the

37 38 39

For more on the last two points, see the text at n 62 below. 36 Geo 3 c 52, ss 6 and 32; In Re Hillas 2 Ir Jur 36. Att-Gen v Manners (1815) 1 Price 411.

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legacy took effect.40 The courts were sensible in recognising reality. Where a legacy and the land out of which the legacies were charged devolved on the same person so that the trustee no longer had to realise money by selling the land, this was held to be a satisfaction of the legacy.41 As a tax on legacies, legacy duty did not touch real or, in Scotland, heritable property. It was one of the purposes of the succession duty of 1853 to tax real property as we shall see below In 1796 Pitt had tried to have a separate tax on real property but failed. Charles James Fox denounced the proposed legacy duty on land as ‘a political measure immoderately increasing the influence of the Crown and full of danger in its obvious consequences to the constitution and freedom of the country’.42 However, in 1805 there was an important widening of the duty in that it was applied to legacies, including rentcharges, annuities and jointures, charged on and taking effect out of real estate. It was also extended to the proceeds of real estate that was directed to be sold and there was much litigation on the distinction between a duty to sell (which gave rise to legacy duty) and a mere power to sell which did not.43 There was also litigation on the effect of a contingent or conditional duty to sell.44 1808 saw new rules for personal or movable property on intestacy.45 These applied to deaths before the passing of the act unless the legacy had been paid, delivered, satisfied or discharged before 10 October 1808.46 1815 saw the rate structure stabilised and lineal ancestors added (1 per cent). The duty only applied to legacies over £20. 1815 saw a new rule directing that two legacies to the same person should be added together, and taxed together, if they exceeded £20. The general £20 exemption was repealed in 1881.47 1845 saw a widening of the definition of legacy (below). 1880 saw a rule exempting the entire estate from succession duty and legacy duty if less than £100; in practice the deduction of debts was allowed despite the clear words of the statute. 1881 saw a rule that where the gross estate did not exceed £300 the payment of £1.50 would clear both the succession duty and legacy duty liabilities of the estate. It is in this context that the repeal of the £20 exemption makes sense.

40 Hill v Atkinson (1816) 2 Mer 45, 35 ER (legacy held appropriated in 1797 and so before 1808). 41 Att-Gen v Metcalfe (1851) 6 Ex 26, within 55 Geo 3 c 184, Pt III. 42 TL, above n 2, at 226. 43 Eg Att-Gen v Holford 1 Price 427 and Adv Gen v Hamilton 18 Sco Sess 2nd ser 636. 44 Att-Gen v Mangles 5 M and W 120. 45 43 Geo 3 c 149, Sch, Pt III: it was this change which was in issue in Hill v Atkinson (1816) 2 Mer 45, 35 ER (legacy held appropriated in 1797 and so before 1808). 46 Hence Hill v Atkinson (1816) 2 Mer 45, 35 ER (legacy held appropriated in 1797 and so before 1808). 47 44 Vict c 12, s 42.

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C. The Legacy Concept As we have seen, the 1796 legislation applied to every legacy given by a will or testamentary instrument out of the personal estate of the person dying after the passing of the Act and upon every clear part of the residue of the personal estate whether title accrued by virtue of a will or testamentary disposition or upon intestacy. However, in general, it had to arise on a death as a result of the testamentary (or intestamentary) generosity of the deceased. So a direction by T to pay T’s debts out of T’s estate did not turn the creditors into legatees and so make them subject to legacy duty—though there was some subtle learning on statute-barred debts.48 Conversely, the release of debt due to the testator did give rise to a legacy.49 Of some curiosity is the effect of a covenant to leave property by will. If the covenant related to a specific sum of money and the testator bequeathed that amount, it was treated not as a legacy but as the payment of a debt. By contrast, the bequest of a share of residue in fulfilment of a covenant to that effect was treated as a legacy as the testator had not bound himself to apply enough or indeed any assets at all.50 The boundary between personal real property and real property was a vital but fraught one. Until the introduction of succession duty in 1853, the effect of falling one side of the boundary rather than the other was duty or no duty; after 1853 the question was usually which of two almost identical duties was due.51 Leases were at first liable to legacy duty but they were moved to succession duty when that charge came in.52 However when Gosschen imposed the additional rate of succession duty in 1888 these did not extend to the certain devolutions of leaseholds.53 A bold argument, that a conditional legacy was not a legacy, was advanced, unsuccessfully, in 1891. The argument was that as the beneficiary had to do something to fulfil the condition the bequest was not due to the testator’s testamentary generosity but to the legatee’s willingness and effort in fulfilling the condition. In Re Thorley T left £250 per annum to his son while he should be managing the business, which consisted of manufacturing food for cattle by a secret process.54 Kay LJ said:

48 The answer seems to turn on whether the debt was extinguished or could be revived: see Williamson v Naylor 3 Y and Coll 208; Turner v Martin 26 LJR (Ch) 216. 49 Att-Gen v Holbrook 3 Yo and Jer 114. 50 Eyre v Munro (1857) 3 K and J 305; Jervis v Wolferstan (1874) LR 18 Eq 18. 51 On why ‘almost’, see below nn 62, 74 and 86. 52 16 and 17 Vict c 7, s 15. 53 51 Vict c 8, s 21—subject to duty under 44 and 45 Vict c 12. 54 [1891] 2 Ch 613; and to the same effect but with more complicated facts Sweeting v Sweeting 1 Drewry 331 61 ER.

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A thing which is claimed under a will being the gift of a testator, is a legacy. The son cannot say ‘I have accepted this. I have accepted the condition under which it is given. I claim it under the will but I say it is not a legacy’.55

There could be no legacy, and so no legacy duty, for testamentary gifts of real or immovable property. As we have seen, its scope was widened in the 1805 Act to include legacies paid out of real estate. This lasted until 1888 when such legacies were transferred to succession duty. The Revenue rewrote the rules on what was a legacy in 1845 (it also made a subtle change to reverse the decision in A-G v Marquis of Hertford)56: Every Gift made by Will or Testamentary Instrument of any Person, which by virtue of any such Will or Testamentary Instrument is or shall be payable, or shall have Effect and be satisfied out of the Personal or Movable Estate or Effects which such Person hath had or shall have had Power to dispose of, or which Gift shall be payable or shall have Effect and be satisfied out or is charged on or rendered a Burden upon the Real or Heritable estate of such person or any Real or Heritable estate or the Rents or Profits thereof, which such Person hath had or shall have had any Right or Power to charge, burden or affect with the Payment of Money, or out of or upon any Monies to arise by the Sale, Burden, Mortgage or other Disposition of any such Real or Heritable Estate, or any Part thereof, whether such Gift be by way of Annuity or in any other Form, and also every Gift which shall have effect as a Donation mortis causa, shall be deemed a Legacy within the true Intent and Meaning of all the several Acts granting or relating to Duties on Legacies.

This was the last statutory change to legacy duty before the introduction of succession duty in 1853.

55

[1891] 2 Ch 613 at 628–9. 14 M and W 284; 8 and 9 Vict c 76, s 4. In order to assist understanding of s 4 the writer has not only kept the original capitals (used for every noun as opposed to other words) but also broken the text into short paragraphs. 56

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V. SUCCESSION DUTY

In 1853 Gladstone introduced succession duty.57 As Daunton has shown, it was meant to be part of Gladstone’s answer to the demands for differentiation of the income tax.58 It is one of the curiosities of death taxation in the UK that we owe two of our major taxes to the Liberal Party’s aversion to principles we find easy to live with; we owe the introduction of estate duty in 1894 to that party’s aversion to progression in the income tax.59 Since 1796 (or even 1780) legacy duty had caught personal property passing on death by will or intestacy but it did not tax real property but neither did it tax passing property settled by D on A for life with remainder to B and passing from A to B on A’s death. Succession duty was intended to catch these two types of succession. First, it caught gifts of real property by will or intestacy; second, it caught property passing on death, whether real or personal, without reference to the nature of the title by which the right to the property was acquired.60 In general the rates for tax were the same for the same as for legacy duty. These rates were, broadly speaking, stable from 1815 to 1909, when Lloyd George increased them. There had been some changes in the rate of legacy duty between 1786 and 1815. Gosschen increased the rates for succession duty in 1888 but these increases were virtually repealed with the advent of estate duty in 1894.61 There was a final flourish in 1947—when, as we have seen, most of them were, in effect, doubled. Apart from obvious rules stemming from the scope of the duties, the succession duty legislation included only one rule that was deliberately different from legacy duty. The legacy duty rule allowing double charges to duty on the same death was excluded.62 Later case law was to throw up an important difference on international aspects but this could probably not have been anticipated by the draftsman in 1853. Since the two duties were, at least in 1853, almost identical in terms of rate of duty and exemptions, one may wonder why Gladstone did not simply extend legacy duty. One suspects that the answer may be that the legacy duty provisions from 1796 were in archaic language and had to be supplemented by references to other Acts. Having a separate Act meant that the rates or scope of the tax could be changed later for one tax and not the other if desired. However, the answer is probably deeper; even the most cursory reading of the 1853 Act shows how it created new concepts 57 16 and 17 Vict c 51 (subsequently SDA); on the 1853 Budget in general, see Sabine Great Budgets [1971] BTR 294. 58 TL, above n 2, at 230–2, and fn 17. 59 TL, above n 2, at 245. 60 Inland Revenue Thirteenth Report. 61 FA 1894, ss 1, 5, 13 and 21 and First Schedule. 62 SDA s 14.

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suitable for the very sophisticated systems of real property law to which the duty was to apply, So s 2 defined the circumstances in which successions arose as follows: Every past or future disposition of property, by reason whereof any person has or shall become entitled to any property or the income thereof upon the death of any person dying after the time appointed for the commencement of this Act, either immediately or after any interval, either certainly or contingently and either originally or by way of substitutive limitation, and every devolution by law of any beneficial interest in property, or the income thereof, upon the death of any person dying after the time appointed for the commencement of this act, to any other person, in possession or expectancy, shall be deemed to have conferred or to confer on that person entitled by reason of any such disposition or devolution a ‘succession.

Sections 3–8 dealt with joint interests, general powers of appointment, the extinction of determinable charges, the treatment of people beneficially entitled to real property subject to a lease for lives, dispositions accompanied by reservation of benefit to the grantor, etc (which were to confer succession) and dispositions to take effect at periods depending on death or made for evading duty (which were also to confer succession). The rules on evading duty were aimed at dispositions which seemed not to confer successions but where there was an engagement, secret trust or other arrangement enforceable in law under which property would pass on the death. A court could declare the apparent succession to be fraudulent and then ‘declare a succession to have been conferred on such person at such time and to such an extent as such court shall think just’. The Act had 64 sections. Of these, attention may first be drawn to ss 10 (rates of tax); 12 (when the successor was also the predecessor); 15 (transferred interest); 16 (chargeability of charities); and 23 (timber). However, also of great interest are the tables for dealing with annuities, s 31 and the Schedule to the Succession Duty Act. Section 31 also made these apply for legacy duty but such tables had long been features of the older duty. The value of an annuity, for example an annuity of £100 per annum for A, was calculated using the first Part of the table which turned on A’s age when the annuity vested; so if A was 31, the value was £1,632 for each £100. Table 2 dealt with annuities payable for joint continuance of two lives. Table 3 dealt with an annuity for a specific number of years: £1,632.90 was the value of an annuity for 27 years. If the annuity were for A until remarriage—a very common provision— Table 1 would be applied, on the basis that A would not remarry. So if A were 31, succession duty or legacy duty would be charged on £1,632 at whatever was the appropriate rate, it being assumed (s 8) that the contingency would not occur. If A did remarry and so the annuity ended, the appropriate portion of the annuity was repaid.

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And so what of the straightforward bequest or devise for A for life? Section 21 stipulated that the rate in Table 1 applied.63 There was no trace of the IHT/CTT/estate duty principle that the life tenant should be treated as entitled to the underlying capital. This was consistent with the logic of the tax which was to tax the benefit received. Making payments followed by adjustments was a very common feature of the practical side of both succession duty and legacy duty systems. An example is the legacy duty provision considered in Attorney General v Dardier.64 Under s 6 legacy duty had to be paid by what we would not call the personal representatives when the residue was delivered or paid out. If the residue included property ‘which shall not be reduced into money’ the executors could set a value on it and pay the duty accordingly. The proviso was obviously aimed at objects such as works of art. In Dardier the executor brought the residuary account to the Inland Revenue office shortly after the testatrix had died and paid duty on the value of certain pictures. Thereafter, and as always intended, the executors sold the pictures in the course of administration and for a greater sum and accounted for these to the residuary legatee. The Court of Appeal held that s 22 did not protect the residuary legatee as it did not apply to property sold in the course of administration. The court noted that the officers of the Crown had been misled by the statement that the executor intended to retain these articles for use by the legatee. They acquitted the defendant and advisers of any intent to deceive and directed the matter as one of a common mistake on the part of the Crown and the executor. In respect of joint interests, suppose that D gives a give legacy to X and Y jointly and that they are liable at same rate. The system starts by charging the whole value at that rate.65 On death without severance, succession duty is due on the value accruing to the survivor. Problems arose where they were not subject to the same rate. If one were exempt and the other not, the practice was to charge the chargeable person at the proportionate value of the benefit at once and then further duty if that person survived and so receives another benefit.

A. Reactions to the 1853 Act The Succession Duty Act 1853 was generally regarded as a good piece of legislation despite the very complex system of property law to which it applied. As the Thirteenth Report said: 63 64 65

Legacy Duty Act 1793 (36 Geo 3 c 52), s 12 (LDA); Succession Duty Act, s 21 (SDA). (1883) 11 QBD 16. LDA, s 16; SDA, s 3.

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Questions, many involving most difficult points of law, have been very numerous and some are still pending before the Court of Exchequer; but it could not be expected that an Act affecting all the various modes in which property may be disposed of, or may devolve by operation of law, could be so framed as not to admit of any objections and on the whole it appears to us to have been less open to successful attack than might have been anticipated.

Judicial views were also favourable; Lord Wensleydale referred to ‘the very able framers of the well drawn Act’ while Wilde B in 1863 refers to the Act as a strictly and remarkably well drawn Act.66 If one has to cavil at this praise at all, it would be to remind oneself that the Inland Revenue had had 73 years of experience with legacy duty many of the provisions of which were taken across. We have seen that succession duty was introduced in order to make the tax system fairer by catching property passing on death which was not caught by legacy duty. However, there was another and more basic reason: money. As we have seen, the yield from succession duty was not great and was usually less than that from legacy duty. Yet when the tax was being debated, speakers assured the House that the yield would be ‘enormous’.67 A Mr Mullings said it would be upwards of £3 million, while Mr Cairns (later Lord Chancellor) said that property in trust was greater than that passing by will and upwards of £4 million could be expected. When officers of the Department suggested £2 million, the figures were denounced as ‘grossly inadequate’ by those opposing the Bill. The First Inland Revenue Report (for 1857) states that when all these estimates were so wide of the mark, ‘we cannot think that much apology is due for errors in the calculations made in this office’. It is interesting to speculate as to why this overestimate occurred. Various suggestions emerge from the Inland Revenue reports. One was that, despite the eminence of Mr Mullings and Mr Cairns, they actually overestimated the amount of real property held in trust. Another was that they failed to make sufficient allowance for charges and incumbrances. A third was that they failed to take account of Pitt’s success in making legacies paid out of realty subject to legacy duty. Perhaps the most interesting, however, is that successions to land were more likely to be to a closer class of relative so that the average rate of duty was lower than that for legacies. The Commissioners of Inland Revenue were, however, clear that they had no reason to think that any appreciable amount of duty was fraudulently suppressed.

66 Braybrooke v Att-Gen 9 HLC 150 at 173 and Earl of Sefton’s Case (1863) 2 Hurl and Colt 362 at 375 (157 ER). I am indebted to Professor Chantal Stebbings of Exeter University for these references. 67 See Inland Revenue Thirteenth Report at 97.

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The propriety of keeping the receipts from the two duties separate was attentively considered when succession duty came into operation. They were assured by the Controller of Legacy Duties that there would be great difficulty in doing so and the attempt would occasion much annoyance to persons rendering accounts at their office. No regulation which could be framed would effectually maintain the distinction. Two years later, it was done.68

VI. IDENTIFYING THE PARTICULAR LEGACY OR SUCCESSION: LITIGATED QUESTIONS

As we have seen, there was much case law deciding how a particular testamentary arrangement fitted into the concept of the legacy and no less important who the legatee was: a matter of great importance since, as we have also seen, this affected the rate of tax. A beneficiary under a secret trust was treated as the legatee—and the apparent legatee as not the legatee.69 Another question was whether a legacy was one by way of condition or trust.70 The answer might be relevant in determining the appropriate rate of duty. In Re Harris,71 T left property to his widow (W) for the maintenance of W (at that time exempt) and of T’s named children. The court held that this created a trust for the children and W; the children’s part was subject to legacy duty and only W’s part was exempt. By contrast, Attorney General v Sharpe72 illustrates the same point but with the opposite result. A sum of money was left to X, a stranger (10 per cent rate) for the testator’s children (1 per cent rate); if there were a trust for the children, the rate would be 1 per cent but if it were a beneficial legacy to X, subject to a condition that X use the money to maintain the children, the 10 per cent rate applied. The court held that the words gave rise to a condition and so the 10 per cent rate applied. Attorney General v Wade showed how legacy duty applied to discretionary trusts.73 Here, the will allowed the trustees to apply income as they might in their absolute and uncontrolled discretion deem right for the maintenance of A. The court held that each and every application of the income for A was a separate legacy. Where there was a double devolution there was a double charge to legacy duty. This rule, also known as the principle of cumulation, is one of 68 69 70 71 72 73

See ibid at 97. Hanson, Death Duties (10th edn, London, 1956) 280. Underhill and Hayton, Law of Trusts and Trustees (16th edn, London, 2003) 34–6. (1852) 7 Ex 344, 155 ER. (1891) 7 TLR 558. [1910] 1 KB 706.

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those rare areas where legacy duty and succession duty differed, as the Succession Duty Act had a specific provision barring double charges of duty.74 The principle is shown by Attorney General v Cleave.75 A gave £10,000 in trust for B (the then wife of C) and then for such of her children as should attain 21. B had seven children who reached 21 but two, D and E, died intestate after reaching 21; this meant that C took their one-seventh shares on the death of B; C did not take out letters of administration and died in the lifetime of B. The five surviving children took the two shares which had devolved on C on C’s death. Applying the principle, the court held that legacy duty was payable in respect of a) beneficial acquisition by C of the two one-seventh shares of D and E; and b) the transmission of those shares to the surviving children under C’s will—but that it was perfectly in order to wait till it fell into possession and to pay at that time. Green’s Death Duties contains an even more extreme example.76 A gave £5,000 to B for life, then to C absolutely. C predeceased A, leaving property to D. D also predeceased A but died intestate; D’s property passed to E. legacy duty was held to be due on each transfer. So A’s personal representatives were to pay legacy duty and hand over to C’s executors; C’s executors paid to D’s administrators, paying legacy duty, and D’s administrators paid their legatees—and paid legacy duty. If A’s trustees had handed over direct to E they would have been liable for the duty for each occasion; by paying E they would have made have made themselves executors de son tort for the estates of C and D.

A. Rates of Tax It is time to return to the actual rate structure and to touch on some of the problems that arose. Looking at it tells us much about older (and, for some, no doubt obsolete or even shocking) attitudes to families and to property. As we have seen, the repealers of 1949 did not think much of a tax which favoured close relatives over outsiders and preferred a tax based on need rather than blood. One most not forget that today’s less formal attitudes may look equally shocking to our successors. The structure was graduated according to consanguinity but not by amounts as shown in table 13.1 above. One problem was the difference between one’s blood relatives (kindred) and those to whom one was related by marriage (affinity). So if T left property to his daughter, the rate was 1 per cent; however, if T left 74

SDA, s 14. (1873) 31 LT 86. 76 (London, 1936) at 225. See also Re Scott [1901] 1 KB 228, dealing with a case arising under the original (unreformed) Wills Act 1837, s 33. 75

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property to his daughter’s husband, the rate was, at first, 10 per cent. This was changed for both legacy duty and succession duty by the Act of 185377; the new rule meant that daughters/sons-in-law who previously paid 10 per cent as strangers in blood were now treated the same as the person to whom they were married. The change was stated to apply to the will of a person dying after the coming into force of the Act but the account in the Inland Revenue’s Thirteenth Annual Report explains that the Treasury gave it power to ignore that restriction. Perhaps curiously to our eyes, it appears that if the daughter and son-in-law were divorced before T died, the son-in law still qualified for the lower rate. Although the spouse was brought within the lower tax bracket by the 1853 Act, the relatives of the spouse were still strangers. So relatives of the husband or wife of the testator, including stepchildren, were strangers unless they qualified in some other capacity. Therefore a reversionary legatee who married the testator’s widow did not qualify for the 1 per cent rate. A divorced spouse of the testator was treated as a stranger. Illegitimate children were strangers—unless legitimated by law of domicile. The English Legitimacy Act 1926 had to make express provision (s 7), as did the Adoption Act 1926 (s 5) for illegitimate children. However, to its shame, as we surely see it now, it was only in 1944 that the tax legislation directed that legacy duty and succession duty should be levied in the case of an illegitimate child as if it had been born legitimate.78 However, one should not rejoice too much—it applied only when the child took on the death of the mother or when the mother succeeded on the death or intestacy of her child.

B. Exemptions These were usually the same for both duties. The first group gave exemptions to particular persons or property So a gift to a spouse was exempt before 1909 (and since 1975), as was a gift to a member of Royal Family (defined as the descendants of George III in 1780).79 Also exempt were gifts of works of art to certain bodies, for example a society or endowed school, for preservation not sale80; heirlooms so long as enjoyed in kind81; a legacy out of a savings bank account in England or Ireland up to a limit of £5082; and a gift to a charity in Ireland was exempt.83 77 78 79 80 81 82

SDA, s 11. FA 1944, s 44. 55 Geo III c 184, sch, Pt III. 39 Geo 3 c 73, s 1; and 55 Geo 3 c 184, sch, Pt III. LDA, s 14; eg Att-Gen v Bruce [1901] 2 KB 391. 26 and 27 Vict c 87, s 42.

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Particularly important was the exemption for money applied in paying the duty. If D left A, as a stranger, a gift of the legacy (£100), D’s personal representatives would deduct the 10 per cent legacy duty at source and pay A £90. If the tax were not deducted the legacy was treated as £100 net of duty; the legacy duty of £10 would be collected from the legatee direct, still leaving A with £90. If, however, D left £A 100 free of duty, D’s wish was clearly that A should be better off by £100, not £90. This would in turn mean that A was going to receive not only the £100 but also the legacy necessary to pay the duty; hence one would face the grossing-up problem familiar to us today in connection with chargeable lifetime transfers of value. So a pecuniary legacy of £100 and a further pecuniary legacy of the amount of the duty would require the legacy to be grossed up, so making the total legacy £111.11 (£111 2s 3d). However, the effect of s 21 of the Legacy Duty Act is that no duty was charged on the money applied in payment of the duty. This meant that the duty would be £10, not £11.11. This reinforced the point made by the Revenue officials in charge of the repeal in 1949, and noted above, that where legacies were left free of duty, the legacy and succession duties simply acted as an additional estate duty. There was a similar exemption for property subject to succession duty which was used to pay succession duty.84 However, the exemptions could only be used for paying the particular duty, so a gift of property subject to succession duty with the direction that it be used to pay legacy duty was not exempt from succession duty. There were also exemptions for small bequests, as we have seen: up to £20 before 1881; in 1949 it was still only £100.85 There were also exemptions where the net value of D’s non-settled estate was below a certain amount. For a long time that was £1,000; by 1947 this figure had risen to £2,000. If this seems low, it may be noted that in 1947 a house was purchased in Royal Leamington Spa for £3,000; it was recently resold for £600,000 having risen to £5,000 by 1963. There was a £1,000 exemption for the legatee who was in the 1 per cent rate bracket, provided that either probate duty or estate duty was paid. After 1909, this exemption was from legacy duty and succession duty if all the property passing on the death did not exceed £15,000 and estate duty was payable. As just seen, some of these rules tie exemption from our two duties to liability to estate duty. The report for 1895–96 shows the effect of these rules was to reduce the take of succession duty (£1.35 million to £1.05 million) and even legacy

83 5 and 6 Vict c 82, s 28; some readers may remember the ‘secret trust’ case of Att-Gen v Cullen (1866) LR 1 HL 190. 84 SDA, s 18. 85 Increased by FA 1947, s 50(2)(a).

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duty (£2.8 million to £2.7 million). Estate duty yield rose from £2.78 million in the first year to £7.56 million. Overall, the take of death duties rose by £2.885 million, of which increase £308 million went to local authorities. The yield from real property was greater than expected because those liable to tax did not use the payment by instalment option (FA 1894, s 6(8)), with interest charged at 3 per cent. There was also a decline after 1894 because 1894 saw the virtual repeal of Gosschen’s surcharge of 1888.

C. International It is now time to look at the major difference between the two duties in the international area. In Thomson v Advocate-General the House of Lords held that legacy duty looked to the domicile of the relevant person dying and not to the jurisdiction where the asset was.86 John Grant, a British-born subject and native of Scotland, made his will and died in 1837. He was held domiciled in Demerara, now Georgetown, Guyana, where Dutch law was in force. The Netherlands had no system of Dutch legacy duty. Was legacy duty payable in respect of property in Scotland? The legislation (then in force for 60 years) was silent on the point. One’s instinctive answer today (especially post-Agassi87) would be ‘Yes—of course’. The property in Scotland had been used to pay legacies to people in Scotland: probate duty was due and was not in issue. The successful argument, however, was that on a death the personal property followed not its situs but the deceased’s domicile. It was clear that if a person died domiciled in the United Kingdom, legacy duty was due even if the property was situated abroad. However, the Revenue also said that it would not try to tax foreign property if the deceased was not a British subject. It is an interesting, but quite irrelevant, question whether John Grant would be held to be domiciled abroad today. Later cases, for example Winans v Attorney-General, placed much greater emphasis on intention.88 It is clear, though, that the Revenue had great difficulties with domicil(e), as the Thirteenth Report shows: Some of the most embarrassing questions are those which turn on the domicil of the deceased and they have become less susceptible of a solution consistent with any uniform principle since the Succession Duty Act came into force…the 86 87 88

(1845) 12 Cl and Finn 1 (Exch Ct of Scotland). [2006] UKHL 23, [2006] STC 1056. [1904] AC 287; on later estate duty litigation, see Winans v Att-Gen (No 2) [1910] AC

27.

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property of a deceased domiciled out of the UK at the time of his death is not subject to Legacy Duty. This applies to personal property devolving by will or intestacy; but the property subject to Succession Duty is, first, real property under a will or intestacy or deed and secondly personal property under a deed. In the case of real property no exemption is conferred by the foreign domicile of the person from whom it is derived. In the case of personalty the law of deeds is considered to be different from that of wills and the time and place of the execution of the deed may be elements in any decisions to the liability of the property to duty. In short, it is much more difficult in such cases to arrive at a certain conclusion than it is even under the Legacy Duty and when it is considered that in one and the same account rendered in this office on the death of person domiciled abroad there may be real property passing by will which is liable to duty; personal property passing under the same will which is not liable; personal property passing by deed which liable and personal property passing under the same or some other deed which is not liable—the intricate state of the law become very apparent. It is very much to be desired, for the sake of the Revenue and for the sake of attaining clearness and certainty in the law, that all property of British subjects at the time of their death should be made liable to duty without reference to their domicil.

VII. CONCLUSIONS

This survey has concentrated on legacy duty and succession duty to see what a donee-based tax might look like. It has also concentrated on a very long nineteenth century (1780–1920), with necessary reference to the rate changes in 1947 and the repeal in 1949. There were a few changes after 1920 but these are mostly ones of detail or amounts of exemptions. So there was an exemption for death on active service for common seamen etc and a separate rule for officers which was at first capped at £5,000 at the time of the First World War.89 What we have shown is the range of issues raised by these old duties. For those who remember their legal history with pleasure, wandering through the nineteenth- and early twentieth–century books is a garden filled with familiar flowers. The writer is convinced that there is much sense in the principle behind these older duties that consanguinity mattered and was a legitimate call on generosity.90 However, one has to accept that today’s policy discussions have a much more determined agenda. The Tax Reform Commission set 89 The exemption for common seamen and soldiers goes back to 1694: 5 and 6 Gul and Mar c 21, s 6. 90 Table 12.9 of the latest HMRC Statistics (above n 12), based on a sample of 1,000 cases taken from 2001, shows that most gifts went to a spouse or to children in the case of those who had them.

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up by the Conservative Party and reporting in October 2006 suggests, among many changes, replacing inheritance tax with a capital gains charge on death (though keeping the exemption for the only or main residence).91 So far, the other main UK political parties have not wanted to abolish taxation on death but instead to make the system more effective. A New Political Economy, published by Compass, ‘the democratic left pressure group’, in 2007, suggests all sorts of possible taxes including a wealth tax and a ‘look at reforming inheritance tax as a way of paying for free long term care’92; a slightly earlier Fabian Society publication also advocates reform to make the tax less voluntary.93 In 2005 the Liberal Democrats produced a policy paper, ‘Fairer, Simpler, Greener’, which identified some of the problems needing to be addressed and ending up advocating an accessions tax.94 It seems as though we may be entering a livelier period of political discussion.

91

Tax Matters: Reforming the Tax System Ch 8 at 8.4.2. At 99. 93 Patrick and Jacob, Wealth’s Fair Measure The Reform of Inheritance Tax (Fabian Society Policy Report No 57, 2004). 94 Liberal Democrats Policy Paper 75, s 3.3. 92

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