Studies in the History of Tax Law - Volume 2 9781474200561, 9781841136776

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Preface Over two almost perfect English summer days in July 2004, the second group of 40 interested people gathered together for the second Tax Law History Conference organised by the Centre for Tax Law which is part of the Law Faculty of the University of Cambridge. As with the first, held two years earlier, our days were passed in the beautiful surroundings of Lucy Cavendish College and this time the air was heavy with the scents of a Cambridge Edwardian garden in full summer. This volume is a collection of the papers delivered over those two days. The occasion would have been impossible without sponsorship from the Chartered Institute of Taxation. Once again I have taken my role as editor very lightly. As I, in my editorial role, look back I am struck by the great richness and variety of the material waiting to be examined. There have always been writers of the history of taxation, especially in the United Kingdom, but the opportunities for new work has never been greater. As the list of papers below makes clear we were ‘discovered’ by participants from the United States. The success of the days caused a group led by Steve Bank and based at the University of California, Los Angeles to organise their own conference in co-operation with our own Cambridge Centre for Tax Law in July 2005. The first two chapters were published in the January 2005 British Tax Review special issue to mark the bicentenary of the Special Commissioners. David Duff has widened his researches in the area of wealth transfer to cover New Zealand; his extended article is due to appear shortly in the Pittsburgh Tax Review. The third Cambridge conference took place in Cambridge in July 2006 and had more participants from continental Europe. The fourth is scheduled for July 2008. It remains for me as Director of the Centre once again to express my thanks to all those who gave of their time to attend the conference making it the happy event it was and, in particular, to those who shared their scholarly investigations with us by giving papers and thus focussing our thoughts. Special thanks go to Janet Rogers who helped with the administration of the conference. 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.

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Preface

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 the hard work. John Tiley Cambridge July 2006

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.

1 The Special Commissioners from Trafalgar to Waterloo JOHN F AVERY JONES

ABSTRACT THE SPECIAL COMMISSIONERS were introduced by Pitt in 1805 to take some of the work away from the general commissioners by dealing with claims for charitable reliefs under Schedules A and C. This was their sole function until the abolition of income tax in 1816. The problems of interpretation of the oddly-worded charitable exemption were not resolved until Pemsel’s case in 1891. ‘Practically the Special Commissioners are identical with the Board of Inland Revenue.’1

I. INTRODUCTION

T

HE SPECIAL COMMISSIONERS celebrate their bicentenary in 2005. Their history can be divided into two main eras: the first from their introduction in 1805 to the abolition of income tax in 1816, a period when they dealt with certain claims for exemption from tax (including the still-topical one of determining whether public schools and hospitals qualified for tax relief), relieving some of the burden on the General Commissioners. The second era starts with the reintroduction of income tax in 1842: this time the Special Commissioners also dealt with Schedule D assessments and Schedule D appeals at the option of the taxpayer in order to preserve confidentiality of their affairs from the General Commissioners. This chapter will deal with the first era roughly corresponding to the period from the battle of Trafalgar to that of Waterloo.

1 Special Commissioners v Pemsel (1891) 3 TC 53, 99 per Lord Macnaghten. (This was said in relation to their original function of handling claims for exemption, not hearing appeals.)

4 John F Avery Jones Originally both assessment and appeals were the province of the General Commissioners and formed a continuous administrative process leading to the correct figure. The Special Commissioners’ decisions on claims for exemption were also administrative, but exercised judicially as there was no right of appeal. Although these claims are no longer made to the Special Commissioners, the connection is preserved as the Special Commissioners are the sole appeal body in relation to all such refuted claims.2 If one of the original Special Commissioners returned today he would find virtually all3 of these original exemptions still in the Act, and he would even find the statutory wording of them familiar. Remarkably most of the original claims were still being made to his successors until 1965.4 The Special Commissioners’ assessing function started in 1805 since they assessed tax on Schedule C income where the recipient did not make a return or if he made an arrangement to pay the tax direct to the Bank of England without declaring the income to the General Commissioners. This lasted for only one year, becoming unnecessary in 1806 by the introduction of the paying agent deducting tax at source. As well as the taxpayer’s option to have his Schedule D assessment made by the Special Commissioners, many other assessing functions followed. All assessing functions ended in 1965 leaving only the appellate function introduced in the second era with the Schedule D appeals heard by the Special Commissioners at the taxpayer’s option: this was subsequently expanded beyond Schedule D. To put the history of the Special Commissioners into perspective, one must start with the state of development of income tax at the time they were first introduced. Land tax, which had existed since 1688 (and under another name effectively from 1671), was the main direct tax in the eighteenth century. In spite of its name, land tax included a tax on deemed income from personal property, including public offices,5 and annuities and other yearly payments, expressions that would later be taken over by 2

But see below nn. 169 and 170 for a possible exception. Except the Schedule C exemptions for non-resident aliens, which was not repeated in the 1842 Act, see below n. 148, and for foreign ministers, which was repealed in 1964, see below n. 161. 4 Until 1925 for the charitable exemptions, other than for the British Museum, see below n. 120. 5 Adam Smith fully understood the meaning of the expression: ‘The emoluments of offices are not, like those of trades and professions, regulated by the free competition of the market, and do not, therefore, always bear a just proportion to what the nature of the employment requires. They are, perhaps, in most countries, higher than it requires; the persons who have the administration of government being generally disposed to reward both themselves and their immediate dependants rather more than enough. The emoluments of offices, therefore, can in most cases very well bear to be taxed. The persons, besides, who enjoy public offices, especially the more lucrative, are in all countries the objects of general envy, and a tax upon their emoluments, even though it should be somewhat higher than upon any other sort of revenue, is always a very popular tax. In England, for example, when by the land-tax every other sort of revenue was supposed to be assessed at four shillings in 3

The Special Commissioners from Trafalgar to Waterloo 5 income tax:6 the operation of the tax on personal property was not particularly effective.7 The half-way stage in the transition to taxation of actual income was Pitt’s Triple Assessment8 of 1798. This allowed persons to elect to pay 10 per cent tax on their total income (with lower rates for small incomes and nothing on £60 or below) as an alternative to paying a multiple (not always three times despite its popular name) of the amount of the previous year’s tax on various items of luxury expenditure (male servants, horses, carriages, hair powder, etc.), but it contained no provisions for computing such income. In other words, the taxpayer had an option the pound, it was very popular to lay a real tax of five shillings and sixpence in the pound upon the salaries of offices which exceeded a hundred pounds a year, the pensions of the younger branches of the royal family, the pay of the officers of the army and navy, and a few others less obnoxious to envy excepted’: Wealth of Nations Bk.V, Ch.2, art.3 (1776, not long before the introduction of income tax). 6 In addition to land, land tax taxed: (a) money, debts, goods, wares, merchandises, chattels or other personal estate at the rate of 4s. in the pound based on an annual yield of 1 per cent.; (b) the holding of ‘any publick Office or Employment of Profit’, wording that was adopted for income tax; (c) ‘an Annuity, Pension, Stipend, or other Yearly Payment’, also adopted for income tax; and (d) shares ‘in the New River Company [which was logical as they were regarded as realty, see Townsend v Ash (1745) 3 Atk. 336, on the theory that the company held its assets on trust for its shareholders; later a trust for conversion was implied and is still found in Companies Act 1985 s.182(1)(a)], in the Thames waterworks, or in Marybone or in Hampstead waterworks, in any office or stock for insuring of houses in case of fire, or in any lights, or in the stock or stocks for printing of books in or belonging to the house commonly called the king’s printing house’, and all companies of merchants in London and the Bank of England (s.57). The items adopted for income tax can be traced back even further to a 1671 Subsidy (22 & 23 Car 2 c.3 ss.2–8) which taxed land, items (a) and (b) and also contained charitable reliefs: see n. 58, and PE Soos, The Origins of Taxation at Source in England (IBFD Publications, Amsterdam, 1998) 109 (‘Soos’). The Land Tax Perpetuation Act 1798 (38 Geo 3 c.60) changed land tax into a perpetual tax with a fixed quota for each town, parish, etc., and moved the taxation of personal property into another Act which was not perpetual, and like income tax today, had to be renewed every year. The first of such Acts was 39 Geo 3 c.3, which covered the same assets and applied for the year beginning 25 March 1799 (for some reason the land tax year never changed to 5 April) and therefore applied at the same time as Pitt’s income tax of 1799. Notwithstanding the Perpetuation Act the land tax on item (d) was made redeemable by the Land Tax Redemption Act 1802 (42 Geo 3 c.116 s.13), also suggesting that this item was akin to realty. See Soos at 140. Land tax was finally repealed by FA 1963. On the history of land tax, see W Phillips, No Flowers, by Request [1963] BTR 285. 7 Adam Smith had said: ‘If the greater part of the lands of England are not rated to the landtax at half their actual value, the greater part of the [capital] stock of England is, perhaps, scarce rated at the fiftieth part of its actual value’ (Wealth of Nations Bk 5 Ch.2 art.2 (1776). This resulted from land tax becoming a fixed proportion for each district. M Daunton, Trusting Leviathan, the Politics of Taxation in Britain 1799 to 1914 (CUP, Cambridge, 2001) at 33 (‘Daunton’) says: ‘In theory, this tax [Land Tax] was a national rate of 1s, 2s, 3s, or 4s in the £ on the income not only of land but also of personal property and office. . . . Reality was different, for the tax was confined to land’. . . . A Hope-Jones, Income Tax in the Napoleonic Wars (CUP, Cambridge, 1939) at11 (‘Hope-Jones’) also states that the attempt to tax offices and personal property failed. 8 38 Geo 3 c.16. Simon’s Taxes (3rd edn., Butterworths, London, looseleaf) at A1.403 records that ‘it was associated with a scheme proposed by the Speaker, Addington, from an idea by JBowles in 1796 (Two letters addressed to a British Merchant, 4th ed pp 31 and 76) that voluntary contributions in excess of the Triple Assessment might be made to the Bank of England; this scheme raised almost as much as the main tax itself had produced.’

6 John F Avery Jones between paying an income tax or an expenditure tax. That the Triple Assessment yielded only £1.8m, less than half its expected yield,9 with large numbers of people declaring incomes of under £60, caused Pitt to go back on his promise not to impose an income tax (made in the debates on the Triple Assessment). In 1799 he imposed such a tax (although it was still in relation to land, the main source of wealth and so a tax on deemed income) at 10 per cent,10 which turned out to be not much more successful than its predecessor, collecting only £6m instead of the estimated £10m, although this was a considerable improvement on the £1.8m yield from Triple Assessment. The income tax removed the voluntary element of the Triple Assessment, i.e. paying tax on one’s expenditure without disclosing one’s income. It was now necessary to declare one’s income; a sensitive issue, particularly so in relation to trading profits, as this was the first time an attempt had been made to tax them. Only 25 years before, Adam Smith had warned: the state of a man’s fortune varies from day to day and, without an inquisition more intolerable than any tax and renewed at least once every year, can only be guessed at. His assessment, therefore, must, in most cases depend upon the good or bad humour of his assessors and must, therefore, be altogether arbitrary and uncertain.11

Income required a definition for the first time; it was divided into four major heads: (1) land (14 Cases, which demonstrates the importance of land at the time), (2) trades, employments and interest and annuities (2 Cases), (3) foreign income (2 Cases12), and (4) income not falling under any other head.13 The tax return merely required a statement that the tax paid was not less than one tenth of the taxpayer’s income, although a return under each head could be required as part of the appeal process. Addington, who had succeeded Pitt, repealed Pitt’s income tax in his budget on 5 April 1802 following the Peace of Amiens on 25 March 9 The yield was £1,855,996 (1870 Report of the Board of Inland Revenue); Pitt had expected £4.5m. 10 39 Geo 3 c.13 (‘1799’), although the Schedule is substituted by c.22, an act that also extended the time limit for making returns. For articles on the 1799 Act see BEV Sabine, ‘Great Budgets’ [1970] BTR 201; W Phillips, ‘The Origin of Income Tax’ [1967] BTR 103 and ‘The Real Objection to the Income Tax of 1799’ [1967] BTR 177; C Stebbings, ‘The Budget of 1798: Legislative Provision for Secrecy in Income Taxation’ [1998] BTR 651. 11 Wealth of Nations, Bk V, Ch.2 art.4. 12 Identical to Addington’s Cases IV and V of Schedule D and still effectively unchanged, see the writer’s ‘Taxing Foreign Income from Pitt to the Tax Law Rewrite—the Decline of the Remittance Basis’ in J Tiley (ed.), Studies in the History of Tax Law (Hart Publishing, Oxford, 2004), Ch.2. Foreign income was subject to land tax only if it fell within item (a) in n. 6. 13 This last feature was the main difference from the schedular taxes (impôts réels) to be found later in Europe, which covered a specific list of items, such as immovable property, industrial and commercial establishments (including the case of a branch or agency or permanent establishment, shipping enterprises, railway companies, transatlantic cables, aerial navigation companies and electrical power undertakings, insurance companies, banks), mortgages, directors’ fees, earned income, transferable securities, and various credits and annuities (League of Nations, Double Taxation and Tax Evasion, Report and Resolutions submitted by the Technical Experts to the Financial Committee of the League of Nations, 1925).

The Special Commissioners from Trafalgar to Waterloo 7 1802.14 War with France was declared again, and, little more than a year later, on 18 May 1803 he was obliged to reintroduce an income tax, thinly disguised by the name property tax.15 Like Pitt’s tax, Addington’s 180316 tax was a schedular tax but, unlike with Pitt’s, the tax under each schedule was collected separately so that no return of total income was required, thus removing the main concern about Pitt’s tax. Addington’s tax owed much more to land tax than to Pitt’s income tax: many of Addington’s schedules corresponded to items taxed by land tax (such as land, public offices and employments, and annuities and other yearly payments17), and the tax was administered by General Commissioners chosen from the Land Tax Commissioners. Research by Piroska Soos has shown that claims made (by others) for the originality of Addington’s tax have been exaggerated; in particular there was nothing original about deduction of tax at source, a feature of land tax since 1688,18 the origins of which have been traced back to a lay subsidy granted to Henry VIII in 1512.19 Three of Addington’s 1803 provisions for deduction of tax at source were virtually identical to the 1797 land tax, two were similar and three were new but based on the same principles.20 Addington merely adopted a collection mechanism contained in another tax in force at the time. The surprise is not that Addington used deduction at source, but that Pitt had failed to do so in his 1799 tax. The result was a great improvement on Pitt’s 1799 Act, raising almost twice the tax at half the 14 This was not all gain, since in 1816 the Chancellor said that Addington imposed other taxes of £5m p.a. (HC Deb, vol.33, col.423). This was denied in evidence to the First Report of the Select Committee on the Income and Property Tax in 1852 (‘1852 Select Committee’) q.54 but I have not investigated which statement was correct. Although there is no actual First Report of the Committee, the minutes of evidence give a useful contemporary view of the tax about nine years after it was reintroduced from the point of view of all the participants, such as the Board, Special Commissioners, General Commissioners and their clerks and surveyors, plus three witnesses from the United States. (The Second Report 1852 is restricted to Schedules A and B.) 15 The 1803 Act provided a ‘Contribution on the Profits arising from Property, Professions, Trades, and Offices’. Even the 1842 Act was ‘An Act for Granting to Her Majesty Duties on Profits arising from Property, Professions, Trades and Offices’ and it is indexed under Property and Income Tax in Chitty’s Statutes (5th edn., Sweet and Maxwell, London, 1895). 16 43 Geo 3 c.122 (‘1803’). For an article on Addington’s Act see W Phillips, ‘A New Light on Addington’s Income Tax’ [1967] BTR 271. 17 See above n. 6 for the items taxed by land tax. 18 Soos, above n. 6, at 181, traces the origin of this misconception to the official Exposition of the 1803 tax, the purpose of which was to distinguish Addington’s from Pitt’s tax, and in doing so the Exposition concentrated on deduction at source as a principle . The Inland Revenue annual reports beginning in 1857, particularly the historical survey in the 1870 and 1885 reports from which historians have frequently quoted, contributed to the misconception by quoting from the Exposition and wrongly stating repeatedly that taxation at source started in 1803 (above n.6 at 186). 19 Soos, above n.6 at 36. 20 The three that were the same as land tax were two in Schedule A and one in Schedule E (deputy receiving payment, or fund for division); the two similar ones related to dividends paid by companies and by the Bank of England, etc.; and the three new ones related to annual payments and two within Schedule E (payments to another person, and payments to a clerk or deputy) see Soos, above n.6, at 152–181.

8 John F Avery Jones rate.21 Pitt returned to office in 1804 and in the following year presented his nineteenth and last budget.22 This 1805 Act23 increased the rate of tax from 1s (5 per cent) to 1s 3d (6.25 per cent) in the pound; it paid Addington the compliment of merely consolidating Addington’s 1803 Act with some amendments, one of which was the introduction of the Special Commissioners.24 After Pitt’s death Lord Henry Petty in the 1806 Act,25 in spite of the Whigs’ opposition, not only re-adopted the tax but increased the rate to 2s in the pound (10 per cent), Pitt’s original rate and double Addington’s original rate. This continued in force until the repeal of income tax in 1816. Cunningly, one of the 1806 changes reduced the minimum from £60 to £50, thus bringing into charge all those who had been declaring income just below the previous £60 limit, whose assessments could then be raised to realistic amounts. The 1806 Act also formed the basis for the income tax when it was reintroduced in 1842 and many features of it are still in the legislation today. In 1805 the existing types of Commissioners were first the Commissioners for the Affairs of Taxes,26 the predecessors of the Commissioners of Inland Revenue, who also administered the assessed taxes on such items as men 21 Addington’s 1803 tax at 1s in the pound raised £5,341,907; Pitt’s 1799 tax at 2s in the pound raised £6,046,624 (Annual Report of the Commissioners of Inland Revenue 1870) in the first year, £6,244,438 in the second year and £5,628,903 in the third year. 22 He had presented 18 successive budgets from 1783 to 1801. 23 45 Geo 3 c.49 (‘1805’). The Act was passed on 5 June 1805. Pitt returned to office on 16 May 1804; Addington was created Viscount Sidmouth. The long title is ‘An Act to repeal certain Parts of an Act, made in the forty-third Year of His present Majesty [i.e. Addington’s 1803 Act, see above n.16], for granting a Contribution on the Profits arising from Property, Professions, Trades and Offices; and to consolidate, and render more effectual, the provisions for collecting the said Duties.’ Regulations in Addington’s 43 Geo 3 c.99 (‘1803 Management’) passed before Addington’s 1803 Income Tax Act (or c.150 in Scotland), dealing with management of assessed taxes, were continued by 1805 s.2; 1806 s.4; 1842 s.3; consolidated by TMA 1880. (Here and in subsequent references the 1803, 1805, 1806 and 1842 Acts and subsequent consolidation Acts of 1918, 1952, 1970 and 1988 will be referred to by the year only.) 24 Other lasting improvements made by the 1805 Act include: adding ‘adventure or concern in the nature of trade’ to trade for Schedule D; taxing ‘the full amount of the balance of the profits and gains’ under Schedule D; the ‘wholly and exclusively’ rule for deductions under Cases I and II of Schedule D, and the prevention of deductions for capital employed and losses not connected with or arising out of such trade (s.93). Contrary to the statements in Simon’s Taxes, above n.9, at A1.406, the 1805 Act did not transfer assessments on mines and quarries from Schedule D to Schedule A: they were included in Schedule A in 1803; nor did the 1805 Act introduce the provisions charging a husband on his wife’s income: they were contained in 1803 s.91. 25 46 Geo 3 c.65 (‘1806’). Pitt had died in January 1806. With increased efficiency the amount collected was double the 1805 amount at £12,822,056 although the increase in rate was only 60%. W Phillips describes the 1806 Act as what Addington’s 1803 Act would have been but for Pitt’s opposition ([1967] BTR 271, 280), see in particular the deduction at source for Schedule C described in the text below at n.206. 26 The origins of the Commissioners for the Affairs of Taxes can be traced back to the Agents for Taxes who were established in 1665 and later called the Commissioners for Taxes. In 1670 they managed ‘the earth money’. In 1711 they were reconstituted as the Office for Hides, but regained their old title in 1718 when the hide duties were discontinued. They dealt with the land tax and the assessed taxes. In 1785 Pitt transferred to them a miscellaneous collection of duties upon carriages, wagons and horses from the Stamp and Excise Offices (25 Geo.3 c.47). In addition came Pelham’s window tax, and Pitt’s shop tax, commutation duty and subsequent additions

The Special Commissioners from Trafalgar to Waterloo 9 servants, horses, carriages, and hair powder.27 Next were the familiar General Commissioners (or Commissioners for the general purposes of the Income Tax Act) chosen from the Land Tax commissioners and using the same districts (or divisions,28 who were required to have a high property qualification29 and who to the assessed taxes, including income tax (I am grateful to John Jeffrey-Cook for this information). They merged with the Board of Stamps (dating from 1694) to become the Commissioners of Stamps and Taxes in 1834 (4 & 5 Will IV c.60 s.8), which was their title in 1842. They subsequently merged with the Board of Excise in 1849 (12 Vict.c.1) to become the Board of Inland Revenue (the Board of Excise were demerged and amalgamated with the Board of Customs in 1908). It is now proposed that the Boards of Customs and Excise and Inland Revenue should merge. They were first referred to in legislation as the Board of Inland Revenue by TMA 1880, presumably as a (not very successful) attempt to prevent confusion with the General, and Special, and other types of Commissioners. They are still referred to as ‘the Board of Inland Revenue’ in the Tax Law Rewrite’s draft Income Tax (Trading and Other Income) Bill. 27 In fact most of the work of the Commissioners for the Affairs of Taxes was done by the Secretary, Matthew Winter, Winterwho was an able administrator. He was originally appointed by Pitt in 1785 to deal with the assessed taxes. See Hope-Jones, above n. 7, at Ch.III. 28 Originally land tax was collected by reference to counties and to such cities, towns, etc., as were important in the 17th century, with the result that cities that became important later (such as Liverpool, Manchester and Birmingham) did not have land tax commissioners separate from those of the counties in which they were situated, and that some of the towns that had once been important, such as the Cinque Ports, became no longer so and still had commissioners (the ultimate example being the once-important town of Dunwich in Suffolk which disappeared into the sea). Commissioners were authorised to subdivide counties into each ‘hundred, lathe, wapentake, rape, ward or other division’, which was the origin of the expression ‘divisions’ (hundreds and wapentakes were Anglo-Saxon districts). Although the city districts did not arise from any division they also became known as divisions. The 1803 Act adopted the land tax divisions for income tax by requiring each land tax division to appoint general commissioners from the land tax commissioners. Special arrangements existed for the appointment of general commissioners in the cities, for example in London appointment was by the Mayor and Aldermen, the Governor and Directors of the Bank of England, the Directors of the East India Company, the South Sea Company, the Royal Exchange Insurance Company and the London Assurance Company. The reason for the special commissioners acting as general commissioners in Ireland when income tax was extended to Ireland in 1853 was that the Land Tax was never imposed in Ireland and so there were no land tax commissioners who could appoint general commissioners. The Customs and Inland Revenue Act 1879 s.24 (consolidated as TMA 1880 s.38) provided a mechanism for substituting poor law parishes where new parishes were created for poor law administration. The Revenue Act 1884 s.6 substituted poor law parishes for land tax parishes for income tax purposes and so the income tax divisions diverged at this point from land tax divisions. The 1918 Act therefore defined divisions as being income tax divisions. Further information about the history of divisions is contained in the Income Tax Codification Committee Report, 1936, Cmd.5131 (‘the Codification Committee’) notes to cl.346. Finally, ITMA 1964 s.1(6) gave the Lord Chancellor (in Scotland, the Secretary of State) power to alter boundaries of divisions. In 1952 (Sched.. 1 Pt.1 para.5) general commissioners were still appointed from the land tax commissioners; this connection formally ended with the Tribunal and Inquiries Act 1958 s.7. 29 The property qualification for general commissioners, but not official commissioners, consisting of real estate of a certain annual value, personal estate of a certain capital or annual value, or a combination of both. It varied between England and Scotland (there was a Scots pound in those days) and between city and county divisions, see the Acts of: 1803 ss.12–15; 1805 ss.14–19 and 21; 1842 ss.10–14; 1918 Sched. 3; 1952 Sched. 1; repealed by the Tribunals and Inquiries Act 1958 s.7(2). The property qualification for additional commissioners was half that of the general commissioners. The property qualification was abolished for land tax commissioners by the Land Tax Commissioners Act 1906 but continued for general commissioners until 1958. For further information on the property qualification for general commissioners, see the Codification Committee (above n. 28) notes to cl.352.

10 John F Avery Jones ‘honourably distinguished this country . . . gentlemen generally of ability, and in every instance strongly impelled by feelings of public spirit’. Additional Commissioners with half the property qualification of the General Commissioners were appointed by the General Commissioners to make assessments subject to appeal by either party to the General Commissioners, and subject to confirmation by the General Commissions in the absence of an appeal.30 Next were the Governor and directors of the Bank of England, the directors of the East India Company and of the South Sea Company who acted as general commissioners in relation to income on their stocks (later known as Official Commissioners31). Lastly, there were commissioners for duties under Schedule E payable by judges, the Houses of Parliament, public departments, corporations, and on public pensions and annuities.32 The only government employees involved, apart from the Commissioners for the Affairs of Taxes, were the surveyors (originally the same as the inhabited house tax and window tax surveyors),33 who received an additional £20, on top of their existing £90 per annum, for dealing with income tax from 1805,34 and their overseers, the inspectors.35 The 1805 Act added Commissioners (originally Assistant Commissioners36) for the Special Purposes of the Income Tax Act. The provision appointing them reads: That the Commissioners for the Affairs of Taxes for the Time being, together with such other Persons to be appointed as herein-after mentioned, shall be 30 The Acts of: 1803 s.18; 1805 ss.25–27 (appointment), 126, 128 (assessment); 1806 s.21; 1842 s.16; 1918 s.61; 1952 s.6, repealed by ITMA 1964 Sched. 6. Commissioners were exempt from serving in parochial offices until 1965 on its repeal by TMA 1964. They were also exempt from jury service until 1974 on the coming into force of its repeal by the Criminal Justice Act 1972, although, by Juries Act 1974 Sched. 1, chairmen of tribunals are exempt, and this could apply to chairmen of general commissioners. 31 1805 s.31; 1806 s.33; 1842 s.24; 1918 s.68; 1952 s.9, abolished by ITMA 1964 Sched. 6. The commissioners in relation to the Bank of England also assessed the bank under Schedule D: 1805 s.32; 1806 s.35; 1842 s.24; 1918 s.68; 1952 s.9, repealed by ITMA 1964 Sched. 6. 32 1805 ss.161–163, 168, 169; 1806 ss.33–41, 44; 1842 ss.30–34; 1918 ss.69, 70; 1952 ss.10, 11. These were not included in 1803. 33 1803 Management s.20 appointed inspectors and surveyors ‘appointed for the Duties on Houses and Windows and other Taxes charged by Assessment’ to act and gave the Treasury power to appoint them; 1805 s.35; 1806 s.48; 1842 s.37; 1918 s.75; 1952 s.13, transferred from the Treasury to the Board by ITMA 1964 s.3. 34 An Act of 1808 (48 Geo 3 c.141) s.5 permitted the appointment of 10 inspectors general who could visit the surveyor and inspector, ask them questions under oath, and could require the general commissioners to state a case for the opinion of the judges of the Court of Record at Westminster on anything concerning the execution of the Acts or the conduct of the clerk, assessor or collector. Three surveyors giving evidence to the 1852 Select Committee (see n. 14) (which was before the start of appeals to the courts in 1874 and before an earlier procedure introduced by The Queen’s Remembrancer Act 1859 of a special case-stated procedure for revenue appeals to the Court of Exchequer) said that fewer than 1 in 2,000 cases went to the judges from which it seems that there were some appeals. The Solicitor’s Office said on 17 Dec. 1842 that there was no such appeal (The National Archives (TNA): Public Record Office (PRO) IR99/102, 59). 35 The inspector was originally the overseer of the surveyors and the title of today’s inspector as sole survivor is a case of job title inflation. 36 References to assistant commissioners were dropped in the 1842 Act.

The Special Commissioners from Trafalgar to Waterloo 11 Commissioners for the special Purposes of this Act; and it shall be lawful for His Majesty, His Heirs or Successors, under the Royal Sign Manual, or the Lord High Treasurer or the Commissioners of His Majesty’s Treasury, or any Three or more of them, for the Time being, by Warrant under his or their Hand and Seal or Hands and Seals, from time to time to appoint such and so many other Persons [not exceeding Three37] to be Assistant Commissioners for such special Purposes as he or they respectively shall think expedient;38

It may come as a surprise today that the Commissioners for the Affairs of Taxes, who are now the Board of Inland Revenue, were ex officio special commissioners, and that the Special Commissioners were originally appointed as their assistants, hence their original title of Assistant Commissioners. Even in 1891, Lord Macnaghten could say ‘[p]ractically the Special Commissioners are identical with the Board of Inland Revenue’.39 It may be even more of a surprise that this provision was still to be found in the Income Tax Act 1952,40 although by then it had been regarded as an anachronism for many years. For example, the Codification Committee41 noted in 1936 that the Board of Inland Revenue never acted as special commissioners except in the performance of purely ministerial duties; they never took part in making any assessment or hearing any appeal. The 1955 Royal Commission said the same: In practice they [the Board] take no part in the Commissioners’ appellate work, since to do so would be inconsistent with the complete independence of the appellate tribunal. We think that the legal situation should now be brought in accord with the practice and that members of the board should no longer rank as Special Commissioners.42

Professor Wheatcroft, writing in 1962 just before the ending of this arrangement, said, with some understatement, of their dual loyalty—to the Board when exercising administrative functions, and independently when exercising appellate functions—that it ‘appears theoretically undesirable’.43 37

Not included 1806, and see below n.228 in consequence. 1805 s.30; 1806 s.31; 1842 s.23; 1918 s.67(1); 1952 s.8, repealed ITMA 1964 Sched. 6. The quoted text is that of the 1805 Act with the 1806 amendments (other than cross-references to the 1805 Act and grammatical changes) being shown in square brackets (continued in the text below at n. 48). The quotations have been separated into paragraphs for ease of reading; the original is in a single paragraph. 39 Special Commissioners v Pemsel (1891) 3 TC 53, 99. This was said in relation to their function of handling claims for exemption, not appeals. In practice, however, by 1851 the Board did not carry out the duties of the Special Commissioners except in the case of illness etc: 1852 Select Committee (see above n.14) q.162. 40 S.8(1). 41 See above n.28, notes to cl.345. The committee comprised many well-known names in tax, including A.M. Bremner, Reginald (later Sir Reginald) Hills, E.M. (later Judge) Konstam (author of Konstam’s Law of Income Tax which ran to 12 editions between 1921 and 1952), and F.D. Morton (later Lord Morton of Henryton). 42 Cmd. 9474, para.954. 43 G.S.A Wheatcroft The Law of Income Tax, Surtax and Profits Tax (Sweet & Maxwell, London, 1962) para 1-045. 38

12 John F Avery Jones The divorce of the Special Commissioners from the Board of Inland Revenue finally occurred in 1965 by the Income Tax Management Act 1964. This was the first separate taxes management act since 1880,44 which gave effect to many of the management recommendations of the 1920 and 1955 Royal Commissions. The document appointing special commissioners required them to obey the directions of the Treasury and the Commissioners of Inland Revenue, a somewhat unsuitable requirement for someone exercising appellate functions.45 The divorce from the Treasury took longer. It was not until 1984 that the Lord Chancellor took over their appointment.46 II. THE ORIGINAL SPECIAL PURPOSES

So what were the special purposes for which the new type of commissioners were appointed?47 Initially there were two, the first relating to claims for relief under Schedule A (then a tax on ownership of land based on the annual value) and the second to claims for exemption under Schedule C (interest on government securities), both involved charitable exemptions and the latter some additional exemptions and an assessing power in the absence of returns. The above quotation continues: Which said Commissioners for the Affairs of Taxes and Assistant Commissioners, or any Two or more of them, [without other Qualification being required than the Possession of their respective Offices,48] shall have full authority to execute the several Powers given by this Act to Commissioners for special Purposes, either in relation to the Allowances specified in Number Five,49 Schedule (A) of this Act, or in relation to the special Exemptions granted from the Duties mentioned in Schedule (C) of this Act.50

Below we consider the law that the Special Commissioners administered and the problems of interpretation that they faced, necessarily including the subsequent history of its interpretation. 44 There had been a Revenue Bill in 1921 to give effect to the management provisions of the 1920 Royal Commission but it was never passed. 45 For examples, see TNA:PRO IR40/1013 (appointment of Col. F. Romilly in 1860) and IR40/1792 (appointment of J. Sanderson , former Chief Inspector of Stamps and Taxes). 46 FA 1984 Sched. 22, para.1. 47 The Income Tax Acts have never listed the special purposes; they have to be found in various places in the legislation. 48 Added 1806. Although the 1805 Act was silent on whether the property qualification for General Commissioners (see above n. 29) applied to Special Commissioners, the qualifications varied according to districts and were therefore inapplicable to the Special Commissioners, and the 1806 Act added these words to clarify this. It therefore never applied to the Special Commissioners. 49 This became No.VI in 1806. 50 1805 s.30; 1806 s.31; 1842 s.23; 1918 s.40, 67; 1952 s.8; TMA 1970 s.4. A further charitable exemption equivalent to the Schedule C exemption for yearly interest and annual payments under Schedule D was introduced by 1842 s.105. This was granted by the Special Commissioners and should have been cross-referenced here but the draftsman was copying out 1806. The quotation continues below at the text to n. 185 after setting out the exemptions from Schedules A and C.

The Special Commissioners from Trafalgar to Waterloo 13 Charitable Exemptions Schedule A The allowances, or exemptions, then contained in Part V of Schedule A in respect of which claims were made to the Special Commissioners, related to rent received by a charity. In the Schedule this followed exemptions from tax on the deemed income from its own occupation of property for a university,51 hospital,52 public school,53 or almshouse:54 51

See The College of Preceptors v Jenkins (1919) 7 TC 162 for a body that did not qualify. ‘Hospital’ formerly had a wider meaning than it does today and this wording can be traced back to 1503: see below n. 56. In Mary Clark Home v Anderson [1904] 2 QB 645 Channell J said at 653: ‘No doubt it is now generally used solely in the sense of an institution for the relief of the sick suffering from physical ailments or physical injuries. No great while ago, at any rate in the time of Lord Coke, the word included institutions for the relief or alleviation of mere poverty, and certainly of the aged. There is an even older and wider meaning than those referred to during the argument, in which the word means little more than a resting-place or guest’s place; it is, however, clearly not used here in that very wide sense, and whether it is used in the sense that includes institutions for the relief of poverty does not, I think, arise in the present case for in each of the Acts [income tax and inhabited house duty] words are used which do include institutions of which that is the object.’ The Shorter OED gives as older meanings ‘a charitable institution for the housing and maintenance of the needy, infirm, or aged (obsolete except in English legal use and in proper names); a university hall or hostel (1536); a charitable institution for the education and maintenance of the young (1552);’ see below nn.56 and 58 for early statutory use. The mental hospital in Needham v Bowers (1888) 2 TC 360 did not qualify because it had no endowment paying running costs; the wealthy patients subsidised the poorer ones. (The same applied to inhabited house duty, which also gave an exemption for a hospital, both in that case and in Musgrave v Dundee Royal Lunatic Asylum (1895) 3 TC 363.) On the other hand, the hospital in Cawse v Committee of the Lunatic Hospital, Nottingham (1891) 3 TC 39, 42 (‘it intends to exempt anything that is practically of the character of a hospital being of an eleemosynary character’), which had endowments contributing to the running costs, and the convalescent home for the benefit of members of a friendly society (for the exemption of such societies, see below text at n. 127 onwards) in Royal Antediluvian Order of Buffaloes v Owens 13 TC 176, where the maintenance of members paid for out of the funds of the society did qualify as a hospital. The test for qualifying seems to have been whether the running costs were paid substantially from an endowment or by those using the services; but see the movement away from this approach in relation to public schools in the next note. 1805 covered the necessary repairs of hospital buildings; 1806 said repaired and maintained by the funds of such body. 1806 extended the exemption to such buildings not occupied by a member but by a person paying rent in the case of hospitals, etc., whose income does not exceed £50 p.a. It also added an exemption for cottages with an annual value not exceeding 40s. 53 For schools qualifying as public schools, see Ereaut v The Girls’ Public Day School Trust Ltd (1930) 15 TC 529 which discusses the earlier authorities. Originally, the emphasis was on whether the running costs were paid by the fees or by a charitable endowment: see Blake v Mayor and Citizens of London (1886): 18 QBD 37; (1887) 19 QBD 79 and the emphasis on the annual grant from the City Corporation as a reason for deciding against the institution in Needham v Bowers (1888) 2 TC 360, and for it in Cawse v Committee of the Lunatic Hospital, Nottingham (1891) 3 TC 39. By the time of the Girls’ Public Day School Trust case, when, as Lord Atkin pointed out at 567, there had been a great increase in state and local authority funding for schools, this aspect had become much less important, and was merely a factor to be considered. See TNA:PRO IR 86/6, 164 for a decision of the Special Commissioners in 1859 that the Baptist college qualified even though some students paid fees. 54 In Mary Clark Home v Anderson [1904] 2 QB 645 the court considered both this and the exemption from inhabited house duty for a ‘house provided for the reception or relief of poor 52

14 John F Avery Jones claims relating to this deemed income were made to the General Commissioners. The exemption for rents claimed before the Special Commissioners is narrower than the exemption for deemed income since universities (and originally in 1803 public schools) are excluded, but this was widened in 1805 to apply to all charitable trusts and public schools.55 The exemption for rents developed out of early sixteenth century exemptions for universities, schools and hospitals.56 Similar wording to the income tax provision can be traced back at least to the forerunner of land tax, a subsidy to Charles II in 1671, and the progression of the income tax exemption is shown in the table. This history explains a number of puzzling features of the 1805 provision. First, the 1671 and 1688 land tax exemption (and earlier provisions dating persons’, with which an almshouse was equated. The case concerned an institution that was financed entirely by its charitable endowment. The issue was essentially whether the inhabitants were poor when they had to have an income of between £25 and £55 pa; they had to provide their own food and clothing, which presumably those with an income below the lower limit would be unable to do. Channell J said at 654: ‘I do not know any standard of poverty, nor how I can lay down any rule; the only thing to guide me is this: these ladies go to the institution for the sole reason that they are poor, and the institution is absolutely charitable; it may fairly be called an “almshouse,” although one would not care to hurt the feelings of the residents by so calling it in common parlance.’ Presumably in common parlance an almshouse was for the destitute, but that was not true of almshouse in this context. The general charitable exemption was not in issue in the case because it concerned tax on the occupation of the almshouse itself, not rent. 55 1803 Sched. A No.IV; 1805 s.37 No.V; 1806 s.74 No.VI; 1842 s.60 Sched. A No.VI; 1918 Sched. A rules No.VI r.1; 1952 s.103, repealed by FA 1963 Sched.13 on the repeal of the original Schedule A. The Codification Committee (see above n.28) drew attention to the disadvantages of hospitals, etc., having a different procedure applying to this and the next exemption, and recommended that the local procedure (see below n.175) should apply to both. The difference in procedure was deliberate in relieving the General Commissioners of investigations into the application of the income which the Special Commissioners were better placed to undertake: see the quotation from the Guide to the 1806 Act below at n.98. 56 For example, the Subsidy 12 Hen VII c.13 (1496–7) 2 Stat Realm 644, 646 contains an exemption for Oxford and Cambridge, Eton and Winchester. The Subsidy 19 Hen VII c.32 (1503–4) 2 Stat Realm 675, 677 exempted possessions ‘belonging to any Collage Hospitall Hall or House of Scolers in any of the Universites of Oxenford or Cambrigge, the Charterhouses in all Englond, the House of Syon, or to the College of our blessed Lady of Eton the College of our blessed Lady of Wynchestre byside Wynchestre’ . . . . The Subsidy 5 Hen VIII c.17 (1513–14) 3 Stat. Realm 105, 111 exempted: ‘Rentys . . . belonging or apperteyning to any College Hospitall Halle or other House of Scolers in any of the said Universities of Oxonford or Cambrigge, or of the said Colleges of Winchester and Eton neither to any of the Charterhouses within this realm of Inglond nor to the House of Syon ne to the House of Dertford . . .’. Oxford, Cambridge, Winchester and Eton were saved from the Dissolution of Colleges Act 1547 (1 Edw. 6 c.14 s.19). The Subsidy 7 Edw VI c.12 (1552) 4 Stat. Realm 176, 189 exempted: ‘the goods or lands of any College Hawll or Hostell w’in the Universities of Oxforde and Cambrige or any of them, or to the goods of lands of the College of Wynton founded by Bisshop Wykam, or to the goods of lands of the College of Eton next Wyndesore, or to the goods or lands of any Comon Free Gramer Scole w’in the Reale of Englande or Wales, of to the goods of any Reader Scole Maister or Scoller w’in the said Universities and Colledges or any of them there remaynyng for Studie w’out fraude or covyn, or to the goods or lands of any Hospitall Measondew or Spytlehouse prepayred and used for the Sustentacon and Relief of poore People.’ 1 Eliz 1 c.21 s.54 (1558), 23 Eliz c.15 (15801), 4 Stat. Realm 684, 697-8, 1 Car I c.6 (1625), 5 Stat. Realm 9, 21 and 16 Car I c.2 (1640), 5 Stat. Realm 58, 77 are all similar. A measondieu and a spittlehouse are both hospitals.

The Special Commissioners from Trafalgar to Waterloo 15 Table 1: Derivation of the Charitable Exemption Subsidy of 1671 and first land tax 1688

1803

1805 to 199657

[This named five hospitals (Christ’s Hospital, St Bartholomew, Bridewell, St Thomas, and Bethlehem), ‘any College or Hall in either of the universities,’ three colleges that we would now call public schools (‘Eaton’, Winchester and Westminster), and then continued]: ‘or any hospital, almshouse or free school whatsoever, for or in respect of any Rents or Revenues payable to the said Hospitals, being to be Received and Disbursed for the immediate Use and Relief of the Poor in the said Hospitals.’58 [From 1693 these exemptions for land tax continued and another section taxed land belonging to a hospital or almshouse that had been assessed at the time of an Act of 1693, adding]: ‘and that no other lands, tenements, or hereditaments, revenues or rents whatsoever, then [1693] belonging to any hospital or almshouse, or settled to any charitable or pious uses as aforesaid, shall be charged, taxed or assessed by virtue of this present act.’59

‘The amount of the Rents and Profits of Messuages, Lands, Tenements, or Hereditaments, belonging to any Hospital, or Alms House on proof before the respective Commissioners of the due Application of the said Rents and Profits to charitable Purposes only.’

‘Or on the Rents and Profits of Messuages, Lands, Tenements, or Hereditaments, belonging to any Hospital, public School, or Alms House, or vested in trustees for charitable purposes,60 [so far as the same are applied to charitable Purposes only61].’62

57 The present wording is a general charitable exemption for income from land: ‘exemption from tax under Schedules A and D in respect of any profits or gains arising in respect of rents or other receipts from an estate, interest or right in or over any land (whether situated in the UK or elsewhere) to the extent that the profits or gains—(i) arise in respect of rents or receipts from an estate, interest or right vested in any person for charitable purposes; and (ii) are applied to charitable purposes only’: 1988 s.505(1)(a) (current). 58 22 & 23 Car.II c.3, s.45, V Stat. Realm 693, see Soos, above n.6, at 109. The original land tax is 1 Will & Mar c.20 s.21 (this seems to be the first reference to almshouse). The reference in the quotation to the ‘said hospitals’ must have included almshouses, universities, public schools and free schools: see the wide former meaning of hospital above in n.52, particularly in the OED. Note the reference to relief of the poor before ‘charitable’ was used. 59 The 1671 and 1688 exemption ultimately became 38 Geo 3 c.5 (1797) s.25, and the 1693 exemption became s.29. The Act of 4 Will & Mar c.1 s.25 was the first of a succession of land tax acts in the same form. The 1693 Act exempted rents payable to hospitals or almshouses received and disbursed for the immediate use and relief of the poor of such hospital or almshouse only, and so rents applied for other purposes were assessable, as were rents from properties not then belonging to the charity, the exemption attaching to the original site: Cox v Rabbits 3 App Cas 473. 60 The exemption for rents of property vested in trustees for charitable purposes was added by an earlier 1805 Act, 45 Geo 3 c.15 s.4, presumably to correct an oversight in the 1803 Act; such an exemption had applied for land tax: see above n.59. A charitable body corporate is within this expression: ‘It cannot be doubted that property held by a body corporate and unincorporated ‘for the promotion of education, literature, science, or the fine arts’ is technically held upon a charitable trust’: IRC v Scott 3 TC 134, 141, applied to a body incorporated by Royal Charter in R v Special Commissioners ex p. The University College of North Wales (1909) 5 TC 408. 61 These words were restored to this position in 1806 but were applicable in 1805 in the following paragraph of the quotation: see text below at n.89. They qualify rents, not lands: see R v Special Commissioners ex p. Essex Hall (1911) 5 TC 636. 62 1805 s.37 No.V; 1806 s.73 No VI; 1842 s.60 No.VI (which adds literary and scientific institutions: see Mayor of Manchester v McAdam (1896) 3 TC 491, but not any of the Scots

16 John F Avery Jones back to at least 1580) was given in terms of hospitals and other institutions, and so income tax merely continued this practice. Secondly, land tax, which applied only to England, had dealt with ‘any College or Hall in either of the universities’ in the opening provision, making it unnecessary to add a general reference to universities as well as hospitals, etc. Transferring this exemption into income tax, which initially applied to Great Britain, was therefore defective in two respects: the omission of the opening words and, even if they had been included, the need now to cover Scots universities.63 Both defects would have been cured if there had been a general reference to universities; the result was that no universities were exempt in 1803, and from 1805 universities had to qualify under the general exemption for charitable trusts. Thirdly, Addington’s 1803 provision was seriously defective if it was intended to mirror the land tax exemptions. It included only the 1693 part of the land tax exemption, but no longer restricted to land owned in 1693, and even then the exemption for charitable trusts was omitted in favour of a requirement for the application of the rent to charitable purposes; it overlooked the earlier land tax exemption which was contained in a different section. This had the effect of excluding public schools when free schools had been covered by the land tax provision, hence their addition by the 1805 Act. This is particularly surprising since public schools are included in the Schedule A exemptions for occupying their own buildings in the immediately preceding part in both the 1803 and 1805 Acts.64 Fourthly, a separate Act in 1805 corrected another error in the 1803 Act by adding all charitable trusts, thus fully reproducing the 1693 land tax exemption which combined hospital and almshouse (but not free schools) with all charitable trusts. What the history does not explain is why institutions as well as charitable trusts were referred to either in 1693 or in 1805.65 Nor does it explain why all charitable trusts qualify for exemption of their rents but not for their occupation of land.66

institutions in Sulley v Royal College of Surgeons of Edinburgh (1892) 3 TC 173, Farmer v The Juridical Society of Edinburgh (1914) 6 TC 467 or IRC v The Aberdeen MedicoChirurgical Society (1931) 16 TC 237); 1918 s.37(1) (changed from claims being made to the Special Commissioners to appeals to them by FA 1925 s.19: see below n.120); 1952 s.447(1)(a); 1970 s.360(1)(a); 1988 s.505(1)(a), until redrafted by FA 1996 to cover all rents applicable and applied for charitable purposes (see above n.57 for the current wording). 63 The University of St Andrew’s was founded in 1413, Glasgow University in 1451 and Edinburgh University in 1582. 64 See text above at n.53. 65 This was the basis for the unsuccessful argument in R v Special Comrs ex p. The University College of North Wales (1909) 5 TC 408 at 412 that the general charitable provision was restricted to charities analogous to the named institutions. Normally the named institutions will be charitable, but it is possible that the convalescent home maintained for the benefit of members of a friendly society in Royal Antediluvian Order of Buffaloes v Owens 13 TC 176, which was held to qualify as a hospital, was not charitable. 66 This anomaly was pointed out by Buckley LJ in R v Special Commissioners ex p. Essex Hall (1911) 5 TC 636 at 654 where the charity lost the exemption by occupying by itself rather than letting to a related charitable body.

The Special Commissioners from Trafalgar to Waterloo 17 These unanswered questions must have raised the question in the minds of the Special Commissioners whether the explanation was to be found in the meaning of ‘charitable purposes’ in the Schedule A exemption. Did it have a narrower meaning for income tax? Unfortunately there seems to be no information about how the exemptions were administered before 1816; although assessment records have survived, there are no other records as the Treasury decreed that they should be destroyed.67 But one can trace the origin of the argument that charitable purposes might have a special meaning for income tax purposes to an opinion of the Law Officers in 1856 who advised the Special Commissioners that there was a distinction between parochial purposes and charitable purposes ‘in the sense in which this last phrase is used in the Income Tax Acts’. The opinion argued that because a gift for parochial purposes had the effect of reducing the poor rate for owners of valuable properties it could not be charitable for income tax purposes, even though the Master of the Rolls had assumed in a case in 1856 that such a gift was charitable under the law of charities.68 The Board wondered whether this distinction had wider implications and consulted the Treasury, who wisely told them not to disturb existing practices on the basis of the opinion and to leave any changes to legislation. Gladstone did try to tax charities in 1863 because of the discrepancy he perceived between endowed charities not paying tax on their income while the income of unendowed charities came from donations out of taxed income, but was forced to withdraw the proposal.69 He succeeded in passing legislation in 1885 to tax some endowed charities by imposing a tax on the property of bodies corporate and unincorporate (except for trading companies) known as corporation duty. This duty contained a strangely-worded exemption for property or income: ‘legally appropriated and applied for any purpose connected with any religious persuasion, or for any charitable purpose, or for the promotion of education, literature, science, or the fine arts’.70 In the context of this provision, the draftsman cannot have intended ‘charitable

67

1852 Select Committee, above n.14, q.14, 1274. Correspondence between the Treasury and the Board of Inland Revenue in August and September 1863, Parliamentary Papers 1865 XLI microfiche reference 71.311. This opinion is referred to in Pemsel by Lord Halsbury at 70, and see also below n.84 for a different point taken from the same document. 69 Daunton, above n. 7, at 213. The discrepancy could be avoided by making an annual payment to charity (by deed of covenant) but that may not have been widely used at the time. 70 Customs and Inland Revenue Act 1885 s.11(3) (part of this wording followed an exemption from local rates for ‘societies instituted for the purposes of science, literature or the fine arts exclusively’ in the Scientific Societies Act 1843). There were also other exemptions for property applied for the benefit of the public, friendly societies, property voluntarily contributed to the body in the previous 30 years, and acquisitions within 90 years on which legacy or succession duty had been paid. An editorial comment in J.M. Lely (ed.), Chitty’s Statutes (5th edn., 68

18 John F Avery Jones purpose’ to have its normal legal meaning, as the Court of Appeal later decided,71 since all the other named purposes are charitable. It seemed possible that the draftsman’s use of this wording fortified the Special Commissioners in their view that the same interpretation applied to other references to charitable purposes in income tax, but Parliamentary Counsel’s Office has no papers on this Act which suggests that it was drafted within the Revenue; it is understood that this was not unusual at the time. Although the connection with the 1885 Act cannot be proved, it was about the same time as this legislation, in 1885–1886, that the Special Commissioners started to apply a more restricted meaning of charitable purposes for Schedule A, as a change of policy. Lord Macnaghten confirms that this was a recent change of policy: What are charitable purposes within the meaning of these Acts the Legislature had nowhere defined. But from the very first it was assumed, as a matter not open to controversy, that the exemption applied to all trusts known to the law of England as charitable uses or trusts for charitable purposes. On that principle, without inequality and apparently without difficulty, the law was administered in England and Scotland, and afterwards when the tax extended to Ireland, throughout the United Kingdom. At length, about three or four years ago, the Board of Inland Revenue discovered that the meaning of the Legislature was not to be ascertained from the legal definition of the expressions actually found in the statute, but to be gathered from the popular use of the word ‘charity.’ Proceeding on this view, they refused remissions in cases in which the remission 1895) states: ‘These exemptions are so numerous as to exhaust by far the greater part of the property held by corporate and unincorporated bodies. The principal property not exempted is that held by the London city companies and not devoted by them to the purposes mentioned in subs.(3).’ Daunton, above n.7, gives the yield of the tax in 1912–13 as only £49,441. 71 In Re Bootham Strays, York. IRC v Scott (1892) 3 TC 134, distinguishing Pemsel on the basis that here charity comes between other specific exemptions, whereas in Pemsel it came after the specific exemptions and so had the effect of including any other charitable purposes. Lord Herschell said that ‘It is unnecessay and would be undesirable to attempt a definition of what are “charitable purposes” within the meaning of the exemption. It is sufficient to say, that giving those words the widest interpretation of which they are capable short of the technical one to which I have referred [i.e. the meaning in Pemsel] the present case is not within them.’ The Solicitor’s Office, having started by applying the same interpretation as for income tax (see the Shipmasters’ Society of Aberdeen, TNA:PRO IR99/1, 12), in the light of In Re Bootham Strays they changed to applying the popular meaning of charity as the meaning left open by that case (see IR 99/1, above, at 94). This document shows that many problems of interpretation had to be considered by the Solicitor’s Office, which also led to considerable litigation about the exemption, including: Society of Writers to the Signet v IRC (1996) 3 TC 257 (taxable except as to the endowment of a chair of conveyancing at the University of Edinburgh), The Incorporation of Tailors in Glasgow v IRC (1887) 2 TC 297 and The Linen and Woollen Drapers’ etc Institution v IRC (1887) 2 TC 651 (both taxable on funds comprising subscriptions and, in the latter case, donations used for paying discretionary pensions to members and their families), IRC v Forrest (Institution of Civil Engineers) 3 TC 117 (exempt as being for the promotion of science), Gresham Trustees v IRC (1897) 4 TC 304 (surplus rents from the Royal Exchange taxable), The Royal College of Surgeons of England

The Special Commissioners from Trafalgar to Waterloo 19 had been claimed and allowed as a matter of right for more than forty years continuously.72

The issue of the meaning of charitable purposes in the income tax exemption was ultimately resolved by the House of Lords in the leading case on the law of charities known to every law student, Pemsel’s case, or to give it its full title, Special Commissioners v Pemsel.73 Although the Special Commissioners’ decision was final, the House of Lords decided in Pemsel that the remedy of an order (‘rule to show cause’) calling on the Special Commissioners to show cause why a writ of mandamus should not issue requiring them to give the relief was available to the taxpayer.74 This enabled the courts to decide whether they were right in law in not doing so. The two opposing views in Pemsel were the taxpayer’s that ‘charitable purposes’ in the Schedule A exemption has the meaning in English law (although the taxing statute by then applied to the whole of the UK) applied by the Court of Chancery in interpreting the Statute of Elizabeth,75 with the references to the institutions being mere tautology; and the Special Commissioners’ that the context requires a popular meaning to be given to ‘charitable purposes’, restricting it to the relief of poverty, in order to remove the tautology. A possible third explanation is that the problem has nothing to do with the meaning of ‘charitable purposes’ but relates to hospitals, public schools and almshouses, which originally had a specific meaning in English law emphasising their eleemosynary character by requiring their running costs to be paid by charity rather than by the users. In the v IRC (1899) 4 TC 344 (taxable as no separation between funds for the advancement of surgery and those for the interests of surgeons), Att.-Gen. v Mayor of London (1913) 6 TC 313 (taxable on sinking fund), Grand Lodge of Masons of Scotland v IRC (1912) 6 TC 116 (exempt on funds for necessitous masons). There is a separate index to corporation duty cases in the early volumes of TC. 72

(1891) 3 TC 53 at 90. (1891) 3 TC 53. The passage known to every law student is from Lord Macnaghton’s speech at at 96: ‘“charity” in the legal sense comprises four principal divisions: trusts for the relief of poverty, trusts for the advancement of education, trusts for the advancement of religion, and trusts for other purposes beneficial to the community not falling under any of the preceding heads.’ 74 It had been argued at 59 that the correct procedure was a petition of right. Lord Halsbury deals with the point at 64, and Lord Herschell at 86. This left the Special Commissioners at risk for costs which at common law the Crown did not pay or receive (Blackstone’s Commentaries says that ‘As it is his [the Crown’s] prerogative not to pay them to a subject, so it is beneath his dignity to receive them’), because mandamus lay against them in their capacity of persons charged with a statutory duty, not as agents of the Crown: R v Special Commissioners ex p. Dr Barnardo’s Homes (1919) 7 TC 646, 652 (on the Schedule D exemption). Other similar cases where the writ of mandamus was used to appeal the Special Commissioners’ decision on charitable exemptions are R v Special Commissioners ex p. University College of North Wales (1909) 5 TC 408, R v Special Commissioners ex p. Essex Hall (1911) 5 TC 636. No right of appeal was ever introduced for Schedule C and so this procedure provided the only remedy. 75 43 Eliz c.4. 73

20 John F Avery Jones cases on public schools, this requirement was later relegated to being merely one of the factors to be considered in deciding whether the institution was a public school.76 The Special Commissioners in Pemsel, showing cause why they had not given the exemption, contended that charity was restricted to the relief of poverty, on the ground that the purpose of the taxing Acts was different from the purpose of the Statute of Elizabeth, the former, for example, being restricted to activities in the UK. They therefore contended that the exemption did not extend to the missionary activities of the Moravian church. A narrower meaning of charitable purposes explained why an exemption for a hospital, public school or almshouse was followed by an exemption for charitable trusts generally.77 As a contrary argument the taxpayer suggested that the Act drew a distinction between incorporated hospitals, public schools or almshouses, and charitable trusts, which, on the Special Commissioners’ argument, meant that there was no exemption for an unincorporated hospital, public school or almshouse.78 Initially the Special Commissioners’ argument succeeded in Scotland. Scots law does not recognise the English law definition of charity,79 and so it was much easier to argue for an ordinary meaning of the term which could be applied throughout the UK.80 As is well known, the decision in the House of Lords, by a majority of three to two and after considerable difference in judicial opinion in the courts below,81 was that the English law meaning applied. One of the reasons in support mentioned by Lord Macnaghten, which is interesting from our point of view, was that the relief was granted by the Special Commissioners based in London, and so no decisions on the relief had to be made by any Scots body which might not understand English law of

76 See the cases on the meaning of ‘hospital’ in above n. 52, and the movement away from this interpretation in the later cases on public schools in above n. 53. 77 In the Court of Appeal Lopes LJ at 316 argued that including both the named institutions and charitable trusts was surplusage and so the technical meaning could not be intended. Lord Esher MR, however, said that not all the large schools and universities were charities. In the House of Lords Lord Herschell at 87 considered that the listed institutions were there out of caution or to quiet the fears of those who were apprehensive that they might not fall within the general exemption. The Special Commissioners put forward a further argument based on the exemption for the British Museum, which is dealt with below at n. 118. 78 At 60. 79 Although the Scots judge in Pemsel, Lord Watson, said at 82 that the expression had been used in Scots statutes in substantially the same sense as interpreted by the English courts. 80 Baird’s Trustees v Lord Advocate (1999) 25 SLR 535; 15 Sc. Sess. Cas. 4th Ser. 682. 81 In the High Court, (1888) 22 QBD 296, Lord Coleridge CJ was in favour of the popular meaning of charity applying and found against the taxpayer on that test, and Grantham J was in favour of the technical meaning, but withdrew his opinion to avoid a draw; in the Court of Appeal, (1889) 22 QBD 305, Lord Esher MR and Lopes LJ favoured the popular meaning but gave the taxpayer the exemption on the facts, while Fry LJ was in favour of the technical meaning, and agreed that if he were wrong they were entitled to the exemption on the facts. In the House of Lords, Lord Halsbury LC and Lord Bramwell dissented, doubting whether the gift qualified on the popular meaning.

The Special Commissioners from Trafalgar to Waterloo 21 charities.82 What is more, Lord Macnaghten referred to the same Parliamentary paper of 186583 in which the Special Commissioners stated clearly that the exemption was given pursuant to the Charitable Trusts Act 1853 to all stock in the names of the Official Trustees of Charitable Funds (which obviously applied the English law of charities) without further enquiry. Parliament was therefore aware of the Special Commissioners’ practice in applying the English legal meaning of charity when passing subsequent legislation.84 On the context of the exemption, he turned the argument on its head, saying that it demonstrated that the legislature considered that hospitals, public schools and almshouses were charitable purposes which displaced the popular meaning of charitable purposes,85 and in any case all of those institutions had a definite meaning in English law. He brushed aside the tautology: ‘there may be a superfluous expression here or there, but the Act will be consistent throughout’.86 Given that the wording of the exemption originated in the early sixteenth century long before the statute of Elizabeth, although the origins were not referred to in argument, the majority in the House of Lords were surely right, although one sympathises with the Special Commissioners’ desire to find a logic for the words of the statute. The Special Commissioners did not accept the decision readily. Initially they considered whether the reliance on the Charitable Trusts Act 1853 meant that they should restrict the exemption to cases covered by that Act, which was restricted to endowed foundations and institutions taking effect in England and Wales, but wisely they decided against it.87 Even eighteen years after the case, in 1909, they were still trying unsuccessfully to distinguish it by restricting the scope of educational charity, as opposed to the religious one in Pemsel, to the education of the poor by virtue of the context of this provision.88 This coupling of the income tax relief to the law of charities has resulted in a debate which is still continuing today, particularly in relation to public schools and private hospitals in which, if it is proposed to limit income tax relief, it is necessary to change the law of charities. The latest event is the issue of a draft Charities Bill on 27 May 2004 containing for the first time a statutory definition of charity. 82

At 99. This presumably refers to the publication of the correspondence between the Board and the Treasury: see above n.68. 84 At 101–102. See text below at n.113 for legislation preventing deduction of tax in these circumstances. The Customs and Inland Revenue Act 1885, see above n.70, is, however, an exception which clearly uses a different meaning. 85 At 99–100. 86 At 101. 87 TNA:PRO IR 86/7, 207. 88 R v Special Comrs ex p. The University College of North Wales (1909) 5 TC 408 at 413. Such a restricted meaning applied to the earlier subsidies (see above n.56) including the 1671 Subsidy and 1688 land tax exemption for free schools quoted in the text above at n.58. 83

22 John F Avery Jones Application of the Schedule A Income for Charitable Purposes The 1805 exemption for rents was granted by the Special Commissioners on proof of the application of the income for charitable purposes. The quotation in the table above continues: The said Allowances89 to be granted on Proof before the Commissioners to be appointed for special Purposes,90 under the Authority of this Act, of the due Application of the said Rents and Profits to charitable Purposes only, and in so far as the same shall be applied to charitable Purposes only. The said Allowances to be claimed and proved by any Steward, Agent, or Factor acting for such College, Hall, School, Hospital, or Alms House, or other Trust for charitable purposes, or by any Trustee of the same, by Affidavit to be taken before any Commissioner for executing this Act, in the District,91 [where such person shall reside92] stating the Amount of the Duties chargeable, and the Application thereof, and to be carried into Effect by the Commissioners for special Purposes, to be appointed under the Authority of this Act, and according to the Powers vested in such Commissioners, without vacating, altering, or impeaching the Assessment to be made, under this Act, on or in respect of such Properties; which Assessments shall be in force and levied notwithstanding such Allowances.93

Presumably the reason for allowing the assessment to stand is that the tenant deducted and retained tax on paying rent.94 The charitable landlord therefore needed to reclaim this tax, for which he needed to show how the rent was applied, thus enabling the Special Commissioners to police the exemption. There were, however, cases where by concession the assessment was discharged, thus giving permanent relief without the landlord having to show how the income was applied.95 89 1806 Sched. A No.VI is clearer in stating that the exemptions for the land occupied by these institutions are to be granted by the General Commissioners. This is followed by the exemption for rents and profits and the statement that it is granted by the Special Commissioners, although the 1805 provision regarding the Special Commissioners relates only to rents and profits and so cannot apply to the first set of exemptions. 90 In this and subsequent quotations italics have been added to the references to the Special Commissioners to highlight them. 91 See above n.29 for the origin of divisions. 92 Clarification added in 1806. 93 Addington’s 1803 Act, Sched. A, gave effect to this exemption either by vacating the assessment or by obtaining a certificate of exemption and so this is a change in the procedure. 94 This originally applied to all leases. Rent under long leases became an annual payment by FA 1940 s.17. 95 TNA:PRO IR 86/4, 82. Another reference showed that with Treasury authority from 1845 the assessment was discharged where the annual value of the property was between £2m and £3m, which seems to be an extremely high figure but is clearly stated in the document (TNA:PRO IR 86/7, 190). However, the Schedule C exemption for government securities registered in the name of the Official Trustees of Charitable Funds was applied automatically by preventing the deduction of tax at source by Charitable Trusts Amendment Act 1855 s.28.

The Special Commissioners from Trafalgar to Waterloo 23 The Special Commissioners’ task was to see that the income was applied for charitable purposes only. The primary reason for their involvement seems to have been that it was recognised that the General Commissioners were overworked. The justification given in the contemporary Guide to the 1806 Act was: These Properties [referring to the introduction of a system of withholding for Schedule C in 180696] being removed from the Jurisdiction of the Commissioners for general Purposes, will relieve them and those who act under them, from a great Load of Duty, and will enable them to apply more directly to the great Objects under their Care, the Profits arising from Land, Trade, and Professions. And even in these a Jurisdiction has been established which will further relieve them, I mean the Jurisdiction of Commissioners for special Purposes established in London, under the Authority of the Crown, for granting Exemptions on Account of Charities; the whole Jurisdiction of Commissioners in the Districts being now confined to Exemptions and Allowances on the Ground of Income, except in the Cases of Colleges, Hospitals, and Alms-houses, where they still retain their Authority of granting Exemptions for the Duties charged thereon, and Allowances for necessary Repairs.97 This will necessarily lessen the Trouble and Attendance of the Commissioners. It will be found too, that the Mode adopted of granting Allowances will be much less troublesome. They will be Matter of easy Calculation, and will require fewer Entries than have been found heretofore necessary. These, with other less momentous Alterations, have been introduced with the view of giving Facility in the Execution of the Act; in which regard has not only been paid to the time and Attention of the Commissioners, but to the Public at large.98

This quotation suggests that problems had arisen in relation to the burdens placed on the unpaid general commissioners. Granting a relief depending on the application of income for charitable purposes involved investigation of how the rent was applied, for which the general commissioners’ local knowledge was of no advantage, and which would have been an additional burden for them. The task was also unsuited to the general commissioners because the rent might be from land within the jurisdiction of one District (as Divisions99 were then called) of General Commissioners, but the application for charitable purposes might be made elsewhere.100 The relief was granted by the Special Commissioners giving a certificate and order for payment to the receiver-general of stamps and taxes101 who repaid the taxpayer; it was not possible to claim the relief 96

See text below at n.204. This is a reference to the exemption from Schedule A for the land they occupied: see text above at n.55. 98 Guide to the Property Act (2nd edn., Joyce Gold, London, 1807) at 11. xviii–xix. This guide does not have an author’s name and was presumably written within the Revenue. 99 See above n.28 for the origin of the expression divisions. 100 Addington’s 1803 Act, Sched. A, required the claims to be made ‘before the respective [General] Commissioners’. 101 The duties of receivers general are contained in 3 Geo 4 c.88 (1822). Receivers-general were abolished by 1 & 2 Will 4 c.18 and their duties were transferred to receiving 97

24 John F Avery Jones before assessment.102 The tenant would have deducted tax from the rent and so the relief was necessarily given on a repayment claim, which had the added advantage that the application of the income for charitable purposes could be verified.103 As a matter of practice from the early days, the exemption was granted for reinvested income; the policy was reconsidered in 1893 but no change was made.104 The repayment system was open to fraud and various safeguards were introduced such as certificates by two special commissioners, one of whom had to present it to the Board personally, and the Receiver-General giving a daily list to the Special Commissioners for cross-checking.105 Schedule C Charitable Exemptions Claims relating to the differently-worded charitable exemption applying to Schedule C were also made to the Special Commissioners; the difference in wording is presumably because the Schedule A exemption was copied from land tax, which had no equivalent to Schedule C. It should be pointed out that to modern eyes the references in Schedule C to annuities, dividends and shares are confusing, although they are still in the legislation today.106 These are explained in Dowell’s Income Tax Laws107 as follows: On the creation of the ‘consols’ in 1752, of annuities ‘consolidated into one joint stock of annuities,’ the annuities dealt with were made payable in half-yearly dividends on January 5th and July 5th, hence the word ‘dividends,’ meaning these shares of the bank annuities. The word is now used to mean, in a general sense, interest of money in the funds. Besides the redeemable annuities, the National Debt comprised certain terminable annuities and the ‘unfunded debt,’— Exchequer bills and bonds, treasury bills etc., bearing interest, hence the special mention of ‘interest’ in the schedule of charge. inspectors of taxes. One may note in passing that Jane Austen’s banker brother, Henry Austen, was appointed receiver-general for Oxford in about 1813, with the sureties of £30,000 put up by his brother Edward and his uncle being called on the failure of his bank and his consequent bankruptcy in 1816: C Tomalin Jane Austen (Penguin Books, London, 1998) at 242, 257). 102 1805 s.214; 1806 s.207 (both made to the receiver-general for the county in which the property was situated); 1842 s.62; ITA 1918 s.40(3); 1952 Sched. 6 para.3, repealed ITMA 1964. 103 See above n.93. 104 TNA:PRO IR 86/7, 190. This is still an issue: see Helen Slater Charitable Trust Ltd v IRC [1980] STC 150 for the latest case on this topic. 105 TNA:PRO IR 86/2, 26 (29 July 1847), extended on 17 Aug. 1847 to a procedure involving the Comptroller General. 106 1988 s.49(3) applying to the exemption for the Treasury, National Debt Commissioners and the Crown: ‘“dividends” means any interest, public annuities, dividends or shares of annuities’. 107 Quoted from the 1926 edn. (Butterworths), at 440. They were probably confusing at the time. On 6 Aug. 1842 the Solicitor’s Office advised against an argument put forward by Rothschilds that they were in receipt of interest and not dividends or annuities on a foreign loan on the basis that ‘there is no doubt that the term dividends is applicable to interest and is commonly used to designate it’ (TNA:PRO IR99/102, 30).

The Special Commissioners from Trafalgar to Waterloo 25 The Schedule C charitable exemption was as follows (with the present equivalent, now applying to Schedules D108 and F following the abolition of Schedule C in 1996, for comparison, to show how little the wording has changed): 1805 ‘That nothing herein contained shall be construed to extend to charge any Corporation, Fraternity, or Society of Persons established for charitable Purposes only; nor to charge the Profits arising from any such Annuities, Dividends, or Shares, which, according to the Rules or Regulations established by Act of Parliament, Charter, Decree,109 Deed of Trust, or Will, shall be applicable by the said Corporations, Fraternities, or Societies, or by any Trustee or Trustees, to charitable Purposes only, and in so far as the same shall be applied to charitable Purposes only; [or the Stock or Dividends in the Names of any Trustees applicable to the Repairs of any Cathedral College Church or Chapel and to no other Purpose and in so far as the same shall be applied to such Purposes110], provided the Application

Now . . . ‘where the income in question forms part of the income of a charity, or is, according to rules or regulations established by Act of Parliament, charter, decree, deed of trust or will, applicable to charitable purposes only, and so far as it is applied to charitable purposes only; exemption from tax under Schedule D in respect of public revenue dividends on securities which are in the name of trustees, to the extent that the dividends are applicable and applied only for the repair of— (i) any cathedral, college, church or chapel, or (ii) any building

108 The Schedule C exemption was extended to yearly interest and annual payments under Schedule D by 1842 s.105. The case of R v Special Comrs ex p. Dr Barnardo’s Homes (1921) 7 TC 646 relates to the Schedule D exemption. Income during administration of an estate was held not to be income of the charitable residuary beneficiary. This was a Pyrrhic victory since it followed that nor was it income of an individual residuary beneficiary for higher rate tax purposes, thus leading to long drawn-out administration of estates, until reversed by FA 1922 s.30, now 1988 Pt.XVI. 109 Meaning order of the Court of Chancery: see Camille and Henry Dreyfus Foundation Inc v IRC (1955) 36 TC 126 at 152 and 156. 110 Added by 1806 s.103. It is not clear why this is not already covered by the previous exemption for charitable trustees, but it is still contained in 1988 s.505(1)(d). The Board had pointed out in its correspondence with the Treasury in 1863 (see above n.68) the anomaly that if charitable purposes had a narrower meaning for income tax the Dean and Chapter of St Paul’s could claim exemption on Schedule C income, but not on rents, used to repair the Cathedral (Lord Macnaghten makes the same point in Pemsel at 100). The existence of this provision was used to support the argument in Pemsel (1891) 3 TC 53 at 57 that the scope of the tax exemption was different from the scope of the law on charities, with this anomaly as a consequence; and to the contrary at 61 and 101 that tautology in an Act was not uncommon, and that in 1842 the passage of the Bill would have been facilitated by the Church party seeing the specific exemption (which overlooks the fact that it dates from 1806). H.M. Konstam, Konstam’s Income Tax (12th edn. Stevens and Sweet & Maxwell, London, 1952) §313: see above n.41 suggested that it covers trusts that are not wholly charitable, such as a charitable trust subject to a power of appointment among the settlor’s relatives, as in R v Special Comrs ex p. Rank’s Trustees (1922) 8 TC 286, which does not seem particularly

26 John F Avery Jones 1805 thereof to such Purposes shall be duly proved before the Commissioners for special Purposes to be appointed under this Act, by any Agent or Factor, on the Behalf of any such Corporation, Fraternity, or Society, or Trustee or Trustees, or by any of the Members or Trustees.’111

Now used only the purposes of divine worship;’112

As a mechanism to prevent the need for reclaims by charities the Charitable Trusts Amendment Act 1855 allowed the Charity Commissioners to certify to the Bank of England that interest was payable without deduction of tax on stock in the public funds in the name of the Official Trustees of Charitable Funds, later the official custodian for charities, thus removing any jurisdiction of the Special Commissioners in relation to its exemption.113 The existence of this provision was strong support for the taxpayer’s argument in Pemsel’s case that the scope of the tax exemption for charities was the same as the scope of English law on charities.114 Another provision of the 1805 Act granted the Trustees of the British Museum the same exemptions from tax under Schedules A and C as applied to charities.115 There may have been doubt at the time whether the British Museum was charitable; the courts did not decide that it was until 1826.116 The separate exemption of the British Museum is still contained in the Act convincing. Konstam also pointed out the lack of any equivalent Schedule D exemption. Repairs of collegiate churches and chapels and chancels of churches based on a 21–year average were deductable under Schedule A: 1803 Sched. A No.III Fourth (chancel repairs only); 1805 Sched. A No.IV Fourth; 1806 Sched. A No.V Third; 1842 Sched. A No.V Third; 1918 Sched. A No.V r.1(c); 1952 s.93(1)(c), repealed FA 1963. 111 1799 ss.5, 88 (general charitable exemption); 1803, s.68 (essentially the same as the text); 1805 s.74; 1806 s.103 (with the addition mentioned in the previous note); 1842 s.88 Sched. C Third (and see the equivalent Schedule D exemption for yearly interest and annual payments in s.105, added by 1842 s.105, and also granted by the Special Commissioners); 1918 s.37(1)(b) applied by the Special Commissioners s.40 (changed by FA 1925 s.19, see n. 120); 1952 s.447(1)(b), 1970 s.360(1)(c); TA 1988 s.505(1)(c)(i) (general charitable) (repealed on abolition of Sched. C by FA 1996). Also 1918 s.37(1)(c), 1952 s.447(1)(c), 1970 s.360(1)(d); 1988 s.505(1)(d) (trusts for the repair of cathedrals etc) changed to Sched. D on the abolition of Sched. C by FA 1996. 112 TA 1988 s.505(1)(c), (d). 113 Incorporated into 1952 Sched. 8, para 8 by Charities Act 1960; 1970 Sched. 5, para.4; 1988, Sched. 3, para 4, repealed FA 1996. 114 Special Commissioners v Pemsel (1891) 3 TC 53 at 61 and see 101–102. 115 1805 s.170; 1806 s.155; 1842 s.149; 1918 s.38; 1952 s.451; 1970 s.363; 1988 s.507. Before 1970 this was expressed as the same exemptions as are granted to ‘charitable institutions’, which was not particularly appropriate. 116 British Museum Trustees v White 2 Sim and St 594, although a devise of land to the Museum was void as offending the statute of mortmain. A charitable body corporate qualifies for the Schedule A exemption for rents vested in trustees for charitable purposes: see above n. 60.

The Special Commissioners from Trafalgar to Waterloo 27 today, although it is clear that the Museum would be covered by the general charitable exemptions.117 The existence of this exemption was a basis for the Special Commissioners’ argument in Pemsel’s case that the scope of the tax exemption for charities was different from the scope of the law on charities.118 More convincing is Lord Macnaghten’s explanation in that case119 that a specific relief was necessary for Schedule A for the Museum’s own buildings, since it was not a university, hospital, public school or almshouse, and so it was natural that the other exemptions were spelt out at the same time because their omission might have cast doubt on whether they applied. Later History of Claims for Charitable Exemptions The Special Commissioners’ duties in connection with claims for these exemptions for charities continued until 1925,120 following which claims for exemption were made to the Commissioners of Inland Revenue. The Special Commissioners’ connection with these claims was preserved by making them the sole appeal body on refusal of such claims, determining appeals in like manner to an appeal against a Schedule D assessment,121 which in 1925 was the only jurisdiction of the Special Commissioners in relation to appeals. They still hear such appeals today because appeals against a claim made to the Board lie to the Special Commissioners.122 The British Museum was for some reason not included in this change in 1925, although it cannot have been overlooked as its exemption was by then contained in the next section of the 1918 Act following the charitable exemptions. The Special Commissioners’ jurisdiction over claims for exemption under Schedules A and C for the British Museum continued until 1965,123 together with the other Schedule C reliefs dealt with next. The Special Commissioners are still the appeal tribunal in relation to claims by the British Museum, since these are also appeals against a claim made to the Board.124 The Tax Law Rewrite proposes to abolish the distinction between claims made to the Board and to an Inspector by providing for all claims to be made to an Officer of the Board, which will, if enacted, consequently end 117 TA 1988 s.507 together with the Trustees of the National Heritage Memorial Fund, the Historic Buildings and Monuments Commission for England, and the Trustees of the Natural History Museum. 118 (1891) 3 TC 53 at 57. 119 At 101. 120 FA 1925 s.19. 121 From 1842 Schedule D appeals were the original appellate function of the Special Commissioners. This accounts for the rather puzzling current reference to ‘proceedings which under the Taxes Acts are to be heard and determined in the same way as an appeal’, the former reference to Schedule D being dropped when in 1965 the choice of appealing to the Special Commissioners was no longer restricted to Schedule D. 122 TMA 1970 Sched. 1A, para.10. 123 ITMA 1964 Sched. 2. 124 See above n.122.

28 John F Avery Jones the Special Commissioners’ exclusive jurisdiction over these exemptions in their bicentenary year.125 Other Schedule C Exemptions The other Schedule C reliefs for which claims were made to the Special Commissioners were as follows:126 (1) Friendly Societies, Savings Banks, Trade Unions, Industrial and Provident Societies Friendly societies Provided always, and be it further enacted, That nothing herein contained shall be construed to extend to charge the Stock or Dividends of any Friendly Society established under or by virtue of an Act, passed in the thirty-third Year of the Reign of His present Majesty, intituled, An Act for the Encouragement and Relief of Friendly Societies,127 provided the Property therein shall be duly claimed and proved by any Agent or Factor on the Behalf of any such Society, or by any Member thereof, before the Commissioners authorized to be appointed for special Purposes by this Act.128

Friendly societies flourished in the last 40 years of the eighteenth century with the rise in the number of industrial workers.129 They were mutual insurance societies with their officers being elected from the members; in return for contributions collected at a monthly meeting, usually held in an inn, they provided sickness benefits and money for funerals. Their numbers were significant; it has been estimated that by 1803 there were 9,672 societies with a total of 704,350 members, rising to 925,429 members, or 125 This is not clear in the draft Income Tax (Trading and Other Income) Bill but is clarified in a subsequent consultation paper: see http://www.inlandrevenue.gov.uk/rewrite/cc-04-06pers-rel-comm.pdf, para.11 and Annex 1. 126 1805 s.92; 1806 s.103; 1842 s.88; 1918 s.39; 1952 ss.438–446. The penalty for fraudulent claims for exemption under Schedule C was £500 plus treble the duty on the Schedule C income. Note that this is the fixed penalty, not the maximum penalty. 127 33 Geo 3 c.54 (1793) providing for registration of societies after their rules had been approved by the justices at quarter sessions. There were subsequent Acts dealing with registration in 1896 and 1908. 128 1799 s.4; 1803 s.67 (the same but with the exemption being claimed before the General Commissioners for the district where the society was established); 1805 s.73; 1806 s.103; 1842 s.88 Sched. C, First; ITA 1918 s.39(1), claims being made to the Special Commissioners by s.40; ITA 1952 s.440; claims were transferred to the Inspector by ITMA 1964 Sched. 2 with appeals to the Special Commissioners: see above n.147; 1970 s.332; 1988 ss.460–466. The 1842 Act limited the exemption to sums assured of less than £200 and annuities of less than £30 p.a.; currently £750 and £156 (for contracts made before 31 Aug. 1987) but they were higher before then and were reduced because friendly societies became used for tax avoidance. 129 Information about the history of friendly societies is taken from: P.H.J.H. Gosden, SelfHelp (Batsford, London, 1973), Ch.1.

The Special Commissioners from Trafalgar to Waterloo 29 8.5 per cent of the population, by 1815. Societies were concentrated in industrial areas, membership being as high as 17 per cent of the population in Lancashire. The Act of 1793 referred to in the quotation above gave advantages to registered societies,130 to which this tax exemption was an additional advantage; many, however, existed in unregistered form.131 An Act of 1817132 introducing savings banks enabled registered friendly societies to invest at favourable rates in savings banks, which invested with the National Debt Commissioners. Direct investment with those commissioners was permitted by an Act of 1819, but before that the 1793 Act required investment in public stocks or funds, hence this relief.133 With the rudimentary actuarial knowledge of the time and the expenditure on drink at their monthly meetings, many were not run on sound principles and failed. The 1819 Act required the justices to approve the tables according to which benefits were paid in order to improve their financial stability.134 The Income Tax Act 1853135 extended this Schedule C exemption to Schedule D. When income tax was reintroduced in 1842 an exemption on income from the National Debt commissioners and interest paid to depositors was introduced for savings banks,136 which were non-profi-making bodies for the purpose of encouraging savings by the poor. In contrast to friendly societies, trustees rather than their members managed them. As mentioned above, the 1817 Act enabled registered friendly societies to deposit funds with savings banks. Savings banks became large holders of government debt; by 1841 the National Debt Commissioners were indebted to savings 130 Registration enabled a society to sue (and therefore protect its funds) and be sued. Unregistered societies existed in the form of partnerships, which effectively meant that no action could be taken against a defrauding member because all partners were required to sue on behalf of the society. 131 An exemption for income of unregistered friendly societies under £160 was introduced by FA 1904 s.8, later 1918 s.39; ITA 1952 s.440; 1970 s.331; 1988 s.459. The figure is still £160. 132 57 Geo 3 c.130. 133 See n.127 s.6. 134 59 Geo 3 c.128. 135 S.49. For a question about exemption for bank interest of friendly societies, see TNA:PRO IR 86/3, 176 and at 205 where it also refers to granting a Schedule A exemption which seems to imply that it must have been a charity. 136 The tax exemption is found in 1842 s.88 Sched C Second; 1918 s.39(3) (if certified under the Savings Bank Act 1863); an exemption for interest paid to depositors applied to all savings banks, whether or not certified, but limited to £5 p.a. was introduced by FA 1894 s.36 and increased to £15 (but excluding interest from the National Debt commissioners) by FA 1924 s.24; all interest paid to depositors made chargeable by FA 1920, Sched. 3; 1952 s.439; the first £15 of interest exempted by FA 1956 s.9(1) except for surtax; 1970 s.339; 1988 s.484, repealed FA 1996 on the repeal of Sched. C. See Queen v Special Commissioners In re Yorkshire Penny Bank (1889) 2 TC 510 for an example of the settlement of a dispute about the exemption for savings banks. Penny banks were a later development from 1850 for poorer people to overcome the one-shilling minimum deposit normally required by ordinary savings banks. The Yorkshire Penny Bank in the case was founded in 1859 by the philanthropist Colonel Akroyd of Halifax who put up a guarantee, thus making it safer than other savings banks. By 1900 it had deposits of more than £12m. See TNA:PRO IR99/103, 143 for an opinion of the Solicitor’s Office that stock in the name of trustees for a savings bank was not exempt.

30 John F Avery Jones banks to the sum of £24.5m.137 They were paid a rate of interest fixed by statute which, because of falling interest rates throughout the nineteenth century, became in excess of market rates as soon as rates were fixed, resulting in legislation limiting the amount of deposits.138 Saving banks appealed more to domestic servants and children than to industrial workers. Gladstone’s Income Tax Act 1853139 gave relief for life insurance premiums on insurance on the life of the taxpayer or his wife up to a maximum of one-sixth of taxable income. This was added to the list of claims to be made to the Special Commissioners. The relief is interesting as the culmination of a long-running debate on whether there should be differentiation between the taxation of earned income (‘precarious income’), out of which savings had to be made for old age and death, and income from land and the funds (‘spontaneous income’), which continued after death.140 Among the proposals were the radical leader Joseph Hume’s that income should be taxed in proportion to the capital value so that the capitalisation of earned income took account of the period of earning and the uncertainties of trade, while income from the funds was capitalised in perpetuity. The Revenue regarded this as ‘utterly impracticable’. Another was J.G. Hubbard’s that a proportion of earned income should be deducted on the basis that it ought to be saved, which was essentially the solution ultimately adopted much later in 1907141 for earned income relief. John Stuart Mill proposed an expenditure tax under which the deduction for what was actually saved would be automatic, but he accepted that it was impracticable. Disraeli had supported differentiation in his budget of 1852 which was defeated. Gladstone preferred to deal with the issue by imposing death duties on the capital producing spontaneous income. His life insurance relief was a nod in the direction of differentiation by giving relief for a specific form of savings, although it had nothing to do with differentiation, being available to taxpayers with any type of income. 137 Gosden (see above n.129), Table 8.1. The statements about savings banks are taken from Ch 8. 138 For example, an Act of 1824 (5 Geo 4 c.62) limited deposits to £200, with a maximum of £50 in the first year and £30 in subsequent years. This was reduced to £150 in total by the Savings Bank Act 1828. By requiring rules of new savings banks to be submitted to a barrister, that Act was the first step in the creation of the Registrar of Friendly Societies. 139 1853 s.54 (the relief was also available to employees who were required by Act of Parliament to pay premiums out of Schedule D or E income (Schedule D at the time applied to employment income other than public offices or employments) for a widow’s annuity or provision for his children); 1918 s.32, amended FA 1920 to extend the relief described in brackets to payments required by the terms and conditions of employment. There was an earlier life assurance relief of the proportion of the tax corresponding to the proportion of income paid in premiums which was introduced by 1806 s.178 but limited to taxpayers with income below £150 p.a. 140 For a more detailed summary of the debate see Daunton, above n.7, at 83–85, 91–102. Even in 1803 The Times (11 July 1803) records this point as the objection most generally urged against income tax. 141 FA 1907 s.19.

The Special Commissioners from Trafalgar to Waterloo 31 Further exemptions from tax under Schedules A and C were added to the Special Commissioners’ claims jurisdiction for industrial and provident societies, which date from 1862 and are similar in nature to friendly societies except that they have corporate status.142 Their exemption was repealed in 1933 by the same section that unsuccessfully attempted to tax mutual trading, and was held by the House of Lords to be ineffective in Ayrshire Employers Mutual Insurance Association Ltd v IRC.143 An exemption from tax under Schedules A, C and D was added for trade union provident funds in 1893,144 22 years after trade unions became legal in 1871; trade unions had been prohibited by the Combination of Workmen Acts 1799 and 1800, which were relaxed in 1824 and tightened again in 1825.145 Claims by friendly societies and the bodies covered by these subsequent exemptions continued to be made to the Special Commissioners until 6 April 1965, following which they were made to an Inspector;146 but appeals against refusal of the claim still lay to the Special Commissioners, thus preserving the original link between these claims and the Special Commissioners, a link which continues today.147 (2) Non-residents Stock of Foreigners exempted Nothing in this Act contained shall be construed to extend to the Profits arising from any Annuities, Dividends and Shares, bona fide belonging to any Person not being a Subject of His Majesty, and not being resident in Great Britain, during such Time as the same shall continue the Property of such Person, provided that such Property shall be duly claimed and ascertained in the Manner herein-after mentioned.148 142 Industrial and Provident Societies Act 1862, s.15; 1867 Act ss.12, 13, limiting the exemption to societies not allowing a member to have an interest in it exceeding £200; 1893 Act s.24 granted exemptions under Scheds A and C; 1918 s.39(4), repealed by FA 1933 s.31(2). A 1905 Departmental Committee on Income Tax (1905 XLIV microfiche ref.111.405) suggested that the possibility of limiting the transactions with non-members, which were taxable, should be looked into. This shows that the practice of limiting mutual trading to transactions with members was already in place. Subsequent provisions were introduced for payment of interest gross: FA 1933 s.32; 1952 s.442; 1970 s.340; 1988 s.486. 143 (1946) 27 TC 331. The section taxed profits from transactions with members that would be taxable if there were transactions with non-members. It is, however, possible to have mutual trading with non-members, for example insurance where the insured shared in surpluses but was not constituted a member. 144 Trade Unions (Provident Funds) Act 1893 granted exemptions from tax under Scheds A, C and D, later 1918 s.39(2); 1952 s.440; 1970 s.338; 1988 s.467. 145 39 Geo 3 c.81; 39 & 40 Geo 3 c.106; 5 Geo 4 c.95; 6 Geo 4 c.129. 146 ITMA 1964, Sched. 2. 147 TMA 1970 s.46C(3)(b) applying from 1996–1997, previously Sched.2, referring to TA 1988 s.459, 460. TMA 1970 s.46C also gives the Special Commissioners exclusive jurisdiction over appeals relating to the exemptions for trade unions; and Sched. 1A, para.10 for savings banks (until 1995–1996) as this was a claim made to the Board, but see above n.125. 148 1803 s.71; 1805 s.77; 1806 s.103 5th (relief was not necessary in 1799 because foreigners were not taxed on British income). By 1805 s.90 if the stock was in the name of a trustee, agent or factor, he had to prove on oath that the income belonged to a foreigner entitled to the

32 John F Avery Jones This exemption had existed since 1803 apparently for the benefit of Dutch merchants who invested149 in the Funds, but it was not continued in the 1842 Act. From 1842 non-residents were taxed on a source basis on domestic Schedule C income. In 1915, however, a measure of relief for non-residents was reintroduced for this income. Initially, 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: this condition was subsequently deleted.150 Appeals relating to such relief lay to the Special Commissioners.151 The relief also applied to such securities held within a foreign life assurance fund, being a fund representing liabilities to non-resident policyholders, of a UK insurance company.152 Foreign income of a foreign life assurance fund, which was remitted to the UK and invested in such securities, was also exempt; the exemption was claimed before the Special Commissioners. The 1906 Act introduced a system of deduction at source by paying agents.153 At the same time this Act extended tax under Schedule C to foreign public revenue ‘dividends’154 payable in Great Britain,155 with the result that this this foreign income belonging to a non-resident alien was exemption. 1806 s.110 (First) required all Schedule C exemptions to be verified by affidavit and the Special Commissioners could also require examination of persons on oath. While this exemption was not repeated in the 1842 Act the Special Commissioners have always dealt with matters relating to non-residents, no doubt because there were no relevant General Commissioners for non-residents, for example FA 1924 s.27 appeals on domicile, residence or ordinary residence; FA 1925 s.20 appeals on claims for reliefs for non-residents such as British subjects, persons in the service of the Crown, residents of the Isle of Man or Channel Islands, resident abroad for health reasons, widows of husbands in Crown service (FA 1920 s.24); exemption for interest on certain government securities held by non-residents (until 1995–1996), exemption of foreign dividends of non-residents (F(1909–1910)A 1910 s.71(2)); deduction of tax from non-residents’ copyright royalties (FA 1927 s.25). 149

Although the Netherlands was under French rule about this time. F(No.2) A 1915 s.47 (the non-domiciled condition was repealed by FA 1916 s.44); 1918 s.46; 1952 s.195; 1970 s.99; 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 UK held by non-domiciled persons or non-ordinarily resident British subjects. The scope of the relief was therefore the same as what remained of the remittance basis for foreign stocks, shares and rents after FA 1914 s.5. 151 FA 1924 s.27. 152 FA 1916 s.44. 153 See text above at n. 25. The 1806 Act provided that Schedule C ‘shall extend to all publick Annuities whatever payable in Great Britain out of any publick Revenue in Great Britain or elsewhere [ italics added], and to all Dividends and Shares thereof which shall become payable after the Fifth Day of April One thousand eight hundred and six . . .’ (s.103). 154 See above n.107. 155 1806 s.108; 1842 s.96; expanded upon by another Act in the same year, 5 & 6 Vict. c.80; extended to foreign companies by 1853; amended 19 & 20 Vict. c.36; extended to colonial companies by Revenue (No.2) Act 1861; extended to cases where the stock was on a UK register by Revenue Act 1866 s.9; extended to income from Indian institutions by Revenue Act 1868 s.5; amended by Customs and Inland Revenue Act 1885, which states that the previous 150

The Special Commissioners from Trafalgar to Waterloo 33 exempted when it was paid in Great Britain. This exemption was not included in the 1942 Act, when it was presumably overlooked that the effect was that tax became payable (and was in fact collected as it was deducted at source) on all foreign public revenue dividends paid in Great Britain, regardless of the residence and citizenship of the owner.156 The reason seems to have been that such interest was usually paid by bearer coupons, and so the Revenue effectively had to assume that the person collecting the interest in Great Britain was the owner. Not only was this a claim to extra-territorial taxation,157 but it also created the anomaly that foreign interest on non-public securities, which was taxable under Schedule D, was exempt in the hands of non-residents. Not surprisingly, this gave rise to problems for the Special Commissioners. Almost immediately the Treasury granted a concession for foreign Schedule C income of foreigners, and that of Colonialists, but only where the income arose and the foreigner resided in the same colony.158 Following this, fraud was detected when residents gave coupons to non-residents for collection, with the consequence that an affidavit from a non-resident was a prerequisite when claiming exemption.159 An exemption for foreign Schedule C interest payable in the UK where the owner or beneficiary was not resident was eventually introduced in 1910; the Special Commissioners dealt with appeals against refusal of the exemption.160 (3) The Crown and Foreign Ministers A further Schedule C exemption for the Crown and foreign ministers, also to be claimed before the Special Commissioners, was added by the 1806 Act: enactments had been found inadequate for assessing foreign dividends and adds the provisions about bankers selling coupons; and again by Customs and Inland Revenue Act 1888. The frequency of these amendments shows that, not surprisingly, taxing foreign dividends paid in Great Britain even when owned by non-residents created difficulties. 156 The Solicitor’s Office had to advise on this as early as 6 Aug. 1842, adding that practical experience may suggest points upon which the property tax is capable of being improved (TNA:PRO IR99/102, 30) and see also the record of advice on 20 Sept. 1842 (TNA: PRO IR86/5, 1), in which it was recorded that the intention of the Chancellor was not to tax them. It also advised in 1849 on similar problems relating to a loan raised by the British Guiana Bank (TNA: PRO IR99/103, 592, 603). 157 This was not unique; a non-resident director of a UK resident company working wholly outside the UK held a public office ‘within the UK’ in McMillan v Guest (1942) 24 TC 190. 158 TNA:PRO IR99/103, 604 gives the date of the Treasury letter as 7 Oct. 1842, thus showing that the problem arose immediately after the 1842 Act. For an example of the problems of a Canadian temporarily in the UK receiving US income in the UK, see TNA:PRO IR 83/23; and see also IR 86/2, 64. The Treasury decided in 1856 not to extend the concession (TNA: PRO IR 86/2, 12). In 1853 when the paying agent system was extended to dividends of foreign companies the concession was extended to them (TNA: PRO IR 86/6, 57). 159 TNA:PRO IR 86/7, 4 (9 Apr. 1866). 160 F(1909–10)A 1910 s.71(2); Revenue Act 1911 s.13 (beneficiary of a trust with power to call for transfer of the securities); 1918 Sched. C General Rule 2(d); 1952 s.190; 1970 s.100; 1988 s.48, repealed FA 1996. By FA 1924 s.27 appeals to the Special Commissioners were determined in like manner to an appeal against a Schedule D assessment.

34 John F Avery Jones Table 3. Exemption for the Crown and Foreign Ministers in 1806 and Now 1806 Now Stock belonging to His Majesty and Foreign Ministers exempted The Stock or Dividends belonging to His Majesty, in whatever Name the same may stand in the Books of the Bank of England, and also the Stocks or Dividends of any accredited Minister of any Foreign State resident in Great Britain, provided the Property thereof shall, if standing in the Name or Names of any Trustee or Trustees, be duly proved before the said commissioners for special purposes by such Trustee or any One of such Trustees.161

No tax shall be chargeable in respect of the stock or dividends belonging to the Crown, in whatever name they may stand in the books of the Bank of England.162

The Crown is exempt from tax by virtue of the prerogative right to claim immunity and so no such exemption is found for other types of income.163 This exemption may have been needed because it was the paying agent and not the recipient who was assessed; it has survived the abolition of both Schedule C and the assessment of paying agents. A similar issue arises when tax is deducted at source from a payment to the Crown,164 except under Schedule A which provided that a receiver on behalf of the Crown shall allow the deduction.165 The Special Commissioners are still the appeal tribunal in relation to claims by the Crown, being an appeal against a claim made to the Board.166 161 1806 s.103 Sixth; 1842 s88 Fifth; 1918 r.2(b), (c) Sched. C general rules; 1952 s.119; the exemption for foreign ministers was repealed by the Diplomatic Privileges Act 1964 which came into force on 1 Oct. 1964 before ITMA 1964 Sched. 4 Table came into force, which transferred these claims to the Board with the General or Special Commissioners having jurisdiction to review the Board’s decision on an appeal Sched. 4, para. (3) (this review jurisdiction was not continued after 1970, except in relation to surtax in 1970 s.33(2)); 1970 s.106(2) (now the Crown only); 1988 s.49(2). 162 1988 s.49(2). See previous note for the repeal of the foreign ministers’ exemption. There was also an exemption from Schedule A for the house occupied by a foreign minister in 1805 Sched. A III Seventh, with which the Special Commissioners were not concerned. 163 Boarland v Madras Electric Supply Corporation Ltd (1955) 35 TC 612. FA 1960 s.39, reversing IRC v Whitworth Park Coal Co Ltd (1959) 38 TC 531, imposed tax on the Crown where it was not ultimately borne by the Crown; 1970 s.524; 1988 s.829. The 1955 Royal Commission had foreseen this problem (Cmd.9474, para. 994). 164 FA 2000 s.112. 165 1805 Sched. A No.III Ninth; 1806 Sched. A No.III Ninth; 1842 s.60 Sched. A No.IV Ninth; 1918 Sched. A No.VIII r.4; 1952 s.174; repealed FA 1963 Sched.13 on the repeal of the original Schedule A. 166 See above n.122.

The Special Commissioners from Trafalgar to Waterloo 35 (4) The Commissioners for the Reduction of the National Debt, and the Treasury The remaining Schedule C exemptions merely required that information should be transmitted to the Special Commissioners for checking in accordance with the following power: and also in relation to the examining, auditing, checking and clearing the Books and Accounts of Dividends delivered to the Inspector, under the Authority of this Act, and the Certificates of Assessment and Exemptions transmitted by the respective Commissioners for general Purposes from their respective Districts, in respect of the said last mentioned Duties;167

These exemptions were: Table 4: Exemption for the National Debt Commissioners 1805 and Now 1805 Now Commissioners for the Reduction of the National Debt Provided always, and be it further enacted, That nothing herein contained shall be construed to extend to such Part of the publick Annuities as have been or shall be transferred to the Commissioners appointed or to be appointed by virtue of an Act, intituled, An Act for vesting certain Sums in the Commissioners at the End of every Quarter of a Year, to be by them applied to the Reduction of the National Debt;168 shall, from Time to Time, cause to be transmitted to the Commissioners for special Purposes to be appointed under this Act, and Account of the total Amount of Stock as shall have been transferred to the said Commissioners.169 167

No tax shall be chargeable in respect of the stock or dividends transferred to accounts in the books of the Bank of England in the name of the Treasury or the National Debt Commissioners in pursuance of any Act of Parliament, but the Bank of England shall transmit to the Board an account of the total amount thereof.171

1805 s.30 continued from the text below at n.185. It continues in the text below at n.214. 26 Geo 3 c.31. 169 1803 s.69 (but with the information being transmitted to the City of London General Commissioners); 1805 s.75; 1806 s.103 3d; 1842 s.88 Sched. C Fourth; 1918 r.2(a) Sched. C general rules; 1952 s.119(1); changed to transmitting to the Board by ITMA Sched..4 Table, with the General or Special Commissioners having jurisdiction to review the Board’s decision on an appeal: Sched. 4 para (3) (This review jurisdiction was not continued in 1970, except in relation to surtax in 1970 s.33(2); 1970 s.106(1); 1988 s.49. The relief does not depend on the making of a claim, and accordingly the relief may be claimed in the course of an appeal to either body of commissioners. The 1842 Act adds at the end: ‘also the payments to be made 168

36 John F Avery Jones Table 4: (continued) 1805

Now

Stock in the name of the Treasury Provided always, and be it further enacted, That nothing herein contained shall be construed to extend to such Part of the publick Annuities as are or shall be transferred to the Accounts in the books of the Bank of England, in the Name or under the Description of the Lord High Treasurer of England, or of the Commissioners of His Majesty’s Treasury, in pursuance of any Act or Acts of Parliament, and the Governor and Company of the Bank of England shall, from time to Time, cause to be transmitted to the said Commissioners for special Purposes, an account of the total Amount of Stocks as shall have been transferred to the said respective Accounts.170

The reason for the Special Commissioners’ involvement with all these claims was, as with the charitable claims, partly caused by the desire to relieve the General Commissioners from some of their duties, particularly ones that did not require their local knowledge. Reference has been made to the contemporary explanation of the Act in cutting down the work of the General Commissioners,172 although the 1806 Act changes removing their involvement in assessing income under Schedule C were more important in this respect.173 Another reason can be seen with hindsight. By the time of the Codification Committee there were two main types of claim: local (made to by the commissioners for the reduction of the national debt on account of the Waterloo subscription funds’. There is also an exemption for trusts for the reduction of the national debt: FA 1928 s.30; 1952 s.459; 1970 s.364; 1988 s.514. 170 1803 s.70 (but with the information being transmitted to the City of London General Commissioners); 1805 s.76; 1806 s.103 Fourth; 1842 s.88 Sched. C Fourth; 1918 r.2(a) Sched. C general rules; 1952 s.119(1); changed to transmitting to the Board by ITMA Sched.4, Table, with the General or Special Commissioners having jurisdiction to review the Board’s decision on an appeal, Sched. 4, para. (3) (This review jurisdiction was not continued in 1970, except in relation to surtax in 1970 s.33(2)); 1970 s.106(1); 1988 s.49(1). The relief does not depend the making of a claim, and accordingly the relief may be claimed in the course of an appeal to either body of commissioners. 171 1988 s.49(1). 172 See above n.98. 173 See the text below at n.204.

The Special Commissioners from Trafalgar to Waterloo 37 the Inspector with appeals to the General Commissioners), and central (made to the Board with appeals to the Special Commissioners174), of which there were at least nine variants, one of which was this claim made to the Special Commissioners without any right of appeal. The Committee discerned the existence of a principle that claims that did not throw up special problems or involve any serious risk of unfortunate results from varying local decisions should be determined locally; and those of greater difficulty or those where uniformity throughout the country is of special importance are dealt with centrally.175 The exemptions for the Crown, foreign Ministers, the Treasury and the Commissioners for the Reduction of the National Debt fit into the latter category. They are central functions for which the paid special commissioners were more suitable than local general commissioners; in Addington’s 1803 Act claims for exemptions for the Treasury and the National Debt Commissioners were transmitted to the City of London General Commissioners.176 Foreigners also do not fit into the jurisdiction of the General Commissioners. It is less clear why claims by friendly societies were thought to require the involvement of the Special Commissioners; Addington’s 1803 Act had provided for claims to be made to the General Commissioners for the district where the society was established, which seems appropriate.177 There was in 1805 a suspicion that organisations of workers were of a revolutionary character suspected of making improper use of the exemption for friendly societies from the Combination Acts.178 Perhaps it was also an indirect method of having some central control over such societies which were otherwise outside government control, being local, registered locally with quarter sessions, governed by their members, and not always financially sound. Administering claims seems to have been mainly a clerical task that involved a lot of work. We do not have any figures for the pre-1816 era, but the 1852 Select Committee was told that one special commissioner with the assistance of 29 clerks dealt with 69,833 claims amounting to £73,818.18s.4d, of which £24,960 was repayment to charities.179 Only about 300–400 of these claims were dealt with by the special commissioner personally. The Solicitor’s Office was also frequently called upon to advise 174 The claims for charitable exemptions that were originally made to the Special Commissioners had by FA 1925 s.19 been moved into this category: see above n.120. 175 Report, para.166. 176 Ss.69, 70. 177 1803 s.67. 178 A well-known example being the prosecution in 1833 of the Tolpuddle martyrs who were members of a friendly society. An Act (39 Geo 3 c.79) making illegal any societies with branches is contemporary with Pitt’s Act and demonstrates government concerns. A friendly society whose members were limited to one trade was an illegal trade union. Gosden (see above n.129) also records unsuccessful attempts by government from 1813 onwards to try to find information about membership of friendly societies (37). 179 1852 Select Committee: see above n.14, at qq.559, 585, 628, 654.

38 John F Avery Jones on charity claims.180 Most of the other claims were for repayments on income under £150. The number of claims was also increasing rapidly.181 Thus, the legislation today still contains much of the original wording of all these claims. Claims were still made to the Special Commissioners until 1925 for the charitable claims (except for the British Museum) and 1965 for the others. The Special Commissioners are still the sole appellate body for the claims that were originally made to them in 1805 and 1806 where these still apply.182 The Original Assessing Function of the Special Commissioners The 1805 Act gave power to the Special Commissioners to assess those who failed to make returns of Schedule C income, which in the text comes after their power to deal with Schedule C claims for exemption: or to the assessing such Persons who shall neglect to make a Return of the Profits on which the said last mentioned Duties arise, or who shall pay the said Duties into the Bank of England;183 [or to the charging and assessing the Profits arising from Annuities Dividends and Shares of Annuities paid in Great Britain out of the Public Revenues of Ireland, or any Foreign State as, and with the Exception, herein mentioned184];185

Although this particular power lasted only one year, it is worth noting because it was the first of a long line of assessing functions of the Special Commissioners, continuing in 1806 with the successor arrangement of assessing paying agents under Schedule C, followed in 1842 by assessing under Schedule D at the option of the taxpayer, and later including surtax.186 The original system of assessing Schedule C income was that taxpayers were required to make a return of dividends from public funds to the General Commissioners187 following the display of ‘church door’ 180 See TNA:PRO IR99/102, 300–311 for 39 cases (many dealing with more than one charity) in July 1843, most of which were approved; see also 335–337 and 390–392. 181 For example, 1843 69,722 claims; 1860 127,317; 1890 322,785; 1900 567,644 (TNA:PRO IR 86/7, 129 which gives figures for each year). In 1877 the Claims part of the Special Commissioners’ office had 38 people working there (Chief Examiner of Claims, Assistant Chief Examiner, 6 clerks (1st class), 13 clerks (2nd class), 13 clerks (3rd class) and 4 extra clerks. The assessment part of the office was smaller, with a total of 15 staff (TNA:PRO IR74/224). See also IR74/190 for the position in 1881. 182 But see above n.125. 183 Deleted 1806. 184 Added 1806. The exception referred to is presumably the exemption for foreigners (see the text above at n.148). See the text above at n.155 for the assessing provision. 185 Continued from the text above at n.50. The quotation continues above at n.167. 186 And many other separate provisions. Apparently a member of the staff of the Board of Inland Revenue was appointed a special commissioner for the sole purpose of making surtax assessments: see H. G. S. Plunkett, ‘The Income Tax Management Act 1964’ [1964] BTR 177 at 181. 187 1803 s.72; 1805 s.78.

The Special Commissioners from Trafalgar to Waterloo 39 notices.188 The General Commissioners assessed the income returned and transmitted the returns to the City of London Additional Commissioners (Addington’s Act189) or to the Special Commissioners (Pitt’s 1805 Act190). From 1805, in the absence of a return to the General Commissioners,191 the Special Commissioners had the power to assess by making an estimate on the basis of the best information they could obtain.192 Alternatively in the 1805 Act, a person could declare his intention to pay the tax into the Bank of England, in which case he made the return and sent the receipt for the tax to the Special Commissioners, and in default the person was liable to pay treble the duty.193 The advantage of this method was confidentiality, as it prevented the General Commissioners knowing how much income a taxpayer had from ‘the Funds’. There was a counterpart to this procedure introduced in the 1805 Act enabling the General Commissioners to make a Schedule D assessment with an identifying number and letter but no name; the taxpayer then paid the sum to the Bank of England or Receiver General so that the collector never received a copy of the assessment.194 This Schedule D procedure was much used in the City of London; in 1812 £207,236 out of £968,266 (21 per cent) was paid direct to the Bank of England.195 This preservation of confidentiality is a recurrent theme. As Professor Chantal Stebbings has written, ‘[i]n the complex social attitudes of the eighteenth century, what a man appeared to be was at least as important as that which he actually was’.196 Addington’s schedular system in general prevented one official knowing a taxpayer’s total income; these provisions went further and preserved confidentiality for income even within a single schedule. 188 1803 Management s.27; 1805 s.110; 1806 s.60; 1842 s.47; 1918 s.98, repealed FA 1942 Sched. 10 (a reference survived in 1952 Sched. 5, para.5 in relation to (old) Schedule A assessments until repeal by FA 1962). A general notice requiring returns was posted at the door of the parish church, hence the name. Lord Hanworth MR in Kelly v Rogers, (1935) 19 TC 692, 708 said: ‘I think the Attorney-General is right in saying that the status of taxability arises as soon as there had been the general notice given which imposes under section 100 [of the 1918 Act] a duty upon the subject to make his return’ . . . . The Codification Committee (see above n.28) (paras.152–156) proposed discontinuing the practice, which in any case was not by then relied upon against a taxpayer who did not make a return: this eventually happened in 1942. 189 1803 s.74. 190 1805 s.82. 191 1803 s.73. 192 See the text below at n.200. 193 1805 ss.81, 89 (treble duty, to be compared to double the duty for other defaults which were increased from double in 1806). 194 1805 ss.151, 152; 1806 s.142; 1842 ss.137–138; 1918 s.156, repealed FA 1942 Sched. 10. 195 Hope-Jones, above n.7, at 55. In the UK as a whole for 1855–1856 according to the 1856 Inland Revenue annual report 1,063 general commissioners’ assessments were by number and letter out of 272,219 (0.4%) on which the tax was £99,373 out of £4,612,849 (2%). By then secrecy was obtained instead by the taxpayer’s option to be assessed by the Special Commissioners. 196 ‘The Budget of 1798: Legislative Provision for Secrecy in Income Taxation’ [1998] BTR 651 at 652. This article explains the background to the issue of confidentiality.

40 John F Avery Jones The 1805 power for the Special Commissioners to assess Schedule C income in the absence of a return made to the General Commissioners was as follows: That every Person, Corporation, Company, or Society whatever, entitled unto any Shares in such publick Annuities, except as aforesaid, who shall not within the time herein limited for Delivery of such Statements, made a Return thereof, to be charged in their respective Districts, according to the Directions of this Act, shall be charged and assessed to the Duties contained in the said last mentioned Schedule, by the Commissioners for special Purposes to be appointed under this Act, which said Commissioners shall from the best Information they can obtain, whenever it shall be necessary, make an Estimate of the Profits of each Person, Corporation, Company, or Society, who shall not already have been assessed by the Commissioners in their respective Districts for the accruing Profits,197 and shall made an Asssessment thereon at the Rate prescribed by this Act; and the said Commissioners for special Purposes shall have the like Authority in all Cases where such Returns shall have not been made under the said recited Act,198 in or for any Year preceding the Fifth Day of April 1805; and the Sum so assessed shall be recoverable as a Debt to His Majesty on Record,199 in like Manner as is directed by this Act in other Cases.200

The tax on Schedule C income was payable by trustees and the ‘chamberlain,201 treasurer, or other officer of any corporation, company, or society’. Where a court had control of such property, which might last a considerable time, the Special Commissioners had a further power to apply to the court for directions enabling the proper assessment of the income, presumably to deal with cases where title to the property was disputed and so no return could be made: That the Commissioners for special Purposes, to be appointed under this Act, shall have Authority, and they are hereby required to make, from Time to Time, Application to any Court having the Direction or Controul of Property arising from the said publick Annuities, for such Directions and Orders as may be necessary to secure a due Assessment of all such Property as aforesaid; and the Order of such Court shall be binding upon the Acts of the said Commissioners, as well as upon the respective Parties interested in such Property, as far as relates to the

197

See above n.187. Addington’s 1803 Act s.73: see above n.191. 199 A pre-Judicature Acts 1873–1875 form of action, trial by record, under which the court ordered inspection of the record, the only defence to which was that the record did not exist. This was effectively a simple way of recovering the tax. See now TMA 1970 ss.65–68, s.68 still referring to a debt of record. ITMA 1964 s.8 extends the power for the Revenue to take proceedings in the County Court within the Court’s limits. 200 1805 s.80. In 1803 s.80 the tax was a debt due to the Crown if not paid within 6 months. 201 The reference to chamberlain and treasurer is still to be found in TMA 1970 s.71(2). On similar wording in the Jamaican statute the officer was held not to be personally liable for the tax: Income Tax Comr v Chatani [1983] STC 477. 198

The Special Commissioners from Trafalgar to Waterloo 41 Assessment to be made under this and the said recited Act,202 and the Officers of such Court shall act in obedience to such Order in like Manner, and such Order shall be of the like Effect as if made in a Cause depending in such Court.203

Even with the 1805 changes, the whole system was obviously an administrative nightmare and it is not surprising that it was repealed by the 1806 Act.204 That Act added the then extremely large205 penalty of £100 on clerks to general commissioners whose commissioners, having failed to assess Schedule C income, did not send whatever information they had to the special commissioners. Although this is not stated to relate to earlier years, it makes sense only in relation to them, and was therefore retrospective. This suggests that it was a last ditch attempt to make the system work. Addington, as might be expected, had originally proposed a system of withholding for Schedule C in his 1803 budget speech but was forced to abandon it because of Pitt’s opposition. Taxing this income was considered a breach of faith; loan Acts had contained a clause stating the interest was not subject to taxation.206 It was presumably tolerated only because of the war. Pitt was not therefore in a position to introduce deduction at source in 1805. It was left to the Whig Lord Henry Petty to introduce a system of deduction at source by paying agents in the 1906 Act. In the 1806 Act the paying agent deducted tax and paid it to the Bank of England207 with the assessing commissioners passing information to the Special Commissioners;208 this had the added advantage of relieving the General Commissioners from some more of their duties.209 From the confidentiality point of view this provision was even better as no returns had to be made of this income. The Schedule C exemptions set out above continued to be granted by the Special Commissioners, certified by them to the Bank of England, which paid gross and delivered certificates of exemption to the King’s Remembrancer.210 The only change made by the 1842 Act was that 202

Addington’s 1803 Act. 1803 s.77; 1805 s.85. This power is not included in the 1806 Act because deduction at source made it unnecessary. 204 1806 s.31. This preserved the power to assess and grant the exemptions for former years. 205 The same penalty for not taking the oath of secrecy; to be compared to the £50 penalty on a taxpayer for conviction before a court for not making a return. 206 For example, Appropriation Act 1797 (37 Geo 3 c.144): ‘Money lent on Security of this Act not to be rated to any Tax.’ It is interesting that when capital gains tax was introduced in 1965 and gains on gilts were included, the gain within the original discount on issue was exempted. 207 1806 s.106; 1842 ss.93, 94; 1918 Sched. C Rules as to interest payable out of public revenue etc. rr.6–8; 1952 Sched. 8; 1970 Sched. 5; 1988 Sched. 3, repealed FA 1996. 208 1806 s.105; 1842 s.89; 1918 Sched. C Rules as to interest payable out of public revenue etc. rr.1–5; 1952 Sched. 8; 1970 Sched. 5; 1988 Sched. 3, repealed FA 1996. The Special Commissioners made three copies of the information giving them to the Office for Taxes, the King’s Remembrancer and the Auditor at the Receipt of Exchequer. 209 See the quotation from the Guide to the 1806 Act in the text above at n. 98, which emphasises the reduction of work for the General Commissioners. 210 1806 s.110 Second and Fourth. 203

42 John F Avery Jones the Special Commissioners certified that the exemption applied and gave an order for repayment directed to the receiver-general of stamps and taxes to pay on production of the order.211 Withholding, as was to be expected, was far more effective; Schedule C tax receipts increased enormously from £244,306 in 1805–1806 to £3,377,923 in 1806–1807.212 As we have seen,213 the 1806 Act also extended the same system of withholding to foreign public revenue dividends payable in Great Britain. The paying agent gave particulars to the Board and to the Special Commissioners who assessed the paying agent. How the Special Commissioners’ Functions were Exercised The 1805 Act set out the Special Commissioners’ powers to deal with all these claims: shall also have full Authority to do any other Act, Matter, or Thing hereby directed or required to be done by Commissioners for special Purposes, to be appointed under this Act; and all Powers, Provisions, Clauses, Matters, and Things contained in this Act for ascertaining the Amount of any Duty, Exemption, or Allowance mentioned in this Act, shall be used, practised, and put in Execution by the Commissioners so appointed or to be appointed, in ascertaining the Amount of Duty, or any Exemption or Allowance placed under the Cognizance or Jurisdiction of the said Commissioners so appointed or to be appointed:214

Restrictions were added. It was made clear that they could not overrule any assessment made by the General Commissioners, or any exemption granted by them: Provided always, that it shall not be lawful for the said Commissioners appointed or to be appointed, to alter any Assessment made by Commissioners in their respective Districts, or any Exemption, Abatement, or Allowance which they may lawfully grant, or any Certificate thereof;

Unlike the General Commissioners, who could question the taxpayer and summon witnesses and examine them on oath,215 the Special 211 1842 s.98 Second, cross-referring to the Sched. A No.V (relating to tenths, procurations, chancel repairs etc) repayment procedure in s.61 adopted by 1842 by which the General Commissioners certify particulars to the Special Commissioners who order repayment (this may have been a wrong cross-reference because the more relevant procedure was that of the charitable exemptions in No.VI of Sched. A (which was No.V in 1805) because the exemption was granted by the Special Commissioners without involvement by the General Commissioners: see above n.102); 1918 Sched. A No.V r.6) 212 Board of Inland Revenue Report 1870 at 184. Addington’s tax had collected £644,826 in 1803–1804 and so the yield had decreased. The amount of government debt was also increasing and so the whole increase after 1806 is unlikely to be due to better collection. 213 See the text above at n.155. 214 Continued from the text above at n.167. 215 1803 Management s.26; 1805 s.141; 1806 s.134; 1842 s.125; 1918 s.144; 1952 s.59; TMA s.52(2); SI 1994 No.1812 reg.3 (power to summon witnesses). See above n.148 for an

The Special Commissioners from Trafalgar to Waterloo 43 Commissioners had no power to summon any person when dealing with these claims. All questions relating to these claims had to be answered by affidavit made before a general commissioner:216 nor [shall it be lawful] for the said Commissioners so appointed or to be appointed to summon any Person to be examined before them; but all Enquiries by or before the Commissioners so appointed or to be appointed shall be answered by Affidavit, to be taken before One of the Commissioners for general Purposes in their respective Districts, which such Commissioner or Commissioners is and are hereby authorized to take on Oath or Affirmation on unstamped Paper; and no such Affidavit shall be liable to any Stamp Duty217 whatever;

It is thought that the paper procedure by affidavit was originally introduced to avoid trouble and expense for the taxpayer in dealing with a body based only in London instead of local general commissioners, but it became an inconvenience. The only exception to this affidavit procedure was a provision in the 1806 Act which enabled the Special Commissioners to examine on oath those making an affidavit claiming exemption under Schedule C.218 The Presiding Special Commissioner had pointed out to the 1920 Royal Commission219 the inconvenience of not being able to have a meeting to settle any matters in dispute, but nothing was done. By way of example, in Watkins v Jones220 the Special Commissioners had decided an appeal against an income tax assessment when the issue was the amount of life assurance premium relief available, claims to that relief having been added in 1853221 to the claims to which the affidavit procedure applied. The Special Commissioners had stated a case for the opinion of the High Court; the issue was whether they had jurisdiction to do so, their decision on this claim being final. Rowlatt J was troubled about whether there had been a true appeal to the Special Commissioners, in which case the casestated procedure applied, or whether it was not an appeal at all but some other proceeding which they called an appeal. This did not stop him from deciding the case: ‘I am not sure what I ought to do, whether the whole thing ought to be set aside as being coram non judice; but I am going to deal exception in which the Special Commissioners could require examination on oath. When in 1842 the Special Commissioners heard Schedule D appeals at the option of the taxpayer they were given the same powers as the General Commissioners. 216 See the reference to claims being made by affidavit in the text above at n.91. Affidavit and oath included ‘an affirmation in the case of quakers or other persons entitled by law to make an affirmation in lieu of an affidavit or oath’: 1842 s.192. 217 The stamp duty would have been 2s for an affidavit not used in a court of law (Stamp Act 1804 Sched. A); the Act gave a general exemption for affidavits of this type. It was an offence under Stamp Act 1694 (5 & 6 Will & Mar c.21) s.11 to create a document on paper before it was stamped. Stamp Act 1891 s.3 still deals with documents on stamped paper, as did s.15 in its original form, stamping of documents liable to a fixed duty within 30 days being a matter of concession. 218 1806 s.110 First: see above n.148. 219 Minutes of Evidence qq.13, 488–13, 490 Cmd.288–4 at 675. 220 (1928) 14 TC 94. 221 S.54.

44 John F Avery Jones with it, with very great doubt as to whether what I am going to say is going to be of any importance to anybody’.222 He did, however, refrain from awarding costs to the Inspector in case he had no jurisdiction. The Codification Committee in 1936, after referring to the evidence to the 1920 Royal Commission and to further evidence they had received from the Special Commissioners, described the provision as having often caused embarrassment, and proposed to change it in their Codification Bill.223 Nothing having changed, the 1955 Royal Commission expressed surprise about the procedure applying to these reliefs.224 It recommended that the normal appeal procedure apply (with the consequent right of appeal to the courts on a point of law), in harmony with the 1925 changes225 to claims by charities that were originally subject to the same rules. This time something was done, and the affidavit procedure was finally repealed with effect from 6 April 1965 by the Income Tax Management Act 1964, 160 years after it had been introduced. Finally, there follows a general authority for the Special Commissioners to exercise their powers: and such Commissioners for special Purposes aforesaid shall have Authority to use, exercise, and apply all the Powers of this Act, as effectually as any other Commissioners are hereby authorised to use, exercise or apply the same, so far as the same Powers relate to the jurisdiction given to such Commissioners;

Unlike general commissioners,226 special commissioners were paid. Accordingly there was initially a limit of three appointees in addition to the commissioners for the affairs of taxes who were ex officio special commissioners: and the said Assistant Commissioners [not exceeding Three as aforesaid,227] shall and may be allowed such Salary for their Pains and Trouble, and such incidental Expenses, as the said Lords Commissioners now or for the Time being, or the said Lord High Treasurer shall direct to be paid to them; 222

At 109. Report, para.172 and Note to cl.345. Affidavit evidence was proposed to be retained for evidence from non-residents in cl.303(5). 224 By then these reliefs to which the original procedure still applied were: national insurance supplementary pension schemes (1952 s.381), House of Commons’ members’ pension fund (s.385), savings banks, friendly societies, and registered trade unions (ss.439, 440), the British Museum (s.451), and pre-1916 life assurance premium relief (s.225), the last of which they recommended moving to the General Commissioners. The affidavit procedure was then contained in 1952 ss.441, 451(2). 225 See above n.120. 226 ‘. . . no Fee, Reward, Salary, Pay, or Compensation, shall be demanded, allowed, paid, or taken by any such Commissioner on any Pretence whatever’: 1805 s.24; 1806 s.25; 1842 s.186 (by implication, omitting any mention of payment for general commissioners, and the same for later Acts). 227 Dropped in 1806 and see the following para. in consequence. 223

The Special Commissioners from Trafalgar to Waterloo 45 That limit of three appointees was removed in the following year but a safeguard was added that details of appointments in excess of three had to be laid before Parliament: [provided always, that whenever the Number of Assistant Commissioners to be appointed as aforesaid with a Salary shall exceed three, the Lords Commissioners of the Treasury shall cause an Account of such Appointments and Amounts of Salaries to be laid before each House of Parliament within Twenty Days after such Appointment, if Parliament shall then be sitting, and if Parliament shall not be sitting, then within Twenty Days after the Meeting of the next Parliament228].

Because of the lack of records it is not known whether more than three special commissioners were appointed in this first era. It seems unlikely because, following the reintroduction of income tax in 1842, one special commissioner dealt with all these claims,229 leaving his two colleagues to deal with the assessment and appeals work that had been introduced in 1842.

POWER FOR THE SPECIAL COMMISSIONERS TO TAKE OVER THE DUTIES OF THE GENERAL COMMISSIONERS

In 1806 the Special Commissioners were given power to take over the duties of General Commissioners if no general commissioners are appointed or if they neglect or refuse to act, and the Land Tax Commissioners do not make an appointment.230 To us this may appear to be a harmless provision similar to reserving certain appeals to the Special Commissioners, but translated into today’s terms it was a power for the Board of Inland Revenue to substitute themselves for general commissioners. It was substituting government employees for the independent general commissioners, the idea of which would have been shocking at the time. Using this power it is said that in 1814 the Commissioners for the Affairs of Taxes removed the City of London General Commissioners and appointed the Special Commissioners in their place.231 The City had a preponderance of Schedule D taxpayers, 228 Added 1806 s.32; 1842 s.23 (no longer any reference to exceeding three); 1918 s.67(5); 1952 s.8(5); TMA 1970 s.4(2), repealed FA 1984. 229 See 1852 Select Committee (see above n.14) qq.161, 620, 1043. There were still only three special commissioners in 1881 (Inland Revenue establishment records in the Board’s library). I am grateful to John Jeffrey-Cook for pointing out that the Imperial Calendar names four ‘Commissioners for managing the income tax’, who are different from the Commissioners for the Affairs of Taxes: John Dally, C Cullen, Richard Thompson and James Earnshaw from 1809 to 1811, who may be the original Special Commissioners, but further research is needed. In 1812 John Dally disappeared, leaving the other three until 1816. The Assessor and Collector was S B Harrison and Clerk W E Willoughby. 230 1806 s.13; 1842 s.8; 1918 s.60. 231 This is reported in Hope-Jones, above n. 7, at 28–29 and 133–134 citing The Examiner of 11 Dec. 1814 and The Courier of 14 Dec. 1814, which I have not checked. There is, however, no reference to it in The Times although there are contemporary articles about the City

46 John F Avery Jones and it was accordingly a focus for the objection to the inquisitorial nature of the tax. Even the City Corporation had refused to pay tax on its Billingsgate property in 1806.232 In 1814 the City surveyor resigned; presumably he found the opposition to the tax too strong. If it really happened, the removal of the City of London General Commissioners was unwise because it must have increased the City’s opposition to the tax; the City’s petition against the continuation of the tax after the war was, as we shall see, an important factor contributing to the repeal of income tax in 1816.

III. THE REPEAL OF INCOME TAX

The 1806 Act provided that income tax would continue ‘until the 6th of April following the definitive signature of a treaty of peace and no longer’.233 Following the Battle of Waterloo 31 petitions were presented to Parliament against its continuation, including, predictably, a strong one from the merchants, bankers and traders of the City of London. Mr Baring MP said ‘he really believed that a meeting of so much respectability had never been collected on any former occasion whatever’.234 In March 1816 the government put forward a motion for the continuation of the tax based on economic need, but for a limited pre-determined period only. The debate is interesting for its insights into the objections to the tax. The two most sensitive issues were the need for traders to disclose their financial position and the taxation of Schedule C interest. Presenting the City’s Petition Sir William Curtis said: Did they ever for one moment suppose that this tax was to be continued at the caprice of any minister, when there was no occasion for it, and that the houses of individuals were to be entered, their books examined, and their secrets divulged in a manner which no Briton could bear, and which no Briton ought to bear? Such an idea had never entered their minds.235

And, as another MP said, ‘[a]s far as the commercial world was concerned, the great evil of the tax consisted in that inquisitorial visiting which laid open to the world, with the most ruinous effect, the exact situation of every man’s affairs, however he might wish for concealment’.236 There is some exaggeration, particularly in the second quotation, as the information was

complaining about income tax, particularly one on 14 Dec. 1814 reporting a discussion at Common Hall, which must cast some doubt about whether it really happened. 232 233 234 235 236

Hope-Jones, above n. 7, at 134. S.227. 1805 s.233 was the same. The 1803 Act (s.231) said 6 May instead of 6 Apr. HC Deb, vol.33, col.391; col.407 for the City Petition; col.413 for Mr Baring’s comment. HC Deb, vol.33, col.409 (Sir William Curtis). HC Deb, vol.33, col.435 (Mr William Smith).

The Special Commissioners from Trafalgar to Waterloo 47 given to the general commissioners, who took an oath of secrecy, rather than to the world, although in the City they were likely to be one’s competitors. The quotations show once again the importance then attached to confidentiality, particularly of business affairs. The Chancellor of the Exchequer even accepted that ‘the machinery here has lost its simplicity and its facility’,237 as he had not been able to discover any complete remedy for the complaints. Lord Liverpool’s government must have thought that there was an overwhelming economic case for continuing income tax. Total government debt had risen to £834m, twice the size of GNP (compared to £2m or 5 per cent of GNP in 1688), with interest charges taking over a half of total tax revenues, and there was also the necessity of contributing to a sinking fund in order to maintain confidence in government debt in the City.238 National expenditure had been running at £30m during the war and it was hoped that it would reduce to £20m. Other taxes and the surplus in the consolidated fund amounted to £6m, while the income tax and war taxes brought this up to £28m. Reducing the income tax to one half would reduce the income by £8m and a further reduction in agricultural taxes was proposed of £1m. This would leave a borrowing requirement of £12m in the current year and £6m to £8m thereafter,239 on top of the already high level of borrowings. Despite the case for continuing the tax in order to reduce debt, the government suffered a surprise defeat by 37 votes (201 in favour and 238 against). Income tax expired, resulting in the loss of 27 per cent of total tax revenue240 overnight. As The Times said next morning:241 With heartfelt joy we offer our congratulations to the country, on a victory as important as any that was ever obtained over the military Despot of Europe—a victory over the fiscal despotism of the income tax . . . We are delivered, we and our posterity, from a fiscal inquisition. Never more will a British Minister dare to propose the subjecting his countrymen in time of peace to so odious and galling an oppression. This was indeed the first time, in the history of the world, that such a measure had ever been proposed, save under the pressure of a formidable war; and it has been defeated . . . .

Thus ended the first era of the Special Commissioners.

237

HC Deb, vol.33, col.430. Daunton, above n.7, at 47. There seems to be something missing in these figures, which may be to do with the sinking fund (introduced by Pitt in 1786) to repay the borrowings. 240 Daunton, above n.7, at 35, table 2.1 (the figure is for 1810–1814). 241 19 Mar. 1816 at 3. 238 239

2 Access to Justice before the Special Commissioners of Income Tax in the Nineteenth Century CHANTAL STEBBINGS #

ABSTRACT The judicial appellate function of the Special Commissioners of Income Tax was given to them when the Income Tax was reintroduced by Sir Robert Peel in 1842. Over the next 100 years this initially minor function gradually came to dominate the work of the tribunal. In constitution and nature the Special Commissioners were unequivocally an arm of the Executive, a dispute resolution body made up of paid civil servants, but nevertheless they established themselves as a body with predominantly judicial functions within the highly specialised field of tax. While the notion of access to justice was not articulated as a discrete concept, its principal constituent elements of simplicity, cheapness, speed, proximity and effectiveness of dispute resolution were recognised as desirable qualities within the nineteenth century legal process. They were equally desirable in the fiscal process, perhaps even more so, since the aim of that process was to ensure that government enjoyed a constant and predictable stream of public revenue. This chapter examines the extent to which the Special Commissioners in their appellate function were, both in fact and in perception, accessible to the taxpaying public in the context of practical litigation and of the esoteric nature of tax and of the fiscal process

W

HEN SIR ROBERT PEEL reintroduced the Income Tax in 1842 after a suspension of over 25 years, one of the few major changes he made to Pitt and Addington’s legislation was to give the Special Commissioners of Income Tax a new appellate adjudicatory function. He gave commercial taxpayers under Schedule D the option of appealing to that tribunal (the Special Commissioners) from their assessment by the local

# 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.

50 Chantal Stebbings Additional Commissioners and from a new mode of assessment by the Special Commissioners themselves.1 Peel had revived the tax to address a deficit of some £5 million, and the provisions with respect to the Special Commissioners aimed at fully tapping the immense commercial wealth which an economy at the height of an industrial revolution enjoyed. The aim of the fiscal process was to ensure that the government enjoyed a constant and predictable stream of public revenue through the imposition of taxes which were, virtually by definition, unpopular. The extension of the Special Commissioners’ function from a primarily administrative one of granting certain charitable exemptions under Schedule A and performing duties under Schedule C,2 to an appellate and essentially judicial one was an act of political expediency. It aimed to address the still potent objection of the trading community to an inquisitorial tax which would otherwise require them to disclose their incomes to the local lay Additional and General Commissioners, who might well be their competitors in trade and to whom it might be ‘prejudicial or vexatious’ to give such information.3 The Inland Revenue wanted and needed to afford every facility to the taxpaying public to ensure that all incomes were returned and fully and properly charged to the tax. Peel’s solution was to allow commercial taxpayers to choose to appeal to, and indeed to be assessed by, a tribunal of paid civil servants within a department of central government concerned exclusively with the complex field of tax law and the fiscal process: the Special Commissioners. The Special Commissioners in their appellate function constituted a practical solution to a very real popular grievance and perceived fiscal shortfall. The unstated premise was to constitute a major element in the legislative regime for taxpayer protection by enabling a taxpayer to challenge a decision of the Inland Revenue where he believed it to be unjust and thereby to ensure that the Inland Revenue collected tax only in accordance with the law. Nevertheless the evidence suggests that this tribunal was relatively little used throughout the nineteenth century. Official statistics and other evidence show that the Special Commissioners were not widely employed in their appellate function in terms of numbers of appeals heard, nor indeed in their assessing function under Schedule D, though the statistics did not always clearly distinguish between the two functions.4 Some ten years after 1 HC Deb, series 3, vol. 62, cols. 657–658, 18 Apr. 1842, per Sir Robert Peel. See Income Tax Act 1842 (5 & 6 Vict. c.35) ss.130–131. 2 45 Geo.III c.49 ss.30, 37, 73–85 (1805); J. Avery Jones, ‘The Special Commissioners from Trafalgar to Waterloo’ (paper presented at the Cambridge History of Tax Law Conference, July 2004), this vol. p3. See too A. Hope-Jones, Income Tax in the Napoleonic Wars (CUP, Cambridge, 1939) 23–28; A. Farnsworth, ‘The Income Tax Commissioners’ (1948) 64 LQR 372. 3 HC Deb, series 3, vol. 62, col.657, 18 Apr. 1842. See too C. Stebbings, ‘The Budget of 1798: Legislative Provision for Secrecy in Income Taxation,’ [1998] BTR 651. 4 This merely reflected the prevailing school of thought that the determination of an appeal by a tax tribunal was merely part of the assessment. In 1919 the Presiding Special Commissioner observed that ‘the duty of assessing [railway companies and their officials] includes the duty of

Special Commissioners of Income Tax in the 19th Century 51 the income tax was reintroduced, one Special Commissioner said that the right of appeal to his tribunal from assessments made by the Additional Commissioners under Schedule D had ‘very seldom been exercised’,5 an opinion confirmed by a number of surveyors. Of the three surveyors from London appearing before the Hume Select Committee in 1851–1852, none had ever had an instance of a party electing to appeal to the Special Commissioners instead of to the General Commissioners.6 It was a particularly rare occurrence for provincial surveyors, at least in the early years. In 1849 a surveyor from Chichester wrote to the Board of Inland Revenue requesting instructions when a taxpayer gave notice of his intention to appeal to the Special Commissioners from an assessment made upon him by the local Commissioners. He was told, somewhat impatiently, that he would, ‘of course’, receive instructions from the Special Commissioners.7 Even in 1863, by which time the Special Commissioners as an appellate body had been established for 20 years, they were hearing only some 150 appeals a year in England.8 Naturally they heard many more in Ireland, since they constituted the only appellate body in that country when the income tax was extended to Ireland in 1853,9 and in the same year they heard 3,300 Irish appeals in total, though this figure included appeals settled by correspondence and was not limited to Schedule D appeals.10 The Board of Inland Revenue regularly expressed its surprise that so few commercial taxpayers availed themselves of this confidential process. 11 hearing appeals where a right of appeal exists’: Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers (1919–20), vol. xxiii (Pts 1 & 2), q.13,408, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. This view of the status of the appeal as essentially an administrative act endured into the following century. 5 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers (1851–2), vol. ix (1), qq.1119, 1553, Command 354, per Edward Cane, Special Commissioner. See too ibid., qq. 1564–1565 per Edward Hyde, surveyor, and q.806 per Edward Welsh, surveyor. 6 Ibid., q.1602, Command 354, per Edward Hyde, Charles Levien, Francis Tarleton, surveyors. 7 The National Archives (TNA): Public Record Office (PRO) Records of the Boards of Stamps, Taxes, Excise, Stamps and Taxes, and Inland Revenue (IR) 86/2, Board Minute, 16 Nov. 1849. 8 House of Commons Parliamentary Papers (1863), vol. xxxi (607), Command 528. 9 16 &17 Vict. c.34 ss.20, 21. As the Assessed Taxes did not apply to Ireland, there was no existing machinery on which to engraft the income tax administration, and accordingly a new system based entirely on the surveyors and the Special Commissioners was introduced. The surveyors acted as assessors, while the Special Commissioners both made the assessments and heard all appeals. 10 House of Commons Parliamentary Papers, above n.8, (607), Command 528. See too Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers above n.4, (Pts 1 & 2), q.13,728, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. In 1918–1919 there were 2,149 appeals in Ireland as against 446 in Britain: ibid., q.13,414. 11 First Report of the Commissioners of Inland Revenue, House of Commons Parliamentary Papers (1857), vol. iv (65) at 32 of the Report, Command 2199, Sess.1. In 1868–1869 there were nearly 2,400 special assessments out of a total of 380,000 people assessed under Schedule

52 Chantal Stebbings The tension of an overtly administrative governmental body based in London exercising adjudicatory functions, the economic importance of its role and the complexity and technicality of the law it was implementing combine to suggest that one reason for such slight use of the tribunal could be that it challenged contemporary notions of access to justice and was, as the regular courts of law were perceived to be, inaccessible. The object of this chapter is to examine the extent to which the Special Commissioners in their appellate function met that challenge and were, both in fact and in perception, accessible to the taxpaying public in the context of practical litigation and of the esoteric nature of tax and of the fiscal process. The accessibility of the Special Commissioners directly determined the extent of their efficacy as the formal safeguard of Schedule D taxpayers in the legislative regime of income tax. When Peel engrafted the judicial function on the hitherto exclusively administrative functions of Pitt’s Special Commissioners of 1805,12 he was himself immersed in a legislative, political and ideological culture, not only of extra-judicial dispute resolution, but of an acute awareness of the problems of accessibility to the regular courts, both superior and inferior. While in the nineteenth century the concept of access to justice was not articulated as a discrete concept as it is today, that did not mean it was perceived as either unimportant or undesirable. The general consensus—with a few notable exceptions—was that the main elements of accessibility, namely simplicity, cheapness, speed and proximity, were the right of any litigant in the English courts of law. The truth underlying the common saying that justice through the courts was open to all, rich and poor, like the Ritz Hotel, was increasingly uncomfortable. Rather less altruistic was the undeniable need to streamline the procedures of the courts in order to keep pace with the growth in legal business engendered by immense commercial and technological development. In a masterly overview of the state of the superior courts of the Common Law at the dawn of the Victorian age, Henry Brougham exposed the trouble, expense, delay, inconsistency and technicality which litigants had to endure.13 The process was overly dependent on form and a rigorous adherence to complex and detailed rules, exacerbated by fictions, verbosity and repetition.14 He put forward comprehensive and pragmatic proposals for reform15 and called for ‘the pure, prompt, and cheap administration of D: Thirteenth Report of the Commissioners of Inland Revenue, House of Commons Parliamentary Papers (1870), vol. xx (193; 377) at 122 of the Report, C. 82. 12

45 Geo.III c.49 ss.30, 37, 73–85 (1805). HC Deb, New Series, vol.18, cols.127ff, 7 Feb. 1828, per Henry Brougham. 14 See the First Report of the Common Law Commissioners, House of Commons Parliamentary Papers (1829), vol. ix (1), Command 46; First Report of the Commissioners for Inquiring into the Process, Practice and System of Pleading in the Superior Courts of the Common Law, House of Commons Parliamentary Papers (1851), vol. xxii (567), Command 1389. 15 HC Deb, New Series, vol.18, cols. 127ff, 7 Feb. 1828, per Henry Brougham. 13

Special Commissioners of Income Tax in the 19th Century 53 justice throughout the empire’.16 Though speaking with reference to the work of the Privy Council, his words reflect the views of liberal reformers with respect to the administration of justice in general: It is the worst of all follies, the most iniquitous, as well as the most mistaken, kind of policy, to stop litigation—not by affording a cheap and expeditious remedy, but by an absolute denial of justice, in the difficulties which distance, ignorance, expense, and delay produce.17

Delays and expense in the Court of Chancery were notorious, and the court’s portrayal by Charles Dickens in Bleak House in 1853 was widely accepted as accurate. The process was described in Parliament as ‘slow . . . nearly insensible’,18 and it was said that ‘few entered the court of chancery without alarm, and none escaped from it without suffering’.19 Suits took so long that persons interested often died before the action was determined; costs were exorbitant and frequently consumed a large proportion of the property which was the object of the litigation.20 The debates on the establishment of local courts for the hearing of small civil cases, which ultimately produced the system of County Courts in 1846, revealed similar perceptions at the very time when the Special Commissioners of Income Tax were being given appellate judicial powers. Pragmatic and rational reformers such as Henry Brougham saw the inconveniences of taking small cases, notably for the recovery of small debts, to the superior courts, where the expense of litigation amounted almost to a denial of justice,21 and said that inevitably it was bound to deter litigants from pressing even a good cause. Brougham wanted to provide ‘cheap justice, and near justice, and speedy justice’ for the people of this country.22 There were, however, dissenting voices. Traditionalist conservatives such as Lord Lyndhurst argued ‘that cheap law did not always mean cheap justice, nor expeditious law expeditious justice’.23 His view of the administration of English justice was that it ‘was more pure than that of any other country in the world . . . not only uncorrupted and incorruptible . . . but . . . above suspicion’.24 He thought the difficulties of expense and delay were inseparable from any system of justice based on an adherence to rules, and indeed that they might even be desirable, in that they served the primary object of the system, which was to avoid litigation. To make justice 16

Ibid., col.131. Ibid., col.159. 18 HC Deb, series 2, vol.5, col.1034, 30 May 1821, per M.A. Taylor. 19 Ibid. 20 HC Deb, series 1, vol.19, col.261, 7 Mar. 1811, per M.A. Taylor. 21 HL Deb, series 3, vol.18, col.858, 17 June 1833, per Henry Brougham. 22 Ibid., col. 891, 17 June 1833. Similar arguments were made in the debates on the Supreme Court of Judicature Bill in 1873, eg by the Attorney General in HC Deb, series 3, vol.216, col.643, 9 June 1873. 23 HL Deb, series 3, vol.18, col.869, 17 June 1833, per Lord Lyndhurst. 24 Ibid., col.870. 17

54 Chantal Stebbings too accessible would be to undermine the preventive part of the system. He put the litigiousness of the American people down to an over-accessibility of justice, and argued that this maintained them in an almost constant state of strife. Similarly in 1828 Solicitor General Tindal had argued that if law was too cheap it became ‘an unmitigated evil’: The hand of one man would be perpetually raised against the hand of another; no fancied grievance would be allowed to sink into oblivion; no petty assault would be either forgiven or forgotten; and the courts would be occupied with the endless quarrels of the peevish and the discontented.

Expensive law, he concluded, ‘operates as a wholesome check on the spirit of litigation’.25 The widespread fear of litigation among the public was accepted by most legislators and reformers to be unacceptable. Ultimately the demand for an accessible system of regular courts resulted in the complete recasting of the system of superior courts and a uniform code of procedure outlined in the Schedule to the Supreme Court of Judicature Act of 1873, the latter going far towards achieving the ‘cheapness, simplicity, and uniformity of procedure’26 which had been desired some 40 years before. Within the period of Peel’s ministries, it found expression in a continuous programme of legislation simplifying the procedures in the superior Common Law courts by introducing uniform methods of starting actions, reducing or removing technicalities and fictions,27 and in the creation of the new County Courts system, introduced in 1846 by a Whig administration but on the basis of the legislation undertaken by Peel’s ministry.28 These early reforms were not radical and were limited in their effectiveness, but constituted a considerable step towards the facilitation of the administration of justice in the regular courts.29 The desirability of accessible dispute-resolution bodies was the unstated premise in the creation of the new statutory tribunals, though not the prime reason for their creation. Unlike with litigants in the regular courts of law, the new tribunals of the nineteenth century were created in order to implement new, and often controversial, government policy. Pragmatic 25

HC Deb, New Series, vol.18, col.852, 29 Feb. 1828. HL Deb, series 3, vol.214, col.337, 13 Feb. 1873, per the Lord Chancellor. 27 Uniformity of Process Act 1832 (2 & 3 Will. IV c.39) provided for a uniform writ of summons; Real Property Limitation Act 1833 (3 & 4 Will. IV c.27). See too Common Law Procedure Acts 1852 and 1854 (15 & 16 Vict. c.76; 17 & 18 Vict. c.125); Re simplification of pleading, see W.S.Holdsworth, ‘The New Rules of Pleading of the Hilary Term, 1834’ (1923) 1 Cambridge Law Journal 261. 28 Act for the More Easy Recovery of Small Debts and Demands in England 1846 (9 & 10 Vict. c.95). 29 See generally Baron Bowen, ‘Progress in the Administration of Justice during the Victorian Period’, Select Essays in Anglo-American Legal History (Little, Brown & Co., Boston Mass., 1907) i, pp.516ff. 26

Special Commissioners of Income Tax in the 19th Century 55 politicians and legislators recognised that policy could be implemented only if those members of the public with a perceived or real grievance were afforded an accessible and effective process for its resolution. Thus the constitution and procedures of the new tribunals reflected an acknowledged need for accessibility. The Special Commissioners were like other statutory tribunals in that their function was to implement legislation, in their case certain elements of the income tax legislation. While all statutory tribunals implementing regulatory legislation were required to implement government policy expeditiously, it was of especial importance in the fiscal field for it brought with it a direct and unrelenting pressure and expectation to conclude any litigation before them swiftly and effectively so as to ensure the constant and predictable stream of revenue into the government’s hands. Just as the period of Peel’s political activity saw the reform of the regular courts to render justice more accessible, so it saw the creation of the early statutory tribunals on a broadly common model, notably the Tithe Commissioners in 1836,30 the Copyhold Commissioners in 1841,31 the Inclosure Commissioners in 184532 and the Railway Commissioners in 1846.33 When he strengthened the role of the Special Commissioners in 1842 and gave them judicial powers, Peel did so in a period of particularly dynamic and original law reform and pressing fiscal demands. Not only was it necessary for any income tax tribunal to be accessible in order to achieve its fiscal aims, it would, in the prevailing legal and political culture, be expected. Informed commercial opinion favoured a dispute resolution body which was effective, but which was not too expensive nor too slow. Commercial taxpayers were ‘in favour of quick justice, even if it is not the highest’.34 The accessibility of the Special Commissioners to the taxpayer had a number of facets. The most obvious was an awareness of their existence and function; the most substantive was expense; the most intangible was the perception of their effectiveness and the most intractable was the intellectual accessibility of the underlying legislation. The Special Commissioners as a tribunal were prima facie accessible to the taxpaying public only if the public knew of their existence and functions, and were informed as to how to use the tribunal. Whereas the appellation ‘Commissioners’ is today perceived as inaccessible in that it is generally not understood, that was not the case in the nineteenth century. Boards of Commissioners were commonplace, and while the name conveyed little more than the very broad concept 30

Tithe Commutation Act 1836 (6 & 7 Will.IV c.71). Copyhold Act 1841 (4 & 5 Vict. c.35). 32 Inclosure Act 1845 (8 & 9 Vict. c.118). 33 Railway Commissioners Act 1846 (9 & 10 Vict. c.105). 34 This was the conclusion of the Birmingham Chamber of Commerce in 1905 after extensive debate: Minutes of Evidence before the Departmental Committee on Income Tax, House of Commons Parliamentary Papers (1905), vol. xliv (245), q.1965, Cd. 2576, per Arthur Chamberlain JP. 31

56 Chantal Stebbings of someone empowered by government to exercise authority in a specialised area of public life, that sufficed to ensure familiarity with the general nature of any body of Commissioners. Familiarity with the notion of Commissioners, however, did not mean that the existence of the Special Commissioners of Income Tax was generally known. The confusion lay in distinguishing between the various bodies of Commissioners, the ‘cloud of Commissioners’ as Charles Buller called it in the House of Commons in 1842,35 involved in the administration of income tax. One prominent member of the Tax Bar explained how he constantly had to explain the difference to the public between the Commissioners of Inland Revenue, the Special Commissioners and the General Commissioners. ‘There is’, he said, ‘extraordinary confusion—more than you would believe possible—about it’.36 Even as late as 1920, as is the case today,37 the existence of the Special Commissioners was unknown to most taxpayers and, even if they saw the name on an official form, they would not know how those Commissioners differed from the other bodies in the tax sphere.38 The evidence confirms that the power of recourse to the Special Commissioners for both assessment and appeal under Schedule D was largely unknown, and even where it was realised to be an option, it was rarely used by smaller traders, even when in later years it was found to be a sensible route in areas which felt dissatisfaction with either their surveyor or their local Commissioners. Furthermore, while in the early years of the revived income tax the times, dates and location of the appeal hearings of the General Commissioners were regularly announced in The Times, even with the order of the wards to be heard, there was no such publicity for the Special Commissioners.39 This served to reinforce public ignorance of the tribunal. In the absence of any general cultural knowledge of the Special Commissioners as an institution such as existed with Justices of the Peace or even with General Commissioners, taxpayers were dependent on official information for publicising the existence and function of the Special Commissioners. There were three possible sources of this information—the surveyor, the official notices and the clerk to the General Commissioners. During the nineteenth century, most taxpayers requiring advice about their tax affairs would ask either the surveyor or the clerk to the General 35

HC Deb, series 3, vol.62, col.999, 22 Apr. 1842 per Charles Buller. Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, (Pts 1 & 2), q.16,032, Cmd. 288-5, per A.M Bremner, barrister, on behalf of the General Council of the Bar of England. 37 See H.H. Monroe, Intolerable Inquisition? Reflections on the Law of Tax (Hamlyn Lectures, 33rd Series, Stevens, London, 1981) 78. 38 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers above n. 4, (Pts 1 & 2), q.13,444, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. See too ibid. q.534, Cmd. 288-1, per Sir Thomas Collins, Chief Inspector of Taxes. 39 See, eg, The Times, 7 Dec. 1842, 5 col. e. 36

Special Commissioners of Income Tax in the 19th Century 57 Commissioners. The extent to which the former was approached depended largely on his character and standing in the locality, and the extent to which he was known to act impartially rather than as a ‘government man’. As far as advising on approaching the Special Commissioners was concerned, however, he had no personal interest in the matter and had no reason to give anything other than honest advice and fully to inform the taxpayer of the options open to him. The clerk to the General Commissioners was, like his Commissioners, independent of the Inland Revenue. He was generally a local solicitor, and was usually clerk to various other bodies of Commissioners such as the Additional Commissioners and the Land Tax Commissioners, as well as being clerk to the Justices of the Peace. He was inevitably a well-known figure in the district. His function was to advise his Commissioners on points of law and procedure, as well as to deal with the administrative aspects of the work of his Commissioners. As such he would certainly have been fully cognizant of the existence and function of the Special Commissioners, and as a usual source of information on tax matters in the nineteenth century, he was in the ideal position to publicise the tribunal. As will be seen below, however, he faced something of a personal conflict in this respect. The principal and orthodox way in which taxpayers should have been informed of the nature and functions of the Special Commissioners was through the official notices of the income tax process. The notice to make returns under Schedule D consisted of the delivery by the parish assessor to each taxpayer coming within that Schedule40 of the notorious ‘Form 11’ and the subsequent circulation of the church door notices, which in clear and straightforward language instructed all taxpayers to make their returns to the assessor.41 Form 11 itself was long and detailed, reflecting the complex nature of Schedule D. Being the first step in the assessment process it naturally made no mention of the question of appeals, but it was the first intimation to a taxpayer of the existence of the Special Commissioners in their new assessing function,42 since taxpayers were asked to indicate if they were ‘desirous of being Assessed by the Special Commissioners appointed by the Crown’.43 As one of ten notices and declarations contained in the return, and with no accompanying explanation, it provided the minimum information, and as such was limited in its 40 It seems that the official time limit of 21 days from the issue of the precept to the assessor by the General Commissioners for the giving of such notice was unknown to most taxpayers. It was meant to be affixed in a public place such as the church door, but few examined it: see Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, (Pts 1 & 2), q.13,429, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 41 TNA: PRO IR 9/6A, Form 7 (1854). 42 Such assessments were known as ‘special assessments’ and were made under the authority of the Income Tax Act 1842 (5 & 6 Vict. c.35) s.131. 43 TNA: PRO IR 9/4 Pt 2, Form 11 (1857).

58 Chantal Stebbings accessibility. An example of Form 11 from 1887 shows the right to be assessed by the Special Commissioners as being particularly obscure.44 Once the assessment had been made, whether by the local Commissioners or the Special Commissioners, the question of informing a taxpayer about his right of appeal became relevant. In the case of ordinary Schedule D assessments the notice of the sum with which a taxpayer had been charged, the notice of first assessment, Form 64, would be issued by the clerk to the Additional Commissioners. Some early notices of first assessment under Schedule D were brief and uninformative with regard to appeals. A typical such notice issued in Durham in 1868 stated the assessment which the General Commissioners had made and bore the signature of the clerk to those Commissioners. The notice then read: If you have any cause to appeal against the same, you must give Notice in writing, to Mr KING PATTEN, the Surveyor of Taxes at his Office, situate in Stockton-on-Tees, and appear personally before the Commissioners on the day appointed for hearing the case. The day of Appeal is fixed for the TWENTY-FIRST DAY OF NOVEMBER INSTANT, at the ATHENAEUM WEST HARTLEPOOL at half past ten45 . . .

The official notice thus made no specific mention of appeal to the Special Commissioners, and is the one reproduced in most income tax manuals of the nineteenth century,46 itself suggesting the slight use of the Special Commissioners in their appellate function. It would be reinforced by church door notices publicising the time and place of appeals before the General Commissioners, but no such notices existed for appeals to the Special Commissioners. Where a taxpayer had been assessed by the Special Commissioners, he would receive notice of the sum in which he had been assessed. The Board of Inland Revenue envisaged that notice would then be given by either party of its wish to appeal, and desired to be informed so that the necessary arrangements for hearing and determining these appeals could be made.47 To that end, Form 65, which was the notice of assessment by the Special Commissioners, stated the assessment and included the instruction: If you have any Cause to Appeal against the Assessment, you must give me Notice in Writing, on or before the ________day of____________ addressed to my Office, situate at _________________________________. Due notice will be given you of the time and place appointed for hearing such Appeal. 44

TNA: PRO IR 88/1, Form 11 (1887). TNA: PRO IR 9/2, Form 64 (1868). 46 See, eg, C Senior, Hand-Book of Income Tax Law and Practice (Simpkin, Marshall & Co, London, 1863) 42, 213. 47 TNA: PRO IR 86/1, Board Minute, 20 Jan. 1843. 45

Special Commissioners of Income Tax in the 19th Century 59 The signature to the notice was that of the surveyor.48 The notice did not, therefore, make it explicit that the appeal was to the Special Commissioners, though the Act itself did.49 Not only was the bare minimum of information about the Special Commissioners included in the notices, the evidence shows that not every taxpayer received a notice of appeal at all. It was the practice in some areas for only those taxpayers whose assessments did not exactly reflect their returns to be given the opportunity to appeal.50 Furthermore, each district tended to produce its own personalised income tax forms, notices, receipts and demands, and while they were all broadly in the same format with similar wording, there were often notable divergences from the official form. It was, for example, a common practice to vary the notices with the legitimate object of facilitating the appeal hearings for the appellants. This was because it was usual to ascertain the number of appeals before fixing the days for hearing them. This permitted the clerk to the General Commissioners to give each appellant a more precise time and date for his appeal. In such cases the notice of first assessment read: N.B.- If you have any cause to appeal against the same, you must give notice in writing within ten days from the date hereof, to Mr ________, the Surveyor of Taxes, at his office, situate at ___________, stating the parish and the number of this notice..... The day of appeal will then be made known to you, but no appeal can be heard unless such notice is given within the proper time.51

It was a small step from making such alterations to the benefit of the taxpayer to making alterations to the benefit of the administration, a point which was vividly illustrated in 1871. The later years of the nineteenth century were a time of particular unrest in relation to the income tax, with numerous local rebellions against assessments and perceived excessive surcharges under Schedule D. One such rebellion in Exeter in 1871 revealed profound discontent within the local administration of the tax. These tensions could have been effectively relieved by appealing against the assessments to the Special Commissioners as a body untainted by any local commercial connection and with no interest in the individuals’ professional standing. Nevertheless, it emerged in the course of an official enquiry by the Board of Inland Revenue into the rebellion that the Special Commissioners had not been appealed to because they 48 TNA: PRO IR 9/4 Pt 2, Form 65 (1850s). See too Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers (1862), vol. xii (131), qq.122, 406, Command 370, per Charles Pressly, Chairman of the Inland Revenue Department. 49 Income Tax Act 1842 (5 & 6 Vict. c.35) s.131. 50 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.1522, Command 354, per Edward Hyde, surveyor. 51 Senior, above n. 46, 214.

60 Chantal Stebbings were almost entirely unknown by the Exeter traders. To the Board’s considerable concern52 it learned that its instruction that notification of the option should be printed on every notice of assessment had been ignored, and some clerks to the local Commissioners had printed their own notices on which the information was omitted.53 The official enquiry did not make any suggestion as to the object of the clerks in doing this, but an obvious motive would be financial. Clerks were, until 1891,54 remunerated by poundage, namely a fixed rate in the £ on the sum raised by the tax. The allowance was 2d in the £,55 and was for all the clerical and administrative duties directed to be done under the General and Additional Commissioners. It was thus in the clerk’s interest to keep as many assessments and appeals in the hands of his Commissioners rather than the Special Commissioners. Poundage was undoubtedly lucrative to clerks. It provided their remuneration and the expenses of their office, namely the rent of their premises, the salaries of their assistant clerks, stationery and other routine expenses.56 When James Dickens, a Special Commissioner, gave evidence before the Select Committee on the Income and Property Tax in 1851, he gave the expenses of his Department since 1842 as £18,000, and observed that some £40,000 had been saved by way of poundage as a result of assessments not being made by the local Commissioners.57 The poundage was paid to the clerks to the General Commissioners and to their assessors and collectors, and in 1855 the clerk to the City of London Commissioners received £7,000 in poundage from income tax.58 The income tax and the assessed taxes yielded a total of £78,000 in poundage in the year ending 1861.59 There was, therefore, a strong incentive to corrupt clerks to fail to draw the attention of taxpayers to the possibility of appealing to the Special Commissioners, and corrupt 52 The confidence of the Board in its forms and notices was considerably undermined. See Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers, above n. 48, qq.122, 406, Command 370, per Charles Pressly, Chairman of the Inland Revenue Department. 53 Fifteenth Report of the Board of Inland Revenue, House of Commons Parliamentary Papers (1872), vol. xviii (259) at 54, C. 646; Sixteenth Report of the Board of Inland Revenue, House of Commons Parliamentary Papers (1873), vol. xxi (651) at 36, C. 844. 54 Taxes (Regulation of Remuneration) Act 1891 (54 Vict. c.13) s.1. 55 Income Tax Act 1842 (5 & 6 Vict. c.35) s.183 ; 16 & 17 Vict. c.34 s.57. 56 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, qq. 764–769; 2714, Command 354. 57 Ibid., qq.1151–1152, Command 354, per James Dickens, Special Commissioner. 58 For details of the clerk’s poundage in the City of London in 1849, see Ibid., qq. 767–769, Command 354, per Edward Welsh, surveyor for the City of London; Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers, above n. 48, (131), q.2396, Command 370, per Edward Welsh, surveyor for the City of London. 59 Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers, above n. 48, qq.179–180, Command 370, per Charles Pressly, Chairman of the Inland Revenue Department.

Special Commissioners of Income Tax in the 19th Century 61 clerks, unfortunately, were not unknown. In 1862 the surveyor for the City of London expounded at length about the now infamous corruption of the clerk for that division, who had sold the Schedule D returns to use as waste paper. The returns were eventually recovered from Billingsgate market where they were being used to wrap up dried fish.60 Even if a clerk stopped short of a physical mutilation of the notice, he could always simply fail to mention the option when giving general tax advice to the public. In the Exeter case, the Board reprimanded the clerks to the local Commissioners for not drawing the attention of the taxpayers to their right to appeal to the Special Commissioners. The Board also took more direct action, and as a result in 1873 an Act was passed which provided that only notices prescribed or approved by the Board were to be used.61 The legislation was clearly effective since from that date the notices of first assessment, invariably, as in this example from Durham in 1873, included the following additional words:62 If you are assessed under Schedule D, and do not claim exemption on the ground of your whole Income from every source being less than £100 or Abatement on the ground of such income being less than £300, you can, if you so desire, Appeal to the Commissioners for Special Purposes, instead of to the Commissioners for General Purposes, on giving Notice to that effect in Writing to the Surveyor within the period above stated, and the day for hearing Appeals by the Special Commissioners will be notified to you in due course . . . . The Day of Appeal is fixed for ________ the ___________ November 1873, at 11am at the Court House, Durham.

Signed Clerk to the Commissioners This was the notice in the correct form, clearly informing the taxpayer of his option of appealing to the Special Commissioners, though giving no information about the nature of that body nor how it differed from the General Commissioners. The statement did not particularly stand out from the rest of the notice, and, as was remarked, ‘no one cares to devote much time to studying these notices. They just look and see how much is demanded’.63 When an accountant was asked in 1919 why appellants went to the General Commissioners, he replied that his experience was that theirs was the first reference on the tax form, and that if they were 60 Ibid., qq. 2414–2419 per Edward Welsh, surveyor for the City of London. See too the obstructive actions of the clerk at Louth, Sixth Report of the Commissioners of Inland Revenue, House of Commons Parliamentary Papers (1862), vol. xxvii (327), at 352–354, Command 3047. 61 Customs and Inland Revenue Act 1873 (36 & 37 Vict. c.18) s.9. See too Taxes Management Act 1880 (43 & 44 Vict. c.19) s.15(2). 62 TNA: PRO IR 9/2, Form 64 (1873). 63 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, (Pts 1 & 2), q. 15,923, Cmd. 288-5, per A.M Bremner, barrister, on behalf of the General Council of the Bar of England.

62 Chantal Stebbings clearly told otherwise, they would go before another tribunal. The witness thus stressed the importance of the initial notice and agreed that the choice of tribunal was dictated entirely by the taxpayers’ ignorance.64 This limited degree of public awareness of the Special Commissioners continued at the end of the nineteenth century and beyond. Even well-informed commercial men were not always fully aware of the tribunal and its process.65 This general unfamiliarity with the existence and function of the Special Commissioners was compounded by the inaccessibility of the legislation. Even an educated and astute taxpayer found difficulty in ascertaining the nature of the Special Commissioners’ duties from the primary legislation. The problem was not so much one of the physical inaccessibility of the legislation, since a series of the statutes could generally be found in the relatively common private libraries and reading rooms in most towns and cities. Once a series had been located, however, the substantive law of income tax was to be found not in one Act, but in several. The principal Act was that of 1842, which was later amended by the Act of 1853 and others, and of course incorporated by reference the various Acts regulating the administration of the taxes, notably those of 1803, 1808 and 1810. The almost insurmountable barrier as far as ordinary taxpayers were concerned was an intellectual one. The statutory provisions were lengthy, each section following the traditional convention of being expressed in one continous sentence, were rarely in a logical order, were sometimes contradictory and were couched in often archaic language. The expression of complex and technical law in an obsolescent form, and the need to integrate the provisions of the different Acts rendered the law utterly obscure to the taxpaying public.66 A wine and spirit merchant, who had also been President of the Liverpool Chamber of Commerce, said in 1863 that he knew few men who understood the tax laws, and that he even had to employ more than one solicitor to ensure their full understanding of an issue.67 Even the new consolidation Act of 1918 was described as ‘a mass of confused patchwork’, and the complexity of the legislation in turn rendered the simplification of the forms and notices more difficult.68 The forms and notices had to reflect the legislation accurately, for 64

Ibid., (Pts 1 & 2), q.19,854–19,855, Cmd. 288-5, per C. Hewetson Nelson, accountant. See the confusion of Arthur Chamberlain, representing the Birmingham Chamber of Commerce before the Departmental Committee on Income Tax in 1905, at Minutes of Evidence before the Departmental Committee on Income Tax, House of Commons Parliamentary Papers, above n. 34, (245), qq.1950–1953, Cd. 2576. 66 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, (Pts 1 & 2), q.16,028, Cmd. 288-5, per A.M Bremner, barrister, on behalf of the General Council of the Bar of England. 67 Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers (1863), vol. vi (303), qq.427–440, Command 424, per Christopher Bushell, wine and spirit merchant and formerly President of the Liverpool Chamber of Commerce. 68 See Report of the Departmental Committee on the Simplification of Income Tax and Super-tax Forms, House of Commons Parliamentary Papers (1924), vol. xi (41), para. 6, Cmd. 65

Special Commissioners of Income Tax in the 19th Century 63 if they did not, then it amounted to the interpretation of the legislation by the Inland Revenue.69 A leading member of the Tax Bar maintained in 1919 that tax legislation should be ‘clear and simple, or at least expressed in clear and simple language’. ‘I do not say’, he continued, ‘that you can have a simple tax, but you can have a tax expressed in simple language. Make it as simple as you can’. 70 ‘I want to have the whole thing plain’, he said, ‘so that any man of ordinary intelligence can look at the Act himself or can look at a pamphlet concerning it and understand it. That would be a splendid thing’.71 This view had popular support. ‘An Englishman’, it was observed in 1905, ‘is generally satisfied if he is quite clear what is the law, whether he likes the law or not, but now no Englishman is satisfied that he gets quite the right law in income tax matters’.72 Taxpayers would have to wait nearly 100 years for a central initiative such as the Tax Rewrite Project, which aims to recast the direct tax legislation in clearer and simpler language and to restructure it in a more logical form so as to render it easier to use. In the nineteenth century tax law remained isolated by its complexity, and consequently inaccessible to all except those who were involved with it on a daily and professional basis. Another issue which rendered the Special Commissioners culturally inaccessible was secrecy of their hearings and the absence of any reporting of their decisions. Both were the result of the oath of secrecy the Commissioners had to take to the effect that they would not disclose any information received in the course of the performance of their duties under Schedule D.73 Whereas the issue of secrecy had been central to the extension of the Special Commissioners’ jurisdiction to Schedule D appeals in 1842, public opinion became less concerned about it as the nineteenth century progressed,74 but nevertheless the oath and its consequences were retained. Though decisions of principle were recorded, albeit in brief note form, in the Precedent Books of the Special Commissioners for their own internal guidance,75 there was no public accessibility to such decisions. Had 2019, where the Committee said it was unable to recommend any far-reaching or fundamental re-casting of forms. 69 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, (Pts 1 & 2), q.15,952, Cmd. 288-5, per A.M Bremner, barrister, on behalf of the General Council of the Bar of England. 70 Ibid., at q.15,947. 71 Ibid., at q.16,032. 72 Minutes of Evidence before the Departmental Committee on Income Tax, House of Commons Parliamentary Papers, above n. 34, q.1967, Command 2576, per Arthur Chamberlain JP, representing the Birmingham Chamber of Commerce. 73 Income Tax Act 1842 (5 & 6 Vict. c.35) Sched. F. 74 See Minutes of Evidence before the Departmental Committee on Income Tax, House of Commons Parliamentary Papers, above n. 34, qq.1941–1948, Cd. 2576, per Arthur Chamberlain JP, representing the Birmingham Chamber of Commerce, where he observed that ‘There is nothing nowadays to hide. Why should not a man do it? All officials have their income known. Why should it be possible for every official to bear to see his income published in a red book, and business men alone feel that they cannot bear publicity’. 75 See, eg, TNA: PRO IR 86/3.

64 Chantal Stebbings there been so, even at the Commissioners’ discretion so as to ensure individual privacy, taxpayers would have become more accustomed to the nature and process of the tribunal. While this was first proposed only in 1920,76 it was not introduced until 199477 despite a longstanding popular demand for the decisions to be reported. ‘Now, half the beauty of the law’, said one Schedule D taxpayer in 1905, is that when one is arguing before judges one can quote previous cases, and we know where we are. We say, ‘This has been decided there, and that has been decided there’ and so you can go from one to the other. But with the Commissioners we do not know what they have decided in the cases of the last thirty men they have had before them. We do not know how much they have allowed off Brown and refused off Smith, because Brown had a more pleasing manner or a more ready wit. That is where the income tax appealer is at a disadvantage , that he has no knowledge of their proceedings.78

As it was, appellants attended appeal hearings with little informed idea about the likely outcome of their appeal. As The Times described to its readers in 1854, As each applicant left the room he was met by his fellow-objector at the door with inquiries as to how far he had succeeded, hoping thereby to anticipate the result in their own cases, but the shrugs and nods given in reply announced that they might all as well have remained at home.79

The secrecy of proceedings meant that insights into the appellate work of the Special Commissioners were rare and fortuitous. For example, in 1856 The Times reported an appeal hearing of Income Tax Commissioners in Ireland, necessarily Special Commissioners, where the appellant, a Roman Catholic priest, took the opportunity of stating his objection specifically to the taxation of his income when it consisted of the voluntary offerings of his flock, and generally to the treatment of the Roman Catholic clergy by the British government.80 It availed him little, and the Special Commissioners having proved ‘inexorable and hard of heart’,81 he 76 Report of the Royal Commission on the Income Tax, House of Commons Parliamentary Papers (1920) vol. xviii (97), para. 362 (c), Cmd. 615; Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, (Pts 1 & 2), q.7707, Cmd. 288-3, per H. Lakin-Smith, Association of British Chambers of Commerce; ibid., q.25,406, Cmd. 288-6, per Peter Rintoul, on behalf of the Chartered Accountants of Scotland. 77 Taxes Management Act 1970 s.56D. And see too S Oliver, ‘Tax Tribunal Reports’ [1980] BTR 229. 78 Minutes of Evidence before the Departmental Committee on Income Tax, House of Commons Parliamentary Papers, above n. 34, q.1940, Cd. 2576, per Arthur Chamberlain JP, representing the Birmingham Chamber of Commerce. See too ibid., q.1953. 79 The Times, 11 Mar. 1854, 8 col. a. 80 The Times, 10 Oct. 1856, 7, col. e. 81 The Times, 13 Oct. 1856, 7, col. d.

Special Commissioners of Income Tax in the 19th Century 65 determined to appeal to the regular courts of law. These proceedings became public only because doubtless the appellant, the only participant in the proceedings not bound by an oath of secrecy, disclosed the proceedings in order to further his political aims. This lack of publicity, and the consequent reliance on hearsay and gossip, left appellants with a sense of injustice; they suspected, though could not know, that they had not been treated fairly and equally with their fellow taxpayers. Such perceptions undermined the accessibility of the tribunal. Having at least some idea of how the tribunal might decide in their own particular case, they would have felt more able to approach it. While ignorance of the existence and functions of the Special Commissioners was an obvious barrier which the evidence shows was relatively common, having become aware of the tribunal and the service it could offer, it could be accessible only if it were not prohibitively expensive. Of course, by definition, the tax tribunals were not for the abject poor. If an individual were paying income tax at all, it meant that his income came above the exemption allowed by the taxing Acts. Accordingly the income tax tribunals were used by the middle and lower middle classes, principally the commercial and professional classes. That was equally so in the regular courts, dominated as they still were by actions concerning land, and suitors in the ordinary legal process had for years complained of the prohibitive cost of litigation. A number of factors contributed to the expense of proceedings before any adjudicatory tribunal, and one of the most evident, if not the most substantial, was that of location. The inconvenience and expense to a litigant of court proceedings in London had been a major complaint against the regular courts for years. The cost to the parties of taking themselves and their witnesses to London, and remaining there for the possibly long duration of the trial, rendered much litigation prohibitively expensive. The distance a litigant had to travel to recover a small debt—in some instances some 50 miles to recover a debt of less than 40 shillings— was one of the problems which gave rise to the creation of the County Courts in 1846, and when new tribunals were established in relation to the restructuring of land rights in the 1830s and 1840s, the importance of an easily accessible location in the locality and its effect of keeping the cost of summoning witnesses to a minimm was clearly recognised. The primary concern was to establish a convenient location for the geographical area the tribunal was serving.82 It was maintained in the context of tithe commutation, for example, that the tribunal ‘should go from place to place where the matters in question were to be settled’.83 Under one general inclosure provision the meetings for conducting business were to be held in one of the parishes or townships where lands were to be inclosed, or within seven 82 83

Inclosure Act 1845 (8 & 9 Vict. c.118) s.55, ‘some convenient place’. HC Deb, series 3, vol.33, col. 886, 12 May 1836, per William Blamire.

66 Chantal Stebbings miles of the boundary of one of them.84 In taxation matters the accepted model for 200 years had been local assessment and appeal, with central control, and so the essential and obvious geographical structure of the administration was to have local tribunals and not a centralised one in London. Accordingly the Triple Assessment Act of 1797 specified the appeals location as ‘the usual place of holding parochial meetings’,85 and the Valuation (Metropolis) Act 1869 specified any local public room.86 The General Commissioners of Income Tax sat in hundreds of small divisions throughout the country. The Special Commissioners, however, were based in London, and prima facie relatively inaccessible. An ancient tenet of the administration of the Common Law in England, however, was that of the circuit, of itinerant judges bringing justice to the doorstep of the people twice each year. The concept was originally introduced in order to ensure a knowledgeable uniformity and consistency in the application of law, free from the influence of local faction. Even though the original purpose of the circuit system was essentially political, it did accustom the people to the availability of central justice in their own locality, and so any centralised tribunal was not necessarily and automatically perceived as inaccessible. While the Special Commissioners were based in London,87 their duties extended over the whole country. Since they originally numbered only three,88 and as such were comparable to a superior court of law, while the General Commissioners numbered in their thousands, it was clear that they could hear cases outside London only if they went on circuit. The original legislation of 1842 giving the Special Commissioners adjudicatory duties provided that they would hear any appeal ‘in the District in which such Appellant shall be chargeable’,89 and so, ‘for the convenience of taxpayers’, they went on circuit all over the country solely to hear appeals.90 They went out on circuit usually once, sometimes twice, a year, depending on the circumstances,91 totalling some three to four weeks annually.92 Thus a taxpayer having chosen to be assessed under Schedule D by the Special Commissioners and then wishing to appeal against that assessment, or 84

Common Fields Inclosure Act 1836 (6 & 7 Will. IV c.115) s.7. Triple Assessment Act 1797 (38 Geo. III c.16) s.63. 86 Valuation of Property (Metropolis) Act 1869 (32 & 33 Vict. c.67) s.63 provided that appeals were to be heard in ‘any room maintained out of the proceeds of any rate levied wholly or partly in the metropolis . . .’. 87 Variously at Broad Street, Lancaster Place, the Old Jewry, Somerset House, and Kingsway. 88 Excluding the members of the Board of Inland Revenue who were appointed ex officio. 89 Income Tax Act 1842 (5 & 6 Vict. c.35) s. 130. 90 Report of the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 76, para. 358, Cmd. 615. 91 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.1106, Command 354, per James Dickens, Special Commissioner. 92 Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers, above n. 67, q. 2511, Command 424. 85

Special Commissioners of Income Tax in the 19th Century 67 wishing to appeal against a Schedule D assessment of the Additional Commissioners, could wait to have his appeal heard when the Special Commissioners came to his town.93 As a rule taxpayers had to have their appeals heard in their own location. When a taxpayer who could appear before the Special Commissioners in his own district of Newcastle only at ‘great inconvenience’ to himself asked to appear before them in London, he was firmly told by the Board of Inland Revenue that his assessment by the Special Commissioners would be discharged and a fresh assessment made by the local Commissioners, thus enabling him to appeal to the latter at Newcastle.94 It seems however, that there was a measure of flexibility and that the Board made every effort to enable taxpayers to appeal to the Special Commissioners. There are many examples of the Board informing taxpayers that they could appeal to the Special Commissioners against an assessment made by the General Commissioners even though the appeals had already been heard in their district, and could do so by attending at the office in London.95 Unlike the judicial circuits, the Special Commissioners’ itinerary was not fixed. Their provincial sittings depended on which districts gave rise to appeals. Nevertheless, the Special Commissioners did only go to the main towns and cities, and not to smaller communities. It would have been prohibitive in terms of time and expense for them to do so, and in this sense the General Commissioners were more accessible than the Special Commissioners.96 The 130 appeals to be heard in 1849 entailed only two or three days of appeal hearings in London and visits to 27 towns and cities in England, from Truro to Newcastle.97 Because appeals to the Special Commissioners were few in each place, they began hearing them at 10am and completed the hearings in the morning, and moved on to the next place the following day and followed the same pattern, sitting every day except Sunday.98 In 1863 they attended to hear appeals in 88 places. In England they sat in 39 centres from Plymouth to Liverpool. In most places they heard just one appeal, but in major centres they heard more, though still not a large number. In Plymouth for example they heard five, and in Manchester 93 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.1062, Command 354, per Edward Cane, Special Commissioner. 94 TNA: PRO 1R 86/1, Board Minute, 13 May 1843. 95 See. eg, TNA: PRO 1R 86/1, Board Minutes, 4 Dec. 1845 and 30 Dec. 1845. 96 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, (Pts 1 & 2), q.15,924, Cmd. 288-5, per A.M Bremner, barrister, on behalf of the General Council of the Bar of England. 97 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, qq.1068–1071, Command 354, per James Dickens, Special Commissioner. The places visited were Bury, Norwich, Lynn, Leicester, Derby, Doncaster, Leeds, Normanton, York, Whitby, Newcastle, Manchester, Liverpool, Wolverhampton, Birmingham, Kidderminster, Worcester, Gloucester, Stroud, Clifton, Newport, Swansea, Taunton, Plymouth, Truro, Bath and Slough. 98 Ibid., q.1077, per James Dickens, Special Commissioner.

68 Chantal Stebbings nine. The greatest number were heard in Somerset House, where they heard 41. In Ireland they heard many more and were on circuit for about three months each year,99 hearing on average 50 appeals in each of the 50 or so centres at which they sat. In the larger centres such as Dublin and Cork they heard over 300 appeals in each.100 There was necessarily more predictability of times and locations in Ireland, if only because the Special Commissioners heard so many more appeals in that country. At the end of the nineteenth century they began their appeals in Ireland on the first Thursday in September and had a clear and predictable pattern of hearing appeals thereafter until midDecember. 101 Not only did appellants always know when they would be heard, they had ample time to prepare for the hearing since assessment notices were always issued in good time.102 The accessibility of the Special Commissioners in Ireland was in contrast to that of the surveyors, since most surveyors lived in Dublin and had large districts and many taxpayers had to make long rail journeys to discuss their assessments with their surveyors.103 One new and important aspect of accessibility was that appeals could be, and in many cases were, settled by correspondence, and this was rendered considerably easier for all parties with the introduction of the uniform penny post by Rowland Hill in 1840. Thereafter instead of letters being paid for by the recipient on the basis of distance and the number of sheets used, with a single letter sent a short distance costing 4d, all letters were to be charged by weight at the flat rate of one penny per half ounce, whatever the distance. The facility of fast, reliable and cheap postage enabled some appeals to be settled without recourse to personal attendance at a hearing, and accordingly cut down considerably on the potential expense to individual taxpayers, notably in not having to take time away from their business or profession. From the first days of the Special Commissioners’ appellate jurisdiction, they endeavoured to settle as many appeals by correspondence as possible, particularly for districts where very few appeals were listed.104 While the problem of geographical accessibility was understood, that of physical accessibility of the courtroom and its proceedings was not, even after the reforms of the late nineteenth century. While the new Law Courts in the Strand were such as to reflect the majesty of the law, they were inconvenient for litigants, principally because the acoustics were so poor. A well known example is the leading case of Speight v Gaunt in 1883, which in full 99 Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers, above n. 67, q.2511, Command 424. 100 House of Commons Parliamentary Papers, above n. 8, at 607. 101 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,730, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 102 Ibid., qq.13,731–13,732, per G.F. Howe, Presiding Special Commissioner. 103 Ibid., q.13,740, per G.F. Howe, Presiding Special Commissioner. 104 TNA: PRO IR 86/2, Board Minute, 8 Oct. 1850.

Special Commissioners of Income Tax in the 19th Century 69 and well considered judgments gave an invaluable exposition of the rules of delegation and consequent liability of trustees and which few in the crowded courtroom could actually hear on the day.105 The appropriateness of locations, the desirability of striking a balance between the formality necessary to engender respect for the proceedings and sufficient informality so as not utterly to utterly intimidate the litigants, was to be questioned only by a later age. It is not easy to tell from the few reported cases in the nineteenth century exactly where the Special Commissioners sat when hearing appeals on circuit. Occasionally, however, the precise location is mentioned. When hearing appeals in Chester in 1884 for example, the Special Commissioners sat in the Queen’s Hotel,106 and when hearing an appeal in Leeds in 1896 they sat at the office of the surveyor of taxes.107 While few saw anything untoward in hearing income tax appeals at an inn or hostelry, as General Commissioners often did, nor in the discomfort of appellants having to wait in the cold and possibly the rain for hours to be heard by local Commissioners, by 1920 there was some official cause for concern at the use of the premises of the Inland Revenue. The Royal Commission felt it had to recommend that appeal hearings of the Special Commissioners on circuit should not be held in the offices of Inspectors of Taxes, showing an awareness, if little else, of the dangers of any additional evidence of partiality.108 The most significant element in expense, however, was undoubtedly that of the charges of solicitors and counsel, if briefed. Litigation before the regular courts showed that expense was almost entirely dependent on the need for professional legal advice and representation, and that in turn depended largely on the complexity and formality of the procedures adopted. Certainly in the regular courts of law, the procedures were notoriously complex and had been the subject of complaints by litigants and reforming lawyers since the early years of the nineteenth century. When tribunals of a new kind began to be introduced in the early nineteenth century, governed by their parent statutes and with dual administrative and judicial powers, the opportunity and the need were there for legislators to design new, informal and swift procedures which addressed novel political and social needs. In the context of the fiscal tribunals, and the Special Commissioners in particular, the needs were highly specialised. Procedures had to be precise, clear and expeditious, in order to ensure that flow of public revenue on which the government depended, and yet had to be so within a highly technical and detailed sphere of activity. An accessible system was a simple system, but the desire for simplicity had to be balanced against the need for justice.109 105

Speight v. Gaunt (1883) 22 Ch D 727; 9 App Cas 1. Broughton and Plas Power Coal Co.Ltd., v. Kirkpatrick (1884) 2 TC 69. Leeds Permanent Benefit Building Society v. Mallandaine (1897) 3 TC 577. 108 Report of the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 76, para. 365 (d), Cmd. 615. 109 Ibid., para. 649. 106 107

70 Chantal Stebbings When the income tax was reintroduced in 1842 the Special Commissioners had no special instructions to follow as to their procedures other than the provisions of their parent Act of Parliament and the most general and apparently informal guidance.110 In one sense that made them relatively accessible, though that accessibility was limited, as examined above, by the inaccessibility of the legislation itself. The absence of detailed instructions, coupled with the newness of the tribunal in its appellate function, the lack of any previous general cultural knowledge of it in its assessing function and its secret hearings, meant that its procedures, though simple, were largely unknown. The procedure to be followed in order to be assessed by the Special Commissioners consisted merely of signing and dating a box on Form 11, the Schedule D tax return, and forwarding it to the local assessor within 21 days,111 sealed in an envelope addressed to the surveyor and marked ‘For Special Assessment’.112 Bypassing the local Commissioners,113 the matter was thereafter entirely in the hands of the surveyor and the Special Commissioners, the latter arriving at an assessment largely on the basis of the former’s report. 114 As Edward Hyde, surveyor, observed in 1851, ‘[i]t is all under the control of the Government’.115 The taxpayer had no direct communication with the Special Commissioners.116 110 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, qq.1269, 1276–1278, Command 354, per James Dickens, Special Commissioner. 111 It seems that the official time limit of 21 days from the issue of the precept to the assessor by the General Commissioners for the giving of such notice was unknown to most taxpayers. It was meant to be affixed in a public place such as the church door, but few examined it: see Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,429, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 112 See, eg, TNA: PRO IR 9/1, Form 11 (1840s). Though the instructions said the return should be sent to the assessor for him to forward it to the surveyor, in practice many taxpayers sent it directly to the surveyor: Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,430, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. By the Form 11 of the first year in which such assessment was possible, if a taxpayer wanted to be assessed by the Special Commissioners he was to give notice on a form obtainable from the assessor in a process which ensured no confidentiality at all: TNA: PRO IR 9/1, Form 11 (1842). 113 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, qq.153–154, Command 354, per Charles Pressly, Commisioner of Inland Revenue. 114 Ibid., qq.1039–1047, 1050–1051, 1158–1174, per James Dickens and Edward Cane, Special Commissioners, and qq.1589–1594 per Edward Hyde, surveyor. But see Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, qq.13,686–13,687, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 115 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.1608, Command 354, per Edward Hyde, surveyor. 116 The claims for exemptions were usually made to the Special Commissioners through the hands of the surveyor too, though some were made by the parties directly to the Special Commissioners, as for example claims for charitable institutions and for repayments on commuted tithes: ibid., qq.548–549, per John Fuller, Special Commissioner.

Special Commissioners of Income Tax in the 19th Century 71 The institution of an appeal before the Special Commissioners was equally simple and straightforward. An aggrieved taxpayer merely had to give notice to the surveyor as instructed in the notice of first assessment. The Commissioners then had the power to demand any further particulars they could request under the authority of the Act, but since the Act did not specify which documents they could call for, not only were the Special Commissioners themselves in some doubt as to the extent of their powers in this respect,117 some appellants were reluctant to co-operate on the basis of an absence of express authority in relation to specific documents. Clearly a wide and potentially intrusive discretion had been left in the hands of the Commissioners, as a result of which appellants did not know precisely what an appeal would entail. In this sense, the procedure was inaccessible.118 The appellant had to go to the trouble and expense of providing his business accounts for the past three years, but that was not peculiar to the Special Commissioners; he was required to provide this information if he appealed to the General Commissioners. The public perception of this was that it was both onerous and intrusive. The appellant having been informed of the time and place, the Special Commissioners would hear his appeal in person, though where all the information which the Special Commissioners called for was forthcoming, and all the parties agreed, in practice the appeals were often settled without the appellant having to attend a hearing personally.119 Though to some observers the system of notices and elections appeared unduly complicated, it was considerably simpler than the formal writs and pleadings of the regular court process, and as such had stood the test of time.120 And furthermore, there were no court fees to pay. The procedure during the appeal hearing was also significantly less formal than that in the regular courts, and accordingly more accessible to the taxpaying public. It was by way of rehearing, originally by two Special Commissioners and a member of the Board of Inland Revenue.121 Thereafter the appeals were heard by two Special Commissioners, who were assigned to the task by the Board and were granted imprests for the purpose,122 and who came to specialise in the hearing of appeals, with the 117 Ibid., qq.1195–1200, Command 354, per James Dickens and Edward Cane, Special Commissioners. 118 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, qq.13,471–13,475, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 119 Minutes of Evidence before the Select Committee on Income Tax, House of Commons Parliamentary Papers (1906), vol. ix (659), q. 2709, Cd. 365, per Walter Gyles, Special Commissioner. 120 Minutes of Evidence before the Departmental Committee on Income Tax, House of Commons Parliamentary Papers, above n. 34, q.57, Cd. 2576, per W. Gayler, a member of the Committee. 121 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.1121, Command 354, per James Dickens, Special Commissioner. 122 TNA: PRO IR 86/2, Board Minute, 14 Oct. 1848.

72 Chantal Stebbings rarely used possibility of calling in the third to act as umpire in case of disagreement.123 James Dickens, a Special Commissioner, observed that on appeals more was settled by means of personal communication with the appellant than by written information. It is clear that oral evidence was integral to the determination of the appeal.124 The Special Commissioners were empowered to summon any person to appear before them, but only in the context of appeals.125 Otherwise they had to proceed by affidavit. The hearings were private, with just the Commissioners, the appellant and the surveyor from the appellant’s district. Indeed, this was part of the raison d’être of the Special Commissioners, to enable the commercial community to be taxed secretly, away from the prying eyes of their rivals. There was some tension between the need for publicity to prevent fraud and the desire for secrecy to protect private commercial interests, but that was the political price which Peel had to pay, as Pitt had had to, for the imposition of the tax.126 The hearings were in many ways largely in the nature of an arbitration, with all the parties gathered together privately and seated not in a courtroom but at tables in an ordinary chamber. Indeed, hearings before the Special Commissioners had all the advantages of arbitration without its disadvantages—the proceedings were relatively informal and private; the judges had the necessary specialised knowledge; the process was inexpensive from point of view of litigant and relatively swift. Indeed while there were many complaints as to the conduct of appeals before the General Commissioners, where appellants might have to wait for hours for their case to be heard, and often had to go home again without it being heard at all, the Special Commissioners, partly because of the small number of appeals but also because of their efficiency and expertise, heard all their appeals on the day appointed.127 The simplicity and informality of the procedure was such that an appellant could argue his case himself and so professional legal representation was unnecessary. Legal representation was deemed undesirable in that it could only add complexity, delay, formality and, of course, expense, unnecessarily 123 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, qq.1064–1066, Command 354, per Edward Cane, Special Commissioner and qq. 545, 620, 624, per John Fuller, Special Commissioner. Although the Board of Inland Revenue were ex officio Special Commissioners, they only very exceptionally acted as such: see ibid., q.163, per Charles Pressly, Commissioner of Inland Revenue. 124 Ibid., qq.1225–1233, per James Dickens, Special Commissioner. 125 Income Tax Act 1842 (5 & 6 Vict. c.35) s.23. See too Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,489, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 126 See HC Deb, series 3, vol. 62, col.1000, 22 Apr. 1842, per Charles Buller; col.1024, per Mr Wakley, and col. 1025, per Sir Robert Peel. 127 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.1308, Command 354, per James Dickens, Special Commissioner.

Special Commissioners of Income Tax in the 19th Century 73 and was accordingly prohibited. This provision was found in the Taxes Management Act of 1803, which applied to all taxes under the management of the Commissioners for the Affairs of Taxes and thus included the income tax. That Act prohibited the representation of either party by any ‘barrister, solicitor, attorney, or any person practising the law’,128 in the course of an appeal before the ‘said Commissioners’. Those Commissioners were ‘the Commissioners for putting in Execution the said Act or Acts’, and necessarily excluded the Special Commissioners since the legislation predated them. The Act was incorporated by reference into the Income Tax Act of 1842, and constituted a formal prohibition on solicitors or barristers appearing before all Commissioners,129 but in the Taxes Management Act of 1880 the prohibition was expressly applicable to General Commissioners.130 In 1898, however, that provision was repealed and it became lawful for the General Commissioners to hear any barrister or solicitor in any appeal, either viva voce or in writing,131 on the basis that the prohibition had both caused resentment among appellants and the professions, and been ignored to a large extent. Certainly there had been complaints that appellants before the General Commissioners could not be represented by their solicitor or counsel. It seems that the practice had grown up of allowing solicitors and barristers to appear before the General Commissioners, at the request of the appellants and with the consent of the Commissioners, and that experience had shown that proceedings had been unchanged in terms of delay and cost. It was pointed out in Parliament that the prohibition caused hardship in some parts of the country, particularly in the case of female appellants.132 While it kept costs relatively low, the prohibition undoubtedly undermined a taxpayer’s accessibility to justice from the Special Commissioners, since he had nothing with which to combat the considerable collective experience of the Inland Revenue against whose decision he was appealing. When the substantive income tax legislation and the taxes management legislation were combined in a single statute in 1918, the provision permitting the General Commissioners to hear legal representation was unchanged.133 In 1903 the Revenue Act provided that if the General Commissioners refused to allow a barrister, solicitor or accountant to plead before them, as they were entitled to do since the wording of the provision was merely permissive, the appellant could transfer his appeal to the Special Commissioners, who were required to hear the appellant’s professional representative. It was ultimately 128

43 Geo.III c.99 s.26 (1803). The Land Tax Commissioners were expressly excluded: see 38 Geo.III c.16 s.65 (1798). 130 Taxes Management Act 1880, (43 & 44 Vict. c.19) s.57(9). 131 Finance Act 1898 (61 & 62 Vict. c.10) s.16. 132 See the introduction of the new clause by Lord Edmond Fitzmaurice in HC Deb, series 4, vol. 59, cols. 128–129, 13 June 1898. See too Minutes of Evidence before the Departmental Committee on Income Tax, House of Commons Parliamentary Papers, above n. 34, q.55, Cd. 2576, per W. Gayler, a member of the Committee. 133 Income Tax Act 1918 (8 & 9 Geo.V c.40) s.137(3)(a). 129

74 Chantal Stebbings made mandatory for General Commissioners to hear barristers, solicitors and accountants in 1923.134 In all the legislation on the point of legal representation before the income tax tribunals, only the General Commissioners were expressly referred to, leaving the position of the Special Commissioners in some theoretical doubt. Special Commissioners were thus not mentioned in the context of legal representation in the legislation and it could accordingly be argued that legal representation was always permitted before them. The practice, however, suggests that it was not, since the reports of cases in the regular courts which began as appeals before Special Commissioners, though few, invariably show lay representation before the tribunal. So, for example, when in 1875 a company appealed against an assessment to the Special Commissioners at Somerset House, the Commissioners told the company’s solicitor that though he could remain in the room he could take no part in the proceedings.135 As a result the appellants, who were often companies or partnerships, were generally represented before the Commissioners by one of their partners,136 directors137 or officers.138 Once permitted, however, eminent tax counsel were employed to come before the tribunal in important cases, notably A. M. Bremner, described by D.M. Kerly K.C. to the Royal Commisson of 1920 as having more experience in income tax cases than anybody else.139 Where the sums at stake were large, and where the Inland Revenue would fight the case to the highest court, appellants with the resources and determination would match the government as far as possible and appoint the most experienced and able counsel.140 In smaller cases, and sometimes in those before the General Commissioners, accountants were often employed to represent appellants. A significant deterrent to any litigant, from the point of view both of expense and of delay, was the provision for numerous appeals. Litigation was always expensive, even without the employment of lawyers, since it occupied the time and attention of the parties, and where the appeal provisions allowed 134 Finance Act 1923 (13 & 14 Geo. V c.14) s.25. See too HC Deb, series 5, vol. 166, cols. 269–270, 3 July 1923. 135 Imperial Fire Insurance Company v. Wilson (1875) 1 TC 71. 136 In Watney & Co. v. Musgrave (1880) 1 TC 272, when the Special Commissioners heard an appeal by a brewing partnership against an assessment, the younger partner, James Watney junior, represented the partnership. See too Goslings and Sharpe v. Blake (1889) 2 TC 450. 137 In Andrew Knowles & Sons Ltd v. McAdam (1877) 1 TC 161 the company was represented by David Chadwick MP, who was also one of its directors. See too Reid’s Brewery Co.Ltd.,v. Male (1891) 3 TC 279. 138 In San Paulo (Brazilian) Railway Co.Ltd., v. Carter (1895) 3 TC 344 the appellant company was represented by its Secretary. 139 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,612, Cmd. 288-4, per D.M.Kerly, KC, member of the Commission. 140 Ibid., q.15,927, Cmd. 288-5, per A.M Bremner, barrister, on behalf of the General Council of the Bar of England.

Special Commissioners of Income Tax in the 19th Century 75 recourse to the regular courts of law, the full expense of appointing attorneys and counsel and of court fees made the costs rise alarmingly. Furthermore, the danger of having costs awarded against him were he to lose his appeal to the courts constituted a real deterrent to the taxpayer. When the Special Commissioners were given their adjudicatory duties in 1842 there was no appeal from their decisions to the regular courts of law. In this the income tax tribunals were distinct from other statutory tribunals, since most of the new tribunals were given the right of appeal on a point of law to a court of law. The Special and General Commissioners were denied this right for reasons of public policy. Throughout the nineteenth century the income tax was unpopular, and though a right of appeal might have been desirable to mitigate any resentment to the tribunals, the political judgement was that the degree of unpopularity was such that appeals could well be so numerous as to severely cripple the assessment and collection of tax. Accordingly initially the only permitted recourse was an internal one to the Board of Inland Revenue in London, by an early form of case stated.141 If a taxpayer appealed to the Board of Inland Revenue from the decision of the Special Commissioners, he was heard by some five or six men,142 and had some opportunity of putting further evidence to the Board though still, it seems, without legal representation. He would be written to by the secretary to the Board to give such information as would be necessary to elucidate the case.143 The decision of the Board was final.144 It seemed that this provision soon ceased to be used. Only in Ireland was an appeal allowed from the Special Commissioners’ assessment to the assistant barrister for the county.145 There was therefore no danger of the cost of appealing to the Special Commissioners escalating through the possibility of further appeals. If appeal to the courts of law had been permitted, it would have operated as a considerable deterrent to ordinary taxpayers because of the inequality in the respective standing of the parties. This was equally seen in relation to the right of appeal given from the decisions of the Railway Commissioners, where traders were inhibited from approaching the tribunal, knowing that the immensely wealthy and powerful railway companies would not hesitate to fight an adverse decision through every court open to them. Appellants would have been similarly wary of the Board of Inland Revenue and its unlimited resources to fight a point of principle had wide appellate powers been given to the Special Commissioners. The restriction on the right of appeal to the regular courts 141 Income Tax Act 1842 (5 & 6Vict. c.35) s.131; Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, qq.1061, 1124, Command 354, per James Dickens, Special Commissioner. 142 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.1125, Command 354, per Edward Cane, Special Commissioner. 143 Ibid., q.1136. 144 Ibid., q.1067. 145 16 & 17 Vict. c.34 s.22 (1853).

76 Chantal Stebbings from the Special Commissioners endured until it could no longer be sustained in the light of a general and uniform power of appeal given to the regular courts by the Judicature Act of 1873. Accordingly in 1874 the surveyor and the appellant were permitted to appeal to the High Court by way of case stated on a point of law.146 The process was criticised as being excessively technical for an appellant, particularly in relation to strict and short time limits,147 and, of course, professional legal representation then became necessary. The denial of appeal on a point of fact was always strenuously resisted. It was in opposition to the central tenet of English law that questions of fact were best decided by a jury, of whose nature even the Special Commissioners partook. Furthermore, the added delay and expense which the parties would have to endure if such appeal were allowed, since it could only satisfactorily be addressed by the judge retrying the case with the witnesses or going through the shorthand notes himself, were not regarded as acceptable.148 One of the principal reasons why the General Commissioners were perceived by some taxpayers as untrustworthy as a dispute resolution body was the domination of that tribunal by the surveyor, and, therefore, by the government. The domination undoubtedly existed, principally because the lay, part-time and unremunerated nature of the General Commissioners led to their being insufficiently informed and knowledgeable about income tax in general and individual taxpayers’ financial affairs in particular, and so tended to accept the assessments of the surveyor unquestioningly. Since the surveyor was the representative of the crown, a common feeling was that he was primarily motivated to secure as high a revenue as possible. Another cause of distrust was a perception that the lay General Commissioners, being often rivals in trade to commercial taxpayers, might use the financial information about the taxpayers to their own advantage. Though this perception was unsubstantiated, when allied to a natural disinclination to divulge private financial details to friends and colleagues, it limited a free and open access to the tribunal. The establishment of the Special Commissioners as an appellate tribunal for Schedule D fully addressed the second complaint, since they were entirely independent of the General Commissioners and were untainted by local vested interests. They did not, for example, give instructions to the General Commissioners, and never had any contact with them,149 146 Customs and Inland Revenue Act 1874 (37 & 38 Vict. c.16) s.9. See generally C. Stebbings, ‘The Appeal by way of Case Stated from the Determinations of General Commissioners of Income Tax: An Historical Perspective’ [1996] BTR 611. 147 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.23,895, Cmd. 288-6, per Randle F. W. Holme, solicitor, on behalf of the Law Society. 148 See ibid., qq.15,928–15,931, Cmd. 288-5, per A.M Bremner, barrister, on behalf of the General Council of the Bar of England. 149 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.1303, Command 354, per Edward Cane, Special Commissioner.

Special Commissioners of Income Tax in the 19th Century 77 even when they were hearing appeals against local assessments on circuit.150 Their sole communication with the locality was with the surveyor. Indeed, proceedings to hear appeals on circuit were postponed until all the surveyors’ reports had been made.151 It might be thought, however, that the establishment of the Special Commissioners would exacerbate the first source of concern. The Special Commissioners were, after all, paid civil servants, members and servants of the government department responsible for the direction and control of the machinery and systems necessary to raise the revenue, and who possessed clear assessing duties as well as judicial ones. They were based in London, appointed by the Treasury, remunerated out of an annual vote of Parliament,152 and were pensionable under the Civil Superannuation Acts. They were generally experienced Inland Revenue officials or men with legal training.153 Furthermore, while most people were not familiar with the nature and duties of the Special Commissioners, if they had heard of them they almost invariably believed, rightly, that they were members of the Inland Revenue.154 The Special Commissioners said they made every effort to stress their independence and concern for the truth, and in the opinion of one Special Commissioner this perception was beginning to become established by the close of the nineteenth century.155 If, however, the General Commissioners, as laymen with no connection with the Inland Revenue, had difficulty persuading the public that they were independent and impartial, how much more so for the Special Commissioners. And yet, despite the distrust of the General Commissioners and a common antipathy to the surveyor, the Special Commissioners were rarely, if ever, accused of any partiality whatever. The intimate relationship with the 150

Ibid., q.1305 per James Dickens, Special Commissioner. TNA: PRO IR 86/2, Board Minute, 8 Oct. 1850. In 1851 each of the three Special Commissioners was paid a fixed salary of £600 p.a. and two guineas a day when out hearing appeals: Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, q.160, Command 354, per Charles Pressly, Commissioner of Inland Revenue; Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers, above n. 48, q.121, Command 370, per Charles Pressly. In 1920 the Presiding Special Commissioner was paid £1,200 p.a. and the others were paid between £850 and £1,000 p.a: Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,609, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 153 Report of the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 108, para. 360, Cmd. 615; Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, qq.13,599–13,5603, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 154 Ibid., q.15,923, Cmd. 288-5 per A.M Bremner, barrister, on behalf of the General Council of the Bar of England. 155 See Minutes of Evidence before the Select Committee on Income Tax, House of Commons Parliamentary Papers, above n. 119, q.2709, Cd. 365, per Walter Gyles, Special Commissioner. 151 152

78 Chantal Stebbings Executive was made quite clear at the inception of the judicial function of the tribunal, for in 1842 Peel referred to them as ‘appointed by the Government’ and expressly distinguished them from the local Commissioners who were ‘appointed by parties independent of the Government’.156 In juxtaposing the tribunals in this way, he was unambiguous about their status as a government and a local tribunal respectively.157 The point was not taken by the opponents to the Bill. Indeed, the anomalous position of the Special Commissioners and the conflict of interests inherent in their position were only exceptionally questioned over the next 100 years. Randle Holme, a solicitor giving evidence to the Royal Commission on the Income Tax on behalf of the Law Society in 1919, was tenacious in revealing his concerns. Although the tribunal stood ‘as appellant tribunal without appeal from their decisions on questions of fact, between the Inland Revenue and the taxpayer, and called upon frequently to decide questions involving enormous sums of money, the same men also exercise other functions in the capacity of Inland Revenue officials’. He urged ‘that these conflicting duties should not be reposed in one set of men. Those who exercise judicial should not also be called upon to exercise administrative functions—a distinction which, so far as I know, is carefully preserved in all other judicial bodies in the country’.158 The same witness saw how inappropriate it was to appoint ex-surveyors and inspectors as Special Commissioners159 and appreciated the absurdity not only of the Special Commissioners hearing appeals against their own assessments but of an appeal to the Board of Inland Revenue from the determination of the Special Commissioners, where one party had been the Board itself.160 Mr Holme’s was, however, a lone voice. As a lawyer he saw and understood the conflict of interest, the possibility of bias, and the need for justice to be seen to be done, but his concerns and those of the Law Society were not, it seems, shared by the public. The prejudices of the taxpaying public against ‘government men’ were only rarely directed to the Special Commissioners,161 possibly because the fear of local commercial espionage outweighed the fear of government rapacity.162 Certainly public attitudes 156

HC Deb, series 3, vol. 62, col. 657, 18 Apr. 1842, per Sir Robert Peel. Ibid., col. 1384, 2 May 1842. 158 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, qq.23,891,24,017, Cmd. 288-6, per Randle F. W. Holme, solicitor, on behalf of the Law Society. In practice the Special Commissioners ensured as far as they could that the same two Commissioners who signed the assessment did not also hear the appeal, though, as for many years as they numbered only three in total, this was not entirely possible. 159 Ibid., q.23,891. 160 Ibid., q.23,898. 161 There is an allusion to some public apprehension that taxpayers did not receive fair treatment because the Special Commissioners were Revenue officials in the evidence of G.O. Parsons, the Secretary to the Income Tax Reform League: ibid., q.1853, Cmd. 288-1. 162 Minutes of Evidence before the Select Committee on Inland Revenue and Customs Establishments, House of Commons Parliamentary Papers, above n. 48, q.473, Command 370, per Charles Pressly, Chairman of the Inland Revenue Department. 157

Special Commissioners of Income Tax in the 19th Century 79 were gradually changing in this respect. By the close of the nineteenth century a declining reluctance to disclose private financial affairs to an official body could be discerned.163 A representative of the Association of British Chambers of Commerce told the Royal Commission on the Income Tax in 1920 that after many years of experience his opinion of the Special Commissioners was ‘that they are absolutely excellent and fair in every particular’,164 and the Secretary to the Income Tax Reform League said that he felt the taxpayer received ‘the best of treatment’.165 Members of the Bar, too, were entirely satisfied with the Special Commissioners, for in saying so in 1919, D.M. Kerly KC added that ‘appeals to them are regarded as likely to be thoroughly well considered and thoroughly well decided’.166 Official inquiries of the early twentieth century confirmed the public perception of the Special Commissioners as an impartial and expert tribunal. The Report of the Royal Commission in 1920 spoke about the public confidence in and approval of the tribunal,167 and the Committee on Ministers’ Powers in 1932 said that it was generally agreed that it was impartial, but recognised that this was despite its conflicting functions and unusual status. ‘All we can say about it’, continued the Report, ‘is that it is a standing tribute to the fair-mindedness of the British Civil Service: but the precedent is not one which Parliament should copy in other branches of the administration’.168 In commenting on this, Hubert Monroe detected ‘a note of complacency’.169 This perception was, unsurprisingly perhaps, shared by the Special Commissioners themselves.170 They appreciated their unique position as civil servants performing important judicial functions,171 but saw no inconsistency, at least in practice, in performing both administrative and judicial duties.172 A Special Commissioner in 1906 said his tribunal was ‘actually independent in every way of the Inland Revenue in the consideration of

163 Minutes of Evidence before the Select Committee on Income Tax, House of Commons Parliamentary Papers, above n. 119, q.3259, Cd. 365, per Sir Henry Primrose, Chairman of the Board of Inland Revenue. 164 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.8185, Cd. 288-3, per H. Lakin-Smith, on behalf of the Association of British Chambers of Commerce. 165 Ibid., q.1853, Cmd. 288-1, per G.O. Parsons, Secretary to the Income Tax Reform League. 166 Ibid., q. 13,770, Cmd. 288-4, per D.M.Kerly, KC, member of the Commission. 167 Report of the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 108, para. 359, Cmd. 615. 168 Report of the Committee on Ministers’ Powers, House of Commons Parliamentary Papers (1931–2), vol. xii (341), 86, Cmd. 4060. 169 See Monrue, above n.37. 170 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,612, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 171 Ibid., q.13,811. 172 Ibid., q.13,781.

80 Chantal Stebbings appeals, and we do our utmost to convey that fact to the public’.173 The Presiding Special Commissioner in 1919 maintained robustly that in their appellate function his Commissioners constituted ‘an entirely impartial body between the taxpayer and the Revenue’,174 and indeed was sensitive to any imputation to the contrary, as when he was questioned about ‘his’ Department, and promptly responded: ‘I am not a Revenue Department witness, please’.175 The Special Commissioners did not act under the formal directions of the Board of Inland Revenue in their judicial function and the Presiding Special Commissioner said that never had the Board of Inland Revenue made the slightest attempt to influence his decision,176 though, as Hubert Monroe observed, ‘absence of pressure and ambiguity of position, perhaps, involve different issues’.177 They were undoubtedly, however, dedicated civil servants, maintaining the highest traditions of the service in the nineteenth century, a picture vividly and convincingly drawn by Anthony Trollope, himself a civil servant in the Post Office, in The Three Clerks, published in 1858. The Special Commissioners in their appellate function constituted, with the General Commissioners, the most formal and the oldest legal expression of taxpayer protection in income tax. While they were undermined in their accessibility by their anomalous position as an arm of the Executive performing judicial functions and the complexity of the legislation they were created to implement, these were matters which were largely beyond their control. In their procedures, location and cost they were a very accessible tribunal which provided swift, cheap, expert and effective justice. Unlike the regular courts of law, they constituted a real service to the public and not, as has been said of the regular courts, ‘an adjunct of the honours system’.178 This counted for little, however, if their existence was unknown. The Special Commissioners failed in the prerequisite of accessibility, namely publicity. The reasons for this lie in the demands of the fiscal process and the culture of the civil service. In order to ensure co-operation with the fiscal process and guarantee that the commercial profits of the country were fully taxed, the Board of Inland Revenue had to be able to offer the taxpayer a right of appeal to a tribunal which was accessible and effective. The Board saw the existence of the right rather than the use of the process as its real

173 Minutes of Evidence before the Select Committee on Income Tax, House of Commons Parliamentary Papers, above n. 119, q.2709, Cd. 365, per Walter Gyles, Special Commissioner. 174 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,582, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 175 Ibid.,q.13,574. 176 Ibid., q.13,812. 177 See Monroe, above n. 37, 80. 178 B. Abel-Smith and R. Stevens, Lawyers and the Courts Heinemann, (London, 1967) 98.

Special Commissioners of Income Tax in the 19th Century 81 value, since, while it shared with the taxpayer the desire to have appeals determined promptly and effectively, it had the further interest in that it wanted to keep the number of appeals low. It was well known that in all spheres of litigation a simple and cheap appeals system would probably, if not certainly, lead to a substantial increase in litigation. That would have overwhelmed the Special Commissioners, already busy with exemptions and other administrative duties, and would have unacceptably hindered the fiscal process rather than expedited it. Similar considerations had resulted in a reluctance to allow appeals to the regular courts from the decisions of all the income tax commissioners. The Board realised that it had to keep some control over the right of appeal to the Special Commissioners, to decide as far as possible when it was used rather than to facilitate widespread public demand for it. So while the Board could not and would not wish to ignore the existence of the Special Commissioners, it had no real incentive to publicise it widely. The evidence suggests that the Board paid lip service to publicity. It could have arranged for the existence and function of the tribunal to have been better publicised on the notices of first assessment. It was aware that individual districts and towns were producing their own forms and introducing amendments, and indeed there are complaints in the minutes of the Board about the cost of this printing from the 1840s. If only to ensure economies of scale, the Board could have insisted, through legislation if necessary, that only official forms be used, and it could have ensured that those forms carried the necessary notification of the appeal option to the Special Commissioners. This was not done until 1873 when the Board’s hand was forced. A few cases, on the other hand, were beneficial in publicly confirming the existence of provision for taxpayer protection and building confidence in the taxation process. The minutes of the Board show a steady number of queries relating to such appeals and show the Board jealously protecting the right of appeal. When a taxpayer complained that he had been denied the right to appeal to the Special Commissioners from an assessment made upon him by the Additional Commissioners, ‘insisting upon his right so to do’, the Board ordered that the necessary arrangements should be made for his appeal to be heard by the Special Commissioners when they were next in the district. The surveyor was instructed, the Special Commissioners informed, and the taxpayer given notice.179 This, however, as with the Board’s repeatedly expressed concern as to the paucity of numbers of taxpayers using the Special Commissioners, was somewhat disingenuous. The Board was reactive and very rarely proactive in relation to the Special Commissioners. In the matter of appeals it was far more proactive in encouraging taxpayers to appeal to the General Commissioners, a finding supported by a survey of the Inland Revenue forms and notices. A simple 179

TNA: PRO 1R 86/1, Board Minute, 13 Apr. 1843.

82 Chantal Stebbings example is the proliferation of church door notices for the General Commissioners and their absence for the Special Commissioners. The whole system was based on central control and local administration, which was of course the original conception of tax administration. The attitude of the Board to the right of appeal to the Special Commissioners is an expression of the attitude of the wider Executive to its administrative tribunals, and indeed of the Victorian Legislature as a whole. The Executive was entirely pragmatic about the dispute resolution function of administrative tribunals. They were not created in order to provide an accessible and effective service to the public, but primarily to implement government policy in controversial areas. These bodies had to be accessible in order to achieve that, but it was not the prime objective. From this perspective the Special Commissioners existed as part of the fiscal process to implement the tax legislation relating, among other things, to Schedule D. Their judicial function was a mere adjunct to their administrative function. By the same token, the swift, efficient and expert adjudication of the Special Commissioners unfortunately had no wider impact on the administration of justice, because they, like all statutory tribunals in the nineteenth century, were regarded not as organs exercising the judicial power of the state but as part of the administration of the state. This was reflected in the indifference with which the judiciary and legal profession regarded the income tax tribunals. This was even in contrast to the attitudes of lawyers to other administrative tribunals, since on the whole they resented them when it appeared that they were rivalling their own traditional role in the courts. The fact that this was less marked in relation to the Special Commissioners constitutes an early example of the legal profession’s perception of tax law as an alien field, not really law at all, and so lying outside their particular expertise.180 Neither judges nor lawyers regarded the income tax tribunals as part of the regular legal system. Such attitudes, along with a narrower conception of justice than is prevalent today, resulted in adjudication before the Special Commissioners being regarded as something quite outside the legitimate sphere of judicial concern. The culture of the civil service in the nineteenth century strengthened this perception of the Special Commissioners.181 It enjoyed a particularly strong esprit de corps since it was still relatively small, and was united by strong central leadership, common interests and uniform and rigid methods of administration. It esteemed process highly, and was often accused of valuing it as an end in itself. ‘It is an inevitable defect’, it was said in 1866, that bureaucrats will care more for routine than for results . . . . Their whole education and all the habit of their lives make them do so. They are brought young into the particular public service to which they are attached; they are occupied for 180 Hubert Monroe observed the lack of interest shown by the Bar in the evidence given on their behalf to the Royal Commission on the Income Tax in 1920: Monroe, above n. 37, 78–79. 181 See generally M Daunton, Trusting Leviathan (CUP, Cambridge, 2001) 180–223.

Special Commissioners of Income Tax in the 19th Century 83 years in learning its forms—afterwards, for years too, in applying those forms to trifling matters . . . Men so trained must come to think the routine of business not a means, but an end—to imagine the elaborate machinery of which they form a part, and from which they derive their dignity, to be a grand and achieved result, not a working and creaking instrument.182

In so doing it sometimes distanced itself from the wider context of its activity and was not always sensitive to the practical needs and aspirations of the general public. Again, its total familiarity with the existence of the Special Commissioners lessened its sensitivity to the lack of awareness in the general taxpaying public and the need to publicise the tribunal strongly and widely. To this extent familiarity did indeed breed, if not contempt for the needs of the taxpayer, certainly a striking degree of detachment. The inertia of the Executive in publicising the Special Commissioners left the majority of taxpayers with little practical option but to accept the actions of the Inland Revenue, and as such undermined the value of the Commissioners as a tool of taxpayer protection. Well informed, robust and articulate taxpayers could perhaps penetrate the system, though the ignorant and meek had little chance of doing so. The great majority of taxpayers accepted the payment of income tax as a necessary evil and all wanted a system which they could understand so as to be able to assert their rights. That included legislation and regulations they could follow, and an accessible appeals process. They did not want to have to search for information; they wanted and needed a clear and prominent notice as to their rights of appeal in their notices of assessment, which of course they read primarily to find out how much they owed the Revenue. It was understood that complex law and complex administration were counter-productive and ultimately reduced the public revenue, because ‘the taxpayer dreads having to master what his rights and duties are’,183 but little was done to address this. Most taxpayers were daunted by the bureaucracy of the Inland Revenue, which was highly specialised, dealing with particularly complex law and regulations, and were suspicious of all government departments at a time when the central administration increasingly interfered in a variety of aspects of citizens’ private lives. Reasons other than inaccessibility were suggested for the slight use of the Special Commissioners. In the decade following the reintroduction of income tax it was suggested that they were underused because taxpayers much preferred the local knowledge of the General Commissioners.184 It was later suggested that the Special Commissioners were avoided because 182

See The Times, 17 Oct. 1866, 10 col. c. Minutes of Evidence before the Select Committee on Income Tax, House of Commons Parliamentary Papers, above n. 119, qq.2781–2782, Cd. 365, per Walter Gyles, Special Commissioner. 184 Minutes of Evidence before the Select Committee on the Income and Property Tax, House of Commons Parliamentary Papers, above n. 5, qq.1587–1588, Command 354, per Edward Hyde, surveyor. 183

84 Chantal Stebbings they were perceived as being part of the Inland Revenue,185 and again that the very raison d’être, namely privacy, was increasingly unimportant to taxpayers. However the evidence consistently shows that throughout the nineteenth century the issue of privacy remained a very real one, that the local knowledge of the General Commissioners was becoming gradually less important and that the role of the surveyor in making assessments was slowly becoming accepted as necessary. This should have led the Special Commissioners to grow in popularity, but the evidence shows that the numbers of appeals before them remained constant throughout the nineteenth century,186 and only grew markedly after they were entrusted with the new super-tax in 1909–1910.187 No clear pattern of use had emerged during the nineteenth century. The Presiding Special Commissioner in 1919, himself an ex-Revenue official, believed that this was partly due to fashion and circumstance. In relation to assessments by the Special Commissioners he believed that a large number indicated some local tensions between the taxpaying public and the surveyor or the General Commissioners, and that once the taxpayers had chosen this kind of assessment, they tended to remain with it.188 Those choosing a special assessment and expecting thereby to bypass the surveyor were mistaken.189 Some trends could be discerned, notably the use of special assessment by the more prosperous tradesmen as opposed to those in a small way of business, and the considerable use of assessment by the Special Commissioners by professional men, mainly medical practitioners and also solicitors, probably because they particularly did not want their private financial concerns to become known by men who were in all likelihood their patients or clients.190 These were, however, issues on the fringes of the problem. The slight use was predominantly the outcome of the inertia of the Inland Revenue in adequately publicising and promoting the role of the Special Commissioners. 185 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.8280, Cmd. 288-3, per William Cash on behalf of the Institute of Chartered Accountants. 186 Ibid., qq.13,681–13,684, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. 187 See analysis by V. Grout, ‘The First Hundred Years of Tax Cases’ [1976] BTR 75 at 78. By the end of the second decade of the twentieth century, the Special Commissioners were hearing about 1,500 income tax appeals a year: Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.13,414, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. He also pointed out that about 100 super-tax appeals a year and some 350 excess profits duty appeals were listed each year. 188 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, qq.13,624, 13,627, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner, a view supported by Sir Thomas Collins, Chief Inspector of Taxes: ibid., qq.559, 562, Cmd. 288-1. 189 Ibid., q.13,626, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner. See too ibid., q.560, Cmd. 288-1, per Sir Thomas Collins, Chief Inspector of Taxes. 190 Ibid., qq.13,634–13,647, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner.

Special Commissioners of Income Tax in the 19th Century 85 The numbers mark another and ultimately more important issue, namely the type of appeal the Special Commissioners were hearing. The expertise of the Special Commissioners, their complete mastery of the increasingly complex law and process of taxation, the growing confidence in their impartiality felt by the admittedly small section of the taxpaying public and the legal profession with whom they came into contact, and, paradoxically, the limited pressure of business, led to their evolution into a highly specialised body. Though initially their appellate powers constituted a relatively minor element in their overall duties, they quickly grew in significance. In 1906 a Special Commissioner said that the chief duties of his tribunal were the making of special assessments and hearing appeals, and of the two he felt the latter was the more significant,191 and by 1920 it was confirmed as their most important and characteristic duty.192 The duty was important not because of the mere numbers of appeals which they heard, but because they heard only the most difficult, intractable or financially substantial cases.193 Members of the Tax Bar would always advise taxpayers whose cases turned on difficult points of law to appeal to the Special Commissioners, for only they could fully understand the issues involved.194 The modern character of the Special Commissioners is as an expert tribunal with a highly specialised jurisdiction playing a significant part in the development of tax law. It is a character which was determined by the very consequences of the Commissioners’ exclusivity and failure to be widely accessible to the taxpaying public. The principal reason behind their original appellate powers was essentially a political and transient one, and their subsequent evolution was shaped by pragmatic considerations and cultural influences. In a sense their development confirmed the inequality in strength between the Inland Revenue and the taxpayer, in that it revealed a major tool of taxpayer protection being undermined to serve the ends of the administration rather than of the taxpayer it was seeking to safeguard. That is not to say the safeguard was eliminated; merely that its scope was significantly less than the legislators had originally envisaged through the majority of taxpayers being unaware of their rights of appeal to the Special Commissioners. For those who were aware, however, the tribunal was, as it is today, a model of efficient, swift, affordable and expert adjudication. 191 Minutes of Evidence before the Select Committee on Income Tax, House of Commons Parliamentary Papers, above n. 119, q.2707, Cd. 365, per Walter Gyles, Special Commissioner. 192 Report of the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 108, para. 358, Cmd. 615. 193 Ibid., para. 362. 194 Minutes of Evidence before the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 4, q.15,921, Cmd. 288-5, per A.M Bremner, barrister, on behalf of the General Council of the Bar of England and q. 19,798, per C. Hewetson Nelson, accountant. See too ibid., q.13,769, Cmd. 288-4, per G.F. Howe, Presiding Special Commissioner; Report of the Royal Commission on the Income Tax, House of Commons Parliamentary Papers, above n. 108, para. 358, Cmd. 615.

3 The Rise and Development of the Concept of ‘Total Income’ in United Kingdom Income Tax Law: 1842–1952 JOHN HN PEARCE

ABSTRACT Income tax, as reintroduced by Peel, was akin to a flat percentage levy on the national income. There was no need, in theory, for a concept of ‘total income’; and income tax was praised because it was necessary to deal with total income only in limited circumstances. In 1842 a person was exempt from income tax if ‘the aggregate annual amount of his income’ was less than £150: the expression ‘total income’ appeared as a synonym in 1853. The legislation defined neither ‘income’ nor ‘total income’: but help could be obtained from the Income Tax Act 1842 and from other sources. It could be said that total income depended upon the amount of the income required to be brought into account; and that the amount of the total income was the amount on which an individual was to be charged to income tax. The role played by total income was transformed during the early twentieth century. The Finance Act 1907 introduced differentiation. The Finance (1909–10) Act 1910 introduced graduation and reintroduced a personal relief. But income tax now had a patchwork quality, and there was a ‘jump’ in tax paid if a taxpayer moved categories. The First World War intensified these problems, because the war saw a major increase in the yield from income tax and a proliferation of income tax rates. Recommendations on these matters, made by the 1920 Royal Commission, were enacted in the Finance Act 1920. That Act retained the expression ‘total income’, and the expression was appropriate to refer to the amount of income brought into account for income tax purposes. But the 1920 Act also introduced the expression ‘taxable income’ to describe the income on which the taxpayer was to be charged to income tax, so that the relationship between terms existing at the end of the nineteenth century now ceased to exist. The Finance Act 1927 provided for the expression

88 John HN Pearce ‘taxable income’ to be superseded, and the provisions relating to total income were collected, for the first time, in the Income Tax Act 1952. In conclusion it is suggested that, in the history of income tax law, continuities in form may mask changes in substance. The most important change in substance may be a change from a flat rate tax to a graduated tax, with the crucial developments taking place during the early twentieth century.

I. INTRODUCTION

‘A

day’, said the Codification Committee in 1936, ‘total income from all sources is a vital factor in income tax law, but such was not always the case’.1 I entirely agree. It is my view that the concept of ‘total income’ owes its present importance to a series of developments during a 20-year period in the first third of the twentieth century: and that those developments took the concept away from the peripheral role that it had played earlier, when, in 1842, income tax was reintroduced. T THE PRESENT

II. THE NINETEENTH CENTURY: THE POSITION IN THEORY

‘I propose’, said Peel, when reintroducing income tax, ‘to levy a tax upon the income of the country’;2 and this way of putting the proposal may be taken to signal that Peel’s concept of an income tax differed markedly from the concepts that we may hold today. In the same speech, Peel went on to say that: The proposal which I make is a proposal for a tax on the income of this country; and if I once begin to make a distinction with respect to different kinds of income, it will be absolutely necessary that I should abandon the Income-tax. . . . If there is to be an Income-tax at all, it must be uniformly laid upon all income, and in no case whatever can I allow a distinction to be drawn. . . . The tax I propose is 3 per cent. upon income, and from that tax no remission or reduction can be made on account of any class who are thought at all competent to pay it.3

Income tax allowances for children had existed during the Napoleonic period, and were to exist again later: but they did not exist under Peel.

1

Report of the Income Tax Codification Committee (1936) (Cmd. 5131) 30 (para. 48). Hansard, Third Series, vol. 61, col. 903, 18 Mar. 1842. 3 Ibid., cols. 914–915. In his speech at the end of the debate Peel stated ‘I am of opinion that, if you establish this tax, you ought not to make any exemptions.’: Hansard, Third Series, vol. 61, col. 1187, 23 Mar. 1842. 2

Income Tax Law: 1842–1952 89 Deductions for life insurance premiums had existed during the Napoleonic period and were to exist again later: but they, too, did not exist under Peel. The concept of income tax as a flat percentage levy on the national income was carried further under Peel than it was at any other time—either before or since. Important operational consequences could be made to follow. For if income tax was a percentage levy on the national income, and if a good deal of income tax could be deducted and collected at the source (as it could, for example, in the case of public revenue dividends charged under Schedule C) then only partial returns of income were necessary—to deal with the income that could not be deducted at the source (the profits of a trade, for example). But that was all that was required. There was no need, as a matter of pure theory, either for a general return of income or for a concept of total income. The expression ‘total income’ does not occur in the Income Tax Act 1842.4 These points appeared in Victorian justifications of the income tax system. The ‘Report of the Commissioners of Inland Revenue . . . for the Years 1856 to 1869’, for example, quoted a passage from the 1803 ‘Exposition’ of the income tax system,5 in which praise was given to the income tax system because of the principle of deduction at source. The Report then went on to say that: To the foregoing remarks, it might have been added, that the system leaves unrevealed to all those connected with the assessment to the tax the total income of any person, except those who claim entire exemption from it, or those who seek to obtain an abatement of duty.6

The income tax system, in other words, was deserving of praise because the need to deal with an individual’s total income arose only in very limited circumstances. A justification of the income tax system in these terms had other implications. For if the Victorian income tax system deserved praise because of the characteristics it actually possessed, it followed that an income tax system with different characteristics should be condemned. The two sides of this coin both appear in the writings of G.H. Blunden, who, at the end of the

4

5 & 6 Vict. c. 35. ‘An Exposition of the Act for a Contribution of Property, Professions, Trades and Offices in which the Principles and Provisions of the Act are fully considered with a view to Persons Chargeable, as Persons Liable, to the Tax by way of Deduction and the Officers chosen to carry it into Effect’. For the ‘Exposition’ see A. Farnsworth, Addington: Author of the Modern Income Tax (Stevens, London, 1951) 74–86. 6 ‘[13th] Report of the Commissioners of Inland Revenue on the duties under their management for the Years 1856 to 1869 inclusive . . .’ (1870) (C. 82). The passage quoted is at 121. 5

90 John HN Pearce nineteenth century, published a number of articles on income tax in The Economic Journal.7 The articles overlap; but in one of them, ‘A progressive income-tax’, published in 1895, Blunden said: The distinguishing characteristic of this tax, and that which makes it the most effective engine of its kind in the world, is the avoidance of general returns of income, and the adoption of the plan of taxing the income, wherever possible, at the source. . . . Nearly two-thirds of the total yield of the tax are thus secured without the necessity for a direct application of any kind to the ultimate payers, and no statement of the entire income of the individual is asked for in any case whatever, except where total or partial exemption is claimed.8

And in another of his articles, ‘The Future of the Income Tax’, published in 1901, Blunden said: Now, it has so far been found impossible to construct a really progressive income tax upon a stoppage-at-the-source basis. In order to apply progressive rates it would be necessary to ascertain at the outset what is the aggregate amount of each taxpayer’s income, and a full and complete return of every source would be needed from each contributor. Thus two of the greatest merits of the English system, which make it the admiration and envy of foreign economists, would have to be sacrificed to render the application of a real progressive scale possible. More than this, when the chief safeguard against evasion had been destroyed, the imposition of progressive rates would operate with irresistible force in inducing concealment of all income from invisible sources, and the tax would beyond all question become a mighty instrument of demoralisation.9

Considerably earlier, in a passage that we may find unexpected today, Gladstone had told the House of Commons in 1860 that: Everybody must feel that perhaps the most dangerous of all propositions that could be made in a country like this would be an attempt upon abstract principles to devise a graduated tax on incomes, aiming at an adjustment of different rates of assessment, according to the means of the taxpayer.10

7 In addition to the articles mentioned in the text, Blunden also wrote ‘The Position and function of the Income Tax in the British Fiscal System’ (1892) 2 The Economic Journal 637. With a memorandum submitted in 1904 to the Departmental Committee on Income Tax, Sir Henry Primrose, the Chairman of the Board of Inland Revenue, appended a note written ‘by a late Surveyor of Taxes, Mr Blunden, a most capable Revenue Official and a writer of many excellent articles on economic subjects’: Appendix to the Report of the Departmental Committee on Income Tax . . . (1905) (Cd. 2576) 16. 8 GH Blunden ‘A Progressive Income-tax’ (1895) 5 The Economic Journal 527. The passages quoted are at 527 and 528. 9 GH Blunden, ‘The Future of the Income Tax’ (1901) 11 The Economic Journal 157. The passage quoted is at 161. 10 Hansard, Third Series, vol. 157, col. 1676, 30 Mar. 1860.

Income Tax Law: 1842–1952 91 And three years after that, in 1863, Gladstone had said: when you apply the principle of graduation to a tax on incomes, except in the limited case in which we are able to do it fortified by tradition . . .—when, I say, you adopt it as the general rule of your legislation, it means merely universal war, a universal scramble among all classes, every one endeavouring to relieve himself at the expense of his neighbour, and an end being put to all social peace, and to any common principle on which the burdens of the State can be adjusted.11

III. THE NINETEENTH CENTURY: THE POSITION IN PRACTICE

Although I have developed the concept of income tax as a flat percentage levy on the national income, I have also quoted passages that indicate that this concept was not taken to its ultimate conclusion. The Income Tax Act 1842 provided that incomes below £150 should be exempt from income tax.12 (That amount had been £60 during the Napoleonic period.) Section 163 of the 1842 Act dealt with this point; and that section provided in part that: any Person charged or chargeable to the Duties granted by this Act . . . . who shall prove before the Commissioners for General Purposes, in the Manner herein-after mentioned, that the aggregate annual Amount of his Income, estimated according to the several Rules and Directions of this Act, is less than [£150] . . . , shall be exempted from the said Duties . . . .13

The crucial expression is ‘the aggregate annual amount of his income’, and I have put this expression in italics. Different wording appeared in section 28 of the Income Tax Act 1853.14 That section provided in part that: The Exemption granted by the [Income Tax Act 1842] . . . to Persons whose . . . Incomes are less than . . . [£150] a Year shall be limited and restricted under this Act to Persons whose whole Incomes from every Source are less than [£100] . . . a Year . . .’

11

Hansard, Third Series, vol. 170, col. 622, 23 Apr. 1863. The nineteenth century system of income tax in the United Kingdom has striking similarities with the system of income tax in Hong Kong. See M. Littlewood, Tax Reform in Hong Kong in the 1970s: Sincere Failure or Successful Charade? in J. Tiley (ed.), Studies in the History of Tax Law (Hart, Oxford, 2004) 379–417. 13 Many years later Sir Josiah Stamp said of this state of affairs ‘[n]o one was required to make a return of his total income as an integral feature of the tax unless he liked, and he only did so to claim a privilege. Such a personal statement was incidental to the system rather than vital to it’: Sir Josiah Stamp, The Fundamental Principles of Taxation in the Light of Modern Developments (Macmillan, London, 1923) 17. 14 16 & 17 Vict. c. 34. 12

92 John HN Pearce The section then went on to provide (again in part) that: Provided always, that any Person who shall be assessed or charged to any of the Duties granted by this Act, or shall have paid the same either by Deduction or otherwise, and who shall claim and prove, in the Manner prescribed by the said Act [i.e. the 1842 Act], that his total Income from every Source, although amounting to [£100] . . . or upwards, is less than [£150] . . . a Year for the Year of the assessment of his Profits or Gains, shall be entitled to be relieved from so much of the said Duties assessed upon or paid by him as shall exceed the Rate of Fivepence for every Twenty Shillings of his Profits or Gains . . . .

Here, too, I have put important expressions in italics. To the best of my knowledge and belief, section 28 of the 1853 Act is the first provision in the income tax legislation to use the expression ‘total income’. But the expression ‘total income’ has arrived by a process that I have seen described as ‘lexical drift’. Section 163 of the 1842 Act had referred to ‘the aggregate annual Amount of his [i.e. the taxpayer’s] income’. This then became ‘whole Incomes from every Source’ in the first part of section 28 of the 1853 Act; and then, finally, ‘total Income from every Source’ later on in that same section. The second extract I have quoted from section 28 of the 1853 Act provided for a new and different benefit for taxpayers with incomes marginally in excess of the amount entitled to outright exemption from income tax; and this further benefit came to be known as the ‘abatement’. After 1853, the amount of the exemption and the amount and form of the abatement were varied from time to time; and the abatement came to be graduated. In one of these variations, made by section 8 of the Customs and Inland Revenue Act 1876,15 the expression ‘total income from every source’ was replaced by the expression ‘total income from all sources’: the first appearance known to me of the expression now to be found in section 835(1) of the Income and Corporation Taxes Act 1988.16 From 1853 onwards, therefore, a taxpayer whose ‘total income from every source’ (or some equivalent expression) was less than a certain amount was entitled to exemption from income tax; and a taxpayer whose total income was marginally above that amount was entitled to an abatement. But what was this total income? The legislation did not address this question directly.17 There was no definition—either of ‘income’ or of ‘total 15 16 17

39 & 40 Vict. c. 16. 1988 c. 1. There was a curious exchange during the enactment of the 1842 Act: Mr. P. Scrope said, that great interest was felt out-of-doors as to the mode of imposing the tax on particular classes of income. He wanted a definition of income. . . . Sir R. Peel: I mean to adopt the general principle of the measure of 1806, which was brought in by Lord Henry Petty, under the Government of Lord Grenville and Lord Grey, and if the hon. Gentleman will look into that statute he will find a definition of income

Income Tax Law: 1842–1952 93 income’.18 Those concerned with the actual operation of the system, therefore, had to look for help elsewhere: and it was possible to obtain some guidance from other provisions of the 1842 Act; and then, later, by the end of the nineteenth century, from case law and other legislation as well. So far as the 1842 Act was concerned, section 163 referred to the income tax exemption being available to a person: who shall prove before the Commissioners for General Purposes, in the Manner herein-after mentioned, that the aggregate annual Amount of his Income . . . is less than [£150 a year] . . . .

The ‘Manner herein-after mentioned’ was dealt with in section 164 of the 1842 Act. The claimant was to provide a signed declaration and statement: declaring and setting forth therein all the particular Sources from whence the Income of such Claimant shall arise, and the particular Amount arising from each Source, and also every Sum of annual Interest or other annual Payment reserved or charged thereon, whereby the Income shall or may be diminished, and also every Sum which such Claimant may have charged or may be entitled to charge against any other Person for or on account of the Duty made payable by this Act, or which he may have deducted or retained, or may be entitled to deduct or retain, under the Authority of this Act, from or out of any Payment to which he may be or become liable . . . .

Section 164 also provided that the signed statement and declaration should be ‘in such form as may be provided under the authority of this Act’. These words provided a link with section 190 of the 1842 Act, which provided for returns to be made in accordance with the rules and directions in Schedule (G.) to that Act. Schedule (G.), in its turn, contained a number of rules; and the last of these, Rule XVII, had the title ‘Lists, Declarations, and Statements of Discharge, or in order to obtain Exemptions’. The Rule, as set out in the 1842 Act, looked like this: XVII.— Lists, Declarations, and Statements of Discharge, or in order to obtain Exemptions. First.— Declaration of the Amount of Value or Property or Profits returned, or for which the Claimant hath been or is liable to be assessed: Second.— Declaration of the Amount of Rents, Interests, Annuities, or other annual Payments, for which the Party is liable to allow and deduct the Duty, with

and various details, which will afford a more satisfactory answer to his question than I can now give him’: Hansard, Third Series, vol. 61, col. 995, 21 Mar. 1842. However, I am unaware of any definition of ‘income’—either in the 1842 Act, or in ‘the measure of 1806’. 18 This state of affairs forms the point of departure for M. Daunton, ‘What is Income?’ in Tiley (ed.), above n. 12, 3–14.

94 John HN Pearce the Names of the respective Persons by whom such Payments are to be made, distinguishing the Amount of each Payment: Third.— Declaration of the Amount of Interest, Annuities, or other annual Payments, to be made out of the Property or Profits assessed on the Claimant, distinguishing each Source: Fourth.— Statement of the Amount of Income derived according to the Three preceding Declarations: Fifth.— Statement of any Payment which the Claimant may be liable to make, and out of which he may be entitled to deduct or retain any Portion of the Duty charged upon him, and of any Charge which he may be entitled to make against any other Person for any Portion of such Duty.

Rule XVII of Schedule (G.) is still with us. It is the direct ancestor of section 836 of the Income and Corporation Taxes Act 1988. The first comment I want to make on these provisions is that, in terms, they merely described the information to be given in statements, declarations and returns. But that leads straight on to my second comment, which is that these provisions could also be made to serve a larger and more important purpose. For, in the absence of specific provisions as to how an individual’s total income was to be calculated, it was possible to look at these provisions, and to draw appropriate inferences. And one of the most important judgments bearing on the concept of total income, the judgment of Scrutton LJ in Earl Howe v CIR19 shows this material being deployed in this way. I have one further comment to make. It is these provisions that provide the point of departure for a major feature of the concept of total income— the proposition that, in calculating total income, charges on income are to be deducted. Many years later, in another of the most important judgments bearing on the concept of total income, Viscount Radcliffe, in CIR v Frere,20 quoted from section 164 of the 1842 Act, with its reference to ‘every sum of annual Interest or other annual Payment reserved or charged thereon, whereby the Income shall or may be diminished’, and went on to observe: Nothing, I agree, is ever plain when one comes to deal with the income tax code, but I would, with respect, have thought it reasonably clear that, when the makers of the 1842 Act wished to prescribe what was to be taken as the ‘aggregate annual amount’ of a man’s income for the purposes of their Act, they allowed the amount to be reduced by the sum of any annual interest payable out of his income, but not by the sum of any interest that did not qualify as ‘annual’. If you like to put it that way, they thought that annual interest and other annual payments ‘diminished’ the income, or that the amount required to pay them was not the payer’s income at all: they do not seem to have thought of other kinds of payment as having this effect.

19 20

[1919] 2 KB 336, 349–353; (1919) 7 TC 289, 301–304. [1965] AC 402, 421; (1964) 42 TC 125, 149.

Income Tax Law: 1842–1952 95 Pausing there, it follows that the ability to deduct charges on income in calculating total income arose, originally, in the context of a claim for exemption from income tax. I stated earlier that, by the end of the nineteenth century, it was also possible to obtain help from case law when looking for guidance on the nature of total income. In this connection I had in mind the case of Tennant v Smith (Surveyor of Taxes), decided by the House of Lords in 1892.21 That case is generally cited in connection with another point (that a benefit in kind must be capable of being converted into money); but in a House of Lords that found unanimously for the taxpayer, Lord Macnaghten began his speech by observing that: The appellant, who is the agent at Montrose for the Bank of Scotland, being assessed for income tax, claims an abatement. The question is whether his ‘total income from all sources’ is or is not less than £400. That depends upon whether he has to bring into account the value of a free residence provided for him by the bank in the bank premises. Notwithstanding the opinion of one of the learned Judges of the Court of Session, I think it is perfectly clear that nothing is to be brought into account on a claim to relief except what is chargeable for the purpose of assessment.

On the basis of this passage, I consider that it may be said that ‘total income from all sources’ depended upon the income required to be ‘brought into account’, and that the income required to be brought into account was the income on which the taxpayer was chargeable for the purpose of assessment to income tax.22

21 [1892] AC 150; (1892) 3 TC 158. The quotation from the speech of Lord Macnaghten may be found at 161 and 169 respectively. 22 In Tennant v Smith Counsel for the successful taxpayer is reported as arguing as follows (see (1892) 3 TC 158 at 161): ‘The abatement of 120l. is granted to persons whose income from all sources is under 400l. It has been suggested that “income” there means something different from income which is liable to taxation; but that cannot be. If we look at the exemption of “income” under the 150l. limit, we find that it is in terms, income liable to be taxed; and therefore, where the Act grants an abatement in the case where the “income from all sources, though amounting to 150l.” (and therefore outside the scope of exemption) “or upwards is less than 150l.” it is clear that “income” means the same in each case. Section 163, 5 & 6 Victoria c. 35., confers exemption on any person charged or chargeable to the duties conferred by that Act, either by assessment or by way of deduction, upon proof that the aggregate amount of his income estimated according to the rules and directions of the Act is less than 400l. Clearly, therefore, “income” there means income assessed according to the rules and regulations of the Act for purposes of taxation. We conceive, therefore, that the real question in this case is whether the assumed annual value of the occupation of this portion of the Bank premises is income for the purposes of these Acts both for the purpose of taxing and for the purpose of exemption.’ It is my opinion that this line of argument is completely correct.

96 John HN Pearce I also find it helpful to consider the terms of section 8 of the Finance Act 1898.23 This section provided that: Any individual who having been assessed or charged to income tax or having paid income tax either by deduction or otherwise claims and proves in manner prescribed by the Income Tax Acts that his total income from all sources, although exceeding [£160] . . . , does not exceed [£700] . . . , shall be entitled to relief from income tax equal— (a) if his total income does not exceed [£400] . . . , to the amount of the income tax upon [£160] . . . ; and (b) to (d) [corresponding provision was then made in three other cases].

From the provisions of this section, I infer that it was necessary to begin by calculating the amount of the income on which an individual was to be charged to income tax, and that it was this amount that constituted the individual’s total income. This total income was then considered; and, if appropriate, the taxpayer obtained the benefit of an abatement. The abatement operated on the amount of income tax payable; and, if there was an abatement, there was less income tax to pay. My overall conclusion is that, in the income tax system I have been considering, and in the case of an individual, there was a definite relationship, of a particular type, between the amount of the income chargeable for the purpose of assessment, the amount of the income required to be brought into account, and the amount of the ‘total income from all sources’—and that the amount of the ‘total income from all sources’ was the amount of the income on which an individual was to be charged to income tax. This particular type of relationship was to cease to exist as a result of the important legislative developments of the early twentieth century.

IV. THE EARLY TWENTIETH CENTURY

(1) Preliminary It was the official hope, of both Peel and Gladstone, that the existence of the income tax was merely temporary.24 But income tax continued to exist. And the longer income tax continued to exist, the more difficult it became to treat its existence as temporary. It was also unsatisfactory,

23

61 & 62 Vict. c. 10. In 1853, Gladstone said of income tax that ‘it is not adapted for a permanent portion of your fiscal system, unless you can by reconstruction remove its inequalities’ (Hansard, Third Series, vol. 125, col. 1364, 18 Apr. 1853.) This sentence was quoted (in a slightly different form) by Asquith in his 1907 Budget Speech (Hansard, Fourth Series, vol. 1 172, col.1201, 18 Apr. 1907). See text around n. 34 below. 24

Income Tax Law: 1842–1952 97 of course, to regard income tax as being, in the words of Sir Stafford Northcote, on: a sort of Mahomet-coffin footing, suspended between the idea of being a permanent portion of our financial system and a temporary tax some day or other to be removed.25

I find it completely unsurprising, therefore, that, after a time, the view began to be advanced that income tax should be treated as having a permanent existence, and dealt with accordingly. In a speech at Ipswich on 14 January 1885, Joseph Chamberlain observed that: I observe that Prince Bismarck some time ago proposed to the Reichstag an income tax to be graduated according to the amount of the income, and to vary according to the character of the income. We already have done something in that direction in exempting the very smallest incomes from taxation. But I submit it is well worthy of careful consideration whether the principle should not be carried a little further.26

Nine years later, in 1894, Sir William Harcourt, Chancellor of the Exchequer from 1892 to 1895, wrote that: I must deal with the Income Tax as it would be impossible in the present state of opinion to raise the larger amount from indirect taxation, and if the Income Tax is to be continued as it clearly must at a high level it will be indispensable to reform it at both ends.27

A note among Harcourt’s papers records that: It is plain that with the increased and increasing expenditure Income Tax must be treated as a permanent tax. It is essential therefore to redress its admitted inequalities. It is generally felt that it presses too heavily on the lower and too lightly on

25 Cited in S. Buxton, Finance and Politics: an Historical Study (1783–1885) (A John Murray, London, 1888) ii, 174. 26 C.W. Boyd, (ed.) Mr Chamberlain’s Speeches (Constable, London, 1914) i, 146. Of this speech, Gladstone’s Secretary, Edward Hamilton, observed: ‘Chamberlain has been breaking silence again, and, though nobody speaks better, his speeches are certainly not over-judicious. He has been giving utterance to all kinds of extreme and somewhat wild ideas, smacking very strongly of socialism and airing such ideas as free education, radical reform of the basis of our present taxation system, the application of the “3F’s” to land in Great Britain, &c. These projects may and no doubt will come about; but to broach them now is calculated to alarm and possibly retard their being brought within the range of practical politics’ (D.W.R. Bahlman, The Diary of Sir Edward Walter Hamilton 1880–1885 (OUP, Oxford, 1972) ii, 773 (entry for Thursday, 15 Jan. 1885). Hamilton ended his career as Joint Permanent Secretary to the Treasury: see below n. 33. 27 M. Daunton, Trusting Leviathan: The Politics of Taxation in Britain, 1799–1914 (CUP, Cambridge, 2001) 250.

98 John HN Pearce the higher rates of income. You must therefore have what may be called a normal Income Tax with (1) alleviation at the lower end (This is effected by the allowances under £500) (2) You must also have enhancement at the upper end.28

And towards the end of his career, in 1901, Harcourt said that: I see nothing in the principle of a graduated income tax which can be objected to. It is founded on a sound principle—that those who have the larger means should pay the higher proportion. . . . I am afraid you will never be able to give greater abatements than you give at present. What we have to look to is a higher scale for the richer people. That will be the tendency of the alteration of the income tax.29

The carrying out of the decisive changes was undertaken by the Liberal Government that gained the major electoral victory of 1906; and it was this Government that ended the quiet half century, which had begun after 1853, in the history of the United Kingdom’s income tax. In May 1906 a House of Commons Select Committee was appointed: to inquire into and report upon the practicability of graduating the Income Tax, and of differentiating, for the purposes of the Tax, between Permanent and Precarious incomes.

With these terms of reference, I find it completely unsurprising that the Committee: deemed it to be beyond the scope of our inquiry to consider the desirability or equity, on general grounds of public policy, of the various proposals which have been placed before us, and the questions of principle which they raise.30

In other words, the arguments that Blunden had been putting forward just a few years earlier were inadmissible.31 The Committee reported in November 1906 that graduation of the income tax was practicable, and that differentiation between earned and unearned incomes was practicable. (Following the 1920 Royal Commission I take graduation to be ‘the principle of increasing the rate of tax as the income increases’ and differentiation to be ‘the generally accepted word for the principle of distinguishing between one kind of income and another by means of different rates of tax’32).

28

Ibid., 250 and n. 74. Hansard, Fourth Series, vol. 96, cols. 525–526, 1 July 1901. 30 Parliamentary Papers 1906 IX, Report from the Select Committee on Income Tax, pp. ii and iii. 31 See text above to nn. 7 to 9. 32 Report of the Royal Commission on the Income Tax (HMSO, London, 1920) (Cmd. 615) 24 (para. 105). This report is subsequently cited as ‘RC’. 29

Income Tax Law: 1842–1952 99 (2) The Finance Act 1907 Of the two topics considered by the Committee, it was differentiation between earned and unearned incomes that was the first to receive attention.33 In his 1907 Budget Speech Asquith said: I start with this proposition, and a most important proposition it is, that it [i.e. income tax] must now be regarded as an integral and permanent part of our financial system. If that proposition is once enunciated and admitted, it makes it impossible to justify, if there be any practical way of escape, the present incidence of the income-tax. ... We now recognise the tax to be a permanent part of our system; and . . . I think that we must do something . . . to arrive at some scheme, without destroying the essential features or the productive character of the tax, which differentiates incomes, not only as to amount, but also as to the source whence they are derived and the conditions under which they are enjoyed.34

The 1920 Royal Commission later took the view that ‘[i]t is from 1907 that the modern Income Tax counts the years of its life’.35 Legislation to give 33 Asquith was willing to make more progress—and more rapidly. He had wished to introduce differentiation in his 1906 Budget, but was prevented by Treasury opposition. ‘I was at once met with the objection, which was considered fatal, that Gladstone had always declared that any such scheme was impracticable. I therefore thought it wise to fortify myself with an inquiry by a strong Select Committee of the House of Commons, appointed ad hoc and presided over by Sir Charles Dilke, which presented a formidable report before I submitted the project to the House. It received general approval, and has become an essential part of our income tax machinery.’ [H H Asquith], Memories and Reflections (Cassell, London, 1928) i, 254. For his 1907 Budget, Asquith was also willing to think in terms of graduating the income tax, finally abandoning his plans for its introduction in the face of opposition to it from Sir Edward Hamilton, Joint Permanent Secretary to the Treasury, Sir Henry Primrose, Chairman of the Board of Inland Revenue, and Reginald McKenna, Financial Secretary to the Treasury, and on the ground that differentiation was enough to proceed with during one session. (See B.K. Murray, The People’s Budget 1909/10: Lloyd George and Liberal Politics (OUP, Oxford, 1980) 98–99.) Primrose told Hamilton on 3 Feb. 1907 that ‘it would be very unfortunate if ideas more revolutionary than any that the [1906 Select] Committee ventured to hold, should take their rise from the Treasury itself.’ (Daunton, above n. 17, 334 and n. 2.) Sir Edward Hamilton and Sir Henry Primrose had both retired by the time that Lloyd George came to prepare his 1909 Budget (Murray, above, 101). 34 Hansard, Fourth Series, vol. 172, cols. 1199 and 1202, 18 Apr. 1907. Asquith returned to these themes during the Committee stage of the Finance Bill. ‘He was perfectly certain that it was the duty of the Government to retain the [income] tax, and he could not imagine any Chancellor of the Exchequer contemplating our financial future in the absence of the incometax, and, he would say, the income-tax at a substantial figure. He would say that the incorporation of the income-tax as a permanent part of the financial machinery of the country was incumbent on them, but they should see that as among the classes on whom it fell its incidence was as fair and equitable as possible. Now that they had come to the conclusion that it was not a temporary but a permanent tax, their first duty it seemed to him was to see how far they could make it fair among those upon whom it fell’: Hansard, Fourth Series, vol. 177, col. 764, 3 July 1907. Sir John Clapham commented ‘A foreigner might have admired the swift English resolve to make permanent a tax which had existed continuously for sixty-five years’: Sir J.H. Clapham, An Economic History of Modern Britain (CUP, Cambridge, 1938) iii, 404. 35 RC, above n. 32, 2 (para. 9).

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effect to the principle of differentiation was introduced in the Finance Act 1907,36 where section 19(1) provided that: Any individual who claims and proves, in manner provided by this section, that his total income from all sources does not exceed [£2,000] . . . , and that any part of that income is earned income, shall be entitled, subject to the provisions of this section, to such relief from income tax as will reduce the amount payable on the earned income to the amount which would be payable if the tax were charged on that income at the rate of nine pence.

The procedure to be followed on such a claim was the same as for a claim for exemption from income tax, for section 19(6) of the 1907 Act provided that: Subject to the provisions of this section, all the provisions of the Income Tax Acts which relate to claims for exemption, relief, or abatement, or the proof to be given with respect to those claims, shall apply to claims for relief under this section and the proof to be given with respect to those claims.

In this manner the concept of ‘total income’ was called out to do duty in a second major location: but the location was one advantageous to the taxpayer—just as it was in the case of the exemption or abatements.

(3) The Finance (1909–10) Act 1910 The principle of graduation received attention two years later, in 1909. In his Budget Speech Lloyd George said: The income tax, imposed originally as a temporary expedient, is now in reality the centre and sheet anchor of our financial system. The principles of graduation and differentiation . . . are in the lower stages of the income tax scale already recognised by abatements and allowances. It remains to complete the system by extending the application of these principles . . . .37

The principle of graduation was given effect with the imposition of supertax by section 66 of the Finance (1909–10) Act 1910.38 Subsections (1) and (2) of that section provided in part that: (1) In addition to the income tax charged at the rate of one shilling and twopence under this Act, there shall be charged, levied, and paid for the year beginning on . . . [6 April 1909], in respect of the income of any individual,

36 37 38

7 Edw. 7 c. 13. Hansard, Fifth Series, vol. 4, col. 507, 29 Apr. 1909. 10 Edw. 7 c. 8.

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the total of which from all sources exceeds [£5,000] . . . , an additional duty of income tax (in this Act referred to as a super-tax) at the rate of sixpence for every pound of the amount by which the total income exceeds [£3,000] . . . . (2) For the purposes of the super-tax, the total income of any individual from all sources shall be taken to be the total income of that individual from all sources for the previous year, estimated in the same manner as the total income from all sources is estimated for the purposes of exemptions or abatements under the Income Tax Acts; but, in estimating the income of the previous year for the purpose of super-tax, [various adjustments were to be made] . . . .

As Lloyd George had put the matter in his Budget Speech: Total income for the purposes of the tax will be ascertained in the manner prescribed by Statute for determining total income for the purposes of the present income tax exemptions and abatements . . . .39

It is my opinion that the introduction of super-tax was the most important single event in the rise of the concept of total income. The importance of what took place, of course, consisted in the fact that the concept of ‘total income’ became relevant for calculating the tax liability of those individuals who were the subject of (unfavourable) special attention because their incomes were larger than average, as well as those who were the subject of (favourable) special attention because their incomes were smaller than average. The manner in which ‘total income’ was to be calculated, however, was the same: the calculation made for the purpose of the income tax exemption (or the abatements) was now to be made for the purposes of super-tax as well. So the material relevant for calculating whether total income was small enough to attract exemption (or an abatement) from income tax accordingly also became relevant for calculating whether total income was large enough to attract super-tax. And, indeed, one of the leading cases on the calculation of ‘total income’, Earl Howe v CIR,40 was a super-tax case. Earl Howe had appealed against a super-tax assessment made on him for the 1916–1917 year of assessment. But the Finance (1909–10) Act 1910 was also relevant for the concept of total income in another major context: for the Act reintroduced a personal relief—the personal relief for children. The decision to do this, it is clear, was Lloyd George’s own. The decision involved the rejection of a scheme prepared by the Inland Revenue to extend the abatements; and the (Gladstonian) Permanent Secretary to the Treasury said of it that it

39 40

Hansard, Fifth Series, vol. 4, col. 510, 29 Apr. 1909. [1919] 2 KB 336 (CA); (1919) 7 TC 289.

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‘introduces a new principle into our fiscal system, and in a rather ridiculous way’.41 The first sentence of section 68(1) of the 1910 Act provided that: If any individual who has been assessed or charged to income tax, or has paid income tax either by deduction or otherwise, claims and proves, in manner prescribed by the Income Tax Acts, that his total income from all sources, although exceeding [£160] . . . , does not exceed [£500] . . . , and that he has a child or children living and under the age of sixteen years at the commencement of the year for which the income tax is charged, he shall be entitled, in respect of every such child, to relief from income tax equal to the amount of the income tax upon ten pounds.

This is complicated drafting—and is consequently capable of prompting the reflection that matters might perhaps be handled differently. By 1911, therefore, the concept of ‘total income’ was at work in four major areas, instead of just one, as had been the case a mere half dozen years earlier. The concept was now important for differentiation, graduation and personal reliefs, as well as for the exemption (and abatements). In 1911, however, the graduation of income tax nevertheless had a patchwork quality. A taxpayer with an income of less than £700 per year might well be capable of benefiting from one or more of the exemptions (or abatements), the differentiation in favour of earned income, and the personal relief for children. A taxpayer with an income of more than £700 but less than £3,000 per year could benefit from the differentiation in favour of earned income only. A taxpayer with an income of more than £3,000 but less than £5,000 did not benefit at all; and a taxpayer with an income of more than £5,000 had the additional liability to super-tax. This state of affairs had the consequence that there was a ‘jump’ in the income tax paid if a taxpayer moved from one category to another. Thus, on my calculations, in the year of assessment 1911–12, a single man who had an earned income of £3,000, and who, consequently, obtained the benefit of the differentiation in favour of earned income, paid income tax of £125, leaving him with £2,875 net of income tax. A single man who had an earned income of £3,001, and who, consequently, did not obtain the benefit of the differentiation in favour of earned income, paid income tax of £175 1s 2d, leaving him with £2,825 18s 10d net of income tax. An increase of £1 in income had therefore led to an increase of more than £50 as regards liability to income tax, and to a state of affairs in which the individual with the higher gross income had the lower income net of income tax. Anomalies of this nature attracted much attention over the following decade. 41 Murray, above n. 33, 137–138, 164–165. The Permanent Secretary was Sir George Murray.

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Against this general background I do not find it at all surprising that the 1920 Royal Commission should state that: Even before the war it was plainly desirable that yet another and a more comprehensive inquiry should be held, and a Commission was, we understand, on the point of being established when war broke out.42

(4) The First World War As I view the matter, the First World War did not transform the concept of total income—the concept continued to operate in the same manner in the same four major areas. But what the First World War did do, on the other hand, was to transform the more general income tax environment in which the concept of total income was operating. The primary point, of course, is that income tax was required to produce much larger sums for the government. The net produce from income tax rose from £43.5 million in 1913–14 to £303.6 million in 1918–19—nearly a sevenfold increase in just six years. And the net receipts from super-tax rose from £3.3 million in 1913–14 to £35.6 million in 1918–19—more than a tenfold increase. 43 How, operationally, was this accomplished? The most obvious component of this increase was the raising of the standard rate in the pound: from 1s. 2d. in 1913–14 to 6s. in the pound in 1918–19—more than a fivefold increase. So far as smaller incomes were concerned, the limit of the exemption was reduced from £160 to £130: a move which the Inland Revenue considered had more or less doubled the number of individuals with incomes over the exemption limit. And so far as larger incomes were concerned, super-tax consisted in 1913–14 of a single rate of 6d. in the pound, and liability to super-tax began when total income exceeded £5,000. By 1918–19 the highest rate of super-tax was 4s. 6d. in the pound; and liability to super-tax began when total income exceeded £2,500. But for present purposes, I think it important to note that increases in the rates of income tax were accompanied by increases in the numbers of those rates. In 1913–14, unearned income was subject to income tax at the standard rate only: in 1918–19 it was subject to income tax at five different rates. In 1913–14, there were two rates of income tax for earned income:

42 RC, above n. 32, 2–3 (para. 10). On 22 July 1914, Felix Cassel, an opposition Conservative MP, referred to ‘the Royal Commission which is about to be appointed’. See Hansard Fifth Series, vol. 65, col. 465, 22 July 1914. 43 Figures from Sir Bernard Mallet and C.O. George, British Budgets: Second Series: 1913–14 to 1920–21 (Macmillan, London, 1929) 397 and 400.

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in 1918–19 there were six. In addition, in 1918–19, there were also seven special lower rates for those in the armed forces. And finally, so far as supertax was concerned (and leaving aside the nil rate), there was one rate in 1913–14, but eight in 1918–19. That makes a grand total of four rates for 1913–14, but 26 for 1918–19.44 To complete the picture there were also more personal reliefs than there had been earlier. In 1913–14 the only personal relief was the relief for children. By 1919–20 there were also personal reliefs for a wife, and for certain dependent relatives. These further personal reliefs also depended upon the taxpayer having a total income that did not exceed a stated amount.45

(5) The 1920 Royal Commission In 1919, after the First World War, a Royal Commission on the Income Tax was constituted. The first consolidation Act relating to income tax law, the Income Tax Act 1918,46 came into force at this time, and the Royal Commission acknowledged its existence.47 The Commission reported in the following year, and permitted itself a little rhetoric when it stated that: Pressing as was the need for reform before the war it is even more imperative now. Taxation has so greatly increased since 1914 that it is more than desirable, it is vital to our country’s future, that now, when the national burden is at its heaviest, it shall be fairly distributed, and the individual share fitted with sympathy and discrimination to the back that will for many years have to bear it. That burden is the monetary cost of preserving inviolate the national freedom.48

The 1920 Royal Commission also stated that: As the result of the five-fold increase in the standard rate of tax during the war it became necessary to extend direct graduation to all incomes, but the method employed operates so unfairly between one taxpayer and another that the

44 I have derived this material from the Appendices to the Report of the Royal Commission on the Income Tax (HMSO, London, 1920) (Cmd. 615). See Appendix 1, 3 (para. 21) and Appendix 3 at 17 and 25. 45 These reliefs were introduced by s. 27 of the Finance Act 1918 (8 & 9 Geo. 5 c. 15) and s. 21 of the Finance Act 1919 (9 & 10 Geo. 5 c. 32). 46 8 & 9 Geo. 5 c. 40. 47 ‘We feel it right that we should acknowledge at the outset how greatly our task has been lightened by the recent consolidation of the whole of the Income Tax legislation into one comprehensive Statute, the Income Tax Act of 1918. Had we been obliged to have recourse to the tangled mass of legislation which that Act superseded and repealed our position would have been much more difficult and uncertain’: (RC, above n. 32, 1 (para. 4). But the Royal Commission also recommended ‘that steps should be taken in due course to prepare a Bill that shall contain the whole law on the subject in the most modern and approved form’: RC, above n. 32, 89 (para. 398). 48 Ibid., 3 (para. 10).

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removal of the resulting inequities has been one of the most important subjects of our inquiry.49

The Royal Commission accordingly came forward with its own scheme for a unified income tax computation. So far as differentiation was concerned, the Commission was ‘satisfied that some such discrimination is desirable and just’.50 It proposed that earned income of £2,000 or less should be reduced by a fraction of one-tenth; and used the expression ‘assessable income’ to describe the income remaining after this reduction had been made.51 So far as the personal reliefs were concerned, the Royal Commission envisaged their retention. The Commission referred to the personal reliefs that had come into existence over the previous ten years as ‘the family allowances’, and stated that: We . . . recommend that the family allowances should be treated as deductions from the gross income in such a way as to reduce that income for all purposes, and that the rate of tax should be determined by reference to the amount of income left after those allowances have been made.52

Indeed, it is possible to go further, and to say that the Commission favoured the expansion of the system of personal reliefs: for, by proposing a personal relief for single persons and a separate larger personal relief for married couples, the income tax exemption no longer needed to exist as such—and the Commission’s proposals envisaged that it would be abolished. The Commission used the expression ‘taxable income’ to describe the income remaining after the personal reliefs had been deducted from the assessable income, and envisaged that it was upon this taxable income that the individual taxpayer would be called on to pay income tax.53 So far as graduation was concerned, in a passage that shows how much opinion had moved in just a few years, the Royal Commission stated that: We do not feel called upon to defend with arguments the principle of graduation of the Income Tax. Direct graduation of the tax was bitterly opposed for many years, but it is now almost universally admitted to be as sound in principle as it is imperatively necessary in practice. We are therefore concerned more with the practical than with the theoretical aspect of the subject—not so much with the principle as with the means by which that principle can be translated into practice.54

49 50 51 52 53 54

Ibid., Ibid., Ibid., Ibid., Ibid., Ibid.,

28 (para. 126). 24 (para. 106). 24–26 and 31 (paras 106–113 and 139). 60 (para. 269). 29 and 31 (paras 129 and 139). 29 (para. 128).

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Against this background, the Royal Commission recommended that the first £225 of taxable income should be charged to income tax at half the standard rate of income tax, with the excess being charged at the full standard rate. And the Commission considered ‘that graduation on incomes exceeding £2,000 can best be effected by means of Super-tax in addition to the ordinary Income Tax’.55 The Commission accordingly concluded that ‘[t]he scheme which we have finally decided to recommend is as follows’: From the assessable income (which . . . is the actual investment income, or the earned income reduced by one-tenth) should be deducted the allowances for the taxpayer himself, his wife, children, dependent relatives, &c. in order to arrive at the taxable income. This taxable income where it does not exceed £225 should be charged at half the standard rate of tax. If the taxable income exceeds £225, the first £225 should be charged at half the standard rate of tax, and the excess over £225 at the full standard rate of tax.56

I have three inter-related comments to make about the Royal Commission’s scheme for a unified income tax computation. My first comment relates to a matter that is readily visible. The Royal Commission’s Report made extensive use of two new expressions— ‘assessable income’ and ‘taxable income’. Of these, ‘taxable income’ is the more important for present purposes: for this expression is used to denote the income on which the taxpayer is to be charged to income tax. But, earlier on, I stated my opinion that, under the Victorian system of income tax, the amount of income on which the taxpayer was to be charged to income tax was accurately specified by the expression ‘total income’. The arrival of the new expressions ‘assessable income’ and ‘taxable income’ appeared bound, therefore, to have an impact on the meaning of the existing expression ‘total income’. My second comment relates to a matter that is much less readily visible. The Royal Commission was completely clear that the expression ‘assessable income’ was appropriate to describe income after the reduction for earned income had been made. But what expression was appropriate to describe income before that reduction? The Royal Commission, as far as I can see, did not deal with its material in such a way as to suggest that it had one particular expression in mind. I have noticed occurrences of the expressions ‘actual income’, ‘actual total income’ and ‘total income’.57 I think it possible to say that we are dealing with a concept in search of a label. My third comment relates to the expression ‘total income’ itself. This expression was already in use in the Income Tax Acts. The scheme for the

55 56 57

Ibid., 35 (para. 151). Ibid., 31 (para. 139). Ibid., 26, 27, 32 and 33 (paras 115, 116, 141, 142, 144 and 145).

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unified income tax computation put forward by the Royal Commission, however, did not obviously assign any particular role to this existing expression: and, as I have said, the meaning of the expression ‘total income’ was bound to be affected by the introduction of the new expression ‘taxable income’. The future meaning (if any) of the expression ‘total income’ appeared to wait upon developments. So, as I view the matter, the Royal Commission’s scheme for a unified income tax computation existed in a context in which there was (on the one hand) a concept in search of a label and (on the other hand) an existing expression whose role (if any) required redefinition. There was an obvious way of dealing with this situation in legislation to implement the Royal Commission’s recommendations.

V. THE FINANCE ACT 1920

The Report of the Royal Commission on the Income Tax is dated 11 March 1920;58 and the Chancellor of the Exchequer, Austen Chamberlain, presented his Budget to the House of Commons on 19 April of that year. In his Budget Speech the Chancellor 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, which I will come to in a moment, 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. . . . In the Finance Bill I will deal only with those recommendations of the Royal Commission which relate to the graduation of the tax and the various allied measures for better adjusting the burdens to the taxpayer’s back . . . . I propose to adopt, with one or two trifling modifications in favour of the taxpayer, all the recommendations of the Commission on the subjects which are being included in the Finance Bill, that is to say in regard to differentiation and graduation of the tax, and I use the term ‘graduation’ to include the various reliefs associated with family responsibility.59

The separate Bill to carry out ‘the general reform of the Income Tax’ never reached the statute book.60 But the legislation to give effect to the Royal 58

Ibid., 141. Hansard, Fifth Series, vol. 128, cols. 91–93, 19 Apr. 1920. 60 ‘It may be mentioned here that the Bill, introduced later, embodying many of the remaining recommendations of the Royal Commission, was dropped owing to the opposition aroused. This was the last occasion on which the practice of introducing a separate Revenue 59

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Commission’s proposals for a unified income tax computation was enacted as part of the Finance Act 1920,61 in a statute apparently described by Leading Counsel (who, I daresay, had warmed to his task on behalf of his client) as having ‘effected an entire revolution in the matter of both income tax and super-tax’.62 In that Act, and so far as income tax was concerned, section 16 preserved the differentiation in favour of earned income by providing for a fraction of one-tenth to be deducted from earned income for the purpose of ascertaining the individual’s assessable income. Section 17(1) then provided that: 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 shall be entitled for the purpose of ascertaining the amount of the income on which he is to be charged to income tax (in this Act referred to as ‘the taxable income’) to have such deductions as are specified in the five sections of this Act next following made from his assessable income.

The next five sections then dealt with the personal allowance (section 18), and with deductions for relatives taking charge of a widower’s or widow’s children (section 19), for widowed mothers (section 20), for children (section 21) and for dependent relatives (section 22). Section 23 then provided for the first £225 of taxable income to be charged at half the standard rate. And finally, for present purposes, the Finance Act 1920 also provided that the income tax exemption and the abatements should cease to exist. Section 17(1) of the Finance Act 1920 contained the expressions ‘total income’, ‘assessable income’ and ‘taxable income’: and the use of the three different expressions was clearly quite deliberate. The expression ‘total income’ was not defined in the 1920 Act. But, bearing in mind the introduction of the new expression ‘taxable income’, the obvious meaning to attribute to the expression ‘total income’ was to the effect that it meant the amount of income required to be brought into account for income tax purposes. This meaning was consistent both with the speech of Lord Macnaghten in Tennant v Smith63 and with the overall framework for the unified income tax computation devised by the 1920 Royal Commission.

Bill was followed. Such a Bill was a great convenience for dealing with administrative matters, but difficulty was always experienced in finding the necessary time for its progress, and for this reason the Treasury have since that time adopted the practice of covering all necessary measures in one Bill—the Finance Bill’: Mallet and George, above n. 43, 245–246. 61

10 & 11 Geo. 5 c. 18. Per Warrington LJ, describing the submissions of Leading Counsel for the taxpayer in Kennard Davies v CIR [1923] 1 KB 370, 380; (1922) 8 TC 341, 359. 63 [1892] AC 150; (1892) 3 TC 158. See text above n. 21. 62

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Support for the proposition that the expression ‘total income’ was indeed understood in this manner at this time may be derived (first) from documents produced by the Inland Revenue and (secondly) from case law. So far as Inland Revenue documents are concerned, the ‘General Note to Clauses 15 to 22’ of the Finance Bill 1920, contained in the Inland Revenue’s ‘Notes on Clauses’ for that Bill, introduced the new legislation like this: New System The differentiation in favour of earned income is to be effected under the new scheme by the simple expedient of deducting from the total income a sum equal to one-tenth of the earned income, subject to a maximum deduction of £200. The balance so arrived at is described as ‘assessable income’. Graduation is to be effected by (a) A personal allowance from ‘assessable income’ of £135 in the case of a single person and £225 in the case of a married couple. (b) Deductions from ‘assessable income’ in respect of children, dependent relatives, etc. The balance so arrived at is described as ‘taxable income’. The final stage of the graduation is effected by charging the first £225 of the ‘taxable income’ at one-half the standard rate and the balance at the standard rate.64

The Inland Revenue’s ‘Notes on Clauses’ for the 1920 Finance Bill also included a (hypothetical) worked example:65 The practical working of the new graduation scheme is illustrated by the following example:— A’s total income consists of a salary of £750. He is married, has two children under sixteen, and maintains his widowed mother. A will have to pay £74 17s. Income Tax, calculated on the following lines. From the earned income of £750 a deduction of £75 is made—i.e., the differentiation allowance of one-tenth in favour of earned income—the first stage in the graduation. A’s assessable income is therefore £675. The second stage in the graduation is now reached and the following deductions are made: (a) £225, the personal allowance for the married couple, (b) £36 for one child and £27 for the second child, and (c) £25 for the dependent relative. The total deductions amount to £313, and leave a net sum of £362, which represents A’s taxable income, that is, the income on which tax will actually be charged. The third stage of the graduation is now reached, and under Clause 22 [enacted as section 23 of the Finance Act 1920] the first £225 of the £362 taxable income will be charged at 3s. in the £ (half the standard rate) and the balance, £137, at 6s. in the £ (the standard rate).

64 65

Inland Revenue: Finance Bill 1920, ‘Notes on Clauses’, 5. Ibid., 17.

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The tax payable is, therefore:£225 £137

at at

3s 6s Total

£33 15s 0d. £41 2s 0d. ————————— £74 17s. 0d. —————————

So far as case law is concerned, the construction of sections 15 to 18 of the Finance Act 1920 arose for consideration in the case of Kennard Davis v CIR where, in the King’s Bench Division, Sankey J said: I read those sections as follows. You have first of all to ascertain the total income, sometimes called ‘the income’, sometimes called ‘the income from all sources’, and when you have got that you are entitled to have a sum taken from it, referred to in sections 16 and 17, in respect of the earned income, and when you have taken that sum from the ‘total’, or the ‘total from all sources’, or the ‘income’, you get what is called the ‘assessable income’. But then when you have got the assessable income you are still entitled to have an allowance, and then you arrive at the ‘taxable income’, that is, the amount upon which the subject has to pay tax. There is the total income from all sources, there is that deduction which brings it to the assessable income, and there are those allowances which bring it to the taxable income.66

So much for the provisions of the Finance Act 1920 relating to income tax— but what about super-tax? The 1920 Royal Commission had stated that: We consider that graduation on incomes exceeding £2,000 can best be effected by means of super-tax in addition to the ordinary Income Tax. We consider that that tax should continue in its present form, a tax graduated solely by reference to the amount of the income without other considerations.67

The proposals made by the 1920 Royal Commission for a unified income tax computation were, accordingly, proposals for an income tax computation only: and the enactment of those proposals by the Finance Act 1920 did not, therefore, affect super-tax. In Kennard Davis v CIR68 the taxpayer claimed, among other things, to be entitled to deduct personal reliefs in computing his liability to super-tax—but the Special Commissioners, Sankey J, and the Court of Appeal all held that he was not entitled to do this. So, pausing there, how was the concept of ‘total income’ to be understood for income tax purposes and for super-tax purposes after the enactment of the Finance Act 1920? I stated my opinion, earlier on, that, under

66 67 68

[1922] 2 KB 805, 818; (1922) 8 TC 341, 352. RC, above n. 32, 35 (para. 151 and 152). [1922] 2 KB 805 (Sankey J), [1923] 1 KB 370 (CA); (1922) 8 TC 341.

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the Victorian system of income tax, the ‘total income from all sources’ was the amount of the income on which an individual was to be charged to income tax. So far as income tax was concerned, the expression ‘total income’ was now appropriate to refer to the amount of income required to be brought into account. But the expression ‘total income’ was no longer appropriate to refer to the amount of the income on which an individual was to be charged to income tax: for the expression ‘taxable income’ had been brought into existence to refer to this amount. So far as income tax was concerned, therefore, the type of relationship that had existed between expressions under the Victorian system of income tax had now ceased to exist. So far as super-tax was concerned, however, it is my opinion that the meaning of the expression ‘total income’ remained unaffected by the legislation contained in the Finance Act 1920. It followed that the expression ‘total income’ could accordingly continue to refer to the amount of the income on which an individual was to be charged to tax. In these circumstances, it has to follow, I think on the analysis I have presented that, after the enactment of the Finance Act 1920, the expression ‘total income’ did not have precisely the same meaning for income tax purposes as it did for super-tax purposes. Against this background it is not perhaps altogether surprising that the Report of the Commissioners of Inland Revenue for 1921, in its discussion of the legislative changes made by the Finance Act 1920, provided explanations for the expressions ‘gross income’, ‘actual income’, ‘earned income’, ‘investment income’, ‘assessable income’ and ‘taxable income’—but not for the expression ‘total income’.69 The explanation of the expression ‘total income’ had indeed become intricate—but, as I view the matter, the task was not impossible as long as income tax and super-tax were carefully distinguished.

VI. THE FINANCE ACT 1927

Seven years later this distinction ceased to be possible. The Finance Act 192770 provided that ‘super-tax shall not be charged for the year 1929–30 or any subsequent year’.71 It was considered that the existence of two taxes—the ordinary income tax and the additional duty of income tax known as super-tax—was causing difficulty and confusion to those who had to pay both. The two taxes 69 Sixty fourth Report of the Commissioners of His Majesty’s Inland Revenue for the year ended 31st March, 1921 (HMSO, London, 1922) (Cmd. 1436) 80. 70 17 & 18 Geo. 5 c. 10. 71 S. 38(1) Finance Act 1927 (concluding words).

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were imposed for the same year, but on different bases: so separate returns were necessary. The Finance Act 1927 accordingly contained provisions combining income tax and super-tax into one tax with one basis of assessment, so that a single return of income, made annually, would normally suffice for all purposes. Super-tax (regarded as an additional duty of income tax) was accordingly replaced by surtax (regarded as a deferred instalment of income tax). The relevant changes were made in Part III of the Finance Act 1927, where section 38(1) provided in part that: Income tax for the year 1928–29 and every subsequent year shall, instead of being charged at a single rate, be charged at a standard rate and, in the case of an individual whose total income from all sources exceeds a stated amount, at a rate or rates exceeding the standard rate in respect of any part or parts of his income in excess of that amount . . . .

At this point ‘total income’ was made the concept through which legal expression was given to the underlying conception of income tax as a single graduated tax. A graduated income tax was very different from the income tax reintroduced by Peel; but if income tax was a graduated tax (as it clearly now was) then total income from all sources was now a vital factor in income tax law. It is also at this point that the expression ‘total income’ was first defined in general terms for the purposes of the Inland Revenue’s legislation (on the basis that it is appropriate to describe what was provided as a ‘definition’72). Section 38(2) of the Finance Act 1927 provided that: The expression ‘total income’ in relation to any person means the total income of that person from all sources estimated, as the case may be, either in accordance with the provisions of the Income Tax Acts as they apply to income tax chargeable at the standard rate or in accordance with those provisions as they apply to sur-tax.

It is this provision that is the earliest direct lineal ancestor of the present section 835(1) of the Income and Corporation Taxes Act 1988—the section devoted to ‘“Total income” in the Income Tax Acts’. But if income tax and the former super-tax were to be combined, adjustments would be necessary. And in particular, in the present context, it would be necessary to deal with the earned income allowance and the personal reliefs: for these were available for income tax purposes, but not for

72 There had been an earlier partial definition in s. 15(5) of the Finance Act 1925 (15 & 16 Geo. 5 c. 36). That subsection had provided that ‘In this section the expressions “earned income” and “total income” mean respectively earned income as estimated in accordance with the provisions of the Income Tax Acts and total income from all sources as so estimated.’

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super-tax purposes. And I think that it may be argued that the way in which these matters were handled was less than wholly satisfactory—both in the context of income tax and in the context of surtax. In the context of income tax, it was provided that the earned income allowance and the personal reliefs should be deducted not from the individual’s income, but from the income tax chargeable. The crucial legislative provision in this context was section 40(1) of the 1927 Act which provided that: The enactments set out in Part I of the Fifth Schedule to this Act [being enactments relating, principally, to what we now think of as personal reliefs] in so far as they provide for relief from income tax either by means of a deduction from assessable income or from the amount of earned income or from the amount of total income, shall . . . have effect as if they provided for relief from income tax by means of a deduction from the amount of income tax with which any individual is chargeable equal to tax at the standard rate on the amount of the deduction from income to which he would have been entitled under the said provisions . . . .

The Inland Revenue’s ‘Notes on Clauses’ are not without their Panglossian passages; but in my opinion ‘Notes on Clauses’ for the Finance Bill 1927 contained a better than average Panglossian passage73 in declaring that: The various personal and other allowances which form the basis of the present system of differentiation and graduation of the Income Tax charged at the standard rate, are under the existing law expressed as deductions from income in order finally to arrive at an individual’s ‘taxable income’. Sub-clause (1) of the Clause [i.e. clause 37, enacted as section 40 of the Finance Act 1927] preserves these allowances in their present amounts (with one small exception . . .) but expresses them in terms of tax at the standard rate.74 The present graduation of the tax is thus preserved intact but the change in the manner of expressing the allowances should be simpler for the taxpayer inasmuch as it will eliminate certain technical expressions – ‘assessable income,’ ‘taxable income’—and will certainly help the smooth working of the new scheme.

Despite this optimistic forecast, we, today, may regard the legislative provision actually made in the Finance Act 1927 as incomplete. For although section 40(1) of that Act provided that the enactments set out in Part I of the Fifth Schedule should have effect as if they provided for relief from income tax by means of a deduction from the amount of income tax, the Finance Act 1927 did not go on to make any direct textual amendments to achieve this result. After the enactment of the Finance Act 1927, therefore, 73

Board of Inland Revenue: Finance Bill 1927, ‘Notes on Clauses’, 70A. Ibid., at 65, also took the view that ‘[t]his change . . . should make matters clearer to taxpayers.’ 74

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the legislation in force was designed to operate on the amount of income tax for which a taxpayer was liable, but the relevant statutory text consisted largely of material in the Finance Act 1920 which was expressed to operate on income and not on income tax. It was only when the income tax legislation was next consolidated (in the Income Tax Act 195275) that the appropriate detailed amendments to the statutory text were made. The passage I quoted from ‘Notes on Clauses’ also indicated that the expressions ‘assessable income’ and ‘taxable income’ were to be eliminated. These expressions too were not removed by direct consequential amendments made by the Finance Act 1927; but the references to these expressions disappeared in the Income Tax Act 1952. Immediately before the enactment of the Finance Act 1927, therefore, the expression ‘total income’ existed in the context of income tax: and it was possible to derive help, in ascertaining its meaning, by considering the meaning of the related expressions ‘assessable income’ and ‘taxable income’. In the context of income tax, the Finance Act 1927 retained the expression ‘total income’ with the same meaning as before, but provided for the extinction of the related expressions ‘assessable income’ and ‘taxable income’, whose existence provided valuable help in ascertaining what ‘total income’ meant. So much for the treatment, in the Finance Act 1927, of the expression ‘total income’ in the context of income tax. How about the treatment, in the Finance Act 1927, of the expression ‘total income’ in the context of surtax? The new section 38(2) of the Finance Act 1927 established that this meant the total income of a person from all sources estimated in accordance with the provisions of the Income Tax Acts ‘as they apply to sur-tax’. So how was the ‘total income’ of a person to be estimated in accordance with the provisions of the Income Tax Acts as they applied to surtax? Since surtax could be regarded as the successor to super-tax, an obvious opening hypothesis was that total income for surtax purposes was to be ascertained in the same manner as total income for super-tax purposes had been ascertained earlier. And that, as far as I can see, is how everybody was supposed to act, and how everybody did act. But was the matter as straightforward as this? One important critic of the Finance Act 1927 thought that the situation was much less tidy. The argument ran like this. ‘Total income’ for the purposes of super-tax was to be ‘estimated in the same manner as the total income from all sources is estimated for the purposes of exemptions or abatements under the Income Tax Acts’ (see section 66(2) of the Finance (1909–10) Act 1910): and it was because the computation of ‘total income’ for super-tax purposes was expressed in this way that it became legitimate to examine the material contained in the forms for

75

15 & 16 Geo. 6 & 1 Eliz. 2 c. 10.

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claims for exemption from income tax under the Income Tax Act 1842 (as Scrutton LJ had done in the Earl Howe case76). This linkage had been safely carried forward when the income tax legislation was consolidated in 1918, where the relevant material was to be found in section 5(1) of the Income Tax Act 1918. The problem was that the Finance Act 1927 provided for the repeal of section 5(1) of the Income Tax Act 1918, and did not go on to make any equivalent provision for the purposes of surtax. So, in these circumstances, it became possible to say that the statutory mechanism which underpinned the conclusion that ‘total income’ should be computed in accordance with the same principles for income tax and for surtax was no longer necessarily in existence. And if that was right, then how was ‘total income’ to be calculated for surtax purposes, and (more specifically) could charges on income be deducted? The previous statutory mechanism which had led to the conclusion that charges on income could be deducted was not obviously engaged. And one inference that could safely be drawn from the new section 38(2) of the Finance Act 1927 was that total income for income tax purposes and total income for surtax purposes were capable of being different. As the important critic put the matter, ‘[i]f effect had to be given to these arguments, the resulting confusion would be formidable’.77 And, in particular, if effect had to be given to the proposition that charges on income were not deductible in computing total income for surtax purposes, it would follow that when the Duke of Westminster entered into deeds of covenant in favour of his servants, those deeds were ineffective to reduce the Duke’s total income for surtax purposes—with the further consequence that the decision reached in the Duke of Westminster’s Case78 was wrong. But as the important critic (writing in 1951) felt compelled to conclude: it is thought unlikely that, at the present day, the courts would hold that the line taken in the Duke of Westminster case and other cases as to the computation of total income for surtax purposes was wrong . . . .79

VII. THE INCOME TAX ACT 1952

The important critic I have referred to was Sir John Rowlatt of the Office of Parliamentary Counsel, the son of the High Court Judge who decided 76

[1919] 2 KB 336; (1919) 7 TC 289. See text above n. 19. ‘Income Tax Bill [1951]—Notes on Clauses’ 160. 78 CIR v Duke of Westminster [1936] AC 1; (1935) 19 TC 490. 79 ‘Income Tax Bill [1951]—Notes on Clauses’ 161. The argument presented involves the proposition that the Legislature ‘missed fire’ (as Lord Macmillan put the matter in Ayrshire Employers Mutual Assurance Association Ltd v CIR (1946) 27 TC 331, 347). In my opinion, trends in judicial interpretation over the last half century have further diminished the prospects (such as they ever were) for this argument: see, eg, the speech of Lord Reid in CIR v Luke [1963] AC 557, 577; (1963) 40 TC 630, 646. 77

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many tax cases in the years following the First World War;80 and I view Sir John Rowlatt as a critic of importance because he was the drafter of the next consolidation of the income tax legislation: the Income Tax Act 1952.81 At the time of its enactment, this was the longest Act on the statute book;82 and, in my opinion, the 1952 Act is the most incisive, intellectually, of the four income tax consolidation Acts. The Income Tax Act 1952 was the first leading Act relating to income tax to contain a section relating to ‘total income’. The relevant section was section 524, which had the sidenote ‘Meaning of, and provisions as to, total income’; and Sir John Rowlatt’s ‘Notes on Clauses’ stated that: This clause collects, so far as is possible, the exiguous and unsatisfactory provisions on which the meaning of the words ‘total income’ for income tax purposes rests. The whole position as to this subject is most puzzling but surprisingly few difficulties now arise in practice . . . .83

Section 524 of the Income Tax Act 1952 had five subsections. Of these, subsection (1) contained the definition of ‘total income’, and was derived from section 38(2) of the Finance Act 1927. Subsection (2) contained a direction to observe the rules in Schedule 24 to the 1952 Act: and this subsection may be traced back to section 190 of the 1842 Act.84 Subsection (3) was a provision for attributing income to years of assessment, and was derived from section 39(2) of the Finance Act 1927. Subsection (4) provided that assessments that were final for the purposes of tax at the standard rate for any year of assessment were also final for estimating total income. This subsection was derived, in part, from section 42(4) of the Finance Act 1927; but was also derived, in part, from section 18 of the Income Tax Act 1918, which, in its turn, was derived from section 18 of the Finance Act 1915.85 And, finally, subsection (5) applied subsection (4) for the purpose of estimating total income for surtax purposes in a number of particular contexts. This subsection was derived from a number of sources, but none of these went back further than 1945. So, of the five subsections in the section of the 1952 Act devoted to ‘total income’, only one may be traced back to 1842—and three of the five did not exist at all in 1918, at the time of the previous consolidation of income tax

80 Sir John Rowlatt features in Sir Harold S. Kent, In on the Act: Memoirs of a Lawmaker (Macmillan, London, 1979). 81 15 & 16 Geo. 6 & 1 Eliz. 2 c. 10. 82 When the Income Tax Act 1952 was in Committee Sir John Rowlatt was asked ‘Is it true that this is the longest Bill there has ever been?’ and answered ‘I know of no longer one’. First Report by the Joint Committee . . . upon the Income Tax Bill [1951–52], 44 (Q. 214). 83 ‘Income Tax Bill [1951]–Notes on Clauses’, 133. 84 Schedule 24 to the Income Tax Act 1952 was the descendant of Rule XVII to Schedule (G.) to the Income Tax Act 1842. (See text above preceding n. 19 above, and see now s. 836 of the Income and Corporation Taxes Act 1988.) 85 5 & 6 Geo. 5 c. 62.

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law. But, by 1952, with a section of its own in the leading statute relating to income tax, the concept of total income may be said to have risen, and to be fully developed. VIII. CONCLUSION

The material I have considered appears to me to prompt a further and more general reflection. There are, unquestionably, major features of income tax law that may be traced back to a very early period in the history of the subject—the Schedular system of charging is the obvious feature to mention here. This state of affairs appears capable (to me at least) of leading on to the impression that, just as Athena is supposed to have burst, fully armed, from the head of Zeus, so income tax burst, fully developed, from the head of the younger Pitt (or, as the case may be, Addington). But it is my opinion that this is not the only way—and perhaps not the most illuminating way—to approach the history of income tax law. As in the case of the British Constitution, significant continuities in external form may mask significant changes in internal substance. But if that is right, what changes in particular should we identify, and when in particular did those changes take place? So far as my first question is concerned, the Royal Commission on the Taxation of Profits and Income, in its Second Report, in 1954, provided an answer in no uncertain terms. The Commission declared that: The history of income tax in this country is the history of a change from what was virtually a flat rate tax charged uniformly on all incomes to a progressive tax charged at increasing rates as income increases.86

The concept of ‘total income’ is the concept through which the principle of income tax as a progressive tax is given legal effect. So far as my second question is concerned, Sir Josiah Stamp, speaking in 1919, was of the opinion that ‘[e]ven our own income tax up to fourteen years ago was rather a tax in rem than a tax in persona [sic]’; and he was clearly of the view that, at the time that he was speaking, the personal taxation of income was increasing in importance.87 I commend these sentiments. As I view this matter today, the most illuminating single theme in the history of income tax law in the United Kingdom consists in the transition from what was essentially a flat-rate tax to what is unquestionably a graduated tax. And, so far as that transition is concerned, I take the view that the crucial events took place in the early twentieth century. 86 Royal Commission on the Taxation of Profits and Income (Second Report) (HMSO, London, 1954) (Cmd. 9105) 42 (para. 137). 87 Stamp, above n. 13, 17–24. The passage quoted is at 17.

4 Official Deliberations on Capital Gains Tax 1955–1960 DAVID STOPFORTH

ABSTRACT The second half of the 1950s saw a dramatic rise in the standard of living in the UK and spectacular gains on the stock market, yet there was no tax on the capital gains of speculators or longer term investors. However, the question of taxing such gains was given regular serious official consideration. This chapter uses the 1955 Royal Commission’s views on whether a tax should be imposed on capital gains as the starting point for a review of the official documents of the Treasury and the Inland Revenue on the subject. It examines the motives of those who attempted to introduce a capital gains tax in 1956 and how, after major disagreements, they were eventually thwarted by a lack of readiness on the part of the Inland Revenue. The preparations which took place in anticipation of the introduction of the tax in the 1957 Budget are analysed and the reasons for its rejection are explained, largely by reference to its inability to produce enough revenue to pay for substantial reductions in surtax and estate duty. The Conservatives’ desire to reduce those taxes led to the matter being reconsidered in late 1959, and the chapter scrutinises the strong views for and against taking action and the Revenue’s continued resistance. However, in 1960 it was decided to deal with specific avoidance schemes designed to convert trading income into tax-free capital profit, but only because of the political dangers of failing to act.

1. INTRODUCTION

A

begins by reviewing what was said in June 1955 about a possible capital gains tax (CGT) by the Royal Commission on the Taxation of Profits and Income, the subject had already been considered many times by governments of both hues.1 In 1946, at the LTHOUGH THIS CHAPTER

1 For a review of the period before 1955, see D. Stopforth, ‘Deliberations over Taxing Capital Gains—The Position Up to 1955’ in J. Tiley (ed.), Studies in the History of Tax Law (Hart Publishing, Oxford, 2004).

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behest of the Chancellor, the Inland Revenue had formed an internal group to consider how a CGT could be implemented, and used the United States system as a model to study. Their report put forward such a negative view of the practical problems of bringing in the tax that the matter was eventually dropped. However, that report became the basis of all subsequent papers put to the many Chancellors who raised the possibility of introducing the tax. The Revenue continued its resistance, even when reports of high-profile cases of large tax free capital profits on takeover bids became common. Consequently, it might be thought that when, in 1955, the majority of the Royal Commission reported that they did not favour the taxation of capital gains, the matter would be closed, at least for a few years. However, this was not to be the case and the subject was frequently returned to by Chancellors before a full CGT was finally introduced ten years later. This chapter reviews the official documents covering only the first five years of that period as, in June 1960, the events directly leading to the introduction of a limited tax on short-term capital gains in 1962 began. The background to that tax warrants its own chapter.

2. THE FINAL REPORT OF THE ROYAL COMMISSION 2

The Royal Commission’s terms of reference did not specifically include the consideration of a capital gains tax, but, in response to a request for clarification, the Labour Chancellor of the Exchequer (Gaitskell) stated in February 1951 that it was entitled to explore the question of charging income tax or profits tax on any capital profits.3 This was interpreted to mean that they should consider whether capital gains should be brought within the scope of income tax, even if gains would perhaps be excluded from the normal impact of progressive tax rates.4 To assist them in their enquiries they requested a paper from the Inland Revenue stating what the Board’s views were on the question of taxing capital gains and what revenue might be expected from doing so. The Board’s detailed paper not only reviewed the policy arguments for and against taxing capital gains, but also outlined a possible scheme of taxing them and the practical consequences for the Revenue, taxpayers and tax practitioners. It even went so far as to provide brief descriptions of the system for taxing capital gains in the USA and in eight European countries. The Revenue’s summary sets out the ten main points of its paper, and all but one of them

2

Cmd. 9474, June 1955. Ibid., at para. 80. Labour lost the Oct. 1951 election and the Conservatives came into power for the following 13 years. 4 Ibid., para. 81. 3

Official Deliberations on CGT: 1955–1960 121 is either entirely negative towards taxing capital gains or contains a hedged positive statement followed by a negative rider.5 The Revenue’s negative views were reflected in the Report of the Majority of the Commission who concluded that they could not safely attach any weight to the economic arguments advanced in favour of the tax and that it would possibly create a serious disincentive to private saving.6 They believed that such a tax would not correct any inequity between different taxpayers as it would probably create at least as many inequities as it would remove.7 It was not just these principles which persuaded them to reject the tax but also the practical problems such as the extra staffing required and the need to relieve reinvestment and provide exemptions for specific classes of assets such as the main residence. Furthermore, it was emphasised that the yield would be highly variable and the tax would have adverse knock-on effects on other taxes, particularly estate duty. However, immediately following the outright rejection of a tax on capital gains, the Majority Report went on to consider whether the distinction between capital profits and revenue profits rested on a satisfactory basis. It concluded that it did not as there was a lack of uniformity in the decisions on similar cases which depended upon which tribunal had considered them. This led to it putting forward the now famous ‘badges of trade’ to help distinguish between capital profits and income profits.8 In seeking an objective test of a profit motive which would lead to an income tax charge, it considered suggesting a rule which would treat any profit to be income if it arose from a realisation made within some fixed period of acquisition. However, believing such a fixed rule had drawbacks which outweighed its advantages, it concluded that there should be no single fixed rule of that type.9 With two union leaders (Woodcock and Bullock) and a Labour sympathising economist (Nicholas Kaldor) as members of the Royal Commission, it is not surprising that there was a Minority Report. These three were completely unable to agree with the views of the others on capital gains and produced a refutation of each of their main arguments. Furthermore, they pointed out the significance of the omission of capital profits from taxation in creating many opportunities for tax avoidance, illustrating their views with real world examples and concluding that ‘so long as capital gains remain exempt . . . it is impossible to deal with . . . the conversion of income into capital gains in all its possible forms by specific pieces of legislation’.10

5 6 7 8 9 10

See the annex to Ch. 2 of the Minority Report of the Royal Commission at pp. 425–464. Ibid., at para. 107. Ibid., at para. 99. Ibid., at para. 116. Ibid., at paras 114–116. Ibid., at para. 47.

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Kaldor was clearly behind the criticism of the Revenue’s estimate of the yield of the tax, believing it to be understated by a factor of between four and seven. In contrast, the majority view was that it was impossible to make a clear estimate of yield, and that even the Revenue’s figures were speculative, particularly as so much depended on the eventual structure of the tax. Much of the Revenue’s resistance to taxing capital gains was based upon complexity and administrative problems, points dismissed by the Minority Report on the ground that, as so many countries had such a tax, the problems were not so formidable as sometimes suggested and were certainly not beyond an efficient tax administration.11 Given the views of the majority, and the fact that the Minority Report was produced by those from the other end of the political spectrum from the Conservative government, it might be thought that the taxation of capital gains was a matter which would be laid to rest awaiting a future Labour government. Surprisingly, this was not the case.

3. THE MACMILLAN REVIEW

Despite the resounding rejection of a tax on capital gains by the majority of the Royal Commission, Harold Macmillan, in his new appointment as Chancellor of the Exchequer, began 1956 with a series of memoranda to Sir Edward Bridges, the Permanent Secretary to the Treasury, entitled ‘First Thoughts from a Treasury Window’,12 and one such thought was that ‘we should be in a position to consider capital gains tax, pros and cons and practicability’.13 Although the 60 per cent real growth in equities over the three years to the end of 1955 may have been on the Chancellor’s mind (see Appendix), he appears to have been prompted by a paper from the Revenue giving its preliminary views on the Royal Commission’s Reports.14 This repeated the broad arguments for and against such a tax in the Minority Report but warned that, if it was a starter, the pros and cons of policy ought to be looked at well in advance. The Revenue’s response to the Chancellor’s initial musings was a short paper for the Budget Committee. It records that CGT ‘has strong appeal from the point of view of social equity . . . [where] capital gains are the main form of accretion to wealth which go free of charge’15 and that the greatest sense of injustice arose from Stock Exchange investments, land transactions and the sale of shares in close companies whose accumulated

11 12 13 14 15

Ibid., at para. 70. PRO IR63/203, 18–29. Ibid., at 28. Ibid., at 58–59. PRO T171/471, at Part 13.

Official Deliberations on CGT: 1955–1960 123 profits had not borne surtax. The Revenue stated that taxing capital gains, which ‘are disliked by the workers’,16 might help induce organised labour to join a fight against inflation. However, it considered the arguments against the tax to be ‘very strong’,17 as it would be politically controversial and be an addition to the tax code ‘in a field in which little previous experience exists’.18 Added to this, the Committee was warned of the length and complexity of the legislation required and the many anomalies which would be discovered and require correction in later Finance Acts. The Budget Committee discussions indicate uncertainty over what to advise the Chancellor other than that it would be very risky to announce approval of the tax in principle before a thorough investigation of the implications and workings of it had been carried out. It was decided to report this to the Chancellor and to emphasise that, even though there might be political advantages and a good case in equity for such a tax, the revenue raised would be small in relation to the administrative complexity involved.19 The Chancellor appears to have been unimpressed with this lack of clear guidance and wrote to the Financial Secretary (Henry Brooke), the Economic Secretary (Sir Edward Boyle) and the Permanent Secretary to the Treasury (Sir Edward Bridges) in the following terms: 1. Whatever decision we want to make on this, we must be in a position to make one at all. 2. Time presses. The Inland Revenue paper is very complicated. We want something far simpler. 3. I would like you to look at this and report to me urgently what can be done.20

The Economic Secretary responded the same day and was in favour of taxing capital gains, finding the arguments of the Minority Report ‘most convincing’.21 He supported the principle that it was reasonable and equitable that capital gains should be taxed because they increased the capacity to spend or save. But there were four other specific reasons which he thought merited giving the tax serious consideration. First, he estimated that although over the two years ending December 1955 the total price inflation had been just over 10 per cent and wage inflation only slightly higher, there had been a bull market in equity shares under which real values had increased by over 40 per cent in 1954, with a further sharp appreciation between April and July 1955. (The actual figures are in the Appendix.) He also brought to the Chancellor’s attention the fact that the dividends paid

16 17 18 19 20 21

Ibid., at para. 4. Ibid., at para. 6. Ibid., at para. 7. PRO T171/469 at BC 56, 2nd meeting, 19 Jan. 1956. PRO T172/2127. 23 Jan. 1956. PRO T171/471.

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during 1955 by the 2,838 companies for which details were held had been increased by an average of 21 per cent. Accordingly, he believed that ‘the disparity between the position of equity shareholders and that of the professional and salaried classes and—more especially—those who live on small incomes’22 was beginning to be felt rather keenly irrespective of trade union opinion. In effect, he thought that there were many middle class Conservative voters who would favour the introduction of a capital gains tax. His second reason was that as ‘all political parties . . . are committed to the basic idea of an expansionist economy, shares in growth stocks are virtually certain to secure fairly substantial capital gains over a period of years’.23 Thus, as the government had deliberately fostered this expansion by incentivising increased investment, any capital gains were to a considerable extent the result of economic policy, and he believed it was therefore reasonable that the resulting gains should be subject to tax. The third reason was ‘the familiar point about the connection between capital gains and tax avoidance’.24 In support, he quoted extensively from the Minority Report and referred to his own practical experience of such avoidance when he managed the affairs of a small family investment trust. Finally, he argued that a capital gains tax would help in the battle against inflation by restraining consumer demand, and again quoted the Minority Report to support his views. However, he was unsure of the psychological effect of the tax on the trade unions, but thought it would be minimal ‘unless we do the job properly and unless we give the impression that we really believe in it as a matter of equity between one class of taxpayers and another’.25 Even though he foresaw the practical difficulties of extra pressure on the Inland Revenue and a long complicated Finance Bill, he believed that such a tax would create considerable support for the government and make it politically easier ‘to make highly desirable adjustments in the incidence of our progressive tax system as and when economic circumstances allow’.26 He saw it as an important policy decision which would ‘certainly cause a major sensation . . . but I still feel it is one we should take’.27 Treasury officials were much more cautious as they were unsure about the economic effects of such a tax. The bulk of their paper focused on the Chancellor’s request to have a far simpler tax than the Revenue had put forward. However, they could find nothing which would be simple without causing serious anomalies and difficulties and leaving a situation

22 23 24 25 26 27

Ibid. Ibid. Ibid. Ibid. Ibid. Ibid.

Official Deliberations on CGT: 1955–1960 125 where ‘the ingenious would very soon be driving a coach and four through the simple scheme’.28 They concluded that ‘a good deal of work would have to be done before a minimum scheme could be ready . . . and the problems involved are so difficult and important that we ought not to commit ourselves . . . until we are in sight of solving them’.29 With such a disparity of opinions, one might have expected major disagreements at the next Budget Committee. However, in the absence of the Economic Secretary who so strongly favoured the tax, the Chairman of the Board of Inland Revenue (Sir Henry Hancock) managed to get the upper hand. Although the Economic Adviser to the Government (Sir Robert Hall30) favoured the tax as it would relieve the pressure of inflation, the minutes record an attack by Hancock on all the major points in favour of its introduction. Hall’s diaries show that more than a week before this meeting he had grave concerns as he expected there to be ‘violent arguments about a capital gains tax [as] Hancock . . . has almost moral objections or says he has’. 31 First, Hancock argued that it would be unwise to introduce a new tax which was likely to raise only some £40m to £60m a year in six to eight years from the date of its introduction. Secondly, he doubted that the tax would curb inflation or restrain stock exchange booms, and thought it would have a placating effect on trade unions for only a short period of time. Next, he pointed out that although there might be some merit in the social equity argument, the tax would have a depressing effect on initiative. Finally, there were the administrative objections, He estimated that 500 skilled staff would be required, and a further 300 clerks would be needed to administer capital gains tax. Although the full impact of the additional work would not be felt until 15 months after its introduction, nobody could see how recruitment and training could be speeded up in such a dramatic fashion as to cause no adverse effects in other areas of activity. A particular area of sacrifice which Hancock had in mind was the collection of back duty, where he estimated both a loss of £20m a year and a long-term effect on taxpayer compliance. Given the staffing difficulties, Hancock had been advised by his Chief Inspector of Taxes that he would need three years’ notice to bring in an effective scheme, and advised that ‘intensive work

28

PRO T172/2127, 25 Jan. 1956. Ibid., at para. 6. 30 Hall is described by Macmillan as ‘our tame economist’ who is ‘very inarticulate—even on paper’, a point which he found not altogether a disadvantage. However, he did at least ‘find him sensible’ and not prone to being dogmatic: P. Catterall (ed.), The Macmillan Diaries, The Cabinet Years 1950–1957 (Macmillan, London, 2003), 523. 31 A. Cairncross (ed.), The Robert Hall Diaries 1954–61. (Unwin Hyman, London, 1991), 58. Hall also records that he does not think he will get on very well with Hancock as he ‘rather fancies himself as an economist and puts forward arguments that I don’t think hold water at all’(58). 29

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would have to be done by a small expert team and someone should visit the United States to find out how the tax was administered there’.32 Hall records the meeting and his views on Hancock in his diary: We have also had a lot of argument about a capital gains tax. Hancock is very much against it, it seems to me mainly for emotional reasons. He is ‘an ultraConservative type, reasonably intelligent [but] using his brain to support what he thought politically desirable.33

The following day the Chancellor met senior officials to discuss the practical difficulties of legislating on capital gains tax in time for the Finance Bill 1956. He ruled it out as being inadvisable, given the need to examine at close quarters how the US system worked before dealing with the drafting of the many clauses required, even if only stocks, shares, land and the sale of businesses were to be included. Also relevant to this decision were the reduction in the collection of back duty as a result of reallocating inspectors to a new tax and the then current high price of equities. Despite all of the above, the Chancellor still thought ‘there was a very strong political case for some action on the capital gains front to redress to some extent the impact of the other measures which he had in mind . . . . He [wanted] to do something to help the managerial class—as for example by extending the earned income relief above £2,000 a year, [which would] be extremely difficult to do if one could not throw in something to please working class opinion’.34 Although discussion took place about whether there could be preliminary legislation in 1956, followed by detailed legislation in 1957, this idea was dismissed because of the pressure which would develop for exemption from various quarters. There was no clear decision on what to do until Hall wrote to the Chancellor after the above meeting to urge that detailed studies should be made of the drafting and administrative problems so that Ministers were not precluded from introducing such a tax in future merely because of the time factor. Whilst supporting the tax in principle, despite the expected yield being small, he had an ulterior motive: I think that it is very desirable to reduce the level of surtax, especially on earned incomes. It is very difficult to do this from a political point of view unless either expensive concessions are made to lower incomes, or some tax is imposed which seems to be against the rich. A capital gains tax is ideal as appearing to be against the rich, and I think could be combined with some surtax operation . . . with great economic advantage.35

32 The Committee therefore recommended to the Chancellor that this should be done and that a capital gains tax should not be rushed into if and when it was to be introduced. 33 Cairncross, above n. 31, 58 and 165. 34 PRO T172/2127, 27 Jan. 1956. 35 PRO T171/471, 31 Jan. 1956, Robert Hall.

Official Deliberations on CGT: 1955–1960 127 The Economic Secretary recorded his strong agreement with the above views and the Chancellor merely noted ‘I agree’.36 At last, after almost a month of prevarication, a decision on how to proceed had been made. The Revenue was asked to begin a study of the technical and administrative problems of introducing capital gains tax so that in June it could provide Ministers with everything necessary to enable them to go ahead next year if they decided to do so.37 Given that Revenue officials would be actively involved in the Budget and Finance Bill over this period, the Chancellor agreed to their request to extend the time limit to September or October provided the preparatory work was completed in time for the 1957 Budget.

4. A MEDDLING PRIME MINISTER

Just when everything seemed settled, the Prime Minister (Eden) met the Chancellor privately and suggested his own package of measures for the forthcoming 1956 Budget. What he proposed was a meeting between himself and the TUC in a further effort to secure its co-operation in a policy of wage restraint which he would link to the immediate introduction of a capital gains tax. This would, he thought, help deflect criticism over the decision to remove the bread and milk subsidies and to increase the Bank Rate, both of which would be relatively more painful for the less well–off. Not for the first time, the two individuals had clashed over Eden’s interfering style38 and the Chancellor felt it necessary to put his views in writing so that there would be no misunderstanding. He explained that ‘your proposed package will not do’,39 and went on to describe how he had already looked at capital gains tax ‘with exactly the same purpose as is in your mind—with a view not so much to its positive results in terms of revenue but to its effect as a gesture or flag’.40 The practical and administrative reasons for not going ahead were set out for the Prime Minister, and the Chancellor warned that charging gains at the standard rate of income tax, as suggested in the Minority Report, was hardly practical politics. He was thinking in terms of something like a quarter or a third of the standard rate.

36

Ibid. PRO T171/471, Vol. 3, Part 13e, 2 Feb. 1956. 38 Macmillan had found Eden’s interference when he was Foreign Secretary to be infuriating and was bitterly resentful of being moved to the post of Chancellor. He resisted for over two months by laying down terms and conditions to ensure he would serve with considerable independence. See A. Horne, Macmillan: Volume I of the Official Biography (Macmillan, London, 1989) 371–380. 39 PRO T172/2127, 13 Feb. 1956. 40 Ibid. 37

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Macmillan clearly resented the Prime Minister’s interference and firmly but politely rejected his package, while attempting to draw the sting by bringing to his attention that we are ‘even sending our people to America so as to be ready for such a system should we wish to adopt it next year’.41 With no CGT, Eden would not back off. He insisted that the food subsidies should remain. This led to an even wider split between them, with an eventual compromise over the subsidies negotiated by intermediaries who carried messages between the Chancellor, who threatened to resign, and Eden, who avoided speaking to him.42

5. RUNNING OUT OF STEAM

With a Prime Minister in favour of introducing a capital gains tax and a Chancellor who could see considerable political advantages in doing so, it seemed that once the Revenue had completed its investigations there was a very high probability of its introduction in the 1957 Budget. As is shown below, the decision not to go ahead seems to have been heavily influenced by the Revenue. With direct authority from the Chancellor, a senior Revenue official visited the USA in the summer of 1956 to meet his counterparts so that he could closely examine the detailed workings of their system of taxing capital gains. The Budget Committee had already agreed that the Revenue would make a submission to the Chancellor on this subject,43 but the official had collected a great deal of material and was reluctant to produce the submission until October as he wished to analyse the material and do a thorough job. The Treasury did not think this further delay mattered unless it prejudiced the introduction of the tax in 1957.44 Shortly before the Revenue’s report was produced, the Treasury wrote to the Economic Secretary and to the Chancellor pressing upon them the need for tax reductions: If . . . CGT is the political price . . . for really substantial reductions in income tax (at surtax levels too) and in estate duty, I would not rule it out, though I think that the new tax would be heavily criticised.45

The Chancellor agreed and wanted ‘the possibility of a CGT to compensate for a substantial reduction in estate duty . . . examined’.46

41 42 43 44 45 46

Ibid. Catterall, above n. 30, 528, 20 Jan. 1956 and 536–537, 14 and 15 Feb. 1956. PRO T172/2127, 26 July 1956. Ibid., Memorandum to Sir Edward Bridges, 22 Aug. 1956. PRO IR63/205 at 45, Henry Brooke. Ibid., at 42.

Official Deliberations on CGT: 1955–1960 129 The exact contents of the Revenue report could not be found in the Public Record Office files.47 However, its contents are referred to in other memoranda which show that it set out the pros and cons of a capital gains tax, an explanation of the United States system and a possible scheme for operation in the UK. The Revenue went on to suggest a tax rate of 25per cent which it estimated would produce a long term average yield of £30m a year (with fluctuations between nil and £150m), but concluded by emphasising that the decision to go ahead was essentially a political one.48 Importantly, consideration of a capital gains tax was linked with another memorandum from the Revenue on income tax and estate duty and ‘no decisions can be taken until we know what room, if any, there is going to be for tax reductions’.49 The issue was considered at a meeting in the Chancellor’s room on 2 January 1957, when the Chairman of the Board of Inland Revenue reiterated that, although such a tax was feasible, it would require a major effort with very little return. He emphasised that there would be no revenue for about two years, and thereafter it would be approximately £30m a year if death were regarded as an occasion of charge and £20m a year if it were not. Furthermore, he stated that it would be extremely difficult to have everything in place to introduce such a tax in the 1957 Budget. The minutes of the meeting record the Chancellor’s conclusion that there should be no CGT and do not indicate that he wished any further consideration of the matter. Within a few days of his decision, Macmillan replaced Eden as Prime Minister and the new Chancellor, Thorneycroft, was provided with a briefing by the Treasury which reported upon his predecessor’s decision not to introduce a capital gains tax. It went on to advise: The most appropriate occasion . . . would be in a Budget . . . to effect other changes which . . . were politically difficult. It does not seem likely that this year’s Budget will provide such an opportunity. There is also the practical obstacle that . . . many months of intensive work are needed . . . and [it is] impossible . . . by April.50

The new Chancellor agreed that it would be inappropriate, even if were practically feasible, to proceed with a capital gains tax in the forthcoming Budget. He instructed that ‘there was at present no need to reach any conclusion of principle on the merits of such a tax’.51 The matter was for the

47 The files merely state that the Revenue notes on CGT are not bound in the library copy. The relevant memorandum is M165, but despite checking related files and subsequent Finance Bill files the writer could not find it. 48 BC/57/03 Part A, Nov. 1956. 49 Ibid. Memorandum to Sir Roger Makins (Joint Permanent Secretary of the Treasury), 20 Nov. 1956. 50 PRO IR63/205, 46. 51 Ibid. at 54.

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time being laid to rest. However, the Revenue’s efforts were not wasted as it had accumulated a reasonable degree of expertise on the subject and had worked out a broad outline of how a capital gains tax would operate in the UK. It was to be a few years before it would need to revisit the subject, as the next two sets of Budget papers indicate that the tax was not even on the agenda. Even the TUC submission to the Chancellor in February 1958 does not mention the taxation of capital gains, as it had done the year before.52 Perhaps the collapse in the price of quoted UK equities in 1956 and 1957 had taken the pressure off. However, that was about to change.

6. A PROBLEM THAT WOULD NOT GO AWAY

The 18 months up to October 1959 had seen spectacular returns of almost 100per cent on the UK stock market. Macmillan’s statement two years earlier that the British public had never had it so good clearly had much merit and helps explain why, in October 1959, the Conservatives won power for a third time with an overall majority of 100 seats. There seemed to be little political need for them to introduce a capital gains tax, but the subject came up yet again. Amory, the Chancellor, asked his outgoing Financial Secretary (Simon) for his suggestions on the shape of the 1960 Budget. The response he got made it clear that there could be no total remission of revenue and that a major reform of taxation should be the main theme. What he had in mind was ‘mitigation of the present penal rates of surtax and estate duty [which] should if possible, for electoral reasons, be carried through in the first session of Parliament’.53 However, the political dangers in going ahead were made clear: It is highly desirable to give no colour to the image which the Opposition seeks to paint of the Government as the friends exclusively of tycoons, speculators and very rich men: indeed it would be desirable to take vigorous steps to counter such an image. Therefore, no concession to the wealthier sections of the community should be isolated or unmitigated.54

His paper goes on to explain how to reach the desired objective in startlingly plain terms. . . . . it will be extraordinarily difficult to give the required relief in the surtax burden . . . unless accompanied by some attempt to tax at least short term speculative gains. So long as we stand out against this, we will increasingly be stigmatised

52 53 54

PRO IR63/207. PRO T171/506. Sir Jocelyn Simon to Amory, 21Oct. 1959. Ibid.

Official Deliberations on CGT: 1955–1960 131 (however unfairly) as the friend of the speculator and the shady financier. The ordinary working man cannot understand why his overtime earnings should attract the full standard rate of tax while successful stock exchange speculation should escape tax free.55

He saw particular advantages in a Conservative government bringing in a scheme to tax short term gains as ‘we can write into it provisions to ensure that it is fair [and] which it will be difficult for any subsequent government to eradicate.’56 What he suggested was a generous system for setting off capital losses, the removal of any inflationary gains from charge and a reduction of any gains arising as a result of a fall in interest rates. Long-term gains were to be left alone, but gains made within a five-year period were to be taxed on a sliding scale. He wanted to see the revenue raised ‘dedicated to reduction of surtax . . . [as] it is the only likely manner of getting surtax rates down’.57 He believed that such action was ‘consonant with true Tory principles . . . [and] should go far to making our tax code fairer . . . and to taking all the sting out of Socialist propaganda on this front’.58 The new Financial Secretary enthusiastically supported his predecessor’s suggestions, having long felt that there were sound economic and social arguments for such a tax. However, in its political aspects he warned that it ‘would meet with deep hostility from a considerable number of Conservative backbenchers’.59 The government’s Economic Adviser also pitched in to support the introduction of a capital gains tax. He pointed out that ‘all the books now . . . explain how to turn what would normally be income into a capital gain’ and ‘there is a sort of class barrier among . . . senior employees between those who can supplement their income from capital and those who cannot’.60 He also took the view that the retention of profits within a business after paying a relatively low flat rate of tax which could then effectively be received as a tax free capital gain was ‘a very important psychological factor in wage negotiations’ so that ‘if we have a capital gains tax, we could be much more positive in arguing with the unions that profits were already dealt with through the tax system’.61 At the same time as requesting the paper from the former Financial Secretary, the Chancellor asked the Revenue to consider whether some capital gains could be taxed by treating them as income. The Revenue’s

55 56 57 58 59 60 61

Ibid. Ibid. Ibid. Ibid. PRO T171/506, Sir E Boyle to Amory, 29 Oct. 1959. PRO T171/506, Sir R Hall to Mr Bell, 12 Nov. 1959. Ibid.

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response62 was that it would not be practicable to deal with capital gains by extending the conception of income, and that it would be necessary to devise a scheme specifically to tax capital gains and then have some restriction on its scope. It suggested that it might be confined to stocks, shares and business assets, or that some arbitrary time limit should be set within which there would be a presumption that the taxpayer was operating with a profit-seeking motive and so make a trading profit. A very narrow proposal to limit the tax to gains derived by financiers engaging in takeover operations was said to be too complicated and difficult to operate. Despite the Revenue’s misgivings, the Chairman of the Board of Inland Revenue admitted at a meeting with ministers that ‘if a Government wishes to bring in a capital gains tax, then the Revenue would just have to get on with it, and that would be that’,63 notwithstanding the extra burden on overloaded staff and the great many specialists who would be diverted from the more remunerative investigation of back duty. It seems the Chancellor was persuaded not to act by the Revenue’s difficulties, but he did ask it to reconsider the possibility of taxing profits made as a result of takeover bids. It came back to him with a paper covering the much wider field of transactions which it believed to be of a trading nature but which were being carried out in such a way that the profits emerged in a capital form.64 The most basic type of transaction was isolated purchases and sales of real property through separate investment holding companies which were required to carry profits on investments to capital account and were debarred from distributing those profits by way of dividend. The fact that the individuals behind the companies would have been engaged in dealing did not mean that the companies they set up must also be dealers, even if they held property derived from those individuals. The Revenue had reviewed this whole area and found that considerable amounts of tax were being lost and that a more subtle device had evolved which was more difficult to attack under the current law. In its most simple form, a building company was formed to construct, say, a block of offices which, once completed, was not sold. The shareholders accessed the company’s profit by selling their shares to a company looking for investment, often an insurance company. The Revenue admitted that it had no firm information about the extent to which this device was being used, but thought it was probably widespread as Counsel for a taxpayer had mentioned in a chat with Revenue Counsel on another matter that he was surprised that no action had been taken against it.

62 63 64

PRO T171/506 M254, Johnstone to Amory, 21 Oct. 1959. PRO T171/506, 29 Oct. 1959. PRO IR63/211, 277–282, 23 Feb. 1960.

Official Deliberations on CGT: 1955–1960 133 The scheme had been taken even further by arranging for the building company to sell its properties to a dealing company at a price which would result in no trading profit to the seller. The dealing company would simultaneously acquire the shares in the building company for an inflated price, so creating a tax-free capital gain for the shareholders. The dealing company would then write down the value of the shares acquired to the amount that the building company had been paid for its property, and the resultant dealing loss would be available to set off against the profit made on selling on the properties it had bought. By such means, tax-free capital profits were being received without any corresponding trading profit being charged. The Revenue had also discovered similar devices which were ‘frequently used to put taxable profits on the capital side of the line . . . based on transactions between dealing and investment companies . . . under common control’,65 and had also brought to light a device which combined various elements of the other schemes. When compared to all these devices, the profits of takeover bidders did not, in the Revenue’s view, amount to a serious problem and would in any event be caught by its proposals to counter the other schemes. The Revenue told the Chancellor that ‘the only comprehensive remedy . . . is a general tax on capital gains [which] we assume is not a starter at present’.66 What it suggested instead was specific anti-avoidance provisions under which: — shareholders would be liable on an amount equal to a proportion of the price received for their shares as if the company had sold its trading assets in the normal way and paid out a dividend. — an investment company acquiring an asset from an associated dealing company would be liable to tax on any profits derived from the sale of that asset and conversely any profit which an investment company derived from selling an asset to an associated dealing company would be subject to tax. — a combination of devices would also be caught.

As the Financial Secretary told the Chancellor in his comments on the Revenue’s paper: now that the Inland Revenue have brought these highly significant instances of tax avoidance to our notice, we quite obviously cannot leave matters as they are. Nobody in the House of Commons is going publicly to defend the kind of practices described . . . and I should have thought that we have no alternative but to legislate on the lines the Inland Revenue propose.67

As a result, the legislation went ahead in the form the Revenue suggested.68 65 66 67 68

Ibid., 279. PRO IR63/211, 23 Feb. 1960. PRO IR63/211, 283, 24 Feb. 1960. Ss. 21–26 FA 1960.

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Even these provisions were a long way short of having a full capital gains tax, but as the Financial Secretary said: An interesting point is that we have here an instance where you cannot legislate against tax avoidance without, in effect, introducing a sort of capital gains tax over a limited part of the field. This does not scare me very much—indeed I think there will be numerous advantages, both practical and political, in edging our way into the capital gains tax field by tackling instances of tax avoidance that are obviously indefensible. 69

The flaw in the tax system caused by not taxing capital profits was to create problems which were never going to go away until a full scale capital gains tax was introduced. A Conservative government was only going to creep towards a resolution.

7. CONCLUSION

One of the consistent themes of this period is the desire to reduce the burden of surtax and estate duty and to use a tax on capital gains both to produce the revenue to do so and to help deflect any political criticism. The reality is clear: the intention was to take additional tax from the wealthy and to give it back to those with high incomes through surtax reductions. Another recurrent theme is the publicity being given to the large tax-free profits of speculators and those involved in takeover bids. Economic success and the spectacular performance of the stock market were only exacerbating the problem and magnifying the feeling of those with no capital that they were not obtaining a fair share of the increased prosperity. A capital gains tax was very much seen as a price for obtaining industrial peace and wage restraint in a period where the number of days lost due to industrial disputes was at its highest for almost 30 years and the number of individual stoppages was at unprecedented levels. A major stumbling block was the continued Revenue argument that it did not have enough staff to cope with a capital gains tax, so that the far more lucrative back duty work would suffer if it were introduced. There seems to have been no effort to get over this barrier, as the official papers show no indication of any discussions on how to resolve the staffing issue. These staffing considerations, combined with the expected relatively low yield and the predicted enormous complexity of the legislation, led those Chancellors who were very close to introducing a capital gains tax to back off. Only when specific avoidance schemes had reached the point of being likely to

69

Ibid.

Official Deliberations on CGT: 1955–1960 135 cause major political embarrassment did the government feel obliged to act, and then only to block the specific schemes involved. Dealing with the fundamental flaws in the system created by having high taxes on income and no tax on capital gains was always just one step too far. As Macmillan famously said of the second half of the 1950s, ‘most of our people have never had it so good’,70 but in the absence of a tax on capital gains some never had it as good as others. On the retirement of the Chancellor (Amory) in 1960, he and his Treasury Ministers (Anthony Barber and Sir E. Boyle) and Senior Treasury Officials (Hall, Lee and Padmore) met for a farewell lunch. Hall records that it ‘was technical and professional to the end as we talked most of the time about how long it would take to educate the Conservative Party to accept a capital gains tax’.71 They never did fully learn that lesson, but did bring in a limited tax on short-term capital gains in 1962. It was to be a further three years before a newly elected Labour government introduced a fully comprehensive capital gains tax in 1965. APPENDIX UK EQUITY REAL RETURNS Year

Value

1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960

7.4 -3.1 -6.1 22.9 42.9 4.8 -11.7 -5.5 45.2 54.8 -0.1

Source: Barclays Capital Gilt—Equity Study, available at www.barcap.com/eqs/. Note: real geometric average annualised percentages.

70 71

Speech to a Conservative rally in Bedford, 20 July 1957. Cairncross, above n. 31 pp. 241–242.

5 Excess Profits Tax Litigation PHILIP RIDD

ABSTRACT War generates additional spending, which has to be funded by the Exchequer. It is well known that the Napoleonic Wars were responsible for the invention of Income Tax in 1799. Other major wars have also spawned new taxes. In the First World War Excess Profits Duty was created, and it produced a quarter of the total wartime tax revenue. It is therefore not surprising that Excess Profits came to mind as the Second World War approached. The financing of hostilities was prefaced by the imposition in 1937 of the National Defence Contribution (later Profits Tax) and by the introduction in early 1939 of Armaments Profits Duty. Excess Profits Tax came in under the Finance (No.2) Act 1939. The Armaments Profits Duty was repealed before any duty had been assessed, but the National Defence Contribution survived the introduction of Excess Profits Tax, with the taxpayer having to pay whichever of those two impositions produced the higher liability. Wartime conditions also have their effects on the workload of the Courts of Justice.The purpose of this chapter is to present an epitome of the case law to which Excess Profits Tax gave rise. In the period 1939–1946, to which Excess Profits Tax related, there were various books and other publications concerning the tax, and the early case law received some coverage. Relatively little was published after the repeal of the tax in 1945, but the case law continued to accumulate until 1961. This chapter may well represent a first attempt to gather up all that case law and see how Excess Profits Tax fared in the courts. The aim of the chapter is to give a flavour, rather than an exhaustive analysis, of the cases, with a view to stimulating interest in the topic on its own account, and to demonstrating, if to an exiguous extent, that the case law has a lingering relevance, particularly for Income Tax. I. INTRODUCTION

I

chapter of Three Men on the Bummel, first published in 1900, Jerome K. Jerome examined the character of the German people. He remarked that ‘their everlasting teaching is duty’, and went on to

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describe their idea of duty as ‘blind obedience to everything in buttons’. He continued, ‘[h]itherto, the German has had the blessed fortune to be exceptionally well governed; if this continues, it will go well with him. When his troubles will begin will be when by any chance something goes wrong with the governing machine.’ Wise words, indeed. The author then completed his paragraph with a note of optimism, viz. ‘[b]ut maybe his method has the advantage of producing a continuous supply of good governors; it would certainly seem so’. Sadly the history of the next 45 years showed that Jerome’s wisdom of warning was not matched by an accuracy of prophecy. In a previous piece the writer sketched the workings of the Excess Profits Duty of the First World War against the decided cases (171) which it spawned. This chapter will now attempt the same task in respect of the Excess Profits Tax (‘EPT’) of the Second World War. Some 117 EPT cases have been discovered, nearly all of them in either Tax Cases or Annotated Tax Cases. The paper will examine them under various headings and subheadings, though some of them in fact relate, as will be indicated, to more than one heading or sub-heading. Except where otherwise stated, statutory references are to the Finance (No.2) Act 1939. First, however, this introduction will close with a thumbnail sketch of the background and of how EPT worked. The financing of hostilities had been prefaced by the imposition in 1937 of the National Defence Contribution (later Profits Tax) and by the introduction in early 1939 of Armaments Profits Duty. The latter was repealed before any duty had been assessed, but the National Defence Contribution survived the introduction of EPT in the Finance (No. 2) Act 1939, with the taxpayer having to pay whichever of those two impositions produced the higher liability. EPT worked on the basis of comparing standard pre-war profits, as ascertained under section 13, with the profits in wartime periods, so that any excess of the latter over the former was charged to tax, and any deficiency was carried back or forward, and thus the tax operated cumulatively over the wartime period. Computation was by reference to income tax principles, as adapted by Part I, Schedule 7. Various provisions dealt with changes in the trade or business, so that the comparison exercise was, at least broadly, on a like to like footing. The main provisions required adjustments where there had been changes in the average amount of capital employed in the trade or business, and Part II, Schedule 7 laid down provisions for computing capital. EPT applied to chargeable accounting periods, the first of which was to start on 1 April 1939. EPT was initialled charged at 60 per cent, but this was increased by the Finance Act 1940 to 100 per cent, though on the footing that there would be a post-war rebate of 20 per cent. At the end of the War the rate reverted to 60 per cent. Liability to EPT was a deduction for the purposes of income tax.

Excess Profits Tax Litigation 139 The chapter will deal only with those statutory provisions which gave rise to litigation. It will proceed under five headings, viz particular EPT provisions (sub-headings 1–11) computation (sub-headings 12–22), avoidance (sub-headings 23–24), and miscellaneous (sub-headings 25–31), followed by a few remarks in conclusion.

II. PARTICULAR EPT PROVISIONS

1. Section 12—Scope of Charge—UK Trade or Business By section 12(1) the charge to EPT was imposed on ‘profits arising in any chargeable accounting period from any trade or business to which this section applies’, and by section 12(2) ‘subject as hereinafter provided, the trades or businesses to which this section applies are all trades and businesses carried on in the United Kingdom, or carried on whether personally or through an agent, by persons ordinarily resident in the United Kingdom’. Six cases call for examination under this sub-heading. In Marsh v CIR (1943) 29 TC 120 the taxpayer, who acted as a traveller for five firms, failed in a contention that he was not in business as a commercial agent, but was an employee of each of the five firms. In CIR v Turnbull (1943) 29 TC 133 the taxpayer, a marine engineer, successfully contended that he was the employee of two particular companies. In Sethia v CIR (1947) 28 TC 153 the taxpayer, a jute, wool and general merchant, failed in a contention that his business had not ended on 18 March 1940, when he had transferred it to a company. In Public Trustee (Evans’ Executor) v CIR (1949) 28 ATC 151 the Public Trustee, executor of the will of Thomas Evans, who had owned a dry goods business carried on in the West Indies, failed in a contention that he was not carrying on the business. Croom-Johnson J rejected a submission that section 12(2) did not extend to a person who was acting in a representative or fiduciary capacity, holding that there should be no qualification of the plain language of the provision. In MacMahon and MacMahon v CIR (1951) 32 TC 311 two sisters, advised by their brother whose business was to buy and sell properties, themselves bought and sold between 1943 and 1948 four properties (two hotels and two houses), making a total net profit of £23,788. They contended that they had not been engaged in a trade, or in an adventure in the nature of a trade. No supporting evidence was given before the General Commissioners, though some ‘evidence’ was given in the course of the taxpayers’ solicitor’s argument. The Commissioners dismissed the appeals, and the Court of Session was very brief in upholding the decision as one which the Commissioners could properly have reached.

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Wood v Public Trustee as Executor of Sir Alex Black deceased (1952) 33 TC 172 concerned the several businesses of Sir Alex Black Bt who, up to his death on 28 June 1942, was a trawler owner, fish merchant, cold store proprietor, coal merchant and estate developer. After his death the executors ran the businesses in much the same way as they had been conducted before the death, apparently making profits of some £29,000, but selling the businesses piecemeal on various dates between June and December 1943, except for the two estates which were not sold until 1946 and 1949 respectively. Overturning a decision of the General Commissioners for Grimsby, Vaisey J held that the executors were carrying on a trade, except for the estate management element.

2. Section 12(3)—Exemption of Professions By section 12(3) the charge to EPT did not apply to ‘the carrying on of a profession by an individual or by individuals in partnership . . . if the profits of the profession are dependent wholly or mainly on his or their personal qualifications’. Five cases call for consideration here. Three cases concerned opticians. In Webster v CIR (1942) 21 ATC 165 Macanghten J upheld a decision of the General Commissioners for Darlington, holding that the taxpayer was carrying on the business of supplying and selling spectacles to which the eye-testing was ancillary. In CIR v Carr (1944) 23 ATC 240 the Court of Appeal, reversing Macnaghten J, restored a decision of the General Commissioners for Prescott that the taxpayer’s profits were derived from a profession and were dependent wholly or mainly on his personal qualifications. Macnaghten J made the remarkable observation that the nearest analogy to an optician was a truss-maker. In Neild v CIR (1948) 27 ATC 328 the facts were that the optician made a prescription and had the lenses made on the premises and fitted to a frame, the resulting spectacles being sold to the customer/client. His net profit was £2,902. He appealed against an EPT assessment in the sum of £1,402, and the question arose whether £750 of the £2,902 was professional profit, with the remainder being trading profit. Macnaghten J answered in the affirmative, but his decision was overruled. The Court of Appeal discerned the correct principle for this type of case from CIR v Marx [1919] 1 KB 647, where Warrington LJ made it clear that severance of a global profit was appropriate only where two separate businesses were being carried on, and not where there was a single business comprising both professional and trade activities. On the facts of the present case the Court of Appeal held that there was no evidence to support a finding that the profession was separate and severable from the trade. In Loss v CIR (1945) 24 ATC 468 Joe Loss, the well-known band leader, who selected and trained members of his band, paid them, and negotiated

Excess Profits Tax Litigation 141 engagements through an agent, contended unsuccessfully that he was exempt from EPT, because he carried on a profession dependent wholly or mainly on his personal qualifications within section 12(3). In Ward, Bateson and Smith (Young and White) v CIR (1948) 27 ATC 169 the three appellants comprised a firm which carried on business in the Portsmouth area as surveyors, estate agents, auctioneers and valuers. The General Commissioners dismissed the appellants’ appeal in principle, holding that the business was not a profession. On appeal, Singleton J upheld the Commissioners’ decision on the basis that there was evidence before them to support the decision at which they had arrived. But the Judge was troubled. The judgment concluded, ‘I find it difficult to deal with these cases when an optician one day is said to be professional, and another day another optician is said to be non-professional, on facts, so far as I can see, which are just the same. The answer which is given is that it is a question of fact in each case. I am inclined to the view (though perhaps I ought not so say this, as it has not been argued) that there may well be two things being carried on; and if that may be so in the case of an optician, still more, I think, it may be so in the case of a firm whose description embraces four different heads’.

3. Section 12(3)—Limitation on Exemption of Professions By the proviso to section 12(3) the exemption of professions from the charge was qualified so that the charge would apply to those engaged in a ‘trade or business consisting wholly or mainly in the making of contracts on behalf of other persons or the giving to other persons of advice of a commercial nature in connection with the making of contracts’. One case arose on this. In Escritt & Barrell v CIR (1947) 26 ATC 33 the taxpayer firm carried on business as land and estate agents, auctioneers and valuers. The only controversy was about tenant right valuation and estate management activities. The Special Commissioners held the proviso to section 12(3) to be applicable, but Atkinson J reversed the decision because there was no evidence before the Commissioners to suggest that the relevant activities related to any contracts whatsoever.

4. Section 12(4)—Charge to Cover Investment, or Other Holding, Companies Section 12(4) provided that, where the functions of a company or society incorporated by or under any enactment consisted wholly or mainly in the holding of investments or other property, there should be deemed to be a business carried on by the company or society.

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This provision was the subject of a contention in CIR v Desoutter Bros Ltd, which will be considered in detail at 17 below. The contention did not concern the meaning of section 12(4). Rather, it was that, as section 12(4) brought into charge income from investments or other property in the hands of an investment company, it implied that profits from investments or other property held by any other type of corporation were excluded. The Court of Appeal held that section 12(4) was intended to bring into the net a type of corporation which would or might otherwise be excluded from it and, once that was appreciated, there was no shadow of a foundation for the company’s argument.

5. Section, 13(2)—Standard Profits—Working Proprietor Section 13 provided the regime for determining standard profits. For trades or businesses which commenced before 1 July 1936 the base was the profits in the 1935 to 1937 period, the taxpayer having an element of choice amongst those years. For trades or businesses commencing on or after 1 July 1936, the standard was ascertained by applying a statutory percentage to the average amount of capital employed in the chargeable accounting period in issue. A third basis was available where the trade or business had a ‘working proprietor’ or more than one ‘working proprietor’. This arose under section 13(2), the original of which was replaced by a substituted version in section 31 of the Finance Act 1940. By section 13(2)(a) ‘working proprietor’ was defined as ‘a proprietor who has, during more than one half of the chargeable accounting period in question, worked full time in the actual management or conduct of the trade or business’. By section 13(2)(b) ‘proprietor’ was defined as ‘in the case of a trade or partnership, a partner therein, and, in the case of a company, any director thereof owning more than one-twentieth of the share capital of the company’. The definitions gave rise to six cases, which will now be examined. In CIR v Frank Stone (Kidderminster) Ltd (1942) 21 ATC 17 the issue was whether Mrs Stone, a director and the company secretary of a company which carried on the business of rug and carpet fringe manufacturers, worked full time in the business. The General Commissioners for Kidderminster recorded difficulties in understanding the meaning of ‘full time’, and they concluded that Mrs Stone was indispensable to the business and therefore to be regarded as a ‘working proprietor’. This reasoning was not, on the Crown’s appeal, supported by Counsel for the company and Lawrence J remitted the case to the Commissioners to find whether Mrs Stone did work full time in the actual management or conduct of the business. In CIR v Alexander Stirling Ltd (1943) 22 ATC 158 the issue was whether Margaret Stirling worked full time in the company’s business, that of grocers’, butchers’ and fishmongers’ outfitters. The Special Commissioners

Excess Profits Tax Litigation 143 decided that she did, but the Court of Session reversed that decision, holding that the test was whether the individual’s working time exceeded one half of the chargeable period. On the facts Mrs Stirling worked full time in July, but during the remainder of the year she was working just about half of what she worked in that month. In Wilkie, Neck and Smith v CIR (1946) 25 ATC 111 the three taxpayers together conducted a seasonal trade as refreshment caterers in New Brighton. Their contention, that they worked full time, was held by the Special Commissioners and Wrottesley J to fail on the facts. For more than one half of each accounting period the business was inactive, so that no one was working in it. In CIR v Heaver Ltd (1949) 28 ATC 132 John T. Heaver and John Heaver Jr. worked full time in the management or conduct of the company’s trade as coach designers, and each held 200 shares, which was just over 7 per cent of the capital. But Article 13 of the company’s Articles of Association provided that the qualification of a director was 500 shares. Overruling the General Commissioners for Amesbury, Croom-Johnson J held that the two directors concerned were not directors in law. The judge then referred to the rule in Royal British Bank v Turquand (1856) 6 E & B 327, that persons contracting with a company and dealing with it in good faith may assume that acts within its constitution and powers have been properly and duly performed, and are not bound to inquire whether acts of internal management have been regular, but he held that there was no basis upon which that principle could be held applicable to the present case. In Smart v CIR (1949) 29 TC 338 Mrs Minnie Smart carried on business as a hotel proprietor at the White Swan Hotel, Alnwick. The premises were owned by her husband, Algernon, and he helped in the business, as well as conducting his own business as a garage proprietor in adjoining premises. There was a full-time manageress at the hotel. After 16 June 1941 Mr and Mrs Smart lived in the hotel. Previously Mrs Smart visited the hotel, normally daily, to attend to her duties as proprietor. Four points were in issue. Three concerned the amount of deductions in respect of the rent payable to the husband for the premises, of his salary for his work in the business, and of the cost of his board at the hotel (allowable by trade custom). On all those three items the General Commissioners for Coquetdale directed figures rather higher than those put forward by the Revenue but lower than those put forward on behalf of Mrs Smart. The fourth issue was whether Mrs Smart had been a full time working proprietor within section 13(2) for the first two relevant accounting periods, it being accepted by the Revenue that the test was satisfied for the four later periods. The Commissioners concluded that Mrs Smart had not been a full time working proprietor in the first two periods. Croom-Johnson J dismissed both Mrs Smart’s motion for a remitter to the Commissioners and her appeal against their decision on all four issues.

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In CIR v T. W. Law Ltd (1950) 29 TC 467 T. W. Law, baker and confectioner, died in 1930, leaving the residue of his estate, including the business, on trust for his widow for life, and thereafter for his children in equal shares. In 1936 the taxpayer company was acquired to take over the business. The widow and two sons each owned five shares in the company, and the remaining 1,485 were held by them jointly as trustees. The company contended that the two sons were ‘proprietors’ within section 13(2). The issue would also have arisen in relation to the widow but, by concession, the Revenue treated her as a working proprietor. The appeal succeeded before the Special Commissioners but, on appeal by the Crown, Romer J reversed the decision. Romer J distinguished earlier authorities which decided that, where a qualification clause did not require a director to hold his qualification shares in his sole name or in his own right, a joint registration sufficed. But he held that, while a joint owner has a legal interest in the entirety of the subject matter of the joint tenancy, that does not mean that he ‘owns’ that subject matter, and clearly he did not do so because he could not on his own perform normal acts of ownership such as selling or mortgaging the subject-matter.

6. Section 13(3) and (9)—Adjustments to Standard Profits to Reflect Changes in Capital Under the proviso to section 13(3) a trade or business which commenced on or before 1 July 1936 was entitled to an increase in its standard profits if the average amount of the capital employed in any chargeable accounting period was greater than the average amount of capital in the standard period; correspondingly the provision required a decrease in the standard if the capital diminished. The adjustment was by application of the statutory percentage to the increase or decrease in the average amount of capital. The statutory percentage was, by section 13(9), 8 per cent, but 10 per cent if a controlling interest was held by a corporate partner or by the directors of a company. Four cases require to be examined. In J. Bibby & Sons Ltd v CIR (1945) 29 TC 167 the appellant company was a private company, its business being seed crushing and oil refining. The directors owned 209,332 ordinary shares out of the total issue of 500,000. Three of the directors were, in the capacity of trustees of their sister’s marriage settlement, the registered joint holders of 57,500 ordinary shares. The three directors had contingent interests under the settlement. In relation to the increase in its standard profits, it was in the company’s interest to establish that its directors had a controlling interest, but the Revenue did not agree that the trustee holding fell to be taken into account. Overruling the Special Commissioners and Macnaghten J, the Court of Appeal and the House of Lords unanimously decided in favour of the company. The judges

Excess Profits Tax Litigation 145 considered that the question was simply who owned the shares, and thereby held power, and it did not matter what, if any, beneficial interest attended the ownership. In CIR v James Hodgkinson (Salford) Ltd (1949) 29 TC 395 the issue was whether, in determining whether a company was director-controlled, account could be taken of shares in relation to which a director held power of attorney. The Special Commissioners held in the affirmative, but their decision was overruled by Croom-Johnson J and the Court of Appeal. Croom-Johnson J held that the powers of attorney could not have the effect of a proxy because they were out of time under Article 83 of the Articles of Association. The Court of Appeal agreed, but also added that, even if votes had been permitted by virtue of the powers of attorney, it would have been the mother and son voting by their agent, not the director voting for himself. In Joseph Appleby Ltd v CIR (1950) 29 TC 483 the main issue was whether, under the Articles of Association, the executors of a deceased shareholder had voting power in respect of 5,473 shares, although their names were not on the company’s register. On construction of the Articles, both the Special Commissioners and Danckwerts J found that the executors were entitled to exercise the right of voting, the effect of which was that the company was not director-controlled. In John Shields and Co (Perth) Ltd v CIR (1950) 29 TC 475 the issue was whether the company’s directors had a controlling interest in terms of the governing directorship of a Mr Farquharson. The Court of Session held that his power was irrelevant, because voting power lay with a Mrs Bell, who was the first named trustee of a large block of shares and, while Mr Farquharson had power to alter that position, he had not exercised that power.

7. Section 14(1)—Ascertainment of Standard Period/Chargeable Accounting Period By section 14(1) profits were to be computed in respect of the standard period or any chargeable accounting period, and a proviso directed apportionment where a standard period or chargeable accounting period, as defined, was not an actual accounting period. The determination of a trade’s or business’s accounting periods was, by section 22(f), to be done under the rules in section 20(2) of the Finance Act 1937 for the purposes of the National Defence Contribution. The first of those rules was that, where the accounts of a trade or business were made up for successive periods of 12 months, each of those periods was to be an accounting period. The second rule dealt with the position where accounts had earlier been drawn on a 12-month basis, but had ceased to be so drawn. The third rule, relating

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to any other case, directed that the periods were such, not exceeding 12 months, as the Commissioners of Inland Revenue should determine. The direction for apportionment, under the proviso to section 14(1), was, however, susceptible of disengagement, the proviso ending ‘unless the Commissioners, having regard to any special circumstances, otherwise direct’. One case arose. In Jenkins Productions Ltd v CIR (1944) 29 TC 142 the accounts of the business of a furniture manufacturing and wood-working company were drawn up, audited, and presented to the directors every half-year ending 30 June and 31 December. In addition yearly accounts to 30 June, based on the half-year accounts, were made up and presented to the shareholders in annual general meeting. All the shareholders were, in fact, directors. The Court of Appeal, overruling Macnaghten J and restoring the decision of the Special Commissioners, held that it was plain that there were yearly accounts made up to 30 June. But the Court of Appeal drew attention to the Board’s power to disengage the apportionment rules, noted that the paramount object of the statutory machinery was to ascertain the real profits of the standard period, and expressed the view that the existence of two half-yearly accounts which together precisely covered the standard period amounted to ‘special circumstances’ within the exception at the end of the proviso to section 14(1). The Court stood the case over while the Board might consider those observations. The Board then made a direction under that exception that the profits should be determined by aggregating the profits for the two half-years ended 30 June and 31 December 1935.

8. Section 16—Change of Persons Carrying on a Trade or Business Section 16 made provision for situations in which there was a change in the persons carrying on a trade or business. The basic rule in section 16(1) was that the old trade or business was deemed to have been discontinued and a new trade or business was deemed to have been commenced. By section 16(5), though, on a transfer, after 1 April 1939, of part of a trade or business as a going concern, the part transferred and the part not transferred were deemed to be a continuation of the original trade or business, with just apportionments being made of profits, losses and capital employed. Section 16(6) applied where there was a transfer before 1 April 1939 of all, or the main part of, a trade or business which had been carried on immediately before 1 July 1936 and was substantially the same business. The provision gave the incomer a right of application to have his standard profits computed as if he had carried on the transferred trade or business from its commencement ‘subject, however, to such modifications (including modifications as respects the computation of capital) as may be just’. The quoted words were repealed, but in effect replaced, in a wider-ranging provision in section 38(4) Finance Act 1940. Three cases call for consideration.

Excess Profits Tax Litigation 147 In CIR v Spirax Manufacturing Co Ltd (1946) 29 TC 187 the taxpayer company was incorporated in 1931 to manufacture steam traps and strainers with a view to sales to Walker, Crossweller & Co Ltd, which had previously bought such products from an American company. By an agreement made in May 1939 the taxpayer company bought, for £10,800, the part of the Walker company which sold the steam traps and strainers, including the goodwill, and all the Walker company employees and travellers connected with that part of the business transferred to the taxpayer company. The taxpayer company contended that section 16(5) applied, with the consequence that its standard would be increased (the corollary being that the Walker company’s standard would be decreased). The Revenue denied that there had been a transfer of a going concern, as an essential part of the Walker company’s business was the buying of the steam traps and strainers, a function not taken on by the taxpayer company which, as the manufacturer, could not be a buyer. The Revenue’s argument, which at best seemed to have only a modicum of technical merit, failed before the Special Commissioners and before Atkinson J. Fredk. Smith Ltd v CIR (1950) 29 TC 419 was, in the modern phrase, ‘fact-intensive’. The outline of the facts, given in the headnote cannot be improved upon, and it ran as follows: ‘[t]he Appellant Company carried on business as brewers. During the year 1941 it purchased from a company carrying on business as maltsters but owning some licensed houses where beer purchased by it was sold, ten tied and two managed licensed houses, and, by a subsequent transaction, a malt house and one tied and one managed licensed house; thereafter the Company malted at the malt house for use in manufacturing its own beer and business was carried on in the licensed houses much as before the purchase, but only the Company’s beer was sold there. In 1942 the Company purchased from a person carrying on business as a brewer the brewery and nine tied and one managed licensed houses, together with the goodwill of the brewery business and the full benefit of all contracts and quotas in connection therewith. Thereafter the Company brewed its own beer at the brewery and the Company’s beer was sold at the licensed houses’. The question was whether the taxpayer company had merely acquired properties which were business assets, or whether it had acquired part of a business, in the case of the 1941 transactions, or the whole of the business, in the case of the 1942 transaction, so that section 16(5) and section 16(4) were respectively engaged. And that question turned principally on whether goodwill had been transferred. The topic of goodwill was fully examined, including the traditional division into the dog, cat, and rat, varieties. In the result the Commissioners concluded that there was no transfer of goodwill in respect of the tied houses but, apart from that, the Commissioners accepted the Crown’s contentions that section 16(5) and (4) applied. On appeal Croom-Johnson J held that there was no evidence to support the

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Commissioners’ conclusions in relation to the 1941 transactions, but the Court of Appeal considered that there was evidence to support all of the Commissioners’ conclusions. In Stratford-on-Avon Picture House Co Ltd v CIR (1954) 34 ATC 402 the taxpayer company, which carried on the business of cinema proprietor in Stratford-on-Avon, decided to extend its activities to include Leamington. In October 1936 the company contracted to buy three cinemas in Leamington from another company, together with a fourth cinema which that other company was in the course of buying. Completion took place in March 1937. In effect the taxpayer company achieved a form of cinema monopoly in Leamington because, as evidence established, a fifth cinema would not be sustainable. The purchase cost £141,000 in total. The historic cost to the original owners was agreed as £74,000. The company made an application under section 16(6), and it was granted. The result was that the company took over the standard profits of the previous owners referable to the four cinemas by way of addition to its own (1935) standard. The company contended that it was entitled to an uplift in capital under the proviso to section 13(3) on the basis that one or other of the provisions in paragraph 1 of Part II, Schedule, 7 applied. The Revenue accepted this as to £74,000, but no more. The Special Commissioners upheld the Revenue’s view and Harman J dismissed an appeal. He examined the scheme of the Act and concluded that, if section 16(6) applied, there was no room for application of the proviso to section 13(3), because that would involve a double benefit for the same cause. Indeed he was not happy that £74,000 was admissible, considering that nil was the correct figure on the Revenue’s argument. The Court of Appeal found section 16(6) troublesome, but eventually reached agreement with the reasoning of Harman J.

9. Section 17—Inter-connected Companies Section 17, much of which was repealed and replaced by section 28 Finance Act 1940, made various provisions in relation to inter-connected companies. Section 17(1), which directed that intra-group indebtedness should be disregarded for computational purposes, gave rise to one case. Section 17(6), which defined a subsidiary as a company of which at least 90 per cent of its ordinary share capital was owned by another company, gave rise to two cases. In Trinidad Petroleum Development Co Ltd v CIR (1946) 25 ATC 87 the subsidiary relationship between certain companies had ceased in 1937, but the Law Lords were clear that there was nothing in the statutory language to confine the application of section 17(1) to cases where the subsidiary relation existed both in the standard accounting period and in the relevant chargeable accounting period.

Excess Profits Tax Litigation 149 In English Sewing Cotton Co Ltd v CIR (1947) 26 ATC 79 the taxpayer company argued that a relationship within section 17(6) had ended because the Treasury had, under a loan agreement, attained a beneficial interest in the stock of the subsidiary concerned, but that was found not to have been an incident of the loan agreement or any of the attendant circumstances. In Lamb Brothers (Humber Sales) v CIR (1949) 28 ATC 187 the shares in the taxpayer company were owned as to 60 per cent by another company, and an imaginative contention, that the 90 per cent requirement in section 17(6) was not definitive, inevitably failed.

10. Section 18(1)—EPT Deductible for Income Tax Section 18(1) provided that EPT payable for any chargeable accounting period was deductible for income tax as an expense incurred in that period. Two cases are conveniently dealt with here. In CIR v John Dow Stuart Ltd (1949) 31 TC 272 the appellant company’s business, that of building contractors, flourished in the early years of the war but then suffered setbacks, so that for EPT purposes profits in three periods were followed by deficiencies in two. The issue concerned the company’s income tax position for 1941–1942 to 1945–1946. The company argued that EPT liabilities were deductible even to the extent that they had not actually been paid and were eventually expunged by deficiencies. The argument succeeded throughout, though it was a split decision in the House of Lords. CIR v Duncan MacLeod & Co Ltd (1950) 29 ATC 118 was a sequel to CIR v Ross and Coulter & Ors (Bladnoch Distillery Co Ltd), and related cases, discussed at 24 below, and concerned deductibility for income tax purposes of a payment made under a mutual arrangement made to achieve dischedulearge of the total liability of several parties. The report is not easy to follow, but the result appears to have been that part of the payment was accepted to be EPT and therefore to have been deductible.

11. Section 21—Assessment, Collection, Appeals, etc. Section 21 dealt with procedural matters. By section 21(1) EPT was payable one month after assessment. Section 21(2) short-circuited other procedural matters by applying the National Defence Contributions provisions in Schedule 5 to the Finance Act 1937, but included a proviso relating to appeals which, amongst other things, provided that there should be no appeal in respect of any matter within the EPT provisions left to the discretion of the Commissioners of Inland Revenue. A case on the proviso, London and National Property Co Ltd v CIR, is described at 19 below, which leaves one case to be dealt with here.

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In Mayfair Circuit (Control) Ltd v CIR (1952) 31 ATC 453 the taxpayer company appealed against an EPT assessment only to find that the Special Commissioners increased the amount assessed. The company required a case to be stated for the opinion of the High Court. The Revenue sought payment of the tax. By section 149(4) of the Income Tax Act 1918, later section 64(10) of the Income Tax Act 1952, income tax was to be paid in accordance with the assessment of Commissioners who had been required to state a case. The Court of Appeal upheld an Order 14 judgment in favour of the Revenue, concluding that the income tax rule had been carried through to EPT via section 21(2) of the principal Act carrying through paragraph 4 Part II Schedule 5 Finance Act 1937, as preserved by section 531(1)(b) Income Tax Act 1952.

III. COMPUTATION

Section 14(1) provided that profits should be computed by the application of income tax principles (see 19 cases at 12–14 below), as adapted by the provisions of Part I of Schedule 7 (see 13 cases at 15–19 below). Section 14(2) applied Part II of Schedule 7 for computation of the average amount of the capital employed in a trade or business (see 14 cases at 20–22 below). These rules applied alike to standard periods and to chargeable accounting periods.

12. Computation of Profits—Whether Trading Receipts In Barr, Crombie & Co Ltd v CIR (1945) 24 TC 55 the issue concerned a payment made on early termination of an agreement under which the taxpayer company carried on the business of ship managers for one particular shipping company. The agreement provided that in such an event the remuneration due to the taxpayer company from that date until the expiry of the full 15–year term would become due immediately. Overruling the Special Commissioners, the Court of Session held that the payment was a capital payment made in respect of the termination of the relations between the two companies. In CIR v Iles (1947) 29 TC 225 royalties paid to a sand and gravel merchant under agreements, by which he allowed others to work his pit, were held to be capital receipts. In Waterloo Main Colliery Co Ltd v CIR (1947) 29 TC 235 the company had, in its chargeable accounting period ending on 30 June 1943, a liability to pay royalties under mineral leases amounting to some £7,975, but it was entitled to set off some £3,284 in respect of ‘shortworkings’, so that a net £4,691 was paid to the lessors. The figure for shortworkings was a carried

Excess Profits Tax Litigation 151 forward figure from previous years of amounts by which minimum payments of rent had exceeded the royalties due. Part of the colliery’s area had been requisitioned under the Defence (General) Regulations 1939, and this resulted in a receipt of £11,596 from the Ministry of Works by way of compensation for expenditure and for lost profit. The decision was that only the actual payment of £4,691, and not the full royalties of £7,975, was a deductible expense, and, secondly, that the receipt of £11,596 was an income, not a capital receipt. In CIR v Rustproof Metal Window Co Ltd (1947) 29 TC 343 the company, the holder of a patent of a galvanising process, had in 1939, at the request of the government, granted to another company a licence to use the patent, and it received royalties of £3,000. The main issue was whether the £3,000 was an income or capital receipt. This was the only issue argued in the Court of Appeal, which held, overruling Atkinson J and restoring the decision of the Special Commissioners, that it was an income receipt. Three other issues were resolved by Atkinson J. First, he held that the £3,000, if income, was not income from an investment within paragraph 6 of Part I, Schedule 7. Secondly, he held that a fee under a service agreement was paid to a director in respect of his remuneration as manager. Thirdly, he held that a deduction fell to be made in respect of £340 out of the £3,000, because it was received on trust for or on behalf of the individual who had assigned the patent to the company in 1936. In Jay’s the Jewellers Ltd v CIR (1947) 29 TC 274 the taxpayer company’s business included pawnbroking, and the issue related to unclaimed surpluses following sales of pawned items. The company contended that unclaimed surpluses were not receipts of its trade. The Revenue contended that all surpluses were trade receipts in the years of the sales, any payments to pawners being expenses of the trade when made. Alternatively, the Revenue contended that surpluses became trade receipts as and when the relevant limitation period elapsed without the pawner having made a claim. Atkinson J upheld the Special Commissioners’ decision which favoured the Revenue’s alternative contention. The judge held that the true accountancy view demanded that the surpluses should be treated as paid into a suspense account, with unclaimed surpluses being transferred to the profit and loss account on expiry of the limitation period. The judge distinguished Morley v Messrs Tattersall (1938) 22 TC 51 on the ground that in the instant case a new asset came into existence on expiry of the limitation period. Harry Ferguson (Motors) Ltd v CIR (1951) 33 TC 15 involved a tremendous tussle, largely on the facts, as to whether sums totalling £185,350, together with a small amount of interest on £21,000 of that sum, were capital or income receipts of the appellant company. The sums had been paid by the company’s managing director under agreements made in 1923, 1927 and 1935. The background was complex and obscure. The company’s case, that the agreements comprised a sale to the managing director of such interest as

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it claimed in certain patents relating to a plough, failed because the language of the agreements did not mention, or indicate, a sale, but stated their purpose as being to remunerate the company for its services and assistance, and, as the managing director was not obliged to make payments unless profits arose, the true construction was that the agreements provided for future commercial exploitation of the plough and for division of any profits arising. G. Deacon & Sons v Commissioners of Inland Revenue (1952) 33 TC 66 was a straightforward back duty case in which £28,000 was held to be understated business profits of a hosiery manufacturer. It is perhaps worth adding that, of the various explanations put forward, the taxpayer eventually reposed his faith in a story that the bulk of the money represented betting winnings, and a bookmaker’s runner was called to substantiate the story. Predictably the evidence broke down, and it even reached a stage of farce in that it was established that at least one horse, recorded as the winner, had not in fact competed in the race. In Orchard Wine and Spirit Co v Loynes (1952) 33 TC 97 the taxpayer firm, a wine and spirit manufacturer and dealer, which was engaged in compounding and manufacturing a whisky liqueur called ‘Hector McDonald “Glen Mist”’, received a payment under an assignment of its trade mark, secret process, and goodwill. The receipt was held to be a trading receipt. Moschi v Commissioners of Inland Revenue (1952) 33 TC 442 was a straightforward back duty case. Mr Bension Moschi, a refugee from Germany, was an underwear manufacturer from 1933 onwards. The sums concerned, some £39,000, were held to be business profits. Donovan J described the taxpayer’s conduct as ‘a disgrace to his native community, whatever that may be’. CIR v Dadswell (1954) 35 TC 645 concerned rebate payments made by the Ministry of Food to a miller in 1949. Roxburgh J, reversing the decision of the Special Commissioners, held that the payments were trading receipts referable back to chargeable accounting periods commencing on 1 January 1942 and ending on 30 September 1945. He said, ‘[a]uthority in my view establishes the proposition that if it can be said at the moment of discontinuance that the payment for some work already done has not been finally settled, even though there is no legal claim for any more, then if a further payment is made afterwards, even though it is wholly gratuitous, the account can be reopened so as to let in what is analogous to a trade debt at the figure actually received. If, on the other hand, the item is not analogous to a trade debt, or if there has been a final settlement, the account has been finally closed’.

13. Computation of Profits—Deductible Expenditure In Julius Bendit Ltd v CIR (1945) 27 TC 44 the company contended that the transactions concerned, though having the normal trappings of sale,

Excess Profits Tax Litigation 153 were not commercial transactions, and that the profits should be computed on commercial principles by reference to the market value of the goods, but the decision was that this was not tenable on the facts. In Fairrie v Hall (1947) 26 ATC 102 the taxpayer, a sugar broker, was successfully sued for libel by another sugar broker, who had been appointed Deputy Director of Sugar Supplies at the Ministry of Food, and who was wrongly accused by the taxpayer of having disgracefully abused that position by acting in it to the advantage of his own business and the businesses of his clients. The damages were £550 and costs payable to the plaintiff were £3,025. The courts rejected the taxpayer’s claim for deduction of the £3,575 in computations of his business profits, because the expenditure had not been laid out with a view to earning profits and that, considered as a loss, it was not incidental to the trade and attributable to the taxpayer in the character of trader. Smith’s Potato Crisps (1929) Ltd v CIR (1948) 30 TC 264 and Rushden Heel Co Ltd v CIR (1948) 30 TC 298 were cases heard together in the Court of Appeal and the House of Lords, and the result in the first case was found to govern the second, so that reasoned speeches were not needed in the House of Lords in the second case. Both EPT cases were accompanied by income tax cases, and the first pair of cases is more generally known by the title of the income tax case, viz. Smith’s Potato Estates Ltd v Bolland. The identities of the Smith companies differed because the profits of the subsidiary company were assessable to EPT on the parent under section 17(6). The issue was whether costs incurred in tax litigation were deductible in computing profits for tax purposes. In Smiths Crisps £622 10s 1d had been expended on an appeal to the Board of Referees against a decision by the Revenue under section 32 of the Finance Act 1940 that, for EPT purposes, the deduction in respect of the remuneration of a Mr Young should be restricted to £3,500, rather than that the full actual remuneration of £6,486 14s should be allowed. The Board of Referees decided that £5,800 should be allowed. Mr Young was the successful manager of a large potato farm in Lincolnshire. In Rushden Heel there had been a successful appeal to the Special Commissioners against a direction by the Revenue under section 35 of the Finance Act 1941 that certain transfers of shares within a family company had had, as their main purpose, the avoidance or reduction of liability to EPT, and the attendant costs were £141 19s. The issue turned mainly on whether the money had been wholly and exclusively laid out or expended for the purposes of the trade within Rule 3(a) of Cases I and II of Schedule D under the Income Tax Act 1918. The House of Lords, by a bare majority, gave a negative answer. In the words of Lord Simonds: ‘neither the cost of ascertaining taxable profit nor the cost of disputing it with the Revenue authorities is money spent to enable the trader to earn profits in his trade. What profit he has earned, he has earned

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before ever the voice of the tax-gatherer is heard. He would have earned no more and no less if there was no such thing as Income Tax. His profit is no more affected by the exigibility of tax than is a man’s temperature altered by the purchase of a thermometer, even though he starts by haggling about the price of it.’ It is a pity that CIR v Pilcher (1949) 31 TC 312 did not come before Lord Denning, securing an opening sentence such as ‘Kent is rightly called the Garden of England, and 1942 was an exceptionally good year for cherries’. In 1942 the taxpayer, who had been a fruit grower and fruit salesman for upwards of 30 years, learnt of the imminent sale, by auction in four lots, of Chekes Court, Tonge. Lot 2 comprised 41 acres and included 17 acres of cherry trees known as the King’s Orchard and 4 acres of apple trees. On inspection the taxpayer decided that the crop of cherries had a value of £2,500 and that the 41 acres had a value of £3,210, a total of £5,710. In the event his successful bid at the auction was £5,500. In addition he had to pay some £194 for unexhausted manurial values, which included the value of work done in the orchard by spraying and by the deployment of artificial manures. The sale particulars made clear that the purchaser would have ‘this year’s crop’. In accordance with local custom the taxpayer was, once he had paid the deposit, allowed on the land. Over six weeks starting on 25 May 1942, and during which completion took place, the taxpayer picked the cherries and sold them for £2,903. The issue was whether there should be a revenue deduction in respect of the price of the cherries. The Special Commissioners determined that there should, as the cherries were fructus industriales and did not form part of the freehold, but Croom-Johnson J and the Court of Appeal held that the cherries were fructus naturalis and that the taxpayer had made a single purchase of the land, the fruit not having been the subject of a separate purchase. The argument about the legal classification of the fruit gave rise to an interesting examination of the law relating to emblements, particularly in the judgment of Jenkins LJ. On what was really the main point the judgments referred to several earlier cases, starting with Coltness Iron Co v Black (1887) 1 TC 287. As Jenkins LJ observed, it was a well settled principle that outlay on the purchase of an income-bearing asset was in the nature of capital outlay, and this applied even to a wasting asset, such as a coal mine, the income from which was literally produced by the consumption of the capital asset itself. The application of that principle to a fruit orchard was, in his view, a fortiori. In James Spencer and Co Ltd [sic] v CIR (1950) 29 ATC 245 the appellant firm, which carried on the business of stevedores, did not take out insurance in relation to its workmen’s accidents, but met claims out of its own resources. For its chargeable accounting period from 1 April to 31 December 1945, the firm sought deduction of some £43,339 in respect of

Excess Profits Tax Litigation 155 ‘accident claims paid and due’ but the Revenue disallowed £38,161, which comprised two elements, viz. (i) the capitalised value of claims for weekly payments and (ii) claims which had not been admitted, or determined, within the accounting period. The Court of Session, upholding the decision of the Special Commissioners, decided that the disallowance was correct. Reference was made to seven Excess Profits Duty cases as establishing that sums in respect of provisional or contingent liabilities, as opposed to actual (admitted or determined) liabilities, were not allowable, though, once a liability became actual, it was allowable even if the quantum were established in a later period, in which event the accounts of the earlier period were, as necessary, to be re-opened.

14. Computation of Profits—Valuation of Stock In CIR v Cock Russell & Co Ltd (1949) 29 TC 387 the taxpayer company conducted a wholesale wine and spirit business. In drawing up its accounts for the year ended 31 December 1945 the company included all its stockin-trade, bar two items, at cost, which was very much less than market value. The two items were pipes of port—a pipe comprised 115 gallons— which it had bought in October 1945 at £810 per pipe. Later in October market prices of port fell, because over 1,000 pipes had become available on the death of a wine merchant who had had a large stock. The company included its two pipes at market value, put at £600 per pipe. The Revenue’s case was that the company ‘must be consistent, must apply the same measuring rod to all of their stock-in-trade, and they were not entitled to go through that stock-in-trade item by item and look to see what in truth was the position’. The company adduced evidence before the General Commissioners for the City of London that their method accorded with the practice of the trade, and that it followed a recommendation from the Institute of Chartered Accountants. There was no evidence the other way, and the General Commissioners upheld the company’s appeal. On appeal by the Revenue, Counsel accepted that the company’s method of valuation had long been accepted in practice, but asserted that the strict legal position was otherwise. Croom-Johnson J dismissed the appeal, holding that there was no justification for departure from the long-continued practice. The Revenue’s case does indeed look like an attempt to manufacture bricks without benefit of straw. In Worthington v Oceana Development Co Ltd v CIR (1949) 65 TLR 726 the point was the same as in Cock Russell, and the Revenue consented to judgment. In CIR v Smith’s Executors (1951) 33 TC 1 the issue was whether certain stock in bond was stock of a trade carried on by the executors of a deceased publican, and on the facts it was held that it was.

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15. Paragraph 4 of Part I, Schedule 7—Deductible Rent, Royalties, etc. Subject to two provisos, paragraph 4 of Part I, Schedule 7 disapplied the income tax principles under which deductions were not allowed for interest, annuities, or other annual payments out of the profits, or for royalties, or (in certain cases) for rent, or the annual value of lands, tenements, hereditaments or heritages occupied for the purposes of a trade or business. Two cases require mention. In CIR v Cranford Ironstone Co Ltd (1942) 29 TC 113 the issue concerned the correct deduction in respect of rent due under mining leases in relation to the company’s standard period. It was held that the full rent payable and actually paid was deductible, notwithstanding arrangements for set-off against tonnage royalties. This decision was followed in Waterloo Main Colliery (see 12 above).

16. Deduction of Foreign Taxes—Paragraph 5 of Part I, Schedule 7, and Section 30 of the Finance Act 1940 As described in the note on the case below, paragraph 5 of Part I, Schedule 7, 10 and section 30 of the Finance Act 1940 made available allowances for Dominion taxes. In CIR v Dowdall O’Mahoney & Co Ltd (1952) 33 TC 255 the appellant company managed, controlled, and resident in Eire, conducted a business of margarine manufacturers and butter merchants, mainly in Eire. The company did, however, have branches in Manchester and Cardiff—incidentally Welsh sensitivities were ignored throughout the case, Cardiff many times being referred to as in England. The company paid Irish income tax, corporation profits tax and excess profits tax on all of its profits, i.e. including those of the UK branches. For each of its seven chargeable accounting periods ending on 31 March 1940 to 1946 the company sought a deduction, in respect of the profits of the UK branches for UK EPT purposes, of a proportion of the Irish taxes. The case pursued an erratic course, and the company eventually lost in the House of Lords. It was held that a deduction was not due under the standard Schedule D Cases I and II rule, Rule 3(a) of the relevant Rules in the Income Tax Act 1918 (expenditure wholly and exclusively laid out or expended for the purposes of the trade) Secondly, the company failed to get home on the two provisions on which it principally relied. First, paragraph 5 of Part I, Schedule 7 disapplied section 27 of the Finance Act 1920, by which in certain circumstances deductions on account of the payment of Dominion income tax were disallowed. Secondly, section 30 of the Finance Act 1940 empowered the making of Orders in Council to provide relief where double taxation

Excess Profits Tax Litigation 157 (EPT) arrangements were made with other governments. Neither provision was applicable. In particular no Order in Council had been made in respect of Irish taxes. The company’s argument was that both provisions indicated a belief on the part of Parliament that, aside from the provisions, a deduction under Case I (or II) would have been available. The argument was particularly strong in relation to the 1940 provision, which included that ‘they shall, in lieu of allowing, in computing profits for the purpose of excess profits tax or the national defence contribution, any deduction in respect of excess profits tax charged in the part of His Majesty’s dominions outside the United Kingdom to which the order relates . . .’. The Court of Appeal inferred an intention on the part of Parliament to confer the deduction. The House of Lords took a stricter line to the effect that a mistaken assumption of the legislature as to the prevailing law cannot be turned into a positive enactment of a change to the prevailing law. In this respect Lord Radcliffe likened the case to Ayrshire Employers Mutual Insurance Association Ltd v CIR (1946) 27 TC 331.

17. Paragraph 6 of Part I, Schedule 7—Investment Income Included in Certain Cases By paragraph 6(1) income received from investments was to be included in the computation of profits where paragraph 6(2) applied, but not otherwise. Paragraph 6(2) designated inclusion in relation to building societies, banks, assurance businesses, and any business consisting wholly or mainly in the dealing in or holding of investments. In CIR v Rolls-Royce Ltd (No. 2) (1944) 29 TC 137 the taxpayer company received, under licence agreements made with three companies, royalty payments in respect of the manufacture and sale of an aluminium alloy and of resilient pipe joints for which it owned patents, the inventions having been made by its own research workers. The Special Commissioners upheld the company’s contention that the royalties were receipts from investments, but Macnaghten J reversed that decision. The judge accepted, though not without some doubt, the Crown’s contention that paragraph 6(1) should be construed as referring to investments acquired by the laying out of money. He did not consider that the test was satisfied by virtue of the fact that the company paid its research workers or the fact that it had paid the prescribed fees on registering the patents. In CIR v Desoutter Bros. Ltd (1945) 29 TC 155 the same issue came up again on facts which were, if anything, less favourable to the taxpayer company than those in CIR v Rolls-Royce Ltd (No. 2). The taxpayer company manufactured electrical and pneumatic tools in Hendon. It was the registered proprietor of British and American patents relating to drills. The exploitation of the latter was the subject of two licence agreements, made

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with a Massachusetts company, which generated royalties. The agreements included obligations on the taxpayer company to supply drawings of the drills and of tools used in their manufacture or in the manufacture of component parts, to permit inspection at the works in Hendon, and to sell component parts. The earlier agreement also provided for the sale of drills. The Revenue’s case succeeded, but the Court of Appeal did not agree with the reasoning of Macnaghten J in Rolls-Royce Ltd (No. 2). In the leading judgment Lord Greene MR declined to accept any general definition or test for solving the type of question in issue. He contrasted the position in which a patent was property held by a manufacturer and that in which it was held by a mere passive owner. In relation to the former instance, he took the view that to describe the manufacturer’s profit from exploiting his monopoly right embodied in the patent as profits from an investment would be a misuse of language. He was unable to accept the test that money had to be put into an invention, because it would exclude from the investment category a situation, for example, in which a mere passive owner acquired the patent under a legacy. For good measure Lord Greene MR then demonstrated that, even if he were wrong on his main ground of decision, the special features of the licences (the obligations to supply drawings and so on) established that the profits were income of the trade or business. He deduced this by construction of the agreements, copies of which were annexed to the case stated. Counsel for the company had objected to the Crown relying on its argument on this point on the ground that the point had not been raised before the Commissioners and further findings of fact were necessary, but Lord Greene, referring to other arguments, observed that in this respect Counsel appeared to be ‘engaged in a form of activity which is sometimes engaged in by persons who inhabit glass houses’. In CIR v Broadway Car Co (Wimbledon) Ltd (1946) 29 TC 214 the taxpayer company carried on business as motor car agent and repairer in premises in Wimbledon of which it was the leaseholder. From July 1939 to August 1940 part of the premises was occupied by an associate company which made aircraft components. In 1940 the motor car business dwindled, and in August 1940 the aircraft component company disposed of its undertaking and vacated the premises. The taxpayer company then sub-let part of the premises for 14 years determinable by either party at any time after the termination of the war, at a rent of £1,150 per annum, to an unconnected company which made aircraft parts. The Court of Appeal, reversing Macnaghten J and restoring the decision of the General Commissioners for St. James, Westminster, held that the underlease was an investment, in the popular sense of that word. In Albert E. Reed & Co Ltd v CIR (1948) 27 ATC 352 the taxpayer company, a paper manufacturer, had various premises, including extensive mill premises at Aylesford, Kent. In September 1940 the company let Stockroom

Excess Profits Tax Litigation 159 No. 4 to another company until the expiration of three months after the end of hostilities at a yearly rent of £2,250. Stockroom No. 5 was partly, later fully, requisitioned by the Admiralty, which paid a compensation rent. The Court of Appeal, overruling Singleton J and restoring the decision of the Special Commissioners, held that the rents were not income from investments within paragraph 6. The Broadway Car Company case was found to be distinguishable. In CIR v Seager (1949) 28 ATC 184 Croom-Johnson J remitted the case to the General Commissioners because they had given no finding of fact as to whether certain compensation moneys, paid in respect of the requisitioning of a garage, were trade receipts or income from investments. In CIR v Tootal Broadhurst Lee Co Ltd (1949) 29 TC 352 the taxpayer company’s business was that of a textile manufacturer and merchant, and its income included patent royalties relating to, first, a crease-resisting process, secondly, a process to prevent felting (shrinking) in woollen goods, and, thirdly, controlling devices on stentering machines, i.e. devices governing the transit of cloth on conveyor belts on drying machines. Again the Special Commissioners decided in favour of the company, i.e. that the royalties were income from investments, but the courts disagreed. In the House of Lords the approach of Lord Greene MR in the Desoutter Bros. case commanded strong support. Electrical and Musical Industries Ltd v CIR (1950) 29 ATC 156 concerned arrangements made in 1934 by which several manufacturers of gramophone records established Phonographic Performance Ltd (‘PP’), a company limited by guarantee, to act for all of them in maintaining their rights under the law of copyright and collecting fees for the grant of licences. Under the detailed arrangements moneys received were the property of PP and, while PP had to distribute in accordance with rules laid down, it could not only deduct in respect of its own expenses but it also had power to set aside a reserve fund. Nevertheless it appeared that the practice had always been to distribute net receipts amongst the participants in their due proportions. In its chargeable accounting period ending on 30 June 1944 the appellant company received from PP some £17,265, and its argument for EPT purposes was that this sum was income from an investment, and therefore not to be brought into account, under paragraph 6(1). Again the Special Commissioners’ decision found no favour in the courts. Their conclusion that there had been an assignment of the copyrights was held to be wrong in law and, while the Law Lords differed on the question whether the relationship between PP and the participating companies was one of agency, they were in no doubt that the participating companies’ interests could not be described as investments, PP really being principally a collector of the company’s trading income. Harry Ferguson (Motors) Ltd v CIR, more fully discussed at 12 above, involved a subsidiary question whether interest on a sum of £21,000 fell

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within this provision as income from an investment. A negative answer fell from Sheil J by reference to CIR v Desoutter Bros. Ltd, and from the Court of Appeal in Northern Ireland by reference to Tootal Broadhurst Lee Co Ltd v CIR. 18. Paragraph 10(1) of Part I, Schedule 7, amended by Section 33(5) of the Finance Act 1941—Directors with a Controlling Interest Paragraph 10 originally provided that, in the case of director controlled companies, directors’ remuneration was not deductible in so far as it exceeded the remuneration in the standard period, except that this did not apply to remuneration of a director who was required to devote substantially the whole of his time to the service of the company in a managerial or technical capacity. The amendment in 1941 changed the general rule so that the whole of the remuneration became non-deductible, not just the excess over the amount in the standard period. Three cases require examination. CIR v Ash Brothers & Heaton Ltd (1943) 22 ATC 237 concerned the remuneration of Mr W.H. Fletcher a director/manager of a company, the business of which was that of stampers and tin plate workers. Mr Fletcher’s remuneration in the standard period was not deductible because in that period he owned more than 5 per cent of the company’s ordinary share capital, but he sold the shares on 4 April 1939, so, as the company argued, paragraph 10(1) did not engage for wartime periods and his remuneration was deductible. The Crown contended that the computations of the standard period and of chargeable accounting periods should be on a like-for-like basis, but there was nothing in the legislation to support that view, so it failed. In Henry Richardson Ltd v CIR (1947) 26 ATC 8 Atkinson J, overruling the Special Commissioners, held that ‘director’s remuneration’ meant remuneration paid to a director for services rendered as a director, and not remuneration paid to a director in whatever capacity the money may have been earned—on the facts, as company secretary. In meeting Revenue concerns about opening the door to avoidance, the Judge mentioned possible counteraction, including reliance on the general anti-avoidance rule in paragraph 9 of Part I, Schedule 7. In CIR v Monnick Ltd (1949) 29 TC 380 the decision in J Bibby (see 6 above) was followed, so that on the facts the Revenue failed to establish that the effect of a power, which had not in fact been exercised, resulted in a company being director-controlled. 19. Paragraph 11 of Part I, Schedule 7 This paragraph provided that, where the performance of a contract extended beyond the accounting period, the profit or loss should be apportioned accordingly. It read: ‘[w]here the performance of a contract extends beyond

Excess Profits Tax Litigation 161 the accounting period, there shall (unless the Commissioners, owing to any special circumstances, otherwise direct) be attributed to the accounting period such proportion of the entire profit or loss which has resulted, or which it is estimated will result, from the complete performance of the contract as is properly attributable to the accounting period, having regard to the extent to which the contract was performed therein.’ In Allen Fairhead & Sons Ltd v CIR (1943) 29 TC 125 the business of the appellant company was to build houses on land which it owned, with a view to sale. The company made an arrangement with the Hearts of Oak Permanent Building Society under which the building society would advance to a purchaser 90 per cent of the purchase price, rather than its normal limit of 70 per cent, the difference being guaranteed by the company and secured by deposits. In 1936 and 1937 the company made deposits of £537 and £463 respectively. Those years were the company’s standard period for EPT purposes, and the company contended that the deposits fell to be included in the computation of its profits for the standard period. The financing arrangement was not an unusual one in the inter-war period. For income tax purposes the Revenue had taken the line that deposits of this nature should be included in the computation of profits, but that ship had gone down in John Cronk & Sons Ltd v Harrison (1936) 20 TC 612. The company’s contention was, therefore, hopeless, unless there could be engaged one of the provisions which, for EPT purposes, modified the application of income tax principles. The company relied on paragraph 11, but the argument failed because there was no contract which extended beyond the company’s accounting period. In London and National Property Co Ltd v CIR (1947) 29 TC 303 the company had in 1931 agreed to grant a lease at a rent of £160,000 per annum, increasing to £200,000 per annum after 25 March 1941. The property concerned was Shell-Mex House in the Strand, which was about to be built on land formerly occupied by the Hotel Cecil. The lease was duly executed. In the company’s chargeable accounting period ending on 31 December 1941 the rental increase duly took place and the rent received for that period was £190,000. The company claimed that paragraph 11 applied, so that the profit from the lease should be spread over the period of the lease. In point of figures the company put forward £189,911 as the average yearly rent over the lease’s 40-year period, a period which would cover the company’s standard period as well as wartime periods. The Revenue considered that there was a ‘special circumstance’ within paragraph 11 and made a direction the substance of which was that ‘the rent of £200,000 payable . . . for certain periods has no reference to any matter performed during the period or any part thereof during which the rent of £160,000 was paid . . .’. Atkinson J said it was plain that the Revenue’s view was a mistaken construction of the agreement or a mistake of fact, and that the alleged special circumstance did not in fact exist.

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The bulk of the case was, however, taken up by a procedural dispute. The Revenue argued that a direction by the Commissioners of Inland Revenue was an exercise of a discretion and, under section 21(2), not appealable. The Special Commissioners accepted that view, but Atkinson J did not agree. He considered that the issue whether there was a ‘special circumstance’ was not a matter of discretion, and it was therefore open to appeal.

20. Paragraph 1 of Part II, Schedule 7—Valuation of Assets Part II of Schedule 7 set out the provisions for computing capital. Paragraph 1 dealt with the valuation of assets for those purposes. Under paragraph 1(2)(b) deductions from the price or value of any assets were to include ‘any such deductions for wear and tear or for depreciation as are authorised by the Income Tax Acts or Part I of this Schedule’. Paragraph 2 of Part I, Schedule 7, opening with the words ‘[t]here may be deducted . . .’, provided for wear and tear allowances as per Rule 6 of the Rules applicable to Schedule D Cases I and II under the Income Tax Act 1918, with an uplift of 10 per cent in respect of the standard period and of 20 per cent in respect of any other accounting period. In CIR v Terence Byron Ltd (1945) 24 ATC 66 one of the company’s theatres, the Alexandria Theatre, Hull, was destroyed by enemy action on 7 May 1941. The issues were whether the company still had the asset which it had originally bought and whether it was still ‘employed in [the company’s] trade or business’. Affirmative answers in favour of the company were given by the House of Lords. CIR v Great Wigston Gas Co (1946) 29 TC 197 concerned the wear and tear on plant and machinery owned by the taxpayer company, a gas undertaking in Leicestershire. In essence the issue was whether the company’s income tax computations, or a variation of them, should carry through to EPT, or whether the EPT provisions required a special computation. The issue related both to the company’s standard period, which was 1936, and to its three chargeable accounting periods comprising 1940, 1941 and 1942. The income tax position was complex, and it produced a disparity in the allowances as between 1936 and 1940–42, which, if carried through to EPT, would be advantageous to the company, in that it promoted a relatively higher figure of profit for the standard period and relatively lower figures for the chargeable accounting periods. But that result would not follow if, as the Revenue argued, paragraph 2 of Part I and paragraph 1 of Part II Schedule 7 applied. Overruling the Special Commissioners and Macnaghten J, the Court of Appeal found for the Revenue. The company’s crucial arguments concentrated on ‘there may be deducted’ and ‘any such deductions . . . as are authorised’ in the two principal statutory provisions, and suggested that in

Excess Profits Tax Litigation 163 both instances the applicability of the provisions was dependent on the taxpayer company choosing to claim the appropriate deductions. The Revenue’s arguments were that choice did not enter into the picture, paragraph 2 of Part I being a direction to the Commissioners of Inland Revenue, and paragraph 1 of Part II referring to ‘authorised’ in the sense of ‘authorised by law’. The Court of Appeal preferred the Revenue’s contentions, and it is fairly clear that a highly influential factor was that the Revenue’s approach involved a comparison of like with like, that is to say, a commonality of method of computation as between the standard period and the three chargeable accounting periods. This might be categorised as a more purposive approach than was traditional in the period in question. Lever Brothers and Unilever Ltd v CIR (1946) 25 ATC 28 concerned two payments to pension trustees made by the taxpayer company in 1940. One payment, £131,196, was in commutation of prospective annual contributions for increased widows’ pensions. The other, £895,329, was to enable pensions to be equalised as between employees of different companies which had become part of the taxpayer company’s group. The issue for EPT was whether the sums were deductible in computing the company’s capital for the chargeable accounting period comprising 1940. The company contended that no deduction should be made, because it had acquired something of equal amount as part of its capital. The company succeeded before Macnaghten J, but failed in the Court of Appeal and the House of Lords. The judge considered that the company had gained something for its money in the form of a contented, or less discontented, staff. The company did not pursue this line, and Viscount Simon dismissed it as not constituting ‘capital’. The contention that the company had a contractual right to compel the trustees to make the increased payments failed because there was no contractual relationship at all, and the possibility of a resulting trust in certain events was dismissed as too remote. Lord Thankerton added that in any event the Special Commissioners had found that neither of these matters was capable of valuation. In CIR v Laurence Philipps & Co (Insurance) Ltd (1947) 26 ATC 161 the taxpayer company, an insurance broker and Lloyd’s underwriting agent, made various loans, in 1934 and succeeding years, to a director and to a salaried employee in relation to those individuals becoming members of Lloyd’s syndicates promoted by the company. The Revenue maintained that the debts were not to be included in the computation of the company’s capital, either because they did not represent ‘capital employed in a trade or business’ within the exclusion provided by paragraph 1 of Part II, Schedule 7, or were ‘investments’ within the exclusion provided by paragraph 3 of Part II, Schedule 7. The company succeeded before the General Commissioners for the City of London and before Atkinson J. The judge found guidance in two Excess Profits Duty authorities, James Waldie & Sons Ltd v CIR (1919) 12 TC 113

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and CIR v Gas Lighting Improvement Co Ltd (1923) 12 TC 503. The judge concluded that the debts arose from the employment in its normal course of business of capital belonging to the company, that they were not investments, and that in any event they were not investments in an ‘outside security’, the phrase used by Lord Cave in the Gas Lighting case. Birmingham Small Arms Co Ltd v CIR (1951) 30 ATC 158 concerned the destruction by enemy action in late 1940 of a large part of the taxpayer company’s machine tools and plant. The company made a claim for compensation in anticipation of the passing of the War Damage Act 1941, which occurred on 26 March 1941. The amount of the claim, £647,012 was settled in November 1945, and it was paid in March 1947. In relation to an EPT assessment for its chargeable accounting period ending on 31 July 1941, the company contended that its claim should be included in the computation of its capital employed in its trade under paragraph 1(1) of Part II, Schedule 7. The contention failed at all stages. There were two points of argument. First, it was said that the claim was a debt within paragraph 1(1)(b) but, as it was an unestablished right to an indeterminate sum payable at a future and uncertain date, it fell short of being a ‘debt’, and that argument was not pursued in the House of Lords. The second issue was whether the claim fell within the reference in paragraph 1(1)(c) to ‘any other assets which have been acquired than by purchase as aforesaid’, and was therefore comprised in ‘capital employed in a trade or business’ within the opening words of paragraph 1. The speeches in the House of Lords provided a negative answer to that question, though differing as to the reasoning. In CIR v Walker Cain Ltd (1953) 32 ATC 170 the appellant company’s subsidiary, Barrett & Co. (Lancashire and Cheshire) Ltd, manufactured soft drinks. In 1943 the Ministry of Food made a scheme to regulate the soft drinks industry. Each manufacturer had to pay its proceeds of sale, less a pre-determined cost allowance, to a pooling company. Every six months the pooling company was to distribute the pool, after due deductions, to the contributors rateably in accordance with their profits. In practice payments were made on account, but final payments were considerably delayed. In respect of EPT for the company’s chargeable accounting period from 1 July to 31 December 1946, it was agreed that payments to the pooling company were deductible, and that payments by that company were receipts even though the amounts were not finalised until 1949. The issue was whether the receipts constituted capital employed in the business in the period in question, so as to produce a favourable adjustment to the company’s standard under section 13(3). The company contended that the right to distributions from the pooling company were assets within paragraph 1(1)(c) of Part II, Schedule 7. The Revenue’s counter was that until payment the rights were a chose in action which should not be taken into account. The Special Commissioners and

Excess Profits Tax Litigation 165 Upjohn J accepted the company’s argument, distinguishing both the Birmingham Small Arms case (discussed above) and the Northern Aluminium case (discussed at 21 below), because in this instance the pool constituted a trust fund of which the Barrett company was a part owner and entitled to be paid cash on the expiry of each six-month period. In the alternative the company relied on paragraph 4 of Part II, Schedule 7, by which profits and losses were deemed to accrue at an even rate throughout a chargeable accounting period and to have resulted, as they accrued, in a corresponding increase or decrease to the capital employed in the business. Upjohn J held that argument to be sound. He gave short shrift to the Revenue’s argument that the asset could not be valued, holding that the value was quite plainly the amount of the ultimate receipt.

21. Paragraph 2 of Part II, Schedule 7 and section 29(1) of the Finance Act 1941—Borrowed Money In relation to chargeable accounting periods beginning before the end of March 1940, paragraph 2 of Part II, Schedule 7 disallowed a deduction in respect of any borrowed money, but section 29(1) of the Finance Act 1941 reversed that rule for chargeable accounting periods ending after the end of March 1940, subject to special rules for straddling periods, and, by section 29(6), the new rule did not apply to building societies, banking businesses, assurance business, or ‘a business consisting wholly or mainly in the dealing in or holding of investments’ (compare paragraph 6 of Part I, Schedule 7 to the 1939 Act). Four cases arose on the former provision, and two on the latter. In Solsgirth Investment Trust Co v CIR (1943) 22 ATC 201 the issue was whether the calculation of the company’s capital on 1 December 1939 should take account of a claim against the Revenue for a repayment. The Court of Session, overruling the Special Commissioners, held that it should, as a matter of the ordinary principles of accounting. Lord Moncrieff observed, ‘[t]he principle to be applied in determining the question appears to be as simple as this, namely, that an overpayment becomes an overpayment as soon as it has been overpaid’. In CIR v Northern Aluminium Co Ltd (1947) 26 ATC 123 the taxpayer company supplied aluminium products at fixed prices to customers in the aircraft production business. The company was a member of the Wrought Light Alloys Association. In 1939 that Association, on behalf of its members, agreed with the Air Ministry a schedule of lower prices for the period from 1 July 1939 to 30 June 1940, the excess to be paid to the Ministry. The letter stipulated that negotiations were to proceed by 30 June 1940 in respect of prices after that date. In the event the negotiations were delayed, and no arrangement was ever made for the period from 1 July to 31

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December 1940. But in October 1942 an agreement was made in respect of prices for 1941, 1942 and 1943, again involving rebates. In 1943 the company paid a rebate of £2,743,469 in respect of 1941. For EPT purposes the company’s accounts for 1941 were reopened and the profit reduced by the amount of the rebate, but the company resisted the Revenue’s view that its capital for 1941 was to be reduced on the basis either that the rebate was a debt within paragraph 2 of Part II, Schedule 7 or that it was an ‘accruing liability’ within section 34(4)(a) of the Finance Act 1940. The Revenue succeeded before the Special Commissioners and before Macnaghten J, the judge regarding the 1939 agreement as amounting to a contract by which, if the contemplated negotiations did not produce agreement, a reasonable price was to be substituted for the sale price. The Revenue did not seek to support that reasoning, and the Court of Appeal and the House of Lords decided in favour of the company because, while in 1941 there was clearly a prospect of a rebate in due course, there could not be said to be a debt until the agreement of October 1942 was made, and likewise there was no liability which was accruing. In CIR v Rowntree & Co Ltd (1948) 27 ATC 28 the taxpayer company had, during 1936, its standard period, obtained facilities amounting to £268,232 under an arrangement made in 1933 with an acceptance house. The acceptance house agreed to accept sight bills drawn by the company, to discount the bills, and to remit the proceeds to the company. The company contended that the £268,232 was not ‘borrowed money’. The Court of Appeal, reversing Macnaghten J and restoring the decision of the Special Commissioners, upheld the company’s contention, as the relationship between the company, the acceptance house and the holders of the bills of exchange was not one of borrower and lender. In CIR v W.G. Bagnall Ltd (1943) 22 ATC 410 the taxpayer company, a locomotive engineer, had unsettled tax liabilities going back to the period of the First World War. The Revenue calculated an under-payment of Excess Profits Duty of some £18,331, but other taxes were considered overpaid and the global tax figure was put at £14,449. Under section 38 of the Finance Act 1926 the Excess Profits Duty was assessable only if fraud or wilful default on the part of the company were established. On 22 September 1937 the Revenue accepted an offer made on behalf of the company in November 1936 to settle for £10,000 all claims for various taxes, interest or penalties up to 5 April 1935. Neither fraud nor wilful default was admitted or proved. For EPT purposes the company selected 1935 and 1937 as its standard period. For reasons which are not apparent the company wanted the £10,000 to be deductible for 1935 rather than 1937. The Special Commissioners accepted that there was a debt at 1 January 1935. Macnaghten J reversed the decision, holding that there was nothing more than a claim at that date. He

Excess Profits Tax Litigation 167 held that ‘debt’ in paragraph 2 of Part II, Schedule 7 was there used in the proper sense of an ascertained sum. In CIR v A. Plein & Co Ltd (1946) 25 ATC 136 the business of the taxpayer company was that of a shipping merchant, mainly in the shipping of goods to South Africa. Many transactions were conducted by the same commercial pattern, and one was taken as typical for the purposes of the litigation. It involved sale to a South African firm of cycle parts (50 gross No 574 cycle crank cotters 3/8 inch with nuts and washers) manufactured by a Birmingham company. The taxpayer company drew a bill of exchange for £81 4s on the South African firm, payable 60 days after sight, directing payment to be made to a bank in Johannesburg. Two weeks later the bank’s London Branch credited the taxpayer company’s account with £81 1s 6d, the 2s 6d deduction being in respect of the bank’s document forwarding charge. At the same time another account of the company was debited with £83 3s 10d, being the adjusted figure endorsed on the bill and the amount expected to be paid by the South African firm in due course. The issue was whether the credit of £81 1s 6d was borrowed money within section 29(1) of the Finance Act 1941. The Special Commissioners held that the sum was borrowed money, reliance being placed on obiter remarks in Bernard v Gahan (1928) 13 TC 723. Wrottesley J confirmed the decision. As he described it , ‘[t]he course of business adopted here enabled this company to employ that credit in other business’. He held that there was material upon which the Commissioners could properly have found that the sum in issue was a ‘temporary advance’. In CIR v 1933 Housing Society Ltd (1946) 25 ATC 355 the taxpayer society was formed for the purpose of providing and managing houses for letting to persons of the working classes at sub-economic rents in accordance with the policy of the housing legislation, and the issue was whether the company’s business consisted wholly or mainly in the dealing in or holding of investments. The General Commissioners for the Duchy of Lancaster and Atkinson J answered in the negative. The judge said that dealing in investments involved buying and selling, but the society did not do that.

22. Paragraph 3 of Part II, Schedule 7—Moneys not Required for Purposes of Trade or Business Paragraph 3 of Part II, Schedule 7 provided that in the computation of the capital of a trade or business ‘any moneys not required for the purposes of the trade or business shall be left out of account’. Apart from the two cases below, this provision arose in the Laurence Philipps case at 20 above. In Thomas Roberts (Westminster) Ltd v CIR (1946) 25 ATC 449 the taxpayer company was a supplier of road materials, i.e. limestone, granite, and similar material. The company had a practice of buying land, as opportunities

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arose, from which those materials could be extracted. To that end it kept stocks of ready money. As at 31 March 1940 and 1941, it had some £30,000–£50,000 on current account at the bank, and £18,000 on deposit account. It also held some £40,000 worth of readily saleable securities. For EPT purposes the question arose to what extent those amounts could count as capital, so that any excess over the figure of capital in the standard period would give rise to an uplift in that figure by 8 per cent of the excess. That turned on whether all or any of those amounts were, under paragraph 3 of Part II, Schedule 7, to be left out of account because they were ‘moneys not required for the purposes of the trade or business’. The Revenue allowed some amount (unstated) to be included as capital, but considered that the balance should be left out of account. On the company’s appeal the General Commissioners held that the amount to be included as capital should be increased by £5,000. Atkinson J dismissed an appeal by the company, holding that the Commissioners had applied the right test, not limiting themselves to thinking of the commitments to be met in the near future, but extending to a level which they regarded as reasonable, viz. reasonable possibilities of money being wanted for unexpected transactions. The decision reached on application of that test was regarded by the judge as one of fact on which he should not interfere. A similar issue arose in Acme Flooring and Paving Company (1904) Ltd v CIR (1948) 27 ATC 41 in respect of a large amount of cash held at the bank by a company engaged in the business of manufacturing and laying wooden blocks for the purposes of street paving and parquet flooring. The company contended that the money was required to re-establish its 1939 stock position, but the Revenue was successful in its view that that applied to only part of the money.

IV. AVOIDANCE

In 1915 concerns about avoidance of Excess Profits Duty led to section 44(3) of and paragraph 5 of Part I, Schedule 4 to the Finance (No 2) Act 1915 which prohibited fictitious or artificial transactions or operations, on pain of a fine, on summary conviction, of up to £100, and, for computational purposes, nullified deductions which such transactions or operations might otherwise have achieved. Avoidance scarcely featured in the litigation, though paragraph 5 was successfully invoked by the Revenue in one case, and was an alternative basis for decision in another case, both being decisions of the Court of Session. The behavioural effect of the statutory provisions is unknown. In 1939 section 44(3) of the 1915 Act was not replicated, but the computation provision made something of a re-appearance in paragraph 9 of Part I, Schedule 7, viz. ‘[n]o deduction shall be made in respect of any transaction

Excess Profits Tax Litigation 169 or operation of any nature in so far as it appears that the transaction or operation has artificially reduced or would artificially reduce the profits’. As will be seen, fiction was not resurrected, and the concept of artificiality was transferred from the transaction or operation to the reduction of profits which might be achieved. It is a matter of mild lamentation that paragraph 9 generated no litigation, the only mention of it being the throw-away line of Atkinson J in the Henry Richardson case at 18 above. But in contrast to the position relating to Excess Profits Duty, the antiavoidance story does not stop at the founding Act. Presumably the obvious limitations of paragraph 9 of Part I, Schedule 7 came to be understood and considerable avoidance activities were entered into on the basis that they could not be attacked for artificiality. Section 35 of the Finance Act 1941 provided the Revenue with a new weapon. It applied, with retrospective effect, where the Commissioners of Inland Revenue were of opinion that the main purpose for which any transaction or transactions were effected was the avoidance or reduction of liability to EPT. In such circumstances the Commissioners were empowered to direct such counteracting adjustments as they considered appropriate. In retrospect it looks obvious that the Revenue would have difficulty in establishing avoidance as ‘the main purpose’. Parliament intervened again, by section 33 of the Finance Act 1944. First, the term ‘main purpose’ was expanded to ‘the main purpose or one of the main purposes’. Secondly, by section 33(3), it was enacted that where ‘the main benefit which might have been expected to accrue from the transaction or transactions during the currency of excess profits tax was the avoidance or reduction of liability to tax’, avoidance or reduction of EPT was to be deemed to be ‘the main purpose or one of the main purposes’. These provisions were also retrospective, but not so as to enable a fresh direction where a previous one had been cancelled or varied by a decision of the Special Commissioners made before 25 April 1944. Meanwhile section 24 Finance Act 1943, another provision capable of operating retrospectively, counteracted avoidance by means of disposal of stock at less than market value. A considerable body of litigation resulted.

23. Section 35 of the Finance Act 1941, as amended by Section 33 of the Finance Act 1944 Sixteen cases arose under these provisions. In 15 of them, the facts generally concerned changes in the ways in which businesses were owned and run. For the sake of economy 14 of those cases will not be described in detail. In 12 of them the Revenue’s counteracting directions were upheld, those cases being Pinner and Willis Ltd v CIR (1944) 23 ATC 160, Frodingham Ironstone Mines Ltd v CIR (1945) 24 ATC 310, Cooke & Ferguson Ltd and Ryecroft Electric Ltd v CIR (1945) 24 ATC 338, Ingham and Johnson v CIR

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(1946) 25 ATC 439, Fields and Pateman v CIR (1946) 25 ATC 274, E.V. Saxton & Sons v CIR (1946) 25 ATC 362, Marshall Castings Ltd and Cindal Aluminium Ltd v CIR (1946) 34 TC 122, British Pacific Trust Ltd v CIR (1947) 26 ATC 17, CIR v David Allen & Sons (Billposting) Ltd & Ors (1947) 26 TC 126, Harridges (Wholesale) Ltd v CIR (1947) 26 ATC 289, Cumberland Coal Company (Whitehaven) Ltd v CIR (1949) 28 ATC 18, and Star Cinemas (London) Ltd and Majestic (Derby) Ltd v CIR (1952) 31 ATC 14. Only in two cases were appeals against counteracting directions successful, those cases being CIR v Earthwork and Construction Ltd (1948) 27 ATC 88 and Joseph Smith (Cleckheaton) Ltd and Rawfold Spinning Co Ltd v CIR (1949) 28 ATC 221. The fifteenth case, Crown Bedding Co Ltd and South Wales Flock Co Ltd v CIR (1946) 34 TC 107 is still cited, from time to time these days, so it will be described in some detail. The appellant companies (‘Crown’ and ‘Flock’) were bedding manufacturers. Crown was a family company, three of the directors being brothers called Seccombe, and the directors’ shareholdings gave them a controlling interest. Flock was a subsidiary, 2,640 of its 5,000 issued shares being owned by a wholly owned subsidiary of Crown; 1,360 of the shares were owned by the brothers Seccombe and by their mother; 1,000 shares were owned by a manager, Mr Pinchin, his acquisition having been on the footing that, if the business failed, the Seccombes would buy him out. Flock’s business did fail in 1940, when the import of rags into South Wales ceased entirely. The Seccombes duly arranged for Crown to buy out Mr Pinchin’s shares. On 1 June 1941 Crown also acquired the 1,360 shares from the Seccombes and their mother. The effect for EPT, counteraction apart, was that Flock became a wholly owned subsidiary and its standard profits, about £3,000, would be added to Crown’s profits. The Revenue made a direction in relation to the transaction involving the 1,360 shares under section 35 of the Finance Act 1941, as amended by section 33 of the Finance Act 1944, that Flock’s profits should continue to be computed for EPT as if it were an independent company. Crown’s and Flock’s appeals against the direction were unsuccessful before the Special Commissioners, Macnaghten J and the Court of Appeal. The Revenue’s case concentrated on section 33(3), i.e. it was said that the EPT advantage was the main benefit of the transaction, and was therefore deemed to be the main, or a main, purpose of it. The companies were unable to produce anything significant by way of a different main benefit. The auditor suggested that there was a moral obligation to treat the shareholders alike, but that was described by Lord Greene MR as ‘just nonsense’ (at 116). Other than that it was said to be an advantage to Crown to be rid of minority shareholders, but three of the four individuals were directors of Crown, and the other was their mother, so Lord Greene MR agreed with the Commissioners that that benefit was ‘of a very trivial and hypothetical nature’ (at 114).

Excess Profits Tax Litigation 171 On the other hand the evidence was that Crown was unlikely to produce profits of an order to attract EPT liability, so that no benefit of any nature was likely to accrue from the transaction. The Court of Appeal did not favour a restrictive construction of section 33(3). As Somervell LJ put it in his short concurring judgment, that ‘would introduce into this section a dividing line between probabilities and possibilities which would be extremely difficult to apply and which there are no words in the section to suggest exists’. The final case, Dixon & Gaunt Ltd and James Hare Ltd v CIR (1947) 29 TC 289, involved a procedural wrangle. On 30 August 1940 James Hare Ltd made a transfer of 7,000 shares in Dixon & Gaunt Ltd. In 1945 the Revenue made a direction under section 35 of the Finance Act 1941, as amended, founded on the opinion that avoidance or reduction of liability to EPT was, or was deemed to be, the main purpose or one of the main purposes of the transaction. On the companies’ appeal, each side contended that the other should open and call evidence. The Special Commissioners held that the appellants should do so, but they declined, and the Commissioners confirmed the direction. Atkinson J did not agree. His judgment first explained that the statutory provisions and the various Regulations had not applied to appeals against directions under section 35 the familiar income tax provision, then in section 137(4) of the Income Tax Act 1918, which put the burden on the taxpayer to prove that an assessment was too high. The judge then considered Thomas Fattorini (Lancashire) Ltd v CIR (1942) 24 TC 328, which related to the provision, then section 21 of the Finance Act 1922, which dealt with the undistributed income of close companies, and he also considered two EPT cases (Crown Bedding Co Ltd, and Marshall Castings Ltd) mentioned above. Finally he applied the standard rule that the answer follows from asking ‘[i]f no evidence is given, who wins?’—and his answer was that the appellants would win, so the Crown must open. In the judge’s view it had not been open to the Commissioners to confirm the direction because ‘they knew no more about the case than the usher in this Court. There was no evidence before them.’ The report ends with spirited efforts by junior Counsel for the appellants to prevent a remitter to the Commissioners, but the judge was not persuaded.

24. Section 24 of the FA 1943—Disposal of Company’s Stock at Under Value Whisky played a significant role in the fiscal side-show of the Second World War. In terms of fiction Compton McKenzie wrote the comic masterpiece, Whisky Galore, in which the inhabitants of the Todday islands liberated the liquid contents (uisge beatha galor) of the sunken steamship, the Cabinet Minster—to their own advantage, and to the disadvantage of HM

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Customs & Excise. The book opens with mention of a shortage of whisky in the islands, and this reflected fact. The price of whisky had rocketed some twentyfold or more, there were restrictions on the manufacture of whisky, and the holders of stocks released little for sale because extensive release would only lead to profits disappearing under the burden of EPT. In these circumstances an avoidance scheme was hatched, with the ultimate object being that stocks of whisky would be held by persons who could dispose of them for full value without incurring liability to EPT. Section 24 of the Finance Act 1943 was enacted to counter the scheme, with retrospective effect (subsection (8). The scheme involved disposal of stocks for less than their full market value, so that provided the touchstone for application of the provision, which then set out mechanisms for calculating the avoided tax and visited liability proportionately among those who were to have benefited financially from the scheme, though ultimately all were liable as joint and several liability was imposed. CIR v Ross and Coulter & Ors (Bladnoch Distillery Co Ltd) and allied cases (1948) 27 ATC 409 were decided by the House of Lords on 12 March 1948. The Revenue had succeeded before the Special Commissioners in all of the cases. All bar one case then proceeded to the Court of Session, which reversed the Special Commissioners’ decisions, holding that section 24 had no application. The remaining case proceeded to the High Court, where Atkinson J followed the Court of Session’s reasoning, but, on appeal, the Court of Appeal disagreed with that reasoning and restored the Special Commissioners’ decision. In the event the House of Lords agreed with the Court of Appeal, rather than the Court of Session, on the fundamental issue in the cases, but disagreed with the Special Commissioners on other points, and the result was that the cases were remitted to the Special Commissioners for re-determination. The fundamental question was whether the original shareholders, despite the limitations of their knowledge, had been involved in transactions ‘effected in connection with or in association with’ transactions by which the whisky was disposed of at an undervalue (section 24(1)(b)), though it should be made clear that, as well as the context of section 24 as a whole, other expressions within it called for particular examination. According to the speech of Lord MacDermott the taxpayers’ approach became known as the ‘knowledge construction’ and the Crown’s approach as ‘the Olympian retrospect construction’. Lord MacDermott dissented, the other four Law Lords agreeing with the Court of Appeal that knowledge was not necessary. The Law Lords were, however, able to meet their own concerns about the harshness of the measure when they came to address the second main issue. As mentioned earlier, the end result was a remitter to the Special Commissioners to consider afresh the apportionment of the EPT liabilities. The juridical basis for this was that the Commissioners had exercised their discretion wrongly or, negatively but perhaps more accurately, they had not

Excess Profits Tax Litigation 173 exercised the discretion judicially. Their method of apportionment had been to impose the maximum liability on the original shareholders. That came about through an approach called, in the language of the case, the ‘tainted money theory’, denoting an exercise to trace the money through bank accounts into the hands of the true recipients, with extrapolation into the apportionment. The House of Lords was clear that the statutory wording did not drive exercise of the discretion in a way which would impose maximum liability on the original shareholders. Further, they concluded that such an approach was wrong because application of the tainted money theory produced a figure in excess of the true financial benefit to the original shareholders. That benefit was the amount by which the sale price of the shares exceeded the market value of the shares at the time of transfer on the footing that the company was to continue as a going concern. The Commissioners had wrongly ruled that market value out of their consideration, in one case specifically ruling as irrelevant the evidence of value given by a chartered accountant. Tacked on to Ross and Coulter was a specific issue about a commission of £1,250, in relation to which one David Lannon had been held liable for part of the overall EPT liability. There was an issue whether Mr Lannon received the sum on this own account or on behalf of Glazier & Sons Ltd, of which he was an employee, and the latter view was held to be correct. Each of the allied cases was the subject of a separate set of speeches by the Law Lords. The facts of some of the cases were not materially distinguishable from, and the like result followed as in, Ross and Coulter, but several additional minor issues were resolved. For present purposes only one matter will be mentioned. In CIR v DP McDonald & Sons Ltd & Ors 27 ATC 255 (The Original Shareholders’ case) 27 ATC 255 Lord Thankerton used language to become familiar many years later in the Ramsay series of cases: ‘[i]n my opinion, the Special Commissioners were entitled, on the evidence, to find that these transactions of purchase of the shares, which were completed on the same day, were interdependent and, in substance, constituted one transaction by which Mr McGlone acquired control of the McDonald and Fort William companies from the original shareholders’. The cases were said to have involved EPT of over £4.5m. The matter did not end there, as CIR v Bladnoch Distillery Co Ltd and allied cases (1949) 28 ATC 471 showed that the appetite (thirst?) for litigation survived the visit to the House of Lords. The conclusions reached by the Special Commissioners under the remitters engendered all-round dissatisfaction and a return visit to the Court of Session. There were four strands to the case. On the first, the Special Commissioners were held inadequately to have implemented the House of Lords’ decision and a further remitter was ordered. On the second, a grievance by one individual, that others had been permitted to be heard by the Commissioners, was rejected because section

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24(7) specifically provided that ‘on any such appeal any other person specified in the direction shall be entitled to appear and be heard’. On the third strand, the Commissioners of Inland Revenue were found wrongly to have made a fresh direction, and a further remitter resulted. On the fourth strand, the Special Commissioners were found correctly to have declined to apportion a specific sum to one individual under proviso (i) to section 24(1), in that this was a proper exercise of the Commissioners’ discretion with which the Court could not interfere.

V. MISCELLANEOUS

The EPT provisions were extensively altered by the Finance Act 1940, and subsequent Finance Acts were not without something to say on the subject. To some extent the chapter has already dealt with the changes, but this heading will sweep up the balance of the changes, cover a few bankruptcy matters, and end with two truly miscellaneous items.

25. Paragraphs 8(2) and 9(4) of Part IV, Schedule 5 to the FA 1940 Rendering the principal company of a group liable to EPT on the whole of the group’s profits necessitated consequential provisions of some complexity. The effect of paragraph 8(2) of Part IV, Schedule 5 to the FA 1940 was that the principal company could demand from any subsidiary a sum corresponding to the amount of EPT attributable to the subsidiary concerned. Paragraph 9(4) then made payment of any sum demanded under paragraph 8(2) a deduction for income tax purposes. The Finance (No. 2) Act 1945 contained provisions enabling subsidiaries to recover from the principal company appropriate proportions of any post-war refunds of EPT. In Fielding & Son (Werneth) Ltd v Green (1951) 32 TC 347 the company failed in an attempt to get a greater deduction for income tax purposes than the amount of £57,796 paid by agreement to its parent in full settlement of its EPT liability to 30 June 1946 on the basis that the parent should be entitled to all EPT post-war refunds.

26. Section 39 of the Finance Act 1941—Application of Changing Law Section 39(1) of the Finance Act 1941 provided that, in applying income tax principles under section 14(1) of the principal Act, regard should be had to income tax law in force with respect to the year of assessment in which the relevant chargeable accounting period ended, though subject to any

Excess Profits Tax Litigation 175 enactment providing to the contrary. Section 39(2) extended that principle so that, vis-à-vis any chargeable accounting period, the profits for the standard period should be computed in the same way. Thus the profits of the standard period were capable of being a moving feast. Section 39 was the subject of an alternative argument on the part of the Revenue in CIR v Great Wigston Gas Co, discussed at 20 above. In that case the Court of Appeal expressed obiter approval of the Revenue’s argument that election by the taxpayer company for the renewals basis of wear and tear allowances for the three chargeable accounting periods in issue would engage section 39(2) and direct the same basis to be applied in respect of the company’s standard period.

27. Section 37 of the Finance Act 1946—Relief for Terminal Expenses North of Scotland Hydro-Electric Board v CIR (1961) 40 ATC 206 concerned the Electricity Act 1947, under which the undertakings of the Scottish Power Co Ltd and of a subsidiary, Grampian Electricity Supply Co, vested in the appellant Board. The Board carried out various repairs and renewals which had been deferred due to wartime conditions. Subject to certain conditions, which were satisfied in this case, section 37 of the Finance Act 1946 provided relief where the owner of a business carried out, before 31 March 1954, work postponed due to wartime conditions, but the provision did not extend to situations in which there has been a change in the ownership of the business. The appellant Board claimed the relief on the footing that it was due under section 14 of the Electricity Act 1947. There was no doubt that that provision imposed on the Board liability for EPT, but its wording did not in terms address questions of computation. The Board’s case succeeded in the House of Lords by a 4–1 majority, the decision turning on the construction of section 14(7) of the 1947 Act.

28. Paragraph 5 of Schedule 9 to the Finance Act 1946—Right of Appeal Relating to Terminal Losses Paragraph 5 of Schedule 9 to the Finance Act 1946 furnished a right of appeal to the Board of Referees where a person was dissatisfied with a determination of the Revenue as to what, if any, relief he was entitled to in respect of terminal losses under that Act. In R v Board of Referees ex parte Calor Gas (Distributing) Co Ltd (1954) 35 TC 476 the taxpayer company failed to get mandamus of a decision of the Board of Referees that it had no appeal jurisdiction in relation to the exercise of a discretion conferred on the Revenue under section 39(4).

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29. Bankruptcy In In re Moschi, R v Commissioners of Inland Revenue, ex parte Moschi (1953) 35 TC 91 Mr Moschi’s wife, Rachel, failed in her application for an order for rescission of the bankruptcy on the grounds that the true facts showed that the EPT assessment should never have been made. Following In re Calvert (1899) 4 TC 79, Danckwerts J held that, unlike an ordinary judgment, a final assessment to tax cannot be reopened in bankruptcy proceedings. In In re Pratt, CIR v Phillips (1950) 31 TC 506 the Revenue succeeded in a contention that, under section 33(1)(a) of the Bankruptcy Act 1914, it could make priority claims for different years in respect of different taxes. Likewise in CIR v Liquidators of Purvis Industries Ltd (1957) 38 TC 155, proceedings against the liquidators for misapplication by neglect, it was held that the Revenue could, under section 319 of the Companies Act 1948, select different years in respect of different taxes for the preferential element. In In re A Debtor (No. 335 of 1947) (1948) 27 ATC 362 the Revenue successfully applied for an order for service out of the jurisdiction of a bankruptcy petition relating to a Mr Theophile, a Roumanian citizen, who had gone to live in Eire. 30. Rates Somerset County Valuation Committee v South Somerset and District Electricity Co Ltd (1947) 26 ATC 452 The respondent company was a private electricity undertaking liable to pay rates on its premises. Rateable value for such undertakings was ascertained on a profits basis, which involved calculating the profits and apportioning them between rent, rates and tenant’s profit. The company contended that EPT was deductible in calculating the profits, alternatively that it should be taken into account in the valuation. The point had arisen in relation to Excess Profits Duty, and that tax had been held deductible in Port of London Authority v Orsett Union [1919] 1 KB 84, a Divisional Court decision (the point was not in issue when the case proceeded to the House of Lords) and in Newton-on-Ayr Gas Co Ltd v Ayr Assessor, an unreported Court of Session decision in 1923. The Assessment Appeals Committee of the Somerset Quarter Sessions and the Divisional Court followed those previous decisions, but the Court of Appeal, by a majority, disagreed. The judges did not see any distinction between EPD and EPT, but the majority were clear that EPT, like income tax, was not an expense in earning profit, but was an application of profit when earned, and section 18 of the principal Act supported that view because, if it had been wrong, section 18 would not have been needed. But the company’s alternative contention succeeded on the footing that EPT,

Excess Profits Tax Litigation 177 like income tax, would be one of the factors influencing the hypothetical tenant’s mind. 31. Construction of an Agreement—Nature of EPT LC Ltd v GB Ollivant Ltd (1944) 23 ATC 54 By an agreement made in 1933 the property, assets and goodwill of a business, principally that of merchants in West Africa, were sold on terms which included yearly payments, relating to the ensuing eight years to 1941, of half of the profits as ascertained under principles set out in the agreement. The main term applied ‘the general principles . . . of ordinary commercial practice’. It was provided that no deduction should be made for income tax. In the event EPT, which had not of course been foreseen, assumed importance. For the year ending on 31 August 1940 the calculation would, if no deduction were to be made for EPT, show £82,502 as payable to the vendor, but would, if EPT were deducted, produce a loss of £26,996. In the event the vendor’s claim failed at all stages, but it was a close-run thing in the House of Lords. Powerful dissents were made by the Lord Chancellor and Lord MacMillan. The five speeches are not entirely easy to follow. The vendor’s primary, and probably only, contention was that ‘general principles of ordinary commercial practice’ did not require the deduction of EPT. The purchaser took the line that the only purpose of such general principles related to the drawing up of a profit and loss account ‘showing the divisible profits’. It seems that those last four words generated the division of view in the House of Lords. Lord Wright recorded the vendor’s Counsel as having admitted ‘that, for the purpose of drawing up the profit and loss account of a trading company, excess profits tax must be deducted if ordinary commercial practice is to be followed’. The minority view seems to have been on the basis that no such admission had been made or should be accepted. The dissenting view was that it is not the function of a profit and loss account to produce a figure of divisible profits, but to ascertain a pre-tax figure. It was accepted on the purchaser’s side that, irrespective of the express term in the agreement, income tax would not be deductible. Lord MacMillan could not in this respect differentiate EPD. He also remarked, ‘it seems to me unintelligible that the payment of a tax levied on profits after they have been earned should be construed to be a payment made in order to earn these profits’.

VI. CONCLUSION

In Chapter XII of A History of Income Tax the late Basil Sabine set out a compact exposition of UK taxation in the Second World War. He noted

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that, while income tax remained the main source of the Exchequer’s income, EPT, combined with National Defence Contribution, reached ‘remarkable figures’, including just over £500m in 1943–1944 and 1944–1945. His overall conclusion was that ‘the Government and its advisors could present a remarkably successful balance sheet’. Yet his assessment of EPT was a shade ambivalent, stating, ‘EPT, however, was the really onerous wartime fiscal measure, possessing the inherent objections of depleting reserves, encouraging evasion and extravagance both in revenue and capital expenditure and setting no premium on efficiency. Despite these undoubted disadvantages, its impact was cushioned by not ungenerous standards, especially when borrowed money was included in the addition for capital, post-war refunds, the later increases in minimum standards, and the lowering of the rate to 60% in 1945’. The passage then concludes with a further injection of realism by setting out the following quotation from F. G. Moult’s ‘Economic Consequences of EPT’ Fiscal Press London, 1943: ‘there is more than a little doubt whether an equivalent amount of money could have been raised by other taxation which would not have resulted in at least as much restriction of output, particularly if the political implications are considered’. With a few exceptions, notably the Smiths Potato Crisps and Cock Russell cases, the EPT litigation did not make any significant impact on the development of tax law in general, and in this respect it differed from the Excess Profits Duty litigation. Another point of difference lies in the large amount of EPT litigation concerning tax avoidance, as compared with the exiguous amount of Excess Profits Duty litigation in that area. While avoidance was not unknown before and during the First World War, as evidenced by the inclusion of anti-avoidance measures in the Finance (No 2) Act 1915, avoidance of taxes had blossomed in the inter-war period and a variety of anti-avoidance measures had resulted. Attlee commented in 1938 that ‘tax dodgers are always a few moves ahead of any given Chancellor of the Exchequer’ and the truth of that characteristically pithy remark is borne out by the events revealed in the litigation and by the need during the war for retrospective anti-avoidance measures. The bulk of the litigation occurred just after the Second World War concluded, and went on for many years. In a very few of the cases the wind was tempered to the shorn lamb by decisions which gave some latitude to the statutory wording, but the post-war period is generally recognised as producing the high watermark of the literalist school of statutory interpretation, and the EPT cases, like other tax cases of the time, show results which are counter-intuitive in point of justice and are attributable to construing words without adequate regard to their context. As is not unusual with relatively short-lived taxes, EPT generated a crop of books and manuals in its very early years, but relatively little literature after the time of its repeal (1946), although its winding up was a long

Excess Profits Tax Litigation 179 drawn out episode. Significant amounts of EPT were still being collected up to as late as 1975–1976, and the writer, who joined the Revenue in 1971, vividly recalls a door in Somerset House which bore the legend ‘Excess Profits Tax Collection’, a memory tinged with regret that he never opened the door to see what manner of man was engaged on the topic. One of the authors of one of the early manuals suffered, as his daughter recalls, a curious incident. One sunny day he took some proofs across the road and sat on a bench in Regent’s Park to do correcting work. The activity, taking place, as it was, in the neighbourhood of a cluster of barrage balloons, was regarded as suspicious—vigilant officers of the law interrogated him and took some convincing that his activities did not amount to spying.

6 Tax Law and Public Opinion: Explaining IRC v Duke of Westminster ASSAF LIKHOVSKI*

ABSTRACT It has been argued that the decisions of the House of Lords on tax avoidance in the early decades of the twentieth century, and specifically the Westminster case decided in 1935, should be viewed as an expression of an ideological bias in favour of wealthy taxpayers. This chapter claims that another possible way to understand judicial reactions to tax avoidance is to view them as a balancing act between two conflicting aspects of public trust—the need to combat tax avoidance on one hand, and the need to preserve the notion of the rule of law on the other. Pro-taxpayer results may be influenced by ideological bias, but they are also influenced by institutional considerations and by the level of public concern with tax avoidance at the time that a specific case is decided. When public concern declines, the courts tend to favour the taxpayer. This argument is illustrated by contextualising the history of the Westminster case. Based on official documents as well as a variety of non-legal sources, the chapter reconstructs the administrative, political and social setting in which the case was decided. It shows that public interest in tax avoidance grew and then declined between the early 1920s and the mid-1930s. It argues that in the immediate period before the case was decided in 1935, the public (though not professionals) took little interest in the issue of tax avoidance. This, together with the traditional reluctance of British courts to intervene in matters of taxation, was one of the factors that led the Law Lords to reach a pro-taxpayer result in the Westminster case. * I would like to thank the participants of the University of Cambridge Tax History Conference and the University of Toronto James Hausman Tax Law and Policy Workshop, especially John Tiley, David Duff and David Stopforth, for their assistance and comments on previous drafts. Initial research for this article was funded by a Cambridge Centre for Tax Law grant. Additional support was provided by the Israel Science Foundation (grant no. 510/04). I gratefully acknowledge their help.

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T

1935 was a period of regained hope in Britain. Following the severe economic depression of the early 1930s, the final months of 1933 saw a gradual improvement in employment figures. On 30 April 1935 the number of employed workers finally exceeded the peak figure for 1929, the last year before the onset of the Depression.1 On Monday, 6 May 1935, Britain celebrated the silver jubilee of King George V. The next day, Tuesday, the House of Lords gave its decision in the famous IRC v Duke of Westminster case.2 In this landmark case on tax avoidance, the House of Lords decided that a tax avoidance scheme used by the taxpayer to reduce his surtax liability was effective. Is there a connection between these events? Lawyers tend to view judicial decisions as existing in a vacuum, uninfluenced by non-legal events, but more than 100 years of non-formalist legal scholarship have taught us that economic, political, institutional and cultural factors do influence judges.3 This is also true of tax cases. The aim of this chapter is to reconstruct the historical context of the Westminster case, seeking to explain the decision as a result of a number of non-legal factors.4 Specifically, the chapter will argue that the best way to explain the decision of the House of Lords is to view it as a reflection of two major factors: first, the relative lack of general public interest in matters of tax avoidance in the early 1930s and secondly, institutional and cultural constraints that led some law lords to adopt a passive attitude to tax avoidance. Part 2 of the chapter introduces the case. Part 3 outlines some of the interpretative methods that may be used to explain tax avoidance decisions. Part 4 discusses the history of judicial attitudes to tax interpretation and tax avoidance in Britain in the period preceding the decision in the Westminster case. Part 5 examines the non-legal context. It begins with a brief social and legal history of tax avoidance in Britain during the first four decades of the twentieth century. It then examines the vicissitudes of public attitudes to tax avoidance. Finally, there is a discussion of some institutional and cultural factors that played a role in the decision. HE SPRING OF

1

‘Highest Record of Employment’, The Times, 30 Apr. 1935, 17. IRC v Duke of Westminster [1936] AC 1. See, e.g., D. Kennedy, A Critique of Adjudication (fin de siècle) (Cambridge, Mass, Harvard University Press, 1997). 4 For an earlier discussion of the case, written from a lawyer’s rather than a historian’s perspective, see H. H. Monroe, ‘Fiscal Finesse: Tax Avoidance and the Duke of Westminster’ [1981] BTR 200. 2 3

Explaining IRC v Duke of Westminster 185 II. THE CASE

Hugh Richard Arthur, the second Duke of Westminster, was a spoilt playboy and a Nazi sympathiser to boot. He was also the wealthiest man in Britain and, naturally, his legal advisers invested a great deal of effort in devising ways to protect his wealth from taxation.5 His legal affairs were handled by the firm of Boodle Hatfield whose leading tax expert at the time was Frederick Carlton-Smith. He was the solicitor who created the tax avoidance scheme under consideration in the Westminster case, which is somewhat ironic, given the fact that Carlton-Smith was a committed socialist who was often seen walking around the office with a copy of the Daily Worker under his arm.6 The Duke had a number of personal servants. Wages and salaries received by these servants could not be deducted from his income for the purpose of computing his surtax liability. However, rule 19 of the general rules of the Income Tax Act 1918, did allow a taxpayer to deduct the annuities he paid. Therefore, in the summer of 1930, the Duke covenanted to pay some of his employees yearly sums irrespective of the work they might do and regardless of whether they remained in his service. Nothing in the deeds of covenant prevented the employees from claiming full remuneration for any future work that they would do for the Duke in addition to the annuities they received. However, the deeds were accompanied by letters which stated that it was expected that, in practice, the employees would be content with the annuities in addition to sums which would bring their total payment to the level of the salary or wage that they had been receiving prior to the arrangement. The Duke then deducted those payments from his income.7 The Duke was one of the first taxpayers to use this scheme, but not the only one. Its origins may be traced to a 1930 query in a professional journal, The Accountant, in which the scheme was proposed. It also appeared in a 1931 book on taxation. By 1933, a number of taxpayers were using it.8 The Revenue was obviously not pleased with this scheme, and when the matter reached the Special Commissioners in January 1934, they decided 5 L. Field, Bendor: The Golden Duke of Westminster (London, Weidenfeld & Nicolson, 1983), 1–2, 100, 106–107, 146, 260, 268. See also G.E.C., The Complete Peerage (London: St. Catherine Press, 1959), xii, pt. 2, 541–544. 6 V. Belcher, Boodle Hatfield & Co. The History of a London Law Firm in Three Centuries (London, Boodle Hatfield & Co., 1985), 130, 141, 146–147. See also D. Sugarman, ‘Simple Images and Complex Realities: English Lawyers and their Relationship to Business and Politics, 1750–1950’ (1993) 11 Law & History Review 257, 277. 7 IRC v Duke of Westminster [1936] AC 1. See also J. Tiley, Revenue Law (Oxford, Hart, 2000) 93–94. 8 The Accountant Tax Supplement, 16 Aug. 1930, 329; The Accountant Tax Supplement, 23 Aug. 1930, 339; W. Rawlinson and R. Hunter, Practical Aspects of Taxation (London Gee & Co., 1931) 5–6; D. Stopforth, ‘1922–1936: Halcyon Days for the Tax Avoider’ [1992] BTR 88, 97–98, 104.

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that ‘in construing the true effect and substance’ of the deeds made between the Duke and his employees, the payments to those employees who continued to serve the Duke were ‘in substance’ wages or salaries. As such they were not annual payments that could be deducted from the Duke’s surtax income. This decision was affirmed in March 1934 by Finlay J of the King’s Bench, who also relied on a substantive approach.9 However, on appeal, the Court of Appeal reversed Finlay J’s decision. Hansworth MR and Slesser and Romer LJJ all agreed that the annuities could not be deemed salaries and wages and could therefore be deducted.10 The House of Lords heard the case in March 1935 and gave its decision in May 1935. Lord Tomlin decided in favour of the Duke. His main argument was that it was wrong to assume, as the Special Commissioners did, that ‘the Court may ignore the legal position and regard what is called “the substance of the matter” ’. Such a doctrine, he said, ‘involve[s] substituting “the incertain and crooked cord of discretion” for the golden and straight metwad of the law’.11 Tomlin also argued that taxpayers had a right to avoid taxation. ‘Every man is entitled’, he said, ‘if he can, to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.’12 Three of the other Lords concurred. Lord Russell explained that a substantive approach merely means that the court may disregard nomenclature used by the parties to the transaction to ascertain the true legal position. He was unwilling, however, to go any further. ‘The subject’, he said ‘is not taxable by inference or by analogy, but only by the plain words of a statute.’13 Lord Wright’s speech reflected a similar approach.14 Lord Macmillan was the only concurring lord who mentioned the policy consequences of the

9 IRC v Duke of Westminster 19 TC 490. See also Parliamentary Archive, Appeal Cases, vol. 907, IRC v Duke of Westminster, Case for the Appellants, 7–8. 10 Hansworth argued that it was impossible for the annuities to take on ‘chameleon-like, a different nature and colour’ and become wages and salaries if paid to persons still working for the Duke. Hansworth’s curious ontological argument ran in contradiction to previous House of Lords’ decisions in which the Lords had no difficulty in stating that such transformations were indeed possible. See IRC v Blott [1921] 2 AC 171 (1921); IRC v Fisher’s Executors 10 TC 302, 339. Slesser concurred. He expressed support for a substantive approach to taxation, but he said that this did not alter the fact that the payments to the servants were made under deeds and therefore were covered by Rule 19. The third judge, Romer, argued that, legally, the employees could still claim full remuneration for future services on top of the annuity paid to them. This, he claimed, proved that these payments could not be deemed salaries or wages. See the Court of Appeal decision as it was reported in IRC v Duke of Westminster (1935) 19 TC 490. 11 IRC v Duke of Westminster [1936] AC 1, 19. 12 Ibid., at 19–20. 13 Ibid., at 24–25. 14 Ibid., at 31.

Explaining IRC v Duke of Westminster 187 decision. He noted that there were ‘anomalous consequences which might conceivably arise if others adopted the same scheme’. However, he argued that ‘it is not likely that many other employers will follow the respondent’s example, for few employers would care to take the risk to which the respondent has left himself exposed, namely that his servants may quit his employment and take their services elsewhere and yet continue to exact the covenanted . . . payments from him.’15 There was one dissent in this case, by Lord Atkin. It was based on contractual reasoning. He argued that the documents signed by the parties showed that the sums that were being paid to the servants were remuneration and not an annuity and therefore that there could be no deduction. As for the specific issue of tax avoidance, Atkin agreed with the majority that the taxpayer ‘whether poor and humble or wealthy and noble has the legal right so to dispose of his capital and income as to attract upon himself the least amount of tax’.16

III. EXPLAINING TAX AVOIDANCE ADJUDICATION

1. Tax Avoidance Decisions as a Reflection of Political Ideology How can one explain the decision in the Westminster case? One possible approach is found in a book written 25 years ago by legal historian Robert B. Stevens. In this book, Stevens examined, among other things, the history of British canons of tax interpretation and anti-avoidance doctrines.17 Stevens argued that the decisions of the House of Lords on issues of tax avoidance in the early twentieth century can be read as a reflection of the political ideology of many of the Law Lords. In the late nineteenth century, Stevens argues, the courts did not treat tax statutes differently from other statutes and the overall approach did not seem to favour the taxpayer. But then matters changed. With the introduction of progressive income taxation in 1909, a formalist, pro-taxpayer stance on tax interpretation and tax avoidance came to dominate the decisions of the House of Lords. This stance, which enabled the wealthy to avoid taxation, can be partly attributed to the fact that many of the Law Lords sought to serve the interests and to protect the wealth of ‘the established sections of society’.18

15

Ibid., at 28. Ibid., at 8–9, 15. Payments to servants under deeds of covenant were made ineffective as surtax deductions by the Finance Act 1946. See G.S.A. Wheatcroft, ‘The Attitude of the Legislature and the Courts to Tax Avoidance’ (1955) 18 MLR 209, 216. 17 R. Bocking Stevens, Law and Politics: The House of Lords as a Judicial Body, 1800–1976 (Chapel Hill, NC, University of North Carolina Press, 1978). 18 Ibid., at 170–176, 264. 16

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The decision in Westminster was the logical outcome of this stance.19 During the Second World War, the House of Lords changed its approach. Now, some law lords adopted a ‘patriotic’ approach to tax avoidance. According to this approach, all citizens were ‘under an obligation to pay a fair share’ of their taxes. The new position was epitomised by the 1943 House of Lords decision in Lattila.20 However, once the war ended, the Law Lords returned to their old formalist, pro-taxpayer stance.21 Stevens’ argument that formalism in tax avoidance decisions is partly the result of the political convictions of the judges can be seen as a reflection of a more general argument about the politics of legal formalism. Many legal scholars have discussed the affinity between judicial formalism and a freemarket (or in our case, a pro-taxpayer) approach. This affinity is not universal. Legal formalism is not always affiliated with a pro-free market approach. However, in the specific context of nineteenth and early twentieth century law, there was often such an affinity.22 In two previous studies dealing with judicial attitudes to tax avoidance in Israel and in the United States, I have argued that an instrumentalist interpretation of tax avoidance decisions, one which views tax adjudication as serving the interests of the wealthy, must be augmented by other approaches. In one of these studies, whose subject was the transition from a formalist to a substantive approach to tax avoidance in Israeli law in the 1950s and 1960s, I argued that while politics and pro-taxpayer sentiments may have played a minor role in the propagation of a formalist approach to tax avoidance in Israeli tax law in the 1950s, the main cause of judicial formalism was administrative inefficiency—the inability of the Israeli Revenue to deal effectively with tax evasion, let alone tax avoidance.23

19 Ibid., at 206–208. Stevens also mentions other factors which influenced judicial opinion such as the rise of a formalist, ‘scientific’, ‘professional’ approach to judicial law making: ibid., at 183–184, 191–197. 20 Latilla v IRC [1943] AC 377, 381; Stevens, above n. 17, at 347, 392–393. See also Wheatcroft, above n. 16, at 217–218. 21 Stevens, above n. 17, at 393–394. See also J. P. Hannan and A. Farnsworth, The Principles of Income Taxation (London, Stevens & Sons, 1952) 549–554. 22 See generally D. Kennedy, ‘Legal Formalism’ (2001) 13 Encyclopedia of the Social & Behavioral Sciences 8634; D. Kennedy, ‘Two Globalizations of Law and Legal Thought: 1850–1968’ (2003) 36 Suffolk U L Rev 631; A. T. Kronman, Max Weber (Stanford, Cal., Stanford University Press, 1983); R. S. Summers, Instrumentalism and American Legal Theory (Ithaca, NY, Cornell University Press, 1982); W. S. Blatt, ‘The History of Statutory Interpretation: A Study of Form and Substance’ (1985) 6 Cardozo L Rev 799, 807; T. C. Grey, ‘Langdell’s Orthodoxy’ (1983) 45 U Pitt L Rev. 1; P. S. Atiyah and R. S. Summers, Form and Substance in Anglo-American Law (Oxford, Oxford University Press, 1987). It is not clear that opposition to tax avoidance should always be associated with the anti-capitalist politics. In some political contexts, left wing parties may favour the existence of certain tax shelters in order to mitigate the effects of high rates of taxation. See generally, S. Steinmo, Taxation and Democracy (New Haven, Conn, Yale University Press, 1993), 46. 23 A. Likhovski, ‘Formalism and Israeli Anti-Avoidance Doctrines in the 1950s and 1960s’ in J. Tiley (ed.), Studies in the History of Tax Law (Oxford, Hart, 2004) 339.

Explaining IRC v Duke of Westminster 189 Another study examined the history of the landmark American tax avoidance case, Gregory v Helvering. This case was decided by the American Supreme Court in January 1935, four months before the decision in the Westminster case. In my study of Gregory, I argued that the substantive anti-taxpayer approach used in Gregory was the result of the immediate political context in which the case was decided, rather than any long-term ideological convictions of the judges. Specifically, I argued that the decision was mainly the result of the influence of tax avoidance and tax evasion scandals that captured newspaper headlines in the immediate period preceding the decision, especially the attempt by the FDR administration to indict Andrew Mellon, the former Secretary of the Treasury, for tax evasion.24 Of course, the lessons taught by the history of tax avoidance adjudication in Israel or the United State are not necessarily applicable to the British context. Still, these lessons could serve as an incentive for an examination of the British case. Stevens’ argument that politics was one of the main factors shaping the decisions of the House of Lords seems, at first sight, very attractive. This is mainly because some early twentieth century tax avoidance cases do indeed contain remarks that can be interpreted as showing a prowealth bias. One example is the Duke of Richmond case. This 1909 case involved an attempt to reduce the estate duties to which the Duke of Richmond’s estate would be liable. In his speech in this case, Lord Macnaghten ruled in favour of the Duke, noting that the Duke ‘was not under any obligation, legal or moral, to keep his property in a form peculiarly and unnecessarily obnoxious to an impost which I am afraid many people still think unequal and unfair’.25 One can also attempt to find the influence of politics and ideology in the Westminster case itself. For example, it might be argued that Russell’s speech in this case was influenced by his conservative sympathies, while Atkin’s dissent was partly the result of the fact that he had pronounced Labour sympathies.26 However, such an attempt to link political views and tax avoidance decisions, I would argue, needs to be modified. As Raymond Cock’s study of nineteenth century tax cases has shown, mid-Victorian judges were not mere agents of capitalism. Their decisions were not the product of an allegiance to laissez-faire ideology.27 This is also true of 1930s judges.

24 A. Likhovski, ‘The Duke and the Lady: Helvering v Gregory and the History of Tax Avoidance Adjudication’ (2004) 25 Cardozo L Rev 953. 25 [1909] AC 466, 471. 26 On Russell, see Stevens, above n. 17, at 312–313. On Atkin, see G. Lewis, Lord Atkin (Oxford, Hart, 1999), 1, 19, 30. See also Dictionary of National Biography [DNB] 1941–1950, 27 (noting his concern for the ‘underdog’); Stevens, above n. 17, at 284–294. 27 R. Cocks, ‘Victorian Barristers, Judges and Taxation: A Study in the Expansion of Legal Work’ in G.R. Rubin and David Sugarman (eds.), Law, Economy and Society, 1750–1914: Essays in the History of English Law (Abingdon, Professional Books, 1984) 445.

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Macmillan, one of the law lords who decided in favour of the Duke, was appointed in 1924 to the post of Lord Advocate by the Labour party.28 Wright, who also decided in favour of the Duke, produced, together with Atkin, a stream of pro-workman decisions in workmen’s compensation cases in the 1930s.29 Indeed, Atkin himself had no single position on tax matters. In early revenue cases he often decided in favour of the taxpayer.30 It is also important to remember that while Atkin decided against the taxpayer in the Westminster case, his decision was based on contractual reasoning, and that he did recognise what may be called a “right to tax avoidance’.31 The link between class affinity or ideological leanings and tax decisions is even more problematic if we examine the decision in the Westminster case in the lower courts. Finlay J of the King’s Bench gave an anti-taxpayer decision despite being the son of a conservative Lord Chancellor,32 while one of the three judges who decided in favour of the Duke in the Court of Appeal, Slesser, was a former Labour Member of Parliament.33

2. Quantitative Studies One way to examine Stevens’ argument about the effect of non-legal factors on tax avoidance decisions is to try to search for other social factors that may influence a pro-taxpayer or an anti-taxpayer judicial approach. In recent years, a body of empirical studies of American tax decisions has emerged.34 For example, in one such study, Daniel Schneider compiled a database consisting of all the decisions of the American Tax Court rendered between 1979 and 1998, as well as all the published tax decisions of the federal district courts of Los Angeles, Chicago and New York City for the same period. He randomly chose 15 per cent of these decisions (about 500 cases) as his sample and analysed the sample using a number

28

DNB 1951–60, 678. Lewis, above n. 26, at 39, 123. See also Stevens, above n. 17, at 294–302. 30 See e.g. Wankie Colliery v IRC [1921] 3 KB 344, 365 (discussing the Excess Profits Duty); Lewis, above n. 26, 127. Atkin later adopted a more pro-Revenue approach. In 1943 he concurred with Viscount Simon’s pro-Revenue speech in Lattila. See Latilla v IRC [1943] AC 377, 384. See generally Lewis, above at 128–131. 31 IRC v Duke of Westminster [1936] AC 1, 8–9, 15. 32 DNB 1941–50, 251. 33 On Slesser’s politics, see H. Slesser, The Reminiscences of the Rt. Honorable Sir Henry Slesser (London, Hutchinson, 1941), 88–90, 139–140; H. Slesser, The Judicial Office and other Matters (London, Hutchinson, n.d.), 142–143. 34 See generally D. M. Schneider, ‘Empirical Research on Judicial Reasoning: Statutory Interpretation in Federal Tax Cases’ (2001) 31 New Mexico L Rev 325; Symposium: ‘Empirical Taxation’ (2003) 13 Wash U JL & Pol’y 1. For a pioneering earlier work see B. Wolfman, J. L. F. Silver and M. A. Silver, Dissent without Opinion: The Behavior of Justice William O. Douglas in Federal Tax Cases (Philadelphia, Penn, University of Pennsylvania Press, 1975). 29

Explaining IRC v Duke of Westminster 191 of variables such as the judge’s gender, race/ethnicity, educational background, primary professional experience (in private practice, in government service, or as a law teacher), length of service on the bench when deciding the case, and the political party to which the president who appointed the judge belonged.35 Using statistical methods, Schneider sought to uncover links between social factors and the use of specific methods of statutory interpretation. He found that all judges tended to favour a non-literal approach to tax interpretation, but he failed to establish a significant link between the politics, race or gender of the judges and any specific mode of statutory interpretation.36 Schneider also made use of this database to study the links between pro-taxpayer decisions and the social background of the judges. Here his results were more significant. Schneider found correlations between protaxpayer decisions and the judge being a woman, non-white, having an elite education, working before appointment in private practice and being appointed by a president who was a Democrat.37 Another empirical study published recently examined the decisions of the American Tax Court between 1993 and 1997. This study, based on an analysis of about 300 cases, found that Tax Court judges appointed by a Republican president were significantly more likely to decide in favour of the taxpayer. However, an even more significant factor was found to be prior work experience. Republican appointees were more likely to come from private practice rather than government service and the study concluded that work experience rather than the political ideology of the appointing president was the factor that determined a pro-taxpayer bent.38 The empirical work done in the United States suggests that there may be a number of non-ideological factors that influence judicial attitudes to tax avoidance. However, there are three problems with applying the empirical approach to Britain. First, the database of British cases may be too small for significant statistical studies. Secondly, many of the relevant American factors (such as the gender or race of the judge) are simply inapplicable to the early twentieth century British context. Finally, it seems that even those factors that are also relevant in Britain, such as prior work experience, do not point in any clear direction. For example, both Finlay J, who ruled against

35

See Schneider, ‘Empirical Research’, above n. 34. Ibid., at 346. In a subsequent study, Schneider discovered that the methods of statutory interpretation used by federal appellate judges were also ‘fairly unaffected’ by their social background. See D.M. Schneider, ‘Statutory Construction in Federal Appellate Tax Cases: The Effect of Judges’ Social Backgrounds and of Other Aspects of Litigation’ (2003) 13 Wash U JL & Pol’y 257, 258, 289. 37 D.M. Schneider, ‘Assessing and Predicting Who Wins Federal Tax Trial Decisions’ (2002) 37 Wake Forest L Rev 473. 38 M.P. Altieri et al., ‘Political Affiliation of Appointing President and the Outcome of Tax Court Cases’ (2001) 84 Judicature 310, 313. 36

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the taxpayer in the Westminster case, and Lord Tomlin, who ruled in his favour, served as Counsel for the Board of Inland Revenue early in their legal careers.39

3. Institutional Constraints, Trust and Public Opinion Stevens’ account of the history of the House of Lords is not mono-causal. Politics is an important factor but not the only factor, he believes, that influenced judicial attitudes. Stevens also attributed the formalism of the House of Lords to the rise, in the middle decades of the twentieth century, of ‘substantive formalism’—a notion that formalism, rather than a tool to further political interests (or to mask these interests), was simply seen by many Law Lords as an end in itself. In Form and Substance in Anglo-American Law, Patrick Atiyah and Robert Summers also argue that formalism is a deep-rooted characteristic of twentieth century English law. They attribute this formalism to a large number of factors. Many of these factors are institutional: the constitutional relationship between courts and the legislature in England, the relative weakness of English courts as compared to the executive and legislative branches of government, the detailed nature of British legislation. Other factors Atiyah and Summers mention are professional: the composition of the bench and the bar, the professionalism of judges, the small size of the legal profession. Some factors are intellectual or cultural: the influence of legal theory (and specifically of Austinian positivism), the unconscious beliefs held by the public and by lawyers as to the nature and function of judges and the role of different government institutions in creating new norms. Some factors are procedural or administrative: the relative lack of administrative assistance which forces English judges to rely on the arguments of opposing counsel rather than on their own independent legal research.40 Atiyah and Summers also argue that the English approach to statutory interpretation, an approach which favours a literal/plain meaning rule, is partly based on the notion of trust. Judges, they claim, will tend to use a literal approach to statutory interpretation if they believe, as they do in England, that the rest of the machinery of government is working properly— that statutes are drafted with care, that executive agencies and lawyers apply

39 DNB 1941–50, 251; DNB, 1931–40, 865; Belcher, above n. 6, at 147. See also Cocks, above n. 27, at 463; Stevens, above n. 17 (discussing the social background of British judges and the impact of various social and professional factors on different attitudes to judicial lawmaking). 40 Atiyah and Summers, above n. 22, at 1–5, 257, 279–281, 299, 323–324, 329–325, 347–369, 395, 411–415.

Explaining IRC v Duke of Westminster 193 the law reasonably, taking into account substantive reasons even if those reasons were overlooked by the legislature, and that the legislature itself will promptly respond to remedy any deficiency which is discovered in the law.41 The argument that formalism is the result of institutional, intellectual and cultural factors seems applicable to the history of tax avoidance cases as well.42 However, it requires some modification. First, Atiyah and Summers offer a static view of the way English courts function. Their approach should be augmented by a dynamic factor— the vicissitudes of public opinion. This dynamic element is essential because the formalist decision in the Westminster case was not the only approach to tax avoidance cases adopted by English courts. British tax avoidance adjudication was not always formalist, and one has to explain not only why in some cases English courts used a formalist approach to tax avoidance, but also why in other cases they did not. Secondly, the notion of trust used by Atiyah and Summers is onedimensional. It only focuses on the trust that the judges have in other government institutions. But trust is a multi-dimensional concept. We should pay attention not only to the trust that judges have in other government institutions but also to their need to maintain institutional and public trust in the courts. The relationship between tax avoidance adjudication and public trust in the courts is a complex one. Tax avoidance undermines the trust in government.43 On the other hand, a substantive, interventionist approach to avoidance by the courts undermines the supposed boundary between the legislature and the other branches of government and the notion of the rule of law.44 The courts are thus constantly pulled in two opposite directions: on one hand, the desire to intervene in tax avoidance cases in order to contribute their share to the fight against tax avoidance, and, on the other, a desire to preserve the notion of the rule of law by leaving the battle against avoidance to the legislature. These opposing forces mean that the specific result in tax avoidance cases is never predetermined but is instead the outcome of particular conditions existing at the time of the decision.

41

Ibid., at 36–41, 104–105. For the argument that the difference between American and English attitudes to tax avoidance is explained by different notions about the role of statutory interpretation, see J. Tiley and E. Jensen, ‘The Control of Avoidance: The United States Perspective’ [1998] BTR 161, 162; W. D. Popkin, ‘Judicial Anti-Tax Avoidance Doctrine in England: A United States Perspective’ [1991] BTR 283, 285–289. For general discussions of the problems involved in comparing British and American tax law, see J. Tiley, ‘Judicial Anti Avoidance Doctrines’ [1987] BTR 180, 185–190. 43 See J. Slemrod, ‘On Voluntary Compliance, Voluntary Taxes and Social Capital’ (1998) 51 National Tax Journal 485. For historical discussions of the role of trust in the development of the British tax system and especially the need of politicians to shape the tax system in ways which created trust in the state and in fellow taxpayers, see M. Daunton, Just Taxes (Cambridge, Cambridge University Press, 2002) pp. xiii–xiv. 44 See generally Cocks, above n. 27, at 464 (on revenue cases and the rule of law). 42

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When economic conditions deteriorate, tax avoidance often becomes a source of public concern and even public scandal. This is often accompanied by moral panics. A case in point is the United States in 1934–1935, the period in which Gregory v Helvering, the leading American tax avoidance case, was decided. Under such conditions, the courts tend to adopt a substantive, anti-taxpayer, activist approach to tax avoidance. Conversely, when economic conditions improve, tax avoidance is no longer a matter of general public concern. Public opinion is not enraged by the use of tax avoidance schemes to undermine the fairness of the tax system. In such circumstances, courts tend to adopt a more formalist, pro-taxpayer, and passive attitude to tax avoidance, leaving the matter to the legislature. This model of judicial behaviour in tax avoidance cases is the one which I intend to use to explain the history of the Westminster case. The argument is not that this model is the only possible one. Historical events are often caused by multiple factors. Public opinion is merely one factor among many. My discussion of the Westminster case is part of a wider comparative project which, as mentioned above, examines the history of tax avoidance adjudication in a number of jurisdictions and shows that judicial attitudes to tax avoidance were influenced by many factors. The project also shows that different factors had a different impact on judges in different jurisdictions. Instead of arguing that the model just outlined is always applicable, I make a far more modest claim. I merely argue that in the Westminster case the relative lack of general public concern with tax avoidance in the immediate period before the case was decided was one factor influencing the decision, certainly when combined with a rigid institutional conception of the relative role of courts and the legislature in making tax law. In order to prove this argument, the next sections of the chapter seek to place the case in context. This will be done first by reconstructing the legal history of tax avoidance adjudication in the decades preceding the decision in the Westminster case, and then by reconstructing the non-legal context— the social, institutional and cultural history of tax avoidance in early twentieth century Britain.

IV. THE LEGAL CONTEXT

Tax avoidance cases are sometimes viewed as a matter of tax interpretation. At other times, judges will resolve them using notions of substance and form or using specific anti-avoidance doctrines. This section will therefore discuss judicial attitudes to three separate issues: tax interpretation, substance over form, and tax avoidance. The main argument of the section is that there was no coherent approach either to tax interpretation, to the issue of form or substance in tax matters, or to the specific issue of tax

Explaining IRC v Duke of Westminster 195 avoidance.45 This means that the decision in the Westminster case, rather than merely the logical outcome of previous decisions, should be explained by reference to non-legal factors.

1. Tax Interpretation The dominant strand in late nineteenth and early twentieth century British case law favoured a literal/plain meaning approach to the interpretation of tax statutes.46 This was a reflection of a more general characteristic of the late nineteenth century approach to statutory interpretation.47 Some commentators viewed such an approach as neutral, but in fact it often (although not always) led into a pro-taxpayer approach.48 A well-known early example of the literal approach is Partington v AG, decided in 1869 and often cited afterwards. In this case, Lord Crains stated that “if the Crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be’.49 Other late nineteenth century cases adopted a literal/pro-taxpayer approach.50 However, in practice the literal rule was not always followed. Common sense, analogical

45 The fact that there was no coherent approach should not surprise us. Tax decisions are generally not a coherent body of rules based on clear principles, but rather a chaotic mass of conflicting decisions. See Daunton, above n. 43, at 7. This is even more true of tax avoidance decisions. In the United States, the case law on avoidance in the 1930s was described as a ‘mystic field which only the initiate may enter’ where ‘imponderables abound’, ‘attitudes are chaotic’ and there is an ‘anarchy of uncertainty’. See R. Paul, ‘Restatement of the Law of Tax Avoidance’ in R. Paul, Studies in Federal Taxation: Taxation without Misrepresentation (Chicago, Ill, Callaghan, 1937), 73–74. 46 Cocks, above n. 27, at 453; Wheatcroft, above n. 16, at 215; D. Williams, ‘Taxing Statutes are Taxing Statutes: The Interpretation of Revenue Legislation’ (1978) 41 MLR 404, 409. 47 See generally, J. Evans, ‘A Brief History of Equitable Interpretation in the Common Law System’ in J. Goldsworthy and T. Campbell (eds.), Legal Interpretation in Democratic States (Dartmouth, Ashgate, 2002), 67, 80–82. See also Atiyah and Summers, above n. 22, at 3, 100–112. 48 Stevens, above n. 17, at 170. 49 Partington v AG (1869) 21 (n.s.) LTR 370. It should be noted that the case was actually decided in favour of the Revenue. 50 See Pryce v Monmouthshire Canal & Railway Companies [1879] 4 AC 197, 205 (‘in dubio you are always to lean against the construction that imposes a burden on the subject’) (per Lord Penzance); AG v Beech [1899] AC 53, 59 (‘this is a Taxing Act, and it is essential to see that the tax is expressly imposed, that the subject is not taxed without clear words’) (per Lord Ashbourne). See also J. Stamp, The Fundamental Principles of Taxation in the Light of Modern Developments (New rev. edn., Macmillan, London, 1936), 119; J. Houldsworth Shaw and T. Macdonald Baker, The Law of Income Tax (London, Butterworth, 1937), 32; A.E. McBain, Practical Notes on the Law of Income Taxation (London, Sweet & Maxwell, 1950) 91–94; H. Monroe, Intolerable Inquisition? Reflections on the Law of Taxation (London, Stevens, 1981); Popkin, above n. 42, at 290.

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reasoning, considerations of fairness and equality and even economic, social and political considerations were sometimes used by the judges as aids in the process of tax interpretation.51 The watershed event in the ascendancy of a pro-taxpayer approach to interpretation, even at the expense of the literal rule, was Attorney General v Duke of Richmond, decided in 1909.52 In this case, the Duke of Richmond encumbered his estate with bonds in favour of his son and grandson with the sole purpose of avoiding estate duty. Such a transaction was envisaged by section 7(1) of the Finance Act 1894, which stated that ‘in determining the value of an estate . . . an allowance shall not be made [for debts and encumbrances] . . . created by the deceased unless such debts or encumbrances were incurred or created bona fide for full consideration . . . for the deceased’s own use and benefit’. The majority of Law Lords decided in favour of the Duke. They did so using an intention-based approach to statutory interpretation, arguing that the only question in this case was whether the bonds were created, as section 7(1) demanded, ‘wholly for the deceased’s own use and interest’. ‘If you give the expression its strict meaning, adhering slavishly to the letter’, said Lord Macnaghten, ‘no allowance can be made for any debt incurred by the deceased . . .which in the slightest degree operates for the benefit of any other human being.’ However, he continued, such an approach would work against persons who burdened their property for the benefit of their children, friends and public charities, such as hospitals. It would assist only ‘the prodigal, the gambler and such like’. I cannot imagine’, he remarked sanctimoniously, that the legislature ‘intended to put a premium on extravagance purely selfish and to penalize expenditure on objects generally considered more worthy.’53 The minority stuck to a literal approach. Lord Collins agreed that the taxpayer has a ‘right’ to dispose of his property in a way that keeps it outside the ‘meshes of a taxing statute.’ However, he argued, ‘the plain grammatical construction’ of section 7(1) clearly applied in this case.54 Lord Shaw of Dunfermline, in another dissent, reached the same conclusion. He based his decision on ‘the reality and substance of the case’, arguing that the Duke’s scheme was in contravention ‘of the letter as well as . . . the spirit

51 Cocks, above n. 27, at 453–462; Williams, above n. 46, at 408–411; Stevens, above n. 17, at 171. See also Styles v Treasurer of Middle Temple (1899) 3 TC 123, 128–129 in which the court sought to ‘repudiate the notion of there being any artificial distinction between the rules to be applied to a taxing Act and the rules to be applied to any other Act. I do not think such artificial distinctions ever can help anybody in arriving at the true meaning of words and I think with regard to all Acts of Parliament and all documents, that what you really have to do is to apply your best mind to it.’ 52 AG v Duke of Richmond and Gordon [1909] AC 466. 53 Ibid., at 473. 54 Ibid., at 481.

Explaining IRC v Duke of Westminster 197 of the statute’. Thus in Richmond, the majority adopted a non-literal approach to statutory construction because such an approach led to a protaxpayer result. A pro-taxpayer approach was also evident in Drummond v Collins, decided in 1915. In this case, Lord Loreburn declared that ‘courts of law have cut down or even contradicted the language of the Legislature when on a full view of the Act, considering its scheme and its machinery and the manifest purpose of it, they have thought that a particular case or class of cases was not intended to fall within the taxing clause relied upon by the Crown’.55 A similar non-literal, pro-taxpayer approach was found in a case decided by the House of Lords in March 1935, only two months before Westminster. This case, Perry v Astor, involved the taxation of a revocable trust created by a British national in the United States. The question in this case was whether the anti-avoidance provisions of section 20(1) of the Finance Act 1922 were applicable to foreign trusts. The House of Lords decided in favour of the taxpayer, rejecting a literal approach. In his speech, Lord Macmillan argued that when the section was drafted, the legislature did not contemplate its extra-territorial application. ‘Your Lordships in your judicial capacity’, he said, ‘are under a disability from which the Legislature is free, for you have no power to amend the law. However anomalous an enactment may be, it must be applied by the Courts according to its terms.’ But, he continued, this is not the case when the words of a statute ‘according to their natural meaning lead to strangely anomalous results’. Under such circumstances, ‘it is legitimate to examine their statutory context in order to see whether they ought to be construed as they would be if read alone’.56 Despite the fact that a pro-taxpayer attitude to tax interpretation was certainly the dominant approach in late nineteenth and early twentieth century cases, it was not the only one. For example, in some nineteenth century editions of Blackstone, the chapter on taxation included a footnote which stated that ‘it is considered a rule of construction of revenue acts, in ambiguous cases, to lean in favour of the revenue. This rule is agreeable to good policy and the public interest’.57 In some early twentieth century cases, the House of Lords used an non-literal, anti-taxpayer approach to tax interpretation. One example is Levene v IRC, decided in March 1927. Levene was a financier who was a British subject but left England after the First World War and moved to Monaco. The House of Lords decided that he was a resident of the United Kingdom. In his decision in this case, Lord

55 56 57

[1915] AC 1011, 1017. Perry v Astor (1935) 19 TC 255, 288. See Williams, above n. 46, at 409.

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Sumner said that ‘it is trite law that His Majesty’s subjects are free, if they can, to make their own arrangements so that their cases may fall outside the scope of the taxing Acts. They incur no legal penalties and strictly speaking, no moral censure . . .’. He then noted that the words ‘resident in the United Kingdom’, ‘guide the subject remarkably little as to the limits within which he must pay and beyond which he is free’. This, he continued, means that ‘the way of taxpayers is hard and the Legislature does not go out of its way to make it any easier. If it had been possible in this case to apply the principle that a taxing Statute must impose a charge in clear terms or fail, since it is to be construed, contra proferentem, our duty would have been plain, but since the words are plain and it is only their application that is haphazard and beyond all forecast, [the taxpayer] has no remedy.’58 By making the distinction between the meaning of the words of the statute and their application, what Sumner was actually saying was that the contra proferentem (or actually contra fiscum) rule could be ignored in certain cases if the court thought it appropriate to do so. In conclusion, in the body of precedents which the House of Lords could have used in 1935, there was no totally consistent judicial approach to tax interpretation. Both literal and non-literal, pro-taxpayer and pro-Revenue cases existed. This was also true about judicial utterances regarding form and substance in tax law.

2. Form and Substance Just as there were a variety of approaches to the issue of tax interpretation, so there was no clear position of the question of substance over form. There are many early cases in which the courts were willing to use a substantive approach.59 In some early cases, a substance over form approach was used in an anti-taxpayer way. A case in point is AG v Worrall decided by the Queen’s Bench in 1894, where the court decided in favour of the Revenue, stating that ‘the court has to determine what the real nature of the transaction was, apart from the legal phraseology and the forms of conveyancing...we are to look to the truth or substance of the transaction.’60 In a number of late 1890s cases dealing with the taxation of foreign companies, the court ruled against the taxpayer, declaring that that the matter was one ‘of substance and not of form’.61 In a 1904 House of

58

Levene v IRC (1927) 13 TC 486, 501–502 . See generally, G.S.A. Wheatcroft, The Law of Income Tax, Surtax and Profits Tax (London, Sweet & Maxwell, 1962) 1039. 60 (1895) 1 QB 99, 104–105. 61 See e.g. Apthorpe v Peter Schoenhofen Brewing Company, Limited (1899) 4 TC 41, 61 (Romer LJ); St Louis Breweries Ltd v Apthorpe (1898) 4 TC 111, 121. 59

Explaining IRC v Duke of Westminster 199 Lords case, AG v Montague, Lord Halsbury looked at the ‘real substance’ of a transaction in order to rule against the taxpayer.62 The same approach could be found even in early 1930s cases decided by some lower courts. Thus in a 1932 case, Clarkson-Webb, a taxpayer covenanted to pay his brother, as trustee, an annual sum upon trust for his brother’s infant son, and his brother made a similar arrangement. The taxpayer then wanted to deduct the annual sums paid from his income. The purpose of this arrangement was to circumvent the anti-avoidance provisions of section 20 of the Finance Act 1922. However, Finlay J refused to allow these deductions, using a substantive approach, viewing the two deeds not as separate transactions but as parts of a single transaction.63 This, of course, does not mean that Finlay himself was consistent. In another case, Firth, decided in January 1933, merely a month after the decision in Clarkson-Webb, the taxpayer covenanted to pay a certain person an annuity. The deed reserved the power of revocation subject to a written consent of ‘some person appointed’ by the taxpayer. This too was done in order to circumvent the provisions of section 20 of the Finance Act 1922 which attributed to the taxpayer any income which the taxpayer was able to ‘obtain the beneficial enjoyment of’. Judge Finlay acknowledged the fact that ruling for the taxpayer would ‘destroy’ the efficacy of the anti-avoidance provision in section 20, but he refused to read words into the section in a way that made them effective.64 In a similar case, Trustees of Watson, the issue at hand was an educational trust made in favour of a child, in which, in order to circumvent the provisions of section 20, the power of revocation was subject to the formal consent of any one of five persons, and in which the House of Lords held that the income could not be deemed that of the settlor.65 In many cases involving the separate legal entity of companies, the courts adopted a substantive approach.66 Such was the case in Styles, where the House of Lords disregarded the separate legal entity of a company,67 a decision which was followed in Jones.68 The Court of Appeals often followed the same approach as well. In Eccentric Club, the Master of the Rolls said, ‘it is a well recognized principle that in revenue cases, regard must be had to the substance of the transaction . . . and that the form may be disregarded’. The other judges also rejected the reliance on ‘technicalities’.69 62 63 64 65 66 67 68 69

AG v Montagu [1904] AC 316. IRC v Clarkson-Webb (1933) 17 TC 451. IRC v Firth (1933) 17 TC 603, 606. (1932) 17 TC 728. See generally, PRO IR 40/4576, Note by Mr Preston, ‘Form and Substance’. Styles v New York Life (1889) 2 TC 460. Jones v South West Lancarshire Coal Owners Assn. (1927) 11 TC 790. IRC v Eccentric Club (1925) 12 TC 657.

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On the other hand, there were decisions in which the court refused to look beyond the separate legal entity of the company.70 A substantive approach was often relied on when it led to a pro-taxpayer result. Two cases cited by the Law Lords in Duke of Westminster—Scoble, and Perrin—dealt with the taxation of annuity-like payments. In both cases, the courts used a substantive approach, dissecting an annuity in order to hold that certain parts of it represented a return of capital and therefore could not be taxed as income. In both Scoble and Perrin, the courts said that they applied an approach which looked ‘at the whole nature and substance of the transaction’ or ‘the real nature of the transaction’, or ‘the substance of the bargain (ignoring for a moment the form . . .)’, not bound by ‘the mere use of words’.71 The existence of so many remarks on the need to examine the ‘substance’ of the transaction means that it would be wrong to view English tax adjudication prior to the decision in Westminster as formalist. On the other hand, it should be noted that the definition given to the term ‘substance’ was often a very narrow one. For example, Lord Wright said in the Westminster case that the legal effect of a document is its substance.72 With such a narrow definition, it is no wonder that sometimes judges argued that there was no conflict between a substantive and a formalist approach,73 and that in every tax case ‘regard must be had both to substance and to form’.74

3. Judicial Pronouncements on Tax Avoidance Tax avoidance cases may be decided by general rules on tax interpretation. They may be decided by a preference for a substantive or a formalist approach to tax matters. They may also be decided by specific judicial attitudes to the phenomenon of tax avoidance itself. What was the attitude of British courts to tax avoidance prior to 1935? A number of early twentieth century cases explicitly declared that the taxpayer had what may be termed a ‘right to tax-avoid’ (or a right to taxplan). Thus, both the majority and the minority in the Richmond case, decided in 1909, stated that there was such a right.75 In 1927, the Court of Session discussed a transaction in which a father transferred a farm to his

70

See e.g. IRC v The Gas Lighting Improvement Company Ltd (1923) 12 TC 503, 542. Secretary of State in Council of India v Scoble [1903] AC 299, 302; Perrin v Dickson [1930] 1 KB 107, 123. For additional cases, see e.g. Lethbridge v AG [1907] AC 19, 26 (Lord Atkinson ruling for the taxpayer based on ‘the substance of the transaction’). 72 IRC v Duke of Westminster (1935) 19 TC 490, 529. See also IRC v Morgan-GrenvilleGavin [1936] All ER 895, 899. 73 IRC v Fisher’s Executors (1926) 10 TC 302, 339. 74 Alloa Town Council v IRC (1931) 16 TC 451, 462. 75 AG v Duke of Richmond and Gordon [1909] AC 466. 71

Explaining IRC v Duke of Westminster 201 two daughters in order, it appeared, to avoid death duties and also to split up the family income. This motivation, said Lord President Clyde, was irrelevant, as far as the law was concerned, because ‘nobody is under any obligation so to lay out his estate, or the estate of his family, as to make it subject to avoidable taxation’.76 Similarly, in a 1929 Court of Session case dealing with a partnership agreement between a father and his five children (two of them minors), Lord President Clyde said that ‘no man in this country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or to his property as to enable the Inland Revenue to put the largest possible shovel into his stores. The Inland Revenue is not slow—and quite rightly—to take every advantage which is open to it under the taxing statutes for the purpose of depleting the taxpayer’s pocket. And the taxpayer is, in like manner, entitled to be astute to prevent, so far as he honestly can, the depletion of his means by the Revenue.’77 One should not, however, conflate the realisation of certain judges that taxpayers do attempt to avoid taxation, and even that they may have a ‘right’ to do so, with a sympathy for the tax avoider. On the contrary, tax avoidance was viewed as an issue which should be dealt with (although by the legislature rather than by the courts). This is clearly evident in a House of Lords case, Fisher’s Executors, decided in 1926.78 In this case, the profit of a certain company was issued in the form of debenture stock. Two of the speeches in this case referred to the issue of tax avoidance. Lord Shaw of Dunfermline noted that while, from an economic point of view, this transaction may be equivalent to a taxable distribution of dividend in cash, such an economic view could not to be considered by the judiciary. ‘The administrative or financial questions’ underlying the transaction, he said, were for consideration ‘by the Executive and the Legislature, but cannot control the loyalty which we must pay to the text of the statutes and the judicial interpretation thereof’. Otherwise, he cautioned, ‘neither the Crown nor the subject would ever know where they were’.79 Another speech, by Sumner, also mentioned the issue of avoidance. Sumner’s speech was often quoted afterwards because he said that ‘the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so within the law . . . in doing so he neither

76

Linton v Chapman (1927) 13 TC 449, 454. Ayrshire Pullman Motor Services and D.M. Ritchie v IRC (1929) 14 TC 754. See also Hawker v Compton (1922) 8 TC 306 (Sankay J. saying that ‘it is perfectly open for persons to evade this particular tax if they can do so legally. I again say I do not use the word ‘evade’ with any dishonourable suggestion about it. If certain documents are drawn up, and the result of those documents is that persons are not liable to a particular duty, so much the better for them’). 78 IRC v Fisher’s Executors (1924) 10 TC 302. The decision in this case was based on an earlier case, IRC v Blott [1921] 2 AC 171. 79 IRC v Fisher’s Executors (1924) 10 TC 302, 335, 336. 77

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comes under liability nor incurs blame’. But Sumner did not conclude his speech with this remark. Later in his speech, he observed that ‘considerations of justice and public policy’ may ultimately lead to the taxation of debenture stocks, adding ‘how far [their current non-taxation] is tolerable is a matter for the Legislature. . . . I think it may be well be doubted whether, in the long run, it should be permissible’ to issue such stock.80 The same sentiments can be found in Hall, a 1926 case. In this case, profits were distributed to two shareholders in a company in the form of loans. The shareholders then tried to write off the loans in the company’s books. The Revenue regarded the cancellation of the loans as a dividend to the shareholders. The court, however, decided that this cancellation of debt was not effective, that the shareholders were still liable in respect of those loans and that therefore they were not liable for taxation since they did not receive any profits. In deciding this case, Scrutton J said, ‘this is a peculiar and, fortunately, an unusual case. I say fortunately, because if the system pursued in this case became common and the subject attained the result which I think he thought he was going to attain by the transactions which he entered into, he would have undoubtedly escaped liability to contribute to the necessities of this country which he ought to bear and it would probably be necessary for Parliament to intervene and tell him that he should not carry out transactions of this sort.’81 In conclusion, it seems that some British courts in the early twentieth century were willing to use non-literal rules of interpretation, give substance precedence over form and criticise the tax avoidance schemes of taxpayers, calling upon the administrative or legislative branches to intervene to prevent them in the future. One should also note that the courts, including the House of Lords, did not adopt a uniform pro-taxpayer stance and that there are some tax decisions dealing with matters of tax avoidance which were decided in favour of the Revenue. The question whether such positions were characteristic require a quantitative study. The goal of this section was only to show that an explanation of the Westminster case cannot be based solely on internal doctrinal developments. The next section will examine some non-legal factors that might explain the decision. V. NON LEGAL FACTORS

1. Early Twentieth Century Tax Avoidance: A Brief History A comprehensive economic or legal history of tax avoidance in Britain in the nineteenth and early twentieth centuries has not yet been written. It is,

80 Ibid., 340–341. See also PRO IR 40/4576, Note by Mr Preston, Draft Proposal, 2. On Sumner’s tax speeches see generally Stevens, above n. 17, at 264. 81 Hall v IRC (1926) 11 TC 24, 43.

Explaining IRC v Duke of Westminster 203 however, possible to present an outline of such a history based both on the pioneering work of David Stopforth and on primary sources.82 Avoidance of taxation is not a new phenomenon.83 It was certainly an administrative concern by the middle of the nineteenth century.84 Even the use of the term ‘avoidance’ can be found as early as the 1850s.85 However, there was no consistent, ongoing administrative or public discussion of the issue during the nineteenth century.86 Nineteenth century social attitudes to avoidance too were ambivalent. Generally speaking, it seems that during the Victorian era public concern with evasion (let alone avoidance) was minimal.87 This was also the case in the first decade of the twentieth century. According to Stopforth, the first article entirely devoted to tax avoidance was published only in 1911.88 A 1915 book dealing with the super-tax contained only a brief, one-page, discussion on the ‘avoidance of super-tax’ in which the readers were merely advised to ‘take full advantage’ of allowable deductions and the use of companies.89 During the First World War, tax avoidance became more of a concern. One reason may have been the need for more revenue. Another reason, perhaps, was the increased sense of patriotism which the war engendered and which in turn led to more public concern with tax avoiders who were not fulfilling their civic duties. A 1914 letter sent to the Treasury, for example, mentioned an advertisement for a life insurance scheme designed to reduce taxation. According to the advertisement, the scheme had been sold to a well-known Baronet. ‘I think’, the author of the letter wrote, that ‘it is nothing short of despicable and unpatriotic for such people to endeavor to escape the burdens which they ought to pay and so make the burden heavier on the shoulders of other people less able to pay.’90

82 For discussions of specific aspects, see D. Stopforth, ‘Sowing Some of the Seeds of the Present Anti-Evasion System—the 1920s’ [1985] BTR 28; D. Stopforth, ‘Charitable Covenants by Individuals—A History of the Background to their Tax Treatment and their Cost to the Exchequer’ [1986] BTR 101; D. Stopforth, ‘Settlements and the Avoidance of Tax on Income—the Period to 1920’ [1990] BTR 225; Stopforth, above n. 8; D. Stopforth, ‘The Background of the Anti-Avoidance Provisions Concerning Settlements by Parents on their Minor Children’ [1987] BTR 417; D. Stopforth, ‘The Legacy of the 1938 Attack on Settlements’ [1997] BTR 276. See also Daunton, above n. 43, at 110–111. 83 See e.g. Stamp, above n. 50, at 126–127; Wheatcroft, above n. 16, at 210. 84 See Stopforth, ‘Settlements’, above n. 82, at 226–231. 85 Ibid., at 226–227. 86 Ibid., at 230–231. 87 R. Colley, ‘The Arabian Bird: A Study of Income Tax Evasion in Mid-Victorian Britain’ [2001] BTR 207, 220. 88 Stopforth, ‘Settlements’, above n. 82, at 236 citing E.E. Spicer, ‘Some Remarks on Income Tax and Super-Tax and Its Legal Evasion’, The Accountant, 21 Jan. 1911. See also Notes (1900) 63 LQR 213 (a note published in 1900 dealing with the ‘evasion’ of the death duties and stating that ‘evasion’ is doing something which is ‘legally and morally culpable’ and that therefore the use of gifts to escape estate duty cannot be deemed evasion). 89 R.A. Wenham, Super-Tax with Special Reference to the Finance Act 1914 (London, Gee & Co., 1915) 79–80. 90 PRO, T 172/973, Ridge Beedle to Lloyd George, 4 Dec. 1914.

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Immediately after the war, a Royal Commission was established to study, among other things, the issue of ‘tax evasion’, a term which was still used in a way which also encompassed avoidance. Some of the witnesses who appeared before the Commission mentioned various methods of tax avoidance which were practised at the time.91 On the whole, however, the issue of tax avoidance played only a very minor part in the recommendations of the Commission. Its final report mentioned the issues of avoidance only in three short paragraphs. One paragraph discussed undistributed profits in one-man companies. A second paragraph mentioned educational trusts. A third paragraph recommended the enactment of a general anti-avoidance provision similar to the one found in the Excess Profits Duty Act.92 Some of the recommendations of the Commission were put into effect in 1922 when provisions were enacted to curb ‘legal evasion’ by the use of revocable trusts and one-man companies.93 However, it soon became apparent that the 1922 legislation was inadequate.94 In 1925, an Inland Revenue committee was appointed to examine ‘legal evasion’ through the medium of private companies.95 Such ‘legal evasion’, it was felt, was a threat to maintaining the ‘equal and equitable adjustment of the vast burdens that the Exchequer demands’.96 However, officials of the Inland Revenue thought that ‘the practice, though growing, is not yet sufficiently common to impair the equality of taxation in so grave a degree as to cry out for immediate remedy’, and that ‘the question of legal avoidance of direct taxation has not yet attracted much public attention, the facts being but imperfectly known in those quarters from which criticism might most readily come’.97 A further argument was that legislation on that matter would lead to opposition by businessmen who would fear the ‘unjust’ and ‘arbitrary’ discretion of the tax authorities.98

91 See Royal Commission on the Income Tax: Minutes of Evidence (London, HMSO, 1919), paras. 4404–4406, 4409–4411, 8367–8372, 14328–14333, 14376–14385, 21286, 21373, (undistributed dividends and one man companies); paras. 6103–6104, 7014–7028, 8340–8348, 8424–8427, 8599–8601, 14334 (bonus shares); para. 6890 (Channel Islands as a death duties haven); para. 8282 (gifts, trusts and the use of domestic and foreign companies); paras. 13441–13443, 13688, 14408–14419, 14490 (educational trusts); paras. 9424–9570, 13449 (foreign companies); paras. 14114–14119 (the need for a general anti avoidance provision). See also Daunton, above n. 43, at 110–111. On anti-evasion measures implemented in the 1920s, see Stopforth, ‘Sowing’, above n. 82. 92 Report of the Royal Commission on the Income Tax 1920 (London, HMSO, 1920), paras. 575, 576, 635. 93 FA 1922, ss. 20, 21. See also PRO CAB27/338, R.V.N. Hopkins to Chancellor of the Exchequer, 16 Feb. 1926; Stopforth, ‘Charitable Covenants’, above n. 82, at 103; Stopforth, above n. 8, at 88. 94 Stopforth, above n. 8, at 88; Stopforth, ‘Background’, above n. 82, at 423–424. 95 PRO IR 75/127. 96 PRO CAB 27/338, above n. 93. 97 PRO CAB 27/338, Minute by R.V.N. Hopkins, 8/12/1926; PRO 271338, Memorandum of the Board of Inland Revenue, ‘The Principle Forms which Leal Avoidance of Direct Taxation Assumes’, 9. 98 PRO CAB 27/338, Minute by R.V.N. Hopkins, 8 Dec. 1926.

Explaining IRC v Duke of Westminster 205 Public interest in tax avoidance was indeed limited. It was awakened only by short-lived public scandals. Thus, in 1922, William Vestey, one of the owners of the Vestey meat-packing business, was made a peer. The Vesteys had removed their business abroad during the First World War in order to avoid British taxation. Vestey’s peerage led to some criticism by members of the House of Commons and the House of Lords, who argued that there should be ‘no awards given to people for avoiding taxation’.99 Another spike in the relatively quiet 1920s occurred in 1926–1927 following the Houston affair. This was a public scandal which briefly erupted after it was learnt that Sir Robert Houston, a shipping magnate, had become a resident of the Channel Islands, thus avoiding death duties on his estate.100 The affair led to numerous parliamentary questions and newspaper articles.101 One such article, written by Lord Decies, the Director of the British, Tax Payers’ Association, was entitled ‘Why Income Tax is High’. In it, Lord Decies criticised wealthy tax ‘dodgers’ who transferred their assets and themselves out of Britain in order to escape taxation. ‘To leave those whose labours have helped him in the acquisition of wealth, to face the burden of heavy taxation whilst he seeks asylum in a country to which he owes no allegiance merely to escape death duties, super-tax and income-tax, is unpatriotic and altogether reprehensible’, said Decies. Similar sentiments appeared in letters to the press during the same period which accused taxpayers who were using companies to avoid taxation of ‘flinging a heavier burden of taxation on smaller men and women’.102 The public outcry led, in December 1926, to the establishment of a Cabinet committee on tax avoidance.103 The aim of this committee, according to Winston Churchill, the Chancellor of the Exchequer at the time, was to placate public opinion and thus prevent more radical reform in the future. ‘It would be very much better for the present government’, said Churchill, ‘to deal with the more glaring cases of avoidance than to allow the abuse to grow into a public scandal to be dealt with on very drastic lines, possibly by some future Socialist government. It would be a mistake to attempt to

99 ‘Peerage Question’, The Times, 20 June 1922, 19; P. Knightley, The Vestey Affair (London, MacDonald, 1981), 12, 44–46. 100 PRO CAB 27/338, Board of Inland Revenue, ‘The Principle Forms which Legal Avoidance of Direct Taxation Assumes’, 2, 9–12; PRO CAB 27/338, Minute by R.V.N. Hopkins, 8 Dec. 1926. 101 ‘Home Office and the Channel Islands’, The Times, 9 Feb. 1923, 11; ‘Taxation of Channel Islands’, The Times, 23 Feb. 1926, 12; ‘Sir R. Houston’s Estate’, The Times, 2 July 1926, 5; ‘Evasion of Taxation’, The Times, 20 July 1926, 8; ‘Channel Islands and Death Duties’, The Times, 10 Dec. 1926, 8. 102 PRO T 171/265, Lord Decies, ‘Why the Income Tax is High’, Daily Mail Year book London, Associated Newspapers, 1927; PRO T 171/265, C.A. ‘Letter to the Editor’, Manchester Guardian, 29 Jan. 1927. 103 PRO CAB 27/338, Report of the Cabinet Committee on Tax Avoidance (14 Mar. 1927). See also Stopforth, ‘Charitable Covenants’, above n. 82, at 103–106.

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deal with the problem exhaustively, but [the Chancellor] would select, say, three or four of the more extravagant methods of avoidance and deal, if possible, with them.’104 However, even this limited programme was too radical for some members of the committee, whose sympathies lay with the landowning class. Landowners, they said, were attempting to protect their property and the government should not ‘alienat[e] them’. 105 With these goals in mind, the committee decided to limit its discussion to the avoidance of the income and super-tax and not the avoidance of death duties. The death duties were seen as the major concern of landowners who would, committee members thought, vigorously resist any reform.106 The committee submitted its report in March 1927. It proposed a number of different methods of avoidance of the income tax and estate duties, some of which were later enacted in the Finance Act of 1927.107 The reluctance to deal effectively with issues of avoidance was not merely the result of class sentiment. It may also have been the result of genuine constitutional difficulties. This was exemplified in the ineffectual attempts pursued in 1927 to prevent the use of the Channel Islands as a tax haven. The British government exerted pressure on the Islands to tackle the issue of avoidance, urging them to legislate in this matter. But the islanders proved very stubborn. They argued that the islands were not the only tax haven in the British Empire. They added that they were being unfairly discriminated against and that government intervention would gravely impair their constitutional rights and immunities.108 Frustrated Inland Revenue officials remarked sarcastically that the islanders ‘lack the education of living in the great world; they are parochial and touchy and at the same time they have deeply engrained in them certain ill-informed but intuitive prejudices regarding independence and constitutional privilege which many of them probably think are being infringed, though they do not know how.’ Some Inland Revenue officials even toyed with the idea of imposing duties on trade with the mainland or embargoing the islands.109 In the end, however, a compromise was struck. The islands would supply information on residents

104 PRO, CAB 27/338, First Meeting of the Cabinet Committee on Tax Avoidance, 10 Feb. 1927; PRO, CAB 27/338. See generally Daunton, above n. 43, at 34, 80, 102, 133 (discussing Churchill’s view of fiscal reform as a way of undermining socialism). 105 PRO, CAB 27/338, Second Meeting of the Cabinet Committee on Tax Avoidance, 22 Feb. 1927, 5; Fourth Meeting, 8 Mar. 1927, 1. 106 PRO, CAB 27/338, Second Meeting of the Cabinet Committee on Tax Avoidance, 22 Feb. 1927, 5; Fourth Meeting, 8 Mar. 1927, 1. 107 PRO CAB 27/338, Report of the Cabinet Committee on Tax Avoidance (14 Mar. 1927); Stopforth, ‘Charitable Covenants’, above n. 82, at 103–106; Daunton, above n. 43, at 111; FA 1927, ss. 31–32 (undistributed income of companies). 108 ‘Mr. Churchill’s Speech’, The Times, 12 Apr. 1927, 16; ‘Channel Islands and Tax Evasion’, The Times, 22 July 1927, 8; PRO T171/265, Addendum au Billet d’Etat no. IX, 1927 ‘Avoidance of British Direct Taxation by Removal of Residence Domicile and Property out of the United Kingdom’. 109 PRO T171/265, R.V.N. Hopkins to Chancellor of Exchequer, 12 July 1927.

Explaining IRC v Duke of Westminster 207 and companies who might be liable to mainland taxation but would not have to legislate in this matter.110 While government reaction to avoidance in the 1920s and the early 1930s was sporadic and ineffectual, taxpayers and their professional advisers were paying more attention to the issue. Articles about tax avoidance were published in professional journals as early as 1894, but it was only in the late 1920s and early 1930s that tax avoidance became the object of consistent professional attention, as the practice of avoidance moved from the upper to the upper-middle class and became a small-scale industry rather than a craft. This was no doubt partly the result of fears of radical redistributive measures by the Labour government elected in 1929.111 The spread of knowledge about tax avoidance techniques was aided by the emergence of specialist tax journals which began to appear in the late 1920s.112 By the early 1930s there was a visible rise in discussions of tax avoidance in the professional literature. A book published in 1931 claimed that ‘in these days of high rates of income-tax and sur-tax . . . every taxpayer . . . is endeavouring to pay the smallest amount possible’, and that there has not a ‘single intelligent citizen who does not seek to obtain a reduction of his taxation liability by any legal means’.113 In the summer of 1933, the journal Taxation published a collection of sayings by various judges favouring non-intervention in cases of tax avoidance.114 In late 1933, the same journal published a series of articles on tax avoidance which, it explained to its readers, was the result of growing reader interest in the subject of avoidance.115 In December 1934 and in April 1935, it published an article on form and substance in taxation and another article on tax avoidance.116 Another journal, The Accountant, also published articles on the legal avoidance of income tax.117 It was only in 1935, however, that the professional buzz about avoidance finally began to reach the general newspapers.118

110 PRO T171/265, Note of Conclusions Reached at a Conference Held at the Treasury on the 14th and 15th July 1927; ‘Channel Islands and Tax Evasion’, The Times, 22 July 1927, 8; ‘Tax Evasion in Channel Islands’, The Times, 5 Aug. 1927, 7; ‘Tax Evasion in Channel Islands’, 6 Aug. 1927, 10. This, of course, did not resolve the issue, and in the 1930s one could find advertisements for houses in Jersey which stressed the fact that there were ‘no death duties’ there. See ‘Furnished Country and Seaside Houses: Channel Isles, Jersey’, The Times, 20 June 1935, 27, col. 2. 111 For a discussion of Labour’s taxation policy as well as the actual, rather mild, steps taken in practice, see Daunton, above n. 43, at 142–164. 112 Stopforth, ‘Background’, above n. 82, at 432. 113 A.W. Rawlinson and R. Hunter, Practical Aspects of Taxation (London, Gee & Co., 1931), 1. 114 See ‘Legal Evasion’ 11 Taxation (8 July 1933), 230; ‘Legal Evasion’, 11 Taxation (15 July 1933) 240; ‘Legal Evasion’, 11 Taxation (12 Aug. 1933) 302; ‘Legal Evasion’, 11 Taxation (30 September 1933) 390. 115 ‘Legal Extortion: Legal Avoidance’ 12 Taxation (18 Nov. 1933) 109–110. 116 ‘Form and Substance’ (22 Dec. 1934) 14 Taxation 179; J. Wood, ‘The Legal Avoidance of Taxation’ (13 Apr. 1935) 15 Taxation 21. 117 See Stopforth, above n. 8, at 97. 118 Stopforth, above n. 8, at 98.

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The growing interest in avoidance among accountants was accompanied by growing audacity. In an article on tax avoidance published in Taxation three days before the House of Lords’ decision in Duke of Westminster, the author urged his readers ‘to have regard to the material benefits which may result should any of their clients be desirous of taking advantage’ of the numerous tax avoidance schemes enumerated in the article.119 Roger N. Carter, the President of the Institute of Chartered Accountants, gave a speech in December 1935 in which he defended accountants who suggested tax avoidance schemes to their clients. One remarkable argument he made was that ‘on the lowest level, we [accountants] have our living to make’ and therefore must not ‘neglect these opportunities of making friends of our clients’. Another, even more astounding argument was that if accountants did not advise their clients to use a certain scheme, the evil would be small; it would therefore not lead to the enactment of a special provision in the Finance Act, and then ‘the unscrupulous would get away with it’. However, if all accountants advised their clients to use a particular scheme, then this scheme would become an important matter, and ‘if unfairness exists’, it would be dealt with by legislation.120 All this activity resulted in a marked acceleration in the use of tax avoidance schemes in the early 1930s. For example, there was a substantial increase in the number of new settlements on minor children (one of the favourite avoidance devices). According to the Revenue, the number of new settlements in 1929 was only 579. In the year ending in March 1935, however, there were 9,814 new settlements, and for the six-month period between April and October 1935, there were 14,746.121 The use of another popular tax reduction device, deeds in favour of charities, also increased. The number of new deeds in 1930 was approximately 5,000. In 1932, it was 9,545.122 This growth did not go unnoticed. In 1934 Members of Parliament thought that there was ‘a very considerable increase’ in ‘scientific tax evasion’. Neville Chamberlain, the Chancellor of the Exchequer, however, dismissed their concern, arguing that while there had been ‘some increase’ in tax avoidance there was no need to include further preventive legislation.123 Despite Chamberlain’s out of hand dismissal of parliamentary concerns, the Inland Revenue was indeed worried. The growth in tax avoidance led to the formation of an Inland Revenue committee. Its report, submitted in February 1934, contained an estimate according to which some £8 million

119 120 121 122 123

J. Wood, ‘The Legal Avoidance of Taxation—IV’ (4 May 1935) 15 Taxation 69, 70. ‘Legal Avoidance’, (1935) 16 Taxation 175. PRO T171/318, E.R. Forber to Chancellor of the Exchequer, 28 Nov. 1935, 7. Stopforth, ‘Charitable Covenants’, above n. 82, at 107. HC Debs, vol. 289 (1933–1934) col. 143 (question by Mr. Wilmot) (1 May 1934)

Explaining IRC v Duke of Westminster 209 were lost annually due to evasion and avoidance.124 The committee, however, was doubtful about the possibility of finding a ‘complete’ remedy for the problem. Public opinion, it said, would not accept ‘very drastic legislation, with its potential menace to the tax-dodger and to the honest taxpayer alike’. The committee did suggest the enactment of a ‘general clause which would cover various kinds of artificial transactions’. 125 One of the major reasons for this attitude was the realisation that ‘the general scheme of the taxing statutes is such that, as between the various classes of taxpayers, it is much easier for the wealthy taxpayer, than for the poorer one, so to arrange his affairs, the result being that the majority of these “arrangements” simply result in the wealthy taxpayer passing on to his less fortunate brethren, generally, an additional burden which they ought not to be called upon to bear.’126 The report of the committee was sent to the Chancellor of the Exchequer with the recommendation that the matter be dealt with.127 Inland Revenue officials proposed introducing a draft clause to deal with the transfer of assets to persons abroad, which was viewed as the most burning issue, producing an estimated loss to the revenue of £2.75 million.128 In order to distinguish between genuine and tax-motivated transfers, they proposed that the clause would include a motive-based test. The introduction of a ‘tax dodging’ or ‘motive’ test, they argued ‘would be welcomed by large numbers of people who recognize that steps of a drastic nature are needed if a satisfactory remedy for the disease of avoidance is to be secured’.129 But Treasury reaction was unenthusiastic. Treasury officials saw ‘very serious’ parliamentary objections to the proposal because it would leave too much discretionary ‘star chamber’-like powers in the hands of the tax authorities.130 One official, Sir Warren Fisher, remarked that ‘while I feel nothing but contempt for these patriots (presumably in the main well-to-do people) who misuse the law to off load on to their fellow-taxpayers their share of expenses incurred by government in protecting their worthless hides and frequently ill-gotten gains, I cannot think that Parliament would 124 PRO T 175/98 (part 2), Report of the Evasion Committee, 1, 3–4; PRO T 171/318, E.R. Forber to Chancellor of the Exchequer, 5 July 1934. On the committee, see also Daunton, above n. 43, at 111. 125 Ibid., at 4–5, 69–70. 126 PRO IR 40/4576, Note by Mr. Preston, ‘Draft Proposal’, 2. 127 PRO T 171/318, E.R. Forber to Chancellor of the Exchequer, 5 July 1934. 128 PRO T171/318, E.R. Forber to Chancellor of the Exchequer, 28 Nov. 1935. 129 PRO T171/318, P. Thompson to Chancellor of the Exchequer, 20 Feb. 1935. There were precedents for such a test. First, s. 132 of the Income Tax Act 1918 which stated that the taxpayer should not be guilty of any ‘contrivance whatsoever’ (which the courts failed to interpret as forbidding avoidance). Secondly, the Excessive Profits Duty Act of 1915 which mentioned ‘fictitious or artificial’ transactions. See also R.N. Carter, ‘The Professional Accountant, the Taxpayer and the Tax Gatherer’, The Accountant Tax Supplement (20 Oct. 1934) 395, 398. 130 PRO T171/318, Minutes, 22 Feb. 1935.

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or should accept a proposal that the subject may be regarded as guilty of a wrong motive unless he can disprove it. For this would run counter to the fundamental principle of English justice . . . that a man is innocent until he is proved guilty. At the same time, I freely admit that the present immunity of these tax dodgers is a scandal and can only have anti-social consequences.’131 These objections killed the draft proposal.132 In March 1935, two months before the House of Lords gave its decision in the Westminster case, another question was asked in Parliament about the use of foreign corporations as a means of avoiding the surtax. Again, Chamberlain merely assured Parliament that while there is a ‘growth in the practice’, the ‘situation is always closely watched and such appropriate measure as are practicable are taken from time to time as the circumstances require’.133 In June 1935, during a debate on the Finance Act in the Commons, the issue of avoidance was raised again and the Chancellor was asked to deal with it. The Chancellor repeated his previous statements, stating that ‘there was all the difference in the world’ between evasion and avoidance, that it was ‘only human nature that lawyers . . . should turn their wits to seeing how they could get better of the law’ and that the issue was being closely watched by the Treasury.134 But pressure on the Treasury was mounting. In November 1935, the issue of avoidance was again raised by the Inland Revenue. A letter sent to the Chancellor informed him that there was a marked increase in tax avoidance and called for immediate measures to tackle it. One major argument used was that the ‘development of propaganda in favour of evasion has received a notable fillip from the remarks of certain judges in recent Revenue cases’. Specifically cited were the remarks of Tomlin and Atkin in the Westminster case, which Inland Revenue called ‘a flagrant case of evasion’. Such remarks, it was noted, ‘are at once seized upon and given the widest publicity by those who make a living out of pushing avoidance schemes. . . . One of the touting concerns engaged in this traffic is broadcasting printed slips advocating what they call their tax-economising scheme. These slips begin by quoting the most recent dicta of the Judges . . . and their comment in large type is—“A clearer justification . . . has never been made out by the Courts of England”. This referred to a British Taxpayers’ Association brochure entitled ‘Why the Middle Class Family Man Should Adopt the Tax Economising Scheme advocated by the B.T.A.’135 ‘Perhaps the most outrageous evidence of the extent to which avoidance is spreading and is advocated as respectable’, the Revenue complained, ‘is the publication last month by well-known law publishers of a book of Mr. Jasper 131 132 133 134 135

PRO T171/318, Minutes, Sir Warren Fisher, 27 Feb. 1935. PRO T171/318, E.R. Forber to Chancellor of the Exchequer, 28 Nov. 1935, 2 HC Deb, vol. 299, col. 2075, (28 Mar. 1935). ‘Hint to Tax Evaders’, The Times, 20 June 1935, 9. See also Taxation, 29 June 1935, 200. PRO T171/318, E.R. Forber to Chancellor of the Exchequer, 28 Nov. 1935.

Explaining IRC v Duke of Westminster 211 More, a young barrister, which is devoted entirely to the subject of tax evasion. Under the pleasing title of “the saving of Income Tax, Sur Tax and Death Duties,” this text book on the art of legal evasion sets out in detail various schemes.’ It is obvious, Revenue officials concluded, ‘that the position has considerable possibilities for public scandal: in the last year or two there have been a few references to the subject in Parliament but it seems . . . that at any time there may arise a strong public demand for action, accompanied by an exposure of the methods that some people employ for the protection of their wealth from the taxation imposed by Parliament. . . . There can be no doubt that action should be taken as early as possible.’136 Treasury officials were unimpressed. Warren Fisher, the permanent secretary to the Treasury, tried to ignore the issue. ‘Tax dodging’, he noted, ‘especially by the well-to-do, is contemptible beyond all words, but if it is to be tackled at all—not merely tinkered with—we must effectively mobilise the public conscience.’137 The Chancellor, however, finally decided to deal with the matter by legislation. It was therefore proposed to introduce measures to deal with settlements and trusts in favour of children and avoidance by means of British companies in the next Finance Bill,138 one major consideration being that ‘the conjunction of such legislation with the necessity for repairing deficiencies in our armaments appears favourable’.139 In April 1936, Chamberlain’s financial statement finally called attention to the fact that avoidance is ‘growing very rapidly’, using various devices such as the transfer of property abroad, one-man companies and educational trusts and that therefore it is necessary to ask Parliament to intervene. ‘It is extremely unfair that, while some are obtaining relief in this way, others, either because they have scruples about employing methods of this kind or because they simply do not happen to know how to apply them, are not only getting no such relief themselves, but are actually having to pay more than their fair share of taxation.’140 Following this, sections 18–21 of the Finance Act 1936 were enacted. They dealt with the use of companies as a method of tax avoidance, the transfer of assets abroad and settlements on children.141 Following the legislation of 1936 and in subsequent years, interest in the issue somewhat subsided.142 In 1939, the Chancellor of the Exchequer, John 136 PRO T171/318, E.R. Forber to Chancellor of the Exchequer, 28 Nov. 1935. See also J. More, The Saving of Income Tax, Surtax & Death Duties (London, Butterworth, 1935); P. Baker, ‘A Book Review of “The Saving of Income Tax, Surtax and Death Duties”’, (this vol.). 137 PRO T171/318, Minutes, Warren Fisher, 16 Dec. 1935. 138 PRO T171/318, E.R. Forber to Chancellor of the Exchequer, 28 Nov. 1935. 139 PRO T 171/318, Morrison to Chancellor of the Exchequer, 11 Feb. 1936. 140 HC Deb, vol. 311, cols. 45, 46, 48, (21 Apr. 1936). 141 Finance Act 1936, ss. 18–21. See also ‘Income Tax Avoidance’, The Times, 15 May 1936, 16; ‘Making Every Class Pay’, The Times, 21 May 1936, 16; ‘Legal Avoidance and the Finance Act, 1936’,(1936) 17 Taxation 317. 142 On late 1930s measures, see e.g. ‘A Rearmament Budget: . . . Strong Action Against Tax Avoidance’, The Times, 27 Apr. 1938, 18; ‘Facing the Cost’, The Times, 27 Apr. 1938, 19; ‘Defeating Tax Avoidance’, The Times, 17 May 1939, 14.

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Simon, told the Parliamentary Ways and Means Committee that legislation in recent years included many provisions regarding avoidance which had ‘checked to a considerable extent the abuses against which they were directed’ and that consequently there has been a marked decline in tax avoidance.143

2. The Ebb and Flow of Public Concern with Tax Avoidance As this brief discussion shows, tax avoidance was not a constant public concern in the early decades of the twentieth century. The issue emerged sporadically during certain periods. In a companion article on tax avoidance adjudication in the United States, I argued that the judges are influenced by what they read in the newspapers and that tax avoidance scandals were a major factor in shifting American tax avoidance doctrines in a more proRevenue direction in the 1930s.144 Was this also the case in Britain? One way to measure the general public interest in tax avoidance in Britain is by doing a quantitative analysis of newspaper articles. One can count newspaper reports on the subject. I did so using the Official Index of the Times for 1906–1980.145 I searched for articles that mentioned the term ‘tax evasion’ or ‘tax avoidance’.146 The results are summarised in the following table: Table 1. Articles Mentioning the Terms ‘Tax Evasion’ and ‘Tax Avoidance’ in the The Times 1906–1939 Period

1906–1909 1910–1919 1920–1929 1930–1935 1936–1939

143

Articles mentioning the term ‘tax evasion’ 7 45 137 49 109

Articles mentioning the term ‘tax evasion’ (excluding articles dealing with tax evasion prosecutions) 7 7 54 4 108

Articles mentioning the term ‘tax avoidance’ 0 0 8 0 0

Parliamentary Debates, vol. 335, cols. 25–26, (26 Apr. 1938). See Likhovski, above n. 24. 145 It is now possible to by-pass the official index and conduct a word-search of The Times using the Time Digital Archive. Such a search yields similar results. A Times Digital Archive search conducted in the summer of 2004 shows that the term ‘tax avoidance’ appeared in The Times only 3 times between 1930 and 1935 and 67 times between 1935 and 1939. The term ‘tax evasion’ appeared 73 times between 1930 and 1935 and 117 times between 1935 and 1939. 146 In public debates, and even in official government documents in the early 20th century, there was often no clear distinction between tax evasion and tax avoidance and the two terms were used interchangeably. See also L. Stein and H.H. Marks, Tax Avoidance: An Interpretation of 144

Explaining IRC v Duke of Westminster 213 The table indicates, just as does the history recounted in the previous section, that there were certain peak periods in which public interest in matters of tax avoidance and tax evasion grew. There was some interest in the issue during the 1920s (mainly due to the Houston affair) and in the period beginning in 1936, after the Westminster case was decided. The period between 1930 and 1935, however, was a period of little public (though not professional) interest in evasion and avoidance. This fact, I believe, is part of the explanation of the decision in the Westminster case. While in 1935 accountants, lawyers and Revenue officials were devoting much attention to tax avoidance, the issue still did not reach such a level of general public awareness that would have put pressure on the Law Lords to decide in favour of the Revenue in Westminster. Further support for this argument is provided by a qualitative, rather than a quantitative, analysis of articles in The Times dealing with tax avoidance. In the early 1920s, the issue of tax avoidance was mentioned only sporadically in The Times.147 There was a minor surge of interest in the issue in 1926–1927 following the Houston affair. This interest focused on the evasion of death duties by the changing of domicile to the Channel Islands. The issue received attention partly because it was linked to another high-profile issue, the political row over the refusal of the Channel Islands to contribute their fair share to the financing of the First World War.148 Public interest in the issue disappeared after 1927 and only re-emerged in 1936. It was only following Chamberlain’s budget speech of April 1936 that public interest in the issue reappeared.149 This was partly because lawyers took offence at their portrayal by Chamberlain as assistants to ‘smugglers’.150 It was also because one of the schemes targeted was the educational trust. Many taxpayers, apparently, were extremely alarmed by the the Provisions of the Finance Act, 1936 (London, Sweet & Maxwell, 1936), 1. The use of an elite newspaper may be problematic because the results reflect only the opinions of elite journalists and readers. A comprehensive study of the subject would require the analysis of more newspapers. However, since I am interested in the effect of newspaper articles on the Law Lords, and since one can assume that the Law Lords read The Times rather than other newspapers, my reliance on it is less problematic than one would at first assume. 147 See e.g. ‘Supertax Evasion’, The Times, 29 June 1922, 15; Lord Decies, ‘Income Tax Evasion’, The Times, 8 Aug. 1923, 11; ‘Income Tax Evasion’, The Times, 11 Aug. 1923, 9; Honesty, ‘Income Tax Evasion’, The Times, 20 Aug. 1923, 15; J. Stanley Holmes, ‘Income Tax Evasion’, The Times, 21 Aug. 1923, 13. 148 See e.g. ‘The Evasion of Taxation: Domicile in Channel Islands’, The Times, 27 Apr. 1926, 8; ‘Evasion of Taxation’, The Times, 20 July 1926, 8; ‘Channel Islands and Death Duties’, ‘Evasion of Taxation’, The Times, 10 Dec. 1926, 8; ‘“Tax Dodgers” in Channel Islands’, The Times, 2 Mar. 1927, 13; ‘Guernsey & Imperial Exchequer’, The Times, 24 Mar. 1927, 11; ‘News in Brief’, The Times, 13 Apr. 1927, 11; ‘Channel Islands and Tax Evasion’, The Times, 9 June 1927, 9; ‘Tax Evasion in Channel Islands’, The Times, 5 Aug. 1927, 7. 149 ‘Mr. Chamberlain’s Fifth Budget’, The Times, 22 Apr. 1936, 14; ‘An Orthodox Budget’, The Times, 22 Apr. 1936, 15; ‘Higher Rate of Income-Tax’, The Times, 22 Apr. 1936, 9; ‘Avoidance of Tax’, The Times, 14 May 1936, 14. 150 A.T. Macmillan, ‘Income Tax Evasion’, The Times, 29 Apr. 1936, 10.

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attempt to limit the use of educational trusts as a tax avoidance device. There were about ten letters to The Times on this subject in the spring of 1936. One of these letters warned that the new anti-avoidance provisions which targeted educational trusts would lower the birth rate among professionals, ‘the most intelligent, healthy and steady classes . . . the very people whom the nation needs most’. It would be a folly, said the author of this letter, ‘to spend so much on health, education and housing and then to discourage the production of one of the best grades of raw material.’151 A similar public debate erupted over an article published in The Times in March 1938. This article attacked the formalism of English courts in matters of avoidance and called for the enactment of a general anti-avoidance provision. This provision was justified, among other things, as a way of countering Communist propaganda. Apparently, a Communist pamphlet entitled ‘How the Rich Live’ mentioned various tax avoidance schemes.152 The article led to a large number of letters to The Times, most of which supported tax avoidance as a legitimate way to relieve the heavy burden of taxation on the rich.153 This 1938 article also summarised public reactions to tax avoidance. ‘The whole subject’, complained its author, ‘has excited practically no public interest in England. The extent to which these [tax avoidance] devices are used is unknown to most taxpayers, who do not suspect that their own taxes are heavier because others have not paid a due share. It is remarkable that the Government have never made a pronouncement that tax dodging is contrary to the interests of the community.’154

3. Institutional and Cultural Considerations Public opinion was not the only factor that shaped judicial decisions on tax avoidance. Institutional considerations were another important factor. Judicial passivity in tax avoidance cases was not a result of sympathy for the taxpayers. Pro-taxpayer decisions were often justified by notions of the separation of powers and the rule of law. This, it can be argued, reflected the formal English legal style and ‘vision of law’, which Atiyah and Summers so thoroughly documented in Form and Substance in Anglo-American Law,

151

M. Grey, ‘Educational Trusts and the Birth Rate’, The Times, 30 May 1936, 8. ‘Tax Avoidance: How Incomes are Relieved: The Art of the Dodger’, The Times, 24 Mar. 1938, 15. 153 See e.g. Letter by Jasper More, The Times, 28 Mar. 1938, 15; ‘The Tax Avoider’s Case’, The Times, 1 Apr. 1938, 17. 154 ‘Tax Avoidance: How Incomes are Relieved: The Art of the Dodger’, The Times, 24 Mar. 1938, 15. It is interesting to note that this article also explicitly stated that the difference in public awareness of avoidance in the United States and England was one of the factors which prevented an effective fight against avoidance in Britain. 152

Explaining IRC v Duke of Westminster 215 and which Stevens has termed ‘substantive formalism’—the view that legal formalism was an end in itself.155 In Fisher’s Executors, it will be recalled, Lord Shaw of Dunfermline noted that while, from an economic point of view, the transaction in question (capitalisation of profits by their distribution to shareholders in the form of debenture stock) may be equivalent to the distribution of a dividend in cash, such an economic view could not be considered by the judiciary, but instead required the attention of the executive or the legislature, for ‘otherwise, neither the Crown nor the subject would ever know where they were’.156 Lord Sumner’s speech in Fisher’s Executors showed the same attitude.157 There were a number of other cases in which similar sentiments were expressed.158 Indeed, Tomlin’s speech in the Westminster case itself was based on the notion of the need for certainty. He rejected a substantive approach to tax avoidance, not because of its anti-taxpayer implications, but because of its implications for the rule of law.159 This ‘substantive formalist’ approach was also epitomised by a late 1940s case in which Lord Normand said ‘tax avoidance is an evil, but it would be the beginning of much greater evils if the courts were to overstretch the language of the statute in order to subject to taxation people of whom they disapproved’.160 It may be argued, of course, that the call for the legislature and the executive to intervene in matters of avoidance was merely a rhetorical device, and that the real motivation of the Law Lords was, as Stevens claimed, the desire to circumvent the taxation of the wealthy. But it must be remembered that it was not only judges who thought that they could not intervene in these matters but also the very people who were responsible for taxation, the Revenue. The ‘effective cure [for tax avoidance]’, wrote R.V.N. Hopkins, the Chairman of the Board of Inland Revenue, in 1926, ‘lies solely through the statute book’. In dealing with avoidance, a substantive approach, ‘seeking to get rid of what is barren and harmful in dry law, ha[s] at first the appearance of being in [itself] unlawful’.161

155

Stevens, above n. 17, at 283, 319–321. Ibid., at 335, 336. 157 Ibid., 340–341. See also PRO IR 40/4576, Note by Mr. Preston, Draft Proposal, 2. On Sumner’s attitude to tax avoidance see also Stevens, above n. 17, at 264–265, especially n. 121. 158 Hall v IRC (1926) 11 TC 24, 43. See also A.V. Tranter, Evasion in Taxation (London, Routledge, 1929), 85 (citing Scrutton J and stating that ‘judicial interpretation relates to previous acts of the legislature and often does not coincide with the current ethical or political judgments of the community. Even the Judiciary does not entirely disguise its feelings that the existing law falls short of the standard to be expected’). 159 IRC v Duke of Westminster [1936] AC 1, 19. On Tomlin’s approach see also Stevens, above n. 17, at 311–312. 160 Vestey’s Executors v IRC [1949] 1 All ER 1108. See also Knightly, above n. 99, at 8; Stevens, above n. 17, at 366. 161 PRO CAB 27/338, R.V. N. Hopkins to Chancellor of the Exchequer, 16 Feb. 1926. 156

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Similarly, Sir Ernest Gowers, a former Chairman of the Board of Inland Revenue, said in a speech in 1931 that it is the duty of the legislature to act against avoidance. Even this statement, however, was qualified in his speech by the argument that ‘legislation of this sort leads in a direction which is thoroughly repugnant to the British character. . . . The further legislature is forced along these lines the less certain will the incidence of taxation become, and the greater will be the discretionary powers entrusted to the executive authorities.’ This, he feared, would erode public trust in the Revenue which in the last resort depends on ‘the goodwill of the general body of taxpayers’. Since ‘the British taxpayer is still the most conscientious in the world’, the cost of such legislation, he implied, would far outweigh its benefits.162 Gowers was not the only Revenue official who, in 1931, still viewed avoidance as a relatively benign phenomenon. Apparently, among the higher echelons of the Inland Revenue, the official attitude was very forgiving even as late as 1933. An article published in Taxation in 1933 summarised official reactions to the question of avoidance. It noted that the ‘higher officials’ of the Revenue tended to view avoidance ‘with humour and tolerance’. It is only the junior officials who view the practice ‘with contempt and loathing—on the view that such schemes are mainly practiced by the more wealthy members of the community’.163 As noted above, by the middle of the 1930s, as the problem of avoidance grew, the Revenue became more aggressive, and this was evinced by its desire to introduce a motive-based clause in dealing with the transfer of assets abroad. But even in June 1935, a month after the decision in the Westminster case, the Chancellor of the Exchequer rejected a call to deal more strictly with tax avoidance, remarking that there was ‘all the difference in the world’ between evasion and avoidance and ‘of course, when you get taxation up to the level at which it stands in this country you do necessarily very greatly strengthen the inducement to see whether there is some device by which you can legally evade the full amount of tax . . . and it is only human nature that in those circumstances lawyers . . . should turn their wits to seeing how they can get the better of the law.’164 The rule of law as an impediment to a more aggressive approach to tax avoidance was also a major factor in parliamentary debates in the late 1930s. In 1938, during a debate in Parliament, it was suggested that the law be altered so that the Inland Revenue Authorities ‘might have recourse to a plea of equity where the legal claimed had failed’. In response, the Financial

162

‘The Legal Avoidance of Taxation—II’ (1933) 12 Taxation 143. Ibid. On the conservative tendencies of tax officials see also R. Whiting, The Labour Party and Taxation, (Cambridge, Cambridge University Press, 2000) 57. 164 See ‘Legal Avoidance of Income’ (1935) 15 Taxation 198. 163

Explaining IRC v Duke of Westminster 217 Secretary to the Treasury replied that such a principle would be inconsistent with parliamentary control of taxation.165 The fact that the people responsible for tax collection, including the top officials in the Revenue and even the Chancellor of the Exchequer himself, did not think that the fight against avoidance should be conducted by the judges using an ‘equitable’ approach proves that there were serious institutional impediments preventing the judges from adopting an aggressive interventionist stance. Another indication that judicial intervention was simply not an option in Britain at the time can be found in a book entitled Evasion in Taxation, published in 1929.166 The book, written by London University economist, Victor Tranter, discussed at great length the problems of tax evasion and tax avoidance (which Tranter called ‘legal evasion’).167 The author described various methods of tax avoidance in great detail, but when he turned to the remedies to the problems of evasion and avoidance, his imagination, at least as far as using courts to fight avoidance was concerned, failed him. The section in the book dealing with legal remedies to evasion and avoidance suggested only legislative remedies such as ‘amending or reenacting laws to stop the loopholes discovered in the original legislation’.168 Tranter then discussed many existing non-legal remedies such as religious excommunication, the use of publicity for shaming evaders, or increasing the efficiency of the administrative machinery.169 In his proposals for the future, Tranter offered some original remedies. He based his proposals on the criminological distinction between curable and incurable criminals, suggesting that the state deal with ‘curable evaders’ by appealing to their sense of patriotism, educating them in the basics of ‘civics’, initiating public relations campaigns, utilising the services of teachers, accountants and the clergy to prevent avoidance, and using tax amnesties.170 As far as ‘incurable’ tax evaders (and avoiders) were concerned, Tranter had a novel suggestion. ‘So far’, he said ‘evasion is not a certifiable form of insanity nor are there yet mental hospitals which admit to their wards for kleptomaniacs, those convicted of taxation frauds. We segregate those demonstrably and incurably anti-social in a physical sense, such as confirmed criminals, and those anti-social in a mental sense, such as lunatics and idiots, but not yet those anti-social in an economic sense.’ But, he continued ‘if the test is whether or not the individual has done a serious injury to the community and may possibly do so again in the future,

165 166 167 168 169 170

HC Deb, vol. 335, col. 26. (26 Apr. 1938). Tranter, above n. 158. Ibid., at 4. Ibid., at 116. Ibid., 119–152. Ibid., at 153–161.

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there would appear to be no logical reason why fiscal fraud should be treated exceptionally.’171 This discussion, as well as the final suggestion made by Tranter that “a department should be established to make a scientific investigation of the whole question of evasion’,172 seems to resonate with Michel Foucault’s observations about the nature of modernity in work such as Madness and Civilization or Discipline and Punish. However, for the purpose of this chapter, the interesting aspect of Tranter’s book is that while he enlisted almost every political and social institution in the fight against evasion and avoidance: the legislature, administrative agencies, schools, the clergy, accountants, the media and even the lunatic asylum, there was one institution, the courts, which was conspicuously absent from his list. This, I believe, indicates that in Britain at the time, an active anti-avoidance stance by the courts was simply not part of the public ‘vision of law’. It is only in the late 1930s that a public critique of the formalism of English courts in matters of tax avoidance appeared. Specific anti-avoidance measures, it was argued in a Times article published in 1938, fail because their interpretation by the courts is ‘so technical as often to be almost puckish’, thus defeating the purpose of the legislature. Several measures were proposed to deal with the problem of avoidance. One was publicity. Here the article referred to the American example—the efforts of the Roosevelt administration to curb avoidance which had been widely publicised and therefore met with a large measure of public support. The British government, it was argued, had failed to do likewise and had not used publicity as a weapon in the fight against avoidance. In addition, it was suggested that a general anti-avoidance provision be enacted 173 This article led to furious defences of avoidance, for example by Lord Hugh Cecil, the Provost of Eton, who argued that if a certain measure which reduced taxation conforms to the letter of the law it cannot be criticised, to which the obvious answer given by The Times was that sometimes Parliament fails to express itself with sufficient accuracy, and that reliance on technical imprecision is morally improper.174 One may also speculate that judicial intervention in tax avoidance matters was impeded by the idea that such intervention was un-British. Sir Ernest Gowers, a former Chairman of the Board of Inland Revenue, said in 1933 that anti-avoidance legislation ‘leads in a direction which is thoroughly repugnant to the British character’.175 After 1933, such measures

171

Ibid., 162–163. Ibid., at 170. 173 ‘Tax Avoidance: How Incomes are Relieved: The Art of the Dodger’, The Times, 24 Mar. 1938, 15. 174 ‘The Tax Avoider’s Case’, The Times, 1 Apr. 1938, 17. 175 ‘The Legal Avoidance of Taxation—II’ (1933) 12 Taxation 143. 172

Explaining IRC v Duke of Westminster 219 were sometimes implicitly or explicitly equated with German law and, more ominously, with Nazism. German law had always been concerned with avoidance, and various provisions dealing with the issue were enacted by the German legislature. However, the rise of the Nazi party to power in 1933 further increased the scope of substantive intervention by the courts in tax avoidance schemes, based on the reasoning that tax avoidance methods ought to be disregarded, even without specific statutory authority, if they are ‘in violation of the public duty of loyalty imposed on every member of the community’ in the Nazi State.176 British observers did not fail to notice these changes. An article published in the Accountant in the summer of 1935 described how, following the Nazi ascent to power, German law lost its commitment to the principle of rule of law. In fiscal matters this led to a provision which stated that citizens were under an obligation not to use the formalities of law to evade taxation. The article also discussed a specific German Supreme Fiscal Court case decided in 1935 in which the court followed Nazi tax legislation declaring that all tax laws should be interpreted according to the National-Socialist Weltanschauung and that tax avoidance was an offence against ‘the loyalty the citizens owe to one another and to the country’.177 The German precedent was explicitly mentioned in 1938 as an argument against a more active anti-avoidance stance. An article in The Times called for the enactment of a general anti-avoidance provision and mentioned the fact that in Germany the courts disallow transactions motivated by the desire for avoidance.178 During a debate in Parliament, the demand for a general anti-avoidance provision was raised. Ernest Thurtle, a Labour MP, asked the Chancellor of the Exchequer whether he was aware of the fact that in Germany ‘a citizen who successfully obtains exemption from given taxation on some point of law may yet be compelled to pay on the ground that it is equitable, if not legal, that he should pay’. He suggested that the law be altered so that the Inland Revenue Authorities ‘might have recourse to a plea of equity where the legal claimed had failed’. In response, the

176 P. Marcuse, ‘Six Years of National-Socialistic Practice in Taxation’ (1938–1939) 13 Tulane L Rev. 534, 553–559. See also ‘Tax Evasion in Germany: New Law Against “Economic Treason”’, The Times, 10 June 1933, 11; H. Richter, ‘Tax Avoidance: German Methods of Meeting it’, The Times, 29 Mar. 1938, 17; F. Vanistendael, ‘Judicial Interpretation and the Role of Anti-Abuse Provisions in Tax Law’, in G.S. Cooper (ed.), Tax Avoidance and the Rule of Law (Amsterdam, IBFD 1997) 38–39. 177 H. Blumenthal, ‘A Tax-Evasion Frustrated’ (1935) 93 The Accountant Tax Supplement 335–336. See also H. Voit, ‘[Letter]: A Tax Avoidance Frustrated’ (1935) 93 The Accountant Tax Supplement 395. On the Nazi legislation of 1934 which declared that ‘the tax laws should be interpreted according to the conceptions of National-Socialism’, see P. Haensel, ‘The German Tax Reform of 1934–1935’ (1935) 13 Tax Magazine 705. 178 ‘The Tax Avoider’s Case’, The Times, 1 Apr. 1938, 17.

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Financial Secretary to the Treasury replied that such a principle would be inconsistent with the Parliamentary control of taxation. Thurtle was also criticised for his desire to apply principles taken from the legislation of a totalitarian state.179 There is no evidence that the Law Lords were aware of the German/ Nazi position on tax avoidance, but the fact that Sir Ernest Gowers, the former Chairman of the Board of Inland Revenue, said in 1933 that antiavoidance legislation (let alone adjudication) was ‘un-British’ is another indication of the constraints faced by judges willing to confront tax avoidance schemes.

VI. CONCLUSION

So were the silver jubilee of King George V, celebrated on 6 May 1935, and the decision of the House of Lords in the Westminster case the next day connected? They were certainly not connected in any direct way, but the notion that the public mood does influence judicial decisions is, I think, less far-fetched. The aim of this chapter was to uncover some of the factors that led the majority of the House of Lords to decide in a pro-taxpayer way in the Westminster case. While one cannot completely reject the argument that class sentiments or ideological biases influenced the decision, it seems reasonable to assume that two other factors also played a role. First, in the 1920s and 1930s, British courts were not viewed as the proper institution to deal with the problem of avoidance. Instead, as some of the judges who decided such cases expressly said, the problem was seen as one which should be resolved by the executive and the legislative branches of government. This was not merely a rhetorical ploy to justify judicial passivity. As we have seen, Revenue and Treasury officials too did not consider the judiciary an appropriate forum for tackling tax avoidance matters. Indeed, following the rise to power of Nazism in 1933, judicial intervention became even more problematic, because at least some observers came to identify anti-avoidance measures with Nazi law. Institutional concerns, however, were not alone. Another important factor was the dynamics of public opinion. While tax avoidance increasingly captured the attention of accountants and lawyers in the early 1930s, it was not until 1936 that the issue emerged as a major public concern. As long as there was no public pressure to deal effectively with avoidance, the Law Lords did not feel compelled to intervene.

179 HC Deb, vol. 335 col. 26 (26 Apr 1938). See also ‘Old Jewry’, ‘Tax Avoidance’, The Times, 4 Apr. 1938, 15.

Explaining IRC v Duke of Westminster 221 This situation changed in the late 1930s. Public interest in avoidance reawakened in 1936. This led to public debates about such matters as the need for a general anti-avoidance provision or the impropriety of judicial formalism in tax avoidance cases. The changes in public opinion were followed by changes in judicial doctrines in the early 1940s.180 But the story of tax avoidance adjudication during the Second World War deserves a separate study.

180

Wheatcroft, above n. 16, at 217–218.

7 A Book Review of ‘The Saving of Income Tax, Surtax and Death Duties’ by Jasper More1 PHILIP BAKER

ABSTRACT This chapter is a book review of The Saving of Income Tax, Surtax and Death Duties by Jasper More. It is designed to shed light on the development of tax planning in the UK in the 1930s.

I

FIRST ENCOUNTERED Jasper More in the Public Records Office in Kew in 1997. It was not a very auspicious meeting. I had gone to the PRO to carry out some historical research in connection with the Willoughby case2 which was at the time proceeding to the House of Lords. One of the issues in that case was whether what is now section 739 of the Taxes Act 1988 applied to transfers made by a person not ordinarily resident at the time of the transfer (but who subsequently becomes ordinarily resident in the UK). On that issue, there had been some statements made in Parliament when the legislation was first introduced in 1936 by the then Financial Secretary to the Treasury to the effect that the legislation did not apply to transfers by non-residents.3 Despite these statements, the Inland Revenue had subsequently come to apply the provisions where the transferor had been non-resident. I wanted to check whether the statements made by the Financial Secretary were supported by any historical documentation which showed that this was the intention of the government, or whether the comments were simply made off the cuff by the Financial Secretary.4 1

1st ed., Butterworths, London, 1935, 2nd edn., 1937. [1997] STC 995. 3 These are cited in [1995] STC 143 at 161. 4 Several documents confirm that it had indeed been the intention of the government not to apply the original legislation to transfers made by non-residents. 2

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In the course of the research, I looked at what are sometimes referred to as the ‘Pocket Hansard Volumes’ and sometimes as the ‘Board Volumes’ on the Finance Bill 1936. These wonderful bound volumes contain a wealth of information about the enactment of each section of the annual Finance Act. One volume sets out, clause by clause, all the material relating to the passage of that clause through Parliament. A second volume contains the background documentation explaining why that particular clause was introduced in the first place. In the background documentation to what became section 18 of the Finance Act 1936, I found a fascinating document dating, I believe from late 1935 or early 1936.5 This was the originating document for, amongst other things, the anti-avoidance settlement provisions and for section 739. This document introduced me for the first time to Jasper More. The document bears quoting quite extensively for its own historical value (the relevant parts of the document are set out at Appendix 1 to this chapter). It was the reference to a young barrister, Mr. Jasper More, on page 4 of this document which particularly caught my attention. Members of the Revenue Bar tend to live long and practise well beyond the point where other barristers have gone on the bench or retired.6 If Jasper More was practising in the late 1930s, I would have expected to come across his name in cases from the 1950s or even 1960s. However, the name meant nothing to me at the time. I asked some of my colleagues in Chambers, whose collective memory stretches back several hundred years, and no-one recognised the name. What had become of Jasper More? Had this negative comment in the memorandum to the Chancellor of the Exchequer (albeit in a private document) blighted his career for ever? I was intrigued and wanted to discover further information. My starting point was the book referred to in the memorandum that I had found. I had the title to the book and the name of its author, and a relatively simple search in the catalogue of the Institute of Advanced Legal Studies disclosed that it had a copy of both the first edition and the second edition: no further editions after the second edition of 1937 were published. A trip to the Institute, and a request for a copy to come from the Depositary, allowed me to see the impugned text. Those who know me, particularly those who have ever asked me to write a book review, will not be at all surprised that I am now proposing a book review of a book published in 1935.7 It is only surprising that I am now getting round to writing the book review only some 69 years after the book was published. 5

The document is found at PRO IR 63/141, 24 ff. . Heyworth Talbot, in his time the doyen of the tax bar, practised well into his 80s. 7 I am not certain if there were any book reviews published at the time of the original publication: that would be an interesting topic for further research. 6

Review of The Saving of Income Tax 225 The frontispiece of the book shows that Jasper More was a barrister of both the Middle Temple and of Lincoln’s Inn, and that he won the Blackstone Prize in equity in 1930. In July 1935, when he signed off on the text, Jasper More was a tenant at 8 Old Square, Lincoln’s Inn. The book contains a foreword by Lord Decies, the director of the Income Tax Payers’ Society. That foreword indicates that no similar book on the subject of the saving of income tax, surtax and death duties had previously been published. Jasper More’s book supplied a ‘long-felt want’. The foreword ends with the following: In conclusion I may say that the taxpayer will not in any way lay himself open to the charge of having acted dishonestly if he adopts any of the numerous schemes so clearly explained in this book. I wish Mr. Jasper More every success in his undertaking.

The book is notable in a number of respects. First—and something which struck me as soon as I began to read it— was that the book has copious references to decided cases and statute. However, the book has no bibliography and absolutely no references whatsoever to any other secondary sources. Either the author read no secondary sources when preparing the text, or if he read any of them he did not feel it necessary to cite those sources, or there simply were no secondary sources in existence at that time on what one might broadly term the topic of ‘tax planning’. In discussion with one or two colleagues, it has been suggested that there were, perhaps, some earlier books considering the approach to tax planning, and that there may have been short articles in professional journals of the day, such as journals published for accountants.8 On the face of it, at least, every idea contained in the book was the original conception of Jasper More, basing himself simply on the legislation, decided cases and practice commonly known in Lincoln’s Inn at the time. The second point which struck me about the book was that a number of the ‘schemes’ which he discussed for the saving of income tax, surtax and death duties are still with us today, though often subsequent legislation (perhaps prompted by the publication of the book and a detailed reading of it within the confines of the Inland Revenue) has restricted the scope of the schemes or made their implementation more complex. There are obviously topics not discussed in the book—capital gains tax planning, accumulation and maintenance settlements, use of tax treaties, even taxation of the family, for example—and some of the chapter headings would now be

8 Another interesting avenue of further research would be to see the context in which this book was written, and whether the ideas contained in the book were truly original to the author or had previously been discussed in other secondary texts.

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redundant. However, there is a remarkable element of familiarity when one reads some of the chapter headings. (The contents list of the book, with the chapter headings, is attached as Appendix 2 to this chapter.) The third point which struck me on reading the book was how clearly it was written. The background in the tax legislation and case law and the possibilities for tax mitigation are clearly explained and illustrated by examples, the details of the implementation of each scheme are explained, and some indication is given of the costs involved. The first three chapters of the book explain the general background in terms of the law of income tax and surtax and of death duties. In particular, it highlights the fundamental bases on which much of the tax planning is posited: the fact that surtax applied only to individuals; the limitations of death duties only to certain assets in the UK and to gifts made on death or prior to death, for example. The main core of the book is found in Chapters 4 to 13 and the discussion of ‘practical schemes of tax saving’. Chapter 4 on ‘Covenants for Payment of Income’ comes as no surprise to anyone who practised UK tax law before the late 1980s (or even practises now, for that matter). The covenants which he discusses are primarily covenants to give income to the covenantor’s child. There is, however, at page 28 a rather coy reference: ‘a scheme of this kind can even be made use of for the payment of salaries of employees’. The footnote makes a reference to a certain Duke of Westminster9 case. Gifts and settlements are explained both in terms of their income tax/surtax and death duty advantages. This is all relatively standard advice, explaining how outright gifts or gifts into settlements could mitigate the tax liability both of the donor/settlor and of the beneficiary. The chapter on discretionary trusts is quite short, and focuses on the added death duty advantages. Chapter 7 on ‘Estate Companies’ is probably something that is a little strange to the tax advisor of the Twenty-first Century. Essentially, these are companies incorporated to take over the ownership and management of large agricultural estates. Again, there were surtax and possibly death duties advantages in so doing. Chapter 8 on ‘Holding Companies’ suggests something quite different from what we would presently understand by the term. What is proposed here is the use of a holding company which is placed into ‘permanent liquidation’. By making distributions to the shareholders on liquidation, it is suggested that surtax on distributions to shareholders can be avoided. ‘Bonus shares’ in Chapter 9 takes advantage of the pre-capital gains tax days when, if a shareholder was prepared to receive bonus shares rather 9

(1935) 14 ATC 77.

Review of The Saving of Income Tax 227 than a dividend, those shares could be subsequently sold for a tax-free capital gain. The chapter on ‘Investment in Foreign Lands’ relies entirely on the fact that British estate duty was not payable on freehold or leasehold land situated outside Great Britain. The chapter points out, of course, that the land must be purchased in a territory that has a lower estate duty than that applicable in the UK. Chapter 11 on ‘Companies Controlled Abroad’ is, of course, written in the pre-section 739 Taxes Act days. Income accruing to a company controlled abroad would not be attributed for tax purposes to the UK shareholder. There is an interesting discussion of central management and control as a concept for determining residence. The territory primarily identified as ideal for this purpose is not one that would immediately jump to the mind of the Twenty-first century tax practitioner: it is the Dominion of Canada which is recommended for this purpose. Interestingly, in the pre-capital gains tax days, ‘foreign settlements’ are recommended in Chapter 12 for their potential to save British estate duty. The key element here was that the settlement had to have its forum of administration outside Great Britain to fall outside estate duty. The discussion considers the establishment of settlements in New York or in Hong Kong. Finally, Chapter 13 on ‘Foreign Residence and Foreign Domicile’ explains the tax consequences that might flow if an individual became resident outside the UK or was not domiciled in any part of the United Kingdom. The discussion in that chapter is remarkably similar to any discussion one might find today (with the possible exception that there is no discussion of the impact of tax treaties). There is a discussion of the domestic case law on the determination of individual residence, a discussion of the general rules on domicile, and a brief explanation of the remittance basis of taxation. The last six chapters of the book do not offer particular schemes, but rather elaborate on some of the schemes in the first part and might be regarded as something more of a discussion of strategic planning. Chapter 14 on persons resident and domiciled abroad explains the advantages and disadvantages of this status. The chapter on ‘English Landowners’ elaborates on the scheme of using estate companies. Chapter 16 on ‘Insurance’ is quite familiar in part as it explains life insurance as an investment medium. It also discusses the use of insurance policies as a way of making provision for the payment of estate duty. There are brief chapters on the accumulation of income and the provision of annuities, the latter largely explaining how the capital element in annuities is free from tax. Finally, there is a short chapter on the drafting of wills in the context of estate duty, legacy duty and succession duty. Looking back at the book after almost 70 years from the time that it was written, several general comments come to mind.

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First, many of the ‘schemes’ described in the book would now be regarded as fairly standard, rather mild, tax mitigation: covenants to charity; gifts inter vivos and into settlement; even the tax planning for nondomiciled individuals would be regarded as fairly standard. The fact that this book provoked the reaction that is seen in the memorandum that I quoted at the beginning of this article (and which first pointed me in the direction of Jasper More and the book) shows one continuum: advice on tax mitigation will never be welcomed by the tax-collecting authorities, and they will have a tendency to over-react (particularly when they are being called upon to increase tax collections, whether it is to fight a war in Europe or supposedly to fight a war against terrorism). My second comment is a more personal one, though I think many others would agree with it. It seems to me that what Jasper More was doing was fulfilling a task, which is the perfectly reasonable and appropriate task for tax advisors at all times and in all places. That is, he is identifying perfectly legitimate means of tax mitigation, pointing out the advantages, disadvantages and costs involved in adopting a particular route of tax mitigation, and highlighting in particular any pitfalls that need to be avoided by someone who decides to follow that particular scheme. Nowhere in the book is there any suggestion that any of the schemes rely upon some particular loophole in the legislation which the draftsman failed to spot. Rather, most of the schemes take advantage—if that is the correct term—of general limits on the scope of surtax or death duties and the possibility of the potential taxpayer to benefit from those exclusions from tax. In terms of Lord Nolan in the Willoughby case10, Jasper More is simply pointing towards certain indications of freedom from tax which the legislature has presented. It goes without saying that Jasper More assumes full disclosure of all facts to the revenue authorities and impliedly accepts that the revenue authorities would be capable at any point in time of legislating to change the law to counter some of these schemes. In some cases—covenants for children, companies resident abroad—the legislature responded quite soon after the book was published to deal with these situations. So what became of Jasper More himself? For a long time I did not know the answer to that question. The book appeared in only two, pre-Second World War editions. The catalogue of the Institute of Advanced Legal Studies revealed no other legal books written by him. A search of the Tax Cases revealed no litigation in which Jasper More appeared after the Second World War. For a long time, I assumed that he might well have served and been killed during that conflict, and that his name would probably appear in the Book of Remembrance in Lincoln’s Inn. Then, having an odd free moment in Chambers, I recalled that the frontispiece showed that he had been called to the Bar by both Middle Temple and Lincoln’s Inn. 10

Above n.2, at 1004 c.

Review of The Saving of Income Tax 229 Perhaps the archivists of those Inns might have some record of his subsequent career. A few telephone calls were remarkably productive. The archivist and assistant librarian at Lincoln’s Inn supplied some details.11 Jasper More was admitted as a student of Lincoln’s Inn on 19 November 1927. He joined Chambers at 19 Old Buildings in 1933 and moved to 8 Old Square in 1936 (in fact, probably 1935, based upon his introduction to the book). He stayed there until the war broke out in 1939. He was knighted in 1979. He died on 28 October 1987. They were further able to tell me that Jasper More’s father was Thomas Jasper Mytten More and that he was an HM Inspector with the Education Board. Jasper More came from Ben Rhydding in Yorkshire and his father was a JP and had been awarded an OBE. Neither Lincoln’s nor Middle had any information about Jasper More after the outbreak of the Second World War. However, the librarian at Middle Temple was able to add one more key detail. Jasper More had been educated at King’s College, Cambridge, before coming to the Bar. A phone call to the archivist at King’s College Library struck gold.12 She was able to confirm that Jasper More had studied at King’s College and was able to send me a copy of his obituary from the college magazine. The obituary from the King’s College magazine finally resolved all my queries about what had become of Jasper More. Jasper More’s mother was the daughter of the fifth Marquis of Sligo. She married Thomas Jasper Mytten More against the wishes of her father, who wrote to his prospective son-in-law saying ‘your financial position causes me anxiety . . . Everyone who has an account at the Bank should always have some money there.’ The More family, having been Shropshire landowners, had fallen on hard times and Jasper’s father had to take the appointment as an Inspector of Schools to earn his income. Jasper was born in London on 31 July 1907 and won a scholarship to Eton, and then up to King’s where he read history, obtaining a first in Part I and a second in Part II of the Tripos. At King’s he rowed in the college boats and is remembered, amongst other matters, for having cross-examined Lytton Strachey as to whether he (Strachey) believed in hell. The King’s College obituary goes on to say that Jasper was called to the Bar where, ‘at no surprise to his friends, he quickly became an expert in the advantageous management of taxation. Unlike his later books, The Saving of Income Tax, Surtax and Death Duties (1935) does not seem to have been presented to the College Library.’ 11 I am particularly grateful to Mrs Frances Bellis, Assistant Librarian at Lincoln’s Inn, for the information that she supplied me. 12 I am extremely grateful to the archivist and the archivist’s assistant, Dorothea Sartarn, at King’s College for the information she sent me and also for sending me the obituary of Jasper More.

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Jasper More’s legal career stopped at the outset of the Second World War. He served in the Ministry of Economic Warfare, and then in the Ministry of Aircraft Production and Light Metals Control until 1942. In 1943 he was commissioned as a legal officer in the army, and was posted to Italy from 1943 to 1945 and then to the military government in the Dodecanese in 1946. In 1944, he married Clare Hope-Edwards, also from Shropshire, who was a substantial Shropshire landowner in her own right. He never returned after the war to the Bar. Instead, he followed the family traditions as a landowner, farmer and county squire. On the death of the occupying tenant, Jasper and Clare More occupied Lindley Hall, which was the More family’s historical home. He then settled down as a local landowner, becoming a JP, County Councillor and Deputy Lieutenant of the County. In 1960 Jasper More was returned to Parliament as a Conservative MP for Ludlow, remaining there until 1979. The King’s obituary says this: He had no political ambitions, having entered Parliament ‘from family habit’, and was surprised to be made a junior whip on the grounds of his conscientious attendance in the House and in the mistaken belief that he was a member of White’s. In 1970 he was appointed Vice-Chancellor of HM Household with the duty of reporting Parliamentary goings-on to the Queen. His very individual and perceptive commentaries are said to have caused much amusement in the confidential setting of Buckingham Palace.

Aside from serving as a whip, he never held any government post. He retired from Parliament in 1979. Though this is not said in his obituary, I believe he was one of the ‘men in grey suits’ who brought Margaret Thatcher to the leadership of the Conservative party in 1975. He was knighted in 1979, the year he retired from Parliament. Sir Jasper More died in October 1987. He had no children. His entry in Who’s Who for 1988 mentions that he was in practice at the Bar from 1930 to 1939. It also mentions five books that he wrote, including a guide to Italy, a guide to Egypt, and the Shell Guide to English Villages. Intriguingly, it makes no reference whatsoever to the two editions of his book on The Saving of Income Tax, Surtax and Death Duties. Perhaps that was just one book too many to include in the biography of a Conservative grandee. So, Sir Jasper More did survive the critical comments in the memorandum to the Chancellor of the Exchequer; he survived his period of practice at the Chancery Bar; he survived the Second World War; and he went on to retire as an establishment figure. I am certain there is a lesson in that somewhere: but I leave it for others to draw out the lesson.

Review of The Saving of Income Tax 231 APPENDIX 1 Document PRO IR 63/141, 24 ff. M.560. Evasion of Taxation

Income Tax, Sur Tax, Death Duties Chancellor of the Exchequer 1. In July of last year I submitted to you a Report with a view to initiating legislation to combat the avoidance of income tax and sur-tax, in the course of which I suggested that the following forms of evasion, placed in order of their importance to the Revenue, called for immediate consideration:—

(a) Foreign Avoidance (b) Settlements and trusts in favour of minor children. (c) British Companies

Annual loss estimated at that date. £m. 2 3/4 1 1/4 3/ 4

Following this Report you instructed me to have draft Clauses prepared for your consideration dealing with the problem of avoidance in the foreign sphere and with certain aspects of evasion of estate duty which were also referred to in my Report. These Clauses were prepared by Parliamentary Counsel and brought to your notice in February of this year. The Clause dealing with foreign evasion is somewhat formidable and you did not feel able to include it in this year’s Finance Bill; and although the suggested legislation as regards estate duty was not so difficult it was decided not to deal with this in advance of the income tax question. 2. Our further experience of the growth of evasion and the intensification of propaganda in its favour makes it necessary to bring the subject again to your notice and to press upon you the urgency of taking some step to check the evil. And while I do not think that it will be practicable to attempt to deal at the same time with the whole range of tax avoidance, I feel bound to suggest that in deciding on immediate measures the question of action should be considered not merely in regard to foreign avoidance but also to certain other methods of evasion. Since my last Report we estimate that the annual loss of income tax and sur-tax from evasion has increased in the case of

232

Philip Baker Foreign Avoidance Settlements and trusts in favour of minor children British Companies

From £m 2 3/4 to £m 3 From £m 1 1/4 to £m 2 and is rapidly increasing. From £m 3/4 to £m 1 1/4

So that on these three headings alone we estimate that the annual loss of tax by evasion has increased in a twelve-month from under £m 5 to over 6 millions. 3. The development of propaganda in favour of evasion has received a notable fillip from the remarks of certain Judges in recent Revenue cases. For example, in the case of the Duke of Westminster and the Commissioners of Inland Revenue (a flagrant case of evasion) on which the House of Lords delivered judgment on 7 May, 1935, Lord Tomlin said— ‘Every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be.’

Lord Atkin said— ‘It has to be recognised that the subject whether poor and humble or wealthy and noble has the legal right so to dispose of his capital and income as to attract upon himself the least amount of tax.’

Remarks of this kind are at once seized upon and given the widest publicity, by those who make a living out of pushing avoidance schemes, as affording full justification to taxpayers to adopt their schemes. They are used to justify schemes that are legal in form, but are in substance a mere and obvious sham. They are taken as the warrant to use all the forms of law to establish that income does not belong to A, when it is as clear as noon-day that in reality the income is A’s and he has the full use and benefit of it. One of the touting concerns engaged in this traffic is broadcasting printed slips advocating what they call their tax-economising scheme. These slips begin by quoting the most recent dicta of the Judges saying that taxpayers are entitled to evade Income Tax if they can do so legally and their comment in large type is—‘A clearer justification’ (for their tax-economising scheme) ‘has never been made out by the Courts of England’. They wind up— ‘There never was a more attractive means of obtaining “Something for Nothing” from the Inland Revenue officials whose duty it is to ‘search the taxpayers’ pockets’; and those officials admit the Scheme to be strictly legal and in order. So Why Not? . . . It is not “Tax Evasion”.’ (Copies of the slips are set out in Appendix A).

Review of The Saving of Income Tax 233 But perhaps the most outrageous evidence of the extent to which avoidance is spreading and is advocated as respectable is the publication last month by well-known law publishers of a book by Mr. Jasper More, a young barrister, which is devoted entirely to the subject of tax evasion. Under the pleasing title ‘The Saving of Income Tax, Sur Tax and Death Duties’, this text book on the art of legal evasion sets out in detail various schemes for tax avoidance, with an explanation of the legal points to be watched to ensure that they will pass muster, of the advantages that will accrue in reduced tax bills, and of the legal costs incurred in carrying them out. There is a foreword by Lord Decies, Director of the Income Tax Payers’ Society, commending the book, and saying that it supplies a ‘long-felt want’, will be a ‘welcome addition to the textbooks in constant use by solicitors, accountants, etc.’ and should ‘appeal strongly to the much wider circle of taxpayers who are anxious to protect their income, as well as their capital, from the ever-increasing depredations of the State’. It is obvious that the position has considerable possibilities for public scandal: in the last year or two there have been a few references to the subject in Parliament, but it seems to me that at any time there may arise a strong public demand for action, accompanied by an exposure of the methods that some people employ for the protection of their wealth from the taxation imposed by Parliament. 4. In your minute on my Report of last July you said— ‘It is clear that legislation on this subject ought to be undertaken before the extent of the evasion gets much worse’.

and I have assumed that the questions to be determined are the time when action should be taken, the extent of the remedial proposals and the method which should be adopted. There can be no doubt that action should be taken as early as possible, and I imagine that it is easier to deal with a subject of this kind in the earlier than in the later years of a Parliament. I hope it will be possible to introduce legislation in the next Finance Bill. As to the extent of the proposals, I take it that there can be no question but that foreign evasion must be included and I imagine that the proposals about estate duty may stand, subject to detailed consideration. In view of the developments since my last report I have brought forward again—settlements and trusts in favour of minor children and evasion by means of British companies.

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Contents pages of the book CONTENTS

FOREWORD BY THE RIGHT HON. LORD DECIES, P.C., D.S.O. AUTHOR’S NOTE TABLE OF CASES TABLE OF STATUTES ABBREVIATIONS PART I. INTRODUCTORY CHAPTER 1. THE BURDEN OF TAXATION 2. THE LAW OF INCOME TAX AND SURTAX 3. THE LAW OF DEATH DUTIES PART II. PRACTICAL SCHEMES OF TAX SAVING PRELIMINARY NOTE CHAPTER 4. COVENANTS FOR PAYMENT OF INCOME 5. GIFTS AND SETTLEMENTS 6. DISCRETIONARY TRUSTS 7. ESTATE COMPANIES 8. HOLDING COMPANIES 9. BONUS SHARES 10. INVESTMENT IN FOREIGN LAND 11. COMPANIES CONTROLLED ABROAD 12. FOREIGN SETTLEMENTS 13. FOREIGN RESIDENCE AND FOREIGN DOMICILE PART III. SUPPLEMENTARY CHAPTER 14. PERSONS RESIDENT AND DOMICILED ABROAD 15. ENGLISH LANDOWNERS 16. INSURANCE 17. THE ACCUMULATION OF INCOME 18. THE PROVISION OF ANNUITIES 19. THE DRAFTING OF WILLS INDEX

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8 When is a Tax not a Tax but a Tithe? ANDREW LEWIS

I. INTRODUCTION AND ABSTRACT

M

in tithe and not in tax. My purpose in this chapter is to try to distinguish between the two. Although experts in tax may not be much interested in tithe—there are too few interested in tithe to make the reverse comparison—the contrast may serve to intensify understandings as to the nature of tax. My initial analysis suggests that in the following ways tithe is like tax: Y INTERESTS ARE

i. A fixed mulct, often in cash; ii. imposed upon a broad sector of society; iii. occasioned by a regular and fixed set of events; iv. regulated by provisions of secular law; v. collected by a universal authority; vi. applied to purposes deemed indirectly beneficial to those paying. In the following ways tithe is unlike tax: i. primarily due in kind and not in cash; ii. partially regulated and collected by ecclesiastical not secular institutions; iii. due by virtue of divine law.

II. A SKETCH OF TITHE 1

1. Old Testament Origins A tithe is a tenth. The principle that all those Christians living in a parish are obliged to pay one tenth of their income from all sources to the parish 1 This survey was compiled before the appearance of R. H. Helmholz, The Canon Law and Ecclesiastical Jurisdiction from 597 to 1640 (OUP, Oxford, 2004), the first volume of the

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priest is, in England, at least as old as the twelfth century. (Tithe was certainly payable before that, the problem is the emergence of parochial organisation.) Tithing is first found in the law of the Old Testament: e.g. Leviticus 27:30: ‘And all the tithe of the land, whether of the seed of the land or of the fruit of the tree, it is the Lord’s’. No uniform practice is, however, attested in the Torah: in the book of Numbers (18: 20–28) the tithe is said to be due exclusively to the Levites, whereas the provisions of Deuteronomy suppose that the tithe of the third year is to go to the poor and needy as well as the Levites (14: 28–29; 26:12 though, confusingly, Dt 14:22 also insists upon a yearly tithe ‘of all the increase of thy seed that the field bringeth forth year by year’). Nehemiah records (10:37–38) for the post-Exilic period that all the servants of the Temple, priests, singers and even porters shared in the tithe with the Levites. Various modern explanations are offered: a difference between the northern kingdom and Judah or a deliberate substitution of the Levitical tithe for a wider previous custom. The practice is also attested in the New Testament, but somewhat ambiguously as in the words of Jesus: ‘Woe unto you, scribes and Pharisees, hypocrites! For ye pay tithe of mint and anise and cumin, and have omitted weightier matters of the law’ (Mt 23:23).

2. Early Christian Practice In truth there seems to have been no continuity between the Judaic tithe and the early Christian Church’s practice of voluntary donation. The Christian Fathers did appeal to the Jewish practice, but not so much as creating a binding obligation on Christians but as demonstrating that, since even the scribes and Pharisees managed to tithe, Christians ought to be able to do even better than a tenth! Thomas Aquinas, writing in the thirteenth century, considered that the obligation to tithe arose from natural law and not from biblical authority and that the proportion was fixed at a tenth by the authority of the Church.2 At the Reformation many of the reformed churches determined to preserve tithes. To do so they had to fall back upon the regulations of the law of Moses as they generally rejected arguments drawn from the traditions of the church. This gave a biblical quality to later English debates which was historically quite unjustified.3 Indeed it is quite wrong to regard tithing as a universal Christian custom. It is unknown in the Eastern Orthodox churches which are considered by Oxford History of the Laws of England. Ch.8 gives the best account of tithe yet to appear in print. 2

Summa theologica II.2.q.lxxxvii, a.1. Tithes were one of those features of the mediaeval church, like infant baptism, which most Reformers of the sixteenth century were anxious to retain, despite the problems associated with them, in order to stress the inclusiveness of the community of Christian believers. All were members of the community because included in it soon after birth and as members all 3

When is a Tax not a Tax but a Tithe? 237 some to have preserved the approach of the early Church.4 This difference was a source of friction between Christians in the crusader kingdoms of the eleventh and twelfth centuries when the Franks sought to impose tithes upon the local Christian congregations, and again under the regime of the Latin Empire in Constantinople after 1204.5

3. Canon Law–Local Councils and Penitentials There is no canon law of any sort on the subject of tithes, the Bible apart, before the fourth century, and although there are scattered references to an obligation to tithe in local church councils of the next couple of centuries, for example at the Council of Tours 567 and Second Council of Macon 585, there is no canon law statement of universal application on the matter at this date. There is, however, enough evidence from contemporary sermons and other Christian literature to support the notion that the giving of tithe to the clergy existed as a moral obligation upon Christians at this period.6 But it was enforced, if at all, by ecclesiastical sanctions. The penitential canons of Theodore of Tarsus, archbishop of Canterbury in the seventh century, which are the earliest evidence for the payment of tithe in England, bear this out.7 Their formulation is ambiguous at best but they reveal a regulated practice of tithing: Decimas non est legitimum dare nisi pauperibus et peregrinis sive laici suas ad ecclesiam. (Theodore of Tarsus: Penitential U ii. 14.11). were required to contribute to the church’s maintenance. Unlike the case of infant baptism there was at least good, if misleading, biblical authority for tithes. Most Protestant writers were agreed that the tithe regulations in Torah formed part of what they termed the ‘ceremonial’ law of the Jews, which they held not to be binding upon Christians (in this way much other objectionable matter was avoided, for example circumcision and the dietary laws). In order nevertheless to maintain tithe they relied rather upon pre-Mosaic evidence of tithe such as Abraham’s tithing of his spoils in favour of the priest Melchisedec (Gen.14:20 cf. Heb.7:2) and Jacob’s promise to tithe (Gen. 28:22). On the difficulties of infant baptism see D. MacCulloch, Reformation: Europe’s House Divided 1490–1700 (Allen Lane,London, 2003) 148–50. 4 There are references to tithing by the early Greek fathers, such as Chrysostom, but it is not clear what was involved or how long the practice lasted. 5 L. Santifaller, Beiträge zur Geschichte des lateinischen Patriarchats von Konstantinopel (1204–1261) (Böhlau Weimar, 1938) 65–66; R.L.Wolff, ‘Politics in the Latin Patriarchate of Constantinople, 1204–1261’ (1954) 8 Dumbarton Oaks Papers 257–271 and most recently N. Coureas, The Latin Church in Cyprus, 1195–1312 (Ashgate Aldershot, 1997), as noted in the index. I am grateful to Dr Jonathan Harris of Royal Holloway Collge, University of London for assistance in this area. 6 E.g. St Ambrose, serm. xxv.2 (Patrologia Latina xvii.677); Caesar of Arles, serm. xxxiii.1 (Corpus christianorum ciii.144). Caesar’s sermons were attributed to Augustine of Hippo in the middle ages. 7 They may be a later, eighth century, redaction of oral provisions attributed to Theodore: see R.G. Constable, Monastic Tithes from their Origins to the Twelfth Century (CUP, Cambridge, 1964) 25–26. The influences upon these Penitentials were various, including Celtic and Byzantine material: see Constable, above at 26 n.2.

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It is not lawful to give tithes except to the poor and to pilgrims or for laymen [to give] theirs [except] to the church.8

The meaning seems to be that churchmen who have received tithes might not dispense them for other than charitable purposes whilst the laity had in all cases to give their tithes to the church and not directly to other, even charitable, purposes.

4. Secular law—Carolingian Capitularies The earliest secular laws on tithe come from the Carolingians, the rulers of what is now modern France, together with much of western Germany and northern Italy, from the eighth to the tenth centuries. References to a custom and practice of tithing abound in the early Carolingian period, but the earliest general formulation of a legal obligation to pay tithe is found in a Frankish law of the late eighth century—a capitulary of Charlemagne issued at Heristal in March 779.9 Although this was not the beginning of an obligation to tithe it is as good as point as any to date the systematic attempt at enforcement by lay authority: § 7 De decimis ut uniusquisque suam decimam donet atque per iussionem pontificis [episcopi] dispensentur (Lombarda) De decimis ut uniusquisque homo sua decima donet et per iussionem et consilium episcopi in cuius parrochia fuerit dispensentur Concerning tithes that each should give his tithe and that they should be paid out in accordance with the pope’s [the bishop’s] order (Lombard form) Concerning tithes that each person should pay his tithe and that they should be paid out at the order and by the advice of the bishop in whose diocese he will be.

The meaning is somewhat compromised by the capitulary’s being transmitted in two forms, at least one of which is corrupt. The term pontifex in the Frankish version is probably original, but almost certainly means the local bishop (a usage reflected in the service books for use in rites involving bishops being called Pontificals), a meaning which the later alteration strove to maintain by substituting the unequivocal episcopus at a time when pontifex was more normally reserved for the pope, the pontifex maximus. More uncertain is the value to be ascribed to the instruction that tithe is to be paid 8

For the translation see Constable, Monastic Tithe, 25 n. 1. There is support for the view that tithe was thus in origin a matter of secular rather than canon law: Schmid, Jb. d. öst. byz.Ges.VI.93ff., though this depends upon a controversial thesis that tithes are a continuation of the late Roman agricultural canon. 9

When is a Tax not a Tax but a Tithe? 239 at the order (and possibly also advice) of the local bishop. If this permits a layman to pay tithe directly to charitable purposes endorsed by the bishop this conflicts with the penitential discipline of Theodore and with later practice. It may be that at this stage the secular authority was content merely to endorse the principle of tithing, leaving its regulation to the ecclesiastical authorities. The important aspect of the capitulary’s regulation of tithe is the commitment of the secular authority to the enforcement of a matter in origin of exclusively ecclesiastical concern.

5. Anglo-Saxon Laws Carolingian legal influence was widespread and affected Anglo-Saxon England. Soon after the issuing of the capitulary of Heristal two papal agents, accompanied by an envoy from Charlemagne, visited England. During their visit they presided over two church councils which pronounced ‘that all men should strive to give tithes from everything they possess, . . ., and they should support themselves and give alms from the nine parts’.10 This belongs in the hortatory mode of earlier ecclesiastical conciliar provisions but the timing strongly suggests an echo of the Carolingian law. The emphasis upon other charitable giving ‘from the nine parts’ serves to endorse the earlier practice of giving the tithe directly to the church. Although a practice of tithing had existed in England since at least the seventh century (as evidenced by the Penitential of Theodore) the earliest surviving Anglo-Saxon rules providing secular penalties for non-compliance are found in legislation of king Edgar in 959–963.11 Significantly they refer to earlier laws, otherwise not evidenced but probably to be attributed to Alfred the Great. The Tithe of all young animals shall be rendered by Pentecost (Whitsun) and that of the fruits of the earth by the Equinox, and every church due by Martinmas, under pain of the full penalty which the written law prescribes. 1. If, however, anyone refuses to render tithes in accordance with what we have decreed, the king’s reeve and the bishop’s reeve and the priest of the church shall go to him and without his consent shall take the tenth part for the church to which it is due and the next tenth shall be allotted to him, and the eight parts shall be divided in two, and the lord of the manor shall take half and the bishop half whether the man be under the lordship of the king or of a thegn.12

The announced penalties were draconian, a forfeiture of three quarters of the income: this circumstance has here, as elsewhere, led to suggestions that 10 A. Haddan and W. Stubbs (eds), Councils and Ecclesiastical Documents Relating to Great Britain and Ireland (OUP, Oxford, 1869–1878). iii, 456–457. 11 II Edgar c.3. The date of this legislation is uncertain. 12 Cited from A.J.Robertson (ed.,) The Laws of the Kings of England from Edmund to Henry I (CUP Cambridge, 1925) 21–22.

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enforcement of this legislation was sporadic at best and that the legislation was symbolic. Certainly there is no evidence of enforcement, but actual examples of Anglo Saxon law in practice are sufficiently rare for this not to form a useful basis for judgement.13 The essential point is that from the eighth century in the Carolingian empire and at least the tenth century in England the enforced extraction of tithes was formally a matter of secular as well as ecclesiastical law. In the period from the ninth to the eleventh century many tithes fell into lay hands. Economically it is unsurprising that so valuable a resource should be coveted. The process was accompanied by the subordination of clergy to local landowners, a process by which they surrendered their tithes (including the problems of collection) in return for a stipend and support. Alternatively when new churches were erected (as they increasingly were in Europe at this time) on the lands of local landowners and with their financial support priests were appointed on a stipendiary basis with the tithes being collected by landowners. Both developments can be seen as a sort of feudalisation of the Church. The lack of principled regulation of tithes during this period led to the practice famously identified by John Selden as ‘arbitrary consecrations’ of tithe,14 that is the arbitrary granting of tithes to any church and not necessarily one’s established local church (the term ‘parish church’ is tendentious at this period). Such detraction of tithe from an existing church in favour of a newly created church or chapel was, of course, an incentive to the creation of new churches by landowners on their own property. During the eleventh century restoration of the Church’s control of its own affairs, the Church and State struggle traditionally known as the Investiture Controversy, whose offshoot in England culminated in the murder of Thomas Becket, a major gain for the Church was the restoration to the Church of its right to collect tithes directly. A campaign was successfully waged against the continued holding of tithes in lay hands, a campaign in which the identification of tithe as property ‘belonging to the Lord’, utilising biblical authority, and therefore only duly to be collected by his ministers, played a part. Lay jurisdiction over the collection of tithes, apparently established during a period when there was a lay interest in their efficient collection, was, however, a permanent consequence which was not thereafter challenged.

6. Uses of Tithe The use to which tithe was put, once raised, was another matter. This was undoubtedly a matter for ecclesiastical enforcement only. Although there were divergences in formulation, the broad principle was that the tithe 13 For a comprehensive list of Anglo-Saxon lawsuits see P. Wormald, ‘A Handlist of AngloSaxon Lawsuits’ (1988) xvii Anglo-Saxon England, 247–81. 14 J. Selden, A History of Tithes ([London], 1618), 72ff, 468–470.

When is a Tax not a Tax but a Tithe? 241 existed to support three needs: the support of the clergy, the maintenance of the church fabric and the support of the poor.15 There is little evidence of the extent to which this distribution was policed. From at least the twelfth century in England a practice was established whereby tithe was payable to the rector or parson of the parish rather than to the bishop: in many instances the role of rector was fulfilled by an absentee or a monastery who took the greater part, if not all, of the tithe and arranged for a substitute or vicar to provide services within the parish. In most cases the tithe so received appears to have been applied to the general uses of the recipient individual or institution. These will have included both maintenance of church fabric and relief of poverty but it would seem only incidentally and not systematically.16 In this way a system that had begun in the early church as private charity for the support of that church and those dependent upon it became institutionalised as a forced subsidy for the support of those who could represent themselves as responsible for the provision of ecclesiastical services. 7. The Nature of Tithe: Personal tithe Tithe was payable in kind. Those, like soldiers and lawyers, both expressly mentioned in mediaeval discussions, who earned cash incomes were supposed to pay in cash, but those whose income arose out of the largely noncash agricultural economy paid in grain, sheep, wool, eggs and milk and so on. The obligation to pay personal tithes, which might be difficult to assess and easy to evade, led to the practice of making restitution on death for forgotten tithes by payment of a legacy to the church. Evidenced in wills into the early sixteenth century this ‘second legacy’17 or ‘mortuary’ was the subject of ecclesiastical regulation in the medieval period and is mentioned in some vicarage ordinations. 8. Praedial Tithe Those who grew corn or raised animals were obliged to hand over one tenth of the resulting crop or offspring. There was no allowance for seed 15 There was an alternative four-fold division between bishop, parish priest, fabric and the poor which was embedded in the canon law, e.g. C.25 q.1. This led to the practice in Italy of the parish priest receiving only the fourth part, the quartese, of tithes gathered within his parish despite later papal rulings: see X. 3.30.29 and C. Boyd, Tithes and Parishes in Medieval Italy (Cornell UP, Ithaca, NY 1952) 140–146. 16 There is considerable evidence that resident parish clergy took their responsibilities of charity seriously, but this merely accentuated the problem of the non-resident rector who received the greater part of the income without bearing any of its burdens: see, generally, F. Heal, Hospitality in Early Modern England (OUP Oxford, 1990). 17 Where this terminology was used the implication was that there was a ‘first legacy’ or heriot due to a lay lord. See generally R.A.R. Hartridge, Vicarages (CUP, Cambridge, 1930), Appendix C, available at http://library.dur.ac.uk/search/t?SEARCH=A%2BHistory%2Bof% 2BVicarages%2Bin%2Bthe%2BMiddle%2BAges&SUBMIT=Search

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corn and the like which the farmer was expected to find out of his ninetenths share. Praedial tithe was divided for practical purposes into the greater tithe of corn (wheat) and other grain crops and the lesser tithe of all other produce, typically crops like peas and beans raised in private gardens, together with all animal produce. The distinction was primarily an economic one, the wheat harvest being by far the most productive, and in some areas where their value dominated agricultural production lamb and wool were accounted a Great tithe. Various mixed categories came to be recognised, for example fish tithes in some coastal areas and more generally the produce of the operation of mills to grind corn. Fish tithe was levied on individual fishermen’s catches (or shares thereof) where the fish was landed. The mill owner had to pay over a tenth, not of course of the whole amount ground as this had already been tithed in the hands of the grower, but a tenth of the amount of milled grain the miller collected as payment in kind for his milling. The assessment depended upon his declaration and it was recognised that in making this he might deduct a proportion to account for the costs of running the mill, in short, his business expenses. The distinction between personal and praedial tithes here—that in the former but not in the latter allowance was available for expenses—is reminiscent of the difference between earnings in selfemployment and by employees under the modern UK tax regime. Praedial tithes constituted the bulk of tithes both proportionately and economically, and in time tithe became synonymous with agricultural produce and chiefly the Great tithe of grain. From the twelfth century it became common for rectors to appoint substitutes to perform their parish duties. This was possible both because there was a very large pool of unattached clerics willing to take on paid work and because the tithe income of most parishes was sufficient to support at least two persons. Such arrangements had to be approved by the bishop, who would take care to allocate a portion of the tithe income to the substitute or vicar (vicarius is Latin for substitute).18 Such institutions of vicarages form a significant part of the business recorded in thirteenth century bishops’ registers. Once constituted a vicarage was permanent, though there are some examples from the thirteenth century of bishops approving the re-integration of the two benefices, re-establishing a resident rector. Typically the vicar would be allocated the lesser tithes produced by the animals and gardens of his parishioners, whilst the rector would be left with the greater tithes of the grain harvest, though there were sufficient departures in practice from this to make it a mere rule of thumb. Where later there was a vicarage but no record of its creation this would become the 18 There were a number of Church council provisions regulating this culminating in IV Lateran c.32. The practice was stimulated to a degree by the increased policing of the obligations laid on parish clergy to reside in their parishes and confess their people: X. 3.4.3 = IV Lateran c.21.

When is a Tax not a Tax but a Tithe? 243 general rule. This distinction has, until recent Church of England re-orderings, left its mark on the landscape, for where a rector remained in post providing the services and taking all the tithes there would be a rectory ,but where some long-past predecessor had set up a vicar and divided the tithe income with him there would be a vicarage.19

9. Tithe in Monastic and Secular Hands Monasteries were attracted by the possibility of taking over local churches and acquiring their tithe income. It is reckoned by one modern authority that by 1150 one quarter of parish churches in England were in monastic hands.20 In part this was but an aspect of the laicisation of tithe which occurred between the ninth and eleventh centuries, though one which appeared to be more respectable, as the recipients could be represented as part of the ecclesiastical establishment and providers of both ecclesiastical and charitable services. Bishops preferred monasteries to set up vicarages and employ secular clergy rather than serve the parishes themselves, and for this there was authority in canon law.21 Originally monasteries, not being in the business of providing parochial services, had been payers of tithe rather than tithe-owners. But the process of taking over rectories was accompanied by the grant of papal exemptions from paying tithe on their own estates so that, by the end of twelfth century, most monasteries gathered but did not pay tithe.22 In the sixteenth century these monastic holdings were seized by the Crown and distributed in grants to lay men with the consequence that tithe-owners of the greater tithes were frequently thereafter lay.23

10. Enforcement of Tithe in Ecclesiastical Courts Although the church authorities were apparently enforcing the payment of tithes in the internal forum (that is via the penitential system) from at least the seventh century, the systematic enforcement of ecclesiastical law by church courts does not begin until the eleventh century coincident with the process of recovery of tithes from lay hands. Only from the twelfth century 19

See, on all this, Hartridge, above n.16, passive. See G.W.O. Addleshaw, Rectors, Vicars and Patrons (Borthwick Institute, York, 1956). 21 Gratian had in Decretum C.16 rather supported the monks’ right both to serve parishes and to receive their tithes. The eventual acceptance of the alternative view championed at the Lateran Councils of the twelfth century was prepared by a series of local council rulings preventing monks serving cures. 22 This development is the main focus of Constable, above n. 7. 23 Elsewhere, for example in France and Scotland, the practice of granting abbeys to laymen in commendam resulted in a similar transfer of rectorial income into lay hands. 20

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do we have regular records of their activity. Our limited knowledge of AngloSaxon law in practice does not enable us to judge the extent to which secular courts exercised jurisdiction over tithes before the Conquest. To a degree this dichotomy is a false one, as it was Anglo-Saxon practice for the bishop to sit in the local Shire court and for both secular and ecclesiastical business to be transacted there, the separation of a distinct ecclesiastical court on the continental model being one of the first notable acts of William I after the Conquest. After 1066 there is ample evidence of tithe jurisdiction being exercised by both church courts and secular courts in England.24 The Constitutions of Clarendon of 1164 settling questions of disputed jurisdiction between church and state do not mention tithes. Thereafter down to the Reformation the records of church courts regularly record tithe litigation and tithe cases were frequently the subject of trial before Papal Judges Delegate. 11. Enforcement of Tithe in Secular Courts The major exception to the priority of the ecclesiastical courts in tithe suits arose in cases where the claim to take tithe amounted to a claim to patronage—what English law came to call the advowson of the living. This proceeds on the assumption that the patronage of the ecclesiastical living is a right which is valuable largely in proportion to the amount of the tithe claimable. The patron of a valuable living may not sell the right to be instituted to the benefice—that is the ecclesiastical offence of simony conviction for which results in the right of presentation passing to the bishop—but he may sell the advowson itself to someone anxious to appoint another. Since the value of the benefice depends in large part on the tithes accruing a dispute about the right to tithe affects the value of the patronage. By the Constitutions of Clarendon disputes over patronage were a matter of lay, not ecclesiastical, jurisdiction; a possessory assize, Utrum, being available to determine the nature of doubtful cases. In the thirteenth century complaints from clergy that they were being prevented from seeking payment of tithe in ecclesiastical courts by defences constructed out of the need to protect patronage led to statutory intervention. The upshot of a complex of events (not free from modern dispute) was a rule that a claim for more than one-quarter of the whole tithe of the parish had to be brought in the king’s courts utilising the writ of right for advowson of tithes.25 Litigation in this connexion is frequent in the Year book period. 24 E.g. M. M. Bigelow, Placita Anglo-Normannica (Boston, Mass., Little Brown & Co., 1879, repr. 1970), 155 (Bp of Llandaff 1148), 197–198 (Shire ct 1158); R.C. van Caenegem, Law Suits between the Conquest and Magna Carta, Selden Society vols. 106–107 (Selden Society, London, 1990–1991), 197 (Royal ct 1114), 325 (Bp in feudal ct 1150), 394 (Abp of Canterbury ca 1160), 442 (Royal ct 1166), etc. 25 The details involve the supposed statutes Circumspecte agatis and Articuli cleri as well as the Statute of Westminster II c.5. See the useful discussion in N.Adams, ‘Judicial Conflict over Tithes’ (1937) lii English Historical Review, 1.

When is a Tax not a Tax but a Tithe? 245 Until the Reformation jurisdiction over tithes was shared between ecclesiastical and secular jurisdictions with a distinction essentially based upon the proportionate value of the claim. (This reflected in any case the general picture since many supposedly secular matters such as small debts were commonly recovered in church courts, for they had an advantage in local proximity, regularity and relative cheapness over the common law courts.) There were other distinctions. If the tithe had been severed—i.e. if the crop had been harvested, then jurisdiction lay exclusively with the lay court, the severed goods having become the lay property of the tithe-owner.26 Similarly claims to pensions payable by those entitled to tithes—a device frequently adopted in order to provide a means for a parson retiring through ill-health—were litigable by writ of annuity in the secular court.27 On the other hand if the tithe-payer, sued in the secular court, claimed that he was entitled to pay in cash, or set up some other transaction in lieu of payment of tithe in kind, then, before the middle of the sixteenth century, the lay courts would refuse jurisdiction. The legitimacy or otherwise of such a claim to a modus decimandi or means of tithing was held a matter for church law.28 12. Jurisdiction after the Reformation Matters changed at the Reformation, though not to the extent that might now be expected. An attempt to codify and reform the rules of church law applicable in England failed to come to fruition, and the Elizabethan settlement left the church courts to apply such of the pre-Reformation canon law of the western church, including tithes, as best they could.29 The formal prohibition on the teaching of canon law in the universities accompanied by the conversion of their chairs of canon law into Regius chairs of Civil (Roman) Law does not seem to have had a marked effect upon the production of church court lawyers or their knowledge or effectiveness. The critical change was the passing of a statute, 2 & 3 Ed. 6 c.13, already alluded to, which was designed to reinforce the payment of tithes. This secular encouragement was all the more necessary as certain anti-clerical sentiments amongst supporters of the Reformation had fuelled the non-payment of church dues; this was notoriously exemplified in the Hunne case.30 The statute added to the existing methods of enforcement a 26

YBB 38 Edw III 19; Pasch 42 Edw III pl.12; Mich. 43 Edw III 34; Mich 13 Ric II (Ames) 32. YB Mich 5 Edw III 63, 33–35 Edw I (RS) 478; 7 Edw II (SS) 20. 28 YB 19 Edw III (R.S.) 100. 29 See now G. Bray(ed.), Tudor Church Reform: the Henrician Canons of 1535 and the Reformatio Legum Ecclesiasticarum (Church of England Record Society 9, Boydell Press, Woodbridge, 2000). 30 A case of a mortuary: see S.F.C. Milsom, ‘Richard Hunne’s Praemunire’ (1961) lxxvi English Historical Review, 80–82 reprinted in S.F.C Milsom, Studies in the History of the Common Law (Hambledon Press, London, 1985). 27

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penal and popular action at common law for three-fold damages in cases of non-payment. For technical reasons reliance upon this action was uncommon, but it served to underline the lay jurisdiction over tithe which thereafter increased, notably by the courts taking cognisance of the increasing number of cases in which a modus was pleaded. Spurred by the changing economy, which first encouraged tithe-owners to seek payment in cash, and by the effects of inflation, which in a while encouraged those same titheowners to try to undo the bargains they had formerly struck, litigation on moduses was to form a significant proportion of common law tithe suits. At the same time in the middle of the sixteenth century, and for reasons that are not yet fully understood, tithe-owners began to litigate their cases in the equity courts. One motive for this appears to have been the equity courts’ superior capacity to deal with matters involving detailed accounts. Certainly many suits take the form of a call for an account of tithes paid and unpaid, and doubtless there were many tricky matters of fact which could be most readily resolved before a master. But it was in the area of tithe litigation that there developed that most characteristic of equitable inventions, the feigned action at law, in which the parties were required by direction of the court of equity to litigate a fictitious suit at law which could result in a verdict of a common law jury in favour of one or other of the parties. That this was found a suitable method of determining at least part of the question between the parties suggests that requiring them to litigate at law from the beginning was not an impossible option and raises the question of wherein the equity lay. The greater part of this new equitable matter was litigated not in the familiar setting of the court of Chancery but in that long-forgotten cul-desac, the Court of Equity in the Exchequer. In the late sixteenth century the Exchequer court was still primarily a mechanism for litigating the fiscal claims of government, and had not yet developed the generous interpretation of its jurisdictional boundaries which was to allow Gilbert to set the hearing of a suit for breach of promise of marriage in that court in his and Sullivan’s Trial by Jury. Until its demise in the institutional reforms of the early nineteenth century the Equity branch of the Exchequer remained in large part devoted to issues arising out of revenue and fiscal concerns, such as claims arising out of excise; tithe litigation formed a significant part of its business. The connexion between the revenue and tithe was the fact that most lay owners’ entitlement to tithe arose out of the Crown’s granting away of rights and lands seized during the dissolution of the monasteries. The monasteries’ claims to tithe, usually as institutional rectors, passed to the Crown by statute and then into lay hands by grant. Subsequent claims to these tithes were regarded as within the scope of the Exchequer’s fiscal business.31 The earliest reported case of an equity bill for tithes in 31 So in Tildesley v Fleetwood (1588 Exch.) it appeared that the lessee of land from an abbey prior to the dissolution continued to pay tithe to the Crown afterwards. H. Horwitz,

When is a Tax not a Tax but a Tithe? 247 Exchequer is from 1584,32 and the context suggests strongly that a royal interest was relied on and no general jurisdiction over tithe was claimed; indeed rather the contrary. It was denied in The Dean of Windsor v Beverley (1588 Exch.) that being required to pay tithe to the Crown made one an accountant in Exchequer for the purposes of claiming privilege of suing there for ‘thus all controversies of tithe and of all the parsonages in England can be drawn into Exchequer. And this will be a great prejudice and mischief to spiritual courts.’ Similarly in 1591 the Exchequer dismissed a bill from a parson whose only claim to jurisdiction was that the presentation to his living, and hence his own position, was in the Crown’s gift.33 There seems to have been a change of attitude in the following century. It was said in Anon (1607) Lane 39 that ‘if a coppiholder of the king’s manor pretendeth prescription for a modus decimandi against the parson, the right of tithes shall be tried in the Exchequer’; in J.S. v A (1612) Lane 100 a suit of tithes between the impropriate rector and the vicar of a living of which the King was patron was allowed to be brought in Exchequer by English bill or by action in the office of pleas, ‘for it is apparent that the king is supreme ordinary’. It is noteworthy that many of the shifts of Henry VIII’s government to increase its revenue through confiscation and abolition of existing institutions led to comparable extensions of administrative jurisdiction: most famously the Statute of Uses led to the establishment of the Court of Ward and Liveries to manage the affairs of minors brought within the scope of royal wardship. Similarly the confiscation to the Crown of the ecclesiastical revenues of first fruits and tenths led to the Court of that name, whose tasks in administering this revenue raised from incumbents of church benefices were eventually absorbed by the Exchequer. Although the Crown’s direct association with the former monasteries was of short duration it seems to have been sufficient to lead to acceptance that thereafter private rights acquired thereby attracted the support of the Crown’s fiscal institutions. Chancery seems to be have been slower to acquire a jurisdiction in tithe matters. Those sixteenth century Chancery tithe cases which are reported mainly concern prohibitions to ecclesiastical courts, and in at least one case the court is uncertain whether tithes are not exclusively a spiritual matter for the spiritual court: Pleadall v Goddard (1581–2) Ch Cas 157. However, Exchequer Equity Records and Proceedings 1649–1841 (Public Record Office, London, 2001) argues, at 39, that the Exchequer jurisdiction in tithes depended upon the statutes creating the Courts of Augmentations and First Fruits, later amalgamated into the Exchequer and was not essentially equitable in nature. In a review of Horwitz, Macnair points to other evidence suggesting that, in contrast to the Chancery jurisdiction in tithe, it was not usual to demur to an Exchequer tithe bill for want of equity: (2001)22 Journal of Legal History (3) 77. 32 Bycliffe v Hennage (1584) 117 Selden Society 116 (a case of a crown lease and monastic exemption). 33 Anon (1591) 117 Selden Society 137.

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matters of tithe were held to be determinable in Chancery in the 1590s: Moone c. Bond (1591–2) Tot 184. One important substantive change wrought by the changes introduced in the wake of the Reformation was that the secular courts, basing themselves upon the general jurisdiction to entertain claims to tithe granted in the Act of 1549, were no longer hesitant to determine matters of tithe doctrine, such as claims of a modus or the commutation of tithe in kind into a money payment. The commutation of tithe payments in kind into money payments began before the sixteenth century, and in the church courts defendants were able to set up such agreements to pay in cash in defence to suits for payment in kind. Cases were, however, rare.34 After the Reformation such defences are much more common and are determinable in the secular courts. Over time the effects of inflation and advances in agricultural practice caused such payments to fall well below the value of the tithes which they notionally represented. In such circumstances the tithe-owner would try to have the agreement set aside—even if only to re-negotiate a fresh commutation to avoid the inconveniences of receipt in kind, with its concomitant need for storage, immediate consumption or marketing of the produce collected. A substantial amount of learning was generated of which the following late example may serve here as an instance. In Heaton v Cooke (1811) Wightwick 281, heard in the Exchequer in 1810, the plaintiff was the lessee of the impropriate rector of Doncaster— that is a lay rector. (Confusingly he was the Archbishop of York but effectively holding the tithes as a layman.) The Archbishop had leased out the tithe of hay. The tithe-payers did not dispute their obligation to pay tithe, nor were they unwilling to pay the Archbishop’s lessee. Rather they claimed that in lieu of one-tenth of the mown hay they owed a sum of money—actually various sums depending upon the location of the fields in question, 1/- per acre in Hexthorpe, 1/6d per acre in Doncaster itself and 2/- for Crimpsal meadow. The courts took a critical view of such claims as tending to diminish, through inflation, the Church’s rights. Compositions were of three possible sorts. They might have existed since time immemorial, that is since 1189, or they could be proved to have come into existence by agreement between 1189 and an Elizabethan statute of 1571, or they could be shown to have been agreed since that statute. In the last case the composition could be set aside by the tithe-owner at any time on giving notice. In the case of those earlier compositions, called compositions real, of which evidence could be shown that they arose between 1189 and 1571, a high standard of proof was required, usually in the form of a written deed. For a true modus, presumed to have been in existence since 1189, it was sufficient to show a regular practice of payment in cash not countered 34

Cf. Adams, above n.24.

When is a Tax not a Tax but a Tithe? 249 by any contrary evidence of past payment in kind. A major hurdle for defendant tithe-payers in such cases was to overcome the courts’ reluctance to accept that sums of the sort now reasonable could have possibly been in existence in 1189. In some later cases reliance would be placed upon evidence culled from economic historians, but in Heaton the court felt its way by rule of thumb. It was accepted that in 1189 1/- was a possible valuation of an acre of hay but that 1/6 and 2/- was simply too high a figure, too rank, for credence. The court therefore directed that an issue was to be framed to send to a common law jury the question whether or not there was a practice of paying 1/- for Hexthorpe since time immemorial, but it refused to allow a similar question to be put in respect of the other fields, in effect deciding that tithe from these must be paid in kind. The presumption was that such rank moduses were the result of more recent agreements and, in default of evidence sufficient to secure them as compositions real (proved to have been agreed between 1189 and 1571), they were to be regarded as made subsequent to the statute of Elizabeth and liable to be set aside at will. This rule placed tithe-payers in a dilemma. If they claimed a commutation at a reasonable rate judged sufficient to satisfy the present demands of the tithe-owner then they risked litigation designed to have the figure set aside as historically too rank; if, on the other hand, they fixed the level at a credibly low level they merely drove the tithe-owner to litigation in order to get such an uneconomic figure set aside at all costs.

13. Commutation and Abolition Side by side with these private arrangements were statutory schemes of commutation which formed part of the practice of enclosures. There was no necessary connexion between enclosure and tithe payment, except inasmuch as the redistribution of land involved altered incidence of the latter, and the wholesale reallocation of land which accompanied the enclosure of a parish and necessitating a thorough professional survey of the ground was a convenient occasion for distributing the parish tithe proportionately amongst its owners. Eventually all the tithes in England came to be commuted into rent charges under the terms of the Tithe Commutation Act 1836, a procedure which lasted well into the 1840s. Although some disputes continued to come before the courts the majority of difficulties were thereafter resolved before tithe commissioners. The rent charges determined in accordance with the 1836 Act fluctuated in accordance with official tables recording the price of grain. The effects of inflation and the war economy of 1914–1919 necessitated such adjustments that it became necessary to consider total abolition of the principle that an agricultural impost should continue to sustain the income of the Church of England. In 1936 therefore tithes were eventually abolished, the Church’s interest

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being effectively bought out by the government which reimbursed itself by an issue of stock and a charge on those landowners who were thereby relieved of their burden. The surcharge was designed to disappear by the end of the twentieth century and in the meantime was collected through the Inland Revenue.35

14. Conclusion So certainly since the Conquest tithes were subject to enforcement in both ecclesiastical and secular jurisdiction. After the Reformation the secular courts with jurisdiction over tithes included both the Common Law courts and both the courts of Equity. The ecclesiastical courts, whose jurisdiction was not significantly reduced until 1857, continued to enforce payment of tithe at local level until the 1830s. In this period the main role of the church courts was to police the payment of uncontested tithes. At least by the eighteenth century it was common for tithe-payers, on the institution of a new parson, to refuse to pay their tithes, putting him to the trouble of bringing suit in the local Archdeacon’s court—but then to capitulate without seriously maintaining a defence. Genuine litigation over the payment of the valuable greater tithes would come before the courts at Westminster, as did disputes over commutation in the form of moduses. Such variety of jurisdiction over tithes was not peculiar to post-Reformation England.36

III. COMPARISON OF TITHE AND TAX

As a preliminary to a comparison between Tithe and Tax it is necessary to distinguish the various types of imposition referred to as ‘tenths’. A tithe is, of course, a tenth, and the Biblical notion is certainly of this proportion. In practice, and also in mediaeval juridical theory, the actual proportion of income due from a tithe-payer was a matter of customary determination. In this sense every tithe was payable as a modus, sometimes the modus was ten per cent, sometimes not. The levying of an occasional tenth was a staple of mediaeval taxation practice, both secular and ecclesiastical. The important record of church property known as Pope Nicholas’s Taxation, compiled in 1292, arose from a grant by Pope Nicholas IV to Edward I of the fruits of a tenth to be 35

Originally intended to last until 1996 the charge was discontinued in 1976. Constable notes that for Europe generally in the eleventh and twelfth centuries ‘cases concerning monastic tithes were brought before every possible type of tribunal: popes, legates, bishops, and archdeacons; emperors, kings, feudal lords and their officials; councils, synods, committees of arbitrators, clerical and lay, and local groups of doomsmen . . .’: n. 7 above, 121–122. The same could be said of all kinds of tithe dispute and over a much longer period. 36

When is a Tax not a Tax but a Tithe? 251 imposed upon ecclesiastical property. Such levies, whether of church or secular origin, have nothing to do with tithes.37 The occupants of ecclesiastical benefices were required to pay the whole of the first year’s income and one tenth of every subsequent year’s income to Rome. After the Reformation this income was diverted to the royal exchequer as First Fruits and Tenths for which a special apparatus was at first established. Although there may have been some original connexion between the biblical principle of tithe and this levy on the clergy for the benefit of the Pope it does not easily fit the basic pattern of tithing and is best regarded as a separate head of ecclesiastical revenue. Turning to tithe proper there are a number of concluding comments to make upon the analysis with which this chapter began: i. Tithe is a mulct fixed by custom and at times payable in cash. There are two distinctions from tax. Tax, although possibly due in principle by custom, is fixed by specific legislative provision. A closer parallel to tithe is feudal dues like relief and levies for marrying an eldest daughter or knighting an eldest son. These are due if at all by custom. The second distinction is that tithe, although occasionally payable in cash, is primarily due in kind whereas tax seems always to be principally, if not exclusively, due in cash. ii. Tithe, like tax, is imposed upon a broad sector of society and is, in effect, due in principle from all. iii. Tithe, like tax, is occasioned by a regular and fixed set of events, determined and determinable in advance, which both fix and justify the imposition. The main distinction, as above, is that tithe is established by custom and tax by legislation. iv. Tithe is, like tax, regulated by provisions of secular law. In practice, however, although it is correct to say that tithe is due by secular law, the details are a matter for ecclesiastical jurisdiction, at least in England before the Reformation. Where secular courts (in England) determine liability to tithe they do so explicitly by reference to ecclesiastical law. Even after the Reformation when secular jurisdiction becomes more extensive both in volume and nature references to ecclesiastical legal principles are pervasive. v. Tithe is due to a local collector, in principle the parson of the parish. But he is due this by virtue of his official position, his corporation sole, which is both constructed and maintained by universal authority. There is however a difference with those taxes which are due to a central authority, whether pope or king. The development of local taxes, beginning with the poor rate, changes this contrast but raises other issues relating to the differences between rates and taxes. 37 There is a possible connexion in the forms of late Roman imperial taxation but the argument is, in both cases, complex and disputed. See n. 7 above.

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vi. Both tithe and tax may be said to be applied to purposes deemed indirectly beneficial to those paying. Certainly in mediaeval terms the support of the parish clergy, providers of spiritual and sacramental services, the maintenance of the fabric of the church where all in principle worship and the relief of poverty to which all are endemically liable and which might otherwise fall directly upon the charitable concern of all, can each be seen as directly beneficial to the tithepayer. It is significant that opposition to tithe arises with the growth of non-conformist churches and the establishment of alternative, albeit parochially based, provision for the poor. Lastly one may note that, however unimportant in practice, there was always an underlying proposition that tithes were due by virtue of divine law. Whether, with the reformers, one understands this in terms of the contemporary application of biblical texts or, with St Thomas, as an expression of the Divine Will revealed in the traditions of the Church, the consequence into modern times is that tithe is seen as obligatory in a sense that transcends the particular customary provisions being applied. In conclusion, despite many superficial resemblances to lay taxation, tithe best regarded as an imposition sui generis and not a tax.38

38 Helmholz, n.1 above, 435, differs: ‘No tax is ever popular, but the tithe must be accounted a relatively successful one’.

9 The Concept of Taxation and the Age of Enlightenment JANE FRECKNALL HUGHES *

ABSTRACT The aim of this chapter is to examine how the concept of taxation, as we understand it today, developed from the mass of new ideas that came out of the era known as ‘The Enlightenment’ (c. 1688–1800). Such ideas influenced thinking about taxation in England into the nineteenth century particularly, and many remain with us today. The Enlightenment was an age that saw the American Revolution (1775–1783) and the French Revolution (1789), in both of which taxation played a significant part, and which events deeply affected the thinking of English writers of all kinds, whether political, legal, economic or philosophical. During these years the relationship between citizen and government was the particular focus of discussion by writers such as John Locke, David Hume, Adam Smith, Edmund Burke, Thomas Paine and Jeremy Bentham. There was also considerable cross-fertilisation of ideas between them and their European and American counterparts. This chapter is a preliminary examination of the ideas of some of the English, Scottish and Irish writers of the Enlightenment period to reveal contemporary thinking about taxation, and to assess its relevance today, as taxation remains a topic firmly rooted at the heart of that citizen–government relationship.

I. INTRODUCTION

C

ONSIDERATION OF THE Age of Enlightenment is typically accompanied by a number of questions as to what exactly it was, what brought it about and when it began and ended. Indeed, not all scholars accept

* I should like to thank Dr. Lynne Oats (Warwick Business School) for her considerable help on eighteenth century taxation issues; Dr. Quentin Outram, Leeds University Business School, for his assistance with eighteenth century economists; and Dudley Hughes, for putting together Appendix 1.

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it as a recognised phenomenon, seeing the history of changing ideas usually encompassed within it as part of an on-going process. If one does accept the phenomenon, what it was may, perhaps, be summed up as ‘demystification’ in a wide range of subject areas, as theorists began to think and write down their various ideas. What brought it about seems to have been a new freedom to think, untrammelled by the restrictive religious dogmata of previous centuries.1 Men were aware that it was happening. For example, Porter2 cites a letter from Anthony Ashley Cooper, third Earl of Shaftesbury, written to a comrade in the Netherlands in 1706: ‘There is a mighty Light which spreads its self over the world, especially in those two free Nations of England and Holland; on whom the Affairs of Europe now turn; and if Heaven sends us soon a peace suitable to the great Successes we have had, it is impossible but Letters and Knowledge must advance in greater proportion than ever . . . I am far from thinking that the cause of Theism will lose anything by fair dispute. I can never . . . wish better for it than when I wish the Establishment of an intire Philosophicall Liberty.’

The question of dates for beginning and end then arises. The Enlightenment is often taken as synchronous with the ‘long’ eighteenth century, from c.1688 to 1800. However, depending on which particular aspects of Enlightenment thinking one is considering, these dates may vary. This chapter will examine thinking and ideas about taxation, and will consider the period from 1688 to 1799, with works published between these dates forming the focus of discussion. The introduction of income tax in 1799 ushered in a new phenomenon on its own, and so forms a natural terminus of sorts, whereas 1688 is less obvious as a starting point. It ushered in the ‘Glorious Revolution’ with the monarchies of William III and Mary II, so has some constitutional force. However, in terms of ideas about taxation, it does mean that Hobbes and Petty will be excluded, though their influence is clear, certainly upon John Locke, the first thinker considered in the chapter. However, one must start somewhere.

II. HISTORICAL BACKGROUND

The period between 1688 and 1799 was one of immense political upheaval. It encompassed the reigns of William II and Mary II, Anne, George I, George II and George III, and witnessed varying degrees of war and revolution, from the ‘Glorious Revolution’ of 1688, deposing James II once and 1 J. I. Israel, Radical Enlightenment. Philosophy and the Making of Modernity 1650-1750. (OUP, Oxford, 2002) 24. 2 R. Porter, Enlightenment: Britain and the Creation of the Modern World. (Penguin, London, 2000). The cited letter is Letter to Jean Le Clerc (1706), quoted in B. Rand, The Life, Unpublished Letters and Philosophical Regimen of Authors, Earl of Shaftesbury (1900).

The Concept of Taxation and the Age of Enlightenment 255 for all, to wars with France in Europe and North America (Seven Years’ War), and with the former American colonists in the War of Independence. There were Jacobite rebellions, risings in Ireland, and a revolution in France. There was an industrial revolution. During these years, funding for military campaigns and other purposes (for example, paying interest on the National Debt, paying armed forces, day-to-day government administration, etc.) was raised by various taxes, chiefly by land tax and taxes on articles of general consumption (excise duties)3. Land tax was introduced in 1692, and from 1698 ‘was a fixed tax with a quota of assessment applied to each county’4. The county was then responsible for dividing it up between parishes and townships. Other direct taxes were on inhabited houses (1696) and windows (1696, lasting until 1798), on trades via hackney carriages (1694) and hawkers (1697), on births, deaths and marriages (1695), and on bachelors (1695).5 There were variously later taxes on male servants, hair powder, soap and candles.6 In terms of excise duties, there was a tax on salt (from 1694), on seaborne coal (from 1695), also on spices, beer, wine, spirits, tea, coffee, cocoa and tobacco from the same year, and on malt and leather (from 1697). A general excise, however, was seen as ‘politically unacceptable’.7 In 1723, following Walpole’s reform of customs duties, an excise duty on domestic consumption replaced most of the then existing customs duties on coffee, tea, chocolate and coconuts. A similar scheme to extend it to wine and tobacco in 1733 proved unpopular and did not proceed. After the Seven Years’ War, attempts were made to extend excise duty. That on cider imposed in 1763 was so unpopular that it was repealed in 1766. The Stamp Act of 1765 imposed duties on the North American colonies, including one on stamped paper. While most of these too were repealed, the one remaining on tea famously led to the Boston tea party, and the War of Independence. Until the introduction of income tax in Pitt’s 1798 Budget, there was no tax on general income. Until this date, governments had tinkered with existing taxes, varying rates or extending their scope. Mathias and O’Brien8 conclude that the English in the eighteenth century were subject to a greater burden of taxation than their French counterparts 3 J. Black, Eighteenth Century Britain 1688-1783 (Palgrave, Basingstoke, 2001) 194; M.J. Daunton, Progress and Poverty: An Economic and Social History of Britain 1700-1950 (OUP, Oxford, 1995) 407 ff; J. Coffield, A Popular History of Taxation (Longman, London, 1970) 63ff. 4 Black, n. 3 above, 194. 5 J.V. Beckett, ‘Land Tax or Excise: The Levying of Taxation in Seventeenth– and Eighteenth–Century England’ (1985) 100 English Historical Review 288, citing S. Dowell, A History of Taxes and Taxation in England from the Earliest Times to the Present Day (Longman Green, London, 1888) ii, 63. 6 See also J.E.D. Binney, British Public Finance and Administration (Clarendon, Oxford, 1958) and C.D. Chandaman, The English Public Revenue 1660-1688 (Clarendon, Oxford, 1975). 7 Black, n. 3 above, 124. 8 P. Mathias and P.K. O’Brien, ‘Taxation in Britain and France, 1715-1810: A Comparison of the Social and Economic Incidence of Taxes Collected for the Central Governments’ (1976) 5 Journal of European Economic History 601.

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and the taxpayers of other European countries, except, perhaps, for Holland9. Direct taxes formed a smaller proportion of the burden than the indirect excise duties, and were levied in a manner less likely to cause resentment (for example, no one was exempt by rank or privilege). Beckett and Turner10 take this analysis further. Until 1776, the government could levy direct taxes at a high level only when there was war, or war was expected, since up until 1750, direct taxation was a considerable burden as land tax was levied at its highest level. The transfer of this burden on to excise duties was achieved with ‘remarkable success’.11 It is against this background, then, that the ideas of the tax thinkers of the age are examined. The term ‘thinkers’ is used, as this was still very much the age of the polymath, and there were no real boundaries between subject areas, or professions, in the way we see them today. Thus John Locke, David Hume, Adam Smith, Edmund Burke and Jeremy Bentham, for instance, all could, and did, write moral, political and economic and legal philosophy, as well as being doctors, lawyers, Members of Parliament, etc. This chapter confines itself to English, Scottish and Irish thinkers, but there are really three streams of consciousness. Continental Europe and the United States also produced thinkers, who, while they are not forgotten, must for the moment be excluded here, despite cross-fertilisation of ideas.12

III. JOHN LOCKE (1632–1704)

Modern tax theory is often considered as starting with the classical economists, most typically Adam Smith.13 However, there were many forerunners, not least of whom was John Locke. Locke enjoyed a varied career—philosopher, Oxford academic, medical researcher and doctor, and also, consequent on his working for Shaftesbury, a government official who collected information on trade and colonies, economic writer, opposition political activist, and a revolutionary on the triumphant side in the Glorious Revolution of 1688.14 Uzgalis also comments that much of Locke’s work is characterised by opposition to authoritarianism, both 9 P.K. O’Brien, ‘The Political Economy of British Taxation, 1660-1815’ (1988) 41 Economic History Review, 2nd Series 1. 10 J.V. Beckett and M. Turner, ‘Taxation and Economic Growth in Eighteenth–Century England’ (1990) 43 Economic History Review, 2nd Series 337. 11 Ibid., 401. 12 See, e.g., Sir Leslie Stephen, History of English Thought in the Eighteenth Century (3rd edn., Smith, Elder & Co, London, 1902) ii, ch. 2, Pt. III on the French Economists. 13 Kennedy (op. cit.) does consider Adam Smith’s forerunners, but these are in the light of particular taxes considered, e.g., on wages. 14 W. Uzgalis, ‘John Locke’ in E.N. Zalta (ed.), The Stanford Encyclopedia of Philosophy (Winter 2003) 1, available at http://plato.stanford.edu/archives/win2003/entries/locke.

The Concept of Taxation and the Age of Enlightenment 257 on the level of the individual person and of institutions, such as government and church: On the level of institutions it becomes important to distinguish the legitimate from the illegitimate functions of institutions and to make the corresponding distinction for the uses of force by these institutions. The positive side of Locke’s anti-authoritarianism is that he believes that using reason to try to grasp the truth, and determining the legitimate functions of institutions will optimize human flourishing for the individual and society both in respect to its material and spiritual welfare. This in turn, amounts to following natural law and the fulfillment of the divine purpose for humanity.15

Given that the purpose of this chapter is to trace the development of ideas, it is important to note the key events in Locke’s life, as personal experience unarguably affects how individuals think. He was the son of Puritans. His father was a country lawyer, who obtained patronage for his son to be educated at Westminster School, from where he went on to Christ Church, Oxford. His friend from Westminster School, Richard Lower, was responsible for introducing him to the group of individuals clustered around John Wilkins (Warden of Wadham College, and Cromwell’s brother-in-law) who formed the nucleus of the later Royal Society. Leadership of this Oxford group was taken over by Robert Boyle when Wilkins left Oxford on the Restoration of Charles II. Boyle was Locke’s scientific mentor, and Locke knew him well, also Robert Hooke and Isaac Newton. Though another friend, Dr David Thomas, in 1666 he met Lord Ashley (later Lord Shaftesbury), and moved to London to become his physician, political amanuensis and friend. His chief work was as secretary to the Board of Trade and Plantations and secretary to the Lords Proprietors of the Carolinas (he was involved in the writing of the fundamental constitution of the Carolinas), though he also wrote economic papers for Shaftesbury. Shaftesbury left government in 1674, and subsequently became embroiled in what became known as the exclusion crisis—the move to bar James, Duke of York (later James II), from the throne because of his Catholicism. Locke returned to Oxford, where he became a doctor, and then travelled in France. In 1682, he joined Shaftesbury in Holland, whither the latter had fled. His connection with the revolutionary movement was such that the English government tried to extradite him. Eventually he returned to England in 1688, after his cause triumphed. He became a member of the revived Board of Trade in 1696, and served on it until 1700.16 Political life to Locke must always have given the impression of one thing being swept away to make way for something new. As a boy he would have been involved (though his father’s soldiering in the Parliamentary cause) of 15 16

Ibid. Ibid., 1-6.

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the civil war that ultimately resulted in the execution of Charles I, the abolitions of the House of Lords and Anglican Church, and the establishment of the Cromwellian Protectorate. This was followed by the restoration of Charles II, a period of debate over religious toleration for Catholics and dissenters, ending in the Glorious Revolution which swept away James II, and replaced him with William III and Mary—events in which he was personally involved. This was reinforced, in terms of his thinking process, by the new scientific method developed by Boyle of starting from first principles and not being hidebound by the thoughts (albeit of great men) of the past. It was no longer heresy to think differently. Locke saw himself as: clearing the ground a little, and removing some of the rubbish that lies in the way to knowledge.17

While the Essay is not primarily a political document which sheds any light on Locke’s thoughts about taxation, it is crucial in showing how his political thought developed. Following Uzgalis,18 in Book 1 of the Essay, Locke argues that human beings at birth have no innate ideas—that the mind is a tabula rasa (blank slate) until experience starts to write upon it. Sensation and reflection (Book 2) provide the basic material for this, as they create simple ideas—and simple ideas are then combined to create complex knowledge, as men are born with the ability to receive, manipulate and process content. The mind can engage in three kinds of action in putting simple ideas together, the first being to combine them into complex ideas. These latter are of two sorts— substances and modes. Substances are independent existences (God, angels, plants, etc.) and modes are dependent existences (moral ideas, language of politics, culture, etc.). The second action the mind takes is to set ideas beside one another—to give an idea of relations. The third act of the mind is to produce general ideas by abstraction from particulars. This appears to be the process that Locke followed in developing his political theory, especially in The Second Treatise of Government. In Chapter 1, he defines political power. Political power, then, I take to be a right of making laws with penalties of death, and consequently all less penalties, for the regulating and preserving of property, and of employing the force of the community, in the execution of such laws, and in defence of the common-wealth from foreign injury; and all this only for the public good.19 17 J. Locke, An Essay Concerning Human Understanding, Epistle to the Reader (ed. P. Nidditch, OUP, Oxford, 1975) 9-10. 18 Uzgalis, n. 14 above, 9. 19 J. Locke, ‘Second Treatise of Government’ in J. Locke, Two Treaties of Government: A Critical Edition with Introduction and Notes (2nd edn., ed. P. Laslett, Cambridge University Press, Cambridge, 1970) ii, I, 3.

The Concept of Taxation and the Age of Enlightenment 259 In Chapter 2, he discusses the state of nature: To understand political power aright, and derive it from its original, we must understand what estate all men are naturally in, and that is, a state of perfect freedom to order their actions, and dispose of their possessions and persons as they think fit . . .

Here Locke goes back to basic principles (it is an idealised interpretation)— when there was, in theory, a blank sheet, before the existence of civil government, though not before self-government. It was, he says,20 ‘a state also of equality, wherein all the power and jurisdiction is reciprocal’. The key to why we have civil government arises from the evolution of this state of nature to ‘the point where it becomes expedient for those in it to found a civil government’.21 It is a result of the nature and ownership of private property. In discussing the origin of private property, Locke says that God gave ‘the world to men in common’.22 Haworth23 comments that Locke does not start from a position prior to common ownership, that is, where no one owned anything. Common ownership is a stage beyond this (in terms of thinking, at least). However, private property is possible. Locke argues that: every man has a ‘property’ in his own ‘person’. This nobody has any right to but himself. The ‘labour’ of his body and the ‘work’ of his hands, we may say, are properly his. Whatsoever, then, he removes out of the state that Nature hath provided and left it in, he hath mixed his labour with it, and joined to it something that is his own, and thereby makes it his property.24

Thus, if a man picks up acorns from under a tree, apples from a branch or draws water from a fountain, this act is the work of his hand and makes the fruit or water his. As Uzgalis comments,25 if one had to ask the permission of all others before one could pick berries, one would starve to death: private property does not come about by universal consent. (Perhaps this is why Locke starts his theory with common ownership.) The natural corollary of this might be, then, that one could acquire as much private property as one might wish. There are some qualifications. One is waste. As much as anyone can make use of to any advantage of his life before it spoils, so much by his labour may he fix a property in; whatever is beyond this, is more than his share and belongs to others.26 20

Locke, n. 18 above, ii, 2, 4. Uzgalis, n. 14 above, 21. 22 Locke, n. 19 above, ii, 5, 25. 23 A. Haworth, Understanding the Political Philosophers from Ancient to Modern Times (Routledge, London, 2004) 121. 24 Locke, n. 19, above, ii, 2, 26. 25 Uzgalis, n. 14 above, 22. 26 Locke, n. 19 above, ii, 2, 30. 21

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Because of the richness of resources, no one man could use all that was available. Thus far Locke has been talking about gathering fruit and berries, but he goes on to discuss ownership of land, and it is tempting to see here an evolution in the state of society from hunter/gatherers to agriculture and farming. However, he could just be discussing land as a different type of property. His views are similar. A man may have as much land as he can enclose by his own labour. Nor was this appropriation of any parcel of land, by improving it, any prejudice to any other man, since there was still enough and as good left, and more than the yet unprovided could use. So that, in effect, there was never the less left for others because of his enclosure for himself. For he that leaves as much as another can make use of does as good as take nothing at all. Nobody could think himself injured by the drinking of another man, though he took a good draught, who had a whole river of the same water left him to quench his thirst. And the case of land and water, where there is enough of both, is perfectly the same.27

It is fair to say that there have been numerous interpretations of Locke’s theory of property. Macpherson28 sees Locke as advocating the acquisition of unlimited wealth—a ‘spokesman for a proto-capitalist society’.29 In the view of Tully,30 on the other hand, Locke sees new conditions, especially the economic inequality which results from the advent of money, as ‘the fall of man’.31 Tully32 and Arneil33 take a view that Locke’s theory of property is put forward as a defence against colonial usurpation of the territories of the native American peoples and is propounded as a ‘Eurocentric view’—a contention refuted by Buckle34 who maintains that this is based on a misreading of Locke’s text, and that the Second Treatise should not be confined to so narrow an interpretation. There is no doubt that Locke knew an immense amount about America—from his own reading, his own investments in colonial enterprises, and his career in public service (service to 27

Ibid., ii, 5, 32. C.B. Macpherson, The Political Theory of Possessive Individualism (Oxford, University Press, Oxford, 1962). 29 Uzgalis, n. 14 above, 23. 30 J. Tully, An Approach to Political Philosophy: Locke in Contexts (Cambridge University Press, Cambridge, 1993); J. Tully, A Discourse on Property: John Locke and his Adversaries (Cambridge University Press, Cambridge, 1980). 31 Uzgalis, n. 14 above, 23. 32 Tully, Per Approach, n. 30 above; J. Tully, ‘Placing the Two Treatises’ in N. Phillipson and Q. Skinner (eds.), Political Discourse in Early Modern Britain (Cambridge University Press, Cambridge, 1993) 253; J. Tully, ‘Rediscovering America: The Two Treatises and Aboriginal Rights’ in G.A.J Rogers (ed.) Locke’s Philosophy: Content and Context (Clarendon, Oxford, 1994) 165; J. Tully, Strange Multiplicity: Constitutionalism in an Age of Diversity (Cambridge University Press, Cambridge, 1995). 33 B. Arneil, John Locke and America. The Defence of English Colonialism (Clarendon, Oxford, 1996). 34 S. Buckle, ‘Tully, Locke and America’ (2001) 9 British Journal for the History of Philosophy 245. 28

The Concept of Taxation and the Age of Enlightenment 261 Lords Proprietors of the Carolinas35—and he certainly refers extensively to America and its native peoples by way of example to illustrate various points in the Second Treatise. While it may be possible to derive deeper political messages from the text, it may be no more than Locke casting around for suitable illustrative examples from his own experience. It seems undoubted in Locke’s view that the ideas of there being enough for everyone was altered by ‘the desire of having more than one needed’ and the introduction of money for which men might exchange goods they might have obtained otherwise by labour,36 such that economic proportions were distorted,37 leading to frictions, exacerbated by increase in population. This led to civil government. Men being, as has been said, by nature free, equal, and independent, no one can be put out of this estate and subjected to the political power of another without his own consent, which is done by agreeing with other men, to join and unite into a community for their comfortable, safe and peaceable living, one amongst another, in a secure enjoyment of their properties, and a greater security against any that are not of it. This any number of men may do, because it injures not the freedom of the rest; they are left, as they were, in the liberty of the state of Nature. When any number of men have so consented to make one community or government, they are thereby presently incorporated, and make one body politic, wherein the majority have a right to act and conclude the rest.38

In Chapter 8.99 Locke expressly states that uniting into such a community means that individuals hand over power to majority rule—and this is the only lawful form of government. This is a form of social contract theory— an individual agrees to abide by the decision of a community, in return for the benefits bestowed by membership of that community (expounded on more fully in Chapter 12)—protection of life, health, liberty and property. It is this that justifies the imposition of taxes. In Chapter 11.138, Locke states: the supreme power cannot take from any man any part of his property without his own consent. For the preservation of property being the end of government, and that for which men enter into society, it necessarily supposes and requires that the people should have property, without which they must be supposed to lose that by entering into society which was the end for which they entered into it; too gross an absurdity for any man to own. . . . For I truly have no property in that which another can by right take from me when he pleases against my consent. Hence it is a mistake to think that the supreme or legislative power of any common-wealth can do what it will, and dispose of the estates of the subject arbitrarily, or take any part of them at pleasure.39 35 H. Lebovics, ‘The Uses of America in Locke’s Second Treatise of Government’ (1986) 47 Journal of the History of ideas 567. 36 Locke, n. 19 above, ii, 5, 37. 37 Ibid., ii, 5, 48. 38 Ibid., ii, 8, 95. 39 Ibid., ii, 11, 138.

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He goes on: It is true that governments cannot be supported without great charge, and it is fit every one who enjoys his share of the protection should pay out of his estate his proportion for the maintenance of it. But still it must be with his own consent—i.e., the consent of the majority, giving it either by themselves or their representatives chosen by them; for if any one shall claim a power to lay and levy taxes on the people by his own authority, and without such consent of the people, he thereby invades the fundamental law of property, and subverts the end of government. For what property have I in that which another may by right take when he pleases himself?40

While this may seem at odds with the notion Locke developed of the right to private property, it is the fact that the individual has handed over individual rights to a state body that makes it a feasible notion that he should be willing to contribute to the maintenance of that body, because by so doing he will be contributing to his own protection. The state, as a body, can defend his property rights, for example, by acting on his behalf against anyone attacking those rights. While an individual, in a state of nature, would have rights of self-help, if untrammelled, these may overstep proper boundaries in meting out punishment. It is clear that Locke follows Hobbes in some of his thinking. As Jackson41 makes clear, Hobbes thought that the levying of taxes was justified as the price of security, so all citizens should pay taxes. Moreover they should be equally imposed, which, for Hobbes, meant equating taxes to benefits. Benefit was to be assessed by consumption, so a tax on commodities was borne equally by all, and least felt as an imposition. It was further justified because it would benefit those who save their wealth and would penalise those who squander it. The tension identified by Locke inherent in paying tax in return for state protection remains with us to this day. In his examination of the American taxation system, from a Lockean perspective, Epstein42 also gets to grips with this fundamental tension. The institutions of representative government do not function as we might wish. He sees taxation precisely as: the power to coerce other individuals to surrender their property without their consent. In a world—a Lockean world—in which liberty is regarded as good and coercion an evil, then taxation authorizes the sovereign to commit acts of aggression against the very citizens it is supposed to protect. 40 Ibid., ii, 11, 140. P.K. O’Brien and P.A. Hunt, ‘The Rise of a Fiscal State in England, 1485-1815’ (1993) 66 Historical Research 129, at 170 comment that the fiscal system established after the ‘Glorious Revolution’ actually was such that it provided funds to protect not only Britain, but her ‘hegemony over the international economic order’. Protecting assets was the order of the day. 41 D. Jackson, ‘Thomas Hobbes’ Theory of Taxation’ (1973) 21 Political Studies 175, at 176-177. 42 R.A. Epstein, ‘Taxation in a Lockean World’ (1986) 4 Social Philosophy and Policy 49, at 49.

The Concept of Taxation and the Age of Enlightenment 263 He argues that one cannot have government without taxation, yet taxation is ‘institutionalized coercion’. The dilemma is ‘how to preserve the power of taxation while curbing its abuse’43. It is a dilemma of which Locke, when read in context, was only too aware, hence his emphasis on the fact that all members of the political community must adhere to a majority decision. However, inherent in his analysis is the suggestion that there may be a (sizeable) minority who may be unhappy with the majority decision—and they will have to accept it. However, as Locke explicitly says, a legislative power cannot act arbitrarily—and Epstein agrees.44 To escape the horns of this particular dilemma, the power to tax, while an inherent power of government or sovereign, must be regarded as limited. The justification for taxation is the benefit received in return for surrender of individual rights. No one can reasonably object to a condition in which he is better off than he would have been in an ungoverned state—and no one can stand outside the compact: for then the entire arrangement will unravel; for without universal compliance, the monopoly of the state is lost, and the regime of self-help, with all its deficiencies, will emerge anew. The reconciliation of liberty and coercion is found in the stipulation for a return benefit, unobtainable through voluntary agreement, that exceeds in value the losses of liberty and property entailed by the formation of the state.45

Taxation, then is a sort of bargain between the individual and the state, resulting from the social contract. This idea is further explored by Epstein—taxation must provide the state with resources to fulfil the functions it must discharge. It cannot coerce these: citizens by a majority must agree to their imposition. Locke says nothing further about tax—its nature, incidence, collection, etc., are subjects on which he remains silent. All he says46 is that a man should pay out of his estate in proportion to the protection he receives from the state. Arguably this means progressive or proportionate tax rates (in the modern use of these terms) rather than regressive rates, though inherent too in the word ‘protection’ is the notion of whether one should pay on an income or consumption basis. One is bound to wonder, too, exactly what Locke may have meant by ‘estate’. The word comprises a width of meaning from simply ‘whatever a

43 44 45 46

Ibid., 50. Locke, n. 19 above, ii, 11, 138. Epstein, n. 42 above, 53-54. Locke, n. 19 above, ii, 8, 140.

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man owns’ through to the idea of ‘estates in land’ and raises the question whether Locke envisaged everyone having to pay tax, or only landowners (as those possessed of the right to vote because of fulfilling the requirement to hold land). Both views attract support, as indicated in Hughes,47 with Cohen48 regarding Locke as ‘an advocate of property-based oligarchy’ and Tully49 finding ‘democratic tendencies’.50 Epstein51 suggests that this idea of liberty leads, as a natural corollary, to neutrality. If individual liberty should be infringed as little as possible in the state of nature, then the ‘creation of a system of government should strive not to reduce the scope of individual choice from what it was before’—so no person or persons should be able to manipulate taxation such that it affects the choices made by others or creates benefits for one group by depriving others. Thus ensuring that property remains held in the same proportion post-tax as it would be pre-tax minimises the incentive towards evasion as basic preferences remain unaltered. Similarly, there are implications, per Epstein, for costs of administration and rent-seeking (use of the system to favour one group above another). If costs of collection are high or there is political lobbying, then it introduces skewness into the system. Hence a simple system and well defined property rights will help maintain proportionality. Epstein52 goes on to consider the implications of implementing the tax bargain within the context of the American taxation system. For example, paying tax in cash, not kind, will allow the taxpayer to preserve for himself the assets (property) which he values most. As the state protects life, health, liberty and property, presumably these are all items which may be included in any tax base, though there is considerable debate as to how exactly they are to be included. There is the issue of tax subsidies to consider, for example, as ‘[t]he Lockean theory places a flat prohibition upon implicit transfers from the state that leave one group better off and another worse off’.53 This takes us forward in a sense to consider what may be the legitimate uses of taxation revenue, which is something that Locke does not consider. His basic idea is of individuals contributing to state coffers for protection. The concept of the state helping out one sector of the community or the idea of state welfare or charity for those who may be needy cannot easily be accommodated with his thinking as outlined in the Second Treatise. However, if Hughes’s54 interpretation has weight, then Locke may not have envisaged a political state where anyone could not at least work and, in this sense, at least, 47

M. Hughes, ‘Locke on Taxation and Suffrage’ (1990) 11 History of Political Thought 423. J. Cohen, ‘Structure, Choice and Legitimacy: John Locke’s Theory of the State’ (1986) 15 Philosophy and Public Affairs 301. 49 Tully, A Discourse, n. 30 above, 173. 50 Hughes, n. 47 above, 423. 51 Epstein, n. 47 above, 55 ff. 52 Ibid., 57 ff. 53 Ibid., 67. 54 Hughes, n. 47 above. 48

The Concept of Taxation and the Age of Enlightenment 265 acquire property, as inherently there is a notion that all men are self-sufficient in this respect. It would be interesting to hypothesise how Locke’s ideas on taxation might be adapted to accommodate the concepts of state aid/charity, but at present this is outside the scope of this chapter.

IV. THE POST-LOCKEAN PERIOD

There is a considerable gap (as the time line in Appendix 1 shows) before the emergence of the next British/Scottish thinker after Locke, though theorists were at work in continental Europe.

V. SAMUEL JOHNSON (1709–1784)

Johnson is chiefly remembered not as a tax theorist, but for his Dictionary55 and works such as the Lives of the English Poets, the biography written by James Boswell, and the status accorded to him as the ‘first man of letters’, as a founding member of The Club (later dubbed The Literary Club). The original membership of this body included Joshua Reynolds, Edmund Burke and Oliver Goldsmith, and later Thomas Percy, David Garrick, James Boswell, Charles James Fox, George Steevens, Adam Smith, Joseph Banks and Edmond Malone. Johnson contributed regularly in early life to The Gentleman’s Magazine and later started the periodical, The Rambler. He also wrote Parliamentary Debates (published in The Gentleman’s Magazine), which were ‘widely accepted as authentic speeches by the great politicians of the day’56 and in the 1770s wrote four political pamphlets, of which two have direct bearing on taxation, namely The Patriot (1774) and Taxation No Tyranny (1775), the latter concerning the question of American taxation and representation. Johnson defends taxation of the American colonies—and he does so in Lockean terms. This is not surprising. McLaverty57 has traced the influence of Locke’s Essay Concerning Human Understanding on Johnson’s Dictionary, so it is not surprising to find the influence of his political ideas as well. Indeed, one of Johnson’s definitions in his Dictionary of the word ‘property’ is taken from Locke. The significance of Johnson’s argument is its application of Locke’s theory to a practical situation. Locke used America frequently in his Second Treatise as (arguably) a hypothetical example in support of his theory. Johnson has turned this on its head: he is

55 See M. Drabble (ed.), The Oxford Comparison to English Literature (OUP, Oxford, (1998) 512-513. 56 Ibid., 512. 57 J. McLaverty, ‘From Definition to Explanation: Locke’s Influence on Johnson’s Dictionary’ (1986) 47 Journal of the History of Ideas 337.

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using Locke’s theory to support his view of an actual political situation in respect of America: That man, therefore, is no patriot, who justifies the ridiculous claims of American usurpation; who endeavours to deprive the nation of lawful authority over its own colonies, which were settled under English protection; were constituted by an English charter; and have been defended by English arms. To suppose, that by sending out a colony, the nation established an independent power; that when, by indulgence and favour, emigrants are become rich, they shall not contribute to their own defence, but at their pleasure; and that they shall not be included, like millions of their fellow subjects, in the general system of representation; involves such an accumulations of absurdity, as nothing but the show of patriotism could palliate. He that accepts protection stipulates obedience. We have always protected the Americans; we may, therefore, subject them to government.58

The link to Locke’s ideas of taxation being the price paid for protection could not be more emphatically stated. It is a theme Johnson continues in Taxation No Tyranny: they who flourish under the protection of our government, should contribute something towards its expense.59 A tax is a payment, exacted by authority, from part of the community, for the benefit of the whole. From whom, and in what proportion such payment shall be required, and to what uses it shall be applied, those only are to judge to whom government is intrusted. In the British dominions taxes are apportioned, levied and appropriated by the states assembled in parliament. Of every empire, all the subordinate communities are liable to taxation, because they all share the benefits of government, and, therefore ought all to furnish their proportion of the expense.60

The colonies are part of Britain, in the same way as an arm or leg is a part of a body. The potential independence of America would be like Cornwall setting itself up as an independent country, as Johnson imagines later in Taxation No Tyranny. Johnson specifically mentions that Americans enjoy ‘security of property’61 by courtesy of English law, and if they accept law and, it must be accepted as a whole: they cannot simply select piecemeal the laws they want and reject those they do not like—and ‘by a chain which cannot be broken’ must accept ‘the unwelcome necessity of submitting to taxation’.62 Going 58 S. Johnson, ‘The Patriot’ in The Works of Samuel Johnson (Pafraets & Co, Troy, NY, 1913), xiv, available at www.samueljohnson.com, 8-9. 59 S. Johnson, ‘Taxation No Tyranny: An Answer to the Resolutions and Address of the American Congress’ in ibid., xiv, 2. 60 Ibid., 4. 61 Ibid., 7. 62 Ibid., 9.

The Concept of Taxation and the Age of Enlightenment 267 as a colonist to America did not mean being in a ‘state of nature’63 like native inhabitants: colonists were always regulated by the terms of the original charter. The fact that they cannot vote for representatives in an English parliament has been their choice: As man can be but in one place, at once, he cannot have the advantages of multiplied residence. He that will enjoy the brightness of sunshine, must quit the coolness of shade. He who goes voluntarily to America, cannot complain of losing what he leaves in Europe. He, perhaps, had a right to vote for a knight or burgess; by crossing the Atlantick, he has not nullified his right; but he has made its exertion no longer possible. By his own choice he has left a country, where he had a vote and little property, for another, where he has great property, but no vote.64 They have not, by abandoning their part of one legislature, obtained the power of constituting another, exclusive and independent, and more than the multitudes, who are now debarred from voting, have a right to erect a separate parliament for themselves.65

Political representation in the seventeenth and eighteenth centuries was very different from today. Only men who had a certain property qualification could vote. Anglican church members alone could vote and women had no vote at all. Moreover, not all areas of the country were represented by Members of Parliament, so Johnson’s argument in the context of his own times is very valid. In a sense, Johnson does not add anything new in terms of ideas about taxation, though he does explicate how the issue of taxation and representation can be dealt with in Lockean terms. It is interesting to note that Johnson’s close friend and biographer, James Boswell, however, disagreed with him on this issue. Fagerstrom,66 citing Tinker67 gives an example of this in one of Boswell’s letters, to his friend, Temple, in 1775: I am growing more and more an American...I see the unreasonableness of taxing them without the consent of their Assemblies; I think our Ministry are mad in undertaking this desperate war.

VI. DAVID HUME (1711–1776)

As an older contemporary of Adam Smith, Hume was similarly placed within the Scottish Enlightenment. He spent some of his life (1734–1737) 63

Ibid. Ibid., 10. 65 Ibid., 11. 66 D.I. Fagerstrom, ‘Scottish Opinion and the American Revolution’ (1954) 11 The William and Mary Quarterly 3rd Series 252, at 262-263. 67 C.B. Tinker (ed.), Letters of James Boswell: Volume I (OUP, Oxford, 1924) 213-214, 239. 64

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in France, where he completed his first work of philosophy. His works are extensive, and include A Treatise of Human Nature (published in two instalments, 1739 and 1740); An Inquiry Concerning Human Understanding (1748, a different version of Book 1 of the Treatise); An Inquiry Concerning the Principles of Morals (1751, which is a much different version of Book 3 of the Treatise); Essays, Moral and Political (1741–1742), which were eventually combined with Political Discourses (1752, under the title of Essays, Moral, Political and Literary in his collections of philosophical works, Essays and Treatises on Several Subjects (1753) ). (The chronology and sequence of Hume’s work are extremely difficult to unravel.) In 1763 he went to France again as a secretary to the British embassy. He became a friend of Jean Jacques Rousseau, for whom he was instrumental in providing refuge in England in 1766, though the latter accused Hume of conspiring to ruin his character. He also wrote a History of England (1754–1762), which became a standard work for many years. Hume was also a friend of Benjamin Franklin.68 It is difficult to track precisely Hume’s views, as it seems that his thoughts on general issues need to be derived from many different works. He is widely credited with destroying ‘the Lockean concept of social contract theory’,69 which is particularly evident in the essay Of the Original Contract (1748) (in Essays, Literary, Moral and Political). Here Hume discusses philosophical differences between Tories and Whigs on the origin of government, agreeing with the Tory argument for political authority stemming from divine right. Against the Whigs, who espoused Lockean theory, he argues that governments are established by and in violence, not by contractual agreement. ‘In fact, people are in least agreement when forming of new governments’.70 In his essay Of the First Principles of Government (1741), he argues that governments are founded for two basic reasons—to protect public interest and rights to power and property. Government is legitimated by ‘its utility in sustaining property and the conventions of justice in large societies’.71 In Of the Origin of Government (1777, appearing posthumously), he argues that the aim of government is to maintain justice. Men recognise the need for this, but human weakness keeps them from always acting with justice— so it is necessary to establish a government and a duty of obedience. Such authority is always balanced against liberty.72 68 J.M. Werner, ‘David Hume and America’ (1972) 33 Journal of the History of Ideas 439, at 448 ff. 69 Ibid., 439. 70 The Internet Encyclopedia of Philosophy. David Hume (1711-1776). Essays, Moral, Political and Literacy available at www.utm.edu/research/iep/h/humeessa.htm, 9/13. 71 P. Kelly, ‘Hume’ in D. Boucher and P. Kelly (eds), Political Thinkers from Socrates to the Present (OUP, Oxford, 2003) 211. 72 Internet Encyclopedia, n. 70 above, 5/13.

The Concept of Taxation and the Age of Enlightenment 269 In Locke’s theory, the existence of the social contract was the underpinning which legitimated the imposition of taxes. If we deny a social contract, as Hume does, upon what basis then can a government impose taxes? This is a considerable philosophical dilemma—and one which Hume does not directly address. However, there are some indications of his ideas in his moral theory overall, from Book 3 of the Treatise of Human Nature (1740) and from An Inquiry Concerning the Principles of Morals (1751). In Part 2 of the Treatise, he discusses the nature of, and motivation towards, justice, especially justice as regards the ownership of property. He rejects self-love, public interest and private benevolence, and concludes that: our sense of justice is not naturally grounded but artificially derived from education and convention...Hume argues that we depend on society to survive and, being motivated by self-love, we want to advance society. To this end we train ourselves to respect each other’s acquired possessions and to view the stability of possessions as a necessary means of keeping society intact. Slowly this gives us a sense of common interest, a regard for rules, and a sense of confidence in the consistent behaviour of others.73

There are three main rules of justice that emerge—stability of possessions, transference by consent, and performances of promises. These are invented rules, and governments emerge to protect agreements and to force us to make some agreements for the benefit of all. Man invents rules to promote his wish to live in a peaceful society, and also invents civil duties that govern allegiances politically and internationally.74 Paying taxes, then, is perhaps, a civil duty, in support of Man’s desired society. It is possible, however, that one can go deeper into Hume’s theory of ideas for a different grounding in An Inquiry Concerning Human Understanding (1748). He says that impressions and ideas form the basis of all human knowledge, similar to Locke. The senses receive impressions, and ideas in accordance with these impressions link to a causal principle: Any attempt to find some reality underlying these impressions is useless. Reality can be found only in a continuously changing aggregate of feelings bound together by a psychological or social force known as custom. Custom thus replaces a priori reason as the subjective basis of beliefs about causation in external and human nature.75

Applying this to taxation, if one cannot reason from first principles, one has to accept what exists simply because it has been customarily developed. One cannot therefore speculate as to why taxation exists. One can only deal 73 The Internet Encyclopedia of Philosophy. David Hume (1711-1776). Moral Theory, available at www.utm.edu/research/iep/h/humemora.htm, 5/9. 74 Ibid. 75 Werner, n. 68 above, 440.

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with it as it is and use what exists (though this can be changed). This is made explicit in the essay entitled Of the Original Contract (1748): When a new government is established, by whatever means, the people are commonly dissatisfied with it, and pay obedience more from fear and necessity, than from any idea of allegiance or of moral...Time, by degrees, removes all these difficulties, and accustoms the nation to regard, as their lawful or native princes, that family, which, at first, they considered as usurpers or foreign conquerors.76

This may explain the view Hume takes of taxation is his essay entitled Of Taxes (1752). This does not address taxation theory in any way, but discusses how workers may deal with increases in taxes by increasing their labour, rather than by receiving higher wages. If a man works harder, he will thus earn more. He compares the situation to that in countries with harsh climates, where workers must work harder to overcome such a natural disadvantage. He does argue, however, that it is best to tax luxury items, rather than necessities, as the purchase of such items is in some degree voluntary. In his essay entitled Of Civil Liberty (1741), he states his belief that while governments have generally improved, monarchies have improved the most. Free governments show a tendency to degenerate because of excessive debts and taxes. He cites particularly France: The greatest abuses, which arise in France, the most perfect model of pure monarchy, proceed not from the number or weight of taxes, beyond what are to be met with in free countries; but from the expensive, unequal, arbitrary, and intricate method of levying them, by which the industry of the poor, especially of peasants and farmers, is, in great measure, discouraged, and agriculture rendered as beggarly and slavish employment.77

Hume goes on to say that the nobility too suffer as a result of this, as it ruins their estates and beggars their tenants: only financiers gain. If a prince or minister, therefore, should arise, endowed with sufficient discernment to know his own and the public interest, and with sufficient force of mind to break through ancient customs, we might expect to see these abuses remedied.78

Though it were done by no prince or minister, nonetheless a theory to address these ‘expensive, unequal, arbitrary, and intricate’ taxes was developed by Adam Smith. Hume provided the blueprint for Adam Smith’s canons of taxation. 76 D. Hume, ‘Of the Original Contract’ in D. Hume, Essays, Literary, Moral, and Political (Ward, Lock & Co., London, 1875) 275, at 275-276. 77 D. Hume, ‘Of Civil Liberty’ in Ibid., 54. 78 Ibid.

The Concept of Taxation and the Age of Enlightenment 271 VII. ADAM SMITH (1723–1790)

Adam Smith was a leading figure of the Scottish Enlightenment. He knew well David Hume (he edited Hume’s autobiography) and, as a professor of logic (moral philosophy) at Glasgow University, was acquainted with other leading thinkers of the day such as Francis Hutcheson, Thomas Reid and John Millar (also professors at Glasgow), and with Adam Ferguson, Dugald Stewart and William Robertson, all at Edinburgh University. He would also have been acquainted with Lord Kames, Sir James Steuart and Dr James Anderson. He also knew Benjamin Franklin. In 1759 he published The Theory of Moral Sentiments, and in 1776, after returning from France where he had met Voltaire and had been admitted to the society of the physiocrats, he finished and published his great work on economics, An Inquiry into the Nature and Causes of the Wealth of Nations. Along with his particular theory, of great significance was his detailed review of taxes and conditions prevailing at the time he wrote, which he used in support of his maxims. The canons of taxation, which he outlined in Book 5, have become for many the fundamentals of taxation theory. 1. The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is in proportion to the revenue which they respectively enjoy under the protection of the state . . . 2. The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payments, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person . . . 3. Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it . . . 4. Every tax ought to be so contrived as both to take out and keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.79

The first of these has clear links with Hobbes and Locke (‘every one who enjoys his share of the protection should pay out of his estate his proportion for the maintenance of it’) in terms of paying a proportion of one’s income as tax. However, Smith is taking this one step further, in that he is combining more explicitly than Locke does two approaches which may be conflicting—the benefit approach and the ‘ability to pay’ approach.80 Locke is stating that a man should pay ‘his proportion’ for ‘his share of protection’. This could be interpreted in the same way as Smith’s statement, but 79 A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (W. Benton, Encyclopedia Britannica, Chicago, Ill, 1952) v, ch. 2, Pt I, 361. 80 D.P. O’Brien, The Classical Economists (Clarendon, Oxford, 1978) 241.

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it need not be. It remains open to the suggestion that a man’s proportion of income payable may be judged proportional on some other basis than that of ability to pay. Smith’s combination of these ideas was not original and was probably unconscious (Petty too wrote in similar terms).81 Though an acknowledged follower of Hume, Smith’s language in setting out the canons shows traces of social contract theory, but is, one might suggest, very carefully chosen so that such a charge could be rebutted if it arose. There is some hint that Smith also considered progressive taxation: It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in proportion.82

However, as Groves83 comments on this, Smith’s work is ‘like the Bible: one can find in it a justification for many points of view’. In terms of convenience and certainty, Groves84 comments that Smith favoured a tax system that could be easily administered. Substance about which information/values could be ascertained was much easier to tax, as it would not be necessary to investigate individuals’ personal circumstances. One could not easily obtain detailed information about income or wealth. Smith was obliged to accept ‘the best attainable expedients’.85 What a man spends on his house may be indicative of what he spends in total, but if not, one could always count hearths, or, better, windows—though Smith thought it preferable to obtain details by obligatory public recording of leases.86 Property tax was readily ascertainable because based on rental values of land—and ground rent was ‘uniquely suitable for taxation’.87 Smith devoted the majority of his analysis in Book 5 of An Inquiry into the Nature and Causes of the Wealth of Nations to a discussion of taxes on commodities. He distinguished necessities from luxuries, noting that taxes on such items were practical in terms of certainty and convenience, though he ‘favoured the repeal of taxes on salt, leather soap and candles’88 out of concern for the poor. Such taxes also offended against his fourth maxim, because administrative expenses were high. He also acknowledged that people in general would not know how much they might pay by way of consumption taxes, so to some degree the maxim of certainty was infringed.89 81

Ibid., Smith, n. 79 above, v, ch. 2, pt 2, Article 1:361. 83 H.M. Groves, Tax Philosophers: Two Hundered Years of Thought in Great Britain and the United States (ed. D.J. Curran, University of Wisconsin Press, Madison, Wis, 1974) 20. 84 Ibid., 20-21. 85 Ibid., 21. 86 Ibid. 87 Ibid., 22. 88 Ibid., 20. 89 Ibid., 23. 82

The Concept of Taxation and the Age of Enlightenment 273 In terms of his fourth criterion also, he felt that taxes on wages were ineffective, because the effect would be to raise them somewhat higher than the tax (Article 3), and would be disadvantageous to the poor, who were mostly those who worked. Again here, Groves90 feels that he shows his compassion for the poor, revealing his background in ethics, and failing in terms of economics ‘to put his best foot forward’.

VIII. EDMUND BURKE (1729–1797)

Edmund Burke was a well-established literary and political figure in his own time. Though he moved to London after graduating from Trinity College, Dublin (he was the son of an Irish Protestant father and Catholic mother), to train as a lawyer, it is doubtful whether he ever practised. In 1758–1759 he founded the Annual Register, in which he wrote articles on the political and cultural events of the day. In 1759 he became private secretary to William Gerard Hamilton, a Lord Commissioner of Trade, and later Chief Secretary to the Lord Lieutenant of Ireland. In 1765 he became private secretary to the Marquis of Rockingham, who was later Prime Minister, and was himself elected to Parliament, where, with a brief interruption in 1780, he served for 29 years.91 His activity as an MP and political writer embraced five causes: the emancipation of the House of Commons from the control of George III and the ‘King’s friends’; the emancipation of the American colonies; the emancipation of Ireland; the emancipation of India from the misgovernment of the East India Company and opposition to the atheistical Jacobinism displayed in the French Revolution.92

He made many political speeches, a good number of which he published, his oratorical skills being a legacy from his days at Trinity where he had founded a debating society. He was a member of Johnson’s circle. His critique of the French Revolution brought him criticism from his former friends, such as Godwin, Bentham, Paine and James Mill, who thought he had betrayed his faith in political liberty. This was a catalyst for Thomas Paine’s Rights of Man, which Paine wrote in direct response to Burke’s views. One of the main problems in assessing Burke is that he left behind him no identifiable school of thought or philosophy, although he did write a major philosophical work entitled A Philosophical Inquiry into the Origin 90

Ibid., 20. See I. Harris, ‘Edmund Burke’ in Zalta (ed.), n. 14 above, and Thoemmes Continuum: The History of Ideas, Edmund Burke 1729-97, available at www.thoemmes.com/encyclopedia/burke. 92 Drabble, n. 55 above, 146. 91

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of our Ideas of the Sublime and Beautiful (1757). One need look no further than the title to detect Locke’s influence. However, as Sidgewick93 said, ‘though Burke lives, we meet no Burkites’. In many ways he is similar to Johnson, in that he often appears as a political commentator, though he also appears as a practical politician. As Boucher94 succinctly puts it, ‘[he] famously denounces abstract natural rights, emphasising the importance of usage and experience. One calls for the doctor when one is ill, not the metaphysician’. It is in this vein that he approached the American problem, as is evident in his two speeches On American Taxation (delivered 19 April 1774) and On Moving His Resolutions for Conciliation with the Colonies (delivered 22 March 1775). According to O’Gorman,95 Burke did not wish to concern himself with abstract rights and philosophy and kept an enquiring mind, open to newer ideas: I was obliged to take more than common pains to instruct myself in everything which related to our colonies. I was not the less under the necessity of forming some fixed ideas concerning the general policy of the British empire.96

Most of Burke’s peers considered the American problem in terms of Britain’s right to impose tax on the colonists. Unusually, Burke was prepared to ignore this: I am resolved this day to have nothing at all to do with the question of the right of taxation. Some gentlemen startle—but it is true; I put it totally out of the question. It is less than nothing in my consideration.97

He disliked abstract discussion because it provoked differences of opinion as abstract ideas could mean different things to different individuals. Solutions to political problems had to be realistic, not idealistic:98 All government, indeed, every human benefit and enjoyment, every virtue, and every prudent act, is founded on compromise and barter. We balance inconvenience; we give and take; we remit some rights that we may enjoy others; and we choose rather to be happy citizens than subtle disputants.99 93 H. Sidgewick, Essays on Ethics and Method (ed. M. G. Singer, Clarendon, Oxford, 2000) 195, cited by Harris, n. 91 above, 2/20. 94 D. Boucher, ‘Burke’ in Boucher and Kelly (eds.), n. 71 above, 364. 95 F. O’Gorman, Edmund Burke: His Political Philosophy (George Allen & Unwin, London, 1973) 68 ff. 96 E. Burke, ‘On Moving His Resolutions for Conciliation with the Colonies’ in E.J. Payne and F. Canavan (eds), Select Works of Edmund Burke, and Miscellaneous Writings (Library of Economics and Liberty, Liberty Fund, Inc., Indianapolis, Ind., 1999), available at www.econlib.org.library/LFBooks/Burke/brkSWv1c3.html, I, 3. 97 Ibid., i, 3, 66. 98 O’Gorman, n. 95 above, 68. 99 Ibid., i, 3, 125.

The Concept of Taxation and the Age of Enlightenment 275 While there is in this shades of the social contract idea, Burke is using this to demonstrate that there should not be any idea of inflexible right. Burke did not object to Parliament’s right to tax, but to the extent it was prepared to go to enforce that right. His solution would have been to restore the relationship which had formerly existed between Britain and the American colonists. He proposed to reconcile them by removing the cause of dispute—the perceived unjust taxes on tea. Although he supported Parliament’s right to tax, Burke believed that the Americans could themselves levy taxes internally:100 to mark the legal competency of the colony assemblies for the support of their government in peace, and for public aids in time of war.101

If the colonists did not want to tax themselves, then they should not be compelled: such coercion would change the nature of the British empire. Their only connection with Britain would then be by trade. Burke’s opinion was that more tax would come to the UK from this external source than from any taxes imposed internally such as the Stamp Tax.102 He was much opposed to the policy of taxing the colonists that George Grenville had begun. He hoped for a ‘voluntary, cultural attachment’103 with ties of common names, blood, ‘which, though light as air, are as strong as links of iron’.104 The Declaration of Independence was a considerable blow. The ensuing war, Burke felt, would destroy (ironically) British liberty. He continued on this theme: Be content to bind America by Laws of trade, you have always done it. Let this be your reason for binding their trade. Do not burthen them with taxes; you were not used to do so from the beginning. Let this be your ground for not taxing.105

IX. THOMAS PAINE (1737–1809)

Thomas Paine was one of the most influential thinkers of his age. Interestingly, he began a career as an exciseman, before being dismissed for fomenting agitation for an increase in excisemen’s pay. He was a friend of Benjamin Franklin, at whose suggestion he sailed to America, becoming involved in the struggle for American independence. He published in 1776 his pamphlet entitled Common Sense, and between 1776–1783, a series of 100 101 102 103 104 105

O’Gorman, n. 95 above, 71. Burke, n. 96 above, i, 3, 90. O’Gorman, n. 95 above, 71. Ibid. Burke, n. 96 above, i, 3, 142. E. Burke, ‘On American Taxation ‘ in Payne and Canavan, n. 96 above, i, 2, 105.

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pamphlets, The Crisis, in support of the American cause, and promoting resistance against England. In 1791, he published the first part of The Rights of Man, after his return to England. This is a response to Burke’s Reflections on the Revolution in France (1790). Knowing that he was about to be arrested, Paine left for France, and in 1792, published the second part of The Rights of Man. He remained in France, becoming a member of the Convention. Opposed to the execution of Louis XVI, he was imprisoned for the year and narrowly avoided being executed.106 He returned to America in 1802, and lived there for the rest of his life, in sadly reduced circumstances. Paine holds a unique position. In the modern vernacular, he ‘put his money where his mouth was’, and actively participated in the revolutionary movements he helped foment. However, because of this, and because of his reputation as a polemicist, ‘commentators have tended to ignore the theoretical aspects of his work’.107 He had a great dislike of Burke’s views (on almost everything), and seldom missed an opportunity to show this. His work is permeated by references to Burke’s contemporary writings and views. Paine’s major innovation in English thinking was an attempt to outline the role of government in a society where economics were subordinate to morality.108 Governments had grown oppressive and corrupt over the years. He saw reform as a three-stage process—political education, political action and then social and economic improvement. Political action could include revolution, which was required to put an end to war, heavy taxation and oppression. His organisation of society is based round the idea of natural rights: man is all of one degree, and consequently . . . all men are born equal, and with equal natural rights.109

To explain what natural rights are, Paine had recourse to the state of nature: ‘Natural rights are those which appertain to man in right of his existence...civil rights are those which appertain to man in right of his being a member of society....Of this kind are all those which relate to security and protection.110

Like Locke, he sees a type of social contract: that individuals themselves, each in his own personal and sovereign right, entered into a contract with each other to produce a government: and this is the only 106

Drabble, n. 55 above, 723. W. Christian, ‘The Moral Economics of Tom Paine’ (1973) 34 Journal of the History of Ideas 367, at 367. 108 Ibid. 109 T. Paine, The Rights of Man. Part the First, available at www.infidels.org/library/historical/thomas_paine/nights_of_man/part1.html, 18. 110 Ibid., 19. 107

The Concept of Taxation and the Age of Enlightenment 277 mode in which governments have a right to arise, and the only principle on which they have a right to exist.111

Christian112 interprets the motivation for Paine’s society as being economic interest: it is economic need which drives men to form a society. Morally they can exist independently, but economically they cannot be self-sufficient. Men, though naturally social creatures, need the protection of the state to restrict the economic aggression of one against another. As Nature created him for social life, she fitted him for the station she intended. In all cases she made his natural wants greater than his individual powers. No one man is capable, without the aid of society, of supplying his own wants, and those wants, acting upon every individual, impel the whole of them into society, as naturally as gravitation acts to a centre.113

However, all men were morally entitled to a share in government, because they paid tax. Paine remarks that under the new French constitution, ‘every man who pays a tax of sixty sous (2s 6d in older English currency) is an elector’.114 So, for Paine, government was a socio-economic contract. This shows the absorption of the ‘no taxation without representation’ cry of the American colonists validated by incorporation into a political philosophy. In other words, taxation means representation and the right to have some say in the conduct of public affairs. Paine has turned this concept on its head. The discussion and analysis of taxation plays an important role in Paine’s The Rights of Man. He is particularly interested in it as a device of oppression, but significantly he discusses the purpose to which government-raised taxes should be put. He provides a wealth of details. For example,115 he comments that before the Hanoverian dynasty, taxes on land were slightly in excess of taxes on consumption, but that this had recently altered to the detriment of the industrial and agricultural poor.116 He cites tax on beer as an example. Tax on beer was not paid by the aristocracy, because they tended to brew their own. He claims that because of taxes on malt and hops, the tax on beer exceeded the whole of the land tax. The aristocracy in his day remained, by and large, still very wealthy. Paine, however, denies any particular bias against them as a class: Independence is my happiness, and I view things as they are, without regard to place or person; my country is the world, and my religion is to do good.117 111

Ibid., 21. Christian, n. 107 above. 113 T. Paine, The Rights of Man. Part the Second, available at www.infidels.org/library/historical/thomas_paine/rights_of_man/part2.html. 114 Ibid., 22. 115 Ibid., 37. 116 A.J. Ayer, Thomas Paine (Faber & Faber, London, 1988) 103. 117 Paine, n. 113 above, 39. 112

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Paine ‘plunges into the details of English taxation’.118 Ayer119 summarises these details. Paine states that £400,000 per annum was raised by William the Conqueror, which had declined to £100,000 in 1466. It rose to £500,000 in 1566, £1,800,000 in 1666 and £17,000,000 in 1791. The increase, especially of the preceding century, he attributes to government extravagance, corruption, and foreign wars. He correctly predicted the eventual inflationary effects of the steep rises in taxation: the Bank of England suspended the exchange of its notes for gold in 1797.120 Paine estimated that £9,000,000 of the £17,000,000 was utilised to pay interest on the national debt, with £8,000,000 left to cover the year’s other current expenses. He allows £1,000,000 for the army and navy. Ayer121 finds this ‘surprising’, though in the light of what Paine says or implies elsewhere about individual needs for protection of economic interest, it is consistent with his views (it was an age when economic blockades were not uncommon). Paine suggests that £500,000 per annum will meet expenses of government. The 300 members proposed for his House of Representatives will be paid in total £75,000. The rest of the money will be paid to 1,773 officials, with a range of salaries. Three will receive £10,000 per annum, and the rest varying amounts between £1,000 (75 persons) and £75. The modesty of some of these salaries is justified by the little work required, though he does not take account necessarily of the level of responsibility inherent in some posts. He proposes to pay revenue officials out of the revenues they collect—presumably (as Ayer122 comments), with some form of monitoring, given the potential for corruption. There are very many statistics provided by Paine. Given the approach he adopted in Pamphlet 9b (The Crisis Extraordinary. On the Subject of Taxation, written in Philadelphia in 1780), this is not surprising.123 He budgets for a population of seven million. One fifth of this will be so impoverished as to need support. Of this group 140,000 will be over 50 or 60, at which age they should receive pensions, those over 60 receiving them at a higher rate. He estimates that 630,000 children will need financial support for their education. He would raise the necessary money for this as follows. ‘[by] abolish[ing] the poor rates entirely, and in lieu thereof, to make a remission of taxes to the poor of double the amount of the present poor-rates, viz. four millions annually out of the surplus taxes. By this measure, the poor will be benefited 118

Ayer, n. 116 above, 105. Ibid., 104 ff. 120 Ibid. 138. 121 Ibid., 104. 122 Ibid., 105. 123 T. Paine, Pamphlet 9b The Crisis Extraordinary. On the Subject of Taxation, available at www.constitution.org/tp/amercrisis12.html, 2. 119

The Concept of Taxation and the Age of Enlightenment 279 two millions, and the house-keepers two millions. This alone would be equal to a reduction of one hundred and twenty millions of the national debt, and consequently equal to the whole expense of the American war.124

He also proposed to abolish the tax on windows and houses (which fell heavily on ‘the middling class of people’,125 and the commutation tax. He was aware that, even after the savings he could make, he would need more money to support these reforms. His solution was a graduated income tax—of 3d per £1, on incomes up to £500 per annum, 6d on incomes from £500 to £1,000, with increments of 3d up to £2,000 and £3,000, 6d to £4,000 and £5,000, and then 1s on each additional £1000 up to £23,000, ‘on the last £1,000 of which the plutocrat will be paying 100 per cent’.126 The most anyone could keep out of his annual income would be £12,370. Thus a man earning £50 would pay 12s 6d and a man with £1,000 would keep £979. These are not punitive taxes. Paine also proposed127 particular uses of tax money—provision for 350,000 poor families; education for 1,030,000 children; ‘comfortable’ provision for 140,000 aged persons (£6 per annum to those over 50 and £10 to those over 60); donations of 20s each for 50,000 births and for 20,000 marriages; allowances of £20,000 for funeral expenses of persons travelling for work, and dying at a distance from their friends; and employment, at all times, for the casual poor in the cities of London and Westminster (which, by its description, seems by means of a ‘comfortable’ workhouse). Ayer comments that there is no provision for poor bachelors or spinsters, no longer children and not yet 50, but that this is ‘most probably a textual oversight’.128 He also proposes an allowance of 3s per week for life to 15,000 disbanded soldiers and sailors, and a proportionate allowance to disbanded officers, with an increase of pay for the remaining body of soldiers and navy personnel. He does not include death duties, which Ayer129 finds ‘surprising’, but if we take Paine at his word, cited earlier, he was interested in being evenhanded. However, he argued that his progressive income tax would destroy primogeniture inheritance, as it would be a better way for individuals to cope with tax on estate income if estates were broken down into smaller parcels inheritable by a larger number of persons—though this does not account for a landowner’s pride in a large estate, or the fact that a parent may not like all his children to an equal degree. Paine revised his opinion on this, as in Agrarian Justice, he advocated death duties of 10 per cent, in general, on every estate. 124 125 126 127 128 129

Paine, n. 113 above, 45. Ibid., 51. Ayer, n. 116 above, 106. Paine, n. 113 above, 49 ff. Ayer, n. 116 above, 107. Ibid., 108.

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Paine then was revolutionary in his proposals. Although he was at root a social contract theorist, he developed this with an economic perspective. In terms of taxes, paying tax for him meant that men had a right to their say in public affairs, and this was not determined by how much each paid. Moreover he took the concept much further than anyone had previously, in that he developed the idea of the benefit (or ‘protection’ in social contract theory terms) that men might expect to receive, by looking at how much money taxes could raise and how it should be spent. This really extended Adam Smith’s analysis of taxes prevailing in his own time, and carried with it ideas of the welfare state. As a concept, it was light years ahead of its time.

X. JEREMY BENTHAM (1748–1832)

Bentham is regarded as one of the ‘founders’ of utilitarianism. He was the son and grandson of lawyers, and though he himself was qualified to practise law he never did so, and devoted much of his life to writing on legal reform. He was influenced by the works of Locke and Hume, and also by the French ‘philosophes’. His influence in France was great: in 1792 he was made an honorary citizen of the French Republic. As Halévy130 notes, Bentham’s moral and political philosophy was founded on three principles: the greatest happiness principle (terminology borrowed from Hume), universal egoism and identification of one’s interests, albeit artificially, with the interests of others. These principles pervade all his work, though they are explicitly set out in the Introduction to the Principles of Morals and Legislation (published in 1789, though first printed in 1780). Bentham’s first work was A Fragment on Government (1776), in which he attacked the legal theory of Sir William Blackstone, particularly the latter’s defence of tradition in law. He also was opposed to other ideas, advocated not only by Blackstone, but also by Locke, such as natural rights, the state of nature, and the ‘social contract’. He held that men had always lived in society, so there could be no such thing as natural rights or a state of nature, such as Locke advocated, and, so, no social contract. Such an idea would entail freedom from restraint, and from all legal restraint. Since a natural right would have to come before any law, it could not be limited by law, ‘and (since human beings are motivated by self interest), if everyone had such freedom, the result would be pure anarchy’.131 To have a meaningful right implies that no on else can interfere with it, so it must be enforceable—and 130 E. Halévy, La Formation du Radicalisme Philosophique (The Growth of Philosophic Radicalism) (trans. M. Morris, Faber & Faber, London, 1972). 131 The Internet Encyclopedia of Philosophy. Jeremy Bentham (1748-1832), available at www.utm.edu/research/iep/b/bentham.htm.

The Concept of Taxation and the Age of Enlightenment 281 this is the province of the law.132 The law protects the interest of the individual—and, by extension, his economic interest and his personal goods and property. To do so, however, it must have enforcers, and these have to be paid for—by taxation. This gives the government the right to interfere with property, as taxation is raised by reference to property—so for Bentham there can be no absolute right to property.133 Bentham’s thoughts on taxation are summarised by Dome,134 whose analysis is followed here. As with many of Bentham’s views on various subjects, his thoughts on taxation are spread out over several different works, including Proposal for a Mode of Taxation (1794), Supply without Burden, or Escheat vice Taxation (1794) and A Protest Against Law-Taxes (1793). Other ideas may be found in his Manual of Political Economy (1798), and another pamphlet of similar date entitled Tax with Monopoly. In the Manual of Political Economy (1798), he stated that ‘[t]he natural and only object of taxation is revenue’.135 He was opposed to enforcing frugality to increase national wealth: a man should be able to make his own choice whether to spend or save without government interference. Any tax should be imposed only to raise revenue, and should be spent on ‘security, subsistence, and enjoyment of the public’.136 However, imposing tax means that taxpayers will have reduced means, and therefore less prospect of enjoyment. Thus Bentham’s criteria for taxation are derived from his utilitarian principles—to obtain revenue, but as painlessly as possible. First object of finance—to find the money without constraint—without making any person experience the pain of loss and of privation. Second object—to take care that this pain of constraint and privation be reduced to the lowest term. Third object—to avoid giving rise to evils necessary to the obligation of paying the tax.137

These principles permeate Bentham’s proposals for tax reform. In Supply without Burden, or Escheat vice Taxation (1794), Bentham proposed to Charles Long (Pitt’s Co-Secretary to the Treasury) a new law to raise revenue without imposing a burden on the populace.138 It was an extension of the escheat law. The current law applied only to landed property that was 132 G.I. Molivas, ‘A Right, Utility and the Definition of Liberty as a Negative Idea: Richard Hey and the Benthamite Conception of Liberty’ (1999) 25 History of European Ideas 75. 133 J. Steintrager, Bentham (George Allen & Unwin, London, 1977) 69. 134 T. Dome, ‘Bentham and J.S. Mill on Tax Reform’ (1999) 11 Utilitas 310. 135 J. Bentham, ‘Manual of Political Economy’ in W. Stark (ed.), Jeremy Bentham’s Economic Writings (George Allen & Unwin, London, 1952) i, 257. 136 Dome, n. 34 above, 321. 137 J. Bentham, ‘General View of a Complete Code of Laws’ in Stark, n. 135 above, iii, 204, cited by Dome, n. 134 above, 321. 138 Ibid., 322.

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left without an heir. Bentham proposed that the state should confiscate all such property in cases of intestacy with no marriage-prohibited relations; that the state should take a half of intestate property in the case of collateral inheritance; that parents could will only half of their property to their successors; and that the property to be restored to the public be sold at public auction to raise money. As one would not normally expect to inherit except from a parent, then this would cause minimum disappointment, or least sacrifice of enjoyment. As Bentham was not a believer in natural rights, the suggestion that such a law might violate the natural rights of inheritors would have no validity. His philosophy actually provided a way round this, in any event. As rights could be granted only by the law, if the law states that a certain proportion of property belongs to the state, then a beneficiary will not feel pain, because he would not be losing any of what he was entitled to inherit: there could only be pain if that to which he was entitled was invalidly taken away. The income brought in by this new law could be used for a variety of purposes—to reduce the capital element of the national debt, to pay interest on the national debt, and to abolish burdensome taxes.139 In this last category were taxes on law proceedings and on medicines, window tax, soap tax and salt tax,140 which reduce utility because they obstruct justice, good health and sanitation, and cause more oppression to the poor than the rich. Bentham also felt that the new law would reduce ‘litigation concerning inheritances, promote marriage, and raise asset prices’141—and so, people might feel better. The new law thus aimed to raise tax without reducing utility, and could increase it. The condition of the poor would be improved in comparison with the rich, so from this perspective, it would also have a redistributive effect. Other measures were proposed by Bentham in his pamphlet entitled Proposal for a Mode of Taxation (1794). In this, his idea was to redress the balance between landowners, who bore a considerable tax burden in the form of land tax, and the commercial classes, who paid none at all on income such as interest received from loans, government and personal annuities, joint stock company dividends, and profits from trade and professional incomes. To address this Bentham divided income into two sorts. The first comprised income from property, for example, rent from land, interest received on loans, government and personal annuities and dividends paid by joint stock companies. The second comprised income such as trade profits and professional incomes, which Bentham regarded as having more uncertainty attached. He classified income as temporary or perpetual. Perpetual income could be passed on from generation to generation (for instance, rent). He proposed to tax income received on a graduated basis above a subsistence 139 140

Ibid., 323. J. Bentham, ‘Supply without Burden or Escheat vice Taxation’ in Stark, n. 135 above, i,

300. 141

Dome, n. 134 above, 323.

The Concept of Taxation and the Age of Enlightenment 283 level. He considered the profits of bankers and stock dealers taxable under this scheme, and offered them, by way of ‘exchange’ a licence arrangement to limit access to their profession,142 although this could possibly create a monopoly, of which he did not approve. Bentham also set out his preferred order of taxes. Indirect taxes were more desirable than direct ones, because a man could choose not to buy a product on which a tax had been imposed. This is certainly true of taxes on luxury goods, of which Bentham approved, but not of taxes on necessities, which he considered oppressive. Direct taxes, in the form of his escheat tax and then on profits with indemnity, were best of all, though there was less of a choice in managing it. Although Bentham was not explicit about this, it is certainly inherent in the way he speaks of taxes across several different works. The worst tax, frequently condemned by Bentham, was a tax imposed on law proceedings, as it was a tax on the distress of individuals. It should be abolished, together with taxes on medicines, on insurance against disaster, on contracts, and on the media of (political) information, such as on newspapers.143 Bentham’s contribution to tax theory was substantial. He enshrined in his philosophy the idea that a tax can only be imposed by law, moving far away from the social contract theorists, who accepted that tax was something paid in return for protection from the state—a voluntary alienation of rights. He did not accept that rights could exist unless granted by law, so he had a diametrically opposed starting point for his philosophy. He had almost made his utilitarian tax philosophy out of Adam Smith’s fourth canon—efficiency. If tax is conceived of along the lines of least sacrifice/maximum utility, then one does not need any other criteria. However, this concept is predicated on human behaviour proceeding along this particular philosophical path, and while Bentham is consistent in all aspects of his moral, political and economic philosophy, it is, again, an idealised approach.

XI. CONCLUSION

The theorists considered here have had an immense influence on the way their own and subsequent generations have considered politics, economics and the law. In terms of the development of tax theory, some views have become more dominant than others. That the issues they address are still current is borne out by the recently reported case where seven Quakers are challenging the government’s right to spend the taxes paid by peace campaigners on war and the arms trade,144 claiming that this is in breach of Article 9 of the European Human Rights Convention—a different twist on an old theme. 142

Ibid., 325. Ibid., 328. 144 J. Bennett, ‘Peace Campaign Seeks Right to Withhold Tax’ Accountancy Age, 17 Feb. 2005, 4; D. Harding, ‘Peace Movement’, Accountancy Age, 10 Mar. 2005, 9. 143

Appendix 1: Timeline

John Locke (1632–1704)

Samuel von Pufendorf (1632–1694)

Baruch Spinoza (1632–1677)

William Petty (1623–1676)

Thomas Hobbes (1588–1679)

Voltaire

Joseph Butler

Baron de Montesquieu

George Berkeley (1685–1753)

Anthony Ashley Cooper, Earl of Shaftesbury (1671–1713)

Giambattista Vico (1668–1744)

Jonathan Swift (1667–1745)

Daniel Defoe (1660–1731)

1620s 1630s 1640s 1650s 1660s 1670s 1680s 1690s 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9

Appendix 1: Timeline

Locke

Shaftesbury

Joseph Butler (1692–1752)

James Mill

David Ricardo

Hegel (1770–1831)

Thomas Malthus (1766–1834)

William Cobbett (1763–1835)

Mary Wollstonecraft (1759–1797)

William Blake (1757–1827)

William Godwin (1756–1836)

Jeremy Bentham (1748–1832)

Thomas Jefferson (1743–1826)

Richard Watson (1737–1816)

Thomas Paine (1737–1809)

Edmund Burke (1729–1797)

Immanuel Kant (1723–1804)

Adam Smith (1723–1790)

Denis Diderot (1713–1784)

Jean-Jacques Rousseau (1712–1778)

David Hume (1711–1776)

Samuel Johnson (1709–1784)

Benjamin Franklin (1706–1790)

Francois-Marie Arouet [Voltaire] (1694–1778)

Charles Louis de Secondat, Baron de Montesquieu (1689–1755)

George Berkeley (1685–1753)

Giambattista Vico (1668–1744)

Jonathan Swift (1667–1745)

Daniel Defoe (1660–1731)

1700s 1710s 1720s 1730s 1740s 1750s 1760s 1770s 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9

Mary Wollstonecraft (1759–1797)

William Hazlitt (1778–1830)

James Mill (1773–1836)

David Ricardo (1773–1823)

Georg Wilhelm Friedrich Hegel (1770–1831)

Thomas Malthus (1766–1834)

William Cobbett (1763–1835)

William Blake (1757–1827)

William Godwin (1756–1836)

Jeremy Bentham (1748–1832)

Thomas Jefferson (1743–1826)

Richard Watson (1737–1816)

Thomas Paine (1737–1809)

Edmund Burke (1729–1797)

Immanuel Kant (1724–1804)

Adam Smith

Diderot

Johnson

Benjamin Franklin

John Stuart Mill (1806–1873)

Auguste Comte (1798–1857)

1780s 1790s 1800s 1810s 1820s 1830s 1840s 1850s 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7

Appendix 1: Timeline

10 The Abolition of the Taxes on Knowledge LYNNE OATS AND PAULINE SADLER

ABSTRACT When first introduced in 1712, and throughout the eighteenth century, the stamp duty on newspapers was primarily intended as a revenue raiser with censorship as a subsidiary, but not unintended, by-product. In the nineteenth century the stamp duty became known more justifiably as a ‘tax on knowledge’ and it was increasingly criticised as being an overt form of statutory censorship. Efforts to have the tax repealed resulted in a compromise in 1836, with a significant reduction in the duty from 4d to 1d. The stamp duty was eventually repealed in 1855, largely as a result of the activities of ‘The Newspaper Stamp Abolition Committee’ and the findings of the ‘Select Committee on Newspaper Stamps’. The purpose of the paper is to give a brief account of the history of the stamp duty up to 1836 and then to examine the events between 1836 and 1855.

I. INTRODUCTION

T

HE STAMP DUTY on newspapers was introduced in Great Britain in 1712 amid considerable controversy and speculation that it would lead to the demise of a burgeoning press, only recently freed from licensing restrictions and rapidly establishing itself as a powerful social and political force. We have shown elsewhere1 that control of the press was not, however, the prime purpose of the newspaper stamp duty; rather that its introduction was part of a huge revenue-raising exercise to fund the War of Spanish Succession.2 The tax was one of many new taxes introduced at the time including taxes on soap, candles, leather and playing cards. 1

P. Sadler and L. Oats, ‘This Great Crisis in the Republic of Letters’ (2002) BTR 353. In the War of Spanish Succession (1702–1713) England and the Netherlands joined to support the claim of the Archduke Charles of Austria to the Spanish throne. England’s involvement was mainly to prevent a union between France and Spain. The war ended with the Treaty of Utrecht on terms that were very favourable for England. 2

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When first introduced in 1712 the tax was primarily intended as a revenue raiser with censorship as a subsidiary, but not unintended, by–product. This is true also for the subsequent increases made to the tax during the eighteenth century. In the nineteenth century, however, the stamp duty became known more justifiably as a ‘tax on knowledge’ and it was increasingly criticised as being an overt form of statutory censorship.3 Efforts to have the tax repealed resulted in a compromise in 1836, with a significant reduction in the duty from 4d.4 to 1d. The stamp duty was eventually repealed in 1855, largely as a result of the activities of ‘The Newspaper Stamp Abolition Committee’ and the findings of the ‘Select Committee on Newspaper Stamps’. The purpose of this chapter is to give a brief account of the history of the stamp duty up to 1836 and then to examine the events between 1836 and 1855. The latter examination will focus on the tactics of ‘The Newspaper Stamp Abolition Committee’ in the pursuit of repeal of the newspaper stamp, and on the proceedings and findings of the ‘Select Committee on Newspaper Stamps’.

II. BACKGROUND: 1712–1819

The stamp duty on newspapers was initially introduced as part of a wideranging revenue raising effort in 1712 to raise taxes to finance a lottery, the proceeds of which were to be used to fund the military campaign associated with the War of Spanish Succession.5 Its introduction was accompanied by two other taxes, a tax on advertisements, and a new excise duty on blank paper made in England. The stamp duty on advertisement applied irrespective of their length. The one shilling duty was to be paid within 30 days after printing or publication to the Receiver General of the duties on stamped vellum, parchment and paper. The officer was to ‘stamp with the proper Stamp, to be provided for that Purpose, one copy of such Advertisement or Advertisements, or to give a receipt for the Duty or Duties hereby charged upon’. From this it would seem that the one shilling was payable once only, rather than on every copy of the advertisement printed. The penalty for non-compliance, on the printer and publisher, was treble the duties, plus costs. The Act put the onus of paying the duty on advertisements on ‘all and every Person and Persons who shall print or publish, or cause to be printed or published, any Advertisement or Advertisements’.6 3 For references to the stamp duties as being ‘taxes on knowledge’ see, eg, National Archives (NA) IR 56/9: ‘The Memorial of the Newspaper Stamp Abolition Committee’, dated Nov. 1850, and also NA: IR 56/19, letter from Treasury Chambers dated Aug. 1854. 4 4d was the headline rate; a 20% discount was available for papers that did not raise their prices beyond the previous stamp duty increase, so the effective duty was 3¹/5 d. 5 Sadler and Oats, above n.1, 359. 6 10 Anne, c.19, CXVIII.

The Abolition of the Taxes on Knowledge 289 Each of these parties, that is the printer or publisher, claimed it was the responsibility of the other to pay, so enforcement became problematical.7 The tax on advertisements added to the woes of the press. It is thought that the first newspaper advertisement in England, offering a reward for information relating to some stolen horses, was one that appeared in Several Proceedings in Parliament at the end of 1650. By Queen Anne’s time it was a flourishing method of promoting business, and the subject of many advertisements was the sale of port and claret.8 Dowell reports that in 1712 there was an average of nine or ten advertisements in the Daily Courant, but after the Act came into force this paper appeared several times with none. It also appears likely that the tax on advertisements contributed to the suspension of the Spectator in 1712. In Dowell’s view, ‘[a] tax on advertisements in newspapers and periodicals tends to check business, and is, therefore, one of the worst kinds of taxes that can be imposed in a great trading community’.9 The paper excise, imposed on the manufacturers of the paper, was payable by the ream, and varied according to the quality of the paper. An ad valorem tax of 25 per cent had been in place on imported blank paper since 1696,10 but the 1712 Act made the tax on imported paper payable by the ream in line with domestic paper. The heaviest taxes fell on imported paper.11 These three taxes, the newspaper stamp, the advertisement stamp and the tax on paper, were to become known as the taxes on knowledge in the early nineteenth century. In its initial incarnation, the newspaper stamp duty, on which this chapter will focus, was imposed on a sheet of paper (1d.) or a half sheet (1/2d.) and required stamping of the paper prior to printing the newspaper. Payment of the duty was denoted by the embossing of an ornate stamp, in red, in a corner of the sheet or half sheet, clearly visible, presumably so as to allow detection of papers sold without prior payment of the duty. The initial failure to extend the duty to publications comprising more than one sheet or half sheet is consistent with the proposition that a secondary aim of the duty was to suppress small and cheap publications.12 After a period of initial resistance, when newspaper proprietors sought to circumvent the tax by using one and a half sheets of paper, in 1725 the duty was extended to every sheet or half sheet of paper ‘on which any journal, mercury, or other news-paper whatsoever, shall be printed’. Newspapers thenceforth 7 F. Siebert, Freedom of the Press in England 1476–1776 (Urbana Ill, University of Illinois Press, 1965). 8 S. Dowell, A History of Taxation and Taxes in England, (London, Longman, 1888). 9 Ibid., 358. 10 8 & 9 William III c.7. 11 10 Anne c.19, XXXII, XXXVIII. 12 J.M. Thomas, ‘Swift and the Stamp Act of 1712’ (1916) 31 Publications of the Modern Language Association of America 247.

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were generally printed on a half sheet of paper, which, folded in half, presented four pages of news. The procedure by which stamping took place remained essentially the same for the ensuing years until the abolition of the newspaper stamp in 1855, evidence of the enduring nature of fiscal impositions, which, once embedded with appropriate collection and accounting mechanisms, are extraordinarily difficult to displace even in the face of changed circumstances, as we will demonstrate later. The sheets of paper had to be delivered to the Stamp Office, initially located in Lincolns Inn and later Somerset House. Stamps were embossed and the stamped sheets returned for subsequent printing. With the growth of the provincial press over the course of the eighteenth century, the inconvenience of having to have paper stamped in London became progressively more acute, and over time stamp offices were established in Edinburgh, Manchester and Dublin. Meticulous accounting records were maintained by the Stamp Office of the amount of duty paid by each newspaper, by reference to the publisher who was legally liable for the duty. The newspapers stamp duty was viewed from its inception and throughout the eighteenth century as a tax on a luxury item. As late as 1797, when the duty was increased to 31/2d., parliamentary discussion made it clear that it was not in the same class as those bemoaned by Adam Smith as falling on the poor, namely taxes on soap, leather and candles.13 In selecting ‘fit objects of further taxation’ the Prime Minister in 1797 made clear his ‘desire of making them fall as lightly as possible on the great sources of national industry and on the lower orders of people’.14 The increase to 31/2d. was gradual, a halfpenny increase had taken place in 1757, and in 1789 another increase occurred with the addition of a further 1/2d., so that immediately prior to the 1797 increase, the duty stood at 2d. per half sheet. The level of tax reached its peak in 1815, when a final halfpenny increase was imposed to bring the tax to 4d. The Chancellor of the Exchequer had intended imposing an additional tax of 1d. on each sheet in 1815, but met opposition on the basis that it would disadvantage circulation of newspapers. Out of concern for profiteering through proprietors of papers increasing the price of papers beyond the amount of the increased stamp duty, a 20 per cent discount was allowed to those who increased the price of their papers from 61/2d. to 7d. only. The Chancellor suggested that ‘no duty would be more cheerfully paid by the public than an increase of one halfpenny on the price of a newspaper’ as their sale depended ‘almost wholly on the situation of public affairs, and as at the present time, and 13 L. Oats and P. Sadler, ‘Political Suppression or Revenue Raising? Taxing Newspapers During the French Revolutionary War’ (2004) 31 Accounting Historians’ Journal 93. 14 Cobbett’s Parliamentary History of England (Johnson Ltd, New York and London, 1966 reprint), Vol. 33, 1797, col. 423.

The Abolition of the Taxes on Knowledge 291 probably for some years to come, a laudable curiosity would be directed to the events which were passing’. The additional price ‘on the publications through which the public derived their information would not be grudged by the purchasers’.15 Further changes were made in 1819 to the newspaper stamp duty by 60 George III c.9, and for the first time a distinction was made between the publication of news and the publication of remarks on news. ‘The latter, as they were published at frequent intervals and at low prices, had come to be more dreaded [by the government] than the intelligence itself.’16 The intention of the Act was laid down in section 1: Whereas Pamphlets and printed Papers containing Observations upon public Events and Occurrences, tending to excite Hatred and Contempt of the Government and Constitution of these Realms as by Law established, and also vilifying our holy Religion, have lately been published in great Numbers, and at very small prices; and it is expedient that the same should be restrained.17

This was the first time that any Act relating to the stamp duties had made overt reference to ‘restraint’, a word with strong connotations of official censorship. Previously the stated rationale for imposing the regime, or for amending it in some way, was revenue raising. Further by section 1: any pamphlets or papers printed periodically, or in parts or numbers, at intervals not exceeding twenty six days between the publication of any two such pamphlets or papers, parts or numbers, where any of the said pamphlets or papers, parts or numbers respectively, shall not exceed two sheets, or shall be published for sale at less than sixpence, exclusive of the duty by this Act imposed thereon, shall be deemed and taken to be newspapers.

By section 2, a sheet was specified as being not less than 21 inches by 17. In addition, the Act established a security system, under which the printing or publishing of a pamphlet or paper ‘which shall not exceed two sheets, or which shall be published for sale at less than sixpence’ could not proceed ‘without first executing a bond to his Majesty, together with two or three sufficient sureties conditional that such printer or publisher shall pay any fine which may at any time be imposed on him for any blasphemous or seditious libel’.18 There may be some doubt about the censorship purposes of the original 1712 stamp duty on newspapers, but there can be no doubt that this was the main reason for the 1819 changes. ‘It was not against the respectable 15

HC Debs, 26/4/1797 vol. xxxi, col 661 London, (1915). C.D. Collet, History of the Taxes on Knowledge (The Thinkers Library Reprint, London, 1933) 9–10, parenthetical comment added. 17 60 Geo III c.9,1. 18 60 Geo III c.9, VIII. 16

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Press that this Bill was directed, but against a pauper Press, which, administering to the prejudices and passions of a mob, was converted to the basest purposes, which was an utter stranger to the truth, and only set forth a continual stream of falsehood and malignity, its virulence and its mischief heightening as it proceeded.’19 By 1830, the stamp duty on newspapers was 4d.20 a copy and The Times cost 7d.

III. EVASION IN THE 1830 S

There were two groups in London which campaigned in particular for the repeal of the stamp duty on newspapers, these being the heaviest of the ‘taxes on knowledge’: the middle class radicals and the working class radicals. Both believed in the education of the working class and that an untaxed press ‘was central to informal adult education’.21 The prevailing attitude in the political community towards education was that it was dangerous to give the working class aspirations which could not be achieved, that the resultant dissatisfaction would lead to instability in society.22 The middle class radicals approached the campaign for the repeal of the newspaper stamp through Parliamentary motions, aspiring to ‘persuade Ministers that [their repeal] would usher in good government, high revenue, free trade, and social peace’.23 The approach of the working class radicals entailed persistent defiance in the guise of the unstamped press, to the point where the law would become unworkable and therefore have to be changed. Conservative politicians were concerned that removal of the newspaper stamp duty would result in a deluge of seditious papers. Newspaper stamps placed newspapers under the control of respectable men, ‘who for their own sakes, would conduct them in a more respectable manner than was likely to be the result of a pauper management’.24 The middle class radicals were of the view that the availability of cheap newspapers ‘would imbue the working classes with truer notions of orderliness, sobriety and political economy’.25 The working class radicals held a different view, that cheap papers would allow them to establish their own press, to educate the working man as to his rights. During the period from 1829 to 1834 financial reform and tax reduction became prominent issues. Sir Henry Parnell’s Treatise on Financial Reform recommended repeal of taxes on raw materials and those seen as checking 19

Ellenborough, 29 Dec. 1819, HC Debs, 1st ser., vol. xli, col. 1591. In practice 3¹/5 d., above note 4. 21 P. Hollis, The Pauper Press: A Study in Working–Class Radicalism of the 1830s (OUP, Oxford, 1970) 3. 22 Ibid., 5. 23 Ibid., 10, parenthetical comment added. 24 Cresset Pelham, 20 Mar. 1832, HC Debs, 3rd ser., vol. xi, col. 492. 25 Hollis, above n. 21, 11. 20

The Abolition of the Taxes on Knowledge 293 the development of manufacture, together with reductions in duties on spirits and tobacco to reduce the incidence of smuggling.26 The 1830 budget saw the repeal of excise on leather and beer and a resolution to reduce the tax on sugar. In 1831, Lord Althorp proposed a reduction in the tax on newspapers, but he was forced to re–cast the budget and the measure was not adopted. Attention turned to parliamentary reform in 1832, then in 1833 Lord Althorp was asked to explain why the reduction in newspaper stamp duty was not resurrected, to which he responded that he would rather see it repealed than reduced, as the repeal would cost some £440,000 in lost revenue which would be better applied to the reduction of other taxes.27 There were no reductions in newspaper stamp duty in the 1835 budget; in 1836, however, Spring Rice reduced the newspaper stamp duty to 1d.28 According to Dowell:29 Ever since the imposition of the tax on newspapers by the last Tory government of Queen Anne, these necessary vehicles of intelligence had proved, in war times, when an increase in the business occurred, an inviting subject for further taxation. The newspaper bore the traces of the various wars in which we had been engaged, as a shield bears the divits of the conflicts in which it has been used—Legge’s additional stamp in the Seven Years’ War, Norths, of the War of American Independence, and a third, due to the great war with France. North and Pitt treated the newspaper as an article of luxury, to be taxed accordingly. But opinions had now altered. Althorp had only abstained from renewing, in 1833, the proposal to reduce the duty originally embodied in his budget of 1831, because he considered the tax should be abolished. It now stood first in the Whig list of taxes to be repealed . . . the tax on intelligence was reduced at a loss to the revenue of £300,000.

The reduction of the tax to 1d. stalled the movement for its complete abolition. 1d. was an amount that ‘privileged’ newspapers such as The Times could absorb, but, together with the draconian penalties for non-compliance, weighed heavily against cheaper newspapers.30 Even with the tax as low as 1d., no proprietor could afford to publish a paper and sell it at a price that the poor could afford. The alternatives were either to sell cheaply without a stamp and face prosecution, or to stamp the paper and raise the price out of the range of the intended reader. Lord Brougham, one of the founders of the Edinburgh Review and whose legal career included the defence of Queen Caroline in 1820, strongly supported the repeal and denounced the last penny as the worst penny of the four. Mr Hickson, an educationist who 26 27 28 29 30

Dowell, above n. 8, 288–289. Ibid., 298. 6 & 7 Will IV c.76. Dowell, above n. 8, 298. Collet, above n. 16, 28–31.

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had been associated with the Hand Loom Inquiry Commission and an active member of Brougham’s abolition campaign, later said31 that in his view the government was ‘afraid of the possibility of a more strongly developed democratic tendency in an absolutely free press’ and so reduced the duty rather than repealing it entirely.

IV. THE NEWSPAPER STAMP AFTER 1836

When the newspaper stamp was reduced to 1d. in 1836 the name of the newspaper was included in the stamp die. Initially some 344 papers had these distinctive dies. The Stamp Office owned the dies, but individual newspapers paid for ‘a moveable section expressing its title, which is inserted in the die for the occasion’.32 This allowed the Stamp Office to withhold stamps where there was a failure to pay advertisement duty, and in this way the two taxes provided a measure of cross-checking against each other. This was only practicable because both were administered by the same body, initially the Office of Stamps and Taxes, absorbed into Inland Revenue in 1848.33 At this time also free postage was allowed to stamped newspapers, the upshot of which was an enormous increase in the volume of papers requiring stamping. Following the reduction in duty, for example, The Times, whose circulation had been steady at around 10,000 copies per annum, began to increase significantly, until by 1855 it had reached almost 60,000.34 The reduction in price consequent on the reduction in the duty also contributed to this increase, although ‘the proprietors, rather than the public, gained, for the price to readers was revised from 7d. to 5d. only’.35 Some organisations sought to circumvent the remaining 1d. tax by having their publications printed in the Isle of Man where they were free, not only of the newspaper stamp, but also other related taxes such as advertisement duty, and then entitled by agreement to free postage throughout mainland Britain. The legislative response to this activity, on 4 September 1848, was an Act granting the Postmaster General discretionary power to charge newspapers from the Isle of Man and the Channel Islands postage at a rate not exceeding that applying to letters.36 31 In evidence to the Select Committee on Newspapers, Select Committee Report, British Parliamentary Papers, (Irish University Press, Shannon, 1971), 464. 32 NA: IR56/46 Reply by the Inland Revenue to a letter from the General Post Office seeking advice as to how to respond to a request from the Postmaster General of Bengal for information on the operation of newspaper stamp duty. 33 H. Dagnall Creating a Good Impression (London, HMSO 1994) 38. 34 O. Woods and J. Bishop, The Story of the Times (London, Michael Joseph, 1983) 55. 35 S. Morison, The English Newspaper, (CUP, London, 1961) 217. 36 J. Belchelm, ‘The Neglected “Unstamped”: The Manx Pauper Press of the 1840s’ (1992) 24 Albion 605. For further evidence of this practice, see the evidence of Mr Cassell before the Select Committee, above n. 31, 214.

The Abolition of the Taxes on Knowledge 295 As noted earlier, the paper had to be stamped before printing took place. Steam power was used to drive the embossing presses for stamps other than newspaper stamps, but so far attempts to adapt a steam driven process for the newspaper stamps had proved unsuccessful, primarily due to the large size of the sheets of paper. These were extremely unwieldy, as a consequence of successive increases in the amount of newspaper stamp duty payable, which forced newspapers to increase the size of sheets rather than use additional sheets which would attract additional duty. In 1852 success in the use of steam presses for stamping newspapers was finally achieved, and the machines were operated by boys as young as 8. At this time only Somerset House employed steam presses; other offices at which newspapers were stamped (Manchester, Edinburgh and Dublin) continued to use the hand stamping process which had been introduced in 1831.37 Evidence of the benevolence extended to the boys operating the steam presses is found in a letter to the Board of Inland Revenue in 1859 which recounts the emergence of the Boys Fund, created from the sale of surplus materials from the Stamp Office, for example wrappers and string in which paper reams arrived but not required for the return journey. The fund was used for such things as the establishment of a lending library and an excursion to Crystal Palace.38 Spoiled newspaper stamps were ‘allowed’ at the stamp office—that is, replaced by other stamps. In cases where the quantities were very bulky, however, there was ‘an arrangement by which an Excise Officer attends periodically at the Newspaper Offices and cuts off the stamped corners of the spoiled sheets, and upon his producing these stamps at the allowances office a warrant is granted for the supply of an equal number of new impressions’.39 By 1853, there were 966 newspapers with distinctive dies containing the name of the newspapers. The proprietors of The Times complained that the sheets were coming back from the Stamp Office damaged, for example with bent corners, in such a way that they could not be put through the highspeed printing presses. They put forward the suggestion that the stamp could be printed at the same time as the paper by having a die incorporated in the type frame. The Stamp Office agreed, and from 1853 the stamp for The Times was printed in black and was of a different design from the one used by the Stamp Office. ‘A locked recording device on the press registered the number of impressions that the die made and the Stamp Office accepted this figure when assessing the duty.’40 37

Dagnall, above n. 33, 38. Reproduced in ibid., 96. NA: IR56/46: 46 Reply by the Inland Revenue to a letter from the General Post Office seeking advice as to how to respond to a request from the Postmaster General of Bengal for information on the operation of newspaper stamp duty. 40 Dagnall, above n. 33, 39. 38 39

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V. THE CAMPAIGN FOR THE ABOLITION OF THE NEWSPAPER STAMP

The People’s Charter Union was formed in London in April 1848, at a meeting attended by about 100 people. Many of the founding Council members had already been involved in the National Association, the latter growing out of the Working Men’s Association in 1841. In March 1849 The People’s Charter Union formed a separate and independent committee called The Newspaper Stamp Abolition Committee, and this eventually evolved into the Association for the Repeal of the Taxes on Knowledge with the sole aim of lobbying for the repeal of the ‘Taxes on Knowledge’. It was largely due to the efforts of this group that the newspaper stamp was repealed. The Council of the People’s Charter Union initially comprised Richard Moore, William Addiscott, John Bainbridge, Henry Hetherington, George Jacob Holyoake, James Hoppey, Joseph Hyde, Henry Mitchell, James Watson, Thomas Wilson and the indefatigable Collet Dobson Collet. The Newspaper Stamp Abolition Committee (the Abolition Committee) included Messrs Addiscott, Bainbridge, Donatty, Hetherington, Hoppey, Hyde, McGuinness, Moore with Collet Dobson Collet as secretary, Francis Place as treasurer and James Watson as sub-treasurer.41 This was not the first time that an association had been formed with the purpose of abolishing the newspaper stamp. An earlier society was formed in 1835, with Francis Place as Treasurer, and presented 300 petitions to Parliament advocating repeal, but in the event Parliament compromised by reducing the tax to 1d. in 1836.42 As noted earlier, this took the steam out of the abolition movement for some years as other, more pressing, radical causes, occupied the minds of reformers. These causes included universal (male) suffrage, centring on the adoption of ‘The People’s Charter’ (a draft Act of Parliament), and the repeal of the Corn Laws. In general the middle classes supported the latter while the working classes supported the former, on the basis that with the attainment of the right to vote they could bring about the repeal of the Corn Laws. After 1836 the campaigners for the abolition of the newspaper stamp turned their efforts to one or other of these causes. While still being advocates for freedom of press, they lost some of their fervour, seeing it as somewhat of a lost cause, and there were very few references to the newspaper stamp in Parliament during the years 1836 to 1849. The Corn Laws were repealed in 1846, but the various Chartist associations continued with increased vigour.43 The Abolition Committee reinvigorated the campaign to repeal the newspaper stamp, and this campaign gathered impetus from 1850. One 41 42 43

Collet, above n. 16, 43, 46, 48. Ibid., 25–29. Ibid., 37–39, 42–43.

The Abolition of the Taxes on Knowledge 297 tactic was to lobby Parliament on a regular basis. Petitions would be presented to Parliament, and sympathetic members of the Commons were persuaded to promote the cause actively.44 As mentioned earlier, the taxes on knowledge in fact consisted of three separate taxes. The newspaper stamp duty was the most well known and the most criticised, and it was the one usually referred to as the tax on knowledge. However, as well as the newspaper stamp there was a tax on advertisements, a chief source of profit for newspapers, and a tax on the paper itself. The year to March 1850 raised the following duties: Advertisements Stamp Paper

£168,162 £356,969 £915,121 £1,440,25245

For the members of the Abolition Committee, dedicated to the removal of all three taxes but primarily focused on the newspaper stamp, it was a matter of deciding which tax should go first. They were not alone in seeking reform of the taxes. In1849 a committee for the repeal of the advertisement tax was formed by newspaper proprietors, and at about the same time a deputation of paper manufacturers and publishers met the Prime Minister, Lord John Russell, seeking review of the paper duty. In 1850, when there were three associations, a motion for the repeal of the taxes on knowledge was put before Parliament, but this failed when Parliament refused to grant an increase in other taxes, thus making a decrease elsewhere impossible. Individual motions to remove each tax separately were also lost. At the same time other campaigners were targeting the window tax and the brick tax and ‘few of those who demanded the repeal of one tax ventured on the defence of another’.46 The Abolition Committee was well aware that the newspaper stamp was not the only tax responsible for social injustice. The Abolition Committee extended its influence by sending out information to most of the stamped newspapers in the United Kingdom, and to the London class publications.47 It had district secretaries in the provinces and promoted its cause widely.48 By way of example, the following two advertisements appeared on the front page of The War Telegraph, a Scottish paper, on 22 November 1854, in amongst advertisements for a Wages Calculator, a Cure for Consumption and Winter Top Coats: 44

Ibid., 58–59. Ibid., 56. 46 Ibid., 58–59. 47 Class publications were publications that confined their content to a single subject matter, for example ‘police intelligence containing only reports before Magistrates’: NA: IR56/22 ‘Case’, 4. 48 Collet, above n. 16, 53. 45

298

Lynne Oats and Pauline Sadler THE TAXES ON KNOWLEDGE A SOCIEITY in aid of the ‘ASSOCIATION FOR PROMOTING THE REPEAL OF THE TAXES ON KNOWLEDGE’ is now being formed in Scotland. The more immediate object of the Association is the Abolition of the Newspaper Stamp. Gentlemen desirous of becoming members are requested to forward their names to the Local Secretary J.W. Finlay 47 King Street, Edinburgh. PROSECUTION OF UNSTAMPED PUBLICATIONS ALL PUBLISHERS interfered with by the Stamp Office, are requested to communicate with C. Dobson Collet, Secretary to the ‘Association for Promoting the Repeal of the Taxes on Knowledge’ 10 Ampton Place, London.

Another tactic employed by the Abolition Committee was to encourage supporters, including newspaper editors and friends, to harass the Board of Inland Revenue regarding the inconsistent way in which the 1836 Act was enforced. Collet commented: ‘the idea of enforcing the law that we wished to get repealed was, to some of us, new, and even revolting’. Works published by members of the Abolition Committee were not exempted from this practice.49 The long-suffering solicitor of the Inland Revenue, Mr Timm, was the frequent recipient of communications, pointing out that certain newspapers were flouting the law by not being stamped, and asking why no action was being taken against them. These communications came not only at the instigation of the Abolition Committee, but also from the proprietors of newspapers that were paying the stamp duty.50 The Abolition Committee also took it upon itself, rather mischievously, to write letters to newspaper publishers warning them when their activities fell outside the law.51 The penalties imposed by the 1836 Act52 were often sufficient to make a publisher give in to a warning letter from Mr Timm, and to publish later editions with the stamp. Such an example was The War Telegraph, which was printed in Edinburgh as an unstamped paper until the Board of Inland Revenue challenged its status in late 1854. The proprietor bowed to pressure and agreed to The War Telegraph becoming a stamped paper with effect from 22 November 1854. On that day, a lengthy explanatory statement was published on the second page of the paper (the first page being taken up by advertisements as was common practice at the time), announcing that the paper could no longer be published unstamped on account of a notification from the Board of Inland Revenue ‘that it is their intention to 49 50 51 52

Ibid., 60–61. Ibid., 53. Ibid., 120. Including a £20 per sheet fine for each sheet unstamped.

The Abolition of the Taxes on Knowledge 299 put in force the summary power conferred upon them by the Stamp Act’ which would enable them to stop the publication. On the occasion of its change to a stamped publication, The War Telegraph, changed its name to The Northern Telegraph which the editor hoped would ‘form an epoch in the newspaper literature in Scotland, as the publication of The War Telegraph has already done in the history of the newspaper stamp’. Contained within a file of documents now held in the National Archives is a copy of a letter from the Edinburgh office of the Inland Revenue to Mr Keogh, the Assistant Secretary to the Board, confirming that as long as the publisher started to publish on stamped paper, prosecution for publishing on unstamped paper would not proceed:53 Inland Revenue Edinburgh, 23 November 1854 To Thomas Keogh esq Etc etc, London. Sir, On receipt of your official letter of the 20th instant, I addressed a communication to the Publisher of ‘The War Telegraph’ who at once, expressed his readiness to have his paper registered as a Newspaper, and printed on stamps. On the following day he intimated to his readers that it was his intention to bow to the decision of the Board. It happened, fortunately, that a distinctive die had been ordered and received some time ago, so that the necessary forms having been completed, and the requisite quantity of paper stamped and delivered out during the course of the day, The War Telegraph, of this morning, appeared, for the first time, as a stamped newspaper. Copies of the impression of the 22nd and 23rd instant accompany this letter. As I have not received any written answer to my letter of the 21st instant, I have not deemed it expedient to address any letter to the publisher of The War Telegraph in reference to the suit in Exchequer. But I have sent a verbal message requesting him to call here, and should he come, I shall explain to him, that should he continue to print his paper on stamps, the proceedings in Exchequer will not be continued against him. I have the honour to be, Sir, Your most obt servant

One of the causes of the inconsistency in enforcing the 1836 Act was the ambiguous way in which it had been drafted. Under the 1819 Act a publication was deemed to be a newspaper if it was published at intervals not 53

NA: IR56/21.

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exceeding 26 days between editions, if it did not exceed two sheets, defined by size, or if it cost less than 6d., exclusive of the duty.54 Prior to this the stamp duty applied simply to ‘all Books and Papers commonly called Pamphlets, and for and upon all News Papers, or Papers containing publick News, Intelligence or Occurrences, which shall . . . be printed in Great Britain, to be dispersed and made publick . . .’.55 The 1836 Act specifically repealed all previous legislation relating to stamp duty, and stated that the duty payable was as per the amounts set out in Schedule (A.) of the Act.56 Instead of keeping the application of the duty simple, Schedule (A.), after setting out the amounts of the duties, included some deeming clauses regarding the definition of newspapers chargeable with the duties. The first of these clauses read: ‘[a]ny Paper containing public News, Intelligence, or Occurrences printed in any part of the United Kingdom to be dispersed and made public’. This took the definition back to the pre-1819 Act when newspapers were not defined in terms of periodicity, size or cost. The second clause related to publications containing only, or principally, advertisements and did not appear to give rise to concern. It was the third clause from which most confusion arose. For some inexplicable reason, and apparently in direct contradiction of the first clause, the third of the 1836 clauses reinstated the 1819 requirements in respect of periodicity, size or cost. As evidenced by the way warnings to, and prosecutions of, newspapers ensued after 1836, Mr Timm clearly did not take the third clause to have any effect on the first, a matter that was open to legal challenge. In his view, as expressed to the Select Committee57 the third definition ‘renders liable publications containing remarks or observations on news, not news substantially’. A long drawn out prosecution on this matter was that of the Household Narrative of Current Events edited by Charles Dickens. The Household Narrative was a monthly publication, and it was partly unstamped. Under the definition in the first clause, it was obviously a newspaper; under the definition in the third clause, it was not because it was published at intervals exceeding 26 days. It seems the prosecution was initiated in 1850 and the case was still pending in 1851. It was mentioned in the written record of a deputation to Prime Minister, led by Mr Joseph Hume: ‘I hope Dickens will press on the decision in his case; and then we must have a great meeting on the subject. It cannot—must not sleep’.58 The decision was eventually handed down in December 1851. The Court of Exchequer, by a three to one majority, Martin B, Platt B, Pollock CB, with Parke B dissenting, found for the defendant. The judges in the majority stated that the ‘language adopted in the Schedule . . . is calculated to raise some doubt’ and ‘the question is 54 55 56 57 58

60 Geo III c.9, I. 10 Anne c.19, 1. 6 & 7 Will IV c.76, I, XXXII. Schedule (A.) to the Act is reproduced in Appendix A. Select Committee Report, above n. 31, 9. Collet, above n. 16, 61, 64, 80. The case is A–G v Bradbury & Evans (1853) 7 Ex 97.

The Abolition of the Taxes on Knowledge 301 not free from doubt’,59 but their Lordships decided that the construction of the statute meant that the third clause in the Schedule limited the first, and no new taxes were introduced by the 1836 Act. Parke B said: ‘by its very title the statute of Will. 4 is an Act to “reduce” the duties on newspapers; and its preamble recites that it is expedient to “reduce” them. It must therefore be taken that no new duty was imposed . . .’.60 As a consequence of the decision, monthly periodicals were removed from the stamp duty net. In Collet’s view ‘[t]hey forgot that the reduction of the duty from 3 1/4 [sic] to 1d. was not inconsistent with the extension of the penny duty to a new class of papers’.61 As far as the Abolition Committee was concerned, the verdict ‘neither elated nor depressed us. It gave a start, indeed, to monthly unstamped publications, but a conviction would have destroyed the Stamp all the sooner’.62 The question was one which exercised the Select Committee, the proceedings of which pre–dated the decision and which is considered in the next section. VI. THE SELECT COMMITTEE ON NEWSPAPER STAMPS

In March 1851 Lord Brougham presented a petition to the House of Commons from the Committee of Management of the Whittington Club and Metropolitan Athenaeum in the Strand, praying for the abolition of the stamp duty on newspapers, the advertisement duty and the excise duty on paper. Lord Brougham said that the reduction of the stamp duty to 1d. had proved advantageous to the middle and higher classes as well as to newspaper proprietors, however the 1d. stamp was just as large a barrier to the peasantry as the 3d. stamp had been. If the 1d. were to be removed, ‘valuable information of a practical character for the agricultural classes could be wrapped up together with general and local news, [and] a salutary stimulus would be given to popular instruction’.63 The Select Committee on Newspaper Stamps was established in April 1851 under the chairmanship of Mr Milner–Gibson, at the invitation of Lord John Russell and on the strength of a deputation of Members of Parliament rather than a motion to the House of Commons.64 Over the course of the period from 2 May 1851 to 20 June 1851, the Committee examined a variety of witnesses including officers from the Board of Inland Revenue as well as newspaper proprietors and distributors. The Committee probed a number of different aspects of the practical application of the newspaper stamp duty, as well as the implications of its abolition. One key 59 60 61 62 63 64

Ibid., per Platt B, at 106, and per Parke B, at 120 respectively. Ibid., per Parke B, 120–121. Collet, above n. 16, 83. Ibid., 83. HC Debs, 21 March 1851, vol. cx, col. 1206–7. Collet, above n. 16, 61, 64, 80.

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recurring issue was the whole question of determining what came within the ambit of the duty, with markedly different interpretations of extant practice being expressed by different witnesses. The solicitor to the Inland Revenue, Mr Timm, and the Assistant Secretary to the Inland Revenue, Mr Keogh, both attempted to explain the approach of the Board of the Inland Revenue towards enforcement, which was clearly not uniform. The Board chose not to interfere, on the whole, with what it called ‘class publications’, being those addressed to one particular subject where only small items of public news were included. Mr Timm suggested that it would be difficult to get a jury to say they were newspapers, and since they did not serve the purpose of newspapers generally, refrained from taking action against them. The general view of other witnesses on the issue of class papers, however, was that such papers had received some form of permission to publish without stamps, and that registration as newspapers entitled them to publish a portion of their print run on stamped paper so as to obtain free passage through the postal system. Certainly this was the view of Mr W.H. Smith.65 Mr Cassell, publisher of the Freeholder, a monthly publication and the organ of the freehold land movement, said that he had availed himself ‘like many others, of the penny stamp for the facilities of transmission through the post’.66 No express permission had been received for this; however having received a warning that he exposed himself to penalties, he interpreted the subsequent failure of the Board to follow up as approval to continue this practice, unlike the publishers of The War Telegraph. Publishers seemed to be aware of the treatment given by the Inland Revenue to their fellows. Mr Collet objected to this practice, interpreting the failure of the Inland Revenue to prosecute as favouritism leading to inequity between different publishers.67 He conceded, however, that the question was not one of the Inland Revenue giving false certification to publishers to obtain stamped paper, but rather the publishers obtaining such certification under false pretences.68 In Collet’s view, ‘if the law cannot bear the decision of the jury, and if the law officers will not enforce it, it ought to be altered’.69 The law should therefore be enforced or repealed. Another issue examined by the Committee was the position of monthly publications. Witnesses were aware of the case of Dickens’ Household Narrative being before the court. Mr Cassell said that he though the Inland Revenue had selected it as a test case in order to settle the question whether monthly publications could be liable for stamp duty.70 He stated that if the 65 66 67 68 69 70

Select Committee Report, above n. 31, 428. Ibid., 207. Ibid., 124. Ibid., 125. Ibid., 127. Ibid., 209.

The Abolition of the Taxes on Knowledge 303 decision went against Dickens, then publishers of monthly periodicals would have to decide whether to discontinue.71 In correspondence with the Inland Revenue, Mr Cassell had mentioned Dickens as part of his own defence. ‘I thought it would at once be inferred that an individual like Charles Dickens would not go recklessly to break the law; and I was labouring under the same impression’.72 Collet73 said that the Inland Revenue should have proceeded against all the publications of Bradbury and Evans, who apparently published four registered newspapers of which they stamped only a portion, Punch, the Lady’s Companion, the Household Narrative and Household Words. The Committee also questioned the extent to which the newspapers stamp duty inhibited the diffusion of knowledge amongst the working class. Hunt, when questioned about the educational effect of newspapers, responded ‘I think the law and police reports for instance, in a newspaper, offer almost the only chance that an uneducated man has of learning what the law is’.74 On whether the working classes reviled the newspaper stamp, Mr Bunting, of the Norwich Reformer, said ‘the professed efforts of the Government to forward education are laughed at by a great proportion of the working classes on account of their retaining stamps on newspapers’.75 Stamped newspapers were entitled to transmission free of postage as long as they were no more than two ounces in weight. Some witnesses suggested that evasion of postal charges was widespread, with other items being passed off as stamped newspapers. This highlighted the difficulties in the Post Office monitoring, which was felt to be inadequate, although the Post Office denied systematic fraud. The Committee explored the possibility of repealing the newspaper stamp duty and substituting a low postal charge, but were of the view that this would not create surplus revenue.76 In order to provide the Select Committee with evidence of the practice of passing off unstamped papers through the post, Mr Collet arranged for the postage of selected papers to each of the committee members and was able then to confirm in his evidence that no duty or postage had been paid thereon.77 In the final result, the report of the Committee reflected a compromise, but one that nevertheless worked in favour of the Newspaper Stamp Abolition Committee. The report stated:78 How far it may be expedient that this tax should be maintained as a source of revenue, either in its present or any modified form, your Committee do not feel themselves called upon to state; other considerations, not within their province, 71 72 73 74 75 76 77 78

Ibid., Ibid., Ibid., Ibid., Ibid., Ibid., Ibid., Ibid.,

210. 209. 146. 349. 333. xxxviii. 153. xl.

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would enter into that question. But, apart from fiscal considerations, they do not consider that news is in itself a desirable subject for taxation.

VII. REPEAL OF THE DUTY ON ADVERTISEMENTS AND ON NEWSPAPERS

The final, and perhaps most telling, sentence was the one (set out immediately above) added by Mr Cobden as the last amendment to the draft report. Repeal of the newspaper stamp duty did not follow immediately, and the Report of the Select Committee was the subject of considerable comment in ensuing months.79 In April 1852, Mr Milner–Gibson renewed his appeal for the repeal of the stamp duty on newspapers. By this time Mr Disraeli was Chancellor of the Exchequer and the issue came up in conjunction with the 1852 Budget with 100 votes in favour of the repeal and 199 against.80 A change of government intervened and the Abolition Committee were required to put pressure on the new Prime Minster, Mr Gladstone. In 1853 they achieved the goal of repealing the advertisement duty, but the paper duty and newspaper stamp remained in place. The Bill for the repeal of the stamp duty on newspapers was read for the first time on 20 January 1855, and it was finally enacted on 15 June 1855.81 The security system and the tax on paper remained in place, however, for the further attention of the Abolition Committee, whose goals would not be achieved until all the taxes on knowledge had been vanquished.

VIII. CONCLUSION

The reduction of the stamp duty on newspapers from 4d. to 1d. in 1836 slowed down the movement for the repeal of the tax as other pressing social issues engaged the minds of radicals and reformers of the time. The formation of The Newspaper Stamp Abolition Committee in 1849 provided momentum once again in the push for repeal. The increasingly effective tactics of the Abolition Committee, and the influence it had in political circles, gradually wore down resistance to the removal of the tax. The Abolition Committee was instrumental in bringing about the establishment in 1851 of the Select Committee on Newspaper Stamps. The repeal in 1853 of the tax on advertisements, and, more significantly, the repeal of the tax on newspapers in 1855 was a measure of the success of the Abolition Committee in its aim to remove the most infamous of the taxes on knowledge.

79 80 81

Collet, above n. 16, 61, 64, 82. Ibid., 61, 64, 92. 18 & 19 Victoria c.27.

The Abolition of the Taxes on Knowledge 305 APPENDIX

6 & 7 Will IV cap 76: SCHEDULE A Containing the Duties imposed by this Act on Newspapers; (that is to say,) For every sheet or other Piece of Paper whereon any Newspaper shall be printed And where such Sheet or Piece of Paper shall contain on One Side thereof Superficies, exclusive of the Margin of the Letter–press exceeding One thousand five hundred and thirty Inches, and not exceeding Two thousand two hundred and ninety five inches, the additional Duty of And where the same shall contain on One Side thereof a Superficies, exclusive of the Margin of the Letter–press, exceeding Two thousand two hundred and ninety five Inches, the additional Duty of Provided always, that any Sheet or Piece of Paper containing on One Side thereof a Superficies, exclusive of the Margin of the Letter–press, not exceeding Seven Hundred and sixty–five inches, which shall be published with and as a Supplement to any Newspaper chargeable with any of the duties aforesaid, shall be chargeable only with the Duty of And the following shall be deemed and taken to be Newspapers chargeable with the said Duties; viz. Any Paper containing public News, Intelligence, or Occurrences printed in any Part of the United Kingdom to be dispersed and made public: Also any Paper printed in any Part of the United Kingdom weekly or oftener, or at intervals not exceeding Twenty–six Days, containing only or principally Advertisements: And Also any Paper containing any public News, Intelligence, or Occurrences, or any Remarks or Observations thereon, printed in any Part of the United Kingdom for Sale, and published periodically in Parts or Numbers at Intervals not exceeding Twenty–six Days between the Publication of any Two such Papers, Parts or Numbers, where any of the said Papers, Parts or Numbers respectively shall not exceed Two Sheets of the Dimensions herein–after specified, (exclusive of any Cover or Blank Leaf, or

£

s.

d.

0

0

1

0

0

1/ 2

0

0

1

0

0

1/ 2

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any other Leaf upon which any Advertisement or other Notice shall be printed,) or shall be published for Sale for a less Sum than Sixpence, exclusive of the Duty by this Act imposed thereon: Provided always, that no Quantity of Paper less than a Quantity equal to Twenty–one Inches in Length and Seventeen inches in Breadth, in whatever Way or Form the same may be made or may be divided into Leaves, or in whatever Way the same may be printed, shall, with reference to any such Paper, Part or Number as aforesaid, be deemed or taken to be a Sheet of Paper: And provided also, that any of the several Papers herein–before described shall be liable to the Duties of this Act imposed thereon, in whatever Way or Form on the same may be printed or folded, or divided into Leaves or stitched, and whether the same shall be folded, divided or stitched, or not.

EXEMPTIONS

Any Paper called ‘Police Gazette, or Hue and Cry’, published in Great Britain by Authority of the Secretary of State, or in Ireland by the Authority of the Lord Lieutenant. Daily Accounts or Bills of Goods imported and exported, or Warrants or Certificates for the Delivery of Goods, and the Weekly Bills of Mortality, and also Papers containing any Lists of Prices Current, or of the State of the Markets, or any Account of the Arrival, Sailing or other Circumstances relating to Merchant Ships or Vessels, or any other Matter wholly of a Commercial Nature; provided such Bills, Lists or Accounts do not contain any other Matter than what hath been usually comprised therein.

11 The Abolition of Wealth Transfer Taxes in Canada DAVID G DUFF *

ABSTRACT The chapter is an historical analysis of the disappearance of wealth transfer taxes in Canada in the 1970s and 1980s.

I. INTRODUCTION

T

intergenerational transfer of wealth have declined significantly over the last 30 years in most developed countries, particularly in English-speaking countries where these taxes have traditionally taken the form of estate-type taxes based on the net wealth of persons dying while domiciled in the taxing jurisdiction.1 In the United Kingdom, the share of total tax revenue and gross domestic product represented by wealth transfer taxes decreased substantially from 1972 to 2002,2 and calls for the repeal AXES ON THE

* In preparing this chapter I have benefited greatly from excellent research assistance by Doug Robertson, a student entering the second year of the J.D. program me at the University of Toronto Faculty of Law. I am also indebted to the Social Science and Humanities Research Council of Canada for financial support. 1 In contrast to estate-type taxes, inheritance-type taxes apply to amounts received by living beneficiaries resident in the taxing jurisdiction. For the most part, these taxes are combined with taxes on inter vivos gifts, which are generally integrated to a greater or lesser extent with the tax on estates or inheritances. In the United States, eg, the Gift and Estate Tax applies to the cumulative value of gifts and bequests made by each donor. Similarly, a lifetime accessions tax applies to the cumulative value of gifts and inheritances received by individual donees. For an excellent—though now somewhat dated—review of wealth transfer taxes in OECD countries, see OECD, Taxation of Net Wealth, Capital Transfers and Capital Gains of Individuals (Paris, OECD, 1988) at 76–120. 2 See OECD, Revenue Statistics of OECD. Countries, (2003), available at http://hermia. ingentaselect.com/vl=4595239/cl=65/nw=1/rpsv/ij/oecdstats/ 16081099/v55n1/contp1-1.htm (in 1972, estate and gift taxes accounted for 2.3 per cent of total revenues in the UK and 0.7 per cent of gross domestic product; in 2002, these figures were 0.6 per cent and 0.2 per cent respectively).

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of inheritance tax are often heard.3 In the United States, the role of wealth transfer taxes also declined during this period,4 and legislation will phase out the federal gift and estate taxes by the year 2010.5 Wealth transfer taxes have also been abolished in Australia, Canada and New Zealand. Whatever the advantages or disadvantages of these taxes,6 commentators are often puzzled by the apparent political vulnerability of wealth transfer taxes since they generally apply only to a small percentage of substantial estates.7 For some, political opposition to these taxes stems from psychological factors, such as the association between the tax and death,8 or an irrational

3 See, e.g., B. Bracewell-Milnes, Euthanasia for Death Duties: Putting Inheritance Tax Out of its Misery (London, Institute of Economic Affairs, 2002). For alternative arguments, advocating reform of the inheritance tax, see R. Patrick and M. Jacobs, Wealth’s Fair Measure: The Reform of Inheritance Tax (London, Fabian Society, 2003); and D. Maxwell, Fair Dues :Towards a More Progressive Iinheritance Tax (London, Institute for Public Policy Research, 2004). 4 See OECD, above n. 2 (in 1971, wealth transfer taxes accounted for 1.74 per cent of total tax revenues and 0.45 per cent of gross domestic product; in 2001, these figures were 1.25 per cent and 0.36 per cent). 5 Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No. 107–16, § 501, 115 Stat. 38, 69 (2001). The phase-out is accomplished by increasing the exclusion amount and reducing rates between 2002 and 2009, culminating in repeal for the year 2010. Under a sunset provision, however, the legislation providing for this phase-out and repeal is itself repealed after 31 Dec. 2010—resulting in the restoration of the 2002 exclusion amount and rates! For a detailed description of this legislation, see T. J. Klooster, ‘Repeal of the Death Tax? Shoving Aside the Rhetoric to Determine the Consequences of the Economic Growth and Tax Relief Reconciliation Act of 2001’ (2003) 51 Drake L Rev 633. According to one commentator, ‘[t]he fact that there will be two presidential and four congressional elections before the estate tax is fully repealed means that it is possible that the repeal will never happen at all or that the sunset provision will stand and the estate tax will return in 2011’: M. R. Wampler, ‘Repealing the Federal Estate Tax: Death to the Death Tax, or Will Reform Save the Day?’ (2001) 25 Seton Hall LJ 525 at 534. 6 The merits of these taxes are widely disputed. Advocates tend to emphasise their contribution to tax progressivity, their social role to lessen inequalities and unequal opportunities, and their assumed economic superiority to income taxes. See, eg, M. J. Graetz, ‘To Praise the Estate Tax, Not to Bury It’ (1983) 93 Yale LJ 259; E. Rakowski, ‘Transferring Wealth Liberally’ (1996) 51 Tax L Rev 419; and J. A. Pechman, Federal Tax Policy (5th edn., Washington, DC, Brookings Institution, 1987) at 234 (commenting that wealth transfer taxes have ‘less adverse effects on incentives than do income taxes of equal yield’). Critics, on the other hand, condemn their relatively low revenue yield, high collection costs, avoidability, and alleged impact on savings and entrepreneurship. See, eg, R. E. Wagner, Death and Taxes: Some Perspectives on Inheritance, Inequality, and Progressive Taxation (Washington, DC, American Enterprise Institute, 1973); J. C. Dobris, ‘A Brief for the Abolition of All Transfer Taxes’ (1984) 35 Syracuse L rev 1215; E. J. McCaffery, ‘The Uneasy Case for Wealth Transfer Taxation’ (1994) 104 Yale LJ 283; and E. J. McCaffery, ‘The Political Liberal Case Against the Estate Tax’ (1994) 23 Phil & Pub Aff 281. For my own views on wealth transfer taxation, see D.G. Duff, ‘Taxing Inherited Wealth: A Philosophical Argument’ (1993) 6 Can J L & Juris 3. 7 In the UK, eg, it is estimated that only 3.5 to 4 per cent of estates pay any inheritance tax: Maxwell, above n. 3, at 11. In the US, approximately 2 per cent of households are required to pay estate tax: S. Dinan, ‘Senate Republicans Unable to End Estate Tax Before 2010’, The Washington Times, 13 June 2002. 8 See, eg, R. Bird, ‘The Taxation of Personal Wealth in International Perspective’ (1991) 17 Can Pub Pol’y 322 at 330 (pointing to ‘the conjuncture of two events [death and taxes] that few people contemplate with pleasure’).

The Abolition of Wealth Transfer Taxes in Canada 311 optimism on the part of many people that they will actually be subject to the tax.9 For others, it is largely ideological, reflecting a conservative emphasis on individual enterprise and an increased hostility to redistributive taxation.10 Although conservative electoral victories have certainly contributed to the decline of wealth transfer taxes,11 however, more progressive political parties have also been willing to abandon these taxes and have been reluctant to restore them once repealed.12 In addition to these explanations for the decline and repeal of wealth transfer taxes, public choice theory provides an alternative account, emphasising the political costs and benefits of different tax policies and the tendency for electoral competition to promote ‘political efficiency’ in the revenue structures adopted by governments over time.13 To the extent that wealth transfer taxes entail greater political costs and fewer perceived benefits than other tax measures yielding comparable revenue yields, it is not surprising that they might be politically vulnerable. This chapter examines the abolition of wealth transfer taxes in Canada, relying on public choice theories of politically efficient revenue structures to help explain this result. Part 2 outlines the essential elements of this theoretical approach and its implications for tax policy. Part 3 surveys the history of wealth transfer taxes in Canada, examining the events leading up to the repeal of these taxes. Part 4 explains the relevance of public choice theory to the abolition of wealth transfer taxes in Canada and offers brief conclusions on the significance of this experience for the future of wealth transfer taxes in other countries. II. PUBLIC CHOICE THEORY AND TAX POLICY

In the fields of public finance and tax policy, much writing is essentially normative, establishing criteria for an ideal tax structure and evaluating 9

See, eg, Graetz, above n. 6 at 285. See, eg, K.G. Banting, ‘The Politics of Wealth Taxes’ (1991) 17 Can Pub Pol’y 351 at 364. See also E.J. McCaffery, Fair Not Flat: How to Make the Tax System Better and Simpler (Chicago, Ill, University of Chicago Press, 2003) at 66 (suggesting that wealth transfer taxes contradict ‘common-sense morality’). For a detailed study of the relationship between ideological perspectives and wealth transfer taxes in Canada, see L. Philipps, Taxing Inherited Wealth: Ideologies About Property and the Family in Canada, LL.M. Thesis, Osgoode Hall Law School (1992). 11 In the US, eg, Republican control of the Congress and the White House precipitated repeal of the federal estate tax in 2001. Likewise, in Australia, electoral victory by the Liberal Party under Malcolm Fraser preceded the repeal of the federal estate tax effective on 1 July 1979. 12 In Canada, eg, it was the Liberal Party under Prime Minister Pierre Trudeau which repealed the federal gift and estate taxes in 1971, notwithstanding that Trudeau had campaigned and won the 1968 election by promising a ‘Just Society’. Similarly in Australia, Labour Prime Minister Gough Whitlam promised to abolish federal death duties in 1975 in an unsuccessful bid to stay in office. 13 See, eg, W. Hettich and S.L. Winer, Democratic Choice and Taxation: A Theoretical and Empirical Analysis (Cambridge, Cambridge University Press, 1999); and W. I. Gillespie, Tax, Borrow and Spend: Financing Federal Spending in Canada., 1867–1900 (Ottawa, Carleton University Press, 1991). 10

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actual tax regimes against this ideal.14 In contrast, public choice theories of politically efficient revenue structures are largely positive, attempting to explain the kinds of tax structures and tax reforms that actually exist in modern democratic societies.15 For this purpose, it assumes that the main political actors—voters, politicians and political parties, and organised interest groups—act according to their self-interest, subject to various constraints such as those associated with the costs of information and organisation.16 Voters, for example, are assumed to cast their ballots for candidates and political parties whose platforms are expected to maximise their net utility through policies that maximise the benefits that they expect to receive from government expenditures while minimising the costs of taxes that they expect to pay.17 Since the probability of one’s vote affecting the outcome of an election is negligible and information about these policies and their likely consequences takes time and effort to obtain, however, public choice theory predicts that most voters will remain ‘rationally ignorant’ of most policies,18 particularly tax issues that are inherently complex.19 Since the expected benefits of acquiring information are greater where policies touch on one’s most immediate interests, however, voters are likely to devote more

14 This is true of traditional public finance as well as more recent theories of optimal taxation. See, eg, R.A. Musgrave, P.B. Musgrave and R.M. Bird, Public Finance in Theory and Practice (Toronto, McGraw-Hill Ryerson Ltd, 1987); and J.A. Mirrlees, ‘An Exploration in the Theory of Optimum Income Taxation’ (1971) 38 Rev Econ Stud 175. It is also true of much legal tax scholarship, particularly scholarship based on the Haig-Simons concept of income, and the concept of tax expenditures pioneered by Stanley Surrey. See H. C. Simons, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy, (Chicago, Ill, University of Chicago Press, 1938); and S. S. Surrey, Pathways to Tax Reform: The Concept of Tax Expenditures (Cambridge, Mass, Harvard University Press, 1973). 15 Gillespie, above n. 13, at 14–17. Not surprisingly, of course, these positive theories may have normative implications regarding, eg, constitutional arrangements regarding the manner in which revenue decisions are made. See, eg, J.M. Buchanan and G. Tullock, The Calculus of Consent: Logical Foundations of Constitutional Democracy (Ann Arbor, Mich, University of Michigan Press, 1962). See also Gillespie, above n. 16, at 17 (suggesting that ‘a positive model of revenue structure could assist those of us who advise governments on the tax changes that ought to be made’). 16 For a useful introduction to public choice theory, see D.C. Mueller, Public Choice II (Cambridge, Cambridge University Press, 1989). 17 See, eg, Gillespie, above n. 13 at 17 (explaining that political parties in the pursuit of electoral victory attempt to ‘maximize the political benefits from spending and minimize the political costs of financing the spending’). 18 See, eg, A. Downs, An Economic Theory of Democracy (New York, Harper and Row, 1957), chs 11–13. 19 See, eg, D.G. Hartle, ‘Some Analytical, Political and Normative Lessons from Carter’ in W. N. Brooks (ed.), The Quest for Tax Reform (Toronto, Carswell, 1988) at 415 (suggesting that most voters’ perceptions of their own interests are ‘more likely than not, seriously flawed when it comes to the details of the tax structure as a whole’); and Banting, above n. 10 (emphasising that ‘[m]ost voters are not well-informed about the complex world of taxation’ and that ‘[t]here is limited understanding not only of technical language and abstract concepts such as equity, but also of elementary issues such as whether one would benefit from a specific proposal’).

The Abolition of Wealth Transfer Taxes in Canada 313 resources to inform themselves about these measures.20 As a result, affluent individuals and corporations can be expected to be much better informed and well-advised about the taxes they pay and about the tax policies proposed by politicians and political parties.21 Politicians and political parties are assumed to maximise their utility by winning elections,22 which they are more likely to accomplish by adopting platforms that maximise the perceived net utility of the largest number of voters,23 and by promoting their politics and images.24 As economic analysis predicts that a perfectly competitive market tends toward an equilibrium at which economic resources are efficiently allocated, so public choice theory predicts that competition among political parties tends toward a political equilibrium where public policies assume a politically efficient form.25 Interest groups constitute a third group of political actors who are central to public choice theories of political efficiency. Unlike voters and politicians, who are assumed to maximise their own individual utilities, interest groups are assumed to promote the common interests of their members,26 for example by informing members about public policy issues affecting their interests,27 lobbying politicians and political parties in order to obtain policies favourable to members,28 and promoting policies that advance the common interests of members through direct advertising and the mass media.29 Since the organisation and operation of these groups are not costless, however, public choice theory predicts that relatively small numbers of

20 D. G. Hartle, Political Economy of Tax Reform: Six Case Studies, Discussion Paper No. 290 (Ottawa, Economic Council of Canada, 1985) at 25. 21 See, eg, Banting, above n. 10, at 353 (observing that ‘those with a large stake in tax battles inform themselves and equip themselves with a phalanx of professional advisors’). 22 See, eg, Downs, above n. 18 at 28. 23 See, eg, Mueller, above n. 16 at 214 (suggesting that ‘competition for votes between candidates leads them ‘as if by an invisible hand’ to platforms that maximize social welfare’). 24 See the discussion of ‘probabilistic voting’ in ibid. at 196–216. 25 See, eg, Hettich and Winer, above n. 13, at 2; and Gillespie, above n. 13, at 16. See also D. Shaviro, ‘Beyond Public Choice and Public Interest: A Study of the Legislative Process as Illustrated by Tax Legislation in the 1990s’ (1990) 139 U Penn L Rev 1 at 88 (referring to a process of ‘natural selection’ that can play a role notwithstanding the motivations of some politicians or political parties). 26 See, eg, M. Olson, The Logic of Collective Action: Public Goods and the Theory of Groups (Cambridge, Mass, Harvard University Press, 1971) at 5–8. 27 See, eg, D.G. Hartle, The Expenditure Budget Process of the Government of Canada: A Public Choice-Rent Seeking Perspective, Canadian Tax Paper No. 81 (Toronto, Canadian Tax Foundation, 1988) at 62–63 (referring to this as the ‘intelligence function’ of organised interest groups). 28 Ibid., at 61 (observing that this lobbying generally involves the provision of information or funding). See also Mueller, above n. 16 at 205 (noting that interest groups ‘try to increase the welfare of their membership by reducing candidate uncertainty over how their membership votes’). 29 See, eg, Hartle, above n. 27 at 61 (referring to ‘costly publicity campaigns designed to convince tens of thousands of voters to support a desired candidate or party on a desired policy decision’); and Hartle, above n. 28 at 414 (emphasising the ‘capacity of special interest groups to influence the mass media’).

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persons with common interests are more likely to be represented by organised interest groups than large numbers of persons with common interests.30 In the field of tax policy, these considerations suggest that relatively small groups of taxpayers with common interests are much more likely to exercise political influence through organised interest groups than large groups of taxpayers with more diffuse interests.31 Given these assumptions about key political actors, one can readily speculate on the kinds of public policies that can be expected to maximise political efficiency. Since voters are predicted to be better informed about matters that touch on their immediate interests and less knowledgeable about other issues, for example, public choice theory suggests that political efficiency may be achieved by targeting government benefits to groups of voters who are apt to be well-informed about the benefits that they receive while distributing the related costs widely among groups of voters who are less likely to perceive the burdens that they bear.32 The more complex the nature of the specific policy, moreover, the less likely it is that those who bear these costs will perceive the burden, lessening further the political costs of the policy.33 Differential transactions costs and collective action problems suggest a similar strategy for politically efficient public policies, involving the conferral of benefits on selected groups of voters who are well-represented by organised interest groups, and the allocation of related costs among more diffuse groups of voters for whom the financial and organisational barriers to collective political action are much greater.34 With respect to tax policy, public choice theory suggests that a politically efficient revenue structure will minimise the political costs associated with each tax—utilising each revenue source ‘up to the point at which the marginal political cost is equal for all such sources’.35 Over time, moreover, a tendency toward political efficiency suggests that governments will increase and decrease tax rates on specific revenue sources as their relative political costs change, introduce new taxes when the political costs of so doing are less than the political costs from increasing the rate of an existing tax, and repeal old taxes when their political costs exceed those associated with other taxes.36 Other things equal, the political costs of a tax are likely to be larger as administration and compliance costs increase since, the former reduce net revenues (making higher rates or other taxes necessary to maintain the same

30 See, eg, Olson, above n. 26 at 46–52 (describing large unorganised interest groups as ‘latent’ groups). 31 See, eg, Banting, above n. 10, at 353; and Hartle, above n. 19, at 413–415 (emphasising the influence of narrow and special interest groups in tax policy). 32 See, eg, Hartle, above n. 27, at 67. 33 Ibid., at 67–68. 34 Ibid. 35 Gillespie, above n. 13, at 18. 36 Ibid.

The Abolition of Wealth Transfer Taxes in Canada 315 level of expenditure) and the latter increase the effective burden of the tax.37 In contrast, the political costs of a tax are likely to be lower where the number of persons subject to the tax is large since the burden is spread widely and the costs of organised opposition increased.38 The political costs of a tax may also be reduced through concessions for narrow and special interest groups who are generally well-informed about taxes that affect them and already represented by organised interest groups.39 Other important determinants of the political costs of taxes include vertical tax competition (the occupation of the same revenue source by different levels of government in a federal system), horizontal tax competition (the pursuit of mobile revenue sources by different national or sub-national governments), and base elasticity (the extent to which revenues automatically increase with economic growth). In principle, the occupation of a revenue source by one level of government tends to increase the political cost of its imposition by another level of government, since at least some organised opposition to the tax is likely to exist already, the collection of tax by the second government increases the effective rate of the tax, and the first government itself can be expected to oppose the measure.40 Political costs are also high for mobile revenue sources, since those subject to the tax may threaten to or actually relocate these sources to jurisdictions with lower taxes, thereby depriving the higher-tax jurisdiction of revenue and economic activity.41 Base elasticity, on the other hand, decreases the political costs of a tax, since economic growth allows governments to increase spending without having to increase effective tax rates.42 A final factor affecting the political costs of taxes is what W. Irwin Gillespie describes as ‘tax preference’—a preference for one kind of tax versus another notwithstanding that amounts owing under each tax would be identical.43 While different tax preferences might turn on compliance costs

37 Ibid. at 22–23 and 29–30; and Hartle, above n. 27, at 48 and 52 (observing that higher compliance costs ‘can be thought of as an increase in the tax burden’). 38 Gillespie, above n. 13, at 22–23; and Hartle, above n. 27, at 48. As the number of taxpayers affected by an established tax increases, however, political costs can be expected to increase because groups opposing the tax are likely to attract new members: Gillespie, above n. 13, at 22–23. 39 On the politically efficient use of tax concessions, see ibid., at 37–39. 40 Ibid., at 27–28. See also Hartle, above n. 27, at 49 (explaining that governments are likely to oppose occupation of the same revenue source by another level of government because ‘taxpayers may incorrectly assign the “blame” to the “wrong” government; second, taxpayer opposition probably mounts exponentially as effective rates rise on a given base [so that] the political costs of future revenue increases by the “prior” occupant are raised even further; [and] thirdly, with higher tax rates evasion and avoidance becomes increasingly attractive and enforcement costs are raised’). 41 Gillespie, above n. 13, at 28–29. 42 Ibid., at 30. 43 Ibid., at 26 (hypothesising that voters ‘may not be indifferent between two revenue sources, for each of which the tax per dollar’s worth of tax base could be equal for a given taxpayer’).

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or other non-revenue impacts,44 they might also depend on judgements about the appropriateness or fairness of alternative revenue sources.45 As Gillespie explains, a preference for one tax over another ‘could arise because one revenue source is judged by citizens to be the product of their own, meritorious efforts (say, labour income), whereas another revenue source is judged not to be the result of hard work (say, an inheritance, a gift or a lottery win)’.46 Alternatively, he suggests, different tax preferences might exist ‘because one revenue source is judged by taxpayers to have unhealthy, immoral or sinful connotations (expenditures on alcoholic beverages and tobacco products), whereas the connotations of another revenue source are seen as healthy, moral or meritorious (expenditures on milk, footwear and clothing for children and expenditures on charitable donations)’.47 Whatever the reasons for these tax preferences, the political cost to introduce, maintain or increase a tax for which a large number of voters have a lower preference will be greater than the political cost to introduce, maintain or increase a tax for which a large number of voters have a greater tax preference.48

III. THE ABOLITION OF CANADIAN WEALTH TRANSFER TAXES

The specific events leading to the abolition of wealth transfer taxes in Canada began somewhat innocuously with the release of the Report of a Royal Commission on Taxation (the Carter Commission) in February 1967.49 At that time, succession duties were collected in the provinces of British Columbia, Ontario and Quebec, while the federal government collected its own gift and estate taxes—reducing the rate of estate tax in provinces with their own succession duties, and transferring to each other province 75 per cent of estate tax revenues collected within the province.50

44 See, eg, ibid. (suggesting that different tax preferences ‘could arise because verification of one revenue source interferes more directly in the conduct of a citizen’s affairs (say, a direct tax on incomes, compared with an indirect tax on imports)’). 45 Ibid., at 27 (noting that voters may be less politically opposed to taxes that are perceived to be fair than they are to taxes that are perceived to be unfair). 46 Ibid., at 26. 47 Ibid. 48 Ibid. 49 For a useful discussion of the Carter Commission, see L. MacDonald, ‘Why the Carter Commission Had To Be Stopped’ in Brooks, above n. 19, 351 at 351–353. 50 Succession duties were introduced by provincial governments between 1892 and 1903 and by the federal government in 1941. In 1946, most provinces abandoned their succession duties to the federal government in exchange for ‘rental payments’ which were originally 50 per cent of revenues from the federal tax in each province, but were increased to 75 per cent in 1965. A federal estate tax replaced the federal succession duty in 1957. See G.E. Carter, ‘Federal Abandonment of the Estate Tax: The Intergovernmental Fiscal Dimension’ (1973) 21 Can Tax J 232.

The Abolition of Wealth Transfer Taxes in Canada 317 The repeal of these taxes began at the federal level as the federal government responded to the Report of the Carter Commission, and continued at the provincial level as provincial governments responded to federal repeal.

1. Federal Abolition: 1967–1971 Of the many recommendations in the Report of the Carter Commission, the most central was its conclusion that ‘taxes should be allocated according to the changes in the economic power of individuals and families’.51 Emphasising that ‘[t]he first and most essential purpose of taxation is to share the burden of the state fairly among all individuals and families’,52 the Report rejected any distinction among different sources of changes to a taxpayer’s economic power,53 proposing a ‘comprehensive tax base’ according to which ‘all the net gains . . . of each tax unit’ should be subject to tax ‘on an annual basis’.54 Among the implications of this approach, capital gains and losses which were not recognised at the time would be taken into account on an accrual basis irrespective of any sale,55 and gifts and inheritances would be included in the comprehensive tax base for the year in which they were received.56 For administrative reasons, however, the Commission retreated from accrual treatment for capital gains and losses, recommending instead that these gains and losses should be recognised on a realisation basis, as well as when property is transferred by way of gift or on death.57 Since gifts and inheritances would be included in the recipient’s income, however, the Commission also recommended that separate wealth transfer taxes should be repealed.58

51 Royal Commission on Taxation (Carter Commission), Report (Ottawa, Queen’s Printer, 1966), i, at 9. See also ibid., iii, at 39 (suggesting that taxes should be based on ‘the sum of the market value of goods and services consumed or given away in the taxation year by the tax unit, plus the annual change in the market value of the assets held by the unit’). In adopting this approach, the Commission was obviously inspired by the broad definitions of income formulated by US economists Robert Haig and Henry Simons. See R.M. Haig, ‘The Concept of Income—Economic and Legal Aspects’ in R.M. Haig (ed.), The Federal Income Tax (New York, Columbia University Press, 1920) 27 at 59 (defining income as ‘the money value of the net accretion to one’s economic power between two points of time’); and Simons, above n. 14, at 50 (defining personal income as ‘the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and end of the period in question’). 52 Royal Commission on Taxation, above n. 51, i, at 4. 53 Ibid., at 9 (emphasising that if a person ‘obtains increased command over goods and services for his personal satisfaction we do not believe it matters, from the point of view of taxation, whether he earned it through working, gained it through operating a business, received it because he held property, made it by selling property or was given it by a relative’). 54 Ibid., iii, at 39. 55 Ibid. 56 Ibid., at 41. 57 Ibid., at 368–380. 58 Ibid., at 473 and 513.

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While the Commission’s Report was hailed by leading tax academics as ‘a landmark in the annals of taxation’,59 the reaction of business and professional interests and affluent Canadians were overwhelmingly negative.60 Although repeal of wealth transfer taxes and a proposed reduction in the top marginal rate would provide some benefit for affluent individuals, this would be more than offset by the full taxation of capital gains and the inclusion of gifts and inheritances in income.61 At the end of April 1967, then Finance Minister Mitchell Sharp announced a timetable to deal with the Report, inviting comments on the major recommendations by September of that year, and promising a White Paper incorporating the government’s proposals thereafter and draft legislation to be enacted by the end of 1968.62 By autumn 1967, Sharp had received over 1,000 responses, including 150 substantial submissions, mostly from corporations and business and professional organisations, and mostly critical.63 The government’s first official response to the Report came on 30 November 1967, when the Minister of Finance tabled the federal budget. Identifying as common concerns in the submissions that he had received both the uncertain impact of such far-reaching reforms and the need to attract foreign capital, Sharp announced that whatever proposals the government would ‘place before parliament and the public in the form of a White Paper and ultimately in draft legislation’ would ‘undoubtedly be influenced’ by the Report of the Commission, but ‘will be more in the nature of reforms to the existing tax structure rather than the adoption of a radically different approach’.64 In other words, the government would adopt a more piecemeal approach to tax reform, rather than the comprehensive framework adopted by the Commission. Before any more specific proposals could be formulated, however, the government was thrown into turmoil when then Prime Minister Lester Pearson announced his intention 59 A.C. Harberger, ‘A Landmark in the Annals of Taxation’ [1968] Can J Econ, Supplement No. 1, 183–194. See also J. G. Head, ‘Evolution of the Canadian Tax Reform’ (1973) 1 Dalhousie LJ 51 at 52. 60 See, eg, the detailed review in R. Gardner, ‘Tax Reform and Class Interests: The Fate of Progressive Reform, 1967–72’ (1981) 3 Canadian Taxation 245. See also M. Bucovetsky and R. M. Bird, ‘Tax Reform in Canada: A Progress Report’ (1972) 25 Nat Tax J 15 at 17–18; and Head, above n. 59, at 58–59. 61 While the Report estimated that 64 per cent of Canadian taxpayers would pay lower taxes under its proposals, these reductions averaged only about 5 per cent of taxes otherwise payable and were generally limited to taxpayers with incomes of less than $35,000 in 1964. Royal Commission on Taxation, above n. 51, vi, at 62, Table 36–7. In contrast, 27,000 taxpayers with incomes over $35,000 could have expected to pay an additional $1,000 on average, while an estimated 633 individuals with incomes over $300,000 could have expected to pay an average of more than $67,000 in additional taxes: MacDonald, above n. 49, at 360. 62 Hon. M. Sharp, ‘Tax Reform—The Fiscal Context’, Address at Banquet of the Nineteenth Tax Conference, 24-26 Apr. 1967, in Report of Proceedings of the Nineteenth Tax Conference (Toronto, Canadian Tax Foundation, 1967) 471 at 473. 63 Gardner, above n. 60, at 248. 64 Canada, House of Commons Debs, (30 November 1967) at 4906 (Mr. Mitchell Sharp).

The Abolition of Wealth Transfer Taxes in Canada 319 to resign in December 1967 and a leadership race and federal election intervened.65 With a new Liberal government under Prime Minister Pierre Trudeau, the promised White Paper was predictably delayed. In April 1968, the new Finance Minister Edgar Benson announced a change in the government’s tax reform schedule, explaining that major reforms would not be presented until some time in 1969.66 In the interim, however, the government signalled its rejection of the Commission’s comprehensive tax base by introducing major revisions to the federal gift and estate taxes in the October 1968 federal budget: exempting inter-spousal transfers, integrating these two taxes in the form of a cumulative progressive tax, and increasing rates on estates valued at less than $5 million.67 Defending the continued existence of a separate gifts and estate tax, the Finance Minister explained that he respected ‘the intellectual coherence and elegance’ of the Commission’s recommendation, but that ‘the overwhelming weight of Canadian opinion is against it now, and many Canadian practices and institutions would be seriously disrupted if we embraced this proposal’.68 Not surprisingly, given the increased impact on small and medium-sized estates, the amendments to the gift and estate tax generated considerable political opposition, particularly from owners of small businesses and family farms who had played a relatively minor role in opposition to the Royal Commission Report.69 In Western Canada, where farming interests were particularly strong, the provincial governments of Alberta and Saskatchewan acceded to this sector by refunding the provincial share of the federal estate tax to estates from which it had been collected.70

65 As a contender in the race for leadership of the Liberal Party, Sharp insisted that he was in no position to take a public stance on tax reform: Hartle, above n. 19, at 412. Before the leadership campaign came to an end, however, Sharp withdrew in favour of Pierre Trudeau, who became Liberal leader and Prime Minister on 6 Apr. 1968. Under Trudeau, the Liberals called a federal election for 25 June 1968, which they won handily and formed a majority government. 66 Head, above n. 59, at 61. 67 An Act to amend the Income Tax Act and the Estate Tax Act, R.S. 1968–1969, c. 33. See, eg, M. B. Jameson, ‘Proposed Estate Tax Changes’ in Report of the Proceedings of the TwentyFirst Tax Conference, 1968 (Toronto, Canadian Tax Foundation, 1969) 72. 68 Canada, House of Commons Debs, (22 October 1968), at 1685 (Mr. Edgar Benson). 69 Gardner, above n. 60, at 251. See also R. M. Bird, ‘Canada’s Vanishing Death Taxes’ (1978) 16 Osgoode Hall LJ 133 at 137 (observing that the amendments to the federal gift and estate taxes ‘gave rise to considerable public outcry, to the point where it appears the whole experience may have made the government particularly cautious in this area when designing its major tax reform over the next few years’). 70 Provincial Finances 1969 (Toronto, Canadian Tax Foundation, 1969) at 58. In Alberta, this legislation came into effect on 1 Apr. 1967. In Saskatchewan, refunds commenced on 1 Apr. 1969. In its 1969 budget, the Government of Manitoba announced that it would also introduce legislation to refund the provincial share of the federal estate tax unless the federal government resolved the ‘competition for economic advantage’ satisfactorily: M. Goodman, ‘Checklist’ (1969) 17 Can Tax J 155 at 161–162. The legislation, however, died on the Order Paper when a provincial election was called, and was not reintroduced by the social democratic New Democratic Party that came to power.

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In this context, the long-awaited White Paper was finally released on 7 November 1969.71 Although explicitly rejecting the Commission’s comprehensive tax base,72 as well as several other proposals such as family taxation73 and the elimination of all resource tax incentives,74 the White Paper agreed with the Commission Report that, as a general rule, capital gains should be fully taxable at ordinary rates.75 In order to prevent the concurrent application of capital gains tax and estate tax ‘at a most inconvenient time’, however, the White Paper rejected the Commission’s proposal that capital gains should be recognised when property is transferred at death, recommending instead that ‘the person who inherits the assets be treated as if he had purchased them at their cost to the deceased’ plus ‘part of the death taxes paid on the assets in question—the part that relates to the capital gain’.76 In the case of gifts, though, the White Paper recommended that capital gains be taxable in the year of the gift and that the person receiving the property be treated ‘as if he had purchased the asset for its fair market value’.77 Finally, and unexpectedly, the White Paper recommended that shareholders in widely-held Canadian corporations should be required to recognise accrued gains and losses every five years—though only half of these gains and losses would be recognised for tax purposes.78 In the White Paper itself, the Minister of Finance welcomed ‘public discussion of the proposals . . . before Parliament is asked to approve a bill to implement tax reform’.79 For this purpose, the government’s preferred vehicle was the parliamentary hearings on the White Paper conducted by the House of Commons Standing Committee on Finance, Trade and Economic Affairs and the Standing Senate Committee on Banking, Trade and Commerce. Unlike Congressional Committees in the United States, these committees had limited staff and minimal technical knowledge, and were completely unprepared for 71 Hon. E.J. Benson, Proposals for Tax Reform, (Queen’s Printes, Ottawa, 1969). For useful summaries of the White Paper’s proposals, see Bucovetsky and Bird, above n. 60, at 18–20; and Head, above n. 59, at 61–67. 72 Benson, above n. 71, para. 3.3, at 36 (stating that the government ‘rejects the proposition that every increase in economic power, no matter what its source, should be treated the same for tax purposes’). 73 Ibid., para. 2.5, at 15 (noting that the Commission’s proposed family unit would create a ‘tax on marriage’). 74 Ibid., para. 5.24, at 64 (concluding that ‘special rules are still needed for the mineral industry’). 75 Ibid., paras. 3.13–3.18, at 38 (proposing as well special rules to exempt gains on the sale of principal residences and to tax only half the gains of widely-held Canadian companies). In order to prevent retroactive application of the tax, the White Paper also proposed that tax should apply only to gains accruing after a stipulated ‘valuation day’: ibid., para. 3.16, at 38. 76 Ibid., para. 3.42, at 42. 77 Ibid., para. 3.41, at 42. 78 Ibid., para. 3.33, at 40–41. This approach had been considered in the Commission’s Report, but was not specifically recommended: Royal Commission on Taxation, above n. 51, iii, at 344 and 378–380. 79 Ibid., paras. 1.1 and 1.4, at 5.

The Abolition of Wealth Transfer Taxes in Canada 321 the difficult task of reviewing and commenting upon detailed tax proposals.80 The Commons committee alone received 524 briefs and 1,093 letters, and heard 211 oral presentations from 820 individuals.81 The vast majority of these submissions were from corporations and business associations,82 most of which were highly critical of the proposals to tax capital gains at ordinary rates and to tax accrued gains on widely-held shares every five years.83 Many organisations also objected to the taxation of capital gains as well as gifts and estates, notwithstanding the White Paper’s proposal to defer the recognition of gains on bequests until the property is ultimately sold.84 The Ontario government released a set of counter-proposals in June 1970, recommending significantly lower capital gains tax rates, taxation of accrued gains at death, and a simultaneous and substantial reduction in wealth transfer taxes.85 Small business owners organised a broader campaign of public advertisements, letters, speaking tours, and rallies under the banner of the Canadian Council for Fair Taxation, established in December 1969.86 According to the group’s founder and President, John Bulloch, the combination of capital gains tax and the estate tax amounted to ‘an attack on the middle-class values of hard work, thrift and initiative’ and a ‘confiscation of the money and resources of the huge middle segment of the population’.87 At the height of the campaign, the government was reported to be receiving protest letters at a rate of 7,000 each day.88 When the parliamentary committees reported in the autumn of 1970, it was not surprising that they would ‘reflect in varying degrees the overwhelmingly hostile reaction of representatives of the business and professional organisations from whom the bulk of the brief and other submissions were received’.89 According to the Commons committee, the one-half inclusion

80

Bucovetsky and Bird, above n. 60, at 21. Standing Committee on Finance, Trade and Economic Affairs, Eighteenth Report Respecting the White Paper on Tax Reform (Ottawa, Queen’s Printer, 1970) at 5. 82 Gardner, above n. 60, at 252. 83 Bucovetsky and Bird, above n. 60, at 21; and Head, above n. 59, at 67–70. 84 R.M. Bird and M.W. Bucovetsky, Canadian Tax Reform and Private Philanthropy, Canadian Tax Paper No. 58 (Toronto, Canadian Tax Foundation, 1976) at 34. See also the summary of various submissions in Hartle, above n. 20, at 66–72. 85 Hon. C. MacNaughton, Ontario Proposals for Tax Reform in Canada (Toronto, Department of Treasury and Economics, 1970). 86 See Gardner, above n. 60, at 252; and Philipps, above n. 10, at 133–134. 87 R. Anderson, ‘Benson meets hostile response at public meetings on proposals’, Globe and Mail, 11 Feb. 1970, 1. 88 R. Anderson, ‘Tax reform fight found producing hysteria’, Globe and Mail, 21 Feb. 1970, B1. 89 Head, above n. 59, at 70. See also Bucovetsky and Bird, above n. 60, at 21 (concluding that their limited staff and minimal technical knowledge ‘meant that the two Committees were unlikely to serve as anything else than a sounding board for those segments of public opinion that were most vocal’). 81

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rate for shares of widely-held corporations should be extended to all capital assets,90 the five-year realisation rule for these shares should be abandoned,91 and the proposal to tax accrued gains at death should be restored in order to prevent indefinite deferral.92 Since the last of these recommendations would, the committee noted, ‘magnif[y] the problem, brought to the committee’s attention innumerable times, of the concurrent impact of the two taxes at the same time, at death’, a further recommendation proposed a reduction of the federal estate tax ‘across the board, either by reducing the rates or by expanding the brackets’.93 The Senate committee went further, recommending a distinction between short-term and long-term gains and a rate of tax on the latter limited to the lesser of 25 per cent or half the marginal income tax rate of the taxpayer,94 and the postponement of tax on transfers of property by gift as well as at death, with a carry–over of the donor’s cost to the recipient.95 In addition, the committee suggested, the government ‘might well consider abandoning the estate tax field to the provinces’.96 The government released its final tax reform package in the form of draft legislation accompanying the federal budget on 18 June 1971.97 Following the recommendations of the Commons committee, the draft legislation adopted a one-half inclusion rate for all capital gains and losses accruing after a designated valuation day,98 dropped the White Paper proposal to tax accrued gains on widely-traded shares every five years,99 and accepted the Carter Commission’s original proposal to tax accrued gains when property is transferred on death as well as by gift.100 Following the recommendation of the Senate committee, the government decided to abandon the estate and gift tax field to the provinces.101 The reasons for the government’s decision were expressed in four short paragraphs in its Summary of 1971 Tax Reform Legislation. First, it explained, the combination of capital gains tax and estate tax at death ‘could in some instances result in substantial tax impact arising on the death of a taxpayer’.102 Secondly, it continued, ‘[a] reduction in federal 90

Standing Committee on Finance, Trade and Economic Affairs, above n. 81, at 26. Ibid. 92 Ibid., at 33. 93 Ibid., at 33 and 34. 94 Standing Senate Committee on Banking, Trade and Commerce, Report on the White Paper Proposals for Tax Reform Presented to the Senate of Canada (Queen’s Printer Ottawa, Sept. 1970) at 59–60. 95 Ibid., at 61. 96 Ibid., at 45. 97 Hon. E.J. Benson, Summary of 1971 Tax Reform Legislation (Ottawa, Queen’s Printer, 1971). 98 Ibid., at 30 and 32–33. 99 Ibid., at 30. 100 Ibid. 101 Ibid., at 33. 102 Ibid. 91

The Abolition of Wealth Transfer Taxes in Canada 323 estate taxes to the extent suggested by the Commons committee would result in a revenue loss of about half the $55 million now received by the federal government from this source’ after payment of the provincial share to provincial governments.103 Thirdly, it concluded, ‘[t]wo provinces now return their entire share of estate taxes to estates and it is no longer possible to establish a uniform national system of death duties through federal legislation’.104 As a result, it concluded, ‘[i]n these circumstances, it has been decided that the federal government will vacate the estate and gift tax field on December 31, 1971’.105 Thus, it would seem, the introduction of capital gains tax at death, the low revenue yield for the federal government, and the disparate effects of federal and provincial joint occupancy of the field led to the repeal of the federal gift and estate tax. Unstated, of course, was the organised opposition to capital gains and wealth transfer taxes reflected in public campaigns and submissions to the parliamentary committees. By sacrificing the federal gift and estate tax, the government finally obtained the acquiescence of organised interest groups to the introduction of capital gains tax and the recognition of accrued gains at death. In a letter to the editor of the Toronto Daily Star, Canadian Council for Fair Taxation President John Bulloch praised the ‘highly nationalistic’ tax legislation for abolishing wealth transfer taxes ‘that would, in combination with capital gains taxes, have forced the sale of family businesses, frequently to foreign interests’.106 The construction industry and the Canadian Real Estate Association welcomed the repeal of the federal gift and estate tax because ‘the small builder is still the backbone of the residential construction industry’.107 The business press was generally favourable, characterising the tax reform legislation as ‘a far superior tax plan’ to the White Paper.108 Aside from a critical editorial in the Toronto Daily Star,109 and unfavourable commentary from a few Canadian tax

103

Ibid. Ibid. 105 Ibid. 106 J.F. Bulloch, Letter to the Editor, Toronto Daily Star, 22 June 1971, 7. 107 K.B. Smith, ‘Budget, Tax Reaction’, Globe and Mail, 19 June 1971, B13. 108 I.H. Asper, ‘Benson iceberg becomes Benson Compromise and a political timebomb is defused’, Globe and Mail, 19 June 1971, B3. 109 ‘Santa to the rich’, Editorial, Toronto Daily Star, 30 June 1971, 6 (arguing that the abolition of federal wealth transfer taxes ‘clearly violates a principle to which society should give some deference: equality of opportunity. And it overlooks without justification a perfectly good source of government revenue’). The editorial proceeded to describe the repeal of the federal gift and estate tax as ‘but one example of Mr. Benson’s depressingly long march from Carter’s central concern with tax equity’, adding that: ‘[t]he people who would have directly benefited from its implementation were not heard in Ottawa: their small voices ignorant, and poor, were submerged in the flood of glossy briefs that poured into the capital from all the vested interests.’ 104

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academics,110 the predominant public response to the repeal of the federal gift and estate tax was silence.111 In Parliament, where the Liberal Party held a comfortable majority, enactment of the draft legislation was never in doubt. While the ProgressiveConservative Leader of the Opposition criticised the government for the inconsistency of amending the gift and estate tax in 1968 and repealing it three years later,112 he and the members of his parliamentary caucus generally supported the decision to repeal the federal gift and estate tax. In fact, several complained that since provincial governments might continue to levy succession duties, the taxation of capital gains at death could create ‘extreme hardship’—particularly for family farms.113 Only members of the social democratic New Democratic Party opposed abolition of the tax, criticising the government for abandoning the Prime Minister’s 110 See, eg, G. Bale, Letter to the Editor, Globe and Mail, 25 June 1971, 7 (describing repeal of the federal gift and estate tax as ‘tax regression rather than tax reform’). See also R. M. Bird, ‘The Case for Taxing Personal Wealth’ in Report of the Proceedings of the Twenty-Third Tax Conference, 1971, above n. 10, at 24 (defending wealth transfer taxes on ‘moral, social and economic grounds’ and emphasizing the need for ‘a reaffirmation of the national interest in taxing wealth ibid.’); and J. Bossons, ‘Economic Overview of the Tax Reform Legislation’ in, 45 at 54 (concluding that the repeal of the federal estate tax ‘would provide a substantial windfall for a relatively small number of present wealth holders’ equivalent to ‘a lump-sum transfer of approximately $4.5 billion to individuals who currently own wealth that would be taxed in future years under the estate tax’). 111 Bird, above n. 69, at 133. 112 See, eg, Canada, House of Commons Debs, (23 June 1971) at 7307 (Mr. Stanfield) (arguing that ‘the minister put the country through a lot of turmoil and trouble by an increase in estate taxes in an attempt to reduce the tax on very small estates. Now, with great fanfare the minister announces its abolition, also for the very best of reasons’); and ibid. (17 Dec. 1971) at 10572 (Hon. Robert Stanfield) (contending that after the reform of the estate tax in 1968, the minister of finance was ‘doing away with all of what he put before the House two years previously and all that he had fought for in the House’). 113 Ibid. (8 Nov. 1971) at 9447 (Mr Gordon Ritchie) (suggesting that the federal capital gains tax in combination with provincial estate taxes ‘will create extreme hardship in agriculture and in the farm units as we know them today’). See also ibid. (22 June 1971) at 7226 (Hon. Marcel J.A. Lambert) (arguing that with the introduction of a federal capital gains tax, ‘[t]he people for whom this means another tax on top of other taxes are the farmers and ranchers, particularly those who live in provinces where the removal of the estate tax is meaningless’); ibid. (8 Nov. 1971) at 9416 (Mr Cliff Downey) (suggesting that despite the abolition of the federal estate tax, ‘really there will be no respite for many people in this country in respect of estate taxes, simply because there has not been sufficient consultation with the provinces’); ibid. (9 Nov. 1971) at 9483 (Mr A.P. Gleave) (arguing that ‘I really do not see how you can have an estate tax as well as a capital gains tax applied to the farming industry. You can have one or the other, but I doubt that you can have both. If you have both the result will be a tax jungle because a number of provinces have indicated they are going to retain and even increase estate taxes’); ibid. (15 Nov. 1971) at 9568 (Mr Wallace Bickford Nesbitt) (suggesting that following the repeal of the federal estate tax, ‘[u]ndoubtedly some of the provinces will move into the estate tax field, as a result of which Canadians in certain parts of Canada will, in effect, be taxed doubly as compared with Canadians in other places’); and ibid. (15 Nov. 1971) at 9589 (Hon. Marcel J.A. Lambert) (suggesting that federal and provincial estate taxes have contributed to foreign ownership of Canadian businesses, and are ‘the reason family businesses have been sold to strangers, whether they are from the United States or elsewhere’).

The Abolition of Wealth Transfer Taxes in Canada 325 campaign promise of a ‘Just Society’ by ignoring equality of opportunity and tax progressivity.114 After minor technical amendments, the draft legislation was passed on 17 December 1971, and came into effect on 1 January 1972.

2. Provincial Abolition: 1971–1985 At the provincial level, the federal government’s decision to repeal the federal gift and estate tax was generally opposed.115 Although the Province of Quebec had long favoured exclusive provincial jurisdiction of death taxes116 and welcomed federal abandonment of the field,117 most other provinces objected to the loss of revenue from federal rental payments and feared the possibility of tax competition among provinces opting to collect their own succession duties.118 Smaller provinces in particular complained about the lack of prior consultation and the absence of adequate notice to establish their own gift and succession duties, as well as the administration and collection costs that this would entail,119 asking the federal government to maintain the existing system of estate and gift taxation for at least a year

114 See, eg, ibid. (14 Sept. 1971) at 7803 (Mr J. Edward Broadbent) (arguing that the abolition of the estate tax is detrimental to the principle of equality of opportunity, and that the Liberal party ‘which governs this country is the one which talks about equality of opportunity. This is the same party that is abolishing estate taxes. So much for justice in that area’); ibid. (15 Sept. 1971) at 7840–7841 (Mr David Orlikow) (describing gift and estate taxes as ‘one of the basic features of every progressive tax system’); ibid. (17 Sept. 1971) at 7955 (Mr. John Gilbert) (suggesting that the abolition of federal wealth transfer taxes ‘will further stratify the Canadian people into an economic caste system’); and ibid. (10 Dec. 1971) at 10369 (Mr John Burton) (arguing that ‘it is absolutely essential, if we are to have any sort of just society at all, to tax inherited wealth’). 115 Carter, above n. 50 at 239. 116 See, eg, Report of the Proceedings of the Federal-Provincial Conference, 1963 (Ottawa, Queen’s Printer, 1964) at 47; and Prime Minister Pierre Trudeau, The Taxing Powers and the Constitution of Canada, Government of Canada Working Paper on the Constitution (Ottawa, Queen’s Printer, 1969) at 34. 117 M. Bélanger, Secretary of the Treasury Board, Province of Quebec, addressing the Canadian Tax Foundation’s Twenty-Third Tax Conference, in Proceedings of the TwentyThird Tax Conference, 1971, above n. 110, at 267 (stating that ‘[t]here is some benefit in having at least one more field of taxation where there will no longer be joint occupancy’). 118 See, eg, H. I. Macdonald, Deputy Treasurer and Deputy Minister of Economics, Province of Ontario, addressing Canadian Tax Foundation’s Twenty-Third Tax Conference, in ibid. at 260 (criticising the federal government’s decision as ‘a withdrawal from fiscal leadership, an invitation to tax avoidance, and an undermining of the equity considerations which loom so large in the federal tax reform program’). Although provincial governments would gain some revenue over time from the taxation of accrued gains at death, revenue estimates suggested that these were unlikely to exceed revenue losses from the abolition of the federal estate tax: Bossons, above n. 110, at 56 (projecting annual losses for all provincial governments of $160 million in 1972, growing to $451 million in 2002). For a similar conclusion, see Bird and Bucovetsky, above n. 60, at 54–55. 119 Carter, above n. 50, at 241.

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from 1 January 1972, to give them time to address the implications of the federal proposal.120 Although the federal government refused to accede to this request, it nonetheless offered to administer and collect provinciallyimposed succession duties and gift taxes for a period of three years, provided that: (1) the agreements were entered into by at least four provinces; (2) each participating province would agree to a model Act under which the base of the tax would be the same for all provinces; (3) ‘some degree of uniformity of rates would be provided under the model Acts having regard to the rates now in effect in those provinces imposing their own succession duties’; and (4) ‘it would be clear that the federal government’s role is purely administrative and that the presentation to the public would make it clear that it is a provincial, not a federal tax’.121 In Alberta, where the provincial share of the federal estate tax had been refunded since 1967, the provincial government made it clear that it had no intention to enter into any such agreement and would not introduce its own wealth transfer tax.122 In Manitoba and Saskatchewan, however, where the social democratic New Democratic Party (NDP) had won provincial elections in 1969 and 1971, as well as the four Atlantic Provinces, provincial governments accepted the federal government’s offer and introduced largely uniform succession duties and gift taxes.123 In order to protect their succession duties, British Columbia and Ontario entered into agreements with the federal government for the collection of gift tax, and Quebec enacted its own gift tax which it collected as of 1 January 1972.124 At the beginning of 1972, therefore, the federal government was collecting the uniform succession duty for six provinces and gift tax for eight provinces, the governments of British Columbia, Ontario and Quebec were collecting their own succession

120

The National Finances, 1971–72 (Toronto, Canadian Tax Foundation, 1972) at 49. Hon. P.M. Mahoney, Parliamentary Secretary to the Minister of Finance, House of Commons Debates, (19 Oct. 1971), 8851. See also D.H. Clark, Department of Finance, Ottawa, addressing Canadian Tax Foundation’s Twenty-Third Tax Conference, in Proceedings of the Twenty-Third Tax Conference, 1971, above n. 110, at 275–276. The offer to collect provincial succession duties was extended only to the seven provinces (other than British Columbia, Ontario and Quebec) that did not collect their own succession duty at the time. The offer to collect provincial gift tax was extended to the nine provinces (other than Quebec) that had entered into federal-provincial tax collection agreements in the field of personal income taxation. 122 Hon. G. Miniely, Provincial Treasurer, Alberta, 1972 Budget Address, (Edmonton, Treasury Department, 1972) at 6 (stating that the provincial government ‘will not . . . enter into an agreement for the collection on our behalf of succession duties, and estate and gift taxes, as we have no intention of imposing these taxes on citizens of Alberta’). 123 Provincial and Municipal Finances 1975 (Toronto, Canadian Tax Foundation, 1975) at 87. According to one commentator at the time, ‘revenue considerations were of primary concern to these six provinces; they concluded that they simply could not afford to give up this source of revenue’: W.D. Goodman, The New Provincial Succession Duty System: An Examination of the Succession Duty Acts of the Atlantic Provinces, Manitoba and Saskatchewan, Canadian Tax Paper No. 56 (Toronto, Canadian Tax Foundation, 1972) at 1. 124 Provincial and Municipal Finances 1975, above n. 123, at 87. 121

The Abolition of Wealth Transfer Taxes in Canada 327 duties, Quebec was collecting its own gift tax, and Alberta levied no wealth transfer taxes. Not surprisingly, this situation did not last very long. Of the six provinces accepting the federal government’s offer to administer and collect provincial succession duties, Prince Edward Island was the first to repeal its succession duty legislation, which it did before any tax was even collected.125 Estimating that total collections from the new tax over three years would amount to only $240,000,126 the provincial government apparently concluded that the anticipated revenue was simply not worth the effort. In his Budget Speech in 1973, however, the Province’s Minister of Finance proudly declared that ‘Alberta and Prince Edward Island are presently the only two provinces without some form of death duties’.127 Fearing the loss of investment to this ‘tax haven’, the government of Nova Scotia accelerated the expiry of its succession duty and gift tax from the three-year period established by the federal government to 31 March 1974.128 Blaming ‘the tax policies in other provinces’, New Brunswick’s Minister of Finance announced the repeal of his province’s succession duty and gift tax effective 31 December 1973.129 Newfoundland completed the abolition of wealth transfer taxes in Atlantic Canada by repealing its succession duty and gift tax effective from 9 April 1974.130 In Western Canada, where Alberta became Canada’s first ‘death tax haven’ when it refused to enact a succession duty or gift tax in 1972,131 provincial wealth transfer taxes lasted only a few more years. Although the Premier of British Columbia promised in June 1972 to repeal his province’s succession duty and gift tax by 1 April 1973,132 the election of an NDP government the next month put this policy on hold.133 When the collection agreements with the federal government expired at the end of 1974, British Columbia assumed the administration of its own gift tax, 125

Bird and Bucovetsky, above n. 60, at 40. Ibid., n. 122. 127 Hon. T.E. Hickey, Minister of Finance, Prince Edward Island, Budget Speech (Charlottetown, Department of Provincial Treasury, 1973) at 5. 128 Nova Scotia, Budget Address (23 Feb. 1973). For references to the ‘tax haven’ problem, see the exchange between the Nova Scotia Minister of Finance and an opposition member in Nova Scotia, House of Assembly, Debates and Proceedings (23 Feb. 1973), 936. 129 Hon. J.-M. Simard, Minister of Finance, New Brunswick, Budget Speech (20 Mar. 1973) (Fredericton, Finance Department, 1973) at 23. For family farms and fishing businesses, provincial succession duty ceased to apply from 31 Mar.1973. 130 Provincial and Municipal Finances 1975, above n. 123, at 87. 131 Hartle, above n. 20, at 75. 132 ‘B.C. to cancel death duties and gift tax’, Globe and Mail, 2 June 1972, B2. 133 See British Columbia, Debates of the Legislative Assembly (24 Oct. 1972) at 235–236 (Hon. D. Barrett), where Premier David Barrett defended the continuance of the provincial succession duty as follows: ‘[i]f one rich man leaves because of this law or because of succession duty then I say let him go. And good riddance! We’d be far better off without him rather than having someone living around here who’s trying to escape their social and financial responsibility to the people of British Columbia . . . We say the rich are welcome, the capital we want it to stay, but it must pay its fair share.’ 126

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and NDP governments in Manitoba and Saskatchewan began collecting their own succession duties and gift taxes.134 The election of the conservative Social Credit Party in British Columbia at the end of 1975, however, marked the beginning of the end of wealth transfer taxes in Western Canada. In his 1977 Budget Speech, British Columbia’s Minister of Finance announced that the provincial succession duty and gift tax would be abolished in order to prevent the ‘forced’ sale of family farms and businesses to ‘outsiders’ and ‘to encourage the retention and accumulation of capital by residents of British Columbia’.135 Later that year, the NDP government in Saskatchewan announced that it would repeal the provincial succession duty and gift tax, notwithstanding the government’s conviction that ‘a tax on wealth is a fair tax’—attributing this decision to the abolition of these taxes in other provinces and ‘a widespread opinion that the successors of the average citizen will be subject to the tax’ even though it applied to less than 3 per cent of estates in Saskatchewan.136 Although the NDP government in Manitoba maintained its commitment to provincial wealth transfer taxes in its 1977 budget,137 a Conservative government was elected later that year, and repealed these taxes in early 1978.138 By 1978, therefore, Ontario and Quebec were the only Canadian jurisdictions that continued to collect succession duties and gift taxes.139 In each of these provinces, however, provincial governments had adopted a policy of gradually reducing these taxes over time—viewing these taxes as temporary measures to maintain revenues until ‘the capital gains tax matures’.140 In Ontario, where rates were originally increased in 1972 in order to compensate

134

Provincial and Municipal Finances 1975, above n. 123 at 87. Hon. E.M. Wolfe, Minister of Finance, British Columbia Budget (Victoria, Department of Finance, 1972) at 23. 136 Hon. W.E. Smishek, Minister of Finance, Saskatchewan, Budget Speech (Regina, Treasury Department, 1977) at 30. 137 Hon. S.A. Miller, Minister of Finance, 1977 Manitoba Budget Address (Winnipeg, Department of Treasury, 1977) at 16. According to the Minister, ‘[w]e believe the federal government belongs in the estate tax field, and we are prepared to vacate it, if and when Ottawa recognizes its responsibility. In the interim, we believe the provincial Succession Duty Act should be maintained.’ 138 Bird, above n. 69, at 140. 139 Like British Columbia, Ontario began collecting its own gift tax in 1975 after the collection agreement with the federal government expired. 140 Hon. W.D. McKeough, Treasurer of Ontario, 1972 Ontario Budget (Toronto, Ministry of Treasury, Economics and Intergovernmental Affairs, Taxation And Fiscal Policy Branch, 1972) at 37. See also Ontario, 1973 Budget (Toronto, Ministry of Treasurer, Economics and International Affairs, Taxation and Fiscal Policy Branch, 1973) at 29 (emphasising the ‘undesirable impact on small businesses, family farms and Canadian ownership’ and noting that other provinces were vacating the field); and Mr R. Garneau, Minister of Finance, Quebec, Budget Speech (18 Apr. 1972) at 18 (promising ‘the gradual abolition of succession duties’ with reductions ‘made in light of possible action on the part of the other provinces and the impact of the capital gains tax’). 135

The Abolition of Wealth Transfer Taxes in Canada 329 for the loss of federal rental payments,141 basic exemptions were increased from $100,000 to $150,000 in 1974,142 $250,000 in 1975,143 and $300,000 in 1977.144 Making the perceived connection between succession duty and capital gains tax explicit, the 1977 Budget also made capital gains tax payable at death creditable against succession duties.145 Two years later, the provincial government repealed Ontario’s succession duty and gift tax, declaring that ‘the continuation of this tax is hurting our economic performance and costing us jobs’ and that ‘the present combination of other taxes provided government with an adequate return as wealth is accumulated’.146 In Quebec, succession duties were reduced by 20 per cent in each year from 1974 to 1977, resulting in a total reduction in tax otherwise payable of 80 per cent by 1977.147 With the election of the sovereigntist and social democratic Parti Québecois (PQ) in November 1976, however, the final 20 per cent reduction that had been scheduled for 1978 was cancelled in the new government’s first budget.148 The next year, the PQ government announced that the provincial succession duty would be retained but substantially amended, with rates based solely on amounts received by each beneficiary, total exemption of bequests between spouses, and further exemptions for transfers to children and other dependents.149 The legislation, which was introduced in the National Assembly in June 1978, was enacted on 22 December 1978, and

141 Hon. W.D. McKeough, Introduction to Supplementary Estimates and Tax Legislation (Toronto, Ontario Department of Treasury and Economics, Taxation and Fiscal Policy Branch, 1971) at 27. 142 Hon. J. White, Treasurer of Ontario, 1974 Ontario Budget (Toronto, Ministry of Treasury, Economics and Intergovernmental Affairs, Fiscal Policy Division, 1974) at 12. 143 Hon. W.D. McKeough, Treasurer of Ontario, 1975 Ontario Budget (Toronto, Ministry of Treasury, Economics and Intergovernmental Affairs, Taxation and Fiscal Policy Branch, 1975) at 27. 144 Hon. W.D. McKeough, Treasurer of Ontario, Ontario Budget 1977 (Toronto, Ministry of Treasury, Economics and Intergovernmental Affairs, Fiscal Policy Division, 1977) at 18. 145 Ibid. (explaining that ‘this credit mechanism will result in ever-increasing reductions in succession duty over time, as the value of capital assets increases and the Succession Duty Act is amended periodically to recognize the effect of inflation’). This approach had been recommended by a provincial advisory committee in 1973 in order to address the perceived ‘double tax burden’ from succession duty and capital gains tax at death: Ontario Advisory Committee on Succession Duties, Report (Toronto, the Committee, 1973) at p. v and 10–14. 146 Hon. F.S. Miller, Treasurer of Ontario, Ontario Budget 1979 (Toronto, Ministry of Treasury and Economics, Fiscal Policy Division, 1979) at 5 and 6. 147 Mr R. Garneau, Minister of Finance, Quebec, Budget Speech (28 Mar. 1974) at 19; Mr R. Garneau, Minister of Finance, Quebec, Budget Speech (17 Apr. 1975) at 19; and Mr R. Garneau, Minister of Finance, Quebec, Budget Speech (11 May 1976) at 35. 148 Mr J. Parizeau, Minister of Finance, Minister of Revenue, and Chairman of the Treasury Board, 1977–78 Budget Speech (12 Apr. 1977) at 52 (noting that the Carter Commission had recommended the abolition of succession duties on the basis that inheritances should ‘be taxed as if they were income for those receiving them’ and adding that ‘governments have not adopted this theory, but have used the partial taxation of capital gains as a reason for removing succession duties’). 149 Mr J. Parizeau, Minister of Finance, ministre des Finances, ministre du Revenue, and président du Conseil du trésor, 1978–79 Budget (18 Apr. 1978) at 50–51.

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came into effect immediately.150 Over the next several years, the tax raised up to about $45 million per year,151 but the government faced continuing pressure to abolish provincial wealth transfer taxes ‘because such duties do not exist elsewhere in Canada’.152 With a new Minister of Finance, and a provincial election on the horizon (which it lost), the PQ government repealed Quebec’s succession duty and gift tax on 23 April 1985.153

IV. CONCLUSION

Writing in 1978, Canadian economist Richard Bird characterised the disappearance of Canada’s wealth transfer taxes as ‘strange’.154 More recently, Cedric Sandford argued that the abolition of Canadian wealth transfer taxes ‘had an accidental element about it’.155 Although there is certainly a large element of contingency to the events culminating in the abolition of these taxes, public choice theory suggests that the outcome was neither ‘strange’ nor entirely ‘accidental’, but a logical response to the shifting political costs of these and other taxes. The Carter Commission’s proposals to tax gifts and inheritances as income and capital gains at death significantly increased the political costs of the federal gift and estate tax as well as provincial succession duties— taxes for which the political costs were already high, given their application to a relatively narrow group of people. While the 1968 amendments to the federal gift and estate tax might have lowered political costs by rejecting the Carter Commission’s proposal to tax gifts and inheritances as income and exempting inter-spousal transfers, political costs were clearly 150 Succession Duty Act, L.Q. 1978, c. 37. For a detailed review of the revised legislation, see R. Raich, ‘An Overview of the New Quebec Succession Duty Act’ in Report of the Proceedings of the Thirtieth Tax Conference, 1978 (Toronto, Canadian Tax Foundation, 1980) 725. Among the many revisions to the provincial succession duty, one of the most important was replacement of a ‘transmissions basis’ whereby the tax applied to property situated outside the province only if the deceased was domiciled in the province and the beneficiary was resident or domiciled in the province with an ‘accessions basis’ according to which the tax would apply to all property situated outside the province received by a person resident or domiciled in Quebec on the death of another person. Although the constitutionality of this approach was called into question by the British Columbia Court of Appeal in A-G of British Columbia and the Canada Trust Company v Ellett Estate [1979] CTC 134 (BCCA) (ruling on a provision of the British Columbia succession duty enacted in 1972), it was accepted on appeal to the Supreme Court of Canada in A-G of BC v Ellett Estate [1980] CTC 338 (SCC). 151 See the revenue figures reported in Mr G.D. Levesque, Minister of Finance, Québec, 1986–1987 Budget (1 May, 1986) at 20. 152 Mr J. Parizeau, minister des Finances, Québec, 1983–84 Budget (10 May 1983) at 24. 153 Mr Y.L. Duhaime, minister des Finances, Québec, 1985–86 Budget (23 Apr. 1985) at 17 (stating erroneously that ‘Québec has . . . been the only province to collect succession duties’ since capital gains became partially taxable in 1972). 154 Bird, above n. 69, at 133. 155 C. Sandford, Why Tax Systems Differ: A Comparative Study of the Political Economy of Taxation, (Fersfield, Fiscal Publications, 2000) at 105.

The Abolition of Wealth Transfer Taxes in Canada 331 increased by integrating the gift and estate taxes and increasing federal rates on estates valued at less than $5 million. Not surprisingly, these amendments galvanised farming and small business interests, increasing further the political costs of Canadian wealth transfer taxes and federal tax reform more generally. Although the White Paper attempted to contain these political costs by rejecting the taxation of accrued gains at death, the proposals to tax capital gains at ordinary rates and widely-held shares every five years were politically very costly, since these measures would ‘impose obvious and substantial new burdens on a relatively small but affluent, articulate and well organised section of the community which could hardly be expected to stand idly by’, resulting in benefits that ‘would be widely dispersed over the relatively unorganised mass of taxpayers at the bottom of the income scale’.156 Clearly expecting opposition from organised interest groups, the government attempted to manage the tax reform process by referring its proposals to parliamentary committees. These committees, however, were completely unprepared for this task and served mostly as ‘sounding board[s] for those segments of public opinion that were most vocal’157—namely, the organised interest groups that had opposed the Carter Commission’s proposals from the outset. Predictably, the parliamentary committee reports ‘reflect[ed] in varying degrees the overwhelmingly hostile reaction of representatives of the business and professional organizations from whom the bulk of the briefs and other submissions were received’.158 Finally, confronting the prospect of substantial revenues from the introduction of capital gains tax versus minimal revenues from the gift and estate tax (75 per cent of which were transferred to provincial governments or abated in the case of provinces collecting their own succession duties), the federal government opted to withdraw from the wealth transfer tax field, enacting a capital gains tax on half the amount of the gain with accrued gains taxable at death. At the provincial level, several governments endeavoured to maintain wealth transfer taxes, though the eventual abolition of these taxes was probably inevitable when Alberta refused to enact a provincial succession duty and gift tax in 1972. With low revenues, high administrative costs, and the risk of inter-provincial migration, wealth transfer taxes were abolished in Atlantic Canada by 1974, Western Canada by 1978, and Ontario in 1979. While Quebec held out, substantially amending its succession duty in 1978, even it succumbed to the pressures of horizontal tax competition, repealing its succession duty and gift tax in 1985. Opponents of wealth transfer taxes are apt to take comfort both from their abolition in Canada and other countries, and from public choice explanations for these events, and proponents may despair. As an advocate 156 157 158

Head, above n. 59, at 69 and 70. Bucovetsky and Bird, above n. 60, at 21. Head, above n. 59, at 70.

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of these taxes myself,159 this is not what I intend. While political costs and benefits may influence the choices that governments make among different revenue sources, these are not the only factors, as political values and ideologies as well as the structure of state institutions can also play an important role.160 Indeed, public choice theories themselves acknowledge the influence of these other factors in the role that preferences for different taxes can play in the political costs of these taxes.161 Nonetheless, it is important to be realistic about the considerable political challenges that are apt to make the retention or reintroduction of wealth transfer taxes especially difficult. As experience in Canada suggests, the political costs of these taxes tend to be much higher than those of broadbased income, consumption, or payroll taxes, and can increase significantly if the burden on small and medium-sized estates is increased. In a federal system, moreover, the political costs of wealth transfer taxes are greatly increased by joint occupancy by both levels of government (vertical tax competition) and mobility among sub-national jurisdictions (horizontal tax competition). Although the costs of horizontal tax competition in this field may be reduced by applying the tax to inheritances received by beneficiaries who are resident or domiciled in the taxing jurisdiction, since these persons are likely to be less mobile than affluent retirees, the example of Quebec (where this ‘accessions basis’ was adopted in 1978 but provincial succession duty and gift tax were repealed in 1985) suggests that wealth transfer taxes in a federal jurisdiction should be collected by the federal government. For those who wish to preserve and restore the taxation of wealth transfers, then, what lessons can be drawn from the abolition of these taxes in Canada? Reflecting on public choice accounts of tax policy and the historical experience in these countries, three conclusions seem evident. First, if wealth transfer taxes are to be maintained or reintroduced, the political costs of these taxes cannot be allowed to increase beyond a level that is necessary to their essential purposes. Basic exemptions, for example, must exclude small and medium-sized estates, and special rules must minimise the burden on family-owned enterprises and principal residences—ideally by deferring the collection of tax until these assets are sold rather than exempting these transfers from tax altogether. Capital gains taxes must be adjusted to lessen the combined impact of two taxes when property is transferred by gift or on death, for example by permitting the donor’s cost to carry over to the recipient. Administrative and compliance costs must be minimised by integrating federal and sub-national taxes or abolishing the

159

Duff, above n. 6. See, eg, Banting, above n. 10, at 352–355 (considering literature on the politics of redistribution as well as public choice theory, and concluding that these approaches should be understood as complementary, not contradictory). 161 Above nn. 43–48 and accompanying text. 160

The Abolition of Wealth Transfer Taxes in Canada 333 latter, by eliminating complex rate structures based on the size of an estate and the shares received by different classes of beneficiaries, and by statutory rules designed to minimise opportunities for avoidance. Horizontal tax competition must be discouraged by ensuring that wealth transfer taxes are collected by federal governments in federal systems and by applying these taxes to gifts and inheritances received by beneficiaries who are resident or domiciled in the taxing jurisdiction in addition to property situated in the taxing jurisdiction and transfers of property by persons domiciled in the taxing jurisdiction. Secondly, if governments are to enact the legislative measures necessary to preserve or re-establish wealth transfer taxes, methods must be devised in order to protect public decision-making processes from the influence of organised interest groups who can be expected to oppose these measures. In Canada, for example, the Carter Commission was able to produce a Report that was hailed as ‘a landmark in the annals of taxation’ because it had both the institutional mandate and the financial resources to engage in a thorough and non-partisan analysis of tax policy. In contrast, the parliamentary committees that considered the federal government’s White Paper proposals in 1970 were thrust into a highly political exercise without the knowledge or resources to withstand the pressure exerted by organised interest groups that dominated the process. Although this was only one of many factors that led to the eventual abolition of wealth transfer taxes in Canada, its impact at the time may have been decisive. Finally, if these taxes are to retain and attract public support, efforts must also be made to increase their perceived benefits. One strategy for this purpose might be to earmark the revenues from these taxes to a particular expenditure programme, especially a programme that complements the redistributive objectives of the tax such as early childhood education for children from low-income families. More generally, a greater ‘tax preference’ for wealth transfer taxes might result from less emphasis on the revenues raised from these taxes, which are bound to be less than taxes on income, consumption or payrolls, and more explicit acknowledgement of their symbolic and social function to lessen inequalities and unequal opportunities.162 Public support for these taxes might also be improved by

162 In this respect, see Ontario Committee on Taxation, Report (Toronto, Ontario Printer, 1967), iii, 136 (emphasising the social purpose of wealth transfer taxes ‘to control the growth in this country of an economically powerful minority whose influence is based upon inherited wealth’); and Taxation Review Committee, Full Report (Canberra, Australian Government Publishing Service, 1975) at para. 24.4 (recognising the role of wealth transfer taxes as to ‘limit . . . the growth of large inherited fortunes, a trend that most people would agree to have undesirable social consequences’). See also Bird, above n. 69, at 138 (suggesting that public support for the wealth transfer taxes in Canada was weak because ‘revenue was clearly the main purpose of [these] taxes so far as most Canadians and Canadian governments were concerned’).

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applying these taxes to amounts received by living beneficiaries rather than the aggregate amount of a deceased’s estate, demonstrating that the tax is intended not to punish those who have succeeded in life or to compound the misery of death, but to regulate the distribution of wealth and opportunities among beneficiaries for whom a gift or inheritance is largely undeserved. In fact is interesting to note that the decline in wealth transfer taxes in OECD countries has been much greater among countries with estatetype taxes than countries with inheritance-type taxes.

12 A Tale of Two Systems: The Divergent Tax Histories of Australia and Canada RODNEY FISHER

ABSTRACT It is generally considered that Australia and Canada had somewhat analogous beginnings, with both countries having a received common law heritage and a federal system. In both countries the balance and distribution of power between the Federal/Dominion and state/provincial governments is a matter prescribed in the constitutions adopted by the countries. Additionally, Australia and Canada are broadly comparable states in respect of political constitution and institutions. While the countries share a common heritage, each has developed a very different approach to the balance of revenue powers between the central and state governments. While Australia has seen the taxation power, which started as a shared power, follow an almost inexorable path towards centralisation, in Canada the initially shared revenue power has tended to move away from the central government to the provinces. These differences derived initially from constitutional differences, with the legislature and courts in each country contributing to the significant divergence in the paths taken within each of the federations. This paper examines the development of these differences that have emerged between the two systems, analysing the contributing factors in determining the particular path followed in each country from the time of its federation.

I. INTRODUCTION

T

a federal state as a political and governmental structure may be described as one where governmental power is ‘distributed between a central . . . authority and several regional . . . authorities, in such a way that every individual in the state is subject to the HE CONCEPT OF

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laws of two authorities, the central authority and a regional authority’.1 A federal state may vary in operation from a loose conglomeration of similarly-minded states at one extreme, to a closely controlled and centralised structure at the other, but the ‘essence of any federal system is the division of legislative powers between the central and regional legislatures’.2 Such an allocation of powers may initially fall for determination by the constitution, or other certificate evidencing the creation of the federation, but over time the allocation of powers will not remain static, reflecting the evolving circumstances in the federation, and external influences impacting on the balance of power. Australia and Canada both represent relatively modern examples of federations, having somewhat analogous beginnings, and being broadly comparable states in terms of political constitution and institutions. Both Australia and Canada began their current incarnations as British colonies, although under very different circumstances, with Canada not being subject to the convict beginnings thrust upon Australia. These colonial beginnings are reflected, in that both Australia and Canada seek to function with Westminster governments. Both countries have large geographic areas with relatively small and scattered populations which were built with the assistance of immigration, and both are economically rich in mineral and rural resources. Among the differences, still reflected in the current construction of the regimes, was the much more significant influence of the French in the European settlement of Canada. The early laws of both countries reflected the predominance of the British, with the reception of English laws in both Australia and Canada.3 English common law distinguished broadly between colonies acquired by settlement, in which case English law became the initial law of the colony, and colonies acquired by conquest or cession, in which case the law of the conquered people continued in force except to the extent necessary to establish and operate the government institutions of British colonial rule. Australia and Canada both provide examples of the adoption and application of British rules in disregard of the existence of aboriginal peoples in occupation of much of the land prior to the arrival of Europeans.4 The situation in Canada was complicated because of French claims to large areas, making it often unclear whether a particular territory should be treated as having been acquired by settlement, conquest or cession. While broadly comparable in terms of early development, in each of the jurisdictions the initial allocation of taxing power envisaged for each 1

P. Hogg, Constitutional Law of Canada (4th edn, Toronto, Carswell, 1997) 104. C. Gilbert, Australian and Canadian Federalism 1867–1984: A Study of Judicial Techniques (Melbourne, Melbourne University Press,1986) 2. 3 Also in Canada, although to a lesser extent, from France. 4 Until the decision in Mabo v Queensland (No 2) (1992) 175 CLR 1, Australian common law operated on the basis of terra nullius. 2

Divergent Tax Histories of Australia and Canada 337 level of government was very different, Canada opting for a centralist approach while Australia adopted a more decentralised allocation of power. Throughout the period since, however, both regimes have evolved to be vastly different from the initial proposals, Australia now displaying centralist control of taxation while Canada has moved taxation power to the provinces. This chapter charts the progress of this evolution in the allocation of taxing power in these two federations. Beginning with the constitutions in each regime, the chapter examines the forces and influences which have seen each of the countries move to the opposite end of the spectrum from where each first began.

II. DEVELOPING A CONSTITUTION

The major impetus for the federation of the British North American colonies emanated from the political difficulties in the united provinces of Canada. The genesis of the federal system in Canada lay in a political compromise between the proponents of unity and the proponents of diversity. Benefits offered by confederation were seen to include political representation, greater military strength, and the economic advantages from a common market and the increased wealth which would permit the undertaking of large public projects. Confederation conferences at Charlottetown, Quebec City, and London culminated in the passing by the British Parliament of the British North America Act 1867, giving effect to the confederation scheme, which created a single Dominion with a bicameral parliament comprising the representative House of Commons and the appointed Senate. A broadly analogous path was followed by Australia in the latter part of the nineteenth century. The benefits in commerce from inter-colonial cooperation and a uniform customs policy, and the desire for defence against the perceived threat from the French and Germans in the Pacific, proved sufficient impetus to convince the otherwise opposed free-traders and protectionists to join forces in the establishment of a federated Australia. The path to federation was marked by Constitutional Conventions in Sydney, Adelaide and Melbourne, culminating in the passing by the British Parliament of the Commonwealth of Australia Constitution Act (63 & 64 Victoria, Chapter 12), section 9 of which contained the document now known as the Constitution. In contrast to Australia, no single document in Canada comprised a comprehensive written constitution. The British North America Act 1867 (BNA Act), renamed the Constitution Act 1867 by the Constitution Act 1982, established the rules for the federation and provided for allocation of government powers between the central and provincial governments, making it

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a close approximation to a written Constitution. However not all constitutional rules were codified. In particular, the BNA Act made no general provision for its own amendment. Amendment required a joint request from the House of Commons and the Senate to the British Parliament, leading to the suggestion that the ‘Canadian framers of the BNA were content for the imperial Parliament to play a role in the process of amending the new constitution’.5 With the enactment of the Constitution Act by the British Parliament in 1982, procedures for amendment were incorporated in Part V of the Constitution Act 1982, the particular procedure being determined by the type of amendment sought.6 By contrast, the Australian constitution is entrenched, containing the procedural requirement for its own amendment, with broadly only one procedure regardless of the nature of the amendment.7 A further difference between the constitutional documents arises in relation to the establishment of the judiciary. While the BNA Act gave authority for the establishment of a supreme court, it did not establish the Supreme Court.8 Again the suggestion has been that the framers looked to the Judicial Committee of the Privy Council as the final appellate authority, and were content to leave this function in British hands. The Supreme Court of Canada has since been created by ordinary federal statute,9 but being a creation of ordinary statute, its existence, composition and jurisdiction rest on ordinary statute, and can be amended, or the court disbanded by statute. Again by contrast, the Australian Constitution provides for the creation of the High Court of Australia with original and appellate jurisdiction, putting the existence and operation of the High Court outside the reach of ordinary federal statute. While not suggesting that it would be political acceptable, or even contemplated, to impinge on the existence or operation of the Supreme Court of Canada, the High Court of Australia does occupy a theoretically more inviolable position.

5

Hogg, above n. 1, 5. Providing for five amending procedures depending on the nature and scope of the amendment: — S. 38—a general amending procedure requiring assent of federal Parliament and 2/3 of provinces representing 50% of the population; — S. 41—a unanimity procedure requiring consent of federal Parliament and all provinces; — S. 43—some-but-not-all, requiring assent of federal Parliament and affected provinces; — S. 44—assent by federal Parliament alone; and — S. 45—assent of each provincial legislature alone. 7 S. 128; requiring an amendment be passed by an absolute majority of both Houses of Parliament, and passed at a referendum requiring a double majority, that is a majority of voters overall, and a majority of voters in a majority of states. There are alternative procedures available in limited circumstances. 8 S. 101 authorised federal Parliament ‘to provide for the constitution, maintenance, and organization of a general court of appeal for Canada’. 9 Supreme Court Act RSC 1985. 6

Divergent Tax Histories of Australia and Canada 339 Balance of Power In the development of the Canadian constitution the suggestion has been that ‘[t]here are many indications that the framers of the BNA Act planned a strong central government’.10 Indeed ‘[n]o intention of the Fathers of Confederation was more clear than that the new nation was to have a strong central government’.11 The clearest expression of this opinion was seen to come from Sir John Macdonald at the Quebec Conference, where he considered that the major error in the US model had been in allowing states to reserve to themselves all sovereign rights, except for specific centrally allocated powers. His suggestion, which won the day, was that this process be reversed in the Canadian context.12 Evidence in support of this proposition for a strong central government is seen in the fact that the BNA Act provided only limited enumerated powers to the provinces, with the residue given to the federal Parliament. In particular, the Canadian constitution was seen as envisaging a fiscally dominant central government. The taxation power allocated to the federal Parliament was a power to make laws in relation to ‘the raising of money by any mode or system of taxation’,13 thus extending to any form of taxation, whether it be direct or indirect. By contrast, provinces were granted a more restricted power which allowed for the making of laws in relation to ‘direct taxation within the province in order to the raising of revenue for provincial purposes’.14 Provinces were additionally granted power to make laws in relation to licences in order to raise revenue, this then constituting a taxing power rather than a regulatory power.15 The Canadian approach of creating a strong central government is in stark contrast with the allocation of powers granted by the Australian Constitution. The approach adopted in Australia involved the allocation of a limited number of enumerated heads of power to the federal government, with any federal legislation needing to be grounded within one of the allocated heads of power to be valid. The colonies, on becoming states, retained all residual powers. This model manifested an intention for decentralised government, with states retaining significant power, reflecting the desire of the smaller states at the time to prevent the more populous states from becoming dominant. The powers allocated to the central government did include a broad power to impose taxation, but this is to a significant degree explicable by reference to the defence power, with the argument being that: unlimited power of taxation must accompany the unlimited responsibilities of the commonwealth. One of the foremost of its duties . . . was to provide for 10

Hogg, above n. 1, 116. F. Scott, Essays on the Constitution (Toronto, University of Toronto Press, 1977) 17, quoting Pope, Confederation Documents 54–55. 12 Scott, above n. 11, 18. 13 S. 91(3) Constitution Act 1982. 14 S. 92(2) Constitution Act 1982. 15 S. 92(9) Constitution Act 1982. 11

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the common defence of Australasia, and it may be necessary to devote not only the last ship, but the last shilling to that object. It is impossible to cast the duty of defence on the commonwealth without giving them unlimited taxing power.16

The federal parliament was also given an exclusive power to impose customs and excise, a power which had previously been exercised by the states. However, while losing the power to levy customs and excise, the states retained full power for other forms of taxation, coexistent with the federal power. Reassurance was given that ‘[w]ith regard to direct taxation . . . the colonies will possess in future every power which they now possess’.17 Further, ‘[t]here is no doubt that all the parliaments of the states will have precisely the same powers of [direct] taxation as they have at present . . . . It is possible that both parliaments might impose taxes on the same thing. That cannot be helped.’18 In what may be seen as an expression of confidence in future Commonwealth governments, or alternatively as exhibiting a degree of political naivety, Sir Samuel Griffith expressed surety that ‘the federal parliament would never impose direct taxation excepting in a case of great national urgency’.19 The clear intention, then, was that while the federal parliament was granted a broad power for taxation, such a power would be used only in funding defence, with the real power for direct taxation remaining with the states. The reasons for the divergent approaches in the two regimes lie with the political and economic circumstances of the time. The smaller Australian colonies were eager to guard against domination of any federal government by the populous states, with retention of a power to levy direct taxation being seen as essential for the states to retain a degree of independence. By contrast the Canadian experience suggested a desire for a greater degree of unity, with the provinces retaining powers only in regard to local matters, as illustrated by the taxing powers allocated to the provinces. While the nature of the operation of a federation is determined not only by the courts, but by complex historical, economic and social factors, the suggestion has been that ‘[n]otwithstanding the superficially centralist design of the Canadian constitution, and apparently more regionalist tilt of the Australian, the supreme judicial tribunals in each country have wrought great changes in the actual operation of the two constitutions’.20 It is with the role played by the supreme judicial tribunals in each country that much of the remainder of this paper deals. 16 Official Record of the Debates of the Australian Federal Convention, Vol. 1, Sydney, 1891 (Legal Books, Sydney, 1896) 675 (Deakin). 17 Ibid., 674 (Deakin). 18 Ibid., 907 (Griffith). 19 Ibid. 20 Gilbert, above n. 2, 3.

Divergent Tax Histories of Australia and Canada 341 III. USE OF TAXATION POWER

While both the Canadian and Australian central governments were vested with the power to impose direct taxation, neither sought to avail itself of the opportunity to impose direct taxation on income in the early years of federation. The Canadian provinces and the Australian colonies commenced tentative moves to impose direct taxation in the latter part of the nineteenth century, with various moves to tax personal and company income. These taxes became more necessary for both the provinces and the states when, on federation, they lost the power to impose customs and excise duty. Given that customs and excise duties generated in the region of some 80 per cent of tax collected in both Canada and Australia, it is little wonder that when the central governments took over this power, they found no necessity to levy a direct tax for some time after federation. Having lost the power to levy customs and excise, the regional governments were forced to seek new areas in which to raise revenue.

Imposing Direct Taxes Just as the central governments in Canada and Australia eschewed the imposition of direct taxation after their respective federations, the central governments were both driven by the funding exigencies created by the First World War towards imposition of direct taxation. In 1915 the Australian government imposed its first income tax, designed to finance the shortfall in funds required to sustain the war effort. The tax, seen as a wartime measure, heralded the entry of the Australian central government into the income tax arena, a field which it would not again leave. Canada introduced a war profits tax in 1916, followed in 1917 by corporate and personal income taxes. As with Australia, the taxes were seen as temporary only, with direct taxes intended to remain the realm of the provinces. Reflecting this intention, the federal rates of income tax were substantially reduced in Canada during the inter-war period. It would seem, then, that this period in history witnessed the start of the exercising of the power to levy direct income taxes by the central governments in both regimes, and this must be seen as historically significant, in that it created the tendency towards a central control of the revenue power. It is suggested however that this period, while being the start of the central imposition of income tax, was not a watershed period in the shift of the taxation power base from the regional governments towards the central government. Events which were to follow would prove of much greater significance in evidencing the power-shift to central control of finances in both countries. Continuing the parallels between the two federations, the 1930s saw investigations into the income tax systems in both Australia and Canada. In both

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countries, direct income tax was levied at both the central and regional level, making for a system which was complex and difficult to administer. In Australia, the Ferguson Royal Commission recommended the adoption of uniform legislation and administration by the Commonwealth and states, the outcome from which was the introduction of uniformity under the Income Tax Assessment Act 1936 (Cth). While this uniformity reigned for a short period, a diversity of amendments by the Commonwealth and states reintroduced differences. In Canada, the Rowell-Sirois Commission described the imposition of income taxation as chaotic, with federal, provincial and municipal taxes at different rates on different bases, creating a complex burden which varied by region. The solution proffered by this Commission would involve only the central government levying taxes on personal and corporate income, a recommendation which was rejected by the provinces. Second World War The exigencies of the war effort during the Second World War once again forced the central governments in Australia and Canada to take primacy in the imposition of direct income taxes. However the different approaches taken by Australia and Canada marked a watershed in the later ongoing balance between the direct taxing powers of the central government and the regional government in each country. Australian Approach The Australian government was keen to take a monopoly on the imposition of income tax, at least for the duration of the war, and in 1941 the central government offered the states a grant in compensation for withdrawing from the field of income taxation, an offer which the states did not accept. The Australian government, at the 1942 Premiers’ conference, again attempted to negotiate an agreement for the states to relinquish their income taxes, this time with the added guarantee that the states would have the right again to impose income tax after the war, but again without success. As it transpired, the states may have been better advised to accept this offer, since the events that unfolded saw the states effectively precluded from re-entering the income tax field. Frustrated by the states’ seeming intransigence to forego income taxing powers in the short term for the greater good of the defence of the nation, the Australian government acted unilaterally in 1942 to centralise income taxing powers. In what has been seen as “undoubtedly and quite openly a . . . federal legislative scheme for excluding the states from the field of income tax’,21 the path chosen was by way of the introduction of four Bills: — the Income Tax Act 1942; which set an income tax rate higher than the combined existing state and Commonwealth rates; 21

Gilbert, above n. 2, 15.

Divergent Tax Histories of Australia and Canada 343 — the Income Tax Assessment Act 1942; which gave priority to payment of the Commonwealth income tax over state income tax; — the States Grants (Income Tax Reimbursement) Act 1942; which provided for Commonwealth financial assistance to those states which did not impose their own state income tax; and — the Income Tax (War Time Arrangements) Act 1942; which allowed for the Commonwealth to take over state income tax officers, premises, equipment, and records. The latter of these measures may appear rather ironic, given that there had been a transfer of Commonwealth taxation resources to the states as a result of the 1923 agreement, and now these state resources would be transferred back to the Commonwealth. The practical result of these measures was effectively to centralise the power to raise income taxes. The states were not prepared lightly to surrender these powers, however, and the matter became a question for the High Court in South Australia v Commonwealth,22 (First Uniform Tax Case), the basis of the challenge being that the Commonwealth lacked the constitutional power for the legislative provisions that had been introduced. The contention put forward by the states was that the provisions were in breach of the Constitution since they were ‘in fact a single legislative scheme, and that the substance, purpose and effect of it is to make the Commonwealth Parliament the exclusive taxing authority in the Commonwealth in respect of income tax, and to prevent the States from exercising their constitutional powers in relation to income tax’.23 Such a scheme, it was argued, demonstrated ‘an interference with and a discrimination against the States’,24 for which the Commonwealth had no constitutional power. Essentially, the Australian government argument contended that, of the several heads of power granted to the federal government, only one must be found relevant to provide validity to the provisions. Rather than address the question of a legislative scheme, the federal government argued for the validity of each of the individual legislative measures, suggesting that: The Court is not concerned with the wisdom or fairness of the legislation. The only question is one of power. It is enough if the legislation can possibly operate for the peace, order and good government of the Commonwealth, whether with respect to defence, or taxation, or borrowing, or grants, or matters incidental

22 The State of South Australia & Another v The Commonwealth & Another; The State of Victoria & Another v The Commonwealth & Another; The State of Queensland & Another v The Commonwealth & Another; The State of Western Australia & Another v The Commonwealth & Another (1942) 65 CLR 373 (hereafter South Aust v Cth). 23 Ibid. (Ligertwood KC for South Australia). 24 Ibid., 389.

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thereto. If the legislation can possibly operate in respect of any one of these things, then the Commonwealth has power, and it does not matter whether it has used the power wisely or unwisely.25

The end result of the challenge saw all four acts held as valid by the High Court, 26 although there was not unanimity within the court on all acts.27 In finding the Income Tax Act valid, Latham CJ determined that the Act in question was ‘merely and simply an Act imposing taxation upon incomes’28 for which the Commonwealth had power subject to certain limitations, none of which had been infringed. McTiernan J found the Act justified not only by the taxing power in the Constitution, but also by the defence power, to which a wide interpretation should be applied. The States Grants (Income Tax Reimbursement) Act 1942 was held valid by a four to one majority. Latham CJ found that the Act did not purport to repeal state income tax legislation or require states to abdicate their power to impose income taxes. In a similar vein, Williams J found no illegal interference with the sovereignty of states, as the matter of whether they levied an income tax was left entirely to the discret ion of the states.29 The Income Tax (War Time Arrangements) Act 1942 was the most contentious of the legislative enactments, being held valid by a three to two majority decision, with both Latham CJ and Starke J dissenting. In the majority finding, Rich J looked to a wide application of the defence powers as supporting the validity of the Act, finding that ‘[i]f the Commonwealth is to wage war effectively, it must command the sinews of war’.30 Williams J had regard to the changing scope of the defence power, in that ‘its application depends upon facts, and as those facts change so may its actual operation as a power enabling the legislature to make a particular law’.31 In their separate dissenting judgments, both Latham CJ and Starke J were not convinced as to the breadth argued by the Commonwealth for the defence power. Latham CJ was unable to establish a sufficient connection between the defence power and the legislation, since ‘even this power has a limit—it is not sufficient to wave the flag as if that were a conclusive argument’.32 Starke J was also unconvinced that the defence power should be

25

Ibid., 398 (Ham KC for the Commonwealth). Ibid., Latham CJ, Rich, Starke, McTiernan and Williams JJ. 27 For a more detailed discussion of the cases see, eg, R. Fisher and J. McManus, ‘The Long and Winding Road: A Century of Centralisation in Australian Tax’ in J. Tiley (ed.), Studies in the History of Tax Law, (Oxford, Hart Publishing, 2004). 28 South Aust v Cth, above n. 22, 412. 29 Ibid., 463. 30 Ibid., 437. 31 Ibid., 467. 32 Ibid., 431. 26

Divergent Tax Histories of Australia and Canada 345 given broad operation, with his Honour seeing the Act as being ‘wholly inconsistent with the exercise by the States of their powers, and of their functions as self-governing bodies’.33 The Income Tax Assessment Act 1942 was also held to be a valid exercise of federal power, with Latham CJ relying on the Canadian case of In re Silver Brothers Ltd34 as being conclusive in regard to priority between taxes at different levels of government, finding as a consequence that the ‘Commonwealth has power, by a properly framed law, to make Commonwealth taxation effective by giving priority to the liability to pay such taxation over the liability to pay State taxation’.35 In the final analysis, the states were forced to vacate the income tax field, with the suggestion being that the High Court had allowed the Australian government ‘by a well-planned combination of recognised constitutional powers, (to) unilaterally convert a formerly concurrent power over income tax into an effectively exclusive one’.36 Canadian approach The Canadian approach to wartime power allocation appears in marked contrast to the legislative mode adopted in Australia. Only months after the initial rejection of the Rowell-Sirois findings, a recommendation was adopted that the provinces withdraw from imposition of personal and corporate income tax for the duration of the Second World War. In return for the provinces abandoning these fields of taxation in favour of the central government, the provinces would receive unconditional payments in compensation for lost revenue. Finding itself alone in this lucrative tax field, the Canadian government increased the rates for both personal and company tax, but undertook to reduce rates at the end of the war, with the intention of creating the conditions which would allow the provinces to again impose income taxation. As becomes evident from the above discussion, at the crux of the critical disparity between the Australian and Canadian central government responses was the attitude of the state or provincial governments to the federal request for an interim transfer of power. The intransigence of the Australian states in refusing to cede primacy in income taxation for the duration of hostilities left the Australian government in the invidious position of defending the nation, while being denied the ability to guarantee the source of revenue to execute the task. The response from the Australian government was the introduction of legislation which, once having been validated by the High Court, had the potential to assume a mantle of permanency. 33 34 35 36

Ibid., 447. [1932] AC 514. South Aust v Cth, above n. 22, 435. Gilbert, above n. 2, 18.

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By contrast, the agreement of the Canadian provinces to an interim shift of income taxing power to the central government allowed for the prospect of a renegotiation at the end of the war for a return to provincial income taxation, without the need to repeal legislation. Such a change would appear much more likely without the impediment of a legislative construct, which would imply the possibility of a more onerous hurdle to overcome. Post-war Developments Having succeeded in gaining the ascendency in the imposition of income tax, the central governments in both Canada and Australia not surprisingly proved somewhat reluctant to relinquish such power at the end of the war. Australia In Australia, two of the Acts which had been found valid by the High Court were temporary Acts with a currency limited to the duration of the war. However the Australian government proved loath to surrender its hard-won powers, and sought to replace the limited term Acts with Acts of unlimited duration. The State Grants (Income Tax Reimbursement) Act 1942 was replaced by the State Grants (Tax Reimbursement) Act 1946–1948, which had unlimited duration, and the Income Tax Assessment Act 1942 was replaced by the Income Tax and Social Services Contribution Assessment Act 1936–1956. Once again the states took the opportunity to test the constitutional validity of these Acts by means of a challenge in the High Court in Victoria v The Commonwealth.37 The State Grants (Tax Reimbursement) Act 1946– 1948 was held to be valid by the whole Court, its basis being in section 96 of the Constitution,38 with Dixon CJ, with whom Kitto J concurred, finding that the power to grant financial assistance to any state is ‘susceptible of a very wide construction in which few or any restrictions can be implied’.39 However the Australian government did not fare as well on this occasion, with a four to three majority of the court determining that the Income Tax and Social Services Contribution Assessment Act 1936–1956 was ultra vires, not being incidental to the Commonwealth taxation powers under section 51(ii). Despite this High Court rebuff, however, the states had already lost both the battle and the war, with the resultant practical effect being a garnering

37 The State of Victoria & Another v The Commonwealth; The State of New South Wales v The Commonwealth (1957) 99 CLR 575 (hereafter Victoria v Cth). 38 S. 96: During a period of 10 years after the establishment of the Commonwealth and thereafter until the Parliament otherwise provides, the Parliament may grant financial assistance to any state on such terms and conditions as the Parliament thinks fit. 39 Victoria v Cth, above n. 37, 605.

Divergent Tax Histories of Australia and Canada 347 of income taxing powers by the Australian government, to the effective exclusion of the states. Canada As with the Australian government, at the end of the war the Canadian government also sought to continue the centralisation of fiscal policy. Because the Canadian power-shift had been the result of negotiation between the central and provincial governments, it may have been expected that a more amicable outcome would be achieved than had resulted in Australia, and this proved to be the case. However the change was not immediate, with the concentration of federal power continuing well into the post-war period.40 The central government negotiated with most provinces to enter ‘tax rental’ agreements, whereby the central government rented from participating provinces41 the right to levy personal and corporate income taxes, in return providing grants (rent) to compensate for the revenue foregone. In the mid-1950s the tax rental agreements became tax sharing agreements, which in turn in the 1960s became tax collection agreements, as the pendulum started to swing away from central control and back to provincial power in the area of direct taxes. Tax collection agreements allowed provincial governments to impose their own income tax at their own prescribed rates, and on condition that the province used the federal tax base, the central government would collect the taxes free of charge, thus requiring taxpayers to complete only one return. Such a system allowed for a return of taxing autonomy to the provinces, without the attendant complexity and duplication in administration and collection which had plagued both the Canadian and Australian systems when income tax had been levied and collected at both the central and regional levels of government. The swing back to provincial power in Canada has been seen as escalating since the mid-1960s.42 The post-war period, then, proved to be a seminal period in the development of the allocation of taxing powers between the federal and regional governments in the two countries. Having waged a long and hard battle to centralise income taxing power, in the face of bitter state resistance, the Australian federal government would not lightly surrender this hard won exclusive power back to the states, and no serious attempt has been made for a return to the states of the power to levy income tax. In marked contrast, the centralisation of taxation power in Canada during the war period had been achieved more by agreement than by conflict. It may be that this centralistion by accord, which may have potentially carried a provincial expectation that such power would be returned after the end of hostilities, 40 41 42

Hogg, above n. 1, 163. All except Ontario, which joined in 1952, and Quebec. Hogg, above n. 1, 164.

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is one factor explaining the return to a more decentralised model for taxation power in Canada than in Australia.

Imposing Indirect Taxes Despite the facility to impose direct taxes being granted to both central and regional governments in Australia and Canada, the evolution of the actual use of the power has witnessed a divergence between the regimes. While direct taxation has been dealt with variously by negotiation or legislation, the path to the current imposition of indirect taxes has seen a path forged through the courts in both Australia and Canada. The determination by the courts inevitably involved a policy-making role, as constitutional language was often broad and vague, leaving judges to incorporate social and economic changes which evolved over time, leading to the suggestion that ‘the court probably has to apply a larger discretionary judgement to its constitutional decisions than it does to its decisions in other fields of law’.43 Indeed it may well be that ‘[w]e are under a Constitution, but the Constitution is what the judges say it is’.44 Canadian Experience As noted earlier, the Canadian provinces lost the power to impose customs and excise, but were granted power in relation to ‘direct taxation within the province in order to the raising of revenue for provincial purposes’.45 Additionally the provinces were granted power to make laws in relation to licences in order to raise revenue,46 the power being seen as a taxing power and not a regulatory power. This division of powers in the Canadian context has seen the adjudication of the courts required in two key areas. The first area of contention has been in determining which taxes are considered direct and which indirect, with provinces restricted to imposition of direct taxes. The second area of dispute has concerned the imposition of indirect licence fees, which will be accorded validity only when directed to defraying the expense of an otherwise valid regulatory scheme.47 The following discussion outlines some of the key decisions in the development of the Canadian common law in this area.

43

Hogg, above n. 1, 128. Hogg, above n. 1, 128, quoting Hughes CJ of the US Supreme Court in E.S. Corwin, The Constitution and What it Means Today (14the edn., Princeton UP, Princeton, NJ, 1978) p. xiii. 45 S. 92(2) Constitution Act. 46 S. 92(9) Constitution Act. 47 Hogg, above n. 1, 742–743, referring to G.V. Le Forest, The Allocation of Taxing Powers under the Canadian Constitution (2nd edn., Canadian Tax Foundation, Toronto, 1981) 155–165. 44

Divergent Tax Histories of Australia and Canada 349 By way of preface to this discussion, it is worth noting that the Constitution of Canada provided no express machinery for settling disputes concerning distribution of legislative power. Until 1949 the power as the final court of appeal for Canada lay with the Judicial Committee of the Privy Council until this mantle was assumed by the Supreme Court of Canada. The Privy Council, in its decisions, was generally seen to establish precedent which gave a wide interpretation to provincial powers and a narrow interpretation to federal powers, thus elevating the power of the provinces, perhaps in partial recognition of the political sensitivities that existed.48 Direct and indirect taxes Because the Canadian constitution restricted the provinces to the imposition of direct taxation, the identification of which taxes were direct and which were indirect became an issue for determination in Canadian constitutional law. From an early time the courts accepted49 the definition of Mills as an authoritative delineation of direct and indirect taxation, this definition holding that:50 A direct taxation is one which is demanded from the very person who it is intended or desired should pay it. Indirect taxes are those which are demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another.

From this the courts drew a distinction as to what was seen as the general tendency of the tax. If the general tendency was for the tax to be paid by every person taxed, the tax would be classified as direct; while if the general tendency saw the tax paid by someone else, the tax would be indirect. On this basis a consumption tax on tobacco was cast as a direct tax, as the tax was payable by the last purchaser and could not be passed on, so ‘the money for the tax is found by the individual who finally bears the burden of it’.51 A useful description of the indirect tax characteristic of being passed on was drawn from the dicta of Rand J, in that:52 If a tax is related or relatable, directly or indirectly, to a unit of the commodity or its price, imposed when the commodity is on the course of being manufactured or marketed, then the tax tends to cling as a burden to the unit or the transaction presented to the market.

48

In particular the appeasement of Quebec. See eg, Bank of Toronto v Lambe (1887) 12 App Cas 575; Atlantic Smoke Shops Ltd v Conlon & Attny Gen [1943] 4 DLR 81. 50 J.S. Mill, Principles of Political Economy (Penguin, Haimondsworth, 1970) Bks. IV and V, ch 3. 51 Atlantic Smoke Shops Ltd v Conlon & Attny Gen [1943] 4 DLR 81, Viscount Simon LC at 87. 52 CPR v Attny Gen Sask [1952] 2 SCR 231, 251–252. 49

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It is noted in the later discussion that echoes of this finding resound in some of the Australian court decisions on the nature of an excise. In application of this principle, courts found a provincial tax on removal of gravel from a quarry to be indirect and unconstitutional if levied on a volumetric basis, since it would cling to the gravel as part of the retail price; but a constitutionally valid direct tax if levied on a flat basis unrelated to volume.53 Direct taxes would include business taxes taking the form of a flat fee,54 or a fee that varied with capital and the number of places of business.55 A provincial tax imposed on purchasers of fuel oil was found by the Privy Council to be an indirect tax analogous to customs duty,56 an impost denied to the provinces. However in a landmark decision for the provinces, the court found that the same fuel tax, when levied on the consumer rather than the purchaser, was a direct tax and thus within the power of the provinces. This decision opened up for the provinces the potential to impose a consumption tax or retail sales tax levied on the consumer at the point of retail sale, as there would be no question of further resale and passing the tax on through subsequent dealing. Such a tax was found valid even when it was the sellers of the product who carried the burden of the collection of the tax, because of the difficulty of collection from the final consumer.57 The echoes of these Canadian decisions would reverberate for a number of years through the Australian common law, as the High Court in Australia battled to address adequately the question of the characterisation of an excise tax. Also of interest for an Australian context is the Canadian finding that a GST was a direct tax, being effectively imposed on the final purchaser for consumption, and thus could be validly imposed by the provinces.58 Licence fees The other avenue of revenue raising available to the provinces was the imposition of licence fees in order to raise revenue,59 the power being then a taxing power rather than a regulatory power. The question at issue which arose for the consideration of the courts concerned when a charge qualified as a licence fee, and when it could be characterised as an indirect tax, which would not be within the purview of the province. It would appear that despite section 92(2) precluding provinces from levying indirect taxes, section 92(9) would authorise indirect licence fees if they were directed to defraying the expense of an otherwise valid regulatory scheme.60 53 54 55 56 57 58 59 60

Allard Contractors v Coquitlam [1993] 4 SCR 371, 398. Brewers’ and Malters’ Association v AG Ont [1897] AC 231. Bank of Toronto v Lambe (1897) 12 App Cas 575. AG BC v CPR [1927] AC 934; followed in Air Can v BC [1989] 1 SCR 1191. Atlantic Smoke Shops v Conlon [1943] AC 550. Re GST [1973] 2 SCR 445. S. 92(9) Constitution Act. La Forest, above n. 47, 155–165.

Divergent Tax Histories of Australia and Canada 351 Licence fees were characterised as regulatory charges if taken in payment for a specific government service, and bearing a reasonable relation to the cost of providing the service.61 In regard to the relation between the fee charges and the costs to be recovered by the fee, the courts have been prepared to allow for more than cost recovery, with charges being able to produce surplus revenue and still be treated as a licence rather than an indirect tax, on condition that the court be satisfied that the impost was not a colourable attempt to levy an indirect tax.62 The decision in Allard Contractors v Coquitlam63 demonstrates just how far the courts have been prepared to stretch the boundaries to find a charge to be a licence rather than an indirect tax. In this case a charge for gravel based on volume extracted was upheld as a regulatory charge connected to road repair, even though the fee was not linked to regulations for roads or repair, there was no requirement to use the gravel for roads or repair, and there was no connection to a regulatory scheme. The court, however, was prepared to infer a connection to road repair, thus avoiding having to find the charge invalid as an indirect tax levied by a province. Similarly in Ontario Home Builders’ Association v York Region Board of Education,64 indirect charges were again upheld as valid as being ancillary to a valid regulatory scheme. However the decision in Kingstreet Investments Ltd v New Brunswick (Dept of Finance)65 does demonstrate a willingness by courts to place a limit on the extent to which they will go to find a charge to be a tax intended to defray the costs under a regulatory scheme. Russell J expressed the view that the levy at issue in this case ‘so far outstretches any cost recovery requirement as to be outside the scope of s 92(9) of the Constitution Act’,66 his Honour being satisfied that it was a colourable attempt to levy an indirect tax. This decision is from a provincial court, however, and it remains for the Supreme Court to give more definitive guidance as to the extent of regulatory charges before taking on the pith and substance of an indirect tax. The High Court in Australia may similarly be seen as having trodden an at times tortured path in attempting to find some validating grounds in what appeared an otherwise invalid state impost. As the discussion highlights, the Australian cases have drawn upon Canadian experiences in attempting to characterise state levies as within the Constitutional bounds. Australian Experience In the allocation of fiscal powers between the federal and state governments in Australia, the Australian government had been granted exclusive power 61 62 63 64 65 66

Shannon v Lower Mainland Dairy Products Board [1938] AC 708. Re Farm Products Marketing Act [1957] SCR 198, 260. [1993] 4 SCR 371. [1996] 2 SCR 929, Iacobrecci J. Unreported; New Brunswick Court of Queen’s Bench, 20 Feb. 2004. Kingstreet Investments, above n. 65, at para 54.

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to levy customs and excise taxes. Having lost such a lucrative source of revenue, the states were keen to find a constitutionally valid replacement for customs and excise duty, with an early attempt being the imposition of a licence fee on liquor. The challenge to this state impost in Peterswald v Bartley67 provides an illustration of the early attitude to the breadth of states powers. Griffith CJ, who had been one of the drafters of the Constitution, assigned to excise a narrow definition as being limited to a tax imposed on goods in the process of production or manufacture, as distinct from a licence which was a direct tax on a manufacturer and thus a valid state impost.68 By limiting an excise to a narrow field, the court was able to allow for a wider range of state impositions which would fall outside the narrow ambit of an excise, thus demonstrating an intention that state powers remain, as far as possible, at large. At the same time a narrow definition of excise would confine the federal taxes which could be cast as an excise. The intent that state power remain largely untrammelled was made clear by the Chief Justice when explaining that any construction of the Constitution which acted to withdraw from the states the power to regulate their internal affairs in connection with trade or business was ‘altogether contrary to the spirit of the Constitution, and will not be accepted by this Court unless the plain words of its provisions compel us to do so’.69 Illustrating the gradual shift away from the narrow view of an excise, Dixon J in Matthews v The Chicory Marketing Board70 found no foundation for a definition limited to domestic manufacture and production, instead finding that a tax would constitute an excise if it was related to production, manufacture, sale or consumption.71 This decision started what may be seen as a series of setbacks for the taxing power of the states, as the broadening view of an excise limited the imposts that could be imposed, and at the same time strengthened the hand of the Australian government. At issue in Parton v Milk Board (Victoria)72 was a levy on a milk distributor rather than a producer. The court followed the decision in Matthews, with a narrow three to two majority finding the impost to be an invalid state excise. In expanding further on dicta in Matthews, Dixon J found the broad requirement that an excise would be any tax on goods before they reached consumption.73 In what can only be seen as a major step towards diminishing the powers of the states, and strengthening the federal hand, his Honour suggested that: [i]n making the power of the Parliament of the Commonwealth to impose duties of customs and of excise exclusive it may be assumed that it was intended to give 67 68 69 70 71 72 73

(1904) 1 CLR 497. Ibid., 509. Ibid., 507. (1938) 60 CLR 263. Ibid., 304. (1949) 80 CLR 229. Ibid., 260.

Divergent Tax Histories of Australia and Canada 353 the Parliament a real control of the taxation of commodities and to ensure that the execution of whatever policy it adopted should not be hampered or defeated by State action.74

With the avenue of levies on goods now closed as a revenue source, the states followed the Canadian example, and turned to the use of charges characterised as licence fees for raising revenue. Such fees were purportedly imposed for the right to carry on business, but were invariably levied on a base such as previous purchases. This was the case in Dennis Hotels v Victoria,75 where the validity of a liquor licence based on previous purchases was at issue. Again in a narrow four to three decision, the court determined that the ‘criterion of liability’ was not the purchasing of liquor, but the acceptance of a licence to carry on business.76 Despite the narrow victory, this case provided a lifeline for the revenue raising of the states, with the validity of a state impost having been confirmed. The use by states of licence fees as validly imposed charges, even if calculated by reference to sales, was strongly affirmed by cases such as Dickenson’s Arcade v State of Tasmania77 and Phillip Morris v Commissioner of Business Franchises (Victoria).78 Such decisions must have given heart to the state Treasurers, who would have been concerned at the erosion of state revenue raising powers following the earlier widening of the ambit of the meaning of an excise. That such was the case was recognised by Menzies J in Dickenson’s Arcade, in suggesting that this new understanding of the validity of a licence fee was ‘an important decision upon the faith of which States have ordered their affairs’.79 The significance of the revenue raised by states from licence fees was again a crucial determination in the upholding of a licence fee in Capital Duplicators v ACT (No 2).80 However the court appeared to be drawing increasingly fine distinctions in preserving the myth that charges based on purchases or sales were licence fees for carrying on a business, and the bubble for the states was finally burst by the decision in Ha v NSW; Hammond v NSW.81 The four to three majority rejected the notion which had grown in previous cases that alcohol and tobacco should be treated as special cases, and determined that the states had stretched the bounds of credibility to breaking point with these imposts. The majority declared that: (t)he maintenance of constitutional principle evokes a declaration that the Dennis Hotels formula cannot support what is, on any realistic view of form and 74 75 76 77 78 79 80 81

Ibid. (1960) 104 CLR 529. Ibid., 569. (1974) 130 CLR 177. (1989) 167 CLR 399. Dickensons Arcade, above n. 76, 212. (1993) 178 CLR 561. (1997) 189 CLR 465.

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of ‘substantial result’, a revenue-raising inland tax on goods. The States and Territories have far overreached their entitlement to exact what might properly be characterised as fees for licences to carry on businesses. The imposts which the Act purports to levy are manifestly duties of excise on the tobacco sold during the relevant periods. The challenged provisions of the Act are beyond power.82

The case effectively completed the shift in taxing power from the states to federal control in Australia. While the Constitution had granted an exclusive excise power to the federal government, the states had, for almost a century, and with the compliance of the courts, retained a thin grasp on a revenue source to which the Constitution had denied access. While court decisions had made it more difficult to retain this revenue, as the court gradually moved from state power to federal power, it was only late in the last century that states finally lost the last vestiges of the imposition of an excise equivalent tax.83 Unlike Canada, where the provinces were constitutionally granted the power to impose licence fees, the Australian states had no such mandate.

IV. APPROACHES OF THE COURTS

Given that it would appear that much of the divergence between the Australian and Canadian development in sharing taxing powers arose from the adjudication of the courts, it is appropriate to consider what elements in the judgments may have been responsible for this. A major characteristic to which much of the divergence has been attributed is the nature of statutory interpretation by the courts in Australia and Canada. The suggestion has been that for much of the century, the High Court in Australia followed a literalist approach in the interpretation of taxation statutes, and this is seen as reflected in the nature of the decisions emanating from the court.84 In the taxation decisions this approach has been suggested as yielding a strong centralist bias. An example used to illustrate this proposition has been the First Uniform Tax Case, with the suggestion being that the decision in the case represented nothing less than a triumph for the literal form over substance, with the court virtually ignoring the federal government’s underlying objective of removing the states from the field of income tax.85 The Canadian approach to statutory interpretation is seen as encompassing a broader and more flexible method of looking for the dominant aspect of the 82

Ibid., 503. Even at this stage, in their dissenting judgement, Dawson, Toohey and Gaudron JJ argued, at 507, for a narrow meaning of excise, suggesting that the extended meaning of excise from Parton could no longer be accepted; their Honours concluded, at 517–518, that the intention of s. 90 was to preclude state imposts which could undermine the common external tariff and because the current levy fell on both domestic and imported goods alike it could not be seen as an excise. 84 See eg, Gilbert, above n. 2. 85 Gilbert, above n. 2, 18. 83

Divergent Tax Histories of Australia and Canada 355 law, with the doctrines of pith and substance, and colourability, resulting in laws disclosing a purpose beyond the power of the particular parliament being struck down. The outcome of this approach has been seen as favourable to the provinces. Both the Privy Council and Supreme Court have been prepared to strike down a tax law which was seen as a colourable invasion by the federal parliament of an area of responsibility reserved for the provinces.86 However, while it is undeniable that court decisions have undoubtedly contributed significantly to the divergence in the evolution of the allocation of taxing powers, it is arguable that the statutory interpretation approach by the courts cannot be seen to fully explain the divergent outcomes. For much of the last century the High Court in Australia did adopt a very literalist approach in the interpretation of taxation (and other) statutes, and this may arguably explain the federal win in the First Uniform Tax Case. However, this same literalist approach arguably allowed the states to continue to impose thinly veiled excise taxes, in the guise of licence fees or franchise fees, hardly demonstrating a centralist tendency by the High Court. Had the court been prepared to adopt a substance approach, or apply the pith and substance and colourability tests applied by Canadian courts, these attempts at state revenue raising may have been invalidated much sooner than proved to be the case. In this circumstance the literalist approach, then, arguably favoured the states, and a decentralised approach, in relation to imposition of indirect taxes. In looking to allot the central role to the courts, an aspect which may be overlooked to a degree, but which is arguably of greater significance in determining the degree of centralistion in the taxing powers, has been the role of the legislatures themselves. The refusal of the Australian states to concede income taxing powers during the Second World War may be seen as an act of brinkmanship which forced the federal government to act as it did. Once the federal government had acted unilaterally, and the matter came before the courts, there could effectively be only one winner, and the path could not be reversed. Having received the endorsement of the High Court, there was no pressure or incentive for the Australian government to allow the states to re-enter the income tax field, as the matter had been finally and conclusively determined. The Canadian outcome of an agreed handover of taxing powers by the provinces during the war period kept open the options for an eventual reversal of the process. Without the finality which accompanied the process in Australia, the way was arguably always open for a further agreement between the central and provincial governments for a return of income taxing powers to the provinces, with this outcome eventually being effectively realised. Ultimately, the path followed for the operation of taxing powers in Canada may be seen as a victory for cooperation over coercion. 86 One example would be Re the Insurance Act of Canada (1906) 4 CLR 488, being held to be a colourable attempt to regulate the insurance industry through tax legislation.

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It may well be the case that ‘[n]o amount of care in phrasing the division of powers in a federal scheme will prevent difficulty when the division comes to be applied to the variety and complexity of social relationships’.87 This would certainly appear to be the case when looking to the division of revenue raising powers in framing a federal Constitution. The illustrative examples of Australia and Canada provide clear evidence that, despite the best intentions of the drafters of a constitution, the judiciary, in the face of social and economic change, can not only undo, but reverse, any intention implicit in the constitutional document. The allocation of powers in the development of the Canadian federation saw the creation of an initially centralised taxation power base, due, among other factors, to a mid-nineteenth century belief that strong national government was necessary to mitigate against the possibility of an Americanstyle civil war.88 Since the 1950s and 1960s this centralism has been reversed, with the balance of taxing power moving from the federal to the provincial governments. The Supreme Court has been instrumental in this trend, being prepared widely to interpret the provincial power to impose licence fees. By contrast, the Australian Constitution was concerned to limit federal powers, with states holding residuary powers, including the power for direct taxation. This power was centralised during the Second World War, due to the impending threat of invasion and, once attained, the federal government has not made any serious attempt to return direct taxing power to the states. As with Canada, the High Court has had a key role in allowing for centralisation of income taxing powers, and finally taking a more substance-based approach in precluding the use of licence fees as a cloak for what in substance amounted to excise levies, a tax denied to the states. While the courts in each country have played a critical role in the shifting balance of taxing power between levels of government, the suggestion has been made that this was a not a role which they had sought, but rather ‘it ought to be emphasised that [the courts] have mostly been forced into this situation because of the inability or unwillingness of the political system to resolve the questions of intergovernmental rivalry, which are resolved eventually through litigation’.89

87

B. Laskin, Canadian Constitutional Law (3rd revd edn, Carswell Co., Toronto, 1969) at 4. See eg, K. Wiltshire, Planning and Federalism: Australian and Canadian Experience (University of Queensland Press, St. Lucia, 1986). 89 Ibid, 93–4. 88

13 The Ever-Elusive Definition of Income: A Historical Perspective from Australia MARGARET M C KERCHAR AND CYNTHIA COLEMAN

ABSTRACT There is no definition of ‘income’ in Australian income tax legislation, either in the Income Tax Assessment Act (ITAA) (1997) or its predecessor ITAA (1936), both of which remain operative today. This is surprising when one considers that the purpose of this legislation is to impose a tax on income. Is the concept of ‘income’ so elusive or changeable that it defies definition? ITAA 1997 contains the basic principle that an entity’s assessable income is the sum of its ordinary and statutory income for the year. While items of statutory income are identified in ITAA 1997, ordinary income is simply described as ‘income according to ordinary concepts’ (section 6–5). In effect, this leaves the definition of ordinary income to the Australian courts through case law precedent. The chapter traces the historical development of the judicial concept of ordinary income in twentieth century Australia. Over this time, the courts have developed a range of tests and attributes to identify ordinary income, and these, and their influence on subsequent judgments, are explored. It might be assumed that this concept of ordinary income is no longer a contentious area, given its fundamental nature and history of case law. However, a recent decision (regarded by many as contentious) by the Full Federal Court of Australia (Stone v Federal Commissioner of Taxation [2003] FCAC 145) on this issue has raised yet again the value of case law precedent. The problems were not resolved by the Full High Court decision (2005) ATC 4234. Indeed, what have we learnt from history and how has this influenced our interpretation of tax law in both the past and present?

I. INTRODUCTION

L

IKE MOST DEVELOPED countries, Australia has relied extensively on a tax on income. In the Australian context, tax on income is fundamental in that it has remained the major source of government

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revenue1 since its introduction at the Federal level over 60 years ago. This chapter presents an overview of the evolution of the judicial concept of income for tax purposes in Australia2 and seeks to analyse the principal causes and effects that have been part of the process. While it would seem reasonable to assume that clarity of meaning would develop over time, the chapter serves to illustrate that wisdom does not necessarily come with age or experience. A contemporary case which best illustrates the contentiousness of the judicial concept of income, and was the catalyst for this chapter, is Stone v FCT. 3 The chapter itself is presented in five sections. The second section examines the development of the legal concept of income from 1936 when the first federal comprehensive income tax legislation was enacted, to date. The third section examines the evolutionary process of the judicial concept of income over the corresponding period. The fourth section of the chapter examines the application of the judicial concept of income in Stone v FCT. The final section reviews the implications of the judicial concept of income in a self-assessment environment and considers how it has influenced both taxpayers and tax administration in practice and reflects on the elusiveness (or otherwise) of the meaning of ‘income’.

II. THE LEGAL CONCEPT OF INCOME

Income tax is a creation of statute and this dictates the starting point of our evolutionary study. The Commonwealth of Australia first imposed a tax on income in 1915 with the Income Tax Assessment Act 1915 in response to the need to fund the First World War effort. This Act was replaced in 1922 and then again in 1936 with the Income Tax Assessment Act 1936 (ITAA 1936) which remains operative today in conjunction with the Income Tax Assessment Act 1997 (ITAA 1997). ITAA 1997 represents the early (beginning in 1993) but incomplete efforts at rewriting ITAA 1936 to render it more user-friendly. This rewriting project (about one third complete) was abandoned by the government in 1998 at the time the decision was made to undertake tax reform (including the introduction of a goods and services tax) on a far more comprehensive scale. Neither ITAA 1936 nor ITAA 1997 defines ‘income’; instead both use the word in combination with many others including taxable income, assessable income and gross income. Under the provisions of ITAA 1936, 1 Net income tax collections in 2000–2001 were A$108,406m, with the next major source of taxation revenue being the goods and services tax at A$26,898m: Taxation Statistics 2000–2001 issued 14 Feb. 2004 and available online at http://www.ato.gov.au. 2 At this stage of its development, the scope of the chapter is limited to the examination of Australian cases—though it is acknowledged there is potential to examine other jurisdictions. 3 Full Federal Court (2003) 53 ATR 214; 198 ALR 541.

An Ever-Elusive Definition of Income: Australia 359 income tax is payable upon the ‘taxable income’ derived during the year of income by any person, whether a resident or non-resident (ITAA 1936 section 17), with taxable income being defined as the amount remaining after deducting from the assessable income all allowable deductions (ITAA 1936 section 6). Similarly, ITTA 1997 at section 4–10 states that ‘your income tax is worked out by reference to your taxable income for the income year’ and at section 4–15 that you ‘[w]ork out your taxable income for the income year like this: Taxable income = assessable income – deductions’. Under the provisions of ITAA 1936, assessable income is defined to mean ‘all the amounts which under the provisions of this Act are included in the assessable income’ (section 6), and in ITAA 1997 at section 6–1, assessable income consists of ordinary income and statutory income, and the following diagram is included at this section to show the relationships among the concepts discussion in Division 6 (ITAA 1997). The implication of the definition of assessable income in ITAA 1936 is that a particular item or receipt can be assessable as income only where specifically characterised as such by the Act, and there are a number of specific sections which do in fact render various classes of receipts as assessable income (for example, ITAA 1936 section 26 (e) renders as assessable income the value to the taxpayer of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to him in respect of,

Assessable income

Ordinary income

Statutory income

Non-assessable non-exempt income

Exempt income

Figure 1: Relationships among Concepts of Income in Division 6 ITAA 1997.

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or for or in relation directly or indirectly to, any employment of or services rendered by him)4. Unless otherwise specified, section 25 of the ITAA 1936 embodies the general concept of income in that this section generally determines the assessability (or otherwise) of a receipt. This section characterises a taxpayer’s ‘gross income’ as assessable, but ITAA 1936 does not include a definition of ‘gross income’. While ITAA 1936 (section6 (1)) does contain definitions of ‘income from property’ and ‘income from personal exertion’, they are circular in nature (in that income from property is defined as all income not being from personal exertion) and ‘serve only to differentiate between different aspects of the undefined whole’.5 Income from personal exertion is defined as income consisting of earnings, salaries, wages, commissions, fees, bonuses, pensions, superannuation allowances, retiring gratuities, allowances and gratuities received in the capacity of employee or in relation to any services rendered. Similarly, ITAA 1997 does not define gross income. The meaning of assessable income according to section 995-1 of the ITAA 1997 is that afforded it by section 6–5 and section 6–10 (and various others sections, but these are the most fundamental in the context of this discussion). Under section 6–5(1) of the ITAA 1997, ‘[y]our assessable income includes income according to ordinary concepts, which is called ordinary income’ and at section 6–5(2) ‘[i]f you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year’. At section 6-10, assessable income also includes amounts which are not ordinary income. These amounts are called statutory income. Amount are included as statutory income by provisions about assessable income (section 6–10(2)), that is, they are specifically included by virtue of other sections (generally contained in Division 15), for example, allowances to an employee or in a service relationship are assessable under section 6–25. Under both Acts there are provisions by which exempt income—receipts specifically excluded from assessable income—is identified. The main issue here is the concept of ‘ordinary income’. According to the provisions of section 25 of the ITAA 1936, there is the all-encompassing view that virtually every receipt could be assessable. In contrast, under ITAA 1997, there is the notion that assessable income includes ordinary income or income according to ordinary concepts. Neither Act provides a clear legal definition of income or of ordinary income, hence the importance of the judicial concept of income, to which we now turn. 4 Since 1 July 1986 many benefits provided by employers to employees which were previously assessable under this section are dealt with under the Fringe Benefits Tax Assessment Act (1986) and s.21A ITAA 1936 which applied from 31 Aug. 1988. 5 R. Kemp, A. Steep and R. Fernandez, Barrett and Green’s Principles of Income Taxation, (4th edn. Butterworths, Sydney, 1991) 24.

An Ever-Elusive Definition of Income: Australia 361 III. THE JUDICIAL CONCEPT OF INCOME

The lack of a clear definition of income, or of income according to ordinary concepts, in effect gives the judicial concept of income its power—the power to create tax law by using a common law approach. Ordinary concepts are regarded as a reflection of society’s values at the time the decision is handed down, and as such are not fixed but continue to evolve.6 They are built on history, tradition and the judicial understanding and interpretation of both statute and society. This interpretation may not be always ‘convenient’,7 infallible or free of bias.8 This section of the chapter explores aspects of this evolution over a similar time period as in the previous section. In Scott v C of T 9 Jordan CJ described the word ‘income’ as: not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concept and usages of mankind, expect in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts.

Unfortunately this is not a very useful statement. It does not discuss the possibility that what is ordinarily seen as income can involve a combination of economic theory, accounting principles, dictionary definitions and precedence. The ordinary taxpayer in the street would not necessarily be interested in the concept of income.10 Barwick, CJ, Kitto and Taylor JJ in Arthur Murray (NSW) Pty Ltd v FCT11 adopted the literal rule of interpretation in holding that fees received by a taxpayer for services to be rendered in the future and held in a suspense account were not income until brought into the revenue account at the time the service was provided. It was the provision of the service, not the internal accounting method, which triggered the derivation of the income. While the High Court was dealing with the timing of derivation, more than the concept of ‘income’ itself, the general understanding among 6 This message is reiterated from time to time: e.g. see FCT v Blake (1984) 84 ATC 4661 at 4663. 7 Hill J quoted in R.Woellner, S. Barkoczy, S. Murphy, and C. Evans, Australian Taxation Law 2004 (14th edn. CCH, Sydney, 2003), 44. 8 For example, fundamental conflict exists between the judicial and economic notions of income. See R. Parsons, ‘Meaning of Income and the Structure of the Income Tax Assessment Act’, Taxation in Australia, 13 Nov. 1978, 378–409. 9 (NSW) (1935) 35 SR (NSW) 215 at 219. 10 J. Waincymer, Australian Income Tax Principles and Policy (2nd edn., Butterworths, Sydney, 1993) 96. 11 (1965) 114 CLR 314 at 320.

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practical business people according to what constituted a derivation of income, that is, according to ordinary concepts, was adopted: In so far as the Act lays down a test for the inclusion of particular kinds of receipts in assessable income it is likewise true that commercial and accountancy practice cannot be substituted for the test. But the Act lays down no test for such a case as the present. The word ‘income’, being used without relevant definition, is left to be understood in the sense which it has in the vocabulary of business affairs. To apply the concept which the word in that sense expresses is not to substitute some other test for the one prescribed in the Act; is to give effect to the Act as it stands.

The Australian courts have not developed a definitive definition of ‘income’. Thus it is necessary to examine the findings for the emergence of the general principles. To some extent they are embedded in ITAA 1936 which does provide definitions of income from personal exertion and income from property (section 6) and allows for the deductability of losses and outgoings incurred in carrying on a business or for the purpose of carrying on a business (section 51): thus it is commonly held that assessable income includes income from personal exertion, income from property and income from carrying on a business. Income does not include capital.12 These general principles accord with Justice Pitney’s notions of income being the ‘fruit or the crop’ and capital being ‘the tree or the land’.13 However this analogy is more of a guide than a definitive description of the difference between income and capital. If the taxpayer is running a nursery business, trees will be trading stock on revenue account rather than capital. Waincymer14 suggests that this analogy works best with easy cases and is not very helpful in dealing with borderline issues. Waincymer quoted Parsons15 who stated ‘to lawyers, metaphors are substitutes for, and not aids to, analysis’.

Income versus Capital and the Assessability of Isolated Transactions The distinction between income and capital was more critical before the introduction of a capital gains tax regime in 1985, but still remains significant, given that capital gains generally receive more favourable treatment in terms of the resultant tax liability. Income and capital remain mutually 12 Although a capital gains tax regime has existed in Australia since 1985, capital gains are generally concessionally taxed as compared to income. The distinction between income and capital remains important even though it has diminished over time with the reduction in the company tax rate from 46 % in 1985 to 30 % in 2004. 13 Eisner v Macomber 252 US 189 (1919). 14 Above n. 19, at 110–111. 15 Ibid. R. Parsons, ‘Income Taxation: An Institution in Decay’ (1986) 3 Australian Tax Forum, 233.

An Ever-Elusive Definition of Income: Australia 363 exclusive for tax purposes. Early leading cases include Bennett v FCT16 in which a lump sum paid to a managing director by three instalments upon the cancellation of his service contract was held to be a capital receipt. The payment was compensation for the loss of the rights under his service contract, not a substitution for the foregone income. In contrast, in Brent v FCT17 the taxpayer, wife of Britain’s ‘great train robber’, Ronald Biggs, entered into an agreement with a newspaper company. She made herself available for interviews with the journalist who wrote the story, granted permission for it to be published and entered into a restrictive covenant not to sell the story to anyone else. Mrs Brent argued that in parting with secret information, she was in effect selling or realising a capital asset. Gibbs J held that the monies were paid as consideration for services rendered and were accordingly assessable. There was no property or copyright because she was not the author of the article, and the restrictive covenant was incidental to the provision of the services. Findings in later cases have proved more controversial. For example, in FCT v Myer Emporium18 it was held that the proceeds arising from an isolated transaction outside the ordinary course of business might also be assessable under ITAA 1936 section 25(1) if the purpose of the transaction was to make a profit. That is, the taxpayer’s subjective intention was relevant. In this case the taxpayer entered into an arrangement to borrow funds whereby it lent A $80 million at a commercial rate of interest to its subsidiary for a period of seven years and three months. The taxpayer then assigned its right to interest to a finance company with large losses, for a lump sum consideration. The Commissioner treated the lump sum as assessable income under section 25(1) of the ITAA 1936. The taxpayer argued, first, that a gain made as a result of a business deal was not income unless it was made in the ordinary course of a taxpayer’s business; and, secondly, the receipt by the taxpayer was the mere realisation of a capital asset. It was held that the proceeds of an isolated transaction, which was outside the scope of the taxpayer’s normal business activities, were assessable income according to ordinary concepts because the taxpayer had entered into the transaction with a profit-making intention. In contrast, in Westfield Ltd v FCT19 the taxpayer (whose business was the design, construction, letting and management of shopping centres) sold at a profit land it had acquired to AMP (with whom it had entered into an agreement to design and build a new shopping centre on the land). Hill J found that the profit was not assessable as income as the resale of land was not part of the taxpayer’s ordinary business activity, nor did the taxpayer 16 17 18 19

(1947) (1971) (1987) (1991)

75 CLR 480; 4 AITR 12. 125 CLR 418; 2 ATR 563. 18 ATR 693, 163 CLR 199; 87 ATC 4363. 21 ATR 1398.

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have a purpose of profit making by resale at the time of acquisition. In his finding, Hill J (at 1406) stated that it did not follow from Myer that every profit made by a taxpayer in the course of his business activity would be of an income nature. The Full Federal Court also adopted this reasoning about the taxpayer’s intention in FCT v Cooling20 where it was held that a lump sum payment received by solicitors to induce them to lease office space was assessable income on the basis that, as it was a commercial transaction, it formed part of the business activity of the firm and it was also a profit-making scheme. In contrast, it was held in Selleck v FCT21 that generally an amount that did not have a sufficient nexus with an earning activity would not be ordinary income. It was not a profit-making scheme because there was no sale of an asset. The taxpayers received a large cash contribution for a fit-out of the new premises, and this enabled them to distribute cash to individual partners. The issue of the assessability of lease incentives was then determined in the Full High Court in the case of FCT v Montgomery22 where it was found (Gleeson CJ, McHugh and Callinan JJ dissenting) that the contribution of A $29.3m by a lessor towards the fit–out of premises as an inducement to the lease agreement was assessable as income in the hands of the lessee. Even though it was an isolated transaction, it was ‘an ordinary incident of transactions of this kind. Its receipt was, then, neither an unexpected nor unintended by-product of the transaction; its receipt was a purpose of entering the transaction’. The assessability of profits from isolated transactions was also considered in the case of Warner Music Australia v FCT23 in which Hill J found that even an abnormal gain (in the sense of infrequent) might be so intimately connected with a taxpayer’s business as to be an incident of the business, even if not an ordinary incident, and therefore ordinary income.

Income from Personal Exertion According to ordinary concepts, income from personal exertion has been held not to include gifts or irregular payments. Early cases that tackled this issue relied upon making an objective evaluation from the taxpayer’s perspective, which reflected the more traditional approach of applying the letter of the law rather than its intent. For example, in Dixon v FCT24 the employer in 1939 informed staff that, should they enlist for military service, the difference between their current 20 21 22 23 24

(1990) (1997) (1999) (1996) (1952)

21 36 42 70 86

ATR 13. ATR 558. ATR 475. FCR 197; 96 ATC 5046. CLR 540; 5 AITR 443.

An Ever-Elusive Definition of Income: Australia 365 wages and the military pay would be met. Dixon CJ and Williams J held the receipt from the employer to be assessable income in the hands of the taxpayer. In doing so, they took several factors into account including the employer’s motives and an objective assessment from the taxpayer’s perspective—that the payment was expected, periodical and was relied upon to meet the family’s living expenses. In contrast, in FCT v Harris,25 it was held that an unsolicited lump sum payment (to a former bank employee from the bank’s superannuation fund) which was unlikely to be repeated was not income according to ordinary concepts. This was despite the fact that the taxpayer had received a similar payment over the following years. In similar facts, Carter J of the Supreme Court of Queensland in FCT v Blake26 followed Dixon and distinguished Harris, holding that supplementary payments to a pension were assessable as ordinary income.27 The concept of adopting the taxpayer’s perspective was also adopted in Hayes v FCT.28 In this case Fullagar J provided an outline of the process of reasoning to be applied in determining whether or not a receipt was income, and concluded that the real question was the character of the receipt in the hands of the recipient and that this needed to be determined objectively— to predict what the view of the taxpayer would have been had he stood back and regarded his situation objectively. This concept came from the English decision of Moorehouse and Dooland.29 Issues to be considered would include: whether the taxpayer was entitled to the receipt; whether the receipt was expected; whether it was a receipt incidental to the taxpayer’s income–producing activities; or whether it was an ordinary receipt of a type regularly received by the taxpayer. The decision by Windeyer J in Scott v FCT30 demonstrated the difficulties in distinguishing between a non-taxable personal gift and a reward for services. The taxpayer, a solicitor, received a monetary gift (£10,000) from a personal friend who was also a client. It was found that the receipt was not income as the taxpayer had already been paid for his services, and that there was evidence of the high personal esteem in which the payer held the recipient, beyond that usually to be expected in a professional relationship. This high personal esteem had initially been generated by the professional relationship, but the court held that this was too remote a connection to render the receipt assessable as income. The income/gift distinction has also arisen in the context of payments to professional sportspersons and given the genesis for this chapter, emphasis 25

(1980) 10 ATR 869. Above n. 6. 27 In response, s.27H (ITAA 1936) was inserted in 1984 specifically to make such receipts assessable. 28 (1956) 96 CLR 47; 6 AITR 248. 29 (1954) 36 TC 1. 30 (1966) 117 CLR 514; 10 AITR 290. 26

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is given here to this distinction. The fundamental dilemma, is as in Scott’s case, was the payment made for services rendered, or in respect of the taxpayers’ personal qualities?31 Prior to Stone, there was general consistency in that such payments (prizes and awards) made to professional sportspeople were assessable as income according to ordinary concepts, in that there was a nexus between the award and their income earning activities. For example, in the case of Kelly v FCT32 the taxpayer was a university student and professional footballer who won a A $20,000 prize from a Perth television station for being the best and fairest player for the season. The Commissioner subsequently included the amount in the taxpayer’s assessable income under section 25(1) of the ITAA 1936. It was held that the amount was ordinary income, even though the payment was made by a third party; there was a direct nexus between the prize and his employment as a football player. This view was also supported in Case 742233 where the taxpayer, an international rugby league player, again a professional footballer, received two payments from the Queensland Rugby League Football Ltd. The payments were made under an agreement which provided that the taxpayer would be paid for playing football for Queensland, for being selected in the Australian team, and an additional bonus for playing well. It was held that the payments were for services rendered and assessable as income according to ordinary concepts.

Income from Business Income from business has been held to be income from personal services or exertion, and this concept that the proceeds of any business ‘are income in accordance with the ordinary concepts and usages of mankind’ was reaffirmed in Montgomery.34 Given that both Acts have similar definitions of a business as ‘including any profession, trade, employment or calling, but does not include occupation as an employee’ (ITAA 1936 section 6(1), ITAA 1997 section 995–1), a judicial dilemma in determining whether or not a taxpayer is carrying on a business has to be expected. For example, in FCT v Whitfords Beach Pty Ltd 35 the Full High Court held that an isolated transaction which constituted a profit-making scheme could also be regarded as the carrying on of a business. In this case, the taxpayer 31 For earlier overseas cases see Seymour v Reed [1927] AC 554 and Moorehouse v Dooland (1955) 36 JC 12, at 29, in which there are contrasting findings. 32 (1985) 85 ATC 4283. 33 Administrative Appeal Tribunal (1991) 22 ATR 3450. 34 Gaudron, Gummow, Kirby and Hayne JJ (at 492 (ATR)) quoting from Myer (1987) 87 ATC 4363 at 4370. 35 (1982) 150 CLR 355 (Full High Court).

An Ever-Elusive Definition of Income: Australia 367 acquired land (its only asset) to ensure continued beach access to property already owned by its shareholders. The company was subsequently sold to a consortium of land developers who rezoned, improved and subdivided the land, selling the blocks at a profit. The taxpayer argued that sales of land were isolated transactions and therefore capital receipts. Gibbs CJ held that the taxpayer was transformed from a company which held land for the domestic purposes of its shareholders to a company whose purpose was to engage in a commercial venture with a view to profit. The Whitfords Beach developers had sought to exploit the principle established in Scottish Australian Mining Co Ltd v FCT36 whereby the proceeds of a mere realisation of an asset were held to be capital. However, some three decades later the judicial concept of income had changed, as evidenced by Mason and Wilson JJ querying the decision by Williams J in Scottish Australian Mining. The difference between the two cases was that in Scottish Australian Mining the land was depleted for mining purposes, whereas in Whitfords Beach the company had been taken over by property developers. Mason J held in Whitfords Beach that, given the massive scale of planned subdivision, it was more than the ‘mere’ realisation of an asset and was instead a business of land development, the proceeds of which were assessable as income according to ordinary concepts. A number of contentious findings in this area have arisen where taxpayers have successfully argued that their activities constitute a business of primary production. For example, in the case of FCT v Walker 37 the taxpayer, who purchased one stud goat which he agisted interstate, was held to be carrying on a business. Ryan J was satisfied that, in spite of the resulting losses, the taxpayer’s activities had the purpose of profit-making. He found that there was repetition and regularity in the taxpayer’s activities and that they were organised in a business-like manner. Another area of activity in which the distinction between a hobby (whereby the proceeds were not income) and a business has come under judicial consideration is gambling. For example, in Evans v FCT 38 Hill J found that although the taxpayer had consistently won money from his gambling activities, he had no system or organisation and they were therefore merely a hobby. Hill J stated that it would not be easy for any taxpayer to establish that his or her gambling activities constituted a business. In terms of the judicial concept of income, Stone’s case embodies many of the concepts explored in this section of the chapter. Stone’s case explores the notions of whether or not prizes and awards are income from personal exertion, whether or not a professional sportsperson is carrying on a business; and the relevance of isolated transactions. Hence this section of the chapter has provided a very brief overview of the evolution of the judicial 36 37 38

(1950) 4 AITR 443. (1985) 16 ATR 331. Federal Court (1989) 20 ATR 922.

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concept of income so as to provide some backdrop to the next section. What it has served to demonstrate is that the judicial concept of income is not fixed and that judicial attitude can change. Over time, the judiciary has appeared less willing to accept a strict literal approach, though finding the balance between literalism and legislative intent has proved challenging and far from predictable. For example, the Full High Court in Cooper Brookes (Wollongong) PTY Ltd v FCT 39 discussed at length the competing interpretations of statutes and acknowledged that questions of degree arise.

IV. FEDERAL COMMISSIONER OF TAXATION V STONE [2005] HCA 21

The facts of the case were as follows. Ms Stone was a world-class javelin thrower and also a full-time employee of the Queensland Police Service. For the year ending 30 June 1999 she earned A$136,448 from her sporting activities. This consisted of A$93,429 in prize money from competing in local and international events; A$27,900 in grants from the Australian Olympic Committee medal incentive scheme, the Queensland Academy of Sport and the Oceania Amateur Athletics Association; A$2,700 in appearances and A$12,419 in sponsorships. Hill J40 in the first instance held that the taxpayer was carrying on a business and that all these amounts were assessable, with the exception of the prize money and the grants. In contrast, the Full Federal Court held that the taxpayer was not carrying on a business, and that only the sponsorship and appearance amounts were assessable as income from personal exertion or for services rendered.

Federal Court Considering each of these findings in more detail, Hill J (at 308) considered that Ms Stone was a professional athlete. ‘In the present case, the business, if there is a business, might be colloquially spoken of as the business of a professional athlete.’ He then, for the sake of convenience, made the distinction between a professional and an amateur athlete, noting that the distinction in sporting circles may not be the same as the business/non-business distinction in tax law. He argued here that while the nature and extent of the activity, and not the intention of the taxpayer, determined whether a business was being carried on, the intention of the taxpayer was not irrelevant. To clarify, an example was given whereby two taxpayers carrying on the same activity could be differentiated according to the purpose for which 39 40

(1981) 147 CLR 297; 11 ATR 949. Federal Court (2002) 51 ATR 297.

An Ever-Elusive Definition of Income: Australia 369 the activity is carried on. Hill J cited the importance of the profit motive (and that it would need to be substantial) in leading to the conclusion that the activity undertaken was a business. A generalisation could not be made simply because an athlete was competing at an elite level—some might clearly be seen to be undertaking a business, while others will be pursing their sport for its own sake. What the professional athlete who carries on a business does is turn the athlete’s talent to account for money by taking advantage of opportunities such as appearance monies, sponsorship, and speaking engagements. Hill J reached his decision (‘not without some doubt’) that Ms Stone turned her ‘undoubted talent to account for money’. This was notwithstanding that many, if not most, of the competitions in which she competed were necessary if she was to qualify for selection to the Australian Commonwealth or Olympic games teams or to enhance and maintain the high standards which she achieved.

Full Federal Court The Full Federal Court41 varied this finding. Heerey, Emmett and Hely JJ (at 74) found that ‘[w]hether a person is carrying on a business will depend upon a number of factors and no single factor will be determinative in a particular case. Thus it will be relevant to determine whether a relevant activity is carried on in a businesslike way and in accordance with commercial principles. If there is system in the activity, coupled with repetition and continuity, that will be indicative of a business. An important factor is whether the relevant activity has a purpose of profit making. However, the fact that the activity does not actually produce a profit is not decisive. Indeed, even where it is not expected to derive a profit, an activity may nevertheless be properly characterised as the carrying on of a business.’ The judges considered various ways by which an athlete might be able to turn his or her talent to account for money. The judgment demonstrates that they gave considerable weight to her subjective intention. They considered whether Ms Stone had undertaken her activities for the purpose of obtaining receipts. They also considered it relevant to consider whether there had been some system in the way in which she engaged in her activities—was this in a business-like way in accordance with ordinary commercial principles? It was found that Ms Stone did not select competitions on the basis of prize money, but rather on the basis of the need to participate in competitions in order to gain competitive experience—which was held not to be indicative of a business activity. 41

Above n. 3.

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Ms Stone clearly pursued sponsorship, but not in a systematic way and only in order to further her aims as a sportswoman, not to derive income from sponsorships. The grants she received were payments that would not have been made but for Ms Stone’s prowess and achievements as a javelin thrower. The fact that she sought them out and that they were paid on a regular basis, however, was found to be not indicative of a business activity. The payments for appearances were similarly characterised. Thus Ms Stone was held not to be carrying on a business, but did she derive income from personal exertion according to ordinary concepts? The Commissioner contended that the prize money was assessable as income according to ordinary concepts because of the direct connection between the use of Ms Stone’s skill and ability with the javelin and the receipt by her of substantial sums of money as the product of that skill and ability. The Commissioner also contended that the prize money was a reward for services rendered and that there was significance in the size of the prizes. It was held that the quantum of the prize money could not determine its character as income. As Ms Stone was not carrying on a business as an athlete, there was no reason for concluding that prize money awarded to her should be treated as income. While her skill and ability enabled her to win prize money, there was insufficient nexus between the two. ‘Ms Stone has not performed a service by throwing her javelin. She has not charged a fee for entertainment’ (at 94). The grants made to Ms Stone were done so as to enable her to bear the additional costs and expenses of competing. The payments were not a reward for services, nor were they made to make up for lost income; hence they were not income according to ordinary concepts. However, it was held that appearance and sponsorship monies were payments made as reward for service and were therefore assessable as ordinary income. The finding in this case, at least in respect of prize money, is in contrast with that of Kelly—the key difference appearing to be that Kelly was a professional sportsperson and that Stone was not—but as evident in the discussion by Hill J, the distinction between a professional and an amateur at the elite level is not straightforward.

High Court The decision of a full bench of the High Court (Gleeson CJ, Gummow, Kirby, Hayne and Heydon JJ) was handed down on 26 April 2005. Their Honours unanimously held that the taxpayer was carrying on a business and that the appearance fees, prizes and grants were all assessable as the proceeds of a business. The Court accepted that the evidence demonstrated

An Ever-Elusive Definition of Income: Australia 371 that the taxpayer’s motivation was her desire to excel, to represent her country and to win medals, not to make money.42 The key factor in holding that the taxpayer was carrying on a business was her acknowledgment that the sponsorship monies formed part of her assessable income. This inevitably led to the conclusion that she had turned her sporting ability to account in return for money.43 The Court stated ‘[t]he sponsorship agreements cannot be put into a separate category marked “business”, with the other receipts being put into a category marked “sport”. Nor can some receipts be distinguished from others on the basis that the activity producing a receipt was not an activity in the course of carrying on what otherwise was to be identified as a business.’ Although the sponsorship arrangements assisted the taxpayer to pursue her sporting activities, they were commercial arrangements and she was able to receive them only because of her sporting ability. The court left open the question whether, if the taxpayer had not been found to be in business, the prizes were paid under an express contract, or whether there was a unilateral contract, as in Carlill v Carbolic Smoke Ball Co.44 If the taxpayer was not carrying on a business, entering into a contract to compete and potentially win a prize would be a contract for services. Payments pursuant to such contracts are always income regardless of whether the recipient is carrying on a business.

V. IMPLICATIONS FOR TAX ADMINISTRATION AND TAXPAYERS

Clearly the judicial concept of income continues to evolve. Stone’s case either demonstrates that Hill J at first instance and the High Court differed from the Full Federal Court on the principles applied in relation to the concept of income, or alternatively, it might be argued that the differing judgments arose from different weight given by the judges to the specific facts of the case. The facts in every tax case are always critical because the principles have to be applied to the facts before the court. It would be unreasonable to expect the legal concept to be so well developed as to leave no doubt. Apart from the difficulties in interpreting the language of statute, there are also difficulties in interpreting intent in the context of contemporary society which itself is dynamic by nature. However, tax administration and taxpayers are important stakeholders in the process, and neither is without influence in terms of both the legal and judicial concepts of income. 42 43 44

FCT v Stone [2005] HCA 21, para. 48. Ibid., at para. 50 [1893] 1 QB 256

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Tax Administration There are two important consequences of the evolution of both the legal and judicial concepts of income from the perspective of the tax administration that need to be considered: the issue of rulings and the recommendations for legislative change. Australia has had a system of self-assessment for income tax purposes since 1986–1987, with one important element of the system being rulings.45 Rulings may be issued by the Australian Taxation Office (ATO) to the public at large (Public Rulings including Product Rulings) or privately to taxpayers on request (Private Rulings including Class Rulings). Rulings set out the Commissioner’s opinion as to the way a tax law would apply to particular facts and are binding. A taxpayer has no right of objection against a public ruling (which can simply be in the form of a media release), but may object to the assessment issued in accordance with the ruling. A taxpayer can object against a private ruling. Penalties apply for disregarding rulings. In practice, public rulings are commonly issued by the ATO where there is an unfavourable judicial outcome, thereby precluding other taxpayers from following precedent, unless of course they are prepared to take the matter further (as did Ms Stone). Otherwise, the ruling effectively becomes ‘the law’. For example, following the decision in Westfield, the Commissioner of Taxation issued in 1992 a public ruling TR92/3 (Income tax: Profits from isolated transaction) expressly to counter the finding by stating that it was the taxpayer’s intention at the time of transaction, not when the asset was first acquired, that was relevant in determining whether or not the gain was assessable as ordinary income. Similarly, the growth in the number of taxpayers claiming losses from primary production activities led to the issue in 1997 of public ruling TR97/11 (Income tax: Am I Carrying on a Business of Primary Production?). In respect of benefits received by sportspersons, the Commissioner in 1999 issued public ruling TR1999/17 (Income tax: Sportspeople—Receipts and Other Benefits Obtained from Involvement in Sport). On the basis of this ruling, benefits received by individuals from involvement in sport (whether as a referee, coach, or amateur or professional participant) were to be treated in the same way as other payments related to employment or the provision of services. This meant that cash payments or other benefits (prizes, awards) were assessable income if connected with employment or services rendered or the exploitation of personal skills in a commercial way—rather than as a windfall gain. However, the finding in Stone has reinforced this interpretation.

45 For more extensive coverage see: C. Coleman, G. Hart and M. McKerchar, Australian Tax Analysis (Thomson, Sydney, 2004).

An Ever-Elusive Definition of Income: Australia 373 The ATO is also able to influence the legal and judicial concept of income by pressing for the introduction of legislation, as evidenced with the introduction of the non-commercial loss regime (ITAA 1997 Division 35) from 1 July 2000. This legislation effectively counters the ‘carrying on a business test’ by denying taxpayers the immediate deductability of losses from such activities unless they are deemed ‘commercial’ (based on specific tests including turnover and the like). Athletes who are carrying on a business will now be subject to this Division.

Taxpayers The Australian tax system is renowned for its complexity,46 not only in respect of legislation (having two operative Acts is a good example), but in terms of its rate of change and the inherent difficulties this poses for taxpayers in a self-assessment environment. How do they cope? Australians have arguably the highest rate of tax agent usage in the world, with over 75 per cent of individuals using an agent and over 90 per cent of businesses doing the same. Obviously this has implications for compliance costs, not just in monetary terms but also in terms of time and stress. A common coping strategy used by agents is to undertake research to ensure that the client’s position is reasonably arguable, rather than to apply for a private ruling. If the tax payer is subsequently audited and receives an unfavourable assessment, there is no penalty where the taxpayer has a reasonably arguable position, whereas a taxpayer who has received a private ruling but ignored it when lodging a return is subject to an automatic 25 per cent penalty. Clearly, given the lack of clarity in the legal concept of income and the confusion that is evident in the judicial concept, combined with the myriad of public rulings, Australian taxpayers have a truly onerous and unenviable task in complying with their tax obligations. A comparison of the three levels of judgment in the case of Stone demonstrates just how fundamental an issue (and one in which a public ruling was previously issued) the meaning of income is according to ordinary concepts, and it remains unresolved.

46 For more extensive coverage see: M. McKerchar, Complexity, Fairness and Compliance: A Study of Personal income Taxpayers in Australia, (Australian Tax Research Foundation, Sydney, 2003).

14 Why was the US Corporate Tax Enacted in 1909? REUVEN S AVI-YONAH *

ABSTRACT This chapter argues that the principal reason the US adopted the corporate tax in 1909 was to regulate corporate managerial power, and that in this regard the 1909 tax differed both from the 1894 corporate tax and from current conceptions of the tax as an indirect tax on corporation’s shareholders. The United States has had a corporate income tax since 1909. Currently, this tax is under significant criticism, with several academics and practitioners calling for its abolition. It therefore seems appropriate in this context to try to determine what led to the enactment of this tax, and whether the original motivation can shed some light on the current debate on whether the tax should be retained.1

I. ANTECEDENTS: AGGREGATE-BASED TAXATION BEFORE 1909

T

income tax, enacted to raise revenues during the Civil War, did not tax corporations, although a withholding tax was imposed on dividends and interest paid by railroad corporations and financial institutions, as well as on amounts added to surplus.2 Instead, under the 1864 version of the tax, ‘the gains and profits of all companies, HE FIRST FEDERAL

* This chapter is based in part on R.S. Avi-Yonah, ‘The Story Behind the Separate Corporate Income Tax’ in S. Bank and K. Stark (eds.), Business Tax Stories (Foundation Press, New York, 2005). I would like to thank the participants of the 2004 tax history colloquium at Cambridge University, and especially John Tiley and Steve Bank, for their help with this project. 1 This chapter addresses only the first question (why the tax was enacted in 1909); for an argument on the second question (why the tax should be retained) see R.S. Avi-Yonah, ‘Corporations, Society and the State: A Defense of the Corporate Tax’ (S.2004). 90 Virginia L Rev 1193. 2 Act of 1 July 1862, ch. 119, §§ 81–82, 12 Stat. 432, 469–470 (repealed 1874). Shareholders and bondholders were permitted to exclude dividends and interest subject to withholding from income: ibid., at § 91, 12 Stat. 473–474 (repealed 1874).

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whether incorporated or partnership, other than the companies specified in this section, shall be included in estimating the annual gains, profits, or income of any person entitled to the same, whether divided or otherwise’.3 The Civil War income tax thus included a form of pass-through taxation that applied to corporations, and the imposition of the tax on the undivided profits of corporations was specifically upheld by the Supreme Court.4 Pass-through treatment of corporate profits reflected the aggregate view of the corporation prevalent at the time.5 It also reflected the fact that most corporations were small, closely-held enterprises, and therefore (like today) it was relatively easy to identify the shareholders and to tax them on corporate profits. For those enterprises that were more widely held, like railroads, a withholding tax collected by the corporation effectively replaced the tax on the shareholder.6 The Civil War version of the income tax was allowed to expire with the end of reconstruction in 1872.7 In 1894, after the financial panic of 1893 and the economic dislocation that followed, the Democrats in Congress were able to pass an income tax bill.8 The debate at the time focused on the protective tariff, which was the main source of revenue for the federal government.9 The tariff functioned as a highly regressive consumption tax, and benefited the manufacturing centres of the Northeast at the expense of the more agricultural South and West.10 The Democrats argued that relying solely on tariffs allowed the newly super-rich railroad, steel and sugar magnates to escape any meaningful tax burden.11 Their argument was further bolstered by the fact

3 Act of 30 June 1864, ch. 173, § 117, 13 Stat. 223, 281–282 (repealed 1874). Also under this Act, a withholding tax was imposed on dividends and interest paid by certain types of corporations, and such dividends and interest payments were excluded from income: ibid., at §§ 120–122, 13 Stat. at 283–285 (repealed 1874). 4 Collector v Hubbard 79 US (12 Wall.) 1, 18 (1870). 5 See M.J. Horwitz, ‘Santa Clara Revisited: The Development of Corporate Theory’(1985) 88 WVa. L Rev. 173, 183–186. 6 Note, however, that this was not a perfect replacement since the corporate rate was 5% with no exemption whereas the top shareholder rate was 10% with a US$600 exemption. See S.A. Bank,’ Entity Theory as Myth in the Origins of the Corporate Income Tax’ (2001) 43 Wm & Mary L. Rev. 447, at 457–458. The decision to treat the withholding tax as the final tax in the case of widely-held enterprises presumably reflected the practical difficulty of collecting tax on a pass-through basis in those cases: ibid., at 522–524. 7 W.E. Brownlee, ‘Historical Perspective on U.S. Tax Policy Toward the Rich’ in J.B.Slemrod (ed.), Does Atlas Shrug? The Economic Consequences of Taxing the Rich (Harvard UP, Cambridge, Mass., 2000)29, 35; D.J. Ventry Jr., ‘Equity Versus Efficiency and the U.S. Tax System in Historical Perspective’ in J.J. Thorndike and D.J. Ventry Jr (eds).,Tax Justice: The Ongoing Debate (Urban Institute Press, Washington, DC, 2002)25, 29; S.R. Weisman, The Great Tax Wars: Lincoln to Wilson—The Fierce Battles Over Money and Power That Transformed the Nation (Simon & Schusler, New York, 2002)101. 8 Brownlee, above n. 7, at 37; Ventry, above n. 7, at 30; Weisman, above n. 7, at 131–146. 9 Brownlee, above n. 7, at 37; Ventry, above n. 7, at 29–30; Weisman, above n. 7 at 138. 10 Weisman, above n. 7, at 138. 11 Weisman, above n. 7, at 136–138.

Why was the US Corporate Tax Enacted in 1909? 379 that the state–level personal property taxes were notoriously ineffective in reaching intangible forms of property, such as stocks and bonds.12 The 1894 Act for the first time imposed a tax of 2 per cent on the net income of all ‘corporations, companies, or associations doing business for profit in the United States, no matter how created or organized, but not including partnerships’.13 At first impression this appears to be a stark departure from the Civil War income tax, which taxed corporate income in the hands of the shareholders and employed withholding at the corporate level only as a collection device. However, Steven Bank has convincingly demonstrated that such a reading of the 1894 Act is misleading.14 First, he points out that dividends from taxable corporations were excluded from shareholder income, so that the corporate tax could be viewed as a collection device for the shareholder-level tax (imposed at the same rate).15 Secondly, the House version of the 1894 Act followed the Civil War income tax in imposing a withholding tax on dividends and interest, except that the tax was also applied to undistributed income and to all corporations.16 Thus, the progression from the Civil War income tax to the House bill to the final version of the 1894 Act can be seen as a gradual process of modifying what was fundamentally a withholding tax imposed on the shareholders.17 Thirdly, the Congressional debates on the 1894 Act show that the principal motive for the corporate-level tax was to reach the shareholders, most of whom were precisely the kind of rich individuals who were able to escape the state-level personal property tax and whose corporations benefited from the high tariffs.18 And finally, Bank points out that the norm throughout the latter half of the nineteenth century was for most corporations to distribute their net earnings out as dividends.19 In that context, imposing a withholding tax on dividends was the most effective way to tax shareholders in widely-held enterprises, and imposing the same tax on additions to surplus was merely another enforcement device to prevent accumulated income from escaping tax. By 1894, the withholding tax was transformed into a tax on all the income of the corporation (distributed or not), but was still seen primarily as a device to tax shareholders.20

12

Ventry, above n. 7, at 29–30. Tariff Act of 1894, ch. 349, § 32, 28 Stat. 509, 556 (held unconstutitional in Pollock v Farmer’s Loan & Trust Co., 157 US. 429, aff’d and modified on reh’g, 158 US 601 (1895)). 14 Bank, above n. 6, at 504–537. 15 Ibid., at 462 (citing Tariff Act of 1894, ch. 349, § 28, 28 Stat. 509, 554). Integration was incomplete because corporations were not eligible for the $4,000 exemption: see ibid., at 462–463, but this can be explained by administrative convenience. 16 26 Cong. Rec. 6831 (1894). 17 Bank, above n. 6, at 517–519. 18 Ibid., at 530. 19 Ibid., at 528–529. 20 Ibid. at 530–531. 13

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Thus, throughout the nineteenth century, there was little evidence at the federal level of direct taxation of corporations as such. Withholding taxes were imposed at the corporate level on both distributed and undistributed income, but those were seen as an indirect way of taxing shareholders, consistently with the aggregate view of the corporation. II. THE 1909 ACT: A REAL ENTITY MEASURE

In 1895, the Supreme Court struck down the 1894 Act as an unconstitutional direct tax without apportionment.21 The Democrats immediately made reinstatement of the income tax a major plank of their platform for the 1896 and 1900 elections, but to no avail.22 With the decisive victory of William McKinley (author of the notorious McKinley tariff of 1890) and his corporate allies in 1896, the income tax issue seemed dead.23 The situation changed with the rise of the Progressives and the accession of Theodore Roosevelt to the White House in 1901. Roosevelt spent his seven years in office greatly expanding the powers of the federal government vis-à-vis corporations. He was the first President to attempt to use the Sherman Antitrust Act, adopted in 1890 but left largely unused until his time, to break up the great monopolies, such as John D. Rockefeller’s Standard Oil Company.24 In addition, he established the Bureau of Corporations to assemble information on, and ultimately perhaps to regulate, corporations.25 He also proposed that all corporations should be incorporated under the authority of the federal government.26 On the tax front, Roosevelt expressed support in 1907 (after another financial panic) for a graduated income tax, but supporters of the tariff within the Republican Party were able to delay consideration of the issue until after the 1908 election.27 The newly-elected President Taft was less of a supporter of the income tax than his predecessor, and was worried about enacting another tax that would be found to be unconstitutional.28 However, he was also faced with increased support for the income tax in Congress and a possible split within his own party between Northeastern opponents of the

21 Pollock v Farmers’ Loan & Trust Co, 157 US 429, aff’d and modified on reh’g, 158 US 601 (1895). 22 Brownlee, above n. 7, at 37– 38; Weisman, above n. 7, at 165–172. 23 Weisman, above n. 7, at 175–177. 24 United States v N Sec Co, 193 US 197 (1904); Standard Oil Co v United States, 221 US 1 (1911). 25 Act of 14 1903, ch. 552, § 6, 32 Stat. 825, 827–828 (codified as amended in scattered sections of 15 USC). 26 M.E. Kornhauser, ‘Corporate Regulation and the Origins of the Corporate Income Tax’(1990) 66 Ind LJ 53, 66 See discussion immediately below. 27 Weisman, above n. 7, 203–205. 28 Ibid. at 211.

Why was the US Corporate Tax Enacted in 1909? 381 tax and Midwestern supporters.29 Eventually, Taft proposed a compromise: Enact a corporate excise tax measured by income, which could withstand judicial scrutiny, and simultaneously submit an amendment to the Constitution to permit enactment of an income tax.30 The legislative debate on the proposed tax was set in the broader context of the debate on tariff reduction. Opponents of tariff reduction, mostly from Northeastern states, viewed high tariffs as essential to protecting American industry, and argued that the benefits of such tariffs extended to ordinary workers as well as to captains of industry.31 Proponents of tariff reduction, mostly from the West and the South, argued that high tariffs raised the price of goods consumed by ordinary Americans to benefit the rich.32 Initially, it seemed likely that the tariff bill (named after its co-sponsors the Payne–Aldrich Tariff) would be enacted by the Republican majority in both houses. In the House, income tax proponents like Cordell Hull (Democrat,Tennessee.) were unable to attach an income tax amendment to the tariff bill. In the Senate, however, progressive Republicans like Robert La Follette (Wisconsin.) and Democrats like Joseph Bailey (Texas) were more effective in arguing for the income tax. La Follette and Bailey argued that since the rich benefited more than the poor from government protection, they should pay more for it, and that enacting the income tax would silence the ‘envious voice of anarchy’ (socialism).33 Ultimately, Senator Nelson Aldrich (Republican, Rhode Island), the main opponent of the income tax, realised that with 19 Republicans threatening to join the Democrats and vote for the income tax, he might lose.34 In a crucial meeting at the White House, Aldrich and Taft agreed to support instead a corporate tax plus a constitutional amendment empowering Congress to levy the income tax, while maintaining high tariffs.35 Aldrich stated, ‘I shall vote for a corporation tax as a means to defeat the income tax.’36 This compromise ultimately passed the Senate by 45 votes to 34 and the House by 195 votes to 183, and was signed into law by the President on 5 August 1909.37 The 1909 Act imposed ‘a special excise tax with respect to the carrying on or doing business’ of 1per cent of net income over $5,000 of ‘every corporation, joint stock company or association, organized for profit’ under US law, and every foreign corporation engaged in business in the United

29 30 31 32 33 34 35 36 37

See ibid., at 226. Ibid., at 227. Ibid., at 211. See ibid., at 211–212. Ibid., at 220–223. Ibid., at 226–227. Ibid., 227. 44 Cong. Rec. 3929 (1909) (statement of Sen. Aldrich). Weisman, above n. 7, at 230–231.

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States.38 Dividends from taxable corporations were excluded from corporate income.39 What was the rationale for the 1909 Act, which is the origin of our current corporate income tax? Proponents of the tax gave several reasons, including the benefits theory and viewing the corporate tax as an indirect tax on shareholders.40 However, as Marjorie Kornhauser has pointed out, a major motive for the act was to regulate corporations.41 The principal vehicle for regulation was the filing of tax returns, which were to be made public.42 But more broadly, the tax itself fulfilled a potential regulatory function—it could serve as a vehicle to restrict the accumulation of power in the hands of corporate management.43 The various motives for enacting the corporate tax, which reflect the three theories of the corporation, can be seen in President Taft’s message to Congress and in the debate that preceded enactment in the Senate. President Taft’s message of 16 June 1909 gives three reasons for enacting a corporate tax (rather than a general income tax, which may be unconstitutional, or an inheritance tax, which did not have sufficient political support among Republicans in the Senate).44 The first reason is that ‘[t]his is an excise tax upon the privilege of doing business as an artificial entity and of freedom from a general partnership liability enjoyed by those who own the stock’.45 This argument is clearly based on an artificial entity view of the corporation as a creature of the state. However, Taft was aware that it is difficult to make this argument for a federal tax when the privileges enjoyed by the corporation derived from state law.46 The reason he made the argument nevertheless was that this formulation was necessary to ensure the tax’s constitutionality, since the Supreme Court had upheld such an excise tax on sugar and oil companies in the Spreckels case.47 Taft added that nevertheless the tax ‘accomplishes the same purpose as a corporation income tax’.48 The second argument made by Taft was that the corporate tax ‘imposes a burden at the source of the income at a time when the corporation is well able to pay and when collection is easy.49 The reference to collection ‘at the source’ relates to the aggregate view of the corporation, since the tax is viewed as a withholding tax imposed on the shareholders (referred to at the 38 Tariff Act of 1909, ch. 6, § 38, 36 Stat. 11, 112–113 (codified as amended in scattered sections of 19 USC). 39 Ibid., 36 Stat. at 112. 40 See discussion of Congressional debate below, nn. 130–154 and accompanying text. 41 Kornhauser, above note 26, at 53. 42 See discussion of publicity below, nn.140–144 and accompanying text. 43 See discussion of regulatory function below, nn. 145–149. 44 See Weisman, above n. 7, at 227. 45 44 Cong. Rec. 3344 (1909) (statement of Pres. Taft). 46 See discussion of benefits argument in the Senate, below. 47 Spreckels Sugar Ref. Cov McClain 192 US 397 (1904), cited in Cong. Rec., above n.45. 48 Ibid. 49 Ibid.

Why was the US Corporate Tax Enacted in 1909? 383 time as ‘stoppage at source’).50 This is similar to the mainstream modern view of the tax, although the reference to the corporations’ ability to pay (as opposed to the shareholders’) has a real entity overtone. Taft probably did not emphasise the nature of the tax as an indirect tax on shareholders because that would have made it more suspect to the opponents of the income tax as well as more vulnerable to a constitutional challenge. Instead, the principal reason Taft gave for enacting a corporate tax was the third one—that it would enable the federal government to exercise some degree of supervision, primarily by obtaining information about the business affairs of corporations. Taft devoted a whole paragraph of his message to this argument, much more than he gave to the first two. He stated the following: Another merit of this tax is the federal supervision which must be exercised in order to make the law effective over the annual accounts and business transactions of all corporations. While the faculty of assuming a corporate form has been of the utmost utility in the business world, it is also true that substantially all of the abuses and all of the evils which have aroused the public to the necessity of reform were made possible by the use of this very faculty. If now, by a perfectly legitimate and effective system of taxation, we are incidentally able to possess the Government and the stockholders and the public of the knowledge of the real business transactions and the gains and profits of every corporation in the country, we have made a long step toward that supervisory control of corporations which may prevent a further abuse of power.51

This remarkable paragraph rests on the real entity view of the corporation as separate from both the state and the shareholders. It identifies corporate management as the source of ‘abuse of power’ and suggests that the imposition of the corporate tax will enable the government, the shareholders and the public to obtain information that will serve as the basis for restricting such managerial abuses of power. While the tax itself is incidental to the regulatory mechanism, this statement is important because it delineates a reason to tax corporations that is unrelated to the tax on shareholders or to the benefits conferred by the state. The tax is imposed on corporations because of the power exercised by corporate management, and management is clearly regarded as distinct from the shareholders (who will in fact be beneficiaries of the supervision over management actions).52

50

Bank, above n. 6, at 517. Cong. Rec., above n. 45. Similarly, in a letter dated 27 June 1909, Taft identified the publicity feature as a particularly important element of the tax, stating that ‘publicity gives a kind of federal supervision over corporations, which is quite a step in the direction of similar reforms I am going to recommend at the next session of Congress’: Letter from William Howard Taft to Horace Taft 8 (27 June 27 1909), in Papers of William Howard Taft (Library of Congress, Manuscript Division, Reel 497), cited in Kornhauser, above n. 6, at 99. 51 52

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The same mixture of motives can also be seen in the Congressional debate over enactment. Proponents and opponents of the tax reflected all three theories of the corporation. Some viewed it primarily as a benefits tax,53 others primarily as a tax on the shareholders.54 However, the predominant strain in the debate was to view the tax as a regulatory device to restrict abuses of managerial power. The artificial entity view of the tax was expressed primarily by those proponents who sought to defend it from a constitutional attack.55 Senator Root, for example, who was one of the main drafters of the bill, defended the tax in part as based on the privilege of limited liability.56 Opponents, however, were quick to point out that since corporations were created under state law, the federal government had no right to tax them under an artificial entity view.57 In addition, opponents pointed out that unincorporated businesses obtained from the federal government the same benefits as corporations.58 The aggregate view was advanced by proponents who argued that the corporate tax was an indirect way to tax wealthy shareholders.59 Opponents argued that the tax did not discriminate between wealthy and less wealthy shareholders.60 Proponent Senator Cummins stated that ‘[s]o far as taxes are concerned, corporations are mere trustees for their shareholders; and their shareholders must pay the tax’.61 Others argued that the tax would be shifted to consumers or wage earners, at least by the strongest corporations in the best position to avoid competition—the trusts.62

53

See below. See below. 55 See, eg, 44 Cong. Rec. 4237 (1909) (statement of Sen. Daniel) (describing a corporation as an artificial entity and defending the constitutionality of a tax on it). 56 44 Cong. Rec. 4006 (1909). 57 ‘The United States did not create these corporations . . . I should like to know whether there is on the part of any Member of the Senate a belief that the Congress . . . can, through the medium of taxation, destroy the corporations that have been created by the several states?’: 44 Cong. Rec. 3977 (1909) (statement of Sen. Cummins). 58 ‘I deny the right of Congress to levy a tax upon the business of corporations as such . . . . It is an arbitrary [classification]; it is an unfair one . . . [I]t is a tax upon the right to do business as a corporation as distinguished from the right to do business as an individual or as a copartnership’: 44 Cong. Rec. 3976 (1909) (statement of Sen. Cummins). 59 See below. 60 ‘Shall we levy an income tax upon the stockholders of all corporations for pecuniary profit, without respect or regard to the extent of the income earned or enjoyed by those stockholders . . . ?’: 44 Cong. Rec. 3955 (1909) (statement of Sen. Cummins); see also 44 Cong. Rec. 4008 (1909) (statement of Sen. Clapp) (similar). 61 44 Cong. Rec. 3975 (1909) (statement of Sen Cummins). See also Kornhauser, above n. 26, at 94 (‘Obviously a tax on the corporation is really a tax upon its stockholders, for otherwise than as a matter of legal reasoning a corporation and its stockholders are one’) (quoting Bureau of Corporations, Taxation of Corporations: New England (US Government Washington, DC, 1909)5–6i. 62 See 44 Cong. Rec. 3985–3987 (1909) (statement of Sen. Borah). Senator Cummins likewise considered that the tax may be shifted from shareholders: 44 Cong. Rec. 3975 (1909) (statement of Sen. Cummins), as did Senator Clapp: 44 Cong. Rec. 4008 (1909) (statement of Sen. Clapp). 54

Why was the US Corporate Tax Enacted in 1909? 385 But by far the most significant debate centered on the real entity view of the corporation and the argument that the tax was a regulatory device. Some of this debate centered on the publicity feature of the tax, but some of it understood the tax as a preliminary measure to control and limit managerial power directly. For example, Senator Flint (a supporter of the tax) stated that ‘it would give a certain amount of control of corporations by the National Government, publicity as to the condition of the affairs of corporations, and supervision to a certain extent over those corporations’.63 Publicity was part of the regulatory scheme, but not the only part. The publicity feature was stressed by many. Senator Dixon, for example, stated that he favoured the tax primarily because of the publicity feature, for he feared the tax itself would not reach wealthy shareholders.64 Senator Newlands likewise supported the tax as ‘securing, through publicity and otherwise, such supervisory control by the National Government as can be constitutionally exercised over corporations’.65 Even Senator Aldrich, the ultra-conservative chair of the Finance Committee, supported the publicity feature.66 Senator Cummins, who opposed the tax, nevertheless supported the publicity feature because the ‘revolution in industry’ resulting from the rise of large corporations ‘is simply a prelude to industrial commercial slavery unless the Government intervenes with its strong arm, and it can not intervene unless it has the information necessary to enable it to act intelligently and wisely’.67 Other Senators, however, emphasised the potential of the tax directly to limit managerial power. Senator Newlands stated, ‘I favor also present legislative action imposing an excise tax in such form as to reach the great accumulated wealth of the country, or its earnings, engaged in corporate enterprise.’68 Nor did he mean by this indirect taxation of wealthy shareholders, because he went on to state that ‘there was no reason why the great combinations monopolizing these industries [protected by the tariff] should not pay some part of the national expenses as well as the masses of the people

63

44 Cong. Rec. 3937 (1909) (statement of Sen. Flint). 44 Cong. Rec. 3941 (1909) (statement of Sen. Dixon); see also 44 Cong. Rec. 4001 (1909) (statement of Sen. Bourne) (favouring of the publicity feature) (‘I personally concur with the President that the corporation net-earnings tax, in view of the publicity feature incident to it, is of infinitely greater importance and will be far more beneficial to this country than either the inheritance or income tax.’). 65 44 Cong. Rec. 3756 (1909) (statement of Sen. Newlands); see also 44 Cong. Rec. 3759 (1909) (statement of Sen. Newlands) (‘securing information which would enable Congress to act intelligently in future with reference to taxation, the regulation of industrial combinations, and the imposition of tariff duties.’) 66 See 44 Cong. Rec. 3930 (1909) (statement of Sen. Aldrich); see also 44 Cong. Rec. 4006–4007 (1909) (statement of Sen. Root) (supporting the publicity feature). 67 44 Cong. Rec. 3965 (1909) (statement of Sen. Cummins). 68 44 Cong. Rec. 3756 (1909) (statement of Sen. Newlands). 64

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who use and consume [their products]’.69 Newlands thus viewed the tax as falling on the accumulated wealth in the hands of the corporation itself, that is, upon corporate management.70 Senator Owen likewise spoke of the ‘enormous volume of corporate wealth’: ‘[t]he most important need of the people of the United States of this generation requires the abatement of the gigantic fortunes being piled up by successful monopoly, . . . which have brought about a grossly inequitable distribution of the proceeds of human labor.’71 Like other Democrats, he would have preferred an income or inheritance tax, but supported the corporate tax for its direct potential impact on corporate— that is, managerial—wealth. Senator Root, a principal draftsman of the tax, and personal friend of the President, likewise emphasised the potential of the tax to reach the wealth accumulated in the hands of corporate management, because he favoured taxing such wealth over earned income: Mr. President, it has so happened that in the development of the business of the United States the natural laws of trade have been making the distinction [between earned and unearned income] for us, and they have put the greater part of the accumulated wealth of the country into the hands of corporations, so that when we tax them we are imposing the tax upon the accumulated income and relieving the earnings of the men who are gaining a subsistence for their old age and for their families after them.72

Opponents of the tax also stressed the regulatory aspect, but suggested that it had the potential of giving the federal government too much power over corporations. For example, Senator Cummins, stated: If this tax is intended not to create a revenue, but if it is intended for the purpose of supervising and regulating corporations, that is quite a different proposition. I should like to know before we get through with this whether it is proposed through this tax to impose supervisory regulations upon all the corporations of the United States . . .You know there is just a little intimation in the message of the President that that is the end which is finally to be reached . . . I think that before

69 44 Cong. Rec. 3761 (1909) (statement of Sen. Newlands); see also 44 Cong. Rec. 3762 (1909) (statement of Sen. Newlands) (‘Justice demands that the various forms of manufactured wealth, in whose favor the taxing power of the Nation is so freely exercised, should make some substantial contribution to the national expenses . . .’). 70 44 Cong. Rec. 4048–4049, 4233 (1909) (statement of Sen. Newlands) (advocating a tax concentrated on the management of the great trusts, and exempting small corporations); 44 Cong. Rec. 4229–4230 (1909) (statement of Sen. Dolliver) (similar). 71 44 Cong. Rec. 3950 (1909) (statement of Sen. Owen). 72 44 Cong. Rec. 4003 (1909) (statement of Sen. Root); see also 44 Cong. Rec. 4006 (1909) (statement of Sen. Root) (distinguishing between earned income and ‘accumulated capital’ which should be taxed). Senator Cummins argued that the corporate tax would not achieve this purpose since it would fall on all shareholders, rather than just on management: 44 Cong. Rec. 4038 (1909) (statement of Sen. Cummins).

Why was the US Corporate Tax Enacted in 1909? 387 the Government of the United States enters upon the work of supervising and regulating all those corporations . . . we had better stop and think a while.73

Cummins, however, was not opposed to all federal regulation through the corporate tax, just to a tax that indiscriminately applied to all corporations, as opposed to the proper targets—the great trusts: If we can regulate our corporations simply through the medium of taxation, we can destroy every trust in a fortnight. It would be a great deal better for the Finance Committee to turn its attention to the imposition of such a tax upon corporations and the persons who actually need regulation, who are exercising powers that are injurious to the American people, destroying competition and invading our prosperity, than to attempt to levy a revenue tax upon all the little shareholders of all the little corporations throughout the length and breadth of the United States.74

Other opponents of the tax likewise supported regulating the large trusts through taxation, referring to the excise tax imposed on the gross income of the sugar and oil trusts in 1898.75 They opposed the proposed corporate tax, however, because it exempted dividends received from other taxable corporations from the tax base, thereby encouraging the formation of holding companies—precisely those companies that formed the legal basis for the trusts.76 Proponents of the tax replied that it was better to attack the trusts via a tax on all corporations than to refrain from attacking them at all.77

III. SUMMARY

We thus see that between 1894 and 1909 a significant change occurred in regard to the justification for the corporate tax. The 1894 tax was conceived as a continuation of the Civil War tax, that is, as a withholding tax on shareholders. The 1909 tax, on the other hand, while still seen by some opponents as an indirect tax on shareholders, was primarily viewed as a regulatory device to restrict managerial power. This goal was achieved most 73 44 Cong. Rec. 3978 (1909) (statement of Sen. Cummins); see also 44 Cong. Rec. 4047 (1909) (statement of Sen. Hughes) (arguing that regulation should be done directly). 74 44 Cong. Rec. 3978 (1909) (statement of Sen. Cummins). Cummins argued that much higher rates would drive the trusts out of business: 44 Cong. Rec. 4232 (1909) (statement of Sen. Cummins). 75 44 Cong. Rec. 4009 (1909) (statement of Sen. Clapp). 76 44 Cong. Rec. 4010 (1909) (statement of Sen. Clapp); 44 Cong. Rec. 4230 (1909) (statement of Sen. Dolliver). Senator Aldrich replied that this was necessary to avoid double corporate taxation and that no for-profit corporation was exempt from tax: 44 Cong. Rec. 4231 (1909) (statement of Sen. Aldrich). 77 44 Cong. Rec. 4036 (1909) (statement of Sen. Davis).

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directly through the publicity feature of the tax, but both proponents and opponents also saw the tax as having the potential to regulate management directly by reducing corporate wealth and therefore restricting managerial power. This shift can easily be discerned by comparing two Supreme Court opinions dealing with the corporate tax. In 1870 the Court decided that the Civil War income tax may be applied to tax shareholders upon the undivided profits of a corporation.78 Fifty years later the Court held that a shareholder may not be taxed on a stock dividend distributed by a corporation since that would be tantamount to taxing her on the undistributed income of the corporation, which is not her income under the Sixteenth Amendment.79 The Court stated: We have no doubt of the power or duty of a court to look through the form of the corporation and determine the question of the stockholder’s right, in order to ascertain whether he has received income taxable by Congress without apportionment. But, looking through the form, we cannot disregard the essential truth disclosed; ignore the substantial difference between corporation and stockholder; treat the entire organization as unreal; look upon stockholders as partners, when they are not such; treat them as having in equity a right to a partition of the corporate assets, when they have none; and indulge the fiction that they have received and realized a share of the profits of the company which in truth they have neither received nor realized. We must treat the corporation as a substantial entity separate from the stockholder, not only because such is the practical fact but because it is only by recognizing such separateness that any dividend—even one paid in money or property—can be regarded as income of the stockholder. Did we regard corporation and stockholders as altogether identical, there would be no income except as the corporation acquired it; and while this would be taxable against the corporation as income under appropriate provisions of law, the individual stockholders could not be separately and additionally taxed with respect to their several shares even when divided, since if there were entire identity between them and the company they could not be regarded as receiving anything from it, any more than if one’s money were to be removed from one pocket to another.80

Thus, by 1920, the Court viewed the corporation as a real entity separate and distinct from the shareholders ‘because such is the practical fact’.81 The same real entity view underlay most, although not all, of the arguments made when the corporate tax was adopted in 1909. 78

Collector v Hubbard 79 US (12 Wall.) 1, 18 (1870). Eisner v Macomber 252 US 189 (1920). 80 Ibid., at 213–214. The Court then went on to state that Hubbard was overruled by Pollock v Farmers’ Loan & Trust Co157 US 429, aff’d and modified on reh’g, 158 US 601 (1895), and was not reinstated by the Sixteenth Amendment: 252 US at 218–219. 81 Ibid., at 214. The other argument advanced by the Court—that cash dividends could not be taxed—interestingly ignores the fact that between 1913 (when the Sixteenth Amendment was adopted and the first individual income tax adopted) and 1936, cash dividends were to 79

Why was the US Corporate Tax Enacted in 1909? 389 What accounts for the change between 1894, when the corporate tax was seen as a withholding device and the aggregate view was dominant, and 1909, when the real entity view was the main reason for adopting a corporate tax? The principal reason is a significant change in the nature of the corporation that occurred in this period. From 1890 to 1916 American capitalism transformed from a system of owner/manager enterprises operating in largely unregulated competitive markets to a system dominated by relatively few large, mostly non-owner-managed corporations in a regulated competitive market.82 In particular, although there were large-scale corporations before the Progressive Era, consolidation began only in the early 1890s and accelerated to a wave of consolidation by merger between 1898 and 1904.83 The key legal change was New Jersey’s adoption in 1890 of a new corporate law that permitted holding corporations.84 This enabled the consolidators to avoid the cumbersome ‘trust’ structures (in which shareholders contributed their shares to a trust in exchange for certificates of beneficial ownership) for the simpler holding company structure of parent and operating subsidiaries. The result was a wave of corporate migration to New Jersey, followed in the 1910s by another migration to Delaware when New Jersey balked at further pro-management rule changes.85 The reaction to the emergence of the ‘trust issue’ from around 1896 onward was a chorus of calls for more regulation. For example, in 1906, Representative Martin of South Dakota defined a trust as ‘a combination of corporations’, identified the resulting ‘evils’ as ‘overcapitalization . . . the tendency to monopoly, and . . . the destruction of individual enterprise and success’, and called for remedial legislation that would combine ‘publicity’, ‘free competition’ and ‘close Federal supervision or regulation’.86 One immediate result was the attempt by President Roosevelt to control the

some extent exempt from tax to shareholders. See Bank, above n. 6, at 533. But dividends were taxed to the extent that the individual rate exceeded the basic or normal rate, and the corporate rate was set higher than the normal rate from 1918, resulting in partial double taxation. See S.A. Bank, ‘Corporate Managers, Agency Costs, and the Rise of Double Taxation’ (2002) 44 Wm & Mary L Rev 167, 181–182 (discussing the historical evolution of double taxation). 82 See M.J. Sklar, The Corporate Reconstruction of American Capitalism, 1890–1916 (CUP, New York, 1988). For background, see generally A.D. Chandler, Jr., The Visible Hand: The Managerial Revolution in American Business (Belknap Press, Cambridge, Mass., 1977). 83 Sklar, above n. 82, at 45–46 and n.4 (noting that little further concentration took place between 1904 and 1954). 84 See Act of 21 Apr. 1896, ch. 185, 1896 NJ Law 309–310 § (9)(104) ; L. Steffens ‘New Jersey: A Traitor State: Part II—How She Sold Out to the United States’ (1905) 25 McClure’s Mag. 41. 85 For the classic debate on whether this was a ‘race to the bottom’ or a ‘race to the top’, see W.L. Cary, ‘Federalism and Corporate Law: Reflections Upon Delaware’ (1974) 83 Yale LJ 663; R.K. Winter, Jr., ‘State Law, Shareholder Protection, and the Theory of the Corporation’ (1996) 6 J Legal Stud 251. 86 40 Cong. Rec. 1849–1851 (1906) (statement of Rep. Martin).

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trusts by using the Sherman Antitrust Act of 1890, which led to the Supreme Court ultimately breaking up the Standard Oil Company, though holding at the same time that only ‘unreasonable’ restraints of trade were illegal.87 Roosevelt was not opposed to the growth of big business; unlike the Populists, he did not believe in turning the clock back to a ‘golden age’ of small producers. But he did favour federal regulation. In his 1907 message to Congress Roosevelt declared: I am in no sense hostile to corporations. This is an age of combination, and any effort to prevent all combination will be not only useless, but in the end vicious . . . We should, moreover, recognize in cordial and ample fashion the immense good effected by corporate agencies . . . . The corporation has come to stay.88

But the following year, he also stated: I strongly advocate that instead of an unwise effort to prohibit all combinations, there shall be substituted [for the Sherman Act] a law which shall expressly permit combinations which are in the interest of the public, but shall at the same time give to some agency of the National Government full power of control and supervision over them.89

Roosevelt’s first concrete proposal was for federal incorporation.90 The Hepburn Bill, introduced in 1908, would have allowed corporations voluntarily to register with a federal office.91 The Bill failed, however, because of Republican opposition to such an expansion of executive branch power. If the Federal government registered corporations, it could also de-register them.92 Ultimately, these concerns led to the Clayton Antitrust Act of 1914 and the establishment of the Federal Trade Commission.93 The same concerns regarding trusts are reflected in the debates over the corporate tax, which was seen by both supporters and opponents as a regulatory measure.94 Kornhauser focused primarily on the publicity feature of the tax, but this was not its only regulatory aspect—both supporters and opponents saw the tax also as having the potential to restrict managerial

87 Standard Oil Co v United States 221 US 1 (1911); see also United States v AmTobacco Co 221 US 106, 179 (1911) (establishing a ‘rule of reason’ standard for interpreting the Sherman Act). 88 42 Cong. Rec. 68 (1907) (statement of Pres. Roosevelt). 89 43 Cong. Rec. 17 (1908) (statement of Pres. Roosevelt). 90 42 Cong. Rec. 70 (1907) (statement of Pres. Roosevelt). 91 HR19745, 60th Cong., reprinted in An Act to Regulate Commerce, Etc.: Hearings on House Bill 19745 Before Subcomm. No. 3 of the House Comm. on the Judiciary, 60th Cong. 3–6 (1908). 92 Kornhauser, above n. 26, at 67. 93 Ibid. 94 Ibid., at 62–63.

Why was the US Corporate Tax Enacted in 1909? 391 power directly.95 Thus Senator Root, the principal drafter of the tax on the Senate side, spoke about the accumulation of wealth in the hands of corporations as a principal reason for the tax.96 Senator Newlands likewise supported the tax because ‘there was no reason why the great combinations monopolizing these industries should not pay some part of the national expenses’.97 Similarly, Senator Owen stated that ‘[t]he most important need of the people of the United States of this generation requires the abatement of the gigantic fortunes being piled up by successful monopoly’.98 And Senator Cummins, an opponent of the tax, likewise spoke about ‘the new force entering American life and American business’ which is ‘a prelude to industrial commercial slavery unless the Government intervenes with its strong arm’.99 Senator Cummins opposed the tax because it applied to all corporations, rather than just to the great combinations, which he thought should be taxed more heavily.100 Senator Clapp was similarly concerned about the trusts but argued that the proposed tax did not address the problem because of the exemption of dividends paid to holding corporations.101 Senator Cummins’s solution was to tax the trusts more heavily: [I]f a company is organized for the purpose of consolidating a dozen other companies with a view to controlling the business in which those companies are engaged for the purpose of being able to direct through a single board the management of the entire field of industry . . . aside from the contravention of public policy involved in such an organization the privilege enjoyed is of priceless value, and instead of being taxed at 2 per cent on the net earnings it ought to be

95

For a discussion of publicity, see ibid., at 69–82. 44 Cong. Rec. 4003 (1909) (statement of Sen. Root). 44 Cong. Rec. 3761 (1909) (statement of Sen. Newlands). Newlands supported in particular taxing all industries benefiting from the tariff: 44 Cong. Rec. 3762 (1909); 44 Cong. Rec. 4049 (1909) (statement of Sen. Newlands) (proposing an exemption for small corporations so as to ‘confine our taxation to these great combinations of capital whose profits have been enormous, whose ability to bear is greater than that of any other class of the community, and whose abuses have awakened the attention of the country and demand legislative cure’.). 98 44 Cong. Rec. 3950 (1909) (statement of Sen. Owen). He stated that corporate wealth of publicly traded corporations amounted to one-third of national wealth: ibid., see also 44 Cong. Rec. 4000–4001 (1909) (statement by Sen. Bourne) (supporting the tax because the tendency of business to consolidate requires strengthening the government’s ability to regulate). 99 44 Cong. Rec. 3965 (1909) (statement of Sen. Cummins). 100 44 Cong. Rec. 3978 (1909) (statement of Sen. Cummins). 101 44 Cong. Rec. 4009–4010 (1909) (statement of Sen. Clapp) (‘[t]he plain invitation, the plain effect of this provision is to encourage the organization of the very kind of corporations, great, powerful, overshadowing, absorbing industries, absorbing industrial life and industrial affairs, by holding out to them immunity from taxation’); see also 44 Cong. Rec. 4230 (1909) (statements of Sen. Dolliver) (focusing on the trust problem as well). Senator Davis, by contrast, thought the solution to ‘the corporations of the country invading every avenue of business and trade’ was ‘that if we can not tax all the corporations, we should tax just as many of them as we can’: 44 Cong. Rec. 4036 (1909). And Senator Aldrich pointed out that no corporation was exempt from the tax: 44 Cong. Rec. 4231 (1909). 96 97

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taxed at 10 or 15 per cent on the net earnings, that it ought to be taxed so heavily that such companies would become not only unfashionable but unprofitable as well.102

The principal reason for the difference between the 1894 tax, a tax on shareholders, and the 1909 tax, a tax on management, was thus the rise of the great trusts in the period between 1896 and 1904.103 By 1909, the trust problem was perceived as the most serious issue facing the country.104 Some Democrats would have liked to turn back the clock and outlaw the trusts, but the majority preferred to follow President Roosevelt and regulate them.105 A primary vehicle for such regulation was the corporate tax, in part because of its publicity feature, but in part because, many claimed during the Congressional debate, the power to tax is the ‘equivalent of the power to destroy’.106 To tax the powerful trusts was seen as the beginning of a federal power to regulate and potentially destroy them. That was the fundamental rationale for enacting the corporate income tax.

102 44 Cong. Rec. 4232 (1909) (statement of Senator Cummins). Senator Newlands made similar arguments: 44 Cong. Rec. 4233 (1909) (statement of Sen. Newlands). 103 By 1900, J.D. Rockefeller had created the Standard Oil Company and capitalised it at $122 million. The following year J.P. Morgan created US Steel in a $1.4 billion transaction. Between 1898 and 1901, the capitalisation of mergers totalled $5.4 billion and 2,274 firms were merged out of existence: Sklar, above n. 83, at 45–46. 104 See H.L. Wilgus, ‘Need of a National Incorporation Law’ (1904) 2 Mich L Rev 358 (1904) (discussing the nature and scope of the trust problem). 105 See Kornhauser, above n. 26, at 63–64 (discussing the political positions on the trusts and the government’s preference for regulation). 106 See, eg, 44 Cong. Rec. 3977 (Sen. Cummins, referring to McCulloch v Maryland 17 US 316 (1819).

15 Entity Theory as Myth in The US Corporate Excise Tax of 1909 STEVEN A BANK*

ABSTRACT Recently, scholars have examined the 1909 corporate excise tax, the first tax imposed against corporations because of their corporate status, and concluded that it was enacted due to developments in entity theory around the turn of the century. According to this scholarship, corporations grew in power and became ‘real entities’ under the eyes of the law and the people. The government sought to regulate this ‘accumulated wealth’ through the corporate taxation. Thus, the origins of the modern corporate income tax can be traced to entity theory and the need to regulate corporate power. This explanation does not stand up to close scrutiny. Upon examining the events leading up to and following the adoption of the 1909 tax, as well as the debates over the 1909 Act itself, it appears that the role of entity theory and corporate regulation in the rise of the modern corporate income tax has been overstated. The 1909 corporate excise tax, like its predecessors, the sugar and petroleum excise taxes during the Spanish–American War, were an attempt to reach shareholder wealth while complying with the constitutional limitations imposed by the Supreme Court in Pollock. While they were both passed with regulatory undertones, the historical significance of this tax became more limited after the constitution was amended to permit income taxation. When the first post-amendment corporate income tax was enacted in 1913, it was essentially a replica of the pass-through corporate taxation employed during the nineteenth century. This ch apter suggests that, rather than appearing in 1909 as a result of developments in entity theory, the modern corporate income tax emerged during the first World War and its aftermath because of a variety of factors. These included the wartime need for revenue, the increase in progressive surtax rates applied to individuals, and a shift toward more conservative dividend policies among corporations. Each of these factors combined to produce a different reality for the taxation of corporate income. The pass-through model was no * Thanks to Reuven Avi-Yonah, Ajay Mehrotra and David Weisbach for helpful comments and suggestions and to Jacob Veltman for his outstanding research assistance.

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longer considered viable. Thus, the modern corporate income tax system developed, not because of a change in the theory of the corporation or because of a desire to regulate it, but because the old system did not fairly and consistently produce the proper revenue.

INTRODUCTION

T

HE FIRST TAX imposed against corporations in the United States because of their corporate status—the 1909 corporate excise tax1— has been a focal point for modern scholars. It appears to represent a shift from the shareholder-focused taxes of the nineteenth century to the corporation-focused tax of the modern classical system. During the Civil War and Reconstruction, shareholders were taxed on an aggregate, or passthrough, basis and the corporation itself was not taxed.2 Although the corporation was targeted in 1894 when the income tax was briefly revived, it was still considered a collection mechanism for the tax on individuals.3 Moreover, because the Supreme Court quickly struck down the income tax as unconstitutional in Pollock v Farmers’ Loan & Trust Co,4 the 1894 tax was ultimately never implemented. Thus, the entity-level corporate excise tax enacted in 1909 is often considered the birth of the modern corporate income tax. According to recent scholarship, the shift from a focus on shareholders to a focus on corporations reflected developments in entity theory around the turn of the century.5 During the Civil War and Reconstruction, the corporation was small and viewed as an aggregation of its individual owners.6 Since this was essentially the description of a partnership, there was little reason to distinguish between corporations and partnerships for tax purposes. During the latter half of the century, however, the underlying attributes of a corporation and a partnership began to diverge as the corporation grew in size and importance. Between 1894 and 1909, the great merger movement and its resulting concentration of wealth in corporate coffers further cemented the status of the large corporation. At the same time, ‘real entity’ theory developed more accurately to reflect the corporation’s separation from its shareholders. The federal government sought to regulate this growth in accumulated corporate wealth through a variety of means,

1

Tariff Act of 5 Aug. 1909, ch. 6, § 38, 36 Stat. 11, 112. Tariff Act of 1864, ch. 173, 13 Stat. 223, 281–285. 3 See generally S.A. Bank, ‘Entity Theory as Myth in the Origins of the Corporate Income Tax’ (2001) 43 Wm & Mary L Rev 447 (‘Entity Theory I’). 4 157 US 429, 572 (1895). 5 See R. Avi-Yonah, ‘Corporations, Society, and the State: A Defense of the Corporate Tax’ (2004) 90 VA L REV., 1193; M.E. Kornhauser, ‘Corporate Regulation and the Origins of the Corporate Income Tax’ (1990) 66 Ind L J 53, 136. 6 Tariff Act of 1864, ch. 173, 13 Stat. 223, 281–285. 2

Entity Theory as Myth in 1909 395 including taxation. Thus, modern scholars have concluded that the 1909 tax was based on and was a reflection of the corporation’s developing status as a real entity for tax and other purposes. This chapter takes a closer look at both the events leading up to and following the adoption of the corporate excise tax in 1909, and the debates over the 1909 Act itself, and concludes that the role of entity theory and corporate regulation has been overstated. Rather than being a successor to the aborted attempt to tax corporations in 1894 and a forerunner to the first post-Sixteenth Amendment income tax in 1913,7 the 1909 corporate excise tax is more properly aligned with its fellow post-Pollock era attempt to tax the sugar and petroleum trusts during the Spanish–American War in 1898. The 1909 tax, like its 1898 predecessor, was an attempt to reach shareholder wealth while complying with the constitutional limitations against an individual income tax under Pollock. While both the 1898 and 1909 taxes were passed with regulatory undertones, there is relatively little evidence of a shift in the conception of the corporation when the 1909 Act was adopted. Perhaps the most telling fact is that when the first postSixteenth Amendment corporate income tax was enacted in 1913, it was essentially a replica of the 1894 Act and its pass-through approach to corporate taxation. It was not until the first World War and its aftermath that the modern corporate income tax began to emerge.

I. 1898 AND THE CONTEXT FOR 1909

Although the 1909 corporate excise tax is often thought of as a successor to the tax struck down by the Supreme Court in Pollock in 1894 and the predecessor to the first post-Sixteenth Amendment income tax in 1913, it is actually much more closely related to the first post-Pollock attempt to tax corporations during the Spanish–American War. As part of the consideration of the War Revenue Act of 1898,8 Congress looked to corporate income as a potential source of revenue that would comply with the strictures laid down in Pollock. The provision as passed focused on two particular industries rather than on corporations generally, but the proposed treatment of corporations and the debate over that proposal lay the groundwork for the 1909 Act. Soon after the income tax was held unconstitutional by the Supreme Court, Congress was faced with the twin problem of declining revenues and rising expenses. William McKinley assumed office in 1896 under what Republicans perceived to be a ‘mandate for a high protective tariff.’9 The ensuing Dingley 7

Revenue Act of 1913, ch. 16, 38 Stat. 114, 166–181. Act of 13 June 1898, ch. 448, 30 Stat. 448. 9 S. Ratner et al., The Evolution of the American Economy (MacMillan, New York, 1979) 390. 8

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Tariff Act erected one of the most highly protective regimes in American history,10 but the high prices it engendered served only to lower imports and cut into federal revenues in an already deficit-laden economy.11 With the expected rise in government expenses from the onset of the Spanish–American War in 1898, Congress had to seek alternative revenue sources.12 Thus, in May of that year, a war revenue bill was introduced with one of its major innovations being the utilisation of an excise tax on the gross receipts of corporations.13 The excise tax was an attempt to toe the line drawn by the Court in Pollock. There, the justices had opined that while the income tax was unconstitutional, ‘excise taxes on business, privileges, employments, and vocations’ might be permissible.14 Thus, in an obvious attempt to parrot the Court’s language, Senator Horace Chilton, a Democrat from Texas and one of the sponsors of the corporate excise tax, described it as ‘a tax on the occupation or privilege of doing business as a corporation’.15 As originally proposed, it would impose only a one-quater of 1 per cent tax on gross receipts, although it was estimated that this would raise between $30 and $45 million, making it one of the principal revenue raisers in the bill.16 There was significant debate as to why the bill targeted corporations rather than taxing all businesses in a particular industry, regardless of their form. While the sponsors may have made this distinction because of constitutional and practical concerns,17 it nevertheless generated much controversy because of the disparate treatment of similarly situated businesses.18 Republican Senator Henry Cabot Lodge from Massachusetts characterised the failure to

10

Ibid. See S.R. Weisman, The Great Tax Wars (Simon & Schuster, New York, 2002) 176–177. 12 Ibid., at 177; ‘Finances in War Time’, Washington Post, 6 Apr. 1898, at 3A; ‘The Financial Situation’, (1898) Commercial and Financial Chronicle 728. 13 ‘This Week in Congress; The War Revenue Bill May be Completed, Passed, and Signed Before Saturday’, New York Times, 22 May 1898. The corporate excise tax was first considered in an amendment to the bill in the Senate. See ‘Taxes to Wage a War’ Washington Post, 17 May 1898, at 4A (noting that it was ‘inserted without the co-operation of the Republican members of the Finance Committee’). The other major innovation was the adoption of a federal inheritance tax: Ibid. See Act of 13 June 1898, ch. 448, § 27, 29, 30 Stat. 448, 464. 14 Pollock, 158 US 601, 637 (rehearing). 15 31 Cong. Rec. 5090 (1898) (statement of Sen. Chilton, Democrat, Texas). 16 Ibid. 17 See, eg, ibid., at 5138 (statement of Sen. Platt, Republican, Connecticut.) (‘You cannot tax the property of a corporation because it is personal property, and because the Supreme Court has said in the income-tax decision that a tax upon personal property is a direct tax. Therefore, they attempt to get away from the inhibition by saying that they put a tax on corporations’); ibid., at 5101 (statement of Sen. Turley, Democrat, Tennessee.) (noting that the significantly undertaxed property in the country is held in corporations). 18 See ibid., at 5090 (statement of Sen. Spooner, Republican Wisconsin.) (‘I know a city in my State, in which one side of a street there is a corporation engaged in the business of manufacturing furniture, and on the other side of the street is a partnership engaged in the business of manufacturing furniture. I think the business is precisely the same. Under this bill, as I understand it, the firm would not be taxed’); ibid., at 5099 (statement of Sen. Lodge, Republican, Massachusetts.) (‘Does not the Senator see that the partnerships, which in the 11

Entity Theory as Myth in 1909 397 tax corporations and partnerships equally as ‘the extreme injustice of the bill’.19 Senator John Spooner, a Republican from Wisconsin, added that ‘[i]t amounts to a bonus to the individual or the private partnership.’20 What is notable about the debate is the extent to which the arguments for both sides contained an element of support for an aggregate view of the corporation. Supporters of the corporate excise tax formally appeared to justify the tax on two grounds. First, they cited several benefits enjoyed by individuals operating a business in corporate form that did not exist when operating in a partnership or as a sole proprietor. For example, corporate shareholders enjoyed protection from limited liability. According to Democratic Senator Thomas Turley of Tennessee, ‘the exemption from personal liability on the part of those who own the corporation . . . is one of the most important benefits that any business man can possess’.21 Additionally, corporate shareholders benefited from the perpetual life feature. Senator Chilton explained that one of the ‘great advantages’ of operating in corporate form was ‘the ease with which the ownership of an interest in a corporation is transferred from man to man or sire to son without embarrassment or delay which comes from the winding up of a private partnership’.22 Most notable about these comments is the extent to which supporters spoke in terms of the benefits realised by the individual shareholders, rather than by the corporate enterprise itself. Secondly, sponsors of the corporate excise tax provision emphasised its virtues as a substitute for the income tax. Senator Chilton noted that ‘[n]o proposition to tax incomes is found in this bill, because it has not been deemed wise to complicate the questions at issue with any doubtful measures pertaining to judicial decisions. But for one, sir, I shall never lose hope that the amassed and idle fortunes of this country can be made to bear some part of the burden justly necessary to protect those fortunes. . . . Next to an income tax and the tax on inheritances, I believe the tax on corporations, which we hope to see levied by this bill, presents more elements of justice than any other tax which it contains.’23 While this view may have been

shoe and leather industry are quite as numerous, and I think more numerous, than corporations, would not have to pay anything, and therefore they would not add it and they would cut the business right out from under these other people’). 19

Ibid., at 5098 (statement of Sen. Lodge). Ibid., at 5099 (statement of Sen. Spooner). Ibid., at 5101 (statement of Sen. Turley). See ibid., at 5092 (statement of Sen. Chilton) (citing the ‘exemption from personal liability which attaches to individual partners’). While this was an oft-cited argument, there did appear to be some recognition of the growing trend of states to permit limited partnerships with the same benefit of limited liability. See ibid., at 4157 (statement of Sen. Bacon, Democrat, Georgia) (noting that ‘the limited-partnership provision . . . is known to the law of every State in the country, under which a partner is only liable for the amount of money which he actually puts in’). 22 Ibid., at 5092 (statement of Sen. Chilton). See ibid., at 5101 (statement of Sen. Turley). 23 Ibid., at 5092 (statement of Sen. Chilton). 20 21

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more muted because of concerns for the constitutionality of a disguised income tax provision in light of Pollock,24 it nevertheless served as an undertone to the debate.25 Opponents also framed their criticism of the corporate excise tax proposal primarily in individual, rather than entity, terms.26 There were two main arguments. First, opponents suggested that corporate stockholders tended to have small incomes and the burden of this tax would thus fall disproportionately on the less wealthy. This was true either because the corporation itself was small or because it was organised as a mutual co-operative society among mechanics or clerks in a common enterprise.27 Thus, rather than reaching the wealthy, this would burden the working class. According to Senator Lodge, this meant that limiting the tax to corporations got it exactly backward. ‘The corporation, as a rule, is made up of many persons with small interests, whereas the great partnerships are made up, as a rule, of only two or three persons, and yet, by this amendment all partnerships are exempted and all corporations are taxed.’28 Secondly, and perhaps in the alternative, opponents argued that the tax would be shifted to consumers and therefore undermine any progressive quality it might be thought to possess.29 To a large extent, this claim went uncontested. Senator Chilton weakly

24 See ibid., at 5137 (statement of Sen. Frye, Republican, Maine) (‘To get away from the difficulty of taxing gross receipts, which the authors of this provision felt might be obnoxious to the decision in the income-tax case, they attempt to tax the franchise of the corporation, or to tax a corporation because it is a corporation’); cf. ibid., at 5139 (statement of Sen. Lindsay, Democrat, Kentucky.) (‘It is impossible in view of the income-tax decision to reach the profits a rising from accumulated wealth, and hence policy and power alone are to be considered. . . . The question of taxing corporations is one of policy and of constitutional power’). 25 This is especially true in light of the fact that an income tax bill was also submitted that directly challenged the Pollock decision. See R. Stanley, Dimensions of Law in the Service of Order: Origins of the Federal Income Tax, 1861–1913 (OUP, New York, 1993) 181 (characterising the debate over the bill as ‘serious’ compared to other income tax proposals introduced between 1895 and 1909). 26 This is not to say that they did so exclusively. See, eg, 31 Cong. Rec. 5098 (1898) (statement of Sen. Lodge) (‘The bill draws no distinction between the large and very profitable corporations and a small corporation which may be just struggling along and making a bare living’). 27 See ibid., at 5136 (statement of Sen. Platt) (‘more than one-half in number of the corporations of this country are but cooperative associations in which men who are able to carry on business and who have small capital have joined their capital; in which mechanics who are skilled are stockholders in manufacturing corporations; in which clerks who are skilled are stockholders in trading corporations’). 28 Ibid., at 5098 (statement of Sen. Lodge). 29 See ibid., at 5099 (statement of Sen. Allen, Progressive, Nebraska.) (‘It is a universal truth that this tax, levied in the first instance on the particular individual or particular corporation or partnership manufacturing these articles, must fall upon the millions of consumers of the articles’). At least one senator pointed out that for corporations in competition with partnerships, they would simply have to bear the costs. See ibid., at 5099 (statement of Sen. Spooner) (‘there is no such tax levied upon individuals and firms carrying on the same business, and therefore they can not add it to the price of their product, and if a corporation carrying on that business adds the tax to the price of its product, the firms and individuals will undersell it and therefore it can not do it.’).

Entity Theory as Myth in 1909 399 offered that ‘[i]t is probable that the consumers will pay the larger part of this tax, but it is not mathematically certain. The tax on corporations is not different from any other tax in that respect.’30 Ultimately, Congress rejected the proposed tax in favour of a tax defined by line of business—sugar and oil. While this was both broader and narrower than the original corporate excise tax, it was commonly understood that the object of the tax was two concerns—the Standard Oil Company and the American Sugar Refining Company.31 The main motivation for the move to an industry-based tax appeared to be federalism.32 This was based on both the practical concern that the states would be deprived of a revenue source as well as the constitutional concern that the proposed tax would interfer with states’ rights, given the fact that states were the primary chartering authorities for corporations.33 Significantly, some argued as well that taxing the corporate gross receipts would be double taxation in light of the state taxation of the corporate stock and the practical, if not legal, equivalence between the stockholder and the corporation.34 Finally, there was also some disagreement about whether this would aid or exacerbate the shifting incidence problem,35 but in the end the revised bill passed with little debate. 30

Ibid., at 5092 (statement of Sen. Chilton). See ‘Voted to Tax Trusts’, Washington Post, 2 June 1898, at 4A. As first proposed, the tax would have been levied on other industries as well, including transportation and public utility corporations. The Commercial and Financial Chronicle was indignant at the singling out of these industries, calling it ‘an odd proposal. It would seem difficult to say on just what principle the selections for taxation named in the proposed amendment were made. The selections appear eminently inequitable’: ‘The Financial Situation’ 66 Commercial and Financial Chronicle (1898) 1018, 1019. 32 31 Cong. Rec. at 5106 (statement of Sen. Spooner) (‘The question is, whether Congress can any more tax the franchise, the right to be, of the corporation than the State can tax a Federal corporation?’). 33 See ibid., at 5098 (statement of Sen. Lodge) (The national government ‘has left to the States as one of their principal sources of taxation the aggregate capital engaged in banks and corporations, and I think to take that from the States or largely reduce it will have the precise effect which it is said we desire to avoid; that is, it will force the State taxation on the class of people least able to bear a heavy direct tax’); ibid., at 5138 (statement of Sen. Platt) (‘The power to tax implies the power to destroy. If the Congress of the United States can impose a tax upon the corporation itself as a corporation, it can destroy it; it can destroy what the State alone can create and what the State has a right to create and a right to maintain; and that is as applicable to one kind of corporation as to another’). 34 Ibid., at 5103 (statement of Sen. Allen) (‘A certificate of stock represents the interest of a stockholder in the aggregate property. If you tax that aggregate property to its full limit, making the taxes imposed on it equal to those imposed on other property, then taxing the stock would be simply double taxation on the property’). The response was that there was no legal restriction, although this did not address the underlying policy claim. See ibid., at 5103 (statements of Senators Turley and Lindsay). 35 Compare ibid., at 5396 (statement of Sen. Platt) (‘It is picking out from all the interests of the country two classes of business where it is absolutely certain that the corporations will not pay the tax, but that it will be paid by the consumer . . . the persons engaged in the business will be very careful in raising the price of oil and sugar to raise it a little more than the tax, so that the consumer will pay not only the tax, but the additional profit to these two 31

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Although the war revenue taxes were repealed a few years later after the need had diminished, the 1898 tax was eventually subject to constitutional challenge on the ground that it was an unapportioned direct tax masquerading as an excise tax. If true, it would be in violation of Pollock. In Spreckels Sugar Refining Company v McClain,36 the Court rejected this challenge. Justice Harlan, writing for the Court, resolved the question fairly summarily: ‘[c]learly the tax is not imposed upon gross annual receipts as property, but only in respect of the carrying on or doing the business of refining sugar. It cannot be otherwise regarded because of the fact that the amount of the tax is measured by the amount of the gross annual receipts’37 This had little precedential value for the collection of the now-defunct sugar and petroleum taxes, but it eventually provided cover for President William Howard Taft when he introduced a corporate excise tax in 1909.38

II. 1909

The 1898 Act’s focus on reaching shareholder wealth continued in 1909. This was evident both during the debates over the income tax bill supporters proposed in defiance of the Court’s decision in Pollock and during the debates over President Taft’s corporate excise tax proposal, which was openly sold as a constitutionally acceptable substitute for a shareholder income tax.

A. Income Tax The corporate income tax is often said to have begun in 1909 when corporations were singled out for an excise tax on corporate income as an amendment to the Payne–Aldrich Tariff Bill.39 To attribute this enactment to the companies’) with E.R.A. Seligman, The Shifting and Incidence of Taxation (2nd., edn., Columbia, CUP, New York, 1899) 286–288 (noting that in the case of a monopoly a tax on gross receipts is not always shifted to the consumer). In the immediate aftermath of the tax, the results were mixed as to whether the tax was actually shifted. See M. West, ‘The Income Tax and the National Revenues’ (1900) 8 J. Pol. Econ. 433, 449 n. 2 (‘It seems quite impossible to say whether or to what extent this tax actually has been shifted to the consumers. Since it was imposed the general tendency of prices has been upward in petroleum, but downward in sugar; but in neither case was there any increase in price at the time the act was passed or for some weeks thereafter’). 36

192 US 397 (1904). Ibid., at 411. 38 See below text accompanying nn. 77 ff. 39 The tariff bill was introduced by House Ways and Means Chair Sereno Payne (Republican, New York) along with an inheritance tax measure. See Stanley, above n. 25, at 191–192. At that time, the tariff raised the lion’s share of the revenue for the federal government and the income 37

Entity Theory as Myth in 1909 401 rise of entity theory, however, is somewhat difficult because of the absence of a general income tax. Corporate income was taxed separately, but it may have been a proxy for a tax on individual income, rather than an entitylevel tax itself. Thus, it is perhaps more appropriate to start by examining the income tax proposals from 1909 that preceded the introduction of the corporate excise tax. Given that the corporate excise tax was proposed in part to forestall the passage of an income tax bill,40 the treatment of corporate income in the context of these proposals may be an important clue to the influence of entity theory in the eventual adoption of the corporate excise tax. The first bill proposing an income tax was introduced by Senator Joseph W. Bailey, a Democrat from Texas, on 15 April 1909.41 The bill was essentially a copy of the 1894 income tax law struck down by the Court in Pollock, and this was done with the express purpose of forcing the Court to reconsider its constitutionality.42 Under its terms, both individuals and corporations were subject to a 3 per cent tax on income in excess of a $5,000 exemption amount.43 As in the 1894 law, the bill permitted individuals to exempt from income dividends received from corporations subject to tax under the Act.44 Given the attempt to repeat the provisions of the previous enactment, this bill obviously could not serve as evidence of a change in Congress’ attitude toward corporate personality. Less than a week after Senator Bailey submitted his bill for an income tax, Senator Albert Cummins, an Insurgent Republican from Iowa, offered an alternative income tax bill. This income tax proposal was even more evidence of an aggregate conception of the corporation than the Bailey

tax and corporate excise tax measures were introduced as amendments to the main tariff bill. The need for an additional revenue source to accompany the tariff bill arose both because protectionists were in favour of customs duties that were sufficiently high to exclude products, which would consequently reduce the revenue raised from such duties, and because free traders were interested in lowering duties downward on goods that would not be excluded, which would also lower revenues. See Editorial, ‘The Craze for New Taxes’ New York Times, 16 June 1909, at 6; ‘Taft Sees a Hope of Reduced Duties’ New York Times, 20 June 1909, at 1. 40 See R.E. Paul, Taxation in the Tax United States (Little, Brown & co., Boston, Mass., 1954) 94–95; R.G. Blakey and Gladys C. Blakey, The Federal Income (1940) 35. 41 44 Cong. Rec.1352 (1909). There does not appear to be any connection between the date on which this income tax bill was introduced and the modern deadline for filing tax returns. Originally, the filing date was on 1 March. The date was moved back to 15 March in 1918 and was not pushed back to its current deadline of 15 April until 1954. See http://www. taxhistory.org/thp/thpwebsite.nsf/Web/TaxHistoryProject:FilingDeadline?OpenDocument (last visited on 19 April 2004). 42 See Blakey and Blakey above n. 40, at 30. 43 44 Cong. Rec 1352 (1909). 44 Ibid. (‘it shall be proper to deduct from such gains, profits, and income . . . the amount received from any corporation, company, or association as dividends upon the stock of such corporation, company, or association if the tax of 3 per cent has been paid upon its net profits by said corporation, company, or association as required by this act’).

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amendment. Under Cummins’ bill, corporations were not subject to tax at all. Instead, Cummins proposed to return to the Civil War method. Thus, individuals would be taxed on ‘[t]he amount received as dividends upon corporate stocks, together with the proportionate share of the undivided profits of corporations issuing such stocks’.45 According to Cummins, under a graduated rate corporate-level tax ‘the stockholders whose incomes are below the minimum fixed by the amendment would bear the highest rate of duty’.46 He cited the example of the United States Steel Corporation, which had an income justifying the highest rate but a large percentage of its stock was held by employees with incomes of less than $1,200 per year.47 As Cummins pointed out, ‘[a]n income duty imposed upon the aggregate income of a corporation rests with equal weight upon those persons who derive some income from a corporation and yet have an aggregate income below the minimum fixed by the statute and those large incomes upon which it is the policy of the Government to attach a duty’.48 Cummins’ proposal to exempt corporations themselves from tax was not uncontroversial, even among his natural allies.49 Senator Isidor Rayner, a Progressive from Maryland, asked ‘[w]hy not put a tax on corporations? . . . We are after the corporations . . . and I thought you were too’.50 Cummins responded to this and similar queries by explaining that his bill ‘reaches the earnings of every corporation in the land and at the same time it does absolute justice among individuals’.51 He explained: I am attempting to reach the aggregate, the ultimate, the final result. The corporation is simply the instrumentality for the enrichment of its stockholders, and if the instrumentality results in conferring upon its stockholders an income above the minimum fixed by the amendment, then it should be taxed; but if that income is below the minimum, there is no more reason for imposing a tax upon it than there would be if it were derived as a salary or as profit in a real estate transaction or as the profits of a farm.52 45

Ibid., at 1420. Ibid., at 1421. 47 Ibid. 48 Ibid. 49 There was also some concern among his allies on other grounds, most notably about the proposal’s high rate and low exemption. See ‘Western Senators for an Income Tax’ New York Times, 19 Apr. 1909, at 3 (‘Some of the Western Republican Senators are not altogether in favor of the Cummins amendment, and did not hesitate to say so to-day. They criticize the unusually high tax it seeks to impose, and they believe, also, that the tax is imposed on incomes ‘too close to the ground’). 50 Ibid., at 1423 (statement of Sen. Rayner). Although Cummins was sometimes described as a ‘corporation attorney’, he was often an opponent of corporations in his legal work and was said to ‘enjoy[] no bitterer enemies’ than the railroads: T. Dreier, Heroes of the Insurgency (Human Life Publishing Co, Boston, Mass, 1910) 43, 48. 51 44 Cong. Rec. at 1423. 52 Ibid., at 1424 (statement of Sen. Cummins). 46

Entity Theory as Myth in 1909 403 This explicit embrace of an aggregate conception of the corporation was not universally shared,53 but the principal objection appeared to be based on the more pragmatic concern about how properly to collect funds in the absence of a stoppage-at-the-source scheme.54 In other words, the argument centered over whether to apply a Civil War or 1894 Act pass-through approach, not whether to tax the corporation qua corporation. Eventually, Bailey and Cummins compromised and introduced an income tax proposal that drew from both the Civil War and 1894 approaches in taxing corporations. Under the Bailey–Cummins amendment, corporations would be subject to the income tax to the extent that their incomes exceeded $5,000, but shareholders would be entitled to apply for a refund for their portion of the tax if their individual incomes fell below $5,000.55 As Cummins explained, the intention of this refund provision was ‘to relieve all persons whose incomes were not more than $5,000 from the operation of this tax.56 While Senate Finance Committee Chairman Nelson Aldrich, a Republican from Rhode Island, managed to forestall an immediate vote on the combined amendment,57 Senator Bailey publicly opined that it would have passed if submitted to a vote that day and others privately agreed.58 53 See, eg, ibid., at 1424 (statement of Sen. Sutherland, Republican, Utah) (concern that if all of a corporation’s shareholders have income below the exemption amount, then ‘notwithstanding the fact that the corporation had an income of $100,000, the corporation would pay no tax’). 54 Senator Smith from Michigan asked how he proposed to reach foreign stockholders or domestic stockholders such as Andrew Carnegie who sought to evade taxes by moving abroad: ibid., at 1423, 1424 (statement of Sen. Smith, Republican, Michigan). Cummins had little in the way of a response to this problem, except to say that the solution would be the same as the one employed in previous enactments for reaching foreign income of any kind. ibid., (statement of Sen. Cummins). 55 44 Cong. Rec. 3137 (1909). The section provided, in relevant part: ‘Any stockholder of any corporation, company, or association the income of which is taxable and taxed under the provisions, hereof, whose total income from all sources does not render him liable to the duty herein provided for, may, at any time within six months after the corporation or association of which he is a stockholder has paid the duty herein required, file a written application with the collector of the district in which he resides, in such form as the Secretary of the Treasury may prescribe, showing that his total income for the year under consideration, computed as hereinbefore set forth, did not exceed $5,000.’ 56 Ibid., (statement of Sen. Cummins). According to the New York Times, the intent was, to relieve double taxation as well as to exempt small incomes. See ‘Income Tax Forces Agree on New Bill’ New York Times, 19 May 1909, at 1 (‘The tax will fall on both individuals and corporations alike, but a system of “rebates” will be provided to prevent the double taxation of an individual income derived in part from corporations. These rebates will be arranged to protect small incomes ordinarily exempt’). 57 Ibid., at 3138. Senator Bailey correctly predicted this manoeuvre: ibid., at 3135 (‘I have believed all the while what the Senator from Rhode Island has repeatedly made manifest, that it is his purpose to avoid, if possible, a direct vote on this question by making a motion to refer it to some committee’). 58 Ibid., at 3136 (statement of Sen. Bailey) (‘After a careful and thorough canvas of the matter, my opinion is that the majority of the Senate this afternoon are in favor of this amendment, and if we could now take the vote, we would write it into this bill’). Henry Cabot Lodge privately expressed the same sentiment in a communication to President Theodore Roosevelt.

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According to estimates, the income tax’s supporters could count on at least 45 votes between Democrats and a large collection of Western Republicans, an amount sufficient to constitute a bare majority.59 As evidenced by the Bailey–Cummins amendment to the tariff bill, the proposed treatment of corporate income in the context of a general income tax was decidedly a reflection of the aggregate conception of the corporation. Although corporations were subject to an entity-level tax in the compromise proposal, the refund provision meant that the tax would be borne only by stockholders who would otherwise be subject to the individual income tax. Not only is this not a real entity theory–driven conception of a corporate income tax, but it is closer to the Civil War pass-through model than the 1894 Act’s more pragmatic use of the corporate income tax as a withholding mechanism. Thus, in perhaps the truest test of its contemporary understanding, Congress appeared to be poised to pass a more aggregate than entity-based version of the corporate income tax.

B. Corporate Excise Tax Notwithstanding the support for an income tax in Congress, Republican leaders managed to delay a vote on the proposed amendment to the tariff bill until they could find a better alternative to meet the predicted shortfall in revenues from the tariff.60 While there is some question whether the idea

See H. Cabot Lodge, Selections from the Correspondence of Theodore Roosevelt and Henry Cabot Lodge, (C. Scribners Sons, New York, 1925) ii, 1884–1918 338–339 (Bailey and Cummins made a combination on an income tax, which included corporations. That scheme would produce so much money . . . that it would involve in a short protection. They had the votes, however, to pass it’). See also W.E. Brownlee, Federal Taxation in America: A Short History (CUP, Cambridge, 1996) 42–43 (‘By 1909, there were enough insurgent Republicans in Congress who supported a graduated income tax to force action. A diverse group of representatives and senators from both parties supported the immediate enactment of such a tax’). Even before Bailey and Cummins joined forces, the New York Times reported that there was sufficient support among Democrats and insurgent Republicans to pass the income tax provision: ‘Income Tax Scares Leaders in Senate’, New York Times, 17 Apr. 1909, at 2 (‘The Democratic strength, joined with that of the radical Republicans, is considered sufficient at the present time to force this tax into the bill’). 59 ‘Income Tax Forces Agree on New Bill’ New York Times, 19 May 1909, at 1. Six more Republican Senators were believed to be capable of being induced to vote for the measure: ibid., Cf. ‘Income Tax May Win’ New York Times, 26 May 1909, at 1 (‘Senators Aldrich and Crane called at the White House last night and told the President that such an amendment to the bill could be carried by a margin of two or three votes. Among the Republican insurgents, however, the impression is generally that Senator Bailey of Texas has destroyed what chances the tax had of passage by separating the Democratic and insurgent supporters of it’); ‘Aldrich Sees Taft About Tariff Bill’ New York Times, 9 June 1909, at 1 (‘Senator Aldrich gave the President to understand that he was in doubt of his ability to hold the situation in hand). 60 See ‘Aldrich Prevents Income Tax Vote’, New York Times, 12 June 1909, at 2.

Entity Theory as Myth in 1909 405 originated with Senator Aldrich or President Taft himself,61 both eventually agreed that the way to forestall the income tax would be simultaneously to advocate a constitutional amendment for an income tax and an excise tax measured by corporate income.62 1. President Taft’s Message President Taft first proposed the tax on corporations in his message to Congress in June of 1909. While he agreed that Congress should and probably does have the right to tax incomes, he counselled against a direct challenge to the Court’s decision in Pollock. ‘This new proposal’, Taft noted, ‘makes it appropriate for me to submit to the Congress certain additional recommendations.’63 Among his recommendations were to propose to the states a constitutional amendment conferring on Congress the right to tax incomes and, in the meantime, to levy an excise tax on corporations measured by income.64 With respect to the corporate excise tax, Taft specifically cited Spreckels as evidence ‘that such a tax as this is an excise tax upon privilege and not a direct tax on property, and is within the federal power without apportionment according to population’.65

61 Compare ‘Letter from Captain Butt to his Sister-in-Law Clara Butt, June 18, 1909,’ in W.H. Taft and F.D. Roosevelt, The Intimate Letters of Archie Butt, Military Aide (Doubleday, Doran & Co, Garden City, NY, 1930) 123–124 (‘The President cast a bombshell in Congress by advocating a tax on the incomes of corporations and also in favor of presenting a constitutional amendment permitting the federal authorities to levy an income tax. Senator Aldrich and Senator Lodge thought they had him weaned away from the income tax proposition, but when they thought themselves safe from this menace he slipped his message, when they were entirely unprepared for it’) with N.W. Stephenson, N.W. Aldrich: A Leader in American Politics (Kennikat Press, Port Washington, NY, 1930) 355–356 (‘And then came the great stroke of the episode. It was given out to the newspapers that on the third day thereafter Mr. Aldrich would submit to the Senate two proposals. One would provide for an amendment to the Constitution empowering Congress to levy an income tax. The other would propose insertion of the corporation tax in the tariff bill. A message from the President made these measures official’). Taft himself seems to have settled the question in his favour. See ‘Letter from Taft to Horace Taft, 27 June 1909’, in H.Pringle, The Life and Times of William Howard Taft (Archon Books, Hamden, Conn., 1965) i, 435 (‘I have gone into this to show you that the situation is not one of my yielding to Aldrich, but of Aldrich yielding to me.’). See also Weisman, above n.11, at 227. According to his biographer, a third possible source for the compromise is Senator Elihu Root, who was one of the primary drafters of the corporate excise tax. See R.W. Leopold, Elihu Root and the Conservative Tradition (Little, Brown & Co., boston, Mass., 1954) 79. 62 See Lodge, above n. 58, at 338–339 (‘in order to beat them [the income tax supporters] we have determined to put in a tax on the net receipts of corporations which was recommended by Taft and which he has just urged in a special message’); S.D. Solvick, ‘William Howard Taft and the Payne–Aldrich Tarif’, (1963) 50 Mississippi Valley Hist Rev 424, 435 (‘Taft indicated he told Aldrich that ‘it was either the corporation tax or the income tax or no bill at all’). 63 44 Cong. Rec. 3344 (message of President Taft). 64 Ibid. 65 Ibid.

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In addition to satisfying constitutional objections, Taft extolled the corporate excise tax as a practical substitute for an income tax. According to Taft, an excise tax measured by corporate income ‘accomplishes the same purpose as a corporation income tax and is free from certain objections urged to the proposed income-tax measure’.66 On the latter point, he was referring in part to the objection that the income tax was an unenforceable measure except by the most inquisitorial of means.67 As he later said in his message, ‘[i]t imposes a burden at the source of the income when the corporation is well able to pay and when collection is easy’.68 The notion that the corporation was a ‘source’ rather than the ‘object’ reinforced the tax’s status as a surrogate for the income tax and the corporation’s status as a surrogate for the stockholder. As Taft later explained in a speech delivered after the corporate excise tax was adopted, it was the best type of income tax they could levy and it embodied many of the ‘“best features of the English income tax law.”’69 Perhaps most revealing on this point is Taft’s initial support for an inheritance tax as a possible alternative in the event of a revenue shortfall. According to the New York Times, ‘[t]he inheritance tax has appealed to him as particularly desirable, because it falls on people who are able to bear it, and because it is easy to collect’.70 The Times later noted that this tax ‘seemed to be a good way to put in force the Rooseveltian policy of abridging the fortunes of the excessively rich’.71 As the House conferees were later quick to remind their Senate counterparts, the House bill adopted an inheritance tax rather than a corporate excise tax to secure the additional revenue.72 It was only when this very direct manner of reaching wealth was foreclosed because of concerns raised in the Senate about the duplication with state inheritance taxes that Taft turned to the corporate tax.73 This suggests the target was individual wealth held in corporate form rather than ‘corporate wealth’ as a separate concept.

66

Ibid. See Bank, above n. 3, at 520–522. 68 Ibid. 69 ‘Taft Favors Income Tax, LaFollette’s Wkly Mag., 2 Oct. 1909, at 13 (reporting on a speech in Denver). 70 ‘Taft Would Reduce Tax on Necessities’, 30 Mar. 1909, at 2. 71 Editorial,’ The Craze for New Taxes’, above n. 39, 72 See 44 Cong. Rec. 4383 (1909) (statement of Rep. Clark, Democrat, Florida.) (‘You brought in a corporation tax over in the Senate. I say that they had no right to add the bill a proposition that was never broached in the House. The House passed an inheritance tax. I would like to dump into this conference the proposition for an income tax’). 73 ‘Taft Would Reduce Tax on Necessities’ above n. 70, at 2; 44 Cong. Rec. 3344 (1909) (message of Pres. Taft); D.W. Detzer, The Politics of the Payne-Aldrich Tariff of 1909 (Ph.D. dissertation 1970), 189–190 (‘After the Ways and Means Committee adopted his proposal [for an inheritance tax], however, an immediate uproar occurred. The president and Cannon discussed a substitute, and they agreed that the farmer and the attorney-general, George Wickersham, should prepare a corporation tax proposal to be introduced to the Ways and 67

Entity Theory as Myth in 1909 407 Despite the popular agreement with this sense that the corporate tax operated as a proxy for an income tax on shareholders,74 there were elements of the President’s message that suggested the intention to target corporations under a real entity perspective. For example, the reference to a corporation’s ‘ability to pay’ could indicate the personification of the entity.75 Further, Taft’s justification of the tax as the price for ‘the privilege of doing business as an artificial entity’ and the ‘freedom from a general partnership liability by those who own the stock’ reflected the distinctiveness of the corporation as a legal entity.76 These rationales for the corporate tax are almost identical to the ones raised by supporters of the tax in the debates over the 1898 bill,77 though, and were probably designed to satisfy the same constitutional fears raised previously. Thus, they are less suggestive of a change in understanding toward the corporation. Another possible sign that Taft’s corporate excise tax proposal was motivated by entity theory was the fact that it exempted small corporations, or Means Committee’). Some suggest that the inheritance tax was proposed only because Taft’s attorney general George Wickersham had yet to draft a corporate tax alternative. See Kornhauser, above n. 5, at 95. Taft had reportedly asked Wickersham to begin drafting a corporate tax bill even before his inaugural address. See J.C. German, Jr., Taft’s Attorney General: George W. Wickersham (Ph.D dissertation 1970) 202. Some reports, on the other hand, suggest that even after a corporate tax bill was drafted, Taft preferred the inheritance tax. ‘See Taft Will Oppose a Tax on Incomes’ New York Times, 21 Apr. 1909, at 1 (‘In case additional revenue is necessary, the President is in favor of trying first an inheritance tax, and next and excise tax on corporations’). Taft himself said in a speech given two months after the bill was signed that he initially preferred an inheritance tax, although this statement was made in the face of growing criticism of the tax. See ‘Taft Defends Tax on Corporations’ New York Times, 22 Sept. 1909, at 7 (‘Mr. Taft said he had favored at first an inheritance tax, but the objection that the States had pre-empted that field had sufficient weight to defeat the proposition’). Regardless of the order of preference, the fact that he viewed both the inheritance tax and the corporation tax as acceptable, but did not propose, as others did, a stamp tax suggests that it is worthwhile to consider the common features of the two provisions. This is not to suggest, though, that Taft was indifferent between the two taxes after he had delivered his message in the Senate. See ‘Taft Will Insist on Corporation Tax’ New York Times, 2 July, 1909, at 16; ‘Taft Takes Hand Again in Tariff’ New York Times, 15 July, 1909, at 2. 74 See, eg, ‘Aldrich Canvasses Senate’, Washington Post, 10 June 1909, at 4C (‘The Senate leader’s invitation to the President to make suggestions resulted in an expression by the President in favor of the imposition of a tax on the dividends of a corporation as a substitute for the income tax provision’); Blakey and Blakey, above n. 40, at 40 (calling the corporation tax ‘an income tax in another form’); ‘Making a Mistake at Washington’ Leslie’s Illustrated Weekly, 1 July 1909, at 1 (‘A tax on the net incomes of corporations, large and small, would simply be a tax on the thrift and industry of the people . . . In all it would fall on the stockholders, great and small’). The original dividends tax proposal had been similarly considered to be an income tax in disguise. Henry Aldrich, Chairman of the Norfolk & Western Railroad commented that ‘[t]he proposal seems to me to be merely an income tax, with this grave objection that it would be unevenly distributed, being levied against some forms of income and not against others’: ‘Aldrich Opposes Tax on Dividends’ New York Times, 24 Mar. 1909, at 5. 75 See Avi-Yonah, above n. 5. 76 44 Cong. Rec. 3344 (1909) (message of Pres. Taft). See Kornhauser, above n. 5, at 103. 77 See above text accompanying nn. 29–30.

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those corporations with annual incomes of $5,000 or less.78 If the corporate tax was a mere proxy for a tax on shareholders, it would be the size of the shareholder’s income, not the size of the corporation’s income, which would dictate the availability of an exemption. This was the method chosen by Senators Bailey and Cummins in their income tax proposal.79 Shareholders with annual incomes of $5,000 or less could apply for a refund of the corporate tax paid under their compromise income tax bill.80 While it appeared to support an entity perspective, the exemption amount was dictated more by practical and political forces than by theory. First, the exemption avoided the practical difficulties that would have followed from the Bailey–Cummins proposal. A similar rationale was raised in 1894 for rejecting such a scheme.81 Secondly, the exemption was politically expedient. A pass-through exemption may have raised constitutional concerns by appearing too close to an income tax, but the real concern was more immediate. While Taft initially opposed any exemptions,82 which would have matched the approach in 1894,83 he was ultimately persuaded by political expediency. According to newspaper reports, ‘[t]he main argument . . . which is said to have brought about the decision to make the change was that if the amendment did not provide for the exemption, representatives of hundreds of small corporations would swoop down on Washington, and not only make things miserable for senators and representatives, but get such an agitation against the corporation tax that the general tariff legislation itself would stand in danger of defeat’.84 Given Taft’s primary concern for tariff reform,85 he had to drop his objections to the exemption. Taft’s statement that the tax would be beneficial as a means of regulating the corporation might provide stronger evidence of a real entity-based motivation. Taft had noted that an incidental benefit of the tax might be the ability ‘to possess the Government and the stockholders and the public of

78 ‘Small’ was defined as corporations with net income of $5,000 or less. See 44 Cong. Rec. 3836. 79 See above text accompanying nn. 68–69. 80 Ibid. 81 See Bank, above n. 3, at 501 n. 291. 82 ‘Taft is to Fix Tax’ Washington Post, 22 June 1909, at 1F (‘President Taft is represented as having been opposed at first to making any exemptions, but ultimately, it is said he came around to the view of others present that it would be well to impose the tax only on corporation incomes in excess of $5,000’). 83 See Bank, above n. 3, at 501 n. 290–291. 84 ‘Taft is to Fix Tax’ above n. 82. There appeared to be substantial evidence that the possibility of small business revolt was a real one. See ‘Joker in Tax Bill’ Washington Post, 28 June 1909, at 1A (reporting on the ‘scores of letters and telegrams that are coming to every senator protesting against the new taxing plan. These come as a rule from small corporations. In many instances little corporations in which the farmers are interested, such as creamery concerns, will be affected. Traveling men who work for corporations are joining in the chorus of opposition.’). 85 See Kornhauser, above n. 5, at 91.

Entity Theory as Myth in 1909 409 the knowledge of the real business transactions and the gains and profits of every corporation in the country’.86 During his campaign, Taft had pledged to continue President Roosevelt’s programme of regulating corporations and he considered this tax a step toward fulfilling that pledge.87 Part of the tax’s political appeal was the fact that it fed off the anti-corporate sentiment that had motivated many of the insurgent Republicans and Progressives from the western states to join the Democrats in their pursuit of a tax on wealth, whether held individually or through corporations.88 Moreover, it suggests that Taft recognised a separation between the stockholder-owners and the corporation itself as run by its managers. While Taft was serious about his commitment to the issue of corporate regulation,89 it is not clear this commitment meant that entity theory was 86 Ibid., See ‘Taft to Send Message Urging Corporation Tax’ New York World, 16 June 1909, at 2A (‘Not only is the President favorable to an amendment providing for a tax upon the net earnings of corporations because of the added revenue it would produce, but much more so on account of the fact that he believes it would bring about a helpful and healthy degree of publicity relative to corporations. This, he believes, would give great satisfaction to the people and at the same time give the corporations a standing otherwise unattainable’). 87 ‘Taft Planned Tax on Roosevelt Lines’ New York Times, 24 June 1909, at 1 (‘Taft is especially pleased over the prospect of success for his corporation tax because he regards it as the first step in his big programme of legislation for the carrying out of the Roosevelt policies, to which he so often pledged himself during the campaign’). According to Nelson Aldrich’s biographer, ‘[t]he corporation tax was paraded before the world as a great stroke of the President’s, as convincing proof that he was wedded to the Progressive policies of Mr. Roosevelt.’: Stephenson, above n. 61, at 355. 88 The Democratic platform in 1908 had practically called for the elements of Taft’s plan. See S.H. Acheson, Joe Bailey: The Last Democrat (MacMillan, New York, 1932) 262–263 (The platform urged Congress to submit ‘a constitutional amendment specifically authorizing Congress to levy and collect a tax upon individual and corporate incomes to the end that wealth may bear its proportionate shares of the burden of the Federal Government’). See Blakey and Blakey, above n. 40, at 45 (‘the President secured the approval of many Democrats, also, for he had “planted himself squarely on the Democratic platform of 1908”’). See also Stephenson, above n. 61, at 355 (‘As if to make sure its passage an ‘avalanche of corporate objectors’ poured into Washington to protest against it’). 89 See Kornhauser, above n. 5, at 96 (noting ‘the consistent attention Taft gave to a corporate tax from the beginning of his presidency’); Lodge, above n. 58, at 339 (‘Taft is particularly interested in [a corporate tax] because under the taxing power you can get at the accounts of all corporations whether they are engaged in interstate business or not.’); Message from Taft on the Income Tax, New York Times, 16 June 1909, at 3 (‘The point in the proposed legislation affecting corporations that especially interests the President is the definite power such a tax will give the Government to inquire into the transactions of corporations, their capitalization and their issues of bonds and stocks along the line of the inquisitorial powers the Roosevelt Administration steadily labored for in regard to inter-State railroads’). As further evidence of Taft’s genuine interest in the corporate tax, its inclusion in the bill was considered necessary to secure Taft’s commitment to the rest of the tariff provisions. See ‘Senators Repudiate a Taft Compromise’ New York Times, 10 June 1909, at 4 (‘One thing in favor of the tax on corporation dividends is that it was the President’s original suggestion, and its passage is expected to have a measurable effect in reconciling the president to the remainder of the bill’). Unlike during the Roosevelt administration, big business and its agents such as J.P. Morgan were fairly well removed from the decision-making process and could not rely upon the ‘gentlemen’s agreements’ that had promised latitude. See R.H. Wiebe, Businessmen and Reform (1962) 81–82.

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motivating his support for a corporate income tax. He originally proposed a tax on dividends,90 which would have been a return to the House version of the 1894 tax and the industry-based dividend tax that preceded it during the Civil War and Reconstruction.91 In both instances, the dividends tax was designed to be a withholding mechanism for a tax on individual shareholders and the contemporary press recognised that the same was true with Taft’s proposal. In describing it, the Commercial and Financial Chronicle noted that ‘[s]uch an impost would be collected from the corporations and not from individual stockholders, but none the less it would be an income tax upon the latter’.92 Taft’s did not make the corporate excise tax based on net income until he needed an alternative to the income tax proposals.93 This suggests that it was not entity theory that led to a tax measured by 90 See ‘Tax on Corporations is Planned by Taft’, New York Times, 23 Mar. 1909, at 1 (describing the bill ‘now in course of preparation’ as a 2 per cent tax on dividends from corporations other than certain financial corporations such as banks). This ‘dividend tax’ designation continued to be reported in the press. See ‘No Income Tax Now; Taft Joins Aldrich’ New York Times, 15 June 1909, at 1 (‘The proposed constitutional amendment will be offered along with the 2 per cent tax on corporate dividends’). 91 See Bank, above n. 3, at 460–461. 92 ‘The Financial Situation’ (1909) 88 Com & Fin Chron 788. 93 See Blakey and Blakey, above n. 40, at 41 (Taft ‘insisted that there must be some alternative to the income tax amendment. Therefore he suggested to Aldrich a tax of 2% on net income of corporations where the earnings were in excess of some specific figure, such as $100,000 or $200,000’). Observers recognised the shift from the dividends tax to the income tax. See ibid. at 43 (Taft’s proposal ‘was of somewhat broader scope than the tax on dividends originally proposed, because it covered income put into surplus as well as that paid out to stockholders’). According to at least one report, the shift from an excise tax measured by dividends to one measured by net income was made when Taft concluded that a dividends tax ‘would operate unjustly’: ‘Taft Seeks Harmony’, Washington Post, 10 June 1909, at 4C. Another report suggested that the dividends tax proposal was rejected because ‘the majority of Republican leaders were opposed to that method’: German, above n. 73, at 202. Given that both a dividends tax and an income tax were circulated to insurgent Republicans for their reaction before Taft’s speech, it is likely that the decision to go with a tax measured by net income was related to its suitability as a substitute for an income tax. See ‘Aldrich Canvasses Senate’ Washington Post, 10 June 1909, at 4C (‘One of these propositions is for a tax of 2 per cent on the dividends of corporations. The other is for a tax of 2 per cent on the net earnings of corporations over $100,000’). One of the principal difficulties with the dividends tax was the fact that it was unlikely to raise sufficient revenue. See ‘Tax on Corporations is Planned by Taf’, above n. 90, at 1 (‘It is learned that when the proposition [for a dividends tax] was first advanced the President was heartily in favor of it. He then was under the impression that it would raise much more revenue that the estimates of the Treasury experts show. On the showing that it would produce only $15,000,000, however, there seemed to be a slight dimunition of enthusiasm about it’); A ‘New Source of Revenue’ New York Times, 24 March 1909, at 8 (describing the estimated revenue from a dividends tax as a ‘pittance.’); Aldrich Promises Plenty of Revenue, New York Times, Apr. 20, 1909, at 3 (Taft’s ‘first idea was to lay this tax on dividends declared by such corporations, but there is reason to believe that he has modified this view somewhat and now favors levying the tax upon the net profits of the corporations, which would include sums carried to surplus accounts as well as dividends’); ‘The Financial Situation’ (1909) 88 Com & Fin Chron 846 (‘It is further reported, however, that since Government experts could only show that $15,000,000 revenue would be obtained at the utmost from such a tax [on corporate dividends], the President’s ardor for it has cooled’).

Entity Theory as Myth in 1909 411 corporate income, even if the decision to use the tax to subject corporations to a measure of federal oversight may have been genuine. Taft also could have accomplished the same thing as part of the Bailey–Cummins income tax. The primary, and perhaps sole, non-tax aspect of the corporate excise tax measure was its publicity feature. Under this provision, all corporate tax returns ‘shall be filed in the office of the Commissioner of Internal Revenue and shall constitute public records and be open to inspection as such’.94 This requirement, which was similar to one already in place for national banks,95 could have been implemented as part of the income tax proposal. Progressive Senators William Borah of Idaho and Joseph Bristow of Kansas made this clear in their statement responding to the President’s proposal: ‘[a]s to the publicity feature, there is no substantial difference between the two measures. In other words, there is the same necessity for securing information and insuring publicity in the income tax as in the corporation tax’.96 Some went further than Borah and Bristow, suggesting that the publicity feature in the corporate excise tax bill was inferior to the one in the income tax proposal. Many of the most objectionable features of the corporate excise tax’s publicity measure had been removed from the bill after intense corporate lobbying.97 While returns would still be made public, information obtained via audits would be kept confidential unless the President ordered its release.98 Furthermore, no real audit would occur of such 94 44 Cong. Rec. 3837. This provision was adopted unchanged. See Act of 5 Aug. 1909, ch. 6, § 38(6), 36 Stat. 11, 116. 95 See ‘Taft Planned Tax on Roosevelt Lines’ above n. 87 24 June 1909, at 1 (‘All corporations will be required to furnish sworn returns which shall set forth in form largely similar to that of the statements now required from National banks their total gross receipts, with detailed specification of the sources of income such as ordinary receipts, income from investments or stocks or bonds of other corporations, and other kinds of income’). 96 ‘Oppose Taft Plan’ Washington Post, 17 June 1909, at 4F. 97 See ‘Taft Planned Tax on Roosevelt Lines’ above n. 87, 24 June 1909, at 1 (‘On the information obtainable when the conference broke up late last night it seemed that the publicity feature of the proposed amendment had been stripped of most of the severity to which the corporation men had been objecting so vigorously’); ‘Corporation Tax Bill is Modified at White House’ New York World, 23 June, 1909, at 5B (‘The chief change made in the proposed amendment was a modification of the publicity feature of the corporation tax, intended to make it less objectionable on the ground that Federal supervision would be inquisitorial’); ‘Publicity Dropped From Taft Tax Plan’ New York Times, 23 June 1909, at 1 (‘After the gathering broke up it was announced that the publicity feature of the tax would add nothing to the publicity already generally given by corporations in their annual statements’). Others disagreed with these assessments, calling the amendments ‘meaningless modifications of the scheme’: ‘The Financial Situation, (1909) 88 Com & Fin Chron 1582, or suggesting the secrecy could easily be overcome with a ‘moderate bribe’: Mr. Taft’s Tax Bill, New York Times, 24 June 1909, at 6. For tangible evidence of the corporate lobbying effort, see 44 Cong. Rec. 4056–4057 (1909) (letters from corporate officers objecting to the publicity provisions). 98 ‘Taft Planned Tax on Roosevelt Lines’ above n. 87, at 1. There was some confusion as to whether Presidential approval would be required for release of the whole return or simply the information obtained upon audit, but opponents in the press tried to emphasizse that it was

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returns in the absence of proof of fraud.99 Senator Cummins argued that these revisions meant that the corporate excise tax’s publicity measure paled in comparison to the one in the Bailey–Cummins bill.100 According to Cummins, ‘[i]t is not in putting the Government in possession of this knowledge that we find the greatest value of the instrument of publicity. Publicity means general knowledge.’101 Senator Moses Clapp, an insurgent Republican from Minnesota, also denied that this was the fulfillment of Teddy Roosevelt’s long quest for publicity of corporate information, calling it ‘a myth born from the fertile brain of legislators’.102 According to Clapp: [t]he only return which is required and the only investigation which is necessary under this proposed amendment is the investigation which relates to the question of whether the corporations have made an honest return of taxation. Beyond that, the secret contract, the mystic power which one great corporation may hold over others, not only as a threat unuttered, but as a menace of conditions, the relation which one great corporation may hold to others by reason of the inward relations of the members of those corporations—there is not, I undertake to say, one line in that amendment which requires publicity along those lines.103

Senator Elihu Root, a Republican from New York who was one of the principal drafters of Taft’s corporate tax provision,104 privately conceded that the comparable provisions in the income tax proposals were ‘exceedingly drastic and injurious’ when compared to Taft’s proposal.105 Thus, not only only required for the latter information. See ‘The Financial Situation’ (1909) 89 Com & Fin Chron 2 (‘Some of the daily papers have made the mistake of assuming that the annual returns required of corporations for the purpose of levying the tax are not to be made public except upon the special direction of the President. There is no such limitation’). 99 ‘Corporation Tax Bill is Modified at White House,’ above n. 97, at 5B (‘It was decided that no investigation shall be made to ascertain whether a corporation shall submit true and accurate returns. The sworn statement of the corporation shall be accepted in all instances except where a presentment of fraud is made by an internal revenue agent, which will be followed by an examination of the corporation’s books’). 100 See 44 Cong. Rec. 4038 (1909) (statement of Sen. Cummins) (‘The measure we have proposed does not go far enough in exposing to the public gaze the affairs of corporations, but the committee amendment stops far short of ours. It will do no good to secure information and hide it under the seal of some office in the Department of Treasury’). Some even questioned whether the publicity feature remained at all after the revisions. See ibid., at 4230–4031 (colloquy of Senators Bulkeley, Republican, Connecticutt, and Dixon,. Republican, Montana). 101 Ibid. See Ibid. at 4047 (statement of Sen. Hughes) (‘It is said that it will secure a desired publicity. I say that it will secure the opportunity for a very undesirable publicity, for we are told that the limited inquiries which are made and the limited information which is disclosed shall be kept secret; that it shall be criminal to disclose it, save at the discretion of the President of the United States’). 102 Ibid., at 4009 (statement of Sen. Clapp). 103 Ibid. 104 See ‘Taft is to Fix Tax’ Washington Post, 22 June 1909, at 1F (identifying Root and Attorney-General Wickersham as the principal drafters of the corporate excise tax amendment). 105 P.C. Jessup, Elihu Root (ii, 230 1938) (quoting letter from Root to Charles F. Mathewson, dated 26 June 1909).

Entity Theory as Myth in 1909 413 was the corporate tax not a prerequisite for Taft’s publicity measure, but it was not altogether clear that it was the strongest publicity measure put forth in the session or one that could advance the fight to regulate corporate activity. Finally, Taft’s regulatory ambitions were hardly evidence of a change in attitude towards the corporate tax. The movement to regulate corporations began well before the turn of the century, with the Interstate Commerce Act in 1887 and the Sherman Anti-Trust Act in 1890 serving as milestones in this effort.106 Such a regulatory impetus naturally carried over to the tax arena. In 1894, William Wilson, the chairman of the House Ways and Means Committee, advocated a corporate income tax for many of the same reasons put forth by Taft in his message: [I]n view of the exemption from personal liability of stockholders, and other privileges which corporations enjoy, but which the individual business or professional man cannot enjoy, the equity of a tax upon their net earnings seems more apparent, while the ascertainment of those earnings would generally be easy and reasonably accurate, and free from the offensive inquisition so much declaimed against in the case of the individual. The very limited public supervision incident to the assessment and collection of such a tax would not work any wrong or any interference with their lawful operations, while as a necessary part of a tax law, and used only for bona-fide purpose, it might be salutary in its influence.107

It is true that the growth of the corporation in the intervening years between 1894 and 1909 may have hastened the imperative for regulation,108 but the concept of regulating corporate wealth through the tax system was hardly new. Thus, while Taft’s message could be interpreted as offering a new vision of corporate taxation–one directed at the entity itself and premised on a regulatory purpose—in reality it was a much more limited advance. The proposal was a creature of the post-Pollock world and its bar on the income tax. 106 See R. Hofstadter, The Age of Reform (Vintage Books, New York, 1955) 232 (‘The longrange trend toward federal regulation, which found its beginnings in the Interstate Commerce Act of 1887 and the Sherman Act of 1890, which was quickened by a large number of measures in the Progressive era, and which has found its consummation in our time, was thus the first response of a predominantly individualistic public to the uncontrolled and starkly original collectivism of big business’). 107 E.W.L. Wilson, ‘The Income Tax on Corporations’, 158 (1894) North American L Rev 1, 7. 108 See R.L. Nelson, Merger Movements in American Industry, 1895–1956 (Princeton UP, Princeton, NJ, 1959) 5 (‘The first recorded merger movement of major proportions occurred as the United States entered the twentieth century, its peak years being 1898 through 1902. In many respects it was the most important of the major merger waves. It transformed many industries, formerly characterized by many small and medium sized firms, into those in which one or a few very large enterprises occupied leading positions. It laid the foundation for the industrial structure that had characterized most of American industry in the twentieth century’).

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2. Congressional Debate During the congressional debate over Taft’s proposal, it became clear that the corporate excise tax fitted well within both the post-Pollock framework and the popular clamor for a need to reach individual wealth through income taxation.109 It is true that the rhetoric used in support of the corporate excise tax appeared to be grounded in a variety of theoretical camps.110 The New York World observed that ‘[m]ore angles have arisen in connection with the corporation tax plan than exist on a thirteen-carat diamond. Each Senator seems to be looking at a different one and no two of them view the situation in the same light’.111 Nevertheless, the constitutional concerns and the popular support for income taxation in some form appeared to be the crux of the compromise that pushed the tax to adoption. One of the initial questions raised in the Senate debates over Taft’s corporate excise tax proposal was why it was limited to corporations. This question immediately linked the debates with those that took place in 1898. As Senator Francis Newlands, a Democrat from Nevada, noted, the Court in Spreckels had approved a tax on all companies, regardless of form, engaged in the sugar and oil refining businesses.112 Since Congress had rejected a more broadly worded corporate excise tax in 1898, opponents placed the debate over this issue in the Congressional Record as precedent for 1909.113

109 See Pringle, above n. 61, at 433 (Pollock ‘had been an excessively unpopular decision and had been a factor in the rise of Bryan and Populism in the Middle West.’). 110 See Avi-Yonah, above n. 5, at 21; 44 Cong. Rec. 4237 (1909) (statement of Sen. Daniel, Democrat, Virginia.) (suggesting partnerships are ‘natural persons’ while corporations are ‘artificial creation[s]’). 111 ‘Income Tax Amendment is Nearly Killed’ New York World, 19 June 1909, at 4A. 112 44 Cong. Rec. 3757 (1909) (statement of Sen. Newlands). See ibid., at 4025 (statement of Sen. Borah). The 1898 war revenue tax served as a significant focal point for discussion during the debates over the corporate excise tax that was subsequently considered in 1909. While there was virtually no discussion of the extent to which the treatment of corporations under the proposed bill differed from the treatment in 1894, there was significant comparison with the treatment in 1898. The changes from a ‘gross receipts’ to a ‘net income’ measure and from an industry to a corporate base were each discussed heavily. See, eg, 44 Cong. Rec. 3979 (1909) (statement of Sen. Cummins) (‘Just such a law was proposed in 1898. It came out of the Committee on Finance as part of the report of the revenue bill for that year. Substantially the only difference between that proposal and this proposal is that there the proposition was to levy a small duty upon the gross receipts of all corporations instead of the net incomes of all corporations.’); ibid., at 3986 (statement of Sen. Borah) (discussing the effects on prices from the 1898 Act); ibid., at 3989 (statement of Sen. Borah) (discussing corporate opposition to the 1898 Act); ibid., at 4016 (statement of Sen. Nelson, Republican, Minnesota) (‘I desire to call the attention of the Senator from Idaho [Borah] to the fact that the material difference between this proposed law and the law of 1898 was that in the law it based it upon the gross receipts, with limited exemption, and that this proposed law bases it upon net earnings’). 113 Ibid., at 3758–3759. Several senators moved to introduce into the Congressional Record some long sections of the 1898 debate on these issues. See ibid., at 3756–3763 (statement of Sen. Newlands with an extensive history of the 1898 Act); 3979 (quoting Sen. Allison); ibid., at 3986 (quoting Sen. Platt); ibid., at 3995 (quoting Senators Allen, Lodge, Frye, Platt, and

Entity Theory as Myth in 1909 415 The principal distinction between the 1898 and 1909 taxes was that they relied on very different bases of taxation to raise similar amounts of revenue. In 1898, the original proposal was for a corporate excise tax based on gross receipts. With such a broad base, Congress could afford to compromise on the target of the tax without sacrificing the revenue. Thus, the tax was levied on all businesses operating in the oil and sugar industries (whether as corporations, partnerships, or something else) rather than all corporations. By contrast, in 1909 the original proposal was for an income tax. With the narrower base of net income, Congress would have had to cover many more industries to satisfy its revenue needs in 1909 than it did in 1898. This distinction was important in the choice to focus on corporations in 1909. If Congress had attempted to expand the 1898 Act’s sugar and oil taxes to cover more industries, it would have come much closer to resembling a general income tax. Limiting the tax to corporations only, rather than partnerships and sole proprietorships as well, was thus designed to help ensure the tax’s constitutionality.114 Presumably, this would be because operating a corporation could be more easily described as a privilege subject to taxation,115 while operating a general partnership or sole proprietorship required no special grant of authority from the state. Taxing partnerships and sole proprietorships would have given the appearance of an end-run around Pollock. The legislative drafters sought to avoid even the appearance of impropriety in crafting the tax provision. The New York World reported ‘[n]o similar legislative proposition has ever been more carefully scrutinized, the general desire being to have it so phrased as to meet the least resistance in Congress and be impervious to attacks in the courts’.116 Spooner). Senator Elihu Root, one of the principal drafters of the corporate excise tax in 1909, (see Jessup, above n. 105, at 226) specifically traced the current language to 1898: see 44 Cong. Rec. 4034 (1909) (statement of Sen. Root). 114 This was commonly understood among the press. See ‘The Financial Situation’, 88 Com & Fin Chron 1582, 1583 (‘Why are partnerships excepted and the tax levied only on corporations and joint-stock associations? The reason is that the United States Supreme Court in 1895 declared the income tax proposition unconstitutional.’); ‘What the Corporation Tax Measure Contains’ (1909) 89 Com & Fin Chron 9, 11 (‘The Corporation Tax is only one step in a much wider scheme. For the present, partnerships and private individuals are not made subject to the tax, because the U.S. Supreme Court in 1895 declared a general income tax unconstitutional’). 115 Even this proposition was not uncontested. See 44 Cong. Rec. 4046 (1909) (statement of Sen. Hughes, Democrat Colorado) (‘It was said . . . that certain privileges were held by those who engaged in corporations; and that is, to some extent—now much limited—true. In the State of Colorado three or more persons may incorporate to do any lawful business. There is no other limitation whatever upon the right to incorporate’). 116 ‘Corporation Tax Plan Introduced in Senate’, New York World, 26 June 1909, at 4B. Taft and Aldrich were intensely concerned with making sure that the corporate excise tax amendment was drafted so as to be completely free from the threat of constitutional challenge. See ‘Aldrich Scents Trouble for the Corporation Tax’, New York World, 24 June 1909, at 6A (‘The Taft–Aldrich corporation tax compromise amendment to the Tariff bill is to be a carefully launched bit of legislation. Constitutional lawyers have been whittling at it all day’). When told the amendment was ready, Aldrich reportedly ‘asked that the experts in constitutional law go over it once again and then sleep on their deliberations’: ibid.

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Senator Aldrich noted that while the Finance Committee had considered the possibility of including partnerships and other business vehicles, it deemed it safer to tax corporations only.117 According to Aldrich, ‘the committee thought it raised a cloud of questions’ and it chose instead ‘to hew closely to the line and follow the suggestions and recommendations of the President in this legislation’.118 More practically, the corporate tax was acceptable because it allocated some of the tax burdens to individual wealth. As Senator Newlands explained: We must therefore have more revenue; and, as the taxation of the Government is levied almost entirely upon consumption, it is right that we should reach out for the fixed wealth of the country in some form, either through income, corporation, or occupation taxes.119

Senator Newlands went on to note that he favoured a tax designed ‘to reach the great accumulated wealth of the country, or its earnings, engaged in corporate enterprise, as an easy and effective way of securing a considerable revenue’.120 Part of the motivation for reaching individual wealth through some form of income tax was to offset the regressive nature of the tariff. Under the tariff, the burden of the levy was primarily in higher prices. Since the poor consumed proportionately more of their income than the wealthy, the tariff taxes were considered highly regressive. Thus, Newlands’ statement that taxes are ‘levied almost entirely upon consumption’ is a reference to the high dependency on tariffs as evidenced by the Payne–Aldrich tariff bill. This sentiment had been a motivating force for the adoption of an income tax in 1894.121 At the time, supporters of the income tax noted that it would ‘supplement’ the tariff so as to ‘put some little of the burden on the wealth of the country’.122 By 1909, the sentiment for adopting some progressive counterweight to the tariff had only grown stronger. The strongly protective Dingley Tariff had triggered, or at least coincided with, a steep ascent in the cost of living between 1898 and 1907—one that far outpaced the rise in earnings.123 The Panic of 1907 only worsened the situation. Consequently, in 1909 there

117 See 44 Cong. Rec. 4028 (1909) (colloquy between Senators Brandegee, Republican, Connecticutt, and Aldrich). 118 Ibid. 119 Ibid., at 3756 (statement of Sen. Newlands). 120 Ibid. 121 See S.A. Bank, ‘Origins of a Flat Tax’ (1996) 73 Denver U L Rev 329, 364–370. 122 26 Cong Rec App at 415 (statement of Rep. Benton McMillin, Democrat, Tennessee); Ibid., at 1610 (statement of Rep. Uriel Hall, Democrat, Montana). 123 J. Buenker, The Income Tax in the Progressive Era (Norton, New York, 1985) 34; Bureau of the Census, US Dep’t of Commerce, Historical Statistics of the United States: Colonial Times to 1970, (1975) pt. 1, at 212 (Series E 183-186).

Entity Theory as Myth in 1909 417 was significant pressure to relieve some of the burden on consumption by imposing a tax on individual wealth.124 It was commonly believed that taxing corporations would burden the shareholders.125 In a report on the state taxation of corporations,126 which was released by the Bureau of Corporations during the debates over the corporate excise tax and which was reprinted and distributed to the entire Senate in a larger than usual quantity,127 the problem of reaching individual wealth invested in corporations was discussed. The report noted that ‘a growing fraction of each man’s wealth is being invested in the shares and bonds of corporations’128 Part of the difficulty was whether to tax the corporation’s property in light of separate taxes upon individual property, including stocks and bonds, and the separate physical presence of corporate property and the individual holders of such property. In its analysis of this issue, the aggregate perspective was clearly evident. According to the Report, ‘[o]bviously a tax on

124 The 1908 Democratic Platform, for instance, called on an income tax ‘to the end that wealth may bear its proportionate share of the burdens of the federal government.’: E.R.A. Seligman, The Income Tax ( MacMillan, New York, 1911) 591–592 (quoting from the 1908 Democratic Platform). 125 See, eg, ‘Making a Mistake at Washington’, Leslie’s Illustrated Wkly, 1 July 1909, at 1 (‘A tax on the net incomes of corporations, large and small, would simply be a tax on the thrift and industry of people. In some instances it would be ruinous. In all it would fall on the stockholders, great and small’); ‘Limits of Taxation’, Wall Street Journal, 31 Aug. 1909, at 1 (‘There is some justice in the claim that assessments of corporations in which individuals hold personal investment real result in the owners of such property contributing to the public revenue. As a question of administration, it is probably much easier to place the burden where it belongs by taxing the corporations, than by requiring the submission of a personal schedule’); ‘The Financial Situation’ (1909) 88 Com & Fin Chron 1525 (‘A tax on net earnings of corporations is an income tax on one class of persons who happen to own stock therein. The fact that, although corporations themselves are not ‘natural persons,’ they are composed of natural persons is overlooked; touch a corporation and the persons composing it are touched.’); A.C. Pleydall, Secretary New York Tax Reform Association, Letter to the Editor, ‘The Corporate Tax’, New York Times, 19 June 1909, at 6 (‘Such a tax would reduce dividends and really be a tax upon the individual stockholder . . . It was stated in a Washington dispatch that the tax on corporate dividends is similar to the English system of taxing incomes ‘at the source”’). See also J. Woodburn, ‘Corporation Income Tax’ (1911) 62 Chautauquan 299, 300 (‘The decision [upholding the corporate excise tax] is a victory for the administration and also for sound, just principles of taxation. Taxes on goods and consumption are unfair in that the poorer elements pay the greater part of them. Taxes on incomes and net profits are taxes on wealth, on privilege, on superfluity. The tax is automatically distributed over the entire vast field of modern industry; and no one suffers appreciably’). 126 US Dept of Commerce REPORT OF THE COMMISSIONER OF CORPORATIONS ON THE SYSTEM OF TAXING MANUFACTURING, MERCANTILE, TRANSPORTATION, AND TRANSMISSION CORPORATIONS, IN THE STATES OF CONNECTICUT, MAINE, MASSACHUSETTS, NEW HAMPSHIRE, RHODE ISLAND, AND VERMONT (17 May 1909) (‘Bureau of Corporations Report’). (Government Printing Office, Washington, DC) 127 See 44 Cong. Rec. 3628 (1909) (order that 2,000 copies of the report be printed). This Report, also attracted the attention of the press in its coverage of the debates over the Corporation Tax bill. See ‘What the States do in the way of Taxing Corporations’ (1909) 89 Com & Fin Chron 133 (noting the relevance of the Report even though ‘[i]t has not been issued with any reference to the proposed Federal Corporation Tax’). 128 Ibid., at 15.

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the corporation is really a tax upon its stockholders, for otherwise then as a matter of legal reasoning a corporation and its stockholders are one. Hence the question whether both the corporation and the stockholders shall be taxed is an interesting problem as to double taxation’.129 It is certainly possible that for some legislators the desire to reach the ‘accumulated wealth’ of the country could be characterised as part of the desire to regulate corporations, and therefore, part of a real entity perspective.130 Nevertheless, the broader context of most such statements reveals the shareholder focus of their remarks. As discussed previously, income tax proponents and tariff critics frequently spoke of levying more tax on the ‘wealth’ of the country rather than its poor via consumption taxes.131 The corporation excise tax was viewed as one avenue for targeting the accumulated wealth of individual shareholders. For example, Senator Root suggested that the corporate tax would be a more narrowly tailored version of the individual income tax: And by the simple course of dropping out from this income-tax measure the parts that are unconstitutional under the decision of the Supreme Court, that are unjust according to the acknowledged judgment of all students of the income tax, that are incapable of enforcement within such a time as to relieve the deficiency that may be before us and by saving the tax upon the stored-up wealth of the country invested in corporations, called an ‘excise,’ we shall have accomplished the great object of the income tax.132

Root’s use of the phrase ‘stored-up wealth’ underscored the degree to which the corporate excise tax was both a reaction to the limitations imposed by the Court and a proxy for an individual income tax. For Root, it was a proxy for a more perfect income tax because it appeared to hit ‘the possessors of the stored-up wealth of the country, which is being invested in the corporations that are doing the business of the country’, rather than ‘[t]he 129

Bureau of Corporations Report, above n. 126, at 11. See Avi-Yonah, above n. 5, at 23 (supporting this view based on a reading of similar statements). This view was also expressed in the press. See Editorial, By Direction of the President, New York Times, 26 June 1909, at 6 (‘It is the outgrowth of the gust of passion that has beswept the land during the years when the public has been appealed to hate and to hamper the corporations, when it has been taught that the word corporation was well-nigh synonymous with chicane, that the people were oppressed and robbed by the managers of the corporations. This law is drawn with intent to gratify the passionate resentment thus awakened, and it is drawn, and, we suppose, will be enforced without the slightest discrimination between shameless offenders and perfectly innocent and law-abiding corporations’). 131 See above text accompanying nn. 119–120. 132 44 Cong. Rec. 4006 (1909) (statement of Sen. Root). See ibid. at 4005 (statement of Sen. Root) (‘the provision to which I have referred as the “corporation tax” saves all of the income tax that is constitutional and can be enforced. It avoids the evils of the income tax provision; it avoids drawing the Supreme Court of the United States through the mire and brambles of political controversy; it avoids the possibility or the probability of creating in the eyes of the world a conflict between two branches of our Government; it avoids the injustice of imposing the same duty upon the toiler, who is earning and laying up the capital for his future years, and upon the possessor of accumulated wealth’). 130

Entity Theory as Myth in 1909 419 men who work, who are laying up out of their earnings provision for the future, and on whom the tax gatherer should be laid most lightly’.133 Under this dichotomy, in both the income tax and the corporate excise tax the focus is on the individual, but the corporate income tax is more narrowly focused on the individual shareholder who is presumably wealthy and whose income is unearned. Publicity was an incidental benefit, with the main goal being to reach shareholder wealth.134 Some disagreed with Root’s assessment that the corporate tax would target the wealthy shareholder, but this still reflected an aggregate view. Thus, one of the immediate criticisms levied against the corporate tax proposal was that small stockholders would bear the large part of the burden for the tax,135 or that the corporate tax would be passed on elsewhere.136 Part of 133

Ibid. There was some evidence of a contrary sentiment. See, eg, ibid., at 4000 (statement of Sen. Bourne, Republican, Oregon.) (‘It is not the revenue feature of this proposed legislation that I deem so important, but the publicity feature incident to its demonstration’). Part of this discounting of the revenue component of the tax may have been the belief that the tariff bill would raise sufficient revenues as written. According to one of the members of the Senate Finance Committee, a minority of the members were of the opinion that no additional revenue would be required. See ibid., at 3936 (statement of Sen. Flint, Republican, California). See also ibid., at 3941 (statement of Sen. Dixon) (‘I shall vote for the corporation-tax amendment as proposed by President Taft in his message, with the full understanding that I believe the chief virtue lies in the publicity feature as applied to large corporations, for I am fearful that the tax that will be imposed by it will, in the end, in many cases at least, be “passed on to the public”’). 135 See ‘Taft’s Corporation Tax Framed to Reach the Rich’ New York World, 18 June 1909, at 5B (‘There were indications to-day of growing opposition to the corporation tax plan. This was chiefly because Senators believed bondholders might escape payment of the tax while the small holders of stock would contribute all the revenue’); 44 Cong. Rec. 4039 (1909) (statement of Sen. Cummins) (‘I want Senators to understand what they are about to do, because the people of the country will understand that it is the shareholders, little and big, who will pay the sum. . . . They will know just one thing, and that is whereas their rich neighbors who are not engaged in corporate enterprise pay no tax, they, because they have endeavored to forward the progress and speed the development of their country, and have taken shares of stock in corporations of an almost infinite number of kinds, have been selected, as it would seem, by the folly of their Government, to bear a burden which they ought not to bear, except in company with others who are similarly situated’). See also ibid., at 4055 (letters expressing the same concern for small stockholders). For a contrary view, see ‘A Tax on Net Earnings’ Wall Street Journal, 18 June 18, 1909, at 1 (‘The theory that they would seriously affect dividends will hardly bear examination in the light of the moderate amount involved in the proposed tax’). Prior to amendment, another concern of the corporate excise tax bill was that preferred stock dividends would be deductable, effectively leaving common stockholders bearing the entire burden. This was later resolved in favour of equal treatment. See ‘Corporation Tax Bill is Modified at White House’ above n. 97 at 5B. 136 This argument was primarily raised by Senator Borah. See, eg, 44 Cong. Rec. 3985 (1909) (‘It has been given out to the country, and has been somewhat extensively assumed, that this is another means of placing a tax upon the wealth of the country; that by this process of singling out corporations we will reach the wealth of the land rather than place a tax upon consumers, or that great body of American citizenship which now bears its undue proportion of the taxes of the country’); ibid., at 3987 (‘The great corporations, which do business upon a large scale practically without competition, where they can raise the price or lower the price 134

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the concern was that the tax effectively acted as a levy on dividends, and bond interest would thus be exempt. Senator Bristow read one constituent letter on the floor of Congress that summarised this fear: Is it fair and consistent with the American idea of fairness and a ‘square deal’ to tax our net earnings—taxes which will come out of the dividends to our stockholders, very many of whom are men in very moderate circumstances and working every day for a living and the support of their families–simply because we are doing business under a charter, while a neighbor doing business as an individual or under a copartnership is entirely free from said tax? And further, does the proposition reach the very wealthiest citizens, such as Rockefeller and Carnegie, whose holdings are not in stocks of corporations, but in bonds?137

As Senator Augustus Bacon, a Georgia Democrat, explained, it was a common practice to convert stock into bonds through a recapitalisation of the corporation, and if this effected a reduction in the corporate tax, the practice would spread widely.138 This would leave only the small and less welladvised stockholders bearing the brunt of the tax burden. To address this concern, Attorney-General George Wickersham and Senator Root chose to apply the tax to the ‘net income of a corporation’, rather than to the ‘net earnings’ or ‘net profit’, in order to ensure that preferred stockholders and bondholders would be burdened alongside the common stockholders.139 Apparently, courts and businessmen had disagreed about the interpretation of the two other phrases, leaving open the possibility that they would exclude from the tax base such ‘fixed charges’ as interest on bonds and dividends on preferred stock.140 One Administration insider explained that the concern was that ‘[u]nder the original plan outlined stocks held by wealthy men could be easily converted into bonds and the tax escaped’.141 By utilising what was thought to be the broader phrase, in spit of the objection of anyone, may include this tax in their charges to the public; while the small company, composed of small stockholders throughout the country, running into thousands and millions, which compose the common citizenship of the country, will have to pay the tax’); ibid., at 3995 (quoting from Cooley on Taxation); ibid., at 3999 (‘the incidence of the tax under the present system seeks the man of limited means’). See ‘Who Pays the Tax?’ LaFollette’s Wkly Mag., 10 July 1909, at 3 (I shall vote for the Aldrich amendment,’ said senator after senator in the cloak rooms, ‘because it is easier to do so than to explain my vote against a ‘corporation tax,’ and yet I know that every corporation which ought to pay higher taxes can pass the tax along to the consumer so that in the end this corporation tax will be paid by the individual taxpayers who now bear more than their proportionate share’). 137 44 Cong. Rec. 4036 (1909). See ‘Taft Plan for Tax Splits Committee’, New York Times, 19 June 1909, at 5 (‘The division here, it is understood, is somewhat geographical, the Eastern Senators being as a general thing opposed to taxing any money connected with bonds, while the Westerners are said to be in favor of finding a way to tax such fortunes as that of Andrew Carnegie, which consists almost entirely of bond holdings’). 138 44 Cong. Rec. at 4007 (statement of Sen. Bacon). 139 See ‘Taft’s Corporation Tax Framed to Reach the Rich’, above n.135, at 5B. 140 ibid.; Editorial, ‘Earnings, Profit, Income’ New York Times, 23 June 1909, at 6. 141 ‘Taft’s Corporation Tax Framed to Reach the Rich’ above n.135, at 5B.

Entity Theory as Myth in 1909 421 Taft hoped to reinforce the corporation tax’s status as a levy against wealthy stockholders.142 Another concern was that the corporate tax would fail to reach wealth not invested in corporations. Thus, Senator Cummins complained that ‘it lays its burdens, not upon those who are able to bear them, but upon all who happen to be shareholders in corporations, without regard to their ability to pay or the extent of the property which they may have accumulated’.143 Senator Clapp went further: ‘[n]ot only does it fail to make such discrimination, but absolutely exempts the man who has gone still further in the process of accumulation and has laid his accumulated savings in the form of bonds’.144 This was particularly outrageous in comparison to the income or inheritance taxes because of the large amount of wealth, and income from that wealth, which was held outside the corporation by even the shareholders most identified with corporate growth. For example, Cummins observed, ‘I do not wonder that a man like Harriman should favor this measure rather than the general income tax; because the part of his great fortune, which has been segregated from the corporations in which he is interested, lies beyond the operation of this law’.145 Finally, the primary motivation for the corporate excise tax is perhaps best revealed by what it did not tax. One of the questions raised was whether corporate shareholders and their subsidiaries would both be 142 Eventually, business lobbyists managed to secure a deduction for the payment of interest on bonds, but only up to an amount equal to the capital stock of the corporation. See ‘Corporation Tax Bill is Modified at White House’ New York World, 23 June 1909, at 5B. Some charged that the ‘net income’ basis for tax was meaningless because of the multitude of avenues for corporate tax avoidance. See ‘The Proposed Tax on “Net” Incomes of Corporations’, LaFollette’s Wkly Mag., 3 July 1909, at 3 (‘Net income is a thing which a most prosperous corporation may not have at all. A corporation may have a huge net income this year, and none at all next year, though just as prosperous. Bonds may be issued, the interest on which will absorb the income. Salaries and other charges may be increased in lieu of dividends. The avoidance of net incomes has already become an important part of high finance, and if President Taft’s proposal is adopted, it will be an essential part of the curriculum of every Captain of Industry’). 143 44 Cong. Rec. 4038 (1909) (statement of Sen. Cummins). 144 Ibid., at 4008 (statement of Sen. Clapp). See ibid. at 4036 (statement of Sen. Bristow, Republican, Kansos) (favouring an income tax because ‘[i]t would then include the bondholders and those who have large fortunes that are not reached by this tax. It would more equitably distribute the burden as to population than this corporation tax’); Ibid., at 4229 (statement of Sen. Dolliver, Republican, Iowa) (‘I believe it will create in our market place a grave sense of injury to find that the rich men doing business without incorporation are exempted, while a score or a hundred men and women in very modest circumstances who have invested a small amount in the stock of organized corporations are required to submit to this public assessment’). 145 Ibid., at 4038 (statement of Sen. Cummins). See ‘The President Takes a Hand’ LaFollette’s Wkly Mag., 26 June 1909, at 13, 14 (‘They [Senators Borah and Bristow] could see no reason, however, for exempting from taxation the vast incomes of individuals like Carnegie and Rockefeller, only a part of whose fortunes are in the form of corporations stocks’).

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subject to the corporate excise tax. While double taxation was generally not an issue because of the absence of an individual income tax, it did arise in the context of holding companies. Thus, the measure proposed to exempt from a corporation’s tax bill ‘amounts received by it as dividends upon stock of other corporations . . . subject to the tax hereby imposed’.146 This caused significant consternation during the legislative debates. Senator Clapp argued against the exemption for corporate shareholders, pointing out that if it is not an income tax, but rather an excise tax for the privilege of operating in the corporate form, then double taxation should be irrelevant.147 Senator Cummins suggested that the implication was that a holding company was not ‘doing business’ at all, a result which he called one of his ‘great objections’ to the amendment.148 The corporate shareholder question was politically tricky for the Administration because of the general disfavor for holding companies. Taxing corporate shareholders offered the Administration an opportunity to attack the holding company practice. Nevertheless, Attorney-General Wickersham’s revised draft of the amendment specifically excluded corporate shareholders so as to avoid any hint of double taxation in the bill.149 Corporate critics lambasted the move: ‘[t]his exemption of the giant concerns that draw enormous tribute from the combination of lesser companies is regarded by many as the most pernicious feature of the bill’.150 As expected,151 the corporate excise tax amendment to the Payne–Aldrich tariff bill passed and was signed into law by Taft on 5 August, 1909. To the extent that the measure was designed to regulate corporations, it was limited and short-lived regulation. In conference, the rate was dropped from 2 to 1

146

See 44 Cong. Rec. 3935 (1909). Ibid., at 4010 (statement of Sen. Clapp) (‘The proposed tax is not a tax upon incomes; it is a tax upon the privilege of doing business. And if such a tax is imposed, surely it should be imposed upon a corporation organized for doing the business of controlling other corporations’). See ibid., at 4230 (statement of Sen. Dolliver) (‘Why [are dividends from corporate subsidiaries exempt]? Because, it is said, the money which they get from the dividends of stock of other corporations which they hold has already been assessed in the subsidiary companies. If it were true that we are levying here a tax upon money, there would be some force in that argument . . . But we are not doing that.’ He then went on to quote from Aldrich to the effect that we are not taxing their profits, but rather their privilege of operating in corporate form). 148 Ibid., at 4030 (statement of Sen. Cummins). 149 See ‘Tariff and Dinne’, Washington Post, 20 July 1909, at 1A. This was a reversal of course from a previous report that an amendment to eliminate the exemption for holding companies would be accepted. See Editorial, ‘Shaping the Corporation Tax’, New York Times, 9 July 1909, at 6. Such a move was heavily criticised by business interests. See ‘The Financial Situation’ (1909) 89 Com & Fin Chron 70 (‘This will mean . . . that these latter will be subject to a double tax, first on the income of the companies controlled and then again on the income which the holding company receives in the shape of interest or dividends on its investments in the securities of its subsidiary companies’). 150 ‘Dividend Tax Now in Bill’, LaFollette’s Wkly Mag., 31 July 1909, at 14. 151 See ‘President Taft’s Plan on Corporation Tax and Tarif’, New York World, 26 June, 1909, at 4D. 147

Entity Theory as Myth in 1909 423 per cent,152 which further limited the extent to which the tax threatened corporate management.153 Furthermore, while the Court upheld the constitutionality of the tax,154 continued criticism of the publicity feature led Congress to restrict, and ultimately eliminate, public access to corporate returns.155 3. 1913 and Beyond To the extent that 1909 represented a shift in corporate taxation, it was one that began with the sugar and oil taxes in 1898 and died by 1913. If Congress had moved from an aggregate to an entity-theory-based perception of the corporation in 1909, one would expect to see that shift manifested in the treatment of corporations under the 1913 Act. This, however, was not the case. As in 1894, dividends were exempt from the individual 152 The rationale was apparently that the extra revenue was not needed. See ‘Taft Takes Hand in Shaping Tariff’ New York Times, 13 July 1909, at 3. Taft apparently pushed to retain the principle despite the declining need. ‘The Financial Situation’ (1909) 89 Com & Fin Chron 126 (‘As far as the corporation tax is concerned, we are told that neither the conferees for the House of Representatives nor the conferees for the Senate have any love for the same; but that the President is insistent that it should be retained, and accordingly it will be retained, though the rate of the tax may be reduced—the President caring nothing about the rate, but being deeply concerned about having the principle of the provision adopted’); ‘The Financial Situation’, (1909) 89 Com & Fin Chron 190, 191 (‘Hardly any one in Congress can be got to confess to having a liking for this corporation tax feature. The President, however, wants the tax, and therefore it is to remain in the bill’). According to one report, this move was anticipated, but Senators held out to appear to be making a bigger compromise. See ‘Conference Settles Minor Tariff Points’ New York Times, 11 July 1909, at 3. 153 See ‘Taft Programme Menaced by Big Senate Combine’, New York World, 20 July 1909, at 4A. In an editorial, the New York Times asserted that this halving of the rate evidenced that ‘the intention is to discriminate against corporations, and rather for regulation than for income’. See Editorial, ‘Corporation Tax Changes’ New York Times, 21 July 1909, at 6. The editorial, however, could not reconcile the decision to exempt holding companies from the tax with its regulatory explanation for the rate cut: ibid. (‘If it is desired to get control of the little corporations, is it not more desirable to get powers of espionage over the holding companies?’). For a contrary view based on the retention of the publicity feature, see ‘Features of the Corporation Tax Bill as Adopted’ (1909) 89 Com & Fin Chron 318 (‘The chief purpose was to take a step in gaining supervisory powers over corporations. Accordingly the main anxiety has been to rush the measure through and get it on the statute books’). 154 See Flint v Stone Tracy Co, 220 US 107 (1911). Although the case was decided two years later, the challenges arose almost immediately after the bill’s passage. See ‘New Corporation Tax Under Fire,’ LaFollette’s Wkly Mag., 28 Aug. 1909, at 12; Editorial, ‘The Corporation Tax Dilemma’ New York Times, 15 Aug. 1909, at 6; ‘Taft Not Worried Over Test of Tax’ New York Times, 19 Aug. 1909, at 6. 155 See J.J. Thorndike, ‘Historical Perspective: Promoting Honesty by Releasing Corporate Tax Returns’ available at http://www.taxhistory.org/Articles/public_returns.htm. For examples of the criticism, see ‘Resolutions adopted by the Board of Directors During 1910’ in Annual Statement of the Trade and Commerce of Saint Louis for the year 1910 (1911) 29 (‘The Board expressed the opinion that paragraph 6 of the Tax Law in reference to publicity of returns by corporations was discriminatory and unfair, and called attention of the Honorable Senators from Missouri and Representative from St. Louis to the same’). See also Sixtieth Annual Report of the Chamber of Commerce of San Francisco (1910) 79 (ordering telegramme sent to Representative protesting the adoption of a corporate tax).

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income tax and the corporate and individual income tax rates were identical. Although integration was not perfect because of the failure to apply the individual exemption to a stockholder’s share of the tax paid at the corporate level, this was the same approach used in 1894 and it is likely explained by the same concerns of administrative impracticality that were used to justify the partial integration approach in 1894.156 Not only was the 1913 corporate income tax a duplicate of 1894’s passthrough approach, there was significant support in Congress for even more explicit pass-through corporate taxation. The Senate Finance Committee and the Democratic Caucus voted in favour of an amendment that would subject individuals to the surtax on the gains and profits of partnerships and corporations ‘whether divided or distributed or otherwise’.157 This rerun of the pass-through business taxation employed during the Civil War and Reconstruction was attacked not so much because it violated the corporation’s status as a separate entity, but rather because it would subject stockholders to double taxation.158 Corporate income would be subject to the individual surtax once when earned and retained and a second time when distributed.159 Although this general undistributed profits tax was subsequently dropped, Congress did adopt a more narrowly focused version that still employed the pass-through structure.160 Under this provision, if a corporation retained

156

See Bank, above n. 3, at 502. 50 Cong. Rec. 3774 (1913) (Statement of Sen. Williams, Democrat, Missouri). The full text of the amendment is as follows: ‘For the purpose of this additional tax, taxable income shall embrace the share of any taxable individual of the gains and profits of all companies, whether incorporated or partnership, who would be legally entitled to enforce the distribution or division of the same, if dividend or distributed, whether divided or distributed or otherwise, and any such company, when requested by the Commissioner of Internal Revenue or any district collector of internal revenue, shall forward to him a correct statement of such profits and the names of the individuals who would be entitled to the same if distributed.’ In response to questioning, Senator Williams tried to suggest that the provision was designed to permit taxation only of the part of the income the shareholder ‘would have the legal right to force the distribution of’, but Senator Root pointed out that, in combination with the instructions to the Service to direct companies to supply names of stockholders who ‘would be entitled to the [profits] if distributed’, it could have no other meaning than to permit passthrough taxation. ibid. 158 ‘Attack New Clause as Double Tax’ New York Times, 6 July 1913, at 5 (‘Financial advisers of persons whose incomes are sufficiently large to make them liable for the surtax provided in the income tax bill have called their clients’ attention in the last few days to a clause that has been inserted by the Senate Finance Committee and adopted by the Democratic caucus, which has occasioned a good deal of concern and has been criticized as indefensible double taxation’). One senator did object to the provision on the grounds that stockholders had no legal right to the money until it was distributed: see 50 Cong. Rec. 3774 (1913) (statement of Sen. Root), but this was more an argument about what is now known as the realisation principle than about the separate personality of the corporation. 159 Ibid. 160 Revenue Act of 1913, ch. 16, § II(A)(2), 38 Stat. 114, 166–167. 157

Entity Theory as Myth in 1909 425 earnings for the purpose of avoiding the shareholder tax on dividends,161 the shareholders would be subject to a surtax on their pro rata share of the earnings as if they had been distributed.162 This meant that in such corporations, the shareholders would effectively be taxed on corporate profits under the same terms as Civil War-era shareholders—’whether divided or otherwise’.163 The retention of such an aggregate feature should have been entirely inconsistent with an entity-theory-inspired move to a corporate income tax. One possible explanation for this provision is that contemporary legislators believed the pass-through penalty tax would not apply to ‘real’ corporations. In trying to allay opponents’ fear that it would interfere with the sound business judgement of a corporation’s directors, the sponsors of the provision suggested that it was primarily designed to ensnare corporations that we would now call personal holding companies.164 This suggests that it would apply only to corporations that were mere shams or alter egos of their owners and therefore ineligible for the entity status normally attributable to corporations. Nevertheless, the provision was not drafted in such a way that it would necessarily be limited to that circumstance. One Senator emphasised this point as he probed further: Suppose that a corporation has been legitimately organized and it can not be said to be fraudulent or formed for the purpose of doing the specific thing of holding property and holding dividends; suppose it is a legitimate corporation and they do not distribute, then is there any way under this bill to tax or get at the dividends which a corporation might hold which has been legitimately organized?165

Senator Williams responded to this query by making clear that such legitimate corporations would also be covered by the undivided profits tax penalty.166 In doing so, Williams conceded that ‘[i]t is a very difficult problem because there is no right to anybody to have a dividend unless the directors declare a dividend’, which effectively granted that the pass-through treatment would apply to more than the simply the sham or alter ego corporations.167 Thus, even if the 1909 corporate excise tax could be characterised as the product of a shift in attitudes, it was one that was short-lived and unrepresentative. Once the corporate tax was reunited with an income tax after the 161 As evidenced, for example, by the fact that the corporation had accumulated earnings that were far in excess of the reasonable needs of the corporation’s business: ibid. 162 Ibid. 163 Act of 30 June 1864, ch. 173, § 117, 13 Stat. at 282. 164 According to Senator Williams, its ‘main purpose is to prevent holding companies. Here is a man, for example, with an income as large as Mr. Carnegie’s income, let us say. There would be nothing to prevent him from organizing a holding company and passing his income from year to year up to undivided profits’: 50 Cong. Rec. 4380 (1913 (statement of Sen. Williams). 165 Ibid., at 5318 (statement of Sen. Borah). 166 Ibid., (statement of Sen. Williams). 167 Ibid., at 5319 (statement of Sen. Williams).

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Sixteenth Amendment was ratified, the taxation of corporations resumed its place as a servant to the individual income tax.

III. CONCLUSION

To the extent that President Taft’s regulatory justification for taxing corporations has historical significance, it is as one of the earliest examples of the failure of such an approach. The Act’s infamous publicity requirement was repealed within two years of passage, and even before repeal the requirement had been pared back significantly. Moreover, any information function of the corporate tax was eventually superceded by the advent of the Securities and Exchange Commission and the requirement of disclosure.168 It was both too low and too easily passed on to consumers or workers to have much regulatory effect.169 The modern corporate income tax did not begin to develop until after the First World War as Congress grappled with a shift in corporate dividend policy that effectively sheltered such earnings from the growing individual surtax rates.170 Ironically, the corporate-level tax was a pro-business compromise. Rather than adopting some form of pass-through taxation to preserve revenue, which would have had the effect of creating a tax incentive to distribute profits, Congress expanded its use of the corporate tax and permitted managers to retain control over dividend policy. 171 The corporate excise tax of 1909 has never really deserved its traditional status as ‘the source of our modern corporate income tax’.172 The tax bore little resemblance to the corporate income tax that arose during the 1920s. As with the sugar and petroleum taxes enacted during the Spanish–American War, it was an attempt to fit within the constitutional limitations imposed by the Court’s decision in Pollock. Rather than being principally motivated by developments in entity theory or a desire to reduce the amount of wealth under corporate control, the tax was an attempt to reach that shareholder wealth that was untouched by tariff taxation.

168 See J.M. Landis, ‘The Legislative History of the Securities Act of 1933’ (1959) 28 Geo Wash L Rev 29. 169 See, eg, ‘Who Pays the Tax?’ LaFollette’s Wkly Mag., 10 July 1909, at 3 (‘in no case will this tax fall upon a corporation controlled by the Federal government, for it will be added to interstate freight and passenger rates; to express, telegraph, and telephone charges; it will appear sooner or later in the increased prices of iron and steel and hardware and machinery and agricultural implements and clothing and food products’). 170 See S.A. Bank, ‘Is Double Taxation a Scapegoat for Declining Dividends? Evidence from History’ (2003) 56 Tax L Rev 463, 489. 171 See S.A. Bank,’ A Capital Lock-In Theory of the Corporate Income Tax’ 94 Georgetown LJ (forthcoming, 2006). 172 Kornhauser, above n. 5, at 54.

16 Bonds, Voluntarism and Taxation CAROLYN C JONES

This is what the President dictated. He said, ‘Give me something like this. . . . The Volunteer tax plan is working so well that it is believed not essential to change at this time to compulsory savings until we have had a chance to step up the volunteer plan to make it include practically everybody in the country.’ Treasury Secretary Henry Morgenthau, Jr. reporting results of a meeting with Franklin D. Roosevelt (22 April 1942)1

ABSTRACT Before the United States’ entry into the Second World War, the income tax was a class tax—assessed on the most prosperous slice of society. As Congress converted the income tax to a mass tax, one paid by average Americans, the gap between Congress’ level of taxation and wartime expenditures grew, along with the threat of inflation. By voluntary financing through bond sales, the Treasury hoped to bridge that gap. Roosevelt’s Treasury Department was especially attached to the bond programme as a ‘democratic’ way of financing the war— one with positive effects on morale and wartime citizen involvement. Despite its efforts, the Treasury found that bond sales lagged behind goals in early 1942. It then moved to quotas and informal sanctioning methods, a shift suggesting that the ‘voluntary programme’ was not entirely voluntary and could be viewed as a form of taxation. As the federal income tax became a mass tax, some of the mass media techniques (for example Disney films and Irving Berlin songs) used to sell bonds were used to suggest that Americans were purchasing victory with their tax dollars. The ‘voluntary’ bond purchaser through the payroll deduction had become by the Second World War’s end, a taxpayer subject to compulsory withholding, not only for social security but also for a new mass federal income tax. The story of that movement is tied, in my view, to the rise of a consumer society, instalment payments, the advertising of the American government and the importance of the concept of the ‘voluntary’. 1 Meeting on President’s Speech (23 Apr. 1942, 10:10 am) Morgenthau Diaries, vol. 520, 11; Henry J. Morgenthau (189–1967) became Roosevelt’s Treasury Secretary in 1932, we left public office in 1945, shortly after Roosevelt’s death. His diaries are to be found in the Franklin D. Roosevelt Library, Hyde Parle, NY.

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Carolyn C Jones I. THE ROLE OF VOLUNTARISM

I

before about the Second World War conversion of the federal income tax from a ‘class tax’—one directed at the wealthiest Americans—to a ‘mass tax’—one paid by average people.2 During the 1930s, taxable returns covered about the top 5 per cent of citizens. The income tax was conceived of as a way of combating those President Franklin D. Roosevelt had called ‘economic royalists’ and what had been described as ‘an unjust concentration of wealth and economic power.’ As war approached, defence expenditures and an increase in the power of the federal government required vastly more revenue than before. In Class Tax to Mass Tax, I concluded that the Second World War tax propagandists utilised themes of consent and individual choice in attempting to legitimise this shift in the nature of the income tax. In tax films and radio messages, the government used non-governmental groups and media figures to illustrate tax compliance and to urge other citizens to join them. Americans were portrayed as choosing enthusiastic endorsement of the tax system over their previous scepticism. This provided a basis by which tax propagandists could contrast the United States with its enemies. Taxation was preferable to the confiscatory practices of the Axis countries. As Roy Rogers and others reminded audiences that ‘your income tax money pays for Victory’, rational Americans as economic actors could make a wise consumer decision by buying victory with their tax dollars. Although Americans’ tax obligations were legally binding, tax administrators were well aware of the degree to which the new mass income tax stretched scarce and irreplaceable resources. The Commissioner of Internal Revenue publicly doubted that a withholding system could be implemented because of adding machine and office supply shortages.3 More revenue agents were needed. Under these circumstances, the public’s willing selfassessment was essential. This shift from class tax to mass tax has been an essential part of the landscape in some of my writing—from the relationship between the adoption of the joint return and gender roles to a rising post-war conservatism to politically charged debates about taxation and justice within the National Council of Churches.4 After thinking about these social groups HAVE WRITTEN

2 C.C. Jones, ‘Class Tax to Mass Tax: The Role of Propaganda in the Expansion of the Income Tax During World War II (1989) 37 Buffalo L Rev 685. 3 Paul to the Secretary (19 May 1942), Morgenthau Diaries, vol. 529, 262 Cann to the Secretary (28 Jul. 1942), Morgenthau Diaries, vol. 554, 285 Memorandum to Assistant Secretary Sullivan from Acting Commissioner Cann (29 July 1942), Morgenthau Diaries, vol. 555, 64 Mr Sullivan to the Secretary (30 Jul. 1942), Morgenthau Diaries, vol. 555, 220. 4 C.C. Jones, ‘Split Income and Separate Spheres: Tax Law and Gender Roles in the 1940s’ (1988) 6 Law & Hist Rev 259; C.C. Jones, ‘Mapping Tax Narratives’ (1988) 73 Tulane L Rev 653. C. Jones, ‘Vivien Kellems and the Folkways of Taxation’ in D. Ernst and V. Jew (eds), Total War and the Law:The American Home Front in World War II (2002), C. Jones, ‘Hard

Voluntarism and Taxation 429 and issues and their relationships to taxation, it seems to me that my understanding of the dynamic of this period has been hampered by focusing too narrowly on the traditional definition of taxation—i.e., legislatively decreed and coerced payments to the state. In 1926 the prominent economist E.R.A.Seligman argued for a social theory of fiscal science.5 Economists had dealt with some problems of fiscal science,6 but more fundamental considerations are involved: ‘the nature of social groups in general; the character of public wants and activities; and the meaning of the state in its fiscal relations’.7 Calling the field virtually untilled,8 Seligman proposed ‘to present in outline at least, a social theory of fiscal science’.9 Seligman’s interest in various social groups was expressed in his earlier essay on the development of taxation from his 1895 collection, Essays in Taxation. He asserted that ‘[i]n all primitive societies voluntary offerings constitute the first form of common contributions,’ usually in the form of services.10 Seligman continued, ‘As society advances, what was at the outset freely given comes to be paid by the individual from a sense of moral obligation. But with the weakness of human nature, in the face of a diversity of interests, even the feeling of duty fails to produce an adequate revenue. The moral obligation slowly becomes a legal obligation, keeping pace with the crystallization of social usage and custom into primitive law; the voluntary offerings become compulsory contributions’.11 This chapter is an initial probe into a conceptualisation of taxation as consisting of more than legislatively decreed and coerced payments to the state. Value transferred to the state may be thought of as ‘voluntarily’ transferred, perhaps because one observes the operative decision as having been made by an individual or a non–governmental group. But, as Seligman noted, compulsion can surely operate in such situations. Recognising such indirect pressure for the state’s benefit especially by groups is important to a fuller understanding of the operation of the American system of revenue collection. By contrast, payments that are legislative pronouncements may nevertheless be ‘voluntary’ if they are not enforced or are under-enforced due to inattention or administrative acquiescence. Here, too, private groups may have important roles to play.

Shells of Community: Tax Equity Debates within the National Council of Churches after World War II’ in J. Thorndike and D. Ventry (eds), Tax Justice: The Ongoing Debate (Urban Institute Press, Washington, DC, 2002). 5 E.R.A. Seligman, ‘The Social Theory of Fiscal Science I’ (1926) 41 Political Science Quarterly 193 and 354. (Praeger, Westport, CT, 2002). 6 Ibid., at 193. 7 Ibid. 8 Ibid. 9 Ibid., at 194. 10 E.R.A. Seligman, Essays in Taxation (9th edn., Macmillan, New York, 1923) at 2. 11 Ibid., at 2–3.

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This broader consideration of traditional taxation alongside ‘voluntary taxation’ is particularly important to understanding Second World War fiscal policy. Those charged with financing the war effort had an enormously difficult task. The Treasury hoped to cover one–half of the war’s expenses with taxes. Congress balked at this level of taxation.12 The balance of the cost of the war needed to be raised by borrowing. There was no serious thought of financing the war exclusively by taxation, a concept labelled as ‘suicidal’ by Seligman in his essay ‘Loans vs. Taxes in War Finance’.13 In what sense were non-bank purchasers of war bonds making payment to the government? They were, after all, making loans to the government and receiving interest in return. Whether Americans were giving up anything of value depended in part on the interest rate. The Treasury was criticised for setting low interest rates on the bonds, a choice that reduced the servicing charges for the government, but perhaps made the bonds less attractive as pure investments. Rising prices could also make bonds a less than attractive investment. A man from Fairhope, Alabama, wrote to Secretary Morgenthau in April 1942: Various agencies of the Treasury over the radio, in the press and by word of mouth are constantly repeating the statement that U. S. Savings Bonds are the safest and best of investments. I would like to know how you expect any intelligent person to believe that . . . Several months ago I bought some U. S. Bonds. Since then, prices have been going up at the rate of about 2% per month. That means the value of my Bonds, in terms of what they will buy, has been declining at the rate of about 2% per month. The small rate of interest received on those Bonds is a joke as an offset to the declining value. [H]ow can you, or any honest person, tell me or any other American citizen that U.S. Bonds are a good investment?14

During the First World War, many Liberty Bonds sold below par, introducing an element of risk for the small investor. The Second World War era 12 J.M. Blum, From the Morgenthau Diaries: Years of War (Houghton Mittlin, Boston, Mass., 1967) 14. See also A Program to Control the Cost of Living (3 Apr. 1942) Morgenthau Diaries 513:83–92. In commenting on taxation to control inflation the Treasury memorandum to President Roosevelt asserted: ‘There is little or no prospect of increasing the tax yield beyond the amount asked for in the Treasury program. The prospect is rather that any demand for a change in the program would result in a tax bill with lowered exemptions and a sales tax at the expense of the proposed corporate and individual surtaxes.’ Morgenthau Diaries 513:87. 13 E.R.A. Seligman, ‘Loans vs. Taxes in War Finance’ in Seligman, n. 10 above, at 715. 14 Mail Report for the Secretary from G.E. Forbush (17 Apr. 1942) Letter from Wm. E. Zeuch, School of Organic Education, Fairhope, Ala. Morgenthau Diaries 517:242, 248 (Fairhope, Alabama, was established as a single tax colony adhering to the beliefs of Henry George). In the Dec. 1941 edition of the American Economic Review, economists G. L. Bach and R. A. Musgrave proposed a ‘stable purchasing power’ bond. Individuals may hesitate to buy ordinary fixed dollar bonds if they anticipate rising prices. A stable purchasing power bond would be redeemed for the number of dollars that would provide the same purchasing power as the issue price of the bond at the issue date: G.L. Bach and R.A. Musgrave, ‘A Stable Purchasing Power Bond’ (1941) 31 American Economic Review 823.

Voluntarism and Taxation 431 bonds were guaranteed to retain par value (although the value in real dollars could change with inflation).15 The safety of the investment added to war bonds’ attraction, while for any given investor the interest rate could be seen as too low to attract ‘voluntary investment’. In this sense, one could characterise bond purchasers as paying something of present value to the government. The chapter will consider this Second World War bond programme as a ‘voluntary tax’ regime, analysing it along three lines. First, it will be examined as distinct from traditional taxation in creating a special feeling of participation, investment and uplift not felt in making compulsory payments. Secondly, the chapter will consider the way in which the bond programme was transmuted by the imposition of ‘voluntary’ goals or quotas. Finally, once social pressure was used to implement the ‘voluntary tax’, questions of economic justice arose as administration officials who had supported steeply progressive tax rates considered the effects of the somewhat coercive bond campaign on citizens at different income levels. Roosevelt administration support for ‘voluntary’ programmes was often based on a belief that bond purchases resulting from free choice were accomplished in the ‘American’ or ‘democratic’ way. Compared to taxes which were levied by an elected Congress with the President’s signature, the individualised assessment involved in a truly voluntary bond purchase was portrayed as more emblematically American. The support these purchases suggested could be seen as creating a sense of participation in the defence effort. For top Treasury officials, particularly for Secretary Morgenthau, this ‘psychological’ or ‘morale’ effect was of great importance. The achievement of these effects, however, was seen as dependent on true voluntarism and lack of coercion. By April of 1942, the results of more voluntary bond campaigns proved inadequate for revenue production and, more importantly, ineffective in removing spending power from an overheated consumer economy threatening high levels of inflation. The morale rationale had to give way to revenue generation and macroeconomic concerns. Pressure applied by employers, union officials, non-profit groups and other intermediate organisations at the government’s instance was designed to more than double the revenue take of the ‘voluntary’ effort. 10 per cent of payroll was to be set aside for bond purchases. While the 10 per cent contribution was not a formal legal obligation, the hope was that the establishment of the payroll and state and county quotas would signal socially acceptable levels of investment in the war effort. The confidence that every citizen—manager, worker, government official—was doing his or her part was to create a level of trust that would revitalise the faltering bond programme. This move to quotas

15

J.M. Blum, above n. 12, 16–30.

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marked a departure from the voluntary morale–generating ideal. More coercive elements crept into the programme—from proposals for door-to-door ‘Fuller Brush’-style selling to ‘police summonses’ ordering bond purchases designed to be placed on parked cars in New York City. Particularly given the lack of capacity within the Bureau of Internal Revenue to enforce formal tax obligations, one can see a convergence between a ‘voluntary’ bond programme with quotas and coercive elements and a coerced tax payment that could not be enforced to any great degree. In both cases the government appropriated the voices of media stars and endorsements of intermediate groups using advertising techniques that had been tested in the mass consumer economy. Another point of convergence was somewhat less dependent on the government’s ability continually to persuade citizens. First the bond campaign and then, in 1943, the federal income tax came to rely heavily on payroll deductions. The use of this technique made it more difficult for a worker to reverse a choice to purchase war bonds on a regular basis and placed the employer into the role of tax collector. A complicated progressive tax regime was seen as inappropriate to a ‘voluntary tax plan’ as Roosevelt is said to have called the bond campaign. Put differently, setting aside 10 per cent of payroll could be seen as antithetical to the progressive ideal for taxation. If poor and rich alike set aside 10 per cent of pay, the poor would be contributing a proportionately greater share of their incomes to the bond campaign. Whether proportionate or regressive in effect, however, the move to quotas in bond sales adds support to the assertions of historian Mark Leff and others that Roosevelt’s rhetoric of soaking the rich and verbal endorsements of progressivity masked an essentially regressive finance system. Moreover, if inflation was to be tamped down, it was the new dollars in the hands of millions of low and middle-income workers that posed the greatest threat to the stability of prices. Morgenthau and his aides struggled to devise messages that would convey the 10 per cent benchmark without seeming to abandon a progressive conception of ability to pay. In the April 1942 radio programme launching the war bond quota, Morgenthau attempted this slalom: All of us who get a regular income should set aside at least ten percent of it every pay day for War Savings Bonds, and those who have been earning especially high pay in the war industries are going to set aside even more.16

Some administration officials, however, citing equity concerns, promoted a graduated system of compulsory borrowing in order better to address ability

16 ‘Dollars in the War’ (23 Apr. 1942 10:00 to 10:30 pm EWT, Blue Network) Morgenthau Diaries, vol. 520, 40, 51.

Voluntarism and Taxation 433 to pay questions and to avoid the negative aspects of social pressure. These officials, including economists John Kenneth Galbraith and Alvin Hansen, seem to have taken some inspiration from John Maynard Keynes’ 1940 book, How to Pay for the War.17 Under the Keynes plan, the proportion of compulsory savings would be fixed by income group-with low income earners having most of their withdrawals from pay in the form of compulsory savings, while wealthier citizens would have a smaller proportion of compulsory savings and a greater proportion of taxation. The bureaucratic battle was waged between advocates of the ‘voluntary plan’ and the promoters of ‘forced lending’, as Morgenthau called it. While the Victory Tax included some refundable features, in the end, Morgenthau and his ‘voluntary plan’ prevailed. In the post-war period there was a changed relationship between ‘morale’ and ‘voluntary taxation’ through bonds. The war effort commanded very high levels of public support. This was not true of post-war programmes to aid reconstruction of Allied and Axis countries. Some suggested that those projects not be funded by compulsory tax dollars but from bond issues subscribed by those who wished their dollars to be used in this way.18 During the world war, the focus was on United States defence and identity with the United States. In the post-war period, more complicated allegiances began to be reflected in the sales of foreign bonds within the United States. Henry Morgenthau, Jr., after stepping down as Treasury Secretary, led the initial sales of Israeli bonds in the United States.19 This trend has continued to this day, with Americans with connections to a variety of nations expressing that connection and participation through bond purchases.20 The end of the Second World War quickly translated into the beginning of the cold war and defence needs remained high. Inflation continued to be a threat. Popular magazines urged Americans to combat this danger with increased savings.21 In promoting more national savings, policy-makers were told to ‘associate in the national savings effort all organized elements of the community, particularly the religious and educational agencies that have consistently over the years emphasized that the good way of life is not measured by bread alone’.22 With the end of the Second World War however, 17 J. Maynard Keynes, How to Pay for the War (Macmillan, London and New York, 1940), see also J. Maynard Keynes, The United States and the Keynes Plan, The New Republic (July 29, 1940) at 156–59. 18 Beardsley Ruml Papers, Regenstein Library, University of Chicago. 19 Israel Bonds (May 1951–), Henry M. Morgenthau, Jr. Papers, Franklin D. Roosevelt Library. 20 A. Chander, ‘Diaspora Bonds’ (2001) 76 NYU L Rev 1005. 21 See, eg, B. Ruml, ‘Our National Need: Savings’, Harper’s Magazine and attached note ‘Dear Beardsley’ from L.J. Markham (Beardsley Ruml Papers, Regenstein Library, University of Chicago, Ill, 28 Sept. 1951). 22 Ibid., at 34.

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Americans began to spend their savings on suburban homes, automobiles and other consumer goods, bringing what historian Lizabeth Cohen has called ‘A Consumers’ Republic’ to fruition.23 During the transformative period of the Second World War as the income tax became a mass tax, the parallel ‘voluntary tax’ or bond programme both contrasted and converged with the new tax regime. The resonating themes of individual choice and participation and the use of quotas and payroll deductions creating a sense of widespread compliance24 were seen as helpful to tax administrators in legitimating the income tax’s alteration. The contrasts emerged most starkly in the questions of incidence of the voluntary tax. Once the focus on winning the world war ended, voluntary taxation through bonds came to be considered for other uses—from funding less popular policies to expressing webs of national affiliations. Consideration of ‘voluntary taxation’ does, I suggest, provide a useful way to look at tax history.

II. THE VOLUNTARY MODEL FALTERS I laid so much stress, and the President is with me on this, that the man who sits at home with his family and has to make up his mind with his family that he wants to set so much aside voluntarily; and when he crosses that bridge, that is a great effort, and it is a great accomplishment toward the moral effort of the country.25 — Henry Morgenthau, Jr., Treasury Secretary, 2 April 1942

In March 1942, the Bureau of the Budget submitted ‘A War Program to Prevent Inflation’.26 As workers became employed and worked overtime in war industries, their increased wages outpaced the production of civilian goods. In a year and a half, the cost of living had increased by 12 per cent.27 The Bureau proposed a comprehensive plan involving price controls, wage 23 L. Cohen, A Consumers’ Republic: The Politics of Mass Consumption in Postwar America (Knopf, New York , 2003). 24 See, eg. D.M. Kahan, ‘Trust Collective Action and the Law’ (2001) 81 Boston University Law Review 333. 25 Inflation Meeting (2 Apr. 1942, 8:30 p.m.), Morgenthau Diaries vol. 512, 202, 236. Morgenthau reiterated this argument in almost the same words in a later meeting: ‘I also, just the way I am asking to have a chance to go through the voluntary plan—the reason I am so strongly for the voluntary plan, I want the man or woman to sit at home and make up their own mind that they want to set aside so much money a week and when they do that and cross that bridge voluntarily, it is a great accomplishment toward the morale of this country.’ Inflation Meeting (3 Apr. 1942, 9:15 am), Morgenthau Diaries, vol. 513, 5, 14. 26 Bureau of the Budget, A War Program to Prevent Inflation, March 26, 1942, Morgenthau Diaries, vol. 512, 163. 27 Ibid., at 2, Morgenthau Diaries, vol. 512, 165.

Voluntarism and Taxation 435 and salary controls, fiscal measures, and other controls such as rationing and direct control of inventories, business plant construction and housing.28 The Bureau programme also advocated compulsory savings—in contrast to the Treasury’s emphasis on ‘voluntary’ purchases of war bonds. The compulsory borrowing could, according to the Budget, be achieved in either of two ways. First, there could be a sliding scale of tax payments and compulsory lending depending on income. ‘For example, give war bonds equal to 80 percent of income tax liability to each taxpayer with less than $1,000 net taxable income; for taxpayers with higher incomes, let the bonds equal a declining percentage of the tax liability: for incomes of $10,000 or more, no bonds would be given.’ A second alternative presented by the Bureau of the Budget was to withhold 5 per cent of incomes above $500 (single) or $1,000 (families), less a $15 credit for each family member and to give war bonds for the amounts withheld.29 By combating inflation’s corrosive effects, the Bureau sought to ‘electrify the country; eliminate pettifogging; fortify the war spirit; give the offensive to the administration; and show to the American people that on this home-front the sickening slogan will not again apply . . . “too little and too late”’.30 The advocacy of compulsory or forced savings rather than voluntary savings by some in the President’s circle came at an unwelcome time for Treasury Secretary Morgenthau. He was concerned about inflation. In a speech before the Advertising Club of Boston in September 1941, Morgenthau had outlined the threat describing the economy as ‘an overloaded steam boiler’. . . ‘If we are to prevent the boiler from bursting, we must damp down the fires by diverting spending away from those articles or commodities in which there is a shortage, actual or potential.’ War bond sales were not going well. In a group meeting with his aides, Morgenthau’s frustration came through: ‘There is nothing in these figures to give me any confidence that we can get [this money]. Now, after all, for the first seven days of April we are nineteen percent behind March and for the first seven days of March we were thirty-seven percent off over February. . . . Here we have got this vast publicity campaign and we are at war and my sales just dwindle out between my fingers.’31

Morgenthau felt that guaranteeing President Roosevelt that he could sell an increasing number of E bonds beginning at $1 billion in July 1942, if he would ‘give us the whole-hearted support of the volunteer plan’, would be

28 A War Program to Prevent Inflation (Tentative Outline), Morgenthau Diaries 512:168–71 29 Morgenthau Diaries, vol. 512,171. 30 Above n. 1, at 4. Morgenthau Diaries, vol. 512, 167. 31 Inflation Group Meeting (8 Apr. 1942 4:00 pm), Morgenthau Diaries, vol. 514, 197, 198–199.

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‘to put my head in a noose’.32 But Morgenthau had already made that proposal to Roosevelt five days earlier in a memorandum which represented a departure from the ‘purely voluntary’ programme that had been portrayed and praised up to that time. For the 44,000 corporations with payroll savings plans in place for war bond purchases, the Treasury suggested a ‘goal’ of 10 per cent of gross wages in bond purchases. The memorandum to FDR went on, ‘We are also proposing to announce, on April 13, a quota for the United States by counties for May, June and July, reaching in July $1 billion per month. We feel also that we have a good chance of reaching this goal if between now and the first of July you move on other fronts.’33 Morgenthau reiterated his ‘morale’ argument again to the President. ‘I think that you will agree with me that if we could reach $1 billion a month through volunteer rather than forced savings, this would be a great accomplishment and benefit for the morale of the country as a whole.’34 Despite the language of voluntarism, the Treasury was counting on massively increased savings levels resulting from the imposition of quotas. The Treasury’s administrative adversaries—in the Bureau of the Budget, the War Production Board (WPB), OPA and the Department of Agriculture— criticised this new twist on the ‘voluntary’ savings programme. These officials did not think that the Treasury could sell sufficient bonds to lowincome groups ‘unless the methods used under the term “voluntary” were actually coercive to a certain extent.’ Even if it could be done, they would rather adopt ‘outright compulsory saving’. Even within the Treasury Department, some of Morgenthau’s top aides favoured compulsory savings. Treasury officials realised that even the change to a quota system represented a reversal of much of what had been put about by the Department in previous bond promotions. As one aide reminded Morgenthau and others in a group meeting: You see, we have been going on all these months opposed to quotas. That is, that was our stated policy rejecting quotas. We have made our program one that people could participate in or not as they chose, one in which the people could determine how much they were to invest with not even a suggestion from the Treasury as to what the dimensions of the program were.35

The Treasury discussions kept returning to the dampening effect that compulsory savings would have on morale. What about the ‘thousands of people all over the country who have been doing good patriotic work, contributing their time and their efforts and their talents’?36 As one aide put 32 33 34 35 36

Ibid., at 201–202. Letter to ‘My dear Mr.President’ (3 Apr. 1942), Morgenthau Diaries, vol. 513, 76, 79. Ibid. Inflation Group Meeting (8 Apr. 1942, 4:00 pm), Morgenthau Diaries, vol. 514, 197, 199. Ibid., at 215.

Voluntarism and Taxation 437 it, ‘[w]hen a person buys a bond now, that is a chance for him to make a voluntary patriotic contribution to his Government, and there isn’t any amount of money you can get out of a legally enforced contribution that is going to make up for the morale that goes along with that voluntary contribution’.37 Further, there could be dire effects on ‘world morale’ if the United States could not get the money from its voluntary campaign and had ‘to go to forced loans to do it’.38 President Roosevelt endorsed the programme of monthly quotas for the nation, and every state and county. In reaching these goals, labour and management would need to display ‘a spirit of partnership’. ‘Working together’, Roosevelt claimed, ‘they can not only insure the success of this vitally important war effort, but they can plant the seeds of improved industrial relations which will bear increasingly rich fruit in the years to come.’39 If war bonds were superior to taxes, so were they also preferable to forced lending schemes that were proposed from time to time during the war. According to Treasury ‘mass psychology’ expert Peter H. Odegard, the voluntary bond programme was more consistent with the citizen’s ability to pay: The voluntary method offers a flexibility of adaptation to the individual’s varying circumstances lacking in the compulsory method. The voluntary method differentiates between the war worker whose income has increased considerably in recent years and the workers on fixed salary whose income has increased little, if at all; between individuals whose ability to invest in War Bonds is affected by prior obligations, such as life insurance and the repayment of mortgage debt and individuals whose ability is not affected by such contractual obligations; between individuals who are members of families in which some or all are working and earning incomes and individuals who are the sole breadwinners in their families. . . . A forced lending plan which failed to make allowance for these differences would almost certainly have an adverse effect on other forms of savings and especially on the voluntary purchase of bonds. Millions whose capacity to buy war bonds has increased considerably during the war would feel that they had discharged their duty in full when they paid the imposed levy.40

The Treasury asserted that forced lending would reduce voluntary bond sales and even additional tax revenues. This depiction of a voluntary programme implemented through the work of thousands of volunteers and private organisations seems to contrast with

37

Ibid., at 216. Ibid., at 226. 39 Draft of Roosevelt Speech for 27 Apr. 1942 submitted to Judge Rosenman by Ferdinand Kuhn, Jr. (11 Apr. 1942), Morgenthau Diaries, vol. 515, 295, 299. 40 P. Odegard, America’s Financial Mobilization: the Problem and its Setting (8 July 1943) in pamphlet distributed by Bankers Federal Savings and Loan Association, Peter H. Odegard Papers Box 31 (Franklin D. Roosevelt Library, Hyde Park, NY) at 8. 38

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the compulsion of taxation imposed by the state. E.R.A. Seligman took a less superficial view in his two-part essay on ‘The Social Theory of Fiscal Science.’ He devoted considerable attention to the character of collective efforts both public and private. Public groups—national, supranational, and supernational—all shared a primary emphasis on needs for protection, justice, and common welfare.41 These wants were fundamental-so fundamental that they are universally desired by all those in the community. Seligman then goes on to discuss compulsion—‘essential features’ of which ‘have . . . never received an adequate analysis’.42 Private groups are viewed as voluntary and the state as coercive. But, Seligman asserted, ‘the line between the private and the public groups is by no means so definite as is frequently assumed. Even in the private group there are all degrees of compulsion involved.’43 He argued: But if it is true that joining a public group (even if not necessarily the public group) is compulsory, is it true that joining a private group is voluntary? Here again there has been much misconception. In many cases, of course, it is entirely free to an individual to join a private association. But are there not private groups where this voluntary character becomes so slight as almost to disappear? Are there not all kinds of social pressure and social disapprobation which virtually force individuals to join certain private groups? Take as an example the groups formed in the United States during the Great War to dispose of the Liberty Loans. Was it practically possible for any business man to refuse to join, even if he felt so inclined? So far as the compulsion to join the association is concerned, there is accordingly no clear line of demarcation between the private and the public group.44

One can observe this interplay between the ‘voluntary’ and the ‘coercive’ in the papers of Bruce Barton from the Second World War period. Barton was one of the most prominent men of the early part of the twentieth century. He was a leading figure in war bond campaigns in New York City during much of the Second World War.45 A popular and prolific author, Barton was perhaps best-known for his 1925 best-seller The Man Nobody Knows—an interpretation of Jesus as vigorous business leader. In 1918, he helped found Batten, Barton, Durstine and Osborn (BBD &O), one of the nation’s largest advertising firms. He served in Congress representing his Upper East Side district as a Republican.46 Barton’s papers provide evidence of the ways in which coercion or compulsion operated in selling

41

Seligman, above n. 5, 356. Ibid., 361. 43 Ibid. 44 Ibid. 45 Morgenthau’s well–known reluctance to have Barton, a political opponent of the Roosevelt administration, appointed is evident in his diaries. 46 W. Sussman, Culture as History (Pantheon, New York, 1984), pp. 122–31. 42

Voluntarism and Taxation 439 billions of dollars of bonds during the Second World War. Sometimes those on the Defense Savings Staff suggested bond promotions that were not in keeping with the theme of voluntarism. For example, one 1944 local promotion included a: ‘Police summons’ distribution on all cars. ‘Summons’ form leaflet required the person to appear at nearest War Bond issuing office headed ‘War-time Violations’ or ‘Please Report Immediately’ or ‘Fine’ and went on to explain value of War Bonds and importance of investing during campaign.47

Barton was kept abreast of his firm’s bond purchases and the expectation that 10 per cent of payroll was to be devoted to bonds. For example, during the Sixth War Loan Drive in late 1944, ‘the Committee’ sent a memorandum to ‘everyone in the New York Office’. The memo reported that ‘up-to-date 83% of the 410 BBDOers in New York have announced their intention of joining the Drive. We had hoped that we might even do better than this. No doubt many of those who haven’t come along with us this time have their good reasons for not doing so. We do feel that there are a few who need just a little more urging and perhaps this announcement will help them make up their minds.’48 The memorandum invites everyone to the drawing for ten free $25.00 War Bonds. ‘P.S.—to the Ladies—Bring your pocketbooks with you.’49 The pressure of quotas and the geographical allocation of those goals caused large corporations and their vendors a good bit of concern. Again, these documents, I suggest, illustrate a fairly coercive environment in which the federal government, state committees and private firms were acting. The existence of state quotas determined in large part by the size of bank deposits caused conflicts. Corporations wished to show their support for bond campaigns in localities in which they had plants or offices. This created problems for a financial centre like New York. Its state chairman wrote a May 1944 letter to corporate officers urging these men that, in deciding the distribution by states of their subscriptions, they give consideration, first, to the proportion of bank deposits in New York and, secondly, to the relationship which New York state’s quota in the drive bears to the quotas of other states to which they may consider allocating credit.50 Odegard had envisaged a state-by-state competition as an inducement to voluntary bond sales. The quota system, however, seemed to have created an image of state campaigns chasing a limited pool of dollars.

47 Preliminary 6th War Plan Advertising Press and Radio Plan (Prepared for 8 Aug. 1944 meeting), Bruce Barton Papers, State Historical Society of Wisconsin, Madison, Wis. 70–3. 48 ‘To Everyone in the New York Office’ (11 Dec. 1944), Bruce Barton Papers 70–73. 49 Ibid. 50 Nevil Ford to ‘Dear Mr. ______’ (19 May 1944), Bruce Boston Papers, 70–72, State Historical Society of Wisconsin, Madison, Wis.

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Not only were employees under pressure to help their employers meet quotas, vendors were reportedly subjected to such pressures. An official at Charles Scribner’s Sons, Publishers, sent a telegram he received from the book section at the Marshall Field store in Chicago. The telegram stated, ‘If you have funds open for bond purchases appreciate you route them to this event. Under no circumstances we ask you to make purchases but happy if you can route normal purchases our way to help achieve goal.’51 Whitney Darrow at Scribner’s complained to Bruce Barton, ‘very obviously all buyers in the store were told to send such a telegram to everyone who does business with them. In a way, isn’t this a form of blackmail? A lot of customers feel they will lose out if they don’t put bond sales through the stores or that they will have a special drag in getting business if they help the stores reach their quota.’52 If employers and vendors were agents of coercion in the sale of war bonds, others expressed concerns about the power utilised by business interests, and particularly advertisers, in assisting the government with its bond campaigns. In an October 1942 speech on ‘War Savings and Newspaper Advertising’, Peter Odegard suggested that freedom of the press in the United States was dependent on the refusal of American newspapers to accept ‘governmental subventions or subsidies’. Odegard continued: It is for this reason, among others that the Treasury Department, as a matter of policy, has not purchased either time or space in promoting the sale of War Savings Bonds and Stamps. . . . The bulk . . . of the advertising time and space devoted to the promotion of War Bonds and Stamps has been paid for by private commercial sponsors, who have done so out of considerations of patriotic service and good public relations.53

Through the Advertising Council with representatives from advertising agencies, their clients and the media, the government was provided with free advertising space for public service announcements.54 Wartime advertisers urged the purchase of war bonds, as Imperial whiskey did in an American Magazine advertisement in January 1945: The best gift you can make is a war bond. And it is one of the best things you can do to help win the war-for the more dollars you put into bonds the sooner we can all enjoy a real Christmas.’ 51 Telegram from R.O. Harbaugh to Chas Scribner Sons (19 Jan. 1944) Bruce Barton Papers (State Historical Society of Wisconsin, Madison, Wis.), 70–71. 52 Letter from Whitney Darrow to Mr. Bruce Barton (20 Jan. 1944) Bruce Barton Pepers (State Historical Society of Wisconsin, Madison, Wis.), 70–71. 53 P.H. Odegard, ‘War Savings and Newspaper Advertising’ (13 Oct. 1942), Peter H. Odegard Papers, Box 31 (Franklin D. Roosevelt Library, Hyde Park, NY); see also P.H. Odegard and A. Barth, Millions for Defense, (1941) 5 Public Opinion Quarterly 399. 54 J. Lears, Fables of Abundance: A Cultural History of Advertising in America (Basic Books, New York, 1994) 248.

Voluntarism and Taxation 441 The advertisement continued, ‘[t]he best luck that can come your way is to have someone give you a bottle of Imperial—for it is one of America’s most enjoyable whiskies.’ Advertisers of appliances suggested the purchase of bonds so that new refrigerators or other modern conveniences could be purchased at the war’s end. 55 This link to consumer purchases would have given pause to critics of contemporary consumption mores like Robert S. Lynd, best known as the co-author of Middletown—a survey of life in Muncie, Indiana, in the 1920s and later in the 1930s. In 1936, Lynd wrote: During the past two decades the business of urging commercial products upon the public as substitutes for more subtle forms of adjustment to job insecurity, social insecurity, monotony, loneliness and other situations of tension has advanced to an effective fine art. . . . [A]s Walton Hamilton has remarked, ‘Business succeeds rather better than the state in imposing its restraints upon individuals, because its imperatives are disguised as choices.’56

Lynd had particular distrust of the assumption that the consumer is rational. ‘[B]usiness on the job, in its shirtsleeves, knows better and practices differently. . . . Great consumer–habit fabricating plants like the J. Walter Thompson Co. and Batten, Barton, Durstine & Osborn, advertising agencies both, do not proceed on the assumption that the consumer is coldly rational; rather following William James and succeeding psychologists, they have a very realistic view of the strife of reason and passion: The cue of passion is to keep imagination dwelling upon those objects which are congenial to it, which feed it, and which by feeding it intensify its force, until it crowds out all thought of other objects. An impulse or habit which is strongly emotional magnifies all objects that are congruous with it and smothers those which are opposed whenever they present themselves.57

Those practised in overcoming consumer reason and reluctance included some figures like George Gallup who began at Young and Rubicam advertising agency and later provided his polling services to the Treasury Department during the 1940s. Advertising executives worked in government during the war, developing public relations strategies with regard to both bond sales and taxation. If war bonds came to represent desired consumer goods, necessary for the good life in a post-war America, at least some social scientists saw a connection to a coercive cult of buying in which business interests had the leading edge.

55

Cohen, above n. 23, 70–74. R.S. Lynd, ‘Democracy’s Third Estate: The Consumer’ (1936) 51 Political Science Quarterly 481, 489. 57 Ibid., at 488. 56

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The Second World War Treasury Department used the language of choice in convincing Americans of the legitimacy of a shift in wartime tax regimes from a class tax to a mass tax. A formally coercive payment was portrayed as a consensual contribution to winning the war. A convergence can be seen in the formally voluntary purchase of war bonds. Close observation of these ‘voluntary’ transactions makes them seem closer to taxation than one would have initially thought—in part through the indirect compulsion of nongovernmental groups like employers and other social groups. Further, the link between bonds and post–war purchases was seen by some social scientists as a continuation of the coercive power of advertisers and businesses.