Studies in the History of Tax Law: Volume 7 9781782257929, 9781849467988

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Preface These papers were given on 30 June and 1 July 2014 at the seventh Tax Law History Conference organised by the Centre for Tax Law, which is part of the Law Faculty of the University of Cambridge. We are happy that the tradition of making the papers available in this form continues, maintaining the high standards our publishers set themselves. Unlike the 2012 conference, the 2014 conference was once again blessed with plenty of summer sunshine and there was many a joyful stroll to be had in the peaceful grounds of Lucy Cavendish College in-between the frantic and serious conference deliberations. We thank those who gave papers and also those who participated in other ways. This was a successful conference, fully subscribed and by all accounts enjoyable. The conference continues as an important part of academic tax law life in both the United Kingdom and the many other jurisdictions again represented. The ongoing success has been such that there will be a Tax Law History VIII, scheduled for July 2016. Of course, there would be no success if it were not for the efforts of the founder of this conference, the late Professor John Tiley. Professor Tiley’s untimely death in the middle of 2013 was noted in the introduction to Volume VI of this series and that volume was dedicated to him. However, the sixth conference and Volume VI (like all those before) were coordinated solely through Professor Tiley’s efforts. In this seventh rendition we have had to struggle through without him, and it was especially a struggle for some of those who have been a part of this conference since its beginnings in 2002. The continuation of Professor Tiley’s legacy was celebrated throughout the seventh conference with a showing of past conference photographs, a dedicated photo for those who had contributed to each conference, the presence of Professor Tiley’s widow, Jillinda, at the conference dinner and a hearty toast to a man who is dear to the hearts of all participants. The contributions in this seventh volume are a fitting tribute. Some are peculiar, some are personal, all are interesting and important, and each and every one is a triumph of academic worth. Sincere thanks go to Sally Lanham at the Faculty of Law, who, through her efficiency and detailed knowledge of how to run these conferences is primarily responsible for the smooth running of the seventh conference. Thanks also to Lucy Cavendish College who worked with Sally to make sure that things ran ‘as usual’ and to Jillinda Tiley, our continuing inside connection at Lucy for these conferences. We must also mention the efforts

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of two ‘originals’ who have attended every conference: John Avery Jones and Chantal Stebbings. Without their kind and gentle support and guiding wisdom we may never have had the courage to attempt a continuation of the conference. Finally, thanks to Bill Asquith and his team at Hart Publishing. It is fitting that Bill took over production matters from Richard Hart at the same time as we inherited the conference and this series from Professor Tiley. It is our hope that we can build a new relationship with Hart Publishing and its affiliates that reflects, at least in part, the long history that existed between Richard Hart and Professor Tiley. Cambridge March 2015

List of Contributors John F Avery Jones CBE, Retired Judge of the Upper Tribunal Tax and Chancery Chamber, former Visiting Professor, London School of Economics. Mark Billings, Senior Lecturer in Accounting and Business History, Business School, University of Exeter. Dominic de Cogan, Lecturer, Faculty of Law, University of Cambridge, Deputy Director of the Centre for Tax Law. Jane Frecknall-Hughes, Professor of Accounting and Taxation, Business School, Hull University, Co-Director of Accounting Research for the Business School. Sunita Jogarajan, Associate Professor, Law School, University of Melbourne. Diane Kraal, Senior Lecturer, Monash Business School, Monash University. Richard Krever, Professor, Monash Business School, Monash University. Michael Littlewood, Professor, Faculty of Law, University of Auckland. Margaret McKerchar, Emeritus Professor of Taxation, School of Taxation and Business Law, University of New South Wales (UNSW). Peter Mellor, Research Fellow, Monash Business School, Monash University. Ann Mumford, Reader in Taxation Law, Dickson Poon School of Law, King’s College London. Lynne Oats, Professor of Taxation and Accounting, Business School, University of Exeter. John HN Pearce, ex HMRC, Associate of the Institute of Taxation, Researcher, University of Exeter. Philip Ridd, Law Reporter, formerly Solicitor of Inland Revenue. John Snape, Associate Professor, Law School, University of Warwick. Chantal Stebbings, Professor of Law and Legal History, Law School, University of Exeter. Miranda Stewart, Professor, Director, Tax and Transfer Policy Institute, Crawford School of Public Policy, ANU College of Asia and the Pacific, Australian National University.

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C John Taylor, Professor, School of Taxation and Business Law, University of New South Wales (UNSW). Richard Thomas, Judge of the First Tier Tribunal (Tax Chamber), formerly Inspector of Taxes. Yan Xu, Assistant Professor, Faculty of Law, Chinese University of Hong Kong.

List of Tables and Figures Table 1.1 Comparison of the treatment of landed property in Pitt’s and Addington’s Acts with Land Tax Table 1.2 Comparison of provisions of Addington’s 1803 Act and Land Tax Table 1.3 Other provisions for deduction of tax at source in Land Tax and Addington’s Act Table 4.1 Membership of Board of Referees, 1915–18 Figure 11.1 Frederick Garling (1806–73) Courthouse, Darlinghurst, c 1840, State Library of New South Wales Figure 11.2 Some key dates and persons in colonial New South Wales Figure 11.3 Frederick Garling (1806–73) Circular Quay, 1839, State Library of New South Wales Figure 11.4 Frederick Garling (1806–73) Moore’s Wharf and Warehouses, Millers Point, ca 1840s, State Library of New South Wales Figure 11.5 Frederick Garling (1806–73) Brigantine, State Library of New South Wales Figure 11.6 Colony of New South Wales: customs duties on liquor 1827–70

1 The Sources of Addington’s Income Tax JOHN F AVERY JONES CBE*

ABSTRACT Addington’s Income Tax of 1803 made significant changes to Pitt’s Act of 1799 but was introduced at short notice less than a month after resumption of the war with Napoleon in May 1803. This chapter examines the sources of the changes from Pitt’s tax made by Addington for which there is no direct record and concludes that the main ones were the Land Tax and Adam Smith’s The Wealth of Nations.

INTRODUCTION

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HATEVER THE TRUTH in general of Canning’s famous jibe that Pitt is to Addington as London is to Paddington—and it is fair to say that Pitt must have been a hard act for anyone to follow1—it cannot be doubted that the importance of their roles were reversed so far as their respective Income Taxes are concerned. This chapter explores Addington’s sources for the major differences between his and Pitt’s tax. The second section considers the nature of a source of income by reference to Adam Smith’s The Wealth of Nations; the third section deals with the difference * I am grateful to Dr Diane Kraal, Senior Lecturer, Monash University, Australia, for her assistance in recommending material about Adam Smith and Ricardo. 1 P Ziegler, Addington: a Life of Henry Addington, first Viscount Sidmouth (London, Collins, 1965) 220, said of Addington that he ‘laboured under three crippling disabilities: that he was not an aristocrat, was not an orator and was not William Pitt’. Ziegler also observed (at 221) ‘Addington’s failure, therefore, was not so much one of achievement as of personality and of will. He was not a bad Prime Minister but he was bad at behaving like a Prime Minister and at convincing others that he was an effective Prime Minister’. Addington was Prime Minister in 1801–04 and held other important posts including that of Speaker of the House of Commons (1789–1801); Lord Privy Seal (1805, 1806–07 and 1812); Lord President of the Council (1806); Home Secretary (1812–21); and Minister without Portfolio (1822–24). He was created Lord Sidmouth in 1805 but for convenience will be referred to throughout as Addington.

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between Pitt’s tax on income and Addington’s tax on sources of income, comparing the latter with land tax; the fourth section considers deduction of tax from sources of income also by reference to land tax; the fifth section brings together the influences of land tax and Adam Smith on the treatment of interest; and the final section draws conclusions. Pitt’s pioneering2 but rather unsuccessful income tax of 17993 suffered from the defect that it was easy to evade as the tax merely required a return of total income. Only if the General or Commercial Commissioners4 were dissatisfied with the return could they require income to be specified under four main headings subdivided into a number of Cases. For example, there are no less than 14 Cases concerning land, dealing separately with letting of land and houses each in relation to three types of lease (rack rent only, premium only, and both rent and a premium), using the actual rent and requiring valuations by the Commissioners where there was a premium.5 2 J Ehrman, The Younger Pitt, vol 3 (vol 3 is split into two volumes in the paperback edition breaking after p 492), The Consuming Struggle (London, Constable, 1996) 262 quotes The Morning Chronicle, 3 November 1798, describing the then-rumoured idea of his tax as ‘a daring innovation in English finance’. 3 An Act to repeal the Duties imposed by an Act, made in the last Session of Parliament, for granting an Aid and Contribution for the Prosecution of the War; and to make more effectual Provision for the like Purpose, by granting certain Duties upon Income, in lieu of the said Duties (39 Geo 3 c 13. 1799), with the Schedule as retrospectively substituted by c 22 (the original Schedule is available at http://books.google.co.uk/books?id=DNs0AAAAIAAJ); see n 39 below for a summary of the changes to the Schedule. Pitt’s original estimate of the yield (at a rate of 10%) on his estimate of the tax base of £102m was £9m–10m, reduced to £7.3m in the summer and then to £6.2m. The final net figure for the first year might have been only £1.671m: Ehrman, n 2 above, 265. For 1800–01 the net yield was some £4.5m, and a gross (of reliefs for small incomes and children) yield for the following year was £5.3m: ibid 267. Pitt’s tax was abolished by Addington, who had replaced Pitt as Prime Minister (using later terminology) and Chancellor of the Exchequer, in his Budget of April 1802 following the Peace of Amiens on 25 March 1802 (42 Geo 3 c 42). 4 Commercial Commissioners assessed trading profits. Their use was not a success as they were too far removed from local knowledge: A Farnsworth, Addington, Author of the Modern Income Tax (London, Stevens, 1951) 21. The Report by the Commissioners for the Affairs of Taxes of 25 April 1800 (they were able to do this because the first year of the tax ran to 5 April 1799) (The National Archives, Public Record Office (TNA) file PRO 30/8/279) Pt 2 said at 281: ‘The total abolition of the Commercial Commissioners (except in London) is most strongly recommended by almost all the Commissioners for the general Purposes of the Acts’. This did not happen. 5 The main headings of types of income in Pitt’s tax were (1) Income of Owners of Lands (comprising Case 1 land occupied by the owner; Case 2 houses occupied by the owner; Case 3 land occupied by tenants at a rack rent; Case 4 land demised to tenants at a fine [premium] and rent (which required taking the rent and adding a further sum in respect of the premium); Case 5 land demised to tenants at a fine only (or with nominal rent) (also requiring a proportion of the premium to be fixed by the Commissioners); Case 6 houses demised to tenants at a rack rent; Case 7 houses demised to tenants at a fine and rent; Case 8 houses demised to tenants at a fine only (or with nominal rent); Case 9 tithes in respect of owners; Case 10 profits or manors, or timber, mines, insurance offices from fire and other profits of uncertain annual amount; Case 11 income of lands occupied by tenants at a rack rent; Case 12 income arising from mines, tithes, woods; Case 13 income from lands demised for a fine with or without rent; Case 14 income of mesne lessors from demises for fines with or without rent); (2) Income arising from Personal Property and from Trades, Professions, Offices, Pensions, Allowances, Stipends,

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These Cases were essentially an aide memoire for taxpayers when completing their returns of total income. This power to require a detailed return was apparently rarely exercised.6 Pitt subsequently wanted to change to a general requirement to make itemised returns but even he could not obtain Parliament’s approval.7 Addington’s ‘property tax’8 of 1803 is sometime portrayed as Pitt’s with the addition of deduction of tax at source which made it work in practice.9

Employments and Vocations, Annuities, Interest of Money, Rent Charge (Cases 15 and 16); (3) Income arising out of Great Britain (Cases 17 and 18); and (4) Income not falling under any of the foregoing Rules. See text at n 33 for Adam Smith’s sources of income. Of these, only category (3) was adopted in Addington’s 1803 tax (see n 9 below). Taking the annual value of a lease premium also applied to Addington’s tax (Sch A r 4) although if the land was not let at a rack rent an estimate of the annual value had to be made so it is not clear why this was included; it was not repeated in the 1805 Act (45 Geo 3 c 49, 1805). 6 G Pellew (Dean of Norwich who was married to Addington’s daughter Frances), The Life and Correspondence of the Rt Hon Henry Addington, First Viscount Sidmouth (London, John Murray, 1847) vol 2, 196, available at http://books.google.co.uk/books?id=QC46AAAAcAAJ. Pellew often cites Nicholas Vansittart (later Lord Bexley) who was Addington’s Secretary to the Treasury as the source of his information on financial matters. Pitt did introduce a Bill on 4 April 1800 (contained in TNA PRO 30/8/279 Pt 2 and also in HC Parliamentary Papers, Fourth Sess 1799–1800, vol 127, the clause being at 230–31, and discussed by Farnsworth, n 4 above, 26–28) to require itemised returns but this provision met with strong opposition and was never included in the amending Act (39 & 40 Geo 3 c 49) (discussed by Farnsworth, n 4 above, 30); Ehrman, n 2 above, 266, suggests at n 3 that the copy of the Bill in TNA may be the only copy, but it is in Parliamentary Papers (as above). 7 Ehrman, n 2 above, 266. 8 An Act for granting to his Majesty, until the sixth Day of May [the reason for May is obscure as the tax year in the Act ran to 5 April] next after the Ratification of a Definitive Treaty of Peace, a Contribution on the Profits arising from Property, Professions, Trades, and Offices (43 Geo 3 c 122, 1803), introduced in his Budget of 13 June 1803 following the resumption of war on 18 May 1803 and passed on 11 August 1803. Note that while Pitt’s tax granted ‘certain duties upon income’ (n 3 above), Addington’s was a ‘Contribution … from Property, Professions, Trades, and Offices’ (emphasis added). The change of title is significant and did more than differentiate it from Pitt’s unpopular tax. Addington is reported as saying in Parliament ‘He had no objection to the present tax being called an income tax, except that he thought that the title assigned to it more fully described its nature’ (Cobbett’s Parliamentary History from the Earliest Period to the Year 1803 (the forerunner of Hansard), available at http://books.google.co.uk/-books?id=Mpw9AAAAcAAJ, 13 July 1803, vol 36, col 1667). Hope Jones, Income Tax in the Napoleonic Wars (Cambridge, Cambridge University Press, 1939) 20 said that ‘The new name did not deceive anyone’. This may have been true but it was not a matter of deception but of proper description. See n 20 below for the titles of the two originally separate Bills leading to Addington’s Act. The title of the 1803 Act continued in the 1842 and 1853 Acts (5 & 6 Vict c 35, 1853); the title of the 1842 Act as the Income Tax Act 1842 dates only from the Short Titles Act 1892. 9 In stark contrast to Pitt’s estimates (see n 3 above), Addington’s estimate of the yield (at a rate of 5% compared to Pitt’s 10%) was £4.7m for a full year and £4.5m for the current year (and this was on the basis of deduction of tax at source on Schedule C income which did not happen because of Pitt’s opposition, see n 62 below); the actual yield was £4.6 to £4.8m in the first year: Addington’s Private Memoir on Finance (June 1803, Sidmouth archive DHC 152M/C1803 OT29) 14; Ehrman, n 2 above, 680; Parliamentary Register 1802–05, 13 June 1803, 572–73 and 30 April 1804, 683; Cobbett’s Parliamentary History, n 8 above, vol 36, col 1597. Farnsworth, n 4 above, 93 sets out a breakdown of Addington’s estimate of the amount

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The difference is far greater than this. In order to have deduction of tax at source one first needed to have a tax on sources of income. Addington’s tax was not an income tax in the sense that Pitt’s had been, a tax on total income for which the derivation of the income was irrelevant, but a tax on separate sources of income, similar to the (later) mainland European impôts réels10 but in principle comprehensive.11 Structurally the starting point was the opposite of Pitt’s; it looked not to the receipt of income but to the origin of the payment—to the source (the tree) that produces the income (the fruit).12 Addington’s own description was ‘duties upon Property producing Income’.13 The contemporary Exposition of the Act which is anonymous but must have been written within the Commissioners for the Affairs of Taxes, described the differences: As the former [Pitt’s tax] was imposed on the general account of income derived from all the sources; the present duty is imposed on each source by itself, in the hand of the first possessor, at the same time permitting and authorizing its diffusion through every natural channel in its course to the hand of the ultimate proprietor. The present measure, then, must be considered as a tax on the first produce,

assessed for 1803–04 of £111.5m compared to the actual assessments of £115.3m, the actual figure being higher in all cases except Schedule C (which he had estimated on the basis of deduction of tax at source). The yield with the increased rates of 1s 3d (6.25%) in 1805–06, and 2s (10%) from 1806–07 subsequently increased to £10.2m in 1808, £12.4m in 1810 and £14.5m in 1815: Ehrman, n 2 above, 681. The provisions for taxation at source are usually claimed to be the reason for the success of Addington’s tax. Ehrman, n 2 above, 678 makes the point that in judging such claims it needs to be borne in mind that ‘a probable majority of those concerned were self-employed (many farmers, small entrepreneurs in trades and manufactures) who continued to pay their taxes in the same manner as before’. Two points may be made in reply. First, deduction at source removed one of Pitt’s main problems with traders claiming deductions for interest without anyone paying tax on the receipt (and in some cases without any interest in fact being paid), see n 55 below for the view of the Commissioners for the Affairs of Taxes in their Report, n 4 above. Secondly, both the annual value for Schedule A and deduction of tax from rent and rentcharges affected the taxation of farmers. 10 Separate taxes on sources of income in which the identity of the recipient was irrelevant. However, the presence of Cases IV and V dealing with foreign income accruing to a resident (where therefore the identity of the recipient is relevant)—the only ones copied from Pitt’s tax—is contrary to the concept of an impôt réel. Thus, in Williams v Singer (1920) 7 TC 387, the fact that the remittance basis had ended for foreign investment income accruing to UK resident trustees for a non-resident life tenant did not result in the trustees being taxed because the income, being foreign income of a non-resident, was not taxable; see Malcolm Gammie ‘The Origins of Fiscal Transparency in UK Income Tax’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2010) vol 4, 33. 11 Sir Josiah Stamp said in 1921 that up to 14 years earlier the UK tax had been a tax in rem (J Stamp, The Fundamental Principles of Taxation in the Light of Modern Developments (London, Macmillan, 1921) 17, available at www.archive.org/stream/fundamentalprin00 stamgoog#page/n8/mode/2up). The reference to 14 years earlier is presumably to Finance Act 1907 s 19 introducing earned income relief where total income did not exceed £2,000. 12 Ehrman, n 2 above, 681–83 categorises Pitt’s contribution to Income Tax as the fundamental one and Addington’s merely an improvement on it. It is respectfully suggested that this does not do justice to the wholly different structure of the two taxes. 13 Private Memoir on Finance, n 9 above, 12–13, also quoted by Farnsworth, n 4 above, 42.

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gradually subsiding itself into a tax upon the income of the ultimate proprietor; affecting in its immediate object the hand that acquires, but extending by direct motion to the hand which converts the income so acquired.14

The famous Schedules A to E, which became a long-lasting feature of the tax, listed the sources of income, without which there could be no tax on the income derived from them, so that, for example a post-cessation trading receipt could not, in the absence of legislation, be taxed because at the time of receipt the trade (the source) no longer existed.15 Source has been rightly described as ‘a more or less coded subtext to income tax and corporation tax statutes’.16 The fact that Addington’s tax represented a major change in the structure of the tax indicates that the changes were thought about in advance. One of Addington’s first acts as Prime Minister (as we would call it today) was to repeal Pitt’s tax in his Budget of 5 April 1802 following the Peace of Amiens on 25 March 1802. In the course of doing so he made a statement of some significance: I think, however, that it [Income Tax] should be reserved for the exigencies and pressures inseparable from a state of war; but at the same time not under the present regulations, although the changes which it might be necessary to make would not be very dissimilar.17

This shows that Addington had already considered what changes would need to be made if Income Tax were to be introduced. It also demonstrated that politically there would be no reintroduction of Income Tax unless war was resumed, as indeed occurred on 18 May 1803. Addington had to introduce a second Budget18 on 13 June 1803 within a month of war being declared. Income Tax was again needed in a hurry and the temptation must have been to re-enact Pitt’s tax. That this did not happen confirms Addington’s quoted statement that at least the outlines of his tax had been thought about in advance, but, on the other hand, the Bills leading to his Act show a number of significant changes demonstrating that important details had

14 Anon, Exposition of the Act for a Contribution on Property, Professions, Trades and Offices (London, J Gold, 1803) 3. 15 See, eg, Carson v Cheyney’s Executors [1959] AC 412; 38 TC 240. The effect was most obvious where the cash basis of accounting was used; on an earnings basis normally receipts would be brought into the final accounts but there could be exceptions such as the forgiveness of a trading debt. The legislation reversing this (in part) is Finance Act 1960 ss 32, 33. 16 Memec v IRC [1996] STC 1336, 1349f per Robert Walker J (who later became Lord Walker of Gestingthorpe). 17 The Times, 6 April 1802, quoted by Farnsworth, n 4 above, 36. Pellew, n 6 above, 195 also states, without giving any source, that ‘Mr Addington, on full consideration, resolved to new-model it [Pitt’s Income Tax] entirely, and to reproduce it as a property tax’ (part quoted by Farnsworth, n 4 above, 41). 18 He had already introduced one Budget for 1803 in December 1802.

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not been worked out in advance. While it was by no means certain that the Peace of Amiens would last, particularly from October 1802,19 it seems unlikely that work would have continued on an income tax before the outbreak of war. This would be consistent with the Bills being drafted with the new approach but with significant changes made to them during the parliamentary process. As an example of the changes made while the Bills were going through Parliament, Addington’s tax was originally contained in two separate Bills, one relating to income from real property and public offices, therefore including what became Schedules A, B and E; and the other relating to personal property containing what became Schedule D, the equivalent of Schedule C not then existing.20 After being introduced they were combined into a single Bill.21 The original Schedule D Bill taxed all interest and annuities under Case III of that Schedule; the first combined Bill moved this charge to a separate Schedule C containing provisions for deduction of tax at source from public revenue interest but was silent on the method of taxing other interest, thus excluding interest altogether from Case III of Schedule D which was left to cover property of an uncertain annual value not charged under Schedule A. The final Bill limited the Schedule C charge to interest on the Funds but, as a result of Pitt’s objections,22 now without taxation at source; deduction of tax from other annual interest was dealt with outside the schedules. These changes to the treatment of interest will be dealt with in more detail below.23

19 France invaded Switzerland in October 1802 and looked like invading Egypt. The United Kingdom never complied with all its obligations under the Treaty of Amiens either; for example, it never evacuated Malta. 20 There are four Bills in HC Parliamentary Papers. These comprise the two originally separate Bills: Session 1802–03 Bill No 120 of 20 June 1803 (as amended by the committee) entitled ‘for granting to His Majesty … a Contribution on the Profits of certain Descriptions of Property and Offices, therein described’, comprising what became Schedules A, B and E (there is an abstract of this Bill in The Times, 28 June 1803); and No 126 of 22 June 1803 (as amended by the committee) entitled ‘a Contribution on the Profits of certain Descriptions of Personal Property and from Professions, and Trades, therein mentioned’, comprising what became Schedule D divided into six cases but also including interest (there is an abstract of this Bill in The Times, 12 July 1803). There are two versions of the combined Bill: No 126 of 5 July 1803 (as amended), and No 164 of 22 July 1803 (as amended on second recommitment) both entitled ‘a Contribution on the profits of certain descriptions of property and from professions, trades, and offices, therein mentioned’. The Times refers to the ‘Property and Income Tax Bill’, for example when reporting its second reading (The Times, 22 June 1803), but this is obviously a name to assist readers (Ehrman, n 2 above, 678 may have been misled by this); ‘Income Tax’ never appears in the title of any of the Bills. Farnsworth, n 4 above, is wrong in saying at 57 that no copies of the two separate Bills survived the fire which destroyed the Houses of Parliament in 1834. 21 Proposed, The Times, 4 July 1803; agreed to, The Times, 6 July 1803. 22 See n 62 below. 23 Text at n 77 below, and Appendix 2.

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It is odd that no record seems to exist24 detailing Addington’s reasons for his significant departures from Pitt’s 1799 tax when designing his own in 1803, particularly as he took an interest in the detail of legislation, for example, trying, albeit unsuccessfully, to obtain information about the successful Dutch taxation.25 We can, however, deduce what are likely to have been their origins. Principal among these are the Land Tax and, it will be argued in this chapter, Adam Smith’s The Wealth of Nations.26

WHAT IS A SOURCE?

Before considering the detail of Addington’s tax as a tax on sources of income it is necessary to consider the nature of a source of income. It is suggested that the nature of sources of income in Addington’s tax was influenced by Adam Smith’s The Wealth of Nations. This was first published in 1776, the fifth edition had been published in 1789, and he died in 1790. The book was extremely well-known and would therefore have been fresh in the minds of those designing income tax from Pitt’s triple assessment of 1798 onwards.27 Indeed Pitt quotes ‘the celebrated author of the Treatise on the Wealth of Nations, Adam Smith’ in his 1798 Budget speech leading to the 1799 income tax in support of his £20 million estimate of the rent of land in the United Kingdom.28 Addington, with his interest in finance, would certainly have been familiar with The Wealth of Nations even though he 24 Unfortunately virtually all the available papers deal with much higher-level questions, such as the balance between taxation and borrowing, that one would expect from a Chancellor of the Exchequer. Addington’s papers are in the Devon Record Office in Exeter. Apart from the ones quoted I found nothing of relevance in the archives for 1802 and 1803. I am grateful to Professor Chantal Stebbings for also sharing with me her own researches of the archives. I have also consulted the papers of Nicholas Vansittart (later Lord Bexley), the Secretary to the Treasury in Addington’s Cabinet, in the British Library and have not found anything of relevance. There is also nothing of relevance in TNA in the Treasury (T 22/10) or Revenue (IR 31/151, 152) files of this time. 25 He noted that in spite of high taxation under French occupation (‘that the total charge of direct Taxation during the war could not be less than 45 per cent on the Capital of every Inhabitant’), ‘the people appear to be still at their ease; industry to prevail, and trade in a considerable degree to have revived since the peace [of Amiens (1802)]’. He continued that ‘I have taken considerable pains to acquire accurate information of the extent and nature of the Dutch Taxation, but the Accounts I have obtained have generally been so technical as to be hardly intelligible to a foreigner’ (Private Memoir on Finance, n 9 above, 9–10, part also quoted by Farnsworth, n 4 above, 42; this is dated June 1803 and the Budget introducing his tax was on 13 June 1803; the document refers to ‘the proposed Bill’). 26 Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (London, W Strachan and T Cadell, 1776). Page numbers are taken from the Penguin Classics version in two volumes, London, Penguin Books, 1999, referred to below as ‘Penguin (Books 1–3)’ and ‘Penguin (Books 4–5)’. 27 38 Geo 3 c 16. 28 Budget speech, 3 December 1798, Parliamentary Register 1796–1802, 104; The Speeches of the Rt Hon William Pitt in the House of Commons (London, 1808), vol 2, 438. This was unsurprisingly out of date. For comparison, Addington estimated income from land (excluding

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does not seem to have referred to it and his biographies do not mention any connection with its author.29 Adam Smith categorised the sources of income in this way:30 Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value31 … All taxes, and all the revenue which is founded upon them, all salaries, pensions, and annuities of every kind, are ultimately derived from some one or other of those three original sources of revenue, and are paid either immediately or mediately from the wages of labour, the profits of stock,32 or the rent of land.33 …

houses) and tithes at £28m; Pitt’s figure for tithes was £4m so that Addington estimate on the same basis as Pitt’s was £24m (Farnsworth, n 4 above, 14 and 89). The figure actually assessed under Schedule A in 1803–04 was £38.7m (which includes houses (estimated at £6m) and Scotland (estimated at £3.5m), so that the actual figure on the same basis as Pitt’s was about £29m: Farnsworth, n 4 above, 89–90, 93. 29 There is no reference to Adam Smith in Ziegler, n 1 above, or Pellew, n 6 above. But, for example, Adam Smith was cited by Mr W Smith MP in the Parliamentary debate on Addington’s Bill on 5 July 1803, Parliamentary Register 1802–05, 713. The story of Adam Smith arriving at Henry Dundas’s (the Lord Advocate’s) house in London where the company included Pitt, Grenville, Addington and Wilberforce at which Pitt asked Adam Smith to be seated first ‘for we are all your scholars’ is regarded as possibly apocryphal by Nicholas Phillipson, Adam Smith, An Enlightened Life (London, Allen Lane, 2010) 268. There is, however, nothing unlikely about that group of people meeting in London. 30 RL Meek, Precursors of Adam Smith (London, Dent, 1973) viii describes Adam Smith’s new division of society into landlords, wage-earners and capitalists as ‘the really central element in that work [The Wealth of Nations]’. The French economists (physiocrats) Quesnay (1694–1774) and Turgot (1727–81) were known personally to Adam Smith from his stay in France in 1764–66, see Andrew Skinner, ‘Introduction’ in The Wealth of Nations, n 26 above, Penguin (Books 4–5) xvi–xvii. Although Turgot listed land, labour, capital and entrepreneurship as four factors of production, and rent, wages and profit as the return from them; the separation of entrepreneurs and employees and therefore profit and wages (sections VI, VII, VIII, LXI, LXV) was his advance on Quesnay: Skinner, ibid xxii; and Meek, ibid 4, suggests that Turgot was influenced in this respect by Richard Cantillon (1680?–1734), who (unusually) is mentioned by Adam Smith, though not on this point (Penguin (Books 1–3) 170–71). RL Meek, Turgot on Progress, Sociology and Economics (Cambridge, Cambridge University Press, 1973) contains a translation of Turgot’s Réflexions sur la Formation et la Distribution des Richesses [Reflections on the Formation and the Distribution of Wealth]. However, there is doubt whether Adam Smith owned the whole of Turgot’s Réflexions (published in the journal Éphémérides du Citoyen in three parts 1769–70): PD Groenewegen, ‘Turgot and Adam Smith’ (1968) 15 Scottish Journal of Political Economy 271, but Skinner in his n 21 cites Meek’s information that Adam Smith possessed the first two parts. 31 Adam Smith’s theory was that the price of a commodity depended on the costs of these three items. Later theory, for example that of Ricardo (1772–1823), regarded wages as the only determinant of prices with capital being regarded as primarily an advance payment of wages (see n 67 below). The modern theory is that prices are determined by the utility of the goods produced. 32 ie capital (other than land) generally, but in the context more specifically relating to trade in the form of fixed capital (machinery) and circulating capital (trading stock), see The Wealth of Nations, n 26 above, Book 1 ch 9 (‘On the Profits of Stock’) Penguin (Books 1–3) 190. The distinction between fixed and circulating capital (avances primitives and avances annuelles) derives from Quesnay and Turgot. In this context stock does not seem to include capital lent at interest, see text at n 67 below. 33 The Wealth of Nations, n 26 above, Book 1 ch 6 (‘Of the Component Parts of the Price of Commodities’), Penguin (Books 1–3) 155–56; repeated in the conclusion of Book I ch 11 (ibid 356).

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The private revenue of individuals, it has been shown in the first book of this Inquiry, arises, ultimately from three different sources; rent, profit, and wages. Every tax must finally be paid from some one or other of those three different sources of revenue, or from all of them indifferently.34

Addington’s Schedules follow the principle but not the detail of this categorisation. Whilst it might be tempting to regard Schedules A and B, D, and E respectively as reflecting ‘the rent of land, the profits of stock and the wages of labour’, with Schedule C as a special case, the fit is far from exact: Schedule D includes both stock (trades) and labour (comprising employments—other than public employments which are within Schedule E—and professions which Adam Smith included within labour).35 The origin of Schedule D in the second of the separate Bills leading to the tax demonstrates that it merely dealt with the whole of personal property income.36 The Cases within it are designed to enable different computational rules, rather than reflecting any division based on Adam Smith’s sources. But the more significant point is that Addington’s sources followed Adam Smith’s principle that a source must produce income in its own right. It follows that Adam Smith did not consider interest to be a source of income, and nor did Addington’s tax. We shall return to the treatment of interest in section V after looking at the effect of Addington’s tax being on sources, and the origin of deduction of tax at source.

DIFFERENCE BETWEEN PITT’S TAX ON INCOME AND ADDINGTON’S TAX ON SOURCES: LAND TAX AS THE ORIGIN OF ADDINGTON’S TAX

The Land Tax,37 which was in force at the time, was the origin of Addington’s tax being a tax on property rather than on the receipt of income. Indeed, 34

The Wealth of Nations, n 26 above, Book 5 ch 2 pt 2 (‘Of Taxes’), Penguin (Books 4–5) 415. Schedule D Case II taxed professions (for Adam Smith’s inclusion with wages see The Wealth of Nations, n 26 above, Book 5 ch 2 pt 2 art III) (‘Taxes upon the Wages of Labour’), Penguin (Books 4–5) 461, employments (other than those within Schedule E) and vocations; Schedule E originally taxed ‘every publick office or employment of profit and every annuity, pension, or stipend, payable by his Majesty, or out of the publick revenue of Great Britain, except annuities before charged by Schedule C’. Adam Smith said of public offices some of which were sinecures: ‘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 regard both themselves and their immediate dependents, rather more than enough. The emoluments of offices, therefore, can, in most cases, very well bear to be taxed’ (Book 5 ch 2 pt 2 art III, Penguin (Books 4–5) 461. As mentioned in n 40 below profits from public offices were taxable under Land Tax (Land Tax Act 1692 [old style] (and all subsequent Acts) s 3), and Soos, n 49 below, 114 has traced its earlier use back to 1688 in an aid to William and Mary (1 Will & Mar sess 2 c 1). 36 See n 20 above for the Bills. 37 Land Tax started in 1692 (4 Will and Mary c 1) but the form of the 1697 Act (9 & 10 Wm 3 c 10) was repeated annually, the last one being that of 1797 (38 Geo 3 c 5), after which the Land Tax Perpetuation Act 1798 (38 Geo 3 c 60) provided that the tax raised by the 1797 35

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Addington’s description of his tax was a tax on ‘Property producing Income’, to which he added ‘I propose a Land Tax and a personal Contribution’.38 That land tax was the origin of his tax being a tax on property will be seen from Table 1.1. Pitt’s 1799 Act merely lists types of income from landed property in great detail, treating rent from land separately from rent from houses,39 Act ‘shall … continue to be raised, levied and paid yearly to his Majesty, his heirs and successors, from and after the twenty-fifth day of March [the land tax year was not changed by the Calendar Act 1751 (25 Geo 2 c 30)] in every year for ever’, a change that Income Tax has still never achieved. The perpetuation of Land Tax was necessary in order to provide for voluntary redemption by the Land Tax Redemption Act 1802 (42 Geo 3 c 116). Despite its name, Land Tax also taxed personal property, at least in theory, see n 40 below. It seems that in practice the contribution from personal property was small: in JV Beckett ‘Land Tax or Excise: the Levying of Taxation in Seventeenth- and Eighteenth-century England’ (1985) C English Historical Review 285, 296 only 7.4% of the yield in 1798 was from personal property. On Land Tax generally, see WR Ward, The Land Tax in the Eighteenth Century (Oxford, OUP, 1953). Land Tax continued until it was abolished by Finance Act 1963 s 68 by which time it yielded only £200,000 pa (there had also been provisions for compulsory redemption since 1949). For an interesting history see William Phillips, ‘No Flowers, By Request’ [1963] British Tax Review 285. Ehrman, n 2 above, 678 is wrong in referring to it as ‘the now defunct Land Tax’; in 1803 the amount redeemed and purchased was £55,819 (First Report of the Commissioners of Inland Revenue, 1857). 38 Private Memoir on Finance, n 9 above, 13, as Farnsworth, n 4 above, 42 points out. He may have had Land Tax in mind here only in relation to tax on land as he goes on to describe Schedules A and B and then adds ‘The Duties on Pensions and Offices to be likewise at the rate of one Shilling in the pound [5%] … Dividends in the funds and in Corporation Stocks to be also charged at 1/- in the pound … Property in trades to be rated by Commercial Commissioners at the like rate of 1/- in the pound on the annual Profits in a similar manner to what was practical under the [ie Pitt’s] Income Tax’. In his Budget speech on 13 June 1803 Addington refers to ‘the times of William and Anne … a great and glorious period in the history of this country’, as the precedent for taxing land and personal property at the same rate (then 4s in the £ (20%) on most income, and 0.5% on stock in trade) (Cobbett’s Parliamentary History of England, n 8 above, 13 June 1803, vol 36, col 1600, quoted by Farnsworth, n 4 above, 43). This is an indirect reference to Land Tax, introduced in 1688 during the reign of William and Mary; it is not clear why Queen Anne was mentioned as the Land Tax was in its final form by 1697, during William III’s reign. This is a poor report of the speech as the reporters had earlier inadvertently been excluded from the public gallery and had subsequently made only sparse reports: Farnsworth, n 4 above, 51. However, this reference is not contained in the report in The Times or in the Parliamentary Register, although Pellew, n 6 above, 201 refers to it. 39 Interestingly the substituted Schedule (see n 3 above) to Pitt’s Act when compared to the original schedule demonstrates a deliberate move in the direction of taxation of income rather than property or annual value, suggesting that the thought process was not complete when it was originally enacted. (Surprisingly the 9 Cases of the Triple Assessment (38 Geo 3 c 16, 1798) were more consistent in referring to income.) In the 1799 Act in Cases 2, 3, 4, 6, 10, 13, 15 and 16 the change is from annual value to income; Case 3 is typical of this, the original saying ‘The annual value of such Lands shall be taken at the full Amount of the Rent reserved’, and the substituted version ‘The income arising from such lands shall be taken’. Cases 9 and 12 originally contained a charge to tax on the property or, in Case 14 the person (mesne lessors); Case 12 originally said ‘Mines, Tythes, Woods, and other hereditaments of uncertain Amount, when occupied by Tenants, to be charged as the same would be charged in the Hands of the Owner, deducting also the Rent payable for the same’, and the substituted version was ‘The Income arising from Mines, Tythes’. Only Cases 1, 11, 17 and 18 and the unnumbered sweeping-up provision in the original Schedule referred to income (any Cases not listed above merely contain cross-references to other cases or wording that was not changed). By contrast Addington’s tax demonstrates a deliberate move in the opposite direction.

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while Addington’s Schedule A closely follows the wording of the Land Tax Act in describing the landed property itself.40 Table 1.1: Comparison of the treatment of landed property in Pitt’s and Addington’s Acts with Land Tax Pitt’s 1799 Act

Land Tax 1697 onwardsa Addington’s 1803 Act

INCOME arising from Lands, Tenements, and Hereditaments Case 1 land occupied by the owner Case 2 houses occupied by the owner Case 3 land occupied by tenants at a rack rent Case 4 land demised to tenants at a fine [premium] and rent Case 5 land demised to tenants at a fine only (or with nominal rent) Case 6 houses demised to tenants at a rack rent Case 7 houses demised to tenants at a fine and rent Case 8 houses demised to tenants at a fine only (or with nominal rent) Case 9 Tythes in respect of Owners Case 10 Profits of Manors, or of Timber or Woods, usually cut, periodically, and in certain Proportions, Mines, Insurance Offices from Fire, and other Profits of uncertain Annual Amount

That all and every Manors, Messuages Lands and Tenements; And also all Quarries, Mines of Coal, Tin or Lead, Copper, Mundick,b Iron and other Mines, Iron Mills, Furnaces and other Iron works, Salt-springs and Saltworks; All Allom-minesc and Works; All Parks, Chases, Warrens, Woods, Underwoods, Coppices and all Fishings, Tythes, Tolls, annuities, and all other Yearly Profits and all Hereditaments or what Nature or Kind soever …

For all Lands, Tenements, Hereditaments, or Heritages, there shall be charged throughout Great Britain …; and the said Duty shall be construed to extend to all Manors and Messuages, to all Quarries of Stone, Slate, Limestone, or Chalk, Mines of Coal, Tin, Lead, Copper, Mundic, Iron, and other Mines; to all Iron Mills, Furnaces, and other Iron Works, and other Mills and Engines of the like Nature; to all Salt Springs and Salt Works; to all Alum Mines and Alum Works; to all Parks, Chases, Warrens, Forests, Underwoods, and Coppices; to all Water Works, Streams of Water, Canals, Inland Navigations, Docks, and Fishings; to all Tythes, Rents, and Compositions for Tythes, Corn Rents, and other Payments in lieu of Tythes; to all (continued)

40 Land Tax also described personal property which was taxable under s 2: ‘any Estate in ready Monies, or in any Debts whatsoever owing to them … or having any Estate in Goods, Wares Merchandises or other Chattels or personal Estate whatsoever’. Section 3 charged the profits of all ‘publick Offices or Employments of profit’, words that were used in Addington’s Act: see n 35 above.

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Table 1.1: (Continued) Pitt’s 1799 Act Case 11 income of lands occupied by tenants at a rack rent Case 12 income arising from mines, Tythes, woods Case 13 income from lands demised for a fine with or without rent Case 14 income of mesne lessors from demises for fines with or without rent

Land Tax 1697 onwards

Addington’s 1803 Act Rights of Markets and Fairs; to all Ways, Bridges, and Ferries, and all other Profits arising out of Lands or Tenements, and all Hereditaments or Heritages throughout Great Britain, of what Nature or Kind soever they be, belonging to any Person or Persons …

Notes: a This wording can be traced back at least to 1688 (1 Will and Mar c 20) and is quoted by William Phillips,‘No Flowers, By Request’ [1963] British Tax Review 44. The references to ironworks, saltsprings, or works, alum mines or works still live on in ITTOIA 2005 s 12 (and CTA 2009 s 39) (see note c below about alum mines); and fishings has become‘rights of fishing’. An earlier First Exposure Draft on Trading Income of Individuals by the Tax Law Rewrite in 1997 had said ‘In 1803, the advantages of the original rule were clear. At the end of the 20th century however section 55 [ICTA 1988] is an anachronism—not just its archaic wording but its very existence’ (commentary to clause 3.1.3 at para 11 in www.hmrc.gov.uk/rewrite/exposure/first/ed1.pdf), but for some reason it was never changed. Following a recommendation of the 1920 Royal Commission (Cmd 615) para 433, from 1926 these items were transferred from Schedule A and taxed under Case I but without being treated as a trade, which they were not because no purchase of the asset sold was involved, with the result that relief for trading losses was unavailable. They are now treated as a trade. b An archaic name for iron persulphide (FeS2) (archaically known as iron pyrite because it emits sparks (Greek pyr, fire) when struck), or arsenopyrite (FeAsS), either of which is popularly known as ‘fool’s gold’. I am grateful to Victor Baker for his assistance with this and the following note. c Alum is a collection of hydrated double salts all containing aluminium, the commonest of which is potash alum or potassium aluminium sulphate dodecahydrate hydrated (K2(SO4)·Al2(SO4)·12H2O). It was used as a dye-fixer for wool and was extracted from shale in North Yorkshire from 1607 (it had earlier been imported from the Papal States which accordingly stopped in Henry VIII’s reign). It has not been mined since about 1855 when a synthetic substitute was invented, which makes the continued existence of alum mines in the legislation today (see note a above) even more surprising. Disused alum mines can still be seen in North Yorkshire, for example, the National Trust Loftus Alum Quarries at Boulby Cliffs.

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The draftsman of Addington’s Act clearly had the Land Tax Act in front of him. The effect of the difference in approach from Pitt’s tax is striking: land comprises one source of income for Addington but 14 types of income (with some duplication) for Pitt.41 But other domestic income which had been two types of income in Pitt’s Act, the only difference between them being whether the amount of income was certain or uncertain, which determined the basis of assessment,42 became many more sources of income in Addington’s Act. Addington divided domestic income into its many constituent sources: trade or manufacture (Schedule D, Case I); professions, employments or vocations (Case II); property of uncertain value not charged under Schedule A (Case III);43 interest on the Funds (Schedule C); public offices or employments (Schedule E); and annual interest, annuities and other annual payments outside the schedules.44 This gave Addington more scope for differences in the method of assessment.45 The only items which are the same in Pitt’s and Addington’s tax are the charge on foreign income in Cases 17 and 18 of Pitt’s Act and Cases IV and V of Schedule D in Addington’s Act.46 Case IV regards the

41 The 1806 Act (46 Geo 3 c 65, 1806) split up Schedule A into three parts and introduced different bases of assessment, eg manors, average of seven-preceding years; mines, fiveyear average; quarries, iron works, etc, preceding year; tithes paid in kind to an ecclesiastical person, three-preceding years. See Coltness Iron Co v Black (1881) 1 TC 287. 42 Case 15: ‘income from any Trade, Profession, Office, Pension, Allowance, Stipend, Employment, or Vocation being of uncertain Annual Amount’ (preceding year (or three-year average) basis), and Case 16: ‘income from Offices, Pensions, Stipends, Annuities, Interest of Money, Rent Charge, or other Payments being of certain Annual Amount’ (preceding year (or preceding year to 5 February, or to the accounting date) basis). Thus trade, profession and vocation, allowance and (surprisingly) employment are necessarily uncertain in amount, while annuities, interest and rentcharges are necessarily certain, with offices, pensions, stipends capable of falling within either category. 43 This was extended by the 1805 and 1806 Acts to include public revenue interest not within Schedule C (because it was not ‘annuities, dividends or shares of annuities’, eg interest on exchequer bills), discounts, short interest; and the 1806 Act adds profits of dealers in cattle and milk where the annual value of the land did not afford a just estimate of the profits, see Anon, Guide to the Property Act, 2nd edn (London, Joyce Gold, 1807) 39–40. 44 See text before n 66 below. 45 Three-year average (Case I), preceding year (Cases II and III), current year (Schedules C and E). Even different tax rates could be applied (under Schedule B the tax rate was 9d in the pound (3.75%), or 6d (2.5%) in Scotland, rather than the normal 1s (5%)), and deduction of tax at source could be applied to certain sources. Addington had also proposed reliefs for small earned income which Pitt opposed, arguing that all income should be treated equally. Although Addington obtained a majority of 150 to 50 he did not press the point and gave the relief to small incomes of all types (s 193): The Times, 14, 15 July 1803; Cobbett’s Parliamentary History, n 8 above, 13 July 1803, vol 36, col 1668. 46 Case IV ‘Interest arising from Securities in Ireland, or in the British Plantations in America, or in any other of his Majesty’s Dominions out of Great Britain, and foreign Securities’ (see n 64 below for the reason for this different treatment of foreign interest); Case V ‘Possessions in Ireland, or in the British Plantations in America, or in any other of his Majesty’s Dominions out of Great Britain, and foreign Possessions’. The difference between Cases IV and V was that the former taxed remittances of the current year, and the latter remittances of an average of

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security as the source in a similar way to Schedule C; the foreign possession is clearly a source in Case V. This reliance on source for foreign income only might be regarded as an anomaly in Pitt’s Act. But it might be said that treating the whole of foreign income as two sources is itself an anomaly that was changed only in 2005 in the course of the Tax Law Rewrite.47 The Income Tax (Trading and Other Income) Act 2005 now deals with foreign income in a similar way to domestic income of the same type. Both taxes also contained a similar sweeping-up clause covering other income.48

LAND TAX AS THE ORIGIN OF DEDUCTION OF TAX AT SOURCE IN ADDINGTON’S TAX

The change in Addington’s tax to being a tax on sources of income made possible deduction of tax at source. This, the most important feature of Addington’s Act, is also derived from the land tax. Dr Piroska Soos49 has noted that five of the provisions of Addington’s Act for deduction of tax at source also featured in the Land Tax Act with very similar wording. These related to (1) rent; (2) rentcharges; (3) company dividends; (4) salaries payable by the Exchequer; and (5) salaries paid to a deputy.50 Addington’s Act contained

the three preceding years which was the same basis as Case I. Pitt’s tax applied the arising and preceding year (or if not existing, an estimate for the current year) bases to the equivalent of Case IV, and remittances of the current year (to 5 February), or the three preceding years, or to the accounting date at the taxpayer’s option, to the equivalent to Case V. 47 Whether or not this was an anomaly Pitt’s wording lasted until 2005 with the courts successfully adapting its interpretation to encompass enormous business changes over this long period: see J Avery Jones, ‘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 (Oxford, Hart Publishing, 2004). 48 In Pitt’s Act: category IV (without any Case number) ‘Income not falling under any of the foregoing Rules’; in Addington’s Act: ‘The Duty to be charged in respect of any annual Profits or Gains not falling under any of the foregoing Rules, and not charged by virtue of any of the other Schedules contained in this Act’. The strange positioning of this in Addington’s Act at the end of Schedule D and before Schedule E arises because in the originally separate Bills (see n 20 above) what became Schedule E was originally Schedule B in the real property Bill and for some reason was placed after Schedule D in the combined Bill. The reason cannot be that the Schedules are in order of importance because although Schedule E income was estimated to be lower than Schedule D, so was Schedule C. Even in the original personal property Bill this provision had to exclude income taxed by the Act derived from the real property Bill. The income must be ejusdem generis with income in the preceding Cases, see Attorney-General v Black (1871) LR 6 Ex 308, 310. 49 PE Soos, The Origins of Taxation at Source in England (Amsterdam, IBFD, 1997) 156. She also notes at 126 a land tax provision in s 135 relating to interest applying only to Scotland entitling a person who owed money at 6% to deduct from his annual rent one-sixth of the 6%. 50 See (i) 1803 Schedule A II r 2; Land Tax Act (LTA) s 17; (ii) 1803 Schedule A II r 3; LTA s 5; (iii) 1803 s 127; LTA s 57; (iv) 1803 Sch E, Fifth; LTA s 32; (v) 1803 s 186; LTA s 109. These provisions are all set out by Soos, n 49 above, 156–80. She traces the principle of deducting and retaining tax back to the new subsidy of 1671 and to pensions paid out of clerical

Sources of Addington’s Income Tax

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three further such provisions which are not found in land tax, relating to interest, annuities and other annual payments,51 salaries required to be paid to another person, and payments to a deputy or clerk out of salaries.52 Thus, out of eight provisions for deduction of tax at source in Addington’s Act, five were contained in the land tax and the remainder were similar in principle. A great advantage of these provisions of Addington’s Act was that the payer could, so long as the payments were made out of taxed income of the same year, deduct and retain the tax on them, thus obtaining tax relief53 and making them taxed income (‘pure income profit’) of the recipient on which he could not be assessed as it had already been taxed. In relation to trading income the procedure was modified by a separate requirement that the General Commissioners give a certificate before the deduction at source procedure could be used.54 This both made it unnecessary for income paid under deduction of tax to be disclosed, and also reduced evasion in relation to claiming a trading deduction for interest, which was a significant problem under Pitt’s tax.55 The advantage of Addington’s system over Pitt’s can be seen from the example in the Exposition of the Act: The occupier, charged with the whole duty, deducts from his landlord a portion of the tax, proportionate to his share of the profits. The superior proprietor, the mortgagee, the annuitant, the creditor by personal contract, and any other legitimate participant of the profits, is subject to the like proportionate deduction, without other interference from the powers created by the act.56

revenues in the sixteenth and seventeenth centuries, and so Addington’s application of deduction of tax at source was far from original. Farnsworth, n 4 above, 44 also quotes the relevant Land Tax provisions. In Parliament Addington claimed taxation at the source which avoided disclosure in relation to land and interest to be the main advantage over Pitt’s tax (The Times, 6 July 1803; Parliamentary Register 1802–05, 5 July 1803, 710). 51

‘Annual payments’ is an expression also used in land tax, see Table 1.2. 1803 s 208 (interest, see Table 1.1); Schedule E, Seventh; Schedule E, Eighth. 53 If the payer’s income was 100, the annual payment 10 and the tax rate 10%, the taxpayer paid tax on 100 (= 10) but retained 1 from the annual payment, making the net tax 9. He was still taxed on 100 (there was a prohibition on deduction from income or trading profits of the payer) but the result is the same as if he had paid tax on 90 (= 9). Because the recipient received taxed income no disclosure of the interest by him was necessary. 54 1803 s 209. See n 78 below for the derivation of this and the general provisions in the Bills leading up to the Act. This separate provision for interest paid out of trading profits survived until 1853 s 40. 55 Interest deduction from trading profits was noted by the Report of the Commissioners for the Affairs of Taxes, n 4 above, 299 as one of the causes of ‘extensive frauds and evasions’ in Pitt’s Act for which they recommended registration of debts, quoted by Farnsworth, n 4 above, 20–21. Addington’s Private Memoir on Finance, n 9 above, 14 refers to his proposals being ‘much less liable to Concealment and Evasion, as no returns of Income will be required except for such as does not arise from visible Property’. 56 Exposition, n 14 above, 4. 52

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The only assessment is on the farmer; all the others are paid out of taxed income starting with the rent. Table 1.2 compares the rentcharges provision in the Land Tax Act and Addington’s 1803 Act, which are extremely similar in their drafting, and the last column sets out the interest provision in Addington’s Act which had no equivalent in Land Tax showing that it is no different in principle.57 Table 1.2: Comparison of provisions of Addington’s 1803 Act and Land Tax Land Tax 1697 onwards (rentcharges, etc)

Addington’s 1803 Tax (rentcharges, etc)

Addington’s 1803 Tax (interest)

Section 5. And whereas many of the Manors, Messuages, Lands, Tenements, Tithes, Hereditaments, and Premises in England, Wales and Berwick-uponTweed,a intended by this Act to be charged with a Pound-rate as aforesaid, stand incumbered with, or are subject or liable to the Payment of several Rent-charges or Annuities, or other Annual Payments issuing out of the same, or to the Payment of divers Feefarm Rents, Rents-service or other Rents thereupon reserved or charged,…

Schedule A, II, Third—Where any such Dwelling Houses, Lands, Tenements, or Hereditaments, are subject or liable to the Payment of any Rent Charge, Annuity, Fee Farm Rent, Rent Service, Quit Rent, Feu Duty, Teind Duty,b or other Rent or annual Payment thereupon reserved or charged, the Landlords, Owners, or Proprietors, by whom any Deductions or Payments shall have been allowed as aforesaid,

Section 208. That upon all Annuities, yearly Interest of Money, or other annual Payments, whether such Payments shall be payable within or out of Great Britain either as a Charge on any Property of the Person or Persons paying the same, or as a Reservation thereout, or as a personal Debt or Obligation by virtue of any Contract, or whether the same shall be received and payable half-yearly, or at any shorter or more distant Periods, there shall be charged for every twenty Shillings of the annual Amount thereof, the Sum of one Shilling, without Deduction, according to and under and subject to the Provisions by which the Duty in Schedule (D.) may be charged; provided, that in every

57 Bill 142 (see n 20 above) in Schs A and B r 4 (at 17) applies the rentcharges provision to interest by reference; it is only in the final Bill 164 that the interest provision (now limited to annual interest) is set out in full in the wording in Table 1.2. The changes to how interest was taxed are set out in n 78 below.

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Table 1.2: (Continued) Land Tax 1697 onwards (rentcharges, etc)

Addington’s 1803 Tax (rentcharges, etc)

Addington’s 1803 Tax (interest) Case where the same shall be payable by any Person or Persons out of any Profits or Gains charged by virtue of this Act, no Assessment shall be made upon such Annuity, Interest, or other annual Payment, but the whole Duty due in respect of such Profits or Gains shall be charged without regard to such annual Payment,

It is therefore declared and enacted by the authority aforesaid, That it shall and may be lawful to and for the Landlords, Owners and Proprietors of such Manors, Messuages, Lands, Tenements, Hereditaments and Premises in England, Wales and Berwick-uponTweed, being charged with a Pound-rate as aforesaid, to abate and deduct, and to detain and keep in his, her or their Hands, out of every such Fee-farm Rent, or other Annual Rent or Payment, so much of the said Pound-rate which shall be taxed or assessed upon the said Manors, Messuages, Lands and Premises, as a like Rate for every

and the Landlords, Owners, and Proprietors, being respectively Occupiers, and charged to the said Duties, shall abate and deduct, and detain and keep in their Hands, out of every such Rent Charge, Annuity, Fee Farm Rent, Rent Service, Quit Rent, Feu Duty, Teind Duty, or other Rent or annual Payment aforesaid, so much of the said Duties or Payments on account of the same as a like Rate of one Shilling for every twenty Shillings on such Rent Charge, Annuity, Fee Farm Rent, Rent Service, Quit Kent, Feu Duty, or any Rent or Composition for Tythes, Corn Rent, or other Payment in lieu of Tythes, or any

and the Person so liable to make such annual Payment, shall be authorized to deduct out of such annual Payment at the Rate of one Shilling for every twenty Shillings of the Amount thereof, except where the Party to whom the Payment is to be made shall produce a Certificate of Exemption or Abatement, as hereinbefore is mentioned;

(continued)

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Table 1.2: (Continued) Land Tax 1697 onwards (rentcharges, etc)

Addington’s 1803 Tax (rentcharges, etc)

such Fee-farm Rent or any other Annual Rent or Payment respectively shall be a just Proportion amount unto, so as such Fee-farm Rent or other Annual Rent or Payment respectively do amount unto twenty shillings per annum, or more;

Teind Duty, or other Rent or annual Payment aforesaid respectively, not being less than twenty Shillings per Annum, shall by a just Proportion amount unto;

and all and every Person or Persons who are or shall be any ways entitled to such Rents or Annual Payments, their respective Auditors, Reeves, Receivers, and their Deputy or Deputies, are hereby required to allow such Deductions and Payments, according to such Rates, upon Receipt of the Residue of such Monies as shall be due and payable to them for such Rents or Annual Payments reserved or charged as aforesaid, without any Fee or Charge for such Allowance.

and all and every Person and Persons who are or shall be anyways entitled unto such Rents, Duties, or annual Payments, their Receivers, Deputies, or Agents, are hereby required to allow such Deductions and Payments, according to such Rates, upon the Receipt of the Residue of such Monies as shall be due and payable to them for such Rents, Duties, or annual Payments, without any Fee or Charge for such Allowance; and the Landlord, Owner, Proprietor, and Occupier respectively, being charged as aforesaid, or having allowed such Deductions or Payments, shall be acquitted and discharged of so much Money as the Deductions or Payments shall amount unto, as if the

Addington’s 1803 Tax (interest)

and the Person or Persons to whom such Payments are to be made, shall allow such Deduction upon the Receipt of the Residue of such Money, and the Person charged to the said Duties shall be acquitted and discharged of so much Money as such Deduction shall amount unto, as if the Amount thereof had actually been paid unto the Person or Persons to whom such Payment shall have been due and payable;c

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Table 1.2: (Continued) Land Tax 1697 onwards (rentcharges, etc)

Addington’s 1803 Tax (rentcharges, etc)

Addington’s 1803 Tax (interest)

same had actually been paid unto such Person or Persons to whom such Rent Charge, Annuity, Fee Farm Rent, Rent Service, Quit Rent, Feu Duty, Teind Duty, or other Rent or annual Payment aforesaid, shall have been due and payable.

and where any Person having allowed such Deductions on account of any such annual Payment as aforesaid, or being liable to allow the same, shall himself be liable to make any such Payment, whether charged upon such first-mentioned annual Payment, or reserved thereout, or payable as a Debt or Obligation by virtue of any Contract as aforesaid, then and in every such Case, and so on upon each successive Payment to be made thereout, there shall be deducted the like Proportion thereof as aforesaid, at the Rate before-mentioned, which Deduction and Deductions shall be allowed in Discharge of so much Money as such Deductions shall respectively amount unto in the same Manner as is provided in respect of the first Deduction; but in every Case where any annual Payment as aforesaid shall, by reason of the same being (continued)

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Table 1.2: (Continued) Land Tax 1697 onwards (rentcharges, etc)

Addington’s 1803 Tax (rentcharges, etc)

Addington’s 1803 Tax (interest) charged on any Property or Security in Ireland, or in the British Plantations, or in any other of his Majesty’s Dominions, or on any foreign Property or foreign Security, or otherwise, be received or receivable without any such Deduction as aforesaid, there shall be charged upon such Interest, Annuity, or other annual Payment as aforesaid, the Duty before mentioned, according to and under and subject to the Provisions, by which the Duty in Schedule (D.) may be charged.d

Notes: a Land tax was originally so limited but was extended to Scotland in 1707 on the Union by 6 Anne c 35. b A Scots term similar to tithes in England; annexed to the Crown after the Reformation and granted to secular owners called Titulars. c In Bill 120 at 19 and Bill 126 at 36–37 (see n 20 for the Bills) refusal to allow deduction was deemed usury. This was not repeated in the combined Bills (or the Act) which provided that the payer was‘acquitted and discharged’ for the amount deducted; refusal to allow deduction incurred a penalty. There is an interesting report of Attorney-General v Page, The Times, 12 July 1811, in which a lender refused the deduction of tax from interest. The borrower stated his case to the Board of Taxes and the lender called in the loan secured on the borrower’s farm. The Board prosecuted the lender, pointing out that the maximum penalty was treble the amount of the loan (£7,200) (1806 s 115), but on the lender accepting that he was wrong a verdict was entered for a penalty of £100. d These exceptions were expanded in 1805 and 1806, see text at n 82 for the 1806 version.

The considerable similarity of wording between land tax and Addington’s Act in relation to rentcharges can be seen, particularly ‘abate and deduct, and detain and keep’, ‘required to allow such deductions’, and ‘without any Fee or Charge for such Allowance’ which demonstrates unquestionably the land tax origins of deduction of tax at source in Addington’s Act. Other provisions for deduction of tax at source in land tax and Addington’s Act are set out in Appendix 1 to this chapter.

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The drafting of the deduction of tax from interest follows the same outline as for rentcharges but in a more modern style; land tax was over 100 years old by then. It should be mentioned that interest on funded58 government debt (‘the Funds’) (‘annuities,59 dividends,60 and shares of annuities … out of any publick revenue’) was taxed separately under Schedule C, with foreigners being exempted until the Income Tax expired in 1816.61 Addington’s original proposal was for deduction of tax at source on funded debt but this was opposed by Pitt;62 it reverted to his original proposal in 58 Funded debt implies the existence of a fund which is mortgaged or assigned to pay the debt. Adam Smith, The Wealth of Nations, n 26 above, Book 5 ch 3 (‘of Public Debts’), Penguin (Books 4–5) 512 explained: ‘Sometimes it [the government] has made this assignment or mortgage for a short period of time only, a year, or a few years, for example; and sometimes for perpetuity. In the one case the fund was supposed sufficient to pay, within the limited time, both principal and interest of the money borrowed. In the other it was supposed sufficient to pay the interest only, or a perpetual annuity equivalent to the interest, government being at liberty to redeem at any time this annuity upon paying back the principal sum borrowed’. For example, Pitt had mortgaged the yield of his income tax for a loan of £11m which, on the repeal of the tax, had to be funded by a new loan of £57m charged on the Consolidated Fund. Only funded debt is within Schedule C. By contrast, Adam Smith (at 511) explains unfunded debt): ‘It consists partly in a debt which bears, or is supposed to bear, no interest, and which resembles the debts that a private man contracts upon account, and partly in a debt which bears interest, and which resembles what a private man contracts upon his bill or promissory note’. He gives as an example of the latter navy and exchequer bills. Unfunded debt was taxable under Case III of Schedule D; there is an express reference there to exchequer bills from 1805 (see n 78 below). 59 Funded debt was then irredeemable and the only return was in the form of an annuity (for life, for a fixed term, or perpetual) with no right to repayment of the capital (see Adam Smith, Lectures on Justice, Police, Revenue and Arms (1763) (Oxford, Clarendon Press, 1896) 247, available at https://openlibrary.org/books/OL7197564M/Lectures_on_ justice_police_revenue_and_arms). 60 Dowell’s Income Tax Laws, 7th edn (London, Butterworths, 1913) 217 explains: ‘On the creation of the “consols” in 1752, of annuities [see n 59 above] 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’. This use was probably confusing even at the time. On 6 August 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 IR 99/102 p 30). The expression was still causing problems as late as Esso Petroleum Co Ltd v Ministry of Defence [1989] STC 805, in which it was held to be limited to interest on securities and did not include interest on damages payable by the Crown. 61 Interest on the Funds held by non-resident non-nationals were exempt: 1803 s 71; 1805 s 77; 1806 s 103 Fifth. Adam Smith notes that ‘the Dutch, as well as several other nations, having a very considerable share in our public funds’ (The Wealth of Nations, n 26 above, Book 5 ch 3, Penguin (Books 4–5) 528); see n 25 above for their continued prosperity during French occupation in spite of heavy taxation. Under Pitt’s 1799 Act no exemption was necessary because non-resident foreigners were not taxed on British income anyway. This relief for foreigners was fully debated in 1806 but no change was made. It was not continued in the 1842 Act; Pellew, n 6 above, vol 2, 199 explained that by then a foreigner could have withdrawn his capital at a profit, which was not the case in 1803. 62 Addington had proposed deduction at source for Schedule C (see his Private Memoir on Finance, n 9 above, 13: ‘to be deducted at the Bank or Office where the same may be payable’), which was contained in Bill 142 (see n 20 above) but Pitt successfully opposed this as late as 13 July 1803 because the conditions of issue were that the interest would be paid ‘without any deduction whatsoever’, and so deduction would be a ‘violation of the public compact entered

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1806.63 Naturally deduction of tax at source was not a possibility for interest on foreign securities (Case IV of Schedule D).64 Since deduction at source applied originally only to interest paid out of taxed income it did not apply where this was not the case.65 Interest will be considered further in the next section.

ADAM SMITH’S THE WEALTH OF NATIONS AS THE ORIGIN OF THE TREATMENT OF INTEREST IN ADDINGTON’S TAX

Interest is clearly income but it is not a source of income because money does not earn income in itself but has to be paid out of some other incomeproducing source (unless it is paid out of further borrowing). Significantly, interest was not treated as a source by Adam Smith:66 The interest of money is always a derivative revenue, which, if it is not paid from the profit which is made by the use of the money, must be paid from some other into between the Government and the holders of stock’ (The Times, 14 July 1803; Parliamentary Register 1802–05, 13 July 1803, 740; Cobbett’s Parliamentary History, n 8 above, 13 July 1803, vol 36, col 1666; the date of 5 July 1803 in Pellew, n 6 above, vol 2, 197 appears to be an error). Pitt therefore rested his argument on the condition about deduction rather than taxation itself; indeed he had included income from the Funds in his 1799 Act under annuities and interest of money in Case 16 without mentioning it specifically. Pellew, n 6 above, vol 2, 198–99 quotes a letter to him from Lord Bexley (Nicholas Vansittart): ‘Mr Pitt replied, that he certainly did not mean that they should be exempted, but that they should be called upon to pay on their dividends as a part of their income. This, I said, would be felt by the stockholders as much as a direct tax; but he persevered in his opinion’. 63 Addington was ultimately proved right. When in 1806 Lord Henry Petty, the Chancellor of the Exchequer in Lord Grenville’s Ministry of All the Talents, introduced deduction at source the income assessed under Schedule C rose from £11.9m to £22.499m (on which tax at 10% = £2.249m): Farnsworth, n 4 above, 67–68. 64 See text at n 46 above in relation to foreign income generally. Presumably no distinction between annual and short interest could be made for foreign interest because there was no possibility of investigating its terms (which is the deciding factor, see n 70 below), and so the security was treated as the source. It is interesting that Case V also treated a dividend from a non-resident company differently from one from a resident company. A UK resident company was transparent for tax purposes, but the source of a dividend from a non-resident company was the dividend itself because it would be impossible to apply transparency to a non-resident body. So long as the share in the company (‘the tree’) remained intact a dividend (‘the fruit’) from a non-resident company was taxable whatever the underlying source, so that a dividend paid out of a capital gain by a non-resident company was taxable (IRC v Reid’s Trustees (1949) 30 TC 431) whereas the same paid by a resident company was not (Cenlon Finance Co v Ellwood [1962] 2 WLR 871). For cases where the ‘tree’ remained intact, see Rae v Lazard (1963) 41 TC 1 (partial liquidation under Maryland law, likened to cutting the tree in two) and Courtaulds Investments Ltd v Fleming (1969) 46 TC 111 (Italian share premium reserve, the distribution of which was treated as a return of capital). See J Avery Jones, ‘Defining and Taxing Companies 1799 to 1965’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2012) vol 5, ch 1, p 1. 65 Deduction became compulsory by Customs and Inland Revenue Act 1888 s 24(3). See Richard Thomas, Chapter 2, for more details. 66 Adam Smith was against taxing interest on the grounds that the amount of a person’s capital stock was a secret and ‘An inquisition into every man's private circumstances, and an

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source of revenue, unless perhaps the borrower is a spendthrift, who contracts a second debt in order to pay the interest of the first.67

Addington’s income tax, unlike Pitt’s,68 followed exactly the same approach as Adam Smith in not treating domestic interest as a source.69 In this respect Addington followed Adam Smith more closely than he did for the contents of the Schedules. In Addington’s tax, annual interest,70 as well as annuities71 and other annual payments, were not sources in their own right but were regarded as coming out of the fund of the payer’s general income.72 Addington’s 1803 Act was careful not to place these within a schedule, which would have implied that they constituted sources, but instead charged tax

inquisition which, in order to accommodate the tax to them, watched over all the fluctuations of his fortune, would be a source of such continual and endless vexation as no person could support’. And secondly (a typically perspicacious comment although relating to taxation on a source, rather than a residence, basis; under a residence basis the incentive is for the owner, rather than the investment, to move), ‘The proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax; and would remove his stock to some other country, where he could either carry on his business, or enjoy his fortune more at his ease’. (Both quotations from The Wealth of Nations, n 26 above, Book 5 ch 2 pt 2 (‘Of Taxes’), Penguin (Books 4–5) 441–42). 67 The Wealth of Nations, n 26 above, Book 1 ch 6, Penguin (Books 1–3) 155. This aspect seems to be original to Adam Smith uninfluenced by Turgot (or, so far as I am aware, anyone else). Turgot had a highly developed section on interest in the last part of Réflexions that Adam Smith did not follow in other respects and had probably not seen for the reasons given in n 30 above, of which Schumpeter, History of Economic Thought (London, Routledge, 1997) 332 said was ‘not only by far the greatest performance in the field of interest theory the eighteenth century produced but it clearly foreshadowed much of the best thought of the last decade of the nineteenth century’. Turgot lists five ways of employing capital: buying a landed estate; investing in agricultural enterprises as a tenant; employing it in industrial or manufacturing enterprises; or in commercial enterprises; or lending it at interest (summarised in his section LXXXIII, in RL Meek, Turgot on Progress, Sociology and Economics (Cambridge, Cambridge University Press, 1973) containing a translation of Turgot’s Réflexions sur la Formation et la Distribution des Richesses [Reflections on the Formation and the Distribution of Wealth]). Presumably if Turgot had been listing sources of income he would have included loans at interest. At the time interest was not regarded as important. D Ricardo, On the Principles of Political Economy and Taxation (London, John Murray, 1817) writing slightly later regarded labour as the prime determinant of price with capital being to a great extent regarded as an advance payment for labour leaving only a small interest element in addition, see G Stigler, ‘Ricardo and the 93% Labor Theory of Value’ (1958) 48 American Economic Review 357. 68 Pitt’s 1799 Act included interest in his Case 16 along with offices, pensions, stipends, annuities, rentcharge or other payments of a certain annual value, see text at n 42 above. Case 9 of Pitt’s 1798 Triple Assessment (38 Geo 3 c 16) was similar. 69 See n 64 above for the treatment of foreign source interest. Interest on funded government debt taxable under Schedule C is mentioned in the text around n 58 above and will not be dealt with here. 70 In essence if the liability cannot by its terms continue for a year the interest on it is short interest; otherwise it is annual interest. See Richard Thomas, Chapter 2, for more details. 71 Note Adam Smith’s reference to annuities not being within his three sources in the text at n 33 above. 72 On the other hand, interest on the Funds and interest on foreign securities do have a source.

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on them ‘according to and under and subject to the provisions by which the duty in Schedule D may be charged’,73 with the 1806 Act specifying this to be under Case III of Schedule D.74 The charging provision was the section from which the quotation is taken, not Case III.75 This referential treatment continued until 1853 when all interest, annuities and other annual profits and gains not charged under any of the other schedules was put into Schedule D contrary to Adam Smith’s approach;76 presumably by then the reason for charging tax on them by reference to, rather than including them in, Case III had been forgotten. They are unlike other sources in that they arise from the payer’s general income, whatever type of income it comprises, rather than a specific income-producing source. The question is whether this treatment of interest can be attributed to Adam Smith’s influence or whether it is merely that where deduction of tax at source applies there is no need for the income to be within a Schedule because it will never be assessed. In answering this we can therefore concentrate on the situations where deduction at source did not apply, although it should be mentioned that provisions for deduction at source existed from the earliest available Bills leading to the 1803 Act77 even though the details changed considerably, as summarised in Appendix 2 to this chapter. Where deduction of tax at source does not apply, we must first make a distinction between annual interest and short interest.78 So far as annual interest is concerned (and annuities and other annual payments) the treatment of

73 1803 s 208 set out in Table 1.2, column 3 (this provision was included for the first time in the Bill of 22 July 1803 at 118–19). The quoted words originally applied to cases where deduction of tax did not apply but in the Act they were added to the first part of the general section thus applying to all yearly interest, resulting in the 1803 form of the section set out in Table 1.2. As has been mentioned dividends were not a source either because companies were transparent. 74 1806 s 114. 75 Attorney-General v London County Council (1900) 4 TC 265, 295–96 per Lord Macnaghten. See John Tiley’s strong criticisms of the successor section (by then no longer applying to annual interest) ‘The Repeal of Section 52 of the Taxes Act 1970’ [1981] British Tax Review 263. 76 1853 s 2. It is interesting to note that Anon, Guide to the Property Act, 2nd edn (London, J Gold, 1807) 40 lists annuities, yearly interest of money and other annual payments as one of the items under Case III, which is clearly not the case in the statute itself. Presumably it was thought that making the distinction between something which is within Case III and something which is taxed ‘according to and under and subject to the provisions by which the duty in [Case III] may be charged’ was unhelpful to the reader. 77 See n 20 above for the Bills. 78 1803 did not specifically deal with short interest. 1805 s 93 expressly included short interest (see n 70 above) for the first time in Case III of Schedule D, Second: ‘The Profits on all Exchequer Bills, and other Securities bearing Interest payable out of the publick Revenue [these were outside the scope of Schedule C], and on all Discounts, and on all Interest of Money not being annual Interest, payable or paid by any Persons whatever, shall be charged according to the preceding Rule in this Case’ (emphasis added).

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such income in circumstances not qualifying for deduction of tax at source continued to develop between the 1803, 180579 and 1806 Acts. It is better to focus on the last of these on the basis that the 1803 Act was enacted under great pressure following the re-declaration of war and it is not surprising that changes had to be made later.80 The equivalent to section 208 of the 1803 Act set out in Table 1.2 in the 1806 Act81 is the exclusive charging section for annual interest whether or not deduction of tax in fact applies. The section lists the cases where deduction does not apply: but [1] in every Case where any annual Payment as aforesaid shall, by reason of the same being charged on any Property or Security in Ireland, or in the British Plantations, or in any other of His Majesty’s Dominions, or on any Foreign Property or Foreign Security, or otherwise, be received or receivable without any such Deduction as aforesaid, and [2] in every Case where any such Payment shall be made from Profits or Gains not charged by this Act, or [3] where any Interest of Money shall not be reserved or charged or payable for the Period of One Year, then and in every such Case there shall be charged upon such Interest Annuity or other annual Payment as aforesaid, the Duty before mentioned, according to and under and subject to the several and respective Provisions by which the Duty in the Third Case of Schedule (D.) may be charged.82

Item (1) seems to be a recognition that the law governing the security, then almost certainly real or immovable property, is not likely to accept deduction of tax in accordance with British tax law.83 In items (1) and (2) the

79 As mentioned, 1805 put short interest into Case III and also specifically dealt with it in the deduction section (1805 s 192), which additionally dealt with payments not made out of taxable income. 80 The whole tax was introduced in the extremely short period of just over eight weeks between the Budget on 13 June 1803 and the Act on 11 August 1803, during which two separate Bills were introduced and then combined, so it is not surprising that some of the details needed to be changed in subsequent years. 81 1806 s 192. 82 1806 s 114 (my addition of the numbers in square brackets). See n 83 below in relation to item (1). The ‘according to’ phrase was first used in Bill 164 at 118–19 in relation to interest charged on foreign property. It was then applied by the Act to payments to which deduction of tax did apply at the last minute not having been in any of the Bills (see the first paragraph of 1803 s 208 in Table 1.2). 83 Since deduction of tax was not mandatory it is not clear why this provision was necessary. Failure to deduct would normally mean that the payer did not obtain any tax relief but the 1803 Act (Schedule D Case 1 r 4) contained an exception from the prohibition on the deduction of annual interest in computing profits for ‘interest of debts due to foreigners not resident in Great Britain’, with the 1806 Act adding ‘or in any other of His Majesty’s Dominions’, which would give relief for interest on a secured debt paid gross to a non-resident foreigner; this was for some reason not repeated in 1842 but had to be reintroduced in 1949 (see Richard Thomas, Chapter 2). Deduction of tax is really only a matter between the parties. When in 1888 it became necessary to deduct tax and pay it to the Revenue if interest was not paid out of taxed income, the Revenue became an interested party. See the obiter remark in Keiner v Keiner (1952) 34 TC 346, 348 that the UK resident husband, who it had been held was not entitled

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referential treatment applies: the assessment is not under Case III but by reference to it. Item (3) is unnecessary as the deduction section does not apply to short interest anyway as it concerns only ‘yearly interest of money’. Short interest was specifically charged under Case III: ‘all interest of money, not being annual interest’.84 The reference to it in the deduction section is probably there only to clarify that the section does not apply to it, although the double provision for short interest is confusing. Effectively, apart from short interest, all payments of domestic interest, annuities and other annual payments, and not just those where deduction at source applied, were outside the Schedules in accordance with Adam Smith’s approach. Accordingly, the conclusion is that one can attribute the nature of Addington’s sources to Adam Smith.

CONCLUSION

Despite the absence of contemporary evidence about the origins of the difference between Addington’s tax and Pitt’s, it is reasonably clear that Land Tax was the origin of Addington’s being a tax on sources rather than on income, and in consequence deduction of tax at source, and that Adam Smith was the origin of the nature of a source of income, as illustrated by Addington’s treatment of domestic annual interest, not that Adam Smith would have approved of taxing interest.85 The strange feature of Pitt’s tax is that he ignored the contemporary precedent of land tax for both sources and deduction of tax, so it was more that Pitt was out of line than that Addington’s tax was original.

to deduct tax from arrears of maintenance payments to his wife in the United States because the obligation was governed by New Jersey law, might if r 21 (the equivalent of the 1888 Act provision in the 1918 Act) applied have been in the position of having to deduct tax and pay it to the Revenue but still pay his wife gross. 84

1806 s 112, Third Case. See n 66 above. He would have been even more against taxing trades, as in this famous passage: ‘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’: The Wealth of Nations, n 26 above, Book 5 pt II art 4 (‘Taxes which, it is intended, should fall indifferently upon every different Species of Revenue’), Penguin (Books 4–5) 462. Objection to inquisitorial powers was a constant tax theme at the time, see Chantal Stebbings, ‘Consent and Constitutionality in Nineteenth-Century English Taxation’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2009) vol 3, 293. 85

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APPENDIX 1 Table 1.3: Other provisions for deduction of tax at source in Land Tax and Addington’s Acta Land Tax 1697 onwards

Addington’s 1803 Tax

Deduction of tax by tenants Section 17 … and the several and respective Tenant or Tenants of all Houses, Lands, Tenements, and Hereditaments In England, Wales or Berwick-upon-Tweed which shall be rated by virtue of this Act, are hereby required and authorised to pay such Sum or Sums of Money as shall be rated upon such Houses, Lands, Tenements or Hereditaments, and to deduct out of the Rent so much of the said Rate as, in respect of the said Rents of any such Houses, Lands, Tenements, and Hereditaments, the Landlord should and ought to pay and bear;

Schedule A II, rule Second—The Occupier or Occupiers of any Lands, Tenements, Hereditaments, or Heritages, being respectively Tenants of the same, and paying the said Duties, shall deduct so much thereof as a Rate of one Shilling for every twenty Shillings of the Rent payable to the Landlord or Landlords for the Time being would, by a just Proportion, amount unto, which Sums shall be deducted out of the first Payments thereafter to be made on account of Rent;

and the said Landlords, both mediate and immediate, according to their respective Interests, are hereby required to allow such Deductions and Payments, upon Receipt of the Residue of the rents.

all Landlords, both mediate and immediate, their respective Heirs, Executors, Administrators, and Assigns, according to their respective Interests, shall allow such Deductions and Payments upon Receipt of the Residue of the Rents,

Section 18 And every Tenant paying the said Assessment or Assessments last mentioned shall be acquitted and discharged of so much Money as the Assessment or Assessments shall amount unto, as if the same had actually been paid unto such Person or Persons to whom his Rent shall have been due and payable …

and the Tenants paying the said Assessments shall be acquitted and discharged of so much Money, as if the same had actually been paid unto the Person or Persons to whom his or their Rent shall have been due and payable: …

Taxation of companies Section 57 [The New River Company, the Thames waterworks, the Marylebone or Hampstead waterworks, or any office

Section 127 … and such Estimate shall be made on the Amount of the annual Profits and Gains of such Corporation, Fraternity, Fellowship, (continued)

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Table 1.3: (Continued) Land Tax 1697 onwards

Addington’s 1803 Tax

for insuring of houses, or in any lights, or the King’s Printing House shall pay four shillings in the pound of the full yearly value] and they and all Companies of Merchants in London, and the Bank of England and all Salaries and Pensions (taxable in London) arising and payable or the General Post-office and Excise-office, charged by this Act shall be assessed by the Commissioners nominated and appointed for the said City, or any Two or more of them, for their respective Shares and Interests aforesaid, and the aforesaid joint Stock or Stocks, and for such Salaries and Pensions; and the same shall be paid by the Governors or the respective Treasurers or Receivers of the said River-waters, and Waterworks, and of the said Offices and Stocks respectively, to such Person or Persons as the said Commissioners, or any two or more of them, shall appoint to collect the same, and be deducted at and out of their next Dividend.

Company, or Society, before any Dividend shall have been made thereof to any other Person or Persons, or publick Bodies having any Share, Right, or Title, in or to such Profits or Gains; and all such other Person or Persons, and publick Bodies, shall allow out of such Dividends a proportionate Deduction in respect of the Duty so charged;

Withholding from public salaries, etc Section 32 … in all Cases where any Pensions, Annuities, Stipends, or other Yearly Payments, or the Fees, Salaries, Wages, or other Allowances or Profits charged by this Act, shall be payable at the Receipt of the Exchequer, or at any other publick Office, or by any of his Majesty’s Receivers or Paymasters in England, Wales, or Berwick-uponTweed, the Tax or Payment which in pursuance of this Act shall be charged for or in respect of such Annuities, Pensions, Stipends, Fees, Salaries, Wages, Allowances, or Profits,

Schedule E, Fifth—In all Cases where any Salaries, Fees, Wages, or other Perquisites, or Profits, or any Annuities, Pensions, or Stipends shall be payable at the Receipt of the Exchequer, or at any publick Office, or by any Officer of his Majesty’s Household, or by any of his Majesty’s Receivers or Paymasters, or by any Agent or Agents employed in that Behalf, then and in every such Case the Duties chargeable under this Act in respect of such Salaries, Fees, Wages, Perquisites, or Profits, or in respect of such Annuities, Pensions, or Stipends, (continued)

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Table 1.3: (Continued) Land Tax 1697 onwards

Addington’s 1803 Tax

shall and may (in case of Non-payment thereof) be detained and stopped out of the same, or out of any Money which shall be payable upon such Pensions, Annuities, Stipends, Fees, Salaries, Wages, Allowances, or Profits, or for Arrears thereof, and shall be applied to the Satisfaction of the Rates and Duties not being otherwise paid as aforesaid.

shall and may, in case of Non-payment thereof, be detained and stopped out of the same, or out of any Money which shall be payable upon such Salaries, Fees, Wages, Perquisites, or Profits, or upon such Annuities, Pensions, or Stipends, or for the Arrears thereof, whenever the same shall happen, and be applied to the Satisfaction of the Duties on such Offices or Employments, or on such Annuities, Pensions, or Stipends respectively (not being otherwise paid) in the Manner directed by this Act.

Payment to deputy Section 109 … That where any Office or Employment of Profit chargeable by this Act, is or shall be executed by Deputy, such Deputy shall pay such Assessment as shall be charged thereon, and deduct the same out of the Profits of such Office or Employment

Section 186 That where any Office or Employment of Profit chargeable by this Act, is or shall be executed by Deputy, such Deputy shall, in all Cases where he shall receive the Profits thereof, be answerable for and shall pay such Assessment as shall be charged thereon, and deduct the same out of the Profits of such Office or Employment; …

and in case of Refusal or Nonpayment thereof, such Deputy shall be liable to such Distress as by this Act is prescribed against any Person having and enjoying any Office or Employment of Profit, and to all other Remedies and Penalties respectively therein respectively contained.

and in case of Refusal or Nonpayment thereof, shall be liable to such Distress as by this Act is prescribed against any Person having the Office or Employment, and to all other Remedies and Penalties respectively herein contained.

Note: a In addition to the provisions about deduction of tax from rentcharges set out in Table 1.2.

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John F Avery Jones APPENDIX 2: CHANGES TO ADDINGTON’S BILLS RELATING TO INTEREST

Both of the originally separate Bills86 dealt with deduction of tax from ‘any interest of money, annuity, or other annual payment … annually paid’ out of what became Schedule A and Schedule D income respectively, subject to obtaining a certificate from the General Commissioners by providing the name and address of the recipient and the amount.87 In both there was also a procedure for the creditor to apply for a certificate that the interest be paid in full. The Schedule A clause was changed to one deducting tax by reference to the rentcharges clause in the first combined Bill, thus confirming the relationship between the land tax provisions for deduction of tax at source (which included rentcharges) and interest. That Bill also contained two clauses relating to deductions from Schedule D income, one in the description of Schedule D income and the other in a separate clause, both requiring a certificate and the latter expressly stating that no certificate was required for interest paid out of profits from land, public offices or income from the Funds.88 The duplication was probably an error made while consolidating the two Bills. The Bill also provided that no deduction was allowed under Schedule D Case I for any annual interest, or any annuity, allowance or stipend ‘in any other manner than as before directed’;89 presumably in consequence, the clauses in the separate Bills permitting the creditor to obtain a certificate from the General Commissioners requiring payment in full were not repeated as its operation would have meant that there was no deduction from trading profits for annual interest paid in full. In the final Bill not only was the duplication within Schedule D continued,90 but a further duplication was introduced in the form of a more general provision permitting deduction of tax at source from the slightly differently-worded ‘annuities, yearly interest of money or other annual payments’ without reference to the type of income out of which they were paid and without needing to obtain a certificate.91 This is the first use of ‘yearly interest’. This clause became section 208, which is set out in Table 1.2. The Act also eliminated the duplication within Schedule D but the section dealing with payments out of Schedule D income subject to obtaining a certificate was retained alongside the general provision (which covered payments out of any type of income without requiring a certificate), which was odd, but the intention

86

See n 20 above for the Bills. Bill 120 at 19 and Bill 126, 36–37; from the clause numbering of Bill 120 this clause was added in Committee, but it is not possible to tell from the Bill or the debates whether this was also the case with Bill 126. 88 Bill 142, 17 (Schedule A r 4) and 45, 107–8 (Schedule D). 89 Schedule D Case I rr 4, 47. 90 Bill 164, 48, 119–20. 91 Bill 164, 118–19. 87

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was reasonably clear—that a deduction from trading profits required a certificate from the Commissioners. Lord Macnaghten described the Schedule D section which became 1803 section 210 as ‘a curious section, and one rather clumsily framed’ in Attorney-General v London County Council.92 The explanation is presumably that what became section 210 was originally in the earlier Bills before what became 1803 section 208 was added in Bill 164 without specifically saying that it was restricted to payments out of non-Schedule D income. Section 210 survived until 1853 section 40 which dispensed with the need for a certificate,93 but since Acts did not then contain repeals even this is not clear. Apart from these provisions for deduction at source, the original Schedule D Bill taxed all interest and annuities under Case III of what became that Schedule; the first combined Bill moved this charge to a separate Schedule C containing provisions for deduction of tax at source from public revenue interest but being silent on other interest, thus excluding interest altogether from Case III of Schedule D which was left to cover property of an uncertain annual value not charged under Schedule A;94 and the final Bill limited the Schedule C charge to annuities, dividends and shares of annuities payable out of the public revenue, that is funded debt, but, as a result of Pitt’s objections,95 now without deduction of tax at source.96

92

Attorney-General v London County Council (1900) 4 TC 265, 296. ibid Lord Macnaghten 296. Bill 142, 37 (Schedule C) and 47 (Case III of Schedule D). The scope of the charge was later extended, see n 43 above. 95 See n 62 above. 96 Bill 164, 40. 93 94

2 Retention of Tax at Source and Business Financing RICHARD THOMAS

ABSTRACT From 1803 to 1969 UK tax law prevented a deduction for annual interest in computing the profits of a trade. This rule was a by-product of Addington’s scheme of deduction of tax at the source and its retention by the payer, which allowed relief in the form of a ‘credit’ against income tax suffered. There were, however, substantial limitations on relief, especially in relation to money raised overseas, caused by the linking of deduction and retention of tax and effective relief. It was not an approach that found favour in any other major country (apart from Ireland which inherited the United Kingdom’s system). This chapter charts the history of the way the UK tax system has allowed relief to businesses, corporate and unincorporated, for the cost of raising finance other than equity finance. It considers whether the United Kingdom’s unique approach hindered or otherwise distorted the ability of business to raise non-equity finance and why it was not adopted for many of the United Kingdom’s other taxes on business but was adopted for Corporation Tax in 1965.

INTRODUCTION

I

T IS A principle (or at least a truism) of comparative international tax that interest on a debt is a deductible expense in arriving at the tax base for profits, and that a distribution of equity (eg a dividend on shares) is not. One only has to look at the OECD (Organisation for Economic Cooperation and Development) Model Double Taxation Convention or the United Nations equivalent to see that. Article 24 in both forbids discrimination in the matter of allowing interest as a deduction.1 1 See www.oecd.org/tax/treaties/47213736.pdf and www.un.org/esa/ffd/documents/UN_ Model_2011_Update.pdf.

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The 2010 draft of the Common Consolidated Corporate Tax Base proposed by the European Commission2 shows that deductions may only be allowed for expenses incurred in earning profits, and that these include interest and the costs of obtaining debt finance, on the one hand, but only the costs of obtaining equity finance on the other, and not the ‘cost’ of any distributions. Textbooks on comparative tax law also take this as the norm, and much of the discussion in them, and a preoccupation with fiscal authorities, is the problem of thin capitalisation which would not exist were there not this stark divide.3 So all major tax systems seem to operate on the basis that, in principle, interest is deductible in computing business profits. What then are we to make of this proposition found in the Rules for the first case of Schedule D (profits of trade) in Great Britain’s Income Tax Act of 1842 (5 & 6 Vict c 35) (‘the 1842 Act’)? Fourth—In estimating the Amount of the Profits and Gains arising as aforesaid no Deduction shall be made on account of any annual Interest … payable out of such Profits or Gains.

1842 is chosen as the example because it marked the start of the revived income tax and because between 1799 and 1816, during which the original income tax operated, there were scarcely any bodies corporate in existence, and it is in relation to such bodies that the issues discussed in this chapter chiefly arise. However similar provisions can be found in the Income Tax Acts of 18034 (43 Geo 3 c 122) (‘the 1803 Act’) and 1806 (46 Geo 3 c 65),5 though both those Acts had a qualification of the prohibition which is considered below. By contrast, in Pitt’s Income Tax Act of 1799 (39 Geo 3 c 103) (‘the 1799 Act’) there was a general allowance for annual interest (whether on debts owing or charged on property), and in section 81 there was this rule for trades: And be it further enacted, That it shall not be lawful for any Persons engaged in any Trade or Manufacture, in filling up the Statement or Schedule of the Particulars of their Income, or on otherwise computing, in pursuance of this Act, their Income arising from such Trade or Manufacture, to make any Deductions therefrom … on Account of Interest for the Capital by them employed therein, unless for Interest, which they are bound to pay to other Persons for the same. (emphasis added)

2 See http://ec.europa.eu/taxation_customs/taxation/company_tax/common_tax_base/index_ en.htm. 3 See, eg PA Harris, Corporate Tax Law: Structure, Policy and Practice (Cambridge, Cambridge University Press, 2013) para 2.1 and V Thuronyi, Comparative Tax Law (The Hague, Kluwer, 2003) para 7.11.3.3. 4 See s 84 containing Schedule D. 5 See s 112 containing Schedule D.

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Reverting to the 1842 Act, an additional prohibition is found in section 159: And be it enacted, That in the Computation of Duty to be made under this Act in any of the Cases before mentioned, either by the Party making or delivering any List or Statement required as aforesaid, or by the respective Assessors or Commissioners, it shall not be lawful to make any other Deductions therefrom than such as are expressly enumerated in this Act, nor to make any Deduction on account of any annual Interest … to be paid to any Person out of any Profits or Gains chargeable by this Act, in regard that a proportionate Part of the Duty so to be charged is allowed to be deducted on making such Payments.

Here is the justification for the no deduction rule of Case I in the 1842 Act. People of the writer’s generation (and before) were brought up in their tax training to know about ‘charges on income’ and ‘deduction at the source’, and of the system introduced by Addington in the 1803 Act, the purpose of which (in which it succeeded) was in modern parlance to ‘close the tax gap’, to reduce evasion by making the ultimate recipient of income which passed through more than one set of hands liable to the tax, but requiring the payer at each stage to deduct out of the payment an amount equal to income tax at the rate in force (one shilling in the pound in 1803, or 5 per cent). If it is only the ultimate recipient who is to bear the tax on income that passes through many hands, it might be thought that there could have been simpler ways of achieving that, for example, by taxing the recipient directly by way of assessment, while giving relief by deduction from income to the payer (as was done in the 1799 Act), or by requiring the payer to deduct tax at source and then to account to the tax authorities for the tax deducted, ie a withholding tax, while also giving relief to the payer for the amount of income paid away. But that was not what was done. Instead, by section 102 of the 1842 Act6 the payer was entitled, but not obliged, to deduct tax and to keep the tax deducted (as a very early form of tax credit) but only so far as it was paid out of his ‘profits or gains’ subject to tax. To compensate the Exchequer for not paying this retained tax to it, payers were charged to income tax on their entire income without taking account of the income paid away to another. Recipients were absolved from tax on their receipts, but if their income was below certain limits, they could claim repayment of some or all of the tax deducted, and kept, by the payer.7 This scheme of retention of tax and charge on the full income explains then why the Fourth Rule of Case I in the 1842 Act expressly prohibited a deduction for annual interest paid out of profits. To allow a deduction in computing a Case I (trading income) profit for income tax purposes would be to give relief twice, as the retention by the payer of the tax deducted 6 Reinforced and simplified in part by Income Tax Act 1853 (16 & 17 Vict c 34) s 40, the Act which also extended the tax system of Great Britain to Ireland. 7 For a masterly account of the system see John Tiley ‘The Repeal of Section 52 of the Taxes Act 1970’ [1981] British Tax Review 263.

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already gave them relief. This prohibition against deduction in computing trade profits applied only to annual interest, but not other interest arising on obligations not capable of extending beyond a year (commonly known as ‘short’ interest); and did not apply to annual interest not payable out of profits and gains. Neither of these types of interest was, in the 1842 Act, subject to the system of retention at source (nor any form of withholding), so a deduction for them in arriving at the profits of a trade, etc was not prohibited by the Fourth Rule of Case I. Thus in relation to interest, there was in the 1842 Act a two tier system: short interest and annual interest not paid out of profits or gains were in principle (ie there was no explicit prohibition) deductible in a Case I computation of taxable trading profits, while annual interest paid out of profits or gains was not deductible, and relief could only be obtained by the payer’s retaining the tax which they could (but were not obliged to) deduct. These tax rules lasted throughout the nineteenth century and well into the seventh decade of the twentieth. They have been through several consolidations. It would be wearisome to refer either to a variety of different sections, etc for the same rule, or to cross-reference them all, so for simplicity’s sake, unless the context requires a reference to the actual section of the time, they will be referred to simply by a name. The relevant names are (with the section numbers in footnotes): — the rule prohibiting a deduction for annual interest paid out of profits or gains in a Case I computation will be referred to as the ‘no deduction in Case I’ rule;8 — the rule prohibiting deduction for capital amounts in a Case I computation will be referred to as the ‘prohibition of capital’ rule;9 — the rule permitting deduction of tax and its retention by the payer will be referred to as the ‘retention of tax’ rule;10 — the rule requiring deduction of tax and its payment to the Inland Revenue by the payer will be referred to as the ‘withholding tax’ rule;11 — the rule allowing relief for ‘short’ interest paid to banks, etc will be referred to as the ‘short interest relief’ rule.12 8 In the 1842 Act it was in the Third Rule of Case I of Sch D, in the Income Tax Act 1918 (‘the 1918 Act’) Rule 3(l) of the Rules applicable to Cases I and II of Sch D and then Income Tax Act 1952 (‘the 1952 Act’) s 137(l). It ceased to apply to annual interest in 1969. 9 In the 1842 Act it was the Fourth Rule of Case I of Sch D, in the 1918 Act Rule 3(f) of the Rules applicable to Cases I and II of Sch D and s 137(l) of the 1952 Act. It ceased to apply to annual interest paid by companies in 1965 and to interest paid by others in 1969. 10 In the 1842 Act it was s 102 (and was simplified in Income Tax Act 1853 s 40) and in the Income Tax Act 1918 (‘the 1918 Act’) Rule 19 of the General Rules. It became 1952 Act s 169 and Income and Corporation Taxes Act 1970 (‘the 1970 Act’) s 52 and finally Income and Corporation Taxes Act 1988 (‘the 1988 Act’) s 348. It was repealed by the Income Tax Act 2007. 11 Enacted as Customs and Inland Revenue Act 1888 s 24, it became Rule 21 of the General Rules in the 1918 Act. It became 1952 Act s 170, 1970 Act s 53, 1988 Act s 349 and remains on the statute book to this day as Income Tax Act 2007 s 874. 12 The legislative history of this relief is set out below in the section ‘How does the payer know that the interest being paid is annual interest?’.

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This system of retention of tax and prohibition of relief for annual interest lasted nearly two centuries. In the twentieth century when other countries introduced income tax on business profits, the UK rules were out of line with most if not all13 other world tax systems which saw interest as a proper deduction in arriving at the profits of a business.14 It was a system which was strongly supported by the Inland Revenue and approved of without any real suggestion of modification by every body which looked into it, including the Hubbard Committee in the 1850s, the 1920 Royal Commission, the Macmillan Codification Committee in the 1930s and the Royal Commission of the 1950s.15 This chapter seeks to establish why the system lasted as long as it did. It is clear from the reports mentioned above that any pressure for change would have needed to overcome decades of entrenched defence of the status quo, and it is not obvious how, apart from contributing to Royal Commissions and the like, the voice of business was then to be heard. It may be that business, as payers of interest, were also perfectly happy with the system: but there are a number of signs that this was not so. This can chiefly be gauged by examining the numerous cases heard by the courts about the retention of tax/disallowance system, looking at the arguments raised by business and what judges had to say. It can also be seen by government reaction to court cases, eg by way of amending legislation, and indeed by the background to legislation introduced for other reasons. The chapter proceeds by suggesting what the problem issues for businesses might be and then considering each to see what the practical effects were by reference mainly to the cases reported on the subject. The issues identified are: — How does the payer know that the interest being paid is annual interest? — How does the payer know that the interest is being paid out of profits or gains brought into charge to tax? — At what rate of tax does the payer deduct? — What are the consequences if the deduction of tax is not legally or practically possible? — What are the consequences for deductibility from total income or in computing trading profits if the interest is not annual interest, or is annual but not paid out of profits or gains brought into charge to tax? — Does the treatment of interest match the treatment of other costs of debt finance? — Were there other ways of financing a business which would allow a deduction to the payer and no withholding on the payee? 13 Ireland retained the UK system when the Irish Free State was established in 1922 and it still applies it: see Taxes Consolidation Act 1997 (No 39 of 1997) (Ireland) Pt 8 ss 1, 2. 14 For instance, it seems none of the tax codes set up in colonies or dominions in the nineteenthcentury contained any such rule as the ‘no deduction in Case I’ rule (or the Addington system). 15 By way of an example of typical reactions see Report of the Royal Commission on the Income Tax, Section III, paras 154–58 (Cmd 615, HMSO, 1920).

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Richard Thomas HOW DOES THE PAYER KNOW THAT THE INTEREST BEING PAID IS ANNUAL INTEREST?

In 1842 a payer of interest had to decide whether the interest being paid was annual interest, as the right of deduction and retention applies only to annual interest. It should be noted that in 1842 there was nothing explicit in the tax law to prevent ‘short’ (ie non-annual interest) being deducted in computing trading profits, if it could be shown that it was incurred for the purpose of the trade. There are numerous tax cases on this question and it is still a matter of some controversy.16 No one was ever in any doubt that if a company issues loan stock redeemable in 60 years the interest is annual, and the same goes for any length of fixed term loan of more than a year. But if a loan for say a fixed term of three months is expressed to require the debtor to pay interest at 5 per cent per annum is that annual interest? The banking firm of Goslings & Sharpe argued that it was, and that it had been so decided by Sir W Page Wood V-C in Bebb v Bunny.17 But the Court of Appeal in Goslings & Sharpe v Blake would have none of it, and held that fixed term loans of less than a year do not give rise to annual interest.18 Their decision is notable for their determining the answer on the basis of substance: they noted that interest on a loan of less than a year might be described as a single sum of money, or as a percentage rate per annum or simply as a percentage, and Lord Esher MR made it clear that usage by commercial men as in the first or third cases was perfectly clear and it could not be proper to find a difference between the three methods of describing interest. Making pedantic distinctions of that nature would ‘render business impossible’. And not for the first time and certainly not for the last, judges remarked upon the difficulty of construing the ‘retention of tax’ rule. In Bebb v Bunny the issue was whether interest on unpaid purchase money was subject to retention of tax by the purchaser. Page Wood V-C held that it was, and also made a comparison with a mortgage. A mortgage, he pointed out, was repayable after six months, but the practice was invariably that the money was left un-repaid so long as the mortgagor continued to pay the interest. That clearly amounted to annual interest, and he could see no distinction between that and purchase money interest which might go on for more than a year. But what is interesting and unusual to the mind of a twenty-first century tax practitioner is that Page Wood V-C said at the start of his judgment that he had consulted the Inland Revenue about their practice. They had told

16 See Her Majesty’s Revenue and Customs (HMRC) Possible Changes to Income Tax Rules on Interest, Consultative Document (27 March 2012). 17 Bebb v Bunny (1854) 1 K & J 216. 18 Goslings & Sharpe v Blake (1889) 2 TC 450.

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him that it had never been doubted that interest on mortgages was within the retention of tax rule and that tax was invariably deducted. They also added that several people had been prosecuted for failure to allow deduction and they paid a fine to escape proceedings. In Leeds Permanent Benefit Building Society v Mallandaine, loans were made by a building society to its members for various periods substantially exceeding a year, with loans repaid in instalments consisting partly of capital and partly of interest.19 Nevertheless, the society refused to allow borrowers to deduct tax from the interest element, partly because they said it could not be distinguished from capital and partly because it was not annual interest. The judges did not comment on this, finding that the society was liable to be assessed whether or not it was annual interest, but the case is mentioned to illustrate the state of confusion in the minds of lenders and borrowers as to what was annual interest. Further confusion is apparent in the case of Lord Advocate v Lord Provost, Magistrates and Council of the City of Edinburgh.20 Here the city borrowed what were described in the case as ‘temporary loans’ from banks. They were stated in the case as being for fixed terms, but many were allowed to run on for over a year. Nonetheless, all parties proceeded on the basis that they were not annual interest. The decision of the Court of Session was that it was ‘short’ interest but was within the withholding tax rule. This needs some further explanation which can be found below.21 But continuing with the question of what interest is short and what annual, in Scottish North American Trust Ltd v Farmer overdraft interest was accepted as short and a six-month loan renewed for another six months was also treated as short without argument.22 In 1915, the government took action which may have reduced the pressure on the distinction between annual and short interest. Section 22 of the Finance Act (FA) 1915 provided: Where interest payable in the United Kingdom on an advance from a bank carrying on a bonâ fide banking business in the United Kingdom is paid to the bank, without deduction of income tax, out of profits and gains brought into charge to income tax, the person by whom the interest is paid shall be entitled, on proof of the facts to the satisfaction of the Special Commissioners, to repayment of an amount equal to income tax on the amount of the interest.23

19

Leeds Permanent Benefit Building Society v Mallandaine (1897) 3 TC 577. Lord Advocate v Lord Provost, Magistrates and Council of the City of Edinburgh (1903) 4 TC 627. 21 See text at nn 46 to 48 below. 22 Scottish North American Trust Ltd v Farmer (1911) 5 TC 693. 23 This it can be seen was legislation of a practice of the Inland Revenue referred to in City of Edinburgh, n 20 above: see section of paper headed ‘Short interest’ in ‘What are the deductibility issues if the interest is not annual interest paid out of PGBIT?’. 20

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It was still necessary for the interest to be paid out of profits or gains, and the relief, which was equivalent to the retention of tax, was only available when the interest was paid to a bank in the United Kingdom (it might, of course, be an overseas bank with a UK branch). In FA 1917 section 15, relief was extended to interest which was not annual interest paid to a stockbroker or discount house carrying on business in the United Kingdom. But a proviso to this relief required that in addition to the payer proving entitlement to relief, the Commissioners of Inland Revenue had to be satisfied that the interest would be brought into charge to tax. They were obviously less trusting of stockbrokers and discount houses than of banks, in relation to whom no such assurance was required. It is also notable that while the relief in FA 1917 was explicitly limited to short interest but did not require payment out of profits and gains, that in FA 1915 was applied to any interest paid out of profits and gains not payable under deduction of tax. The wording of the 1915 relief did leave open the possibility that a claim might be competent for annual interest where the payer, perhaps in collaboration with the payee, did not deduct tax, ie the situation in Goslings & Sharpe. Further discussion of these ‘short interest relief’ rules is set out below. But the enactment of those rules did not end the disputes about what is annual interest and what not. In 1938 the Inland Revenue argued that a loan for exactly a year produced annual interest, and in Ward v AngloAmerican Oil Co Ltd the Court agreed.24 Then in 1969, the year the retention of tax rule for annual interest was repealed, Corinthian Securities v Cato reached the courts.25 It was a dispute, like so many of those about deduction and retention of tax, between the payer and the payee, not involving the Inland Revenue as a party. To quote the headnote in the HMSO Tax Cases: The loan was repayable on demand, but the Plaintiff undertook that no demand would be made if the Defendant met his obligations satisfactorily, including repayment of £1,400 six months from the date of the first advance. The loan was secured by a charge by way of legal mortgage on the Defendant’s house. The Defendant having failed to repay £1,400 at the due date, the County Court made an order in favour of the Plaintiff for possession of the house, suspended on the terms that the Defendant should repay £2,000 forthwith and the balance in six months, together with interest at the due dates. He paid the £2,000 but not the rest. An application to remove the stay as settled on 4th September 1968 on terms that the Defendant should pay certain sums by 11th September and on 1st November 1968, with interest at 12 per cent per annum on a day-to-day basis for the period 1st July to 31st October 1968. On 20th November 1968 he paid £11, which cleared the account to that date on the footing that the interest payable at all material times was yearly interest payable under deduction of tax. 24 25

Ward v Anglo-American Oil Co Ltd (1934) 19 TC 94. Corinthian Securities v Cato (1969) 46 TC 93.

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It was accepted that the original advance was, like all mortgages, a loan giving rise to annual interest, but Mr Cato, the mortgagor, argued that the Court order requiring interest to be paid for four months also involved annual interest from which he had deducted the tax. Corinthian said it was short as involving a new debt lasting only four months. The Court of Appeal (in a case involving tax of under £10!) agreed with Mr Cato. Lord Denning MR put forward the notion that annual interest was present if the loan was in the nature of ‘an investment’: Interest is ‘yearly interest of money’ whenever it is paid on a loan which is in the nature of an investment, no matter whether it is repayable on demand or not. An ordinary loan on mortgage is usually in point of law repayable at six months. But it is still ‘yearly interest of money’. On the other hand, when a banker lends money for a short fixed period, such as three months, and it is not intended to be continued, such a loan is not in the nature of an investment. It is not ‘yearly interest of money’, but a short loan. That is shown by Goslings and Sharpe v Blake.26

He said that the Corinthian loan was an investment. Cross LJ also said: Mr. Leckie submitted that, even if this were not originally a short loan, it became converted into a short loan either by the consent order of 16th July 1967 or by the arrangement made on 4th September 1968, which, he suggested, operated as a waiver by Mr Cato through his counsel of his right to deduct tax. In my view there is nothing in either of those points.27

But not even this case was the last word from the Courts, thanks to the Rossminster organisation. In a simple and bold scheme, Mr Cairns, an employee of Rossminster, borrowed £5,000 from Roy Tucker, the eminence grise of that organisation. He then borrowed about £37,000 from another Rossminster company and four days later paid the £5,000 he had borrowed to the lender as interest in advance for two years. He then novated the obligation to repay to another Rossminster company, paying £32,000, which ended up with the lender. He claimed that the £5,000 was annual interest to qualify for the then relief for annual interest in FA 1972 section 75. In Cairns v MacDiarmid the Court of Appeal held that the £5,000 was not interest at all, but even if it was, it was short interest.28 Sir John Donaldson MR said: It is well settled that the difference between what is annual and what is short interest depends upon the intention of the parties. Thus interest payable on a mortgage providing for repayment of the money after six months, or indeed a shorter period, will still be annual interest if calculated at a yearly rate and if the intention of the parties is that it may have to be paid from year to year (Bebb v Bunny (1854) 1 K & J 216 and Corinthian Securities Ltd v Cato 46 TC 93).

26 27 28

ibid 95. ibid 96–97. Cairns v MacDiarmid (1982) 56 TC 556.

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I would personally wish to avoid the use of the term ‘investment’ as providing any sort of test in the context of whether interest is annual interest, notwithstanding its use in the latter case, because it is possible to have a short term and indeed a very short term investment, eg over-night deposits, and such an investment does not involve any annual interest, regardless of whether the interest is calculated at an annual rate. On the facts found by the Commissioners, the loan to Mr Cairns was never intended to last for more than a few days, albeit he was entitled to postpone repayment for two years. In fact, as was always intended, his liability was discharged within the week, not by repayment but by novation. The payment of £5,000 was not therefore annual interest.29

This remains the last judicial word on the subject. There may be some dispute still about loans for less than a year which are rolled over on identical or very similar terms, and this was clearly a concern of HMRC in their 2012 Condoc.30 The cases discussed above show that businesses seeking to finance their activities with borrowed money frequently would face a difficult issue in deciding whether to deduct tax. They would not necessarily fear the Inland Revenue: what they would fear was the prospect of getting no relief for the payment if they failed to deduct and retain the tax. The attitude of the Inland Revenue was not very helpful, at least officially. Inland Revenue Manuals had for decades told Inspectors of Taxes that the question whether tax should be deducted was one only for the payer and payee, and this led to numerous disputes between them.31 But the Inland Revenue also seem to have adopted what we would now call extra-statutory concessions in relation to short interest paid to banks,32 and they also told Mr Cato, or so he said, that his interest was annual interest.33

HOW DOES THE PAYER KNOW THAT THE INTEREST IS BEING PAID OUT OF ‘PROFITS OR GAINS BROUGHT INTO CHARGE TO TAX’?

The essence of the deduction and retention scheme is that the payer recoups income tax from the payee that the payer has or will suffer on their own income. But the language of the retention of tax rule does not say anything so simple as that. Instead the requirement is that the payment of interest is payable out of the payer’s ‘profits or gains brought into charge to tax’. Many payers have gone, or been taken, to court, many to the House of Lords, in a bid to find what exactly this phrase meant. 29

ibid 581. See n 16 above. 31 And very many more between private payers and payees where annual payments, particularly alimony payments, were involved. 32 As in City of Edinburgh, n 20 above. 33 It was in the Inland Revenue’s interest that it was, as Mr Cato’s personal allowances were reduced as a result of the payment being annual interest. 30

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If the payment was found not to be out of profits or gains brought into charge to tax (PGBIT), then from 1842 to 1888 there was no right of deduction, and any tax deducted would have to be returned to the payee. The payer would then, if a trader, have to persuade the Inland Revenue that the payment was a proper deduction in arriving at Case I, the only other possibility of relief. From 1888, as a result of the enactment of the withholding tax rule the payer had to inform the Inland Revenue of payments not made out of PGBIT and to account to them for the tax. A number of ideas about the meaning of PGBIT have been advanced over the years. They include that: — PGBIT means gross receipts in the case of a trade: accepted by the Court of Appeal in Gresham Life Assurance Society v Styles, but overturned by the House of Lords;34 — PGBIT means only Schedule D profits or gains: dismissed as false by Lord Macnaghten in Attorney-General v London County Council;35 — if a person has no PGBIT in the year the interest is due, a stock of taxed profits of previous years can be brought forward to frank it: dismissed as false in Luipaards’s Vlei Estate and Gold Mining Co Ltd v Commissioners of Inland Revenue;36 — if a person has losses brought forward they must be set against the profits of the year to see if there are PGBIT: accepted in Trinidad Petroleum Development Co Ltd v Commissioners of Inland Revenue;37 — PGBIT of a year is the actual profits (computed in accordance with Rules of the Tax Acts) of the year: dismissed in Allchin v Corporation of South Shields;38 — PGBIT of the year is the lower of the actual profits of the year and the assessed profits (ie by reference to those of the previous year or a three years average): dismissed in Allchin. For an authoritative statement of what are PGBIT we have to turn to Lord Simon’s speech in Allchin’s case: The difficulty that remains to be solved arises from the fact that the figure at which profits or gains are assessed under Cases I and II of Schedule D are not normally the actual profits or gains of the year of charge, but a figure, formerly arrived at by averaging the profits or gains of three preceding years, and now arrived at by taking those of the preceding year. Yet, if an annual payment in any year is made

34 Gresham Life Assurance Society v Styles (1890) 2 TC 633 and (1892) 3 TC 185, respectively. 35 Attorney-General v London County Council (1900) 4 TC 265. 36 Luipaards’s Vlei Estate and Gold Mining Co Ltd v Commissioners of Inland Revenue (1930) 15 TC 573. 37 Trinidad Petroleum Development Co Ltd v Commissioners of Inland Revenue (1936) 21 TC 1. 38 Allchin v Corporation of South Shields (1942) 25 TC 445.

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‘out of profits or gains’ this suggests that it is made out of actual profits or gains and not out of a conventional figure arrived at from the past which is taken to represent them for taxing purposes. What, then, is the proper meaning to put on the phrase ‘payable wholly out of profits or gains brought into charge’ in [the retention of tax rule], and on the phrase ‘not payable, or not wholly payable, out of profits or gains brought into charge’ in [the withholding tax rule]? To give an illustration, if in a given year £900 of interest is paid away out of profits or gains and in that year the actual profits or gains of the payer are £1,000, while in the previous year they were £800, can the interest be regarded as wholly paid out of profits or gains brought into charge? … The ‘profits or gains brought into charge’ must, in my view, mean the actual profits of the year calculated with such deductions, additions, or allowances as the Income Tax law prescribes—the £1,000 in my illustration … This amounts to saying that tax is set off against tax, the tax deducted on paying interest against the tax charged for the same year on an assessed figure of profits or gains from which the interest payment has not been deducted … The proper interpretation of [the retention of tax and withholding tax rules] is to hold that annual payments paid in a particular year, which, if the profits or gains brought into charge for that year were large enough, would have been properly payable thereout, are to be treated as having notionally been paid out of the payer’s assessed income for that year, and the payer is to be allowed to deduct and retain the tax on the annual payments, provided that the amount so deducted and retained does not exceed the amount of tax payable by him in that year on his assessed income. Any such excess he may not retain but he must account for it to the Crown.39

Allchin was decided in 1943. It enabled businesses to know what they had by way of PGBIT. It also enabled them to know authoritatively whether the payments they made were paid out of PGBIT. Businesses were not generally in the position of local authorities (such as South Shields Corporation in Allchin, or the London County Council) who might have several ‘funds’ with taxable income, exempt income or a mix of each. So it might have been thought that it was a safe proposition that if the payment of annual interest was less than their PGBIT, businesses were safe to deduct and retain the tax. But this was not so. Allchin established that whether a payment was paid out of PGBIT was essentially an accounting question, and that the payer did indeed take the payment and the PGBIT and see if the former was no more than the latter. However, all was not sweetness and light for business. Despite the ‘real v notional’ comparison mandated by Allchin, there had to be some nexus between the real payment and the actual funds denoted by the notional amount of profits or gains.

39

ibid 461–63.

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A trio of cases involving the London Underground showed that where a company had issued debentures on the footing that, in accordance with the private Acts governing it, the interest would be charged to capital, the position was that, as a result of its deliberate decision, the company was not paying the interest out of its profits and gains of which it had sufficient to frank the payments.40 Thus it was that the withholding tax rule applied to require deduction and payment of the tax to the Inland Revenue. This was followed in Chancery Lane Safe Deposit & Offices Co Ltd v Commissioners of Inland Revenue, where the company had taken advantage of an accounting standard which allowed it to charge interest to capital on construction projects.41 Though there was nothing in the terms of the loans that required this, a sharply divided House of Lords held, by three to two, that the withholding tax rule applied. A powerful dissent by Lord Reid savagely attacked Lord Macmillan’s speech in Central London Railway and others and pointed out that tax should not depend on the way a company chooses to keep its accounts, but he was unsuccessful in getting his peers to overturn those cases. It followed that the company’s decision affected its tax liability to its detriment as it was unable to recoup the tax even though its profits and gains had been diminished by the payment. Appropriately the last word on this aspect is left to Lord Radcliffe who in Commissioners of Inland Revenue v Frere said: [A]nd it may well be asked what at this stage is the significance of the words ‘out of’ as applied to a payment, the obligation for which was merely the personal one to find the money required out of whatever resources the payer might mobilise for the purpose. The answer was provided by the application of what is in truth an accountant’s, not a lawyer’s, conception, for it was accepted that, so far as the payer was found to have in the relevant year a taxable income larger than the gross amount required to make the payment, to that extent he was entitled to claim that he had made the payment ‘out of profits or gains brought into charge’, and to deduct and retain for his own account tax at what in due course (after 1927) became the ‘standard rate’.42

AT WHAT RATE OF TAX DOES THE PAYER DEDUCT?

Given that tax is deducted from actual payments, it might be assumed that the rate of tax to be deducted was the standard rate applying at the date of payment. But inevitably in this area it is not as simple as that.43 40 Central London Railway Co Ltd v Commissioners of Inland Revenue; London Electric Railway Co Ltd v Commissioners of Inland Revenue; Metropolitan Railway Co Ltd v Commissioners of Inland Revenue (1936) 20 TC 102. 41 Chancery Lane Safe Deposit & Offices Co Ltd v Commissioners of Inland Revenue (1965) 43 TC 83. 42 Commissioners of Inland Revenue v Frere (1964) 42 TC 125, 148. 43 The whole paper owes a debt to Tiley, n 7 above, but this section more than most.

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The retention of tax rule, as it stood in the 1918 Act, provided that the payer ‘shall be entitled, on making such payment, to deduct and retain thereout a sum representing the amount of the tax thereon at the rate or rates of tax in force during the period through which the said payment was accruing due’. This was a changed wording from the 1853 version which specified the rate for when the payment was due (not paid) and the pre-1853 versions which specified the date of payment. ‘Accruing due’ is of course a difficulty if the rate changes during the currency of an accrual period: then the correct rate is a blended rate which will not be the rate applying in the year of assessment of the profits and gains. And if the payment is not made until after the year of assessment of the payment becoming due (as may easily happen if that date is, say, 24 or 31 March) and the rate changes, the deduction nonetheless is made at the accrued rate for the previous year. In FA 1927 the rate for income tax became the rate for the due date (bringing it into line with the surtax rule). But this change did not affect the position when payment was made in a later year than that of becoming due. The rate for the withholding tax rule, however, was ‘the rate of tax in force at the time of the payment’. The difficulty here, however, is illustrated by taking a case where retention of tax rule applied in the year the payment became due, but when it was paid in the next year the withholding tax rule should apply because of a lack of PGBIT. This was governed by Revenue practice and subsequently Extra-Statutory Concession A18.

WHAT ARE THE CONSEQUENCES IF THE DEDUCTION OF TAX IS NOT LEGALLY OR PRACTICALLY POSSIBLE?

In 1880/81 a claim had been made to deduct annual interest paid out of PGBIT in the circumstances where debentures were issued by a company whose operations were all abroad and where the debentures were charged on the foreign property of the company and paid to natives of the country. No tax was deducted (or retained) for what seem to have been practical and legal reasons, but could also have been because the payments did not have a UK source and so did not come within Case III. The claim was rejected in Alexandria Water Co Ltd v Musgrave.44 That case was heard in 1883 and the judges in the High Court acknowledged the hardship it would cause. It cannot have been a unique example of the problem, because the early volumes of Tax Cases are replete with cases where a UK resident company’s sole activities are a trade carried on wholly abroad and it does not seem likely that in every case debt finance was raised in London rather than locally. But it should not be said that the Inland Revenue 44

Alexandria Water Co Ltd v Musgrave (1883) 1 TC 521.

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and the government are slow to act when a real injustice is pointed out. It took only another 66 years before remedial legislation was introduced as section 23 of FA 1949. The Notes for the Guidance of Inspectors on provisions relating to Income Tax in the Finance Act 1949 say of section 23: Section 23 gives relief to concerns controlled in the United Kingdom and operating abroad from the hardship (illustrated by the case of Alexandria Water Co Ltd v Musgrave, 1 TC 521) caused by the disallowance of annual interest payable out of the profits in computing trading profits for Case I of Schedule D, in cases where the concern is not able to deduct United Kingdom income tax in paying the interest abroad to non-resident persons, because of the local law governing payment.

After setting out the terms of the section, the Notes go on: The relief provided by this section will give assistance to UK concerns operating abroad which, owing to foreign exchange and other financial restrictions met with today in certain countries, may have to borrow abroad rather than in this country. The profits made by these concerns assists this country’s foreign exchange position, and the Income Tax relief given by this section removes the deterrent effect of the present rule where such concerns are able to extend their trading operations abroad by the use of further loan capital raised abroad.

It seems that it was the effect after the Second World War of exchange restrictions (and the United Kingdom’s own came along in 1949) and the need to encourage overseas investment that prompted the government to act and not any complaints of hardship by the businesses affected. In the introduction to this chapter, a qualification of the 1803 and 1806 Acts was mentioned. This was a tailpiece to the ‘no deduction in Case I’ rule giving an exception for ‘the Interest of Debts due to Foreigners not resident in Great Britain, or in any other of His Majesty’s Dominions’. It was not reproduced in the 1842 Act: had it been it would probably have been available to the Alexandria Water Company.45

WHAT ARE THE DEDUCTIBILITY ISSUES IF THE INTEREST IS NOT ANNUAL INTEREST PAID OUT OF PGBIT?

It is clear that annual interest paid is given relief from tax by a combination of the retention of tax rule and the no deduction in Case I rule. That relief is given in effect against total income. 45 Assuming that Egypt was not a ‘Dominion’. It appears that in 1803 a ‘dominion’ was any territory subject to the Crown. Mention should also be made of a provision, introduced in FA 1914 s 5, that allowed a deduction for annual interest from (and when paid out of) income charged under Case IV and some income charged under Case V so long as the income had not been remitted to the United Kingdom but had been charged on the arising basis. This rule would not have helped the Alexandria Waterworks Co as it did not apply to a trading activity charged under Case V, and in any event it was extremely difficult for a single entity to have a Case V trade while retaining UK residence.

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Short Interest From 1842 (and in the earlier days of income tax) to 1888, interest that was not annual interest was not the subject of any express legislative treatment. It can then be confidently said that such interest could be deducted in computing the profits of a trade, unless one of the Rules of Case I applied. As originally enacted the withholding tax rule provided: (3) Upon payment of any interest of money … charged with income tax under Schedule D, and not payable, or not wholly payable, out of profits or gains brought into charge to such tax, the person by or through whom such interest … shall be paid shall deduct thereout the rate of income tax in force at the time of such payment, and shall forthwith render an account to the Commissioners of Inland Revenue of the amount so deducted … and such amount shall be a debt from such person to Her Majesty, and recoverable as such accordingly. (emphasis added)

What is notable is that the rule applies to ‘any interest’, not just ‘annual interest’. In City of Edinburgh, the Inland Revenue had argued (in addition to whether the interest was short) that the withholding tax rule should be interpreted literally to include short interest as well as annual interest. The Court of Session agreed, despite the forceful arguments of the City Council that: the principle contended for by the Crown would lead to great practical inconvenience, particularly in the case of short loans obtained from bankers. That may be; but it cannot effect the construction of the Statute, nor does it follow that the revenue Authorities will always insist on their full rights. Indeed, their concession in Answer 4 shows a desire to avoid causing unnecessary trouble. The defenders also suggest that, as regards by much the larger proportion of the claim, the Crown is seeking to exact payment of income tax a second time. That, of course depends on facts and figures which are not before me, and nothing which I now decide can form any warrant for so inequitable a result.46

‘Answer 4’ included this: It is the case that in practice bankers are assessed as traders upon their profits from interest on short loans, and if information be supplied by the defenders shewing that the parties to whom promissory notes were issued or acknowledgements were granted within the period libelled were bankers, the Corporation will not be required to deduct tax from the discount or interest in these cases.47

It is clear that the decision in City of Edinburgh stood as correct for a long time, because in Commissioners of Inland Revenue v Frere Lord Radcliffe said: It is true that in Lord Advocate v Lord Provost, Magistrates and Council of City of Edinburgh, 4 TC 627, the Court of Session decided that ‘interest’ [in Customs and Inland Revenue Act 1888 s 24(3)] covered short interest. The decision itself 46 47

City of Edinburgh, n 20 above, 641. ibid 634.

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has stood for a long time and had better therefore be left alone, but I am bound to say that I think it a singularly ill-judged one, for how in practice can anyone paying short interest on, say, 24 hours’ or 7 days’ money detect at the time of payment whether he is paying it out of profits or gains brought into charge (in which case he has neither right nor duty to deduct), or out of a source which is not such a profit (in which case he is under a statutory duty to deduct and account)?48

City of Edinburgh was heard by the Court of Exchequer Causes in 1903. It did not involve any Case I question. In Scottish North American Trust, the company borrowed short term from bankers to buy shares and other assets which it sold quickly and from the proceeds repaid the loans. The arguments before the General Commissioners were thus: II. For the Company it was contended that the item of interest paid to bankers in New York is not liable to tax, and should therefore be deducted before arriving at the net profits assessable for income tax. The interest in question is not annual interest payable out of the Company’s profits or gains within the meaning of Rule 4 to Case I, of Schedule D. It is a disbursement or expense incurred by the Company in the Company’s business, and allowable by Rule 1 to Cases I and II of Schedule D. It is contrary to the whole scope of the Income Tax Acts to treat the interest accruing to an American citizen from advances over property in America as taxable merely because the owner of the property is resident in the United Kingdom. The assessment also is entirely opposed to the principle of taxation at the source. That principle presupposes the right of the person paying the tax in the first instance to recoup himself from some other person. In this case the Company maintains that there is no liability upon it to tax, as the interest is deducted by the lenders from dividends on securities in their own hands, and the Company has no opportunity of deducting the tax on paying the interest. III. The Surveyor of Taxes (Mr Richard Farmer) maintained: (1) That the interest in question was interest upon capital employed in the business of the Company, and that, therefore, by reason of 5 & 6 Vict. c. 35, s. 100, Case I, Rule 3, it could not be set against or deducted from the profits of the said business.49

The decision was: IV. The Commissioners, on consideration of the facts and arguments submitted to them, were of opinion that the interest paid to bankers in America was not a legal deduction for income tax purposes, and accordingly they refused the appeal and confirmed the assessment.50

In the Court of Session the company’s appeal was successful. This was on the ground that the facilities were ordinary banking facilities by way of overdraft. When the case went to the House of Lords, they had no difficulty in upholding the Court of Session. Any suggestion that the loans were 48 49 50

ibid 153. Scottish North American Trust, n 22 above, 696. ibid 696.

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annual was dismissed summarily, but the Lords had to deal with the contention of Inland Revenue that they were nonetheless disallowed by: Rule 3 [the ‘prohibition of capital’ rule] on the ground (1) that the debit balance against the Company on their current account, as well as the loans made on the loan account, constitute ‘sums employed or intended to be employed as capital’ in the Respondent’s trade or business; and (2) that the interest paid by the Respondents to the bank in respect of these loans comes within the words of the rule as deductions ‘for’ the sum so employed as capital.51

In support the Revenue cited the case of Anglo-Continental Guano Works v Bell.52 The appellant was the UK branch of a German company which borrowed from its Head Office in Hamburg (held not to be interest at all as paid within the same legal entity) and also borrowed from bankers on the basis that the interest was short (as exemplified in the Goslings & Sharpe case). The judges in the High Court in Anglo-Continental Guano appear to have totally misunderstood the issue and in the Court of Session in City of Edinburgh the judges had equally had problems. In the House of Lords Lord Atkinson said: What was decided in [Anglo-Continental Guano Works] was that the sum paid for interest on these loans could not be deducted under Rule 3, on the ground that the money borrowed was employed as capital, and that this interest was a sum deducted ‘for’ this capital; but the case was treated as if it were a case between partners engaged in a partnership business, one or all of whom is or are trading with borrowed capital.53

However, in Scottish North American Trust the ‘prohibition of capital’ rule did not apply. As explained above, the Finance Acts of 1915 and 1917 introduced the ‘short interest relief’ rules. These were general reliefs, ie it did not matter what the nature of the income was that had suffered the tax for which relief was claimed. But even after the enactment of the short interest relief rules, there remained nothing explicit in the Case I rules prohibiting a deduction for short interest in computing profits. Modern day thinking would say that a trading expense would come before a general relief, and indeed this was what Rowlatt J held in Wm H Muller & Company (London) Ltd v Commissioners of Inland Revenue,54 where the company had deducted short interest in its accounts and had not added it back in its tax computation, but it seems that at least until the advent of Corporation Tax, businesses were 51 ibid 696. The General Commissioners had also stated in their succinct decision that ‘[they] were also of the opinion that the sums of money raised by loan and overdraft, as shown in I, were utilised as additional capital’. 52 Anglo-Continental Guano Works v Bell (1894) 3 TC 239. 53 Scottish North American Trust, n 22 above, 708. 54 Wm. H Muller & Company (London) Ltd v Commissioners of Inland Revenue (1928) 14 TC 116.

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allowed a choice of routes to relief. Thus if they had a trading loss without the relief for interest but other taxable income, they would apply the short interest relief rule, adding back the interest in a Case I computation. The ‘prohibition of capital’ issue surfaced again, however, in European Investment Trust Co Ltd v Jackson.55 The company was financed by share capital of £100 by its American parent. Its business was selling cars on hire purchase terms. To finance the purchases of the cars it borrowed £10 million plus on similar terms to an overdraft, money being repaid as the car was sold and as the instalments started coming in. The interest was agreed as being short. The Court of Appeal had no difficulty in finding that the interest was not allowable because of the ‘prohibition of capital’ rule. Slesser LJ said: the question [the General Commissioners] had to consider, in the first place, was this: under Rule 3(f), was the sum ‘employed or intended to be employed as capital in such trade, profession, employment or vocation?’ They have come to the conclusion that ‘the interest paid to the Finance Corporation of America was not an admissible deduction for Income Tax purposes, as the moneys advanced by the Finance Corporation of America were, in our opinion, moneys employed, or intended to be employed, as capital in the trade’. In my view, the only possible way in which it could be said, in the circumstances of this case, that that finding was erroneous in point of law, would be that, on the facts stated by them, it was impossible to come to that conclusion. In my view, there was ample material on which they could, if they wished, come to that conclusion.56

Many learned commentators have had difficulty with this decision: how does the fact that the sums advanced were capital in the sense of capitalising the business lead to the conclusion that the interest on them is ipso facto capital? But it became the law. One explanation for the decision is that it reflects a strain of thinking in the Inland Revenue and the Courts that it was unfair to discriminate between share capital and loan capital. We can see that in Gresham Life where Lord Herschell comments on another case cited there, Alexandria Water Company Ltd, thus: I do not think this, view conflicts with the decision in the case of the Alexandria Waterworks v Musgrave [sic]. The payments of interest to the debenture holders were made out of the profits. These were ascertained by deducting from the moneys earned the expenses incurred in earning them, and of these expenses the payments to the debenture holders formed no part. A portion of the capital was raised by Shares, and another portion by debenture. There was no more reason why interest on the debenture capital should be deducted from the profits than interest on the share capital. Supposing the whole capital had been raised by shares there would have been no pretence for making any such deduction, and the profits

55 56

European Investment Trust Co Ltd v Jackson (1932) 18 TC 1. ibid 15.

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earned by the adventure could not be different, according as the capital was raised wholly by shares, or partly by shares and partly by debentures. It is by no means clear that the case was not within the prohibition of the third rule.57

And in the Anglo-Continental Guano Works case, Cave J said: It is contended by Mr Finlay that in order to ascertain the balance of profits or gains of such trade you must take into consideration the question whether the trader is trading with borrowed money, or with the capital of his own. It seems to me that that is not so—that the gains of the trade are quite independent of the question of how the capital money is found, that the gains of the trade are those which are made by legitimate trading after paying the necessary expenses which you have necessarily to incur in order to get the profits; and that you cannot for that purpose take into consideration the fact that the firm or trader has to borrow some portion of the money which is employed in the business. If you did that it would land you in very extraordinary results.58

And the no deduction in Case I rule which disallowed as a deduction annual interest paid out of PGBIT was seen by judges as having the same purpose as the prohibition of capital rule, namely, to deny any relief for capital matters. The European Investment Trust case can also be seen as the first expression of a ‘thin capitalisation’ approach, given the disparity between the company’s equity (£10) and its debt (£10 million). This whole line of thought, though, is problematic for two reasons. One is that the no deduction in Case I rule does not prevent a business from obtaining the equivalent relief through the retention of tax system. What may be retained can indeed represent tax on income other than trading income and can be seen as a general relief for interest along the lines of the 1799 rule, or indeed the short interest rules. And the second problem is the assumption that treating the interest as disallowable in a trading computation does equate the position to that of share capital. Assume that a company has £10,000 profits and no debt. It pays say 10 per cent income tax (£1,000) and resolves to distribute £10,000 to shareholders. The company pays £9,000 to the shareholders and treats £1,000 as having been deducted from a gross dividend of £10,000. The shareholders are treated as receiving £10,000 less £1,000 tax and have no further liability to income tax.59 Overall £1,000 tax has been paid to the Inland Revenue (taking company and its shareholders together). Assume now that a company has £10,000 profits before annual interest payable of £10,000. It pays 10 per cent income tax (£1,000) (because of the no deduction in Case I rule) and pays the interest after a deduction of £1,000 which it retains. The payees have no further liability. The company

57 58 59

Gresham Life Assurance Society, n 34 above, 196. ibid 245. The question of liability at graduated higher rates after 1910 is ignored.

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has paid £1,000 income tax but retained £1,000 making the net liability to the Inland Revenue nil (taking company and its shareholders together). This is not the same outcome.60 Debt capital, so long as the interest on it is paid out of PGBIT, was more tax efficient than share capital.

Annual Interest not Paid Out of PGBIT The no deduction in Case I rule had no application to such interest. So there was no express bar to a deduction. But no one reading European Investment Trust could be in any doubt that the Inland Revenue would have opposed a deduction on the grounds that the interest was ‘capital’, and no one seems to have tried their luck. It is conceivable that if a company had (just about annual) interest on the type of borrowings and activity that characterised Scottish North American Trust, they might have succeeded. So for a company with no PGBIT there was no relief (and Chancery Lane shows that a company can have PGBIT but still not get relief if the interest is not paid out of it). Some relief was, however, granted by FA 1928 section 19, so that where a payment is made and tax deducted under Rule 21 as not being out of PGBIT, but is in respect of a trade, etc and the tax is paid, the payment: shall, for the purposes of the [loss carry forward rules] be treated as though it were a loss sustained in that trade, profession or vocation…: Provided that no relief shall be allowed under this section in respect of any such payment or any part … which is charged to capital.

That does not help the Central Railway and others or Chancery Lane-type case. It assumes that the payer will have no trading profits before annual interest paid (likely to be the case or it would have PGBIT)61 and that the annual interest cannot be deducted in computing the trading loss (presumably because of the prohibition of capital rule). If that is the case, then quite what the rationale was for allowing the creation of a loss to carry forward and so giving a relief in later periods that the prohibition of capital rule would deny is not obvious.

TREATMENT OF OTHER COSTS (AND PROFITS) OF DEBT

Interest is not the only expense associated with debt capital. Most debt finance involves a variety of expenditure when it is first raised, varying according to whether it is a simple loan from an associated company or 60 A smaller amount of debt, leaving some post-tax profit to be distributed, will show a smaller discrepancy between the post-tax outcomes, but will never equate to all equity treatment. 61 Not necessarily, though. It might have trading profits and short interest relief set against them.

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a bank loan up to a listed debenture. Servicing the loan may involve costs, especially if there are coupons involved, and there will be costs involved in repaying it, and for example negotiating changes in the terms as to repayment, etc. Where the debt is denominated in a currency other than sterling there are other issues relating to exchange gains. There have been a number of cases dealing with such incidental and related expenditure and the income tax treatment of them.

Incidental Expenses In Texas Land & Mortgage Co Ltd v Holtham, a company issued certain debentures and debenture stock.62 The expenses of the issue and placing of such debentures and debenture stock consisted of commission and fees paid to agents and brokers for placing debentures and debenture stock, stamps on debentures and postage and printing, advertising and law charges. In the High Court the company’s claim was dismissed in a few lines. In those lines Mathew J said: The amount paid in order to raise the money on debentures, comes off the amount advanced upon the debentures, and, therefore, is so much paid for the cost of getting it, but there cannot be one law for a company having sufficient money to carry on all its operations and another which is content to pay for the accommodation. This appears to me to be entirely concluded by the decision of yesterday.63

There was writing on the wall for the company, as Cave J is reported as saying to the company’s counsel ‘It is only so much capital. A man wants to raise £100,000 of capital, and in order to do that he has to pay £4,000. That makes the capital £96,000. That is all.’64 There is, however, no evidence in the report of how the expenses were actually accounted for. Nor is any particular rule of Schedule D mentioned as governing the matter: it might be inferred that it was the prohibition of capital rule. In Small v Easson, the Appellant was the sole proprietor of a business carried on in premises of which he was the owner.65 The premises were subject to certain bonds (ie charges by way of mortgage), one of which was called up upon the death of the bondholder, but was ultimately taken over, after a partial repayment, by a beneficiary of the deceased bondholder. In connection with the transfer of the bond certain legal expenses were incurred by the Appellant. The Court of Session disallowed these expenses as being capital and not for the purposes of the trade carried on in the premises. 62

Texas Land & Mortgage Co Ltd v Holtham (1894) 3 TC 225. ibid 260. The ‘decision of yesterday’ referred to by Mathew J is Anglo-Continental Guano Works, n 52 above. 64 Texas Land & Mortgage Co Ltd, n 62 above, 260. 65 Small v Easson (1920) 12 TC 351. 63

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In Ward v Anglo-American Oil Ltd, the company contended that certain notes lasting exactly one year were temporary loans, and that (inter alia) the expenses of issue of the notes and the amount of exchange adjustments an admissible deduction in computing its assessable profits. Singleton J in the High Court overturned the General Commissioners who had given no reasons for allowing the appeal—but he considered only the question of interest. Since he found that the interest was not allowable by virtue of the prohibition of capital rule, he must have decided that the expenses and exchange differences were also within that rule. In Duff v Ascot Water Heaters Ltd, the company paid commissions to the guarantors of loans.66 One of the commissions was disallowed by virtue of the prohibition of capital rule, the crucial issue being the nature of the finance being guaranteed. In Whitehead v Tubbs (Elastics) Ltd, the company paid an amount to remove onerous conditions from a loan agreement with ICFC.67 The Court of Appeal held, dismissing the company’s appeal, that there were two enduring advantages achieved by the payment: (1) the alteration in the terms affecting the loan capital which removed the restrictions imposed by the 1975 agreement; (2) the release of the charges on assets which made them immediately available for raising further loan capital if required. Thus, the expenditure was not allowable by virtue of the prohibition of capital rule, even though shown in the company’s profit and loss account.

Exchange Gains and Losses on Debt Finance In Firestone Tyre & Rubber Co Ltd v Evans, an English subsidiary company discharged a pre-1931 debt to its American parent company during the accounting period ended 31 October 1965.68 The debt was calculated by converting various dollar liabilities to sterling at the dates when the respective component debts were incurred at the exchange rate of US$4.86 to the £, but when the debt was repaid, the exchange rate had fallen to US$2.80. The subsidiary claimed it had incurred an allowable loss for Case I purposes when discharging the debt, by the purchase of dollars at this rate of exchange. The company agreed that if the debt were capital the exchange loss was disallowable. Templeman J held that the Commissioners were entitled to find that 90 per cent of the debt was capital and that that percentage of the exchange loss was disallowable.

66 67 68

Duff v Ascot Water Heaters Ltd (1942) 24 TC 171. Whitehead v Tubbs (Elastics) Ltd (1983) 57 TC 472. Firestone Tyre & Rubber Co Ltd v Evans (1976) 51 TC 615.

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In Pattison v Marine Midland Ltd, a bank had a matched position with the liability being 10-year subordinated loan stock issued to its parent.69 In the High Court, Vinelott J found this was capital and so the exchange loss not allowable by virtue of the prohibition of capital rule. The point was far from moot in Beauchamp v FW Woolworth Ltd, where the House of Lords had no difficulty in holding that a five-year loan was capital and the exchange loss disallowable.70

ALTERNATIVES TO LOAN FINANCING NOT INVOLVING INTEREST

A debtor usually rewards a creditor by paying interest. But in some cases the reward may come from a discount (the difference between the face value of a debt and its issue or subscription price) or a premium (an amount by which the payment on redemption (not including express interest) exceeds the issue price). And the reward may come from a combination of all three. UK tax law as it applies to creditors developed a reasonably clear answer to the question whether the creditor is chargeable to tax on income in respect of a discount or premium. Cases such as Lomax v Peter Dixon Ltd, Ditchfield v Sharp and Willingale v International Commercial Bank Ltd show that a discount is taxable both on realisation and on sale, especially if there is no interest.71 A premium is interest if (taken with any express interest) the annual yield represented by it is not in excess of a ‘normal commercial’ rate. In relation to debtors there are, however, very few cases. In Arizona Copper Co Ltd v Smiles, the company borrowed money at interest and also covenanted to pay a 10 per cent bonus on redemption.72 The High Court held this was not deductible, though the grounds are not clear. In EJ Bridgwater and WH Bridgwater v King, the Appellants, who carried on in partnership the business of estate developers, required finance to acquire and develop an estate.73 They obtained a loan of £15,000 from a company at 5 per cent interest. The loan was secured by a legal charge which provided for the repayment of the loan with a premium or bonus of £6,500. In March 1938, the company, being anxious to obtain repayment of the outstanding balance of the loan, agreed to accept repayment with a reduced premium of £4,000. The partnership claimed to deduct the premium but the Special Commissioners held it was disallowable, being expressly forbidden 69

Pattison v Marine Midland Ltd (1983) 57 TC 219. Beauchamp v FW Woolworth Ltd (1989) 61 TC 542. Lomax v Peter Dixon Ltd (1943) 25 TC 353; Ditchfield v Sharp (1983) 57 TC 555; and Willingale v International Commercial Bank Ltd (1978) 52 TC 242. 72 Arizona Copper Co Ltd v Smiles (1891) 3 TC 149. 73 EJ Bridgwater and WH Bridgwater v King (1943) 25 TC 385. 70 71

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by the prohibition of capital rule. The High Court upheld this as a question of fact for the Special Commissioners, adding that it was clear that the accommodation was not temporary. What can be taken from these two cases is that a premium in excess of a commercial rate of interest is capital and disallowable. This fits the pattern with receipts where, in accordance with Lomax v Peter Dixon Ltd, such a premium received is also capital. Since that case also established that a premium received where no express interest, or less than a commercial rate, is received, is itself interest (not just income) it is to be assumed that all the provisions relating to annual interest will apply to such a premium. In the case of a discount on short-term financing such as a commercial bill of exchange or on the factoring of trade debts, it can be assumed that such a discount would be allowable (probably when suffered). In the case of a discount on a capital financing the discount would be disallowed by the prohibition of capital rule. An asset may also be put into use on terms that payments are made for the use of the asset under a contract of bailment, but which in amount represent the same cash flows as would arise on an amortising loan to acquire the asset. In the period between 1842 and 1965 the predominant form of this type of financing was hire purchase, where the hirer has an option to buy the asset, usually for a minimal sum once all payments have been made. The total of the payments will usually equal the immediate purchase value of the asset plus a return on the seller’s investment equivalent to interest, and in modern hire purchase agreements the sum for the asset and the ‘interest’ element will be spelled out separately. The treatment of the hire payments in the tax return of the hire-purchaser (the ‘borrower’) was established in Darngavil Coal Co Ltd v Francis.74 There, the total hire payments were shown as expenses in profit and loss account and nothing was capitalised in respect of the assets (railway wagons). The case stated reveals why the case came to court: Prior to 29th May 1909, at which date the Secretary of Inland Revenue, Somerset House, London, issued to HM Surveyors of Taxes the circular75 of which a copy was produced to the commissioners and of which an excerpt is annexed hereto, it was the practice of HM Surveyors of Taxes to allow to the tax payer as a deduction in ascertaining profits chargeable under Schedule D of Section 100 of the Income Tax Act, 1842 that portion of the payments made under agreements similar to the one annexed hereto which the Wagon Finance Companies certified that they had treated as revenue, depreciation being allowable on that portion of the payments which had not been so treated as revenue. Subsequent, however, to that date, no such deduction in ascertaining profits has been admitted the whole

74

Darngavil Coal Co Ltd v Francis (1913) 7 TC 1. The circular to the Surveyors deals with all types of transaction involving railway wagons, and not just hire purchase. 75

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payments under the agreements having been regarded by the Crown as payments of capital which should be treated as part of the cost price be taken into consideration in calculating the annual allowance for wear and tear. The present Appeal has been taken in Consequence of the departure indicated in the circular from the practice which formerly prevailed.76

Before the General Commissioners, the company argued for a deduction for the complete hire payments, or if that failed, a deduction for so much of the hire payments as exceeded the depreciated value of the assets at the date of exercise of the option to buy. It based its arguments on the correct legal nature of a hire purchase contract as one of bailment. The Inland Revenue argued for no deduction at all, as the payments represented capital—even the excess over the immediate purchase price was simply an inflated value to recoup the vendor for exceptional credit. It pointed out that the capital nature of the payments ‘becomes even more apparent when the aggregate thereof is compared with the ordinary purchase price of the wagons’.77 The Commissioners found for the Revenue, disallowing the whole of the payments, but in the Court of Session, the Revenue’s attitude as exemplified in the circular was strongly disapproved of: But matters were altered by a circular, which is also printed in the Case, which was sent by the Secretary of the Inland Revenue to the Surveyors of Income Tax, and which practically instructed them in very dogmatic terms that no allowance was to be allowed at all, because all such instalments were not hire at all, but were merely payments towards purchase. My Lords, I must say that I think it is really very much to be regretted that circulars of that sort should be sent forth without taking the advice of the Law Officers, and I think the proof of that has come very much in this case, where the Law Officers, perfectly properly, have found themselves really practically unable to support, without talking nonsense, the contention of the Surveyor.78

This did not bode well for the Surveyor, and in short order Lord Dunedin, Lord President, held: there are two things going on concurrently—there is a sale and purchase agreement under certain term—not a sale at the present moment, but an option on certain terms on a future date to have a sale—and on the other hand there is also concurrent with that a hiring agreement. Now, it is equally clear that so far as the Coal Company have the use of the wagon by the hiring of it during that time, that is a properly deductible expense, just as if the Coal Company had no wagons at all but simply hired their wagons from day to day, in which case it would be a certainly deductible expense. It is equally clear, I think, that they could not claim

76 77 78

Darngavil Coal Co Ltd, n 74 above, 3. ibid 5. ibid 11.

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to deduct the whole of what they paid to the Wagon Company, because a large portion of what they paid is really a payment for an option at a future date to get a wagon at a sum that is far under its real value.79

Lord Mackenzie, in the only other judgment that was more than a concurrence, added: My Lord, I entirely concur. The difficulty has been caused by the issue of a circular addressed by the Secretary of the Inland Revenue to Surveyors of Income Tax. That circular is headed, ‘Hire Purchase, Redemption Hire or Deferred Payment System’, and it sets out ‘No part of the quarterly or other instalments (called ‘rent’) is a payment of interest or a payment of simple hire, and it should not be treated as such or allowed as a deduction.’ We are here dealing with an agreement which is a hire purchase agreement, and the Law Officers of the Crown have admitted that it is impossible to maintain an argument consistent with the circular which I have just read.80

The case was remitted to the Commissioner to make the split. In Rose Smith & Co Ltd v Commissioners of Inland Revenue, there was a claim to error or mistake relief.81 The answer turned on the ‘prevailing practice’ let out, and in this connection the Special Commissioners said: Shortly stated, the excess was due to the following cause: the Company held a number of railway wagons under hire purchase agreements. The payments made under such agreements are made at a uniform annual rate, but it is admitted that they contain both capital and revenue (or hire) elements and that the hire element should be deducted in calculating profits for Income Tax purposes. The hire element may be ascertained by accounting methods, the value of the wagons at the dates of the hire purchase agreements being deducted from the total payments under the agreements and the resulting difference, which is the hire, spread evenly, or averaged, over the years of the agreements, or it may be calculated actuarially, and, when so calculated, it is greater than the average in the earlier and less in the later years of the agreements. The Company had adopted the first, or ‘even spread’, method in its accounts and it had not claimed or obtained as large deductions for hire as it now claimed to be entitled to for the years in question. A statement is appended to this Case giving the figures of the Company’s claim.82

The Inland Revenue Inspector’s Manual of 1997 states that: In commercial reality a hire purchase contract is one of sale and purchase of goods, and the agreement is a means of financing the transaction. The payment for ‘hire’ or ‘interest’ is the difference between the sum of all the instalments under the agreement and the cash sale value of the asset at the date of the agreement. This 79 80 81 82

ibid 11. ibid 12. Rose Smith & Co Ltd v Commissioners of Inland Revenue (1933) 17 TC 586. ibid 587.

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‘hire’ or ‘interest’ element should be spread evenly over the term of the agreement. The accountancy treatment recommended in Statement of Standard Accounting Practice No 21 recognises the commercial reality, and the tax treatment should be consistent with the accounting basis used. If the asset is purchased outright or is returned to the owner, the ‘hire’ or ‘interest’ payments under the agreement will cease.

It is clear that the hire charge element in the dissected instalments is not treated as if it were actually interest: the Revenue Circular said as much.83 Indeed until 1965, and often afterwards, the hirer would prefer not to have the payment treated as interest as this would be annual interest and to get relief the hirer would have had to deduct and retain tax. And, of course, actual yearly interest on a hire purchase contract would also have been disallowable as capital. But there seems to be no evidence that the Inland Revenue took the ‘capital’ point in relation to the ‘interest’ element of a hire purchase contract.

DEDUCTING INTEREST IN A TRADING COMPUTATION IN OTHER TAXES ON PROFITS

For decades the income tax was the only tax on business profits. This changed with the advent of the First World War, and from then on there was, apart from the period between 1924 and 1937, one or more other taxes based on profits. These taxes were additional to the income tax, which continued alongside them. For each of them the question that arose was how the profits of a business were calculated: and for each of them the answer was to adopt income tax rules, those applicable to Case I of Schedule D, with adaptations.

Excess Profits Duty (EPD) The first of these taxes was the Excess Profits Duty introduced by the Finance (No 2) Act 1915. Schedule 4, Part 1, paragraph 2 to that Act provided: The principle of the Income Tax Acts under which deductions are not allowed for interest on money borrowed for the purpose of the trade or business, or for rent, or royalties, or for other payments income tax on which is collected at the source (not being payments of dividends or payments for the distribution of profits) … shall not be followed. 83 A version of the Inland Revenue practice on ‘Railway wagons being acquired under hirepurchase agreements’ apparently issued to the public refers to an allowance for the hire element of the payments being given in annual amounts ‘equal to the “interest” included in the respective instalments’: Leaflet No 175 (July 1938).

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Corporation Profits Tax (CPT) The Corporation Profits Tax was designed as a permanent replacement for EPD at a lower rate. But it lasted only from 1920 until 1924. FA 1920 section 50(2) provided: Subject to the provisions of this Act, profits shall be the profits and gains determined on the same principles as those on which the profits and gains of a trade would be determined for the purposes of Schedule D set out in the First Schedule to the Income Tax Act, 1918, as amended by any subsequent enactment, whether the profits are assessable to income tax under that schedule or not: Provided that … (b) deductions shall be allowed in respect of interest on money borrowed for the purposes of the company … so, however, that no deduction shall be allowed in respect of … interest on money borrowed from a person having a controlling interest in the company, whether directly or indirectly, or whether solely or jointly with other persons, or in respect of interest paid on permanent loans.84

Profits Tax (Formerly National Defence Contribution) (NDC/PT) This was introduced in 1937 as an additional tax on companies. Again we find in FA 1937 Schedule 4 paragraph 4: The principles of the Income Tax Acts under which deductions are not allowed for interest, annuities or other annual payments payable out of the profits … shall not be followed: Provided that nothing in this paragraph shall authorise any deduction in respect of … (b) any interest … paid to any person carrying on the trade or business …

Section 14 of the Finance (No 2) Act 1940 refined this rule so that: (1) No deduction in respect of any interest … shall, by virtue of … paragraph 4 of the Fourth Schedule to the Finance Act, 1937, be allowed in computing the profits of a trade or business for the purposes of … the national defence contribution unless the interest … would, on income tax principles, be an allowable deduction in computing profits but for the express provision contained in [the no deduction in Case I rule].

84 ‘Permanent loan’ was defined in s 52 as ‘a loan of a permanent, character which is secured by mortgage or debentures or otherwise on the assets or income of a company and which, if subject to repayment, is subject to repayment at not less than three months’ notice.’

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Excess Profits Tax (EPT) This was a Second World War excess profits tax similar to the EPD. The provisions as to computation and for interest were initially the same as those for NDC/PT with the exception that no restriction applied where interest was paid to the proprietor.

Excess Profits Levy (EPL) This was a one-off excess profits tax in 1952 (to pay for the Korean War). It generally followed EPT, but the rules for computing profits were the NDC/PT rules. This was subject to FA 1952, Schedule 9, paragraph 7, which provided: The profits or losses shall be computed as if: (a) paragraph (b) of the proviso to paragraph 4 of the Fourth Schedule to the Finance Act, 1937 (which, amongst other things, excludes deductions for any interest … paid to certain directors…) had never formed part of the said paragraph 4.85

As one might expect, these provisions show an increasing sophistication over the years. The EPD provision is seemingly targeted only at the no deduction in Case I rule. But it also seems to lift a prohibition on annual interest not paid out of PGBIT (as there is no reference to PGBIT) even though there was apparently no such prohibition. However, it says nothing at all about the prohibition of capital rule, so that apparently remained in place though it was not at that stage clear that it was Inland Revenue policy to seek to apply that rule.86 This seems to be borne out by the express prohibition in CPT of a deduction in Case I for interest on a permanent loan. The only decided CPT case which addressed the definition is Commissioners of Inland Revenue v City of Buenos Ayres Tramway (1904) Co Ltd, where Rowlatt J merely said that the company’s debenture stock (payable after 80 years and charged on the assets of the tramway) was a permanent loan.87 In a throwaway remark in Commissioners of Inland Revenue v Mashonaland Co Ltd, Rowlatt J seems to be referring to tax law’s unease at making sharp distinctions between equity and debt capital at that time.88

85

FA 1937 Sch 4 para 4 also applied, by a different legislative method, for EPT. But in 1915 it could hardly be said that the application or otherwise of Rule 3 to annual interest was clear, given the only decided case at the time was Anglo-Continental Guano Works, n 52 above. 87 Commissioners of Inland Revenue v City of Buenos Ayres Tramway (1904) Co Ltd (1926) 12 TC 1125. 88 Commissioners of Inland Revenue v Mashonaland Co Ltd (1926) 12 TC 1159, 1168. 86

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Again, it seems possible that given the uncertain state of the law on the application of what had become the prohibition of capital rule, the CPT rule was intended to provide for equality of treatment for equity and debt that represented long-term capital. At first the NDC/PT rules seemed to go back to the EPD ones, but this time they explicitly removed the no deduction in Case I rule.89 They said nothing about ‘capital’ or ‘permanent loans’ but did reproduce the CPT prohibition on shareholder loans. There was, as shown above, an addition in Finance (No 2) Act 1940. It seems that what this achieves is to stress that interest may be disallowed in a NDC/PT computation even though the no deduction in Case I rule is disapplied. It may have been introduced as a result of European Investment Trust, though that case was heard in 1932, or at least as a result of someone in the Inland Revenue recalling the case. This rule was also in place for EPT and EPL. But what the law on these various taxes on profits shows for the purposes of this chapter is that it is perfectly possible to allow interest from which tax has been deducted and retained as a deduction in computing profits in accordance with income tax principles. However, so long as the prohibition of capital rule was interpreted in accordance with European Investment Trust and other cases, the practical effect of overriding that rule was limited.

Summary of the Position Before the Advent of Corporation Tax (CT) What is clear is that throughout the 1950s and the early 1960s, the position was relatively stable, though cases such as Chancery Lane, Frere and Cairns v MacDiarmid had yet to be heard. But the developments charted in this chapter show that the position was very far from simple.90 It can fairly confidently be stated that: A: if a business paid interest on a loan expressed to be repayable after one year or more (annual interest), and: (1) had not decided, or was not required, to charge the payment to capital in its accounts; (2) had income tax either charged in an assessment for the year (irrespective of the basis year) or received under deduction of tax in the year (so long as relating to the year) sufficient to frank the tax on the interest (ie it had sufficient PGBIT); and (3) had deducted tax from the payment, 89

Oddly the NDC/PT provisions refer to ‘interest’, not ‘annual interest’. So far from simple was it that the author is by no means confident that what is said is 100% correct. In particular, the position may be more complicated than set out because of the existence of concessional and other practices by the Inland Revenue. 90

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it was entitled to retain the tax deducted so as to give it the equivalent of relief against its total income, but was not allowed to deduct the payment in a Case I computation. B: if interest was annual, but failed condition 1 above, income tax withheld must be paid on an assessment and no relief was given in a trading assessment and no other form of relief was given eg against total income. C: if interest was annual, but failed condition 2 above, income tax must be paid on an assessment and no relief was given in a trading assessment as such, but the payment was treated as a trading loss and could be carried forward to be deducted from trading income of subsequent years; but no other form of relief was given, eg against total income. D: if interest was annual, but failed condition 3 above,91 relief against trading income could be given if and only if: (1) liability to pay was incurred for the purposes of the trade; (2) payment of the interest was secured on overseas assets of the trade; (3) the interest was payable and in fact paid outside the United Kingdom; (4) the interest was paid to a non-resident; and (5) the interest if paid by a partnership was not paid to partners, or if paid by a company was not paid to a connected company. E: if the interest was short and the business: (1) had not decided, or was not required, to charge the payment to capital in its accounts; (2) had incurred the liability to pay for the purposes of its trade; (3) did not capitalise itself by use of the borrowing; and (4) had sufficient PGBIT to frank the payment, it was entitled to deduct the interest in computing trading profits, but was neither entitled nor required to deduct tax from the payment. F:

if the interest was short and was paid to a UK bank, etc a business that had sufficient PGBIT to frank the payment was entitled to relief against total income. If the interest could qualify either in this way or as a trading deduction (under E above), the business could choose between them, but had to do so before submitting a trading computation allowing the interest. G: if the interest was short but was not paid out of PGBIT the business was required to deduct tax and submit to assessment (unless the Inland Revenue still applied the practice referred to in City of Edinburgh). In 91 It is not clear what happens if condition 1 was also failed. The provision giving this relief was stated to apply notwithstanding anything in the general rules for Case I (eg 1952 Act s 137), but the Chancery Lane rule was not a Case I rule, though it is likely that any attempt to deduct a Chancery Lane-type payment would be unsuccessful.

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this case relief against total income where interest is paid to a bank, etc was not available, but a deduction as a trading expense was, subject to the prohibition of capital rule. The interest was not available as a trading loss carried forward. Thus, a business seeking to finance itself by debt in the first two-thirds of the twentieth century would find not only the mass of different rules for obtaining relief as set out immediately above, but would also find all the difficulties described above in relation to the rate of payment, determining whether there was sufficient PGBIT and determining whether the interest was annual or not. And in addition it would find different rules for other expenses of debt, and in the period from 1938 to 1965 its profits tax computation would also be subject to different rules in relation to the same payments of annual interest. It could, however, if it was purchasing assets, finance that purchase in a way which avoided all the problems of the retention of tax scheme.

Introduction of Corporation Tax The chapter has shown that for taxes other than income tax, the no relief in Case I rule for annual interest payable out of PGBIT did not apply. This was completely understandable, since the reason for that rule in income tax was the ability of a person to obtain effective relief for annual interest through deduction of income tax at source and retention of the tax, rather than by way of deduction against trading or total income. FA 1965 introduced CT in place of both income tax and profits tax on companies. The policy-makers were faced with a choice as to what to do about the various reliefs for interest paid by a company. What the numerous ways of giving relief set out in this chapter show is that the United Kingdom was perfectly capable, and familiar with the concept, of giving relief for a payment in computing income and at the same time collecting tax due from the payee through a withholding mechanism, that is, deducting tax and accounting for it to the Inland Revenue. It was also obviously familiar too with the notion of a deduction for a payment without withholding, leaving it to the Inland Revenue to make a direct assessment. Both of these methods were consistent with international norms and accounting practice, and were not obviously more encouraging of evasion than the deduction and retention system (especially withholding). And they did not require the strange-looking rule forbidding deduction of interest clearly incurred for the purposes of a trade in computing trading income. So the policy-makers could have followed the profits tax rule that had been familiar to companies for nearly 30 years and disapplied the prohibition of capital rule for CT purposes, while requiring companies to deduct income tax from interest paid in appropriate cases and requiring them to

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pay it over to the Inland Revenue, ie withholding it instead of retaining it. The approach of the Inland Revenue to this issue caused some perplexity to Anthony Stainton, the Parliamentary Counsel drafting the CT provisions. He seems to have thought that the Revenue wanted the profits tax approach, and first drafts of the Finance Bill for 1965 followed that approach. But Revenue conservatism won the day, without any explanation in the papers.92 What Part 4 of the Finance Act 1965 (CT) ended up doing was this. The concept of deducting and retaining tax deducted from annual interest was not incorporated into CT. This was achieved in statutory terms by stating that no payment made by a company was to be treated as paid out of PGBIT (a statement of the obvious, one might think, as a company was to be exempt from income tax, but it may have been feared that a company could have argued that income it received under deduction of income tax was PGBIT even though the income tax was set off against CT or repaid). The consequence of this was that the withholding tax rule would apply to all annual interest, and from this it followed that the no deduction in Case I rule became inapplicable for CT since the condition of that rule that a payment be made out of PGBIT could not apply to a company not charged to income tax.93 The scene was set therefore to allow a payment of annual interest by a company as a deduction in a trading computation, alongside short interest. How then to fit other rules into such a scheme? The rule giving a deduction in limited circumstances to annual interest paid without deduction of tax out of foreign income, etc94 would be unnecessary as any such interest was already required to be for trade purposes and so would be deductible. The short interest relief rule would not need to be retained for trading profits computations, and indeed would become inapplicable to companies because of the PGBIT requirement in it. A replacement for interest paid to a UK bank, etc not incurred for trading purposes would be required, which could take the form of a relief against the relevant types of income (Cases V, VI and VIII of Schedule D) or as a management expense, or it could be a general relief against a company’s total income. There is one problem with this type of approach. If the prohibition of capital rule remained in place for CT, then in practice annual interest was very unlikely to be allowed as a Case I deduction (and some short interest 92 Correspondence with Parliamentary Counsel on the drafting of the Corporation Tax and associated provisions in the 1965 Finance Bill, The National Archives, Public Record Office file IR40/16688. 93 Section 130(l) remained applicable to payers of annual interest paid out of PGBIT who were individuals or partnerships carrying on a trade. However, this rule was amended in 1969 to remove annual interest from the prohibition, as the Finance Act of that year completely recast the income tax treatment of interest paid, and also removed annual interest from 1952 Act s 169. 94 See item D in the ‘Summary of the Position before the Advent of CT’ section, above. In 1965 this rule was in 1952 Act s 138.

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might also be disallowed as in European Investment Trust). Keeping this rule would have the effect of removing much of the discrimination against equity funding that the Courts had earlier seen as a desirable principle, but it would put the United Kingdom at odds with most other developed countries. So because FA 1965 abolished the deduction and retention system and disapplied the ‘no trading deduction’ rule for most annual interest, there needed to be some replacement rules. But they did not go along the lines described above. Section 52 of FA 1965 introduced instead the concept of relief for ‘charges on income’, stating: (1)

In computing the corporation tax chargeable for any accounting period of a company any charges on income paid by the company in the accounting period … so far as paid out of the company’s profits brought into charge to corporation tax, shall be allowed as deductions against the total profits for the period as reduced by any other relief from tax. (emphasis added) (2) Subject to the following subsections, ‘charges on income’ means for the purposes of corporation tax payments of any description mentioned in subsection (3) below … but no payment which is deductible in computing profits or any description of profits for purposes of corporation tax shall be treated as a charge on income. (emphasis added) (3) The payments referred to in subsection (2) above are: (a) any yearly interest … and (b) any other interest payable in the United Kingdom on an advance from a bank [etc] …95 (4) No such payment [of interest] made by a company as is mentioned in subsection (3) above shall be treated as a charge on income if: (a)

the payment is charged to capital …96

Later on, in section 53, we find: (5)

… no deduction shall be made in computing income from any source: (b)

in respect of any yearly interest …97

And in section 54: (3)

95 96 97

In computing income from a trade … section 53(5)(b) above … shall [not] prevent the deduction of yearly interest payable in the United Kingdom on an advance from a bank carrying on a bona fide banking business in the United Kingdom …

As in the short interest deduction rule. The Chancery Lane rule, not the prohibition on capital rule in Case I. Thus the provision in s 52(2) only applies to short interest.

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So the position for interest paid by a company at the start of CT was as follows: ‘Short’ Interest Deductible in a Case I computation subject to the prohibition of capital rule (European Investment Trust). Otherwise relief was given as a charge on income but only if paid to a bank, etc. Annual Interest Payable in United Kingdom to a Bank Deductible in a Case I computation98 subject to the prohibition of capital rule. In other cases (including where relief is denied in Case I by that rule) a charge on income on an ‘as credited’ basis. Annual Interest Payable in United Kingdom not to a Bank Charge on income (on an ‘as paid’ basis), deductibility in Case I denied by FA 1965 section 53(5)(b). Annual Interest Payable Outside United Kingdom Charge on income, if certain conditions met, on a paid basis (deductibility in Case I denied by FA 1965 section 53(5)(b)). The ‘charged to capital’ prohibition for annual interest and short interest paid to a bank in FA 1965 section 52(4)(a) seems to represent a recognition that the charges on income system for CT should be aligned so far as possible with the Case I deduction rules, and in those interest charged to capital would not be allowed, not because it was capital within the meaning of the prohibition of capital rule but because it would not appear in a profit and loss account. The 1970 Act successor to section 52(4)(a) was repealed by FA 1981 section 38. Charges treatment was subject to the overriding provision in FA 1965 section 52(1) that the payment must be made out of profits chargeable to CT. If there were no such profits, section 58(8) provided that if paid for the purposes of a trade they may be added to (or create) a loss in that trade.99 This rule equates to that in Income Tax Act (ITA) 1952 section 345 which allowed a carry forward for trade charges only where the withholding tax rule applied and where the interest was not charged to capital. 98 See FA 1965 s 55(3) and also Wilcock v Frigate Investments Ltd (1981) 55 TC 530 for there being no opting out of Case I. 99 FA 1965 s 57(2) allowed similar treatment for excess management expenses carried forward. Other charges not related to a trade or investment business could not be carried forward.

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This CT ‘charges on income’ system seems to be almost as complex as the income tax rules for business finance described above. It retained the ‘no deduction in Case I’ rule for annual interest, even though deduction and retention was abolished. Distinctions between short and annual interest remained. The complexities of ITA 1952 section 138 (deductions where tax not deducted and interest paid abroad) were reproduced in the ‘charges on income’ rules instead of being abolished as they could have been. The approach adopted cannot simply be one governed by conservatism or a desire to keep a lid on evasion. The profits tax rule combined with a proper withholding tax would have been far simpler and just as effective. One reason which emerges from the correspondence with Parliamentary Counsel is the fondness in policy areas of the Inland Revenue for the view that it is not possible to properly allocate interest to a trade if a company has more than one activity. Another, stronger, reason, which emanated more from the technical areas of the Inland Revenue, was the prohibition of capital rule, which was certainly a major factor in the worldview of the Chief Inspector’s branch at that time. The Inland Revenue had gone to court to establish that annual interest, even some short interest, and all associated debt costs were capital and they continued to do so after 1965. And since most annual interest was, even though capital, effectively relieved against total income before 1965, the best way of maintaining the prohibition of capital rule while allowing relief was the way they did it. In 1969, however, the prohibition of capital rule was abolished, but only for interest. It remained in place for other types of debt cost, including exchange losses, until the major financial transaction reforms of Finance Acts 1993 (exchange gains and losses), 1994 (‘new’ financial instruments, ie certain derivatives) and 1996 (so-called loan relationships, ie debt transactions). These finally put an end to the complex systems of relief and denial of relief that had applied both before and after the introduction of Corporation Tax. And the world did not fall in.

3 The Rise of the Finance Act: 1853–1922 JOHN HN PEARCE

ABSTRACT This chapter examines the financial legislation enacted to give effect to the government’s proposals for the coming financial year (as set out in the Budget speech). In 1853, the government’s proposals were enacted in a number of different statutes: in 1922 they were enacted in one statute only. Three developments are considered. The first development was the preparation of a single Bill to deal with all matters essential for the national finances (where important events took place in 1860 and 1861). The second development was the transfer of the task of drafting financial legislation to the Office of the Parliamentary Counsel (where crucial events took place in the 1890s). The third development was the emergence of the Finance Bill as the single vehicle for giving effect to the government’s financial proposals: for, during the period after 1861, those proposals might be split between a Bill known first as the Customs and Inland Revenue Bill and then as the Finance Bill, on the one hand, and a Revenue Bill, on the other hand. After 1921, attempts to enact a general Revenue Bill were abandoned.

INTRODUCTION

T

HIS CHAPTER EXAMINES a transition relating to the financial legislation enacted each year. That transition, which did not begin until after Gladstone’s Budget speech of 1853, and which had ended by 1922, had three characteristics. The first characteristic was that, at the beginning of this period, the Budget speech was followed by the enactment of a number of different statutes; but, by its end, all of the proposals essential for the maintenance of the national finances were placed in one statute. On this matter, important developments took place near the beginning of this period, in 1860 and 1861. The second characteristic was that, at the beginning of this period, each individual statute resulting from the Budget speech was drafted in the government department responsible for

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the administration of the relevant tax or taxes; but, by its end, the entirety of the Finance Bill was drafted in one location only—in the Office of the Parliamentary Counsel. On this matter, the crucial period fell in the middle of this period, during the first half of the 1890s. The third characteristic was that, by the end of this period, it was recognised that the enactment of a single Finance Act was the one and only way that was appropriate for dealing with the enactment of the government’s financial legislation: for, during this period, an alternative method of dividing up that legislation was under consideration, and notably near the end of this period in the years just before the First World War. It was only when attempts to give effect to this alternative method were finally abandoned after 1921 that the transition may be regarded as complete. It may be helpful to begin by outlining the course of events relevant for the enactment of financial legislation at the end of this period in 1922—the course of events still followed today.1 On 1 May 1922, the Chancellor of the Exchequer (Sir Robert Horne) delivered the financial statement (the budget speech) to the House of Commons (technically sitting as the Committee of Ways and Means).2 He spoke for rather more than one hour about estimated future revenue of somewhat less than £911 million and estimated future expenditure of slightly more than £910 million for the coming financial year. When he had finished, the Chancellor moved the first of the Budget resolutions (relating to the duty on tea); and, at this point, there were front bench speeches from the opposition parties and further discussion. The first Budget resolution was then passed, without a division. Eleven further Budget resolutions were then passed, either with no discussion or with very little discussion. No division took place. All the Budget resolutions which would have an immediate effect were accordingly passed, without a division, on the day the Budget speech was delivered. The last Budget resolution was then reached. This took the form: That it is expedient to alter the law relating to National Debt, Customs, and Inland Revenue (including Excise) and to make further provision in connection with Finance.

At this point, on 1 May 1922, the discussion was adjourned; and, as a matter of form, it was on this motion, as adjourned, that the Budget debate took place on 2 and 3 May.3 At the end of the Budget debate, on 8 May, the final Budget resolution was passed; and a Bill was ordered to be brought in. 1 For a general account of the parliamentary procedure relevant for financial legislation as that procedure existed at the end of the inter-war period, see WI Jennings, Parliament (Cambridge, Cambridge University Press, 1939) 315–17. 2 For the proceedings in the House of Commons on 1 May 1922, see Hansard, Fifth Series, vol 153, cols 1019–1131. 3 The material about the legislative aftermath of the 1922 budget speech has been derived from Hansard, Fifth Series, vols 153 to 156.

Rise of the Finance Act: 1853–1922 73 The Finance Bill, containing all the government’s legislative proposals for the coming financial year, was then introduced; and had its second reading on 29 May. The Bill was considered in committee for five days during June, and on report for two days during July. The Bill received its third reading on 14 July; and was then sent to the House of Lords (where the proceedings were entirely formal).4 The Bill received the Royal Assent on 20 July 1922, and became the Finance Act 19225—on a date before the expiry of the limited protection given to Budget resolutions by the Provisional Collection of Taxes Act 1913.6 At the beginning of this period, however, the course of the events relevant for the enactment of financial legislation following on from the Budget speech was very different, as may be observed from the course of events in 1853.7 On 18 April 1853, the Chancellor of the Exchequer (Gladstone) delivered his Budget speech. He spoke for four and three-quarter hours (from about 5 pm in the afternoon until shortly before 10 pm in the evening) about estimated future revenue of slightly less that £53 million and estimated future expenditure of somewhat more than £52 million for the coming financial year.8 When he had finished, however, there was only one motion (relating to Income Tax) before the Committee of Ways and Means. After a little discussion on 18 April, the main opposition amendment to this resolution was then debated on four later evenings, before that amendment was defeated in a division on 2 May. Other amendments were then considered for four evenings; and, at the end of the fourth evening, on 12 May (and most of a month after it had begun to be considered), Gladstone’s original Budget resolution relating to income tax was finally passed, without a division. The Income Tax Bill had its first reading the following day; and was given an unopposed second reading on 20 May. It was then considered for four nights in committee, where it survived 14 amendments and eight divisions. The House of Commons finished dealing with the Income Tax Bill on 6 June. The Bill was then sent to the House of Lords, where it was finally passed on 28 June. Immediately after the House of Commons had finished dealing with the Budget resolution relating to income tax, it turned to consider the Budget resolution to bring in the succession duties. This resolution was then debated

4

Hansard (Lords), Fifth Series, vol 51, cols 513, 521 and 632 (17, 18 and 19 July 1922). 12 & 13 Geo 5 c 17. 3 & 4 Geo 5 c 3. 7 Unless some other source is stated, the material about the legislative aftermath of the 1853 Budget speech has been derived from Hansard, Third Series, vols 125 to 129, from the volumes of Public General Acts for the relevant Parliamentary Session (16 & 17 Vict), and from JB Conacher, The Aberdeen Coalition 1852–1855 (Cambridge, Cambridge University Press, 1968) 70–77. 8 R Jenkins, Gladstone (London, Macmillan, 1995) 149. Hansard, Third Series, vol 125, cols 1423–24 (18 April 1853). 5 6

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on 12 and 13 May; and, at the end of the debate, the resolution was agreed to without a division. The Succession Duties Bill had its second reading only on 10 June when it was agreed to without a division. The main debate on this Bill, however, took place at the Committee Stage, which lasted six nights. The Bill was fought throughout the Committee Stage; and numerous amendments were moved on the third reading. In all, the government survived 12 divisions; and the Bill was finally passed by the Commons on 18 July. The Bill only reached the House of Lords in late July; and there it was debated on both the second and third readings and in committee. Two amendments were rejected (there was a division on one of them) and the Bill was finally passed on 28 July. The government’s numerous other resolutions and Bills of a financial nature, however, occupied very much less parliamentary time, although Gladstone did suffer a reverse over his proposals for the tax on newspaper advertisements. The Bill relating to income tax received the Royal Assent on 28 June 18539 (c 34); and, on 8 July, the Royal Assent was given to a Bill relating to Excise Duties on spirits (c 37) and to one relating to Soap Duties (c 39). The Bill relating to Succession Duties received the Royal Assent on 4 August (c 51); and so did a Bill relating to customs (c 54) and two Bills relating to Stamp Duties (c 59 and c 63). On 15 August, the Royal Assent was given to a Bill relating to Stamp Duties on newspapers (c 71); and also to a Bill relating to the redemption of land tax (c 74). Then, finally, on 20 August, at the end of the parliamentary session, a further five financial statutes received the Royal Assent. They related to duties on horses let for hire (c 88), the assessed taxes (c 90), income tax and insurance (c 91), the amendment of the Land Tax Redemption Act (c 117) and the duties on hackney carriages (c 127). The financial legislation following on from the budget speech was accordingly contained in 14 different statutes. Not only that: statutes dealing with the consolidation of the customs tariff (c 106) and with the consolidation of the customs legislation (c 107)10 had also been enacted. It is not surprising that the Prime Minister, Lord Aberdeen, wrote to a correspondent that ‘Gladstone has raised himself to the highest pitch of financial reputation, and has given a strength and lustre to the Government which it would not have derived from anything else’11 or that a twentieth century historian described Gladstone’s feat in piloting all these Bills through the House of Commons as an ‘extraordinary achievement’.12

9 16 & 17 Vict c 34. The chapter numbers given in the text for Bills receiving the Royal Assent in 1853 are for statutes enacted during this session. 10 The Act consolidating the customs legislation was prepared by Hamel, the Solicitor to the Board of Trade. S Buxton, Finance and Politics (London, Murray, 1888) vol 1, 132 n. 11 Conacher, n 7 above, 77. 12 ibid.

Rise of the Finance Act: 1853–1922 75 ENACTMENT OF A SINGLE MAJOR FINANCIAL STATUTE: 1860 AND 1861

In 1860, however, a major blow was given to this method of giving effect to the Chancellor of the Exchequer’s financial proposals.13 One of Gladstone’s Budget proposals for that year was the repeal of the paper duties, a measure estimated to reduce government receipts by £1 million.14 However, as the Budget proposals came to be considered in Parliament during the summer of that year, it became known that the government’s financial position had changed for the worse—and that the estimated Budget surplus had disappeared.15 The Cabinet did not support Gladstone’s proposal to repeal the paper duties unanimously; for the view that proposed future receipts and proposed future expenditure should both be higher also had adherents. One important Cabinet member who held this view was the Prime Minister, Palmerston. In a document written during the last 12 months of his life, Gladstone stated that: During a long course of years there had grown up in the House of Commons a practice of finally disposing of the several parts of the budget each by itself. And the House of Lords had shown so much self-control in confining itself to criticism on matters of finance, that the freedom of the House of Commons was in no degree impaired. But there was the opportunity of mischief; and round the carcass the vultures now gathered in overwhelming force. It at once became clear that the Lords would avail themselves of the opportunity afforded them by the single presentation of financial bills, and would prolong, and virtually re-enact a tax, which the representatives of the people had repealed.16

Against the background of the changing financial situation, it is not surprising that the government’s Bill to repeal the paper duties (one of a number of Bills brought forward to give effect to Gladstone’s Budget proposals) encountered opposition. In the House of Commons, the majority of 53 obtained on the second reading fell to nine on the third reading. Then, in the House of Lords, the advice of Lord Derby that the needs of the revenue were paramount was accepted; and the House of Lords returned the Bill to the Commons by 193 votes to 104.17

13 In a letter written to Palmerston on 8 February 1860, Gladstone considered the order in which the constituent parts of his financial proposals for that year should be taken in the House of Commons. See P Guedalla Gladstone and Palmerston (London, Gollancz, 1928) 125–26. 14 FW Hirst, Gladstone as Financier and Economist (London, Benn, 1931) 192. 15 Buxton, n 10 above, vol 1, 212. 16 J Morley, The Life of William Ewart Gladstone (London, Macmillan, 1903) vol 2, 31. 17 Buxton, n 10 above, vol 1, 212; R Shannon, Gladstone: God and Politics (London, Continuum, 2007) 137. Shannon went on to say that: ‘The conventions were well understood that the power of the purse lay with the Commons and that the Lords might not amend a money bill. There was no modern precedent for sending a bill back’ (ibid).

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Contemporary discussions of the very considerable implications of the actions taken by the House of Lords included that of Erskine May:18 Never until now, had the Lords rejected a bill for imposing or repealing a tax, raised solely for the purposes of revenue, and involving the supplies and ways and means, for the service of the year. Never had they assumed the right of reviewing the calculations of the Commons, regarding revenue and expenditure. In principle, all previous invasions of the cherished rights of the Commons, had been trifling compared with this. What was a mere amendment in a money bill, compared with its irrevocable rejection? But on the other hand, the legal right of the Lords to reject any bill whatever, could not be disputed. Even their constitutional right to ‘negative the whole’ of a money bill, had been admitted by the Commons themselves. Nor was this strictly, and in technical form, a money bill. It neither granted any tax to the crown, nor recited that the paper duty was repealed, in consideration of other taxes imposed. It simply repealed the existing law, under which the duty was levied. Technically, no privilege of the Commons, as previously declared, had been infringed. Yet it was contended, with great force, that to undertake the office of revising the balances of supplies and ways and means—which had never been assumed by the Lords, during two hundred years—was a breach of constitutional usage, and a violation of the first principles, upon which the privileges of the House [of Commons] are founded. If the letter of the law was with the Lords, its spirit was clearly with the Commons.19

The reactions of members of the government to the action taken by the House of Lords varied greatly. Gladstone was vehemently hostile, writing that the action ‘amounted to the establishment of a revising power over the House of Commons in its most vital function long declared exclusively its own’;20 and telling the House of Commons that opposition members were ‘partisans of a gigantic innovation—the most gigantic and the most dangerous that has been attempted in our times’.21 Palmerston, on the other hand, reacted very differently. He told Queen Victoria that he ‘felt bound in Duty’ to say that the Lords would ‘perform a good public Service’ if they threw out the Bill; and, when the result of the division in the House of Lords was announced, Lady Palmerston was observed applauding in the Ladies’ Gallery.22 Against the background of division, both within the Cabinet and within the House of Commons, it is not surprising that the government 18 The first edition of Erskine May’s work A Practical Treatise on the Law, Privileges, Proceedings and Usage of Parliament had been published in 1844. 19 TE May, The Constitutional History of England since the Accession of George the Third: 1760–1860, 2nd edn (London, Longman, Green, 1863) vol 1, 486–87. A little earlier, Erskine May had described the Lords’ exercise of their power as ‘novel and startling’ (ibid 486). Buxton’s opinion was that ‘financially the House of Lords were in the right, though constitutionally they were probably in the wrong’. Buxton, n 10 above, vol 1, 212. 20 Morley, n 16 above, vol 2, 32. 21 Hansard, Third Series, vol 159, col 1430 (5 July 1860). 22 R Shannon, Gladstone: Volume One: 1809–1865 (London, Hamish Hamilton, 1982) 416. Queen Victoria told her uncle Leopold that the Bill’s rejection was a ‘very good thing’ (ibid).

Rise of the Finance Act: 1853–1922 77 did not seek to reverse the Lords’ decision. The government ultimately contented itself with tabling and passing three resolutions,23 of which the last asserted that ‘to guard for the future against an undue exercise’ of the power of the House of Lords to reject Bills relating to taxation, the House of Commons had in its own hands the power to impose and remit taxes so that ‘the right of the Commons as to the matter, manner, measure and time may be maintained inviolate’. The repeal of the paper duties and the powers of the House of Lords relating to financial matters (if any) were left to await further attention in the future. At one point during 1860, Gladstone had written that ‘The principle of combining … the financial measures of the year is good: but I fear it would often be found so inconvenient as to be unavailable’.24 The following year, however, he found it possible to give effect to this principle. The two leading features of the Budget of 1861 were the repeal of the paper duties and a reduction of one penny in the Income Tax (from 10d to 9d in the pound);25 and in 1861, unlike 1860, the government’s financial position did not deteriorate significantly during the summer months when financial legislation was enacted.26 Gladstone’s opponents in 1861 were the same as in 1860: for he had to face opposition in the Cabinet, in the House of Commons and in the House of Lords. So far as the Cabinet was concerned, a meeting was held on 13 April 1861; and Gladstone recorded that ‘The plan of one Bill was adopted after fighting.’ There was no unanimity within the Cabinet about this matter; and Gladstone also recorded that ‘if we had divided, of which I had fears, it might have gone wrong’.27 This Cabinet victory was followed by what Gladstone, at the end of his life, called a ‘strange and painful incident’.28 Palmerston wrote to Gladstone warning him that, should the House of Commons jib, as it had done in 1860, Gladstone would be fighting this political battle without being able to rely on the principle of the collective responsibility of the Cabinet. ‘I think it right to say beforehand’, Palmerston informed him, ‘that, as far as I am concerned, I do not intend to make the Fate of my administration depend upon the Decision which Parliament may come to on your Proposal’.29 23 The three resolutions are printed in HJ Hanham, The Nineteenth Century Constitution 1815–1914 (Cambridge, Cambridge University Press, 1969) 182. 24 Guedalla, n 13 above, 138. Minute by Gladstone dated 1 July 1860. 25 Hirst, n 14 above, 203 and 210. 26 Gladstone’s own account, written during the last 12 months of his life, was that: ‘I … proposed a budget reducing the income tax by one penny, and repealing the paper duties from October 10, 1861. With this was combined what was more essential than either—the adoption of a new practice with respect to finance, which would combine all the financial measures of the year in a single bill.’ Morley, n 16 above, vol 2, 39. 27 HCG Matthew (ed), The Gladstone Diaries, vol 6, 1861–68 (Oxford, Clarendon Press, 1978) 24. 28 Morley, n 16 above, vol 2, 39. 29 Shannon, n 22 above, 437.

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So far as the House of Commons was concerned, Gladstone’s proposal succeeded by 296 votes to 281: a majority that was narrow, but which proved to be sufficient. So far as the House of Lords was concerned, there were moves to repeat the controversial rejection of 1860; but Lord Derby, though clear that the government Bill was objectionable in substance as well as form, advised their Lordships as to the inexpediency of further resistance and the Bill went through on 7 June without a division.30 The Customs and Inland Revenue Bill, as it was called, received the Royal Assent on 12 June 1861.31 ‘The battle in Parliament was hard’, Gladstone wrote at the end of his life, ‘but was as nothing to the internal fighting; and we won it. We likewise succeeded in the plan of uniting the financial proposals in one bill.’ His verdict on what had happened in 1860 and 1861 was that ‘The House of Lords, for its misconduct, was deservedly extinguished, in effect, as to all matters of finance’.32 But that verdict, of course, was premature. What was accomplished and what was not accomplished in 1861 needs to be analysed carefully. It has been stated of the enactment of the Customs and Inland Revenue Bill that ‘the precedent of the omnibus Finance Bill became established at once’.33 However, if that statement is intended to mean (or to include the proposition) that there was an immediate and complete change from a state of affairs in which, in each parliamentary session, several statutes of a financial nature were enacted to a state of affairs in which only one such statute (containing all the government’s financial proposals) was enacted, then such a proposition cannot be accepted. In 1861, Parliament did not only pass the Customs and Inland Revenue Act: it also passed an Act relating to Excise and Stamps34 and an Act to amend the laws relating to Inland Revenue.35 In 1909, no Finance Act was enacted (the House of Lords rejected the Finance Bill), but a Revenue Act was enacted.36 And, during the half century from 1862 to 1912, there were 11 calendar years (1863, 1864, 1866, 1868, 1883, 1884, 1889, 1898, 1903, 1906 and 1911) in which an Act giving effect to the major proposals relating to the national finances and an Act making detailed alterations to revenue law were both enacted.37 There was, therefore, no immediate and complete change of a once-and-for-all nature. 30

ibid 441–42. 24 & 25 Vict c 20. 32 Morley, n 16 above, vol 2, 39. 33 GHL Le May, The Victorian Constitution: Conventions, Usages and Contingencies (London, Duckworth, 1979) 133. 34 24 & 25 Vict c 21. 35 24 & 25 Vict c 91. 36 9 Edw 7 c 43. This Act received the Royal Assent on 3 December 1909. 37 The relevant statutes enacted were (in 1863) an Act relating to Customs and Inland Revenue (26 & 27 Vict c 22) and an Act relating to Inland Revenue (26 & 27 Vict c 33); (in 1864) an Act relating to Customs and Inland Revenue (27 & 28 Vict c 18) and an Act relating to Inland Revenue (27 & 28 Vict c 56); (in 1866) an Act relating to Customs and Inland 31

Rise of the Finance Act: 1853–1922 79 What was accomplished in 1861 was the bringing into existence of a state of affairs in which all the government’s proposals essential for the maintenance of the national finances were enacted in one statute. It became impossible, accordingly, for the House of Lords to damage the overall shape of the government’s financial proposals by destroying one component part of them, as had happened in 1860. This was an important change, but it was not a change that dealt with all matters arising for consideration in relation to financial legislation: for, at any one time, it was overwhelmingly likely that there would also be provisions of a detailed technical nature in the field of revenue law that could advantageously be enacted. The question how some or all of those provisions could best be enacted (if, indeed, they could be enacted at all) remained to be dealt with. On this question, important developments took place near the end of this period; but, before that, there had been a major development relating to the drafting of financial legislation.

CENTRALISATION OF THE DRAFTING PROCESS

When compared with the situation at later times, the arrangements for the drafting of government legislation during the first half of the nineteenth century may be regarded as informal and haphazard. From 1837 onwards, individuals were appointed by Order in Council to be employed under directions of the Home Secretary in the preparation of Bills for Parliament. It was also the case, however, that, with the growth in the number of government Bills, some departments engaged independent counsel to draw their Bills, while other government departments drew their own Bills, allegedly without legal assistance.38 A Treasury minute, dated 12 February 1869, provided for the drafting of government Bills to be dealt with in a more organised manner. The minute stated that, with the concurrence of the Home Secretary, it had been deemed expedient to create a department, to be called the Office of Parliamentary Revenue (29 & 30 Vict c 36) and an Act relating to Inland Revenue (29 & 30 Vict c 64); (in 1868) an Act relating to Customs and Income Tax (31 & 32 Vict c 28) and an Act relating to Inland Revenue (31 & 32 Vict c 124); the Customs and Inland Revenue Act 1883 (46 & 47 Vict c 10), the Revenue Act 1883 (46 & 47 Vict c 55), the Customs and Inland Revenue Act 1884 (47 & 48 Vict c 25), the Revenue Act 1884 (47 & 48 Vict c 62), the Customs and Inland Revenue Act 1889 (52 & 53 Vict c 7), the Revenue Act 1889 (52 & 53 Vict c 42), the Finance Act 1898 (61 & 62 Vict c 10), the Revenue Act 1898 (61 & 62 Vict c 46), the Finance Act 1903 (3 Edw 7 c 8), the Revenue Act 1903 (3 Edw 7 c 46), the Finance Act 1906 (6 Edw 7 c 8), the Revenue Act 1906 (6 Edw 7 c 20), the Revenue Act 1911 (1 Geo 5 c 2), and the Finance Act 1911 (1 & 2 Geo 5 c 48). 38 The National Archives, Public Record Office (TNA) file T 162/655 (E 4000). Memorandum, ‘The Office of the Parliamentary Counsel to the Treasury’, dated 23 November 1898, and with the initials ‘C.P.I.’ (ie CP Ilbert), paras 1 and 2. There is another copy of this memorandum at TNA file AM 2/71 fos 1–15. This document is subsequently cited as ‘Ilbert’s 1898 memorandum’. See also text around nn 63 and 64 below.

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Counsel, for the purpose of providing for the preparation of government Bills. Whenever, in the opinion of the head of a public department, it was expedient that a Bill should be prepared for the consideration of Parliament, the instructions for the preparation of the Bill were to be framed in the department; the instructions were to be sent in writing to the Parliamentary Counsel Office, through the Treasury; and the Bill, when prepared in the Parliamentary Counsel Office, would be returned, through the Treasury, to the department.39 Henry Thring (later Lord Thring) became the first head of the new department. The arrangements set out in the 1869 minute were to be temporary and provisional in the first instance, but were made permanent by a later Treasury minute of 31 January 1871. The new arrangements could be claimed to have resulted in greater economy; in better control over government legislation as respects policy and finance; and to an improvement in the form of statutes.40 The 1869 minute provided for exceptions to the general rule that government Bills would be drafted in the Office of the Parliamentary Counsel;41 and one exception arose out of the final paragraph of that minute. Where there was a solicitor or other salaried legal officer attached to a department who had been in the habit of preparing Parliamentary Bills for the department, the Bills were, as before, to be prepared in the department. ‘It was to be understood that those departments which were in the habit of preparing their own Bills through the medium of the salaried legal officers attached to them were to continue to do so.’42 It may be inferred with confidence that the revenue departments, which had been in the habit of preparing their own Bills in the years before 1869, continued to do so for a good many years afterwards. It may also be inferred that the revenue departments prepared all the consolidation statutes relating to revenue law enacted from 1869 to 1891; for, in documents prepared in the Office of the Parliamentary Counsel listing consolidation statutes enacted since 1869, those relating to revenue law attract the footnote annotation ‘Drawn independently of the Parliamentary Counsel’s Office’.43 For the most part, the drafters of these consolidation statutes are now unknown,

39

TNA file T 162/655 (E 4000) contains a copy of this Minute. Ilbert’s 1898 memorandum, n 38 above, paras 4 and 6. 41 There were two classes of exception: Bills relating to Scottish and Irish matters (which are not discussed further in this chapter) and Bills prepared by government departments which had been in the habit of preparing their own Bills (the topic discussed in the text). 42 Ilbert’s 1898 memorandum, n 38 above, para 3. 43 The statutes in question were the Stamp Act 1870 (33 & 34 Vict c 97), the Stamp Duties Management Act 1870 (33 & 34 Vict c 98), the Customs Consolidation Act 1876 (39 & 40 Vict c 36), the Taxes Management Act 1880 (43 & 44 Vict c 19), the Inland Revenue Regulation Act 1890 (53 & 54 Vict c 21), the Stamp Duties Management Act 1891 (54 & 55 Vict c 38), and the Stamp Act 1891 (54 & 55 Vict c 39). See TNA file AM 2/54 fos 38–51, ‘Duties and Staff of Parliamentary Counsel’s Office’ (backsheet dated 13 April 1892) at Sch III Pt I; and Ilbert’s 1898 memorandum, n 38 above, at Sch III Pt I. See also text around nn 63 and 64 below. 40

Rise of the Finance Act: 1853–1922 81 although the drafter of the Inland Revenue Regulation Act 1890 may be identified as NJ Highmore, then an Assistant Solicitor of Inland Revenue.44 A significant drafting innovation was made in one of these consolidation statutes; for it was in the Stamp Act 1870 that a section divided into numbered subsections made its first appearance in an Act of the United Kingdom Parliament.45 The drafting of financial legislation by the revenue departments did not, however, continue indefinitely. CP Ilbert joined the Office of the Parliamentary Counsel as Second Parliamentary Counsel in 1886, and went on to become First Parliamentary Counsel from 1899 to 1902.46 In a book published in 1914, Ilbert recalled that: When I first joined the office [of the Parliamentary Counsel], the budget bill and other revenue bills of the year were drawn by officers of the revenue departments, and I well remember a conversation I had with Mr Goschen, who was chancellor of the exchequer at the time when responsibility for putting them into shape was transferred to the parliamentary counsel’s office, in which I then held the second post. This was some time in the early nineties.47 Mr Goschen told me, or reminded me, that until recent times the House of Commons used to discuss the budget of the year on the financial resolutions proposed by the chancellor of the exchequer. And they did not criticise the language of the resolutions; they looked merely to the substance as explained by the chancellor, and argued for or against the financial scheme as a whole, or for or against the propriety of particular taxes. As to the bills based on the resolutions, bills which were usually drawn in very technical language, hardly any one read them or tried to amend them. ‘But now’, he said, ‘members have taken to move amendments or clauses in these bills; and I really must have the bills drawn, if possible, in less technical language, at all events in language which it is easier both for myself and for the average member of Parliament to understand. Therefore I am afraid we must impose on your office for putting these bills also into shape.’48

In this passage, Ilbert gives an account of events taking place some 20 years earlier; and if that account is given only from memory, there must be room for doubt as to whether that account is correct in every particular. The contemporary documentation points to a more gradual transfer. That

44 Parliamentary Papers 1890 (110) Special Report and Reports from the Select Committee on … the Inland Revenue Regulation Bill, Examination of NJ Highmore; and NJ Highmore, The Inland Revenue Regulation Act, 1890 as amended (London, Stevens, 1896) v. Highmore ended his career as Solicitor for the Customs and Excise, and was knighted in 1907. 45 Sir G Engle, ‘The Rise of the Parliamentary Counsel’ (1996) 16 Parliament, Estates and Representation 201. 46 In 1902, Ilbert left the Office of the Parliamentary Counsel to become Clerk of the House of Commons, a position he held until 1921 (Engle, n 45 above, 201–2). 47 Goschen ceased to be Chancellor of the Exchequer in August 1892; so, on Ilbert’s account, this conversation occurred on some occasion during a period ending at that time. 48 CP Ilbert, The Mechanics of Law Making (New York, Columbia University Press, 1914) 66. The book is an edited version of lectures delivered in October 1913 (ibid v).

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documentation nevertheless points, unequivocally, to a transfer taking place during the first half of the 1890s. From its inception in 1869, and for many years afterwards, it was the practice of the Office of the Parliamentary Counsel to prepare a statement of the business transacted in that office during the period ending at the end of the parliamentary session, and for that statement to be printed.49 The work undertaken was listed under a number of headings which changed little from year to year: so, by comparing the contents of successive statements, information about the Office’s involvement in revenue legislation may be obtained. Each statement began with a list of Bills drafted in the Office;50 and, at a later point in the statement, there was a list of miscellaneous work undertaken. Ilbert’s recollections point towards an examination of the statements dating from the early 1890s.51 For the 1890 session, the statement did not show the Office of the Parliamentary Counsel as playing any part in the drafting of the Customs and Inland Revenue Bill for that year. For the 1891 session, the statement did not show that Office as drafting the Customs and Inland Revenue Bill for that year; but the list of miscellaneous work recorded that the office did work on clauses of that Bill. For the 1892 session, the position was comparable. The Office of the Parliamentary Counsel was not shown as drafting the Customs and Inland Revenue Bill; but the list of miscellaneous work included the entry ‘Inland Revenue, Clause’. For the 1893 session, once again, the Office of the Parliamentary Counsel was not shown as preparing the Customs and Inland Revenue Bill; but, for this session, the list of miscellaneous work included the entry ‘Customs and Inland Revenue Bill—revising Bill’, and also an entry recording that the Office had done work on the Notes for that Bill. The crucial change appeared in the statement for the 1894 session. The Office of the Parliamentary Counsel was shown as drafting the Finance Bill. The Office was also shown as undertaking work on various memoranda connected with that Bill. For the 1895 session the Office was again shown as drafting the Finance Bill; and the list of miscellaneous work included the entry ‘Finance Bill. Notes and Proposed Resolutions’. For the rest of the 1890s, the statements always showed the Office of the Parliamentary Counsel as drafting the Finance Bill; and, for the most part, as doing work on Finance Bill resolutions as well. On this evidence, the Office of the Parliamentary Counsel assumed the 49 In 1921 it was agreed that the production of this printed list should be discontinued (TNA file T 162/655 (E 4000)). 50 This particular list of Bills did not include consolidation Bills, which were listed separately at a later point in the statement. 51 The statements of the business transacted in the Office of the Parliamentary Counsel referred to in this paragraph may be found at TNA files AM 3/43 (fos 8–16) (1890 Session); AM 3/44 (fos 1–5) (1891 Session); AM 3/45 (fos 1–5) (1892 Session); AM 3/46 (fos 1–5) (1893 Session); AM 3/47 (fos 1–4) (1894 Session); AM 3/48 (fos 1–4) (1895 Session); AM 2/63 (fos 800–4) (1896 Session); AM 2/67 (fos 684–88) (1897 Session); AM 2/69 (fos 634–38) (1898 Session); and AM 2/73 (fos 249–53) (1899 Session).

Rise of the Finance Act: 1853–1922 83 drafting responsibility for financial legislation in the same year (1894) as the principal statute enacted underwent a change of short title from ‘Customs and Inland Revenue Act’ to ‘Finance Act’. It is difficult to believe that this is a coincidence, but no contemporary comment bearing directly on this point is known. It is possible to go further: for the surviving documentation points to the conclusion that, in the transfer of drafting responsibilities for revenue Bills from the revenue departments to the Office of the Parliamentary Counsel, the preparation of what became Part I of the Finance Act 189452 (imposing estate duty) was of crucial importance. The interest of the Office of the Parliamentary Counsel in this subject may certainly be traced back as far as 1889, when Sir Henry Jenkyns, the First Parliamentary Counsel, prepared two documents with the heading ‘Death Duties’, of which the second had a heading reading ‘Suggestions for alteration’.53 Jenkyns also prepared a later memorandum on the subject of ‘Death Duties’, dated 22 February 1893. This memorandum began by stating that ‘At the request of the Chancellor of the Exchequer [Harcourt] I submit the following observations on the clauses suggested by the Inland Revenue for estate duty’. The first part of the memorandum had the heading ‘General Principle’ and the side note ‘No general principle’. Jenkyns was not an admirer of the draft clauses produced: These clauses do not state a scheme which is plain, either for Parliament, or for the platform, or for those who will have to pay the duty. They are, on the contrary, extremely difficult to understand, and I am not sure that I correctly understand their effect. The scheme establishes, in form at least, four duties, and then amalgamates three of them for the purpose of determining the amount to be paid in each case. The scheme is not, on the face of it, founded on any principle as respects either the property made chargeable to duty, or the amalgamation of different classes of property for the purpose of the progressive duty, nor as respects the assimilation of the duty on realty and personalty. Indeed, both in form and in substance, it appears to be a mere tinkering of the different existing duties, the number and complication of which are at present a subject of bitter complaint.54

The subject of death duties did not receive legislative attention in 1893; but it seems clear that, by that year, draft clauses on this subject had been prepared by the Inland Revenue, and that the Parliamentary Counsel was

52

57 & 58 Vict c 30. TNA file AM 3/43, documents dated 26 November 1889 (fos 309–21) and 27 November 1889 (fos 322–26). 54 TNA file AM 2/58, fos 219–22, Memorandum ‘Death Duties’, dated 22 February 1893, by H Jenkyns. Jenkyns sent a draft clause of his own with his memorandum. 53

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a severe critic of those clauses. There is a ready inference that, should the Office of the Parliamentary Counsel be instructed to draft those clauses, it would be perfectly prepared to do so. During the early months of 1894, while preparations were made for that year’s Budget, it is clear that two different versions of the death duties clauses were in existence: the one produced by the Inland Revenue, the other by the Office of the Parliamentary Counsel.55 It may safely be assumed that the two departments argued in favour of their own draft clauses. For 9 April 1894, the journal kept by Lewis (‘Loulou’) Harcourt, the son of the Chancellor of the Exchequer, recorded: A severe fight all the afternoon in W.V.H[arcourt]’s room at the H[ouse] of C[ommons] between Herschell, Milner, Jenkyns, Melville and Karslake over the Death Duties Bill. I suggested that the place was like a bear-pit, and that I should like to poke buns through the door on the end of an umbrella.56

It may be inferred that the Office of the Parliamentary Counsel had the better of the argument. A further document, dated 13 April 1894,57 had a prefatory note introducing the draft clauses that constituted its contents. The first four clauses of the draft ‘represent the clauses as provisionally settled at the conference’. Clauses 7 to 13 were ‘clauses of the Somerset House [i.e. Inland Revenue] Bill’; but, in addition, ‘Clauses alternative for clauses 7–13 are suggested’. The prefatory note also recorded that alternatives to the ‘Somerset House Bill’ were suggested at later points in the document as well. The working hypothesis, therefore, must be that, at this point, the government department in charge of producing the proposed legislation relating to Estate Duty was no longer the Inland Revenue. The Office of the Parliamentary Counsel had taken charge instead.58

55 In TNA file AM 1/6 fos 12–17, there is a printed document described in the list of contents as ‘Estate Duty—Clauses by Inland Revenue’. This document has an annotation recording that it was printed at the Foreign Office by T Harrison. In TNA file IR 63/3, there is another copy of this same document, which has the manuscript annotations ‘A Milner’, ‘Draft No. 1’ and ‘Bill as drawn by Melvill, after conference with Karslake & Rigby February 1894’. In TNA file AM 1/6, this document is followed (at fos 18–56) by four printed drafts of clauses relating to death duties, and variously dated between 10 March 1894 and 9 April 1894. These drafts have backsheets of the type very generally used by the Office of the Parliamentary Counsel. Of the individuals mentioned, Rigby was the Solicitor-General. For the other individuals mentioned, see the following note. 56 AG Gardiner, The Life of Sir William Harcourt (London, Constable, 1923) vol 2, 289. Of the individuals mentioned, Herschell was the Lord Chancellor, Milner was the Chairman of the Board of Inland Revenue, Jenkyns was the First Parliamentary Counsel, Melvill was the Solicitor of Inland Revenue and Karslake was the Controller of the Legacy and Succession Duty Department. 57 TNA file AM 1/6, fos 66–89. 58 In TNA file IR 62/2410, one set of printed draft clauses, which has a backsheet in the form used in the Office of the Parliamentary Counsel, has the annotation ‘Budget Bill 1894: Sir H Jenkyns draft’. This same piece also has a manuscript document with the heading ‘Sir H Jenkyns Budget Bill’.

Rise of the Finance Act: 1853–1922 85 The depth of the feeling about the contents of the Bill that was being prepared may be gauged from the fact that, on 24 April 1894, Melvill, the Solicitor of Inland Revenue, wrote to Karslake, the Controller of the Legacy and Succession Duty Department, inviting him to add his signature to a letter to Milner, the Chairman of the Board of Inland Revenue, disclaiming responsibility for the Bill or its provisions—and Karslake did so.59 Milner replied a few days later: I think a reply is due from me to you & Karslake with reference to your letter of 25th April. As far as I am a judge in the matter, I quite agree with you in greatly preferring the Estate Duty clauses, prepared at Somerset House, to those wh[ich] have now been laid before Parliament. If the latter have, finally, assumed a somewhat more tolerable shape than that, wh[ich] I at one time feared they would take, it is due principally to the ability and loyalty with wh[ich] you both threw yourselves into the disagreeable task of making the best of a scheme, of the principle of which you disapproved, and amending a draft, which in its whole structure was contrary to your ideas. I feel I owe a debt of gratitude to you both for the manner in wh[ich] you discharged this unpleasant duty. What is more important I know that the Chancellor of the Exchequer who clearly understands your position in the matter, appreciates the great assistance you have rendered in giving the most workable form to the new Bill, for the general scope and framework of which you are in no way responsible.60

In the following year (1895) there is a letter from Jenkyns sending a copy of the draft of the Finance Bill to Milner;61 and it is clear from the annual statements of the business transacted in the Office of the Parliamentary Counsel that the new arrangements, with the Office of the Parliamentary Counsel drafting the Finance Bill, were securely established by the beginning of the twentieth century.62 Confirmation of the transition that took place may be obtained from a lengthy printed memorandum dealing with the work of the Parliamentary Counsel’s Office. This memorandum exists in two different versions, prepared six years apart: and, in both cases, it is paragraph 12 (‘Preparation of Bills by departmental officers’) that is crucial. In the earlier version, which has a backsheet dated 13 April 1892, the paragraph states in part that: At present Budget Bills and other Revenue Bills, and in some cases Colonial Office Bills, are still prepared by and under the responsibility of the legal officer to the department. But clauses for insertion in the Revenue Bills constantly have to be settled in the Office of the Parliamentary Counsel.63

59 TNA file IR 62/2410, Letter, Melvill to Karslake, 24 April 1894, with annotation. This piece does not contain any copy of the letter sent to Milner. 60 TNA file IR 62/2410, Letter (copy), Milner to Melvill, 27 April 1894. Melvill described this letter as ‘A very nice reply’. IR 62/2410, Letter, Melvill to Karslake, 27 April 1894. 61 TNA file IR 63/5, Letter, Jenkyns to Milner, 1 May 1895. 62 See the material specified in n 51 above. 63 TNA file AM 2/54 fos 38–51, ‘Duties and Staff of Parliamentary Counsel’s Office’ (backsheet dated 13 April 1892), para 12.

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However, in the later version, dated 23 November 1898, that passage became: Until recently Budget Bills and other Revenue Bills, and in some cases Colonial Office Bills, were still prepared by and under the responsibility of the legal officer to the department. But this practise [sic] has now been abandoned.64

ACCEPTANCE OF THE FINANCE BILL (ONLY)

Introduction The new arrangements for the enactment of the government’s financial legislation inaugurated in 1861 enabled the government to avoid the problem of having the overall shape of its financial proposals damaged as the result of the House of Lords’ destruction of one constituent part of them. That particular problem, however, had been dealt with only at the cost of raising another—or, at any rate, of bringing that other problem into sharper focus. That other problem was that, at any one time, in addition to the provisions essential for the national finances, there would also be provisions of a detailed technical nature in the field of revenue law that could advantageously be enacted.65 If those provisions (or a selection of them) were to be enacted at all, should they be enacted in a separate statute of their own (a Revenue Act), or combined with the statute enacting the proposals essential for the national finances (known first as the Customs and Inland Revenue Act and then as the Finance Act)? The third and final characteristic of the rise of the Finance Act was the adoption of the latter alternative: and here the events that took place may be divided into two unequal halves. For most of the period after 1861, the government simply accepted that, in practice, it was difficult to enact Revenue Bills, and lived with the problem as best it could. Then, in the years immediately before the First World War, an initiative was undertaken to deal with the problem— and the initiative failed.

The period up to the Lloyd George Initiative (1861–1912) The enactment of financial legislation was considered in a memorandum on the Revenue Acts prepared by Sir Henry Jenkyns and dated 20 November 64

Ilbert’s 1898 memorandum, n 38 above, para 12. (See also n 38 above.) For a contemporary statement of these distinctions see TNA file T 171/34, typed note headed ‘Finance Bill’. From its position in the piece, it may be inferred that the author of this note was the First Parliamentary Counsel, Sir Arthur Thring, and that the note was in existence by 18 April 1913. 65

Rise of the Finance Act: 1853–1922 87 1896.66 Jenkyns began with the proposition that various small amendments of the Revenue Acts were required from time to time. Those minor amendments had formerly been inserted in what were called ‘omnibus bills’;67 and, according to Jenkyns, these ‘were introduced from time to time comparatively late in the session by the Secretary to the Treasury, who got through so much of the Bill as he could, and dropped what proved too contentious’. Jenkyns also stated that: Of late years, owing to the condition of business in Parliament, there has been an increasing difficulty in connection with Bills to effect such small amendments, and successive Chancellors of the Exchequer have been more and more unwilling to introduce such Bills. The result is that in many cases relaxations or improvements in favour of the public, promised by the Chancellor of the Exchequer in deference to demands in the House of Commons, have been made without any legal authority; and it is something of a scandal that public officers should thus break the law. It is clearly undesirable that clauses for minor amendments of the Acts should be inserted in the Budget Bill. Such an insertion is inconvenient to the Government, because, as the Budget Bill is usually contentious and must be passed, the above clauses give scope for obstruction, and make it more difficult to pass the Bill, or at any rate to pass it quickly. It is also undesirable from a public point of view, as clauses containing minor amendments tend to obscure the broad issues which should alone be raised by the Budget Bill.

Jenkyns, therefore, was quite clear that there was, and should be, a distinction between the Bill containing the government’s essential proposals for dealing with the national finances (the ‘Budget Bill’) and a Bill making small amendments of the Revenue Acts (a Revenue Bill). The distinction between the two types of statute was set out in a document prepared in connection with the Revenue Bill of 1911, where it was stated that: This Bill is called a Revenue Bill and not a Finance Bill … as … it contains clauses which deal with general amendments of financial law, and not with the financial arrangements of the year. The provisions absolutely necessary for the financial arrangements of the year, namely, those imposing the tax on tea for the year, and income tax for the year, became law last November.68

The distinction between the Finance Bill and the Revenue Bill was a distinction between the senior partner and the junior partner. If the government 66 TNA file AM 3/50 fos 171–75, ‘Revenue Acts. Memorandum by Sir Henry Jenkyns, 20th November, 1896’. 67 For one occasion when the expression ‘omnibus Bill’ was used by a Chancellor of the Exchequer, see the reply given by Harcourt to a parliamentary question at Hansard, Fourth Series, vol 24, col 481 (7 May 1894). 68 TNA file AM 2/103, fo 400, Notes on Revenue Bill with backsheet dated 21 February 1911.

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could not carry its essential programme for the national finances, embodied in the Finance Bill, it could expect to fall. If, on the other hand, the government failed to make minor amendments of revenue law, there was no particular reason to expect major adverse consequences. An unsurprising operational corollary of this state of affairs was that a Finance Bill could be expected to be introduced fairly soon after the Budget speech—and to be enacted. A Revenue Bill, on the other hand, could only expect to be introduced much later on in the parliamentary session, and very possibly near the session’s end. A Bill that had not gone through all its parliamentary stages by the end of the parliamentary session failed. If a Revenue Bill existed at all, therefore, it existed in a state of tension between comprehensiveness and what may be termed ‘enactability’. The more comprehensive the Bill, the more likely it was that some one or more of its provisions would attract opposition in the House of Commons. That opposition would consume parliamentary time (likely to be scarce); and, accordingly, was capable of leading to the failure of the Bill. The alternative was to present a Bill drawn up so as to maximise its chances of being enacted quickly and quietly; but, if this were done, provisions suspected of being controversial might well be jettisoned. Ministers and officials were fully aware of the constraints within which they were operating. In 1903, faced with objections to the contents of the Revenue Bill, the Chancellor of the Exchequer (Ritchie) stated that it was perfectly obvious that the government could not insist on this Bill being proceeded with if there was no desire on the part of MPs to assist the government in doing what they believed to be in the interests of the public.69 On 3 February 1909, a Treasury official wrote to the First Parliamentary Counsel (Arthur Thring) to say that the Financial Secretary to the Treasury (Hobhouse) was anxious, if he could, to take the Revenue Bill through the House of Commons during the early part of the session when he thought that there might be a good chance of getting it through quickly. ‘But the success of this manoeuvre will he thinks depend almost entirely on the amount of opposition which its several Clauses will be likely to arouse.’ Thring, accordingly, was asked, not only to consider a number of specific points, but also to give his opinion ‘on any other matter which may seem to you to be of doubtful value in the Bill or likely to lead to controversy’.70 ‘Mr Hobhouse is no doubt right in his view’, commented the Chairman of the Board of Customs and Excise.71 ‘It is practically impossible now-a-days to pass any proposal in a Revenue Bill to which there is serious opposition.’72 69

Hansard, Fourth Series, vol 126, col 1023 (30 July 1903). TNA file AM 2/98 fos 164–65, Letter, dated 3 February 1909, from Behrens to Thring. TNA file AM 2/98 fos 175–8, typed note, dated 5 February 1909, with the initials ‘L.M.G.’ (ie Laurence M Guillemard). 72 When the Revenue Bill reached the House of Lords, the government spokesman said of it that ‘this is one of those minor Treasury Bills that generally reach the House at a rather late 70 71

Rise of the Finance Act: 1853–1922 89 During the half century following 1861, therefore, the enactment prospects for a provision whose proper place, according to contemporary thinking, was in a Revenue Bill, were highly uncertain. The provision could be jettisoned at any one of a number of points, both before and after any Bill was presented to Parliament. It was perfectly possible for a candidate provision to be known to officials without ever being brought to the attention of ministers. During the summer of 1912, at a time when it was already foreseeable that legislation of the type enacted in the Provisional Collection of Taxes Act 1913 might be required, Highmore sent Thring ‘a draft clause which I prepared some years ago to provide for the Collection of Income Tax after April 5 and until the tax for the year was imposed’. So far as he could remember, Highmore did not believe that the clause was prepared upon any definite instructions, although he was confident that the clause had never been included in any Bill. Highmore’s draft clause was located in a printed document, prepared in January 1899, headed ‘Inland Revenue Bill’, and containing 27 draft clauses. The opening hypothesis must be that no significant use was made of this document, at any rate at the time that it was originally produced.73 It may be taken as certain, however, that, at any one time, Treasury ministers were either aware of provisions suitable for inclusion in a Revenue Bill, or could take steps to ensure that they were aware of them. It did not follow from this, however, that the government would automatically wish to prepare a Revenue Bill for enactment during the particular parliamentary session in question. In 1897, indeed, the Chancellor of the Exchequer (Hicks Beach) was willing to confine his financial proposals to the renewal of income tax and tea duty, and, accordingly, did not even propose a Budget resolution that it was expedient to amend the law relating to customs and inland revenue (an omission that would have had the consequence that Finance Bill discussion of any matter other than the two proposed would have been out of order). However, the ruse was detected; Hicks Beach staged a tactical retreat; and the appropriate resolution was passed.74 The Finance

period of the session. There is nothing of a contentious character, I believe, contained in the Bill. It is merely to set right a few anomalies at present existing in the law relating to Customs and Inland Revenue’. Hansard (Lords), Fifth Series, vol 4, col 1132 (26 November 1909). 73 TNA file AM 1/42, Letter, Highmore to Thring, 10 July 1912 (fo 50), and printed document with the headings ‘Inland Revenue Bill’ and ‘Draft Clauses’, with backsheet dated 26 January 1899 (fos 51–55). 74 Hansard, Fourth Series, vol 49, cols 1010–11 (20 May 1897) and 1107 (21 May 1897). A typed note, in existence by April 1913 and presumably prepared by Thring, clearly proceeds on the basis that the omission was deliberate and not inadvertent. (See TNA file T 171/34, typed note headed ‘Revenue Bill’.) Another document which points to the same conclusion is a typewritten note headed ‘Finance Bill’, on which the date ‘28 April 1897’ has been written. (See TNA file AM 3/50 fo 181.)

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Act 1897, when enacted, contained a number of provisions amending the revenue legislation in detailed respects.75 If a Revenue Bill was prepared, the Bill might not even be introduced into Parliament, as happened in 1904 and 1908.76 If the government did decide to prepare a Revenue Bill, and if a Revenue Bill was actually introduced into Parliament, that Bill was liable to contain only a selection from the candidate provisions known to ministers and officials. Papers relating to the Revenue Bill of 1903 enable a process with two stages to be observed.77 In the first stage (with comprehensiveness in the ascendant), clauses were assembled; and the draft Bill expanded. So, in 1903, a printed draft of the Bill, dated 23 June, had 19 clauses; another, dated 25 June, had 26; another, dated 29 June, had 52; and another, dated 3 July, had 53. Then, in the second stage (with ‘enactability’ in the ascendant), clauses were jettisoned and the draft Bill reduced. So, in 1903, a printed draft of the Bill, dated 7 July, had 42 clauses; another, dated 17 July, had 22; another, dated 20 July, had 20; and another, dated 24 July, had 19. The Bill was finally introduced into the House of Commons on 27 July; and it then had 19 clauses.78 The Bill, therefore, began its parliamentary career with 19 clauses out of the 53 that had at one time been drafted. The other 34 (well over half) had been jettisoned before the parliamentary process even began. If a Revenue Bill was introduced into Parliament, it became subject to the slings and arrows of parliamentary and political fortune. In 1905, a Revenue Bill was introduced by Balfour’s Conservative government; but it came on for its second reading very late in the parliamentary session. On that occasion the second reading was deferred; and the government abandoned the Bill two days later, shortly before Parliament was prorogued in the middle of August.79 The provisions in that Bill, however, may then be said to have enjoyed good parliamentary fortune: for a Revenue Bill was introduced the following year (1906) by the new Liberal government; the provisions of the 1906 Bill were described as being virtually identical with those of the 1905 Bill,80 and the 1906 Bill was enacted.81 75 60 & 61 Vict c 24. For example, s 5 of that Act contained detailed provisions for the treatment of the income of a married woman; and s 6 (one of the excise provisions) dealt with the sale of tobacco in omnibuses and tramway cars. The statement of business transacted in the Office of the Parliamentary Counsel for the 1897 session records that a Customs and Inland Revenue Bill was also prepared, but that this Bill was not introduced into Parliament (TNA file AM 2/67 fos 684–88). 76 See the statements of the business transacted in the Office of the Parliamentary Counsel for the 1904 and 1908 parliamentary sessions (TNA files AM 2/86 fos 1–5 and AM 2/97 fos 1016–20, respectively). 77 The contents of this paragraph have been derived from the material in TNA file AM 2/85 fos 453–514. In the text, the date given for a print of the draft Bill is the date mentioned on the backsheet of the document in question. 78 TNA file AM 2/85 fos 569–73. Hansard, Fourth Series, vol 126, col 339 (27 July 1903). 79 Hansard, Fourth Series, vol 151, cols 311–12 (7 August 1905) and 877 (9 August 1905). 80 Hansard, Fourth Series, vol 160, col 320 (18 June 1906). The speaker was the Financial Secretary to the Treasury (McKenna). 81 It became the Revenue Act 1906 (6 Edw 7 c 20).

Rise of the Finance Act: 1853–1922 91 A Revenue Bill might also be affected by the wishes of individual MPs and of the opposition. During the Committee Stage of the Revenue Bill in 1903, the Chancellor of the Exchequer (Ritchie) indicated that if one MP ‘thought this clause ought not to be proceeded with, he would not press it’—and this clause was then dropped.82 The Revenue Bill 1903, when introduced into Parliament, had 19 clauses; at the end of its parliamentary proceedings, the Revenue Act 190383 had only 17 sections. In 1909, the Liberal government had informal discussions with the Conservative opposition about the contents of the Revenue Bill. The opposition took exception to three clauses; and these were ‘at once’ withdrawn ‘in order that nothing of a controversial character should be present’.84 During the half century after 1861, therefore, it became increasingly clear that the arrangements relating to the enactment of the United Kingdom’s financial legislation did not result in the enactment of all the financial legislation that the government would ideally like to see enacted. The arrangements produced the essential bare minimum of financial legislation (in the form of the Act known earlier as the Customs and Inland Revenue Act and later as the Finance Act) and a rather small amount of additional material (in the form of the occasional undersized Revenue Act); but these two Acts, even when taken together, still left a significant shortfall. Under the Liberal government in office from 1905, the pressures on the existing system of enacting financial legislation increased still further. The burden of taxation became heavier; and the government made major changes to the taxation system.85 MPs took more interest in the details of revenue legislation. A printed document compiled in 1911, at a time after the Revenue Act had received the Royal Assent, consisted of notes by the Inland Revenue and by Customs and Excise on amendments and new clauses that had been previously tabled by MPs, but which had not been enacted. The document, which ran to 73 pages, dealt with 71 different proposed provisions.86 Officials calculated that the number of amendments and new clauses proposed for the committee and report stages of the Finance Bill was 15 in 1897 but 129 in 1911.87 The field for new clauses was described as ‘practically unlimited’. ‘The number of new clauses is only limited by the

82

Hansard, Fourth Series, vol 127, cols 944–46 (11 August 1903). 3 Edw 7 c 46. 84 Hansard, Fifth Series, vol 11, cols 1226–27 (28 September 1909). 85 The duties on land values introduced in Part I of the Finance (1909–10) Act 1910 (10 Edw 7 c 8) consumed much time and energy during the period immediately before the First World War. For the changes in income tax law made during these years see JHN Pearce, ‘The Rise and Development of the Concept of “Total Income” in United Kingdom Income Tax Law: 1842–1952’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2007) vol 2, 98–102. 86 TNA file AM 2/103, fos 435–72, ‘Revenue Bill: Notes by the Inland Revenue and the Customs and Excise on New Clauses’. This document has a backsheet dated 29 April 1911. The Revenue Act 1911 (1 Geo 5 c 2) received the Royal Assent on 31 March 1911. 87 TNA file T 171/34, carbon copy typewritten document headed ‘Finance Bill’. 83

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fancy of members, and the period for which they can be discussed is equally indefinite.’88 When the House of Lords rejected the Finance Bill in 1909, precipitating the constitutional crisis leading to the enactment of the Parliament Act 1911,89 the system itself was challenged directly. These and other considerations brought about a state of affairs in which the date on which the Royal Assent was given to the Finance Bill became significantly later. During the period from 1861 to 1908, the Royal Assent was never given to the Customs and Inland Revenue Bill (or the Finance Bill) later than some day in August.90 In 1909, as a result of the rejection of the Finance Bill by the House of Lords, income tax was not imposed for the 1909–10 year of assessment until after that year had ended;91 and, in 1910 and 1911, the Finance Bill received the Royal Assent on 28 November and 16 December respectively. It had been the custom to collect income tax on the basis of the House of Commons resolution that the tax should be imposed, although the practice was generally recognised as being dangerous.92 The increasing delays in enacting the Finance Act strengthened the position of those opposed to the practice: and, in Bowles v Bank of England,93 the practice was held to be illegal. The decision in that case led, in its turn, to the enactment of the Provisional Collection of Taxes Act 1913,94 giving limited statutory authority, for a limited period, to House of Commons Budget resolutions.95 Against the background of the shortfall in legislation enacted, there is evidence of new procedures being adopted or considered. Extra-statutory concessions were first reported to the Public Accounts Committee in 1897; and 68 concessions were reported to that committee in 1915.96 The proposition that the Finance Act should contain all the government’s financial proposals also began to be advanced. One official noted that Finance Bills included machinery provisions (designed to make the charge to tax effective): these provisions had been included, for example, in Part I of the Finance

88 TNA file AM 6/1, fos 132–33. Note (carbon copy) headed ‘Revenue Bill’. The note is undated and has no obvious indication as to authorship; but the location of the document makes it likely that it was prepared in 1914 in the Office of the Parliamentary Counsel. 89 1 & 2 Geo 5 c 13. 90 TNA file T 171/34. In this piece there is a list, for the years from 1859 to 1912, of the date of the Budget statement and the date of Royal Assent. C Stebbings, The Victorian Taxpayer and the Law (Cambridge, Cambridge University Press, 2009) 58. 91 The Finance (1909–10) Act 1910 (10 Edw 7 c. 8) received the Royal Assent on 29 April 1910. 92 Stebbings, n 90 above, 55. 93 [1913] 1 Ch 57; (1912) 6 TC 136. 94 3 Geo 5 c 3. 95 For the Provisional Collection of Taxes Act 1913, see generally Stebbings, n 90 above, 53–61 and J Jaconelli, ‘The “Bowles Act”: Cornerstone of the Fiscal Constitution’ (2010) 69 Cambridge Law Journal 582. 96 DW Williams, ‘Extra Statutory Concessions’, [1979] British Tax Review 137 n 3a. See also text following n 67 above.

Rise of the Finance Act: 1853–1922 93 Act 1894, which had imposed estate duty.97 Sir Charles Dilke’s main objection to the Revenue Bill of 1903 ‘was that the whole of these proposals should have been in the Finance Bill. That Bill was not confined only to the new taxes of the year, but it was a measure which always contained the general amendments of the law’.98 The Chancellor of the Exchequer (Ritchie) agreed that ‘There was a good deal of force in the contention that these matters ought to be dealt with in a Finance Bill’. He went on to say, however, that MPs ‘would see that if they were all included it would be impossible to pass that measure within a reasonable limit of time’.99

The Lloyd George initiative, and after (1913, 1914 and 1921) Given the existence of both Finance Acts and Revenue Acts, and also of a shortfall in revenue legislation, the two obvious strategies for dealing with the shortfall were to expand the contents either of the Finance Act or of the Revenue Act. Officials continued to hold the view that the separation of financial legislation into these two components had benefits;100 and the government initiative, announced in 1913, was to seek to expand the role played by the Revenue Bill. The initiative was introduced by Lloyd George in his 1913 Budget speech. The Chancellor stated that amendments moved to the Finance Bill had increased in recent years, and that the Provisional Collection of Taxes Bill (which, at that time, was before Parliament) imposed what was practically a timetable for taxation Bills. It was quite impossible, in his opinion, for any government in the future to carry through its taxation proposals, and to give facilities for a full discussion of every revenue proposal in the middle of the session, without dislocating all other business. ‘It would have the effect of strangling the business of every Government.’ The government had therefore decided ‘to recur to a practice … of having two Bills’. It proposed to confine the Finance Bill ‘to the renewal of temporary taxes and to introduce a Revenue Bill on the basis of a Resolution for the general amendment of the law’.101 The initiative, therefore, consisted of an explicitly formulated intention on the part of government to aim at enacting both a Finance Act and a Revenue Act in each parliamentary session. During both the years 1913 and 1914, that initiative failed, for no Revenue Bill was enacted. 97 TNA file AM 1/35, fos 631–32, ‘Finance Bill: Instructions: Note’ (backsheet dated 18 June 1909). 98 Hansard, Fourth Series, vol 126, col 1020 (30 July 1903). 99 Hansard, Fourth Series, vol 127, col 786 (10 August 1903). 100 See, eg, TNA file AM 1/42 fos 94–96, ‘Financial Legislation: Note’ (backsheet dated 26 January 1912). 101 Hansard, Fifth Series, vol 52, cols 279–80 (22 April 1913).

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In 1913, Lloyd George’s budget speech, in which he announced the government initiative, was made on 22 April. Hansard records that the Revenue Bill was presented on 7 May 1913;102 but, on that day and for more than two months afterwards, there was no text for MPs to consider. It is highly unlikely that Lloyd George spent any significant amount of time in considering the contents of the Revenue Bill before the middle of July. Among other matters he was concerned to defend himself against the allegations made during the Marconi scandal. Officials, on the other hand, were not inactive on this front, and the Revenue Bill went through its expanding comprehensiveness phase. Draft clauses for customs and excise matters had been prepared by 30 April; and draft clauses for the imposts administered by the Inland Revenue went through eight drafts between 1 May and 11 June. A draft Revenue Bill with a backsheet dated 18 June had 46 clauses; and three later drafts, similarly dated 12, 14 and 16 July, had 50, 49 and 46 clauses, respectively. The Revenue Bill’s comprehensiveness phase was then followed by its contracting ‘enactability’ phase. A further draft of the Bill, with a backsheet dated 18 July, had only 18 clauses; and the Revenue Bill, when it was finally available for MPs to study on 21 July, had only 15.103 By this time, also, the ambit of the provisions contained in the Bill had contracted. A memorandum presented to the House of Commons explaining the Bill’s contents began with the statement that ‘This Bill is confined to certain amendments of the law relating to land taxes’.104 On the day after the text of the Revenue Bill was available, the Prime Minister, (Asquith), speaking in the House of Commons, hoped that the Revenue Bill might go through by consent as an agreed measure. MPs could see that the Bill made concessions to demands made in different parts of the House: The Government believe that these concessions are of such a nature and that they have been so carefully worked out in consultation with persons interested, that they might well be treated as non-controversial. If they are so treated we hope the Bill may go through by consent as non-controversial. But I am bound to add that, if there is any opposition to the provisions of the Bill, or if its introduction is made the occasion for an attempt to enlarge its scope so that it will not be possible to give it consideration at this stage of the Session, the government will, with great reluctance, be obliged to withdraw it.105

On 1 August, Lloyd George invited the co-operation of MPs on both sides of the House ‘in helping us to get the Bill’. The government could not 102

Hansard, Fifth Series, vol 52, col 2150 (7 May 1913). TNA file AM 1/42, fos 203–479, 529–621 and 937–54. Copy of Memorandum Explanatory of the Revenue Bill, Parliamentary Papers 1913 (213). The land taxes in question were those dealt with in Part I of the Finance (1909–10) Act 1910. 105 Hansard, Fifth Series, vol 55, col 1878 (22 July 1913). 103 104

Rise of the Finance Act: 1853–1922 95 give the Bill very much time ‘and looking at the amendments carefully it would be quite impossible if they were discussed at any length, to find time to get the Bill through’.106 However, no agreement could be made; and on 12 August 1913, the Bill was withdrawn.107 In this year, therefore, the only financial legislation consequential upon the Budget that was actually enacted was the Finance Act 1913,108 which had four sections only. Section 1 continued the duty on tea; section 2 provided for income tax to be charged for the 1913–14 year of assessment; section 3, which had been added in committee,109 provided for deductions in respect of the expenses involved in earning salaries; and section 4 was the short title. The government’s new initiative had resulted in the most meagre of legislative harvests. If the implementation of the initiative during 1913 may be described as a shambles, the implementation of the initiative during 1914 may be described as a larger shambles.110 During the summer of 1913, Lloyd George had announced the government’s intention to bring in a more comprehensive Revenue Bill early in the next session,111 but no early Revenue Bill materialised. Lloyd George’s own priority at this time was a project to achieve land reform,112 but he was unable to pursue this priority consistently. During most of a period of six weeks beginning in the middle of December 1913, he was almost continually occupied by a fierce dispute with Churchill at the Admiralty over the naval estimates—a dispute that ended with victory for Churchill at a Cabinet held on 11 February 1914. Then, almost immediately afterwards, Lloyd George was again diverted from his project for land reform by the growing crisis in Ireland. During these months, it may confidently be asserted, Lloyd George’s priority was most certainly not the detailed contents of the Revenue Bill. ‘We shall never get the ChofEx to go into the Bill’ the First Parliamentary Counsel wrote to the Chairman of the Board of Inland Revenue early in 1914.113 Officials, however, did give attention to the preparation of material capable of being placed in a Revenue Bill: and, between 7 November 1913 and 9 February 1914, 15 successive drafts 106

Hansard, Fifth Series, vol 56, cols 939–40 (1 August 1913). Hansard, Fifth Series, vol 56, cols 2419–24 (12 August 1913). By the time the Bill came to be withdrawn, at least 51 new clauses had been proposed. (See TNA file T 171/48.) 108 3 & 4 Geo 5 c 30. 109 Hansard, Fifth Series, vol 56, cols 2145–50 (11 August 1913). 110 On the events surrounding the budget of 1914, see BB Gilbert, ‘David Lloyd George: the Reform of British Landholding and the Budget of 1914’ (1978) 21 Historical Journal 117; BK Murray, ‘“Battered and Shattered”: Lloyd George and the 1914 Budget Fiasco’ (1991) 23 Albion 483; and I Packer, ‘The Liberal Cave and the 1914 Budget’ (1996) 111 English Historical Review 620. The account in this chapter largely follows that given in Gilbert’s article (although his explanation of Revenue Bills (at 133 n 50) is not the explanation given in this chapter). 111 Hansard, Fifth Series, vol 56, col 940 (1 August 1913). 112 Gilbert, n 110 above, 117. 113 TNA file IR 63/40 p 491, Letter, Thring to Nathan, 28 January 1914. 107

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of the Revenue Bill were printed, with the number of draft clauses rising from seven to 61.114 It was only in mid-April that Lloyd George gave priority to the contents of his Budget;115 and that Budget has been described as having two distinct strategies. There was a fiscal strategy, which involved increasing taxation to pay for naval expenditure and the reorganisation of local government finance; and there was a political strategy, intended to furnish a reform programme enabling the Liberals to make a powerful progressive appeal at the next general election, due by the end of 1915.116 It could be said in favour of Lloyd George’s overall approach that it was characterised by a large political vision; it could be said against that overall approach that Lloyd George had not thought sufficiently about the detail—and that was where the devil was. In his Budget speech Lloyd George proposed that the charge to Income Tax should be raised from 1s 2d to 1s 4d in the pound, the highest rate since the Crimean war. At the core of the 1914 Budget, however, was land and rating reform. Lloyd George proposed that the national valuation of land separate from premises which was being undertaken for the purposes of the land taxes introduced in 1910 should be made the basis for a new system of rating; and that ratepayers should obtain reductions in their rates according to the improvements that they had made. These proposals led on to a further proposal that there should be a large new system of grants to local authorities; partly to compensate them for the loss of income resulting from the derating of improvements when derating began, and partly to take care of the increased expenses incurred by local authorities as a result of their expanding duties. But, since the immediate financial position of many local authorities was poor, Lloyd George proposed a programme of ‘provisional grants’ to assist them; and these grants were to begin in the current financial year. There was, however, a fatal mismatch between two elements of what was proposed, because, in his Budget speech, Lloyd George made the unnecessary and disastrous error of pledging that the provisional grants would not begin until legislation was passed giving the local authorities power to derate improvements. The immediate legal problem was that this legislation was still to be enacted; it was envisaged that the necessary provisions would be placed in the forthcoming Revenue Bill. (Behind the immediate legal problem was an additional, less immediate, operational problem: for the local authorities could only make use of their proposed derating powers when the national valuation was complete, and that valuation was not complete.) In these circumstances the Conservative opposition could, and did, argue against Lloyd George that the size and contentiousness of the Revenue 114 115 116

TNA file AM 1/44, fos 1–172. Gilbert, n 110 above, 131. Murray, n 110 above, 483.

Rise of the Finance Act: 1853–1922 97 Bill would prevent it from reaching the statute book before the Finance Bill needed to be enacted (at a time when it would gain the benefit of the limited protection given to Budget resolutions by the Provisional Collection of Taxes Act 1913). On this footing there would, accordingly, be a time, a little later in the year, when it would be possible to advance two propositions. The first proposition was that there would be no legislation in existence enabling local authorities to derate improvements, with the consequence (according to Lloyd George’s pledge) that there would be no provisional grants. The second proposition was that legislation (in the Finance Act) providing for increased taxation would have taken effect, so that increased funds would be reaching the Exchequer. The overall conclusion was that Lloyd George’s proposals would result in money reaching the Exchequer for purposes on which he had disbarred himself from spending it. Early in June, therefore, Lloyd George abandoned his first underconsidered plan in favour of a second plan—which was also underconsidered. As it was unlikely that both the Finance Bill and the Revenue Bill could be enacted in the two months before the summer recess, the division of material between the two Bills would be altered. The vital Finance Bill would be given priority; the Revenue Bill would have to be lightened and possibly postponed. On 5 June 1914, Edwin Montagu, the Financial Secretary to the Treasury sent a letter to the First Parliamentary Counsel: When we meet you will be asked by the Chancellor of the Exchequer for a list of the Clauses in the draft Revenue Bill which are pledges from last year and those which are essential, and you will be asked to cut out all the rest. This is the decision of the P.M. and the Chancellor.117

The Revenue Bill had 21 clauses only, when, on 18 June, its text was finally available for MPs to study.118 On the other hand, the Finance Bill now also contained the provisions enabling local authorities to derate improvements, transferred from the Revenue Bill. The proposition that the provisional grants would not begin until legislation had been passed giving the local authorities power to derate improvements was also placed in the Finance Bill. This was a course of action that did not remove the criticism that there was a fatal mismatch between revenue and expenditure, but it was a course of action that gave rise to a new parliamentary difficulty; for it could now also be alleged that the contents of the Finance Bill were no longer in accordance with the Budget resolutions authorising the Bill to be brought in, with the consequence that a considerable part of the Finance Bill was now out of order. The government had major problems, and knew it. The size of the foreseeable excess of government receipts over government expenditure 117 118

TNA file AM 1/44, fo 274, Letter, Montagu to Thring, 5 June 1914. TNA file AM 1/44, fos 232–49.

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displeased ‘Gladstonian’ Liberals. In addition, the Cabinet now realised that they had misunderstood the timetable for which the Provisional Collection of Taxes Act provided. The Finance Bill had to be enacted by 5 August and not 5 September (as had been believed). Asquith wrote to a correspondent on 18 June that: [I]f we could put off the last stage of the Finance Bill (as we thought we could) till Sept[ember], we sh[oul]d have time to do something, but as it has to be passed by Aug[ust] 5th it is quite impossible to get both it and the Revenue Bill by that date.119

The government retreated. The material relating to land and rating reform was removed from the Finance Bill; and, to bring government receipts into line with government expenditure, the rise in the charge to income tax was to be halved, to 1s 3d in the pound. This decrease displeased liberal radicals and the government’s labour allies, who wished spending on social programmes to be increased. The Finance Bill was enacted;120 but, on 17 July, Asquith told the House of Commons that the Revenue Bill would be dropped.121 So in 1914, as in 1913, Lloyd George’s initiative failed to produce a Revenue Bill that was actually enacted. In addition, the overall shape of the government’s financial proposals had had to receive significant modification; and those who wished to allege that the government was incompetent had been given excellent ammunition. Asquith envisaged that the Revenue Bill might be reintroduced in a winter session;122 but the First World War intervened, and Revenue Bills were placed to one side for a number of years. Two points may be made on Lloyd George’s own responsibility for the failure to enact a Revenue Bill in 1913 or 1914. It may certainly be alleged against him that he gave insufficient attention to what needed to be done, and particularly to the details of what needed to be done. One official wrote of his difficulties in 1914 that ‘It all springs from the besetting sin of the creature that he will not work at his business beforehand & betimes, and it serves him perfectly right that he has got it “in the neck”’.123 On the other hand, it may be said that Lloyd George had too much to do, and was overstretched. In the early summer of 1914 he was described by another Liberal

119 Quoted from Packer, n 110 above, 625–26. Packer’s overall conclusion on this whole sequence of events was that ‘In this situation, the Cabinet had to admit that Lloyd George’s ingenious plan to combine immediate new grants with major reforms of rating and grant allocation was impossible. There was simply not enough parliamentary time to allow the scheme to succeed’ (ibid 626). 120 The Finance Act 1914 (4 & 5 Geo 5 c 10) received the Royal Assent on 31 July 1914. 121 Hansard, Fifth Series, vol 64, col 2295 (17 July 1914). 122 ibid col 2328 (17 July 1914). 123 Quoted in A Offer, Property and Politics 1870–1914: Landownership, Law, Ideology and Urban Development in England (Cambridge, Cambridge University Press, 1981) 399. The official was Sir Robert Chalmers.

Rise of the Finance Act: 1853–1922 99 politician as ‘jumpy, irritable, overworked, and unhappy’.124 Gilbert notes that ‘it was typical of the intense pressure of these days’ that, on the day of the 1914 Budget (4 May), ‘before a long speech at three that afternoon for which he was woefully unprepared’, Lloyd George invited CP Scott, the editor of the Manchester Guardian, to lunch with him in order to learn his views about the Chancellor’s old project of Home Rule ‘All Round’.125 A final Revenue Bill was presented to the House of Commons in 1921 with the primary purpose of giving effect to some of the recommendations of the Royal Commission on the Income Tax, which had reported in 1920.126 The report had been signed shortly before the Chancellor of the Exchequer (Austen Chamberlain) delivered his Budget speech, in which he said that: It is quite clear that I cannot deal with the whole of this immense and complicated subject in the Finance Bill, which is subject to statutory limitations as to the time allowed for discussing its different stages. Many of the recommendations go to the root of the system of the Income Tax, and for practical reasons, even if I could include them in the Finance Bill, they could not be brought into effective operation in the year in which they are passed into law. Accordingly, subject to important exceptions … I have decided that the general reform of the Income Tax is a matter which calls for a separate Bill. That Bill will be introduced as soon as possible.127

Chamberlain went on to say that he might well not be able to bring in a Revenue Bill at a very early date as both he and Inland Revenue officials were ‘pretty fully occupied just now’; and progress on the drafting of the Revenue Bill was certainly slow. At a meeting held on 29 September 1920, Chamberlain ‘said he saw very little prospect of getting a Bill this Session and appeared to view without much favour a suggestion to introduce one early next year for passage in the first part of the Session’.128 On 22 February 1921, the Revenue Bill was still due to appear; and Chamberlain was asked whether it would be taken on the floor of the House of Commons. He replied ‘No. I shall ask the House to send it upstairs. That is the only hope of passing it. If the House treats it as a contentious measure it will not be proceeded with.’ He also added, a little later, that ‘the House must understand that if

124

Gilbert, n 110 above, 135. ibid 131. Cmd 615. The Report was signed on 11 March 1920 (see p 141 of that Report). 127 Hansard, Fifth Series, vol 128, col 92 (19 April 1920). 128 TNA file IR 63/99 fos 1–2, Note by Hopkins, dated 2 October 1920, of meeting held on 29 September 1920. On 16 February 1921, Chamberlain told a Deputation from the Federation of British Industries that ‘I had hoped that it might have been possible for me to introduce a Revenue Bill last year … That was not possible. My officials and I were very hardly worked, and it was not possible for me to find the time to get that Bill drafted in time, or even if I had had it drafted, could I have hoped to make progress with it in so crowded a Session. I am hoping to introduce that Bill early this Session and to get it through’ (TNA file T 171/198). Transcript of the shorthand note made of a meeting between a Deputation from the Federation of British Industries and the Chancellor of the Exchequer, 16 February 1921 (at 20–21 of that transcript). 125 126

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it is to be treated as a contentious measure I cannot possibly hope to make progress with it this Session’.129 As a statement of what the parliamentary timetable made possible, these remarks may well have been unexceptionable: but it may, perhaps, still be questioned whether it was wise to specify, in such explicit detail, how those opposed to the Bill could defeat it. When eventually presented to Parliament on 6 April 1921,130 the Revenue Bill became the subject of hostile criticism and a campaign in the press. It also became known that the Bill’s second reading was likely to be opposed.131 The Revenue Bill, therefore, was due to be treated as a contentious measure—the state of affairs likely to be fatal for its enactment—and the government withdrew it.132 According to the Chancellor of the Exchequer (now Sir Robert Horne), the clauses in the Revenue Bill relating to the administration of Income Tax had been completely misapprehended by the public; but ‘the provisions of those Clauses would undoubtedly have excited very considerable controversy—so much so, indeed, that in view of the congested character of this Session it would have been impossible to pass the Bill’—which had, accordingly, been withdrawn.133

The arrival of the Finance Bill (only) A work published some years later stated that the Revenue Bill of 1921: was dropped owing to the opposition aroused. This was the last occasion on which the practice of introducing a separate Revenue 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 that reason the Treasury have since that time adopted the practice of covering all necessary measures in one Bill—the Finance Bill.134

It is not known whether the authors of the work were in possession of any special information when writing that passage; but the proposition advanced was certainly true. The Revenue Bill of 1921 was the last occasion on which a Bill, whose provisions ranged generally over revenue law but which was not a Finance Bill, was presented to Parliament. From the point of view of government, the failure of the Revenue Bills of 1913, 1914 and 129

Hansard, Fifth Series, vol 138, cols 760 and 761 (22 February 1921). Hansard, Fifth Series, vol 140, cols 279–80 (6 April 1921). For further details on the contents of the Revenue Bill 1921 and on its fate see JHN Pearce, ‘The Role of Central Government in the Process of Determining Liability to Income Tax in England and Wales: 1842–1970’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2009) vol 3, 341–43. 132 Hansard, Fifth Series, vol 141, cols 1045 and 1188 (4 May 1921). 133 Hansard, Fifth Series, vol 142, col 219 (25 May 1921). 134 B Mallet and CO George, British Budgets: Second Series: 1913–14 to 1920–21 (London, Macmillan, 1929) 245–46. 130 131

Rise of the Finance Act: 1853–1922 101 1921 hardly pointed towards any further use of such Bills; and, after 1921, the government relied on two other types of Bill when amending revenue law. The government made a certain limited use of programme Bills whose scope was specific. A Bill of this type had better enactment prospects, as officials were well aware. On the day following the judgment in Bowles v Bank of England, two of the Commissioners of Inland Revenue attended upon Thring ‘to talk over with him the Bill rendered necessary by the previous day’s judgment’. One of the points discussed was that ‘it would be advisable that the Bill should only deal with the specific point for which it was introduced, as the Chancellor desires to avoid other revenue matters being brought up for discussion in connection with it’. On this point, Parliamentary Counsel ‘thought that the Bill now proposed should not be a Revenue Bill. This would preclude amendments being put down which had nothing to do with the result of the Gibson Bowles case’.135 It was on this specific basis that the Provisional Collection of Taxes Bill was prepared, and enacted.136 When amending revenue law, however, the government relied almost entirely on provisions placed in the Finance Act; and, in doing so, it was helped by two statutes enacted shortly before the First World War. The Parliament Act 1911 prevented the House of Lords from amending a ‘Money Bill’ (within the meaning of that Act).137 The Provisional Collection of Taxes Act 1913 gave statutory authority to resolutions of the House of Commons, but for a limited period only. The ‘practical effect’ of the Provisional Collection of Taxes Bill, it was noted in April 1913, was to compel a Chancellor of the Exchequer ‘to get the Royal Assent giving effect to his Budget before the summer prorogation of Parliament’.138 These two statutes were capable of acting in combination, and of having a major effect when they did so. The Bill brought forward to give permanent effect to the government’s Budget resolutions needed to be passed within a strictly limited time in order to comply with the timetable set out in the Provisional Collection of Taxes Act 1913; and, accordingly, could expect to receive full party support to ensure its safe passage through the Commons. That Bill might well also be a ‘Money Bill’ within the meaning of the Parliament Act, and, if so, the government did not need to worry about

135 TNA file IR 63/18, Note by Sir Matthew Nathan, ‘Memorandum of Interview’, 6 November 1912. 136 Later programme Bills with a specific scope dealing with aspects of revenue law included the two statutes enabling the PAYE Regulations to be made: the Income Tax (Employments) Act 1943 (6 & 7 Geo 6 c 45) and the Income Tax (Offices and Employments) Act 1944 (7 & 8 Geo 6 c 12). 137 See Parliament Act 1911 s 1(2). 138 TNA file AM 1/42 fo 43, ‘Provisional Collection of Taxes Bill: General Note’ (backsheet dated 4 April 1913).

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the attitude that might be taken in the House of Lords. Bills with these characteristics (modern Finance Bills) had a swifter and surer road to enactment than any other Bills that might be presented to Parliament. If it had been successful, Lloyd George’s 1913 initiative would have had the result that the status and importance of the Revenue Bill would have increased vis-à-vis that of the Finance Bill. In the events that happened, however, the government had Finance Bills which were capable of becoming more powerful weapons in its arsenal, while the attempts to achieve legislative change through Revenue Bills were conspicuous failures. Ritchie, in 1903, had thought that there was force in the contention that the government’s financial proposals should all be in the Finance Bill; but had also thought that the government’s inability to enact such a statute within a reasonable time prevented matters from being handled in this way.139 By the time of the outbreak of the First World War, and certainly after it, this was no longer the case. Following the failure of the Revenue Bill in 1921, the era of the omnibus Finance Bill had indeed arrived; but the journey to this destination may have been more complicated, and taken longer, than may sometimes have been thought. So far as the events examined in this chapter are concerned, the period following the enactment of the Parliament Act 1911 nevertheless had one feature that may, at first sight, be considered unexpected; because, of the 31 Finance Bills between 1911 and the end of 1937, only 13 were certified as ‘Money Bills’.140 The explanation of this paradox is to be found in the expansion of the contents of Finance Bills so that they contained provisions additional to those entitling them to be certified as Money Bills, with the consequence that the Finance Bill could not be so certified.141 No evidence is known, however, where, after the First World War, a government suffered inconvenience because the Finance Bill had expanded beyond the limits that might have been expected.

CONCLUSION

In the sequence of events ending with the arrival of the Finance Act in its position of unquestioned supremacy as the government’s vehicle for changing revenue law, one feature that appeared on many occasions was the shortage of parliamentary time—and this acted as a constraint upon government. 139

See text around n 99 above. The essential source for this statement is Jennings, n 1 above, 402. Jennings begins in 1913; but his information may be supplemented by adding the Finance Act 1911 (1 & 2 Geo 5 c 48) which was not certified (see B Mallet, British Budgets 1887–88 to 1912–13 (London, Macmillan, 1913) 333) and the Finance Act 1912 (2 & 3 Geo 5 c 8) which was certified (see Hansard (Lords), Fifth Series, vol 12, col 807 (7 August 1912)). 141 On this see Jennings, n 1 above, 401–5. 140

Rise of the Finance Act: 1853–1922 103 Sir Henry Jenkyns, in 1896, noted that ‘the condition of business in Parliament’ made it difficult to enact Revenue Bills;142 Ritchie, in 1903, was clear that the Revenue Bill would not reach the statute book unless MPs would assist in its enactment;143 and absence of parliamentary time was of fundamental importance when considering the failure to enact Revenue Bills in 1913, 1914 and 1921. The constraint of an absence of time for the enactment of legislation was in existence well before 1900, and was not confined to financial legislation.144 In 1860, for example, Lord John Russell lamented that the government, which had three-quarters of the whole legislative business of Parliament in its hands, had only one-quarter of Parliamentary time at its disposal;145 and, at the end of 1880, Gladstone found himself confronting ‘the heavy inconvenience of prolonged and manifold legislative arrear’.146 The American political scientist, AL Lowell, writing in 1908, had no doubt ‘that the legislative capacity of Parliament is limited, and the limit would appear to be well-nigh reached, unless private Members are to lose their remnant of time, or debate is to be still further restricted’.147 Bagehot, in his work on The English Constitution dealt with the matter still more generally, writing that ‘the greatest defect of the House of Commons is that it has no leisure … It has an amount of business brought before it such as no similar assembly ever has had’.148 It was not only the House of Commons that had no leisure; the same applied to others. Lloyd George was overstretched in 1913 and 1914;149 and Austen Chamberlain stated that both he and Inland Revenue staff were ‘pretty fully occupied’ in 1920.150 The proposition may be advanced that, in the United Kingdom, at nearly all times during the twentieth century (and in many earlier and later years), the amount of time needed to undertake the business that the government would ideally have wished to undertake exceeded the amount of time available for the undertaking of that business. It followed that not all the business that the government would ideally have wished to undertake could, or would, be undertaken. Some business would be undertaken, some would not. 142

See text following n 66 above. See text around n 69 above. 144 For nineteenth century developments see generally P Fraser, ‘The Growth of Ministerial Control in the Nineteenth-Century House of Commons’ (1960) 75 English Historical Review 444 and V Cromwell, ‘The Losing of the Initiative by the House of Commons, 1780–1914’ (1968) 18 (Fifth Series) Transactions of the Royal Historical Society 1. 145 Hansard, Third Series, vol 157, cols 1731–32 (2 April 1860). 146 Quoted in E Hughes, ‘The Changes in Parliamentary Procedure, 1880–1882’ in R Pares and AJP Taylor (eds), Essays Presented to Sir Lewis Namier (London, Macmillan, 1956) 295. 147 Quoted in SA Walkland, ‘Government Legislation in the House of Commons’ in SA Walkland (ed), The House of Commons in the Twentieth Century (Oxford, Clarendon Press, 1979) 254. 148 W Bagehot, The English Constitution (London, Chapman and Hall, 1867) 141. 149 See text following nn 102 and 112 above. 150 See text following n 127 above. 143

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Given the existence of this constraint, and so far as the enactment of financial legislation was concerned, it made sense for governments to take such steps as they could to ensure that time was well used. If the essentials of the government’s financial proposals would survive intact if placed in a single statute, but might be in jeopardy if placed in a number of different statutes, it made sense to enact those provisions in one statute only. From this point of view, the concentration of the highly specialised drafting function in one particular location could also be regarded as sensible. These measures helped to manage the problem, but they could not solve it. At the beginning of the twentieth century governments could enact their essential programme for the national finances (in the Finance Act), supplemented, every now and then, by a small selection of other provisions (almost certainly uncontroversial ones) placed in a Revenue Act. But there was still a shortfall between the amount of financial legislation that the government would ideally have wished to enact and the amount of financial legislation actually enacted. During the years immediately before the First World War, the government attempted to deal with this problem by making full use of Revenue Bills, but its attempt to do so failed completely. On the other hand, during this same period, the Parliament Act 1911 and the Provisional Collection of Taxes Act 1913 increased the potentialities of Finance Bills. After 1921, Revenue Bills were abandoned, but Finance Bills remained. This outcome may be regarded as the least worst way of managing the problem. But there was a problem—and that problem was still only being managed. Finance Bills were very powerful weapons in the hands of governments; but, having regard to the time constraints to which they were subject, it was still not possible to include all the provisions that the government would ideally have wished. What was absolutely essential would be dealt with, and what was uncontroversial was usefully placed. But there was still not time to deal with everything. Administrative provisions and provisions clarifying the law were two types of provision liable to suffer in a state of affairs where only some of the potential provisions available to be called could be chosen. Not only that: the parliamentary process, in addition to helping to ensure that income tax legislation remained unsatisfactory when considered in its totality, also operated to make the state of that legislation unsatisfactory at the level of particular provisions. It was not possible, the Attorney-General (Inskip) told the House of Commons during the committee stage of the Finance Bill in 1928, to take a group of sections in a Finance Act and to repeal them, re-enacting them from start to finish with the amendments that the government wished to see. ‘That would give facilities for proposing Amendments which would probably make the passage of the Bill impossible.’ The ‘exigencies of Parliamentary time’ accordingly produced a situation in which the government proposed a series of limited amendments to the existing legislation, with a view to restricting the opportunities for proposing amendments liable to slow down the progress of the

Rise of the Finance Act: 1853–1922 105 Bill. In this way ‘difficulties’ compelled the government to ‘adopt expedients’, which, in their turn, produced ‘perplexities’.151 A few days earlier, Inskip had been speaking on the same topic in the Courts. In Lionel Sutcliffe Ltd v Commissioners of Inland Revenue,152 Rowlatt J was required to consider Finance Act 1922 section 21;153 and reference was made in argument to Finance Act 1927 section 31.154 His Lordship was not impressed: This Section 31 is a Section which in five pages introduces piecemeal amendments into Section 21 with the result that the latter section is made perfectly unintelligible to any layman or any lawyer who has not made a prolonged study with all his law books at his elbow, and it is a crying scandal that legislation by which the subject is taxed should appear in the Statute Book in that utterly unintelligible form. I am told, and rightly told, by the Attorney-General—he understands it as much as anybody—that it is only in this form that the legislation can be carried through at all. Then all I have to say is that the price of getting this legislation through is that the people of this country are taxed by laws which they cannot possibly understand.155

After 1922, therefore, as at the beginning of the twentieth century, it was not possible to enact all the provisions that governments would ideally have wished to enact; and what could be enacted could not necessarily be well stated. So, although important matters changed during the period considered in this chapter, important matters remained the same. There continued to be defects in the content and expression of the United Kingdom’s revenue legislation; and the extent of those defects increased incrementally from generation to generation.

151 152 153 154 155

Hansard, Fifth Series, vol 219, col 617 (27 June 1928). (1928) 14 TC 171. 12 & 13 Geo 5 c 17. 17 & 18 Geo 5 c 10. (1928) 14 TC 171, 187.

4 The Board of Referees: ‘A Most Useful Addition to Fiscal Machinery’ DOMINIC DE COGAN, LYNNE OATS AND MARK BILLINGS*

ABSTRACT In this chapter we examine the Board of Referees, an innovative administrative body established in 1915 with the remit of resolving certain questions relating to the assessment of the wartime Excess Profits Duty. The Board is particularly notable for its composition of eminent members of the practical trades, as well as professional accountants and even the occasional MP. We argue that the Board addressed certain shortcomings of the administrative architecture of the time, in particular the absence of an obvious way to control or counterbalance the great expansion of Inland Revenue discretions during wartime. We also highlight the support that the Board provided to the tax authorities with their ready commercial expertise and their ability to buy the wider business community into a tax that could have been very controversial. In terms of the legal framework, the Board was carefully designed but did undergo a significant degree of scope creep, particularly in 1922 which is when our study ends. The debates of the time have some resemblance—and therefore relevance—to recent discussions about the General Anti-Abuse Rule Panel, but the parallels should not be exaggerated.

INTRODUCTION

T

HE EXCESS PROFITS Duty (EPD) was imposed to assist with the costs and distributional consequences of the First World War and only lasted from 1915 to 1926.1 Yet it had an importance to the

* The authors are grateful to Carlene Wynter of Aston Business School for research assistance and to the participants in the seventh ‘History of Tax Law’ Conference for their invaluable comments on an earlier draft. The quotation in the title is from J Hicks, U Hicks and L Rostas, The Taxation of War Wealth (Oxford, Clarendon Press, 1941) 74. The work performed by Dr de Cogan received the generous support of the Leverhulme Trust. 1 The tax was only levied for the years 1915 to 1921 inclusive. Finance Act 1926 s 38 provided for the curtailment of further assessments and claims for relief and thus marks the end

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development of UK taxation that was disproportionate to its short life. In particular, it was used as a testing bed for a number of innovations that later became commonplace.2 In its application to companies, it resembled modern Corporation Taxes more closely than any previous imposition.3 The treatment of corporate groups, losses, depreciation, patents and other items under the EPD was in some respects so advanced that it took until the 1940s for the income tax to catch up.4 In this chapter we focus not on such technical matters but on the administrative innovation of establishing a ‘Board of Referees’, a body of business and accounting experts designed to hear certain appeals relating to EPD liability. Although the existence of the Board is fairly unfamiliar nowadays, it survived the First World War and was abolished only in 1982.5 The Board is of particular interest because it represented a novel form of making decisions, without exact precedent but rooted in the traditions by which consent to the UK income tax had been achieved. There are some tempting parallels here with the Advisory Panel established by the Finance Act 2013 in connection with the General Anti-Abuse Rule (GAAR), although we argue below that these should not be exaggerated. In particular, the Board’s jurisdiction was geared towards reducing tax liabilities in appropriate cases, which is presumably not the case for the GAAR Panel. Our study of the Board emphasises three themes. First, the Board was situated within a deliberate balance of power. The exigencies of war necessitated the grant of sweeping discretionary powers to the Inland Revenue but the constitutional delicacy of this6 was recognised by the building of various limits and safeguards into the legislation establishing the EPD. The procedures by which certain matters could be referred to the Board reflected in large part the absence of an existing institutional mechanism to review discretionary decisions. This function could nowadays be performed

of the duty from an administrative point of view. As a result of the time lag in collection and the need to finalise cases that were ‘undetermined’ at 30 September 1926, however, EPD was still being disputed and collected 15 years after its repeal: see BEV Sabine, A History of Income Tax (London, George Allen & Unwin., 1966) 152; P Ridd, ‘Excess Profits Duty’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2004) vol 1, 101, 129. 2 See, eg, D de Cogan, ‘The Wartime Origins of the Irish Corporation Tax’ (2013) 3(2) Irish Journal of Legal Studies 15, 20–24. 3 See JH Jones, Josiah Stamp, Public Servant (London, Isaac Pitman, 1964) 93. 4 For example, the provision of a patent allowance in the EPD was replicated in the income tax by Income Tax Act 1945 s 35: see D de Cogan, ‘Law and Administration in Capital Allowances Doctrine: 1878 to 1945’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2013) vol 6, 175, 204. 5 By Finance Act 1986 s 156. The Board’s remaining functions were transferred by the same section to the Transactions in Securities Tribunal, which has since been reorganised into the Tax Tribunals. 6 Possibly brought into sharper relief by the Defence of the Realm Act 1914: see JC Stamp, ‘Recent Tendencies Towards the Devolution of Legislative Functions to the Administration’ (1924) 2(1) Journal of Public Administration 23.

Board of Referees: ‘A Most Useful Addition’ 109 comfortably by the courts, but these were the days before modern administrative law.7 Second, getting EPD decisions right was just as important as making them as constitutionally acceptable as possible, and the wide business and accounting expertise of the Board members was instrumental in achieving this.8 Third, the imposition of heavy new taxes could have been extremely unpopular even in wartime. The EPD applied only to ‘trades and businesses’9 but it was necessary to secure the buy-in of potential taxpayers as well as other sectors of the economy anxious that commerce should pay its fair share. It is clear that the reference of controversial matters to a panel of highly respected businessmen helped greatly at least on the former count. We also examine the gradual expansion of the Board’s functions from the original remit. Policy-makers were extremely concerned that the Board should not encroach unduly upon the jurisdiction of other existing institutions, but did see fit to confer further powers on the body as the War progressed. In 1922 the Board was inserted into the appeals structure for the new ‘Super-tax apportionment’ provisions, which are explained briefly below. This activity came rather to define the Board in the inter-war years, and in consequence the 1922 reforms form a natural closing-point for this chapter.

BACKGROUND TO THE BOARD OF REFEREES

The purpose and structure of the EPD have been explained amply elsewhere10 but a brief overview may be useful here. The EPD arose certainly in response to the acute need for finance in 1915, but also to reflect the need to demonstrate a fair distribution of war burdens across society. Rates of Income Tax were increased precipitously, wage-earners on low incomes were brought into the tax for the first time and, of course, many soldiers were giving their lives. How was business going to contribute? This question was made acute by the general increases in prices during the war and the belief that at least some traders were ‘profiteering’ from the nation’s straitened circumstances.11 The first priority was to levy an additional tax on munitions firms, which was duly established by the Munitions of War Act 1915 and administered by the Ministry of Munitions until 1917 when administration passed to the 7

ibid; cf Lord Hewart CJ, The New Despotism (London, Ernest Benn Ltd, 1929). Stamp, n 6 above, 36. 9 Finance (No 2) Act 1915 s 39. 10 In particular see JC Stamp, Taxation During the War (London, Milford, 1932). Josiah Stamp, at the time a senior Inland Revenue official, seems to have been very intimately involved with the establishment of the EPD. His biographer reports as follows (Jones, n 3 above, 94): ‘Naturally [Stamp] did not himself draft the Bill that first introduced the Excess Profits Duty; that was the work of lawyers and parliamentary draughtsmen. But it was he who drew up the plan and the details of its application that were afterwards framed.’ See also Ridd, n 1 above; M Billings and L Oats, ‘Innovation in Tax Design: Excess Profits Duty in the United Kingdom during World War One’ (2014) 24(2–3) Accounting History Review 83. 11 See Billings and Oats, n 10 above, 87–88; Jones, n 3 above, 92. 8

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Inland Revenue.12 The spotlight then moved to other trades, and EPD was the chosen instrument, as was the case in a number of other countries in Europe and beyond.13 The Chancellor outlined the proposed tax on excess profits in his budget speech on 21 September 1915, at which time he also indicated his wish to ‘dovetail’ the EPD with the Munitions Levy in the year following the first year of the operation of EPD.14 The EPD was created by Part III of the Finance (No 2) Act 1915 and applied to ‘trades and businesses’, including those carried on by a company. It did not encompass ‘husbandry in the UK’, ‘offices or employments’ including those holding positions of a personal character such as government servants, or most professions.15 The last of these proved controversial;16 at the Report stage of the Bill the government moved an amendment to specify particular professions such as Barristers, Solicitors and Accountants as being exempt, but the ensuing debate reopened previous discussions relating to the exemption of professions. The question was raised in debates on subsequent Acts, but the government maintained the exemption.17 The tax was initially charged on the excess profit, reduced by £200, of an eligible trade or business. The initial rate was 50 per cent of excess profits; this was raised to 60 per cent in 1916, to 80 per cent in 1917, lowered to 40 per cent in 1919 and then increased again to 60 per cent in 1920.18 The excess profits were calculated by comparing the actual profits of an accounting period with a ‘pre-war standard’.19 In principle this standard should reflect the actual profitability of each tax-paying business before the war, but there were circumstances in which this would be impossible or inappropriate. Taxpayers who had suffered poor trading conditions immediately prior to the war could be heavily penalised by low standards, and new businesses by definition had no pre-war profits at all. Consequently the legislation offered an alternative ‘percentage’ standard which was calculated by multiplying the capital of the trade20 by a statutory percentage, initially 6 per cent for trades operated by companies and 7 per cent for other trades.21 This represented an estimated normal rate of return on capital against which 12

Finance Act 1917 s 24. For an overview see JC Stamp, ‘The Economic Taxation of Excess Profits Abroad’ (1917) 27(105) Economic Journal 26. 14 HC Deb 21 September 1915 vol 74 cols 356–59; Stamp, n 10 above, 48–49. 15 Finance (No 2) Act 1915 s 39. 16 EE Spicer and EC Pegler, The Excess Profits Duty, 5th edn (London, Foulks, Lynch & Co, 1920) 5. 17 In 1918, following a suggestion that the EPD should be extended to the earnings of professional men, the medical profession published a note defending the exemption vigorously, see ‘The Professions and the Excess Profits Duty’ (1918) 1(2992) British Medical Journal 512. 18 See respectively Finance (No 2) Act 1915 s 38; Finance Act 1916 s 45(2); Finance Act 1917 s 20(2); Finance Act 1919 s 32(2); Finance Act 1920 s 44(2). 19 For a discussion of the difficulties in designing the EPD and its relationship to income tax, see Billings and Oats, n 10 above, 89–90. 20 See ibid 92–93 for a discussion of the calculation of capital for these purposes. 21 Finance (No 2) Act 1915 s 40(2). 13

Board of Referees: ‘A Most Useful Addition’ 111 war profits could be compared. All that a taxpayer needed to do in order to use this percentage standard was to show ‘to the satisfaction of the Commissioners of the Inland Revenue that [the profits standard] was less than the percentage standard’.22 Yet further relaxations were built into the legislation for ‘deserving’ taxpayers, and it is here that existing institutions really showed their limitations. In some cases the Inland Revenue had discretionary power to change computation rules,23 giving rise to the problem mentioned above of how to keep this discretion under review. In other cases taxpayers could apply for increased percentages to reflect special circumstances.24 However, in view of the distributive implications of the EPD it was particularly important that special treatments were seen to be provided uniformly to similarly placed taxpayers. This made it impossible to confer the decision on the General Commissioners of Income Tax. Whilst they had long enjoyed comparable powers in relation to depreciation allowances for income tax25 and were used to dealing pragmatically with individual cases, they lacked the national organisation to make consistent decisions across whole classes of taxpayer.26 The courts, on the other hand, tended to avoid detailed questions relating to quantification and valuation, preferring to treat them as matters of fact for first instance tribunals whilst retaining a residual right to overturn decisions thought to stray entirely outside the scope of the statute.27 There were also concerns about the constitutional implications of transferring too much discretion to the Inland Revenue,28 and to some extent about the finite accounting expertise of its staff.29 In this context the attraction of a panel of business and accounting luminaries with the existing expertise to deal with quantitative matters and sufficient authority to help secure consent to the new tax must have been strong. We emphasise throughout, however, that the jurisdiction of the Board was a pragmatic response to a particular set of problems. These might have been solved in a different way or by a different type of body; in particular, it would be interesting to explore in greater depth why policy-makers did not choose to satisfy the need for expertise simply by appointing more accountants to Inland Revenue positions. 22

ibid. Finance (No 2) Act 1915 s 40(3); refer to text at n 30 below. 24 Finance (No 2) Act 1915 s 42; refer to text at n 37 below. 25 Customs and Inland Revenue Act 1878 s 12. 26 To the extent that their jurisdiction under the Customs and Revenue Act 1878 soon became fictional, with the Inland Revenue laying down depreciation rates for classes of taxpayers: see de Cogan, n 4 above, 189; C Stebbings, The Victorian Taxpayer and the Law: a Study in Constitutional Conflict (Cambridge, CUP, 2009) ch 3. 27 de Cogan, n 4 above, 186. 28 See, eg Stamp, n 10 above, 172; RM Haig, ‘The Taxation of Excess Profits in Great Britain’ (1920) 10(4) (Supplement) American Economic Review 3, 98. 29 Billings and Oats, n 10 above, 94. 23

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Dominic de Cogan, Lynne Oats and Mark Billings LEGAL FRAMEWORK: THE FINANCE (NO 2) ACT 1915

Section 40(3): Computation Rules The rules of the EPD were contained within Part III of the Finance (No 2) Act 1915, with further detailed computational provisions in the fourth Schedule. The charging provision was section 38, but for our purposes we must begin with section 40(3), which contains the first reference to ‘a Board of Referees, to be appointed for the purposes of this Part of this Act by the Treasury’. The initial appointment under this provision was announced to the House of Commons on 7 December 1915 by Edwin Montagu, Financial Secretary to the Treasury,30 and the details are discussed below. The substantive significance of section 40(3) was to situate the Board within a carefully structured Inland Revenue discretion to alter the detailed computation rules of the fourth Schedule ‘on the application of a taxpayer in any particular case’. The Revenue was permitted to ‘allow such modifications of any of the provisions of that schedule as they think necessary in order to meet the particular case’ but only in response to the following events: — — — — — —

a change in the constitution of a partnership; the postponement or suspension of renewals or repairs; exceptional depreciation; obsolescence of assets; the necessity of providing plant which will not be wanted after the war; other special circumstances specified in regulations made by the Treasury.

A taxpayer dissatisfied with the modifications allowed by the Revenue or faced with an outright refusal could require their application to be referred to the Board. The Board would then ‘consider any case so referred and have the same powers with respect thereto as the [Inland Revenue] have’. There are a few things worth noticing here. Section 40(3) essentially provided taxpayers with a very broad right of appeal against a Revenue discretion. This played to the strength of the Board as a body with sufficient expertise and status to assess Revenue judgments on the matters listed. However, it sat rather oddly with the insistence elsewhere that the Board’s jurisdiction should be confined to classes of taxpayer. We suggest two explanations for this apparent discrepancy. First, section 40(3) did not create any particular risk of conflict between the Board and the courts. The courts had neither the institutional competence nor the inclination31 to undertake detailed quantitative and accounting decisions. To allow the Board fully to reperform the discretion thus created less of an overlap with the courts than a narrower appeal to the Board on a point 30 HC Deb 7 December 1915 vol 76 col 1292; see also The National Archives (TNA), file T1/11964/3152. 31 See, eg de Cogan, n 4 above, 186–87.

Board of Referees: ‘A Most Useful Addition’ 113 of law.32 Second, it seems that the application procedure in section 40(3) was not used very often or very successfully by taxpayers. Haig observed as follows in 1920: Most of the appeals under this section have had to do with modifications due to a change in the constitution of a partnership. Thus far the Board of Referees has not granted a single appeal of this type, the adjustments made under Part II of the Fourth Schedule having proved sufficient to meet the situation.33

The other thing to notice is the balance of power represented by the capacity of the Treasury to extend the scope of Revenue discretion. We have found only one reference to such an extension, which enabled a depreciation allowance to be made in respect of patents.34 This architecture suggests that the ‘constitutional’ problems with Revenue discretion highlighted by Stamp35 were taken seriously and were attended to at the design stage of the EPD.

Section 42: Pre-war Standard Much more significant than section 40(3) for the activities of the Board was section 42. This provision allowed for increases in the pre-war standard, against which wartime profits were compared in order to calculate the tax charge. This increase could be achieved by three mechanisms, by far the most important of which was ‘an increase of the statutory percentage as respects any class of trade or business’. The other methods were to apply the statutory percentage to some other figure than capital, and simply to alter the pre-war standard for munitions firms meeting certain conditions, but Haig informs us that these were rarely and never used, respectively.36 In contrast to section 40(3) the original jurisdiction lay with the Board, that is to say, the Revenue were compelled to refer any application under section 42 to the Board ‘unless they are of opinion that the application is frivolous or vexatious or relates to matters already decided by a Board of Referees’. This was an important filter,37 yet Haig claimed that it had never been applied by the Revenue at the time of writing in 1920. Once the application had been referred, the Board had power to increase the percentage38 but only for classes of trade, not for individual traders. Predictably, much of the argument around this section centred on the meaning of ‘class’ and indeed on attempts to draw classes narrowly so as to achieve a privileged treatment for very small groups of taxpayers. Stamp voiced particular concern about 32 Especially given the susceptibility of the Board to appeal on a point of law under Finance (No 2) Act 1915 s 45. 33 Haig, n 28 above, 124. 34 Spicer and Pegler, n 16 above, 104. 35 Refer to text at n 27 above. 36 Haig, n 28 above, 127. 37 See Stamp, n 10 above, 172. 38 Or otherwise increase the standard in the ways listed above.

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the Board’s early willingness to allow for geographical subdivision and illustrated his point with hypothetical examples such as ‘the trade of bootmaking in the village of Blank in Perthshire’.39 The same worry is reflected in the Procedures on References to the Board of Referees of 1917,40 at Rule 27: In cases where the application is individual and not representative, a class or subdivision of a class must be capable of definition by special incidents, the essential character of which must be peculiar to the proposed class or subdivision. They must be the incidents, not the accidents, of the trade itself. Furthermore, they should be of substantial importance and material in relation to the liability to Excess Profits Duty.

Over time, settled principles were developed for the application of section 42. Stamp’s book reproduces an official document from 31 March 1916 which contended that increased percentages should only be awarded in respect of ‘unremunerative capital’, ‘the exhaustion of the asset because it is worn out’ and ‘special losses not covered by insurance’.41 This corresponds closely to the reference in Spicer and Pegler’s 1920 textbook to ‘the deferment of yield in the initial stages of the industry’, ‘wasting assets’ and ‘extra normal risk’,42 which suggests that these principles remained relatively consistent during the war. A list of increased statutory percentages fixed by the Board of Referees indicates that the majority were in respect of extractive industries and many related to foreign operations; the highest at 27½ per cent was for gold mining in India and gold mining in Egypt and Sudan.43

Section 45(5): Appeals Whereas the calculation of the percentage standard could be altered under section 42, the decision of the Inland Revenue whether to permit the percentage standard to be used in any given case did not come within the jurisdiction of the Board.44 Instead an appeal was available to the General or Special Commissioners under section 45(5), which again makes sense given the intention to distinguish class and individual appeals. The decisions of the Board under sections 40(3) and 42 could not themselves be appealed to the General or Special Commissioners, but neither were they final. Instead, section 45(5) applied the provisions of the Taxes Management Act 1880 section 59, which had the effect of allowing an appeal to the 39

Stamp, n 10 above, 177. Inland Revenue, Procedures on References to Board of Referees (February 1917), reproduced in Spicer and Pegler, n16 above, 179–82. 41 Stamp, n 10 above, 246. 42 Spicer and Pegler, n 16 above, 92; Billings and Oats, n 10 above, 92. 43 Spicer and Pegler, n 16 above, 187–89. 44 Port of London Authority v Commissioners of Inland Revenue [1920] 2 KB 612 CA. 40

Board of Referees: ‘A Most Useful Addition’ 115 courts on a point of law. This network of appeal provisions was described as ‘unusually full’ in the notes on clauses45 and no doubt again reflected the intention of policy-makers to counterbalance the unconventional powers of the Revenue under the Finance (No 2) Act 1915 as a whole.

LEGAL FRAMEWORK: HOW MANY BOARDS?

We pause here to address a conundrum in the legislation, which is the question of how many different Boards of Referees there were. This point is both trickier than it seems and less important, given that the contemporary literature is generally clear about what it is referring to. The first mention of a board of referees was in Munitions of War Act 1915 section 5(3), which was passed in July 1915. This allowed the Minister of Munitions to refer to ‘a referee or board of referees appointed or designated by him for the purpose’ disputes about the aggregation of net profits or losses of establishments belonging to the same owner, or about the standard used to determine the amount of Munitions Levy. The EPD Board that is the subject of this chapter was created under the authority of Finance (No 2) Act 1915 section 40(3), passed in October of that year. Finance Act 1916 section 55 aligned the rules for EPD and Munitions Levy by providing that section 40(3) would apply to controlled establishments46 ‘as though a referee or board of referees appointed by the Minister of Munitions for the purpose were substituted for the board of referees under the principal Act’. As we shall see below,47 the jurisdiction of the EPD board was subsequently extended to encompass depreciation allowances for income tax in 1918 and the surtax apportionment regime in 1922. The third body was created under Finance (No 2) Act 1915 section 31 and related to the income tax treatment of non-residents. It was discussed in detail by Rowlatt J in the Gillette Safety Razor case48 and seems to be at least conceptually distinct from the EPD Board. It is conceivable that the same personnel served the three Boards, although we have not been able to establish this beyond doubt. Some of the archival material does seem to refer to the EPD and Finance (No 2) Act 1915 section 31 interchangeably,49 which rather suggests that there was no strict dividing line in practice. In any case the structural disorganisation of these provisions supports

45 Inland Revenue, Notes on Clauses, Finance (No.3) Bill 1915, 239. An original copy of this document is held in the Centre for Tax Law office in the University of Cambridge. 46 Controlled establishments were undertakings subject to the controls of the Munitions of War Act 1915, including the Munitions Levy: see s 4 of that Act. 47 Refer to text at n 94 below. 48 Gillette Safety Razor Ltd v Commissioners of Inland Revenue [1920] 3 KB 358. 49 See TNA file T1/11964/3152.

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our suggestion that the concept of a board of referees was a timely expedient, responding to particular political and institutional needs of wartime.

MEMBERSHIP OF THE BOARD

On 9 November 1915, Reginald McKenna, Chancellor of the Exchequer, ‘promised that [referees] would be men experienced in trade, bankers, chartered accountants, manufacturers and so on’.50 Edwin Montagu, Financial Secretary to the Treasury, announced to the House of Commons on 7 December 1915 the Board’s initial membership, intended ‘to bring to bear what is known as business knowledge … and to give confidence to the traders who carry on the trades and businesses concerned’, with two additions (Manville and McLintock) on 1 January 1916.51 Table 4.1 shows that McKenna’s promise was borne out. The initial composition of the Board was approximately one-half traders, one-third accountants and the remainder bankers and MPs, with some overlap between the categories. Nine of the 29 members of the initial Board were accountants, six of whom were past, serving or future presidents of their respective professional bodies. Of the remainder, four were described as bankers and a fifth (Pease) was a director of Lloyds Bank in addition to his other business activities. Two members (Pease and Renshaw) were directors of railways, amongst the largest businesses of the era. The remaining members were active in a range of enterprises such as engineering, textiles, other manufacturing and distribution businesses and shipping, and some had multiple business interests. Three were Members of Parliament, including the Board’s first chairman, Duke, a lawyer by profession. Duke entered the Cabinet as Chief Secretary for Ireland after the 1916 Easter Rising and was replaced as chairman by a businessman, Renshaw.52 Renshaw was succeeded after his death by Kerly, another lawyer, who was not an original member of the Board. Stamp describes the dynamics as follows: Sir Charles Renshaw’s wide knowledge of business and his general sagacity did much to make the earlier proceedings acceptable to the public, but it is generally conceded that the firm grasp of economic principle and the avoidance of legal and statistical pitfalls which characterized the Board’s decisions was due to the influence of Sir Duncan Kerly, who became Chairman upon Sir Charles Renshaw’s sudden death. Sir Duncan’s mathematical and scientific bent combined with his great experience at the Patent Bar made him exceptionally well fitted for the task.53

50

FW Hirst and J E Allen, British War Budgets (London, OUP, 1926) 117. HC Deb 7 December 1915 vol 76 col 1292; ‘Excess Profit Duty’, The Times, 1 January 1916. 52 Stamp, n 10 above, 174–75; HCG Matthew, ‘Duke, Henry Edward’, Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004). 53 Stamp, n 10 above, 175. 51

London and Norwich

Scotland

London

Sir Jeremiah Colman, Baronet

Sir Charles Bine Renshaw, Baronet

Sir Clarendon Golding Hyde

Sir William Barclay Peat

Banker

Yorkshire

The Rt Hon the Lord Faber

Accountant (shipping)

Partner in Pearsons, Contractors

Chairman of Caledonian Railway and a carpet manufacturer

Mustard, starch and blue manufacturers

Chairman

Other information

The Rt Hon Henry Edward Duke KC MP

Members announced 7 December 1915

Location

Information in Official announcements

Table 4.1: Membership of Board of Referees, 1915–18

(continued)

Partner, WB Peat & Co, 1877–1936.(5) President of the Institute of Chartered Accountants in England and Wales (ICAEW), 1906–08(6)

Caledonian Railway was the ninth largest UK-listed company in 1911(4)

Chairman, J and J Colman and Commercial Union Assurance.(2) Commercial Union was the 117th largest UK-listed company in 1911(3)

Director, London County Westminster and Parr’s Bank, 1919–20.(1) The Becketts were a prominent Yorkshire family involved in banking, Conservative politics and newspaper publishing

Additional background information

Board of Referees: ‘A Most Useful Addition’ 117

Cardiff and Newcastle

JA Jones Lloyds

President of the Institute of Chartered Accountants

Horace Woodburn Kirby

Shipping

Leif Jones MP

London

Yorkshire

Albert Illingworth MP

Wool and banking

Tin-plate

Director of Royal Bank of Ireland

South Wales

Dublin

JE Fottrell

Boot and shoe manufacturer

FW Gibbons

Leicester

AW Faire

Flax and yarn merchant

Accountant (shipping)

Belfast

Alexander Cooke

Additional background information

Fuller, Wise, Kirby & Fisher; ICAEW President, 1913–16(14)

President of the United Kingdom Alliance, a prohibitionist temperance organisation; Liberal MP; Privy Councillor from 1916(13)

Watts, Watts & Co; Britain Steam Ship Co; United National Collieries; Burnyeat, Brown & Co(12)

Postmaster-General, 1916–21.(10) As Lord Illingworth, director, National Provincial Bank from 1921(11)

Price Waterhouse partner 1887–1916, senior partner 1913–16(9)

Royal Bank of Ireland was the joint 209th largest UK-listed company in 1911(8)

President of the Scottish Wm Home Cook & Co, Chartered Accountants(7) Society of Chartered Accountants

Other information

Joseph Gurney Fowler

Scotland

Location

Information in Official announcements

WH Cook

Table 4.1: (Continued)

118 Dominic de Cogan, Lynne Oats and Mark Billings

Cardiff

Manchester

Manchester

London

Liverpool

Yorkshire

Leeds

London

Sheffield

Richard Henry March

Leonard F Massey

Algernon Oswald Miles

Charles Douglas Morton

C Hewetson Nelson

Arthur Francis Pease

W Penrose-Green

Joseph Herbert Tritton

Walter Tyzack

Thomas Green & Son;(21) Lord Mayor of Leeds, 1909(22)

Director, Lloyds Bank, 1915–27, and North Eastern Railway Company; chairman and managing director, Pease & Partners, 1906–27;(18) High Sheriff of Durham;(19) Lloyds Bank, North Eastern Railway Company, Pease & Partners were the 16th, 4th and 265th largest UK-listed companies, respectively, in 1911.(20) The Pease family were part of the Quaker family network linked to Lloyds Bank and Barclays Bank

C Hewetson Nelson, Robson & Co(17)

Josolyne, Miles & Co; ICAEW President, 1909–10(16)

RH March, Son & Co; ICAEW President, 1927–28(15)

Cutlery manufacturer

(continued)

Member of Sheffield Committee on Munitions of War(25)

Banker (Barclay’s Bank) Director, Barclay’s Bank, 1896–1918.(23) Barclay’s was the 44th largest UK-listed company in 1911(24)

Locomotive builder

Coal and iron

President of the Society of Incorporated Accountants and Auditors

Chairman of a firm of manufacturers, exporters and dealers in provisions

Ex-President of the Institute of Chartered Accountants

Chairman of engineering works

Accountant

Board of Referees: ‘A Most Useful Addition’ 119

London

Howard Williams

Glasgow

William McLintock

WF Clark

Member added May 1918

Albert William Wyon

London and Coventry

Edward Manville

Duncan M Kerly KC

Members added 1916–17

West Hartlepool

Location

Chartered Accountant

President of the Associated British Motor Manufacturers and ex-President of the Society of Motor Manufacturers and Traders

Chief Partner in Hitchcock Williams & Co, wholesale drapery warehousemen and retailers

Accountant

Other information

Information in Official announcements

WT Walton

Table 4.1: (Continued)

Mining engineer, Aldridge Colliery Company, Walsall(30)

Partner, Price Waterhouse 1887–1937, senior partner 1916–37(29)

Partner, Thomson McLintock, 1901–47(28)

Electrical engineer and motor manufacturer; numerous motoring and business interests, including director of Daimler, 1902 to at least 1928, chairman 1918–28, and partner in Kincaid, Waller, Manville and Dawson, a ‘Westminster electrical engineering consultancy’; Unionist MP 1918–23 and member of various government committees(27)

WT Walton & Son, Incorporated Accountants(26)

Additional background information

120 Dominic de Cogan, Lynne Oats and Mark Billings

Biggart Lumsden and Co, Glasgow; accountant with experience of shipbuilders One of two joint secretaries of the Cotton Spinners and Manufacturers Association, Manchester Linotype and Machinery Ltd, London Metallic Seamless Tube Co, Birmingham North British Rubber Co, Edinburgh

Thomas Biggart

FA Hargreaves

EL Booty

AE Beck

Alexander Johnston JP

Note: (1) TE Gregory, The Westminster Bank: Through a Century (London, Westminster Bank, 1936) vol 2, 294. (2) Department of Biochemistry, University of Cambridge, ‘History’, available atwww.bioc.cam.ac.uk/library/history. (3) J Foreman-Peck and L Hannah, ‘Extreme Divorce: the Managerial Revolution in UK Companies Before 1914’ (2012) 65(4) Economic History Review online appendix. (4) J Foreman-Peck and L Hannah, ‘Extreme Divorce: the Managerial Revolution in UK Companies Before 1914’ (2012) 65(4) Economic History Review online appendix. (5) GD Carnegie, ‘Peat, Sir William Barclay (1852–1936)’ in Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004). (6) P Boys, Past Presidents of the Institute of Chartered Accountants in England and Wales, 1880–2005 (London, ICAEW, 2011) 10. (7) TNA file T1/11964/3152 (acknowledgment letter on appointment). (8) J Foreman-Peck and L Hannah, ‘Extreme Divorce: the Managerial Revolution in UK Companies Before 1914’ (2012) 65(4) Economic History Review online appendix.

Rylands Bros Ltd, Warrington, wire manufacturers, a division of Pearson & Knowles Coal & Iron, the 305th largest UK-listed company in 1911,(32) of which he was a director.(33) Vice-president of the Employers’ Parliamentary Association and President of the Iron and Steel Wire Manufacturers’ Association.(34) Founder member in 1916 of, and active in, the Federation of British Industries(35)

William Peter Rylands

Members added August 1918(31)

Board of Referees: ‘A Most Useful Addition’ 121

(9)

(35)

(34)

(33)

(32)

(31)

(30)

(29)

(28)

(27)

(26)

(25)

(24)

(23)

(22)

(21)

(20)

(19)

(18)

(17)

(16)

(15)

(14)

(13)

(12)

(11)

(10)

E Jones, True and Fair: a History of Price Waterhouse (London, Hamish Hamilton, 1995) 106. D Campbell-Smith, Masters of the Post: the Authorized History of the Royal Mail (London, Penguin Allen Lane, 2011) 718. H Withers, National Provincial Bank, 1833–1933 (London, National Provincial Bank, 1933) vii. TNA file T1/11964/3152 (acknowledgment letter on appointment). DM Fahey, ‘Jones, Leifchild Stratten (1862–1939)’ in Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004). P Boys, Past Presidents of the Institute of Chartered Accountants in England and Wales, 1880–2005 (London, ICAEW, 2011) 10. P Boys, Past Presidents of the Institute of Chartered Accountants in England and Wales, 1880–2005 (London, ICAEW, 2011) 10. P Boys, Past Presidents of the Institute of Chartered Accountants in England and Wales, 1880–2005 (London, ICAEW, 2011) 10. TNA file T1/11964/3152 (acknowledgment letter on appointment). MW Kirby, ‘Pease, Sir Arthur Francis (1866–1927)’ in Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004). RS Sayers, Lloyds Bank in the History of English Banking (London, OUP, 1957) 351. J Foreman-Peck and L Hannah, ‘Extreme Divorce: the Managerial Revolution in UK Companies Before 1914’ (2012) 65(4) Economic History Review online appendix. TNA file T1/11964/3152 (acknowledgment letter on appointment). Leeds City Council, Lord Mayors and Aldermen of Leeds Since 1626 (Leeds, Leeds City Council, 2013). AW Tuke and RJH Gillman, Barclays Bank Limited 1926–1969 (London, Barclays Bank Ltd, 1972) 122. J Foreman-Peck and L Hannah, ‘Extreme Divorce: the Managerial Revolution in UK Companies Before 1914’ (2012) 65(4) Economic History Review online appendix. University of Sheffield, Sheffield Committee on Munitions of War Archive, available atwww.sheffield.ac.uk/library/special/shefmun. TNA file T1/11964/3152 (acknowledgment letter on appointment). DJ Jeremy and C Shaw (eds), Dictionary of Business Biography: a Biographical Dictionary of Business Leaders Active in Britain in the Period 1860–1980 (London, Butterworths, 1985) vol 4, 108–14. JR Edwards, ‘McLintock, Sir William (1873–1947)’ in Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004). E Jones, True and Fair: a History of Price Waterhouse (London, Hamish Hamilton, 1995) 66 and 106. TNA file T1/12192/18545. Background information for these members is taken from TNA file T1/12192/33951, unless otherwise stated. The same file shows that William Peter Rylands, Thomas Biggart and FA Hargreaves were among the eight names suggested by the Federation of British Industries. EL Booty, AE Beck and Alexander Johnston were among the six names suggested by the National Union of Manufacturers. The Federation of British Industries and the National Union of Manufacturers were predecessor bodies of the modern Confederation of British Industry. J Foreman-Peck and L Hannah, ‘Extreme Divorce: the Managerial Revolution in UK Companies Before 1914’ (2012) 65(4) Economic History Review online appendix. R Davenport-Hines, ‘Rylands, Sir (William) Peter (1868–1948)’ in Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004). J Turner, ‘The Politics of “Organised Business” in the First World War’ in J Turner (ed), Businessmen and Politics: Studies of Business Activity in British Politics, 1900–1945 (London, Heinemann,1984) 34. R Davenport-Hines, ‘Rylands, Sir (William) Peter (1868–1948)’ in Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004).

122 Dominic de Cogan, Lynne Oats and Mark Billings

Board of Referees: ‘A Most Useful Addition’ 123 As can be seen from Table 4.1, successive senior partners of accountants Price, Waterhouse & Co, Joseph Gurney Fowler and Albert Wyon (appointed after Fowler’s death in 1916), served as members.54 At the time of his death Fowler ‘was acting for the government to determine the amount of compensation due to those railway companies under state control’.55 Wyon was one of five of the nine wartime Price Waterhouse partners knighted for services to government,56 having served as Government Auditor of Railways and of Irish Railways and Government Accountant of Controlled Canals.57 The accountant members included two of the most eminent accountants of the wartime and post-war eras, Sir William Barclay Peat and William McLintock, both of whom held official roles during the war. Peat was Financial Secretary at the Ministry of Food from 1917 to 1920,58 and McLintock was appointed by the Board of Trade ‘to investigate, supervise, and, sometimes, wind-up German-owned businesses’, and was assistant to the Director of Factory Accounting at the Ministry of Munitions.59 Both had considerable experience of acting for clients in the heavy industries of coal mining, iron and steel, and shipbuilding, and were active in advisory and insolvency work in these industries in the inter-war period.60 Both men, McLintock in particular, served on numerous government committees in the inter-war period and both were involved in the finances of the royal household.61 Non-accountant members, such as Manville, Pease and Rylands also served the government as members of various committees during and after the war. The number of accountants on the Board, and the prominence of several of them, suggests they were highly valued. Long after the First World War, an Inland Revenue official trying to recruit a banker to the Board highlighted their contribution: ‘Like the Accountants … [a banker] would bring to the Board not a specialised knowledge of a particular trade, but a wide knowledge and experience of affairs’.62

54 E Jones, True and Fair: a History of Price Waterhouse (London, Hamish Hamilton, 1995) 106 and 117; TNA file T1/11964/3152 (Treasury Minute, 18 January 1916). 55 Jones, n 54 above, 106. 56 ibid 12–13. 57 HG Howitt, The History of the Institute of Chartered Accountants in England and Wales 1880–1965, and its Founder Accountancy Bodies 1870–1880 (London, Heinemann, 1966) 60. 58 D Matthews, M Anderson and JR Edwards, The Priesthood of Industry: the Rise of the Professional Accountant in British Management (Oxford, OUP, 1998) 152. 59 R Winsbury, Thomson McLintock & Co.: the First Hundred Years (London, Seeley, Service & Co, 1977) 31. 60 GD Carnegie, ‘Peat, Sir William Barclay (1852–1936)’ in Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004); JR Edwards, ‘McLintock, Sir William (1873– 1947)’ in Oxford Dictionary of National Biography, online edn (Oxford, OUP, 2004); S Tolliday, Business, Banking and Politics: the Case of British Steel, 1918–1939 (Cambridge, MA and London, Harvard University Press, 1987) 68–69, 107, 109, 118 and 121. 61 Carnegie, n 60 above; Edwards, n 60 above. 62 TNA file T177/29 (letter from Gerald Canny, Inland Revenue, to Sir Frederick Phillips, Treasury Under-Secretary, 2 December 1936).

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The archival records are silent on the means by which the Board’s initial members were selected. Attempts by industry groups and professional bodies to nominate additional members were rebuffed, but recommendations from such bodies were reflected in later additions to the Board. In early 1916, requests for referees with specific industry experience or backgrounds from the Alkali Manufacturers’ Association, the Central Association of Accountants, the Chartered Institute of Secretaries, the Rubber Growers’ Association and the Shipbuilding Employers’ Federation were all politely turned down.63 But in 1918, after Finance Act 1918 section 24 expanded the jurisdiction of the Board of Referees,64 six referees were added, three of whom were suggested by the Federation of British Industries and three by the National Union of Manufacturers.65 Archival sources indicate that referees were able to express their own opinions on issues related to EPD. In 1917, the Financial Advisory Committee to the Ministry of Munitions, chaired by Sir Clarendon Hyde, expressed grave concern at the integration of Munitions Levy with the Inland Revenue.66 In 1918, Arthur Pease wrote to Andrew Bonar Law, Chancellor of the Exchequer, in support of the decision not to increase the rate of EPD to 100 per cent and suggested other possible changes to EPD.67

CHANGING ROLE OF THE BOARD: RELATIONSHIP WITH THE INLAND REVENUE

Stamp suggests that there was anxiety that the Board continue to comprise ‘men with experience of trade and commerce’,68 although opinion was apparently divided as to whether the Board hearing a particular case should include a member of the same trade.69 He further notes that ‘[t]here was a clear idea too that the cases would be beyond the power and experience of the Board of Inland Revenue to handle, and that the Board of Referees should be an expert body who would arrive at decisions with greater ease and knowledge’.70 In the event, things worked out rather differently. Haig notes with approval that the Board avoided the fate of ‘being overwhelmed by a 63

TNA files T1/11964/841, 5410, 6234 and 29993. Refer to text at n 94 below. 65 TNA file T1/12192/33951 (correspondence August to November 1918). 66 TNA file IR74/229 (resolution of 3 May 1917). 67 TNA file T171/151 (letter of 10 January 1918). On the question of a 100% rate of EPD, see Billings and Oats, n 10 above, 96–97. 68 Stamp, n 10 above, 78. 69 Principles for dealing with conflicts of interest of Board members were set out in a twopage printed ‘Memorandum by the Chairman on Disqualification by Interest’ from Duke accepted by McKenna: TNA file T1/11964/6685, correspondence February 1916. 70 Stamp, n 10 above, 78. 64

Board of Referees: ‘A Most Useful Addition’ 125 multitude of individual cases’,71 which would have been especially damaging given the need to recruit and retain commercially eminent individuals. This was achieved by the rapid development of efficient procedures, but, importantly, also by the attainment of a much more prominent role for the Inland Revenue in practice than the formal structure of EPD seemed to envisage. The creation of an interlocutory hearing was Sir Henry Duke’s distinctive contribution to the Board before his transfer. This procedure was intended to ensure that the points of dispute had been narrowed as far as possible, and the facts established, before the full hearing.72 In this context the Revenue sought to accommodate taxpayers by making ‘every effort to make an adjustment to the extent of its statutory authority’.73 As a result, Haig reported in 1920 that ‘the total number of appeals … entertained amounts to only about one hundred’, and these were heard not by the whole Board but by panels.74 Stamp confirmed in 1932 that the Board had decided only 176 cases under section 42,75 and although he did not give numbers for the relatively unimportant section 40(3) they must have been significantly lower. As Stamp reports, the influence of the Revenue started to filter well beyond the amicable settlement of disputes and the formal power of vetting frivolous and vexatious cases.76 In particular, tax officials including Stamp himself provided much more expert knowledge than the Board of Referees, acting as: expositors of recognized principles77 [which] soon began to be known generally by the small group of solicitors and counsel to whom would-be applicants had recourse and who became specialists in this class of application.78

This was an important function given that the Board, despite advertising special percentage standards in the London Gazette,79 did not publish reasoned decisions. It was inevitable that this combination of Revenue principles and formal Board jurisdiction would lend to the latter a reputation for ‘rubber-stamping’,80 but Haig insists that this should not be read as a criticism. It was always open to the Board to differ from the view of officials, besides which, in his view, the body commanded the ‘greatest confidence’ of the public.81 71

Haig, n 28 above, 124. Note that this has some resemblance to modern Alternative Dispute Resolution, although obviously the wide statutory authority of the Board is distinctive. 73 Haig, n 28 above, 129–30. 74 ibid 124. 75 Stamp, n 10 above, 177. 76 ibid 175. 77 ibid 176. 78 ibid 174. 79 Haig, n 28 above, 129. 80 ibid 136. 81 ibid 136–37. 72

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Haig also notes, interestingly, that the relationship between the Inland Revenue and the Board depended on the circumstances of each application. In some cases, officials considered that the taxpayer was seeking ‘a modification which is unreasonable’,82 in which case they would assume the character of an adversary with the Board acting as arbitrator. In other cases, for example where there was agreement in principle on the need for a higher percentage standard, the Revenue would adopt an amicus curiae role and lend expertise rather than argue its corner. Stamp observes that although the Act appeared to contemplate the Referees becoming a court of inquiry, it ‘quickly became evident that the Revenue Officials, Sir Ernest Clark and myself and later Mr A.C. Alcock, were not merely advocates for a Revenue view, but expositors of recognised principles and the Board, after a time, became largely a body to confirm their findings suggested in the joint arrangement between the Revenue and the applicants’.83

CHANGING ROLE OF THE BOARD: SCOPE CREEP

As explained above, a taxpayer could apply to the Revenue under section 40(3) for a modification of the detailed EPD computation rules and if dissatisfied with the response could appeal to the Board. On the whole, however, the position of the Board in the institutional architecture was associated with its restriction to applications by classes of taxpayer under section 42. There was considerable pressure to expand this jurisdiction and to allow a wider range of individual appeals to the Board, which came from two sources. First, as mentioned above,84 applicants frequently argued that their particular characteristics—geographic or commercial—justified them in being treated within a very narrowly defined class. This could clearly have had the effect of allowing individuated treatments in practice whilst adhering to the appearance of class applications. The Board and its advisers were alert to this problem but did sometimes permit what Haig describes as ‘a high degree of refinement’ in ‘the classification of business’.85 Nevertheless, it seems that some genuine thought was applied to the questions of how to define and represent classes before the Board. In many cases, the latter came down to existing representative bodies such as the London Chambers of Commerce.86 The other source of pressure to accept individual appeals arose from lobbying by ‘isolated Members of Parliament’.87 Stamp observes that this was 82 83 84 85 86 87

ibid 130. Stamp, n 10 above, 175–76. Refer to text at n 40 above. Haig, n 28 above, 128. ibid 129. Stamp, n 6 above, 34.

Board of Referees: ‘A Most Useful Addition’ 127 consistently resisted by the Chancellor and the Revenue, a point expanded in the notes of the latter on the clauses to the Finance Bill 1920: It is obvious that any such extension of the right to apply to the Board of Referees would involve an infringement of the authority of Parliament and would set up the Board of Referees as an independent tribunal to decide the measure of liability in individual cases.88

It also follows from our comments at the beginning of this chapter that there was no overwhelming need to extend the jurisdiction of the Board in this way. The tax institutions of early 1915 lacked a convincing means of reviewing Revenue discretions and of achieving consistent treatment of classes of cases, but the disposal of individual disputes was already well catered for by the General Commissioners, the Special Commissioners and the courts.89 Nevertheless, the Board did acquire additional powers over time, in a way that can scarcely be described as predetermined but still played to the body’s strengths. The least of these extensions was Finance Act 1917 section 25, a broadly-worded provision that allowed the Board to revisit matters already decided but which seems to have been targeted at specific problems relating to rubber-growers.90 A more significant extension was made by Finance Act 1918 section 24,91 which concerned depreciation allowances: Where an application is made to the Commissioners of Inland Revenue for the alteration of the amount of any deduction for wear and tear, the Commissioners, unless they are of opinion that the application is frivolous or vexatious, shall refer the case to the Board of Referees, and that Board shall, if they are satisfied that the application is made by or on behalf of any considerable number of persons engaged in any class of trade or business, take the application into their consideration, and determine the deduction to be allowed.

The critical point here is that this marked the first incursion of the Board into income tax proper. This started to secure the long-term position of an institution that had hitherto been a wartime body for a wartime tax, but on reflection the provision was not as revolutionary as it seems. The quantum of wear and tear allowances (the contemporary term of art for depreciation allowances) was technically up to the General Commissioners to decide in any given case,92 but annual percentage rates had long been agreed between

88 Inland Revenue, Notes on Clauses, Finance Bill 1920, Committee Stage, 81C, which also describe the proposal as a ‘dangerous precedent’. An original copy of this document is held in the Centre for Tax Law office in the University of Cambridge. 89 Even for EPD: see Finance (No 2) Act 1915 s 45. 90 Inland Revenue, Notes on Clauses, Finance Bill 1917, Report Stage. An original copy of this document is held in the Centre for Tax Law office in the University of Cambridge. 91 More commonly known in the contemporary documents in its (slightly) later incarnation as Rule 6 of the Rules applicable to Schedules D Cases I and II, Income Tax Act 1918. 92 Customs and Inland Revenue Act 1878 s 12.

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the Revenue and trade representatives in practice. In this context, allowing the Board to modify wear and tear rates merely recognised the reality of Revenue discretion, with the Board performing a similar review role to that under section 40(3) of the 1915 Act. For this reason, the comment of the Codification Committee that this wear and tear appeal was made futile by the non-statutory agreement of depreciation rates93 rather misses the point. With three years of experience of section 40(3), it cannot but have been obvious to policy-makers in 1918 that the Revenue would make the important decisions, with the Board available as a residual safeguard where necessary. The argument that the Board could be used more generally as a mechanism for dealing with classes of taxpayer was brought further by the Royal Commission on Income Tax which reported in 1920. If depreciation allowances were to be freed from their existing restriction to machinery and plant, rates should be set initially by the Revenue but should be appealable to the Board by analogy with Finance Act 1918 section 24.94 More startling is the role of the Board in connection with a proposal to reclassify as income certain business transactions then treated as capital in nature: Whether the task of discriminating between the profits we propose to include and the profits we propose to exclude should be left to the various bodies of Commissioners concerned is doubtful. If the scope of the tax is enlarged in accordance with our suggestions it will be very desirable to achieve uniformity of treatment; … we recommend that for the purpose of deciding principles and of obtaining uniformity in decisions the Board of Referees … should be entrusted with the power of determining whether particular classes of transactions should be excluded from the scope of the tax as so enlarged. An appeal to the High Court on a point of law should be, of course, allowed.95

Given what we have said previously concerning the relationship between the Board and the Revenue, this could have given the latter a powerful discretion over the scope of the income tax. It is not in the least surprising that such a suggestion was not adopted. More significant than any of this for the future of the Board was its inclusion in the super-tax apportionment provisions of the Finance Act 1922. These rules addressed a discrepancy between the standard income tax and super-tax, the latter essentially comprising the progressive rates of income tax imposed by Lloyd George in 1910.96 Whereas income tax was imposed immediately on the profits of companies,97 super-tax was deferred 93 Report of the Income Tax Codification Committee, vol I, Report and Appendices (Cmd 5131, 1935–36) 148. 94 Report of the Royal Commission on the Income Tax (Cmd 618, 1920) 48. 95 Ibid 20. 96 Finance (1909–10) Act 1910 s 66. 97 See the excellent explanation in J Avery Jones, ‘Defining and Taxing Companies’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2012) vol 6.

Board of Referees: ‘A Most Useful Addition’ 129 until distribution and was only chargeable if the relevant individual met an income threshold. This created an incentive for wealthy taxpayers to operate through companies, which would then retain their income indefinitely in order to avoid super-tax. The apportionment rules allowed the Revenue to tax retained income to super-tax anyway, but required the Special Commissioners to decide of a company that it had not distributed ‘a reasonable part of its actual income from all sources’ over a taxable period.98 A taxpayer dissatisfied with the actions of the Revenue pursuant to such a decision could appeal to the Special Commissioners, following which either party could ‘require the appeal to be reheard by the Board of Referees’.99 This was a major departure for the Board, and the super-tax (later ‘surtax’) apportionment provisions came to dominate its activities in the inter-war period.100 This jurisdiction deserves a study of its own, and accordingly 1922 forms a natural end-point for our review of the Board’s activities. It suffices to observe, once again, that there was a logical thread underlying this scope creep. As with depreciation allowances, the decision whether a reasonable part of a company’s income had been distributed was a numerical problem requiring accounting and commercial expertise. In particular the question lacked the susceptibility to a ‘correct’ answer that would have made it comfortable for the courts of the time. The super-tax apportionment regime therefore engaged the Board in a similar way to the Finance (No 2) Act 1915, albeit in a very different context. This review of the changing role of the Board between 1915 and 1922 strikes us as disorganised, but also somewhat logical in the light of the core strengths of the body. In retrospect, this contributed some confusion on the basic question of what the Board was for, which made the institution somewhat vulnerable in subsequent periods.101 But that is a story for another day.

MODERN ECHOES

We are not now in the midst of an existential conflict, thankfully, but the fiscal and social challenges generated by the financial crash of 2008 are frequently compared to those of the two World Wars. The Board of Referees itself was disbanded in 1982, but it is not difficult to see echoes in the

98 Finance Act 1922 s 21. A comparable system existed in Australia: see L Oats, ‘Undistributed Profits Tax in Australia’ (2000) 15(2) Australian Tax Forum 427. 99 Finance Act 1922 Sch 1. 100 To the extent that a search for judicial precedent involving the Board of Referees uncovers only a handful of cases that do not concern surtax apportionment. 101 For example, see conflict between Special Commissioners and Board of Referees on avoidance jurisdiction in the Second World War, in which the former prevailed: Inland Revenue, Notes on Clauses, Finance Bill 1941, 30. An original copy of this document is held in the Centre for Tax Law office in the University of Cambridge.

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Advisory Panel recently appointed for the purposes of the GAAR.102 The GAAR Panel has two functions. The first is to give an opinion in every case where HM Revenue and Customs (HMRC) seek to apply the GAAR. In contrast to the EPD Board, the opinion of the GAAR Panel is not determinative of any given case but must be taken into account by HMRC103 as well as by the courts on any further appeal.104 The second role of the GAAR Panel is to consider and approve any guidance that is issued by HMRC in respect of the operation of the GAAR.105 There are quite obvious parallels between these two institutions. As with the questions addressed by the EPD Board (modifications to computation rules, increases in the statutory percentage, depreciation allowance rates, super-tax apportionment), the application of the GAAR has a discretionary flavour, or at the least is incapable of a single ‘correct’ answer. It is also undoubted that the members of the GAAR Panel bring considerable expertise to bear on the boundaries of reasonable tax planning. At the time of writing, the individuals concerned were as follows:106 — — — — —

Brian Jackson, VP Group Taxation, Burberry Group plc; Sue Laing, Partner, Boodle Hatfield solicitors; Michael Hardwick, Partner, Linklaters solicitors; Gary Shiels, Adviser to SMEs; Bob Wheatcroft, Partner, Armstrong Watson accountants and member of the Chartered Institute of Taxation.

On the one hand, the ratio of professionals to tradespeople is higher here than in the EPD table reproduced above, which may speak to the intended audience of the GAAR. On the other hand, it has been reported that employees and partners of the ‘Big 4’ accountancy practices were deliberately excluded from initial membership of the GAAR Panel, presumably reflecting recent controversies around private sector political influence.107 All the same, it is plausible that the constitution of the Panel was designed with a view to buying in those likely to be affected by the GAAR, echoing the Board of Referees, albeit appealing to different constituencies: practical 102

See Finance Act 2013 Sch 43 para 1. ibid Sch 43 para 12. ibid s 211(2). 105 HMRC, General Anti-Abuse Rule (GAAR) Advisory Panel: Terms of Reference (May 2013), available at www.gov.uk/government/uploads/system/uploads/attachment_data/ file/358914/GAAR_Advisory_Panel_-_Terms_of_Reference.pdf. 106 C Fuller, ‘GAAR Panel Membership Announced’, Accountancy Age, 22 July 2013, available at www.accountancyage.com/aa/news/2283947/gaar-panel-membership-announced; HMRC, ‘Our Governance’, available at www.gov.uk/government/organisations/hm-revenuecustoms/about/our-governance. 107 N Huber, ‘Experts Doubt Impact of New GAAR Legislation’, accountingweb, 19 July 2013, available at www.accountingweb.co.uk/article/gaar-analysis/544669. See also House of Commons Committee of Public Accounts, Tax Avoidance: the Role of Large Accountancy Firms, 44th Report of Session 2012–13, HC 870. 103 104

Board of Referees: ‘A Most Useful Addition’ 131 trades in the case of the former and lawyers and accountants in the case of the latter. The engagement of representative bodies is another significant element of continuity.108 Interestingly, the role of the GAAR Panel in reviewing HMRC guidance is strikingly close to the position reached in practice by the EPD Board whereby the Inland Revenue developed principles that could be (but generally were not) criticised by the Board. In our view these parallels are sufficiently close to highlight the inherent risk of scope creep. The terms of reference of the GAAR Panel indeed echo the concerns of a previous generation: The panel’s remit extends to the GAAR only and not to any other area of tax legislation and procedure. In particular, the panel’s remit does not extend to considering non-GAAR challenges to tax arrangements.109

Nevertheless, a panel of respected experts with a formalised place in the legal and administrative system is a useful thing to have around. The experience with the Board of Referees suggests that this is not a particularly easy line to hold, albeit that an impressive degree of intellectual effort was put into the matter by senior officials. The parallels between the two bodies, although they are interesting, should not be overplayed. A point of particular importance is that Revenue discretions were relatively unusual in 1915, at least to the extent that they were formalised in legislation. There was a consensus that the exigencies of war necessitated such discretions but also that they were constitutionally dangerous and needed to be confined carefully.110 In the absence of any obvious institution capable of the task, bar perhaps the Special Commissioners, a new body needed to be created in order to carry out the task. In other words, there was an institutional gap that needed to be filled. That was 1915, however, and a century later the institutional constraints are not the same. In particular, we have the benefit of Anisminic,111 Padfield,112 CCSU,113 and a whole body of administrative law relating to the review of discretion, as well as tax tribunals that have access to considerable accounting expertise. In short, Stamp’s reliance on Laski to describe a wide realm of delegated authority that was largely insulated from judicial interference114 is no longer tenable. No doubt the GAAR Panel is useful in terms of expertise and taxpayer acquiescence, but the courts are now quite capable of exercising oversight of HMRC decisions which involve discretion or shades of grey. The GAAR Panel therefore cannot be said to be filling a 108 109 110 111 112 113 114

Refer to text at n 88 above. HMRC, n 105 above. See text at n 28 above. Anisminic v Foreign Compensation Commission [1969] 2 AC 147. Padfield v Minister of Agriculture, Fisheries and Food [1968] AC 997. Council of Civil Service Unions v Minister for the Civil Service [1985] AC 374. Stamp, n 6 above, 28.

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gap quite as convincingly as the Board of Referees, which may make it more vulnerable once the GAAR has become an accepted fixture of UK taxation.

FINAL THOUGHTS

The experience of the Board of Referees in its first few years underlines a point which may be less controversial to tax historians than to others; that is, that practical tax justice—in the sense of the collection of institutions, procedures and practices that go to produce real decisions in real cases—is not set in aspic. Between the passing of the Finance Act 1914 and the Finance (No 2) Act 1915 the world had changed radically, and with it the context of UK taxation. The establishment of the Board of Referees reflected the fact that the existing administrative machinery could not entirely cope with these changes, a point underlined by the fact that even the Board took a while to settle down into a workable equilibrium vis-à-vis the Inland Revenue and other bodies. With the cessation of hostilities a few years later, the context shifted again, although the EPD lasted until 1926115 and appeals therefrom were heard until the mid-1930s.116 So the Board moved on to pastures new, namely, depreciation allowances for income tax and the super-tax apportionment regime. At the time of writing, we are benefiting from a whole range of new bodies that make decisions of tax justice,117 including the GAAR Panel but also the Tax Tribunals and the Supreme Court. In time, these may need to be renewed, reconceived or replaced, which will provide continued interest and work for tax scholars. Inert perfection, in this field, is a fool’s errand.

115

Finance Act 1926 s 38. Refer to n 1 above. 117 See generally J Freedman, ‘Creating New UK Institutions for Tax Governance and Policy Making: Progress or Confusion?’ (2013) BTR 373. 116

5 Tax and the Tax Profession: Assessing Social Standing and Prestige JANE FRECKNALL-HUGHES AND MARGARET MCKERCHAR*

ABSTRACT An important characteristic associated with professions, as opposed to engagement in trade and commerce, is the enhanced social standing that their members have enjoyed. From very early times, professions were deemed fitting occupations for the well educated, ‘spare’ sons of the aristocracy and gentlefolk, who were unlikely to inherit family titles or land to provide them with an income. These ‘spare’ sons typically became clergymen, army/navy officers, medical men or lawyers without significant diminution of their social standing. Engagement in trade (and ‘getting one’s hands dirty’), involving profits and money, was regarded as degrading, unless immensely successful in financial terms—and there is much evidence to this effect. The emergence of the need for financial experts who could understand trade helped establish the various accounting institutes, but their members’ social standing was regarded as tarnished because of the association with trade. The need to deal with the tax arising as a consequence of profit, giving rise to a need also for tax experts, meant that tax and tax activities were similarly regarded and thus taken up by accountants and not lawyers, a situation which continued until relatively recently. The French sociologist, Yves Dezalay, commented, in relation to tax law in Europe, that this area was ‘left fallow’ by lawyers, although one which theoretically fell into the legal domain, because it ‘was disdained by top European lawyers, and … as a consequence, was progressively appropriated by accountancy firms’.1

* The authors would like to thank: the Chartered Institute of Taxation (CIOT) for a grant of £750 towards travelling expenses associated with this project, and for access to material required; and the late John Jeffrey-Cook for his very generous assistance, especially in granting access to his own working papers and research, both published and unpublished, on the history and foundation of the Institute of Taxation (IOT). 1 Y Dezalay, ‘Territorial Battles and Tribal Disputes’ (1991) 54 Modern Law Review 792, 795.

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T

HIS CHAPTER SHEDS light on the underlying background to the social perception of tax and tax practitioners, in an attempt to uncover whether this is a British and European phenomenon and whether it is shared by countries with close ties to Britain, such as Australia.

INTRODUCTION

It is difficult to provide a definition of a profession which is capable of universal agreement. Furthermore, there is no one theory that can explain the development of professions,2 which result from the combination of different elements, informed additionally by the economic, political and legal context of their formation.3 Willmott discusses three perspectives on professional development: functional, interactionist and critical.4 The last sees the ‘emergence of professional bodies … as a means of achieving collective social mobility by securing control over a niche within the market for skilled labour’, and is a ‘strategy for controlling an occupation, involving solidarity and closure, which regulates the supply of professional workers to the market’, also allowing a basis for domination of other bodies and associations operating in the same or a similar work domain.5 It is this last perspective on which this chapter focuses. On the basis of what little has already been said here, there are those who might deny that there is a tax profession. For the purposes of this chapter, it is assumed that there is (the arguments about this being reserved for elsewhere)6 and we largely use the definition of Abbott: ‘a profession is an exclusive occupational group marketing a specialized skill based in some

2 BP West ‘The Professionalisation of Accounting: A Review of Recent Historical Research and its Implications’ (1996) 1 Accounting History 77. 3 NAH Stacey, English Accountancy: A Study in Social and Economic History (London, Gee & Co, 1954); H Willmott, ‘Organising the Profession: A Theoretical and Historical Examination of the Development of the Major Accountancy Bodies in the UK’ (1986) 11 Accounting, Organizations and Society 555; SP Walker, ‘The Genesis of Professional Organization in Scotland: A Contextual Analysis’ (1995) 20 Accounting, Organizations and Society 285; J Maltby ‘“A Sort of Guide, Philosopher and Friend”: The Rise of the Professional Auditor in Britain’ (1999) 9 Accounting, Business & Financial History 29. 4 Willmott, n 3 above. 5 ibid 558. At 557, Willmott suggests that ‘[b]efore the early 1970s “functionalist” and “interactionist” perspectives were dominant’, but since then a ‘more “critical” approach’ has developed ‘which draws heavily upon the work of Weber and Marx’. The functionalist perspective ‘attends to professions as integrated communities whose members undertake highly skilled tasks that are crucial for the integration and smooth operation of society’, which is very much the approach taken in the seminal work of Carr-Saunders and Wilson (see AM Carr-Saunders and PA Wilson, The Professions (Oxford, Oxford University Press, 1933)), whereas interactionism studies professions ‘as interest groups that strive to convince others of the legitimacy of their claim to professional recognition’. 6 These will be the subject of a separate publication.

Tax and the Tax Profession: Social Standing 135 way on esoteric knowledge’.7 As tax falls into the work domain of both accountants and lawyers and lies in the ‘border territory’ between the two,8 even Abbott’s definition does not wholly apply, given that two main occupational groups are involved. However, the extent of their involvement depends upon where they work, as they are not involved to the same degree in different countries. For example, in continental Europe and the United States, it is well known that lawyers are often more involved in tax work than accountants. In the United Kingdom and Australia, it has always been the opposite. The reasons for this are unclear, but it is the contention of this chapter that the association of tax with commerce (as a result of the industrial revolution and increased trade consequent on the growth of Britain and her colonies in the nineteenth century) made tax more appropriate as work for accountants. This was because it was a natural corollary to the commerciallyrelated activities that accountants engaged in during the formative years of their professional development in that period, when income tax became permanent and affected those with whom they dealt; because there was an emergent body of specialist knowledge linked to this work domain; and because the association with trade caused it to be disdained by the law profession. However, the standing of accountants did not remain static, as they developed into a respected professional class (see below). Did involvement in tax work contribute to that development or, given the taint of trade, did it impede it? This is the fundamental question to which this chapter attempts to provide some answers, by reference to the experiences of the United Kingdom and Australia. The remainder of the chapter is structured as follows. The next section examines the social standing of professions in the nineteenth century. Subsequent sections consider the different elements that contribute to social standing; the professional and social standing of UK and Australian accountants; and the contribution that tax made to that professional and social standing and how the situation changed. Conclusions are in the final section.

PROFESSIONAL STATUS

An important characteristic associated with professions, as opposed to engagement in trade and commerce, is the enhanced social standing that their members have enjoyed. From very early times, professions were deemed fitting occupations for the well educated, ‘spare’ sons of the aristocracy and

7 A Abbott, ‘Status and Status Strain in the Professions’ (1981) 86 American Journal of Sociology 819, 820. In n 2, Abbott also comments that if he began with defining ‘profession’ as a concept, ‘[that] would keep us from ever reaching the matter of interest’. 8 J Freedman and M Power, ‘Law and Accounting: Transition and Transformation’ (1991) 54 Modern Law Review 769.

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gentlefolk, who were unlikely to inherit family titles or land to provide them with an income. These ‘spare’ sons typically became clergymen, army/ navy officers, medical men or lawyers without significant diminution of their social standing. Engagement in trade (and ‘getting one’s hands dirty’), involving profits and money, was regarded as degrading, unless immensely successful in financial terms—and there is much evidence to this effect. Rutterford and Maltby make clear that the English system of primogeniture, designed to ensure the intact transmission of landed estates from one generation to the next, often by means of an entail, ‘penalized younger sons’.9 Failing inheriting money from another relative or making an advantageous marriage, ‘[i]n order to maintain their status as gentlemen, they were restricted to employment in respectable professions such as the civil service, the law, the Church, and the armed forces’.10 This solution to the ‘younger son problem’11 had long been recognised but by the 1870s was no longer as widely available, owing to open competition.12 Rutterford and Maltby use the novels of Anthony Trollope to provide contemporary evidence of social attitudes in the period 1847 to 1882, the dates respectively of the publication of Trollope’s first novel, The Kellys and the O’Kellys, and his death. While many criticisms may be levelled at the use of contemporary fiction for historical purposes, if it did not realistically reflect the social mores at its time of writing, then it would hardly be credible or become popular, and Trollope’s novels were extremely popular in their day. Attitudes displayed by Trollope’s characters are likely to be representative of those of contemporary society in the late 1800s, which years constitute a key period for the development of the accounting profession and its fight for recognition. The developing financial professions, such as accountancy, were not considered as respectable as the ‘traditional’ professions of the civil service, the law, the Church and the armed forces. Rutterford and Maltby comment that ‘[i]n Dr Thorne … Augusta de Courcy’s cousin dissuades her from marrying the attorney Gazeby, because he is “a man earning his bread”’,13 while Georgiana Longstaffe, in The Way We Live Now, threatens to marry ‘some horrid creature from the Stock Exchange’,14 which appals her family. ‘When that engagement breaks down, she finds herself reduced to a humiliating marriage to a much younger curate.’15 While financial professions are 9 J Rutterford and J Maltby, ‘Frank Must Marry Money: Men, Women, and Property in Trollope’s Novels’ (2006) 33 Accounting Historians Journal 169, 175 and 178. 10 Rutterford and Maltby, n 9 above, 178. 11 ibid. 12 ibid, citing GC Brodrick, ‘The Law and Custom of Primogeniture’ in Cobden Club Essays Second Series 1871–72 (London, Galpion, 1872) 57, 99–100. 13 ibid 181. 14 ibid 178 fn 6. 15 ibid 181.

Tax and the Tax Profession: Social Standing 137 clearly looked down on, it is evident that there are degrees of respectability in the ‘traditional’ professions as well. A curate is a member of the (acceptable) clergy, but a very lowly one; and an attorney, while a lawyer, might not have been perceived in the same way as a solicitor, as the Law Society makes clear: By the mid-sixteenth century there were two branches of the legal profession— barristers, and attorneys and solicitors. Traditionally solicitors dealt with landed estates and attorneys advised parties in lawsuits. Gradually, these two roles combined and the name ‘solicitors’ was adopted.16

The issue of marriage is outside the scope of this chapter, but there are some telling points about social status made by Rutterford and Maltby,17 for example, in citing the instance of a coal-merchant’s daughter being married for her money by the Hon George (in Trollope’s The Small House at Allington) and subsequently being despised: the money was acceptable, but it was made in trade, which was not, and thus tainted the bride. Defoe, however, writing The Complete English Tradesman, reflects that many English noble families had connections with trade: Fulke Greville, lork [sic] Brooke, who died 1710, married Sarah, daughter of alderman Dashwood of London, and had by her four sons and seven daughters; one of the daughters married the lord Guildford, another the earl of Gainsborough, another the late most noble John Sheffield, duke of Buckinghamshire; the second son married a daughter of Henry duke of Beaufort; the eldest, Francis, married the lady Anne, daughter of John Wilmot, the witty earl of Rochester, by whom he had the father of the present lord Brooke.18

An alderman was a local dignitary who had often made a fortune from trading activities. Attitudes in the Victoria era changed, in reaction to the ‘financial and moral upheaval represented by an economy based on stock market investment’,19 which, combined with the Industrial Revolution, brought to the fore a kind of wealth not based on land as was traditionally the case with the gentry, and not restricted or disadvantaged by primogeniture or entails. As this wealth could be given to daughters, marrying the daughters of wealthy merchants, provided that they were wealthy enough, made those daughters marriageable in the eyes of the landed gentry, but did not give them equal social status.

16 Law Society, ‘History’, available at www.lawsociety.org/aboutlawsociety/whoweare/ abouthistory.law [Accessed 14 August 2011]. 17 Rutterford and Maltby, n 9 above, 189. 18 D Defoe, The Complete English Tradesman, vol 1, in The Novels and Miscellaneous Works of Daniel De Foe (Oxford, DA Talboys for Thomas Tegg, 1841) vol 17, 235. 19 Rutterford and Maltby, n 9 above, 194.

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Abbott defines professional status as ‘a quality entailing deference and precedence in interaction’, which is generated by ‘bases or dimensions of honor—power, wealth, knowledge’.20 However, these dimensions depend on different points of comparison, for example, whether one is comparing hierarchies within a profession (intra-professional status); making a comparison between professions (inter-professional status); or making a comparison with a non-professional (extra-professional status). Abbott comments that data on intra-professional status are rare, though he does refer to Laumann and Heinz’s ranking of legal specialisms,21 ‘headed by securities, tax and antitrust defense’.22 Specialists are usually more preeminent than generalists, with this being particularly clear in medicine and law, where surgeons are regarded as more eminent than general practitioners, and barristers more eminent than solicitors.23 Elements that contribute to professional hierarchies have been variously considered to be income, power, client status and technical complexity in the subject matter dealt with, but Abbott argues that these are all flawed. Barristers often earn less than solicitors; power might be increased at the expense of status;24 and high client status is not always sought by professions seeking to increase their status. Abbott cites the instance of nineteenth-century British apothecaries and surgeons emphasising control of practice ‘not their ability to treat gentlemen’.25 It can be argued, however, that wealthy clients are often accompanied by complex problems of ‘intrinsic professional interest’, which do confer status, hence fields such as accounting can acquire greater status. More complex issues are also sometimes referred to specialists.26 Abbott comments: These hypothesized bases for intraprofessional status have much in common, and most assume that intraprofessional status ultimately reflects the same material variables as does general social status. They also share a generic weakness: the strong general correlations break down on detailed inspection. There are two strategies for dealing with this breakdown. The first would combine all these bases with a theory determining the conditions of their precedence in status conferral. I shall take the second course of suggesting an underlying variable.27

20

Abbott (1981), n 7 above, 820. EO Laumann and JP Heinz, ‘Specialization and Prestige in the Legal Profession: the Structure of Deference’ (1977) 2 American Bar Foundation Research Journal 155. 22 Abbott, n 7 above, 820. 23 ibid 821. 24 Abbott (ibid) cites the example of a US urban district attorney having more effective power than a judge, albeit less status. 25 ibid 822. See also Chantal Stebbings, Chapter 6 in this volume. 26 Supporting a functional theory for intra-professional status. 27 Abbott, n 7 above, 823. 21

Tax and the Tax Profession: Social Standing 139 The variable Abbott suggests is ‘professional purity’, whereby, ‘[w]ithin a given profession, the highest status professionals are those who deal with issues predigested and predefined by a number of [lower status] colleagues’, who have dealt with or removed the human complexities, leaving the matter to be dealt with almost as an abstract. For example, per Abbott, corporate law is professionally purer than law in which: the squalid realities of poverty, racism, and crime play out their drama in real human lives, mocking the pristine abstraction of the law. For the professional, the invention of tax loopholes within the exclusively legal world of corporate law is a much cleaner business.28

However, as Abbot acknowledges, while professional purity is the basis of intra-professional status, the problem is that ‘the public seems to ignore it completely’, with extra-professional status being dependent on other considerations.29 Professionals are generally accorded prestige by the general public, who appear not so concerned with professional purity as they differentiate less between internal hierarchies within a profession. The high public standing of professions is often attributed to power, income and/or education, although power and income are affected by the same kinds of problems as for intraprofessional status. However, Abbott comments that ‘[a]ll upwardly mobile professional groups have emphasized education as a means of collective mobility’.30 He further comments that ‘the overall correlation of education with social status is undeniable’, although the public is often antipathetic to what it considers over-educated elites. To remain as an appreciated element of high status, education must be accompanied by continued professional activity. For example, many married female professionals who withdraw from the workforce do not necessarily retain their high status.31 Abbott also considers that ‘the order-giving power that proceeds from their application of esoteric knowledge’, the latter ‘usually acquired by extensive training’, also confers high status on professionals.32 The professional can confront disorder or non-order, in areas such as law and medicine, with success particularly contributing to his/her standing. He/she does this without personal defilement. This is not unlike the professional purity that contributes to intra-professional status. Per Abbott: The public confers status on effective contact with the disorderly. In practice, the public prizes precisely those contacts which professionals want to escape. As professionals seek the admiration of their peers, they gradually withdraw from frontline practice. As a result, the whole profession gradually shifts towards purer 28 29 30 31 32

ibid. ibid 827. ibid 828. ibid 829. ibid.

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practice … This withdrawal from publicly charismatic disorders, both within individual careers and within professions over time, is a kind of drawing back into purity, a regression. Such professional regression is a fundamental feature of professional life.33

Abbott goes on to comment that when regression occurs, ‘new professions and old rivals’ are waiting to step in and take over the work, with the result being inter-professional conflict and competition, and also a problem in maintaining a public presence.34 There was little conflict, he contends, among eighteenth-century English professionals because their public and intra-professional status and hierarchies were based on purity: ‘[i]t is the general shift from a public status based on gentlemanliness to the more rationalized status based on effective contact that begets … status dynamics’ (‘status dynamics’ meaning professional rivalry).35

ACCOUNTANTS’ STRIVING FOR INCREASED SOCIAL STANDING: UNITED KINGDOM

Accountants, and their formation of professional bodies, especially that of the Institute of Chartered Accountants in England and Wales (ICAEW), in the mid to late Victorian period were bedevilled by defining what ‘accounting’ actually comprised and the kind of work that was fitting for an accountant. This had many implications for the status of the profession. It was evident that accountants did many different jobs. Edwards and Walker cite the instance of one John C Collier of Godalming, Surrey (by reference to census enumerators’ books for 1881) who was a ‘Bank Manager, Accountant, House, Land and Insurance Agent, Distiller of Wood employing 11 labourers, Farmer of 1115 acres employing 6 labourers’.36 It was not uncommon for accountants to carry on several businesses at the same time as being an accountant. Anderson et al refer to these as ‘combined businesses’, and some were clearly trade, as the above quote reveals.37 There is now a substantial body of work which looks at these issues, which is discussed below. Accountants, it seemed, were struggling both to claim jurisdiction over emergent work areas and refine those areas into something that conferred socially acceptable status. 33

ibid 830. ibid 831. 35 ibid 833. 36 JR Edwards and SP Walker, ‘Accountants in Late Nineteenth Century Britain: A Spatial, Demographic and Occupational Profile’ (2007) 37 Accounting and Business Research 63, 77. 37 M Anderson, JR Edwards and RA Chandler, ‘“A Public Expert in Matters of Account”: Defining the Chartered Accountant in England and Wales’ (2007) 17 Accounting, Business & Financial History 381, 389. The ‘jack of all (financial) trades’ activities of English accountants is also mirrored in Australia during a similar period: see GD Carnegie and JR Edwards, ‘The Construction of the Professional Accountant: The Case of the Incorporated Institute of Accountants, Victoria (1886)’ (2001) 26 Accounting, Organizations and Society 301. 34

Tax and the Tax Profession: Social Standing 141 A central issue for the ICAEW was the standing of established practitioners versus new entrants into the field. Established practitioners agreed in the ICAEW’s 1880 Royal Charter on the types of work that were permissible for them (by means of a ‘grandfather clause’) which were not allowed for new entrants in type of work, and later, set additional barriers to entry in terms of the need to pass examinations, a process referred to as occupational closure.38 Members of the predecessor bodies, which merged in 1880 to form the ICAEW, generally had to be in practice as a ‘professional accountant’, ‘accountant’ or ‘public accountant’,39 and the final version of the Charter agreed on ‘public accountant or some business which in the opinion of the Council is incident thereto or consistent therewith’.40 The dilemma for the ICAEW was whether to confine membership to ‘high status practitioners, thus ensuring the almost certain emergence of competitor institutions’41 or to admit everyone, which risked the perception of diminished standing in the public’s eyes.42 The ICAEW tried to do both, while trying to eliminate the soi-disant accountants whose activities were considered as damaging to the occupational group.43 Although the jurisdictions claimed publicly by accountants were reduced in the 30 years prior to initial organisation formation (at least in London, from the evidence of trade directories as examined by Edwards et al44), this excluded ‘ineligibles’ who existed in sufficient numbers to form a competitor group, the Society of Accountants, a body recruited particularly from non-urban districts which the ICAEW founders had neglected, where it was usual for a practitioner to be more of a ‘jack of all trades’—a tendency which long survived in rural districts. Edwards et al list the various jobs that members of the Society were perceived as doing: rent collectors, corn merchants, shopkeepers, valuers, collectors of taxes, bailiffs, secretaries of various concerns, civil engineers, school board clerks, overseers, timber agents, pawnbrokers and manure merchants.45 Anderson et al, considering the years from 1880 to 1900, find evidence in support of auditing, adjustment of partnership and executorship accounts, liquidations, bankruptcies

38 Anderson, Edwards and Chandler, n 37 above; K Macdonald, The Sociology of the Professions (London, Sage, 1995) 131–32. 39 Anderson, Edwards and Chandler, n 37 above, 385. 40 ICAEW, Charter of Incorporation and Bye Laws (London, Henry Good & Son, 1882) 19. 41 JR Edwards, M Anderson and R Chandler, ‘How Not to Mount a Professional Project: the Formation of the ICAEW in 1880’ (2005) 35 Accounting and Business Research 229, 239. 42 H Perkin, The Rise of Professional Society in England Since 1880 (London, Routledge, 1989). 43 Edwards, Anderson and Chandler, n 41 above, 230. 44 JR Edwards, M Anderson and R Chandler, ‘Claiming a Jurisdiction for the “Public Accountant” in England Prior to Organisational Fusion’ (2007) 32 Accounting, Organizations and Society 61. 45 Edwards, Anderson and Chandler, n 41 above, 242, citing from The Accountant, 20 March 1886, 160 (see also Edwards, Anderson and Chandler, n 44 above).

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and receiverships in chancery being regarded as acceptable work, and examine ‘test cases’ from Institute records to see whether valuation, insurance, auctioneering, stock- and share-broking, agency, debt collection, money lending and estate agency were also acceptable.46 Additional work by Frecknall-Hughes47 and Frecknall-Hughes and McKerchar48 has established that tax work, hitherto not considered, was also included in the ‘acceptable’ category. Perhaps, rather tellingly, Anderson et al cite the 1894 case of one ‘Mr ACW Rogers, who enquired [of the ICAEW] whether he could add the words “Income Tax Adjustment Agency” to his sign’ as a chartered accountant.49 The ICAEW denied his request, as the concept of agency was a work area felt to be unfitting for an accountant. As it did not comment on the unsuitability of taxation when it had an opportunity to do so, it is not unreasonable to assume that tax was fitting work. Attempting to define what Abbott refers to as the jurisdiction (‘proper work’) of the profession50 reflects an aim to raise the professional status of accounting and accountants, who were keen to be considered on the same social level as lawyers.51 Aspirations to climb the social ladder and imitate the landed gentry appeared to be part of being a highly regarded professional.52 Their objective was to differentiate themselves from those involved in commerce, which was regarded as infra dignitatem, at odds with the concept of a professional having autonomy and an ideal of public service.53 It is evident, however, that chartered accountancy did provide opportunity for social advancement ‘which straddled the middle-working 46

Anderson, Edwards and Chandler, n 37 above. J Frecknall-Hughes, ‘The Claim to the Tax Domain: Examining the Activities of Accountants in the Late 19th and Early 20th Centuries’ (2015) Accounting, Finance & Governance Review, forthcoming; J Frecknall-Hughes, ‘Contextualising the Development of the Tax Profession: Some First Thoughts’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2012) vol 5. 48 J Frecknall-Hughes and M McKerchar, ‘Historical Perspectives on the Emergence of the Tax Profession: Australia and the UK’ (2013) 28 Australian Tax Forum 275; J FrecknallHughes and M McKerchar, ‘The History and Development of the Taxation Profession in the UK and Australia’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2013) vol 6. 49 M Anderson, JR Edwards and RA Chandler, ‘Constructing the “Well Qualified” Accountant in England and Wales’ (2005) 32 Accounting Historians Journal 5, 43. 50 A Abbott, The System of Professions: an Essay on the Division of Expert Labor (Chicago, IL and London, University of Chicago Press, 1988). 51 SP Walker, Towards the ‘Great Desideratum’: The Unification of the Accountancy Bodies in England 1870–1880 (Edinburgh, Institute of Chartered Accountants of Scotland, 2004). 52 JR Edwards and SP Walker, ‘Lifestyle, Status and Occupational Difference in Victorian Accountancy’ (2010) 34 Accounting, Organizations and Society 551. 53 SP Walker, ‘The Defence of the Professional Monopoly: Scottish Chartered Accountants and “Satellites in the Accountancy Firmament” 1864–1914’ (1991) 16 Accounting, Organizations and Society 257, 268. Edwards et al also comment that during the pre-organisational period, the ‘professionalisation process is marked by “signals of movement” … [with] an occupational group achieving greater economic reward and perceived respectability as the result of an enhanced degree of public recognition of the societal value of the services it offers’: Edwards, Anderson and Chandler, n 41 above, 229. 47

Tax and the Tax Profession: Social Standing 143 class divide’, even if social mobility was not a collective aim.54 However, Walker, examining the 1851 census records for Devonshire, Norfolk and Warwickshire, finds that ‘[a]ccountants were … predominantly positioned on the margins of the middle class and very few of their number exhibited styles of living which contemporaries identified as characteristic of professional men’.55 Lawyers were vituperative about accountants’ professional standing and etiquette, education and social standing.56 Over time, however, accountants’ status changed, and it has ever been dynamic. Abbott,57 from looking at accounting, medicine and law, considers that ‘control of work … brings the professions into conflict with one another and makes their histories interdependent’. A defining characteristic of a profession is an expansion of its ‘cognitive dominion by using abstract knowledge to annex new areas, to define them as their own proper work’.58 Challenges to work jurisdictions begin usually in one of two ways: ‘by external forces opening or closing areas for jurisdiction and by existing or new professions seeking new ground’. Edwards et al indicate that this abstract knowledge comprised ‘a mastery of the techniques and outputs from a system of double entry bookkeeping’, which practitioners then ‘modified … to fulfil new purposes, analysed and interpreted its outputs and developed its potential for generating financial information capable of fulfilling a variety of different purposes’.59 These purposes included accounting, auditing, company registration and annual returns, various aspects of bankruptcy, valuation and financial agency—and also, as shown above, taxation. Insolvency work, however, created a conflict with lawyers, as accountants were able to offer experience associated with dealing with going concerns and exploit opportunities offered by changes in law (the Bankruptcy Acts of 1831 and 1861 and the Joint Stock Company Winding-Up Act 1848), which allowed them to act in an official capacity. Sikka and Willmott comment that the ‘buoyant demand for services in the area of bankruptcy, liquidation and trusteeship’ stimulated a demand for specialist services, which both lawyers and accountants could provide.60 In Scotland they shared duties 54 M Anderson and SP Walker, ‘“All Sorts and Conditions of Men”: The Social Origins of the Founders of the ICAEW’ (2009) 41 British Accounting Review 31, 42. 55 SP Walker, ‘“Men of Small Standing”? Locating Accountants in English Society During the Mid-Nineteenth Century’ (2002) 11 European Accounting Review 377. Perhaps surprisingly, Walker does find evidence of women being involved in accounting in the retailing and farming sectors: ‘while the profession of law was an entirely male preserve, the same was not so of accountancy. The enunerators’ returns for the three counties include thirteen female accountants and two women bookkeepers’ (384). 56 ibid 378. 57 Abbott, n 50 above, 19. 58 ibid 102. 59 Edwards, Anderson and Chandler (2007), n 44 above, 75. 60 P Sikka and H Willmott, ‘The Power of “Independence”: Defending and Extending the Jurisdiction of Accounting in the United Kingdom’ (1995) 20 Accounting, Organizations and Society 547, 551.

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amicably as some solicitors who were ‘leading members of the Solicitors Society practised as accountants’61 and the younger sons of judges and lawyers commonly entered the accounting, rather than the law, profession.62 Walker points to: a close occupational relationship between accountancy and legal professions in Edinburgh. Indeed it may be claimed that the former developed as an offshoot of the latter. Occupational connections between the two vocations were compounded by kinship ties.63

Sikka and Willmott also comment on Macdonald’s view64 that the association in Scotland with the legal profession gave accountants a degree of prestige and facilitated the accounting societies of Edinburgh and Glasgow in obtaining a Royal Charter.65 While Briston and Kedslie challenge the latter view,66 they do not dispute the ‘rubbing off ’ of legal prestige. However, in England lawyers found accounting unacceptable, ‘the price exacted for such professional prostitution being social ostracism from the elite of the legal profession’.67 Even work sorting out corporate failures was similarly tainted. Sikka and Willmott further comment: Although doubtless extreme, the regard in which accountants were held by lawyers is indicated in the colourful reaction of Justice Quaine to the Bankruptcy Act of 1831: ‘The whole affairs in bankruptcy have been handed over to an ignorant set of men called accountants which is one of the greatest abuses brought into law’.68

61 See also Walker, n 53 above; Walker, n 51 above; SP Walker, ‘The Genesis of Professional Organisation in English Accountancy’ (2004) 29 Accounting, Organizations and Society 127; SP Walker, ‘Conflict, Collaboration, Fuzzy Jurisdictions and Partial Settlements: Accountants, Lawyers and Insolvency Practice in the Late 19th Century’ (2004) 34 Accounting and Business Research 247. 62 Walker examines the foundation of the Liverpool, London, Manchester and Sheffield institutes and finds that Liverpool was ‘instigated by lawyers anxious to establish a medium for negotiating the boundaries of bankruptcy work with local accountants’, whereas the others were keen to protect ‘established accountants from interlopers’: Walker, ‘The Genesis’, n 61 above, 127. There is no evidence of jurisdictional wrangling with those involved in valuation, agency and surveying, possibly because professions in those areas were similarly nascent. 63 Walker, n 53 above, 277. Elder sons of chartered accountants also were accustomed to enter the legal profession, and the kinship bond ‘ensured that the senior office bearers of the Society of Accountants could exploit the resources of their lawyer relatives when threatened by competing organizations’ (277–78). R Brown (ed), A History of Accounting and Accountants (Edinburgh, TC & EC Jack, 1905) 198; E Jones, Accountancy and the British Economy 1840–1980 (London, Batsford, 1981) 80. 64 KL Macdonald, ‘Professional Formation: the Case of the Scottish Accountants’ (1984) 35 British Journal of Sociology 174. 65 Sikka and Willmott, n 60 above, 551 n 10. 66 RJ Briston and JM Kedslie, ‘Professional Formation: the Case of the Scottish Accountants—Some Corrections and Some Further Thoughts’ (1986) 37 British Journal of Sociology 122. 67 Sikka and Willmott, n 60 above, 552. 68 ibid.

Tax and the Tax Profession: Social Standing 145 The above quote is typical of many critical comments in contemporary issues of the Law Times and the Solicitors’ Journal and Reporter, the professional journals of the law profession in these years, which displayed a constant sniping about the soi-disant accountants whose activities they took to be representative of the accounting profession as a whole. There is also a vast volume of material regularly included in The Accountant, the accountants’ professional journal, right from its earliest issues, on insolvency and bankruptcy matters, showing accountants claiming this work jurisdiction. The Accountant often comments on lawyers’ disapproval of this, despite an article in its very first issue on ‘Law and Accountancy’ saying, somewhat sententiously that: [t]hey are of two worlds, each distinct in itself. Neither profession ought to trespass on the other. In times past, and under the dictation of work-hunger, either party may have been guilty of breaking into the work of the other; but those times are past and gone, let us hope never to return.69

It continued: A plain understanding only is required to make out separate grounds and domains, which shall be sacred to each profession respectively… If there is to be lasting peace between the two professions some such terms must be arranged, founded in equity and sustaining the self-respect of both. To dabble in law should be utterly renounced by accountants, and to dabble in accounts should be completely renounced by solicitors.

This was in vain. In 1877, a proposal to appoint a professional accountant as one of the auditors of the Incorporated Law Society occasioned the following comment. ‘If solicitors and accountants could but thoroughly understand one another, how much better it would be for both and how much shedding of innocent but vituperative ink could be saved!’70 Sikka and Willmott also make clear that accountants were very proactive in activities designed to enhance the standing of accountants, such as giving evidence to Parliamentary Committees, writing articles and making speeches.71 Ultimately, they succeeded, with the granting of its charter to the ICAEW in 1880, which resulted in a truce, with the Law Times issuing a ‘fair amende’: pointing out for the benefit of the legal profession the distinction which may now be drawn between bona fide accountants and those incompetent and unprincipled persons who, in assuming the title of public accountants, have cast discredit and disgrace upon an essential and honourable profession.72

69 70 71 72

(1874) 1(1) The Accountant (London, October) 7. (1877) 3(130) The Accountant (London, 2 June) 2–3. Sikka and Willmott, n 60 above, 553. (1880) 6(297) The Accountant (London, 12 June) 4.

146

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Accounting is widely recognised as a highly professional vocation, but it has usually been the professional bodies themselves (or their representatives) that laid claim to the status, rather than it necessarily having been earned or conferred on them independently.73 In terms of professional status in Australia, historically accountants aspired to be admitted to one of the two major professional bodies; namely, CPA Australia (or its antecedent bodies which trace back to the formation of the Incorporated Institute of Accountants, Victoria (IIAV) in 1886); or the Institute of Chartered Accountants in Australia (ICAA) (or its antecedent bodies which trace back to the formation of the Adelaide Society of Accountants (ASA) in 1885).74 In the years before the formation of tax professional bodies, in the late nineteenth century, these persons also dealt with tax and their history and background are inextricably linked with accounting and its professional development. The formation of these first professional accounting bodies coincided with a long period of sustained prosperity (1860–90) in most of the Australian colonies, fuelled by mining booms, the establishment of limited liability laws (in the Companies Acts), and the large inflow of British capital. It was during this time that the ‘commercial bourgeoisie’ (made up of urban merchants, manufacturers and financiers) assumed leadership in the economy (this position previously having been the domain of the conservative pastoralists).75 These members of the ‘commercial bourgeoisie’ did include the first accountants in Australia, though typically many engaged in other businessrelated, albeit arguably more vocational, occupations. For example, of the 41 male immigrants who founded the IIAV, only 10 were accountants either at the time of their arrival or in their first known occupation in Australia. A further 11 founders were working as clerks, whilst others were mainly merchants and storekeepers.76 Similarly, the 19 foundation members of the ASA were well known in Adelaide’s commercial, financial and banking circles and regarded as being ‘among a group of elite accountants’.77 Indeed, the ASA’s first President, JB Spence, was Commissioner of Public Works and a member of South Australia’s legislative assembly, both being positions of significant social status within the colony.

73

West, n 2 above. R Linn, Power, Progress and Profit (Melbourne, Australian Society of Certified Practising Accountants, 1996) 203–4. For the history of these bodies see Frecknall-Hughes and McKerchar, ‘The History and Development’, n 48 above. CPA Australia was formed in 1990. 75 WF Chua and C Poullaos, ‘Re-thinking the State Dynamic: The Case of the Victorian Charter Attempt, 1885–1906’ (1993) 26 Accounting, Organizations and Society 691, 698. 76 Carnegie and Edwards, n 37 above, 311. 77 Linn, n 74 above, 57. 74

Tax and the Tax Profession: Social Standing 147 In at least three major respects these Australian foundation accounting professional bodies appeared to share common ground. First, there appeared to be an impetus to differentiate professional accountants, typically from middle class backgrounds, from clerks or book-keepers who were merely employed and therefore regarded as being of lower social status. The professional accountant at the time aspired to achieve a higher status than that of his parents and the prospering colonial society of the late 1800s provided the opportunities for this to be achieved.78 Indeed, many families proudly ‘pushed’ their sons into commerce believing it to be the future of the colony, particularly in the case of Melbourne.79 The second common ground was, of course, that females were not initially permitted to join these bodies. Females typically were engaged in book-keeping, and thus were unquestionably of lower social standing in respect of both gender and occupation.80 Women were regarded as a ‘significant encumbrance’ to the social standing of a profession, at least in the context of accounting in the late 1800s.81 In fact it was not until 1915 that a female (Mary Addison Hamilton) was admitted to the Institute of Accountants and Auditors of Western Australia (an antecedent body of CPA Australia). Whilst Mary is acknowledged as the first woman in the British Empire to be admitted by examination to a recognised accounting body, she sadly failed to rate a mention in the reported histories of either of the major accounting professional bodies in Australia.82 The third common ground shared by the foundation bodies was their desire to establish the existence of accounting as a profession in Australia. Professional status appears to be conferred on vocations that have special knowledge or competence,83 though the Australian accounting profession’s power and knowledge initially did not necessarily lie in the formal claims of special knowledge and unique skills.84 This view is supported by the diverse employment backgrounds of the founding fathers, as previously discussed. However, the founding fathers did appear to have the combination of special (mercantile) knowledge and a willingness to mobilise themselves as an organisation to represent their self-interests, thereby creating a powerful, political base.85

78 R Gollan, Radical and Working Class Politics: a Study of Eastern Australia 1850–1910 (Melbourne, Melbourne University Press, 1960), cited by Chua and Poullaos, n 75 above, 702. 79 Chua and Poullaos, n 75 above, 698. 80 Carnegie and Edwards, n 37 above. 81 West, n 2 above, 87. 82 K Cooper, ‘Mary Addison Hamilton, Australia’s First Lady of Numbers’ (2008) 13 Accounting History 135. 83 West, n 2 above. 84 JF Moore and M Gaffikin, ‘The Early Growth of Corporations Leading to the Empowerment of the Accounting Profession 1600–1855’ (1994) 6 Accounting History 46. 85 West, n 2 above.

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West argues that, apart from technical competence and the formation of a representative body, a profession needs to establish its trustworthiness to clients, the state and the wider community.86 The founding bodies87 from first inception did vigorously pursue professionalisation by various strategies such as strict admission requirements, and by the inclusion of codes of conduct and disciplinary procedures in their memoranda and articles of association.88 These actions were regarded as important in establishing trustworthiness. The ultimate symbol of trustworthiness, given the fervour over some 25 years with which it was pursued by Australian accounting bodies, appeared to be the granting of a Royal Charter. The Institute of Accountants in Australia (ICAA) was constituted under Royal Charter in 1928 after two previously unsuccessful attempts.89 It was the first Royal Charter to be granted to a professional accounting body outside Britain.90 A Royal Charter was regarded as denoting a degree of exclusiveness and members of the ICAA (mainly accountants in public practice) regarded themselves as an elite group (even if self-selected).91 However, it is not apparent that this distinction (ie between the two emergent major bodies themselves) was necessarily appreciated by the state or society more generally. Being recognised as trustworthy, particularly by the state, afforded members of the major Australian professional accounting bodies not only superior social standing,92 but also a range of significant professional privileges (eg self-regulation and the ability to undertake company audits). Further, the state delegated particular regulatory responsibilities to these members’ bodies (such as witnessing statutory applications and passport applications) and it also had made the various technical statements93 jointly promulgated by the major professional bodies enforceable by law.94

86 BP West, ‘On the Social History of Accounting: the Bank Audit by Bruce Marshall’ (2001) 6 Accounting History 11, 14. 87 By the early 1900s there were many city and/or state-based bodies, including the Sydney Institute of Public Accountants (1894–1908); the Tasmanian Institute of Accountants (1897– 1909); and the Queensland Institute of Accountants (1891–1921). Linn includes a useful diagrammatic representation of the antecedent bodies to CPA Australia and the ICAA: Linn, n 74 above, 203–4. 88 LD Parker, ‘Impressions of a Scholarly Gentleman: Professor Louis Goldberg’ (1994) 21 Accounting Historians Journal 1. 89 K Allen, ‘In Pursuit of Professional Dominance: Australian Accounting 1953–1985’ (1991) 4 Accounting, Auditing & Accountability Journal 51. 90 GD Carnegie, ‘The Development of Accounting Regulation, Education, and Literature in Australia, 1788–2005’ (2009) 49 Australian Economic History Review 276. 91 Chua and Poullaos, n 75 above. 92 C Poullaos, ‘Making Profession and State 1907 to 1914: The ASCPA’s First Charter Attempt’ (1993) 29 Abacus 196. 93 Including accounting standards promulgated by the Accounting Standards Review Board and its successor, the Australian Accounting Standards Board. 94 West, n 2 above.

Tax and the Tax Profession: Social Standing 149 The fourth common ground between the founding accounting professional bodies in Australia appears to have been their commitment to furthering their own monopolistic self-interests (both social and economic) and those of their members.95 Membership was restricted.96 Rivalry between the major bodies was intense to preserve and safeguard not only their social status as afforded by their exclusiveness and professional supremacy,97 but arguably, more importantly, their economic rewards.98 Both were viewed as critical to the protection of the accounting profession and to its long-term survival.99 The two major accounting professional bodies in Australia do still today battle for professional dominance (ie those in public practice as opposed to those who are not). Finally, whilst professional status may be difficult to achieve, it does appear that once it is achieved, it tends to be enduring,100 hence its achievement is worthy of pursuit. Certainly achieving professional status by accountants in Australia was a long and arduous process beginning in the latter part of the eighteenth century, hindered in part by the geographic spread of and competition for economic and political ascendancy amongst the various colonies and in particular, between Victoria and New South Wales.101

THE CONTRIBUTION OF TAX TO PROFESSIONAL AND SOCIAL STANDING

It is clear from the prior discussion that tax was regarded as fitting work for accountants, who laid claim to this work jurisdiction in both the United Kingdom and Australia. In the United Kingdom, accountants in the early years of their professional development were looked down on as doing work that was not fit for professionals, especially by lawyers, on to whose work domain they also trespassed, although the main area of professional conflict was insolvency work, not tax. Accountants in both the United Kingdom and Australia both seemed to share a similar professional development in that they were not drawn from the ‘spare sons’ of the landed gentry (they were the commercial bourgeoisie), but made definite pushes to become more elite in the terms of the work they did, and thus become more professional and exclusive and so more socially acceptable. The granting of a charter to

95

Parker, n 88 above; Poullaos, n 92 above. GD Carnegie, JR Edwards and BP West, ‘Understanding the Dynamics of the Australian Accounting Profession’ (2003) 16 Accounting, Auditing & Accountability Journal 790. 97 Allen, n 89 above; Carnegie, n 90 above. 98 Parker, n 88 above. 99 LD Parker, ‘An Historical Analysis of Ethical Pronouncements and Debate in the Australian Accounting Profession’ (1987) 23 Abacus 122. 100 Chua and Poullaos, n 75 above. 101 Carnegie and Edwards, n 37 above. 96

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the ICAEW in 1880 and to the ICAA in 1928 was clearly a sign that the profession had ‘arrived’, reflected in the ‘fair amende’ given by the UK law profession, referred to earlier. Had tax work made any contribution to this and if so, how? The likely answer is ‘yes’. Frecknall-Hughes102 and Frecknall-Hughes and McKerchar103 make clear in this respect the significance of the growth in the complexity, volume and importance of taxation legislation, especially income tax legislation in the latter half of the nineteenth and early part of the twentieth centuries. This gave rise to a requirement for tax specialists. Although Gladstone had signalled in his 1853 Budget an intention to abolish Income Tax by 1860, it remained, and although he made a final call for its abolition in 1874,104 it gradually became evident that it would never be abolished. Increasing numbers of people were affected by it and it was difficult to deal with for individuals, companies and the Inland Revenue, with the tax laws being full of anomalies, loopholes and opportunities for avoidance. People needed advice and help, and accountants with knowledge about tax would gradually become to be regarded as specialists. Hence, tax would be a complex problem ‘of intrinsic professional interest’, which, per Abbott,105 would confer status, particularly if another, less experienced professional had referred the matter on, thus also meeting Abbott’s criterion of ‘professional purity’. The formation of tax professional bodies in the United Kingdom and Australia also reflects this idea of professional purity:106 the UK Institute of Taxation, formed in 1930, drew its members from other existing professions, thus filtering out ‘impurities’; and Australian tax agents had always been subject to registration, thus eliminating the ineligible. A tax professional would also be able to deal with the disorder by application of ‘esoteric knowledge’.107 Tax had led, therefore, to specialism. This relatively swift colonisation of an emerging or unclaimed area appears to be a recurrent feature of the accounting profession and its willingness to develop, which continues in more modern times. For example, Dezalay comments, in relation to tax law consultancy in Europe, that this was an area ‘left fallow’ by lawyers, although an area which theoretically fell into the legal domain, because it ‘was disdained by top European lawyers, and … as a consequence, was progressively appropriated by accountancy firms’.108 The reason for this was that this type of work was seen as not respectable and was on the fringes of what the higher levels of the

102 103 104 105 106 107 108

Frecknall-Hughes, n 47 above. Frecknall-Hughes and McKerchar, ‘The History and Development’, n 48 above. BEV Sabine, A History of Income Tax (London, George Allen & Unwin Ltd, 1966) 116. Abbott, n 7 above, 822. See Frecknall-Hughes and McKerchar, ‘The History and Development’, n 48 above. Abbott, n 7 above, 829. Dezalay, n 1 above, 795.

Tax and the Tax Profession: Social Standing 151 continental legal profession deemed acceptable. Accounting, to which this area was seen as connected, had been viewed as a craft allied with trade, conferring no social status on the accounting practitioner, whereas the practice of law conferred considerable social prestige—what Dezalay inherently attributes to the superiority of ‘the republic of letters’ over ‘the empire of numbers’, and a view which persisted until the 1950s.109 Similarly, audit specialists in the 1960s took the offensive by appropriating greater responsibilities in the tax area, claiming a good knowledge of taxation practice which was supported by a ‘long-standing familiarity with fiscal bureaucracies’.110 Through: their ability to construct tax devices, which make it possible to minimise tax demands by exploiting loopholes in the law, accountants have gradually succeeded in occupying the position of consultants to economic leaders. Their presence at the inception of a transaction, which they helped to structure, ensures that they are well-placed to sell other services.111

Dezalay suggests that the position of the artisan accountant had been considerably enhanced by the award of a Nobel Prize in 1984 to an accountant specialising in research into public accounting: The ‘shiny sleeved’ accountant, object of ironic commiserations from the ‘noble professions’, has been replaced by ‘multinationals providing the business community with all kinds of service’ 112 and whose ‘role henceforth in the establishment, and in the system of economic, industrial and commercial politics, should not be underestimated’.113

Ironically, by involvement in trade, and at an international level, accountants acquired a comfortable life, enhanced professional standing and thus access to higher social status.

CONCLUSION

The increasing importance of taxation, its applicability to a greater number of individuals and entities and the inherent difficulties of applying it, undoubtedly led to a need for experts in the area, as has been discussed. A new body of knowledge and a new work domain emerged, the latter being occupied by accountants, rather than lawyers, who at the time, were more concerned about their battles with accountants over insolvency work. Taxation was associated with commerce and ‘numbers’ and so lawyers 109

ibid 792–93. ibid 797. 111 ibid. 112 Association Technique des Cabinets d’Auditet de Conseil (ATH), L’empire des chiffres: l’information financière, l’audit et la comptabilité (Paris, Favar, 1985) 108, cited by Dezalay, n 1 above, 793. 113 ibid 140, cited by Dezalay, n 1 above, 793. 110

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(especially solicitors) disdained it as part of the work done by low-status accountants, who were not typically the sons of gentlemen, but the commercial bourgeoisie. Solicitors were used to dealing with the estates of the landed gentry, wills, probate, and the like. These latter areas of work might involve tax, but, significantly, the work dynamic was different. Lawyers, as an old, established profession, relied on clients seeking them out or represent them at the end of a process; accountants as a newer profession needed to seek out clients, and tax, based on numbers, derived, for example, from company profits, was an addition to the area in which they offered services to clients. It was an area which required detailed, esoteric knowledge, an ability to create order out of disorder, leading to professional purity, which was enhanced by the later establishment of professional tax bodies in both the United Kingdom and Australia. Thus, because of the need for specialism, tax lost any lower status that might have been associated with ‘numbers’ and thus moved up the professional ladder, such that involvement in this work area would convey high professional and social standing, though the process by which and time at which this was achieved clearly varied from country to country.

6 Tax and Pharmacy: A Synergy in Professional Evolution CHANTAL STEBBINGS*

ABSTRACT The substance and form of taxes, and the way they are administered, have always had potentially profound social effects that were often entirely unforeseen by the legislators introducing them into the fiscal regime. The role of a tax in the social process of professionalisation in the long nineteenth century was one such effect. The medicine stamp duty was introduced in 1783 by a government in urgent need of new sources of public revenue and seeing an opportunity in the immensely popular phenomenon of proprietary medicines. These were medicines with secret compositions and exaggerated claims for their efficacy, invented and sold to the public by unqualified individuals popularly known as quacks. This chapter shows that by granting chemists and druggists a privileged position within its statutory framework, the tax recognised them as a skilled occupational group and affirmed their position as guardians of legitimate pharmaceutical practice. It also shows how the tax was an early and powerful catalyst for occupational unity, as the chemists and druggists came together to oppose it. The chapter concludes that despite these two positive effects of the tax on the occupational coherence of chemists and druggists, the most powerful effect of the tax was a negative one. Unambiguously a tax on a commodity, the medicine stamp duty increased the commercial character of chemists and druggists that was proving the most potent obstacle to full professionalisation, and served to reinforce the general perception of chemists and druggists as mere traders rather than skilled professionals.

INTRODUCTION

T

HE CONNECTION BETWEEN tax and pharmacy was first made at the end of the eighteenth century when a duty, the medicine stamp duty, was imposed on proprietary or ‘quack’ medicines. These were

*

This work was supported by the Wellcome Trust [WT095723MA].

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medicines with secret compositions and exaggerated claims for their efficacy, invented and sold to the public by often unqualified individuals popularly known as quacks. They attracted the taxing eye of the legislature as a suitable object of charge because they were the subject of a thriving trade. This trade was conducted by a wide range of individuals—individual quacks selling their own nostrums, grocers, booksellers and other shopkeepers—all of whom were unambiguously regarded as traders in terms of qualification, status and public perception. However, at the end of the eighteenth century chemists and druggists constituted a rapidly rising occupation. Though chemists were originally individuals who sold chemical substances, and druggists were concerned with the sale of crude drugs of vegetable and animal origin, by the eighteenth century they were largely indistinguishable and the name ‘chemist and druggist’ was understood conjunctively. They were recognised as important providers of pharmaceutical services,1 with the right to buy, prepare, compound, dispense and sell drugs and medicines, wholesale or retail. Despite indications of their growing recognition as an occupational group, chemists and druggists did not constitute a profession in the accepted sense of the term in the eighteenth century and well into the nineteenth century. Professionalism was never an absolute social construct, and its meaning evolved and changed according to the historical period,2 but in the early nineteenth century it was usually applied to the three learned professions, namely, the church, medicine and the law. A constant was that one of the key features of professional status was the requirement for a high level of education.3 In this respect chemists and druggists in the early nineteenth century were not regarded as professionals in the way that physicians, surgeons and apothecaries were.4 Although many chemists and druggists 1 G Sonnedecker (ed), Kremers and Urdang’s History of Pharmacy, 4th edn (Philadelphia, PA, JB Lippincott Co, 1976) 104; J Bell, ‘A Concise Historical Sketch of the Progress of Pharmacy in Great Britain’ (1842) 1 Pharmaceutical Journal 3; WA Jackson, The Victorian Chemist and Druggist (Oxford, Shire Publications Ltd, 1981) 3; JK Crellin, ‘The Growth of Professionalism in Nineteenth-Century British Pharmacy’ (1967) 11 Medical History 215, 215–16. See also R Porter and D Porter, ‘The Rise of the English Drugs Industry: the Role of Thomas Corbyn’ (1989) 33 Medical History 277; J Burnby, ‘The Origins of the Chemist and Druggist’ (2001) 31 Pharmaceutical Historian 27; PM Worling, ‘Pharmacy in the Early Modern World, 1617 to 1841 AD’ in S Anderson (ed), Making Medicines (London, Pharmaceutical Press, 2005) 57–76; JA Hunt, ‘The Evolution of Pharmacy in Britain (1428–1913)’ (2006) 48 Pharmacy in History 35. 2 GJ Higby, ‘Professionalism and the Nineteenth-Century American Pharmacist’ (1986) 28 Pharmacy in History 115; H Siegrist, ‘Professionalization as a Process: Patterns, Progression and Discontinuity’ in M Burrage and R Torstendahl (eds), Professions in Theory and History (London, SAGE Publications, 1990) 178–79. See generally L Loeb, ‘Doctors and Patent Medicines in Modern Britain: Professionalism and Consumerism’ (2001) 33 Albion: A Quarterly Journal Concerned with British Studies 404, 404–9. 3 G Sonnedecker, ‘To Be or Not to Be—Professional’ (1961) 133 American Journal of Pharmacy 243, 245. 4 WJ Reader, Professional Men (London, Weidenfeld and Nicolson, 1966) 32–43; Crellin, n 1 above, 217.

Tax and Pharmacy: Professional Evolution 155 were trained by apprenticeship, a formal specialist education and training requirement was not prescribed as it was, for example, for the apothecaries in their pharmacy work. The occupation of a chemist and druggist was entirely unregulated, and many individuals calling themselves chemists and druggists were completely unqualified, and were little more than dealers in drugs and chemicals.5 Chemists and druggists constituted a heterogeneous group drawn from a number of different occupational backgrounds and included both trained and untrained chemists and druggists, some apothecaries, grocers and assistants in physicians’ dispensaries. In the absence of mandatory educational attainment, the other features associated with professional status, including self-government, exclusivity, prestige and social standing, were lacking. The key issue of education and training did not begin to be addressed until the Pharmaceutical Society of Great Britain was formed in 1841.6 It was recognised that the need to ensure improved and more consistent educational standards was essential in order to raise the status of chemists and druggists and establish them as ‘an honourable profession’7 rather than a trade, and was imperative in the context of rapid developments in pharmaceutical chemistry in the early years of the nineteenth century.8 The question accordingly occupied the energies of the Pharmaceutical Society for the whole of the nineteenth century and beyond. Reforms began with voluntary attendance at formal classes in a School of Pharmacy, culminating in an examination that ensured the individual had a certain competence in pharmaceutical and general chemistry and other knowledge.9 A register of chemists and druggists was set up in 185210 and registration came to depend upon success in the examinations. In 1868, the use of the title ‘chemist and druggist’ and other similar titles, and the right to sell certain poisons, was restricted to registered individuals.11 By 1870, the term ‘chemist and druggist’ suggested a degree of scientific education, and so distinguished chemists and druggists from general medicine vendors.12

5

But see Porter and Porter, n 1 above, 294. Report from the Select Committee on the Pharmacy Bill, House of Commons Parliamentary Papers 1852 (387) xiii 275, qq 492–533; 796–818; 944; Crellin, n 1 above, 217–18. 7 (1844) 4 Pharmaceutical Journal 1; LG Matthews, History of Pharmacy in Britain (Edinburgh, E & S Livingstone Ltd, 1962) 123–24; Sonnedecker, n 1 above, 114–17. 8 SWF Holloway, ‘The Orthodox Fringe: the Origins of the Pharmaceutical Society of Great Britain’ in WF Bynum and Roy Porter (eds), Medical Fringe and Medical Orthodoxy 1750–1850 (London, Croom Helm, 1987) 129, 140–47. 9 (1941) 146 Pharmaceutical Journal 126. 10 Pharmacy Act 1852 (15 & 16 Vict c 56); Pharmacy Act 1868 (25 & 26 Vict c 91); (1851) 57 The Lancet (28 June) 701. 11 Pharmacy Act 1868 (25 & 26 Vict c 91). See generally AM Carr-Saunders and PA Wilson, The Professions (Oxford, Clarendon Press, 1933) 132–41. 12 (1870) 96 The Lancet 592 (22 October). 6

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The aim of this chapter is to assess the role of the tax on proprietary medicines in the growth of the occupational autonomy of chemists and druggists in the nineteenth century. It aims to demonstrate that the tax regime was a force in this process and to ascertain the nature and extent of its contribution to the formation of the modern pharmacy profession. In evaluating how far any element of the pharmacy profession was a social product of tax law and its bureaucratic practice, it seeks evidence of any interaction or synergy between the occupation of chemist and druggist and the imposition of the medicine stamp duty so as to create a dynamic contributing to the professionalisation of chemists and druggists. It explores the extent to which the substantive legislation merely recognised the existing position of pharmaceutical practitioners, or whether the tax was a factor in creating and promoting a transformation from chemists and druggists as mere traders to a coherent and trained body of professional pharmacists. It investigates how, in striving to establish their position within the fiscal regime of the stamp duty in relation to unqualified practitioners, the tax acted as a unifying factor among chemists and druggists which then supported their political and social status. Finally, it examines whether the methods of administration adopted by the revenue boards were material in creating a dynamic of professional evolution.

CHEMISTS AND DRUGGISTS IN THE MEDICINE STAMP DUTY LEGISLATION

When proprietary medicines were first taxed in 1783, the charge was laid on all persons selling medicines in Great Britain. Such individuals were obliged, under penalty, to take out a yearly licence and then to pay a stamp duty on the container of every medicine sold according to its value.13 The Act, however, contained a major exception. Anyone who had served a regular apprenticeship to any surgeon, apothecary, druggist or chemist, or who had kept a shop for three years before the passing of the Act for the purpose of selling drugs and medicines only, not being drugs or medicines sold by virtue of His Majesty’s Letters Patent, was exempt from the requirement to purchase a licence, and, it followed, from the obligation to pay tax on the medicines sold.14 Chemists and druggists, therefore, like other exempted persons, could sell any medicine whatever its nature, without the need for a licence and free from any duty. The broad intention of the Act was to tax unqualified vendors on the medicines they sold and to leave qualified individuals selling regular medicines untouched. The legislators appear to have accepted that there was no 13 14

Medicine Stamp Duty Act 1783 (23 Geo III c 62) ss 1, 4, 5, 7. ibid s 1.

Tax and Pharmacy: Professional Evolution 157 chance of laying down precisely which medicines were to bear the duty and so legislators attempted to tax quack medicines by targeting the quality of the individual vendor. The official understanding was that any preparation sold by a medically unqualified individual must be a quack medicine, and conversely that quack medicines would not be sold by qualified individuals. A distinction of professional status and expertise thus lay at the very heart of the charge. As Stephen Dowell observed in 1884, the tax of 1783 was imposed, in part at least, in the interests of the qualified practitioners.15 The wording of the charging section and the exemptions it included was utterly obscure and it was nothing short of a drafting disaster. The scope of the tax was impossible to ascertain and the looseness of the statutory language and punctuation made the resolution of material issues of interpretation unachievable.16 Nevertheless, transcending these considerable difficulties of statutory language was a clear decision to afford special treatment to chemists and druggists in the legislative code. This overtly favourable position of chemists and druggists was continued when the legislation was recast in 1785, but it both changed in character and became more muted because the emphasis was changed from the nature of the seller to the quality of the product sold.17 No longer were chemists and druggists and other medically qualified individuals entirely exempted from the medicine stamp duty. The charge now depended on the nature of the medicine itself. The Act imposed the charge on every preparation used as a medicine to prevent, cure or relieve any human ailment, if the maker or seller made or sold it under Letters Patent, or claimed a secret art, or an exclusive right in doing so, or recommended it to the public as an effective remedy, or if it was expressly named in a supplementing schedule, which contained over 80 named preparations.18 As the duty was grounded in the nature of the taxed medicine as a quack medicine, it followed that no exemptions could properly be given.19 Nevertheless, the legislature wished to ensure beyond doubt that legitimate medical and pharmaceutical practice was not undermined, and so it exempted medicines sold by their ordinary or scientific names, without any element of quackery in the sense of secrecy, exclusivity or advertising. Specifically it exempted imported natural drugs and chemicals in general use in regular pharmaceutical practice, pure and unmixed drugs sold by medically qualified or licensed individuals, and 15 S Dowell, A History of Taxation and Taxes in England (London, Longmans, Green and Co, 1884) vol 4, 366. 16 See F Spilsbury, Discursory Thoughts Disputing the Construction of His Majesty’s Hon Commissioners and Crown Lawyers, relative to the Medicine and Horse Acts … with Remarks on the Late Trials Concerning the Medicine Act (London, Sold at the Dispensary in Soho Square, 1785) 3. 17 Medicine Stamp Duty Act 1785 (25 Geo III c 79). 18 ibid ss 2, 16. 19 The National Archives (TNA) files T1/624/514–19 (Stamp Office, Observations upon the Present Medicine Act and Proposals for an Improvement of that Duty, 21 May 1785).

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composite medicines which were ‘known, admitted and approved’ remedies for illnesses sold by a qualified person with no element of quackery.20 The category of qualified persons was taken from the 1783 Act, signifying surgeons, apothecaries, chemists and druggists who had served regular apprenticeships, and surgeons serving in the navy or army. The legal expression of the three statutory exemptions to the medicine stamp duty remained unchanged throughout the life of the tax until its abolition nearly 160 years later. Their practical implementation by the revenue boards of central government, however, was another matter, showing that it was not only through the express statutory language that the position of chemists and druggists was protected or promoted. The outstanding example of this is the Board of Inland Revenue’s interpretation of the third exemption, that for ‘known, approved and admitted’ remedies sold by qualified chemists. Throughout the nineteenth century, the board discounted this exemption, maintaining that because it was implicit in the charging provision, it was merely declaratory in nature and had no separate effect so as to take out of the charge a medicine that would otherwise be within it.21 It had been included in order to make it absolutely clear that established remedies which formed the stock of qualified practitioners were not within the very wide general charge to the tax as long as they were not secret, patent, proprietary or recommended to the public.22 A test case in 1903, however, confirmed that the exemption was a material one23 and forced the board to revise its practice. It did so in the widest terms and allowed qualified chemists and druggists to sell proprietary medicines free of duty as long as the formula was disclosed. Furthermore the board did not limit the exemption to chemists qualified by apprenticeship and allowed those qualified by examination to claim it;24 and eventually it even allowed corporate bodies to claim it even though they could clearly not have undergone an apprenticeship.

OCCUPATIONAL AFFIRMATION

The earliest effect on the occupation of chemists and druggists of the statutory expression of the medicine stamp duty, with its general charge, its exemptions and the practice of the revenue boards of central government in 20 Medicine Stamp Duty Act 1785 (25 Geo III c 79) ss 3, 4. See TNA file CUST 118/366 (Board of Customs and Excise and Predecessor, Private Office Papers, Medicine Stamp Duty 1783–1936) at App 1 and para 17; Dowell, n 15 above, vol 2, 18, 20, 95–96. 21 Report from the Select Committee on Patent Medicines, House of Commons Parliamentary Papers 1914 (414) ix 1, q 19; Private Office Papers, n 20 above, 9–10. 22 Private Office Papers, n 20 above, 56; Dowell, n 15 above, vol 4, 367. 23 Farmer v Glyn-Jones [1903] 2 KB 6. 24 J Humphrey, ‘Liability to Medicine Stamp Duty’ (1903) 71 Pharmaceutical Journal 200.

Tax and Pharmacy: Professional Evolution 159 its implementation, was positive and affirmative. In a number of ways the tax recognised, supported and promoted the professional pharmaceutical practice of chemists and druggists. First, the application of statutory provisions to chemists and druggists, expressly described as such, constituted an unambiguous legislative recognition of chemists and druggists as a coherent occupational group. A class could only be made subject to tax, or indeed exempted from it, if its delineation was clearly understood both by the taxing authorities of government and the tax-paying public itself. It was, accordingly, a reflection as to how far it was established in the official mind as a discrete occupation. Furthermore, since the legislation defined them by reference to qualification and training, however fragile that was in reality, it recognised them as a skilled group and thereby acknowledged their expertise. Secondly, the distinguishing of chemists and druggists within the medicine stamp duty legislation and the care taken to ensure that the tax did not impinge on their legitimate pharmaceutical practice supported them as part of the regular medical establishment. Their total exemption as members of a medically qualified group in 1783 sent an implicit but clear signal that the duty was unequivocally directed towards unqualified vendors of medicines, namely quacks, and thereby to exclude such individuals from orthodox pharmacy. Although the approach of the 1785 Act differed substantially in that it targeted quack medicines rather than unqualified vendors, the exemptions granted to chemists and druggists when such exemptions were legally superfluous strongly suggest a continuing underlying policy to protect those suppliers of medicines intended for legitimate use in regular medical and pharmaceutical practice. Through the taxation provisions, therefore, chemists and druggists were expressly recognised as the guardians of legitimate pharmacy. And thirdly, from 1903, the Board’s interpretation of the ‘known, admitted and approved remedy’ exemption gave chemists and druggists for the first time a material advantage over other retailers in selling proprietary medicines. This ‘chemists’ privilege’ allowed them to sell proprietary medicines free of duty while unqualified retailers selling identical medicines had to pay it, and they were thereby unambiguously favoured in what was essentially a non-pharmaceutical context.

PROFESSIONAL UNITY

While the legislative form of the medicine stamp duty had an affirmative effect on chemists and druggists, it was the very existence of the tax which had the most significant effect in promoting the chemists and druggists as a distinct group. The imposition of a tax on medicines unambiguously gave

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them a reason for occupational unity and as such constituted a powerful force for cohesion.25 When it was first enacted, the medicine stamp duty was surprisingly uncontroversial. As with indirect taxes in general it was relatively unobtrusive, exciting little parliamentary or popular discussion, and anyway chemists and druggists were too new, weak and diffuse a group to constitute a focus of opposition and effectively to voice any complaints. Objection to the essential principle of the new tax as an unacceptable burden on the sick poor was largely an individual campaign led by Francis Spilsbury, a London chemist and proprietor of Spilsbury’s Antiscorbutic Drops.26 It was only when the tax was nearly 20 years old that chemists and druggists united as an occupational group in protest against it. The third Medicine Stamp Act 1802 made no changes of principle, but it introduced a new and considerably enlarged schedule of expressly dutiable preparations.27 Chemists and druggists believed it was scientifically and professionally incorrect, failing to draw a realistic and informed distinction between the preparations of the regular practitioner and the ‘pretended arcana of charlatans and nostrummongers’.28 It included some single unmixed drugs such as Spanish juice, refined liquorice, India arrowroot and Turkey rhubarb, and some regular compounded medicines such as Huxham’s tincture of bark, Goulard’s extract and syrup of Tolu, all of which should have been exempt. The new schedule also included items that were broadly or indefinitely described, such as all dentifrices and lozenges,29 items of confectionary such as ginger and peppermint candy, and many toilet articles, such as perfumes and cosmetics. The inappropriate content of the 1802 Schedule and the lack of consultation by the central revenue board constituted one of the earliest unifying factors for chemists and druggists and ignited the first major campaign for the reform of the medicine stamp duty.30 With energy and vision a London surgeon, William Chamberlaine, took a leading role in forming a new Association of Apothecaries and Chemists and Druggists in 1802, a typical nineteenth century social and cultural response seen in relation to

25 See generally JGL Burnby, ‘The Professionalisation of British Pharmacy’ (1988) 18 Pharmaceutical Historian 3. 26 Spilsbury, n 16 above, 12. 27 42 Geo III c 56 (1802). 28 W Chamberlaine, History of the Proceedings of the Committee Appointed by the General Meeting of Apothecaries, Chemists, and Druggists, in London, for the Purpose of Obtaining Relief from the Hardships Imposed on the Dealers in Medicine, by Certain Clauses and Provisions Contained in the New Medicine Act, Passed June 3, 1802 etc (London, Highley, 1804) 17. See the petitions of local druggists: 58 Journals of the House of Commons 79, 84, 103 (10, 13, 17 December 1802). 29 Private Office Papers, n 20 above, 17. 30 They quickly understood that the total repeal of the 1802 Act could never be obtained: Chamberlaine, n 28 above, 11.

Tax and Pharmacy: Professional Evolution 161 most unpopular taxation initiatives. The association adopted a familiar and robust strategy of opposition. It held meetings, printed circulars, advertised, employed a solicitor, took the opinion of counsel, lobbied members of the House of Commons, held regular meetings with the Lord Mayor and other members for the City of London, and challenged the taxing decisions of the revenue boards by correspondence and personal meetings.31 Three tactics were central to the campaign. First, the association urged the immediate submission of petitions to Parliament from all over the country praying for relief from the medicine stamp duty, or calling for its abolition.32 Adopting a common form, the chemists and druggists complained that the Act had subjected them to ‘grievous burthens, inconveniences, and losses’33 and that it ‘bore severely’ on them.34 Secondly, Chamberlaine himself met with an official from the central revenue board and drafted a new schedule in which the offending articles were removed.35 Thirdly, the London committee prepared a memorial to the Lords of the Treasury calling for an end to the prosecution of chemists and druggists for selling those articles, and met the Secretary to the Treasury.36 It was, however, a pragmatic issue rather than concerns of principle or indeed substance that caused the chemists and druggists to unite in longterm opposition to the tax. That issue was the manner of its administration. The central revenue boards were responsible for implementing the tax37 and so vague and ambiguous were the general charging provisions and the exemptions, so numerous were ‘doubts and difficulties’38 in their drafting, that it demanded an extraordinary degree of bureaucratic involvement in the interpretation of the law. Of necessity, or simply in order to be fair, the boards implemented the provisions according to their own, extra-parliamentary, view on them. For example, the board had attempted to mitigate the problems caused by the ill-considered Schedule of 1802 by issuing instructions to its officers to enforce the law but not to prosecute for offences relating to the articles in the schedule that were clearly not meant to be there39 and promised that in general the authorities would not strain the meaning of the Act40 nor prosecute ‘on every trifling and unintentional offence against the Act’.41 31

ibid 10–11. 58 Journals of the House of Commons 60, 79, 84, 103, 157, 183, 211, 223, 237. 33 ibid 35 (29 November 1802). See too The British Critic (May 1804) 556. 34 Monthly Review (August 1804) 423. 35 Chamberlaine, n 28 above, 2–3. 36 ibid 3; Private Office Papers, n 20 above, 18. 37 The Board of Stamps, then of Stamps and Taxes, and, from 1849, the Board of Inland Revenue. 38 58 Journals of the House of Commons 35 (29 November 1802). 39 Chamberlaine, n 28 above, 5. 40 ibid 34–35. 41 ibid 22. 32

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Nevertheless, the role of the central revenue boards in the administration of the tax on the basis of their own interpretation of it caused the most intense and enduring resentment on the part of the chemists and druggists. They objected on the basis of its illegality, its unpredictability and its unfairness. It was exacerbated by the method of enforcement prescribed by the legislation, namely, the system of common informers whereby any individual, even if entirely unconnected with the Stamp Office, could initiate proceedings against a person he suspected of selling dutiable medicine unstamped or without a licence, and if the prosecution were successful, he could claim half the penalty.42 This ‘marriage of justice with malice or avarice’43 whereby informers exploited the uncertainty of the law for their own personal profit, was unpopular with all those subject to it, and profoundly objectionable to the chemists and druggists. From the inception of the Act they complained they were ‘harassed and persecuted’ by the ‘swarms’44 of professional informers to the point of ruin.45 Bureaucratic law-making and its methods of enforcement was an important element in the 1802 campaign of opposition. It continued as a matter of discontent, reaching unprecedented heights in the early 1830s when it led to the revival of the Association of Chemists and Druggists46 and the fresh formation of numerous local associations.

SUCCESS OF UNIFIED ACTION

While the campaigns of the chemists and druggists in 1802 and 1829 constituted a forceful expression of occupational unity, they enjoyed a varying degree of success. In relation to the critical issue of the content of the schedule, the 1802 campaign was singularly successful and obtained concessions and revisions to the legislation, an Act of 1803 adopting the revised Schedule of dutiable medicines suggested by the association.47 While the 1802 association was unsuccessful in relation to the chargeability of lozenges, that matter being partly resolved only in 1815,48 the revived association of 1829 succeeded in obtaining an assurance from the Chancellor of the

42 See generally MW Beresford, ‘The Common Informer, the Penal Statutes and Economic Regulation’ (1957) 10 Economic History Review (NS) 221. 43 ibid 221. 44 Chamberlaine, n 28 above, 2. 45 58 Journals of the House of Commons 60 (7 December 1802). For an example of the process in relation to the medicine stamp duty, see ibid 7–10. 46 Bell, n 1 above, 55; (1941) 146 Pharmaceutical Journal 125. 47 Medicine Stamp Duty Act 1803 (43 Geo III c 73) s 1. For a comparison of the 1802 and 1803 Schedules, making it clear which articles had been removed in the latter, see Chamberlaine, n 28 above. 48 Apothecaries Act 1815 (55 Geo III c 184) s 54.

Tax and Pharmacy: Professional Evolution 163 Exchequer that the much resented duty on soda water would be repealed, which it eventually was in 1833.49 Similarly, in the matter of prosecutions, the association of 1802 enjoyed a considerable measure of success. Legislation in 1803 provided that only persons acting under the authority of the central revenue boards50 could now bring a prosecution and achieved other concessions in relation to limitation periods and the mitigation of penalties.51 Such early and relatively minor successes marked the high point of effective collective action. In opposing the imposition of the charge through the interpretation of the legislation by the central revenue boards, the chemists and druggists faced an intractable challenge. The only solution to such bureaucratic law-making was a complete recasting of the legislation itself to render it as unambiguous as possible and thus minimise the need for discretion by the revenue boards. That was as unlikely as the abolition of the tax itself. The financial imperatives underlying its introduction and the isolationist culture of the central revenue boards ensured its continued existence. Doubts and uncertainties, ambiguities and obscurities thus remained, necessitating the constant interpretation by the central revenue board. Having served to unite the chemists and druggists, albeit for a discrete and immediate purpose which, once fulfilled or frustrated, led to the disbanding of the associations, tax remained a significant and unifying issue for chemists and druggists from 1841. Unlike its predecessors in 1802 and 1829, the Pharmaceutical Society of 1841 was not formed in order to secure the reform of the medicine stamp duty, but to improve the education of chemists and druggists and its underpinning in science, and to raise the status of the occupation.52 Although its principal raison d’être did not lie in taxation, its stated objective to safeguard the business interests of chemists and druggists53 led the society to keep a close and informed eye on the substance and administration of the medicine stamp duty and to create a dialogue with the revenue authorities on behalf of its members. While the Pharmaceutical Society did not engage in campaigns for the abolition or even the substantive reform of the tax, accepting that it was there to stay,54 its watching brief ensured chemists and druggists could understand a sometimes obscure legal

49

Stamp Act 1833 (3 & 4 Will IV c 97) s 20. Or the Attorney-General. 51 Medicine Stamp Duty Act 1803 (43 Geo III c 73) ss 4, 5. 52 See generally SWF Holloway, Royal Pharmaceutical Society of Great Britain 1841–1991: a Political and Social History (London, Pharmaceutical Press, 1991). 53 T Dewar, ‘A Hundred Years of Pharmaceutical Legislation’ (1941) 146 Pharmaceutical Journal 126; Royal Charter of Incorporation of the Pharmaceutical Society of Great Britain, House of Commons Parliamentary Papers 1851 (474) xliii 397, available at http://parlipapers. chadwyck.co.uk/fullrec/fullrec.do?area=hcpp&id=1851-027712&subjectCategory=04055. 54 Although various trade associations of chemists and druggists throughout the nineteenth century continued to campaign for its revision. See, eg (1886) 28 Pharmaceutical Journal 344. 50

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regime and effectively manage their tax liability, and their targeted actions in relation to specific issues the tax threw up ensured that in substance and administration it was kept within professionally-acceptable bounds. This supervisory engagement was evidenced and sustained by an extensive body of correspondence, hundreds of inquiries as to the tax status of individual preparations, regular editorials, articles, advice and instruction on the tax, all of which the society published in its official organ, the Pharmaceutical Journal.55 The editors advised their readers as to the law on the medicine stamp duty fully, conscientiously, accurately and regularly.56 Other journals, notably the Chemist and Druggist addressing the more commercial face of pharmacy, reveal a similarly intense and enduring engagement with the medicine stamp duty. There is scarcely one weekly edition of either the Pharmaceutical Journal or the Chemist and Druggist from their establishment in the middle years of the nineteenth century until the abolition of the medicine stamp duty in 1941 which does not mention the tax, and generally each edition sees dozens of entries. This constant professional debate and thread of discussion on the tax which is so visible in the literature engendered a strong sense of occupational unity.

TAINT OF TRADE

The medicine stamp duty thus had an affirmative effect on the occupation of chemists and druggists in granting them legislative recognition and providing a focus of professional unity. Equally, however, it had a negative effect which undermined any aspiration to professional status, and that was to emphasise and reinforce the commercial nature of the work of chemists and druggists. From the end of the eighteenth century, both professional and commercial activity was inherent in the practice of pharmacy. The professional work of chemists and druggists consisted of the dispensing of medicines prescribed by physicians and the compounding of medicines. But with their roots in the trade of grocer and the retailing arm of the apothecaries, chemists and druggists had a strongly commercial background. Their business activities consisted of the sale of a wide range of general commodities, more or less connected with pharmacy. Drugs and oils, such as castor and cod liver oil, lozenges, paints and colours for artists, dyes, groceries, mineral and aerated waters, wines and spirits, veterinary medicines and, increasingly, toiletries such as soaps and perfumes were all, by custom, sold by chemists

55 56

Founded by Jacob Bell in 1841. See the summary in (1854–55) 14 Pharmaceutical Journal 146.

Tax and Pharmacy: Professional Evolution 165 and druggists.57 By the middle of the nineteenth century they were major suppliers of proprietary medicines,58 both those commercially produced and their own preparations made and retailed under their own names. The commercial nature of the work of chemists and druggists came to be reflected by the term ‘retail pharmacy’, which described the work of the majority of chemists and druggists throughout the nineteenth century and beyond.59 With regard to obtaining professional status, the taint60 of trade was potentially fatal in Victorian England. As John Attfield, the President of the British Pharmaceutical Conference observed in 1883, ‘the trading side of [the chemist and druggist’s] work for the public obscures the professional side’.61 Trade was thought to detract from the respectability of pharmaceutical work and was understood to undermine professional status in four ways. First, it confirmed chemists and druggists as shop-bound, making their living not by charging for attendance and advice, as physicians, surgeons and, to some degree, apothecaries did, but from selling medicines from their shop and conducting their occupation entirely from there.62 Secondly, the sale of proprietary medicines in particular detracted from the respectability of their skilled and responsible pharmaceutical work, partly because such remedies were based on unsound medical knowledge but also because the chemist and druggist would not necessarily know their composition or be able to advise on their use. He merely sold them as a commodity,63 an activity which undermined the notion of a special skill which chemists and druggists were so anxious to promote.64 Thirdly, it meant that the chemists and druggists had a direct interest in the quantity of medicines they sold. This promoted

57 ‘On the Professional Character of the Pharmaceutical Chemist’ (1842) 2 Pharmaceutical Journal 1; H Marland, ‘The “Doctor’s Shop”: the Rise of the Chemist and Druggist in Nineteenth-Century Manufacturing Districts’ in L Hill Curth (ed), From Physic to Pharmacology: Five Hundred Years of British Drug Retailing (Aldershot, Ashgate, 2006) 79, 87–88. 58 Report from the Select Committee on the Pharmacy Bill, n 6 above, qq 2400, 2403; Marland, n 57 above, 98; (1876) 18 The Chemist and Druggist 239. 59 For a brief history of retail pharmacy in the nineteenth century, see (1941) 146 Pharmaceutical Journal 130. Note that their dispensing work increased after the passing of the National Insurance Act 1911. 60 Or ‘stigma’: Crellin, n 1 above, 222. 61 John Attfield, ‘The Future Supply of Drugs to the Public’, Introductory Address to the 20th Annual Meeting of the British Pharmaceutical Conference, Southport, 1883 (London, LSE Selected Pamphlets, LSE Library, 1883) 12. See too ‘On the Professional Character of the Pharmaceutical Chemist’ (1842) n 57 above, 2. 62 They did undertake some prescribing and giving of advice for minor conditions, but they did so from their shop counter. For the prescribing activity of chemists and druggists see Marland, n 57 above, 79–104. 63 ibid; Humphrey, n 24 above, 202; For a modern expression of such concerns, see Sonnedecker, n 3 above, 243, 249. 64 GJ Higby, ‘Professionalism and the Nineteenth-Century American Pharmacist’ (1986) 28 Pharmacy in History 115, 119.

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a commercial rather than a professional morality, in which a strong profit motive was inherent and doubtful ethics were always a suspicion.65 Finally, and most importantly, practising pharmacy primarily as a retail business created and perpetuated a widespread public perception of chemists and druggists as mere traders. In the 1850s chemists and druggists could even be referred to as ‘the drudges of trade’.66 This perception was exacerbated by the widespread involvement of unqualified individuals such as grocers, barbers, booksellers, hairdressers, stationers and tobacconists in the sale of proprietary medicines and sometimes in dispensing. This was a legitimate practice due to the flawed wording of the Pharmacy Act 186867 which allowed such individuals to practise as chemists and druggists as long as they did not use that title, nor sell certain poisons. These factors combined to obscure the line between general shopkeepers and chemists and druggists, to create a strongly commercial ethos of chemists and druggists, and to construct a public perception of trade rather than the provision of a skilled service. This perception was shared to varying degrees by the chemists and druggists themselves. As the President of the British Pharmaceutical Conference observed in 1883, ‘[t]rade and profession form the warp and woof of pharmacy, interwoven in every part of the fabric’.68 Acutely conscious of this ambiguity, chemists and druggists reflected it in their nomenclature. They regularly referred to their work as a calling, craft, occupation or trade69 and themselves as ‘respectable and upright tradesmen’,70 as tradesmen and professionals in the same breath71 and occasionally as ‘semi-professional’.72 Officially too, chemists and druggists were consistently referred to as tradesmen in official government reports and returns,73 and legislative practice in this regard was particularly revealing. The Apothecaries Act 1815 described the work of chemists and druggists as a ‘trade or business’,74 a form of words which was supplied by the chemists and druggists themselves, and later legislation called it a ‘business or calling’.75 Indeed, the legislature had continued difficulty in classifying chemists and druggists. It was in this context of the common perception of chemists and druggists that the medicine stamp duty had a negative role in the process of their professionalisation, because the tax served to affirm and reinforce the 65

F Stearns, ‘The Pharmaceutist as a Merchant’ (1865) American Journal of Pharmacy 198. Referring to the importance of chemical analysis in combatting cholera and the lack of resources afforded to chemists and druggists to undertake it: ‘Letters to the Editor’, The Times, 17 August 1854, 10. 67 25 & 26 Vict c 91 s 1. 68 Attfield, n 61 above, 7. 69 See, eg (1904) 72 Pharmaceutical Journal 337. 70 85 Journals of the House of Commons 512 (4 June 1830). 71 (1904) 72 Pharmaceutical Journal 337. 72 (1886) 28 Pharmaceutical Journal 344. 73 See, eg Report from the Select Committee on the Pharmacy Bill, n 6 above, q 780. 74 55 Geo III c 194 s 28. 75 Pharmacy Act 1852 (15 & 16 Vict c 56) s 8. 66

Tax and Pharmacy: Professional Evolution 167 commercial nature of chemists and druggists and their public perception as mere traders. The medicine stamp duty was unambiguously a tax on a commodity in the strict sense of the term, an article of commerce. It was introduced for entirely financial reasons to raise public revenue, with no social policy objective, and was part of a scheme of taxation which included an impost on a whole range of articles including gloves and playing cards.76 By attaching to all proprietary medicines by whomsoever they were sold, there was no legislative intention to treat chemists and druggists any differently from grocers, booksellers and others who stocked and sold proprietary medicines. So in the sale of these commodities, the legislation treated chemists and druggists as no different from any general trader. The only exception, namely, the permission given to qualified chemists and druggists to sell known, admitted and approved remedies free of the tax after 1903, was not a legal exemption but merely an extra-statutory bureaucratic concession introduced in order to make the tax workable in practice.

CONCLUSION

The medicine stamp duty was not the leading motive force in the growth and character of the pharmacy profession. A formal specialised and prescribed education followed by examination and registration, the formation of a permanent representative professional organisation, the exclusive right to certain titles and, in the early twentieth century, chemists’ and druggists’ position under the National Insurance legislation,77 were the real drivers of professionalisation and began to transform the public perception of chemists and druggists.78 Nevertheless, the medicine stamp duty as expressed in its parent Act and as implemented by the central revenue boards exerted a material influence on the taxonomy of the occupation of chemists and druggists. It has been seen that the legislation protected the professional aspect of pharmacy by expressly providing, through so-called exemptions and where there was no legal need to do so, that the tax would not extend to regular medicines in the course of the exercise of pharmaceutical activity properly so called. It promoted the professional aspect of pharmacy by recognising chemists and druggists as a skilled and discrete occupational group, thereby publicly affirming their status. And the existence of the tax gave the first powerful impetus to uniting chemists and druggists in occupational resistance. The associations of 1802 and 1829 which were created entirely to provide a united opposition to changes in the tax regime 76 The stamp duty on playing cards was one of the longest lived taxes, enduring from 1711 to 1960. 77 JA Hunt, ‘The Evolution of Pharmacy in Britain (1428–1913)’ (2006) 48 Pharmacy in History 35, 39–40. 78 Matthews, n 7 above, 120–24; Crellin, n 1 above, 216–18.

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applicable to medicines in order to protect the trade of chemists and druggists have been described as ‘ephemeral’ associations doing no more than representing ‘the emergence of the chemist and druggist on the political scene’.79 It is indeed the case that these associations endured only as long as it took to resolve the particular grievance and did not promote any agenda of educational reform or professional regulation. These associations were, however, formative in that they constituted unambiguous and early expressions of professional cohesion which as such culminated in the formation of the Pharmaceutical Society, itself an undoubted landmark in the process of professionalisation.80 Historically, however, pharmacy was a case of ‘incomplete’ professionalisation,81 undoubtedly a skilled and ancient occupation but one that fell short of the status of a full profession according to the orthodox perception of that social phenomenon.82 It was, from the middle of the nineteenth century, based on formal specialised intellectual study and training, provided a skilled service to the public, restricted under statutory authority the right to practise pharmacy and controlled the right to do so under the title of chemist and druggist, pharmaceutical chemist or pharmacist and abided by a code of ethics.83 However, in their self-conscious and typically Victorian creation of their profession, chemists and druggists faced the almost insurmountable hurdle of the undeniable and growing commercial aspect of their work.84 It was not only their retail activity in non-pharmaceutical products which was problematic in this respect, it was just as much their relationship with medicines. Chemists and druggists were defined by their product and much of that product was commercially dealt in. As the leading surgeon Sir Astley Cooper observed in 1834, a man going to a druggist ‘goes to buy drugs, as he goes to a grocer’s shop, to buy tea and sugar’.85 Not only had they failed to ensure exclusive control of the provision of medicines, it was clear that they had a direct interest in the quantity of medicines they sold, promoting a commercial morality rather than a professional one in which a strong profit motive was inherent, and entailing non-professional customs such as advertising.86 This central role of the medicine as a commercial

79

Holloway, n 8 above, 130. Through its activities, the position of the chemist and druggist was ‘exalted from that of a mere trader to a member of an educated and scientific profession’: (1876) 18 The Chemist and Druggist 238; Matthews, n 7 above, 117–48. 81 NK Denzin and CJ Mettlin, ‘Incomplete Professionalization: the Case of Pharmacy’ (1968) 46 Social Forces 375. 82 Carr-Saunders and Wilson, n 11 above, 3–31. 83 Sonnedecker, n 3 above, 243. 84 cf Jane Frecknall-Hughes and Margaret Mckerchar, Chapter 5 in this volume. 85 Report from the Select Committee on Medical Education with Minutes of Evidence, House of Commons Parliamentary Papers 1834 (602) xiii 468. 86 Carr-Saunders and Wilson, n 11 above, 435–36. See Marland, n 57 above, 96–97, 102. 80

Tax and Pharmacy: Professional Evolution 169 commodity was highlighted by the medicine stamp duty, serving to intensify the focus on the product rather than the service. In this way, it contributed to the collective view of the public that pharmacy was, at most, a mere occupation, exacerbated the inherent ambiguity within pharmacy practice,87 and exerted a negative influence on the perceptions of professional status in the nineteenth century and beyond. Thereby, the tax had a social impact entirely unforeseen by the legislators who first introduced it into the fiscal regime.

87 This ambiguity still exists: J Burnby, ‘Pharmacy in the Mid-Nineteenth Century’ (1992) 22 Pharmaceutical Historian 3; S Wilson, ‘Pharmacists Can be Both Good Businessmen and Good Professional Men’ in PA Doyle (ed), Readings in Pharmacy (New York, Interscience Publishers, John Wiley & Sons, 1962) 325; Sonnedecker, n 3 above, 243.

7 Plaintive Aristocrati: The Upper Crust in Tax Cases PHILIP RIDD

ABSTRACT Over the period since the introduction of income tax in 1798, one of the great changes in the United Kingdom has been the waning of the importance and influence of the aristocracy; David Cannadine gave the title Decline and Fall of the British Aristocracy to his 1990 book; Alwyn W Turner gave the title A Classless Society to his recent book about the 1990s.1 All the while the aristocracy has not exhibited abundant enthusiasm about paying income tax and other taxes. This chapter complements ‘Plaintive Glitterati’ (see Studies in the History of Tax Law, volume 6) by examining the case law involving the ‘Upper Crust’ to be found in the Tax Cases series of law reports. Some of the cases involved purely technical points but many concerned the thorny, and still topical, area of tax avoidance. One case is, of course, that of the ducal gardener who did not receive wages but benefited from an annuity, a case which, it will be suggested, was poorly argued on the Inland Revenue’s side. Those concerned in the cases range from the peer who wrote The Key to Safe Slam Calling in Contract Bridge, the Irish peer who enlivened parties by singing the Polish national anthem, a peer who was killed in an air raid on Weston-super-Mare, and a peeress who was known as ‘The Lady Who Killed All Her Husbands’. It was a peer who sparked the judicial comment ‘It scarcely lies in the mouth of the taxpayer who plays with fire to complain of burnt fingers’. The cases range over various taxes and cannot be said to illustrate any particular theme or to support any particular argument, but all the same they retain considerable interest.

INTRODUCTION

T

HE LIFE OF Clarence, Lord Emsworth, as portrayed by PG Wodehouse, was in most ways a charmed one. His seat, Blandings Castle, was an earthly paradise, blessed with the perpetual sunshine in which,

1

Alwyn W Turner, A Classless Society (London, Aurum Press, 2013).

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as the author believed, England revelled. Occasionally Lord Emsworth was brought to book by one of his hectoring sisters, or was hounded to do unwelcome tasks by an efficient secretary such as Rupert Baxter. There were even moments when his Droit de Seigneur was overlooked and a pigman (Wellbeloved) or a gardener (McAllister) made difficulties—McAllister inspired the remark that there is no difficulty in distinguishing between a ray of sunshine and a Scotsman with a grievance. But these uncomfortable moments were few and far between. It certainly does not appear that, although the number of staff at Blandings Castle was considerable, Lord Emsworth had any concerns in relation to money. In this respect he differed from many of his fellow aristocrats. It is sometimes said that estate duty was the cause of the decline of the aristocracy. The explanation was, however, much more complicated. Of the works on the subject a leading one is David Cannadine’s The Decline and Fall of the British Aristocracy.2 Taxes received relatively little coverage in that work. That occasions no surprise. The Inland Revenue was always sedulous in maintaining the confidentiality of each person’s tax affairs, and individual Revenue files have been destroyed rather than preserved for the National Archives. But, while certainty and detail can never be achieved, it is well nigh sure that taxes will have played a prominent role in the process. After all, the rate of income tax was 2d in the pound in 1874, or 0.833 per cent. In 1908 the rate was 9d in the pound, or 3.75 per cent. The People’s Budget of 1909 maintained that rate, but imposed a rate of 1s (5 per cent) on incomes above £2,000, and super-tax of 6d in the pound (2.5 per cent) on incomes above £5,000, thereby giving effect to the notion, which seems to have been an anathema in Victorian times, that people should pay in accordance with their means. Taxation boomed to pay for the First World War, and no doubt there was a general, if reluctant, acceptance of that, with the notable exceptions of William and Edmund Vestey (which will be explained below). But peacetime did not bring any relief and tax rates remained at what were, historically, high levels. The same occurred in and after the Second World War. Worse was to follow. During Harold Wilson’s governments of 1964–1970 the combined rate of income tax and surtax reached 83 per cent and there was also an investment income surcharge of 15 per cent, making an aggregate of 98 per cent: it was even possible to fashion examples of circumstances in which the rate would exceed 100 per cent. These few figures are sufficient for present purposes. The demands of the men (and, possibly, a few women) in rude huts in Hinchley Wood, that is to say, the Surtax Office, must have been a major concern for those trying to maintain their stately piles.

2 D Cannadine, The Decline and Fall of the British Aristocracy (London, Yale University Press, 1990).

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It was when researching the cases for a paper called ‘Plaintive Glitterati: Famous People in Tax Cases’,3 that the writer became conscious that there are quite so many tax cases as there are which involve members of the aristocracy. An analysis of the cases follows. It is divided into three sections: General Cases (Cases 1–36), Foreign Income (Cases 37–44) and Avoidance (Cases 45–56). Each section proceeds chronologically. The only source of law used is the reports in Tax Cases and it is to those reports that references are given.

GENERAL CASES

Case 1: Duke of Norfolk v Lamarque (Surveyor of Taxes) (1890) 2 TC 594 The Duke of Norfolk is the premier Duke in the peerage of England. As Earl Marshal he is head of the College of Arms and, under the House of Lords Act 1999, he has automatic admission to the House of Lords. The case concerned the 15th Duke’s liability for tax on manorial dues under Schedule A. The Duke’s claim for a deduction in respect of the costs of collection failed because full profits were held to mean profits unreduced by incidental costs. Stevens v Bishop4 was distinguished as involving expenses which the titheholder concerned had been compelled to expend in order to realise his tithe.

Case 2: Lord Walsingham v Styles (Surveyor of Taxes) (1894) 3 TC 247 The peerage, Lord Walsingham, was created in 1780 for Sir William de Grey on his retirement as Lord Chief Justice of the Common Pleas. The case concerned Inhabited House Duty payable by the 6th Baron in respect of a property comprising two blocks at the junction of Piccadilly and Arlington Street and sub-divided into chambers. Relief was claimed under Customs and Inland Revenue Act 1878 section 13 which provided relief from Inhabited House Duty for unoccupied tenements in a divided house. The claim failed. The premises were held to be in the nature of a hotel. The imprecise judgment leaves an overall impression that section 13 applied only to a building comprising self-contained flats or maisonettes.

3 P Ridd, ‘Plaintive Glitterati: Famous People in Tax Cases’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2013) vol 6. 4 Stevens v Bishop (1888) 2 TC 249.

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Case 3: Lord Mostyn v London (Surveyor of Taxes) (1894) 3 TC 294 The 1st Lord Mostyn was Edward Pryce Mostyn Bt, a politician, who was raised to the peerage in 1831. The case concerned the 3rd Lord Mostyn’s liability under Schedule A in relation to ‘fines’ paid by the tenants of various properties for the renewal of their leases. Payments were made into bank accounts of trustees pending investment in freehold, leasehold or copyhold property in accordance with the terms of Lord Mostyn’s father’s will, so the deposits in the bank were of a temporary nature. Under Income Tax Act 1842 section 60 fines were chargeable to tax under Schedule A unless they ‘have been applied as productive capital’. Temporary deposit in a bank was held insufficient to engage that exemption.

Case 4: Earl of Derby v Aylmer (HMIT) (1915) 6 TC 665 The title of Earl of Derby originated in 1138, twice became extinct, but has existed since its re-creation in 1485. The title does not relate to the City of Derby but to the Hundred of West Derby in Lancashire which includes Liverpool. The case concerned the 17th Earl. In relation to an income tax assessment for 1913–14 in respect of stud fees he claimed a deduction for the diminished value of the stallions which had been the agents by which he had earned the fees. The value of the stallions was put at £20,000 and £40,000 respectively, and their life expectancy was taken at 18 years. The Revenue successfully resisted the claim. Rowlatt J held that Customs and Inland Revenue Act 1878 section 12 was not applicable because, in relation to the diminished value of horses as breeding animals, depreciation was not the result of wear and tear.

Case 5: Duke of Argyll v Commissioners of Inland Revenue (1913) 7 TC 225 The Earldom of Argyll can be traced back to 1457. It has the up and down history common to the mediaeval and the Stuart eras. The 8th Earl was convicted of treason and executed in 1661. The 9th Earl, nothing repentant, took part in the Monmouth Rebellion of 1685 and was also executed. In 1701, the 9th Earl’s son was created the 1st Duke of Argyll. The Duke involved in the case was the 9th Duke. In 1871, he married Princess Louisa, sixth child and fourth daughter of Queen Victoria. The issue in the case concerned an annuity of £6,000 granted to Princess Louisa on her marriage by Letters Patent under a special Act of Parliament (34 Vict c 1) which used the words ‘free of all taxes and assessments and charges’. The Duke appealed against surtax

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assessments for 1909–10, 1910–11 and 1911–12, in respect of the inclusion in each of them of the £6,000 annuity, claiming that the annuity was exempt from surtax. Scrutton J held the exemption to be applicable on the grounds that, in accordance with the normal rule, the later of two conflicting Acts prevailed over the earlier; that the annual statutory re-impositions of income tax did not affect the position, for which reliance was placed on Stewart v Conservators of the River Thames;5 and that super-tax, though first imposed long after 1871, was not to be regarded as distinct from income tax.

Case 6: Earl Howe v Commissioners of Inland Revenue (1919) 7 TC 289 The title of Earl Howe was created for the second time in 1821 for the 2nd Viscount Curzon. The case concerned the 4th Earl. He paid life insurance premiums on a policy charged as a security when he conveyed by way of mortgage his life interest in certain settled estates. On appeal against a super-tax assessment for 1916–17 he claimed a deduction for the relevant payment of premium as an annual payment. In the Irish case of Commissioners of Inland Revenue v Lord Massy,6 Kenny J and Madden J (Pallas CB dissenting) had decided a like case on the lines advanced by Earl Howe, and Sankey J, though he agreed with the dissenting judge, deferred to the Irish decision. The Court of Appeal, feeling no such deference, declined to follow it. Annual payments for income tax purposes were held to be limited to payments which led to income being taxable in the hands of the recipient rather than the payer. Scrutton LJ used the example of paying a butcher an annual sum for the supply of meat for a year as a situation in which the recipient would not be chargeable on the receipt but would merely have to bring it into account in calculating the profits of his trade. The writer recalls this case with fondness, even amusement, because he once cited it in a case before the Special Commissioners in which the taxpayer was contending for the deductibility of a payment which, to his distress, he was forced to make annually, namely, that of his surtax liability.

Case 7: Commissioners of Inland Revenue v Viscountess Portman (1923) 8 TC 527 The title of Viscount Portman was created in 1873 for Edward Portman, a Liberal MP who had been made a Baron in 1837. The Portman family

5 6

Stewart v Conservators of the River Thames (1908) 5 TC 297. Commissioners of Inland Revenue v Lord Massy [1918] 2 KB 595.

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can be traced back to Sir William Portman, who was Lord Chief Justice from 1555 to 1557 and was the original founder of the Portman Estate in Marylebone, the foundation of the family wealth. The case concerned the widow of the 2nd Viscount Portman. The report covers five cases which were heard together in the High Court (Rowlatt J), all involving the supertax complications relating to married couples where they marry, or one of them dies, during a relevant tax year. In Viscountess Portman’s case the assessment in issue was for 1920–21 but that was based on the income for the preceding year, 1919–20, during which Viscount Portman had died (in fact on 16 October 1919). Rowlatt J held that Viscountess Portman was not chargeable by reference to the whole of the income of that year, but only by reference to the part of it during which she was a widow.

Case 8: Commissioners of Inland Revenue v Earl of Haddington (1924) 8 TC 711 The Earldom of Haddington was created for Thomas Hamilton who was Lord President of the Court of Session from 1616 to 1625. The case concerned the 12th Earl. He fought in both World Wars, being awarded the Military Cross in the First World War. On 24 December 1918, the Earl made payments amounting to £3,978 17s. The Revenue accepted that that sum was deductible for super-tax purposes, but considered that half of it was deductible for 1918–19 and half for 1919–20, while the Earl contended that the full amount was deductible for 1919–20. The explanation for the Earl’s stance is apparent from the Case Stated which recorded that the assessment for 1918–19 had in any event to be discharged because the Earl, as a serving member of the military forces, was entitled to relief under Finance Act 1915 section 19. The payments related to charges on certain entailed lands and estates. There were complications in relation to amounts due following the death of the Earl’s father on 12 January 1917. Matters were resolved by an order of the Court of Session made on 27 November 1918. The Earl unsuccessfully contended that nothing had been payable until that order was made.

Case 9: Lord Inverclyde’s Trustees v Millar (HMIT) (1924) 9 TC 14 The peerage, Lord Inverclyde of Castle Wemyss, was created in 1897 for the Scottish shipowner Sir John Burns, 1st Baronet. The case concerned the

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3rd Baron. An interesting and amusing biography of the 3rd Baron, which appeared in Vanity Fair on 21 April 1909,7 concluded: He is of sturdy habit, fond of all outdoor sports, and would like to divide his year into two seasons, one for curling and one for tennis, did not yachts and guns, in their season, shake his constancy. He is a member of the King’s Bodyguard for Scotland, has a covered tennis court and a grouse moor, and a delightful residence at Castle Wemyss on the Firth of Clyde. He is a Unionist Tariff Reformer, because he can’t help it, and is incurably modest.

The issue in the case was whether, for the purposes of income tax in respect of interest received, a deduction should be made in respect of interest paid on unpaid estate duty. The point arose for 1921–22 with reference to events in the preceding year, namely, the receipt by the trustees of interest of £72,231 and the payment by them of £21,847 in respect of interest on unpaid estate duty. The latter interest was provided for by Finance Act 1896 section 18 in which it was stated that interest should be paid without deduction of tax. The trustees’ claim failed at all levels. The main speech in the House of Lords was given by Viscount Cave. The trustees had, by this stage of the proceedings, accepted that there was no statutory provision which specifically provided for the deduction sought. Two arguments were put. One of them was that, despite the prohibition of deduction in section 18, the trustees were entitled to take credit for tax as having been actually paid. This, Viscount Cave considered, would render the prohibition in section 18 abortive, and in any event there was no basis for the premise that payment without deduction of tax equated to a payment which included tax. The second argument was that, as to £21,847 of the £72,231 of investment income, that sum had been received on behalf of the Crown, but that argument failed because no part of the £72,231 was earmarked for the payment of interest on estate duty. The contentions of the trustees were full of ingenuity but devoid of substance, as is testified by the speech of Lord Shaw of Dunfermline, which may conveniently be given here in full, viz ‘My Lords, there are no merits in this appeal’.8

Case 10: Roberts (HMIT) v Lord Belhaven’s Executors (1925) 9 TC 501 The title of Lord Belhaven can be traced back to 1647 when it was conferred on Sir James Hamilton Bt. The executors involved in the case were those of the 10th Lord Belhaven. The case concerned dross bings, a Scottish 7 ‘Men of the Day. No. MCLXVIII. Lord Inverclyde’, Vanity Fair, 21 April 1909, 497. The article was signed ‘Jehu Junior’, an amusing nom de plume. 8 Lord Inverclyde’s Trustees v Millar (HMIT) (1924) 9 TC 14, 27.

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expression denoting mineral waste deposits. They were colliery deposits on an estate at Wishaw, Lanarkshire. The facts of the case suggest that they amounted to about 10,000 tons and had been on the spot since 1894 or earlier. In 1920, shortly before his death, Lord Belhaven sold the bings to various purchasers realising just over £4,000. The appeal was against income tax assessments made in the alternative under Schedules A and D, and was successful. The Schedule A assessments failed because the disposal of the bings was not by way of lease so that the receipts were not rentals: it was not a disposal of a portion of the land. The Schedule D assessments failed because the receipts were not in the nature of annual profits or gains, the disposal being simply an outright sale of a capital asset. It may be said in retrospect that the Crown’s case was utterly hopeless.

Case 11: Earl of Jersey’s Executors v Bassom (HMIT); Earl of Derby v Bassom (HMIT) (1926) 10 TC 367 The title of Earl of the Island of Jersey, usually shortened to Earl of Jersey, was created in 1697 for the statesman Edward Villiers, 1st Viscount Villiers, who was Ambassador to France from 1698 to 1699 and Secretary of State for the Southern Department from 1699 to 1700. The case concerned the 8th Earl. His obituary in The Times of 1 January 1924 was headed ‘Lord Jersey: A great loss to the turf’,9 which was perhaps unsympathetic to his widow and four children, but did reflect one of his major occupations. Indeed the obituary had little else to say about him. The Earl of Derby has been introduced elsewhere. The cases were virtually identical. Each Earl bred, owned and raced, but did not sell, thoroughbred horses. Their stallions served their own mares but also, in much greater numbers, served mares belonging to others. The income tax assessments in issue were on the profits from the serving of outside mares. Was this a trade? Rowlatt J regarded it as settled that, while a breeding establishment might not be a commercial establishment as a whole, allowing stallions to serve outside mares might be isolated as a trade, which was the correct conclusion on the facts of each of these cases.

Case 12: Commissioners of Inland Revenue v Lord Hamilton of Dalzell (1926) 10 TC 406 The title of Lord Hamilton of Dalzell in the County of Lanark was conferred in 1886 on the liberal politician, John Hamilton. The case concerned 9

‘Lord Jersey: A great loss to the turf’, The Times, 1 January 1924, 4.

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the 2nd Baron. It looks at first sight hideously complex, but it all boiled down to an issue of construction of a trust deed, two clauses of which were difficult to reconcile. Lord Hamilton had, in 1915, settled his estates upon himself in life-rent and upon a series of heirs. Under one clause in the trust deed the trustees had power to pay the outgoings of the estate, but another clause appeared to direct them to pay the whole of the income to Lord Hamilton during his life. The question was, therefore, whether he was entitled to the whole income or only to the ‘free income’, ie the income after the deduction of the outgoings. On construction of the deed, it was held that he was entitled only to the ‘free income’.

Case 13: Lord Tollemache v Commissioners of Inland Revenue (1926) 11 TC 277 The Tollemache peerage was created in 1876 for the Conservative politician, John Tollemache. The case, which related to super-tax assessments, concerned the 3rd Lord Tollemache, who, by way of a sideline, wrote a book called The Key to Safe Slam Calling in Contract Bridge.10 The case, which concerned the 3rd Lord Tollemache, related to super-tax assessments. The trustees of the will of Lord Tollemache’s grandfather exercised their discretion to allow Lord Tollemache to live in Peckforton Castle, Cheshire, and they paid the rates on that property and also discharged some of Lord Tollemache’s supertax bills. The questions were whether the annual value of the Castle and the payments of the rates and super-tax bills were to be included for super-tax purposes. As to the annual value issue Rowlatt J said that question was simply ‘Who really has the profits?’ and the answer to that was Lord Tollemache, it making no difference that he did so under the exercise of a discretion. It was also held that the payments of the rates and the surtax bills were payments of Lord Tollemache’s liabilities and must therefore be treated as part of his income. The judge distinguished Commissioners of Inland Revenue v Wemyss.11

Case 14: Commissioners of Inland Revenue v Countess of Longford (1928) 13 TC 573 The Earldom of Longford is an Irish title with a long history, the current line dating from 1785. The case involved the 6th Earl of Longford (1902–61), who inherited the title at the age of 12 when his father died at the Battle of 10 J Tollemache, The Key to Safe Slam Calling in Contract Bridge (Chester, Phillipson & Golder, 1931). 11 Commissioners of Inland Revenue v Wemyss (1924) 8 TC 551.

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Gallipoli on 21 August 1915. He was an Irish nationalist and a man of the theatre, especially the Gate Theatre, Dublin, which he subsidised. He was a playwright and poet. He was a member of the Irish Senate from 1946 to 1948. He seems to have been a huge character in every sense and delighted in throwing parties at which he sang the Polish national anthem. He left no issue, so the title passed to his younger brother, Frank (1905–2001) who was a well known social reformer. When there is doubt whether the assessable party is A, B or C, it is open to the assessing authority to assess each party separately with a view to one assessment sticking and the other two falling away. In this case the Revenue assessed A for the first of five years, B for the next three, and C for the final year. That seems an approach which was bound to lead to a good deal of failure, and so it proved. The 6th Earl, a minor until 1923, had vested interests in possession in settled property, from 1915 in relation to an 1899 settlement, and from 1918 in relation to an 1862 settlement. Super-tax assessments were made in respect of the Earl’s income from 1916–17 to 1920–21, for the first year on his mother as his guardian, for the next three years on the trustees of the 1899 settlement as his trustees, and for the last year on the Earl himself. Although, as indicated, the case was much concerned with the machinery of assessment, there was an issue about income, namely, whether the income of a minor which is being accumulated by trustees was receivable by the minor. Rowlatt J held that it was, because a section in the Conveyancing Act 1881 merely put the trustees in the position of bankers to hold and invest the money on the Earl’s behalf until his majority. The 1920–21 assessment on the minor was upheld on the authority of R v Newmarket Income Tax Commissioners ex parte Huxley.12 The Revenue’s case faced formidable difficulties in respect of the first four years and it duly failed in the House of Lords.

Case 15: Lady Miller v Commissioners of Inland Revenue (1930) 15 TC 25 The Miller baronetcy, of Manderston, was created in 1874 for the diplomat and politician, William Miller. The case concerned Lady Eveline Miller, wife of the 2nd Baronet, who was revered for her work for war hospitals during the First World War and for having provided a convalescent home for wounded soldiers. Following her husband’s death, Lady Miller was entitled to occupy Manderston House under a trust disposition and settlement. The trustees were directed to pay the rates and other burdens on Manderston, liabilities duly discharged. The issue was whether the amounts involved were income 12

R v Newmarket Income Tax Commissioners ex parte Huxley (1916) 7 TC 49.

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of Lady Miller for super-tax purposes. In the House of Lords the principal speech was that of Lord Buckmaster. He considered the position apart from authority, concentrating on Schedule A, which was a tax on the occupier. He declined to accept that the trustees were the occupier by virtue of their power to enter for purposes such as repairs, as that involved no right of occupation, so he concluded that in principle the Revenue’s case was correct. He then turned to the authorities, some of which had been binding in the Court of Session but none of which were binding in the House of Lords. The result of his examination was that Shanks v Commissioners of Inland Revenue13 was approved, Corke v Fry14 was approved as to the result but disapproved as to the reasoning, and Commissioners of Inland Revenue v Wemyss15 and M’Dougall v Sutherland16 were disapproved.

Case 16: Lord Michelham’s Trustees v Commissioners of Inland Revenue (1930) 15 TC 737 The Michelham peerage was created in December 1905 for Sir Herbert Stern, a financier and philanthropist. He died in 1919, bequeathing to his widow an annuity of £25,000. The Chancery Division made an order that the annuity was to be free of income tax and super-tax. The income from the estate was insufficient for the purpose and part of the annuity had to be paid from capital. The main issue was whether for tax purposes the annuity was to be regarded as grossed up for income tax and super-tax, as the Revenue asserted. Rowlatt J, following his own decision in Meeking v Commissioners of Inland Revenue,17 decided in favour of the Revenue and, on a secondary issue, held that the fact that part of the annuity had to be paid out of capital made no difference. His decision was upheld in the Court of Appeal.

Case 17: Annie, Viscountess Cowdray v Commissioners of Inland Revenue (1930) 15 TC 255 The 1st Viscount Cowdray was Weetman Dickinson Pearson, owner of the Pearson conglomerate which is now known mainly for publishing but started in construction. He was ennobled in 1917. The case concerned super-tax for 1927–28. On 14 January 1927, an election was made for separate assessment to super-tax for 1927–28. On 1 May 1927, Viscount Cowdray died. By letter of 20 May his executor purported to withdraw 13 14 15 16 17

Shanks v Commissioners of Inland Revenue (1928) 14 TC 249. Corke v Fry (1895) 3 TC 335. CIR v Wemyss, n 11 above. M’Dougall v Sutherland (1894) 3 TC 261. Meeking v Commissioners of Inland Revenue (1920) 7 TC 603.

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the election. The Revenue’s contention, that the purported withdrawal was ineffective, was accepted by the Special Commissioners. Rowlatt J agreed, saying that the contrary had been argued only somewhat faintly but he decided to allow the Viscountess’s appeal on the ground that an assessment justifiable only on the footing that a woman was a wife could not be made when she was in fact a widow and in respect of a period for nearly all of which she had been a widow. It is impossible to discern any basis for that decision, so it is not surprising that the Revenue appealed. The appeal came on before the Court of Appeal on 17 and 19 February 1930, and again on 28 March 1930 when the Solicitor-General adverted to the Court’s view that the case was proper for settlement and asked for an order for the appeal to be allowed and for the case to be remitted to the Commissioners for the assessment to be adjusted to a figure which had been agreed between the parties. Lord Hanworth MR made a short speech of gratification, seasoned with a recommendation to the legislature to address the problem disclosed. The outcome warrants a little attention because problems can emerge when appeals are compromised. The result in this case is fairly satisfactory because the report makes clear that Rowlatt J’s view cannot be regarded as correct in law. Correspondingly it is clear that the Special Commissioners took a correct view of the law. That is, however, tempered by the fact that there is no reasoned judgment from the Court of Appeal. All the same it is a much more satisfactory outcome than one where the Court of Appeal recommends the parties to settle and all that is known about the outcome is that the matter was settled on terms endorsed on counsels’ briefs, as embodied in an order which is known as a Tomlin order. In a situation of that nature the implicit suggestion, that the High Court judge’s view of the case was doubted, receives no quietus and it is difficult to say that the law is otherwise than as stated in the undisplaced High Court judgment.

Case 18: Lord Wolverton v Commissioners of Inland Revenue (1930) 16 TC 467 The title of Lord Wolverton was created in 1869 for the banker, George Glyn. The case related to the 4th Baron. Against a very complex background the issue was whether amounts paid by trustees in discharge of certain life assurance premiums represented income of Lord Wolverton. It was held that the premiums were not paid out of money to which he was entitled. In the House of Lords Lord Buckmaster opened his speech by remarking that the facts of the case were such that it ‘will be of no assistance to anyone who in the future may be caught in the tangled web of taxation’.

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Case 19: Lord Glanely v Wightman (HMIT) (1933) 17 TC 634 William James Tatem rose from rags to riches as a shipping magnate and was raised to the peerage in 1918 as Lord Glanely. He was killed in an airraid on, of all unlikely spots, Weston-super-Mare, though in accordance with the convention of wartime, The Times of 29 June 1942 did not name the location but referred to it as ‘a west coast town’.18 The case concerned the income from a stud farm which included payments for the service by stallions of mares sent to the stud by outside owners. The main issue was whether that use of the stallions was separable from the Schedule B occupation of the farm, as the Revenue contended. Short of the House of Lords the Revenue was successful but Romer LJ dissented in the Court of Appeal. He considered that there had been extraordinarily little authority on the question of the extent and ambit of Schedule B. He noted that some limitation was needed as otherwise Schedule B would cover an individual who occupied property by sitting therein and writing poetry or novels or painting pictures. He adopted a test suggested by counsel for the Revenue, which was whether the soil of the land was being used as soil. The employment of stallions to service mares passed that test, so, aside from authority, Romer LJ favoured Lord Glanely’s case. Unlike the other judges involved in this case and unlike the Irish judges in McLaughlin v Bailey,19 Romer LJ considered the decision of the House of Lords in favour of the Revenue in Malcolm v Lockhart20 to be distinguishable because that case involved the provision of stallions’ services in locations away from the owner’s stud farm. The House of Lords allowed Lord Glanely’s appeal and the reasoning in the speeches was entirely consistent with the approach of Romer LJ.

Case 20: Earl of Carnarvon v Commissioners of Inland Revenue (1934) 19 TC 455 In 1793, the title of Earl of Carnarvon was created for the third time, on this occasion for Henry Herbert, 1st Baron Porchester. The case concerned the 6th Earl. The Daily Telegraph obituarist, Hugh Massingeberd, caused fluttering in various dovecotes by describing the 6th Earl as a ‘relentless raconteur and most uncompromisingly direct ladies’ man’. That obituary21 opened with the suggestion that ‘the brushwork in his Wodehousian

18 19 20 21

The Times, 29 June 1942, 2. McLaughlin v Bailey (1920) 11 TC 524. Malcolm v Lockhart (1919) 7 TC 99. Daily Telegraph Book of Obituaries (London, Macmillan, 1995) 35–39.

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character appeared somewhat crudely applied’ and dwelt largely on the Earl’s career as a bon vivant, but it did mention that he served in the First World War in the 7th Hussars. In October 1929 the Earl of Carnarvon borrowed £142,000 from a life assurance company to be used next day in part payment of the single premium on a 10-year term life assurance policy. The loan agreement provided that the interest due from time to time should, if not paid, be capitalised. The case related to income tax assessments for years during which the interest had been capitalised. The Earl of Carnarvon successfully claimed deductions in respect of the interest. Singleton J held, on the authority of Commissioners of Inland Revenue v Holder,22 that the interest must be deemed to have been paid by virtue of an advance by the insurance company.

Case 21: Commissioners of Inland Revenue v Viscount Broome’s Executors (1935) 19 TC 667 When Field-Marshal Kitchener was made Earl Kitchener, of Khartoum, in 1912, he was also made Viscount Broome, of Broome in the County of Kent. On the 1st Earl Kitchener’s death in 1916, the Earldom passed to his elder brother, Colonel Henry Kitchener and his son and heir, Henry Franklyn Chevallier Kitchener (1878–1928), became Viscount Broome. Viscount Broome entered the Navy when only 14 years old. After service in the First World War he joined his father in farming activities in Kenya. It was his executors who were involved in the case. The Kitchener male lines ran out in 2011 and the titles are now extinct. Emma Kitchener, who is the 1st Earl’s heir general, is married to the film director and novelist, Lord Fellowes, who believes that changes to the rules for royal succession should extend to peerages, which would enable his wife to become a Countess. The issue was whether the executors should have deducted income tax on the making of certain payments of interest on a loan. The loan of £19,600 was made in 1921 by Earl Kitchener to enable Viscount Broome to acquire all the shares and debentures in Kitchener’s African Estates Ltd and the interest was to be paid half-yearly in Nairobi. At all material times Earl Kitchener and Viscount Broome were resident in Kenya, but Viscount Broome also spent time at his family home in Canterbury, Kent, so he was also resident in the United Kingdom. His executors, who were resident in England, appointed attorneys in Nairobi to obtain a grant of letters of administration, with the will annexed, in Kenya. Of the four payments of interest concerned, two were made to Earl Kitchener personally in London and two were sent to a London bank with instructions to pay Earl Kitchener

22

Commissioners of Inland Revenue v Holder (1932) 16 TC 540.

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through a bank in Nairobi. Finlay J decided in the Revenue’s favour, holding that the situs of the debt was England because the debtors, the executors, were resident in England and the payments were in fact made out of sources in England.

Case 22: Commissioners of Inland Revenue v Lord Forster (1935) 19 TC 738 The title of Lord Forster was conferred in 1919 on William Henry Forster, a Conservative politician. Several transactions formed the background to this case but it is sufficient to mention only the crucial transaction. This was one by which a company covenanted to pay Lord Forster’s premiums on certain assurance policies on his life for a period of eight years from 5 April 1931. The issue was whether the payments made by the company, grossed up for income tax, formed part of Lord Forster’s income for surtax purposes. Finlay J held that they did. The judge relied on what he described as ‘a whole line of cases’ of which he then briefly mentioned, but did not go into the detail of, four, viz Meeking v Commissioners of Inland Revenue;23 Shanks v Commissioners of Inland Revenue;24 Sutton v Commissioners of Inland Revenue;25 and North British Railway Co v Scott.26

Case 23: Countess of Shrewsbury and Talbot v Commissioners of Inland Revenue (1936) 20 TC 538 The Earldom of Shrewsbury, in its second creation, goes back to 1422 and the Earldom of Talbot to 1769. The Countess involved in the case was the wife of the 20th Earl of Shrewsbury, 5th Earl Talbot, and also the Earl of Waterford. The Countess was already married when she ran away with the 20th Earl of Shrewsbury, whom she married in 1882, a son being born soon afterwards. The society scandal apparently never died down. She died in 1940 and The Times carried no obituary. The case, a super-tax case, was an unmeritorious one. The Countess was entitled under the Shrewsbury Estates Acts 1843 and 1862 and a jointure deed of 1910 to two yearly rent-charges of £1,500 each ‘clear of all deductions for taxes or otherwise’. The Revenue’s view was that, for super-tax or surtax purposes, that income had to be grossed up for income tax. That view accorded with a decision of the Court of Appeal in In re Shrewsbury 23 24 25 26

Meeking v Commissioners of Inland Revenue (1920) 7 TC 603. Shanks v Commissioners of Inland Revenue (1928) 14 TC 249. Sutton v Commissioners of Inland Revenue (1929) 14 TC 662. North British Railway Co v Scott (1922) 8 TC 332.

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Estates Act, Shrewsbury v Shrewsbury,27 the headnote to which included: ‘Held, on appeal, that on the authorities, having regard to the provisions of the Income Tax Acts, and on the construction of the Shrewsbury Estate Act, 1843, the appellant was entitled to have her jointures paid in full free from deduction of income tax’. In the light of that Lawrence J reached the inevitable conclusion that the Revenue view was to be upheld.

Case 24: Gray (HMIT) v Lord Penrhyn (1937) 21 TC 252 The title of Lord Penrhyn, created in 1866 for the second time, was conferred on Edward Douglas-Pennant, a Conservative politician. The case concerned the 4th Baron. The main issue was whether a sum of compensation paid by a firm of accountants in respect of negligence by its staff was a trading receipt. Lord Penryhn owned a slate quarry. Two of his employees misappropriated money between 1928 and 1934 by falsifying wage accounts. Lord Penrhyn’s accountants admitted audit errors by staff and in November 1934 paid £5,951 in compensation. The Revenue sought to bring in that sum as a trading receipt for income tax. Finlay J decided in the Revenue’s favour. His view was that the Revenue could re-open the earlier years notwithstanding British Mexican Petroleum Co Ltd v Jackson,28 but he preferred to base his decision on the conclusion, in the light of Green v J Glixten & Son Ltd,29 that the receipt was a business receipt in Lord Penrhyn’s hands just as his outgoings (the exaggerated wages) had been a business payment, and just as the payment by the accountants was a business outgoing so far as they were concerned.

Case 25: Trustees of Earl Haig v Commissioners of Inland Revenue (1939) 22 TC 725 The title of Earl Haig was created in 1919 for Field Marshal Sir Douglas Haig. The case related to the use of his diaries for the purposes of a biography of him by the Rt Hon Alfred Duff Cooper. Earl Haig had left the diaries to his trustees to be published on such terms and conditions as they in their uncontrolled discretion might think fit. Publication in their entirety was considered undesirable because of confidential matter. The trustees agreed to make the diaries available to Duff Cooper on terms that profits resulting from the book would be equally divided. The trustees appealed successfully 27 28 29

In re Shrewsbury Estates Act, Shrewsbury v Shrewsbury [1924] 1 Ch 315. British Mexican Petroleum Co Ltd v Jackson (1932) 16 TC 570. Green v J Glixten & Son Ltd (1929) 14 TC 364.

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against assessments to income tax which had been made on the footing that either Case I or Case VI of Schedule D applied to the profits. The Court of Session held that the correct analysis was that the trustees had received capital payments for the part realisation of an asset.

Case 26: Earl of Normanton v Commissioners of Inland Revenue (1939) 23 TC 403 The Earldom of Normanton is an Irish peerage which was created in 1806 for Charles Agar, 1st Viscount Somerton, Archbishop of Dublin. The case involved the 5th Earl. It concerned the construction of two deeds made in 1935 and 1936 by which the Earl covenanted to pay to trustees sums equal to one-half and one-third of his total income, respectively. A complicating factor arose in that a sum of £9,539 was apportioned to the Earl from the income of Somerly & Postlands Estate Co. It was contended on behalf of the Earl that that £9,539 was to be included in the calculation of the amounts which had been covenanted away. The basis of this was that the language of the deeds of covenant had reflected tax language so that the calculation of amounts involved should include income deemed by tax provisions to be the Earl’s income. It is not apparent from the case whether the Earl did pay to the trustees the enlarged amount. At all levels favour was conferred on the Revenue’s contention that the relevant clauses in the deeds referred to the Earl’s actual total income.

Case 27: Commissioners of Inland Revenue v Lady Wolverton (1940) 23 TC 48 The Wolverton peerage has been introduced elsewhere. This case concerned the 4th Baron’s widow. The case concerned the annual value of Lady Wolverton’s home, Queensbury House, Newmarket. On the death of Lord Wolverton in 1932 Lady Wolverton became entitled to an absolute interest in his residuary estate, which included Queensbury House. The residue was not ascertained until 20 July 1937. The principal contention for Lady Wolverton was that she was not the occupier of the property under Schedule A while the residue remained unascertained. Following success before the Special Commissioners, it looks as though Lady Wolverton’s advisers realised that occupation does not depend upon the existence of a beneficial interest because, on the Revenue’s appeal, Wrottesley J indicated that that point had fallen away. He dismissed the submission that Lady Wolverton occupied the property in the capacity of the executors’ representative because nothing in the facts as found supported it. Although the judge’s

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wording suggested that at least one other argument had been put, it does not appear, and it is difficult to imagine, what it was.

Case 28: Commissioners of Inland Revenue v Glenconner (1941) 24 TC 82 The peerage, Lord Glenconner, was created in 1911 for Sir Edward Tennant, 2nd Baronet, formerly Liberal MP for Salisbury and Lord Lieutenant of Peeblesshire. His sister, Margot, was the second wife of HH Asquith, the Prime Minister. The case concerned the 2nd Baron. In connection with the divorce of Lord Glenconner and his first wife in 1935 he entered into covenants in favour of their two infant sons. During the joint lives of himself and each son Lord Glenconner was to pay an annuity of £750 for the maintenance, education or benefit of each son but, by a proviso, Lord Glenconner might in certain circumstances by deed halve the amount on the son reaching the age of 23 or on Lady Glenconner’s earlier death. In simple terms the settlement was 50 per cent revocable. The Revenue therefore fastened on Finance Act 1936 section 21 and, in relation to surtax assessments for 1936–37 and 1937–38, restricted the deductions from Lord Glenconner’s income to £750 rather than £1,500. His challenge to that restriction was rejected by Macnaghten J. The argument turned on section 21(10) which excepted from the section’s scope a settlement made before 22 April 1936 which, immediately before that date, was irrevocable. Lord Glenconner’s contention was that the exception applied because his covenant could not be revoked before that date but only at a later date. It was held that the exception applied only to settlements which, viewed as at 22 April 1936, were never revocable. The judge thought that no assistance was to be gained from section 21(8) which provided that in certain circumstances a settlement was to be deemed to be revocable.

Case 29: Lady Zia Wernher v Commissioners of Inland Revenue (1942) 29 TC 20 Lady Zia Wernher (1892–1977) married Major-General Sir Harold Wernher Bt (1893–1973) who was the son of a diamond magnate. She was Countess Anastasia Mikhailovna de Torby but she ceased to use that title after her marriage. She was the elder daughter of Grand Duke Michael Mikhailovich of Russia, a grandson of Tsar Nicholas I of Russia. On her mother’s side, she was a descendant of the poet, Alexander Pushkin, as well as from his ancestor Abram Petrovich Gannibal, Peter the Great’s African protégé. Her granddaughters are the Duchess of Abercorn, the Duchess of Westminster, the Countess of Dalhousie, and Princess Alexandra Galitzine. Her younger sister was Countess Nadejda de Torby, wife of George Mountbatten, 2nd

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Marquess of Milford Haven, a descendant of Queen Victoria and maternal uncle to Prince Philip, Duke of Edinburgh. The case concerned National Defence Contribution, subsequently called profits tax, for the calendar year 1938. Lady Zia owned a stud farm in respect of which she was liable to income tax under Schedule B. In addition to other activities, Lady Zia let out the services of a stallion to owners of mares in other parts of the country and from abroad at a letting fee of 300 guineas. It was held that the profits of husbandry fell within the charge to National Defence Contribution in so far as a business was carried on and that the letting out of the services of the stallion might be, and on the facts should be, regarded as a business separate from the other activities of the stud farm.

Case 30: Commissioners of Inland Revenue v Lady Castlemaine (1943) 25 TC 408 Lord Castlemaine of Moydrum, a title in the Irish peerage, was created in 1812 for William Handcock, a politician. The case concerned the 5th Baron. The ancestral seat of the Handcock family was Moydrum Castle near Athlone, County Westmeath, but the house was destroyed by arson at 4 am on Sunday 3 July 1921 during the Irish Troubles. By his will the 5th Lord Castlemaine left an annuity of £3,000, free of taxes and other deductions, to his widow, and an annuity of £250 to his brother, but his residuary estate proved insufficient to fund the annuities. The settled law applicable in these circumstances was that the would-be annuitants were entitled to have the residuary estate divided between them proportionally. While the administration of the estate was under way, the executors made several payments in varying amounts to the widow and one payment to the brother. Lady Castlemaine appealed successfully against surtax assessments, contending that the payments to her were not income but were payments on account of an abated capital sum yet to be ascertained. Macnaghten J noted that the initial payments were made before the executors became aware that the residuary estate would be insufficient and were intended to be on account of the annuity, but he held that, the deficiency having been established, the payments must be regarded as on account of the capital sum to which Lady Castlemaine was entitled.

Case 31: Lord Inchiquin v Commissioners of Inland Revenue (1948) 31 TC 125 The Irish peerage, Baron Inchiquin, was created in 1543 for Murrough O’Brien, Prince of Thomond, who was descended from the great high king, Brian Boru. The case concerned the 16th Baron. The issue was whether Lord

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Inchiquin was resident or not resident in the United Kingdom for 1940–41 and 1941–42. It was accepted that he was resident in Eire for those years and, if he was resident in Eire only, he would be exempt from British income tax under Finance Act 1926 section 23 and Schedule II Part I. The detailed facts were such that it was held that Lord Inchiquin was resident in the United Kingdom in the years in question.

Case 32: Sharkey (HMIT) v Wernher (1955) 36 TC 275 Sir Harold and Lady Zia Wernher have been introduced elsewhere. This case is about the consequences when a trader disposes of stock-intrade otherwise than in an ordinary trading transaction of sale. It arose on an income tax assessment under Case I of Schedule D in respect of the profits of Lady Wernher’s stud farm. The material facts were quite simply that she transferred five horses from the stud farm to her racing and training stables which were not conducted by way of trade. The stud farm accounts showed an acquisition cost figure for the horses and costs incurred during their time on the stud farm. It was common ground between the parties that some figure had to be brought into account on the transfers. The issue was whether that figure should be the costs just mentioned or, as the Revenue contended, the higher figures of the market value of the horses at the dates of the transfers. The case went to the House of Lords, where the Revenue succeeded by a 4–1 majority. The case makes odd reading. The speeches include much reference to earlier cases which do not sit easily one with another, but none of them were cases at House of Lords level, so really the House of Lords had a free hand. Lord Porter agreed with the speeches of Viscount Simonds and Lord Radcliffe, while Lord Tucker agreed with Lord Radcliffe. Viscount Simonds’ speech contained the oddity that he was puzzled by the common ground proposition that any figure need to be included at all, but he did not attempt to justify the fact that otherwise the costs already in the farm accounts would in effect produce a loss, though this was explained, if in obscure terms, in Lord Radcliffe’s speech. He favoured the Revenue’s method because, on the basis that a figure must come in, the only logical way was to regard the matter as if there had been a disposal by way of trade. Lord Radcliffe considered that the contrary argument was very attractive but said its weakness was that it did not explain why cancellation should take place. He preferred the Revenue method because it gave a fairer measure of assessable profits between one taxpayer and another and it made better economics. Lord Oaksey’s dissent was on the footing that income tax was to bear on actual profits and gains, so that expenses on an asset withdrawn from the trade must be withdrawn from the account. Much of the discussion in the

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majority judgments depended on the proposition that the income tax system brought in the otherwise unacceptable proposition that a person may trade with himself, but there is no mention of any statutory provision directing that Lady Wernher should be deemed to be trading with herself contrary to the reality. Cancellation, to use the convenient shorthand term, would have the effect of recognising that the item in the accounts, included because it was the cost of something purchased with the intention of it ultimately being sold, was no longer justifiably included in the accounts because the rationale for it being there was no longer valid. It is surprising that the House of Lords did not find that to be a more acceptable resolution of the case than to invent, without statutory support, a regime of fictional trading.

Case 33: Beauchamp’s Executors v Commissioners of Inland Revenue (1957) 37 TC 90 Major Frank Beachim Beauchamp was made a Baronet in 1918 in recognition of public (military) and local (Somerset) services. The tax which was concerned in the case was the Special Contribution imposed by the Finance Act 1948 with reference to an individual’s income for 1947–48. The assessment in question was made on 30 April 1954, Sir Frank having died on 17 June 1950. The executors appealed on the grounds that the assessment was out of time, the last possible date for it having been 5 April 1954. It was, however, a curious feature of the Special Contribution regime that there was no provision which expressly imposed a time limit for the making of assessments, whether in the Finance Act 1948 or in the Regulations made under it.30 The executors fashioned an argument that, although the Special Contribution was a one-off charge, a time limit was to be derived from various income tax provisions. The argument failed. The plain fact of the matter was that Parliament had imposed no time limit for the making of assessments to the Special Contribution. It may have been an oversight, but there it was—another example of ‘The Case of the Missing Provision’.

Case 34: Commissioners of Inland Revenue v Lord Trent’s Executors (1959) 38 TC 326 The title of Lord Trent was conferred in 1917 on Jesse Boot, the retailer of pharmaceutical and other products. The case concerned Glenborrodale Castle in Argyllshire which Lord Trent had bought in 1933 and which he sold in 1950 subject to a reservation by which he might fell timber until

30

Special Contribution Regulations 1948, SI 1948/2029.

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31 December 1952. In 1951 he sold some of the timber, as standing timber, to a firm of timber merchants, who cut and removed thinnings. Lord Trent had elected to be charged to income tax under Schedule D rather than Schedule B. The question which arose for 1951–52 and 1952–53 was whether Income Tax Act 1952 section 115(1) was engaged: it provided that the tax ‘shall be charged on and paid by the occupier for the time being, and every person having the use of any lands or tenements shall be deemed to be the occupier thereof’. It was held that there had been very slight acts of user by Lord Trent before the sale to the timber merchants and those acts had been insufficient to make him the occupier.

Case 35: Commissioners of Inland Revenue v Duchess of Portland (1981) 54 TC 648 The Dukedom of Portland was conferred in 1716 on the 2nd Earl of Portland, that Earldom having been re-created in 1689 for William Bentinck, the Dutch favourite and close advisor of King William III. The 3rd Duke of Portland was Prime Minister in 1783 and again from 1807 to 1809. The case concerns the wife of the 9th Duke of Portland. The Dukedom became extinct on the 9th Duke’s death but the Earldom survives and the current Earl, the 13th, is an actor under the name of Tim Bentinck who is well known for playing the role of David Archer in the long-running Radio 4 serial The Archers. The issue in the case was the Duchess’s domicile in the light of a then recent change. In Gray (otherwise Formosa) v Formosa,31 Lord Denning MR had referred to ‘the old notion that in English law a husband and wife are one: and the husband is that one’. He noted that, while that rule has been swept away in nearly all branches of the law, ‘the one relic which remains is the rule that a wife takes her husband’s domicile; it is the last barbarous relic of a wife’s servitude’. By the Domicile and Matrimonial Proceedings Act 1974 Parliament addressed that position. Section 1(2) dealt with the position of a woman who was married prior to 1 January 1974 and had her husband’s domicile of dependence: the direction was that she would retain that domicile, as a domicile of choice, if it was not her domicile of origin, until such later date at which that domicile was changed by acquisition or revival of another domicile. The case concerned the tax years 1973–74 to 1977–78. The Duchess was of Canadian origin and remained a Canadian citizen. She had maintained close links with Canada, including owning and maintaining a house in Quebec which she and her husband used on regular annual visits over 20 years. She hoped to persuade her husband to retire to Quebec. She 31

Gray (otherwise Formosa) v Formosa [1963] P 259, 267.

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intended to return to Quebec if her husband should predecease her. In July 1974, they made their customary annual visit to Quebec, and it was on that visit that the case turned. The Duchess’s submission was that she then became domiciled in Quebec because she then abandoned the domicile of choice in England which had been conferred on her by the 1974 Act. Abandonment of a domicile of choice involves, first, ceasing to reside in the relevant country and, secondly, ceasing to reside there permanently or indefinitely. The second point was not in issue. The Special Commissioners accepted that the visit to Canada in 1974 was not made merely casually or as a traveller and that the Duchess thereupon ceased to be resident in the United Kingdom, but their decision in her favour was reversed by Nourse J. The judge noted the consistent patterns from 1948 to 1978 during which the Duchess had been an inhabitant of England and had made visits to Quebec which were insufficient to have made her an inhabitant of Quebec. Her residence in England was not, in his view, displaced by the 1974 visit to Quebec or by any other event in the material period.

Case 36: Whitaker v Cameron (HMIT) (1982) 56 TC 97 The Whitaker baronetcy was created in 1936 for Albert Edward Whitaker, who was a Colonel in the Army and served as a Justice of the Peace, Deputy Lieutenant and High Sheriff for Nottinghamshire. The Baronet concerned in the case was the 3rd Baronet. The case is about an attempt to retrieve the position after a mistake. In October 1957, on his father’s death, Sir James acquired real property in Scotland. Its then value was £12,000. In November 1973 Sir James gave that property to the trustees of a settlement which he had made in 1962. The value was then £139,566, which was £434 short of the value of the property as at the date of the introduction of Capital Gains Tax, 6 April 1965. The basic computation rule applicable provided for time apportionment over the period from acquisition to disposal and this would produce a gain of £68,079. There was, however, the possibility of invoking an alternative rule by which the measure would be the gain or loss on the footing of deemed disposal and re-acquisition on 6 April 1965, which would result in a loss of £434. Finance Act 1965 Schedule 6 paragraph 25(1) provided that an election might be made within two years after the disposal for that alternative rule to be applied. The mistake previously mentioned was that no such election was made in Sir James’ case. Sir James contended that an election under paragraph 25(1) had not been necessary. The contention was based on paragraph 25(2) which provided for certain moderations of the results of applying the alternative rule, including a moderation where a loss accrued on application of the alternative rule but a gain would have emerged on application of the basic rule, as in Sir James’ case.

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The dispute was, in effect, whether paragraph 25(2) was free-standing or whether its applicability depended on an election having been made under paragraph 25(1). The details of the argument were somewhat involved but both the Special Commissioners and Walton J concluded that paragraph 25(2) did not have to be considered unless and until the requisite steps under paragraph 25(1) had been effectively taken.

FOREIGN INCOME

Case 37: Marchioness of Ormonde v Brown (HMIT) (1932) 17 TC 333 Ormond(e) titles go back to 1328 but the most recent Marquessate dates back to 1825 when it was conferred on John Wandesford, Lord Ormonde, an Irish politician. The Marchioness involved in the case, the wife of the 4th Marquess, was the daughter of an American General. The case related to income of trustees under settlements the trustee of which was American and which were governed by the law of Ohio. The Revenue relied on Finance Act 1922 section 20 which in certain circumstances deemed the income of revocable trusts to be the income of the settlor or of the person able to obtain beneficial enjoyment of the property. The Revenue’s case was that the trust income, apart from the annuity element, was assessable under Rule 1 of Case V (income arising) rather than Rule 2 (income remitted to the United Kingdom). Finlay J rejected the Revenue’s case. It had been established that under the law of Ohio beneficiaries had no interest in the capital or income of a trust but merely a right to due administration of the trust. The judge also concluded that section 20 was inapplicable because Lady Ormonde would need the consent of the trustee, and probably the consent of certain annuitants other than herself, to any changes.

Case 38: Perry (HMIT) v Astor (1935) 19 TC 255 William Waldorf Astor, an extremely wealthy American, became the 1st Viscount Astor in 1917. The case concerned the 3rd Viscount. Sadly, the many good things which he did are all forgotten and he is remembered on one account only. He lived at Cliveden which attained a special fame as the place where John Profumo first met Christine Keeler. During the trial of Stephen Ward, Mandy Rice-Davies, when told by prosecuting counsel that Viscount Astor had denied an affair with her or having even met her, famously replied, ‘Well, he would, wouldn’t he?’, which is often transposed to ‘Well he would say that, wouldn’t he?’ In relation to a settlement governed by the law of New York the issue, as in the Ormonde case, was whether taxation applied to the income arising

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or only to the income remitted to the United Kingdom. The case went to the House of Lords where it was decided against the Revenue by a 4–1 majority. The dissentient, Lord Russell of Killowen, considered that departure from the unambiguous meaning of section 20 was not justified. Lord Macmillan, with whom the other three Law Lords agreed, was persuaded by the startling anomalies which would follow from the Revenue’s construction of section 20 that such departure was justified. He adopted the territorial limitation point made by Finlay J in the Ormonde case, concluding that the deeming process of section 20 did not bring into tax income not previously chargeable but merely substituted one person for another as the person liable in respect of tax already chargeable.

Case 39: Duke of Roxburghe’s Executors v Commissioners of Inland Revenue (1936) 20 TC 711 The Dukedom of Roxburghe was created in 1707 to denote the contribution of the 4th Earl Roxburghe to the union in that year of England and Wales with Scotland. The Duke whose executors were concerned in the case was the 8th Duke. The Duchess’s American bankers maintained several accounts for the Duchess which derived from income some of which would, if remitted, be liable to UK tax and some of which would not. The Duchess specifically requested remittances referable to non-UK taxable sources but, through confusion and mistake, the bankers remitted some money referable to UK taxable sources, and hence an assessment under Case V of Schedule D. The Duchess’s appeal was successful in the Court of Session. The Lord President (Normand) and Lord Fleming preferred to regard the Duchess’s instructions as conclusive and the bankers’ entries as corrigible at her request. It was on this latter point that Lord Morison disagreed, his view being that those matters were between the Duchess and her bankers and were no concern to the Revenue which had to proceed as matters actually stood. Lord Moncrieff regarded as irrelevant both the Duchess’s and the bankers’ view of the matter: his view was that, provided the non-taxable sources sufficed, the remittances should be regarded as coming from them.

Case 40: Lord Howard de Walden v Beck (HMIT) (1940) 23 TC 384 The Barony of Howard de Walden has had a chequered history, involving it twice being in abeyance. The title was originally conferred in 1597 on Admiral Lord Thomas Howard, a younger son of the 4th Duke of Norfolk, reputedly for his part in the defeat of the Spanish Armada in 1588. The case concerned the 8th Baron. Its origin lay in a transfer by Lord Howard de Walden to Canada of some £830,856, in return for which the recipient

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Canadian companies issued promissory notes for quarterly payments over a period of 30 years. The appeals were against income tax assessments under Case V of Schedule D. The main issue was whether or not the promissory notes contained any element of income. If so, then there was a secondary issue about how to calculate that element. The Special Commissioners decided the main issue in the Revenue’s favour but favoured Lord Howard de Walden’s method of calculation, so both parties appealed to the High Court. Wrottesley J upheld the Commissioners’ decision on the main issue. He observed that the question whether a series of periodic payments constituted an annuity had caused considerable difficulty to the courts from time to time, and he considered several previous cases. Applying the principles applied in Perrin v Dickson,32 he concluded that ‘if in the payments [Lord Howard de Walden] receives, he is to be treated as in fact having arranged for the repayment of the capital sum he laid out, then it appears that he has so arranged matters as to ensure a return of 4 per cent upon that capital’.33 As to the method of calculation he preferred the Revenue’s approach but threw out the thought that there might be a third method. Strange to say, it does not appear from the discussion of the consequences of his judgment that the case was remitted to the Commissioners for adjustment of the figures.

Case 41: Timbrell v Lord Aldenham’s Executors (1947) 28 TC 293 The title of Baron Aldenham was created in 1896 for the businessman Hucks Gibbs. The case concerned both the 3rd and the 4th Baron. The essential facts were that the family’s London firm was interested in firms trading in Chile and Australia. Sums due from the Australian firm to the London firm would be sent to the Chilean firm and used to reduce the debt of the Chilean firm to the London firm. Assessments to income tax under Case V of Schedule D were raised on the footing that the sums were remittances from the Australian firm to the London firm, but the Court of Appeal held that that was an incorrect analysis of the facts.

Case 42: Commissioners of Inland Revenue v Countess Kenmare (1956) 37 TC 383 The Irish Earldom of Kenmare dates back to 1801. The Countess of Kenmare concerned in the case was the wife of the 6th Earl. She seems to have been quite a character. She was born in 1892 in New South Wales, 32 33

Perrin v Dickson (1929) 14 TC 608. Lord Howard de Walden v Beck (HMIT) (1940) 23 TC 384, 399.

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her maiden name being Enid Maude Lindeman. She married the 6th Earl in 1943. The marriage was short because he died later in the same year. She had previously been married to Roderick Cameron, Brigadier-General Frederick William Lawrence Shepperd Hart Cavendish, and Marmaduke Furness, 1st Viscount Furness. An article in the New York Times of 9 June 2010, headed ‘Fabulous Dead People’,34 was on the subject of her son, Rory Cameron, who led a racy life until he died in 1985. The article stated that the Countess was known for some time as ‘The Lady Who Killed All Her Husbands’, though the allegations were later, if some long time after her death, withdrawn as baseless. It was also said that she ‘had a thing for shipping heirs’, as her first and third husbands shared that characteristic, and that one of her son’s ‘earliest memories was of his mother descending the steps of the Hotel de Paris in Monte Carlo in a cumulus of gray chiffon, a bunch of Parma violets tucked into her tiny waist’. The case related to surtax in respect of the income of a settlement made by a non-resident settlor (the Countess) and with non-resident trustees. There was, however, a UK connection, which was that the settled property comprised stocks, shares and securities in UK companies. The settlement included a power enabling the trustees to declare an absolute trust in the settlor’s favour in relation to a part of the fund not exceeding £60,000 in value in any triennial period. The Revenue relied successfully on Finance Act 1938 section 38. On the first main issue it was held that the terms of section 38 were such that it applied where income of a settlement arose in the United Kingdom notwithstanding other foreign characteristics such as the residence of the settlor and the residence of the trustees. On the other main issue, which was whether the settlement was revocable, it was held that the special power described earlier rendered the settlement revocable because successive exercises of the power might exhaust the trust fund. The Countess’s subsidiary arguments, mainly by reference to machinery provisions, were redolent of desperation and made no headway.

Case 43: Lord Inchyra v Jennings (HMIT) (1965) 42 TC 388 In 1961 Frederick Robert Hoyer Millar, diplomat, was raised to the peerage as Lord Inchyra. The case concerned various benefits which accrued to Lady Inchyra under the testamentary dispositions of her American mother. One particular benefit was entitlement to a payment once yearly from her mother’s death of 1 per cent of the capital value of the residuary estate exclusive of real property. The widower died in 1955. The assessments in

34

‘Fabulous dead people’, New York Times, 9 June 2010.

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issue were made under Case V of Schedule D (income from foreign possessions). The issues were twofold. The first was whether the 1 per cent payments were capital, as Lord Inchyra contended, or income, as the Revenue contended. The second was whether the various payments were from a single source, as Lord Inchyra contended, or from multiple sources, as the Revenue contended. Pennycuick J decided the first issue in the Revenue’s favour and the second in Lord Inchyra’s favour. The judge noted that it was well settled that the nature of the right to a foreign possession must be determined in accordance with the law of the foreign country concerned, which in this instance was the law of the District of Columbia, but he declined to accept that the foreign law should also determine the character of the interest as capital or income for UK tax purposes. The judge considered it impossible that the payments to Lady Inchyra were other than income in her hands. On the second issue the judge considered that the mother’s estate represented a single source notwithstanding that certain of Lady Inchyra’s interests were deferred in enjoyment.

Case 44: Lord Strathalmond v Commissioners of Inland Revenue (1972) 48 TC 537 William Fraser, a businessman in the oil industry, was raised to the peerage as Lord Strathalmond in 1955. The case concerned the 2nd Baron. Lady Strathalmond had income from sources in the United States in 1968–69. She was resident in the United Kingdom, but a citizen of the United States and not a citizen of the United Kingdom. Was the income exempt from tax in the United Kingdom? Pennycuick J answered in the affirmative. Under Article XV of the United Kingdom–United States Double Taxation Treaty of 1946, as replaced by a 1966 protocol, there was a reciprocal exemption in respect of dividends paid by a corporation of one contracting party from tax by the other contracting party ‘except where the recipient was a citizen, resident or corporation of that other Contracting Party’. The Revenue’s case was that the exception applied because Lady Strathalmond was a resident of the United Kingdom. Lord Strathalmond’s case was that the replacement Article XV carried a special definition of resident in the United Kingdom in Article II(1)(g) of the 1946 Treaty which excluded citizens of the United Sstates and therefore excluded Lady Strathalmond. Pennycuick J considered that ‘resident … of that other Contracting Party’ was a compendious expression comprising ‘resident of the United States’ and ‘resident of the United Kingdom’, so the special definition applied. He regarded that construction as ‘almost too clear for words’.

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THE UPPER CRUST: AVOIDANCE

Case 45: Duke of Westminster v Commissioners of Inland Revenue (1935) 19 TC 490 The title Duke of Westminster was created in 1874 for Hugh Grosvenor, 3rd Marquess of Westminster. The Duke involved in the case was the 2nd Duke, who was known as Bendor. After succeeding his grandfather as Duke of Westminster in 1899, he served in the Second Boer War with the Imperial Yeomanry until 1901, as an ADC to Lord Roberts and Lord Milner. He served in the First World War and was awarded the DSO for his part in his squadron’s rescue of 60 survivors from a torpedoed ship in the Gulf of Sollum, Egypt. His obituary in The Times of 21 July 1953 was complimentary, speaking of his charm of personality, his generosity of mind and his capacity to be a good friend.35 The obituary overlooks many features of the Duke’s life which cast rather a different light, notably his part in the ‘outing’ as a homosexual of the 7th Earl Beauchamp which is fully set out in Mad World by Paula Byrne,36 and, in the run-up to the Second World War, his anti-semitic and pro-German stance. The case is generally considered the high watermark of judicial tolerance of tax avoidance activities because the House of Lords firmly rejected the notion that substance might prevail over form, insisting that transactions must be given their proper legal effect. The case concerned the Duke’s claim for deductions of annuity payments in relation to certain surtax assessments. The annuities were created by covenants in favour of many members of the Duke’s staff together with one Detmar Jellings Blow FRIBA. Apart from the case of the latter, the arrangements were in identical form and the covenant with the gardener, Frank Allman, was considered as typical. It was made ‘in consideration of … past services’. It was for a weekly sum payable during the joint lives of the Duke and the annuitant or for a period of seven years, and the payments were declared to be without prejudice to such remuneration as the annuitant might become entitled to in respect to any subsequent services rendered to the Duke. Side letters explained that the staff were expected to be content with their annuity payments though the amounts would be topped up with many payments as necessary to make up their full wages, and they signed acknowledgements of the side letters. The arrangements involved a risk that any staff member might leave the Duke’s employ but he or she would still be entitled to annuity payments during the life of the covenant.

35 36

The Times, 21 July 1953, 8. P Byrne, Mad World (London, Harper Press, 2008).

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The Revenue’s argument was that the deeds provided for the payment of wages, and not for annual payments from which income tax was deductible. The argument failed in the Court of Appeal and in the House of Lords. Lord Tomlin’s speech is the one most often quoted, especially the passage in which he declared that a quietus must be put to the supposed doctrine that a court may ignore the legal position and regard what was called the substance of the matter.37 The circumstance that the covenants were not limited to the duration of the employment was, perhaps, fatal to the Revenue’s cause. It is surprising, though, that the Revenue’s arguments did not try to make more of the fact that each covenant purported to be made ‘in consideration of … past services’; it would presumably have been possible to put forward evidence that past services had been fully rewarded in conventional payments of wages; if so, an argument that the covenants were shams might have been advanced.

Case 46: Commissioners of Inland Revenue v Lord Delamere (1939) 22 TC 525 The title of Lord Delamere was conferred in 1821 on Thomas Cholmondeley, a politician. The case concerns the 4th Baron. It related to a surtax assessment for 1936–37 and concerned an irrevocable settlement made by Lord Delamere in 1932 which included a discretionary power over income for the benefit of Lord Delamere, his wife, their children and remoter issue. In the year 1936–37, partly before and partly after 16 July 1936, the trustees exercised the power in favour of Lord and Lady Delamere’s three infant children, in each case to a sum of about £500 net of tax. The Revenue’s claim to surtax included those sums grossed up for income tax and reliance was placed on Finance Act 1936 section 21 which dealt with revocable settlements and included, in section 21(8), a provision by which certain irrevocable settlements were deemed to be revocable for tax purposes. There were several strands to Lord Delamere’s contentions that section 21 did not apply, but none succeeded; section 21(10) excluded from the operation of the section any settlement made before 22 April 1936 ‘which immediately before that date was irrevocable’, but the word ‘irrevocable’ was held not to carry its normal meaning but to carry the extended meaning provided by section 21(8), so that section 21 applied; the proposition that the terms of the settlement did not ‘provide for the payment to the settlor’ because any payment depended on the exercise by the trustees of their discretion failed because ‘in any circumstances whatsoever’ included the exercise of a

37

Duke of Westminster v Commissioners of Inland Revenue (1935) 19 TC 490, 520.

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discretion; the contention that the settlement was not within section 21(8), because payment to the settlor was not made dependent on the existence of the life of the child, failed because the settlement provided for possible payments during the life of a child; finally the proposition that any income paid before the date when the Finance Act 1936 was passed (16 July 1936) was not caught, but this failed because section 21(1) referred to income ‘in any year of assessment’ and the whole of 1936–37 was, therefore, included.

Case 47: Admiral Earl Beatty’s Executors v Commissioners of Inland Revenue (1940) 23 TC 574 The title of Earl Beatty was created in 1919 for the Admiral of the Fleet, David Beatty. The case concerned a surtax assessment on his executors for 1935–36, and surtax assessments for 1935–36, and income tax and surtax assessments for 1936–37, on the 2nd Earl Beatty and his brother, Peter, all made by the Revenue in reliance on Finance Act 1936, section 18 (transfer of assets abroad). Following Countess Beatty’s death in 1932 the 1st Earl and his sons took action of various kinds in relation to the family finances. One important activity was the transfer in 1934 to a Canadian company (‘Dingley Dell’) of assets valued at US$465,000. In consequence of the complex arrangements the 1st Earl received amounts in payment off of debentures in Dingley Dell which were charged on Dingley Dell’s capital and income. The argument on the executors’ appeal was that he was getting back capital and could not have been getting any income of Dingley Dell. It was held that it was impossible to say that the 1st Earl was not entitled to receive the amount of the debentures out of the income of Dingley Dell. In the cases of the two sons it was accepted that they were liable to tax in respect of the income of the relevant Canadian companies up to 14 February 1937, on which date there were transactions which involved an exchange of interests by way of gifts. Lawrence J held that the 1937 transactions were, when taken with 1933 transactions, ‘associated operations’ which made no difference to the tax position. There is a suggestion in the case that the 1937 transactions took place because of the content of the Finance Act 1936. It is, however, not clear whether it was argued that the 1937 transactions could not be treated as associated operations in that way because they were not in contemplation when the 1933 transactions took place.

Case 48: Lord Howard de Walden v Commissioners of Inland Revenue (1941) 25 TC 121 The Howard de Walden peerage and the 8th Lord Howard de Walden have already been introduced and this case is a further episode relating to the 8th

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Lord’s transfer of a large sum of money to Canada. A memorable line from this case is ‘It scarcely lies in the mouth of the taxpayer who plays with fire to complain of burnt fingers’, which appeared in the judgment of the Court of Appeal delivered by Lord Greene MR (at 134). It was beyond doubt that Finance Act 1936 section 18 (transfer of assets abroad) applied but, by way of damage limitation, Lord Howard de Walden contended that his power to enjoy the income of the Canadian companies was limited by reference to the proportion of his shareholdings in those companies to the shareholdings of others. The courts were clear that this was not supportable against the wording of section 18, especially section 18(3). An argument that light was shown on section 18 by Finance Act 1938 section 28 was dismissed on the ground that subsequent legislation could not legitimately be used to construe earlier legislation.

Case 49: Marquess of Titchfield v Commissioners of Inland Revenue (1941) 25 TC 219 The Dukedom of Portland was conferred in 1716 on the 2nd Earl of Portland, that Earldom having been re-created in 1689 for William Bentinck, the Dutch favourite and close advisor of King William III. The new Duke was also created Marquess of Titchfield. The Marquess of Titchfield involved in the case was subsequently the 7th Duke. The case concerned the legislation in Finance Act 1922 section 21 and Schedule I about apportionment in relation to what later came to be known as close companies. The Marquess of Titchfield was a shareholder in Roomwood Investments Ltd (‘Roomwood’), which was also an appellant. The main issue was whether the trustees of a settlement made by the Marquess were to be regarded as members of Roomwood within Finance Act 1922 Schedule 1 paragraph 8. The argument that they were not to be so regarded was that the provisions were designed to catch people who were liable to super-tax, so that persons such as trustees or corporations, which were not within that catchment, were not covered. The argument made no headway. It was held that apportionment must be amongst the members of the company according to the company’s register, and it was noted that, if the contrary arguments were correct, the intention of the legislature could be wholly frustrated by arrangements for shares to be placed in the names of trustees or corporate bodies. An allied case went to the House of Lords but failed, so the Marquess of Titchfield and Roomwood will have shed no tears at having drawn stumps after the Court of Appeal decision.

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Case 50: Lord Herbert v Commissioners of Inland Revenue (1943) 25 TC 93 The Earldom of Pembroke was first created in 1138. The current (tenth) creation dates back to 1551 when it was revived in favour of Sir William Herbert who had married Annie Parr, sister of King Henry VIII’s sixth wife. Other family titles include Herbert baronies. The family seat is at Wilton House, Wiltshire. The Lord Herbert involved in the case was the eldest son of the 15th Earl and he was subsequently the 16th Earl. A settlement made by the 15th Earl and by Lord Herbert contained provisions by which it was a revocable settlement within Finance Act 1938 section 38. But Lord Herbert took the point that the direction in section 38 was that the settlement income ‘shall be treated as the income of the settlor and not the income of any other person’. This presented the conundrum that the income could not be treated as Lord Herbert’s because he was ‘any other person’ in relation to the Earl of Pembroke as settlor, and vice versa. In other words section 38 simply did not work where there was more than one settlor. It scarcely needs saying that this was unattractive, but the same applies to the Revenue’s submission that it was a matter for the discretion of the Inspector whom to assess. Macnaghten J was perplexed but in the result favoured Lord Herbert’s contention.

Case 51: Lord Howard de Walden v Commissioners of Inland Revenue (1947) 30 TC 45 The Howard de Walden peerage and the 8th Lord Howard de Walden have already been introduced. This case concerned the 9th Baron. His obituary in The Times of 12 July 1999 mentions a curious incident in 1931.38 Lord Howard de Walden had moved to Munich to study German; he bought a car and on his first day out in it he knocked over a pedestrian; that pedestrian, who was unhurt by the accident, was Adolf Hitler; apparently he accepted Lord Howard de Walden’s apology. The main issue in the case was the correct construction of Finance Act 1939 section 13(3). In 1934, Lord Howard de Walden, then John Osmael Scott-Ellis, made a settlement by which the trustee company (‘Established’), a Canadian company, held 15,000 of the issued 25,000 shares in another Canadian company (‘Dufferin’). Then there were six companies, some Canadian, some Kenyan, the shares in which were owned, directly or 38

The Times, 12 July 1999, 25.

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indirectly, by Dufferin and which were under the control of Lord Howard de Walden. The question was whether the income of those six companies could be apportioned to Dufferin. The apportionment legislation had grown gradually. The 1922 and 1927 provisions had been limited to UK companies, with Finance Act 1938 section 41 bringing foreign companies into the picture. The Revenue’s case was that, by virtue of the addition of Finance Act 1939 section 13(3), the income of the six Canadian/Kenyan companies could be apportioned to Dufferin and up from Dufferin to Established, thereby becoming income ‘arising under the settlement’ and taxable on Lord Howard de Walden. The case went up to the House of Lords, where the Revenue lost. The crucial point was that the Revenue’s argument denied giving the same meaning to each of the three references to ‘body corporate’ in section 41(4)(a)(ii) of the 1938 Act, as amended by section 13(3) of the 1939 Act. That ran up against the standard rule of construction that a word or phrase used in a statutory provision will normally have the same meaning throughout. It is possible that if a construction under that standard rule would have rendered section 13(3) a dead letter, the Law Lords might have been persuaded to depart from the rule, but it was accepted by the Revenue that, even on Lord Howard de Walden’s construction, the section would be effective in certain circumstances, though not those of this case.

Case 52: Lord Vestey’s Executor and Vestey v Commissioners of Inland Revenue (1949) 31 TC 1 In Treasure Islands, a book about tax havens by Nicholas Shaxson,39 the Vestey family got a bad press because of the family’s long, and very largely successful, history of tax avoidance, huge amounts of tax being involved as they were highly astute in business matters. The first generation of Vesteys included the brothers, William and Edmund. Edmund was made a Baronet in 1921, while Sir William Vestey (who had been made a Baronet in 1913) was made Baron Vestey in 1922. The case went up to the House of Lords, where the Revenue lost. The facts (using ‘W’ for Lord Vestey and ‘E’ for Sir Edmund) were as follows. By a lease dated 29 December 1921 W and E demised certain properties abroad to a UK company, the rents to be paid to trustees resident in Paris. By a deed dated 30 December 1921 W and E settled the rents payable to the trustees on trust to invest and accumulate the income, with wide powers to W and E to direct how the rents were to be invested. The trust fund comprising the investments and accumulated income was to be divided into two parts, to be held on trust for the children and remoter issue of W and E,

39

N Shaxson, Treasure Islands (London, Bodley Head, 2011).

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respectively, as either might appoint by deed or will. Power was reserved to each of them to appoint by will in favour of his widow, although E subsequently executed a deed relinquishing this power. In 1942, income tax and surtax assessments were made on W’s executors and on E for 1936–37 to 1940–41. The issues were neatly explained in the speech of Lord Simonds: ‘By means of these documents the Vestey brothers obtained immunity from tax in respect of the very large income which was ultimately derived from the rent payable under the lease up to at least the year 1936. The question is whether section 18 of the Finance Act of that year, or alternatively Finance Act 1938 section 38, was so framed as to make them liable for all or any part of it’.40 As to the tax avoidance factor and the Court’s role, Lord Normand observed: ‘Tax avoidance is an evil, but it would be the beginning of much greater evils if the Court were to overstretch the language of the statute in order to subject to taxation people of whom they disapproved.’41 As to Finance Act 1936 section 18, the House of Lords concluded that it did not apply, because the word ‘wife’, both in that section and in Finance Act 1938 section 38, did not include the settlor’s widow (Commissioners of Inland Revenue v Gaunt42 overruled), and because the power to direct investment was jointly held and therefore not acquired by an individual, and there was no ‘power to enjoy income’. As to Finance Act 1938 section 38, the House of Lords concluded that it did not apply because, the ‘property comprised in the settlement’ meant only the property charged with rights in favour of others and therefore did not include the properties which were subjects of the lease; the power to determine the lease was not, therefore, a power to determine the settlement, so neither W nor E nor their respective wives could become beneficially entitled to property comprised in the settlement or income arising therefrom, and neither W nor E had an interest in the settlement; and the power held by W and E as ‘authorised persons’ to direct investments was of a fiduciary character and could not be regarded as conferring any kind of benefit on its holders.

Case 53: Earl Beatty v Commissioners of Inland Revenue (1953) 35 TC 30 The Beatty Earldom has already been mentioned. This case concerned the 2nd Earl. In 1937, the Earl’s half-brother, Ronald Tree, on reaching the age of 40, became entitled to a large sum of money in relation to which 40 Lord Vestey’s Executor and Vestey v Commissioners of Inland Revenue (1949) 31 TC 1, 81. 41 ibid 90. 42 Commissioners of Inland Revenue v Gaunt (1941) 24 TC 69.

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his mother had expressed a wish that he should divide the money equally between himself, the Earl and the Earl’s brother. In relation to the Earl this was achieved in 1938 by a method which resulted in the Earl becoming a shareholder and debenture-holder in Bretisle Ltd, a Canadian company. The Special Commissioners, as the assessing authority for surtax, first learned about the transactions in 1943 and made enquiries. During the enquiry period Congreve v Commissioners of Inland Revenue43 was in progress. Additional surtax assessments (also income tax assessments) were eventually raised on the Earl for 1939–40 to 1945–46 in reliance on Finance Act 1936 section 18. By the time the Earl’s appeals were heard by the Special Commissioners, it was clear that, given the final decision in Congreve, the assessments were correct in principle. The Earl’s continued resistance was based on the proposition that the assessing authority had not made a ‘discovery’ within Income Tax Act 1918 section 125 prior to the making of the assessments. The Special Commissioners, relying on Commissioners of Inland Revenue v Mackinlay’s Trustees44 and Commercial Structures Ltd v Briggs,45 dismissed the Earl’s appeals. In the High Court Vaisey J was not convinced that any ‘discovery’ issue arose but nevertheless dealt with the case on the basis that it did. He held that the discovery referred to in section 125 need not be a complete and detailed or accurate discovery, and that, where the assessing authorities find out, or think that they have found out, the existence of an omission or other error, it is not necessary for them to have probed the matter to its depths, or to define precisely the grounds on which they have made the assessments. He considered that the various authorities favoured the Revenue’s contention. Earl Beatty was therefore one of that unlucky band who paid tax on the strength that Congreve was correctly decided. Congreve was later overruled in Vestey v Commissioners of Inland Revenue.46

Case 54: Lord Chetwode v Commissioners of Inland Revenue (1975) 51 TC 647 Baron Chetwode is a title which was created in 1945 for the military commander, Field Marshal Sir Philip Chetwode, 7th Baronet in a line which stretched back to 1700. The case concerned the 2nd Baron. He was within the catchment of Income Tax Act 1952 section 412 (transfer of assets abroad) in relation to a Bahamian company (‘Attleborough’) in that the 43 44 45 46

Congreve v Commissioners of Inland Revenue (1948) 30 TC 163. Commissioners of Inland Revenue v Mackinlay’s Trustees (1938) 22 TC 305. Commercial Structures Ltd v Briggs (1948) 30 TC 477. Vestey v Commissioners of Inland Revenue (1979) 54 TC 503; see below case 55.

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effect of a settlement which he made in 1967 was that he had power to enjoy Attleborough’s income. The case raised two questions, viz (1) What was Attleborough’s income, the gross investment income or the net income after expenses? and (2) Should Attleborough’s short-term gains be brought in? The Revenue eventually won on both points. The argument for Lord Chetwode on the second point involved acceptance that the Finance Act 1962, by which the tax on short-term gains had been instituted by a new Case VII of Schedule D charge to income tax, had included an adaptation to bring such gains within the scope of Income Tax Act 1952 section 412. The argument was, however, that the provisions in the Finance Act 1965, by which companies became liable to corporation tax rather than income tax, had removed the foundation in that short-term gains could not be translated to income tax liability in Lord Chetwode’s hands because they were not within the scope of income tax before the translation. The short answer to this was that Attleborough, as a nonresident company, was never within the charge to short-term gains tax in the first place, so the 1965 Act had not taken it out of that charge at all. The second point was not pursued in the House of Lords, where the Revenue succeeded on the first point as a matter of construction of section 412.

Case 55: Vestey v Commissioners of Inland Revenue (1979) 54 TC 503 The Vestey family has already been sufficiently introduced. The biggest single question in this complex case was whether the House of Lords would maintain or overrule its own decision in Congreve v Commissioners of Inland Revenue.47 The Congreve point was that Income Tax Act 1952 section 412 (previously Finance Act 1936 section 18) did not apply only to the individual or individuals who had sought to avoid liability to tax by means of a transfer of assets abroad but extended to others who might benefit. The complex settlement concerned was made in 1942 by Sir Edmund Vestey Bt and the 2nd Lord Vestey. It included powers by which the managers of the trusts could direct the trustees to make distributions. In the exercise of these powers the trustees were directed to distribute and did distribute between six beneficiaries the sum of £2,608,000 on various dates between October 1962 and November 1966. None of the six beneficiaries could be said to be a person who had transferred assets abroad. Tax assessments were then made in relation to those sums. While it was the actual distributions which sparked the assessments, section 412 did not, undoubtedly, focus on actual distributions. The Revenue 47

Congreve v CIR, n 43 above.

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had selected only distributees for assessment, but that could not be justified in terms of the statute. In those terms, standing Congreve, all the potential distributees (over 30 in fact) were liable to assessment even though most of them had received nothing. The Revenue was therefore forced into submitting that it had a complete discretion whom to assess, a submission which was duly branded as constitutional heresy. The only way out of the difficulty was for the House of Lords to overrule the Congreve case. It was not a thoroughly appealing course, given that Congreve had stood for 30 years and many people must have paid tax on the footing that it had been correctly decided, but the Law Lords unanimously bit the bullet and decide to overrule Congreve (also Bembridge v Commissioners of Inland Revenue).48 The dark day for the Revenue was made even gloomier by Lord Edmund-Davies who picked up on some observations on Walton J and expressed his disapproval of Extra Statutory Concessions.

Case 56: Countess Fitzwilliam v Commissioners of Inland Revenue (1993) 67 TC 614 The Earldom of Fitzwilliam dates from 1716. The case related to certain consequences arising from the death of the 10th Earl. It concerned capital transfer tax (CTT). The Revenue’s case relied on the principle established in WT Ramsay Ltd v Commissioners of Inland Revenue.49 The complexities of the legislation and of the scheme make it a difficult case to follow. The 10th Earl’s estate amounted, as corrected, to £12.4m. CTT included an exemption where a surviving spouse took an interest in possession. It was therefore easy to leave the Revenue with no claim for CTT, but the simple solution was not adopted because Lady Fitzwilliam was 81 and in poor health, and the CTT bill on her death would be heavy. The top CTT rate was 75 per cent at the time, though there was a prospect that the newly elected Conservative government would reduce CTT rates sharply. The estate was left on trust including a power which gave the trustees an opportunity to keep the position under review for 23 months and to adjust the dispositions accordingly. The five step scheme which was implemented was designed to achieve two results, namely, that Lady Fitzwilliam would end up with £4m and her daughter, Lady Hastings, would end up with £3.8m, in neither case with any CTT being payable. The surviving spouse exemption meant that the Revenue could have no objection to the first result, but the scheme was interlocking and could not be analysed into two distinct sets of components, one set relating to Lady Fitzwilliam and the other to Lady Hastings. Furthermore, 48 49

Bembridge v Commissioners of Inland Revenue (1954) 36 TC 313. WT Ramsay Ltd v Commissioners of Inland Revenue (1981) 54 TC 101.

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the evidence established that Step One of the scheme, appointment on 20 December 1979 of £4m to Lady Fitzwilliam, was taken in the period in which the lawyers concerned were still discussing what to do and some two weeks before the ultimate scheme was identified; Step One could not be segregated entirely from what followed in that the intention was that it would be one component of a scheme, but all the same Step Two to Step Five were still in the melting pot when Step One was taken; there were further difficulties in ascertaining precisely when Lady Hastings became committed to the scheme. The Revenue’s formal determination fixed on all five steps of the scheme but by the time the case came before the House of Lords that view had been abandoned in favour of concentration on Step Two to Step Five as subject to the Ramsay principle. The House of Lords decided against the Revenue. Lord Keith, with whom Lord Ackner and Lord Mustill agreed, accepted that there was a pre-ordained scheme comprising Step Two to Step Five but held that it was not a scheme which was incompatible with the legislation; the rationale was that if what had been done created a charge to tax under Finance Act 1975 Schedule 5 paragraph 4(2), it could not be regarded as ineffective for the purpose of attracting the exemptions in paragraphs 4(4) and 5(5) of that Schedule; delphic as that may be without a detailed examination of Step Two to Step Five and of the legislation, space precludes further explanation. Lord Browne-Wilkinson took the much simpler line that Step Two to Step Five could not be regarded as a single composite transaction because Step One was a key component, critical to the transaction as a whole. Apart from that the case is remarkable only for the uncompromising language of Lord Templeman’s dissenting speech which showed no gentleness towards his colleagues or towards those who devised and participated in the scheme. A pleasant irony is that Lady Fitzwilliam survived to reach the age of 97.

CONCLUSION

Apart from lamenting that Adolf Hitler survived his traffic accident encounter with the 9th Lord Howard de Walden, there is little to say in conclusion. I will venture three thoughts. First, there is a temptation to wonder whether an aristocrat might have been tempted to take a case up to the House of Lords in the hope of a more benevolent reception by those who had achieved the eminence of being members of the peerage. But a careful reading of the cases does not give rise to the slightest suspicion that the House of Lords looked upon aristocratic taxpayers with any special favour. Secondly, recently Stewart Lee wrote an article for The Observer in which he stated: ‘In the current climate of cuts and austerity, drugs and violence are silly schoolyard crimes compared with massive corporate and individual

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tax avoidance’.50 The comment might be criticised as extreme, but it demonstrates the strong public concern these days about tax avoidance, a concern which, as I believe, did not exist in former times, even in periods of austerity such as that which followed the Second World War. Research shows that The Times did inveigh against tax avoidance in 1938, at length, and in 1943, briefly, but reactions in the correspondence columns were mixed. A letter from Mr FN Charlton of Purley, published in the edition of 2 April 1938, read: Tax avoidance or tax dodging, as your leading article unceremoniously describes an ancient sport, is a sport of kings, of finance and industry, to say nothing of the landed aristocracy and gentry, and long may it continue. Familiar arguments, long hallowed in defence of hunting, greyhound racing, and the like, can well be invoked in defence of tax avoidance. It keeps bodies of well-trained professional men and civil servants in regular employment, develops a keen intellect, and (so long as the taxpayer is successful) keeps money in profitable circulation. Furthermore, just as the thoroughbred horse and hound are a valuable export, so are the fees earned by our accountants and lawyers for foreign taxpayers, an invisible export not to be disregarded. Apart from ruining a thriving and valuable industry, your suggestions do no credit to our sporting friends of the Inland Revenue who know how to play the game and observe the traditions of the Old Somerset House tie. The suggestions are tantamount to shooting a fox instead of hunting it.51

It is perhaps worth noting that The Times carried a law report of the House of Lords’ decision in the Duke of Westminster case in the edition of 8 May 193552 but there was no comment about it in leader or correspondence columns in that or subsequent editions. In my view peers of the realm could and, as the chapter shows, did practise tax avoidance without fear of public obloquy. The fact that avoidance of estate duty was easy and rife also did not seem to worry the general public. Thirdly, the hereditary aristocracy had an unhappy time in the twentieth century. The power of the House of Lords was limited by the Parliament Act 1911, and further limited in 1949. The House of Lords Act 1999 removed the automatic right of hereditary peers to sit in the House of Lords, so that the House is now dominated by those who have life peerages under the Life Peerages Act 1958. All the while taxation was bearing hard on the aristocratic budget, though in several instances mitigated by marriage to an American heiress. The cases summarised above do not have any common

50 S Lee, ‘Sex and drugs? Real rock rebels are into tax-efficient accountancy abuse’, Observer, 18 May 2014. 51 FN Charlton, ‘The ancient sport of tax avoidance’, Letter to the Editor, The Times, 2 April 1938, 8. 52 The Times, 8 May 1935.

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theme; any selection of 56 cases might, as this selection does, demonstrate the rigours of the various tax regimes and the determination of the Revenue to administer the tax system; the fact that the cases summarised involve the aristocracy suggests that the Revenue has not shown any favour to rank; judges like to quote the seventeenth century assertion of Thomas Fuller that ‘Be you never so high, the law is above you’; as this chapter shows, tax law is not excluded.

8 The Negotiation and Drafting of the First Australia–United States Double Taxation Treaty of 1953 C JOHN TAYLOR*

ABSTRACT This chapter examines the negotiation and drafting of the 1953 Australia–United States Double Taxation Treaty, which was only the second comprehensive double taxation treaty that Australia had entered into. Using archival sources the chapter examines the process that led to the decision to enter into the Treaty, the negotiation and drafting of the Treaty, the factors that influenced the drafting of the Treaty and the influence of the Treaty on subsequent Australian taxation treaty practice. The examination finds that the primary motivation for entry into the Treaty was not to prevent international double taxation but was rather to prevent credit overspill in the United States and to encourage United States direct investment in Australia by reducing source basis taxation. Both of these objectives could have been achieved by a comprehensive and unilateral lowering of Australian tax rates but, in the economic and political environment of the early 1950s, the most viable source of additional direct foreign investment in Australia was the United States. Hence a targeted approach through a bilateral treaty, which minimised revenue cost, was favoured over unilateral and comprehensive rate reductions. Encouraging investment while at the same time minimising revenue cost and the erosion of source basis taxation were again the major policies that influenced both Australian politicians and officials. The chapter notes the potential contemporary relevance of the Australian experience in negotiating this Treaty for developing countries wishing to attract direct foreign investment while minimising revenue costs. * Some portions of this chapter have been previously published by the author in C John Taylor, ‘The Negotiation and Drafting of the First Australia–Canada Taxation Treaty (1957)’ (2013) 61 Canadian Tax Journal 915; C John Taylor, ‘Factors Influencing Australian Taxation Treaty Practice 1946–1976’ (2012) 27 Australian Tax Forum 571; and C John Taylor, ‘Some Distinctive Features of Australian Tax Treaty Practice: An Examination of Their Origins and Interpretation’ (2011) 9 E Journal of Tax Research 294.

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T

HE EXPONENTIAL GROWTH of Taxation Information Exchange Agreements (TIEAS) in recent years, along with other pressures previously identified, coupled with the misgivings of several OECD countries about earlier decisions made to enter into bilateral comprehensive taxation treaties with what are now lower taxed jurisdictions have again called into question the long-term sustainability of the international network of comprehensive bilateral taxation treaties.1 A genuine question arises as to what both developed and developing countries gain by entering into comprehensive bilateral taxation treaties in this environment. From the perspective of some developing countries any international double taxation and lack of competiveness that currently exists may be a product of its tax rates being higher than those of capital exporting countries that it is trying to attract investment from. Thus, any comprehensive bilateral taxation treaty that it enters into will have at least a short-term adverse revenue effect which can only be offset if the foreign investment the bilateral treaty attracts produces sufficient economic growth and future revenue. Even if a developing country decides to reduce its tax rates to attract foreign investment it might consider that it can do so more flexibly through unilateral measures which it can amend as a matter of domestic law rather than through a series of bilateral agreements for terms of years which are largely based on a model designed by and suited to the economic interests of developed countries. Countries who are capital exporters to potential comprehensive treaty partners could also consider that they have little to gain and some risks attached to entering into comprehensive taxation treaties with less developed countries or with what were once less developed countries. In a world of falling corporate tax rates, cost sharing agreements and patent box companies, countries that once sought lower source basis taxation of particular categories of income are now wondering why they entered into some of their previous treaties at all. Treaties with countries that once provided a predictable lower tax environment for capital exporting countries firms to invest in now play a significant role in base erosion and profit shifting activities of those and newer firms. That certainty of the investment environment for a defined period is the advantage of comprehensive bilateral taxation treaties must now be being questioned in capital exporting countries given that some treaties contain features which facilitate base erosion and profit

1 See, eg PA Harris, ‘Cross-Border Dividend Taxation in the 21st Century: the [Ir]relevance of Tax Treaties’ [2010] British Tax Review 573; and C John Taylor, ‘The Twilight of the Neanderthals, or Are Bi-Lateral Double Tax Treaty Networks Sustainable’ (2010) 34 Melbourne University Law Review 240.

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shifting. The rapid development of TIEA networks is providing information gathering opportunities for capital exporting countries without facilitating the international tax planning strategies that have developed utilising comprehensive bilateral taxation treaty networks. In 1950, Australia was a country that was trying to attract foreign direct investment, particularly from the United States, to assist in the further transformation of its economy from a pastoral and agricultural exporter and manufactured goods importer to one with a more significant manufacturing sector of its own. As will be seen below the Australian attitude was that unilateral provisions in both countries meant that any international juridical double taxation between them was a product of Australia’s tax rates being higher in certain circumstances than those in the United States. Australia realised that any relief from international double taxation that a taxation treaty with the United States could provide would come at a revenue cost to Australia. A judgement therefore needed to be made on whether other considerations could justify enter into a comprehensive taxation treaty with the United States notwithstanding the likely Australian revenue loss. The examination in this chapter of the negotiation and drafting of Australia’s first comprehensive taxation treaty with the United States in 1953 thus has considerable relevance for the current questions raised about the long-term sustainability of the international network of bilateral taxation treaties. Following a discussion of the economic and strategic background against which Australia decided to negotiate a comprehensive taxation treaty with the United States, the chapter then considers the factors that led to the decision to negotiate and examines the extent to which, in the negotiation and drafting of the treaty, Australia achieved its aims of eliminating international juridical double taxation between the two countries while minimising any reduction in Australia’s source country taxing powers. The chapter concludes with observations about the effect of the treaty on subsequent Australian treaty practice and makes observations about the relevance of the negotiation and drafting of the treaty to the current questions concerning the long-term sustainability of the international network of bilateral taxation treaties. The chapter is based on archival research conducted at the National Archives of Australia in Canberra and at the United States National Archives and Records Office in College Park, Maryland.2

2 The principal files consulted at the National Archives of Australia in Canberra have been: (a) Department of External Affairs files: ‘United States of America: Double Taxation Agreement between Australia and United States of America’ Series Number A1838, Control Symbol 827/1/5/ Parts 1, 3 and 4 (hereafter ‘NAA, External Affairs file, Pt 1, Pt3 or Pt 4’ as the case

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C John Taylor ECONOMIC AND STRATEGIC BACKGROUND: AUSTRALIAN ECONOMIC AND STRATEGIC POLICY 1945–50

The United States–Australia alliance is popularly regarded as beginning in 1941 with Prime Minister John Curtin’s famous declaration: Without any inhibitions of any kind, I make it quite clear that Australia looks to America, free of any pangs as to our traditional links or kinship with the United Kingdom.3

Nonetheless Curtin, in the last two years of his Prime Ministership had been distrustful of American plans for the Pacific and had returned to emphasising the British Empire as the base for Australia’s military and economic security,4 emphases that were to be continued by the Chifley Government. The Second World War had produced major changes in the Australian economy and society. Manufacturing as a share of GDP had increased at an unprecedented rate.5 Australian xenophobia as an Anglo-Saxon-Celtic outpost at the edge of Asia had been heighted by the Japanese invasion of Papua and New Guinea and by air and naval attacks on the Australian mainland. Australia embarked on a post-war policy of European immigration to provide the necessary manpower for manufacturing, nation building projects and increased defence security.6 During the period of the Chifley Government, however, the policy intent was for immigration and investment may be); (b) Australian Taxation Office files: ‘Double Taxation; United States of America and Australia’ Parts 1, 2, 3 and 4, Series Number A7073, Control Symbol J245/21 (hereafter NAA, ATO file Pt 1, Pt2, Pt 3 or Pt 4’ as the case may be); (c) Australian Treasury files ‘Double Tax Agreement: Australia–United States’ Parts 1, 2, 3, Series Number A571, Control Symbol 1955/2628 (hereafter ‘NAA, Treasury file US Treaty, Pt1, Pt2 or Pt3’ as the case may be. The principal files consulted at United States National Archives and Records Administration, College Park Maryland have been: (a) General Records of the Department of State, RG59, Accession No 811.512347, Accession No 611.4392/8-2251 and Accession No 611.4392/22152; (b) Office of the Secretary of the Treasury, RG56, Box 139, Central Files: Tax: Double Taxation: Australia; and (c) Assistant Secretary for International Affairs, RG56, Accession No 56-67A245. 3 Herald, Melbourne, 27 December 1941, as quoted in D Day, John Curtin: A Life (Sydney, Harper Perennial, 1999) 485. 4 Curtin’s change of stance is discussed in Day, n 3 above, ch 38, in particular at 577–83. 5 A recent discussion is IW McLean, Why Australia Prospered: the Shifting Sources of Economic Growth (Princeton, NJ and Oxford, Princeton University Press, 2013) ch 8. McLean notes (at 180) that whereas between federation and the First World War the share of GDP originating in manufacturing only increased from 12.1 to 13.5% then reached 16.7% by 1929 and 18.5% by 1939, it increased to 26.2% by 1949. While it did near 30% by 1959, the rate of increase in the years of the Second World War was never subsequently matched. 6 See the discussions of the Chifley Government’s policies in this respect in PL Robertson, ‘The Decline of Economic Complementarity? Australia and Britain 1945–1952’ (1997) 37 Australian Economic History Review 91, 92–94; T Rooth, ‘Imperial Self-sufficiency Rediscovered: Britain and Australia 1945–1951’ (1999) 39 Australian Economic History Review 29, 30–33; T Rooth, ‘Australia, Canada, and the International Economy in the Era of Postwar Reconstruction, 1945–50’ (2000) 40 Australian Economic History Review 127, 129–30; and McLean, n 5 above, 186–87. A more detailed account is SJ Butlin and CB Schedvin, War Economy 1942–45 (Canberra, Australian War Memorial, 1977).

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to be predominantly from, and for the trade to be predominantly with, the United Kingdom. The Chifley Government’s policy of United Kingdom/ Commonwealth preference meant that Australia maintained long-term food contracts7 with the United Kingdom and participated in the ‘Sterling Area’.8 It has been argued that Australia was distrustful of the United States because of disastrous economic relations between the two countries in the 1930s9 and that Chifley was bitter about the terms that the United States had imposed in its post-war loans to the United Kingdom.10 On the basis of the short boom and long depression that followed the First World War, Australian policy-makers during the Second World War had low expectations for the anticipated post-war recovery.11 Australia’s economic performance in the years 1945–49 far exceeded these gloomy expectations. What had been a complementary relationship between Australia as a producer of raw materials and agricultural produce and the United Kingdom as a producer of manufactured goods and a consumer of agricultural products had been significantly challenged by the expansion of Australian manufacturing industry. Despite its relatively poor performance as a food exporter, high wool prices led to Australia having a balance of payments surplus with the United Kingdom. This, coupled with immigration and UK capital investment, led to continued economic growth, inflation and a surge in demand for both capital and consumer goods which the United Kingdom was unable to fully satisfy by 1949.12 By 1949, Australia needed both debt and equity investment in dollars if it were to continue with a policy of economic growth through immigration and the development of manufacturing industry. Imports from the United States had been running at 19 per cent of total Australian imports resulting

7 Long-term food contracts with the United Kingdom are discussed in Rooth, ‘Imperial Self-sufficiency Rediscovered’, n 6 above, 32 and 33–38. 8 The ‘Sterling Area’ had been formed in the early years of the Second World War and included all British dominions and colonies other than Canada, Newfoundland and Hong Kong. Robertson, n 6 above, 94–95, argues that the two functions of the Sterling Area were: (a) to alleviate the effects of the dollar shortage by encouraging members to trade with and invest in each other; and (b) to act as a dollar pool in which members deposited their dollar earnings with the British who then allocated them as they were needed to pay for dollar imports. 9 A point made by Rooth, ‘Australia, Canada, and the International Economy’, n 6 above, 129. In 1936 Australia had diverted trade against United States importers. In 1938 Australia agreed to forego some privileges in the United Kingdom market to facilitate a trade agreement between the United Kingdom and the United States but the United States refused to compensate Australia. The incidents are discussed in MR Megaw, ‘Australia and the Anglo-American Trade Agreement, 1938’ (1974–75) 3 Journal of Imperial and Commonwealth History 191. 10 A point made by PL Robertson, ‘Official Policy on American Direct Investment in Australia 1945–1952’ (1986) 26 Australian Economic History Review 159. 11 See the discussion in Robertson, n 6 above, 93; Rooth, ‘Imperial Self-sufficiency Rediscovered’n 6 above, 31 and Rooth, ‘Australia, Canada, and the International Economy’, n 6 above, 129. 12 See the discussion in Robertson, n 6 above, and particularly Rooth, ‘Imperial Selfsufficiency Rediscovered’, n 6 above.

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in an increasing need for dollars to pay for them.13 The restoration of the convertibility of the pound sterling in 1947 brought on a dollar crisis in consequence of which, following the suspension of convertibility, countries, such as Australia, in the Sterling Area resolved to significantly reduce their dollar imports.14 One solution to Australia’s dollar difficulties would have been to seek dollar investments or loans from United States and Canadian sources. The Chifley Government, however, was adverse to borrowing from the United States or Canada or from international institutions such as the World Bank (the International Bank for Reconstruction and Development).15 Prior to its election in 1949 the Menzies Liberal/Country Coalition argued that ‘acute dollar restrictions’ were limiting Australia’s development and that Australia should borrow dollars from either the World Bank, the Export-Import Bank or the New York market.16 Following the Coalition victory in 1949 Menzies visited Washington and secured a loan of US$100 million on favourable conditions from the International Bank for Reconstruction and Development.17 In other respects, however, particularly with its emphasis on development of manufacturing industry and immigration, the economic policies of the Menzies Government represented a development of rather than an abrogation of those of the Chifley Government.

1951 DECISION TO NEGOTIATE A TAXATION TREATY WITH THE UNITED STATES

Chifley Government’s Reluctance to Negotiate The United States had persistently offered to enter into a treaty with Australia from 1947 onwards although the issue had been raised informally as early as 1945. A formal approach was made by the United States in October 1947 followed by the submission of a detailed proposal in September 1948. On 24 February 1949, the Australian Government advised the United States that Australia was not disposed to enter into a treaty which went beyond formalising the existing arrangements and that there appeared to be little scope for an agreement which could show a balancing of advantages in any apparent form.18 13 See the discussion in Rooth, ‘Australia, Canada, and the International Economy’, n 6 above, 140. 14 The response of Australia and other countries in the Sterling Area to the 1947 convertibility crisis is discussed in Robertson, n 6 above, 96–98. 15 See the discussion in ibid 100–1. 16 ibid. 17 ibid 100–3. 18 The history of the correspondence is summarised in an Australian Department of External Affairs memorandum to the Minister for External Affairs dated 20 December 1949, NAA, External Affairs file, Pt 1.

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In this period the technical answer of the Australian Treasury and Taxation Office to these offers was that the Australian exemption system and the United States unilateral foreign tax credit system meant that double taxation did not really exist between Australian and the United States. While Australia saw advantages in a bilateral treaty which preserved the existing mechanisms in each country for preventing international double taxation it did not favour any treaty which involved further adjustments. The view of Australian officials was that any double taxation that did occur was caused by differences in tax rates between the two countries rather than the absence of appropriate mechanisms for relieving international double taxation. Australian officials realised, therefore, that any double taxation could only be relieved by reducing Australian tax rates, particularly on dividends paid to foreign shareholders. Based on the precedent of the 1946 Australia– United Kingdom Double Taxation Treaty it was believed that the required Australian concessions, particularly in relation to dividends paid to parents by wholly owned subsidiaries, would cost revenue, and would to some extent provide benefits to the United States Treasury and not to US investors.

The Menzies Government’s Reconsideration of the Position Several factors in combination led to a reconsideration of Australia’s attitude towards entering into a taxation treaty with the United States following the election of the Menzies Government. One was certainly the more positive attitude, discussed above, of the Menzies Government to US investment generally. Nonetheless, for a time, concerns remained about the effect of profit repatriations by direct investors on Australia’s limited dollar reserves.19 The more general geopolitical and financial context was also relevant. The United States did not mention the taxation treaty issue during Menzies’ 1950 visit to negotiate a dollar loan. Nevertheless, it is hard to believe that the assistance given by the United States in the obtaining of that loan could have been absent from the minds of Australian ministers and officials considering whether to agree to the United States request for a taxation treaty.20 Indeed, Spender reported to the US State Department officials that Hughes

19 An internal memo dated 23 March 1950 of the Australian Department of External Affairs to the Minister notes that the second report of the Interdepartmental Committee on Dollar Receipts tentatively recommended against a double taxation treaty with the United States on the grounds of revenue cost and diminution of scarce dollar reserves. NAA, External Affairs file, Pt 1. 20 A draft Cabinet submission for the Minister for External Affairs written on approximately 22 February 1951 notes that ‘while the question had not been raised with the Prime Minister during his visit to Washington this omission was deliberate in order to avoid any suggestion of a bargain in connection with his financial negotiations’, NAA, External Affairs file, Pt 1.

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had expected that Menzies would be pressed for a tax treaty during his visit and was disappointed that he had not been.21 By 1951, the Australian Department of External Affairs was clearly in favour of entering into a double taxation treaty with the United States as a means of maintaining good relations with Australia’s important Second World War ally.22 During this period the military alliance between Australia, New Zealand and the United States was further developed through negotiations, commencing in February 1951, for the ANZUS Treaty.23 The outbreak of the Korean War focused United States’ strategic attention on the Asia-Pacific where Australia, as a European outpost, assumed greater strategic and economic importance than the size of its population and economy would have otherwise warranted. There was also significant lobbying by US business in favour of a double taxation treaty with Australia which received support from existing Australian subsidiaries of US businesses. US business, and to some extent US officials, were more concerned with the discrimination against US business when compared with U K business than with double taxation on nonportfolio investment; an attitude that Australian External Affairs officials were cognisant of.24 Against this background, the Australian treasurer, AW Fadden, commissioned JW Hughes (a Deputy Commissioner of Taxation) and ES Spooner (the chairman of the Commonwealth Committee on Taxation) to report on whether Australia should enter into a double taxation treaty with the

21 Office Memorandum, United States Government, Confidential, To: GFD, Mr Spiegel, From Mr Livesey, ‘Failure to Press Australia for a Tax Treaty’, 9 August 1950, General Records of the Department of State, RG59, Accession No 611.4392/2-2152. 22 A draft submission to Cabinet for the Minister for External Affairs dated approximately 22 February 1951 began with the following comment: ‘An urgent decision by Cabinet is desirable on the question of a Tax Convention with the USA. In view of the current negotiations with the United States on a Japanese peace settlement and security arrangements in the Pacific area, the importance of demonstrating to the United States Government that we are approaching outstanding problems in a co-operative spirit is more than ever apparent. The negotiation of a convention for the avoidance of double taxation, which for more than three years has been constantly urged on us as a mutually beneficial arrangement is an important means of achieving this object.’ NAA, External Affairs file, Pt 1. 23 The ANZUS Treaty was concluded on 1 September 1951 and came into force on 29 April 1952. There is a critical review of the literature on the Australia–United States alliance in D McLean, ‘Australia in the Cold War: A Historiographical Review’ (2001) 23 International History Review 253. 24 See ES Spooner and JW Hughes to AW Fadden MP, Commonwealth Treasurer, 30 August 1950. NAA, External Affairs file, Pt 1. Numerous letters and memoranda from businesses and from businesses groups are contained in several of the files of the National Archives of Australia and the United States National Archives and Records Office relevant to this Treaty. Companies and organisations making submissions included: General Motors Holden; Ferro Enamel; Automatic Totalisators Inc; American Australian Association & Chamber of Commerce Inc; National Foreign Trade Council Inc; Chrysler, Dodge, De Soto; Pan Am American World Airways Inc; Julius Kayse & Co; Lincoln Electric Co; Standard Vacuum Oil Co; and Bristol-Myers Co.

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United States. Hughes and Spooner concluded that Australia should enter into a taxation treaty with the United States, estimating that the likely revenue loss to Australia of £1,750,000 would be offset somewhat by taxing dividends at the rates that the United States had agreed with other British Commonwealth countries, namely, 5 per cent for non-portfolio and 15 per cent for other dividends, and by increased revenues flowing from greater US investment in Australia. The report noted that the United States was seeking a closer relationship with Australia and that many large organisations were interested in permanently establishing or in expanding business in Australia.25 The Treasurer’s submission to Cabinet, consistent with Treasury and Australian Taxation Office advice given to the Chifley Government, was less optimistic, noting that existing US businesses operating in Australia would introduce additional capital in the absence of a treaty and that new US investment in Australia was likely to be of a transient nature and of restricted value to the Australian economy. Negotiation of a taxation treaty with the United States could not be justified on taxation principles but it was necessary to consider political considerations arising out of the relationships between the two countries in the then current circumstances.26 It is possible that the reference to ‘political considerations arising out of the relationships between the two countries in the then current circumstances’ is to both the dollar loan and the ANZUS alliance. On 15 March 1951, Cabinet resolved to commence taxation treaty negotiations with the United States.27

NEGOTIATION AND DRAFTING OF THE 1953 AUSTRALIA–UNITED STATES DOUBLE TAXATION TREATY

Excess Foreign Tax Credit Problem for US Non-Portfolio Investors A key consideration which led government and business in Australia and the United States to favour a taxation treaty between the countries was the excess foreign tax credit problem that existed for US non-portfolio investors. The Spooner and Hughes Report had concluded that this problem was significantly impeding direct investment by US companies in Australia.28 25

Spooner and Hughes, n 24 above. AW Fadden, Treasurer, ‘For Cabinet Sub-Committee, Income Tax and Estate Duty, Double Taxation of Income Flowing Between Australia and the United States of America; Double Estate Duty Imposed on Assets Having Their Situs in Australia Owned by Persons Dying Domiciled in the United States’, 2 March 1951, NAA, External Affairs file, Pt 1. 27 NAA, External Affairs file, Pt 1, copy of Cabinet decision dated 15 March 1951. 28 Spooner and Hughes, n 24 above. 26

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The excess credit position of US companies investing in Australia through subsidiaries29 was a product of Australian rates of tax on corporate profits and on dividends, combined with the limitations on the direct and indirect foreign tax credit allowed by the United States to non-portfolio outbound foreign investment.30 In 1952, the United States relieved international juridical double taxation through a foreign tax credit system. US taxpayers were required to use the lesser of an overall or a per country limitation. In the former case, the credit was limited to the same proportion of the taxpayer’s overall US tax liability, as was the proportion that foreign source income represented of the taxpayer’s global income. In the latter case separate calculations were made in relation to each foreign jurisdiction in which the taxpayer invested with the credit limit for income from each jurisdiction being the proportion of the taxpayer’s overall US tax liability that was the same proportion that income from that foreign jurisdiction represented of the taxpayer’s global income.31 Indirect credits were available where a US corporation owned 10 per cent or more of the voting stock of a foreign corporation from which it received a dividend. An indirect foreign tax credit was also available for underlying tax on dividends received from a second tier foreign corporation when 50 per cent or more of its voting stock was owned by a first tier foreign corporation in which a US corporation held 10 per cent or more of the voting stock.32 Australia recognised that this problem could be dealt with by a reduction in Australian taxes on dividends paid to US companies making direct investments in Australia but wanted to ensure that the reduction was only to such a level as would benefit the US investor rather than the United States Treasury.33 This became a key objective of Australia in the negotiations.

29 In practice equivalent problems did not exist when the US investment was through an Australian branch as the absence of a branch profits tax in Australia meant that Australian tax did not generate excess foreign tax credits for US companies. 30 Memorandum from PS McGovern, Commissioner of Taxation, to the Commonwealth Treasurer (AW Fadden) 15 April 1952, NAA, ATO file Pt 3, p 3 at paras 15–16 and p 4 at paras 19–21. 31 See the discussion of the history of the United States’ foreign tax credit limitation in Michael J Graetz and Michael M O’Hear, ‘The “Original Intent” of US International Taxation’ (1997) 46 Duke Law Journal 1021, in particular at n 141. For a discussion of US rules in 1957–58, see B Magill and WC Schaab, ‘American Taxation Of Income Earned Abroad’ (1957–58) 13 Tax Law Review 115. Shortly after the signing of the Australia–United States Double Taxation Treaty of 1953 the overall limitation on the foreign tax credit was repealed in 1954. In 1960, taxpayers were given the option to use an overall limitation or a per country limitation. The per country limitation was repealed in 1976. A basket system of limitation was introduced in 1986. The number of baskets was reduced to two in 2006. 32 The history of the United States’ indirect foreign tax credit to 1975 is discussed in EA Owens and GT Ball, The Indirect Credit: A Study of Various Foreign Tax Credits Granted to Domestic Shareholders Under US Income Tax Law (Cambridge, MA, International Tax Program, Law School of Harvard University, 1975) 31–33. 33 McGovern, n 30 above, 5 paras 27–28.

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Initial Negotiations in Canberra in 1951 The initial negotiations for the treaty began in Canberra on 17 March 1952. Eldon P King, Special Deputy Commissioner of the United States Bureau of Internal Revenue, led the United States delegation which also included Peter J Mitchell and Earl A Ruth.34 The Australian delegation was led by the Commissioner of Taxation, Patrick McGovern. Other members of the Australian delegation were Mair, Belcher, Hunt, Worland, Orriell, and Beikoff from the Australian Taxation Office and Pryor and Garrett from the Australian Treasury.35 The following discussion of the negotiations is based on McGovern’s report to Fadden and on the first draft of the Treaty produced in those negotiations. The United States’ position was that the Australia–United Kingdom Double Taxation Treaty of 1946 should be regarded as setting the pattern of Australia’s agreements with nations from whom investment capital for development might be expected to be encouraged. The exceptions to this attitude were in areas where the United States legislature had established a precedent in previous US Treaties that it was unlikely to be willing to vary.36 The Australian objective was to ascertain the maximum terms sought by the United States and the minimum terms acceptable to the United States which would remove the deterrent to direct investment by US companies in Australia. The maximum reduction in Australian tax on direct investment by US companies in Australia was governed by the US corporate rate, as Australian taxes at this level would not deter US investment in Australia, while reductions below this level would, through the US foreign tax credit system, produce benefits for the United States Treasury rather than the US investor.37 Australia also sought to oppose provisions which ‘violated the prior right of the country of origin of the income to tax’ and which could do little or nothing to encourage US investment in Australia. Nonetheless, Australia recognised that in some areas, most importantly shipping and aircraft profits, taxation on a residence basis had become so widely recognised as to be the conventional method of taxing rather than being based on any principle of taxation.38 Notwithstanding these differences in objectives and approach, McGovern noted that the initial discussions produced ‘a very substantial degree of

34

ibid 1, paras 1–2. ‘List showing names of persons attending the discussions between United States and Australian Tax Officials’, Federal Taxation Office, 20/3/52, NAA, External Affairs file, Pt 3. 36 McGovern, n 30 above, 4, para 22. 37 ibid 5, paras 27–28. 38 ibid 4, para 29. 35

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agreement upon the matters which might be confidently submitted to the two Governments for their consideration and a draft Convention was prepared’.39

Draft of the Treaty Developed in the Initial Negotiations The following discussion of selected Articles of the draft Treaty40 developed during the negotiations in Canberra in 1952 will highlight similarities to and differences from the 1946 Australia–United Kingdom Double Taxation Treaty, particularly in relation to provisions that are relevant to the balancing of revenue cost against other considerations and to Australia’s subsequent taxation treaty practice and current issues concerning the sustainability of bilateral taxation treaty networks. Definitions Definitions of ‘Resident’ The definition of ‘Australian resident’ in the draft was substantially the same as in the 1946 Australia–United Kingdom Double Taxation Treaty but, as the United States taxed on the basis of citizenship, a US citizen was expressly excluded from being an Australian resident. While McGovern considered that it would have been preferable to have avoided this result, he noted that it had been achieved by the United States in all of its previous Treaties to which he had had reference and that it was a principle on which the United States was likely to be unyielding. As the effect on Australian revenue would necessarily be negligible, he did not consider that it warranted Australian rejection. Following the definition in the 1946 Australia–United Kingdom Double Taxation Treaty meant that dual residents were not treaty residents. This was because, as was the case with the 1946 Treaty, a taxpayer would only be a resident of one of the contracting states if the taxpayer were resident in that contracting state for tax purposes and was not resident in the other contracting state for its tax purposes. Unlike the 1946 Australia–United Kingdom Double Taxation Treaty, the draft contained a specific provision dealing with the residence of companies. Under the draft a ‘United States corporation’ was not an Australian resident. A ‘United States corporation’ was defined as meaning ‘a corporation, association or other like entity created or organized in or under the laws 39

ibid 6, para 30. This draft of the Treaty is Annexure C to McGovern, n 30 above. A summary of the result of the negotiations is contained in McGovern’s letter to Fadden. The author has to date been unable to locate a daily record of the negotiations either in the National Archives of Australia or in the United States National Archives and Records Administration. 40

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of the United States’. A ‘United States resident’ included ‘any United States corporation … being a corporation … which is not a resident of Australia for purposes of Australian tax’. The combined effect of the definitions of ‘Australian resident’, ‘United States corporation’ and ‘United States resident’ appears to have been that a US corporation which carried on business in Australia and was centrally managed and controlled in Australia was not an Australian resident for Treaty purposes but, as it was a resident of Australia for purposes of Australian tax, it was not a US resident for Treaty purposes either. By contrast, as the United States determined corporate residency solely on the basis of place of incorporation, a company incorporated in Australia could only be an Australian resident for Treaty purposes. McGovern merely commented that the reference to ‘United States corporation’ in the definition of ‘Australian resident’, was consistent with the Australian approach and was included for ease in drafting.41 Definition of Permanent Establishment The definition of ‘permanent establishment’ was substantially similar to the equivalent definition in the 1946 Australia–United Kingdom Treaty but, in McGovern’s words, it had been ‘broadened in conformity with Australian aims’.42 Clearly, Australia’s aims in this respect were to maximise source based taxation of the Australian branches of foreign enterprises.43 In addition to indicia of a permanent establishment under the 1946 Australia–United Kingdom Double Taxation Treaty, the draft proposed that a permanent establishment should include a workshop, oil well, office, an agency, a management and the use of substantial equipment or machinery. The most interesting addition to the definition of ‘permanent establishment’ was the specific reference to the use of substantial equipment. The same reference had been included in the 12 June 1950 Supplementary Convention to the 1942 United States–Canada Double Taxation Treaty44 but had not been included in any other United States Treaty up to 1952 and was not included in any other United States Treaty for the rest of the 1950s. However, specific reference to ‘substantial equipment’ was included

41 ibid 7, para 42. The statement that the reference to ‘United States corporation’ being consistent with the Australian approach was presumably a reference to the fact that one of the tests of corporate residency under Australian tax law at the time was incorporation in Australia. See Income Tax Assessment Act 1936 (Cth) s 6(1) definition of ‘resident of Australia’. 42 McGovern, n 30 above, 7, para 46. 43 McGovern noted (ibid 7, para 45) that it was in the interests of Australia to have the term ‘permanent establishment’ cover a wide variety of the means by which a resident of one country can conduct business operations in the other country. 44 See paragraph ‘o’ of Supplementary Convention 12 June 1950 to United States–Canada Double Taxation Convention of 1942.

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in several other Canadian treaties of the 1950s.45 It does appear that the inclusion of the substantial equipment provision in the 1950 Supplementary Convention between the United States and Canada had been at the request of Canada.46 The terms of Canadian treaties in the 1950s suggest that it is possible that a substantial equipment provision at least became one that Canada would agree to in this period. A reasonable conclusion is that Australia argued for the inclusion of a substantial equipment provision on the basis that the United States had agreed to such a provision in its Supplementary Convention with Canada in 1950.47 Industrial or Commercial Profits Article This Article was substantially similar to its equivalent in the 1946 Australia– United Kingdom Double Taxation Treaty, and, like that Article, specifically reserved Australia’s right to continue its existing methods of taxing film business and profits of insurance with non-residents.48 The Article differed from the equivalent Article in the 1946 United Kingdom–Australia Treaty in that, at the request of the United States,49 the draft applied a force of attraction principle in taxing industrial or commercial profits once a permanent establishment was found to exist in the source country. McGovern commented that the difference between this method and the ‘attributable to’ method adopted in the 1946 Australia–United Kingdom Double Taxation Treaty could not materially affect Australian revenue but

45 Canada–South Africa Double Taxation Treaty 1956 Art II(1)(j); Australia–Canada Double Taxation Treaty 1957 Art II(1)(l); Belgium–Canada Double Taxation Treaty 1958 Art II(1)(i)(bb); Finland–Canada 1959 Art II(1)(j). 46 This would appear to be the case from the comments on the ‘substantial equipment’ provisions in the 1942 Supplementary Convention in the letter of transmittal by the Secretary of State (Dean Acheson) to the Senate, Tax Analysts, Worldwide Tax Treaties, United States, Canada, Report of the Secretary of State, 29 June 1950. 47 To date the author has been unable to locate archival evidence, in either the National Archives of Australia in Canberra, the United States National Archives in College Park, Maryland, or in the Canadian National Archives in Ottawa, indicating which country was the originator of the inclusion of a substantial equipment provision in the definition. 48 McGovern, n 30 above, 8, para 57. Division 14 of Pt III of Income Tax Assessment Act (ITAA) 1936 (Cth) included 10 per cent of the gross income of film businesses controlled by non-resident controllers in the taxable income of the relevant non-resident controller. ITAA 1936 Pt III Division 15 included 10 per cent of gross premiums in the taxable income of non-resident insurance companies carrying on business in Australia but which did not have a principal office or branch in Australia. These provisions as they applied in 1953 are discussed in NE Challoner and CM Collins, Income Tax: Law and Practice (Commonwealth) (Sydney, Law Book Co of Australasia Pty Ltd, 1953) paras 907–15 and 916–28. 49 McGovern, n 30 above, 8, para 55, makes it clear that the request to tax industrial or commercial profits using a force of attraction principle was made by the United States. This was United States Double Taxation Treaty practice at the time. See the discussion of the rationale behind the practice in David R Tillinghast, ‘The Revision of the Income Tax Convention between the United States and the Federal Republic of Germany’ (1965–66) 21 Tax Law Review 399, 420–29.

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that, over a period of time, the force of attraction principle was likely to be more favourable to Australia, and hence, Australia did not oppose the United States request.50 The Article also differed from the equivalent Article in the 1946 Australian–United Kingdom Treaty by specifically providing for deduction of all deductible expenses, including executive and general administrative expenses, reasonably attributable to the permanent establishment in calculating its income. The Article specified that it was ‘subject to the principle underlying Section 38 of the Income Tax and Social Services Contribution Assessment Act’ although McGovern did not expressly mention this point in his report to Fadden.51 McGovern commented that the provision provided a safeguard to enterprises of both countries but would not involve revenue cost to Australia as it was consistent with existing practice under Australian domestic law.52 Equivalent provisions had been included in United States Taxation Treaties from 1948 onwards although the provision in the draft omitted the words ‘wherever incurred’ and in this respect followed an earlier variant of the United States provision.53 Inter-connected Companies/Associated Enterprises This Article was substantially similar to the equivalent Article in the 1946 Australia–United Kingdom Treaty. A substantive variation, made at the request of the United States, was that both countries were prohibited from taxing under the Treaty any greater amount than would be possible under their domestic tax law. McGovern commented that this had been requested for administrative reasons and that as it would be open to Australia to

50

McGovern, n 30 above, 8, para 56. ITAA 1936 s 38 dealt with importation and sale in Australia by a manufacturer of goods and read as follows: ‘Where goods manufactured out of Australia are imported into Australia and the goods are, either before or after importation, sold in Australia by the manufacturer of the goods, the profit deemed to be derived in Australia from the sale shall be ascertained by deducting from the sale price of the goods the amount for which, at the date the goods were shipped to Australia, goods of the same nature and quality could be purchased by a wholesale buyer in the country of manufacture, and the expenses incurred in transporting them to and selling them in Australia.’ A contemporary commentary on s 38, Challoner and Collins, n 48 above, para 303, observed that it appeared to embody the principle laid down by the High Court in FCT v W Angliss & Co Pty Ltd (1931) 46 CLR 417. This view would see the principle of s 38 as being concerned with how much of a profit from an international sale of goods transaction was sourced in particular jurisdictions. Challoner and Collins went on to comment at para 303: ‘The effect of s 38 is that overseas manufacturing profit, i.e., the difference between the overseas manufactured cost and the wholesale purchase price is not derived from a source in Australia.’ 52 McGovern, n 30 above, 8, para 59. 53 United States Treaty practice in relation to this provision in this period is discussed in RJ Vann, ‘Do We Need 7(3)? History and Purpose of the Business Profits Deduction Rule in Tax Treaties’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2012) vol 5, 393, 411–13. 51

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amend its domestic tax laws its right to tax was not restricted and the proposal was not opposed.54 Shipping and Aircraft Profits In negotiating the 1946 Treaty with the United Kingdom, Australia had argued strongly but unsuccessfully against taxing shipping on a residence/ place of registration basis. McGovern described the United States representatives as being persistent in pressing for a similar Article to the one in the 1946 Treaty and took this as illustrating the importance which the United States attached to taxing shipping and aircraft profits on a residence basis. In McGovern’s view, even if the United States negotiators could be persuaded to tax these profits on a source basis, the United States Congress would ‘almost certainly’ decline to ratify the Treaty.55 McGovern reported that, while he had pressed the United States representatives to have regard to the fact that, as Australia had no ships trading with the United States, the proposal would merely benefit the United States at the expense of Australia, he admitted that residence basis taxation of shipping and aircraft profits had now become so common in international documents as to have become traditional. He could see no prospect of obtaining a treaty which did not concede a residence basis for the taxation of these profits.56 The resultant annual loss of revenue to Australia was estimated to be £100,000.57 McGovern’s position is an early example of Australia reluctantly modifying its preference for source based taxation in response to developing international practice. Concessional Rate of Tax on Dividends In 1952, Australia still taxed dividends paid to non-residents on an assessment basis at the then current rate of 35 per cent. The Australian Corporate Tax rate was 45 per cent.58 In the 1946 Treaty with the United Kingdom Australia had agreed to exempt from Australian tax dividends paid by wholly owned subsidiaries and to reduce its tax rate on other dividends paid to United Kingdom residents by 50 per cent. Hence, in 1952 the rate of Australian tax payable on dividends paid by Australian companies, other than wholly owned subsidiaries, to UK residents was 17.5 per cent.59 In negotiations the United States delegation did not press for concessions identical to those granted in the 1946 Australia–United Kingdom Treaty but 54 55 56 57 58 59

McGovern, n 30 above, 9, para 64. ibid 9, para 67. ibid 9–10, para 68. ibid 10, para 69. ibid 3, para 15. ibid 10, para 76.

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did argue for a 5 per cent limit on source country taxation of dividends paid by 95 per cent Australian subsidiaries to their US parents. Australia successfully argued for a uniform 15 per cent source country tax rate on all dividends.60 One of the arguments put by Australia for this position was that differential rates in the parent—95 per cent subsidiary situation would discourage US companies from proposals for joint participation with Australian residents in Australian companies.61 McGovern commented that a uniform rate on all dividends flowing from Australia to the United States would leave it open for US–Australian ventures to operate without the US shareholders suffering taxation disadvantages.62 This was because the US Corporate Tax at the time was 52 per cent but was increased to 55.7 per cent when a subsidiary paid a dividend to its parent although the rate was reduced to 54 per cent if both companies elected to file a joint return.63 The combined effect of the Australian Corporate Tax rate of 45 per cent and the treaty rate of 15 per cent on dividends was an overall Australian tax rate on dividends flowing from a subsidiary to a parent company of 53.25 per cent.64 In these circumstances the effect of the US indirect foreign tax credit would have been that very little additional US tax would have been payable when an Australian subsidiary paid a dividend to its US parent, with McGovern noting that prior to recent rate changes, when the corresponding Australian rate had been approximately 54 per cent, there had been a substantial flow of US capital to Australia.65 McGovern’s understanding was that the United States had not previously agreed to a rate of 15 per cent on parent–subsidiary dividends.66 In McGovern’s view, if Australia had not agreed to the 15 per cent rate or had obtained a higher rate of source taxation of dividends, the Treaty with the United States could have had little or no beneficial effect on capital investment in Australia.67 Imposing a uniform rate of 15 per cent on dividends was clearly perceived to be a key benefit of the Treaty by promoting US non-portfolio investment without creating the ‘Treasury effect’. Undistributed Profits Tax Article VIII stated that the Australian undistributed profits tax on private companies was the amount that would have been assessable if Articles VI(1) and VII(1) (which imposed limitations on source taxation of dividends) had 60 61 62 63 64 65 66 67

ibid 10–12 and particularly paras 77 and 90. ibid 11, para 84. ibid 11, para 85. ibid 11, para 80. ibid 11, para 81. ibid 11, para 82. ibid 12, para 90. ibid 12, para 92.

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not been included in the Treaty. An equivalent provision had been included in the 1946 Australia–United Kingdom Double Taxation Treaty. McGovern pointed out that undistributed profits tax in 1952 was calculated as though the undistributed profits were distributed as dividends. Hence the Article meant that the reductions in source taxation of dividends in Articles VI and VII did not operate to reduce the undistributed profits tax payable at source. McGovern commented that the sole purpose of Article VIII was to protect Australian revenue.68 At the time the United States also imposed an accumulated earnings tax on corporations (other than personal holding companies, foreign personal holding companies and tax exempt corporations) and imposed an undistributed profits tax on personal holding companies. US shareholders in foreign personal holding companies were required to include in their gross income the amount they would have received as a dividend if their share of the foreign personal holding company’s income had been distributed to them as dividends. While these taxes were calculated on a different basis to the Australian undistributed profits tax they reflected a shared understanding between Australia and the United States of problems associated in classical corporate-shareholder tax systems with the avoidance of shareholder tax through accumulations of profit at the corporate level.69

68 ibid 12, paras 94–96. Undistributed profits tax was amended by the Income Tax and Social Services Contribution Assessment Act (No 3) 1952, the Bill for which was introduced into Parliament on 18 September 1952. The effect of the amendments was that from the year ending 30 June 1952, ITAA 1936 Pt III Division 7 imposed tax on the undistributed profits of private companies after allowing a deduction of a retention allowance. For the 1951–1952 year, undistributed profits tax was levied at a flat rate of 10/- in the £ or 50%. Undistributed profits tax as it applied in the 1951–1952 year of income is discussed in Challoner and Collins, n 48 above, paras 725–79. At the time McGovern was writing the rate of undistributed profits tax on private companies was based on the tax that would have been payable by its shareholders if a distribution had been made. Hence the drafting of Art VIII reflects a concern which would have applied prior to the 1951–1952 year, namely that, as the rate of tax was based on the tax that would have been payable if a dividend distribution had been made, the limitations on source taxation of dividends in Arts VI and VII of the Treaty would have applied to undistributed profits tax in the absence of Art VIII. Undistributed profits tax on private companies as it applied prior to the 1951–1952 year is discussed in JAL Gunn, OE Berger, JM Greenwood and RE O’Neill, Gunn’s Commonwealth Income Tax Law and Practice, 2nd edn (Sydney, Butterworth & Co (Australia) Ltd, 1948) para 1212. Undistributed profits tax on public companies had been repealed in 1951. 69 United States accumulated earnings tax, undistributed profits tax on personal holding companies and the treatment of undistributed profits of foreign personal holding companies as they stood at this time are discussed in Boris I Bittker, Federal Taxation of Corporations and Shareholders, 1st edn (Hamden, CT, Federal Tax Press, 1959) ch 6. Liability for accumulated earnings tax depended on a finding that the corporation was formed for the purpose of avoiding income tax on its shareholders by accumulating earnings rather than distributing them as dividends. That earnings and profits were allowed to accumulate beyond the ‘reasonable needs of the business’ was determinative of this purpose unless the corporation proved the contrary through a preponderance of evidence. Accumulated earnings tax was imposed at the rate of 27.5% on the first US$100,000 of accumulate income and at the rate of 38.5% on accumulated income above US$100,000. Accumulated income was defined as the corporation’s

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Cultural Royalties The treatment of royalties under the Treaty differed from the treatment given to them under the 1946 Australia–United Kingdom Double Taxation Treaty and provides an example of Australia arguing that the treatment in the earlier Treaty should be distinguished. McGovern indicated that initially the United States had argued for residence taxation of all royalties, including industrial royalties.70 Australia had agreed to taxation of cultural (other than film) and industrial (but not mineral) royalties on a residence basis in the 1946 Treaty. McGovern estimated that taxing all royalties on a residence basis in the Australia–United States context would have produced an annual Australian revenue loss of £350,000.71 Australia had argued that the 1946 Australia–United Kingdom Treaty was distinguishable as UK businesses, unlike US businesses, did not frequently exploit their patents by granting licences to Australian residents. As a result no great Australian revenue loss had resulted from the royalty Article in the 1946 Treaty. The Australian delegation had pointed out that a £350,000 per annum revenue loss was likely to be far in excess of what the Australian Government was willing to concede.72 When pressed, the United States delegation withdrew their insistence on residence basis taxation of industrial royalties but continued to insist on residence basis taxation for cultural royalties.73 As a result Australia would continue to tax industrial royalties on a source basis while the United States would give a foreign tax credit for the Australian tax, thus bearing the cost of relieving international juridical double taxation.74 McGovern pointed out that Article VIII would not apply where a resident of one of the countries carried on business through a permanent establishment in the other country. Nor, consistently with the 1946 Australia–United Kingdom Double Taxation Treaty, did the Article apply to royalties and other payments relating to motion picture films.75 taxable income minus the dividends paid deduction and an accumulated earnings credit under which a corporation was permitted to accumulate US$100,000 during its lifetime. Undistributed profits tax on personal holding companies was imposed at the rate of 75% on the first US$2,000 of the company’s undistributed personal holding company income and at the rate of 85% thereafter. A company’s undistributed personal holding company income was its taxable income less dividends paid and some other adjustments. Companies were able to pay dividends after their undistributed personal holding company tax liability had been determined and to then obtain a refund of the tax paid. US shareholders in foreign personal holding companies included their proportionate share of the undistributed profits of the foreign personal holding company in their gross income. 70 71 72 73 74 75

McGovern, n 30 above, 15, para 124. ibid 15, para 124. ibid 16, para 125. ibid 16, para 126. ibid 16, para 127. ibid 16, para 131.

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Mineral Royalties Article XII taxed royalties for minerals and other natural resources on a source basis. No Article in the 1946 United Kingdom–Australia Treaty dealt with mineral royalties. McGovern considered that this meant that, under that Treaty, such income could be taxed by the source country with the residence country giving a foreign tax credit to relieve double taxation.76 The main function of Article XII was to ensure that the country of source only levied tax on a net basis on mineral royalties.77 At the time Australia taxed royalties on a net basis78 but the United States imposed a 30 per cent gross basis withholding tax on rents and royalties.79 Article XII permitted Australian residents deriving mineral royalties from the United States to continue to be taxed on a 30 per cent gross withholding tax basis or to lodge a return claiming expenses and to have tax imposed at a rate appropriate to the net income.80 McGovern commented that the Article favoured Australia and was considered satisfactory.81 Tax Credits Article XVI obliged the residence country to allow a foreign tax credit in respect of income derived in the source country. The limit of the credit was the lower of the tax in the source country or the tax payable in the residence country. McGovern commented that the Article corresponded, in principle, with the equivalent Article in the 1946 Australia–United Kingdom Treaty but there were significant differences in the drafting due to differences in the taxing codes of the countries concerned.82 The United States proposed to allow such credits as its own laws in operation as at the date of signature permitted. McGovern commented that this would ensure that the United States would not in the future impose a less favourable basis for granting credits for Australian tax.83 McGovern also pointed out that ‘Article XXI would require the United States to allow, in 76

ibid 16, para 134. ibid 16, para 135. 78 ibid 17, para 136. In 1952, ITAA 1936 s 26(f) included ‘any amount received as or by way of royalty’ in a taxpayer’s assessable income. Jurisdictional limits were not expressly stated in s 26(f). Expenses relevant to the derivation of royalty income were allowable as deductions under ITAA 1936 s 51(1). Although no withholding tax applied to payments of royalties to non-residents, under ITAA 1936 s 256(1) the Commissioner could require the payer to retain an amount from the royalty in respect of tax due or which might become due by the nonresident. Section 256(1) as it applied in 1952 is discussed in Challoner and Collins, n 48 above, para 1365. 79 McGovern, n 30 above, 17, para 137. 80 ibid 17, para 138. 81 ibid 17, para 139. 82 ibid 18, para 151. 83 ibid 18, para 152. 77

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respect of Australian income, any liberalized basis of credit which it may adopt in the future’.84 McGovern pointed out that, as Article XVI would not apply where income was taxed in only one of the countries, Australia would not allow a credit for exempt foreign source income as no double taxation would, in fact, exist.85 Hence, the Article would have little or no effect on Australian revenue, except in the case of dividends received by individuals who received a foreign tax credit for withholding tax, but it would bind the United States to continue to allow credits.86 Article XVI also contained source rules for remuneration for services and which deemed film profits and profits from insurance with non-residents which were taxed in Australia under specific provisions to have an Australian source. Both source rules were consistent with the 1946 Australia–United Kingdom Treaty. McGovern commented that the former rule would assist in the application of the credit provisions87 and that the latter rule was inserted because of Australia’s representations and would ensure that the United States granted an appropriate credit for Australian tax assessed under the specific provisions and placed no obligations on Australia.88 McGovern considered that the credit provisions as they applied to undistributed profits tax were not entirely satisfactory.89 Australian undistributed profits tax would be credited by the United States against US tax on the profits of the company. In situations where Australia would be levying the Corporate Tax and the undistributed profits tax, the overall limitation on the US foreign tax credit might mean that the full amount of the Australian tax paid would not be allowed. When profits which had been subject to undistributed tax were distributed as a dividend Australia did not, in effect, tax the dividend and hence the United States would tax the whole of the dividend without allowing any credit.90 McGovern’s view was that undistributed profits tax was, in effect, a substitute for the tax on the ultimate dividend. Hence Australia had argued that the United States should treat it in this way in granting credits. The United States delegation had declined to grant the point but it was known that Canada was pressing the United States on ‘an almost identical matter’. McGovern did not consider that the issue would justify holding up the treaty but, if there were to be further

84 ibid. Article XXI of this draft read as follows: ‘The provisions of this Convention shall not be construed to restrict in any manner, any exemption, deduction, credit or other allowance now or hereafter accorded by the laws of one of the Contracting States in the determination of the tax payable in that State.’ 85 ibid 18, para 154. 86 ibid 19, para 158. 87 Ibid 18, para 155. 88 ibid 18 para 156. 89 ibid 19 para 159. 90 ibid 19 para 160.

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discussions, then it might be appropriate to reopen the issue with a view to reversing the United States’ attitude.91 Reciprocal Collection of Taxes Article XVII required each country to collect on behalf of the Treaty partner taxes that were due to the Treaty partner because of incorrect allowance of a concession provided for in the Treaty. McGovern considered that the issue would arise principally in relation to the concessional rate of tax of 15 per cent on dividends under the Treaty. A Canadian resident could, in the absence of the Article, take advantage of this concession by having the dividend paid to an address care of a US bank or sharebroker and pay Australian tax at the treaty rate of 15 per cent instead of paying Australian tax as high as 35 per cent on dividends received. In corresponding circumstances, the United States would suffer the loss of revenue.92 McGovern’s letter to Fadden contains the following general comments in relation to the draft Article: The draft Article would involve a number of legal difficulties and will, doubtless, require revision. It was, however, included in the draft as an acknowledgement of a principle for the consideration of the two Governments. The Article is advanced as a matter of principle and with the knowledge that its form of expression and maybe the means of its implementation may raise a number of problems for examination by the legal authorities.93

No equivalent Article had been included in the 1946 Australia–United Kingdom Double Taxation Treaty and the United Kingdom had successfully resisted United States’ requests for the inclusion of an equivalent provision in the 1945 United States–United Kingdom Double Taxation Treaty.94 Exchange of Information Article XVII was an exchange of information Article. McGovern commented that no information which would disclose a trade secret or trade process could be exchanged and that the secrecy provisions of each country would prohibit disclosure of information obtained from the other country.95 A comparable provision had been included in the 1946 Australia–United Kingdom Treaty and McGovern regarded it as being required for the 91

ibid 19 para 161. ibid 19 para 163. 93 ibid 19 paras 165–66. 94 See the discussion of this aspect of the negotiation of the 1945 United States–United Kingdom Double Taxation Treaty in John F Avery-Jones, ‘The History of the United Kingdom’s First Comprehensive Double Taxation Agreement’ [2007] British Tax Review 211, 239. 95 McGovern, n 30 above, 19–20, para 167. 92

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satisfactory operation of any treaty that might be entered into with the United States.96 In fact, the provision was identical to the exchange of information Article in the 1946 Australia–United Kingdom Treaty. It is interesting that neither Australia nor the United States appears to have pressed for a broader exchange of information Article. The United States had originally wanted a broader Article in its 1945 Treaty with the United Kingdom97 and Australia in negotiating its 1946 Treaty with the United Kingdom had unsuccessfully sought to extend the purposes for which information could be exchanged but had successfully broadened the persons to whom disclosure could be made. As Australia had eventually come to the conclusion in the 1946 negotiations that the provision was adequate for its needs, it possibly decided to not press for any change from the Article. It is also notable that, while the Article appears to have been regarded as normal and required, there is no indication in any of the correspondence that it was regarded as being one of the key benefits of a taxation treaty. Other Provisions Article XIX was the equivalent of what is now the mutual agreement Article in the OECD Model Treaty. McGovern indicated that Article XIX had been requested by the United States delegation who regarded it as a ‘desirable gesture to taxpayers’.98 Although there was no comparable provision in the 1946 Australia–United Kingdom Treaty, its inclusion was not opposed by the Australian delegation as it imposed no obligation beyond consultation by the taxation authorities.99 Article XX authorised the taxation authorities in the two countries to consult directly with each other (as opposed to consultation at the taxpayer’s request) for the purpose of giving effect to the Treaty. There had been no equivalent Article in the 1946 Australia–United Kingdom Treaty but communication had taken place and was considered to be essential for the smooth carrying out of the obligations under that Treaty. In McGovern’s view, the Article was not essential but it had been requested by the United States delegation and was considered desirable.100 Article XXI provided for the continuation of exemptions, deductions, credits and other allowances and, in the event that more liberal provisions were introduced into either country’s domestic law, for the new provisions to apply. McGovern commented that the Article would have little effect on Australia but was considered desirable in relation to tax credits granted by the United States.101 96 97 98 99 100 101

ibid 20, para 168. See the discussion in Avery-Jones, n 94 above, 237–39. McGovern, n 30 above, 20, para 170. ibid 20, para 171. ibid 20, paras 173–74. ibid 20, para 177.

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Australian Cabinet Decision On 3 June 1952, the draft Treaty (together with a draft Treaty on Gift and Estate Duty) was submitted to the Australian Cabinet which decided: (a)

that the Government should enter into agreements with the United States of America for the relief of double taxation by the two countries in respect of income tax, estate duty and gift duty; (b) that the proposals outlined in the Treasurer’s submission and in the supporting documents should be the basis of the agreements with the United States. The supporting documents included McGovern’s memorandum to the Treasurer dated 15 April 1952.102

Australian Second Draft Treaty McGovern sent the first draft of the Treaty to the Deputy Commissioners in each Australian State. Extensive written comments were made by each Deputy Commissioner.103 In March 1952, a memorandum titled ‘Australia– United States Draft Income Tax Agreement: Matters Requiring Attention’ was prepared in Canberra evidently by the Australian Taxation Office Central Office.104 McGovern advised Fadden on 21 November 1952 that an Australian review of the draft had disclosed that a ‘considerable number of detailed matters will require further consideration’. McGovern regarded the more important of these as relating to: (a) credits; (b) the rate of tax on dividends; (c) collection of tax; (d) shipping and aircraft profits; and (e) governmental remuneration.105 In addition there were ‘some 30 to 40 matters of detail’ on which McGovern considered further face to face negotiation would be desirable.106 He recommended that the United States be advised that Australia was prepared to sign a treaty on the broad lines discussed by the officials at their meeting in Canberra in March 1952 and to indicate that Australia would be willing to have the remaining matters discussed between officials with a view to preparing a document to be dealt with as early as practicable in the new year. McGovern suggested that Fadden might point 102 The terms and date of the Cabinet resolution are set out in McGovern to Fadden, 21 November 1952, ATO file, Pt 4, p 1. Copies of the Cabinet submission are contained in NAA, ATO file, Pt 3, and in NAA, External Affairs file, Pt 4. 103 This correspondence is contained in NAA, ATO file, Pt 3. 104 ‘Strictly Confidential, Australia–United States Draft Income Tax Agreement–Matters Requiring Review’, NAA, ATO file, Pt 4, 94–99. 105 McGovern to Fadden, n 102 above, 1–4. 106 ibid 4.

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out that senior Australian taxation officials would be visiting Canada in about April 1953 and that it would be possible for them to visit Washington for negotiations either before or after their visit to Canada.107 McGovern then wrote to the Commonwealth Solicitor General (Kenneth Bailey) requesting that the draft be examined and invited comments on legal and drafting aspects which might require further consideration.108 Bailey’s reply indicated that he had arranged for HFE Whitlam, who had been involved in drafting the 1946 Treaty with the United Kingdom, and who was still a consultant to the Department, to take primary responsibility for examining the Treaty from a legal viewpoint. Whitlam would be available for discussions with officers of the Australian Taxation Office and would confer with the Parliamentary Draftsman and the Crown Solicitor. Bailey also indicated that he would personally be available for consultation at any time.109 A second, undated, draft of the Treaty was then prepared in Australia. The draft also included comments (evidently by the drafter) on the changes that had been made from the first draft.110 While the drafter made interesting comments on many of the changes in the second draft, only changes more relevant to this chapter will be discussed here. Article II: Interpretation Several changes were made to this Article. The more significant of these were as follows. Definitions of ‘Resident of Australia’ and ‘Australian Resident’ A definition of ‘resident of Australia’ was not included in the first draft. The definition in the second draft was that the term ‘has the meaning which it has under the laws of Australia relating to Australian tax’. The definition was identical with the definition of ‘resident of Australia’ 107

ibid 4–5. McGovern to Bailey, 24 November 1952, NAA, ATO file, Pt 4. 109 Bailey to McGovern, 25 November 1952, NAA, ATO file, Pt 4. 110 The correspondence from Bailey to McGovern, discussed in the text accompanying n 109 above, would indicate that HFE Whitlam was primarily responsible for commenting on the first draft from a legal and drafting viewpoint. It is not clear, however, that Whitlam made the actual drafting changes in the second draft. Clearly the principal assistant parliamentary draftsman C Comas drafted Art XVII of the second draft as Comas sent JQ Ewens (the Parliamentary Draftsman) a memorandum of 1 April 1953 on a draft of Art XVII which he had prepared following a conference between Comas, Ewens, DD Bell (the Crown Solicitor) and Mr Belcher (the Assistant Deputy Commissioner of Taxation). The draft of Art XVII attached to the memorandum is identical with Art XVII in the second draft of the Treaty. The memorandum and draft Art XVII are contained in NAA, ATO file, Pt 4. The second draft is also contained in NAA, ATO file, Pt 4. Hereafter, the second draft will be referred to as ‘the second draft’ and references will be given to page numbers within the second draft itself. 108

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in the 1946 Australia–United Kingdom Treaty. The drafter commented that the definition was included ‘to ensure that it has the same meaning as in Commonwealth income tax law’.111 As was the case with the 1946 Australia–United Kingdom Treaty, the term ‘Australian resident’ was separately defined, although slightly more concisely than in that Treaty, in terms which excluded persons who were residents of the United States for Treaty purposes. Hence, under the second draft, as was the case with the 1946 Australia–United Kingdom Treaty, a dual resident could not be an ‘Australian resident’ (or, for that matter, a ‘United States resident’) but could be a ‘resident of Australia’. Definition of ‘Industrial or Commercial Profits’ The second draft expressly excluded ‘income from the operation of ships or aircraft’ from the definition of ‘industrial or commercial profits’. Income in the form of dividends, interest, rent, royalties and management charges and remuneration for personal services had been excluded from the definition in the first draft. Capital gains were not expressly excluded from the definition in either draft. The drafter commented that the exclusion of income from the operation of ships or aircraft from the definition was ‘in order to ensure that Article III (Industrial or Commercial Profits) does not apply to those profits’.112 Article V of the second draft provided for exclusive taxation of shipping and aircraft profits on a residence basis. The exclusion of such profits from the definition of ‘industrial or commercial profits’ was, as will be seen below, aimed at simplifying the drafting of Article V but both the exclusion and the original drafting of Article V reflected a concern that, in the absence of express exclusions, shipping and aircraft profits could be taxed as part of industrial or commercial profits despite the exclusive residence basis of taxation adopted in Article V. Definition of ‘Permanent Establishment’ The second draft changed the reference to ‘substantial equipment’ from ‘or the use of substantial equipment or machinery’ to ‘a place where or in the locality of which—(i) operations involving the use of substantial equipment or machinery are conducted; or (ii) substantial equipment is installed for the purposes of a contract’. The drafter’s comment on this change was merely, ‘expression “use of substantial equipment” expanded and broadened’.113 The memorandum of March 1952 indicates that another consideration motivating the change was that ‘a United States company may fulfil 111 112 113

Second draft, drafter’s comments, 6. ibid. ibid.

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a contract to erect, say, a powerhouse, by having machinery manufactured in or delivered to Australia and then installing it’. The memorandum noted that the US company would not make ‘use’ of the plant and hence might not have a permanent establishment in Australia under the first draft.114 This would explain the express reference to substantial equipment being ‘installed’ in the second draft. Article III: Industrial or Commercial Profits The first change made by the second draft to the industrial or commercial profits Article was to redraft paragraphs (1) and (2) so that ‘profits’ rather than the entity that made them were exempted. The drafter commented, ‘This accords with the U.K.–Australia agreement and with the Commonwealth income tax law, which exempts income, not businesses’.115 A second change amended paragraphs (1) and (2) so that the reference to a permanent establishment being ‘situated therein’ now referred, in paragraph (1), to a permanent establishment ‘in the United States’ and, in paragraph (2), to a permanent establishment ‘in Australia’. The drafter commented that, ‘It is not desired to imply that a permanent establishment needs to be situated at one site’.116 A third change concerned the saving provision in paragraph (5) of the Article preserving the operation of discretionary powers in domestic law which applied in non-arm’s length transactions where information was insufficient to determine the profit of a permanent establishment. The change involved the omission of the words ‘in accordance with the foregoing provisions of this Article’. The drafter merely commented that the omitted words were ‘not included in the U.K.–Australia agreement’.117 Article IV: Inter-Connected Companies/Associated Enterprises The second draft amended the deemed source rule in the inter-connected companies Article. In the first draft the deemed source rule read as follows: (2) Profits included in the profits of an enterprise of one of the Contracting States under paragraph (1) of this Article shall, unless contrary to the laws of that Contracting State, be deemed to be income derived from sources in that Contracting State and shall be taxed accordingly. (emphasis added)

114 115 116 117

Strictly Confidential, n 104 above, 2. Second draft, drafter’s comments, 8. ibid. ibid.

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In the second draft, paragraph (2) of Article IV was replaced by the following paragraphs: (2) Subject to the provisions of Article XXI of this Convention, profits included in the profits of an enterprise of one of the Contracting States under paragraph (1) of this Article shall be subject to tax by that State as income of that enterprise. (3) For the purposes of Article XVI (credits) of this Convention, profits taxed in accordance with this Article shall be deemed to be income derived from sources in the Contracting State which imposes that tax.

Although the United States had pressed for retention of the words ‘unless contrary to the laws of that Contracting State’118 the drafter commented: The United States … cited the example of a U.S. parent company with an Australian subsidiary trading in both Australia and New Zealand. If Article IV were to be applied, Australia would, in the absence of the words quoted, tax an adjustment made in relation to the New Zealand operations. This would follow because the adjustment would be deemed to have an Australian source. But the adjustment might also be taxed in New Zealand and, in equity, section 23(q) should apply. However, s 23(q) does not apply to income having an Australian source. The words ‘unless contrary to the laws of that Contracting State’ seem to nullify the whole of the paragraph and the two paragraphs proposed are drafted to concede the U.S. point while at the same time permitting Australia to tax an Australian subsidiary on adjustments made to ex-Australian activities, if the adjusted amount is not taxed in the country of origin. For the purposes of credit, the adjustment will be deemed to have its source in the country which makes the adjustment.119

Article VII: Dividends Here the drafter indicated that two policy issues required resolution before the draft could be revised. These were: (a) whether the 15 per cent tax envisaged should be on gross dividends, on dividends included in taxable income or on gross dividends less direct deductions and a proportion of concessional deductions. The same question had been raised by the ATO Memorandum which argued that, ‘The present Australian method of determining the tax payable is to have different rates of tax on various income brackets. Article VII should not specify a maximum rate of 15% and so leave a lower rate to be charged on the lower income brackets—that is, it should be an overall rate not exceeding 15%’.120 The comment reflects the fact that, at the time, Australia still assessed dividends paid to non-residents on a net assessment basis rather than on a gross withholding basis. 118 119 120

ibid 10 and Strictly Confidential, n 104 above, 3. Second draft, drafter’s comments, 10. ibid 12 and Strictly Confidential, n 104 above, 4.

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Article VIII: Australian Undistributed Profits Tax The second draft made no substantive changes to this Article but the drafter commented that, as Australian undistributed profits tax was now at a flat rate, the Article had become redundant. The same point had been made in the ATO Memorandum.121 The drafter commented that retention of Article VIII could only be justified as protection against a possible return to the previous method of assessing undistributed profits tax which had regard to the tax that shareholders would have paid if the undistributed profit had been distributed.122 Article XI: Cultural Royalties The second draft contained a complete redraft of the royalty Article. The royalty Article in the first draft was: Royalties for the right to use copyright of, or in respect of the right to produce or reproduce, any literary, domestic, musical or artistic work (but not royalties or other payments relating to motion picture films) derived from sources within one of the Contracting States by a resident of the other Contracting State not engaged in trade or business in the former State through a permanent establishment, shall be exempt from tax by the former State.

The royalty Article in the second draft was: Royalties (not being royalties in relation to motion picture films or the reproduction by any means of images or sound produced directly or indirectly from those films) for the use, production or reproduction of, or the privilege of using, producing or reproducing a literary, dramatic, musical or artistic work in which copyright subsists shall, if derived from sources within one of the Contracting States by a resident of the other Contracting State not engaged in trade or business in the former State through a permanent establishment in that State, be exempt from tax in the former State.

The drafter commented that the basis of the redraft was that it was inappropriate to refer to royalties for the right to use copyright or the right to produce or reproduce. The drafter noted that the right to tax under Division 14 of Income Tax Assessment Act (ITAA) 1936 Part III was preserved by Article XXI and pointed out that the redrafted Article aimed to make it clear that film royalties were not exempt from source basis taxation. An attempt had been made, presumably by the inclusion of the clause ‘or the reproduction by any means of images or sound produced directly or indirectly from those films’,

121 Second draft, drafter’s comments, 12 and Strictly Confidential, n 104 above, 4. The comments reflect the effect of amendments to Undistributed Profits Tax enacted in 1952, as discussed in n 68 above. 122 Second draft, drafter’s comments, 12.

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to cover royalties relating to the adaption of films for television purposes but the drafter indicated that the matter was still being looked into.123 Article XVI: Credits The second draft substituted a new opening clause in paragraph (2) for the original paragraph (2). The original opening clause in paragraph (2) read: (2) Subject to provisions in force in Australia on the date of signature of this Convention and to such provisions (which shall not affect the general principle hereof) as may be enacted in Australia.

The new opening clause read: (2) Subject to any provisions of the law of Australia which may from time to time be in force and which: (a)

relate to the allowance of a credit against Australian tax of tax payable outside Australia; and (b) do not affect the general principle of this paragraph.

The drafter commented that in the original draft the granting of the credit was subject to existing Australian credit provisions, including ITAA 1936 section 45, even if such provisions were contrary to the general principle of the credit Article. The drafter pointed out that section 45 conflicted with the principle of the credit Article in that section 45 would not allow credit for US tax paid by an Australian resident on a dividend paid by a US company out of Australian source profits.124 Section 45 only allowed a credit for foreign tax paid where either: (a) the whole of the dividend was paid out of ex-Australian source profits; or (b) part of the dividend was paid out of ex-Australian source profits. In the latter case the amount of the credit was the amount which bore the same proportion to the credit otherwise allowable as the ex-Australian source profits bore to the total profits of the paying company.125 The drafter commented that the redraft would not permit the application of any Australian provision which affected the general principle of the credit Article. The drafter went on to list the following points for further discussion with United States officials: allowance of Division 7126 (undistributed profits) tax in US assessments of US shareholders; (b) allowance of credit by the United States for tax paid under section 125 (dealing with interest paid by a resident company to a non-resident)127 with

(a)

123

ibid 16. ibid 18. See the discussion of s 45 in 1953 in Challoner and Collins, n 48 above, para 336. 126 See the discussion of Australian undistributed profits tax at the time, n 68 above. 127 ITAA 1936 s 125 provided that companies paying interest to non-residents, other than companies carrying on business in Australia, were taxed at a rate of 30% on the payment and 124 125

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credit being allowed to US residents entitled to the interest which had been taxed under section 125; the basis for allowing credit for provisional tax.128

The issue of crediting Division 7 tax had been raised at the earlier discussions in Canberra with United States officials and the drafter noted that the United States was unlikely to concede this point.129 Article XVII: Assistance in Collection The assistance in collection Article in the original draft read as follows: Each Contracting State shall collect on behalf of the other Contracting State an amount, due to that other State in relation to taxes which are the subject of this Convention, sufficient to ensure that an exemption or reduced rate of tax granted under this Convention shall not be enjoyed by persons not entitled thereto.

The second draft proposed to substitute the following for the original Article: Each of the Contracting States may collect such amounts in respect of taxes, which are the subject of this Convention, imposed by the other Contracting State as are sufficient to ensure that an exemption or reduced rate of tax granted under this Convention by that other Contracting State shall not be enjoyed by persons not entitled to that benefit.

The drafter commented that, at the time of the original draft, Australia indicated to the United States officials that, from Australia’s perspective, the original Article was an expression of an intention and might need to be re-drafted completely and that the form of the Article might need to be determined ‘in the light of constitutional questions and the need, if any, of Australia to give effect to the article by legislation’.130 The drafter pointed out that the re-drafted Article was not mandatory.131 The intention that the Article not be mandatory can be seen by the substitution of the word ‘may’ for ‘shall’ in the first line. It is also notable that the re-draft omits the phrase ‘due to the other State’ and instead refers to taxes, the subject of the Treaty, which are ‘imposed by the other State’. The intention of the change of wording here would appear to be to avoid an implied admission that the taxes referred to were actually due to the other state.

were entitled to deduct the tax from the interest they paid. The provision did not apply where the paying company could establish to the satisfaction of the Commissioner that the creditor could enforce payment of the interest without deduction of tax at source. See the discussion in Challoner and Collins, n 48 above, paras 869 to 873. 128

Second draft, drafter’s comments, 18. ibid. 130 This is consistent with the view expressed in Challoner and Collins, n 48 above, para 327 that under English private international law no action lies for the recovery of foreign taxes. 131 Second draft, drafter’s comments, 19. 129

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Article XXI: Savings Provision The second draft amended this Article to read: The provisions of this Convention shall not: (a) [as per the original draft]; or (b) affect the operation of Division 14 and 15 of Part III of the Australian Income Tax and Social Services Assessment Act 1936–1953 (or that Act as amended from time to time) relating to film business controlled abroad and insurance with non-residents, or the corresponding provisions of any statute substituted for that Act.

The drafter commented that a proviso from Article III(3) had been transferred to Article XXI to ensure that neither Article III(3) nor Article XI would impinge on Division 14.132 The drafter also commented that paragraph (a) might cause Article IV (dealing with inter-connected companies) to be ineffective except to permit section 136 of ITAA 1936 to continue to operate. The drafter’s reasoning was that paragraph (a) might prohibit Australia from taxing any income which it did not now tax.133 The drafter’s concern may have been that the absence of Australian tax under domestic law in the circumstances dealt with in Article IV(1), other than under section 136, might be construed as an ‘exemption’ for the purposes of Article XXI(a). Alternatively, the drafter may have thought that the calculation of profit under domestic law in the absence of Article IV(1) and section 136 may have involved a ‘deduction’ for the purposes of Article XXI(a). In addition, the drafter commented that paragraph (a) in conjunction with Article IV(2) as revised might require Australia to continue to apply the exemption in ITAA 1936 section 23(q) (dealing with foreign source income of residents not exempt from tax in the source country) to the adjustments made in Article IV notwithstanding a subsequent repeal of section 23(q).134 It appears that the drafter considered that a resident company that was an interconnected company for purposes of Article IV might be able to argue that the section 23(q) exemption should continue to apply in calculating its profit

132

ibid 21. ibid. ITAA 1936 s 136 empowered the Commissioner of Taxation to determine the taxable income of a business carried on in Australia that was either: (a) controlled principally by non-residents; (b) carried on by a company in which the majority of shareholders were non-residents; or (c) carried on by a company which (directly or indirectly) held the majority of shares of a non-resident company. The Commissioner’s powers could be exercised where it appeared to the Commissioner that the business either produced no taxable income or less taxable income than might otherwise be expected of a business of that nature. On appeal from a determination by the Commissioner, Australian Boards of Review had power to make assessments under s 136. 134 ibid. 133

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under Article IV(2) notwithstanding a subsequent repeal of section 23(q) on the basis that the Convention could not be construed as restricting the operation of the existing exemption. Only in determining and taxing the profit of the company on an arm’s length basis (without taking into account the section 23(q) exemption) under Article IV(2) could it be said that the Convention was restricting the exemption.

Negotiations in Washington 1953 Following correspondence between McGovern and King, arrangements were made for an Australian delegation comprising McGovern, MJ Belcher (Assistant Deputy Commissioner of Taxation) and DD Bell (Crown Solicitor) to visit Washington, New York and Ottawa in March and April of 1953 for the purpose of discussions on the United States and Canadian Treaties and to attend the meeting of the United Nations Fiscal Committee. McGovern was given plenipotentiary powers to sign the Treaties.135 On 28 April 1953, McGovern advised that the text of the Treaties had been settled at Washington and that only formal steps in preparation of the documents for approval and signing remained to be completed.136 The Treaties were signed on 14 May 1953 by Sir Percy Spender (Australian Ambassador to the United States) and Mr Bedell Smith (United States Acting Secretary of State).137 The President of the United States submitted the Treaty to the United States Senate for ratification on 3 June 1953.138 The United States Senate ratified the treaty on 19 July 1953.139

135 Several items of correspondence in combination support the statements made in the text. These are: Fadden to Casey, 5 March 1953; GA Jockel, for a Secretary, Department of External Affairs, Memorandum for Commissioner of Taxation, Department of the Treasury, 19 March 1953; Copy, Casey to His Excellency Mr Pete Jarman, Ambassador of the United States of America, Canberra, 12 March 1953; McGovern to The Secretary, Department of External Affairs, 27 March 1953; J Plimsoll (Acting Secretary) Memorandum for the Australian Embassy, Washington, 1 April 1953; Copy, Note, Department of External Affairs to Embassy of the United States of America, 31 March 1953; Cablegram, Department of External Affairs to Australian Embassy, Washington, 14 April 1953. All of these documents are contained in NAA, ATO file, Pt 4. 136 Cablegram, Australian Consulate General, New York, for Mair, 28 April 1953, NAA, ATO file, Pt 4. Correspondence from Mair to the Commonwealth Treasurer on 29 April 1953 indicates that the sender of the cable was McGovern. 137 ‘For Press, Embargo: Not for release before midnight Thursday, 14 May 1953, Tax Convention with USA’, Cablegram, from Australian Embassy, Washington to Minister and Deptartment EA, Treasury, Taxation, PM’s, 14 May 1953; and Department of State, For the Press, No 261, Signing of Three Tax Conventions with Australia, 14 May 1953. All these documents are contained in NAA, ATO file, Pt 4. 138 Cablegram, from Australian Embassy, Washington to Minister and Deptartment EA, Treasury, Taxation, PM’s, 3 June 1953. Copy contained in NAA, ATO file, Pt 4. 139 King to McGovern, 21 July 1953, NAA, ATO file, Pt 4.

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C John Taylor FINAL VERSION OF THE TREATY

The Australian Taxation Office file on negotiation of the Treaty currently does not contain any document forwarding the second draft of the Treaty to United States officials. Nor does the file contain any account of the content of the negotiations. The author has been unable to locate any account of the content of the negotiations in files relating to the Treaty in the United States National Archives and Records Administration. Hence it is necessary to make inferences as to the content of the negotiations by comparing the final version of the Treaty with the first and second drafts. The following comparison will be confined to the Articles previously discussed in this chapter. Article II: Interpretation Definitions of ‘Resident’ The definitions of ‘resident of Australia’ and ‘Australian resident’ and the definition of ‘United States resident’ followed the second draft. As a consequence the words ‘for the purposes of Australian tax’ were omitted at several points throughout the final version of the Treaty. Definition of Industrial or Commercial Profits The change made in the second draft to the definition of ‘industrial or commercial profits’ was incorporated into the final version of the Treaty. Definition of Permanent Establishment The stylistic changes to the ‘substantial equipment’ provision made in the second draft were not found in the final version of the Treaty which corresponds with the first draft except that it included a reference to substantial equipment being ‘installed’. Thus, the final version of the Treaty accommodated the principal concern about the substantial equipment provision expressed in the memorandum of March 1952. Article III: Industrial or Commercial Profits The first change made in the second draft was not adopted in the final version of the Treaty which followed the first draft in this respect. The second change was adopted in the final version of the Treaty. Presumably the Australian argument mentioned in the drafter’s notes, namely, to avoid an implication that a permanent establishment needed to be situated at one site, was effective here. The third change was implemented by omitting the words, ‘in accordance with the foregoing provisions of this Article’.

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The final draft differed from both the first and second drafts in that, understandably, the proviso to paragraph (3) which applied the principle underlying ITAA 1936 section 38 was confined in its operation to determinations by Australia. Article IV: Inter-connected Companies The final version of the Article differed from both the first and second drafts. Consistently with the second draft, the words ‘unless contrary to the laws of the contracting state’ were omitted from the Article. The difficulty identified by the drafter in relation to paragraph 2 of the first draft, namely, that section 23(q) of ITAA 1936 could not apply in situation where in equity it should, because of the deemed source rule in the Article, was dealt with by deleting the deemed source rule and by making the paragraph subject to Article XX (which preserved domestic law exemptions, credits, deductions and allowances and Divisions 14 and 15 of the ITAA 1936). The final version of paragraph (2) of the Article read as follows: (2) Profits included in the profits of an enterprise of one of the Contracting States under paragraph (1) shall, subject to the provisions of Article XX of this Convention, be deemed to be income of that enterprise and shall be taxed accordingly.

Article VII: Concessional Rate of Tax on Dividends Paragraph (1) of Article VII (dealing with Australian tax on dividends) differed from both the first and second drafts by adding the words ‘of the dividend’ after ‘15 percent’. The addition only related to Australian tax on dividends and appears to imply that the tax would be 15 per cent of the gross dividend thus resolving one of the questions raised in the Australian drafter’s comments. Article VIII: Undistributed Profits Tax The final version of Article VIII differed from both the first and second drafts by extending the Article to cover US undistributed profits tax. The extension is not the subject of specific comment in either the US or Australian files that have been examined by the author. It is conceivable that the United States may have asked for the Article to be extended to its undistributed profits tax in case the United States also changed to the former Australian method of calculation at some future time. Article X: Cultural Royalties Article X adopted the wording of the second draft.

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Article XV: Tax Credits The amendment to paragraph (2) of the Article proposed in the second draft (to overcome difficulties with the application of ITAA 1936 section 45) was adopted in the final version. No changes were made to either the first or second draft versions of the Article to deal with the issues (credit for US shareholders for Australian undistributed profits tax, credit for US residents for Australian tax paid under ITAA 1936 section 125 and basis for allowing credit for provisional tax) raised in the drafter’s comments on the Article. Article XVI: Assistance in Collection The assistance in collection Article differed from both the first and second drafts. As was the case with the equivalent Article in the first draft, it used the mandatory verb ‘shall’ instead of the permissive verb ‘may’ used in the second draft. The Article in the final draft read as follows: Each Contracting State shall, so far as it is practicable to do so, collect, and pay to the other Contracting State amounts equivalent to the amounts due to the other Contracting State by way of taxes which are the subject to this Convention, being amounts the collection of which is necessary in order to ensure that the benefits of exemptions from tax, or of reductions in rates of tax, provided for by this Convention is not received by persons not entitled to that benefit.

Changes from both the previous drafts appear to reflect awareness of technical and practical difficulties associated with collecting tax for the other contracting state and also aim to clarify operational aspects. Practicalities are obviously evident in the insertion of the words ‘so far as it is practicable to do so’. The drafting also reflects the technicality that what was to be collected was an amount equivalent to the tax due to the other contracting state not the tax itself. The obligation now only applied where the assistance in collection was ‘necessary’ to ensure that the benefits of the Convention were not received by persons not entitled to them. In the first two drafts, by contrast, the obligation had applied where assistance in collection was ‘sufficient’ for those purposes. Article XX: Savings Provision for Exemptions, Deductions, Credits and Allowances in Domestic Law By relocating the proviso from Article III(3), the final version of this Article adopted the changes proposed in the second draft but did not make any change to paragraph (a) in response to the drafter’s comments.

Inferences Drawn from Comparing the Final Treaty with the Earlier Drafts With the exceptions of the concessional rate on dividends, the failure to adopt all the suggested changes to the tax credit provisions, and the changes

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made to the assistance in collection Article, all of the changes from the second draft can be regarded as alternative drafting approaches to the problems identified in the drafter’s comments on the second draft. That is, these changes are all consistent with an acknowledgement of the validity of the Australian concern but adopt a different drafting approach to deal with the problem. In the case of the changes to Article VIII dealing with undistributed profits tax, the change acknowledges the validity of the Australian argument by making the Article reciprocal. In the case of the change to the assistance in collection Article, one gets the distinct impression of redrafting being done during the negotiations reflecting the accumulated wisdom of experienced tax administrators. Applying the flat rate of source tax to the gross dividend was inconsistent with Australian domestic law and the ATO Memorandum but was an option that the drafter’s comments had left open. The only other point of substance in which the Australian revisions in the second draft did not carry the day were in relation to the conceptually difficult issue of characterising the Australian undistributed profits tax, tax under ITAA 1936 section 125 and Australian provisional tax for US foreign tax credit purposes.

United States Senate Foreign Relations Committee Report As was the usual practice at the time the Senate Foreign Relations Committee (‘the Committee’) submitted a report on the Treaty to the Senate. Discussion of this report highlights aspects in which the Treaty was consistent with and varied from then current United States taxation treaty practice. The Committee noted, with obvious approval, that the Treaty, unlike some United States Treaties such as the 1945 United States–United Kingdom Double Taxation Treaty, did not contain any provisions for the exemption from US tax of capital gains or taxes on accumulated earnings. The Committee went on to note that the Treaty was substantially identical with United States Treaties then currently in force but drew attention to distinctive features of the Treaty.140 Principal among the unusual features from both the United States and Australian perspective was the flat rate of 15 per cent of source taxation on dividends. The Committee commented: This omission is one to which American taxpayer groups may take exception and, as a matter of fact, several witnesses commented on this point. It is understood, however, that United States representatives in their negotiations with Australia made determined efforts to secure the reciprocal exemption. They were unable to do so because of the Australian position that reciprocal reduction of the tax

140 Tax Analysts, Worldwide Tax Treaties, United States, Australia, Belgium, Senate Foreign Relations Committee Report, (S Exec Rpt No 2, 83-1, 2 July 1953).

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on dividends to 15 percent provides more favorable treatment generally than does the corresponding provision of Australia’s tax convention with the United Kingdom.141

Prior to the Committee’s hearing, this issue had been the subject of correspondence between McGovern and King. McGovern had forwarded a memorandum which explained the context in which the concession of the exemption from source taxation on dividends paid by wholly owned subsidiaries to their parents that Australia had been made in the 1946 Treaty with the United Kingdom. McGovern pointed out that the 15 per cent rate in the Australia–United States Treaty represented a greater concession to dividends other than those paid by subsidiaries than had been made in the Australia–United Kingdom Treaty, where the rate of source taxation on such dividends was reduced by one-half to a rate of 17.5 per cent on dividends paid to UK companies and a rate of up to 37.5 per cent on dividends paid to UK individuals. In addition, difficulties had been experienced in the Australia–United Kingdom Treaty in defining a wholly owned subsidiary (particularly on the question of the appropriate treatment of preference shares in a definition) and that having a preferential rate on dividends paid by wholly owned or 95 per cent owned subsidiaries would mean that such companies would not seek Australian equity investment.142 In reply, King commented that McGovern’s explanation ‘stood me in good stead in the final stages of the income tax convention’.143 The Committee further noted that, in contrast to some other United States Double Taxation Treaties, the reciprocal exemption in the royalty Article in the Australia–United States Treaty did not extend to industrial royalties or film rentals and, without further comment, pointed out that a similar exclusion of film rentals from the reciprocal exemption for cultural royalties was found in the United States’ Treaties with Canada and Finland. Nor did the Australia–United States Treaty, unlike some other United States Treaties, provide for the reciprocal reduction of source taxation of interest. It is reasonably clear from this comment and the general tenor of the Committee’s report that the Committee’s view was that source countries retained full taxing rights in relation to categories of income not specifically dealt with in the relevant Treaty.144 141

ibid. The undated memorandum is titled, ‘Taxation of Dividends Paid by United States Corporations’ and McGovern’s covering letter, McGovern to King, 19 June 1953, both are contained in NAA, ATO file, Pt 4. 143 King to McGovern, n 139 above. It seems likely that the reference to the ‘final stages of the income tax convention’ is to the Senate Foreign Relations Committee hearing at which King appeared. In the next sentence of the same letter King refers to the Senate’s advice and consent to ratification as ‘final action’. 144 Tax Analysts, n 140 above. 142

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The Committee also noted that under both the Australia–United States Treaty and United States–Belgium Treaty (which it was also examining at the same time): the articles providing for the mutual assistance in the collection of taxes extends [sic] only to such cooperation as will insure that the exemption or reduced rates of tax granted under the convention shall not be enjoyed by persons not entitled to such benefits.145

SIGNIFICANCE OF THE 1953 AUSTRALIA–UNITED STATES DOUBLE TAXATION TREATY

From an Australian perspective, the Treaty, while consolidating and refining the structure and some of the distinctive features of the 1946 Australia– United Kingdom Double Taxation Treaty, contained several additional features which were to influence Australian taxation treaty practice for the balance of the period prior to Australia joining the OECD in 1971. The Treaty was itself to be the model for the next two Australian Double Taxation Treaties with Canada in 1957146 and New Zealand in 1960. The basic structure of the Treaty, with industrial or commercial profits being defined in exclusionary terms and with there being no interest Article, no capital gains Article and no ‘other income’ Article was a carry-over from the 1946 Australia–United Kingdom Double Taxation Treaty. The structure was not unique. This approach to defining ‘industrial or commercial profits’ can also be seen in several United States Double Taxation Treaties in the 1940s and 1950s (for example, United States–Canada 1942; United States– New Zealand 1948; United States–Ireland 1948; United States–Germany 1954) but not in all of them (for example, United States–United Kingdom 1945; United States–Netherlands 1948). It is also common for United States Double Taxation Treaties in this period not to contain an ‘other income’ Article. It is reasonable to infer that this structure was one that the United States would agree to even if it might not have asked for it. Other features carried over from the 1946 Australia–United Kingdom Double Taxation Treaty included: (a) the savings provisions in respect of ITAA 1936 section 136, the taxation of film income and the taxation of profits of foreign controlled insurance companies; (b) the approach to dealing with residence issues (although this was enhanced in the case of corporate residence); (c) the provisions quarantining Australian undistributed profits tax from the limitations on source taxation in other distributive 145

ibid. See C John Taylor, ‘The Negotiation and Drafting of the First Australia–Canada Taxation Treaty 1957’ (2013) 61 Canadian Tax Journal 915. 146

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Articles; and (d) the deletion of the phrase ‘same or similar conditions’ from the arm’s length adjustment provisions. Several of the additional features of the Treaty were to become part of Australian taxation treaty practice for more than 30 years. The most important of these was agreeing to a flat 15 per cent gross source tax on all dividends. From an Australian perspective, this rate encouraged the right level of US equity participation in Australian companies without producing the ‘Treasury effect’. The second major development was the broadening of the definition of ‘permanent establishment’, particularly by the inclusion of a ‘substantial equipment’ provision. A third feature that was to continue to be part of Australian treaty practice for an extended period was the express reference either to ITAA 1936 section 38 or to its content in the calculation of industrial or commercial profits. Unlike the case with the 1946 Australia–United Kingdom Double Taxation Treaty, the primary motivation for entry into the Treaty was not to prevent international double taxation but was rather to prevent credit overspill in the United States and to encourage US direct investment in Australia by reducing source basis taxation. Both of these objectives could have been achieved by a comprehensive and unilateral lowering of Australian tax rates but, in the economic and political environment of the early 1950s, the most viable source of additional direct foreign investment in Australia was the United States. Hence, a targeted approach through a bilateral treaty, which minimised revenue cost, was favoured over unilateral and comprehensive rate reductions. Encouraging investment while at the same time minimising revenue cost and the erosion of source basis taxation were again the major policies that influenced both politicians and officials. Australian officials achieved this result through an awareness of: the effects of the interaction of corporate and shareholder tax rates in the two countries with the limitations in the US foreign tax credit system; and by comparing effective rates in the 1946 Australia–United Kingdom Double Taxation Treaty. Australia also managed to retain significant source taxing rights through a broader definition of permanent establishment, source basis taxation of industrial royalties, and preservation of domestic law provisions relating to film business and insurance controlled by non-residents. While most capital exporting countries now exempt foreign non-portfolio income, Australia’s targeted approach in this Treaty can still be of value to developing countries seeking to attract direct foreign investment while preserving source country taxing rights.

9 The Drafting of the 1925 League of Nations Resolutions on Tax Evasion SUNITA JOGARAJAN*

ABSTRACT In 1925, the League of Nations published the Technical Experts’ Report and Resolutions on Double Taxation and Tax Evasion. The measures relating to tax evasion proposed almost 90 years ago, such as automatic exchange of information, bear a remarkable similarity to recent proposals to address base erosion and profit shifting. Surprisingly little is known about the League’s 1925 Report and this chapter remedies the gap in the literature by providing a detailed account of the development of the League’s Resolutions on tax evasion. The chapter demonstrates that many of the concerns and issues raised by the League’s Experts in 1925 are still with us today and that much can be learned from history. The attitudes of various country representatives are telling and the drivers for reform are analogous.

INTRODUCTION We live in an age of industrial complexity and differentiation. In former times property rights were simple, and the little capital that existed was largely owned by the producer. Today not only does the same capitalist invest in different enterprises, not only is the producer often dependent for a part of his capital on sums that belong to others, but the old geographical unity has been dissolved, and there is no necessary connection between the residence of the capitalist and the place where his capital is employed. A system of taxation, therefore, which may have been perfectly just under the older and simpler conditions, may now be entirely inadequate because of the failure of government to take account of these new complications in property rights.1

* 1

I am grateful to John Avery Jones and Richard Vann for their comments. Edwin Seligman Essays in Taxation, 2nd edn (New York, Macmillan, 1895) 95–96.

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The emergence of BEPS [Base Erosion and Profit Shifting] as an issue comes through a change in technology and business practices and is part of globalisation. Globalisation of course is not new. But in the last 20 years, the flow of goods and services between countries and international capital flows has exploded worldwide through the growth of the internet and the relentless march of information technology … we need to recognise that with globalisation come problems and risks. Tax rules designed for a very physical age of steam power and iron are illsuited to a world of intangible transactions occurring in cyber-space. Our rules need to adapt to fit the new reality.2

T

HE TWO QUOTES are more than a century apart but bear the same message: the need to adapt international taxation rules to respond to the global economy and changes in industry. In the sphere of targeting tax evasion, the last 20 years has seen the development of the Convention on Mutual Administrative Assistance in Tax Matters;3 the ‘end’ of bank secrecy;4 the proliferation of tax information exchange agreements;5 and most recently, the adoption of the new standard of automatic exchange of information.6 But these measures are not ‘new’. In fact, they were considered or proposed almost 90 years ago. In 1925, the League of Nations published the Technical Experts’ Report and Resolutions on Double Taxation and Tax Evasion which included similar measures to target tax evasion.7 The Technical Experts’ efforts in developing measures to target tax evasion represent the first collective international attempt to address tax evasion. However, little is known about the development of these Resolutions.

2 Todd McClay, ‘Addressing the Issue of Base Erosion and Profit Shifting by Large Multinational Companies’, paper presented at Deloitte National Tax Conference, Auckland, 22 November 2013. 3 The Convention was developed jointly by the OECD and the Council of Europe in 1988 and first came into force in 1995 for five countries. The Convention came into force for a further 17 countries over the next 15 years and was amended by Protocol in 2010. The Amended Convention or Protocol has been signed by 69 countries and has entered into force for 57 countries: OECD, Jurisdictions Participating in the Convention on Mutual Administrative Assistance in Tax Matters Status (OECD, 17 November 2014), available at www.oecd.org/ctp/ exchange-of-tax-information/Status_of_convention.pdf. 4 OECD, The Era of Bank Secrecy is Over: the G20/OECD Process is Delivering Results (OECD, 2011). 5 The Model Agreement on Exchange of Information in Tax Matters was published by the OECD in 2002 and more than 500 tax information exchange agreements have been concluded since that time: OECD, Tax Co-operation 2010: Towards a Level Playing Field (Paris, OECD Publishing, 2010) 9. Some estimates suggest that more than 800 agreements have now been concluded. 6 OECD, Standard for Automatic Exchange of Financial Account Information: Common Reporting Standard (Paris, OECD Publishing, 2014). In October 2014, 51 countries signed the OECD’s Multilateral Competent Authority Agreement relating to automatic exchange of information, while another 30 countries pledged to join the Agreement from 2018. 7 Double Taxation and Tax Evasion: Report and Resolutions submitted by the Technical Experts to the Financial Committee of the League of Nations (Geneva, League of Nations, 1925) 31–35.

Drafting of 1925 League of Nations Resolutions 255 The Report rarely reveals the depth of discussion and considerations which resulted in the final text of the Resolutions. Those authors who have commented on the 1925 Report have generally been limited to analysing the final publication.8 This chapter provides a detailed account of the development of the 1925 Resolutions on tax evasion by examining archival evidence. The next section discusses how the question of tax evasion came before the League and the views of the governments represented by the Technical Experts. This background is very useful in understanding the later views of decisionmakers and the choices made. The third section provides a narrative of the discussions which took place at the five sessions of the Technical Experts in relation to measures to target income tax evasion.9 This narrative demonstrates that the Technical Experts had to decide on ‘larger’ issues (such as the relationship between double taxation and tax evasion; the task before them; and their role as government or technical experts) as well as ‘smaller’ (but no less important) issues such as the practicalities of information exchange. The narrative also shows that the discussions did not take place in a linear, orderly fashion but jumped from issue to issue and many issues were often revisited even after conclusions were thought to have been reached. It is also interesting to observe the change in views from one session to the next. The parallels with later developments are noted where relevant and readers familiar with the OECD work on targeting tax evasion may have a sense of déjà vu when reading the narrative. The fourth section examines the response to the 1925 Report at the League and the somewhat mixed response to the proposals perhaps explains why the measures were not quite as successful as those relating to double taxation. The final section provides some preliminary conclusions regarding the work of the League in targeting tax evasion and the lessons for the current work in this area.

BACKGROUND

It is important to understand how the issue of tax evasion came to be referred to the League as this background helps to explain how later decision-makers approached the issue and the choices that they made. As has been discussed elsewhere, the problem of double taxation was first referred to the League of Nations by the Commission on International Credits at the International 8 See, eg WH Coates, ‘Double Taxation and Tax Evasion’ (1925) 88 Journal of the Royal Statistical Society 403. 9 The Technical Experts also discussed measures to target tax evasion in relation to succession or death duties but that discussion is not included in this chapter. However, it is noted where appropriate that even those Experts who were keen to introduce measures to target tax evasion were in fact primarily interested in targeting tax evasion in relation to succession or death duties.

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Financial Conference of 1920.10 The Provisional Economic and Finance Committee of the League eventually commissioned four eminent economists to provide an impartial, intellectual study of the issue and the economists submitted their final report to the League in April 1923.11 However, as early as February 1922, the Italian representative on the League’s Provisional Economic and Finance Committee, Commendatore Bianchini, who had previously drafted the terms of reference for the Economists’ Report, suggested that the League also commission a conference of officials to reach a practical solution on some of the more pressing difficulties involved.12 He provided the Rome Conference of 1921 as an example of what the League could aspire to.13 The Committee thought that such a conference could be useful but on the suggestion of Hawtrey, the British representative, agreed that a conference of officials be postponed until the Economists’ Report was available as the officials were not sufficiently knowledgeable of the conditions in other countries to make any real progress in the preparation of an international conference.

Genoa Conference The problem of double taxation was raised again at the Genoa Conference which was held from 10 April to 19 May 1922. The Genoa Conference was attended by representatives from 34 countries to discuss global economic problems following the Great War. The Conference was a busy one, hampered by a sore throat epidemic,14 and while there may be some question as to the overall success of the Genoa Conference,15 it certainly appears to have had an important influence in international tax matters, particularly in

10 Sunita Jogarajan, ‘Stamp, Seligman and the Drafting of the 1923 Experts’ Report on Double Taxation’ (2013) 5 World Tax Journal 368, 369–72. 11 GWJ Bruins et al, Report on Double Taxation: Submitted to the Financial Committee (Geneva, League of Nations, 1923). 12 Minutes of the First Meeting of the Sixth Session of the Financial Committee of the Provisional Economic and Financial Committee held at 11 am on 23 February 1922 in Geneva (League of Nations Archives, United Nations Geneva: Box R 333, EF/Finance VI/PVI). 13 The conference resulted in the conclusion of the first multilateral treaty on double taxation: Convention for the Purpose of Avoiding Double Taxation between Austria, Hungary, Italy, Poland, Roumania and the Kingdom of the Serbs, Croats and Slovenes (signed 6 April 1922), reproduced in League of Nations, Double Taxation and Fiscal Evasion: Collection of International Agreements and International Legal Provisions for the Prevention of Double Taxation and Fiscal Evasion (Geneva, League of Nations, 1928) 73–75. The 1925 Report mentions that the Treaty was signed on 13 June 1921 but the published version records that the Treaty was signed on 6 April 1922. The Treaty was only ever in force between Austria and Italy. 14 Associated Press, ‘No playtime at Genoa’, New York Times, 14 April 1922. 15 Wilson Harris, ‘The Genoa Conference’ (1922) 1 Journal of the British Institute of International Affairs 150; Alfred Dennis, ‘The Genoa Conference’ (1922) 215 North American Review 289; Carole Fink, The Genoa Conference: European Diplomacy, 1921–22 (Chapel Hill, NC, University of North Carolina Press, 1984) 303–7.

Drafting of 1925 League of Nations Resolutions 257 drawing attention to the question of international tax evasion. There were three commissions at the Conference (the Financial Commission, Economic Commission and Transport Commission) which were responsible for developing recommendations for the restoration of Europe. The Financial Commission was largely concerned with broader issues such as international credits, foreign exchange, international debts and similar matters, but there was some discussion of international taxation.16 First, the Financial Commission asked the League to expedite its enquiries into double taxation.17 Second, the Financial Commission asked the League to also look into the issue of flight of capital. This was formalised as Resolution 13 of the Financial Commission which read as follows: We have considered what action, if any, could be taken to prevent the flight of capital in order to avoid taxation, and we are of the opinion that any proposals to interfere with the freedom of the market for exchange, or to violate the secrecy of bankers’ relations with their customers are to be condemned. Subject to this proviso, we are of the opinion that the question of measures for international cooperation to prevent tax evasion might be usefully studied in connection with the problem of double taxation which is now being studied by a Committee of Experts on behalf of the League of Nations. We therefore suggest that the League should be invited to consider it.18

On the request to expedite the enquiry into double taxation, the Secretariat of the Financial Committee of the League considered it therefore desirable to modify the existing procedure on the issue.19 On the Resolution regarding flight of capital, the Secretariat prepared a Note with additional information for consideration at the upcoming session of the Financial Committee.20 The Note was based on private information gleaned by the Secretariat from discussions with representatives at the Conference and is illuminating in understanding country positions. The Note explained that the issue of flight of capital was first raised by Havenstein, the Director of the Reichsbank (the

16 RG Hawtrey, ‘The Genoa Resolutions on Currency’ (1922) 32 Economic Journal 290; Fink, n 15 above, 232–57. 17 Memorandum by the Secretariat of the Financial Committee of the Provisional Economic and Financial Committee on ‘The Work of the League in Financial Matters’ (League of Nations Archives, United Nations Geneva: Box R 360, EFS 287 A 370, May 1922). 18 Note by the Secretariat with regard to Resolution 13 of the Genoa Financial Commission, Relating to Tax Evasion or the Flight of Capital (League of Nations Archives, United Nations Geneva: Box R 360, EFS 282 A 165, 30 May 1922). 19 Memorandum by the Secretariat of the Financial Committee of the Provisional Economic and Financial Committee on ‘The Work of the League in Financial Matters’ (League of Nations Archives, United Nations Geneva: Box R 360, EFS 287 A 370, May 1922). 20 Note by the Secretariat with regard to Resolution 13 of the Genoa Financial Commission, Relating to Tax Evasion or the Flight of Capital (League of Nations Archives, United Nations Geneva: Box R 360, EFS 282 A 165, 30 May 1922). The Secretariat to the Provisional Economic and Financial Committee were Frank Nixon of Great Britain, Léon-Dufour of France and Jan van Walre de Bordes of the Netherlands. It is impossible to say with certainty who was the author of the Note but if there was an individual author, it was most likely Dufour who acted as Secretary for the Economists’ Report and the 1925 Report.

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central bank of Germany between 1876 and 1945), and seconded by Professor Bonn at the Committee of Experts elected by the Financial Commission.21 The matter was immediately opposed by Dubois of Switzerland and therefore not subject to discussion. The Financial Commission was divided into three sub-commissions on currency, exchanges and credits and the issue was raised again two days later at the First Sub-Commission on Currency by the German member of the Sub-Commission.22 He asked that measures be taken to prevent the flight of capital caused by ‘the turning of the screw’ with regard to taxation so as to ensure that the full yield from taxation was secured. The Chairman of the Sub-Commission responded that the issue related to exchanges rather than currencies and therefore was not within the purview of the First Sub-Commission. However, the Committee of Experts subsequently submitted a draft Resolution to the effect that the question came within the competence of the First Sub-Commission on Currency and not the Third Sub-Commission on Exchanges.23 At a joint session of the two sub-commissions, the Italian and German representatives reiterated the need for the issue of flight of capital to be referred to the Economic Commission.24 The Secretariat was not privy to the subsequent discussions which resulted in the drafting of Resolution 13 but highlighted the difference in wording between the first two sentences of the Resolution. The first referred to the flight of capital while the second referred to measures to prevent tax evasion. The difference was considered significant as tax evasion was possible by means other than the exportation of capital and the exportation of capital could be undertaken for reasons other than tax evasion. The Secretariat suggested that there were three different ideas for consideration by the Financial Committee which fell within the scope of the Resolution. First, there was the concept of ‘double taxation’ as a result of foreign investment from one country due to favourable conditions in the other host country rather than any considerations related to exchanges or evasion. The Secretariat noted that some economists were of the view that double taxation in relation to such investments was merely theoretical and in reality, almost always eliminated by the laws of economics.25 Second, there was the 21 The Committee of Experts consisted of all the assembled government officials and financial authorities, primarily from Western European countries and veterans of various post-war international gatherings: Fink, n 15 above, 233. 22 The Sub-Commission on Currency was tasked with restoring the integrity of European currencies. Among other things, the Sub-commission recommended the return to the gold standard: ibid 235. 23 The Sub-Commission on Exchanges was tasked with restoring stability to the international exchanges and, among other things, recommended the abolition of ‘futile and mischievous’ exchange controls: ibid 237. 24 The Economic Commission was responsible for international trade and tariffs. 25 One prominent economist who held such a view was Sir Josiah Stamp, one of the authors of the 1923 Economists’ Report: see Jogarajan, n 10 above, 380.

Drafting of 1925 League of Nations Resolutions 259 concept of ‘tax evasion’ and the Secretariat noted that bilateral cooperation to prevent tax evasion was not new and there were already a number of treaties between countries for the purpose of suppressing such evasion.26 The Secretariat noted that these treaties had a broader scope than just targeting tax evasion due to capital exportation. The third concept was the ‘depreciation of exchanges’ whereby capitalists placed capital abroad due to a rapid fall in the value of their domestic currency. Capital exportation in this situation was not due to tax evasion and was likely to be the case of German and Austrian capitalists.

Financial Committee’s Response The Resolution of the Genoa Conference was one of the first matters considered by the Financial Committee at its next session held in June 1922.27 The session was attended by Wallenberg (Vice-President of the Stockholm Enskilda Bank, Sweden); Arai (Japan);28 Avenol (Inspecteur des Finances, France); Bianchini (Head of the Italian Banking Association, Italy); Figueras (Director of the Bank of Bilbao, Spain); Janssen (Director of the National Bank, Belgium); Niemeyer (Controller of Finance to the British Treasury, Great Britain); Pospisil (Director of the Prague Savings Bank and ViceChairman of the Banking Committee of the Banking Authority at the Ministry of Finance, Czechoslovakia); and Tornquist (Tornquist Company, Argentina). Although the Financial Committee members were mainly bankers, they were divided over the question of ‘flight of capital’. The Belgian representative in particular was quite vocal as to the necessity for measures to tackle tax evasion, while the representatives from Sweden, Czechoslovakia, France and Great Britain considered the issue to be more complex and the question of bank secrecy to be of particular importance. At the first meeting of the session, the President of the Committee, Wallenberg (Sweden), opined that it was difficult to adopt measures to prevent the flight of capital. However, Janssen (Belgium) responded that the matter should be examined thoroughly as tax evasion was growing at an even greater rate due to the increases in taxation since the war. He did not consider it ‘right’ that only a few countries would benefit from the prevailing situation. He noted that prior to the war, both Belgium and Switzerland 26 Sunita Jogarajan, ‘Prelude to the International Tax Treaty Network: 1815–1914 Early Tax Treaties and the Conditions for Action’ (2011) 31 Oxford Journal of Legal Studies 679, 687–90. 27 Minutes of the First Meeting of the Seventh Session of the Financial Committee of the Provisional Economic and Financial Committee held at 11:15 am on 6 June 1922 in Geneva (League of Nations Archives, United Nations Geneva: Box R 334, Doc No 21260, E&F/ FINANCE/7th Session/PV1). 28 Arai appears to have been a temporary member of the Financial Committee and there is no biographical data available on him.

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benefited from the flight of capital but since the war, capital was also leaving Belgium. While acknowledging that it was practically impossible to prevent the flight of capital and that the exchanges could not be controlled, Janssen considered it necessary that countries be able to ‘rediscover’ the capital which had left the country. For that reason he thought it beneficial to draft a treaty providing that each government should undertake to respond to the questions of other governments. An international conference with a view to concluding such a treaty would be useful and should be initiated by the League. Avenol (France) explained that the background to the Resolution of the Genoa Conference was particularly relevant. The reason for the German request was because the Reparations Commission had previously investigated the question of flight of German capital and requested that the German Government adopt preventative measures through exchange controls. However, such measures were condemned at the Genoa Conference and the German Government therefore suggested that, instead of exchange controls, measures to prevent international tax evasion should be adopted with the aim of rediscovering capital which had left a country and subjecting it to tax after appropriate investigation. It was accepted that complete international fiscal control was impossible but it was considered that if they could agree upon a practical system of limiting double taxation, the corollary of such a system would be a measure of fiscal control as relief would only be granted if it was proven that taxes had been paid in one of the two countries. Further measures were not considered practicable as it was not possible to exercise any sort of control on bank deposits which were highly liquid. In addition, any measures against bank deposits would be opposed by the banks in particular countries as the bankers there were not at all prepared to forgo the obligations of professional secrecy. He acknowledged that it was preferable to introduce uniform taxation of bank deposits in all countries but practically impossible. However, it was possible to introduce practical measures to address the taxation of dividend income. Such measures could consist of fiscal controls together with measures destined to prevent double taxation, extending the current enquiry of the League rather than requiring new responsibilities. Janssen (Belgium) observed that evasion mainly occurred in relation to personal taxes, particularly where they were progressive (such as the supertax and succession duties). Providing the example of a Belgian who died with deposits in French and British banks, he considered that there should be no objections to the banks providing Belgium with information as to the amount of the deposits and that a multilateral treaty to that effect should and could be concluded. However, the British representative, Niemeyer, reminded his colleagues that the Genoa Conference had also condemned all proposals limiting the freedom of the exchange market and proposals which would violate the secrecy between bankers and their clients. He noted that

Drafting of 1925 League of Nations Resolutions 261 in England, the statements of taxpayers were confidential and the British tax authorities would not be able to communicate such information to a foreign administration. The question of flight of capital was allied to that of double taxation and he felt that useful discussion could only be had with the advantage of the Economists’ Report on double taxation. Popisil (Czechoslovakia) stated that he considered banking secrecy to be an economic principle of great importance. Czechoslovakia had had an unfortunate experiment with a system of Treasury control over banks which had led to capital hoarding. Wallenberg agreed with both Avenol and Niemeyer and noted that in Sweden, voluntary statements were made by 98 per cent of taxpayers and there was a great danger of hampering the entrepreneurial spirit of businessmen if the suggested controls were undertaken. Further, the controls under consideration would require additional administrative officials which would increase the cost to the government and he opined that the issue should only be dealt with as a corollary to double taxation. Janssen, on the other hand, stated that voluntary disclosure only represented, at most, 60 per cent of total income in Belgium and that it would soon be necessary to increase taxation to compensate for the loss of revenue due to tax evasion. Therefore, he could not support the second part of the Resolution of the Genoa Conference which rejected any measure of control over banks. Janssen responded that Wallenberg’s argument as to the risk of discouraging enterprise was a strong one but he did not believe that there would be any serious danger of this if they restricted themselves to international exchange of information with regard to inheritances. Avenol (France) summarised that there were in essence, two points of view: that of the financial administrators who were sceptical as to the honesty of taxpayers, and that of the bankers who disliked all control and would find it difficult to tolerate any control by a foreign government. While he thought that no practical solution could be suggested until the Economists’ Report was received, he questioned whether the Economists’ Report would in fact provide the governments with information of practical value as they were theorists. He suggested that it would be more beneficial if the Committee was strengthened with representatives from the various Ministries of Finance who could determine how any arrangement regarding exchange of information could be of practical value. The Committee eventually adopted the following Resolution, subject to a reservation by Janssen: Having discussed the question of the flight of capital and having accepted the views of the Conference of Genoa, as expressed in Resolution 13, the Committee decides to continue the investigation of this question simultaneously with that of double taxation.

Janssen’s reservation related to the fact that he could not accept that the Genoa Conference had entirely rejected the principle of controls over banks

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as such controls were already in existence in various countries. At a later meeting in the same session,29 the Committee decided that the issue should be addressed as ‘tax evasion’ rather than ‘flight or export of capital’. Avenol suggested that the Committee consult with governments that had already concluded treaties on the issue (Belgium, France and Great Britain) as to the extent that such treaties were useful and how they could be modified or extended.30 The Committee also decided to consult three other countries at the same time: Italy, the Netherlands and Switzerland. Three months later, the Financial Committee revisited the issues of double taxation and tax evasion and agreed that the six countries would also be invited to send a representative to discuss the two issues at an upcoming conference.31

Various Governments’ Views The Secretary-General of the League, Sir Eric Drummond, wrote to the six governments on 29 August 1922 requesting their views on the problem of tax evasion and that they nominate a representative to attend the planned meeting to discuss the two issues of double taxation and tax evasion. The government responses to the Secretary-General’s letter generally expressed support for the efforts to address double taxation and mixed support in relation to tax evasion. All six governments agreed to nominate a ‘government expert’ to meet on these issues. The response from the French Government only nominated their representative and did not provide their views on tax evasion.32 The Dutch, Italian and Swiss responses were relatively brief. The Dutch Government stated that it had not concluded any treaties expressly addressing tax evasion but provided the text of its agreement with Belgium regarding information exchange which indirectly addressed the issue.33 29 Minutes of the Fifth Meeting of the Seventh Session of the Financial Committee of the Provisional Economic and Financial Committee held at 3:30 pm on 8 June 1922 in Geneva (League of Nations Archives, United Nations Geneva: Box R 334, Doc No 21260, E&F/ Finance/7th Session/PV5). 30 These Treaties are discussed in Jogarajan, n 26 above, 687–90. 31 Minutes of the Fifth Meeting of the Eighth Session of the Financial Committee of the Provisional Economic and Financial Committee held at 10:30 am on 6 September 1922 in Geneva (League of Nations Archives, United Nations Geneva: Box R 334, Doc No 23159, EFS/ Finance/8th Session/PV5). This background demonstrates that the driver for the establishment of the Technical Experts of the League of Nations was in fact concerns regarding tax evasion and not double taxation, as has been suggested elsewhere: Michael Graetz and Michael O’Hear, ‘The Original Intent of US International Taxation’ (1997) 46 Duke Law Journal 1021, 1080. 32 Letter from French Ministry of Foreign Affairs to Secretary-General of the League of Nations (League of Nations Archives, United Nations Geneva: Box R 360, Doc No 24978, 29 November 1922). It is possible that there was a separate letter from the French government outlining their views on the two issues but this was not found at the archives. 33 Letter from van Panhuys, Netherlands Legation to Secretary-General of the League of Nations (League of Nations Archives, United Nations Geneva: Box R 360, Doc No 10/24763/15697, 18 November 1922). This Treaty is listed at n 38 below.

Drafting of 1925 League of Nations Resolutions 263 It was supportive of efforts to address double taxation and importantly, while also supportive of a multilateral treaty to address tax evasion, considered the right of banks to withhold information to be sacred. The Italian Government reminded the Committee that their delegates at the Genoa Conference had also raised these issues and that Italy had already entered into a Treaty with the Successor States of the Austro-Hungarian Monarchy to address double taxation.34 The Rome Conference of 1921 had also provided for the conclusion of treaties regarding mutual assistance to prevent tax evasion, although no such treaty had been concluded to date. The Swiss Government responded, perhaps somewhat surprisingly given their later views, that although they had not concluded any international treaties with respect to double taxation or tax evasion,35 the Federal Council was of the opinion that such international treaties on this question would be advantageous.36 The Belgian Government, consistent with their earlier representations, provided quite a lengthy response explaining that the issue of flight of capital was of considerable importance for Belgian tax revenue.37 Although Belgium had not concluded any treaties expressly addressing tax evasion, the issue was indirectly addressed in the earlier exchange of information treaties with France, the Netherlands and Luxembourg.38 Belgium strongly supported a multilateral treaty to facilitate international cooperation on tax collection, particularly with regard to death duties.39 The Belgian Government was especially concerned that foreign cash and securities of Belgian residents and shareholdings in foreign companies generally escaped Belgian death duties. Under the multilateral treaty contemplated by the Belgian Government, all participating countries would be required to inform another participating 34 Letter from the Secretariat to Members of the Financial Committee transmitting letters from the Governments of Belgium, Italy and Switzerland, 17 November 1922 (League of Nations Archives, United Nations Geneva: Box R 360, Doc No EFS 380(1) A 213 (1), 17 November 1922). The Treaty is listed at n 13 above. 35 Although the Swiss Federal Government had not entered into any tax treaties in its own capacity, Treaties had been entered into between Switzerland and other countries on behalf of the cantons, such as the agreement between the Canton of Vaud and Great Britain: see Sunita Jogarajan, ‘The Conclusion and Termination of the “First” Double Taxation Treaty’ [2012] British Tax Review 283, 283–306. 36 Letter from the Secretariat to Members of the Financial Committee transmitting letters from the Governments of Belgium, Italy and Switzerland (League of Nations Archives, United Nations Geneva: Box R 360; Doc No EFS 380(1) A 213 (1), 17 November 1922). 37 ibid. 38 Convention Regulating the Relations between the Administrative Services of France and Belgium (concluded 21 August 1843), reproduced in League of Nations, n 13 above, 211; Convention Regulating the Relations between the Administrative Services of Netherlands and Belgium (concluded 24 May 1845), reproduced in League of Nations, n 13 above, 213; Convention Regulating the Relations between the Administrative Services of Belgium and Luxembourg (concluded 11 October 1845), reproduced in League of Nations, n 13 above, 213. 39 The concern over death duties is likely attributable to the yield from such taxes at that time. For a discussion of the death duties in various countries in the early twentieth century, see Duke of Argyll, ‘Death Duties in Foreign Countries’ (1903) 5 Journal of the Society of Comparative Legislation 25.

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country of all of the holdings of a resident of the second country located in the first country upon the death of a resident of the second country. For example, upon the death of a British resident, all participating governments would inform Great Britain of the holdings of the British resident in their country. The Belgian Government considered that such exchange of information would not interfere with the freedom of the market or violate bank secrecy, addressing two of the main concerns previously raised, but noted that they had not considered the practicalities of the proposal. The British Government response was also quite lengthy and reflected some of the tensions between the Board of Inland Revenue and the Treasury seen previously.40 The response was written by the Board and stated that there were two existing Treaties which indirectly addressed tax evasion (with the Canton of Vaud and the United States of America) and one Treaty, with France, which directly addressed the issue.41 However, the Board noted that the monetary result from exchange of information under the French Treaty was very small and that the Treaty had been heavily criticised by British financial and business interests as it was thought that the Treaty had a prejudicial effect on business relations between the two countries and impeded cross-border investments, which in turn decreased stamp duty revenue due to a decrease in such investments. In addition, exchange of information under the Treaty meant that in some situations there was, in effect, correctly under each country’s domestic tax laws, double taxation. At the request of the Chancellor, the Board added that it was willing to explore the possibilities of any suggestions made by the League with regard to tax evasion.42

40

See Jogarajan, n 35 above, 296–97. Note by the Board of Inland Revenue on Measures for International Co-operation to Prevent Evasion of Taxation (Doc No T2044/239/1922, UK National Archives file IR 40/3419 Pt 3); Declaration Relative to Succession or Legacy Duties on Property of British Subjects Dying in the Canton of Vaud or of Citizens of the Canton of Vaud Dying in the British Dominions (concluded 27 August 1872), reproduced in League of Nations, n 13 above, 141–42; Convention between the United Kingdom and the United States of America Relative to the Disposal of Real and Personal Property (signed 2 March 1899), available in UK National Archives file IR 40/3419 Pt 3. The Convention was communicated to the League (see Bilateral Conventions Still in Existence or Expired Concerning Double Taxation and the Evasion of Taxation: Memorandum by the Secretariat (League of Nations Archives, United Nations Geneva: Box R 364, F39, 29 May 1923)) but does not appear in the League’s 1928 collection of tax related agreements (see League of Nations, n 13 above, 238–50) or the United Nations’ list of international agreements 1843–51 (see United Nations, World Guide to International Tax Agreements 1843–1951 (New York, 1951) vol 3, 343–59); Agreement between France and Great Britain for the Prevention of Frauds in connection with Succession Duties (concluded 15 November 1907), reproduced in League of Nations, n 13 above, 214. 42 Note on League of Nations Double Taxation and Tax Evasion by ‘PJG’ to Sir R Hopkins (12 December 1922), contained in UK National Archives file IR 40/3419 Pt 3. ‘PJG’ is likely to have been Sir Percy James Grigg who was Principal Private Secretary to the Chancellor of the Exchequer at the time. The recipient was Sir Richard Hopkins who was Chairman of the Board of Inland Revenue at the time. 41

Drafting of 1925 League of Nations Resolutions 265 THE TECHNICAL EXPERTS

The government representatives nominated by the six countries were Clavier (Director-General of Direct Taxation, Belgium); Blau (Director of the Federal Taxation Department, Switzerland); d’Aroma (Director-General of Direct Taxation, Italy); Damste (Director-General of Direct Taxation, Customs and Excise, Netherlands); Sir Percy Thompson (Deputy-Chairman of the Board of Inland Revenue, Great Britain); and Baudouin-Bugnet (Director-General of Direct Taxation, France).43 Meanwhile, the Czechoslovakian Minister for Foreign Affairs had written to the Secretary-General of the League asking that a representative of his country, Valnicek, be permitted to join the Technical Experts in their deliberations as Czechoslovakia had already concluded Treaties on the issue and Valnicek had been in charge of the negotiations of those Treaties. The proposal was accepted by the Council and Valnicek (Head of Department at the Ministry of Finance) became the seventh member of the Technical Experts.44 The Secretary for the Experts was Léon-Dufour from France. The Technical Experts held five sessions between June 1923 and February 1925. The Italian representative, d’Aroma, was elected as President of the Technical Experts without debate. It is apparent from the minutes of the meetings that he was a strong leader who pushed his colleagues to reach compromise positions rather than letting them agree to disagree. His leadership approach perhaps helps to explain the form of the 1925 Report which is made up of unanimously agreed upon general principles accompanied by numerous exceptions rather than alternative positions.45

First Session The first session of the Technical Experts was held in Geneva in June 1923. Seligman, one of the authors of the Economists’ Report, was not a member of the Technical Experts but was in Geneva at the time of the first session. He observed that the Technical Experts were initially wary of one another and even questioned the motives of some of their colleagues.46 But after the first meeting ‘when the men sat eye to eye around a green baize table’ 43

League of Nations, n 7 above, 3. Note by the Secretary-General (League of Nations Archives, United Nations Geneva: Box R 362, C.278.1923.II, 17 April 1923); ‘Second Meeting (Public) Twenty-Fourth Session of the Council’ (1923) League of Nations Official Journal 6/552, 555. 45 One contemporary commentator strongly criticised this aspect of the Report and suggested that the many exceptions negated the usefulness of the general principles: Coates, n 8 above, 408–9. 46 Edwin Seligman, Double Taxation and International Fiscal Cooperation: Being a Series of Lectures Delivered at the Académie de droit international de la Haye (New York, Macmillan, 1928) 143. 44

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and got to know each other better, subjected to the ‘indefinable but friendly atmosphere of the League’, their whole attitude changed. Doubt and suspicion gave way to warm friendships and a certainty of accomplishment. The Chicken or the Egg: Double Taxation or Tax Evasion? The whole of the first meeting was in fact spent discussing the order in which the two issues of double taxation and tax evasion would be addressed.47 This preliminary discussion foreshadowed a divide that would continue throughout the five sessions. The President (Italy) suggested that the Experts should first consider tax evasion and then double taxation. However, Thompson (Great Britain) pointed out that any measures to address double taxation would have implications for tax evasion. For example, if they adopted the second method in the Economists’ Report, the exemption method, the residence country would collect the taxes and would inform the source country of the amount, thereby rendering tax evasion almost impossible. In support of this approach, Thompson noted that public opinion in Great Britain and other countries was such that it would be considered acceptable for source countries to provide residence countries with relevant information to enable the proper collection of tax from residence countries’ citizens but that the public would not accept residence countries providing source countries with information so that the source country could collect the proper amount of taxes from a non-resident. The President accepted Thompson’s suggestion and agreed that the issue of double taxation would be considered before tax evasion. This procedure was accepted by Baudouin-Bugnet (France) who nonetheless asked that the Experts treat the two issues as connected to one another. In support of this view, he stated that it was generally the wealthy who were involved in tax evasion in France as they were subject to double taxation on foreign investments. However, public opinion meant that double taxation could not be addressed without also having measures against tax evasion. Valnicek (Czechoslovakia) agreed with both Baudouin-Bugnet and Thompson and added that it was also necessary to consider the operation of the judicial system in the country which was to collect the taxes. He cited recent legislation in Czechoslovakia and Germany as an example and suggested that the Experts look to those countries for guidance although such detailed measures probably could not be adopted by the Experts. Blau (Switzerland) insisted that the two issues were not connected and asked that they be dealt with separately. Switzerland could possibly adhere 47 Minutes of the First Meeting of the First Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 11 am on 4 June 1923 (League of Nations Archives, United Nations Geneva: EFS/DT/1–4 Session/PV, EFS/DT/PV1(1)). The minutes are in French. Discussions at the United Nations followed a similar path.

Drafting of 1925 League of Nations Resolutions 267 to treaties regarding double taxation but it was impossible for it to enter into any treaties targeting tax evasion due to the political organisation of the country. The Swiss did not envisage participating in any measures relating to administrative or judicial assistance.48 Clavier (Belgium) agreed with Baudouin-Bugnet that the two issues were connected but was prepared to address them separately given the concerns of the Swiss. The President, while also agreeing that the two issues were connected, suggested that the two issues be addressed separately in light of the Swiss position. The Experts agreed with this proposal and it was decided that the Experts would first consider the issue of double taxation followed by tax evasion. Exchange of Information The Experts had 11 official meetings at the first session and the issue of tax evasion was only briefly considered again at the end of the tenth meeting.49 The President declared that the most important and delicate point for the Experts was to get the collaboration of the banks to stop tax evasion. He suggested that the Experts could consider the possibility of preparing a treaty on administrative and judicial assistance. Baudouin-Bugnet and Valnicek agreed with the President’s proposal and noted that their governments were equally interested in measures to prevent tax evasion as they were in measures to avoid double taxation. Blau, however, pointed out that there were 25 cantons in Switzerland, each with their own tax authority, and they did not even exchange information with one another. He asked for more information on international tax evasion so that he could highlight to his government the importance of the issue. Clavier (Belgium) responded that tax evasion was very important from the standpoint of public morality and international solidarity and the faith of honest taxpayers would be sacrificed for the benefit of the unscrupulous taxpayer if measures to prevent tax evasion were not adopted. In their report to the Financial Committee,50 the Experts stated that they recognised that the value and efficacy of any measures to address double

48 The issue could also arise in the reverse as we have seen with the development of Tax Information Exchange Agreements (TIEAs). TIEAs were developed in response to a 1981 United States report on tax evasion which suggested that TIEAs could make tax evasion more difficult by closing the gap in the tax treaty network as the United States did not have double taxation treaties with most of the jurisdictions which were generally considered tax havens: Steven Dean, ‘The Incomplete Global Market for Tax Information’ (2008) 49 Boston College Law Review 605, 650. 49 Minutes of the Tenth Meeting of the First Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 4 pm on 8 June 1923 (League of Nations Archives, United Nations Geneva: EFS/DT/1–4 Session/PV, EFS/DT/PV10(1)). The minutes are in French. 50 Double Taxation and Evasion of Taxation: Report by the Government Experts (League of Nations Archives, United Nations Geneva: Box R 364, F50, 10 June 1923).

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taxation would depend greatly on international cooperation in detecting tax evasion and in determining the proper amount of taxes and incomes. The Experts ‘warmly recommended’ the adoption of further measures such as treaties for legal assistance and information exchange, as had already been concluded between several countries.

Second Session The second session of the Technical Experts took place four months later in October 1923. There were 10 meetings in the session and the issue of tax evasion was not considered until the last meeting.51 Defining the Task The President recalled that Blau had previously raised the sensitive issue of bank secrecy in connection with tax evasion but the President hoped that the Experts could nonetheless agree a fixed set of guidelines that were acceptable to all countries. He noted that there were two elements to ending tax evasion: discovery of assets hidden abroad and collection of taxes on those assets once discovered. With regard to tax collection, the President pointed out that the Rome Conference of 1921 had thought it necessary to include representatives of the Ministries of Justice and suggested that the Experts collaborate on this issue with the Legal Section at the next session. The Experts agreed to this proposal. The President then suggested that the Experts examine two issues: whether it was necessary to enact rules and treaties to discover taxable wealth in order to achieve a more equitable tax and whether it was necessary to enact rules and treaties to ensure the effective recovery of taxes which the taxpayer sought to evade. The Experts agreed with the proposed procedure. Valnicek suggested that the Experts consider four categories of measures: enhanced border control; prevention of tax evasion achieved through industrial and commercial transactions; judicial assistance for tax collection; and exchange of information. However, he could not accept the removal of bank secrecy, although he acknowledged that it would be the most effective measure. He noted that Germany had recently adopted special laws to restore bank secrecy and that banks played an important role in the Czechoslovakian economy and removal of bank secrecy could exert an unfortunate 51 Minutes of the Tenth Meeting of the Second Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 9 am on 13 October 1923 (League of Nations Archives, United Nations Geneva: EFS/DT/1–4 Session/PV, EFS/DT/PV10 (1)). The minutes are in French.

Drafting of 1925 League of Nations Resolutions 269 influence on the value of Czechoslovak currency. Baudouin-Bugnet agreed with all of the comments but highlighted that the Experts had not actually defined what they meant by bank secrecy. The Secretary proposed the following Resolution: On tax evasion, the experts unanimously recognised the need to prepare measures, based on international agreements, and having two separate objects: The first object is to try and discover the object which is taxable from the point of view of double taxation. On the other hand, the experts think that it is advisable to consider means for combating fraudulent practices which tend to hamper the effective collection of taxes. The study of these various measures started in this session and will be continued in March 1924.

Both Blau and Thompson stated that they had to make a formal reservation with regard to the second paragraph. Blau pointed out that it would be impossible to adopt in Switzerland as each canton was sovereign in tax matters. The cantons did not exchange information or provide administrative assistance between them. He noted that since the war, federal taxes had been introduced but these were minimal and largely temporary. Blau noted that he could therefore agree to measures in connection directly with bilateral treaties for double taxation but he could not go further and adopt any Resolutions which created general exchange of information involving the violation of bank secrecy and possibly even postal and telegraph secrecy. Thompson agreed that it was necessary to take steps to end tax evasion but he had to make a reservation as Great Britain would be prepared to share information with foreign governments in respect of the imposition of tax on their own nationals but not on British nationals. The President suggested that Thompson’s concerns could be addressed in bilateral treaties while Baudouin-Bugnet noted that the French Government would also have difficulty in agreeing to any Resolutions which required the provision of information with respect to French nationals. However, he did think that all governments should inform other governments where there were false declarations as extradition was possible in the case of theft. Returning to the Resolution proposed by the Secretary, Clavier suggested that they add to the second paragraph ‘the Experts will consider at a later date whether measures can be foreshadowed for ensuring a general equitable assessment of taxation’ to appease the qualms of Blau. Blau was agreeable on condition that any exchange of information and action undertaken under the second paragraph apply to concrete cases of double taxation only. He noted that the removal of bank secrecy had been rejected by overwhelming majority in the Swiss National Council. In support of the Resolution, Baudouin-Bugnet noted that the French tax authorities and the Budget

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and Financial Commission had recently sought to introduce various measures to prevent tax evasion but the proposals were rejected by the Finance Minister on the basis that the measures would not be effective if they were not sanctioned by international agreement. The Experts adopted the text of the Secretary’s Resolution, with Clavier’s addition. Discovering ‘Missing’ Wealth The Experts then turned to consider the details as to how ‘missing’ wealth could be discovered. The categories of: income on real property owned by a national of one country in another; mortgages; income of industrial and commercial enterprises; and earned income, were relatively uncontroversial and the Experts agreed that countries could exchange information in relation to these categories as the question of bank secrecy did not arise. However, this was subject to a reservation from Thompson who pointed out that he could not commit the British Government to provide information to a foreign government to tax a British national in a foreign country. Baudouin-Bugnet questioned whether the contemplated exchange of information would mean that tax officials were in violation of the principle of professional secrecy as some tax information was always kept private.52 Clavier explained that any exchange of information pursuant to international treaties would be within an official’s line of duty and therefore not a violation of professional secrecy. Baudouin-Bugnet was satisfied with that explanation. The discussion then turned to income from securities which the President considered to be the main problem in relation to tax evasion, especially since the war. The issue arose due to the widespread use of bearer securities which made it difficult for tax authorities to identify the holders of securities.53 Clavier suggested that the Experts could propose the procedure which had been successfully adopted in Belgium. In Belgium, the payer was obliged to withhold tax at the highest rate and the taxpayer would receive a refund upon making a declaration or alternatively, no tax was withheld if the taxpayer provided identification information and that information was transmitted to the taxpayer’s country to ensure the proper collection of taxes. This system may seem quite familiar today but it did not receive 52 In France, any disputes between the taxpayer and the tax authorities with respect to schedular taxes on real property were resolved in the Conseil de Prefecture and those sessions were public. However, schedular taxes and the general income tax on income could raise sensitive issues and tax authorities were bound to secrecy and the Conseil de Prefecture sessions were private. 53 In its first major publication on harmful tax competition, the OECD identified the existence of bearer shares as one of the most harmful characteristics of a regime: OECD, Harmful Tax Competition: an Emerging Issue (Paris, OECD Publishing, 1998) 33. The OECD continues to monitor the existence of bearer shares in countries and push for abolition or the introduction of appropriate safeguards: see, eg OECD, Tax Co-operation: Towards a Level Playing Field (Paris, OECD Publishing, 2008) 16–17, 90; OECD, n 5 above, 289–90.

Drafting of 1925 League of Nations Resolutions 271 any support from the other Experts. Blau declared that public opinion in Switzerland was such that his government could never agree to such procedures. Damste (the Netherlands) and Thompson were also critical for reasons of practicality and because it would involve a violation of bank secrecy. Clavier responded that the public could be educated through press campaigns, conferences, etc but noted that his proposals did not even have support in all Belgian circles and were merely his personal views. The Secretary proposed the following Resolution which was adopted by the Experts: The governments in various countries could commit to provide reciprocally the information necessary for tax purposes on: 1. 2. 3. 4.

Real property (capital value and income); Mortgages (income and capital value); Industrial and commercial enterprises (income and capital value); Earned income.

Third Session The third session of the Technical Experts was held in Geneva in April 1924, approximately five months after the previous session. There were 15 meetings in the session and the issue of tax evasion was only considered in the last two meetings. Interestingly, although they were short of time and had not completed their discussion on double taxation, the Experts considered it important that they discuss tax evasion at that session to demonstrate that the issue had not been overlooked.54 It should also be noted that this was the first session that was attended by representatives of the International Chamber of Commerce (ICC). The ICC did not object to measures targeting tax evasion as they recognised that it was the counterpart to measures eliminating double taxation but the ICC declined to participate or comment on the measures relating to tax evasion, a position they maintained throughout the League’s work on double taxation and tax evasion. Practicalities of Information Exchange The Experts’ discussion on measures to combat tax evasion focused on the practicalities of the proposed exchange of information on income from real property, mortgages, business and earned income which had been agreed to at the previous session. 54 Minutes of the Fourteenth Meeting of the Third Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 10 am on 7 April 1924 (League of Nations Archives, United Nations Geneva: EFS/DT/1–4 Session/PV, EFS/DT/3ème Session/PV14 (1)). Minutes are in French.

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Automatic or Specific Exchange Valnicek (Czechoslovakia) raised the question as to whether the proposed exchange of information would take place generally or only in the case of specific situations when requested by a particular government.55 If they were considering the former system, he suggested that it would be better to establish a central clearing-house where information could be sent automatically without requests from countries. Baudouin-Bugnet (France) suggested that both systems should operate concurrently. However, he did not support the creation of a clearing-house as he felt that that would unduly lengthen the process and thought that a clearing-house could be established later if considered necessary. Income from Securities The Experts then turned to consider the exchange of information in relation to income from securities which they had not been able to agree to at the previous session. Baudouin-Bugnet informed the Experts that the French Government had recently drafted legislation regarding the surveillance of securities to counter tax evasion. The law required banks to receive prior authorisation before paying coupons (interest/dividends) and permitted French tax authorities to enter banks and review all documents regarding securities, current accounts, etc.56 Further, taxpayers were required to declare all foreign income and false declarations would result in severe penalties. Finally, false statements regarding dividends and interest would give rise to correctional penalties, the first time that such penalties were used for offences of that kind. Valnicek noted that similar legislation was introduced in Czechoslovakia and was considered draconian in comparison to pre-war laws. Baudouin-Bugnet added that, in France and England, any person could ask a private or public company for the names of all of its owners (including foreigners). He suggested that a similar mechanism could be introduced for tax authorities of different countries. Damste endorsed the proposal but Blau stated that Switzerland could never introduce such measures due to the political situation in the country as the cantons were fiscally independent and the Federal Confederation could not impose such requirements on the cantons. 55 Automatic exchange of information was endorsed as the expected new standard by the G20 Finance Ministers and Central Bank Governors on 19 April 2013. The OECD published its Common Reporting Standard for automatic exchange of information in tax matters on 13 February 2014 with 44 early adopters, including the seven countries represented by the Technical Experts nine decades earlier: see OECD, n 6 above. 56 Finance Act 2008 (UK) Sch 36 para 5 permits the UK tax authorities to serve notice on financial institutions in respect of customers with UK addresses holding non-UK accounts but these notices have to be approved by a Judge of the Tax Chamber. See, eg TC00174 [2009] UKFTT 224 (TC) which concerned an application to serve 308 notices on financial institutions.

Drafting of 1925 League of Nations Resolutions 273 Bank Secrecy Baudouin-Bugnet opined that the proposed laws would not violate bank secrecy as tax officials were bound by absolute professional secrecy and therefore confidentiality with regard to the general public was maintained.57 However, Thompson pointed out that the Genoa Conference, in referring the issue of tax evasion to the Experts, had done so on the proviso that any measures put forward by the Experts would not violate bank secrecy. He thought that the proposed measures were outside the Experts’ mandate. The Secretary reiterated Baudouin-Bugnet’s earlier point that there were two aspects to bank secrecy: towards the public and towards tax officials. He was also of the opinion that the provision of information by banks to tax officials who were bound by professional secrecy was not a violation of bank secrecy. The President stated that the Experts should not be bound by the statement of the Genoa Conference as he was a delegate to the Conference and could say that the delegates there were almost entirely concerned with political goals. Clavier declared that he also did not think that the proposed measures amounted to a violation of bank secrecy. Blau pointed out that when Switzerland had introduced war taxes which involved a violation of bank secrecy, considerable capital had left Switzerland. Germany had had a similar experience and since restored bank secrecy. Blau did not think that a distinction could be made that the provision of information to tax officials did not violate bank secrecy. Scope of Information Exchange The President (Italy) raised the question as to whether the proposed exchange of information would be limited to another country’s nationals only or whether a county would also provide information regarding its own nationals so that they could be taxed in the other country. For example, if there was an English national with income in France and a French national with income in England, he queried whether the British Government would only provide information in relation to the income earned by the French national in Britain to enable France to impose any residence-based taxes, or whether the British Government would also provide information regarding the British national to enable France to impose any source-based taxes. Thompson (Great Britain) reiterated his earlier view that the British public would never accept any measures against British nationals which were designed to benefit foreign tax authorities. However, Baudouin-Bugnet (France) thought that the French Government would provide the British Government with information regarding French nationals as it was important that all countries worked together to prevent tax evasion. Damste noted that the recently 57 A similar argument is used by the OECD with regard to information exchange and bank secrecy: OECD, Improving Access to Bank Information for Tax Purposes (Paris, OECD Publications, 2000) 9.

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drafted treaty between the Netherlands and Belgium provided for mutual assistance in all situations as this was considered fair. Baudouin-Bugnet suggested that Thompson would perhaps reach the same conclusion as the others once he had considered the matter further as it was wrong for honest taxpayers to pay for fraudulent taxpayers regardless of whether they were domestic or foreign. Bilateral or Multilateral In response to Thompson’s concerns regarding the scope of any information exchange, Clavier proposed that the matter be left to bilateral treaties and Britain, for example, could conclude different exchange of information provisions to those concluded by the European countries. However, the President and Baudouin-Bugnet were not agreeable as the Experts’ position was that the taxpayers of all countries should be treated the same. Clavier also thought that universal agreement was required on this issue as, otherwise, mobile capital would simply flow to countries that protected bank secrecy, inadvertently protecting tax evaders. Blau agreed that any measures against tax evasion should be universal but declared that Switzerland would not be able to participate due to the political situation in the country. Reciprocity Valnicek stated that his duties included bank inspections to determine the deposits of foreigners wishing to avoid taxes in their own country and in Czechoslovakia. He wondered whether he should provide such information to the other country if there was no reciprocal treatment. Clavier felt that information sharing should be secondary to reciprocity. Blau declared that it was a fallacy that Switzerland provided safe haven to large amounts of foreign capital as the amount of Swiss capital invested abroad was in fact far greater than the amount of foreign capital in Switzerland. He noted that a report was due to the Reparations Commission on measures to ascertain German capital abroad and suggested that the Experts look to those measures before making any decisions. He also thought it particularly important for the Experts to learn the view of the United States. Push for Compromise The final meeting commenced with Clavier presenting the following proposal on measures to be taken to suppress tax evasion: Governments of various countries could commit to provide to each other the information necessary for the assessment of taxes in relation to: 1. 2.

Real property (capital value and income); Mortgages (capital value and income);

Drafting of 1925 League of Nations Resolutions 275 3. Industrial, commercial and agricultural enterprises (capital value and income); 4. Labour income including directors’ fees; and 5. Income from securities, deposits and current accounts where affidavits or some other document is in the possession of the State. An international agreement would be desirable in this regard.58

Clavier insisted that the Experts had to make a decision with regard to tax evasion as it would be unacceptable for them, as delegates of governments, to reach Resolutions regarding double taxation which was of interest to individuals and not to conclude any Resolutions in relation to tax evasion which was of interest to governments. He highlighted that the proposed text would not violate bank secrecy. Thompson declared his acceptance of the proposed text. The British tax authorities had no information on the owners of land and mortgage securities but did possess information regarding business income, salaries and wages, royalties and to some degree, income from securities. However, he did not think that Clavier’s proposal would stop tax evasion as it could only be completely suppressed with legislation for the full exchange of information, which would lead to the violation of bank secrecy. He proposed that the Experts begin their report on tax evasion by affirming the principle that ‘the severity of measures to be taken by Governments should vary depending on the scale of tax evasion in their respective countries’. He felt that the British public, for example, would not accept the British Government taking actions against tax evasion when such evasion practically did not exist in Great Britain. Further, the issue of bank secrecy had been extensively discussed in England and it was concluded that the violation of bank secrecy would cause more harm than good. Clavier opined that governments could not know the extent of tax evasion if they had not taken measures to suppress it and it would therefore be dangerous for the Experts to affirm the principle posed by Thompson. Thompson did not agree with Clavier and stated that the English tax authorities knew that the amount of tax evasion in England did not exceed a small percentage of the total budget. He declared that he would not object if the Experts affirmed the principle that each country could take severe measures to prevent tax evasion and that all countries should participate in mutual assistance in this area but with two reservations. First, that any measures were a function of the extent of the evasion and second, that a country would not be obliged to undertake measures if it considered them unnecessary. Baudouin-Bugnet agreed with Thompson’s point as it would not be possible to ask a country to be more severe towards its own nationals than towards foreigners. 58 Minutes of the Fifteenth Meeting of the Third Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 3 pm on 7 April 1924 (League of Nations Archives, United Nations Geneva: EFS/DT/1–4 Session/PV, EFS/DT/3ème Session/ PV15 (1)). Minutes are in French.

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Baudouin-Bugnet added that he understood the British position regarding bank secrecy but noted that the issue of tax evasion was linked to double taxation. He suggested that if the British Government did not do anything to counter tax evasion, the French Government would not do anything to avoid the imposition of double taxation on British subjects. He hoped that it would be possible for the British public to recognise that it was necessary for the British Government to take action to counter tax evasion as those measures were related to those designed to avoid double taxation. He pointed out that even the ICC accepted that measures against tax evasion were the counterpart to measures against double taxation. The Experts accepted the text proposed by Clavier but noted that this decision did not prejudice the discussion at the next session.

Fourth Session The fourth session was held approximately six months later, in October 1924.59 Unlike the earlier sessions, considerable time was spent at this session discussing the measures to target tax evasion and the discussion was not left to the end of the session. Revisiting Bank Secrecy The discussion resumed on the issue of bank secrecy (relating to exchange of information on income from securities) which had been the subject of reservations at the previous session. Clavier (Belgium) pointed out that, under the Experts’ proposed Resolutions, an English national with securities or deposits in Belgium would be taxed in Belgium on the income from those assets.60 However, countries could agree through bilateral treaties for a reduction or exemption of the tax on production of an affidavit. Clavier urged his colleagues to unanimously agree to the Resolution as there would be no violation of bank secrecy. He stressed that such a recommendation would not bind their respective governments but would ease the Experts’ conscience as they had to protect general interests and not just eliminate double taxation.

59 Baudouin-Bugnet and Thompson were called to other duties by their respective governments and were replaced by Borduge, the new Director-General of Direct Taxation, and Canny, from the Board of Inland Revenue, respectively. 60 Minutes of the Third Meeting of the Fourth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 4 pm on 21 October 1924; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); EFS/DT/4ème Session/PV3 (1), United Nations Geneva. Minutes are in French.

Drafting of 1925 League of Nations Resolutions 277 Borduge (France) pointed out that under this proposal, a British national with investments in Belgium could avoid the imposition of schedular taxes in Belgium on production of an affidavit and not pay the income tax in England unless the British tax authorities were informed about the Belgian income. He proposed that they include a provision whereby the person paying the interest or dividend would be required to inform the taxpayer’s country of residence that the tax was not paid, thereby enabling the general income tax to be imposed by the country of residence. Canny (Great Britain) accepted Clavier’s scenario but could not accept Borduge’s proposal as it would not be possible for banks to provide the relevant information. Not surprisingly, Blau (Switzerland) agreed with Canny and thought that bank secrecy would be undermined if banks were required to provide such information to tax authorities. The delegates in favour of information exchange (Clavier and Borduge) raised four arguments as to why bank secrecy would not be violated: practice under domestic laws; similarity to information regarding salary and wages; distinction in bank operations; and nature of information to be exchanged. Clavier noted that similar disclosures were already required in France under recent legislation and that tax authorities were permitted to investigate banks in Italy to establish the wealth tax. As such, he thought that bank secrecy should not be an issue as the laws of several countries already required such disclosure. Further, tax authorities would be required to hold such information in strict confidence. Canny, however, felt that the proposed measures inevitably raised the issue of bank secrecy where the country did not already have a procedure for the provision of such information under domestic laws. He declared that there was no hope of Great Britain agreeing to such measures as neither the government nor public opinion would accept such a proposal. Borduge also pointed out that in many countries, employers were required to report to the tax authorities the amount of salary and wages paid to employees and the disclosure of interest and dividend income should be viewed similarly. Blau responded that the disclosure of salary and wages was not required in most Swiss cantons. Valnicek thought that the disclosure of information by banks to governments was a much broader and more important issue than the declaration of salary and wages due to the prominent role played by banks in economic life. He felt that Borduge’s proposal could pose a currency risk for the countries concerned and challenge their entire economic organisation. He was prepared to accept measures to identify the recipients of such income but only in such a way that did not involve the violation of bank secrecy. Clavier then suggested that, as brokers were also permitted to perform the same operations, banks were not acting as banking institutions when paying coupons. As such, a simple solution would be to declare that the payment of coupons could be done by government approved agents.

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Blau responded that he could not accept such a distinction as the Swiss authorities and the Swiss people considered secrecy to apply to all banking operations and the fact that brokers also made such payments was irrelevant. He noted that bank secrecy was fundamental to their existence and that the German experience, where the violation of bank secrecy had severe consequences for the economy and required urgent repeal, strongly indicated that the Experts should not consider any measures which would violate bank secrecy. He further noted that in Switzerland, a proposed tax on capital which would require investigations into banks had been rejected by the voters. Clavier thought that the public were uninformed and if it were put to the voters as to whether they wanted further tax increases to allow a small number of very wealthy taxpayers to avoid tax or measures to prevent tax evasion, the majority would accept measures which included a violation of bank secrecy. Clavier also noted that the current proposal only required the disclosure of the nationality and identity of the beneficiaries and he hoped that most governments would agree to this as non-participating countries would become a haven for evaders, to the detriment of participating countries. Damste agreed that the provision of such information regarding individual coupon payments could not be considered a violation of bank secrecy. Technical versus Government Experts Borduge felt that the current objections were based on narrow national perspectives whereas the Experts were concerned with resolving large international problems. He thought that the Experts should consider the issue as technical experts rather than from national perspectives. He suggested that the Experts should propose the best technical solution and it would be up to governments to address public opinion and balance conflicts of interest. Canny was of the opposite view and felt that the Experts were there to represent the views of their governments and to ascertain what practical measures they could take to address the problems faced by governments. He declared that he could not agree to a technical solution which he knew his government would not and could not accept as that would leave his government in the intolerable position of having to disavow its chosen expert. The President noted that the Experts were meeting as technical experts and that their Resolutions were not binding on their respective governments. The Secretary highlighted that a similar issue had arisen in relation to the draft Mutual Assistance Pact of 1923 which had been approved by Lord Robert Cecil, but was rejected by the British Government. He suggested that the League’s committees did not have to concur with public opinion and perhaps it would be the case that public opinion would one

Drafting of 1925 League of Nations Resolutions 279 day agree with the views of the committees. Further, there would be no purpose in having such committees if they could not make any changes to existing laws or policies. The Experts accepted that their role was as technical experts and that their decisions did not bind their governments but Blau noted that it would be difficult for him to accept any proposals which he knew could not be agreed to by his government and were contrary to public opinion. Push for Compromise (Again) The Experts formed a sub-committee comprising Borduge, Canny and Blau to find an acceptable compromise. The sub-committee presented the following text which they agreed to unanimously: In view of the very special nature of the problem of fiscal evasion, the experts consider that they must, at the outset, submit the following observations, which should be read together with the text of their recommendations: (1)

Unlike double taxation, in connection with which any problems arising between two States can be settled appropriately by means of bilateral conventions, the question of fiscal evasion can only be solved in a satisfactory manner if the international agreements on this matter are adhered to by most of the States and if they are concluded simultaneously. Otherwise, the interests of the minority of States, who would alone have signed the conventions, might be seriously prejudiced. (2) As regards the carrying out of the recommendations, which the members of the Committee, in their capacity of technical experts submit, as being in their opinion the most suitable for counteracting fiscal evasion, the experts desire to emphasise the fact that it will only be possible to carry out these recommendations in any given country if, in the first place, public opinion in that country is sufficiently prepared, and secondly, if the Government of the country considers that the measures advocated are not only compatible with public opinion, but also are required for the collection of its own taxes. The experts recommend that Revenue Authorities should undertake to supply to other countries such information as may be required for tax assessment, for which purpose it is necessary to ascertain: 1. 2. 3. 4. 5.

Property (capital value and income); Mortgages (capital value and income); Industrial, commercial and agricultural enterprises (capital value and income); Income from labour, including directors’ fees; Income from securities, deposits and current accounts evidenced either by an affidavit or any other document evidencing payment of such income.

In the opinion of the Committee, it is essential that practically universal agreement should be reached on this subject in order to obviate the serious disadvantages

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which might result for certain countries, if the procedure in question were adopted by a minority of States only.61

The President proposed that item 5 also refer to ‘capital values and income’. This suggestion provoked a strong response from Blau who explained that he was supportive of the text put forward by the sub-committee as governments could address the issue of information exchange bilaterally, in accordance with domestic legislation. However, requiring banks to provide information regarding capital values would violate bank secrecy and would result in investments being moved to countries which did not adopt such measures. He felt that taxpayers would rather earn lower interest than be required to disclose their assets to tax authorities. Canny shared Blau’s concerns but was prepared in the spirit of conciliation to support the President’s amendment on condition that it was not altered and that it was supported without reservation by all Experts. Clavier proposed that they add the following statement: ‘to facilitate the extension and generalisation of the measures, it is desirable that the rates of tax are not excessive’. The Secretary recommended that the text be included in the report rather than in the Resolutions which Clavier accepted. Canny, however, thought that the comment was unnecessary as every government wanted to impose tax in the least burdensome way but was required to impose high taxes at that time to maintain a balanced budget. The President suggested that the Experts state in their report that they were asked to examine the issue of tax evasion in order to achieve justice but also because increasing the tax base would enable the tax rate to be reduced. He noted that it was not their place to suggest a lower rate and suggested that they include a comment in the report that if governments had a broader tax base due to prevention of tax evasion, they could recover higher amounts with lower tax rates. Canny proposed that they add to the end of the text that ‘the information given by the States can have a general or special purpose (for example, focus on nationals of the State which would give information)’. This addition would address concerns raised by Thompson in the previous session that Great Britain could not provide information on British nationals to enable them to be taxed in another country.62 Damste understood the British perspective but felt that every country should provide information on its own 61 Minutes of the Fourth Meeting of the Fourth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 10 am on 22 October 1924; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); EFS/DT/4ème Session/PV4 (1), United Nations Geneva. Minutes are in French. 62 In practice, this attitude was not limited to taxpayers with British nationality. Under Finance Act 1951 (UK) s 27, banks were required to inform the Inland Revenue regarding interest payments but recipients could notify the bank that they were not ordinarily resident in the United Kingdom and the bank would not inform the Revenue.

Drafting of 1925 League of Nations Resolutions 281 nationals. He felt that the Experts should set out general principles regarding the exchange of information. Borduge also felt that the Experts could not support any measures which would favour taxpayers moving to another country to avoid taxes. Canny understood the concerns of his colleagues but noted that it was impossible for the British Government to introduce legislation which would enable the exchange of information with regard to British nationals. He was prepared to withdraw his proposed amendment and simply make a personal reservation. However, the President felt that a reservation would weaken the scope of the Resolution and preferred to find a compromise. Blau supported Canny’s proposal and suggested that the information could only relate to ‘persons domiciled in the State’. Borduge was prepared to accept the amendment and suggested that the text ‘in respect of persons or companies domiciled in these States’ be included in the Resolution. Canny accepted the compromise text on condition that his colleagues agreed to the possibility of reopening the issue. Relationship Between Double Taxation and Tax Evasion Clavier queried whether the proposed text meant that the two issues of double taxation and tax evasion were to be treated separately rather than as interrelated questions. Canny responded that it would be left to countries to decide in bilateral treaties whether the two issues would be related but he felt that the Experts should not be too prescriptive as it was already the case in practice that the two issues were addressed by separate treaties. Blau agreed with Canny that the two issues of double taxation and tax evasion did not have to be connected. Borduge noted that his predecessor, Baudouin-Bugnet, believed that the two issues were closely linked and that governments would only be prepared to address double taxation if, at the same time, measures were taken to address tax evasion. He explained that the proposed text represented a compromise between him and his British and Swiss colleagues. He made the concessions on the Preamble and his colleagues accepted clause 5 of the Resolution in return. Vlanicek noted his agreement with Borduge’s comments and his acceptance of the proposed text. Clavier noted that there was discord among his colleagues as to the connection between the two issues of double taxation and tax evasion. He felt that it was important to bind the two issues closely otherwise rich taxpayers would benefit from the measures to remove double taxation while continuing to defraud governments through tax evasion. He considered it an important question of public morality. Nonetheless, in order to achieve agreement, he was happy not to insist on amendments to this effect. Damste was also of the view that the two issues should be linked as it was a matter of justice but accepted that it was sometimes difficult to accommodate notions of justice in tax as it could harm countries’ economic interests.

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The President noted that the text presented by the sub-committee was considered approved subject to a reservation by Blau who would consult his government.63 Damste noted that the text was not satisfactory but accepted it in the spirit of conciliation. Administrative and Judicial Assistance The Experts turned to consider the questions of administrative and judicial assistance.64 Damste (Netherlands) proposed the following Resolution to counter international tax evasion: 1.

States shall provide mutual assistance to recover in their respective countries and according to its rules and law, taxes due in other countries. 2. In principle, the rule in (1) shall only apply in the case of a debt which has the force of res judicata. Until a debt has acquired that force, protective measures may be carried out in order to ensure the rights of the creditor state. 3. The implementation and application of the previous provisions will be in accordance with the enforcement measures that are common to the laws in force of both countries. 4. The collection of foreign taxes should be given priority but after all taxes of the country exercising the collection.

He explained that the first point was the general statement of principle. The second point addressed situations such as in the Netherlands where tax authorities would not collect the tax until the outcome of a court appeal was known. The third point ensured that taxpayers were treated the same whether taxes were being collected in their country or in another. For example, if imprisonment for unpaid tax debts was not possible in the taxpayer’s country of residence, it could not be applied in the foreign country although such measures may exist in that country. The fourth point was one of trust and mutual respect. Valnicek agreed with the first three points of the proposal but was unable to agree with the fourth point as it would raise too many difficulties for countries, particularly as private creditors were likely to object as it could jeopardise their claims. Damste was prepared to withdraw the fourth point and explained that the difficulty did not arise in the Netherlands where the

63 Minutes of the Fifth Meeting of the Fourth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 4 pm on 22 October 1924; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); E.F.S./D.T./4e Session/P.V.5 (1), United Nations Geneva. 64 Minutes of the Sixth Meeting of the Fourth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 10 am on 23 October 1924; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); E.F.S./D.T./4e Session/P.V.6 (1), United Nations Geneva.

Drafting of 1925 League of Nations Resolutions 283 tax authorities were subordinate to mortgagees except in the case of property taxes. Clavier also accepted the removal of the fourth point. Valnicek also noted that the first three points were already addressed in the Treaty between Germany and Czechoslovakia.65 However, there were two further principles included in the Treaty which had not been considered by Damste. The first, incorporated in Article 8, established the principle of reciprocity: The authority to whom an application is addressed must comply with it and must employ the same means of coercion as are applicable for enforcing an application made by the authority of the country to which the application is made or an application by an interested party for the same purpose … A means of coercion which may be lawful in the territory of the State to which an application is made shall not be employed, unless the State making such application would be in a position to use a similar means of coercion in the case of an analogous application being made to itself.

The second, sovereignty of the requested state, was embodied in Article 14 as follows: Administrative and legal assistance may be refused if the State to which application for assistance is made considers such assistance likely to endanger its sovereign rights or safety.

Damste agreed that the first was important but not the second. Leaving aside the question of principle, Canny asked Damste whether he felt that the draft Resolution would practically result in the recovery of a significant portion of revenue from other countries that would otherwise be lost. Damste responded that the Dutch experience indicated that significant sums could be recovered from their nationals who took refuge in Belgium. Canny also noted that the issue of administrative and judicial assistance was dissimilar to that of tax evasion as this issue could be addressed bilaterally whereas tax evasion had to be addressed by the largest possible number of countries. The issue was not of particular importance to Great Britain due to its geographic location. Further, he explained that he had consulted English lawyers who suggested that Damste’s proposal would repeal a longheld practice in England and disregard a principle in English law that no account should be taken of the tax laws of other countries and that they should be completely ignored. The British lawyers did not think it possible to repeal the English law. From the British point of view, if a country was in favour of any kind of taxes, that country should collect those taxes and refrain from claiming assistance from other countries. More importantly, the ease with which a country collected taxes largely depended on the 65 Treaty between the German Reich and the Czechoslovak Republic concerning Legal Safeguards and Legal Assistance in Matters of Taxation (signed 31 December 1921) 17 LNTS 403, reproduced in League of Nations, n 13 above, 215–20.

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willingness of taxpayers and the majority of taxpayers were willing to comply because they believed that the tax authorities were working in the interests of their country. He considered it likely that this goodwill would disappear if tax authorities were collecting taxes on behalf of other countries. As such, Canny thought that Damste’s proposal would not result in any real advantage and could possibly result in disadvantages for Great Britain in the collection of its taxes. Further, the British views which he had mentioned applied also in the case of the Dominions and a Canadian would not be prosecuted in England for failing to pay taxes in Canada. In conclusion, Canny proposed the following text: States could consider allowing other States access to its tribunals and courts of justice, if necessary, to achieve the recovery of tax debts with the force of res judicata. If this principle was adopted, States could put them into execution through bilateral agreements.

Clavier preferred Damste’s proposal as it was based on provisions included in the draft Treaty between the Netherlands and Belgium. As to the usefulness of such measures, he noted that Belgium was similarly interested in targeting Belgian nationals who achieved considerable wealth during the war and had taken refuge in the Netherlands. As there were reservations to the proposals of both Damste and Canny, it was agreed that Canny, Clavier and Damste would form a sub-committee to draft a compromise text. The sub-committee presented the following text: States should consider the possibility of allowing other States the intervention of their administrative and judicial authorities to collect their tax debts having the force of res judicata. If this principle was adopted, states could conclude between themselves, agreements that may contain the following provisions: 1.

States will recover in their respective countries, each according to its own rules of law, the tax payable in the other country, even by non-nationals. However, the requested State shall not be required to apply a means of enforcement which is not prescribed by the law of the requesting State. 2. The income tax receivable will be considered in the requested State as nonpreferential debts. 3. The prosecution and enforcement will be executed on production of an official copy of enforceable instruments and documents evidencing that the tax claim is final. If this claim is not final, precautionary measures may be taken. 4. The tax payable in the country that holds the proceedings will be retained before those of the other country.66

66 Minutes of the Seventh Meeting of the Fourth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 5 pm on 23 October 1924; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); EFS/DT/4ème Session/PV7 (1), United Nations Geneva. Minutes are in French.

Drafting of 1925 League of Nations Resolutions 285 Blau noted that he would prefer for a large number of countries to participate in the measures and he objected to the bilateral nature of the proposed Treaties. Canny responded that every country should be free to provide administrative and judicial assistance to the extent that it suited them and the relations between two countries was the primary consideration. He noted that bilateral treaties had already been concluded in this regard between the Netherlands and Belgium and Germany and Czechoslovakia and these countries had not invited other countries to participate. Damste agreed that the consensus of many governments was necessary for the discovery of hidden assets but with regard to tax debts, bilateral treaties were sufficient. Blau pointed out that the likely scenario was that a taxpayer with debts owing in Switzerland would simply move to a country which did not have a treaty with Switzerland. Canny noted that he had already compromised in agreeing that the tax debts of one country could be enforced in the courts of another and he could only do so on the basis that such measures were left to bilateral treaties. Blau responded that he would not insist on any amendments and the text was adopted unanimously, subject to consideration by the legal department. Following further reflection, the President proposed that the fourth item should be deleted as it was unnecessary and this was agreed to by the Experts.67 The Resolution on ‘collection of tax’ in the 1925 Report reflects this text, subject to wording changes.

Fifth Session The fifth session was held in Geneva in February 1925, approximately five months after the previous session. In general, this was a comparatively short session which focused on finalising the Experts’ Resolutions and report but revisited some of the earlier discussion regarding the measures against tax evasion. Revisiting Bank Secrecy (Again) Blau noted that he had not been able to give his full support to the Experts’ proposed measures against tax evasion at the previous session.68 He had since fully considered the practical impact of the proposed text and was 67 Minutes of the Eighth Meeting of the Fourth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 10 am on 24 October 1924; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); EFS/DT/4ème Session/PV8 (1), United Nations Geneva. 68 Minutes of the Third Meeting of the Fifth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 11 am on 3 February 1925; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); EFS/DT/5ème Session/PV1 (3), United Nations Geneva.

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particularly concerned about the proposed exchange of information in relation to securities, deposits and current accounts. In his opinion, comprehensive exchange of information in this regard could only be achieved with the violation of bank secrecy. He had first considered whether the Experts could limit the proposed exchange of information to concrete cases which were the subject of a request from the tax authorities of a country. However, after further deliberation, he concluded that this approach would not achieve the results sought by the Experts. After providing an explanation as to the importance of bank secrecy,69 including its role in civil law regarding the rules of good faith in the interpretation and execution of contracts, he declared that he was unable to agree to the Resolutions proposed by the Experts. He elaborated on the disadvantages that would be caused by the violation of bank secrecy and suggested that the measures proposed by the Experts to curb tax evasion were unnecessary as tax authorities already possessed some of the relevant information. By way of compromise, he proposed that the exchange of information be limited to information which was already in the possession of tax authorities. He also considered it important that any proposal included conditions regarding sovereignty. Valnicek noted that in the case of Czechoslovakia’s agreements with Germany and Austria,70 the contracting countries were required to assist each other in establishing the tax base but only if a specific request had been made. Where a request was made, countries could provide information obtained from banks. He considered it regrettable that Czechoslovakia did not have a similar agreement with the Netherlands, which was where the large Czechoslovakian companies had hidden their capital during the war. He did not agree with Blau’s conclusions that bank secrecy would be violated. While he thought that it was possible to violate bank secrecy if all of the major countries agreed, he noted the problems that had arisen in Germany and France where bank secrecy was suppressed after the war but soon reinstated. Borduge also did not agree that the Experts’ proposals would result in the violation of bank secrecy as taxpayers would be aware in advance that income earned overseas would be reported to their tax authorities. As to Blau’s arguments that the proposed measures would hinder capital flows, Borduge noted that the Experts were not proposing to introduce a new tax but simply to apply the laws already in place in different countries more effectively. As to the financial costs and practicability of the proposed measures, Borduge provided the example of the US tax administration system which he 69 For discussion of banking secrecy in Switzerland, see Walter Meier, ‘Banking Secrecy in Swiss and International Taxation’ (1973) 7 International Lawyer 16. 70 See n 65 above for the German Treaty; Treaty between Austria and Czechoslovakia for the Adjustment of Taxation at Home and Abroad, in particular for the Avoidance of Double Taxation in the Field of Direct Taxation (concluded 18 February 1922), reproduced in League of Nations, n 13 above, 21–26.

Drafting of 1925 League of Nations Resolutions 287 considered to be efficient, effective and inexpensive. Borduge queried what information Blau thought was already in the possession of tax authorities and could be exchanged, as Borduge recalled that the Experts had previously agreed that tax authorities did not possess the necessary information. As such, he did not consider Blau’s proposal to be a practical solution. Unsurprisingly, Canny, on the other hand, supported Blau’s proposition and wholeheartedly agreed with the concerns raised by Blau with regard to the Experts’ proposed text. Clavier did not think that the Experts’ text violated bank secrecy but, in the spirit of conciliation, was prepared to find some other text which was favourable to both Canny and Blau. He suggested that the text be amended to only require disclosure regarding interest income earned abroad and not the capital values of deposits in foreign bank accounts. He considered the latter to violate bank secrecy but not the former. As had been stated by Borduge previously, such disclosure was similar to declarations regarding salary and wages made by employers. Further, Clavier thought that Blau’s proposal could even aid in tax evasion if some countries chose to assist taxpayers. The President suggested that the discussion be continued at the next meeting and asked that his colleagues ruminate on Blau’s proposal as he preferred a unanimous solution, even if it was not as immediately effective. At the next meeting, Clavier presented (unrecorded) amendments to the proposed text while Borduge proposed the insertion of the following paragraph instead: Two experts were of the opinion, however, on second reading, that it would be sufficient, at least initially, to limit the disclosure requirements requested of various governments due to the operation of their tax systems.71

The President preferred that Borduge would agree to Clavier’s amendments as Borduge’s proposed text indicated that the Experts were not unanimous. Borduge responded that there were clearly two opposing views and thought that it was better to present the facts in their true light: the Experts, with the exception of Blau and Canny, recognised that there was a perfect system in which all tax evasion would be suppressed. The President reiterated his earlier view that the Resolutions should be unanimous. Clavier highlighted that his proposed text represented a compromise, taking into account all of the different views and clashes of principles. He suggested that it was a starting point with further measures being possible as public opinion and government views changed. Damste was also of the opinion that it was necessary to examine the issue from a practical point of 71 Minutes of the Fourth Meeting of the Fifth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 4 pm on 3 February 1925; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); EFS/DT/5ème Session/PV1 (4), United Nations Geneva. Minutes are in French only.

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view and he felt that it was unproductive to recommend a proposal which would never be accepted by the British Government, for example. The President again appealed to Borduge to join the rest of the Experts in agreeing to Clavier’s compromise text or to propose amendments to that text which would take into account his views. Borduge responded that the fundamental problem with the proposed text was that it suggested that information exchange between governments was a solution to the problem of tax evasion when it was clearly evident that some governments would not communicate any information of real importance. The Swiss Government, for example, would not provide information on equity securities. After some discussion it was decided that Blau, Borduge, Clavier and Canny would attempt to reach a compromise text which reflected all views. Unfortunately, the minutes of the subsequent two meetings do not capture the discussion which took place and simply record that ‘after discussion’ the Experts agreed to the following text relating to tax evasion: In view of the very special nature of the problem of tax evasion, the experts consider that they must, at the outset, submit the following observations, which should be read together with the text of their recommendations: (1)

Unlike double taxation, in connection with which any problems arising between two States can be settled appropriately by means of bilateral conventions, the question of fiscal evasion can only be solved in a satisfactory manner if the international agreements on this matter are adhered to by most of the States and if they are concluded simultaneously. Otherwise, the interests of the minority of States, which would alone have signed the conventions, might be seriously prejudiced. (2) As regards the carrying out of the recommendations, which the members of the Committee, in their capacity of technical experts submit, as being in their opinion the most suitable for counteracting tax evasion, the experts desire to emphasise the fact that it will only be possible to carry out these recommendations in any given country if, in the first place, public opinion in that country is sufficiently prepared, and secondly, if the Government of the country considers that the measures advocated are not only compatible with public opinion, but also are required for the collection of its own taxes. The experts consider that the effective method of avoiding tax evasion is for the revenue authorities to undertake to supply on a basis of reciprocity to other countries, in respect of persons or companies domiciled in those countries, such information as may be required for tax assessment, for which purpose it is necessary to ascertain both the income and capital value of: 1. 2. 3. 4.

5.

Immovable property; Mortgages; Industrial, commercial or agricultural undertakings; Movable securities, deposits and current accounts as determined by means of affidavits or any other documents proving the existence of capital or the payment of the income; Earned income, including directors’ fees.

Drafting of 1925 League of Nations Resolutions 289 Nevertheless, having regard to circumstances of different kinds, the experts recognise that this exchange should be limited actually to the information which is in the possession of States or which the States can obtain in the course of their fiscal administrations. In the opinion of the Committee, it is essential that agreement on the subject of tax evasion should be reached, if not universally, at least by a majority of States, in order to obviate the serious disadvantages which might result for certain countries, if the procedure in question were adopted by a minority of States only.72

This text is what appears in the 1925 Report. The two key changes to the earlier text were the insertion of the principle of reciprocity in the fourth paragraph and the insertion of the fifth paragraph, limiting the scope of the information which could be exchanged. Economic and Moral Interests Clavier returned to the proposed text on tax evasion at the next meeting.73 He commented that the measures against tax evasion were of benefit to all countries and not just those countries which were suffering from tax evasion at that time. Further, all countries were economically interdependent and those that suffered greatly from tax evasion were forced to borrow substantially to rebuild regions devastated by war. Consequently, these countries would print more money to repay the loans, devaluing their currencies. Countries which maintained their currencies would nonetheless be affected as traders in countries with depreciated exchanges would not be able to continue purchasing from countries with a higher exchange. This would result in the exports of the higher exchange countries being paralysed and industrial production slowing down which would lead to increasing unemployment. Similarly, tourism in these countries would suffer because tourists from countries with devalued currencies would stop visiting. As such, it was in the interests of all countries to curb tax evasion to avoid the devaluation of currencies. In addition to economic interests, Claiver felt that there was a moral interest which was one of the essential factors of the work of the League towards peace. There was no discussion of Clavier’s comments but the Experts must have agreed to them as his comments are reflected in the Experts’ conclusions on tax evasion in the 1925 Report. 72 Minutes of the Fifth and Sixth Meetings of the Fifth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 11 am on 4 February 1925; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); EFS/DT/5ème Session/PV1 (5 and 6), United Nations Geneva. Minutes are in French. 73 Minutes of the Seventh Meeting of the Fifth Session of the Committee of Government Experts on Double Taxation and the Evasion of Taxation held at 10 am on 5 February 1925; League of Nations Archives; Double Imposition et Evasion Fiscale vol III 4–5 Sessions du Comte des Experts Gouvernmentaux (1516); EFS/DT/5ème Session/PV1 (7), United Nations Geneva. Minutes are in French.

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The League received a number of official responses to the 1925 Report (eg from the British government; International Chamber of Commerce; International Shipping Conference) but these responses did not comment on the tax evasion section of the Report. However, this section of the Report was examined in some detail by the Financial Committee.74 The discussion reflects the same country representations made at the Experts’ sessions. As to the Experts’ recommendations on the ‘assessment of tax’, the first bullet point was accepted without discussion. In relation to the first paragraph of the second bullet point on public opinion and government views, Niemeyer (Great Britain) noted that some countries would not agree to the collection of information that they did not require themselves, just for the benefit of another country. He did not want to express an opinion as to whether the British Government would be favourable towards sending information to other countries. Dubois (Switzerland) similarly noted that it would be very difficult for Switzerland to adopt the proposed measures due to public opinion but especially because of the different cantonal laws under which taxes were imposed. A referendum would be required to amend the Federal Constitution to enable the Swiss Confederation to legislate in this area. Nonetheless, he declared that he approved of the stated goal of the measures. Pospisil (Czechoslovakia) noted these comments but felt that the recommendations in the Report were cautious enough to address these objections. Pospisil also thought that the cautiousness of the remaining paragraphs was likely to mitigate any concerns that could arise in relation to the exchange of information on movable securities, deposits and current accounts. Dubois, after declaring once again that he supported measures to prevent tax evasion, queried whether the Experts’ proposals were in fact the best solution. He was concerned that the proposed measures would affect the movement of capital, at a time when the reconstruction of Europe required large international movements of capital, and bring about many disadvantages as indicated by the experience of countries such as France and Switzerland, which had experimented with affidavits and other documents. De Chalendar (France) felt that any amendments to water down the Experts’ language would open the door to tax evasion. Dubois responded that he was not requesting any amendments but simply felt that the drafting of future treaties would face many obstacles.

74 Minutes of the Sixth Meeting (First Part) of the Eighteenth Session of the Financial Committee of the Provisional Economic and Financial Committee held on 6 June 1925 (evening) in Geneva (League of Nations Archives, United Nations Geneva: F/18ème Session/PV6(1), 1ère Partie).

Drafting of 1925 League of Nations Resolutions 291 The Secretary reported that he had obtained information authorised by the President of the United States that, despite stringent controls in the United States, there was extensive capital movement and business prosperity there. Any complaints related to specific rules but not to general principles. After some discussion, it was agreed that the Financial Committee were not opposed to the wording adopted by the Experts but felt that the importance of the flow of capital in economic terms and for global reconstruction should be recognised by the Finance Committee in their report. On that note, they approved the section on ‘assessment of tax’ in the 1925 Report.75 As to the Experts’ recommendations on the ‘collection of tax’, Dubois queried the scope of the first recommendation that ‘each State shall recover within its territory, in accordance with its own law, taxes due in another State, including taxes due from persons not nationals of the latter State’. As he understood it, if Italy was owed a tax that needed to be collected in Switzerland, the taxpayer could be an Italian residing in Switzerland or a Swiss, French, German, etc person residing in Switzerland. D’Aroma (President of the Technical Experts), who was in attendance, agreed with Dubois’ interpretation. Dubois queried how such a measure could be enforced given the different laws in countries. Pospisil responded that there would be two scenarios. If the country’s domestic legislation allowed for such action, there would be no problem. If the country’s legislation did not allow for such action, the position would depend on the strength of the Treaty ratification in that particular country. He felt that the current text was broad enough to cover all cases. D’Aroma noted that the Legal Section of the League had reviewed the text, while the Secretary reminded the Committee that existing treaties between Czechoslovakia, Germany and Austria adopted similar ideas. Niemeyer noted that the Technical Experts did not propose that all countries were obligated to initiate an action and countries could determine the best course of action for their circumstances. Dubois asked D’Aroma whether the Technical Experts had considered a universal multilateral agreement. D’Aroma responded that that was considered the ideal solution but the Experts accepted that bilateral treaties would advance a solution in the interim. On that note, the Financial Committee approved of the text on ‘collection of tax’.

75 The Financial Committee’s Report to Council on the 1925 Report recorded the Committee’s support for the Experts’ proposal to convene a larger international conference to draft international treaties based on the 1925 Report but imposed one condition on the future conference: ‘to take into consideration the disadvantage of placing any obstacles in the way of the international circulation of capital, which is one of the conditions of public prosperity and world economic reconstruction’: Report to the Council by the Financial Committee on the Work of its Eighteenth Session held at Geneva from June 4th to 8th 1925 (League of Nations Archives, United Nations Geneva: C.335.1925.II).

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Sunita Jogarajan CONCLUSION

It is fair to say that the proposals in the 1925 Report, which were later embodied in the two Model Treaties targeting tax evasion, did not achieve their goal of preventing tax evasion through capital exportation. Farquet has found that ‘the 1920s and 1930s [were] something of a golden age of opportunity for avoiding taxation through the relocation assets’.76 The failure of the proposals is of little surprise once their development is understood. The Resolutions were agreed to on the basis that they were not binding on countries and with many compromises. One wonders whether a number of alternative proposals would have had more success. On the other hand, the Secretary was prescient in stating that public opinion would change and that the Experts should develop the best solutions although it may not yet be their time. The question then for policy-makers is whether they seek immediate or eventual reform. The President of the Technical Experts did not expect the proposals to be immediately effective but he probably did not expect them to take 90 years to come to fruition! The key changes in the last 90 years that have enabled these proposals to be realised are the changing approach of the public regarding privacy and governments’ intolerance of countries aiding tax evaders. Starting with the OECD’s ‘Harmful Tax Competition’ project in the late 1990s, there has been a gradual shift in outlook. Similarly, public expectations regarding privacy have changed, particularly with various technological changes. But changes in opinion are not enough. The striking similarity between the adoption of various measures now and their proposal in the 1920s is that both instances were in response to a crisis. The financial and budgetary crisis following the Great War brought about the first multinational effort to target tax evasion, while the recent global financial crisis has brought about the large-scale adoption of measures targeting tax evasion.

76 Christophe Farquet, The Rise of the Swiss Tax Haven in the Interwar Period: An International Comparison, Working Paper No 27 (European Historial Economics Society, 2012) 3.

10 In the Beginning: Taxation in Early Colonial New Zealand MICHAEL LITTLEWOOD*

ABSTRACT For the first five years of the colonial period, from 1840 to 1845, the New Zealand Government was insolvent, spiralling deeper and deeper into debt and failing to pay salaries and other bills. It conscientiously adopted the revenue-raising methods proposed by London (mainly land sales and customs duties) plus several others (notably liquor licensing, a tax on auctions, and borough council rates), but the revenues raised never came close to covering spending. In desperation, it resorted to borrowing, printing money and experimenting with an income tax—an extraordinarily innovative move in 1844. Unsurprisingly, none of these measures proved satisfactory. London blamed the Colony’s governors, but the real problem was that its economy was simply too small to sustain a government even remotely resembling the British colonial norm.

INTRODUCTION

F

OR THE FIRST five years of the colonial period, from 1840 to 1845, the finances of the New Zealand Government were a shambles, mainly because the British Government wanted the Colony to become financially self-sufficient sooner than was feasible. It was of course recognised that it would be necessary to establish colonial rule first, and then introduce the measures that would enable the colonial government to pay for itself, but Britain was naturally loath to allow the new Colony to constitute a

* I am grateful to Simon Dew, David V Williams, Peter Harris, Francis Dawson, John Ip, Ned Fletcher, Claire Charters, Amokura Kawharu, Janet McLean, and Ken Palmer for their thoughts on various aspects of this chapter. I am grateful also to Mary Breckon, Conor Tinker, Hartley Spring and Daniel Bowler for helping with the research on which it is based and to the University of Auckland for funding their assistance.

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drain on the Imperial Treasury. Instead of paying itself, therefore, the British Government instructed the government of New South Wales (founded as a penal colony in 1788 and by 1840 well established) to lend monies to the embryonic New Zealand Government to cover its start-up costs. So far, so good, but the funds advanced by New South Wales were so meagre that the New Zealand Government found itself insolvent almost from the start. The problem was not that the government of the new Colony failed to establish a tax system. On the contrary, the inaugural Governor, William Hobson, enacted all the revenue-raising laws London had envisaged and, insofar as funding allowed, the machinery to implement them. The principal source of revenue was the right of pre-emption; that is, the government claimed for itself the exclusive right to purchase land from the native Maori people. It then exercised that right and so acquired land, which it on-sold to settlers at a profit. The government also introduced customs duties, liquor licensing, and a tax on land and goods sold at auction. These measures produced as much money as could be sensibly expected, but that was never enough. The basic problem was that the settler population was tiny: 2,000 in 1840 and still only 13,000 in 1845.1 Consequently the colonial economy was simply too small to sustain a government even remotely resembling the British colonial norm. The Maori population was larger, at about 80,000,2 but it afforded little in the way of taxable capacity. Maori generally welcomed small pakeha (non-Maori) settlements because the settlers brought valuable technologies with them, such as blankets, nails and guns (and also tobacco), but they were naturally unenthusiastic about paying taxes for the purpose of maintaining the colonial regime. Moreover, throughout the period with which this chapter is concerned, the British military presence in the Colony was miniscule. Generally there were fewer than 100 British troops in New Zealand, with up to a couple of hundred more brought over from Sydney in times of crisis.3 Since most Maori tribes had been enthusiastically buying guns for several decades,4 the British forces were not strong enough to confront them, let alone to provide ongoing protection for isolated rural communities. The settlers were thus permitted to remain in the Colony entirely at the sufferance of the local Maori communities, who could have slaughtered them or thrown them out

1 Statistics New Zealand, Long-Term Data Series, Population; available at http://web. archive.org/web/20080305185447/http://www.stats.govt.nz/tables/ltds/ltds-population.htm. 2 ibid; I Pool, Te Iwi Maori: A New Zealand Population, Past, Present and Projected (Auckland, Auckland University Press, 1991) 58–63; P Adams, Fatal Necessity: British Intervention in New Zealand 1830–1847 (Auckland, Auckland University Press, 1977) ch 1. 3 Adams, n 2 above, 217–18. 4 R Fitzroy, Remarks on New Zealand in February 1846 (London, W & H White, 1846; facsimile edn, University of Otago, 1969) 43–44; Adams, n 2 above, ch 1; J Belich, The New Zealand Wars and the Victorian Interpretation of Racial Conflict (Auckland, Penguin, 1988) 19–21.

Taxation in Early Colonial New Zealand 295 at any time. Likewise, the colonial government itself was permitted to exist only at Maori sufferance.5 The New South Wales and British Governments grudgingly supplied further funds (as loans, to be repaid as soon as possible), but not enough. The New Zealand Government consequently spiralled deeper into debt. It failed to pay salaries and other expenses. Profiting from land sales proved problematic, mainly because speculators claimed to have purchased vast acreages directly from Maori vendors before the Colony was established. Chief among these was the New Zealand Company, which had been formed in the United Kingdom for the purpose of colonising the country. Customs duties also caused problems. In particular, there were thousands of miles of coastline featuring thousands of natural harbours, remote from officialdom and suitable for the discreet unloading and hiding of cargos.6 Smuggling was consequently rife and impossible to prevent (especially with London complaining about the cost of the Colony’s Customs Department). The imposition of customs duties was also bitterly resented by both the Maori and settler communities. By early 1844 the Governor, Robert FitzRoy, who had succeeded Hobson in 1843, was desperate. In March of that year he waived the right of pre-emption; that is, he allowed settlers to purchase land directly from Maori, subject, however, to a fee of 10 shillings per acre. But that was more than most land was worth, so very few purchases occurred; and a few months later he therefore reduced the fee to one penny per acre. That encouraged purchases (and therefore economic growth) but only at the cost of foregoing revenues. In May 1844, still desperate, FitzRoy resorted to printing money, something his instructions expressly forbade him to do. In September, more desperate still, he abolished customs duties and replaced them with a tax on property (both real and personal) and incomes. As in the United Kingdom, where the income tax had been reintroduced in 1842 (it having been introduced in 1799 to finance the war against Napoleon and abolished after he was defeated at Waterloo in 1815),7 this was intended to encourage trade and economic growth. The tax on property and incomes was an extraordinarily avant-garde measure for a tiny, remote

5 Fitzroy, n 4 above, 13–32; W Swainson, New Zealand and its Colonization (London, Smith, Elder & Co, 1859) 186–87. But see T Bunbury, Reminiscences of a Veteran (London, Charles J Skeet, 1861). 6 See, eg Fitzroy to Stanley, 29 September 1844, British Parliamentary Papers (BPP) 1845 (369) XXXIII.239, 11. 7 See generally S Dowell, A History of Taxation and Taxes in England (London, Longmans Green, 1884, republished by Frank Cass & Co, London, 1965), vol 3, 92–120; B Sabine, A History of Income Tax (London, George Allen and Unwin, 1966) chs 2–4; B Sabine, A Short History of Taxation (London, Butterworth & Co, 1980) ch 8; M Daunton, Trusting Leviathan: the Politics of Taxation in Britain, 1799–1914 (Cambridge, Cambridge University Press, 2001).

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and newly-established Colony; unsurprisingly it failed and in 1845 it was repealed and the customs duties were revived, bringing to a close this first chapter in the history of the colonial New Zealand tax system.8

HOBSON AND THE ESTABLISHMENT OF THE COLONY

In the last few years of the eighteenth century and the first few years of the nineteenth, the first European settlers arrived in New Zealand.9 Some were rugged entrepreneurs dealing in timber and flax but most were whalers, sealers, convicts who had escaped from the penal colonies in Australia or sailors who had deserted their ships—a wild and lawless lot, guilty, according to the British government, of ‘every species of crime and outrage’.10 There were also some missionaries and some private attempts at agricultural settlement, notably those orchestrated by the New Zealand Company. By the late 1830s, there were about 2,000 Europeans living in the country. In 1839 the British government decided to colonise New Zealand.11 The rationale offered by the Colonial Office was that it was unacceptable to allow a society of Britons ‘of bad or doubtful character’ to evolve without any proper system of government; and unacceptable also to allow them to take advantage of the islands’ native inhabitants (that they would take advantage of Maori, if left ungoverned, was sensibly regarded as inevitable). For the British government to colonise New Zealand would be, it was acknowledged, an ‘essentially unjust’ endeavour, ‘fraught with calamity to a numerous and inoffensive people, whose title to the soil and to the sovereignty of New Zealand is indisputable’. It might even lead to their extinction, if experience elsewhere was anything to go by. But it would be better than letting the New Zealand Company colonise it without any form of governmental control, let alone what might emerge from the microcommunities of traders and feral colonial riffraff. As for the Company, it was naturally opposed to any attempt to restrain its operations.

8 See also P Goldsmith, We Won, You Lost, Eat That!: A Political History of Tax in New Zealand (Auckland, David Ling, 2008). 9 See generally AH McLintock, Crown Colony Government in New Zealand (Wellington, Government Printer, 1958) chs 1 and 2; MFL Pritchard, An Economic History of New Zealand (Auckland, Collins, 1970) ch 2; Adams, n 2 above, ch 2. 10 Normanby to Hobson, 14 August 1839, BPP 1840 (238) XXXIII.587, 37. See, eg R Wolfe, Hell-Hole of the Pacific (Auckland, Penguin, 2005). 11 This and the following direct and indirect quotations are from Normanby, n 10 above. See also eg I Wards, The Shadow of the Land: a Study of British Policy and Racial Conflict in New Zealand 1832–1852 (Wellington, Government Printer, 1968).

Taxation in Early Colonial New Zealand 297 Lord Normanby’s Instructions to Hobson It was decided that the job of establishing the new Colony would be given to Captain William Hobson of the Royal Navy. Hobson was born in 1792 in Ireland; joined the Navy at the age of nine; and served in the Napoleonic wars and in the Caribbean.12 On 14 August 1839 he was appointed ‘Her Majesty’s Consul at New Zealand’. The despatch making the appointment was issued in the name of the Secretary of State for War and the Colonies, the Marquess of Normanby (an undistinguished Whig politician). It was most likely composed, however, by James Stephen, who served as the Permanent Under-Secretary of State for the Colonies (that is, the senior civil servant in charge of the day-to-day running of the Colonial Office) from 1836 to 1847. As a civil servant, Stephen was answerable to the Secretary of State (the member of the Cabinet responsible for the army and the colonies); but Normanby and his successors generally allowed Stephen an extraordinary degree of latitude in formulating and implementing policy, for which reason he was sometimes referred to as ‘Mr Over-Secretary Stephen’. He was a crucial figure in the colonisation of New Zealand and in the evolution of the British Empire generally. It is convenient, in discussing the documents emanating from the Colonial Office, to identify them by reference to the persons in whose names they were issued (for example, Normanby), even though they were generally drafted by Stephen or under his direction. Since New Zealand was ‘a sovereign and independent state’, Normanby’s despatch continued, it could not be colonised other than by ‘the free and intelligent consent of the natives’; Hobson’s first task, therefore, was to persuade as many Maori as possible to give that consent. To that end, Normanby suggested he should point out to the Maori ‘the impossibility of her Majesty’s extending to them any effectual protection’ from unauthorised colonisation unless they ceded sovereignty to her. Should that argument fail, he was to resort to offering ‘presents or other pecuniary arrangements’. Hobson was directed also to persuade the Maori chiefs to agree to sell their land only to the Crown and to no one else; and he was to announce that titles to land would be recognised only if either derived from or confirmed by the colonial government. Small purchases conducted on equitable terms would be confirmed, but the British regime would not recognise titles acquired by sharp practice or the vast estates that the New Zealand Company claimed to have purchased. So as to discourage landbanking, Hobson was to impose a tax on unimproved land; and if the tax fell into arrears, the

12 JC Beaglehole, Captain Hobson and the New Zealand Company: A Study in Colonial Administration (Northampton, MA, Smith College, 1928); GH Scholefield, Captain William Hobson (London, Oxford University Press, 1934); McLintock, n 9 above, ch 6; P Moon, Hobson, Governor of New Zealand (Auckland, David Ling Publishing, 1998).

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land would be forfeit. Once he had by these means ‘obviated the dangers of the acquisition of large tracts of country by mere land-jobbers’, his next task would be ‘to obtain, by fair and equal contracts with the natives’ as much land as would be ‘progressively required for the occupation of settlers’.13 To begin with, Normanby continued, New Zealand would be subordinate to New South Wales.14 The reason was that establishing a separate Colony would have required parliamentary approval, which might have been difficult to procure; whereas extending an existing Colony to cover extra territory could be done under the prerogative, without troubling Parliament.15 New Zealand was emphatically not, however, to be a penal settlement. Hobson would be its Lieutenant-Governor, answerable to Sir George Gipps, the Governor of New South Wales. As soon as possible the new Colony was to be self-financing. At the outset, that would plainly be impossible, so it would be financed by loans advanced by the government of New South Wales. Such loans would have to be repaid, however, ‘at the earliest opportunity’. To this end, Normanby proposed that there should be duties on the importation of tobacco, spirits, wine, and sugar; these, he said, would ‘probably supersede the necessity for any other taxation’. As for the revenues to be made by buying land from Maori and selling it to the settlers, they were to be kept separate from the government’s other revenues and applied, first, to the expenditure incurred in generating them (buying the land, surveying it, building roads on it, and so on) and, secondly, to the cost of ‘removing emigrants’ from the United Kingdom ‘to the new Colony’.

Treaty of Waitangi Hobson arrived in New Zealand on 29 January 1840 and set about persuading as many Maori as possible to cede sovereignty to the Crown.16 He was remarkably successful, for only a week later, on 6 February 1840, a treaty was signed at Waitangi in the Bay of Islands, 200 kilometres north of what is now Auckland. The signatories were Hobson on behalf of the Crown and about 40 Maori chiefs on behalf of themselves and their peoples. Over the next few months, more Maori chiefs signed, bringing the total

13 On the process of land acquisition in colonial New Zealand generally, see S Banner, ‘Conquest by Contract: Wealth Transfer and Land Market Structure in Colonial New Zealand’ [2000] Law and Society Review 47. See also M Hickford, Lords of the Land: Indigenous Property Rights and the Jurisprudence of Empire (Oxford, Oxford University Press, 2011); S Banner, Possessing the Pacific (Cambridge, Harvard University Press, 2007). 14 See generally McLintock, n 9 above, chs 2 and 3. 15 ibid 49 and 98–99. 16 ibid 56.

Taxation in Early Colonial New Zealand 299 eventually to more than 500. Some tribes, however, declined to sign.17 The Treaty was in both Maori and English. It was very short, consisting of only three brief Articles. Article I conferred on the Crown either ‘sovereignty’ (English version) or ‘kawanatanga’ (Maori version; the word is usually translated as ‘governorship’).18 Article II guaranteed Maori ‘the full exclusive and undisturbed possession of their Lands and Estates Forests Fisheries and other properties’ and also conferred on the Crown ‘the exclusive right of pre-emption’ (according to the English version; the Maori version merely gave the Crown the right of first refusal). It seems clear that the government would have claimed the exclusive right to acquire land, even in the absence of the Treaty, on the basis that it was a standard aspect of the process of colonisation. It was also expedient as a matter of regularising land tenure19 and a prerequisite to raising revenue by means of land sales, for if settlers could purchase land direct from Maori, it would be impossible for the Crown to profit by buying land from Maori and selling it to settlers.20 Article III extended to Maori ‘all the rights and privileges of British subjects’. The status and meaning of the Treaty were contentious from the beginning and remain so today.21 But whatever its legal effect, the Treaty marked, more or less, the founding of New Zealand as a British colony. In commemoration of its signing, 6 February, Waitangi Day, is New Zealand’s principal national holiday.

Lord Russell’s Instructions to Hobson On 7 August 1840, the British Parliament enacted legislation allowing for New Zealand to be established as a separate Colony, meaning that its government would be answerable direct to the Colonial Office in London rather than to New South Wales.22 Three weeks later, Lord John Russell (a leading Whig, instrumental in the democratisation of Parliament and later 17 See generally C Orange, The Treaty of Waitangi (Wellington, Allen & Unwin, 1987) and M Palmer, The Treaty of Waitangi in New Zealand’s Law and Constitution (Wellington, Victoria University Press, 2008). 18 See, eg Palmer, n 17 above, 61–63. 19 R Boast, Buying the Land, Selling the Land: Governments and Maori Land in the North Island 1865–1921 (Wellington, Victoria University Press, 2008) 19–31. 20 See Adams, n 2 above, 14 and 194–200; P Spiller, J Finn and R Boast, A New Zealand Legal History (Wellington, Brooker’s, 1995) 131. 21 See, eg R v Symonds (1847) NZPCC 387; Wi Parata v Bishop of Wellington [1877] 3 NZ Jur (NS) 72; New Zealand Maori Council v Attorney-General [1987] 1 NZLR 641 (HC and CA); P McHugh, The Maori Magna Carta: New Zealand Law and the Treaty of Waitangi (Auckland, Oxford University Press, 1991); P Joseph, Constitutional and Administrative Law in New Zealand, 4th edn (Wellington, Brookers, 2014) chs 2 and 3; DV Williams, A Simple Nullity? The Wi Parata Case in New Zealand Law and History (Auckland, Auckland University Press, 2011); Palmer, n 17 above. 22 New South Wales and Van Diemen’s Land Act 1840 (3 & 4 Vict c 62) (UK) s 2.

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Prime Minister)23 succeeded Normanby as Secretary of State for War and the Colonies; and on 9 December 1840 a despatch was sent to Hobson with fresh instructions (in Russell’s name but presumably drafted by Stephen).24 Together with the despatch, were sent four other more or less standard-form documents. The first was the Charter by which the British Government in the name of Queen Victoria had formally established New Zealand as a separate Colony (‘Now know ye that we … do hereby erect the said islands of New Zealand … into a separate Colony’) and established also the office of Governor, an Executive Council and a Legislative Council.25 The second was Letters Patent, appointing Hobson Governor and Commander-in-Chief (though with hardly any troops);26 the third was a set of Royal Instructions, informing Hobson in more detail as to what was required of him (and binding also on his successors);27 and the fourth was ‘A Schedule of a Future Civil Establishment’.28 The Executive Council, in accordance with the British Imperial norm, would be composed of the Governor plus the three senior civil servants in the Colony (the Colonial Secretary, the Treasurer and the AttorneyGeneral). The Governor would be obliged to consult it ‘in all things’, but it was to consider only matters proposed by him and in any event he was not bound to follow its advice.29 The Legislative Council, likewise in accordance with the Imperial norm, would be composed of the same four civil servants (conveniently referred to as the ‘official’ members) plus three prominent members of the settler community (the ‘unofficial’ members) and its role would be to make laws.30 Since the official members constituted a majority

23

J Prest, Lord John Russell (London, Macmillan, 1972). Russell to Hobson, 9 December 1840, BPP 1841 (311) XVII.493, 25. The following direct and indirect quotations are from this document. See Hickford, n 13 above, and Adams, n 2 above. 25 Charter for Erecting the Colony of New Zealand, and for creating and establishing a Legislative Council and an Executive Council, and for granting certain powers and authorities to the Governor for the time being of the said Colony, 16 November 1840, Russell, despatch to Hobson, 9 December 1840, enclosure 1, BPP 1841 (311) XVII.493, 31. 26 Letters Patent appointing William Hobson, Esq, Captain in the Royal Navy Governor and Commander-in-Chief in and over the Colony of New Zealand, 24 November 1840, Russell, despatch to Hobson, 9 December 1840, enclosure 2, BPP 1841 (311) XVII.493, 25. 27 Instructions to our trusty and well-beloved William Hobson, Esq, our Governor and Commander-in-Chief in and over Our Colony of New Zealand, or in his absence to Our Lieutenant-Governor, or the officer administering the Government of the said Colony for the time being, 5 December 1840 (‘Royal Instructions’), Russell, despatch to Hobson, 9 December 1840, enclosure 3, BPP 1841 (311) XVII.493, 34. 28 Colonial Department, Estimate of the Charge of defraying the Expense of the Colony of New Zealand for the first Year which will elapse after the receipt there of the Commission appointing Captain Hobson the Governor of the New Zealand Islands, November 1840, Russell, despatch to Hobson, 9 December 1840, enclosure 4, BPP 1841 (311) XVII.493, 42. 29 Royal Instructions, n 27 above, paras 35–36. 30 ibid para 3. 24

Taxation in Early Colonial New Zealand 301 and were expected to vote as a block, the Governor’s formal control was complete, unless his subordinates rebelled.31 The Royal Instructions required Hobson also to appoint a SurveyorGeneral and to instruct him to conduct a survey of New Zealand, to divide ‘the whole of the said Colony’ into counties (of about 1,600 square miles), hundreds (about 100 square miles) and parishes (about 25 square miles).32 These divisions would serve as the basis for local government, along the same lines as in ‘that part of our United Kingdom of Great Britain and Ireland called England’ (where Russell himself had led the reform of local government only five years before).33 The land (other than some which would be reserved for public purposes) would then be ‘divided into lots, consisting of not more than one square mile each’ and any person paying a stipulated ‘uniform price per acre’, either in the Colony itself or in the United Kingdom, would be granted ‘such unappropriated land within the said Colony as may be selected by him or her’; and the Surveyor-General’s duties would include maintaining a register of all such grants.34 It was provided also that any person effecting in the United Kingdom a purchase of land in New Zealand would be entitled to ‘the free conveyance’ of a number of emigrants ‘named by them’, the number being calculated by the Colonial Office in proportion to the number of acres purchased.35 As to the problem of the very large claims made by settlers (in particular, the New Zealand Company) on the basis of ‘contracts or grants said to have been made by the native chiefs’, he instructed Hobson to deal with these by establishing a Commission to determine them.36 As to taxation, Russell reiterated the advice of Lord Normanby (or, at least, James Stephen repeated in Russell’s name the advice he had earlier issued in Normanby’s): that Hobson should rely on customs duties (in particular, on spirits, tobacco, tea, coffee and sugar) and on ‘an annual tax’ on all privately held land ‘not actually in cultivation’, non-payment of which would be followed by ‘confiscation and seizure of the land’. He confirmed that the New Zealand government would in the first instance finance itself by borrowing from New South Wales, but that was to be the government’s ‘single debt’ and it was to be speedily repaid. Russell warned Hobson against any further borrowing and Hobson would no doubt have preferred

31 M Wight, The Development of the Legislative Council, 1606–1945 (London, Faber & Faber, 1946) 100–17; A Mills, Colonial Constitutions (London, John Murray, 1856). 32 Royal Instructions, n 27 above, paras 37–41. 33 Municipal Corporations Act 1835 (5 & 6 Will 4 c 76) (UK); Prest, n 23 above, 95–99; J Redlich and FW Hirst, The History of Local Government in England (London, Macmillan, 1958) 128 and 132. 34 Royal Instructions, n 27 above, paras 44–45. 35 ibid para 55. 36 See generally Adams, n 2 above.

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to follow this platitudinous advice if he could. But the funds made available to him were simply insufficient to do what London required him to do, so it is difficult to see what he could have done other than resort to borrowing— which is what he did. The ‘Schedule of a Future Civil Establishment’ set out in very broad terms the colonial budget. The ‘principal officers’ would be the Governor (salary £1,200), the Colonial Secretary (£600), the Chief Justice (£1,000), the Attorney-General (£400), the Surveyor-General (£600), the Colonial Treasurer (£600), the Collector of Customs (£500) and the Protector of Aborigines (£400). Russell allowed a further £6,000 for other salaries and incidentals, £5,000 for public works and £3,000 for contingencies, so the total annual budget came to £19,300.37

HOBSON’S TAXING STATUTES

On 3 May 1841 Hobson, having received his instructions from Russell, announced that New Zealand was now a separate Colony; and he was then sworn in as its inaugural Governor. He first convened the Legislative Council on 24 May 1841 at Auckland and enacted a series of statutes,38 most pertinently the Land Claims Ordinance 1841 and the Customs Ordinance 1841. There followed statutes providing for liquor licensing, a tax on auctions and a local government land tax.

Land Claims The Land Claims Ordinance 1841 gave statutory force to the right of preemption asserted by the Crown on the basis of (or confirmed by) the Treaty of Waitangi;39 provided also that claims based on private purchases by settlers from Maori would be ‘null and void’ unless confirmed by the Crown;40 and provided finally for a Commission to inquire into such claims.41 The Ordinance thus formed the basis for the Colony’s system of land tenure and also, the Governor hoped, for profiting by land sales.

37 Assessing the value of money across time is difficult. Some idea of relativities might be gleaned from the fact that Hobson allowed £40 per year for a schoolteacher, £41 for a police sergeant and £125 for a ‘clerk, 3d class’: J Coates (Clerk of Council), Estimate of the Probable Expenses of the Government of New Zealand for One Year, 1841, BPP 1843 (134) XXXIII.269, 3. 38 McLintock, n 9 above, 132–34. 39 Land Claims Ordinance 1841 s 2. 40 ibid s 2. 41 ibid ss 3–13. See Spiller, Finn and Boast, n 20 above, 137–38.

Taxation in Early Colonial New Zealand 303 Customs Duties Customs duties had been an important source of revenue in the United Kingdom for centuries42 and were routinely used in British colonies,43 so it was naturally intended that they would be used in New Zealand too.44 The Customs Ordinance 1841 generally replicated the New South Wales legislation verbatim, though the rates of tax were lower. They were as follows: (1)

(2) (3) (4) (5) (6) (7) (8)

4 shillings per gallon on spirits produced in the United Kingdom, in ‘the British possessions in America’, in New South Wales or in Van Diemen’s Land (Tasmania); 5 shillings per gallon on spirits produced elsewhere; 15 per cent by value on wine; 9 pence per pound avoirdupois on unmanufactured tobacco; 1 shilling per pound avoirdupois on manufactured tobacco, other than cigars and snuff; 2 shillings per pound avoirdupois on cigars and snuff; 5 per cent by value on tea, sugar, flour, meal, wheat, rice ‘and other grain and pulse’; and 10 per cent by value on ‘all other goods’, other than those produced or manufactured in the United Kingdom, New South Wales or Van Diemen’s Land.45

The system was essentially much the same as any other customs system. The master of any ship arriving in the Colony was obliged to report to an authorised customs officer within 24 hours of arrival.46 He was not permitted to unload any part of his cargo except under the supervision of a customs officer. Officers were entitled to board the ship and to ‘free access’ to ‘every part’ of it; and any hidden goods they found were forfeit.47 If the master of the ship breached any of these rules his cargo was forfeit;48 for serious offences his ship was forfeit also;49 and he was liable to substantial monetary penalties, typically £10050 but for some offences as much as £500.51 The penalty for the basic offence of smuggling (and for various

42

Dowell, n 7 above, vol 1, ch 9. For example, Customs Act 1839 (NSW). On the use of customs duties in the British colonies in North America, see Dowell, n 7 above, vol 2, chs 6 and 7. 44 Normanby to Hobson, 14 August 1839, BPP 1840 (238) XXXIII.587, 37; D McGill, The Guardians at the Gate: the History of the New Zealand Customs Department (Wellington, Silver Owl Press, 1991). 45 Customs Ordinance 1841 ss 1, 17 and 54 and Table. 46 ibid ss 11 and 15. 47 ibid s 16. 48 ibid s 66. 49 ibid s 57. 50 ibid ss 11 and 12. 51 ibid ss 4 and 47. 43

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other offences) was either £100 or three times the value of the goods smuggled, whichever was higher.52 The penalty for obstructing a customs officer was £100; the penalty for using force against a customs officer was either transportation (to where was not specified, presumably New South Wales, Van Diemen’s Land or Norfolk Island)53 or three years’ hard labour; and the penalty for shooting at a customs officer was death.54 The master of any naval vessel or any vessel ‘duly employed for the prevention of smuggling’ was authorised to require any ship to ‘bring to’ (that is, stop); and to ‘fire at or into any such ship’ that failed to do so, but only after ‘first causing a gun to be fired as a warning’.55 Ancillary to the Customs Ordinance 1841 was the Distillation Ordinance 1841, which prohibited the distillation of spirits in the Colony, as a means of supporting the duty on the importation of spirits.56 Brewing and winemaking were not prohibited, so presumably flourished.

Liquor Licences Imported liquor was subject to customs duty, but from the beginning the New Zealand government also raised a significant part of its revenues by restricting the selling of liquor except pursuant to a licence; and then issuing licences at a fee. This was provided for by the Licensing Ordinance 1842, but even before the Ordinance was enacted Hobson’s administration had started issuing licences for a fee.57 That seems to have been done on the basis (presumably correct, as a matter of law) that the relevant New South Wales legislation, in particular, the Licensed Publicans Act 1833 (NSW), applied in New Zealand.58 In any event, the Ordinance set up New Zealand’s own licensing regime. It provided that selling any quantity less than two gallons of ‘any spirituous liquor, wine, ale or beer’ without a licence was an offence punishable by a fine of £50; and any liquor ‘hawked about or exposed for sale’ without a

52

ibid s 71. See generally R Hughes, The Fatal Shore (London, Pan, 1988). 54 Customs Ordinance 1841 ss 78 and 79. 55 ibid s 58. See, now, Customs and Excise Act 1996 (NZ) s 142. 56 Distillation Ordinance 1841 s 1. 57 That this was so is apparent from the fact that the government’s accounts refer to liquor licences as a source of revenue in 1840: Abstract of the Receipts and Disbursements of the Colony of New Zealand, for the Years 1840, 1841 and 1842, BPP 1844 (328) XXXIV.775, 2. 58 See DV Williams, ‘The Pre-History of the English Laws Act 1858: Mcliver v Macky (1856)’ (2010) 41 Victoria University of Wellington Law Review 361 and DV Williams, ‘The Annexation of New Zealand to New South Wales in 1840: What of the Treaty of Waitangi?’ (1985) 2 Australian Journal of Law and Society 41. The New Zealand Customs Duties Act 1840 (NSW) provided for a system of wholesale liquor licensing, but that was a temporary measure apparently designed to prevent the importation of untaxed liquor from New Zealand into New South Wales. It expired in 1841. 53

Taxation in Early Colonial New Zealand 305 licence was forfeit to the Crown.59 There was no prohibition on sales of more than two gallons; the licensing regime, in other words, was aimed exclusively at the retail trade. Licences were obtainable by applying on a prescribed form and supplying a certificate ‘of good fame and reputation’ signed by ‘at least five substantial householders’ residing locally.60 Licences were granted for a year only, but were renewable. The fee was £30 per year.61 No distinction was drawn between selling liquor for consumption on the premises and selling for consumption elsewhere; a licence entitled the licensee to do both. Selling liquor on credit was forbidden and ‘drunkenness’ was an offence, though the Ordinance was silent as to how that was to be assessed.62

Tax on Auctioneers The Auctioneers Ordinance 1842 provided for both a licensing system for auctioneers and also a tax on the selling of land or goods by auction, called auction duty.63 Again, however, the government had instituted a system of charging fees and tax before legislating.64 As in the case of liquor licensing, the legal basis for these imposts was presumably the New South Wales legislation, namely the Licensed Auctioneers Act 1828 (NSW). Auctioneers Licences The Ordinance prohibited the sale of ‘any estate, goods or effects by way of auction or in any way whereby the highest bidder shall be the purchaser, either by public sale or otherwise’ unless the seller was licensed.65 The cost of a licence was £30 per year.66 The applicant was also required to furnish his own bond for £200 and two sureties for £100 each. If an auctioneer failed to pay any auction duty for which he was liable, these sums (£400 in total) would be forfeit and he would lose his licence.67 Any person selling land or goods by auction without a licence was liable to a fine of £100 59

Licensing Ordinance 1842 ss 1, 29 and 30. ibid s 4 and Schs B and C. 61 ibid s 15. To be precise, the fee was £40 where the house to be licensed was ‘within the limits of any borough’ and otherwise £30. But as is explained below, whilst the Municipal Corporations Ordinance 1842 provided for the Governor to establish boroughs, none were in fact established. The fee charged was presumably, therefore, £30. 62 Licensing Ordinance 1842 ss 24 and 32. 63 Auctioneers Ordinance 1842 ss 1 and 15. 64 That this was so is clear from the government’s accounts (which show receipts from ‘auction duty’) and also from the Ordinance itself, which provided for the continuation of licences that had been granted before it came into effect: Auctioneers Ordinance 1842 s 7. 65 ibid s 1. 66 ibid ss 4 and 5. 67 ibid ss 6 and 12. 60

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‘for every such offence’; and any person acting as an auctioneer was ‘deemed to have been unlicensed’ unless he produced his licence on the spot.68 Any licensed auctioneer conducting his business in any manner contrary to the provisions of the Ordinance was liable to a fine of £50.69 Auction Duty The Auctioneers Ordinance 1842 also required every auctioneer to pay a duty of one per cent on the proceeds of every sale by auction effected by him.70 This duty was administered by means of requiring every auctioneer to render to the government every month a ‘full and true account’ of ‘every lot or article’ that he had sold the previous month and of the price at which he had sold it, together with a statement as to when and where every sale had taken place.71 The auctioneer was authorised to retain the amount of the duty out of the proceeds of sale or to recover it from the person by whom he had been employed.72

Local Government Taxation The Municipal Corporations Ordinance 1842 was based on the Municipal Corporations Act 1835 (UK).73 That Act had been steered through Parliament by Russell (then Home Secretary), it was an important component of the Whig reforms of the 1830s, and it radically reformed the grotesquely anti-democratic system of local government in England.74 The Ordinance provided for a system of local government whereby every settlement ‘having a population of more than two thousand souls’ would be constituted as a borough; every borough would be governed by a Council ‘elected by the burgesses thereof ’ and comprising a mayor and 11 aldermen; and for every borough there would be a body corporate so that, in effect, the Council would be able to hold property, enter into contracts, and so on.75 ‘Every male inhabitant’ of the borough, if ‘of full age’, would be entitled to vote, but only on payment of 20 shillings.76 Women were ineligible to vote but the franchise was nonetheless broader than in England, where it was based on a property qualification.77 68

ibid ss 10 and 11. ibid s 13. 70 ibid s 2. 71 ibid s 3. 72 ibid s 2. 73 See GWA Bush, Decently and in Order: the Government of Auckland 1840–1971 (Auckland, Collins, 1971) 19–27. 74 Redlich and Hirst, n 34 above; Prest, n 23 above. 75 Municipal Corporations Ordinance 1842 ss 1 and 2. 76 ibid ss 9, 12 and 29. The term ‘full age’ was not defined. 77 Municipal Corporations Act 1835 (5 & 6 Will 4 c 76) (UK) s 9. 69

Taxation in Early Colonial New Zealand 307 The basic point of this scheme was to relieve the central government’s fiscal woes by shifting as large a part of the burden as possible onto the borough councils.78 First, the councils would be responsible for building and maintaining roads, waterworks, wharfs and various other public works; establishing markets; providing paving, lighting and cleansing; and doing anything else ‘necessary for the good order health and convenience’ of the borough’s inhabitants.79 Secondly, the councils would be required to appoint and to pay ‘a sufficient number of fit men … to act as constables for keeping the peace by day and by night’, such appointees to have, within the limits of the borough, the same powers and privileges as a constable appointed by the government itself.80 The councils would also be charged with maintaining a police station and a gaol ‘for the safe custody of persons awaiting their trial for offences committed within the borough’.81 As to how this was to be paid for, the principal source of every council’s funds was to be the ‘borough rate’.82 Every council would be empowered to levy ‘an equitable rate or assessment, in the nature of a borough rate in England, upon all real property within the limits of the borough’—in other words, a tax on land.83 The tax would be imposed ‘so often as shall be deemed necessary’; and it would be paid in the first instance by the occupier of the property and, if the property was unoccupied, by the owner.84 Liability was to be determined by reference to the value of the land.85 In the case of non-payment, the council could sell the land and any goods situated on it and put the proceeds towards the unpaid tax.86 If a voter was a ratepayer (that is, if he was the occupier of land or in some circumstances the owner), the 20 shillings he had paid would be set off against his liability to rates.87 In addition to rates, each council would be able to derive funds by charging for the use of public facilities owned by its corporation. In particular, the government planned to grant to the corporations land ‘on the sea-shore’, so that they could build wharves, quays and like facilities and profit by charging for their use.88 Councils would also be able to charge tolls for the use of roads, bridges, market-places, and so on; and to impose fines for breaches of bylaws enacted by them.89 78 Municipal Corporations Ordinance 1842 ss 5, 6 and 61–65; Russell to Hobson, n 24 above; Bush, n 73 above, 20–26. 79 Municipal Corporations Ordinance 1842 ss 5 and 6. 80 ibid ss 61–63. 81 ibid ss 63–65. 82 ibid s 67. 83 ibid s 67. As to how the rating system worked in England at that time, see Redlich and Hirst, n 33 above, 25–27 and 160–62. 84 Municipal Corporations Ordinance 1842 ss 67 and 68. 85 ibid ss 69 and 71. 86 ibid ss 72 and 73. 87 ibid s 12. 88 Fitzroy to Stanley, 22 October 1844, BPP 1845 (369) XXXIII.239, 40 and 42. 89 Municipal Corporations Ordinance 1842 ss 75–77. See also ss 8 and 51.

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Hobson established Wellington as a borough on 21 July 1842 and a council was subsequently elected.90 Presumably he was preparing to establish Auckland as a borough, too, but that never happened because the Colonial Office disallowed the Ordinance.91 Its objections were twofold.92 First, the Ordinance would have transferred certain classes of Crown land to the borough corporations,93 which was unacceptable to the Crown. Secondly, the Ordinance would have made the borough councils responsible for buoys, beacons and lighthouses,94 and that, too, was unacceptable to the Crown, because supervising navigation was the prerogative of the Navy. The recently-established Wellington Borough Council was therefore dissolved, no other councils were established, and New Zealand’s first brief experiment in local government came to an end.

Land Tax Although instructed to establish a land tax, Hobson did not do so. Moreover, he seems not to have explained to London why he had not established a land tax; and London seems not to have asked. It seems likely, though, that the reason was that the colonial government was finding the question of land troublesome enough already, without complicating it by imposing a tax. The main problem was that the government’s refusal to recognise pre-treaty purchases (especially those of the New Zealand Company) had naturally given rise to enormous conflict. Also, the government’s own gains on land sales were effectively a tax and perhaps it was thought that selling land at a profit and then taxing it would be politically unsustainable. Perhaps, too, Hobson’s plan was to resolve these problems first; and only then to introduce the planned land tax. In any event, the Colonial Office seems not to have pressed Hobson to pursue the original plan. Moreover, when a tax on land (and also on personal property and incomes) was introduced in 1844, it proved (as will be seen) a spectacular failure. It would seem unsound, therefore, to attribute the Colony’s insolvency to the lack of a land tax.

90 McLintock, n 9 above, 134; Local Bills Committee, Inquiry into the Structure of Local Government (Wellington, Government Printer, 1960) para 18. 91 On the Crown’s power to disallow colonial legislation, see K Roberts-Wray, Commonwealth and Colonial Law (London, Stevens, 1966) 368–73 and 396–401. See also J Salmond, ‘The Limitations of Colonial Legislative Power’ (1917) 33 LQR 117. 92 New Zealand Government Gazette, 6 September 1843, 219; Minutes of the Legislative Council, 25 June 1844, BPP 1845 (247) XXXIII.71, 30 (referring to a despatch dated 9 January 1843); Hope to Somes, November 1842, BPP 1844 (556) XIII.1, 520. 93 Municipal Corporations Ordinance 1842 s 7. 94 ibid s 6.

Taxation in Early Colonial New Zealand 309 PUBLIC FINANCE UNDER HOBSON

Expenditure The nature and scale of Hobson’s administration can be discerned from the accounts he sent to London, even though they are unsatisfactory in various respects. The least unsatisfactory of them are those for 1842, in which Hobson estimated that his expenditure for the year would total £56,597.95 Most of the money would go on salaries and wages. His own salary was the largest, at £1,200, and another £666 was allowed for a secretary, an aide-de-camp, and so on. Major heads of expenditure included the Customs Department (£4,910), the Commission for Hearing Land Claims (£1,350), the Chief Protector of Aborigines and his Department (£2,480), the Survey Department (£8,869), the Department of Police and Gaols (£7,043 for the Police and £1,257 for the gaols) and public works (for example £1,000 for the courthouse at Auckland and £860 for the gaol at Wellington). Hobson was much criticised by the settlers for the extravagance of his spending. In particular, the New Zealand Company and its friends in London maintained a vicious campaign against him. But their propaganda was plainly self-interested and consisted largely of distortions and untruths.96 Even so, Hobson’s planned spending of £56,597 was about three times the £19,300 proposed by the Colonial Office. But the Colonial Office’s budget, too, can be discounted. Its aim was to colonise New Zealand and in order to do that it needed to persuade the Treasury that it could be done at minimal cost. Thus, the Colonial Office’s figure was based on what it thought the Treasury might find acceptable, rather than on any calculation of what the venture might actually require.97 Even so, it is necessary to acknowledge that the settlers’ complaints were not entirely without foundation. In particular, whilst Hobson’s own ethics were impeccable, most of his subordinates took advantage of the opportunities their positions offered for personal enrichment, in particular by buying land.98 Nor was unethical behaviour confined to the senior ranks of the administration: pilfering from government stores and construction sites was rife.99 95 This and the following figures are from Shortland (then Colonial Secretary), Estimate of the Probable Expenditure of the Government of New Zealand, for the Year 1842, BPP 1843 (134) XXXIII.269, 27. See also J Hight and HD Bamford, The Constitutional History and Law of New Zealand (Christchurch, Whitcombe & Tombs, 1914) 165–67. 96 See, eg Fitzroy to Stanley, 15 October 1845, BPP 1846 (337) XXX.151, 137. 97 McLintock, n 9 above, 89–93. 98 See, eg Hobson to Stanley, 12 February 1842, BPP 1844 (556) XIII.1, 444; Stanley to Hobson, 28 August 1842, BPP 1844 (556) XIII.1, 446; Stanley to Hobson, 27 June 1843, BPP 1844 (556) XIII.1, 451. See also McLintock, n 9 above, 130 and 162–63; McGill, n 44 above, ch 1. 99 Hobson to Stanley, 15 January 1842, BPP 1843 (134) XXXIII.269, 10.

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On balance, Hobson’s handling of the Colony’s finances was probably better than could reasonably be expected.100 Given the size of the Colony, the governmental apparatus he put in place was absolutely skeletal. For example, the Customs Department (several dozen men and some rowboats) seems far too small to have effectively policed so many miles of coastline; and the Survey Department (a dozen surveyors, plus a support team of about 60) was very modest, given that its basic function was to measure and map a territory somewhat larger than the United Kingdom. Moreover, all aspects of government were rendered more expensive by the fact that the Europeans living in the Colony were not concentrated in a single settlement. Rather, there were several larger settlements (Auckland, Wellington, Russell and Nelson) and a multitude of smaller ones; and the government was required to govern all of them. The cost of government was consequently greater than it would have been if the Colony had been based around a single settlement (as in New South Wales, for example). That said, the level of government spending was disproportionate to the scale of the Colony’s economy. The public record seems to contain virtually no calculations as to the size of the economy or its taxable capacity. Rather, both Hobson and the Colonial Office seem to have simply assumed that the economy would be large enough to support the kind of government they regarded as appropriate—an assumption that turned out to be hopelessly unrealistic.101

Revenues On the revenue side, Hobson estimated that from its principal source of funds—land sales—the government would in 1842 derive £50,000.102 And, he thought, the government’s other revenues would come to £23,520: specifically, £15,000 from customs duties, £3,000 from publicans’ and other licences, £1,500 from Auction Duty, £1,020 from the Post Office (which was thus expected to be more or less self-financing), and £3,000 from fees and fines (the Courts likewise were expected to be substantially self-financing). He thus concluded that the government’s total revenues for 1842 would come to £73,520 (£50,000 + £23,520), easily enough to cover its projected expenditure of £56,597. This happy calculation was complicated by the fact that the Colonial Office had instructed Hobson to set aside half of the net proceeds from

100

See, eg Hobson to Stanley, 4 August 1841, BPP 1843 (134) XXXIII.269, 1. McLintock, n 9 above, 90. 102 This and the following figures are from Willoughby Shortland (then Colonial Secretary), Estimate of the Probable Amount of Revenue of the Government of New Zealand, for the Year 1841, BPP 1843 (134) XXXIII.269, 24. 101

Taxation in Early Colonial New Zealand 311 land sales to fund immigration. The proper calculation was therefore as follows. Land sales would come to £50,000. From that, it would be necessary to deduct the relevant expenditure, namely (a) £2,000 for purchasing land from Maori; (b) £2,480 towards costs incurred by the Protector of Aborigines; (c) £8,869 for the Survey Department; and (d) £1,000 for building roads and bridges. Once these items were deducted, the net revenues from land sales would come to £35,649. Of that, half would go to financing immigration; so only the other half, £17,824, would be available for the general expenses of the government. On this basis, the government would more or less break even. To put it another way, the government would operate at a profit, but the profit would be used to fund immigration. In fact, life was far more difficult. Hobson’s estimates of expenditure were close enough, but his estimates of revenue were hopelessly optimistic. The accounts are not easy to follow and in various respects incomplete (perhaps because, in the interests of frugality, the Colonial Treasurer was not permitted to hire enough staff), but the Colonial government’s revenues seem generally to have been only about half of what Hobson expected, so he resorted to borrowing.103 He wrote to London (nominally to Lord Stanley, who had succeeded Russell as Secretary of State for War and the Colonies when the Conservatives defeated the Whigs in the 1841 election),104 advising that the Colony’s revenues had ‘miserably disappointed’ his expectations and that he consequently faced a ‘financial crisis’.105 He adverted, too, to the ‘utter impossibility of carrying on the government of the Colony’ without financial support from Britain.106 He also explained how he had made up the shortfall in the Colonial government’s revenues. First, he had resorted to the Land Fund (that is, the fund generated by land sales and intended to be set aside for funding immigration).107 Secondly, under ‘the most pressing emergency’ he had ‘very reluctantly’ drawn bills of exchange on the British Treasury for £5,000 (and within a month, he added, he would be obliged to do the same again).108 He sold these bills to the New Zealand Banking Company (established in 1840)109 and to banks in Sydney, at a discount. In effect, he was borrowing from the banks and promising that the British government would repay the 103

See Stanley to Shortland, 13 March 1843, BPP 1843 (134) XXXIII.269, 43. Stanley later served as Prime Minister for three separate terms (all brief: 1852; 1858–59; 1866–68) and as the leader of the Conservative Party for 22 years—still a record (1846–68). 105 Hobson to Stanley, 15 January 1842 and 29 March 1842, BPP 1843 (134) XXXIII.269, 10 and 21. 106 Hobson to Stanley, 15 January 1842, BPP 1843 (134) XXXIII.269, 10. 107 Hobson to Stanley, 29 March 1842, BPP 1843 (134) XXXIII.269, 21. 108 ibid. 109 Hight and Bamford, n 95 above, 167; New Zealand Banking Company Ordinance 1840. The New Zealand Banking Company failed in 1845. The Bank of New Zealand, an unrelated venture, was established in 1861: ‘Bank of New Zealand: the Twenty-First Anniversary’, New Zealand Herald, 14 October 1882, 5. 104

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debt. Whether his instructions from London authorised him to raise funds in this way is debatable, but the banks appear to have been confident that the British Government would honour his bills—and, indeed, it did, though Stanley warned him that if he did it again he might find himself personally liable to repay the debt.110 By April 1842, the colonial government was £65,000 in debt111 and in June Hobson advised London that he would require another £25,000;112 but in September he died, leaving the problem to someone else.

SHORTLAND’S ADMINISTRATION

When Hobson died, it fell to the senior member of his administration, the Colonial Secretary, Willoughby Shortland, to administer the government pending the arrival of a successor and he served in that capacity for 15 months, from 10 September 1842 (when Hobson died) until 26 December 1843 (when Hobson’s successor, Robert Fitzroy, arrived). Like Hobson, Shortland had made his career in the Navy.113 During his term in office, very little happened. Most pertinently, there was no reform at all of the Colony’s tax system. He continued to borrow and both the economy and the government’s finances continued to decline. But it is difficult to see what else he could have done. On 13 March 1843, Stanley wrote to Shortland, blaming Hobson for the colonial government’s insolvency.114 He informed Shortland that the British Government would supply one last subvention, but of only £10,000, not the £25,000 which, according to Hobson, was needed. The difference, Stanley said, Shortland would have to make good by cutting spending. Shortland cut spending as instructed but continued to operate at a substantial deficit, which he covered, in part, by a novel method: issuing debentures (meaning instruments entitling the bearer to the payment of a stipulated sum on a specified date and purportedly secured over the government’s future revenues), which he sold to banks and other deal-makers at a discount.115

110

Stanley to Hobson, 9 July 1842, BPP 1843 (134) XXXIII.269, 21. Willoughby Shortland (Colonial Secretary), A Statement of the Liabilities of the Colony of New Zealand, BPP 1845 (134) XXXIII.269, 25. 112 Hobson to Stanley, 27 June 1842, BPP 1843 (134) XXXIII.269, 23. 113 GC Boase, ‘Shortland, Willoughby’ in S Lee (ed), Dictionary of National Biography (London, Smith, Elder & Co, 1897) vol 52. 114 Stanley to the Officer Administering the Government of New Zealand, 13 March 1843, BPP 1843 (134) XXXIII.269, 43; Treasury Minute, 10 March 1843, BPP 1843 (134) XXXIII.269, 48. 115 ‘Financial Embarrassments: Mr Shortland’s Loan of £15,000 at 15 per cent’, New Zealand Colonist and Port Nicholson Advertiser, 16 June 1843; ‘Alpha’, letter to the editor, New Zealand Colonist and Port Nicholson Advertiser, 23 June 1843. 111

Taxation in Early Colonial New Zealand 313 He used this method of financing the government without any legislation authorising him to do so; whether it was lawful for him to do that is unclear.

FITZROY’S GOVERNORSHIP

The next Governor was the aristocratic Robert FitzRoy (1805–1865).116 His father was General Lord Charles FitzRoy; his grandfather was the 3rd Duke of Grafton; he was a descendant of Charles II (and Barbara Palmer, perhaps the most notorious of Charles’s several mistresses); and his mother was a daughter of the first Marquess of Londonderry. He joined the Navy in 1819 at the age of 13 and in 1831 he was appointed Commander of HMS Beagle with instructions to survey the coasts of the southern parts of South America, at that time inadequately charted. He sought a scientifically inclined companion for the voyage and offered the post to Charles Darwin, who accepted. Darwin was then 22 years old. The Beagle circumnavigated the globe, pausing notably at the Galapagos Islands (whose wildlife proved famously crucial to Darwin’s subsequent formulation of the theory of evolution) and returned to England in 1836. In 1841 he was elected as a Conservative MP for Durham and served until 1843 when he was appointed Governor of New Zealand.117 FitzRoy arrived in Auckland on 23 December 1843.118 The colonial government was insolvent; the economy was depressed; many of the settlers were destitute and some were starving; and serious racial conflict was brewing in Wellington and in the Bay of Islands.119 For all these problems the settlers almost universally blamed the government. Its chief sin, they said, was not to have resolved the land question, but it was guilty of other mistakes also. In particular, the imposition of customs duties had, according to the settlers, destroyed the Colony’s trade; and the government itself had let wages and other expenses fall into arrears.120 Even though Shortland had endeavoured to cut spending in accordance with Stanley’s instructions, the government had no money at all. Its liabilities exceeded its assets, its ongoing revenues covered only about two-thirds of its ongoing obligations and the salaries of the Colony’s civil servants were several months in arrears.121 Within days of arriving in the Colony, FitzRoy 116 J Gribbin and M Gribbin, Fitzroy: the Remarkable Story of Darwin’s Captain and the Invention of the Weather Forecast (London, Hodder Headline, 2003); P Moon, FitzRoy: Governor in Crisis 1843–1845 (Auckland, David Ling Publishing, 2000). 117 Gribbin and Gribbin, n 116 above, 190–97. 118 ibid 212. 119 Fitzroy, n 4 above, 26. 120 See generally SMD Martin, Address from the Inhabitants of Auckland to Governor Fitzroy, 26 December 1844, BPP 1845 (247) XXXIII.71, 20. 121 Shortland to Fitzroy, 8 January 1844, BPP 1845 (131) XXXIII.13, 6; Shortland, Estimates of expenditure and revenue for 1843 and 1844, BPP 1845 (131) XXXIII.13, 7–11. See also Fitzroy, n 4 above, 16.

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felt himself obliged to procure funds by drawing further bills on the British Treasury, though his authority to do that was dubious at best.122 On 11 January 1844, a fortnight after his arrival in the Colony, FitzRoy wrote to Stanley advising that he had already drawn bills on the British treasury for £2,850; that he intended within a few days to draw more bills for another £2,000; and that yet further assistance from the British government would soon be ‘absolutely necessary’.123 But the Colony’s accounts were in such disarray, he said, that he was unable to estimate the amount required. Three months later he had formed a clearer view of the scale of the deficit: another £20,000 from Britain, he advised Stanley, was urgently needed.124 Ultimately, he continued, the Colony’s prospects were excellent, for its resources were abundant and its productiveness extraordinary, but there was no possibility of the Colony’s becoming financially independent in the immediate future. Further grants of £10,000 per year for another three years would therefore be required, he said, if the Colony was to be ‘rescued from ruin’. FitzRoy initially planned to meet at least some of the government’s immediate needs by issuing further bills on the British Treasury, but he was forced to abandon that plan when it became evident that the banks would be unwilling to buy them.125 On 14 May 1844, he convened the Legislative Council so as to enact a series of revenue-raising measures, as follows.126

Debentures: Printing Money As recounted above, Shortland had raised funds by issuing debentures, that is, by borrowing. FitzRoy went further; he enacted the Debentures Ordinance 1844, which authorised him not only ‘to issue debentures’ but also ‘to make the same a legal tender’.127 These debentures were ‘payable in two years or sooner’; they bore interest at five per cent; and they were issued ‘in such small sums as to be available in lieu of a circulating medium’.128 Specifically, he issued debentures in denominations ranging from five

122 Fitzroy to Stanley, 15 April 1844, BPP 1845 (131) XXXIII.13, 12; see also A Kennedy (of the New Zealand Banking Company), letter to the Colonial Secretary, 5 January 1844, BPP 1845 (131) XXXIII.13, 5; Fitzroy to Stanley, 11 January 1844, BPP 1845 (131) XXXIII.13, 3. 123 Fitzroy to Stanley, 11 January 1844, BPP 1845 (131) XXXIII.13, 3. 124 Fitzroy to Stanley, 15 April 1844, BPP 1845 (131) XXXIII.13, 12. See also Fitzroy to Stanley, 15 October 1844, BPP 1845 (369) XXXIII.239, 28. 125 Fitzroy to Stanley, 15 April 1844, BPP 1845 (131) XXXIII.239, 12. 126 Minutes of the Legislative Council, 14 May 1844, BPP 1845 (247) XXXIII.71, 34; McLintock, n 9 above, 160–61. 127 Debentures Ordinance 1844, title and ss 1 and 2; Minutes of the Legislative Council, 14 May 1844, BPP 1845 (247) XXXIII.71, 34; Fitzroy, n 4 above, 25–27. 128 Fitzroy to Stanley, 15 April 1844, BPP 1845 (131) XXXIII.13, 12. See also Minutes of the Executive Council, 25 March and 10 April 1844, BPP 1845 (131) XXXIII.13, 14.

Taxation in Early Colonial New Zealand 315 shillings to £50.129 In other words, he attempted to overcome the government’s insolvency by printing money. He was acutely aware that this was contrary to his instructions but, as he explained to Stanley, he had no money and it would have been equally contrary to his instructions to wind up the government or cut salaries that had been mandated by London. Issuing debentures had therefore been necessary, he said, ‘to save the Colony from the extreme distress if not utter ruin’ that would otherwise have followed.130 As to how they would be repaid, he explained to the Legislative Council, somewhat optimistically, that he had ‘confidence in the assistance’ of the British Government.131 FitzRoy admitted to Stanley that he expected the British Government to disallow the Ordinance on account of its incompatibility with the Royal Instructions; ‘but in the meantime’, he said, ‘the beneficial results of the measure will have been in full operation, and the disallowance, provided that means be obtained for liquidating the debt incurred, will not cause inconvenience’.132 Stanley accepted that the circumstances had perhaps justified the issuing of debentures, but he disapproved of their being issued in small denominations so as to be used as a substitute currency.133 The British Government therefore disallowed the Ordinance134 and Stanley instructed FitzRoy to withdraw from circulation the debentures he had issued and to finance their redemption by issuing new debentures in denominations of not less than £50, even if doing so required the payment of ‘a somewhat higher rate of interest’.135 FitzRoy duly bought back the smaller-denomination debentures by issuing in their stead larger-denomination debentures bearing interest at eight per cent.136

Cranking up Customs Duties Secondly, FitzRoy amended the customs legislation (against the united opposition of the unofficials).137 Under the original legislation, goods 129 RP Hargreaves, From Beads to Banknotes: the Story of Money in New Zealand (Dunedin, John McIndoe, 1972) 39–46; Hight and Bamford, n 95 above, 175. 130 Fitzroy to Stanley, 15 April 1844, BPP 1845 (131) XXXIII.13, 12. See also Fitzroy to Stanley, 16 October 1844, BPP 1845 (369) XXXIII.239, 30 and eg Stanley to the Officer Administering the Government of New Zealand, 13 March 1843, BPP, 1843 (134) XXXIII.269, 43. 131 Minutes of the Legislative Council, 14 May 1844, BPP 1845 (247) XXXIII.71, 34. 132 Fitzroy to Stanley, 16 October 1844, BPP 1845 (369) XXXIII.239, 30. See, too, Fitzroy to Stanley, 22 October 1844, BPP 1845 (369) XXXIII.239, 41. 133 Stanley to Fitzroy, 27 October 1844, BPP 1845 (131) XXXIII.13, 16. 134 Stanley to Fitzroy, 30 April 1845, BPP 1846 (337) XXX.151, 1; New Zealand Government Gazette, 22 November 1845, 127. 135 Stanley to Fitzroy, 27 October 1844, BPP 1845 (131) XXXIII.13, 16. 136 New Zealander, 28 June 1845, 1. See also Grey to Stanley, 23 November 1845, BPP 1846 (712) XXX.333, 7. 137 Minutes of the Legislative Council, 20 June 1844, BPP 1845 (247) XXXIII.71, 61.

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imported from the United Kingdom, New South Wales or Van Diemen’s Land (presumably the three largest sources of imports) had been exempt;138 now that exemption was withdrawn (except that imports of livestock were still exempt).139 To ameliorate the effect of this extension to the scope of the system, however, the general rate of duty was reduced from 10 per cent to five per cent.140 The duty on beer was raised from 10 per cent to 15 per cent; the duty on wine was raised from 15 per cent to 20 per cent; and the duty on spirits imported from the United Kingdom or from British colonies in the Americas or Australia was raised from four to five shillings per gallon (to match the duty imposed on spirits imported from other places).141 A special rate of duty, 30 per cent, higher than the rate applicable to any other class of goods, was imposed on the importation of guns, gunpowder and ammunition,142 so as to slow down the rate at which some Maori tribes were arming themselves.143 FitzRoy also repealed the Distillation Ordinance 1841 (which, as explained above, prohibited the distillation of spirits).144 His thinking was twofold. First, the prohibition was ineffectual because smuggling and illicit distillation were rife and impossible to prevent. Secondly, he thought that permitting distillation would benefit the colonial economy by encouraging industry, in particular the cultivation of barley, hops and wheat.145

Local Government Taxation (Again) Thirdly, FitzRoy attempted to establish a system of local government. As in 1842, the aim was to establish borough councils so as to shift onto them a substantial part of the cost of government.146 The new Ordinance (the Municipal Corporations Ordinance 1844) mostly followed the earlier one (the Municipal Corporations Ordinance 1842) verbatim, except that the features of the earlier Ordinance that London had found objectionable (and on the basis of which it had disallowed the earlier Ordinance) were removed; that is, the 1844 Ordinance did not transfer Crown land to the borough corporations and it did not trespass on the Admiralty’s prerogatives as to

138

Customs Ordinance 1841 Table. Customs Amendment Ordinance 1844 s 1 and Table. 140 ibid Table. 141 ibid Table. 142 ibid Table. 143 W Brown, Debate on the Customs Amendment Bill 1844, Minutes of the Legislative Council, 18 June 1844, BPP 1845 (247) XXXIII.71, 24. 144 Distillation Repeal Ordinance 1844. 145 Fitzroy to Stanley, BPP 1845 (369) XXXIII.239, 40–42. 146 Fitzroy to Stanley, 29 September 1844, BPP 1845 (369) XXXIII.239, 11. See also Treasury Minute, 10 March 1843, BPP 1843 (134) XXXIII.269, 48. 139

Taxation in Early Colonial New Zealand 317 lighthouses and other navigational aids.147 The new Ordinance also provided that it would not come into effect until approved by London148—but that never happened, so it never came into effect and no borough councils were ever established under it.149

Auctioneers’ Licences (Again) Fourthly, FitzRoy abolished auction duty and to some extent made good the revenue loss by increasing the charge for auctioneers’ licences (from £30 to £40 per year), the rationale being that the licence fee was easy to collect whereas the duty on goods sold by auction was highly susceptible to evasion (there being no reliable method of verifying auctioneers’ accounts of how much, or how little, they had sold at auction).150

Abolishing Customs Duties and Taxing Land and Incomes Despite FitzRoy’s endeavours, the fiscal crisis continued to worsen.151 Even having cut government spending, FitzRoy could not reduce it below £36,000 per year; and the most he thought he could raise locally was £15,000. Moreover, things were getting worse, not better; future revenues were likely to be lower still; and the government’s reliance on customs duties (by far the most productive tax) was aggravating the difficulty by discouraging trade. As FitzRoy observed, customs duties were inescapably problematic in New Zealand because of the ease of smuggling. They had worked tolerably well for the first year or so after they were introduced but by 1844, as a result of ‘general poverty’ and the ease of smuggling, they generated only £10,000 per year in revenue and cost £4,000 per year to collect.152 Why smuggling was a more serious problem in New Zealand than in the Australian colonies, FitzRoy did not explain. It seems likely, however, that there were three main reasons. First, the New Zealand coast features a much larger number of natural harbours than are to be found in Australia. 147 Municipal Corporations Ordinance 1844 ss 6 and 7; cf Municipal Corporations Ordinance 1842 ss 6 and 7. 148 Municipal Corporations Ordinance 1844 s 84. 149 New Zealand Government, Ordinances of New Zealand (Wellington, Government Printer, 1871) xi; Bush, n 73 above, 27. 150 Auctioneers Amendment Ordinance 1844; Fitzroy to Stanley, 22 October 1844, BPP 1845 (369) XXXIII.239, 40–42. 151 Fitzroy to Stanley, 20 August 1844, BPP 1845 (247) XXXIII.71, 79; Andrew Sinclair (Colonial Secretary), Estimate of the Probable Amount of Revenue of the Government of New Zealand for the Financial year 1844–45, BPP 1845 (247) XXXIII.71, 87. 152 Fitzroy to Stanley, 29 September 1844, BPP 1845 (369) XXXIII.239, 11; Fitzroy to Stanley, 16 September 1844, BPP 1845 (247 XXXIII.71, 140.

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Secondly, there were already in New Zealand numerous small settler communities scattered along the coast, whereas there were not in Australia. And, thirdly, New Zealand’s Maori population tended to engage with the settler economy to a far greater degree than the Australian Aborigines. In any event, a serious aspect of the problem was that the customs duties were provoking great discontent not just among the settlers but also among the Maori who lived nearby.153 Before customs duties were introduced, visiting ships had been able to anchor wherever they chose and trade with whomever they liked. But the Customs Ordinance 1841 forbade them to land anywhere but at designated harbours (referred to colloquially as ‘ports of entry’), where the duties were collected.154 Maori living near a port of entry objected to paying the higher prices the duties entailed; Maori living in other parts of the Colony resented the fact that foreign ships could no longer lawfully trade with them. Wherever they lived, Maori were easily able and powerfully incentivised to facilitate smuggling. Prominent among the opponents of the customs duties was Hone Heke (c 1807–1850), a Maori leader born near the Bay of Islands.155 He was the first Maori signatory to the Treaty of Waitangi but later resiled from it. He was opposed to the British regime’s customs duties partly because he objected to paying them and also because they deterred foreign ships (economically beneficial to Maori) from visiting the district. Heke and his people also imposed their own tax on visiting ships: £5 per ship.156 Even more opposed than settlers of British origin were those who had come from the United States or France. Since the beginning of the nineteenth century a large number of American whalers had been using the Bay of Islands as a base for their South Pacific operations and a number of Americans had taken up residence there to service their needs. The Americans were unenthusiastic about British rule generally and especially resented the customs duties. Not only were they reluctant to pay taxes to a regime they opposed, but they regarded the customs duties, with good reason, as discriminatory. As indicated above, the Customs Ordinance 1841 had provided for preferential treatment for imports from the United Kingdom and its other colonies;157 and these preferences were in effect an anti-American measure, for after the United Kingdom and its colonies, the United States would seem to have been the leading source of imports. The US government had appointed a Consul and a Vice-Consul in the Bay of Islands (prior, 153

Fitzroy to Stanley, 29 September 1844, BPP 1845 (369) XXXIII.239, 11. Customs Ordinance 1841 ss 11–15. 155 F Rankin Kawharu, ‘Story: Heke Pokai, Hone Wiremu’ in Dictionary of New Zealand Biography (Wellington, Department of Internal Affairs, 1990) vol 1, 195; Belich, n 4 above, chs 1–3; P Moon, Hone Heke: Nga Puhi Warrior (Auckland, David Ling Publishing, 2001); J Cowan, The New Zealand Wars (Wellington, Government Printer, 1922, reprinted 1983). 156 Cowan, n 155 above, vol 1, 16. 157 Customs Ordinance 1841 Table. 154

Taxation in Early Colonial New Zealand 319 indeed, to Hobson’s appointment)158 and the Vice-Consul had complained to the US government about the British regime’s anti-American customs duties.159 The Colony’s French residents were likewise opposed to the customs duties. The 1844 amending legislation had removed the preferences,160 but the Americans and the French remained resentful. They suggested to the local Maori that the aim of the British was to take all their land and make them all slaves; they equipped them with a famously effective slogan, ‘No taxation without representation’; and they promised that their governments would supply with arms and ammunition any Maori rebelling against the British.161 At the top of a prominent hill at a place called Kororareka, across the Bay from Waitangi, the British had erected a flagpole, from which they flew the Union Jack as a symbol of British sovereignty; on 8 July 1844 Hone Heke’s ally Te Haratua cut it down.162 FitzRoy had too few troops to confront Heke and Te Haratua, so he wrote to the Governor of New South Wales (still Sir George Gipps) seeking aid. Gipps duly despatched a ship with 150 troops and order was for a while restored, though Heke continued to provoke the government by flying an American flag (supplied to him by the acting US Vice-Consul) from the stern of his canoe.163 On 16 September 1844, FitzRoy wrote to Stanley advising that he was about to abolish customs duties and establish in their place a tax on property.164 This was, he said, ‘the only measure that can avert extreme misery and save the Colony from utter ruin’. He was apprehensive about taking such a radical step without prior approval from London, but hoped that Her Majesty ‘would be graciously pleased to sanction such unprecedented proceedings, in consideration of the unprecedented nature of the case’. Later the same day, clearly worried about what he was about to do, he wrote to Stanley again:165 We have no money … The receipts of customs are diminishing monthly, owing to general poverty … From colonial sources alone I cannot, under existing circumstances, entertain the smallest hope of raising more than at the rate of £15,000 per annum … The effect of the Customs’ establishment in New Zealand has been most pernicious, and, if continued, would be fatal to the prosperity of the Colony, not only in a commercial point of view, but in a political sense, for it would 158 R McNab, Historical Records of New Zealand (Wellington, Government Printer, 1908– 1914), vol 2, 604–22. 159 W Mayhew (US Vice-Consul to New Zealand) to J Forsyth (US Secretary of State), 21 February 1842, reproduced in R McNab, n 158 above, vol 2, 620. 160 Customs Amendment Ordinance 1844 Table. 161 Fitzroy, n 4 above, 42–43; Cowan, n 155 above, vol 1, 20–21. 162 Fitzroy to Stanley, 20 August 1844, BPP 1845 (247) XXXIII.71, 88; Fitzroy to Gipps, 4 September 1844, BPP 1845 (369) XXXIII.239, 95; Cowan, n 155 above, vol 1, chs 3 and 4. 163 Fitzroy, n 4 above, 42–43. 164 Fitzroy to Stanley, 16 September 1844, BPP 1845 (247) XXXIII.71, 139. 165 Fitzroy to Stanley, 16 September 1844, BPP 1845 (247) XXXIII.71, 140.

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alienate from us a large portion of the aborigines, would cause open opposition, indeed, rebellion, and involve us not only in hostilities with the native race, but possibly with France or America.

Three days later FitzRoy convened the Legislative Council and within a fortnight the Property Rate Ordinance 1844 had become law.166 It abolished customs duties and provided for a curious hybrid tax on property and incomes. The Ordinance was consistent with developments in the United Kingdom, where the income tax had been revived in 1842 with a view to reducing customs duties so as to encourage trade.167 Moreover, the revival of the British income tax had coincided with FitzRoy’s brief stint as an MP; and he had been a member of the government (Sir Robert Peel’s Conservative administration) that had revived it. This new tax enjoyed considerable popular support168 and according to FitzRoy was ‘unanimously and cheerfully approved by men of all parties in this country’.169 The Ordinance proved impossible to administer, however, and in April 1845, after it had been in force for only six months, it was repealed and the customs duties were revived.170 Property Rate Ordinance 1844 The Property Rate Ordinance 1844 was simple in the extreme, comprising only three and a half pages in total. It provided, first of all, for the repeal of the customs legislation, with effect from 1 October 1844.171 Secondly, it imposed a new tax on wealth and income.172 Every person who was resident in the Colony and whose property (both real and personal) and annual income combined came to more than £50 was obliged to file a return, and liability was calculated on that basis;173 that is, liability was based on the value of the taxpayer’s property and the amount of his or her annual income, added together. Judged by modern standards, the idea of simply adding the value of a person’s property to the amount of his annual income

166 Minutes of the Legislative Council, 19, 24, 26 and 28 September 1844, BPP 1845 (247) XXXIII.71, 142. 167 See Dowell, n 7 above, vol 3, 105–12; Sabine, Income Tax, n 7 above, ch 4; Sabine, Short History, n 7 above, ch 8; Daunton, n 7 above. 168 Southern Cross, 14, 21 and 28 September 1844. 169 Fitzroy to Stanley, 29 September 1844, BPP 1845 (369) XXXIII.239, 11. 170 Property Rate Repeal Ordinance 1845. 171 Property Rate Ordinance 1844 s 1. See generally, O Kabzamalov, ‘New Zealand’s Forgotten Income Tax’ (2010) 16 Auckland University Law Review 26 and K Heagney, The Genesis and Early Evolution of New Zealand Income Tax: an Examination of Governor Fitzroy’s Experiments with Taxation, 1843–1845 (PhD thesis, Massey University, 2009). 172 Property Rate Ordinance 1844 ss 2, 3 and 4. 173 ibid s 7 and Sch. See also Fitzroy to Stanley, 22 October 1844, BPP 1845 (369) XXXIII.239, 40–44.

Taxation in Early Colonial New Zealand 321 and taxing the total seems bizarre and inequitable.174 Likewise, such a tax would no doubt have been wholly unacceptable in the United Kingdom in the nineteenth century. The rates of tax, however, were low enough that the inequity would be easily tolerable—or so, at least, FitzRoy hoped. If a person’s property and annual income combined came to less than £50, he was not liable for any tax at all. If the total was more than £50 but less than £100, he was required to pay £1; if the total was more than £100 but less than £200, his liability was £2, and so on.175 Total liability, however, was capped at £12.176 Thus, the tax was charged at an effective rate of about one per cent, and much less for taxpayers whose property and income combined greatly exceeded £1,200. The basic idea was to tax all those who owned property worth more than £50, all those whose incomes were more than £50 per year, and also all those whose property and annual income combined came to more than £50. Women were liable to tax on the same basis as men, but Maori of both sexes were exempt.177 No provision was made for the taxation of corporations, which were apparently therefore exempt (though the number of corporations operating in New Zealand at that time was tiny). The tax was confined to property and income ‘within the Colony of New Zealand’.178 Residents of the Colony were therefore not taxed on property situated elsewhere or on income derived from elsewhere. Distinguishing between taxable domestic income and non-taxable offshore income was much later, in the early twentieth century, to become a matter of notorious difficulty in numerous British colonies and dominions,179 but FitzRoy’s Property Rate Ordinance 1844 was repealed before the issue arose. ‘Property’ was defined as meaning ‘every description of property whether real or personal’; and for the purpose of the tax, property was to be accorded its ‘marketable value’ as at the date the taxpayer was required to file his return.180 No express allowance was made for debts or liabilities; it would seem therefore that the legislative intent was to impose the tax on gross assets, not net wealth, though whether the government attempted to administer it on that basis is unclear. ‘Income’ was defined as meaning ‘the net yearly profits of any trade business or profession, rents arising from real property, interest on money lent, pay salaries annuities pensions and every other description of income

174 That this was how the Ordinance was intended to be interpreted is confirmed by the report in the Southern Cross, 28 September 1844. 175 Property Rate Ordinance 1844 Sch. 176 ibid s 5 and Sch. 177 ibid ss 20 and 23. 178 ibid 1844 s 2. 179 See, eg M Littlewood, ‘The Privy Council, the Source of Income and Stare Decisis’ [2004] British Tax Review 121. 180 Property Rate Ordinance 1844 s 3.

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whencesoever or from whatever source the same respectively may be derived’.181 A complication arose from the fact that the government wanted to collect the tax immediately, rather than in arrears. For that reason, the Ordinance provided that the taxpayer’s income would be ‘taken to be the probable amount thereof for the year following the date of [his] return’.182 This rule presumably contributed to the difficulties the government encountered in administering the Ordinance. The tax was imposed on net income,183 so it was clearly intended that taxpayers would be permitted to deduct some classes of expenditure; but the Ordinance said nothing at all as to what those classes might be. For instance, the Ordinance was silent as to whether wasting capital expenditure was deductible in full when incurred, or not at all, or deductible over the life of the asset. Again, however, the Ordinance was repealed before the issue became problematic. A striking aspect of the system was that every tax return was in effect to be made public. Specifically, every collector was required to produce a statement listing ‘the name and description’ of every person from whom he had received a return and also the amount of tax which each of them proposed to pay. These lists were to be ‘posted in some conspicuous place or places within the district’ and published in the Government Gazette.184 This is the more notable in that a particular concern in Britain in the nineteenth century was the idea that Britons, whether resident in Britain or the colonies, should not be required to divulge the state of their finances to the state.185 As FitzRoy observed, however, the Ordinance did not require taxpayers to disclose either the value of their assets or the amount of their income. Rather, all they were required to do was to specify the amount of tax they proposed to pay and to declare that that amount was not less than the amount due; and, as is explained above, no one was liable to pay more than £12. Thus it was supposedly impossible to infer the extent of a man’s wealth or income from the amount of tax that he paid. According to FitzRoy, the system required ‘no exposure of affairs or property, a certain degree of obscurity being purposely obtained’.186 In other words, as the Southern Cross (Auckland’s leading newspaper) put it, anyone concerned to protect his privacy could simply pay the maximum tax of £12, ‘and thereby prevent every possible clue to his real estate or income’.187 No doubt that satisfied the Colony’s wealthier residents but it was perhaps less convincing to poorer taxpayers, for whom £12 would have represented several months’ income. 181 ibid s 4. That the tax was imposed on net income and on wealth simpliciter adds weight to the argument that the intention was to tax gross asset values, not net wealth. 182 Property Rate Ordinance 1844 s 4 (emphasis added). 183 ibid s 2. 184 ibid s 14. 185 Sabine, Income Tax, n 7 above, ch 2. 186 Fitzroy to Stanley, 29 September 1844, BPP 1845 (369) XXXIII.239, 11. See also Fitzroy to Stanley, 22 October 1844, BPP 1845 (369) XXXIII.239, 40–44. 187 Southern Cross, 28 September 1844, BPP 1845 (247) XXXIII.71, 159.

Taxation in Early Colonial New Zealand 323 Failure of the Property Rate Ordinance The Property Rate Ordinance 1844 came into effect on 28 September 1844. Only six months later, however, it was repealed, the property and income tax was abolished and the customs duties were revived. The difficulties the government had encountered in administering the Ordinance included the following.188 First, many land claims were still unresolved and the settlers naturally took the position that they were not obliged to pay tax on property to which the title remained in doubt. Secondly, the Ordinance imposed the obligation to file a return only on persons ‘resident within the Colony’;189 non-residents were consequently not liable to tax. That was important because many of the Colony’s largest landowners were absentees, resident in the United Kingdom. Worse, the absentees were generally richer than the settlers, who accordingly regarded this aspect of the system as grossly inequitable. Thirdly, as also indicated above, the Ordinance suffered from several serious drafting deficiencies, for example, as to deductions. Fourthly, the government had virtually no capacity to monitor taxpayers’ compliance and instead relied upon the settlers’ willingness to report on each other; but it transpired that the settlers were generally unwilling to do that. Consequently non-compliance was not merely widespread but general. In some parts of the Colony, FitzRoy reported, to have enforced the tax would have required the government to commence legal proceedings against ‘nearly all’ the putative taxpayers.190 Since he was unwilling to attempt that, the tax generated hardly any revenue.191 The overall effect of the Property Rate Ordinance 1842 was thus a significant fall in the government’s revenues because it produced virtually no revenue, and for the six months it was in force the government collected no customs duties either.

Waiving the Right of Pre-emption In March 1844, FitzRoy announced that he would waive the right of preemption in some circumstances;192 that is, settlers would be permitted to buy land direct from Maori. They would, however, be charged a fee of 10 shillings per acre, effectively compensating the government for the profit it would have made by buying and on-selling the land.

188

Kabzamalov, n 171 above, 35–41. Property Rate Ordinance 1844 s 7. 190 Fitzroy, n 4 above, 45. 191 McLintock, n 9 above, 157. 192 Fitzroy, ‘Proclamation, 26 March 1844’, New Zealand Government Gazette, 26 March 1844. See also A Ward, An Unsettled History: Treaty Claims in New Zealand Today (Wellington, Bridget Williams Books, 1999) 95–99. 189

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One of FitzRoy’s reasons for waiving the right of pre-emption was that he simply lacked the funds to exercise it (that is, to purchase land from Maori for the purpose of on-sale to settlers);193 and waiving the right for a fee was seen as a means of overcoming that difficulty. The more serious problem, however, was that the value of land had collapsed and he thought charging a fee per acre would be a more reliable source of revenue than buying and selling.194 The market, however, was in an even worse state that he realised and very few settlers were prepared to pay a fee of 10 shillings per acre on top of whatever price was stipulated for by the Maori vendors. Indeed, many grants that had been approved had nonetheless not been issued, for no other reason than that the fee exceeded the value of the land.195 Six months later, therefore, FitzRoy abruptly reduced the fee from 10 shillings per acre to 1 penny per acre.196 That encouraged sales, which was good for the economy, but it entailed the abandonment of land sales as a source of revenue. Another factor prompting the concession was that Maori living near colonial settlements had become increasingly discontent at not being free to sell their land to settlers at its full value. In other words, they objected to the way in which the government had used the right of pre-emption to take for itself a substantial part of the land’s value. FitzRoy feared that not waiving the right of pre-emption would lead to the committing of ‘outrages’ by Maori, to ‘anarchy and confusion’, and perhaps even to civil war.197 Since the settlers and the Maori were both opposed to the government’s profiteering use of the right of pre-emption, FitzRoy was in a difficult position. Reducing the fee, he explained to London, was not merely prudent but ‘absolutely necessary … to prevent insurrection’.198 The difficulties were exacerbated by the settlers’ attempts to incite discontent among Maori; and perhaps, too, by Maori attempts to incite discontent among the settlers. According to FitzRoy, a group of settlers had even offered ‘a large sum as a reward’ for whichever of them succeeded in most ‘stirring up … the natives’.199

Local Government (Third Attempt) In April 1845, FitzRoy made yet another attempt to ameliorate the colonial government’s finances by establishing a system of local government (though a more limited system than had been provided for by the Municipal 193

McLintock, n 9 above, 66. Fitzroy, ‘Memorandum on the Sale of Lands in New Zealand by the Aborigines’, 14 October 1844, BPP 1845 (369) XXXIII.239, 23; Pritchard, n 9 above, 34 and 55. 195 Fitzroy to Stanley, 16 September 1844, BPP 1845 (247) XXXIII.71, 140. 196 Fitzroy ‘Proclamation’, 10 October 1844, BPP 1845 (369) XXXIII.239, 22. 197 Minutes of the Executive Council, 10 October 1844, BPP 1845 (369) XXXIII.239, 24–25. 198 Fitzroy to Stanley, 14 October 1844, BPP 1845 (369) XXXIII.239, 20. 199 ibid. 194

Taxation in Early Colonial New Zealand 325 Corporation Ordinances of 1842 and 1844) and shifting some of the responsibility for roads and other public works onto local communities.200 The Public Roads and Works Ordinance 1845 provided for the establishment of ‘districts’, in each of which there would be elected a Board of Commissioners who would be authorised to build and maintain roads, bridges, wells, waterworks, conduits, sewers, market places, landing places ‘and other works of public utility’.201 In order to finance such works, the Boards of Commissioners would be empowered to levy a ‘rate’ upon the occupiers of land within the district, to impose tolls for using the roads within the district, and to charge for the use of facilities established or maintained pursuant to the Ordinance.202 More specifically, the Board would determine the rate ‘at a certain sum per acre upon all land within the district’, such sum being not more than a ceiling set by the voters.203 The obligation of paying the rate fell on the occupier of the land or, if the land was unoccupied, on the owner.204 Land belonging to the Crown or to ‘any of the aboriginal inhabitants of the Colony’ was exempt.205 Any person liable to pay the rate could instead provide ‘work or labour’ upon any of the works being undertaken by the Commissioners, such work or labour to be valued and performed in accordance with regulations to be promulgated by the Commissioners.206 The Commissioners were required also to post ‘in some conspicuous place’ a list of the names of all those liable to pay the rate, together with the number of acres in respect of which the rate was payable and the amount payable.207 Those whose names appeared on the list then had a month to object, any such objections being determined by the Commissioners themselves.208 Once the time for objecting had passed, the rate became payable and payment could be enforced by sale of the land or of goods situated on it.209 The Public Roads and Works Ordinance 1845 was thus intended to introduce a more rudimentary system of local government than had been envisaged by the Municipal Corporations Ordinances of 1842 and 1844. The 1845 Ordinance would shift the burden of providing roads and some other public works onto local communities, but that was all. The earlier statutes, in contrast, had envisaged that the borough councils would be responsible for a broader range of public works (street lighting, for example) and also for 200 See Bush, n 73 above, and K Palmer, Local Authorities Law in New Zealand (Wellington, Brookers, 2012) 1056–57. 201 Public Roads and Works Ordinance 1845 ss 2 and 10. 202 ibid 1845 ss 5–18. 203 ibid s 11. 204 ibid s 12. 205 ibid s 27. 206 ibid s 12. 207 ibid s 13. 208 ibid s 13. 209 ibid ss 14 and 15.

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policing and anything else ‘necessary for the good order health and convenience’ of the borough’s inhabitants.210 Moreover, central to the earlier statutes, as indicated by their titles, was the creation of corporations to hold property and to act on behalf of the boroughs; the 1845 Ordinance provided for nothing comparable. Finally, the administrative machinery envisaged by the 1845 Ordinance was minimal; Boards of Commissioners would be empowered to appoint agents to assist them in carrying out their functions under the Ordinance, but that was all. The earlier Ordinances, in contrast, had provided not only for municipal corporations but also for mayors, auditing, returning officers, and so on. In other words, the earlier Ordinances had envisaged an ongoing bureaucracy resembling a modern organ of local government; the Public Roads and Works Ordinance 1845 was much less elaborate. Despite its more modest aims, the Ordinance was as unsuccessful as its predecessors. Whether any Boards of Commissioners were established under it is unclear;211 but it appears that, if they were, they were subsumed by a broader process of constitutional reform that dominated the period from 1846 (when legislation providing for an elected Colonial Parliament was enacted by the British Parliament) until 1854 (when a Colonial Parliament was eventually convened).212

END OF AN ERA

Meanwhile, more serious problems were brewing. On 10 January 1845, Hone Heke had again chopped down the flagpole at Karorareka;213 and FitzRoy had again sought military aid from Gipps, asking for 200 troops for three months. This was, he said, ‘absolutely indispensable to prevent plunder and massacre’.214 Troops were despatched from New South Wales; the colonial government resurrected the flagpole; and Heke chopped it down again. The government erected a flagpole sheathed in iron, but that, too, Heke chopped down.215 The government put up a fourth flagpole; and on 11 March 1845, Heke chopped it down. Serious racial conflict followed216 and war broke out between, on one side, Heke and his followers and, on the other, British troops supported by some Maori.217 210

Municipal Corporations Ordinance 1842 s 5; Municipal Corporations Ordinance 1844

s 5. 211 Bush, n 73 above, 27; Local Bills Committee, Inquiry into the Structure of Local Government (Wellington, Government Printer, 1960) para 19. 212 See generally, McLintock, n 9 above, chs 12–19. As regards New Munster (the South Island), the Public Roads and Works Ordinance 1845 was repealed by the Town Roads and Streets Ordinance 1849 s 1. 213 Cowan, n 155 above, chs 3–9. 214 Fitzroy to Gipps, 21 January 1845, BPP 1845 (517–II) XXXIII.389, 3. 215 See, eg Fitzroy to Stanley, 26 March 1845, BPP 1845 (517–II) XXXIII.389, 6. 216 ibid. 217 See generally Belich, n 4 above, chs 1–3; Cowan, n 155 above.

Taxation in Early Colonial New Zealand 327 On 30 April 1845, Stanley wrote to FitzRoy, relieving him of the governorship (though FitzRoy did not receive the despatch until October).218 In June, George Hope, the Under-Secretary of State for War and the Colonies, explained in the House of Commons that the reasons for recalling FitzRoy were that he had not kept the British Government sufficiently informed of what was going on in the Colony; that he had failed to follow his instructions regarding finance, the land question and the establishment of a militia; that he had not dealt appropriately with the ‘natives’; and that the legislation he had promoted had been ‘hasty and apparently inconsiderate’.219 This was unfair; a more reasonable assessment would be that FitzRoy had done an exemplary job in circumstances rendered impossible by the manifestly inadequate support, both financial and military, supplied by London; and that the real reason for his recall was that the New Zealand Company’s friends in Parliament had succeeded in embarrassing the government over the state of affairs in the Colony.220 As one contemporary commentator observed, the wisest course FitzRoy could have taken would have been to sit quietly with his arms folded and done nothing until the British Government had sent more money and more men.221 Back in the United Kingdom, FitzRoy returned to the Navy and made perhaps his most memorable contribution: he invented the weather forecast;222 that is, he instituted the practice of systematically collecting meteorological data with a view to predicting what the weather was going to do next. In 1865, he killed himself by cutting his throat with a razor.223 The next Governor of New Zealand was Sir George Grey, to whom the British Government gave a salary of £2,500 (more than double FitzRoy’s £1,200)224 and a feasible level of financial and military support (including about 1,000 troops),225 thus implicitly acknowledging that it had not adequately supported Hobson, Shortland or FitzRoy. Grey was also instructed to put the interests of the settlers ahead of those of the Maori, and the colonisation of New Zealand proceeded on that basis. He was to prove devious, manipulative and a towering figure, perhaps the most important in New Zealand’s colonial history. But that is another story.

218 See Fitzroy to Stanley, 15 October 1845, BPP 1846 (337) XXX.151, 137. See also Stanley to Grey, 13 June 1845, BPP 1846 (337) XXX.151, 68. 219 House of Commons Debates, 17 June 1845, vol 81 cols 752–53, available at http:// hansard.millbanksystems.com/commons/. 220 Moon, n 116 above, ch 10. 221 F Mathew, The Founding of New Zealand, the Journals of Felton Mathew (J Rutherford (ed), Dunedin, AH & AW Reid, 1940) 225. 222 Gribbin and Gribbin, n 116 above. 223 ibid 283. 224 Stanley to Grey, 28 June 1845, BPP 1846 (337) XXX.151, 75. 225 Fitzroy, n 4 above, 50; McLintock, n 9 above, 93.

11 Customs Revenue in the British Colony of New South Wales 1827–1859 And Inquiries Concerning Frederick Garling, Artist and Customs Department Employee DIANE KRAAL*

ABSTRACT Customs duties in the British Colony of New South Wales provided important funds for the economic development of the settlement. This significant source of revenue led to the Colony’s Customs Department being established, in Sydney 1827, to administer the collection process. The shift from physical assessments of duty by powerful individuals to a process with legislated and more regulated procedures was not without challenges. The first aim of this chapter is to provide insights into five early inquiries concerning the system of the Colony’s customs duties, legislation and practice. With a particular focus on the last two inquiries, it is asked whether any modifications were made to legislation and practice. The second aim is to provide a fuller account of the employment of Frederick Garling (1806–1873) with the Customs Department, Sydney. He was found guilty of serious neglect of duty by the NSW Board of Inquiry of 1858/59. Today, Garling is a recognised Australian colonial artist for his genre of marine watercolours.

INTRODUCTION

I

N THE BRITISH Colony of New South Wales (NSW) customs duties provided important funds for infrastructure, were used as a tool to temper alcohol consumption and to protect the early development of

* The author is grateful to the Department of Business Law and Taxation, Monash University, Australia, for the travel grant provided to present her research at the Tax History Conference, University of Cambridge (Lucy Cavendish College), United Kingdom, July 2014. Thanks also to Richard Mitchell for his comments on a draft of the chapter.

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industry. This chapter has two aims. The first is to provide insights into the inquiries concerning the system of the Colony’s customs duties, and customs legislation and its practice. From 1827, the Colony’s Customs Department was established with a Collector of Customs as its head.1 Previously the Colony’s Naval Officer collected customs duties for which he received a percentage of the takings and other emoluments; however, the Colony’s first investigation into customs duties found this payment arrangement to be open to corruption.2 In the ensuing period, to 1859, a further four investigations into the Colony’s customs processes were undertaken. These serve as early instances of attempts at tax reform and are analysed later in the chapter. That the Colony of NSW levied customs duties at all seems to be at odds with Adam Smith’s Wealth of Nations (1776) which called for a departure from the closed and tariff-protected mercantile systems required by eighteenth century European maritime trading companies. By the nineteenth century, Smith’s book had become widely disseminated; it was a highly influential political economy treatise, particularly for his argument, inter alia, that customs duties have the consequences of inducing domestic business complacency and raising prices. He contended that trading on open markets was one way of increasing overall economic wealth.3 In 1824, Smith’s theory was put into practice when the trading port of Malacca (in Malaya) was handed over to the British and customs duties were immediately proclaimed as abolished. This was a significant move, given that duties had been collected there from at least the time of the fourteenth century Malay Sultanates. Malacca’s repealed customs duties earnings were initially replaced by revenue from rents on arable land and licensed tax farms for local goods and services.4 By contrast, Adam Smith’s rationale against customs duties was arguably not applicable to the early penal Colony of NSW. The Colony’s Governor King (1800–1806) was the first to levy a duty on spirits in an attempt to dampen the consumption of imported liquor by settlers and convicts that was fuelled by a cartel operating within the Colony.5 As the Colony of NSW

1

Sydney Gazette, 10 April 1827. JT Bigge, Report of the Commissioner of Inquiry, on the State of Agriculture and Trade in the Colony of New South Wales (Adelaide, Libraries Board of South Australia, 1966/1823) vol 3, 84, 89. 3 Smith also argued that customs duties threatened the free market’s sole purpose: that of consumption of production. See K Sutherland (ed), Adam Smith: an Inquiry into the Nature and Causes of the Wealth of Nations (Oxford, Oxford University Press, 2008). 4 British Library, London, Straits Settlements Records (SSR) V165, 12 December 1826. For a fuller account of early British Malacca and its Enlightenment-driven trade policies, see also D Kraal, ‘Of Taxes: an Enquiry into Dutch to British Malacca 1824–1839’ in John Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2013) 393–420. 5 NG Butlin, Forming a Colonial Economy (Cambridge, Cambridge University Press 1994) 78. 2

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progressed into the 1820s, customs duties remained, and increased, as there were few taxing alternatives for the British, given the young Colony’s rudimentary agriculture and still underdeveloped markets for saleable goods. The second aim of this chapter is to provide a fuller account of the employment of Frederick Garling (1806–73) with the Customs Department in Sydney, NSW. He had been a Customs employee since 1827 and was found guilty of serious neglect of duty by the 1858/59 NSW Board of Inquiry.6 Today, Garling is recognised as an important Australian colonial artist, whose output of marine watercolours was prodigious. Current biographical entries in arts publications on Garling’s maritime brushwork have glossed over the less commendable aspects of his life. This chapter ‘balances the ledger’ in relation to his role with the NSW Customs Department. A selection of Garling’s paintings is used as a motif to this chapter to illustrate some places referred to in this historical narrative on customs revenue (see Figure 11.1).7 The research that forms the basis for this chapter investigates NSW customs revenue collection (particularly duties on spirits) from the greater Port Jackson (Sydney Harbour) area from the 1820s to the 1860s and its importance to the Colony. Five early and formal inquiries into the Customs Department are analysed and it is asked whether any subsequent modifications were made to legislation and practice. Finally, the veracity of current biographical entries on Frederick Garling is questioned. The research assembles early legislation and makes a contribution to the literature about customs collection practice in the Colony of NSW. The knowledge of the circumstances surrounding the artistic output of Frederick Garling during his time as a Customs Department employee is extended. 6 New South Wales Parliament Legislative Assembly, ‘Report of the Board of Inquiry into Charges against Certain Officers of the Customs Department in connection with the ‘Louisa’; together with Minutes of Evidence (October to December 1858), and Appendix’ in Votes and Proceedings of the Legislative Assembly during the Sessions 1858–1859 (Sydney, Government Printer 1859) 679–869. 7 For a range of biographical entries on Garling, see J Campbell, Watercolour Painters, 1780–1980: including an Alphabetical Listing of over 1200 Painters (Adelaide, Rigby, 1983); B Chapman, The Colonial Eye: a Topographical and Artistic Record of the Life and Landscape of Western Australia 1798–1914 (Perth, Art Gallery of Western Australia, 1979); J Kerr, The Dictionary of Australian Artists: Painters, Sketchers, Photographers and Engravers to 1870 (Melbourne, Oxford University Press, 1992); A McCulloch, E McCulloch Childs and S McCulloch, The New McCulloch Encyclopedia of Australian Art (Fitzroy, Miegunyah Press, 2006); J McDonald, Art of Australia: Exploration to Federation (Sydney, Pan Mcmillan, 2008) vol 1; P McDonald and B Pearce, The Artist and the Patron: Aspects of Colonial Art in New South Wales (Sydney, Art Gallery of New South Wales, 1998); W Moore, The Story of Australian Art: From the Earliest Known Art of the Continent to the Art of To-day (Sydney, Angus and Robertson, 1934/1980) vol 1; B Smith, Place, Taste and Tradition: A Study of Australian Art Since 1788 (Sydney, Ure Smith, 1945); M Terry, Maritime Paintings of Early Australia 1788–1900 (Melbourne, Miegunyah Press, 1998); G Walsh, ‘Garling, Frederick (1806–1873)’ in Australian National University National Centre of Biography (ed), The Australian Dictionary of Biography (Canberra, Australian National University, 2006), online. at www.adb.anu. edu.au/biography/garling-frederick-2080/text2605.

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Figure 11.1 Frederick Garling (1806–73) Courthouse, Darlinghurst, c 1840, State Library of New South Wales. The courthouse construction was funded from customs duties and used convict labour to dig the foundations

BACKGROUND

Necessary and useful background literature consulted for this chapter has included general histories concerning New South Wales and its colonial customs revenue, and the move from monopolistic practices to free trade; such as those by Kingston, Hirst, Hoskins and Karskens.8 The use of rum for barter in the early days of the NSW settlement (as described by Clark, Blainey and Hughes) has given an understanding of the unusual prominence of alcohol and its consumption in that penal society.9 The book by Evatt delves into the legal basis for the overthrow of the Colony’s Governor Bligh (1806–08) who is perhaps more infamously known as the captain of the ‘Bounty’ and its mutiny in 1789. The rebellion in NSW against Governor Bligh was an event that had a direct nexus with the Colony’s rum trade.10 8 B Kingston, A History of New South Wales (Melbourne, Cambridge University Press, 2006); JB Hirst, The Strange Birth of Colonial Democracy: New South Wales 1848–1884 (Sydney, Allen and Unwin, 1988); I Hoskins, Sydney Harbour: a History (Sydney, University of NSW Press, 2009); G Karskens, The Colony: a History of Early Sydney (Crows Nest, Allen and Unwin, 2009). 9 G Clark, A History of Australia (Melbourne, Melbourne University Press, 1963–81) vol 1–3; G Blainey, The Tyranny of Distance (Melbourne, Sun Books, 1966); R Hughes, Fatal Shore (London, Collins Harvill, 1987). 10 H Evatt, Rum Rebellion, 4th edn (Sydney, Angus and Robertson, 1944).

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Alcohol was widely used as a panacea for the hard and rough life in a convict settlement. Evatt has provided an understanding of the power wielded by vested interests, which rose up against the impost of customs duties on spirits. Mills and Smith tender a comparison between modern and early tax regimes of NSW. The authors contend that the design of the early colonial tax systems grew from administrative concerns, rather than Adam Smith’s tax maxims of equity, certainty, convenience and efficiency.11 This chapter considers their position, but nonetheless seeks to discover the extent to which Smith’s ideals were acknowledged in the Colony of NSW in the context of the early customs operations. Smith’s maxims of taxation underpin much contemporary taxation legislation, tax reform and modern tax publications.12 Today it is still accepted that a properly functioning political economy contains two distinct objectives: to raise revenue, or enable people to generate enough revenue for subsistence, and to supply the state with enough revenue to provide for public services.13 Butlin’s statistical data is useful to understand the underpinning of the Colony of NSW’s decisions to retain and augment customs revenue.14 In what might otherwise have been a dreary official recounting of departmental history, David Day’s commissioned book captures the history of the Australian Customs service, from 1788 to 1901, in a sweeping and colourful narrative of persons and incidents.15 Day provides the context and a brief mention of the 1858/59 official inquiry into the NSW Customs Department.16 Thus, this chapter provides further details and insights into customs collections up to 1859. In particular, the closer reading of the 1856/57 and 1858/59 NSW parliamentary inquiries and reports on the Customs Department give the focus for this chapter. Other primary sources on customs have included the reports of the London-appointed commissioner JT Bigge, the two audit reports by the Hobart collector of customs, G Barnes, and the Historical Records of New South Wales. Revenue data has been sourced from the NSW Returns of the Colony.

11 S Mills, Taxation in Australia (London, Macmillan, 1925); JP Smith, Taxing Popularity: the Story of Taxation in Australia, Research Study No 43 (Sydney, Australian Tax Research Foundation, 2004). See also S Reinhardt and L Steel, A Brief History of Australia’s Tax System (2006), available at http://archive.treasury.gov.au/documents/1156/HTML/docshell. asp?URL=01_Brief_History.asp. 12 For example, Australian Treasury, Australia’s Future Tax System: Architecture of Australia’s Tax and Transfer System (Canberra, 2008); JE Stiglitz, Economics of the Public Sector, 3rd edn (New York, WW Norton, 2000); C Sandford, M Goodwin and P Hardwick, Administrative and Compliance Costs of Taxation (Bath, Fiscal Publications, 1989). 13 Sutherland, n 3 above, Book IV, 275. 14 Butlin, n 5 above. 15 D Day, Smugglers and Sailors: the Customs History of Australia 1788–1901 (Canberra, Australian Government Publishing Service, 1992). 16 ibid 211.

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Lord Sydney, the British Home Secretary, lobbied for NSW as site for a penal colony, but he had to gain the co-operation of the maritime behemoth, the English India Company (EIC).17 Finally, in 1788, the Colony of NSW was proclaimed and placed under the Governorship of Arthur Philip (1788–92), but only after the appeasement of the EIC’s trade monopoly mandate. The Colony of NSW was administered at Port Jackson, Sydney, with the support of that motley military assembly, the New South Wales Corps. The new Colony encompassed the vast areas east of the 135th meridian, between the latitudes of 10°37’S at Cape York and 43°39’S, including what is now Tasmania.18 Even though early Sydney was merely a penal colony, the EIC was concerned about protecting its trade, supported by the restrictions imposed by the Navigation Acts, which forbade trade between British colonies and foreign ships. The Acts ensured English trade was carried in English vessels, preventing Britain’s colonies from trading directly with the former North American colonies, the Netherlands and France.19 Based on the economic theory of mercantilism, which posited wealth was increased by restricting trade to one’s colonies, the unintended consequence of the Navigation Acts was, however, increased freight prices and reduced competitiveness. In the initial decades, the Colony of NSW incurred net expenditure to London, in terms of food and supplies for the military, convicts and its few free settlers. Because of the Colony’s remoteness, rum in particular, could be bought from American trading vessels, despite the Navigation Acts. Both illicit and legal spirit imports brought problems. For instance, in the 1790s Lieutenant-Governor Philip King introduced a customs duty to control the oversupply of rum, brandy, wine and beer into Norfolk Island (part of the Colony of NSW) as a policy tool to control drunken behaviour and to provide funding to support orphaned and neglected children.20

17

Hoskins, n 8 above, 20. On 26 January 1788, Arthur Phillip arrived with the First Fleet to found a convict settlement at Port Jackson, Sydney. Phillip’s authority covered eastern Australia and included most of New Zealand except for the southern part of South Island, see Governor Phillip’s Instructions, 25 April 1787, FM Bladen (ed), Historical Records of New South Wales (Sydney, Government Printer, 1901). In 1803 the first European convict settlement was established in Tasmania, then called Van Diemen’s Land. In 1834 the first European settlement on the Victorian coast was established at Portland and became the District of Port Phillip from 1835. In 1851 this area was separated from the Colony of NSW and named the Colony of Victoria. 19 The first great Navigation Act of 1651 was aimed at Dutch shipping and renewed at the Restoration by Acts of 1660 and 1663, see www.constitution.org/eng/conpur_ap.htm. The Navigation Acts were repealed in 1849 and 1854 under the influence of a laissez faire philosophy. 20 Lt-Governor King to Rev Johnson, 7 August 1800, Bladen, n 18 above, vol 14, 135–36. 18

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Later, in 1800, when King was appointed Governor of NSW, he introduced a tax on imported spirits, referred to as ‘assessments’. His policy was not only a direct attack on the growing monopoly on imported spirits (driven by a former officer, John Macarthur, and the New South Wales Corps) but also attempted to address the problems of a dissolute populace. Macarthur and the New South Wales Corps, colloquially known as the ‘Rum Corps’, grew a cartel from the military perquisites of imported spirits. King created the position of Naval Officer, a non-military post, which primarily involved collection of the assessments.21 King overcame the reluctance to use the term ‘customs duties’ (as duties went against Adam Smith’s and the liberal call for laissez faire trade) and introduced ad valorem duties on non-British goods as a deterrent to American traders, with the monies paid into the gaol and orphan funds.22 King’s efforts to control the rum monopoly failed, a direct result of receiving intimidation concerning his lack of legislative power to levy duties and defamation by John Macarthur’s rum cartel. The cartel later meted out the same tactics against his successor, Governor William Bligh (1806–08).23 In 1806, free settlers in the Colony sent a petition to Governor Bligh complaining of the trade monopoly policy under the Navigation Acts. One consequence of the policy was that their produce was bought by the government at a fixed price. The petitioners wanted freedom of trade, the ‘right to buy and sell commodities on the open market’ (as promoted by the acolytes of Adam Smith).24 In the absence of coinage in the Colony, rum was used to barter for labour and goods. Bligh announced penalties against the free importation of liquor and established regulations for its sale, which ultimately led to his overthrow by John Macarthur and the ‘Rum Corps’. Bligh’s successor, Lachlan Macquarie (1810–21), continued the struggle against the smuggling and corruption connected to the liquor trade by calling for the Naval Officer to receive a salary, or five per cent of collections, and not be concerned with trade.25 These recommendations were not implemented. Macquarie passed regulations to increase the level of import duties on spirits (using the volumetric method) in 1812, 1814 and 1818. While he was able to apply the revenue raised to his zealous public infrastructure programme, there was little deterrent effect on overt alcohol consumption; and smuggling increased as a consequence (as foreshadowed by Adam Smith).26 From 1819, a British statute, Duties in New South Wales 21 Regulations for English or Foreign Merchant Vessels arriving at Port Jackson, vol 4, 144–46. Government and General Order, 10 March 1805, vol 5, 569–70. 22 Day, n 15 above, 36. The ad valorem method calculates duty on the value of goods. 23 Evatt, n 10 above, 348–53. 24 ibid 106. See also, Bladen, n 18 above, vol 6, 250. 25 Day, n 15 above, 86. 26 Bigge, n 2 above, 58. See also, Bladen, n 18 above, Despatch Macquarie to Castlereagh, 10 April 1810, vol 7, 338–42. Sutherland, n 3 above, 451–54.

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Act, was finally passed and provided retrospectively for the NSW Governor to levy customs duties. Duties for imported goods, other than spirits, remained based on the ad valorem method.27 While still a convict colony under Governor Ralph Darling (1825–31), the NSW Legislative Council was created in 1825 to advise the Governor. In 1827, Darling established the Colony’s Customs Department along with the role of Collector of Customs, which for the first time was a civil and salaried position. The Collector was answerable to the Board of Customs, London and his Department’s practice procedures followed those of Britain.28 Transportation of convicts from Britain to the Colony of NSW ended in 1840, and a greater vision for the Colony began to find its roots.29 From 1851, the gold rush at Bathurst invigorated the struggling Sydney economy and stimulated large increases in the free settler population. In 1852, the NSW colonial government took over control of the Colony’s Customs Department from London. From June 1856, upon the proclamation of responsible self-government for the Colony, the newly elected NSW Parliament, inter alia, enacted further legislation and rules of practice for its Customs Department. Figure 11.2 shows some key dates and persons.

Colony at Sydney 1788 est. Governor King (1800–1806) Governor Bligh (1806–1808) Governor Macquarie (1810–1821) NSW Customs Dept. est. 1827 NSW self-government & parliamentary inquiry, 1856 NSW parliamentary inquiry, 1858

Figure 11.2 Some key dates and persons in colonial New South Wales

NARRATIVE OF CUSTOM DEPARTMENT INQUIRIES

From 1819 to 1858, there were five inquiries into customs practice in the Colony of NSW. This section turns briefly to the three earliest inquiries 27 Duties in New South Wales Act 1819 (59 Geo III c 114) (UK). Duty rates on spirits varied depending on alcohol volume. 28 Day, n 15 above, 165–71. 29 The Colony of Victoria (District of Port Phillip to 1851) never accepted convicts. Van Diemen’s Land received convicts until 1853, and in 1856 became the Colony of Tasmania.

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which were instigated by the Colonial Office in London. The first, in 1819, was investigated by John T Bigge, and the other two by George Barnes in 1839 and 1845. In 1819, Bigge was asked, inter alia, to inquire as to whether customs duties could be increased without harm to the Colony’s prosperity.30 By the time of Bigge’s visit to NSW the EIC trade monopoly over colonial territories, including NSW, had been revoked under the East India Charter Act 1813, hence the encouragement from London for the Colony to become self-sufficient.31 Bigge observed that the Naval Officer received five per cent of NSW custom duties receipts. For duty on goods using the ad valorem method, the calculations were supposed to draw on manifest and cargo invoices, but these documents did not include the value of goods. The problems Bigge highlighted were that of no independent check on the estimates of value, and that all duties collected were retained in the hands of the Naval Officer until the end of each quarter. The Naval Officer gave no bond for the period he held this public revenue.32 Bigge noted that an earlier change, to sharing one-third of the proceeds from seizures of smuggled goods among the customs boat crew, had done little to stem smuggling.33 Bigge recommended using customs duties on imports to protect the development of the domestic brewing industry. Subsequent to the Bigge Report, duties were increased in 1822.34 Bigge’s recommendation that the post of Naval Officer be replaced was adopted in 1827 with the appointment of a Collector of Customs on a salary (with the percentage on customs removed). There was a requirement for the Collector to provide a security payment.35 New Customs Regulations were eventually passed by the NSW Legislative Council in 1830, 1832 and 1834, with the latter Act repealing its predecessors.36 George Barnes, the Collector for Hobart, Van Diemen’s Land, conducted two investigations into the Customs Department in Sydney (see Figure 11.3). First, in 1839, Barnes was ordered by the London Colonial Office to check on the state of the Sydney customs accounts and report on the character and

30

Bigge, n 2 above, letter, Bathurst to John Bigge, 6 January 1819. Day, n 15 above, 104. For the East India Charter Act 1813 (53 Geo III c 155) (UK), see www.dialogue.hubpages.com/hub/Indian-Charter-Acts. 32 Bigge, n 2 above, 84. 33 ibid. The change to a one-third sharing arrangement for the Customs boat crew was made in February 1820. 34 Duties in New South Wales Act 1822 (3 Geo IV c 96) (UK). 35 Bigge, n 2 above, 89. 36 Customs Regulation Act 1830 (11 Geo IV 6) (NSW); Customs Regulation Act 1832 (1 Wm IV 5) (NSW) (an amendment to 11 Geo IV 6); and Customs Regulation Act 1834 (5 Wm IV 15) (NSW) (a new Act repealing predecessors). 31

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Figure 11.3 Frederick Garling (1806–73) Circular Quay, 1839 State Library of New South Wales. The painting depicts a typical scene that George Barnes would have encountered on his audit trip to Sydney

qualification of Customs officers.37 Barnes found that the Landing Surveyor, Thomas Jeffrey, did not spend enough time on the wharves, bonded warehouses or checking accounts; rather more time was spent making commissions from official seizures of smuggled goods. Barnes also questioned the usefulness of a single Tide Waiter (often on board a ship having meals or resting) while smuggling could proceed.38 Subsequent to Barnes’ inquiry a replacement Customs Duties Act that increased rates of duty was enacted in September 1840.39 In 1845, Barnes was ordered to Sydney again upon allegations that Gibbes, the Collector, and Jeffrey, the Landing Surveyor, had been taking customs money for personal expenses. Further, spirits had clandestinely vanished from warehouses, and some merchants were in the habit of removing bonded goods without paying duty.40 Barnes found that none of the assertions could be evidenced, and the matters did not progress. Barnes did, however, find numerous errors in the Customs Department accounts. He provided instructions for the proper checking of export goods and recommended that accompanying export documents be signed by a Customs officer at the wharf.41 As a result of the second Barnes Report, new

37 National Archives, Kew, United Kingdom, Custom House, London (CUST) files: 34/620/ fol 45, Custom House to George Barnes, 20 July 1839. 38 CUST 34/620/fol 1–143, George Barnes’ Report, 30 April 1840. Note, the Tide Waiter was to remain on board a vessel until duty was paid or goods landed. 39 Customs Duties Act 1840 (4 Vict 11) (NSW). 40 CUST 34/267/fol 271, Custom House to George Barnes, 26 April 1845. 41 CUST 34/267/fol 292, George Barnes’ Report, 24 September 1945.

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and more extensive NSW Customs Regulations legislation was enacted in November 1845.42 This chapter now turns to the two NSW Parliament instigated inquiries.

1856 Parliamentary Inquiry In 1856, the Legislative Assembly was created when NSW attained selfgovernment. The government initiated the appointment of a Select Committee to inquire into the management of its Customs Department, and future arrangements for customs collection.43 The Committee’s progress report details the in-depth interviews conducted over two weeks with senior Customs employees and other persons familiar with customs procedures. The Customs Department employees, in order of seniority, were Colonel John GN Gibbes, Collector of Customs and Frederick Garling, Landing Surveyor, employees for 22 and 29 years, respectively; William N Llewellyn, Chief Clerk and Arthur W Rolleston, First Landing Waiter, employees for 14 and seven years, respectively. Public witnesses were George Thornton, a NSW Custom House agent for 18 years; Henry Fisher, Justice of the Peace (JP) and a Custom House agent for 25 years; and William M Aldis, a Sydney tobacco merchant. The following paragraphs, providing details of customs operations, are derived from responses to the Committee’s questions on improvements to procedures, the extent of smuggling to evade customs duties, the regularity of stocktakes and anecdotal reports of drunkenness on duty. John Gibbes, Collector of Customs John Gibbes, Collector of Customs, was the head of the Customs Department and responsible for both indoor and outdoor staff. Attending to queries from the public was his most time-consuming responsibility. Gibbes also managed the bank account and paid monies received by Customs to the Colonial Treasury. 42 Customs Regulation Act 1845 (9 Vict 15) (NSW). Note also the minor Customs Regulation Act (1845 Amendment) Act 1846 (10 Vict 9) (NSW); and Customs Regulation (1845 Amendment) Act 1849 (13 Vict 43) (NSW). 43 New South Wales Parliament Legislative Assembly, ‘Progress Report of the Select Committee on the Customs Department; together with the Proceedings of the Committee, Minutes of Evidence (November 1856 to February 1857), and Appendix’ in Votes and Proceedings of the Legislative Assembly during the Sessions 1856 and 1857 (Sydney, Government Printer, 1857) 27–101. The page numbers cited are those from the copy provided by the State Library of Victoria. Note that from 1819 to 1856 there were three increases to the volumetric rates of customs duty, Customs Duties Act 1840 (4 Vict 11) (NSW); Customs Duties Act 1852 (16 Vict 7) (NSW); and Customs Duties Act 1855 (19 Vict 14) (NSW), see www.legislation. nsw.gov.au/maintop/tables.

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Gibbes both tendered a statement and described the duties performed by his staff.44 For example, the Warehouse-keeper, David Nash, was in charge of the stock book, which recorded all warehoused goods and was responsible for the keys to the bonded warehouses. (See Figure 11.4.) He provided them to Customs Department staff (the Lockers) based at warehouses, who were tasked to receive goods from vessels and hold the keys until customs duties were paid. On receipt of signed documentation from the Cashier, Nash would instruct the Lockers to release goods from bond. The Committee identified bonded warehouses as a weak link in the customs collection system. Warehouses in the Colony were privately operated and goods were placed in store, if landed without the applicable customs duty being paid. Gibbes stated that the British Warehousing Act was applicable to the Colony, however warehouse rules and regulations were framed under NSW Customs Regulations legislation.45

Figure 11.4 Frederick Garling (1806–73) Moore’s Wharf and Warehouses, Millers Point, ca 1840s, State Library of New South Wales. By the 1840s there were around 22 bond stores and the wharves included: Moore’s, Campbell’s, Lamb’s, Bott’s, Walker’s, Macnamara’s, Town’s and Smith’s 44

ibid 43-46. See Warehousing Act 1825 (6 Geo IV c 114) (UK). For the NSW Colony warehouse regulations, see Customs Regulation Act 1845 (9 Vict 15) (NSW) (as amended 1846 and 1849) ss 62–81. 45

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A bond was only repaid if the goods were re-exported, or upon payment of the duty. For instance, the Collector, Gibbes, was questioned about cigars, casks of rum and spirits being taken from a bonded warehouse and the possibility of bond certificates begin burned and, presumably, the bond money being unaccounted for. Gibbes, denied this ever happening, and noted that it was Frederick Garling’s duty, as Landing Surveyor, to look after the bonded warehouses.46 The Committee suggested additional revenue sources, for instance, placing a tax on bonded warehouses. Gibbes responded that it was a good idea, but inequitable, given some warehouses ‘might only be half full of goods’.47 The Committee suggested the government rent or lease out warehouses but Gibbes thought this would result in a loss (due to labour costs) and saw private warehousing services being efficiently farmed-out under licence.48 When asked about the charges for bonding goods, such as rent, being excessive, Gibbes noted that ‘the whole system is bad’, but then did not agree with the idea of government regulating warehouse charges.49 Gibbes was questioned on the duties of the Tide Surveyor, who was in charge of four staff (called Tide Waiters) who awaited the tide for incoming and outgoing vessels to guard against smuggling. Gibbes noted that Tide Waiters were paid on an hourly basis and that they were over-stretched. He was of the view that both the Lockers and Tide Waiters were underpaid, and open to receive ‘gifts’ from shippers.50 When asked specifically about steamer vessels and smuggling, Gibbes said that it was difficult to deal with as ‘stop time’ cost shippers money. Gibbes was of the view that ‘smuggling in this port is very small, compared to what many persons might think’.51 Gibbes stated that Frederick Garling, as the Landing Surveyor and in charge of all outdoor staff, was not well paid given the extent of his duties.52 Gibbes mentioned only two or three cases of Tide Waiter intoxication on the job.53 When asked about the sobriety of the Lockers, Gibbes stated it was the duty of Frederick Garling to check such matters. He again admitted there was too much work for Garling, and agreed with the suggestion of an additional appointment of an Inspector of Warehouses.54

46 New South Wales Parliament Legislative Assembly, n 43 above, paras 52, 56. In the 1839 inquiry by G Barnes, it was reported that the NSW Colony’s Customs Department had discrepancies in the accounts, CUST 34/620/fol 1–143, George Barnes’ Report, 30 April 1840. 47 ibid 51, para 96. 48 ibid 50, paras 75, 90–92. 49 ibid 52, paras 125, 128. 50 ibid 52, para 119. 51 ibid 52, para 131. 52 ibid 51, paras 108, 115. 53 ibid 39, para 95. 54 ibid 49, paras 55, 72.

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When the Committee asked whether there should be new customs rules and regulations for the whole Department Gibbes replied: ‘Yes’.55 He elaborated that since the Customs Department handover to Colonial government in 1852, no printed instructions were available ‘as to how duties were to be carried out’.56 At the conclusion of the interviews the Committee asked for any other suggestions regarding the improvement of the administration of the Customs Department. No answer from Gibbes was recorded.57 George Thornton, JP and Former Custom House Agent Thornton was a JP and had been a Custom House agent for 18 years. His view overall was that the Customs Department’s system of revenue collection was bad and ‘inefficient’. His comments first concerned the bonded warehouse system which he described as ‘defective in many respects’.58 For instance, warehouse-keepers could bond their goods in their own stores. Thornton had much to say about Frederick Garling’s warehouse supervision in his capacity as Landing Surveyor: ‘Well I should be at a loss to tell you what that gentlemen’s duties have ever been.’ He continued, the only check on the bonded warehouses ‘is a lock and key kept by the Locker’. Thus any amount could be ‘plundered and a great deal of evaporation goes on’ with the spirits.59 Thornton asserted that the Colonial government was being defrauded of revenue because the Lockers were too ignorant to competently measure spirits in a cask, although their duty statement required that skill. In another slight to Garling, Thornton suggested appointing someone qualified to supervise bonded warehouses.60 Thornton did not think it equitable to charge bonded warehouses a fee based on the quantity of merchandise, given the differences in the quality of goods. He saw a bonded store’s success as based on ‘the liberal conduct and character of proprietors’.61 He was against a storage rental fee in lieu of a tax, for ‘how can you legislate on men’s private arrangements?’,62 and commented that the hours of opening of the private bonded warehouse system were ‘inconvenient’ for shippers. Further, he did not favour a government bonded warehouse as it went against ‘the vested rights of proprietors of bonded warehouses’.63

55 56 57 58 59 60 61 62 63

ibid 54, para 174. ibid 36, para 33. ibid 55, para 205. ibid 57, paras 16, 18, 20. ibid 58, paras 26, 28, 31, 46. ibid 59–60, paras 60, 79. ibid 62, paras 137, 146. ibid 63, para 164. ibid 61, paras 112–13.

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On being queried over warehouse stocktakes, Thornton claimed that there were no stocktakes of goods kept in bond over a two to three year period. In the end old stock was sold by the owner to cover duty, but in the case of liquor, much had evaporated by this time. Furthermore, in relation to poor procedures and lost revenue, he informed the Committee that the bonded warehouse-keeper could purchase goods, duty unpaid, to cover his rent.64 Thornton revealed that some Tide Waiters, whose role was to board a ship and check for dutiable goods, would receive gifts from the ships’ captains, or were observed to have never been on board a ship they claimed to have checked for duty, indicating a clear conduit for smuggling.65 The hourly rate paid to a Tide Waiter, rather than a salary, was given as one reason for poor performance. Thornton said that at night there were no Customs boats in Sydney Harbour to guard against smuggling. As in the interview with Gibbes, the Committee was interested in staff sobriety during working hours. According to Thornton, the character of the Lockers varied, and ‘some Lockers are drunkards’.66 Thornton’s interview then covered the indoor business conducted in the Long Room at Custom House. Thornton had a good opinion of Gibbes, the Collector, but a poor opinion of some others in the Long Room, as ‘uncivil and disobliging’ persons. He strongly criticised the Long Room hours of 10 am to 3 pm as being inconvenient for the public.67 Even though Thornton was being questioned on the Long Room staff, he made particularly disparaging remarks about Frederick Garling: ‘As regards the office itself, or the present occupant of it, they are both utterly useless and unsatisfactory. I cannot conceive the services he performs in the department. He seems to walk around with his hands in his pockets. He does not assist the Collector in the slightest.’68 Thornton took the opportunity to suggest that an Inspector of Warehouses be appointed and that the Landing Surveyor role be abolished. In a veiled reference to Garling, Thornton concluded that, ‘revenue from Customs might be increased to an enormous extent by the department being properly regulated and properly officered’.69 Thornton informed the Committee that the valuation of liquor to determine duty (under the long-abolished ad valorem system of duties) had been wild guesses.70 Duties based on physical assessments of ship tonnage had

64

ibid 58, paras 49–50. ibid 60, paras 85, 92. 66 ibid 68, para 91. 67 ibid 65, paras 14, 16. 68 ibid 66, paras 42–47. 69 ibid 68, paras 85–87. 70 Ad valorem duty for liquor was repealed by the Duties in New South Wales Act 1822 (3 Geo IV c 96) (UK). 65

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been repealed long ago. Thornton was of the opinion that ad valorem could be used again, and be beneficial to the importer and government revenue. He suggested that for duties to be more equitable, goods invoices could provide a guide to ad valorem valuation. However, the Committee noted that goods were sometimes marked up 100 per cent on the invoice price and discontinued that line of questioning. Thornton claimed there were too many clerks, their salaries too high and their duties incorrectly divided. In another veiled reference to Garling, Thornton claimed that some senior positions were appointed from London without reference to ability or the fitness of the parties.71 Consistent with the other interviewees, he noted that no fresh rules and regulations had been issued since the handover of the Department in 1852 and so frauds ‘are perpetrated in many small bonded warehouses’.72 Thornton made suggestions for improvement to the Customs Department as follows: (1) (2) (3) (4) (5) (6) (7)

A Board of Customs should be appointed as speedily as possible. Individual drunkenness, incompetence and other irregularities of some officers in the Department should be remedied. The whole machinery of the Department might be regulated. Abolish the role of Tide Waiter and extend business hours. Appoint a Night Watchman for each wharf. Each newly-appointed officer should first pass an examination in arithmetic. An Inspector of Warehouses should be appointed.73

Frederick Garling, Landing Surveyor After the illuminating interview of Thornton, the Committee’s next interviewee was Frederick Garling. The transcript shows Garling had been with the Customs Department from its establishment in 1827, and in 1847 was appointed to the position of Landing Surveyor by the Lords of the Treasury, London. In this capacity, he was the head of the outdoor business, which included seven Landing Waiters, three Tide Surveyors, the Warehousekeeper and nine Lockers, three Coast Waiters, four Tide Waiters and the Baggage Searchers; as well as the substation and outer port employees. The Committee, with an eye to protecting revenue into the future, asked Garling questions in relation to fraud prevention. Garling claimed that stocktakes in Sydney’s 22 bonded warehouses were occasionally undertaken, perhaps ‘once in three years’ but specified no exact time. When asked

71 72 73

New South Wales Parliament Legislative Assembly, n 43 above, 67, paras 57, 65. ibid 68, paras 80, 86. ibid 69, para 96.

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about establishing a government warehouse, as being more convenient for the public, as well as the appointment of an Inspector of Warehouses, he answered, ‘it would not be any greater check than at present’.74 The Committee tried for a response to anecdotal information about the practice of changing descriptions of spirits to gain a lower rate of duty: Garling answered: ‘Never. It is not allowed.’ Another curt answer was given when he was asked whether the Lockers were respectable men. Upon a query about whether the short opening hours of bonded warehouses were ‘convenient’ for the public Garling answered, ‘I have never heard any complaints’.75 Garling sanguinely confirmed unchanged customs regulations since the handover of the Department in 1852.76 The Committee was concerned about the other limb to fraud: smuggling. Garling simply answered, ‘I do not think there is, due to the low rate of duty’. When pressed on the need to lock the hatches of in-port ships at night to prevent smuggling, Garling answered, ‘I do not think it worthwhile’.77 The Committee, undeterred by his unhelpful answers, then asked whether Tide Waiters had been dismissed for drunkenness, Garling answered: ‘Yes’. When queried about contributing factors to such irresponsible behaviour, Garling said that the Tide Waiters pay ‘was ample’.78 When Garling was probed about suggestions to improve his Department, he had none, except to suggest a few extra Tide Waiters.79 William Llewellyn, Chief Clerk Llewellyn, the Chief Clerk, managed the Department’s correspondence, the expenditure accounts and supervised the clerks. The statement of duties tendered by the Collector, Gibbes, did not specify the Chief Clerk as responsible for the activities of the lower clerks, positions one to 11. For instance, Charles H Manton, who at the time was the seventh clerk, processed documentation for outward vessels and entered export entries in the books—but the statement of duties was silent as to his line manager.80 Llewellyn confirmed that no new rules or regulations had been issued since the handover to Colonial government in 1852. He was asked procedural questions on activities inside Custom House, to which he gave straightforward answers. He denied hearing of complaints against his officers in the Long Room.81 The Committee pressed Llewellyn about procedures to protect against 74 75 76 77 78 79 80 81

ibid 70, paras 31–32, 44. ibid 71, paras 55, 63, 67, 77. ibid 72, para 101. ibid 72, paras 107–8; 174, para 171. ibid 72, 74, paras 125, 172. ibid 74, para 194. ibid 43, App C, Statement of Duties. ibid 81, para 177.

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smuggling, such as the illegal landing of goods at inlets well away from Sydney’s Circular Quay. The questions were about matters outside Llewellyn’s area of responsibility, and hence his answers unhelpful. Arthur W Rolleston, First Landing Waiter Rolleston’s duties were to examine goods landed on the wharf, check them against the ships’ manifest and subject them to duty, or place them in bond. He was in charge of the five Landing Waiters. Rolleston had received no new rules or regulations since the 1852 handover and stated the he had ‘brought them from home [London] with me’.82 Rolleston was asked about procedures regarding exportation of goods, for instance, for any deficiencies in cask volumes for re-export, and he said Frederick Garling was normally called in. It was the Landing Surveyor who was responsible for checking for any deficiencies in casks upon exit from a bonded warehouse. The Committee asked a range of questions about smuggling to which short, non-committal answers were given.83 For instance, Rolleston said there was no check to compare a cask’s volume on leaving a ship to its volume on entering a bonded warehouse. He had never heard of a fraud in such circumstances, although he acknowledged that Customs officers did not accompany goods from ship to store.84 The Committee queried anecdotal accounts of drunkenness among Landing Waiters and Tide Waiters, to which Rolleston answered ‘you will always hear remarks of that sort’.85 Henry Fisher, JP, Custom House Agent and Merchant Henry Fisher, an active Custom House Agent of 10 years, carried out Custom House business on behalf of merchants and individuals. He had also formerly been a proprietor of a bonded warehouse for 16 years. The Committee posed a leading question to Fisher about whether ‘the greatest roguery may be going on, and robbery of revenue’. Fisher answered ‘you run a great risk as no superior of Customs has any control over the shipment of goods’.86 The Committee members were concerned with the sobriety of Customs officers, to which Fisher answered: ‘With one or two exceptions, very good’.87 The Committee asked about suggested improvements in relation to the bonding system and the concept of a government store. Fisher was negative, and claimed there was no site in Sydney large enough for a government 82 83 84 85 86 87

ibid 86, para 147. ibid 85, paras 100–9. ibid 87, 88, paras 175, 227. ibid 88, para 208. ibid 89, para 12. ibid 92, para 69.

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bond store.88 The Committee enquired about the equity of the government taking no risk when goods are in store. Fisher saw the situation as ‘equitable’, given the merchant had the benefit of credit, for duty was not due until goods were taken out of store, upon sale.89 Fisher had no suggestions about outward shipment of goods, and regarded the Landing Waiters and Lockers as ‘efficient’. When asked about the risk of unprotected goods being transported from ship to store, Fisher answered that there was little risk as fines were so heavy.90 Fisher mentioned that Frederick Garling occasionally visited his bonded warehouse and saw him on duty from 11 am to 1 pm visiting warehouses two or three times a week; and every day at the larger wharves.91 In response to the query on the need for an appointment of an Inspector of Warehouses, Fisher stated that it would unnecessarily deplete Garling’s role.92 William H. Aldis, Tobacco Merchant and Bonded Warehouse Owner Aldis found the Customs Department ‘anything but efficient’.93 He claimed to be the victim of regular discrepancies in the weighing of his tobacco. Aldis mentioned ‘inconvenience’ and costs in moving his goods to other warehouses.94 The Committee asked about the risk of taking goods from a bonded warehouse to a vessel without a Customs Officer escort, and Aldis replied that the purchase of an export permit should suffice.95 Aldis’ main grievance concerned an instance of his tobacco being charged more duty than a competitor’s, although it was of equal weight. At the time Aldis had complained vigorously to Garling, who took no action.96 Analysis of 1856 Inquiry The main themes to the Committee’s inquiry were the sobriety of officers, smuggling and its connection to Customs staff remuneration, Customs procedures and scope, and the possibility of introducing an Inspector of Warehouses. In relation to rumours about staff lack of sobriety, Gibbes, Garling, Rolleston and Fisher did not see Customs officer drunkenness while on duty

88 89 90 91 92 93 94 95 96

ibid 91, para 44. ibid 96, para 121. ibid 93, para 87. ibid 95, para 121. ibid 97, para 151. ibid 98, para 28. ibid 97, paras 95, 13. ibid 98, para 31. ibid 99–100.

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as a significant issue. However, Gibbes saw Tide Waiters open to receiving gifts because of poor remuneration, a point corroborated by Thornton. On the issue of stocktakes, Garling seemed satisfied with the occasional two to three year stocktake in each of the 22 bonded warehouses. By contrast, Thornton asserted that there were no stocktakes at all of goods kept in bond. The contradiction is seen again in relation to smuggling, whereby Garling asserted there was none due to the low rate of duty, in which he was supported by Llewellyn’s and Rolleston’s similarly unhelpful answers. Thornton claimed that low pay for Tide Waiters was a facility for smuggling. When Gibbes was questioned about various methods of smuggling, he was evasive and short in his answers; for instance, denying bond certificates had ever been burned or related monies unaccounted. The Customs Department was bound to follow the Customs Regulation Act 1845, which had sanctions against smuggling, but most sections were about rules for seizures upon non-payment of duties.97 Much like Gibbes, Garling’s interview was characterised by limited and often monosyllabic, ‘yes/no’ answers. The Committee had interviewed Thornton prior to Garling and, armed with Thornton’s negative revelations, subjected Garling to more incisive questioning. On the question of an additional appointment of an Inspector of Warehouses, Gibbes agreed, noting that Frederick Garling did not have the time to visit and inspect all warehouses. The appointment was also supported by Thornton. Thornton and Aldis both saw the Customs Department system as bad and inefficient, and both thought poorly of Garling’s work practices and supervision. To the contrary, Fisher was generally positive about Garling and the Customs Department, and had no substantive suggestions for improvements to procedures. Gibbes, and his interviewed staff, acknowledged that practice procedures had not changed, nor had written instructions been provided since the handover of the Department to the Colonial government in 1852. Despite prompting by the Committee, none of the Customs Department staff had suggestions for improvement to practices, and merely agreed, in a noncommittal manner, to Committee suggestions, such as those about bonded warehousing; albeit Gibbes conveyed a position of laissez faire market ideals in his answers on government intervention into private warehouse charges. In February 1857, the Committee submitted its progress report to the NSW Legislative Assembly, stating that non-completion was due to ‘the great number of witnesses who were still to be examined’.98 Given the 97 See Customs Regulation Act 1845 (9 Vict 15) (NSW) (as amended 1846 and 1849) ss 82–134. 98 New South Wales Parliament Legislative Assembly, n 43 above, 29. The Committee tendered a progress report, however there was no final report for that inquiry, per the author’s examination of subsequent parliamentary session records.

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interviewees’ contradictory answers, it is not surprising that the Committee was at an impasse and needed to call more witnesses. However, no final inquiry was undertaken, nor any final report tendered. The only NSW customs-related pieces of legislation passed after the 1856/57 inquiry was an amendment to the existing Customs Regulations, which placed a duty on gold, a duty on opium and a fee on spirit merchants.99 William Still was appointed to the new role of Inspector of Warehouses but, as will be shown later, his position had no real authority. No changes were made to the Tide Waiters’ remuneration, despite the possibility of their low payments encouraging corruption. No new staff duty statements were issued, and criticisms of Frederick Garling were not further investigated; nor were Thornton’s suggestions for improvement to the Customs Department implemented after the inquiry. In the aftermath of the inquiry there was no significant increase to Customs revenue, which in 1856 was £314,000 and in 1857 was £332,000.100 Reference was made to the levying of duties based on ship tonnage and ad valorem methods. The early practice of duty based on vessel tonnage required a physical assessment, which was a conduit to bribes and other abuses, and was thus repealed. Ad valorem (duty based on the value of goods) requires a strong system of support documentation, which in the mid-nineteenth century was still underdeveloped. The influence of Adam Smith’s ideas was evident in the comments of Gibbes, Thornton, Garling, Fisher and Aldis on the need for equity, convenience and efficiency in government fees and customs practice. Thornton was firm in his opinion that a bonded store’s success was based on ‘the liberal conduct and character of proprietors’, and saw it as inappropriate to ‘legislate on men’s private arrangements’. Frederick Garling, the Artist Relevant information on Frederick Garling’s family and other career as an artist is covered at this point. In 1806 Frederick Garling (junior) was born to Frederick and Elizabeth Garling in London; he was one of five children. His father, Frederick Garling (1775–1848), a solicitor, practised in London as an attorney in the Court of King’s Bench, and in the Court of Chancery until 1814. In that year, Garling (senior) was selected to go to Sydney to conduct cases before the Court of Criminal Jurisdiction and the newly-established

99 Customs Regulation (1845 Amendment) Act 1857 (20 Vict 22) (NSW), effective 23 February 1857; Opium Duties Act 1857 (21 Vict 1) (NSW), effective 20 November 1857; and the Wholesale Spirit Merchants Act 1857 (20 Vict 38) (NSW), effective 18 March 1857, available at www.legislation.nsw.gov.au/maintop/tables. 100 State Library of NSW, Sydney, New South Wales, Australia, Returns of the Colony, 1822–57.

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Supreme Court and Governor’s Court. Garling (senior) had been recommended to the Colonial Office by Jeffery Bent. In August 1814, the Garling family arrived in Sydney. Garling (junior) was essentially a self-taught artist, although he received some tutoring from the professional painter and traveller, Augustus Earle.101 In 1826 (the year before he joined the Customs Department), Garling was official artist to Captain James Stirling’s exploration of the Swan River in Western Australia.102 In 1829, two years after his appointment to the NSW Customs Department, Garling married Elizabeth, eldest daughter of Lieutenant Ward of the First Regiment (and niece of General Hawkshaw of the East India Co service). Elizabeth had migrated to Australia in 1825 with her mother, three younger sisters and brother. Garling and Elizabeth had 11 children.103 Garling’s widowed sister-in-law, Susannah Bedwell, died in May 1854 leaving an additional 11 children under 21 years to his guardianship.104 It has been extravagantly reported that upon Garling’s 1827 appointment to the Customs Department he had proceeded to paint pictures of all new vessels anchored in Sydney Harbour.105 While this is an exaggeration, nonetheless, a conservative estimate of Garling’s output of paintings would be in excess of 270. Of these, 120 are dated between 1820 and 1859 while over 100 paintings have no date.106 In addition to Garling’s annual Customs Department salary of £575, his earnings as an artist have been reported to be £100 per year at around 1847.107 Today, Garling is noted as ‘undoubtedly Sydney’s most prolific colonial marine artist’.108 However, most art biographies on Garling merely regurgitate the legend, started by Moore, that Frederick Garling was a weekend painter.109 Given few of Garling’s 1850s paintings survive, there has been

101 See the oil painting of Frederick Garling, attributed to Augustus Earle, available at www.acmssearch.sl.nsw.gov.au/search/itemDetailPaged.cgi?itemID=177835. 102 See the Art Gallery of Western Australia information on Frederick Garling, artist, available at www.artgallery.wa.gov.au/education/documents/ArtoftheSwanRiverSettlementnew.pdf. 103 Walsh, n 7 above. 104 J Bowen, ‘Legacy of a Lawyer: The Story of Frederick Garling and his Descendants and the Beginnings of the Legal System in Australia’ (Unpublished manuscript, MLMSS 7844, State Library of New South Wales, 2005) 11. See also, www.australianroyalty.net.au/individual.php ?pid=I73875&ged=purnellmccord.ged. 105 See the 1934 book, Moore, n 7 above, 18. 106 See author’s listing of Frederick Garling’s paintings, available at www.frederickgarlingpaintings.tripod.com/. 107 For Garling’s salary, see New South Wales Parliament Legislative Assembly, n 43 above. For his artist earnings see R Neville, Frederick Garling in the Picture Gallery Supported by the Jean Garling Bequest (Sydney, State Library of New South Wales, 2003) 4. 108 Kerr, n 7 above, 287. 109 Moore, n 7 above. For examples of perpetuations of the myth about Garling, see Terry, n 7 above; McCulloch, McCulloch Childs and McCulloch, n 7 above; Kerr, n 7 above.

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a suggestion ‘that the Customs Office absorbed most of Garling’s time’.110 This view needs to be considered alongside George Thornton’s observations from the 1856/57 inquiry about Garling as the Landing Surveyor, who ‘seems to walk around with his hands in his pockets. He does not assist the Collector in the slightest’.111 On the other hand, John Gibbes’ evidence supported Garling’s performance as Landing Surveyor, and suggested additional help through the appointment of an Inspector of Warehouses to assist Garling’s overload of work.112 It is important to note that Gibbes was also Garling’s art patron and knew Garling (senior) socially as well as being part of other elite groups in Sydney. Additionally the Garlings had close ties with the former head of Customs, the disgraced John Piper.113 Bearing in mind these extra facts on Garling the artist, we shall now turn to the details of the 1858 inquiry into the Customs Department.

1858 Parliamentary Inquiry The failure to introduce effective revenue-protecting customs legislation and procedures in the Colony of NSW was exposed by a high-value fraud. The NSW Colonial government had to act in response to public gossip about an irregular Customs clearing, with the dispatch of the brigantine Louisa in September 1858, her sudden return to Sydney Harbour, and her subsequent hasty departure. (See Figure 11.5.) An alleged consignment of rum, whisky, brandy, claret and tobacco was central to the rumours. The NSW Parliament promptly established a Board of Inquiry into the Louisa incident. The Board of Inquiry, which commenced in October 1858, was asked to determine the facts of the transactions and throw light on the conduct of certain Customs officers. In February 1859, the Board reported its findings after formally interviewing selected Customs Department employees and a range of witnesses from the public.114 In summary, consignees James and William Stewart and William Gibbes (son of the Collector of Customs, John Gibbes) devised a scheme to defraud public revenue. Four Customs officers were closely associated with the 110

Neville, n 107 above, 105. New South Wales Parliament Legislative Assembly, n 43 above, 66, paras 42–47. 112 ibid 49, paras 55, 72. 113 Bowen, n 104 above, 106. See Frederick Garling’s painting for John Piper, Guests in the Dome Room of Captain John Piper’s Mansion, at Point Piper, c 1856, private collection, available at www.acms.sl.nsw.gov.au/item/itemDetailPaged.aspx?itemID=66015. By 1827 John Piper as Naval Officer had become infamous for his mismanagement of Customs collections in NSW, see Day, n 15 above, 162–67. 114 The summary and narrative that follow are based on the New South Wales Parliament Legislative Assembly, n 6 above. The page numbers cited are those from the copy provided by the State Library of Victoria, Australia. 111

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Figure 11.5 Frederick Garling (1806–73) Brigantine, State Library of New South Wales. This brigantine was similar to the Louisa

fraud. The arrangement was for Customs officers to clear a large quantity of spirits and tobacco out of bond for export, but instead the goods went into Sydney, duty free, for local consumption. Narrative of Facts In September 1858, the brigantine Louisa was docked at a berth in Sydney Harbour outbound to New Caledonia. Captain Riddel and Chief Officer Thomas Cramer took on board over 95 empty hogsheads supposed to contain spirits. Other ‘ballast’ was loaded and stored. Edward Newton, a Tide Waiter, who had brought the ‘goods’ to the Louisa, refused to take a receipt for the three to five dray loads of goods although this was required by regulations. On the day before departure, the consignees, William Gibbes and the Stewarts, visited the vessel and replaced Captain Riddel with Captain King, and then discharged other personnel, except for the cook. Later in the day Charles Manton, a Customs Long Room Clerk, took the export bonds from the Stewarts for goods that would have been sufficient to fill about 30 bullock drays. The export entries included: 200 casks of gin; 28 hogsheads of rum; 15 quarter casks of whiskey; 31 hogsheads and 14 quarter casks of brandy; 15 cases of claret and 8 half-tierces of tobacco. Manton acted

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according to the approved procedure of John Maddocks, Customs Cashier, and placed the bonds in his Long Room desk. However, he neglected to report the bonds to his superior, Maddocks. Edward Newton, Tide Waiter, ‘examined’ the export entries for the goods, but in his final version of the export warrant, no spirits or tobacco was listed. On 2 September, Edward Rogers, Warehouse Clerk, allowed the issue of a larger number of export warrants for dutiable goods than could be delivered to the Louisa, given the time available. There was no evidence of a cross-check by Rogers’ superior, the Warehouse-keeper, David Nash. The Board asked William Still, the newly appointed Inspector of Warehouses, about the discrepancy between the export documents and the goods. He claimed a lack of real authority attached to his position, ‘I am passed over and these matters go to the Collector or Landing Surveyor’.115 Michael Brown, the Custom’s Locker, should have delivered the spirits from the Chilean bond store to Newton, the Tide Waiter, for loading on the Louisa, but instead he passed the goods out of the warehouse loft and into the streets of Sydney.116 Given that Newton was working at another bonded warehouse on the day the Louisa set sail, it was clear that he could not have accompanied any goods from the Chilean bond store to the vessel, as required by the Regulations. As for the tobacco, Brown acted on export documentation that showed it was issued from Walker’s bond store on the day after the Louisa sailed. Thus the tobacco was also dropped from the loft into the backstreets. Newton, the Tide Waiter, procured a signature to the export warrant from John Bramwell, a Landing Waiter, to show that the spirits and tobacco stated on the original export warrant had been shipped. The export entry for the goods had the signatures of Customs officers Brown, Newton and Bramwell as to their shipment on 2 September 1858. The Stewarts and William Gibbes paid the wharfage fee at the cheaper per day rate, rather than per package (in anticipation of minor cargo). Four witnesses confirmed they saw very few loads of any kind came to Grafton wharf on the day the Louisa set sail. They stated that the vessel did not appear full, certainly not to the extent of the weight of goods in 30 bullock drays. Newton, the Tide Waiter, incorrectly handed both Customs copies of the export warrant to the consignees. Charles Manton, Long Room Clerk, then attended the Louisa and cleared the vessel’s manifest in return for a ‘payment’ from William Stewart. Manton’s attendance on board the vessel was outside normal Customs procedures, and in any case such an extreme course of action would ordinarily only be undertaken by the Chief Clerk. 115

ibid 767. Day, n 15 above, 196. The Collector of Customs, John Gibbes, provided licences to Warehouse-keepers. The Chilean bond store was owned by William Stewart, and William Gibbes (son of John Gibbes) had a financial interest in the store. 116

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On 2 September 1858, the Louisa sailed from the wharf in Sydney Harbour with consignees (the Stewarts and William Gibbes) on board. These men transferred to a steamer at Bradley’s Head (within the harbour) and the Louisa sailed on with her cargo of empty casks and ballast. Edward Newton, the Tide Waiter, received back from the consignees the irregularly completed export warrants, and then handed them to Charles Manton, who put them in his Long Room desk. The next day, when rumours about the shipment started circulating in Sydney, James Collier, the Tide Surveyor, was asked to examine the ship’s papers and found the warrants had not been co-signed by Manton. Collier reported this to his superior, Frederick Garling, who asked Manton to correct the paperwork and let the matter drop. William Llewellyn, Chief Clerk, was stopped by the Harbour Master in the main street and informed of a rumour that no bond had been taken for the Louisa. Llewellyn then asked a subordinate to check the export bond, who reported that all was found to be correct. The Louisa arrived in New Caledonia and discharged the empty casks. The vessel returned to Sydney on 7 October 1858. Custom officers wanted to see the log book to ascertain how the Louisa had arrived back so soon, given the large quantity of goods supposedly shipped; and their suspicions were further aroused when the Louisa hoisted the royal yard, which they interpreted as a warning signal to accomplices. The Louisa applied to be cleared out of Sydney Harbour after hours, which Manton, the Long Room Clerk, attended to (on board the vessel) which was irregular. Clearance was given without a Post Office certificate from New Caledonia, an initialled manifest or the vessel being visited by the Tide Surveyor for the necessary rummage certificate.117 The charted course for the Louisa was westwards to Navigator Islands (American Samoa) but instead she sailed south for Hobart Town. The Louisa then went north to Jervis Bay where William Stewart embarked, and the vessel sailed on to Howe Island. James Stewart, with the help of Gualter Soares, a Custom House officer, escaped the Colony by ship to join his brother on the Louisa just off the coast of Howe Island. The Board’s Findings John Maddocks, the Cashier, was acquitted of any neglect of duty with regard to the export bonds. However, he was censured for not tightening procedures for export bonds or pointing out to the Collector the shortcomings of accepted practice.

117 These documents from a vessel’s captain were required by the ‘Act of Council 1848, 15 Victoria, No 12’, New South Wales Parliament Legislative Assembly, n 6 above, 684.

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Michael Brown, the Locker, was found to have conspired to defraud revenue for his part in removing the dutiable tobacco from Walker’s bond store without proper checks after the Louisa had sailed. The Board described his actions as ‘disgraceful and odious behaviour’. Edward Newton, Tide Waiter, whose signature appeared on the export entry verifying the original list of goods for shipment, was found to have conspired to defraud the revenue, been disgraceful and of reckless behaviour. He was described as a drunken character, who, despite a record of being abusive to others, had been reinstated to his position. He did not check or sign the Louisa manifest as required by the regulations. Manton’s reckless behaviour was found to contribute to the conspiracy to defraud the revenue. Further, on the vessel’s return to Sydney, Manton cleared out the Louisa without a Post Office certificate, an initialled manifest or a rummage certificate. The Board found it could not attribute an honest motive to Manton’s actions and that he prevented detection of the disgraceful fraud. John Bramwell, Landing Waiter, signed (without examination) the adjusted quantity of goods listed in the export warrants. At the time he was not attached to Grafton wharf at which the Louisa was lying. The Board found that he had no intention to defraud, but deserved punishment for his negligence in the matter. Edward Rogers, Warehouse Clerk, was found to be negligent, untrustworthy and defied regulations. He issued to Newton a larger number of export warrants for dutiable goods than what could actually have been delivered. David Nash, Warehouse-keeper, was found answerable for Rogers’ negligence. Nash was found culpable for neglect arising from his loose system for recording the transfer of goods and poor supervision of Rogers. Nash contributed to the disorganisation of the Customs Department. According to witnesses, John Bremer, a Tide Surveyor, was known to be drunk on duty. The Board was of the view that there should be further inquiries to establish the truth. Gualter Soares, Custom House officer, was found an accessory after the fact to the fraud and facilitated the escape of James Stewart to Howe Island. John Gibbes, the Collector, was the subject of detailed discussion in the Board’s report.118 The Board found the Customs Department to be disorganised, having no unity of action or practice, and undefined duties for many officers. Irregularities in dutiable goods were unchecked leading to fraud, with no attempt at concealment. For example, the Collector’s attitude to a Tide Surveyor’s rummaging as ‘not necessary’ went against Customs Regulations.119 Further, Charles Manton’s actions regarding the Louisa

118

New South Wales Parliament Legislative Assembly, n 6 above, 691–97. General Orders of the Board of Customs, Tide Surveyor’s Instructions, art 12, New South Wales Parliament Legislative Assembly, n 6 above, 691. 119

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were justified by the Collector, which surprised the Board. The Collector ‘appeared’ to dispense with the need for a Post Office certificate.120 The Collector also dispensed with the need to physically certify all dutiable export goods and indicated it was adequate to just check the form, although this was against instructions. The net result was that the original spirits and tobacco had been diverted into consumption in Sydney. The unrealised customs duties were almost £2,400. Checks were carried out by disreputable, drunken or ill-educated Tide Waiters. Witnesses stated that Tide Waiters got intoxicated and did not stay on board vessels overnight. A vessel could discharge goods after hours as Tide Waiters were only in attendance during business hours. The Collector failed in his duty to provide written and correct instructions for the Tide Waiters. There was laxity of practice. For example, upon request from a shipper, the Warehouse-keeper would issue export warrants without a check. Junior officers often decided against re-gauging of spirits before issue, which went against regulations. The bond practices provided no security to Customs revenue.121 Large amounts of dutiable goods were exported to places where Customs did not exist, for example, Howe Island. In the Board’s opinion, the Customs Department’s poor organisation was frequently taken advantage of for fraudulent purposes. It had allowed smuggling to be carried on almost without check. The Collector had contributed to the irregularities by not issuing written instructions. The report then turned to Garling. Frederick Garling, the Landing Surveyor, was immediately responsible for all the outdoor business. He was charged with keeping a check on daily receipts of revenue, including the Landing Waiters’ books. He was required to visit several wharves daily, check that landed cargo agreed with the manifest, and occasionally check gauging and weighing. In the Board’s opinion, Garling either insufficiently knew the outdoor business, or was very reluctant to answer questions.122 Despite the evidence of previous misconduct and instances of intoxication of Edward Newton, Tide Waiter, Garling continued Newton’s employment. In regard to the Louisa, Garling was found guilty of serious neglect of duty. Further, the Board found that Garling was ‘unworthy of the confidence which has been reposed in him, and of the high position he holds’.123 120 Contrary to ‘Act of Council, 15 Vict, No 12, sec 34’, New South Wales Parliament Legislative Assembly, n 6 above, 692. 121 As required by the Customs Regulation Act 1845 (9 Vict 15) (NSW) (as amended) and see G Willmore and E Beedell (eds), The Mercantile and Maritime Guide (London, William McKenzie, 1856). 122 New South Wales Parliament Legislative Assembly, n 6 above, 698. 123 ibid.

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Llewellyn, Chief Clerk, was deemed responsible for a large amount of the disorganisation of the indoor business. The Board found he failed in his duty to bring to the notice of the Collector the rumours regarding the Louisa. It was recommended his position be dispensed with. The Board drew notice to the conspicuous defects in the organisation and management of the Customs Department. It suggested modifications to the administration and practice of the Department as follows: (1) The indoor and outdoor practices should be regulated by the minutes of the Executive Council, or by orders of Treasury. (2) After hours work should be at pre-set rates and paid through the Collector. (3) A Bond Office should be established and bonds enforced. (4) Bonded stores should be licensed, accessible and away from free stores. (5) Licences for bond stores should be issued from Treasury and all goods issued from a bond store should be re-gauged and re-weighed. (6) The position of Inspector of Warehouses should be established. (7) Repayment for bonds should be made on production of a certificate that goods have been landed at their port of destination. (8) Drays and lighters should be licensed. (9) Appointments to the Customs Department should be on probation. (10) All outdoor officers should wear a uniform. (11) Most Tide Waiters should be substituted by Landing Waiters. (12) Remaining Tide Waiters should get a permanent salary, and procedures for their duties on board vessels should be tightened. (13) Guard boats should patrol the harbour at night. (14) A Court of Appeal should sit to hear complaints. (15) A similar Act to that passed on 27 August 1857 in the Colony of Victoria should be considered because the Customs Regulation Act 1845 (9 Vic 15) (NSW) (as amended) was found to be inadequate.124 On 22 February 1859, the NSW Parliament established the Department of Trade and Customs as an initiative in response to the inquiry findings.125 The Board’s terms of reference did not include a review of the conduct of the shippers, the Stewarts or William Gibbes. However, evidence showed that they were parties to fraud and referred them to the attention of the Crown Law Officers. There were grounds for similar proceedings against Customs officers Newton, Manton and Brown.126

124 125 126

ibid 699–700. Victoria’s legislation was the Customs Act 1857 (20 Vict 4) (Vic). Day, n 15 above, 210. New South Wales Parliament Legislative Assembly, n 6 above, 691.

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Analysis of 1858 Inquiry Consistent with the seriousness of the 1858/59 Board’s findings, Frederick Garling and John Gibbes were forced to resign. Indeed, as early as the 1839 George Barnes Report, it was found that Thomas Jeffrey, the then Landing Surveyor, did not spend enough time on the wharves, bonded warehouses or checking accounts. The situation remained unchanged by Jeffrey’s successor, Frederick Garling. The 1846 Barnes Report called for a physical check to certify all dutiable export goods, and not just a signing of forms. The Collector had dispensed with that physical check.127 Barnes also found that spirits had been removed from warehouses and some merchants habitually took goods from bond without paying duty. The situation had remained unchanged to 1858. Garling’s extra family responsibilities, comprising 22 children in the years leading up to the Louisa incident, are suggested by the author as one of the motivating factors for Garling’s output of art, and consequent neglect of his Customs role. John Gibbes’ son, William Gibbes, went before the courts and was sentenced to two years in gaol, while Edward Newton was sentenced to 12 months. Charles Manton was acquitted and Michael Brown was discharged. James and William Stewart, who claimed to be mere agents of William Gibbes, absconded from the Colony and were not tried.128 Despite the Board’s finding that the Customs Regulation Act 1845 (as amended) was inadequate, it was not repealed until 1864. The Customs Duties Act 1855 was not repealed until 1871. After the inquiry, the next NSW customs-related legislations passed were only the Tobacco Duties Act 1861, which changed the rates, and the Customs Duties Act 1865, which imposed additional duties for a limited time.129 By 1858 the major concerns from the earlier 1856/57 inquiry, including prevention of smuggling to protect the revenue, lack of provision of written customs procedures to staff and drunkenness on duty, still had not been addressed. Despite George Thornton’s suggestions from 1856/57 being bitingly thorough, particularly in relation to Frederick Garling, they were ignored. For instance, the low rates of pay to Tide Waiters (which were seen to encourage smuggling) had remained. Although the suggestion of a new Inspector of Warehouses had been taken up, the role was powerless and ineffective.

127

ibid 693. See Sydney Morning Herald, 3 January, 23 February and 7, 10, 11, 13 June 1859. 129 Tobacco Duties Act 1861 (25 Vict 10) (NSW); Customs Duties Act 1865 (29 Vict 3) (NSW); Customs Regulation (1845 Amendment) Act 1857 (20 Vict 22) (NSW); Customs Duties Act 1855 (19 Vict 14) (NSW); and Customs Duties Act 1871 (34 Vict 24) (NSW). 128

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Customs duties on spirits were an important component of revenue to the Colony. From 1827 its contribution to revenue was 50–60 per cent; from 1835 20–40 per cent; from 1845 15–18 per cent; and 1851 to 1859 25–28 per cent. From 1836 to the 1850s the only other large revenue stream was from land sales.130 How effective were the various inquiries in terms of protecting or increasing the revenue to the Colony? Figure 11.6 shows a slight increase in the value of revenue from customs duties after the 1839 and 1845 Barnes inquiries. There was a revenue increase after the 1847 appointment of Frederick Garling as Landing Surveyor—which was not difficult as his predecessor, Thomas Jeffrey, spent most of his official time making commissionable seizures and collecting bribes from ships’ masters.131 The other increases in customs revenue came with the general rise in the population after the 1851 gold rush and the two parliamentary inquiries into customs in 1856/7 and 1858/59. 450,000 400,000 350,000

Pounds

300,000 250,000 200,000 150,000 100,000

0

(1) 1827 1828 1829 1830 1831 1832 1833 1834 1835 1836 1837 1838 (2) 1839 1840 1841 1842 1843 1844 (3) 1845 1846 (4) 1847 1848 1849 1850 (5) 1851 (6) 1852 1853 1854 1855 (7) 1856 1857 (8) 1858 1859 1860 1861 1862 1863 1864 1865 1866 1867 1868 1869 1870

50,000

Year

Figure 11.6 Colony of New South Wales: customs duties on liquor 1827–70 Notes: 1 1827 NSW Customs Department established 2 1839 George Barners reports on NSW Customs Department 3 1845 George Barnes reports on NSW Customs Department 4 1847 Frederick Garling appointed as Landing Surveyor 5 1851 Gold rush in NSW 6 1852 Colonial government takes over control of Customs Department 7 1856/57 Colony of NSW responsible self-government and Select Committee Inquiry into Customs Department procedures 8 1858/59 Board of Inquiry into Louisa shipment

Source: NSW Colonial Secretary, Returns of the Colony, ML4, State Library NSW.

130 131

State Library of NSW, n 100 above, and Butlin, n 5 above, 246. Day, n 15 above, 195.

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In providing insights into the inquiries concerning the customs duties, legislation and practice of the Colony of NSW, this chapter has, for the first time, systematically covered customs legislation over the period 1819 to 1871.132 The formal inquiries into the NSW Customs Department conducted by Bigge, Barnes and those instigated by the NSW Parliament in 1856 and 1858 have been covered. The lack of up-to-date legislation and associated regulations, written practice instructions for customs staff, departmental incompetence and other irregularities was exposed by the watershed case concerning the Louisa. In the immediate aftermath of the Louisa incident, the 1845 Regulations legislation, covering customs practice, was only partly repealed in 1864. The lengthy process of interviewing witnesses to the 1858/59 inquiry and the resultant weighty report were rendered ineffective. Decisions by pre1827 NSW Governors indicated a commitment to Adam Smith’s call for laissez-faire trade. Various witnesses to the 1856/57 NSW inquiry made reference to Adam Smith’s tax maxims, indicating that the old system of patronage was being supplanted by concerns about proper governance practices for the collection of revenue and the public service generally. Another development was the shift away from physical assessments of duty, but still the system fell short of today’s evidence-based assessments based on invoice documents. After the 1858/59 inquiry, the NSW Parliament established the Department of Trade and Customs, but a discussion on its effectiveness in changing daily Customs collection practice is outside the scope of this analysis. However, it might be stated that, even today, customs administrators globally are still progressing through integrity enhancing measures, such as adequate salaries and working conditions, control systems and accreditation of third parties that include customs agents.133 The chapter also set out to provide a fuller account of the employment of Frederick Garling with the Customs Department. It is clear that, despite the evident concerns of the 1856/57 Committee on smuggling’s impact on the revenue, Garling continued to receive his public service salary and in return seriously neglected his responsibilities, as was determined by the 1858/59 inquiry. After giving consideration to Garling’s prolific output of art works over the decades of his employment, it is suggested by the author that he used his paid employment time in the pursuit of his artistic output, which was driven by his increased family responsibilities.

132

See Appendix to this chapter. International Monetary Fund (IMF), Revenue Mobilization in Developing Countries (Washington, DC, IMF, 2011). 133

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Current biographies reiterate the myth about Frederick Garling as a weekend gentleman painter.134 Walsh’s entry in the Australian Dictionary of Biography, in particular, needs to be corrected, for it claims that Garling ‘gave detailed evidence on the state and workings of the Customs Department’. This is quite contrary to the transcripts and the 1858/59 Board’s opinion, that Garling either insufficiently knew the outdoor business, or was very reluctant to answer questions.

APPENDIX: COLONY OF NEW SOUTH WALES: CUSTOMS DUTIES AND CUSTOMS REGULATIONS LEGISLATION

Duties in New South Wales Act 1819 (59 Geo III c 114) (UK), enacted 12 July 1819 Duties in New South Wales Act 1822 (3 Geo IV c 96) (UK), repealed 15 September 1840 Warehousing Act 1825 (6 Geo IV c 114) (UK) Customs Regulation Act 1830 (11 Geo IV 6) (NSW), repealed 22 July 1834 Customs Regulation Act 1832 (1 Wm IV 5) (NSW), repealed 22 July 1834 Customs Regulation Act 1834 (5 Wm IV 15) (NSW), repealed 7 November 1845 Customs Regulation Act 1845 (9 Vict 15) (NSW), repealed 1873 Customs Regulation (1845 Amendment) Act 1846 (10 Vict 9) (NSW), repealed 1873 Customs Regulation (1845 Amendment) Act 1849 (13 Vict 43) (NSW), repealed 1873 Customs Regulation (1845 Amendment) Act 1857 (20 Vict 22) (NSW), repealed 1864 Customs Duties Act 1840 (4 Vict 11) (NSW), repealed 1898 Customs Duties Act 1852 (16 Vict 7) (NSW), repealed 1855 Customs Duties Act 1855 (19 Vict 14) (NSW), repealed 1902 Wholesale Spirit Merchants Fee Act 1857 (20 Vict 37) (NSW), repealed 1882 Opium Duties Act 1857 (21 Vict 1) (NSW), repealed 1871 Tobacco Duties Act 1861(25 Vict 10) (NSW), repealed 1871 Customs Duties Act 1865 (29 Vict 3) (NSW), repealed 1866 Customs Duties Declaratory Act 1871 (34 Vict 24) (NSW), repealed 1866 134

Moore, n 7 above.

12 The Development of Centralised Income Taxation in Australia, 1901–1942 RICHARD KREVER AND PETER MELLOR

ABSTRACT By the time of Federation in Australia in 1901, all of Australia’s six States (then British Colonies) had introduced income taxes in some form. This chapter traces the subsequent development of the centralisation of Australia’s income taxation system from 1915, when the central (Commonwealth) government first joined the States in the income tax field, until 1942, when the Commonwealth government moved to usurp State income tax rights entirely, supposedly for the period of the Second World War and shortly thereafter. The allegedly temporary change adopted in 1942 has remained in place since. The Commonwealth’s entry into the income tax field in 1915 is often explained as a wartime finance measure. The chapter explains how other motives, particularly the goal of extending Commonwealth jurisdiction over State regulated economic fields, may have been an equal or greater consideration. Partial but incomplete harmonisation of the State and Commonwealth income tax legislation in 1936 mitigated but did not eliminate the administrative burdens imposed by parallel State and Commonwealth taxes. Attacks on Australian soil in 1942 brought about the conditions the Commonwealth government needed to consolidate economic control over the States by monopolising the income tax field.

INTRODUCTION ‘This is trenching on the doctrine of Unification, but the whole development of commerce, business, and finance throughout the world tends today towards centralization.’1

1 W Finlayson (Brisbane), Commonwealth Parliamentary Debates, House of Representatives (CPDHR), vol 78, 6223–24 (27 August 1915).

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‘The Federal Government ought to resist the tendency to be loaded up with duties which the States should perform. It does not follow that because something ought to be done the National Government ought to do it.’2

T

HE NATIONAL GOVERNMENT’S takeover of the income taxes of Australia’s States in 1942 was one of the most significant events in the history of Australia’s federal system of government. While expressed at the time to be a wartime measure only, centralised income taxation has remained in place in Australia to the present day, and, along with the exclusive imposition of the goods and services tax also at the national level, accounts for the very high degree of vertical fiscal imbalance in Australia compared to most other major federal countries. This chapter highlights the key steps in the centralisation of direct (income) tax and indirect taxation in Australia in the first half of the twentieth century. The chapter also identifies a range of factors that led ultimately to the takeover of the income tax field by the central government in 1942 and, importantly and in contrast to other jurisdictions such as Canada which also saw a consolidation of taxing power at the central government level during the war, the continuation of a centralised system after the War. Different protagonists stand responsible for Australia’s unique revenue centralisation and consequent level of vertical fiscal imbalance. The shift of indirect taxation to the central government is mostly attributable to the judiciary, which in a series of judgments that follow through until recent times progressively narrowed the States’ tax bases by characterising various State levies as ‘excise’ taxes, reserved exclusively to the national (Commonwealth) government. The broad interpretation of excise taxes to encompass charges far outside the conventional understanding of the term stands in stark contrast to, say, the work of the Canadian Supreme Court to ensure tax bases for Canadian provinces in a not dissimilar constitutional division of taxing rights. By means of a creative interpretation of the term ‘direct taxes’, the Canadian Supreme Court allocated to provinces many levies, including sales tax, that clearly fall outside the scope of direct taxes as the term is understood in economic and, outside Canada, legal circles.3 The shift of income taxes to the Commonwealth, in contrast, is entirely the work of the federal government, albeit endorsed after the fact by the country’s High Court. The appropriation of State taxing powers by the central government in the midst of the Second World War is usually explained

2 President C Coolidge, Address to the College of William and Mary, Williamsburg, Virginia (15 May 1926), quoted by H Gregory (Swan), CPDHR, vol 152, 1366–67 (28 October 1936). 3 Atlantic Smoke Shops, Ltd v Conlon [1943] AC 550. For discussion of this case and the direct-indirect tax distinction, see A Schenk and O Oldman, Value Added Tax: A Comparative Approach (Cambridge, Cambridge University Press, 2007) 5–6, citing N Brooks, The Canadian Goods and Services Tax: History, Policy, and Politics (Sydney, Australian Tax Research Foundation, 1992) 141.

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as a short-term response to wartime fiscal needs and economic imperatives that for a variety of reasons remained in place following the end of hostilities until today. A closer look at the political and economic struggles in Australia in the preceding decades, however, suggests the most important reasons for the move involved Australia’s institutional response to the emerging views worldwide about the importance of economic management at the national government level, and the establishment of sufficient fiscal and constitutional powers at that level to be able to carry out that role.

INTRODUCTION OF FEDERAL INCOME TAXATION IN AUSTRALIA

Emerging Issue of Control of the Economy The Commonwealth government’s first serious forays into national economic management following Federation involved first a move to regulate inter-state trade and commerce, and second an attempt to control the problem of monopolies smothering efficient competition. A newly appointed High Court viewed federal intervention in the economy with scepticism, and both initiatives failed. First to go was the Commonwealth’s legislative power to regulate employment conditions of State railway employees as part of inter-state trade and commerce, struck down by the Court in a 1906 decision setting out a narrow reading of the central government’s commerce powers.4 Three years later, the Court found key elements of the government’s antitrust legislation, modelled directly after the successful US Sherman Act 1890, unconstitutional. Even after the outbreak of the First World War, Australian States exercising the legislative power over prices and wages5 they held as part of their plenary legislative powers as self-governing British Colonies6 and retained under the Constitution, remained the governments that played the predominant role in social and distributional policy. This would remain the case for the next two and a half decades.7

4 Federated Amalgamated Government Railway and Tramway Service Association v New South Wales Railway Traffic Employees Association (1906) 4 CLR 488 (High Court of Australia) (‘Railway Servants Case’). 5 Wages were the first to be controlled by the Australian Colonies, in the late nineteenth century; extensive price controls, particularly in New South Wales, followed at the outset of the First World War: H Wilkinson, State Regulation of Prices in Australia: A Treatise on Price Fixing and State Socialism (Melbourne, Melville & Mullen, 1917) 19. The Commonwealth’s power to control prices in wartime under the defence power was upheld by the High Court in Farey v Burvett (1916) 21 CLR 433. 6 The powers were not unfettered; see K Booker, ‘Plenary Within Limits: Powell v Apollo Candle’ in G Winterton (ed), State Constitutional Landmarks (Sydney, Federation Press, 2006) 52. 7 J Smith, The Changing Redistributional Role of Taxation in Australia Since Federation (PhD thesis, Australian National University, 2002) ch 4.

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The Commonwealth government’s initial response to judicial interpretations restricting its economic powers was to pursue constitutional amendment via national referenda. In the following decade, referendum proposals to grant the central government greater powers over monopolies,8 trade and commerce,9 corporations,10 and industrial matters11 all failed to pass under the strict constitutional requirements to obtain a majority of the population overall, and also a majority of the population in a majority (four or more) of the six States. The Commonwealth government’s attempts to establish central economic powers through co-operation and negotiation also floundered. A 1915 wartime referendum to provide the Commonwealth with nationalisation powers was withdrawn12 after agreement had been reached with the States for them to make a referral of the powers to the Commonwealth instead, but in the end only New South Wales followed through with the referral.13 Weeks after a parallel agreement by the States for the Commonwealth to become sole borrower on overseas markets for all Australian governments for two years to fund its war operations, New South Wales announced its decision not to accede to a specific limit on its borrowings.14

8 26 April 1911 (nationalisation); 31 May 1913 (trusts and nationalisation); 1915 (trusts and nationalisation, withdrawn 4 November); 13 December 1919 (temporary extension of power in relation to trusts, nationalisation); 4 September 1926. 9 26 April 1911, 31 May 1913, 1915 (withdrawn 4 November), 13 December 1919 (temporary extension of powers). 10 26 April 1911, 31 May 1913, 1915 (withdrawn 4 November), 13 December 1919 (temporary extension of powers), 4 September 1926. 11 31 May 1913, 1915 (withdrawn 4 November); also 13 December 1919 (temporary extension of powers) and 4 September 1926. 12 Then Prime Minister WM Hughes (West Sydney), CPDHR, vol 79, 7265–66 (4 November 1915). After the bitterness of the debate on these measures, Hughes ‘came to the conclusion that it was inexpedient to introduce this discordant element into the political life of the country’: E Scott, Australia During the War: Official History of Australia in the War of 1914–1918, 1st edn (Sydney, Angus & Robertson, 1936) vol XI, 308. 13 Commonwealth Powers (War) Act 1915 (NSW), enacted on 21 December 1915; see P Tate SC, ‘New Directions in Co-operative Federalism: Referrals of Legislative Power and Their Consequences’, paper delivered at the Constitutional Law Conference, Sydney, 18 February 2005, p 6, available at www.gtcentre.unsw.edu.au/sites/gtcentre.unsw.edu.au/files/ mdocs/5_PamelaTate.pdf. 14 Premier W Holman (Cootamundra), New South Wales Parliamentary Debates, Assembly, vol 61, 4108–109 (1 December 1915). Over half of all New South Wales borrowings in 1915 were expended on railways: Government of New South Wales, Official Year Book of New South Wales 1916 (1917) 428. The railways were explained at the time to be essential to expansion of the State’s wheat yield: Premier Holman, quoted in ‘Wheat Yield, Railway Factor’, Sydney Morning Herald, 17 January 1916, 10; the railways have also been shown to have been an ‘extremely profitable investment’ over the whole period 1853 to 1920: B Davidson, ‘A Benefit Cost Analysis of the New South Wales Railway System’ (1982) 22(2) Australian Economic History Review 127, 144–45. Nevertheless, New South Wales’ subsequent decision to proceed with a £2 million bond placement in London on 4 January 1916 led to a ‘not unnatural feeling, on the part of the Commonwealth and the five States which were parties to the agreement of November, that their claims were prejudiced’: Scott, n 12 above, 491–92.

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Taxation Powers and Vertical Fiscal Imbalance At the time of Federation, customs duties and income from land sales were the major sources of government revenue. Apart from some detailed constitutional provisions to deal with revenue allocation in the first decade after Federation and the essential requirement of the federal compact that customs and excise duties should become exclusively national imposts, the Constitution included few provisions limiting the scope of taxation by either level of government. A long-running debate in the lead-up to Federation between ‘free traders’ (predominantly in New South Wales), favouring a lower federal tariff and greater reliance on direct taxation, and ‘Protectionists’ was effectively settled in a compromise at a secret Premiers’ conference in 1899 that effectively bought off the free trade camp with a constitutional measure that guaranteed redistribution of three-quarters of Commonwealth customs revenue to the States for 10 years.15 Numerous prominent figures, including Edmund Barton, Frederick Holder and George Reid, stated views immediately after Federation that the Commonwealth should only resort to direct taxation in an emergency.16 High federal tariff rates were also immediately established with the Commonwealth’s first Tariff Act in 1902.17 The other main constitutional provision addressing the imbalance established a permanent mechanism for ‘surplus revenue’ of the Commonwealth to be returned to the States.18 A transfer of funds by the Commonwealth to trust accounts of its own instead of their return to the States (associated with the introduction of a Commonwealth old age pension scheme) was, however, upheld as valid by the High Court in October 1908,19 a finding which has entrenched the fiscal imbalance ever since. 15 See C Saunders, ‘Vertical Fiscal Imbalance: Constitutional Origins’ in D Collins (ed), Vertical Fiscal Imbalance and the Allocation of Taxing Powers (Sydney, Australian Tax Research Foundation, 1993) 55, 60–61. A federal takeover at Federation of the substantial State debts accumulated to that time also did not eventuate, in part through the opposition of the free traders: C Saunders, ‘Government Borrowing in Australia’ (1989) 17(2) Melbourne University Law Review 187, 189. 16 Barton had been a prominent opponent of free trade in the Federation debate as a member of the New South Wales Parliament before becoming Australia’s first Prime Minister on 1 January 1901; Frederick Holder was Premier of South Australia before being elected to the first Australian Parliament in March 1901 as a member of the Free Trade Party and becoming the first Speaker of the House of Representatives, and George Reid was Premier of New South Wales for a large part of the 1890s as a proponent of free trade and became Australia’s fourth Prime Minister in 1904. See the discussion of their comments in the later debate on the Land Tax Assessment Bill 1910: L Groom (Darling Downs), CPDHR, vol 56, 2605–6 (6 September 1910). 17 P Lloyd, ‘100 Years of Tariff Protection in Australia’ (2008) 48(2) Australian Economic History Review 99, 122. See also P Lloyd, ‘Customs Union and Fiscal Union in Australia at Federation’ (2015) 91 (293) Economic Record 155, 158–59. 18 Constitution s 94. 19 New South Wales v Commonwealth (1908) 7 CLR 179 (21 October 1908) (‘Surplus Revenue Case’).

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The transfer of principal tax bases to the central government while State governments retained full power over economic management and social programmes meant the new nation almost from day one would face a substantial fiscal imbalance in favour of the new Commonwealth government unless the States alone expanded land and income taxation to replace their lost customs duties.20 Income taxation in some form had already been introduced by all of the Australian States in their capacity as separate British Colonies by the time of Federation in 190121 and as long as the Commonwealth stayed out of the field, there would be room for increased State reliance on income taxation as a growing source of revenue.

The Commonwealth Moves into the Direct Tax Field, 1910–1915 The initial Commonwealth entry into the direct tax field had no fiscal objective. A progressive land tax to break up large land holdings and facilitate ‘closer settlement’ was an important plank in the Labor party’s 1910 election platform in keeping with political debate in Australia throughout the late nineteenth century, and soon after the election the newly installed Labor government led by Prime Minister Andrew Fisher introduced legislation to adopt the tax.22 The debate both during the election campaign and afterwards in Parliament was fierce. Critics included the former Prime Minister Deakin and Sir John Forrest, by that stage the last remaining member of the Commonwealth Parliament of the six then Colonial Premiers who had attended the secret conference of 1899.23 Deakin’s advocacy in particular was attacked by proponents of the tax as inconsistent with his alleged true views.24

20

Saunders, ‘Vertical Fiscal Imbalance’, n 15 above, 59–61. For discussion of the introduction of these taxes, see I vanden Driesen and R Fayle, ‘History of income tax in Australia’ in R Krever (ed), Australian Taxation: Principles and Practice (Melbourne, Longman Professional, 1987) 27–31; P Harris, Metamorphosis of the Australasian Income Tax, 1866–1922 (Sydney, Australian Tax Research Foundation, 2002). 22 See C Goodwin, Economic Enquiry in Australia (Durham, NC, Duke University Press, 1966) 121–22; C Coleman and M McKerchar, ‘The History of Land Tax in Australia’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2010) vol 4, 281–88. 23 See text at nn 15–16, above; George Reid had resigned his seat on 24 December 1909. A photograph of Premiers Forrest, Kingston, Reid, Turner, Dickson and Braddon at the 1899 Conference is reproduced at http://constitution.naa.gov.au/stories/argy-bargy/pods/premiersconference-1899/index.html. 24 In the election campaign, Fisher pointed out that in 1908 Deakin had once indicated hypothetical support for a federal land tax; see ‘Mr Deakin and the Land Tax, Mr Fisher’s Researches in “Hansard”’, Sydney Morning Herald, 4 April 1910, 8. A similar point was made in the parliamentary debate over the Tax Bill by Attorney-General Hughes in response to Deakin’s quotation of renowned Columbia University economist Edwin Seligman as an authority who opposed land taxation as a federal government source of revenue; see WM Hughes, CPDHR, vol 58, 4471–72 (12 October 1910); Deakin was quoting Seligman in ‘The Relations of State and Federal Finance’ (1909) 190(648) North American Review 615, 617: CPDHR, vol 58, 4454–55. 21

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While land taxes were used in some States, none had a progressive land tax in place and in this sense the Commonwealth tax did not overlap fully with the State imposts. The political, as opposed to revenue, significance of the overlap that did exist was not lost on critics, however. In the debate in the Senate over the Bill introducing the tax, the primary criticism voiced by critics was a thin-edge-of-the-wedge concern: the tax would start a process that would inexorably lead to unification and centralisation of land taxes.25 Subsequent to enactment of the tax, it was attacked on constitutional grounds, on the basis that the Commonwealth’s power of taxation could not be exercised in this way for a purpose other than purely revenue raising.26 The High Court rejected the argument and the door was open to the use of national taxes as tools of national economic management. The Commonwealth’s second foray into the direct tax field came in December 1914, half a year into the First World War, when a Commonwealth probate duty was enacted (together with a significant increase in the previously enacted land tax). This time revenue need was a key factor behind the proposal. While Australia was one of only two nations participating in the First World War that did not adopt conscription, it was a full participant in the War, with the national government bearing most of the costs of the war effort. With all countries borrowing to wage war, the scope for funding the war by debt was limited and by late 1914 the Commonwealth was looking for ways to supplement its revenues. With probate duties in effect at the State level, this initiative marked the first true overlap between central and State tax bases. At this point, the move was strongly criticised by Forrest and others in the Parliament, on the issue of ‘double taxation’ and breach of the Federal compact,27 decrying the increase in general government expenditure and lack of economy that made the tax necessary. A motion led by former Prime Minister Joseph Cook to have the probate duty expressly limited to the duration of the War failed28 and protests at the State level failed to deter the Commonwealth government.29 25 See, eg the comments of Senator E Millen (New South Wales), Commonwealth Parliamentary Debates, Senate (CPDS), vol 58, 4767 (19 October 1910). 26 Osborne v Commonwealth (1911) 12 CLR 321 (31 May 1911). Some uncertainty over the extent of this power resulting from the earlier split decision against the Commonwealth on a similar point in R v Barger (1908) 6 CLR 41 (26 June 1908) was finally dispelled by the High Court decision in Fairfax v Federal Commissioner of Taxation (1965) 114 CLR 1. It is now accepted as the established rule; see P Hanks, ‘Constitutional issues of Australian taxation’ in R Krever (ed), Australian Taxation: Principles and Practice (Melbourne, Longman Professional, 1987) 37–39. 27 Forrest, for example, stated that ‘I am quite certain this dual taxation was never contemplated by the framers of the Constitution, nor do I regard it as justifiable or reasonable’: CPDHR, vol 75, 1543 (10 December 1914). 28 See, eg W Watt (Balaclava) and J Cook (Parramatta), CPDHR, vol 75, 1627 and 1701 (11 and 12 December 1914). 29 Protests included a motion against the permanent nature of the tax tabled by the Opposition in the Tasmanian Parliament (see ‘The New Federal Taxation, Land and Probate Duties,

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In mid-1915, half a year after the federal probate duty was adopted, the government proposed its third foray into the direct tax field, the adoption of an income tax. With continuing competition for borrowings, revenue needs were growing and expanding wartime profits were an obvious source of income. Tariff revenues remained robust, contrary to the expectations of some that war would lead to a decline in customs receipts,30 and notwithstanding major changes to the structure of the tariff that were in many respects consistent with a shift from a protective tariff to one aimed only at revenue raising,31 as the ‘free traders’ from the Federation debate might have hoped.32 However, the costs of waging war were well above the cost of peacetime governance and the revenue shortfall was growing. At the same time, Commonwealth attempts to intervene more forcefully in the national economy had been stymied by the courts declaring Commonwealth legislation unconstitutional, rebuffed by voters turning down referenda proposals to provide the federal government with explicit economic powers, and undermined by State governments backtracking from co-operative commitments. The land tax experience suggested that the only path to expansion of economic powers might be through tax laws. Prime Minister Fisher’s announcement on 22 July 1915 of the plan to introduce a national income tax (coinciding with debate on a war loan Bill) to operate in parallel with the separate State income taxes provoked strong criticism in many quarters33 and prescient predictions that the impact of concurrent income taxation on the ability of the States to service their substantial borrowings would lead to a Commonwealth takeover of State debts and, ultimately, the income tax field.34 Federal Powers of Taxation’, The Leader, 12 December 1914, 25). The Victorian Premier stated that that the move was ‘disconcerting to the State Treasurers’; see report on the comments of Sir Alexander Peacock in ‘Federal Probate Duty, Disconcerting to States’, Bendigo Advertiser, 5 December 1914, 10. 30 Scott, n 12 above, 481; see also Commonwealth Bureau of Census and Statistics, Trade and Customs and Excise Revenue of the Commonwealth of Australia for the Year 1915–16 (Melbourne, 9 May 1917) Table XI. 31 See, eg L Groom, CPDHR, vol 75, 1664–65 (11 December 1914). Debate on the changes was truncated due to the exigency of the War (see G Sawer, Australian Federal Politics and Law, 1901–1929 (Melbourne, Melbourne University Press, 1956) 194, fn 83). Falls in effective tariff rates during and after the War proved to be brief and were quickly reversed in the 1920s: Lloyd, ‘100 Years of Tariff Protection in Australia’, n 17 above, 123, Table 5. 32 For insights into the views of the free traders at Federation, see M Booker, The Great Professional: A Study of W. M. Hughes (Sydney, McGraw-Hill, 1980) 50–51, citing WM Hughes and WT Dick, Federation as proposed by the Adelaide Convention: set forth, discussed and illustrated by diagrams (Sydney, [sn], 1897). 33 Sir J Forrest (Swan) in particular spoke out against concurrent taxes on bases that were not envisaged as being available to the federal government at Federation; see CPDHR, vol 78, 5244 (22 July 1915). 34 ibid; see also the detailed discussion of Forrest’s statements in ‘Double Taxation’, Sydney Morning Herald, 27 July 1915, 8.

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While the government presented the law as a ‘war measure’, it readily admitted support for Commonwealth income taxation was based on its non-tax objectives and noticeably made no mention of timelines or any plans for a limited life for the statute.35 One of the most significant aspects of the Commonwealth income tax was the unambiguous signal it gave as to the relationship the government envisaged between national and State tax laws going forward. This was evidenced from the treatment adopted for interest payments on Commonwealth- and State-issued debt. The legislation provided an exemption from tax for interest on specified Commonwealth war bonds36 but not for interest on State bonds, at a time when most States exempted interest on their own bonds from their income taxes.37 At the same time, the Commonwealth enacted national legislation, subsequently upheld by the High Court, that exempted interest on Commonwealth bonds from all State income taxes.38 The combined effect of the measures was to devalue immediately all outstanding State debts and raise State borrowing costs relative to Commonwealth borrowing costs.39 After 1923, Commonwealth and State loans were made expressly subject to Commonwealth income taxation,40 but a reciprocal provision making Commonwealth loans subject to State income tax was never proclaimed to commence.41

35 The Attorney-General in his Second Reading speech described the tax as an ‘instrument of social reform’: WM Hughes, CPDHR, vol 78, 5844–45 (18 August 1915); see also 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) 313, 318. 36 See, in the legislation as enacted, Income Tax Assessment Act 1915 (Cth) s 11(e), enacted on 13 September 1915. 37 Income Tax Act 1915 (Vic) s 17(h). 38 Commonwealth Inscribed Stock Act 1915 (Cth) s 5, enacted on 16 August 1915. The validity of this provision was later upheld by the High Court in Commonwealth v Queensland (1920) 29 CLR 1. 39 W Fleming (Robertson), CPDHR, vol 78, 6565 (1 September 1915) noted the proposal would cause State debt to ‘depreciate in value to a very great extent; and as the indebtedness of the States is very heavy, those which are not possessed of sinking funds or redemption moneys will be in a very difficult position’. In the event, while interest on State securities was not made exempt under the 1915 Commonwealth income tax, collection of the tax on this income was not enforced until 1923, which presumably lessened the impact on State bond prices which might otherwise have been brought about. See the terms of an undertaking given in 1916 by the Acting Prime Minister (Senator G Pearce) to the Premier of New South Wales, subsequently set out in Commonwealth Government, Conference of Commonwealth and State Ministers: Memoranda, Report of Debates, and Decisions Arrived At (Melbourne, May–June 1923) 39 (published in Commonwealth Parliamentary Papers, Second Session 1923, vol 2, Pt I). 40 Taxation of Loans Act 1923 (Cth) s 3. 41 ibid s 4. By 1923, the availability of tax-free government securities had come to be seen as a ‘great boon’ to high-income investors, and there was also concern that the issuance by the Commonwealth of taxable loans would lead to large movements of capital to tax-free State loans instead; this was also described as ‘rather a serious question’ for those States which taxed their own loans: Sir W Lee (Tasmania), in Commonwealth Government, Conference of Commonwealth and State Ministers: Memoranda, Report of Debates, and Decisions Arrived At (Melbourne, May-June 1923) 41. Internal advice to the Victorian government as late as 1930 suggested that the Commonwealth ‘should be pressed’ to allow State taxation of

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The Commonwealth’s 1915 income tax drew elements from the income tax legislation of each of the various States, none of which mirrored the legislation of any other State. The Commonwealth’s move thus guaranteed a lack of harmonisation of State and federal income tax laws for residents in every State. The differences were often profound, with taxes levied on different bases,42 different legislative foundations,43 and fundamentally different approaches to relieving shareholders of double taxation on distributed company profits.44 One important feature of the new law, in stark contrast to the UK precedent, was the adoption of a global income model that aggregated all types of income and expenses together to determine taxable income. A possible motivation for rejection of the UK schedular model may have been commitment of Australian politicians to the goal of progressivity based on progressive rates applying to a taxpayer’s total income.45 Even before the Commonwealth 1915 income tax had been enacted discussion on the relationship between State and Commonwealth income taxation had commenced. During the debate on the Commonwealth’s constitutional amendment proposals in September 1915, then AttorneyGeneral Hughes noted that, in May of that year, an Opposition member had ‘declared that there ought to be Unification, so far, at any rate, as taxation goes, only one taxing power in Australia’.46 Almost immediately after the adoption of Commonwealth income taxation, intergovernmental conferences of ministers and officials began discussions on the problems of concurrent income taxation. There was general

Commonwealth securities; it was recognised, however, that obtaining the agreement of the Commonwealth to this move may have depended on Victoria ending its exemption for its own loans: Commissioner of Taxes (Vic), Memorandum to the Under Treasurer, ‘Income Tax Act— 1930 Amendments’ (31 October 1930) 2, Public Record Office, VPRS 10265/P/O Unit 21. 42 For example, the Commonwealth tax did not extend to ‘casual profits’ on asset transactions, but these were fully taxed in New South Wales from 1914 (Income Tax (Management) Act 1914 (NSW) s 2(3)). The Commonwealth tax included an amount in respect of ‘imputed income’ of owner-occupiers of land (Income Tax Assessment Act 1915 (Cth) s 14(e)), as did the income taxes of Victoria (Income Tax Act 1915 (Vic) s 11) and South Australia (Taxation Act 1915 (SA) s 22(VIII)). Lottery winnings were taxable in the Commonwealth law (Income Tax Assessment Act 1915 (Cth) s 14(h)) and that of Tasmania (Land Tax and Income Tax Act 1910 (Tas) s 3(b)) but not elsewhere. 43 A single law described the tax base and imposed tax at specific rates in three States while separate assessment and imposition Acts were used in New South Wales, Western Australia and, from 1910, Tasmania, as well as federally where the split was required by the Constitution, s 55. 44 The Commonwealth tax provided a dividend deduction system while Western Australia used a dividend imputation system and other States had dividend exemption regimes. See J Taylor, ‘Development of and Prospects for Corporate-Shareholder Taxation in Australia’ (2003) 57(8) Bulletin for International Fiscal Documentation 346. 45 See JAL Gunn, Commonwealth Income Tax Law and Practice (Sydney, Butterworth & Co, 1943) 2–3. 46 CPDHR, vol 78, 6223–24 (27 August 1915).

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agreement by all parties that the income taxes should be ‘unified’ in the sense of using a common base and a single administration in each State collecting taxes on behalf of the State and Commonwealth, but no agreement on which level of government should be responsible for that administration or on which base should be adopted as the common base.47 By 1920 it had become clear that concurrent income taxes using different tax bases and administered by different tax offices was both inefficient from the perspective of revenue collection and unnecessarily costly to all parties. The ‘mere patchwork’ of efforts to address the situation up to 1920 had accomplished little48 and the Commonwealth adopted two initiatives in response, seeking co-operative tax administration agreements with the States and appointing a Royal Commission on Taxation to find a more lasting solution to the problems of concurrent taxation. Initially, agreement was reached with one State only, with Western Australia agreeing that the Commonwealth could collect both Commonwealth and Western Australian income and land taxes. The wide-ranging Royal Commission on Taxation (William Warren Kerr, Chair), established in 1920, issued five reports over its life. The first report, released in 1922, adopted the recommendations of many prominent witnesses, and recommended ending concurrent taxation by allocating income tax exclusively to the Commonwealth. The second report of the Royal Commission issued the following year dealt with the question of federal-state financial relations, with the third through fifth reports issued in the first half of that year addressing other issues. The second report set out forcefully the case for the Commonwealth’s exclusive jurisdiction over income tax,49 relying on two primary arguments. The first was the importance of progressivity as an objective of the income tax. It was thought that progressivity would be harder to achieve where income was derived and taxed across different States. The second, derived from the work of the leading US public finance economist at the time, Professor Edwin Seligman from Columbia University, was the ‘complications of inter-State taxation and the difficulty of getting at the income derived from inter-State sources’50 if separate State taxes were retained. Seligman had

47 R Maddock, ‘Unification of Income Taxes in Australia’ (1982) 28(3) Australian Journal of Politics and History 354. 48 DB Copland, ‘Some Problems of Taxation in Australia’ (1924) 34(135) Economic Journal 387, 388, reproduced in W Prest and RL Mathews (eds), The Development of Australian Fiscal Federalism: Selected Readings (Canberra, Australian National University Press, 1980) 35. 49 Royal Commission on Taxation (W Warren Kerr, Chair), Second Report of the Royal Commission on Taxation (13 April 1922) (Melbourne, Published for the Commonwealth Government by the Government Printer for the State of Victoria, 1922) 79. 50 E Seligman, ‘Newer Tendencies in American Taxation’ (1915) 58 Annals of the American Academy of Political and Social Science 1, 9–10 (March), cited in Warren Kerr Royal Commission, Second Report of the Royal Commission on Taxation, n 49 above, 77.

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set out his views early in 1915, two years after the adoption of individual income tax in the United States, when teething problems were still being ironed out. Ironically, and apparently unknown to the Royal Commission, Seligman had later reversed his views. Noting improvements in State tax administrations and the successful establishment of the US federal income tax, Seligman began to advocate concurrent state and federal income taxation in the United States, with State taxes based on the federal return,51 a system subsequently adopted in Canada. While now viewed as an important document from the long-term point of view, in the short term the Royal Commission’s findings in relation to federal-state income tax arrangements did not have significant impact. At the Premiers’ Conference of May-June 1923, the Commonwealth government put forward a Memorandum which took the opposite approach to that of the Commission and proposed a withdrawal of the Commonwealth from income taxation, except in relation to companies and high income individuals, and discontinuation of the per capita grants which had been in place since 1910. The States countered with a seemingly ambitious proposal for the Commonwealth to withdraw from all income taxation and receive financial assistance from the States. In the event, a compromise outcome was reached (New South Wales dissenting, and Tasmania absent),52 but was not implemented (in part pending availability of further tax statistics), and the alternative path was taken of providing for agreements to be made for Commonwealth income tax to be collected by the States and State income taxes to be collected by the Commonwealth where taxpayers derived income derived in more than one State.53 The Melbourne office of the Commonwealth Commissioner of Taxation assumed the latter responsibilities. While a single agency in each State was responsible for the collection of State and Commonwealth income taxes from 1923, separate tax bases and returns were a continuing concern for taxpayers.54 A related area of concern was the growing risk of double State taxation in addition to the concurrent State and Commonwealth taxation. In the absence of agreements on the

51 E Seligman, ‘The Next Step in Tax Reform’, Presidential Address to the Ninth Annual Conference of the National Tax Association (11 August 1915) 12, reproduced in the 9th edn of Seligman’s work, E Seligman, Essays in Taxation (New York, Macmillan Co, 1921). 52 Commonwealth Government, Conference of Commonwealth and State Ministers Held at Melbourne, May–June, 1923: Memoranda, Report of Debates, and Decisions Arrived At (Melbourne, Published for the Commonwealth Government by the Government Printer for the State of Victoria, 14 August 1923). 53 Income Tax Collection Act 1923 (Cth), enacted on 1 September 1923. This was taken up by all of the States except Western Australia, for which the Commonwealth collected income tax. 54 See, eg ‘Double Income Tax’, The Register, 17 March 1926, 8, reporting calls by the Associated Chambers of Commerce for ‘the Federal Government to retire from the field of income taxation’, but noting also the concerns expressed about possible loss of the per capita grants to the States.

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source of income, businesses operating across State borders could find the same income subject to tax under more than one State income tax law. In May 1929, at the prompting of his State Commissioner of Taxation, the New South Wales Acting Premier proposed joint State government action on the multi-State income issue through a conference of Commissioners, a proposal which was immediately endorsed by the Victorian Premier55 and separately sought by the Associated Chambers of Commerce.56 State Taxation Officers met in Melbourne in October and agreed on a common formula for apportionment of profits on inter-state sales.57 The agreement by administrators failed to attract universal political support, however, and in the end was only adopted in South Australia and Victoria.58 A suggestion by the Victorian Commissioner that abolition of the Commonwealth Central Tax Office (located in Melbourne and responsible for collection of taxes of taxpayers with income in more than one State) would benefit large taxpayers led to no action.59 Income tax administration concerns continued to distract the business community and individual taxpayers as the Depression took hold. In 1930, special State income taxes for unemployment relief began to appear60 and, at the same time, the Commonwealth moved to introduce a federal wholesale sales tax.61 Reductions in the tax-free threshold brought lower income ranges into the individual income tax system, and this in turn led to the development of a formal collection machinery based on tax stamps.62 55 Ernest Buttenshaw, Acting Premier of New South Wales, to Sir William McPherson, Premier of Victoria (Circular), 13 May 1929; McPherson to Buttenshaw, 22 May 1929, Public Record Office VPRS1207/P1/Unit 110. McPherson had also previously been President of the Melbourne Chamber of Commerce. 56 (1929) 6(12) Monthly Journal of the Melbourne Chamber of Commerce (June) 284. 57 The common formula split the income between States where a trader sold in another State through a branch or agent while allocating 100 per cent of the profit to the State of sale where items were sold by independent branches that imported and maintained their own stock. A separate rule applied to manufacturers with 66.6 per cent of the profit attributed to the State of manufacture and 33.3 to the State of sale where the goods were sold through an agent or branch. 58 Taxation Act 1930 (SA) s 30, enacted 6 November 1930; Income Tax Acts Amendment Act 1931 (Vic) s 7, enacted 30 December 1931. 59 Deputy Commissioner on behalf of RM Weldon, ‘Duplication of Taxes’, dated 7 February 1930, Public Record Office VPRS1207/P1/Unit 110. The second Royal Commission on Taxation, discussed in the section on ‘Path to Uniformity’ below, in 1934 would also reject abolition of the Central Office: Royal Commission on Taxation (Justice D Ferguson, Chair), Third Report of the Royal Commission on Taxation (12 April 1934) (Canberra, Commonwealth Government Printer, 1934) 162. 60 See, eg the lengthy and complicated Unemployment Relief Act 1930 (Vic), enacted on 2 June 1930. For discussion of the ‘Depression taxes’ and their impact on the lower wage and income earners, see Smith, n 7 above, 40–42. 61 Sales Tax Assessment Act (No 1) 1930 (Cth), enacted on 18 August 1930. 62 The first of these was an instalment system process involving tax stamps introduced in South Australia in 1931: Taxation Act 1931 (SA). See T Hytten, ‘Collecting Income Tax at the Source’ (1932) 8(2) Economic Record 278, reproduced in Prest and Mathews, n 48 above, 283; see also SJ Butlin and CB Schedvin, War Economy, 1942–1945 (Canberra, Australian War

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A political spat in 1930 also highlighted to the Commonwealth an unanticipated risk from the shared tax administration system then in place. One significant outcome which was achieved by the Premiers Conference of mid-1923 was the establishment of the voluntary Loan Council to co-ordinate the substantial borrowings of the Australian governments. The idea was prompted in part by the difficulties the Commonwealth had encountered when seeking to roll over maturing war loans to ordinary borrowings between April and June 1923.63 The State and Commonwealth governments agreed that the Loan Council would assume responsibility for all borrowings by the States and Commonwealth and established an informal arrangement to this effect in 1923. The election of fervently anti-federalist State premier Jack Lang led to the withdrawal of New South Wales from the voluntary arrangements in 1925 but following the fall of the Lang government in 1927, the Loan Council was formally established as a statutory body controlled by the Commonwealth in 1927 and the imposition of compulsory Loan Council arrangements followed.64 However, after taking office again on 4 November 1930, Lang refused to participate in Loan Council activities and attempted to repudiate the State’s debt. While the Commonwealth had been granted relief on war debts to the United Kingdom by the British Government in April 1931,65 New South Wales’ debtors were not willing to abandon their claims and rather than risk default that could affect the entire country’s credit rating, the Commonwealth stepped in and met payments due to creditors.66 Under ‘severe financial pressure’,67 Lang joined an agreement in the context of a June 1931 economic plan adopted by the Commonwealth and Premiers (the ‘Premiers’ Plan’), which included a process of ‘voluntary conversion’ of local indebtedness and continued commitment to repayment of overseas State debts,68 but while the Prime Minister put forward the agreement as ‘one indivisible

Memorial, 1977) 571–75. The Commonwealth’s own tax stamps in 1942 seem to have led to evasion, with illicit stamps trading at a discount of up to 50 per cent: ibid 573. 63 R Gilbert, The Australian Loan Council in Federal Fiscal Adjustments, 1890–1965 (Canberra, Australian National University Press, 1973) 62–63. 64 ibid 191–94. 65 See ‘War Debt Relief, Britain Helps Australia, Postponement of Payments, Announcement in House of Commons’, Sydney Morning Herald, 17 April 1931, 11. The report noted that ‘Mr Lang stated at Adelaide yesterday that the British Government’s decision would greatly hearten those who were working for the adoption by the Federal Government of the Lang plan’. 66 A Twomey, ‘The Dismissal of the Lang Government’ in G Winterton (ed), State Constitutional Landmarks (Sydney, Federation Press, 2006) 129, 143. 67 Saunders, ‘Government Borrowing in Australia’, n 15 above, 196. 68 G Sawer, Australian Federal Politics and Law, 1929–1949 (Melbourne, Melbourne University Press, 1963) 11–12, 21–22.

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plan’, Lang maintained that he had only agreed to one component of the Plan, relating to the internal conversion loan.69 In any case, the State made no effort to repay the Commonwealth for debts already covered by the central government and the relationship between the Commonwealth and New South Wales quickly deteriorated following a further default by New South Wales in early 1932. Justifying its actions by reference to the Loan Council agreement,70 the Commonwealth directed New South Wales taxpayers to pay all State income tax direct to the Commonwealth71 and banks to deliver up funds in State bank accounts; Lang responded by ordering the closure of the State Tax Department and directing State government employees not to bank State revenue.72 When Lang refused to withdraw this direction, the New South Wales Governor, Sir Philip Game, dismissed Lang’s government and State collection of Commonwealth income tax resumed.73

69 See ‘Premiers’ Conference Ends, £556, 000, 000 Conversion Loan, Approved by Loan Council, Proposed Temporary Loan of £8, 500, 000’ and ‘Mr Scullin’s Statement’, Sydney Morning Herald, 11 June 1931, 9–10. The latter report noted that Prime Minister Scullin had proposed that a further sub-committee be formed to look at the issue of the earlier default by New South Wales (and the associated failure of the Savings Bank of New South Wales); Lang reportedly replied that he was ‘prepared to go on with it’, and that he was ‘not particularly anxious to be a martyr and go to gaol, but if you insist on putting me there, I shall go quite cheerfully and quite unrepentant’. Lang later also noted that the Loan Conversion Agreement was the only document which had been placed before the Conference for signature: JT Lang, The Turbulent Years (Sydney, Alpha Books, 1970) 135. 70 The newly installed Lyons Government also enacted Commonwealth legislation to put beyond doubt that its payments to creditors on behalf of New South Wales were in fact the result of a legal obligation (the bonds themselves legally still being only between the bondholders and New South Wales) and so would be legally repayable by New South Wales to the Commonwealth: Sawer, n 68 above, 51. See Financial Agreements (Commonwealth Liability) Act 1932 (Cth). 71 See ‘State Income Tax, Payable to Commonwealth Bank, Official Directions’, Sydney Morning Herald, 8 April 1932, 9. The report noted that the direction had been given by way of a Proclamation by the Governor-General under the Financial Agreements Enforcement Act published in a special issue of the Commonwealth Gazette requiring payment of the State tax to the Commonwealth Treasurer or persons authorised by the Treasurer; a further publication of the Gazette at the same time set out a notice by the Treasurer (also Prime Minister, J Lyons), specifying that the Commonwealth Bank, at its head office in Sydney, was such an authorised person, and taxpayers were from that date required to make payment of the tax at that location. The report pointed out that pursuant to these directions, payment of the tax in the specified manner would be a good discharge of the liability but that payment in any other way would not, but would ‘involve [the taxpayer] in liability to heavy penalty’. 72 Twomey, n 66 above, 146–48. 73 ibid 152–54. The financial restrictions placed on New South Wales were also lifted, after it was reported that immediate assurances were to be given by the incoming Premier that ‘steps will be taken as early as possible to repay to the Commonwealth the amounts that have had to be paid on the State’s behalf ’: see ‘Attachment of State Revenues, May Soon Cease’, Sydney Morning Herald, 14 May 1932, 14; Emergency Legislation Suspension Act 1932 (Cth), enacted on 17 May 1932.

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Concerns over the efficiency of tax administration, inconsistent Commonwealth and State income tax bases, and the absence of agreement on taxing rights over cross-border sales eventually prompted the Commonwealth government to appoint a second Royal Commission on Taxation in 1932 to develop a blueprint for ‘uniform and simplified’ income tax legislation across the country.74

PATH TO UNIFORMITY

The second Royal Commission on Taxation announced in September 1932 comprised retired New South Wales Supreme Court Justice (from June 1934, Sir) David Ferguson and Melbourne accountant EV Nixon. The Royal Commission quickly began hearings, taking evidence on income tax in Sydney in November 1932. The Royal Commission also heard evidence in all other capitals. Evidence presented to the Royal Commission included both technical advice75 and an emphatically presented76 report from the business community offered by State Chambers of Commerce.77 A number of witnesses at the Sydney hearings advanced a scheme for centralised income tax presented some years before by leading Professor RC Mills, Dean of the Faculty of Economics at the University of Sydney.78 The Commission also made use of, and extensively quoted from, a report79 offered to a 1932 Premier’s Conference by Victoria’s newly appointed Assistant Minister of Railways, Colonel Harold Cohen.80 Referring to the 1929 Resolution of State Taxation

74

Prime Minister J Lyons, CPDHR, vol 135, 96 (1 September 1932). Important in this respect was a report prepared by accountant JAL Gunn who would emerge as an important author of early guides to income taxation in Australia. See ‘Taxation Laws, “A Dreadful Maze”, Injustices to Companies, Instalment System Advocated’, The Argus, 19 July 1933, 9. 76 One account described Sydney Chamber of Commerce President Spencer Watts being joined at the evidence table by two other witnesses, ‘each in turn hammering home, with a sheaf of documents, what they regarded as the glaring weaknesses and complexities of the present system’: ‘Tax Reform, Royal Commission, “Harassing Industry”, New System Urged’, Sydney Morning Herald, 23 November 1932, 9. 77 ‘Simplification of Tax Laws’, News, 29 November 1932, 1. 78 The proposal had first been articulated by Mills in 1928 in a speech delivered in Hobart that was subsequently published as RC Mills, ‘The Financial Relations of the Commonwealth and the States’ (1928) 4(1) Economic Record 1, reproduced in Prest and Mathews, n 48 above, 63. For an account of the use of the arguments by witnesses before the Royal Commission, see ‘Finance Problems, Commonwealth: States, By Professor RC Mills of Sydney University’, Lecture No 5 to the Summer School at Robertson, Sydney Morning Herald, 13 February 1933, 4. 79 Memorandum Submitted by the State of Victoria in respect of Income Taxation on Interstate Trading, Record of the Conference of Commonwealth and State Ministers, held in Melbourne, from 24 to 29 October 1932 (unpublished), App E, 13–15, National Archive Series A463 Control Symbol 1963/2246. 80 ibid. 75

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Commissioners for a uniform profit apportionment formula to avoid double taxation of income derived in cross-State border sales (a proposal only adopted by Victoria and South Australia), Cohen castigated, albeit in subdued language, the political failure of other States to adopt a uniform scheme, foreshadowing external (presumably Commonwealth) intervention to address the problem. The first report released by the Royal Commission, in late 1933,81 dealt with technical tax design issues, recommending adoption of an imputation system to relieve double taxation of profits derived through a company82 and restriction of the then existing Commonwealth undistributed profits tax to private companies. The Royal Commission’s second report addressed the issue of concurrent income taxation by the Commonwealth and States, while a third report addressed further technical issues. The problems of concurrent taxation, the Royal Commission concluded, derived not from the two layers of tax but rather from inconsistent legislation. The solution, it argued, was adoption of a uniform tax across all taxing jurisdictions.83 The Royal Commission envisaged a single law with the possibility of some purely local provisions,84 but generally based on a subjection of State policy to the policy of the common legislation. The Commonwealth Act was seen as the appropriate basis for the uniform Act, as a result of the ‘sounder principles’ underlying the Commonwealth Act and the greater familiarity of residents of all States with that Act as against the legislation of any State other than their own.85 The Royal Commission was remarkably cavalier in its rejection of State interests in its pursuit of uniformity. States’ rights, it asserted, were secondary to the aim of uniformity,86 with the State interests dismissed as ‘abstract constitutional rights’.87 81 Royal Commission on Taxation (Justice D Ferguson, Chair), First Report of the Royal Commission on Taxation (28 August 1933) (Canberra, Commonwealth Government Printer, 12 January 1934). It can also be noted that the release of this Report came shortly after the formal establishment of the Commonwealth Grants Commission by an Act of 30 May 1933. By this stage, the approach to fiscal assistance to weaker States was based on the concept of fiscal capacity rather than specific disabilities incurred as a result of Federation, and a range of enquiries had been held and special assistance payments made to Tasmania, South Australia and Western Australia in the late 1920s and early 1930s: see J Smith, ‘Redistribution and Federal Finance’ (2002) 42(3) Australian Economic History Review 299 (suggesting that ‘[t]he interests of the smaller States had increasingly come to lie in a system that centralized income taxation’). 82 Taylor, n 44 above, 348. 83 Royal Commission on Taxation (Justice D Ferguson, Chair), Second Report of the Royal Commission on Taxation (5 February 1934) (Canberra, Commonwealth Government Printer, 1934) 55–56. 84 ibid 57. 85 ibid 58. 86 ‘[T]he rights which any Government would be asked to suspend or surrender as a result of agreeing to the adoption of a uniform Act are not of real importance’: ibid 57. 87 ibid 60.

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The report of the Royal Commission set out in some detail its preferred design for uniform legislation. Recommendations included a mandatory common deduction rule to prevent concessional deductions for locally favoured industries and adopting uniform concessional deductions for individuals. Somewhat imperiously, the report set out the social policies the authors viewed as appropriate national objectives that might be favoured by way of concessional deductions, rejecting the New South Wales concession for dental expenses,88 for example, while endorsing the Commonwealth and Western Australia concessional treatment of donations to health research, for example.89 In contrast to its concessional health deduction, New South Wales’ core inclusion provision was the optimal model for assessing ‘casual profits’ (ie capital gains), in the view of the Royal Commission.90 On the key issue of apportionment of income of multi-state businesses, the Royal Commission heard evidence of the anomalous and inconsistent formulae used across the country91 and recommended universal adoption of a single general formula92 modelled on the 1929 scheme,93 which had since been taken up in South Australia and Victoria.94 Separately, the Royal Commission recommended on the basis of what was recognised to be limited evidence95 that the profit of banks be apportioned between the States based on the proportion of assets and liabilities in the State as against total assets and liabilities, the formula then used by Queensland and Tasmania.96 The Royal Commission was well aware of the problems of potential double taxation resulting from international cross-border taxation. The Commonwealth, but not the States, had signed up to a UK Dominion Income Tax Relief scheme that provided unilateral UK tax relief from double taxation of income derived by UK residents where the income had been subject to Commonwealth tax and other mechanisms were available to provide relief in the United Kingdom for State taxes, but there was no need for comprehensive reciprocal relief as Australian jurisdictions only taxed local source income. This had changed in 1930 when the Commonwealth moved

88 Ferguson Royal Commission, Third Report of the Royal Commission on Taxation, n 59 above, 106. See Income Tax (Management) Act 1928 (NSW) s 19(2)(d)(i). 89 Ferguson Royal Commission, Third Report of the Royal Commission on Taxation, n 59 above, 107. 90 ibid 129. 91 Ferguson Royal Commission, Second Report of the Royal Commission on Taxation, n 83 above, 78, 80. 92 ibid 83. 93 See section on ‘Concurrent Income Taxation, 1915–1932’, text at nn 55–58 above. 94 Ferguson Royal Commission, Second Report of the Royal Commission on Taxation, n 83 above, 84. 95 Ferguson Royal Commission, Third Report of the Royal Commission on Taxation, n 59 above, 144. 96 ibid 144.

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to tax residents on world-wide income. At the time, the Commonwealth proposed an exemption for income derived from (and presumably taxed in) the United Kingdom but in the course of parliamentary debate the government realised singling out the United Kingdom could upset other allies and the exemption was eventually modified to apply to income from all jurisdictions where it had been taxed in those jurisdictions.97 From 1931, many of the State income taxes began to include different types of foreignsource income derived by residents, sometimes providing relief from double taxation with foreign tax credits.98 The report explicitly avoided any recommendation in respect of the significant revenue losses resulting from the unilateral exemption system used to avoid double taxation99 but did propose a uniform rule for determining the Australian-source profits of non-resident enterprises doing business in Australia or selling goods in Australia.100 Finally, the Royal Commission recommended the establishment of a joint authority to collect all income taxes101 and, in its third report released the following year, recommended harmonised arrangements for taxpayers’ objections and appeals and creation of a specialised tax court.102 Given the difficulties that had been encountered in the 1929 attempt to devise a common profit apportionment rule for cross-border sales, reactions to the Royal Commission report were surprising. Following release of the proposed model legislation, a number of conferences with participation by Commonwealth and State Ministers and Taxation Commissioners and officials were held, with the members of the Royal Commission also invited to participate, and by 1935 the participants had agreed on almost all key elements of a model law. Alternative suggestions put forward in other fora, most notably the view of then Victorian Attorney-General and Deputy Premier (and future conservative Prime Minister) Robert Menzies, expressed at a February 1934 Conference of Commonwealth Ministers and State Premiers, that the Commonwealth should retire from the income tax

97

See Gunn, n 45 above, 157–58. See, eg Income Tax Acts Amendment Act 1931 (Vic) ss 2–3, subjecting to tax income of a resident derived while temporarily engaged in service overseas for a Victorian employer, with a foreign tax credit available. 99 Ferguson Royal Commission, Second Report of the Royal Commission on Taxation, n 83 above, 74. The exemption system finally adopted in the uniform law remained in place until replaced with a general foreign tax credit system in 1987. A specific inclusion and foreign tax credit system for dividends had been adopted in 1947. 100 The proposal would deem the Australian profit of a non-resident manufacturer to be the sale amount in Australia less the wholesale value of the goods in similar circumstances in the home country, and expenses of transportation and sale (subsequently described as the ‘home consumption value method’). For other non-resident merchants, the profit would be the sale amount less purchase price and such expenses. See Ferguson Royal Commission, Second Report of the Royal Commission on Taxation, n 83 above, 75. 101 ibid 63. 102 Ferguson Royal Commission, Third Report of the Royal Commission on Taxation, n 59 above, 156. 98

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field, had no apparent impact on the harmonisation process. Almost all changes from the model released by the Royal Commission, for the most part made to bring the provisions of the draft into closer agreement with the acts of some of the States, and thus achieve a larger measure of uniformity, were endorsed by the Royal Commission members participating in harmonisation meetings.103 The Commonwealth version of the law was introduced into the Commonwealth Parliament in late 1935, with debate following in early 1936. It was clear throughout the parliamentary debate that many Opposition members, at least, did not see the harmonisation process as the end of the matter,104 with suggestions that genuine uniformity could only be achieved with one taxation measure and a single controlling authority.105 The law passed easily, however, and the States then followed with their versions of the harmonised income tax law.106 Tasmania was first off the mark with legislation at the beginning of 1936,107 before the Commonwealth had passed into law in mid-year. However, perhaps disappointingly for local taxpayers, this took the form of an amending Act providing for section by section replacement and renumbering of the provisions of that State’s existing 1910 Act (as amended),108 rather than enactment of a new Act as implemented in the other jurisdictions. Tasmania’s early adoption of a harmonised law had pre-empted further negotiations between taxation officials during 1936, and was prepared in the middle of a lengthy period when a statute law revision process was being carried out in that State, so that the tax Act was immediately subject to numerous revisions, some by Proclamation which may even have created doubts as to the legal validity of the changes.109 Several recommendations of the second Royal Commission on Taxation were not adopted in some or all jurisdictions. The proposal for a joint administrative authority did not proceed and existing arrangements for State collection of Commonwealth income tax were continued (and vice versa in Western Australia). Similarly, the proposal for a taxation review

103 See the Second Reading Speech to the Income Tax Assessment Bill 1935, Treasurer R Casey (Corio), CPDHR, vol 148, 2716–18 (5 December 1935). 104 See, eg J Leckie (Victoria), CPDS, vol 150, 1885 (20 May 1936). 105 EJ Harrison (Wentworth), CPDHR, vol 150, 975 (29 April 1936). 106 Income Tax Assessment Act 1936 (Cth), enacted on 2 June 1936; Income Tax Assessment Act 1936 (SA), enacted on 22 October 1936; Income Tax (Management) Act 1936 (NSW), commenced (by Proclamation) on 1 November 1936; Income Tax Assessment Act 1936 (Qld), commenced on 21 December 1936; Income Tax (Assessment) Act 1936 (Vic), commenced on 12 January 1937; Income Tax Assessment Act 1937 (WA), commenced on 24 December 1937. Unlike the Commonwealth Act, the State Acts generally continued to be imposed on a source basis and contained exemptions for out-of-state income. 107 Land and Income Taxation Act 1935 (Tas), enacted on 16 January 1936. 108 Land and Income Taxation Act 1910 (Tas). 109 See Proclamations Confirmation Act 1937 (Tas).

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court did not eventuate,110 although Tasmania subsequently enacted its own rules allowing arrangements to be made for the Commonwealth’s Board of Review to carry out appeal functions under the Tasmanian Act.111 The Commonwealth and all States other than New South Wales, concerned about any shift to a wider deduction formula112 and rejecting criticism by the Opposition leader,113 adopted a stricter nexus requirement for one limb of the expense recognition measure allowing deductions for outgoings ‘necessarily incurred’ in carrying on a business.114 New South Wales retained its broader prior deduction rule.115 New South Wales also refused to jettison its existing concessional deduction for dental expenses.116 Significantly, only four of the six States adopted directly the recommended 1929 scheme for allocation of income of multi-state businesses. The proposal for a scheme of apportionment of profits of banks based on assets and liabilities was legislated by all States. Tasmania had enacted a variation of the 1929 scheme in respect of other businesses in 1934117 but Queensland maintained its approach of taxing 50 per cent rather than 33 per cent of profit on in-state sales of goods manufactured in another State used by other States.118 The Commonwealth and all States apart from New South Wales adopted the approach recommended by the Royal Commission for computation of profits from the sale of goods by overseas manufacturers as the difference between sales price and wholesale price in the manufacturer’s home jurisdiction,119 while New South Wales applied a calculation that yielded higher profit measurements.120 South Australia also

110 A Commonwealth Bill for this purpose seems by June 1937 to have been dropped; see CPDHR, vol 153, 307 (23 June 1937). 111 Land and Income Taxation Act 1938 (Tas) s 2(XVI). 112 They were described as ‘unwilling to run the risk’ of broadening the deduction rule; see A McLachlan (South Australia), CPDS, vol 150, 1844–55 (19 May 1936). 113 CPDHR, vol 150, 964 (29 April 1936). 114 See Income Tax Assessment Act 1936 (Cth) s 51(1). This wording was apparently intended to overcome the effect of the High Court decision in 1930, Federal Commissioner of Taxation v Gordon (1930) 43 CLR 456, allowing deduction by a grazier of fees to the relevant industry association. 115 Income Tax (Management) Act 1936 (NSW) s 60(1). As it turned out, the Commonwealth subsequently (in 1944) endorsed the New South Wales approach and adopted the rule nationally:Income Tax Assessment Act (No 2) 1944 (Cth) s 6, introducing s 160(2)(d) to the Commonwealth 1936 Act. 116 Income Tax (Management) Act 1936 (NSW) s 89(1)(f). 117 See Land and Income Taxation Act (No 2) 1934 (Tas) s 2(VI), and new s 111(1)(ii) in Land and Income Taxation Act 1935 (Tas). 118 Income Tax Assessment Act 1936 (Qld) s 28(7). Queensland regarded the 66.6 per cent allocation to the State of manufacture as an appropriation of revenues that should belong to the State where the item is sold; even its 50 per cent allocation was generous, in the view of the Queensland Premier; see Queensland Parliamentary Debates, vol 170, 1904 (2 December 1936). 119 See, eg Income Tax Assessment Act 1936 (Cth) s 38. 120 Income Tax (Management) Act 1936 (NSW) s 36. See the views of then New South Wales Assistant Treasurer (later a member of the Committee appointed by the Commonwealth

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retained a unique deeming rule relating to in-state treatment of profits on the sale of imported minerals.121 The States maintained a variety of divergent approaches to taxation of dividends received by shareholders. New South Wales, for example, taxed dividends on a source basis and allowed rebates to shareholders on a similar basis to the (shareholder relief) scheme adopted by the Commonwealth.122 In Victoria, however, dividends continued to be exempt.123 The Commonwealth also amended its undistributed profits tax provisions so as to apply only to private companies,124 while the practice of the States in this regard also varied: New South Wales and Tasmania took a similar approach to the Commonwealth,125 but other States such as Victoria and South Australia made no specific provision for such profits. In reality, thus, the ‘harmonised’ income tax was something of a hybrid. While all States had adopted most of the central design features of the common law, there were enough differences to defeat the key goals of harmonisation in terms of reduced taxpayer and tax administration compliance burdens and reduced distortions from State to State.

AUSTRALIA AT WAR, 1939–1942

On 3 September 1939, Britain and France declared war on Germany due to its invasion of Poland two days earlier. Within hours of the announcement from London, Australian Prime Minister Robert Menzies declared Australia also at war with Germany. In the early years of the War, the Commonwealth seems to have favoured loan finance as a source of funds and been slow to increase taxation, so that even by the time of its November 1940 Budget, Treasurer Arthur Fadden was able to show that Commonwealth taxation at the time was only slightly higher than the 1932–33 level as a percentage of national income.126 In absolute terms, however, taxation was growing as the national income rose from depression levels to wartime levels, and

in 1942 to consider uniform taxation) ES Spooner, cited in ‘Financial, Overseas Manufactures, Assessment of Income Tax’, Sydney Morning Herald, 8 July 1936, 17; ‘Income Tax, Oversea Manufacturers, Mr. Spooner Explains’, Sydney Morning Herald, 9 July 1936, 6. 121 Income Tax Assessment Act 1936 (SA) s 53. The provision specified taxable income from this activity to be 10 per cent of the actual cost of treatment, including a reasonable charge for land, buildings and machinery. 122 Income Tax (Management) Act 1936 (NSW) ss 52–56. 123 Income Tax (Assessment) Act 1936 (Vic) s 14(v). 124 Income Tax Assessment Act 1936 (Cth) ss 103–109 (Div 7). 125 Income Tax (Management) Act 1936 (NSW) ss 135–146 (Div 9); Land and Income Taxation Act 1910 (Tas) ss 77–84 (Div VIII). 126 SJ Butlin, War Economy, 1939–1942 (Canberra, Australian War Memorial, 1955) 363–64.

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in nominal terms, the 1940 Budget, along with a tax increase earlier in the year, would have almost doubled the Commonwealth income tax take.127 There was, at the same time, a widespread perception that tax burdens were increasing, perhaps exacerbated by rises in income and shifts to higher marginal tax rates and the Commonwealth government was conscious of political risks with reliance on taxation to fund more of the war effort. Two factors complicated the picture further. The first was a proliferation of special taxes on different types of income, apart from the primary income tax. Only half of the tax revenue realised by the States from taxes imposed on income was attributable to the primary income tax,128 and the incomplete harmonisation of the primary legislation had no impact on the anomalies and administrative and compliance burdens from the multitude of different taxes across the nation. At the same time, harmonisation of the primary income taxes started to disintegrate as the Commonwealth and States introduced unilateral changes from the harmonised scheme. Significant departures included changes in the Commonwealth129 and New South Wales130 rules for shareholder taxation and the reimposition of an undistributed profits tax on public companies by the Commonwealth.131 The second was the growing risk of a backlash over perceptions of varying contributions across the country as a result of widely diverging tax rates. Two States (Queensland and Tasmania) had top rates substantially above the average, and up to almost double the rates of the lowest top rate State (Victoria).132 In an effort to ameliorate the problem, the Commonwealth committed to a combined State and Commonwealth top marginal tax rate of 70 per cent, but achieving this was problematic. The Commonwealth law had, since its introduction in 1915, allowed a deduction for State income taxes, which reduced taxable income for Commonwealth purposes.133 The value of Commonwealth relief thus depended on a taxpayer’s marginal Commonwealth tax rate. A proposed solution offered by former Prime Minister and influential Labor spokesperson James Scullin was to replace the deduction for State taxes at the Commonwealth level with a credit for State taxes, an approach

127 Estimated tax of £34 million, including £14 million from a May mini-budget, and the government proposed raising an additional £31 million: ibid. 128 Maddock, n 47 above, 357. 129 Income Tax Assessment Act 1939 (Cth) s 3. 130 Income Tax (Management) Amendment Act 1939 (NSW) s 2(1)(a), enacted 7 November 1939. 131 Income Tax Assessment Act 1940 (Cth) s 11, enacted on 27 May 1940. The undistributed profits tax continued to apply to public companies until 1951: Y Grbich and B Cooper, Undistributed Profits Tax: A Critical Analysis (Sydney, Taxation Institute Research and Education Trust, 1979) 9. 132 Butlin, n 126 above, 384. 133 ibid 364; Income Tax Assessment Act 1915 (Cth) s 18(b).

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that would have the effect of fully equalising tax burdens across the country.134 The compromise, he conceded, would allow the States to increase their rates ‘on the ground that such action would not injure the taxpayers … the only effect being the loss of a certain amount of revenue by the Commonwealth’135–in effect, State taxes could rise to crowd out completely any Commonwealth tax without any rise in the combined tax burden. Scullin’s proposal for uniformity achieved through differential sharing of tax revenue, offered in the interest of political compromise, appears not to have been his preferred option. Unification, in the sense of a Commonwealth takeover of income taxation, offered a more direct solution.136 The view was shared by some in the conservative camp.137 Scullin’s credit for state taxes proposal and a proposed modification he suggested to cap the credit at the level of 1940–41 State tax rates was rejected by the government at this point, which for the moment appeared to have no fall-back position. However, by mid-1941, the conservative camp had evidently shifted to the view that unification (a Commonwealth takeover of income taxation) offered the simplest solution to the dilemma. Faced with growing budgetary pressures, frustrated over the fragmentation of fiscal policies and laws across the country, and unable to set significantly higher tax rates in the face of widely divergent State marginal rates, the Commonwealth government proposed that the States temporarily vacate the income tax field.138 The proposal was quickly rejected by the States.139 The Commonwealth government responded with a plan for a compulsory national loan scheme (in effect a tax that would be repaid after the war) incorporated in the September 1941 Budget. The advantage of the ‘loan’ characterisation was that it would allow the Commonwealth to impose different rates in different States in

134

Butlin, n 126 above, 385. J Scullin (Yarra), CPDHR, vol 165, 991–92 (12 December 1940). 136 ibid. Scullin declared that ‘he had no hesitation in asserting that the most effective way to deal with the problem is to amend the Commonwealth Constitution with the object of achieving real unification’. He also noted the alternative of seeking voluntary agreement of the States for a withdrawal from the taxation of higher incomes. 137 See, eg the comments of ES Spooner in the debate following presentation of Scullin’s proposed credit for State tax compromise: ‘what action the Commonwealth might take under its war-time emergency powers is a matter for consideration, and I am convinced that if uniformity is reached in this way, the public, after the war, will not permit a return to the present system’: ibid 995–96. Spooner would be appointed to Cabinet a few months later. 138 See ‘Income Tax, State Withdrawal Supported, Division Hampers War Effort’, Canberra Times, 27 June 1941, 4. 139 See ‘States Reject Uniform Tax Plan, Commonwealth to Decide Next Step, Mr. Fadden Disappointed, Mr. Forgan Smith’s Alternative’, Sydney Morning Herald, 28 June 1941, 13. The report noted Fadden’s statement of regret at the decision, ‘[b]ecause I feel that the States viewed the matter from an angle of undue and unwarranted fear that the Commonwealth was seeking power to usurp the functions of the States, and that they looked upon the proposal as a permanent surrender of rights, rather than as a temporary measure’. 135

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response to different State tax rates without breaching the constitutional requirements for non-discriminatory taxation across the Commonwealth. The Budget failed to pass, a victim of rambunctious politics within the governing conservative camp. The Prime Minister, Robert Menzies, had spent the first third of 1941 in the United Kingdom to support Britain’s war effort. He returned to Australia to discover political support within his party had evaporated and he was forced to cede the Prime Ministerial post to the Treasurer and leader of the junior Country Party partner in the conservative coalition, Arthur Fadden. Two independent members of the lower House, however, upset over the coalition’s treatment of Menzies, voted against the Budget, leading to the fall of the government. Following agreement by the independents to support a Labor government, Labor Opposition Leader John Curtin accepted and assumed the post of Prime Minister on 7 October 1941. The Commonwealth political turmoil provided the New South Wales Labor government, newly elected in May 1941, with the opportunity to pursue an overhaul and increase of State taxes, in part to compensate for a substantial cut in the State’s loan allocation from the Loan Council for works for non-war purposes.140 Following the defeat of the Commonwealth Budget, New South Wales enacted a replacement income tax that incorporated previously separate unemployment relief and social services taxes. The tax incorporated a broad range of changes that deviated dramatically from the harmonised tax model including, significantly, the introduction of full residence taxation of worldwide income together with the use of a foreign tax credit rather than the exemption used in the Commonwealth tax;141 a new concessional deduction; restrictions on charitable deductions;142 and also, significantly, the narrowing of the scope of exemptions for interest on Commonwealth and State loans.143 The harmonised profit allocation rule for cross-border sales was also replaced with a measure that taxed 100 per cent of profit on sales in the State by out-of-state manufacturers together with a rebate payable to those manufacturers, capped for taxes paid in the State of manufacture.144 By the time the newly appointed Commonwealth Labor government introduced its Budget on 30 October 1941 to replace

140 See, eg ‘Defence of Loan Cut, Mr. Fadden Replies to Premier’, Sydney Morning Herald, 1 September 1941, 6. 141 Income Tax Management Act 1941 (NSW) s 204, enacted on 24 October 1941. 142 Income Tax Management Act 1941 (NSW) s 87(2)(b). An unlimited deduction was later added, however, for gifts to a public fund established to purchase a ship to replace the HMAS Sydney: Income Tax Management (Amendment) Act 1942 (NSW) s 2(1)(b)(ii). 143 The exemption was removed in respect of dividends paid wholly and exclusively out of interest from Commonwealth and State loans; interest itself in both cases remained exempt: Income Tax Management Act 1941 (NSW) s 19(k). See discussion in text at nn 36–41 above. 144 Income Tax Management Act 1941 (NSW) s 39.

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the failed conservative Budget,145 State-Commonwealth harmonisation was dead.146 The end for State income taxation came quickly. In January, as the Australian press suggested Canada, which like Australia had both federal government and State (or provincial in the case of Canada) income taxes, would move to a uniform levy at the federal level,147 the Commonwealth government explored the unification option.148 Initial surveys indicated the likelihood of strong State opposition to the idea149 and it became clear that the Commonwealth would need something to bolster its case if unification were to have any chance of crossing political hurdles. The Japanese bombing of Darwin on 19 February 1942 provided a perfect backdrop for the Commonwealth government’s planned approach and on 23 February, four days after the Japanese attack, the Commonwealth appointed a Committee on Uniform Taxation, commissioned to provide prompt advice on wartime finances in a fiscal and military emergency.150 Importantly, the Commonwealth took great care to ensure its plans were not presented as a takeover of State taxation. Rather, as the name of the Committee suggested, the move was presented as an equity initiative to replace inconsistent tax burdens across the States with a fair and uniform nation-wide tax regime. Membership of the three-person Committee was carefully chosen to engender bipartisan support. The Committee’s Chair, Professor RC Mills, was the recently appointed chairman of the Commonwealth Grants

145 See ‘Chifley Budget Hits Higher Incomes, £8, 500, 000 More Required From Companies, Measures to Control Banks’, The Mercury, 30 October 1941, 1. 146 ES Spooner, the conservative federal politician who would later serve on the committee appointed to devise a unified income tax, said of the New South Wales changes, ‘There went the result of our work’: ES Spooner in F Bland (ed), Changing the Constitution: Proceedings of the All Australian Federal Convention, 25–26 July 1949 (Sydney, New South Wales Constitutional League, 1950) 67, cited in Gilbert, n 63 above, 247–48. 147 See, eg ‘Income Tax in Canada, Federal Monopoly’, Sydney Morning Herald, 20 January 1942, 3. 148 Commonwealth Government, Memorandum, Uniformity of Commonwealth and State Income Taxes, January 1942, National Archive Series A571/166 Control Symbol 1943/1468, cited in C Saunders, ‘The Uniform Income Tax Cases’ in HP Lee and G Winterton (eds), Australian Constitutional Landmarks (Cambridge, Cambridge University Press, 2003) 62, 67. 149 The Memorandum, ibid, reported the views of the State Premiers on the proposed compensation, indicating opposition in general to the scheme from all of them, except the Premier of South Australia. 150 Committee on Uniform Taxation (Professor RC Mills, Chair), Report of the Committee on Uniform Taxation (28 March 1942) (Canberra, Commonwealth Government Printer, 1942) 1. See ‘Uniform Taxes, For War Period, Committee Appointed to Formulate Plan’, Canberra Times, 26 February 1942, 2 (reporting that ‘[t]he committee will thoroughly explore the income tax field of the Commonwealth and the States and seek a formula for their amalgamation into a uniform scheme under one taxing authority to meet the essential revenue requirements of the Commonwealth and the States’). While the Committee was appointed on 23 February, the Commonwealth withheld a public announcement until 25 February.

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Commission.151 The Rt Hon J Scullin was, as noted previously, a senior and well-respected Labor MP who had been ‘recognised on both sides of the House as technically expert and shrewd in taxation matters’.152 The Hon ES Spooner was a Minister in the conservative Menzies and Fadden governments and previously Assistant Treasurer in the conservative government of New South Wales. A little over a month later, on 28 March 1942, the Committee’s report was issued.153 The Committee’s Report concluded that, in the context of the need for the Commonwealth to exercise its revenueraising capacity to the fullest in wartime without the restriction of the States being present in the income tax field, uniform taxation should be imposed by the Commonwealth for the duration of the War and one year thereafter.154 The fiscal position of the States, the Committee suggested, could be protected by the payment of grants calculated as the average of income tax collections in the State in 1939–40 and 1940–41 (less cost savings as a result of the scheme), with a procedure for the States or the Commonwealth to submit a claim for adjustment of the compensation from 1942–43, to be referred to an independent authority for investigation and report.155 The proposal for a single Commonwealth income tax was endorsed by the federal Cabinet in mid-April156 and presented to a Premiers’ Conference soon after, on 22 April. Not surprisingly, the Commonwealth usurpation of income tax powers was opposed by all the States. Ignoring State views, the Commonwealth pressed ahead with its uniform income tax scheme, enacting legislation to implement the scheme on 7 June. The Commonwealth scheme was implemented by way of four separate laws: — the Income Tax Assessment Act 1942, containing the Commonwealth’s uniform tax assessment law and a rule giving priority to payment of Commonwealth income tax over State income tax; — the Income Tax (War-time Arrangements) Act 1942, providing for transfer of State taxation office equipment and staff to the Commonwealth to administer the expanded Commonwealth income tax; — the States Grants (Income Tax Reimbursement) Act 1942, providing for payment of financial assistance to the States conditional on States’ abandoning State income taxation; and — the Income Tax Act 1942, imposing the tax at a uniform rate across the country.

151 For discussion of Mills’ role on the Grants Commission, see P Groenewegen, ‘RC Mills (1886–1952) and Australian Fiscal Federalism, with Special Reference to the Methodology of the Grants Commission’ (2001) 36 History of Economics Review 66, 72. 152 Butlin, n 126 above, 384. 153 Committee on Uniform Taxation, n 150 above. 154 ibid 2. 155 ibid 4. 156 Saunders, n 148 above, 65.

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The laws placed no legal constraints on States’ power to impose income taxation. If upheld as constitutionally valid, they would, however, have had the practical effect of ending State income taxation. They provided for Commonwealth income tax rates high enough to generate revenues for Commonwealth and State expenditures. There was, thus, no room for additional income taxes that would be needed by any State that opted out of the scheme. The Commonwealth laws were, as expected, immediately challenged in the High Court in what became known as the First Uniform Tax Case. Only four of the six States joined the action, however, with New South Wales and Tasmania declining to join the High Court challenge. New South Wales Labor Premier William McKell was in a particularly difficult position as a strong opponent of the scheme personally, but forced to withdraw by his party’s State conference in June. McKell is reported to have said at this conference that ‘[i]t has been the States, particularly New South Wales and Queensland, that have been in the vanguard of social legislation … The very moment you accept these proposals you settle for all time the possibility of any State giving you any social legislation of any value’.157 While the laws followed the recommendation of the Committee on Uniform Taxation, establishing arrangements for the duration of the war and one year following the end of the war, the form which the legislation for the uniform tax scheme took in four separate Acts meant that the determination of the validity of the Acts did not proceed solely in relation to the Commonwealth’s defence power, but also the Commonwealth’s taxation and grants powers and the question whether the four Acts could be considered collectively as a scheme involving an impermissible purpose of interfering with the powers of the States.158 Six weeks after its enactment, on 23 July, the High Court dismissed the States’ challenge, upholding the constitutional validity of all four laws,159 though different members of the Court dissented on particular elements.160 157 D Rawson, ‘McKell and Labor Unity’ in M Easson (ed), McKell: The Achievements of Sir William McKell (Sydney, Allen & Unwin, 1988) 26, 44, citing Sydney Morning Herald, 15 June 1942. It has also been noted, however, that the McKell government was the first to transfer constitutional powers (as opposed to finance) to the Commonwealth in planning for postwar reconstruction (Commonwealth Powers Act 1942 (NSW), 24 December 1942): K Turner, ‘William (later Sir William) John McKell’ in D Clune and K Turner (eds), The Premiers of New South Wales, vol 2, 1901–2005 (Sydney, Federation Press, 2006) 251, 266. 158 Saunders, n 148 above, 72–74. 159 South Australia v Commonwealth (1942) 65 CLR 373 (‘First Uniform Tax Case’). 160 Chief Justice Latham and Justice Starke dissented as to the validity of the War-time Arrangements Act (providing for transfer of State taxation office equipment and staff) under the defence power, and Justice Starke also dissented as to the validity of the Grants Act which provided for payment of conditional financial assistance to the States under s 96 of the Constitution. Furthermore, Justice McTiernan only upheld the priority rule in the Assessment Act under the defence power.

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While the High Court took care to note that the ruling in no way constrained the constitutional power of the States to impose separate income taxes, it conceded that the scheme was one that in practical terms left the Commonwealth with virtually limitless de facto power to assume responsibility for programmes that had been States’ responsibilities. The constraint on the exploitation of that power, the Chief Justice said, could only be political, determined by the voters who elected the Commonwealth government; the grants power in the Constitution imposed no constitutional restriction on this outcome.161 The High Court’s decision appeared to garner widespread support among the general public and was applauded in some quarters as putting to rest a contentious fiscal distraction, allowing the government to move on with wartime policies.162 It had not gone unnoticed, however, that the key laws in the scheme had been upheld by the High Court on grounds apart from the Commonwealth’s defence power, an outcome that could allow the Commonwealth constitutionally to continue its wartime arrangements after the War.163

CONCLUSION

The prediction of some made during the debate on the uniform tax legislation in 1942 that the temporary wartime scheme might become permanent164 proved to be accurate. An examination by Commonwealth and State Treasury officials in 1953 of ‘the technical problems involved in the resumption of income tax by the States’,165 for example, did not lead to any specific proposal for resurrecting State income taxation,166 and the uniform scheme would survive the further High Court challenge in 1957 largely

161

First Uniform Tax Case, n 159 above, 429. ‘The High Court’s Decision’ (editorial), Sydney Morning Herald, 24 July 1942, 4. 163 K Bailey, ‘The Uniform Income Tax Plan (1942)’ (1944) 20(2) Economic Record 170, 187, reproduced in Prest and Mathews, n 48 above, 309, also discussed in Saunders, n 148 above, 69. 164 See Saunders, n 148 above, 69 and references there cited. 165 See Commonwealth and State Treasury Officers, ‘Resumption of Income Tax by the States’ in Prest and Mathews, n 48 above, 347. The Commonwealth Solicitor-General, Crown Solicitor for New South Wales, Solicitor-General of Victoria and Commonwealth Commissioner of Taxation were also consulted as part of this inquiry. 166 A later commentary on the process noted that Commonwealth officials had been particularly obstructionist in relation to this process: ‘[t]he Commonwealth Treasury exercised great ingenuity in raising difficulties and feeding them backstage to Under-Treasurers of States which were opposed or lukewarm to resumption’. See JA Maxwell, ‘Another Look at Resumption of Income Taxation by the States’ (1966) E1(22) Economic Papers 1, also cited in Prest and Mathews, n 48 above, 360. 162

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intact.167 The foundation for the vertical fiscal imbalance that has shaped the Australian geo-political landscape since proved enduring. While the decision to enact the legislation for the uniform income tax scheme may have seemed to the casual observer at the time to have been made and implemented very quickly in the wartime conditions of 1942, it might be asked whether centralised income taxation and consequent Commonwealth control over economic and social programmes was an inevitable outcome in Australia simply waiting for the appropriate implementation trigger. On the one hand, the intergovernmental agreements in 1923 for collection of Commonwealth and State income tax by the States, the 1927 agreement for centralisation of government borrowing, the 1929 agreement for allocation of the income of multi-State businesses, and the enactment of income tax legislation by the Commonwealth and all States in 1936–37 on largely harmonised lines, all appear to indicate that political compromises to address the problems of concurrent income taxation could be achieved. At the same time, the deviations from the agreements in each case might suggest Australian States and the Commonwealth were (and are) incapable of reaching the level of compromise and agreement needed for a genuinely sustainable federal jurisdiction capable of providing the level of social and economic leadership required in the second half of the twentieth century and beyond. With the benefit of hindsight, some commentators explain the Commonwealth takeover of income taxation solely in terms of macroeconomic policy, with no mention of wartime financial needs as a factor.168 It remains an open question whether the experience of the evolution of a centralised income tax system in the period 1915 to 1942 is the story of inevitability or coincidence of circumstances.

167 Victoria v Commonwealth (1957) 99 CLR 575 (‘Second Uniform Tax Case’). One finding of the First Uniform Tax Case, n 159 above, was overruled, however (with three judges dissenting), namely, that the provision of the Income Tax Assessment Act 1942 (Cth) which had conferred priority for payment of Commonwealth income tax over State income tax was valid. 168 See, eg P Smyth, ‘The Historical Context for Action’ in A McClelland and P Smyth (eds), Social Policy in Australia: Understanding for Action, 3rd edn (Melbourne, Oxford University Press, 2014) 81, 90.

13 A Historical Account of Taxes on Goods and Services in the Transition to Post-Socialist China YAN XU*

ABSTRACT The taxes on goods and services, subject to a very brief interruption, have been separately applied since their inception in early times in modern China. Until now, the Value Added Tax (VAT) is still an incomplete tax as the tax on goods is separate from the tax on services according to the basic legislation, although the two taxes are moving towards an integrated system. The adoption of bifurcated taxes on goods and services has caused a number of problems for the economy and businesses. The question is why the government did not choose a normal VAT system in the first instance if the separation is inefficient. This chapter addresses the question by way of an examination of the historical development of the system of taxes on goods and services in modern China and argues that the design of the system was historically constrained by a number of factors including economic foundations, the level of tax administration and inter-governmental fiscal relations.

INTRODUCTION

E

VEN THOSE UNFAMILIAR with Chinese history would know that China is an ancient country—undoubtedly the oldest among great powers in the modern world. Its history goes back 4,000 years and Chinese civilization, though interrupted in history many times by various forces, remains almost intact up to this day. The long history has profound influences on many political and socio-economic institutions that are still

* The author would like to thank participants in the Cambridge History of Tax Law Conference 2014 for their helpful comments and questions. The usual disclaimers apply.

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in force in the country today. Although modern China is young (arguably it emerged only after the creation of a Republican government in 1912)1 the development of modern China cannot be understood separately from the long history of the country. The long process of transformation from feudal to imperial to republican to socialist, and to, currently, a hybrid market economy, reflects not only the change of political fundamentals, but the evolution of social infrastructure and economic conditions. With the initial forced open-door to more active engagement with other parts of the world, China has introduced and incorporated many modern and new elements into its institutions, such as a modern tax law system based on a market economy, while at the same time keeping some basic features, such as a disproportionally powerful executive branch of government, unaltered. Taxation has been implemented in the country since its recorded history started 4,000 years ago. The tax changes are inevitably inseparable from the social and political changes over the era. Historically, direct taxes, in particular land taxes, were the most important taxes in terms of government revenue given that China was largely an agrarian economy. However, with the development of the economy, taxes on the transaction of goods began to become an extremely significant contributor to government revenue and in the last two decades taxes on goods and services have become the most critical government revenue source. Historically, sales taxes on goods were adopted in China shortly before the fall of the last imperial dynasty, the Qing Dynasty (1644–1911). The Republican China (1912–1949) that sent the legacy of imperial rule to historical museums was a time of great turmoil with foreign (Japanese) invasion (1937–1945), an internal Civil War (1927–1949) and the rise of militant warlords (1916– 1928) whose power remained into the 1930s and 1940s in the absence of an effective central control. The consolidation of power by the Communist Party of China (CPC) in 1949 led to a hiatus in tax reform, as state entities and communes assumed responsibility for the welfare of workers and labourers and direct profit appropriations from state enterprises replaced taxes as the major source of government revenue. The chaos of the Cultural Revolution (1966–1976) and the consequent economic decline in the late 1960s and early 1970s prompted a dramatic turn in economic policy by the CPC and in late 1978, the socialist state began a shift to a so-called ‘socialist market economy’. For the 35 years since, a Communist leadership has presided over a unique hybrid state-owned and market economy. Corporatisation of state-owned enterprises, along with the growth of private enterprises (including some foreign owned) prompted a return to taxation as the source of government revenue and from 1980, rudimentary consumption taxes were implemented on a trial basis on selected industries in some selected regions according to temporary regulations by the executive branch 1

Guo Tingyu (ed), Modern History of China (Taipei, Zhengzhong Publishing House, 1980).

Taxes in the Transition to Post-Socialist China 395 of government.2 These went through several iterations over the next 15 years as socialist-trained government officials came to grips with the features of a market economy. The Value Added Tax (VAT), a widely adopted modern consumption tax, was formally introduced into the tax system in 1994. A provisional regulation enacted in 1994 in anticipation of final laws to be enacted by the central legislature has remained effective for the last 20 years. One consequence of taxation by administrative regulations is the flexibility to change the rules easily and the changes to China’s VAT over the past quarter century in many ways tell the story of modern Chinese history. Unlike a conventional VAT or Goods and Services Tax (GST), the Chinese VAT, as it was designed, primarily applied to the sale of goods with a very limited range of services in relation to the sale of goods.3 To tax the provision of most other services and the transfer of intangibles and immovable properties effectively, another tax, business tax (BT), was introduced, which was in essence a turnover tax with no deduction allowed for input tax paid on acquisitions.4 This feature, though at odds with a normal VAT, was surprisingly not discordant with the overall Chinese VAT when taking into account that input tax on the purchases of fixed assets was not deductible from output tax under the VAT rules.5 The VAT, together with the BT and Consumption Tax (the Chinese term for excise tax), have since emerged as the foremost revenue source for the government, in particular for the central government, since a bigger share of the VAT revenue and all the revenue from the Consumption Tax go to the centre.6 The ‘VAT family’ was reformed once at the end of 2008, 2 An experimental VAT was applied to the machinery industry in Liuzhou, Guangxi and Shanghai in 1980. In 1981, the Ministry of Finance (MOF) issued the Provisional Measures on VAT (Draft) and applied the Measures to the two industries of machinery and agricultural equipment as well as three types of products, ie sewing machines, bicycles and electric fans. 3 These services were processing, repairing and replacing. Provisional Regulations on VAT (State Council, 13 December 1993, effective 1 January 1994) (PRVAT) art 1. 4 Provisional Regulations on BT (State Council, 13 December 1993, effective 1 January 1994) (PRBT) arts 1, 4. 5 PRVAT art 10. 6 The VAT alone has accounted for about 30%of total tax revenue since 1994. The combined revenues from VAT, BT and Consumption Tax have contributed more than 50% of total tax revenue during the same period. VAT is a central-local shared tax and its revenue is split at the ratio of 75 to 25 between central and local governments. See the State Administration of Taxation (SAT), ‘Statistical Data of Tax Revenues from 1994 to 2008’, available at www. chinatax.gov.cn/n8136506/n8136593/n8137633/n8138817/index.html; see also Tax Policy Department of the MOF, ‘Analysis on the Increase in Tax Revenue 2009’, available at http:// szs.mof.gov.cn/zhengwuxinxi/gongzuodongtai/201002/t20100211_270552.html; Tax Policy Department of the MOF, ‘Analysis on the Increase in Tax Revenue in 2010’, available at http:// szs.mof.gov.cn/zhengwuxinxi/gongzuodongtai/201102/t20110201_436195.html; and Tax Policy Department of the MOF, ‘Analysis on the Increase in Tax Revenue in 2011’, available at http://szs.mof.gov.cn/zhengwuxinxi/gongzuodongtai/201202/t20120214_628012.html. For details of the tax revenue-sharing arrangement, see the State Council Resolution on the Application of a Tax-sharing Fiscal Administrative System in China (State Council, 15 December 1993, effective 1 January 1994).

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bringing the purchases of fixed assets into the creditable scope of input tax in the VAT.7 A pilot reform of absorbing the BT into the VAT has been rolled out nationwide since August 2013.8 Among all the hotly debated issues about the pilot reform are concerns about ways of attributing tax revenues from the integration, identifying the role and function of local tax administrations after the merger, and clarifying technical details of the tax treatment on some types of services, such as financial services and sales of residential housing. Thus far, however, little attention has been paid to the reason why separate taxes on the sale of goods and the supply of services were retained during the 1994 tax reform. If the separation was inefficient and posed high costs on both the government and the economy, why did the government not opt for a normal VAT system in the first instance? To understand the answer to this question, one must look before the 1994 reform to appreciate how the decision-makers in 1994 were constrained by decisions made long before. This chapter is organised as follows. The second section follows this Introduction and examines how the BT on the supply of services was created and evolved at different historical stages of modern China since 1949. The third section discusses the historical constraints that applied to the design of VAT and the extent to which the constraints may impact on the present tax reform. The final section concludes this chapter. CREATION OF A BUSINESS TAX ON THE SUPPLY OF SERVICES IN CHINA

Turnover Taxes from 1949 to 1978 Even before the foundation of the People’s Republic of China (PRC) in October 1949, areas that were brought out of the control of the Nationalist 7 Amended PRVAT, amended PRBT, and amended Provisional Regulations on Consumption Tax (State Council Order No 538, No 540, No 539, 10 November 2008, effective 1 January 2009). 8 The pilot reform was first launched on transportation and certain selected modern industries in Shanghai in January 2012 and it then extended to eight provinces and municipalities in August 2012. It was finally applied to all other parts of the country in August 2013. The scope of selected modern industries has been expanding also. MOF and SAT Notice on Issuing the Pilot Reform Scheme of Levying VAT in Lieu of BT (MOF and SAT No 110, 16 November 2011, effective the same day); MOF and SAT Notice on Implementing the Pilot Reform of Levying VAT in Lieu of BT on the Transportation and Certain Modern Service Industries in Shanghai (MOF and SAT No 111, 16 November 2011, effective 1 January 2012); MOF and SAT Notice on Implementing the Pilot Reform of Levying VAT in Lieu of BT on the Transportation and Certain Modern Service Industries in Eight Provinces (and Municipalities) (MOF and SAT No 71, 31 July 2012, effective 1 August 2012); MOF and SAT Notice on Tax Policies for Implementing the VAT Pilot Reform on the Transportation and Certain Modern Service Sectors Nationwide (MOF and SAT No 37, 24 May 2013, effective 1 August 2013); and MOF and SAT Notice on the Inclusion of the Railway Transportation and Postal Industries in the Pilot Reform (MOF and SAT No 106, 12 December 2013, effective 1 April 2014).

Taxes in the Transition to Post-Socialist China 397 Party by the CPC each had in place a taxation system. Taxes on production and sales of goods and temporary business tax on the provision of certain services were introduced in some regions. To avoid the inconsistency of taxation across regions, the new CPC government made particular efforts to unify the rather diverse tax systems upon the formal establishment of the country. The first national tax conference, which was held in Beijing in late November 1949, lasted half a month with the passage of draft Enforcement Guidelines of National Taxation and of a decision to introduce 14 types of taxes that were to be imposed nationwide.9 Among the 14 taxes, product tax and industrial and commercial taxes, together with salt tax and customs tariff, were designated as the focal point of the tax system.10 The draft Enforcement Guidelines were then passed and promulgated by the Government Administration Council (GAC) of the Central People’s Government, the then State Council, in January 1950. The Provisional Regulations on Product Tax and Provisional Regulations on Industrial and Commercial Taxes were also passed and issued by the same agent at the same time.11 The product tax applied to 10 types of goods, including cigarettes, clothes, food, industrial products, building materials, cosmetics and agricultural products at rates ranging from 3 per cent to 120 per cent. This tax was an ad valorem tax and producers, brokers and importers of the goods were the taxpayers. The wide range of tax rates was not conventional by modern standards for a consumption tax and the application of these multiple tax rates could be rather challenging, even in an advanced tax administration system with the support of modern information technology. Obviously, these widely diversified tax rates provided prejudiced tax treatment on taxable goods, but this lack of neutrality was presumably intended by the government— using discriminatory tax rates to adjust sales prices of different types of goods, and thereby controlling and regulating the prices of goods. The industrial and commercial taxes consisted of two categories of tax: a business tax and an income tax on industrial and commercial entities. The Business Tax was calculated either on the turnover of an entity at rates of 1 per cent to 3 per cent, or on the gross revenue of the entity at rates of 1.5 per cent to 6 per cent according to the types of business.12 There were 104 types of business, including supply of agricultural and industrial goods and provision of transportation and financial services and some types

9 Liu Zuo, Sixty Years of Taxation in New China (China Finance and Economics Publishing House, 2009) 4–6. 10 ibid. 11 ibid 7. The two Regulations were amended on 19 December 1950 by the GAC and the MOF issued two implementation rules on the two types of taxes on 21 December 1950. The amended regulations on product tax reduced taxable types of goods to eight from 10 and the amended regulations on industrial and commercial taxes added one more calculation and collection method on the BT. 12 Provisional Regulations on Industrial and Commercial Taxes art 9(1).

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contained subcategories according to the relevant legislation.13 State-owned enterprises (SOEs) paid the business tax, but not the income tax,14 and enterprises with joint state-private ownership paid both the business tax and income tax.15 The forming of the joint state-private enterprises at the time was a measure to make use of the private sector to boost economic recovery, while at the same time confining its development to the extent that it would not endanger the leading status of the state-owned economy. State monopolies, impoverished artisans and household sideline businesses, and nonprofit entities could be exempt from the industrial and commercial taxes, including the business tax upon approval by the central government.16 All revenues from the product tax and industrial and commercial taxes belonged to the central government, and the legislative power over the two types of taxes, along with all other taxes to be applied nationwide, was vested with the GAC and its agents, mainly the Ministry of Finance (MOF) and the central tax authority, which was not a separate government entity but a subsidiary body under the MOF. The business tax was, presumably, a continuing tax from the period of the Republic of China. The major purpose of introducing such a tax in the Republic period was to replace a harmful tax on the passage of goods through inland barriers that was widely levied by local governments as a major revenue source at the time.17 The calculation and collection method adopted by the PRC government was similar to the one employed in the Republic period, but the destination of the tax revenue was the centre in the PRC period, not local, as in the Republic period. The business tax was employed primarily to adjust profits of industrial and commercial entities,

13

ibid Sch 1 (Tax Rates on Business Categories). ibid art 5. However, this does not mean state-owned enterprises paid no Income Tax. The burden on them did not come in the form of Income Tax as such but in the form of profits remittance to the government. 15 ibid art 6. The Regulations did not mention private entities for the taxes, but presumably they were subject to the taxes and paid both the business tax and income tax, as the joint private-public entities did. In 1950, China was in the recovery period, which lasted from 1949 to 1952. This period was meant to recover and develop China’s economy after a long period of wars and battles. Policies adopted by the CPC were in a transition from the New Democracy period to a period of ‘socialist transformation’ which was adopted in 1953 by the Party in its ‘General Line for the Transition Period’. Private ownership of businesses was not particularly discouraged in the recovery period, since the government needed private sectors to boost economic development at the time. However, the 1953 policy of ‘socialist transformation’ of capitalist industry and commerce gradually nationalised the private sector. It is worth noting the nationalisation was not taken via confiscation but by state capitalism, ie state-private joint economic activities. Bennis Wai-yip So, ‘The Policy-making and Political Economy of the Abolition of Private Ownership in the Early 1950s: Findings from New Material’ (2002) 171 China Quarterly 682; see also Antonia Finnane, ‘Tailors in 1950s Beijing: Private Enterprise, Career Trajectories, and Historical Turning Points in the Early PRC’ (2011) 6 Frontiers of History in China 1, 117–37. 16 Provisional Regulations on Industrial and Commercial Taxes art 8. 17 Wu Zhaoxin, History of the Tax System of China (Taiwan, Shangwu Press, 1965) 283–87. 14

Taxes in the Transition to Post-Socialist China 399 which was similar to the application of the product tax. As is seen, the business tax at the outset took a different path and assumed a different function from a consumption tax on goods and services. The scope of the business tax was slightly broadened by a GAC notice issued on 31 December 1952. The notice provided that the tax on special consumption behaviour (excise tax) was renamed as cultural and entertainment tax applying to movies, operas, music and dance performance and things alike. Consequently, the provision of services by restaurants, hotels and ballrooms that was previously subject to the tax on special consumption behaviour was moved to the business tax, being taxed at rates of 5 per cent to 15 per cent.18 The overall tax system was amended during 1952 to 1953. One key impetus was the fact that tax revenues declined as a portion of total fiscal revenues, despite a quick economic growth over three years of economic recovery from 1949.19 The dramatic changes in the state’s economy, namely, the substantial rise of the state economy in stark contrast to the shrinking of the private economy,20 brought new challenges to taxation. The major change of the reform was to introduce a commodity circulation tax and to amend the business tax so as to guarantee the government’s tax revenue. Legal documents regarding the amendment were promulgated by the GAC at the end of 1952. The commodity circulation tax applied to 22 types of goods from basic and luxury items such as cotton, cigarettes and alcohol to production materials, including steel, coal and mineral oil, and taxpayers were provided with a relatively simple rate structure but the rates were still rather diverse, ranging from 7 per cent to 66 per cent. Goods on which the tax was already paid were not subject to any other tax when they were sold at the retail stage nationwide.21 The major amendment of the business tax was to change the collection point from wholesale to production. However, this change provoked strong reaction from some taxpayers and tax officers

18 Liu, n 9 above, 12. This move was perhaps because the number of intermediate transactions of goods was reduced as a result of direct transactions between producers and sellers. This adversely affected the business tax revenue from the point of wholesale. 19 ibid 12. 20 A study found that during the period from 1949 to 1952, although the private industrial sector achieved a 54% growth in gross output, its share of national industrial output reduced from 63% to 39%, and the share of the marketed output of private industry sharply declined from about 88% in 1949 to around 44% in 1952. As to private commerce, the number of commercial firms was only slightly reduced during the period because the state trading sector was not able to replace the extensive private trading web. However, the Threeanti and the Five-anti Campaigns launched at the end of 1951 and in early 1952, particularly the Five-anti Campaign against the bourgeoisie including bribery and tax evasion, resulted in the rapid shrinking of the share of turnover of private business. It was found that even after the climax of the Campaigns, local officials continued to impose harsh measures on capitalists by levying heavy taxes. The bad situation of private commerce was not improved until the end of 1952 when its turnover was recovered to the pre-campaign level. See n 15 above. 21 Liu, n 9 above, 13–14.

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because, as it happened, the change made the tax administration complicated and it increased burdens of industrial enterprises but reduced burdens of wholesalers—and private wholesalers even paid no business tax.22 The commodity circulation tax and business tax did not operate like a sales tax. The sales prices were set administratively and the purchase of certain goods by final consumers could be subsidised, in a sense, since the final sales prices could be kept deliberately low by the government, and thus the tax burdens had to be borne by the taxpayers. It is hard to imagine, 60 years later, how capable the tax administration would have been to apply the multiple rates correctly to transactions of different types of taxable goods, as well as to set sales prices that reflected the supply and demand conditions of the market. It is likely that such ‘accuracy’ of getting right prices and exact tax rates was never achieved. Although the 1953 tax amendment did not reduce the total types of tax and change the tax system, the situation of multiple-taxes-multipleimpositions on industrial and commercial businesses was improved to a degree. As it turned out, the change in the business tax led to favoured treatment for private commercial entities, particularly large private wholesalers, but not state-owned industrial and commercial entities. The tax amendment aroused an unexpected political disturbance, owing largely to the view that taxation should apply to the state-owned entities and private entities on an equal footing.23 This view was deemed politically unacceptable at the time and violated a CPC resolution that tax policy should act as one of the measures to control the private capitalist economy.24 Another reason for the disturbance was the change of collection point in the business tax and its consequent effect on changes of tax burdens on different types of entities. It was found that the amendment did not follow the general tax policy adopted by the government of the time; that is, tax burdens of industrial entities should be lighter than those of commercial entities; production materials and daily necessities should be more lightly taxed than consumption materials and luxury items; and private industrial and commercial sectors which were beneficial to the national economy and people’s livelihood should be taxed less than those without that benefit. This political disturbance heavily influenced the following tax development and the government’s tax policies. Some preferential tax policies were adopted for state-owned entities only during the first Five Year Plan (FYP) period (1953–57). For example, 135 types of goods produced by the state-owned heavy industrial enterprises were exempted from the commodity circulation tax and the product tax, and wholesales of industrial goods by state-owned commercial entities were 22

ibid 14–18. The amendment was condemned by local leaders and the then Chairman Mao Zedong. See n 15 above. 24 Liu, n 9 above, 14–15. 23

Taxes in the Transition to Post-Socialist China 401 exempted from the business tax. The 1952–53 amendment of the tax system was problematic also from a legal perspective. The amended rules were promulgated only one day before the implementation of the amendment, which made it difficult for both taxpayers and tax authorities to follow. For the period of 1950–57, the revenue from turnover taxes, mainly the product tax and business tax, was the major revenue source for the government, contributing around 65 per cent of total tax revenue in 1957, as compared to 46.5 per cent in 1950. The revenue from agricultural taxes declined sharply, and Income Tax and other taxes only contributed a small share to the total tax revenue.25 The ‘socialist transformation’ policy adopted by the CPC in 1953, which targeted transformation of agriculture, handcraftsmanship and capitalist industry and commerce, employed state capitalism to transform the private sector. The process of transformation was completed at the end of 1956. The transformation made the state’s economy dominated by state-owned and collective-owned enterprises. The economy was now largely state-run and operated under state plan controls. It is worth considering why the imposition of the product tax and business tax was needed during and after the socialist transformation, when the public sector was the leading party of the economy and most assets and businesses were owned and managed by the government. It seems that the government could directly set prices of goods and demand remittance of profits of various entities engaged in the production and sales of goods and provision of services without resorting to taxation for revenue purposes. Presumably, the existence of taxation can be appreciated against the background that since there was almost no (free) market at the time, the function of determining and adjusting prices by a market had to be assumed by the government. Taxation could also be used as an additional way to extract revenues from entities and to equalise the profits level of entities by imposing higher rates on those producing and selling non-necessity goods, or providing unnecessary basic services. Another reason for the existence of taxation would be that a state-controlled public economy may not be able to achieve efficiency without high costs, and the profit-making ability of state-owned or controlled entities was low as they did not have autonomy to make decisions on business production and operation. Thus, the government could not completely rely on profits remittance from state and collectively owned entities for revenue purposes, making taxation a necessary supplement to raise further revenue. Taxation might also be a means for the central government to obtain information regarding SOEs since many of them were effectively controlled by the local governments and profits from SOEs might not have been fully delivered to the central government. By taxing the turnover of commercial and industrial

25

ibid, 34.

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entities, it would be administratively easier for the central government to know the situation of business operation of the entities and thus control their profits and reduce differences of profits among the entities so that no entities could be generally left better off than other entities. This met the political objective of the socialist government at the time, that is, ‘equality’ of entities (and people) and egalitarian distribution of profits. The two decades from 1958 to 1978 were a rough and bumpy period of tax development in China. The tax system was overhauled twice, in 1958 and 1973, respectively. The two reforms simplistically simplified the tax system, thanks to the influence of the political view at the time that taxation was nothing but an exploitation tool of the capitalists. In the 1958 tax reform, the government thought the Soviet Union’s tax regime was the appropriate direction of its endeavour and the turnover taxes should be used as the major tax and implemented comprehensively across the country.26 The system of industrial and commercial taxes was thought to be too complicated since an enterprise had to pay several taxes and the same type of tax was levied several times on goods during the process of manufacturing, and therefore it was necessary to further simplify the tax system. As a result of such thinking, the commodity circulation tax, product tax, business tax and stamp duty were integrated into a single tax called Consolidated Industrial and Commercial Tax (CICT). New legislation on the CICT was passed by the National People’s Congress Standing Committee (NPCSC) in September 1958 and all the old regulations and rules on the previous four taxes were accordingly abolished.27 Manufacturers, agricultural product purchasers, importers and service providers were the taxpayers, but the state financial institutes, including banks and insurance enterprises, healthcare, agricultural machinery service units and scientific research institutes were exempt from the tax.28 There were in total 108 taxable items and the tax rate could be as low as 1.5 per cent and as high as 69 per cent.29 Tax payable was mainly based on the turnover or sales value of the goods or services.30 The 1958 reform for the first time subjected the sale of goods and the supply of services to the same turnover tax for simplification purposes. Certain discretionary powers regarding the implementation of the tax, such

26 CPC Committee of the MOF, Report on Structuring the Industrial and Commercial Tax System and Implementing the Turnover Tax on SOEs (30 December 1955), cited in Liu, n 9 above, 37. 27 Regulations on the Consolidated Industrial and Commercial Tax (Draft) (State Council, 13 September 1958, effective 13 September 1958) (RCICT); Implementation Rules of the Regulations on the Consolidated Industrial and Commercial Tax (Draft) (MOF, 13 September 1958, effective 13 September 1958). 28 RCICT arts 2 and 10. 29 RCICT Sch (Taxable Items and Tax Rates). 30 RCICT arts 4–8.

Taxes in the Transition to Post-Socialist China 403 as tax reductions and exemptions, were devolved to the provincial governments, but the central government quickly strengthened its control in 1961.31 The 1973 tax reform took place in the middle of the Cultural Revolution (1966–76). Due to the influence of the overall political environment, taxation was regarded as a system suitable for a capitalistic industrial and commercial system and hence incompatible with the socialist economy.32 Based on the guidelines of consolidating tax types, simplifying collection methods and reforming the irrational industrial and commercial taxation system, the government started its third large-scale tax reform from 1968, which went through three stages from first applying one single rate to one enterprise after integrating all taxes on enterprises, to applying one single rate on one sector of industries, and finally to applying a single industrial and commercial tax that absorbed all previous taxes, including the CICT, to the SOEs. Collective-owned enterprises paid the CICT and income tax. Compared to the previous CICT, taxable items were reduced from 108 to 44 and the number of tax rates was down from 141 to 82. The administration of the industrial and commercial tax was devolved to the provincial governments.33 However, the simplified industrial and commercial tax confused many tax officers, as the nature of whether the tax was a tax on enterprises or a tax on goods (and services) was ambiguous. Determining tax rates according to the types of enterprises was rather difficult due to the differences of specific characteristics of production and operation of enterprises. The decentralisation of tax administrative power led to very little standardisation in the collection of taxes and the application of tax policies across the country. After the reform, there were only 13 types of tax left, and even though the industrial and commercial tax paid by SOEs was still the largest source of tax revenue, the revenue from this tax shrank significantly before it gradually bounced back to a more normal level.34

Taxes on Goods and Services from 1979 to 1993 China’s economy was gravely disrupted by the Cultural Revolution, which prompted the government to refocus its effort on economic development and

31 CPC Central Committee, Approval of the CPC Committee of the MOF Report on Improving the Fiscal System and Strengthening Fiscal Administration (15 January 1961); CPC Central Committee, Provisional Regulations on Adjustment of the Administration System (20 January 1961). 32 Liu, n 9 above, 56–64. 33 ibid. 34 ibid 64.

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commit to ‘reform and opening’ from late 1978. Taxation was reconsidered a significant fiscal lever to facilitate economic development and to redistribute income and wealth. The economy was gradually liberalised with the emergence and rapid development of the private sector from countryside to urban areas. Farmers were allowed to keep the produce beyond the planned quota and sell the produce in the market at an unregulated price.35 In urban areas, stateowned industries were allowed to sell output above state-planned quota and the adoption of a duel price system facilitated sales of the above-quota commodities by these industries at market prices, and meanwhile private businesses were permitted to exist and operate in the market.36 The government also opened up the door to foreign investment in an attempt to develop the economy.37 To attract foreign investment and to ensure foreign investors, the government passed a series of foreign income tax laws from 1980 to 1981, which formally set up a foreign income taxation system.38 With regard to domestic taxation, the major project during that period was to transform the payment made by SOEs to the government from profits delivery to income taxation.39 The government also begun to reconstruct the indirect taxation system and to trial applying VAT to some industries in some selected regions for the purposes of reducing double taxation on taxpayers in the previous turnover taxation system. A notice issued by the MOF in December 1982 provided that, from the beginning of 1983, enterprises manufacturing machinery, agricultural equipment, sewing machines, bicycles and electric fans should pay the VAT according to the Provisional Measures on VAT. The VAT co-existed with the product tax that was applied to all other enterprises. In September 1984, the NPCSC approved a decision on delegating to the State Council the power to enact relevant regulations for the industrial and commercial tax reform. The State Council then published a notice, approving a provisional method of furthering the ‘profits to tax’

35 Loren Brandt et al, ‘China’s Great Economic Transformation’ in Loren Brandt and G Thomas Rawski (eds), China’s Great Economic Transformation (Cambridge, Cambridge University Press, 2008) 9. 36 ibid 10. 37 ibid 11. 38 These laws include Income Tax Law on Chinese-Foreign Equity Joint Ventures (NPC, 10 September 1980, effective 10 September 1980); Income Tax Law on Foreign Enterprises (NPCSC, 13 December 1981, effective 1 January 1982); and Law on Individual Income Tax (NPCSC, 10 September 1980, effective 10 September 1980). The first two laws were replaced by the Income Tax Law on Foreign-invested Enterprises and Foreign Enterprises in 1991 (NPC, 9 April 1991, effective 1 July 1991), which was further replaced by the Law on Enterprise Income Tax in 2008 (NPC, 16 March 2007, effective 1 January 2008). The Law on Individual Income Tax has been amended five times since promulgation. 39 Taxation of income on SOEs was governed by the Provisions on Income Tax of SOEs (Draft) and Measures on Adjustment Tax of SOEs issued by the State Council in 1984. The legislation was replaced by the Provisional Regulations on Enterprise Income Tax issued by the State Council in December 1993.

Taxes in the Transition to Post-Socialist China 405 reform for SOEs submitted by the MOF, together with publication of the Regulations on Product Tax (draft), Regulations on VAT (draft) and Regulations on BT (draft). The three Regulations came into effect on 1 October 1984. However, the period between promulgation and implementation of the Regulations was too short for both taxpayers and tax authorities to digest and to follow. This had been a typical problem with legislation and enforcement of laws and regulations in China until very recently. The 1984 reform divided the previous CICT into three separate sales taxes: the product tax on industrial enterprises, the BT on enterprises in the service sector, and the VAT. The BT applied to 11 types of non-agricultural activities outside of manufacturing, including wholesale, retail, transportation, construction and installation, banking and insurance, post and telecommunications, publishing, entertainment, utilities, and processing and repairing.40 There were four rates ranging from 3 per cent to 15 per cent,41 and tax payable was calculated on gross receipts or gross mark-up in the case of wholesale.42 A variety of services, for example, transfer of research outcomes and provision of technology consultancy service, were exempt from the tax.43 The exemption was allowed on a discretionary basis by local governments. Provincial governments were also granted the power to set up tax thresholds, decide assessable periods and other administrative issues regarding the tax.44 The VAT applied to entities and individuals that produced or imported taxable goods. Tax payable was calculated on the sales value and applicable rates that varied from 6 per cent to 16 per cent—12 rates in total. The tax was implemented through a method of presumptive crediting but not the ‘credit-invoice method’ that was used for VAT of consumption type in many countries.45 Although credit was allowed for tax paid on raw materials and most tangible intermediate goods, it was not allowed for tax paid on capital goods. The scope of the VAT was much smaller than that of the product tax in that there were only 12 taxable items under the VAT whereas there were 260 taxable industrial goods and another 10 taxable items for farming, forestry, animal husbandry and fishery products under the product tax.46 A rather complex tax rate structure ranging from 3 per cent to 60 per cent was applied in the product tax.47 The product tax was a multilevel sales tax on manufactures and levied according to the sales value of the taxable goods.48 The value of the goods sold was the price paid by the purchasers 40 41 42 43 44 45 46 47 48

Regulations on BT (Draft) art 1. ibid Sch (Taxable Items and Tax Rates). ibid art 3. ibid art 6. ibid arts 5 and 9. Regulations on VAT (Draft) arts 6 and 7, Sch (Taxable Items and Tax Rates). ibid; Regulations on Product Tax (Draft) Sch (Taxable Items and Tax Rates). Regulations on Product Tax (Draft) Sch (Taxable Items and Tax Rates). ibid arts 3–5.

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(if they were a state-owned or a collective-owned entity), which differed from the international practice where the tax base was usually the producer price. This difference was a salient feature of the product tax and it led to a much higher tax rate than the normal tax on goods.49 No commodity was subject to more than one type of sales tax. The turnover tax nature of the BT, the product tax and the VAT gave rise to the cascading effect of the taxes across the business cycle. The co-existence of VAT and product tax made the analysis of the cascading effect even more complex. There were considerable differences between the statutory tax rates and the effective tax rates across different economic sectors. The particular design of export rebates deprived Chinese exporters of the competitive edge which otherwise would prevail.50 By the late 1980s, with the absorption of many product tax items into the VAT, the scope of the product tax withered. However, the complexity of the sales tax, in particular the multiple-rates structure, was unaltered and it rendered the Chinese sales tax system fairly distinguishable from other sales tax systems. As some studies found, there were over 250 different tax rates imposed under the three sales taxes.51 This feature can be understood from the historical background that the sales tax regime was designed at the time of the ‘profits-to-tax’ reform. Since the economy was still largely a planned economy, price setting was controlled by the government. Sales tax rates were employed as an instrument to regulate profits (and prices) among different economic sectors.52 However, the government intervention in the market process of determining prices was counter-productive for efficient resource allocation and equal competition. A World Bank Report argued that tax reforms cannot be separated from price reforms. Without price reforms, the multiple sales tax rate structure could not be unified because of the need to use indirect taxes to equalise sectoral profitability differentials arising from price distortions.53 The function of the indirect taxes in ensuring profits equalisation in China’s fixed-price environment of the time led the indirect taxes to be more like direct taxes.54 The World Bank argued that tax policy should not be used as a surrogate for correcting price distortions.55

49 ibid art 4. For example, assuming the tax rate on a mechanical watch movement was 55%, for a purchase of 100 yuan, 55 yuan was taken as tax and 45 yuan left for the producer. The tax paid was about 122% of the producer price. The 55% rate of product tax was in effect 122%. 50 For a detailed discussion of the cascading effect, see World Bank, China: Revenue Mobilization and Tax Policy (World Bank, 1990) 38. 51 Roy Bahl, Fiscal Policy in China: Taxation and Intergovernmental Fiscal Relations (1990 Institute, 1999) 30. 52 ibid. 53 World Bank, n 50 above, ix–x. 54 ibid 3. 55 ibid xvi.

Taxes in the Transition to Post-Socialist China 407 The unduly complicated sales tax system also caused high administration and compliance costs and slowed the revenue growth that otherwise would be achievable under a simpler rate regime. Moreover, even though tax rates and bases may have been determined by the central government, these sales taxes were not levied in a uniform way across China. Provincial and even lower-level governments could grant reductions and exemptions to businesses in their relevant jurisdictions without approval from the higher authority. This feature was not unique to the area of sales taxes. The balance of revenues accruing to the central and local governments had been changed to favour the provinces. The decentralisation of the expenditure responsibility to lower levels of government, however, did not make any corresponding decreases in expenditure responsibility of the central government, leading it to face not only budgetary pressures but also difficulties in effectively implementing tax policy to pursue macro-economic stabilisation and equalisation objectives.56

VAT and Business Tax from 1994 to 2008 The earlier reform devolved power from the central to lower levels of government in implementing tax rules and policies. Although decentralisation made local governments more responsive to local needs, it caused decreases of central tax revenue in the total tax revenue and of the share of government revenue in GDP from 1978 to 1993.57 The fall in enterprise income tax revenue and the insignificant contribution from the narrowly-based individual income tax forced the government to rely more on the sales taxes. However, even though the three sales taxes accounted for about two-thirds of total tax collection by 1992, they fell from 12.2 per cent of GNP in 1985 to 8.4 per cent in 1992.58 The continuing decrease of revenues, along with other problems in the economy such as inflation59 and budget deficit,60 56

ibid xvii. The World Bank Report (1990) estimated that the share of tax and non-tax revenues was down from 34% of GDP in 1978 to just under 20% in 1988: World Bank, n 50 above, 2, Table 1 China: Budgetary Revenues 1980–89. The fall in total tax and non-tax revenues in GDP was a continuing trend during 1979 to 1993. See also Bahl, n 51 above, 4–15. The non-tax revenues included fiscal extra-budgetary funds, which had been controlled and used by local governments to avoid sharing revenues with the central government, and enterprise extra-budgetary funds, which since 1987 could no longer be regarded as a legitimate part of government revenue. World Bank, China: Country Economic Memorandum, Macroeconomic Stability in a Decentralized Economy (World Bank, 1994) 28–33. 58 See Bahl, n 51 above, 5–8. 59 The World Bank Report (1994) found that by June 1993, year-on-year inflation was at 13.9% and by August 1994, it had reached 23.5 per cent: World Bank, n 57 above, viii. 60 The budget deficit was estimated at an average rate of 2.3% of GDP from 1987 to 1993. However, the consolidated government deficit was averaged between 5.5 and 6.2% over the same period: ibid 27. 57

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urged the central government to reconstruct its tax system and recentralise its control over the revenue system. The chief objective of the reform in indirect taxation was to replace the product tax with VAT. The product tax used to be the largest tax among the three sales taxes in the early period after the 1984 industrial and commercial tax reform, but there was continued decline in its share in the tax revenue and by 1992, the three sales taxes each contributed about the same amount of revenue. The growth rate of product tax (2.7 per cent) was strikingly lower than that of VAT (31.7 per cent).61 The cascading effect of the turnover taxation, in particular the product tax, on the manufacturing sector adversely affected the efficiency in production and distribution of goods. The substitution of VAT for product tax was regarded as an appropriate measure to alleviate the problem. The plan of fully implementing VAT, applying an additional product tax on particular goods and broadening the scope of BT was written into the State Administration of Taxation (SAT) Ten Year Work Plan and Programme Outlines in the Eighth FYP (1991–95) in February 1992. To meet the economic development needs, the tax reform including the turnover tax reform was accelerated and the government decided to implement the turnover tax reform nationwide, at one go, instead of the originally planned gradual phase-in, from 1 January 1994.62 The State Council issued provisional regulations on VAT, BT and Consumption Tax—the proposed product tax on particular goods, on 13 December 1993. The previous regulations on product tax, VAT and BT were all accordingly abolished. The new set of turnover taxation regulations applied to both domestic and foreign taxpayers and almost all critical changes related to VAT were in line with the recommendations made by the World Bank at the time.63 These changes included setting up a standard rate of 17 per cent with a supplementary reduced rate of 13 per cent and zero rate on exports (subject to export rebates); changing the much criticised presumptive crediting method to a credit-invoice method;64 allowing credits for input tax on intermediate goods; postponing the implementation of a fully unified VAT of consumption type; and maintaining a complementary excise tax on selected goods whose consumption the government wished to reduce. The retention of BT in parallel with the VAT was mainly because of the administrative difficulty of bringing a large number of small businesses outside the manufacturing sector as well as financial institutions into the VAT 61

World Bank, n 50 above, 8. State Council Circular on the Approval of the SAT Implementation Methods for Industrial and Commercial Tax System Reform, State Council Circular No 90, 25 December 1993. 63 World Bank, n 50 above, 47–57, 66, 71. 64 As early as in 1987, the credit method began to be used for allowed expense items at certain rates for enterprises. MOF Rules on Improving the VAT Collection Method (MOF, 20 March 1987, effective 1 January 1987). 62

Taxes in the Transition to Post-Socialist China 409 in the reform.65 Tax administration had a turbulent history in China and its development was behind the development of the tax system. From the late 1950s to the 1970s, tax administration was put in a marginal position, and during the Cultural Revolution, the number of tax bureaus was reduced considerably owing to the political view that taxation was an exploitative tool used in a capitalist economy.66 The SAT did not come into being until 1 June 1988 when the General Taxation Bureau under the MOF was taken out of MOF and its functions were placed with the newly formed SAT. The SAT was made a ministerial level central organ in the 1994 tax reform. Before the reform, although the SAT dealt with tax policy and drafted tax laws and regulations, it did not have a nationwide tax administration, and thus a large part of daily work of assessment and collection was performed by the provincial, municipal and county governments, causing difficulties for the central tax authority to effectively supervise tax administration at the local levels as well as win loyalty of the local collectors to the centre. As to the collection of turnover taxes, including the BT, a very complicated procedure was adopted and such complexity imposed unnecessary burdens on taxpayers in terms of paying taxes and complying with the relevant laws and regulations.67 Normally, taxpayers had first to visit the in-charge tax bureau for determining the appropriate rate for each business activity since there were multiple rates of the turnover taxes and taxpayers were not clear about the way of determining rates on their own. Tax assessment was done manually with little or no use of computers throughout most of the period from the 1950s. The administration of BT was rather demanding because of the sheer number of small businesses, which usually did not have appropriate accounting records. To ease the BT administration, a surcharge on the wholesale price of the goods that was counted for ‘business tax’ on behalf of retailers, was imposed on wholesalers in some regions. Another reason for keeping the bifurcation of BT and VAT in the reform was the need to provide certain revenue sources for local governments to fulfil their expenditure responsibilities. The 1994 tax reform established a formal tax sharing system and split tax administration into national and local levels.68 The BT was expressly assigned as a local exclusive tax in the 1994 tax reform, and the tax revenue excluding that from railroads, bank and insurance company headquarters was given to local governments.69 This was slightly different from the case prior to the reform when the revenues collected from the BT, along with the product tax and the VAT, was 65

World Bank, n 50 above, 49. ibid 329. 67 For detail of the turnover tax administration, see ibid 123. 68 State Council Resolution on the Application of a Tax-sharing Fiscal Administrative System in China, n 6 above. 69 The BT revenue from the railroads, bank and insurance company headquarters was assigned to the central government, ibid art 3(2). 66

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shared between the central and local governments, except certain revenues from the three sales taxes which were expressly allocated to the central government, such as the BT revenue from railroads, bank and insurance company headquarters, and offshore oil activities of foreign companies and joint ventures.70 Before the 1994 tax reform, unlike most other countries, the central government did not have a tax collection mechanism of its own as noted above, and thus it had to rely on local governments to collect taxes and remit tax revenues. This means that even though China offered little formal fiscal autonomy to local governments and there was no local discretion as to revenue sharing at the time, local governments had enjoyed de facto control over the fiscal system by using informal methods, such as providing preferential tax treatment for enterprises simply because they were responsible for implementing the fiscal and tax system. This type of decentralisation caused a number of problems, including, inter alia, reducing the transparency of the tax system and constraining the centre’s ability to reverse the declining tax-to-GDP ratio. With the 1994 reform, China’s national tax service for the first time began to have its own tax collection mechanism throughout the country, and to take control over the administration of central taxes and shared taxes, notably VAT (and Consumption Tax), that was previously in the hands of local governments. The BT, however, remained being administered by the local governments. The strengthening of central control in taxation has helped reduce the considerable divergence in tax administration across the country. The much simpler, more uniform and co-ordinated administration system has quickly improved tax collection results: the VAT has become the most important revenue source for the central government, whereas the BT is the largest tax revenue source for the local governments.71

Reform in 2009 and Further Reform from 2011 Onwards The VAT, BT and Consumption Tax were overhauled by the State Council as part of a large stimulus package to deal with the global financial crisis at the end of 2008. Revised regulations on the three taxes came into effect on 1 January 2009.72 The most significant change in the VAT was to allow input tax on purchases of equipment and other non-real property fixed assets to be credited against output tax. This can be seen as a step forward towards a consumption-type VAT like that usually applied in many other

70 71 72

World Bank, n 50 above, 86. ibid 8; Bahl, n 51 above, 8. See n 7 above.

Taxes in the Transition to Post-Socialist China 411 jurisdictions.73 The changes in the BT and Consumption Tax were made primarily for the purposes of accommodating the revisions made in the VAT. For example, one important change in the BT was to apply the destination principle to cross-border services. The 2009 reform did indicate policymakers’ willingness to eventually including the BT into the VAT net. The merger of the two taxes, as with many other reforms in China, was first trialled in some selected regions. Based on a series of rules issued by the MOF and SAT since November 2011, the first pilot reform was launched in Shanghai in the areas of transportation and other modern services, including research and development and technology services, information technology services and cultural and creative services.74 Under the pilot scheme, the national tax bureau in Shanghai was responsible for the collection and administration of VAT on pilot services. Taxpayers engaged in the pilot services were entitled to deduct their input tax from output tax provided they had a verified special VAT invoice or any other recognised invoice, such as an import memo from customs authorities.75 Two more tax rates, 11 per cent and 6 per cent, were provided for the transportation and other pilot services, respectively. The pilot reform scheme as a whole reduced the tax burden on the pilot service sectors, and was considered conducive to the development of the tertiary industry in China. Following the pilot reform in Shanghai, the State Council approved an expansion of the trial to eight provinces (and two municipalities).76 The 10 regions spread over Northern, Central, Eastern and Southern China. The total GDP of these regions was estimated to account for over 50 per cent of the total GDP of China in the first half of 2012.77 The framework of the Shanghai pilot was used for the new trialled regions, with some necessary fine-tuning.78 The expansion aimed to impact the overall economic development of the country from 2012. Based on the experience of the two-phase trial, the reform was made nationwide fairly quickly, only one year after the 2012 expansion. This, not surprisingly, proved to be too hasty, given that the trial in the selected regions created complexity in the implementation of the VAT and led to unequal treatment between taxpayers in pilot and non-pilot regions and pilot and non-pilot services, as well as an increase 73 For details, see Xu Yan, ‘China’s VAT Experience’ in Tax Analysts, The VAT Reader (Tax Analysts, 2011) 319–53. 74 MOF and SAT Notice (2011) No 111, 16 November 2011. 75 The special VAT invoices were adopted in the credit-invoice mechanism introduced in the 1994 reform for the purposes of preventing tax fraud and ensuring compliance with VAT laws. 76 See n 8 above. These regions are Beijing, Tianjin, Jiangsu, Anhui, Zhejiang, Fujian, Hubei, Guangdong, Xiamen and Shenzhen. 77 National Bureau of Statistics of China, GDP Growth in the First Half of 2012 (in Chinese) (13 July 2012), available at www.stats.gov.cn/tjfx/jdfx/t20120713_402817898.htm. For provincial GDP growth statistics in the first half of 2012, see the website of Enorth, available at http://economy.enorth.com.cn/system/2009/10/27/004250941.shtml. 78 MOF and SAT Notice (2012) No 71, 31 July 2012.

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in administration and compliance costs. The scope of trialled service types continues to expand,79 and it is anticipated that in the end, all service sectors, including the difficult-to-tax financial services and sales of residential houses, will be included within the final merged VAT. The pilot reform has been viewed by policy-makers, commentators and business leaders as a significant measure in further modernising and rationalising China’s consumption tax system, and importantly, it is regarded as an essential step to improve China’s industrial structure and to transform its economic development model to meet challenges from an ever-changing global economic environment. However, a nationwide reform involving the integration of BT and VAT is by no means easy or simple. The reform has involved a number of stakeholders, including the government, businesses of various type and size and final consumers. The reform will have a profound impact on the economy as it is directly and closely associated with the development of the secondary and tertiary industries in the economy. Perhaps most critically, the reform will significantly affect the fiscal relations between central and local governments in China.

IMPLICATIONS OF THE HISTORICAL CONSTRAINTS

The evolution of a pure VAT system in China is historically constrained by two principal factors; that is, the development of the economy and intergovernmental fiscal relations.

Pace of Economic Development There have been many tax reforms in China since 1949. The major reforms implemented before the adoption of the ‘reform and opening’ policy in late 1978 reflected the fundamental economic feature of the country at the time, that is, a state-owned, socially planned economy. The reforms from late 1978 onward have been characterised by a recasting of the nature of the economy into a hybrid economic system, with private ownership becoming increasingly significant. For a relatively long period of modern China, the government placed exceptional emphasis on the development of heavy industry, with the aim of enhancing the overall strength of the country after over 100 years of wars and humiliating semi-colonisation before 1949. The predecessors left the

79 MOF and SAT Notice on Including the Telecommunication Industries in the Pilot Reform (MOF and SAT No 43, 29 April 2014, effective 1 June 2014).

Taxes in the Transition to Post-Socialist China 413 country with an almost collapsed economy. Although the economy during the period of the Nationalist Party rule had entered into an early stage of modernisation and industrialisation, it was rather rudimentary and primitive. The new PRC government was determined to revamp the country and to distinguish its economy from what was seen as the decadence and depravity of the past systems. The particular history of the colonial period of rule by an absolute emperor and invading foreign powers, and later on of the Republic period of rule by a weak and fragile government heavily influenced by powerful foreign countries which adopted a so-called capitalist economy, made the government believe that a socialist system with a planned economy was the right direction for the development of the country and for the protection of its people. As a result, the government took significant efforts to massively transform most of the so-called capitalist (private) industrial and commercial entities into state-owned or collective-owned entities during the period from 1949 to 1956. The heavy industry sector, controlled by various government departments, was encouraged and supported by the government and became the pillar of the country’s economy. Its development was fostered at the expenses of other economic sectors in the pre-economic reform period. The government relied on enterprises, mainly the SOEs, to generate revenue. However, enterprise income tax did not come into being until 1980, and while there was no such tax, payment from the SOEs to the government did exist in the form of profits remittance. The government used a similar method to extract revenues from the agricultural sector in the countryside, but the importance of this sector had been on the decline in the economy. The agricultural sector, however, did make a critical contribution to the government revenue that was then used to finance heavy industrial development in the cities.80 To facilitate the socio-economic development and to finance the provision of public goods and services, the government had to use taxation to obtain revenues, especially before and during the early period of socialist transformation when the state-owned economy was yet to become the predominant part of the economy. However, it was not possible to rely on individual income taxation since the nature of the economy and the level of its development made it difficult, if not completely impossible, for ordinary people to earn

80 In the countryside, with the adoption of the ‘socialist transformation’ policy in 1953, China entered into a large-scale planned industrialisation with a particular focus on heavy industry. The economy was closed to international trade and investment, and the domestic economy was still underdeveloped. The government had to find a reliable source to finance the industrial development. Consequently, agriculture became a major resource for investments in the urban industrial sector. The government successfully transferred massive amounts of resource from the countryside to the urban sector by way of compulsory procurement and controlling the prices of surplus grain sold by peasants to the state, which were often lower than market prices. But sales of industrial goods back to the countryside were set at high prices by the government.

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high salaries and accumulate large amounts of wealth, and the government also deliberately chose a policy of low salary for workers. Although the Enforcement Guidelines of National Taxation issued in 1950 listed salaries tax in the types of tax to be applied nationwide, this tax was never applied before 1980 because of the very low level of average salaries of most workers and the consequent extremely narrow tax base. The essentially closed economy at the time also made it hard for the government to resort to customs tariffs for revenue purposes. As the industrial sector accounted for the largest proportion of the economy, consequently and naturally, turnover taxation on enterprises manufacturing, distributing and selling goods became the focus of the overall tax system. This focus had not been changed until recently. In the turnover taxation system during the early period of the new government, the product tax was applied to the industrial manufacturing enterprises as both a tool to extract tax revenue and a tool to adjust the profit margins of different enterprises. The BT was separately applied to the wholesale, retail and service sectors for a similar function. The separation remained only until 1958 when the two taxes were merged into a single turnover tax, CICT, applying to all industrial and commercial entities. The CICT was implemented until the 1984 tax reform after the adoption of the economic reform policy. This single tax on both goods and services was not designed to increase the efficiency of the turnover taxation system and solve the problems of the system, typically double taxation on taxpayers, but simply for simplification purposes that served the political view at the time. The role of taxation in the economy starkly diminished in the pre-1978 reform period. Although there was no crisis at the macro-economic level before the economic reform introduced in late 1978, the emphasis on the development of heavy industry drained investment from basic infrastructure, and the use of compulsory public procurement on peasants and the application of low sales prices of agricultural products sold by peasants to the state but high prices of industrial goods sold back to them put peasants in a disadvantageous position and contributed to the stagnation of agricultural development. The government’s strict price controls led to inefficient resource allocation, and shortages of consumer goods and housing were common.81 The economic decline caused by the Cultural Revolution eventually prompted the government to adopt the ‘reform and opening’ policy. The transformation from a command economy in which almost everything was determined by the government to a market economy in which market forces play a major role dramatically changed China’s economy and brought about the highest

81 Donald JS Brean, ‘Fiscal Reform in Modern China’ in Donald JS Brean (ed), Taxation in Modern China (New York and London, Routledge, 1998) 2.

Taxes in the Transition to Post-Socialist China 415 sustained rate of economic growth in the modern world to the country. During the economic transition, tax reforms are tightly intertwined with other economic reforms, notably the state enterprises and price reforms, and are affected by the progress in political and social dimensions. The previous single turnover tax, CICT, was regarded as incapable of meeting the economic development needs, and the cascading effect of the turnover taxation gave rise to excessive tax burdens and unequal tax treatment on taxpayers, mainly enterprises.82 Introducing a VAT like that applied in other jurisdictions was thought by the government to be a way to solve the problem. However, instead of applying VAT on all industrial and commercial sectors, the government broke down the single tax into three sales taxes: the product tax, the VAT and the business tax, according to the type of the objects of these taxes. The reason seems to be simple: it was unrealistic or impossible to have a wholesale implementation of VAT under the circumstances where all necessary modern institutions in a free market economy, such as price-setting and adjusting, banking and accounting, were still not in place. VAT was nevertheless introduced, as an experiment, on a limited range of goods. A dual-track sales tax system, combining the turnover type of product tax and the BT with a comparatively more conventional VAT, was thus adopted to avoid confronting radical change of the previous turnover taxation among manufacturing sectors as well as other sectors. The three sales taxes were used to perform the role in adjusting sectoral profitability differentials stemming from price distortions when the prices were still administratively set. The choice of a triangular sales tax system implies that the design of the tax system has to be in line with the overall nature of the economy, as well as broader structural changes in the economic system. When the Chinese government decided to adopt such a system, it was well aware of the resultant distorting effects of the divergent taxes on the production and distribution of goods and provision of services, but, as the economy was still in transition and a free market was yet available, it thought it would be more desirable to adopt a gradual approach rather than rashly altering everything. It was believed that this approach could allow economic agents to have time to gain experience in dealing with the new economic environment, and allow the government to avoid unnecessary consequences and threatening effects that might be caused by the changes.83 The VAT was formally introduced to replace the product tax in the 1994 reform after the government became more familiar with the application of the tax and the market economy was further developed to a more mature level. The replacement of the Product Tax by VAT also met the government

82 83

Liu, n 9 above, 67. Brean, n 81 above, 3.

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revenue needs. The 1994 VAT covered the most important economic sector— manufacturing—and applied to all entities engaged in manufacturing and distributing goods. The VAT was implemented on a production basis, as noted above, serving as the most profitable source of tax revenue, on the one hand, and on the other hand imposing an unduly excessive burden on taxpayers that was caused by the cascading effect of the production-type design. Theoretically, it would be more efficient if the VAT was extended to the service sector because a pure VAT of consumption type applying to all goods and services could alleviate the cascading effect, provide a neutral competitive environment and increase compliance and administrative efficiency, among other things.84 However, in reality, compared to the manufacturing sector, the development of China’s service sector started relatively late, and service providers were scattered and tended to be smaller in size. It would be more costly to substitute VAT for BT than to keep the BT for a temporary period. The choice of continuing the separation of the VAT and BT, and the choice of imposing a production-type VAT at the time, were presumably driven by the government thinking of the cost and benefit of the reforms: maximising the collection of tax revenue while keeping the collection and administration costs low. The production-type VAT was ultimately changed to a consumption-type VAT, though only partially, in the 2009 reform after a good development period of the market economy, and the VAT has begun to move towards a conventional VAT covering both the supply of goods and the provision of services. The BT is expected to fade away from the historical arena in the next few years. Although it is a rather lengthy process for China to fully implement the VAT, it is the case that successful tax reform does rely on sound development of economic foundations.

Intergovernmental Fiscal Relations VAT reforms in modern China are inextricably tied up with the changes in intergovernmental fiscal relationships. While China is a unitary state, the implementation of laws and regulations and the fulfilment of expenditure responsibilities on a daily basis have to be carried out by local governments. In the area of taxation, while the tax legislative power has long been highly concentrated on the central government, tax administration has largely been performed and influenced by local governments. Turnover taxes have always been the major taxes in the tax regime in modern China, and reforms in the turnover taxation system are inevitably affected by the fiscal relationships between the central and local governments. 84 Sijbren Crossen, ‘A VAT Primer for Lawyers, Economists, and Accountants’ in Tax Analysts, The VAT Reader (Tax Analysts, 2011) 23–51.

Taxes in the Transition to Post-Socialist China 417 Almost all tax reforms since 1949 have been accompanied by the change of fiscal powers between the central and local governments. During the initial period from 1949 to 1957, central control was tight and effective, but the strict centralisation reduced the fiscal autonomy of local governments and acted as a disincentive for local governments to boost productivity. Supported by the then Chairman Mao Zedong, fiscal decentralisation was introduced in the 1958 reform, together with the introduction of the CICT.85 Local governments, in particular those at the lower level, were given the discretionary power to provide exemptions, reductions and even increases of the CICT in administering the tax.86 The central government quickly recentralised its control in 1961, however. During the Cultural Revolution, the 1973 tax reform once again decentralised the fiscal power and the CICT was merged with all other taxes into a single tax applying to taxpayers. During the period from the commencement of the economic reform in late 1978 and the introduction of the tax reform in 1994, fiscal decentralisation was a continued feature of the public economic system, though it was not officially explicitly provided. Local governments, in particular provincial governments, enjoyed high autonomy in tax administration and even tax legislation to a certain degree. Notionally, the legislative power exclusively rested with the central legislature and the applicable regulations regarding taxes were issued by the executive branch of the central government via delegation. In effect, however, the provinces decided how the regulations were interpreted and implemented within their jurisdictions. As the central government had to rely on local governments to collect and administer taxes, it was not very strict with the approaches taken by the local governments in tax collection and administration so long as provinces delivered required tax revenues according to the planned quota set up by the central government.87 The analysis of the fiscal relationships between the central and local governments cannot be complete without taking into account the revenueexpenditure balance between them. Historically, central expenditures far exceeded central revenues and the gap had to be made up by transfers from the local to the centre, but very often the transfers were not enough to cover the shortfall. This imbalance between available revenues and expenditure responsibilities in the case of the central government became worse during the 1980s and early 1990s, a period characterised by fiscal decentralisation. This fiscal decentralisation constrained the central government’s ability to effectively implement tax policies and apply macro-economic management across the whole country. The 1994 tax reform was as a result designed to recentralise the fiscal power for the central government. The most profitable revenue source, the VAT, was designated as a shared tax with the central 85 86 87

Liu, n 9 above, 50–51. ibid 51. World Bank, n 50 above, 333.

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government taking a much larger share.88 As a compromise, the BT was assigned as a local tax, excluding the tax revenue from a few particular types of taxpayers. The fiscal recentralisation brought about by the 1994 tax reform has had a profound impact on intergovernmental fiscal relationships in China. The revenue balance has been changed to favour the centre, whereas the local governments have had to resort to other means to advance their own economic development agenda. Tapping the land resource for revenue has been a principal measure at the local levels in recent years, which has caused many problems that are beyond the tax regime. The alternative method of financing used by the local governments in effect led to de facto fiscal decentralisation.89 The 2009 VAT transformation that mainly aimed at moving towards a consumption-type VAT did not alter the revenue sharing system. The ongoing pilot reform in absorbing the BT into the VAT provides no de jure shifting of revenues on paper, though implicitly changes in the distribution of VAT revenues may have occurred. As studies have pointed out, future developments of the tax system will inevitably have intergovernmental implications.90 How the revenue from the integration of the BT and VAT is attributed across the levels of government will no doubt be a major question for the reformers. Even if the integrated VAT can be improved as a conventional consumption tax, a balanced fiscal relationship between the central and local government will not be likely to occur, unless the central governments can provide a reasonable revenue alternative, such as an enterprise income tax for local governments, and at the same time clarify the expenditure responsibilities between itself and local governments. Apart from the two primary factors, another historical constraint is worth noting, that is, tax administration. Tax administration had been performed manually across all levels of government until recent years in

88 Roy Bahl, ‘Central-Provincial-Local Fiscal Relations: the Revenue Side’ in Brean, n 81 above, 125–49. 89 As reported by various news reports, government analysis and academic research, property prices in many large cities in China, in particular Beijing, Shanghai, Guangzhou and Shenzhen, have soared to a level that is far beyond average people’s affordability. The skyrocketing increase in property prices is said to be, in a large part, driven by local governments’ attempt to extract revenues from selling land use rights. Speculation in property, illegal demolition of residential buildings, collusion between government officials and property developers for illegitimate interests, corruption from the process of land development, and protests against land selling, unreasonable compensation and losing of homes, as well as other problems associated with the land financing such as high local debts, are widespread and have become a very serious problem for the central government. Even though the tax legislation power is monopolised by the centre and its agencies, local governments can impose various fees and charges so long as they are not labelled as tax. Although the central government has released a number of orders regulating local governments’ practice in land financing, the implementation of those orders at the local level seems problematic and the effects remain limited. 90 Bahl, n 88 above.

Taxes in the Transition to Post-Socialist China 419 China. The information system was underdeveloped at the bottom level of tax administration before the 1994 tax reform and even up to today. Before the 1994 reform, unlike most other countries, turnover taxes were not calculated and paid by taxpayers, but determined with the active involvement of officials due to the concern that enterprises and other taxpayers were generally unable to make accurate returns under the previous complicated system. Under the circumstance of a large number of small businesses with the shortage of well qualified personnel, if the BT were absorbed into the VAT, it would be extremely difficult for the central tax authorities to administer the tax and check payments without the assistance of the computerised accounting system and information system. Leaving the administration and collection of the BT in the hands of local governments in the 1994 reform did help alleviate the pressures on the central tax authority, and local administration of the BT could increase the efficiency of the BT assessment and collection. At present, with the promotion of China’s service sector and with a more developed market economy, the number of potential taxpayers is likely to increase, which will add more pressures on tax administration, especially on central tax bureaus if the two taxes were incorporated into one in the ongoing VAT reform. Indeed, administrative feasibility should be taken into account when designing reforms and making laws and regulations.91 If computerised accounting and information systems can be widely and reliably developed across all levels of government in China, it will be possible to effectively implement an integrated VAT, and collect and check tax payments in a more timely and accurate fashion.

CONCLUSION

VAT has been widely adopted in industrialised and developing countries across the world. In China, it has taken a relatively long period of time for the government to adopt a conventional, consumption-type VAT and, at the present time, the process of integrating the tax on goods and the tax on services into a single VAT is still not completed. Why should a move towards an integrated VAT be so difficult? The story of VAT in China reflects the consequences of the political and socio-economic upheaval in the second half of the twentieth century for the country. The historical evidence shows that in China’s case, VAT reform was not simply a tax reform, but rather a cog in a much larger wheel of economic reform and resolution of complex fiscal federalism and political economy factors. The development level of tax administration is also a crucial factor in the process of making decisions and enforcing reforms. 91

World Bank, n 50 above, 131.

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As China’s economy has become more and more mature and tax administration has rapidly developed, the economic reasons for continuing a separated tax on services are diminishing. However, the ongoing reform has to effectively address the imbalanced fiscal relationships between the central and the local. In essence, this reform will not only have an impact on the fiscal and tax arrangements across all levels of government, but also fundamentally affect the distribution of political powers between different levels of government. Historical lessons cannot be ignored if this reform is to succeed.

14 David Hume: Philosophical Historian of Tax Law JOHN SNAPE*

ABSTRACT The riches of Hume’s philosophical history yield an account of the national experience of taxation in England. Hume’s hallmark is scepticism. Scepticism’s implications in the public finance context are examined in the first main part of the chapter. Central to England’s national experience, for better or worse, are lawyers and the law. Hume accordingly reflects on the function of law in relation to taxation and on the nature of taxes themselves. This is the basis of the Humeian theory of taxation: a discussion of its implications forms the second part of the chapter. One function of tax law is to complement property law, the latter being nearly coincident with justice, justice for Hume originating in public utility. Tax law and property are mutually reinforcing, the dominant expedient quality of tax depending upon the justice manifested by property. This is the next level of the theory and it is discussed in the third part. English history discloses political settlements broken by the consequences of failing to recognise the issues arising at each of these levels. Particular questions emerging from the wealth of Hume’s historical illustrations—the final level of his theory—are discussed in the fourth and last part.

INTRODUCTION History, the great mistress of wisdom, furnishes examples of all kinds; and every prudential, as well as moral precept, may be authorized by those events, which her enlarged mirror is able to present to us.1

* I would like to thank Dr Dominic de Cogan, University of Cambridge, for comments on a previous version. A conversation with Prof Jeremy Waldron, on his visit to Warwick in 2011, provided an important inspiration for this extended work on Hume. 1 D Hume, The History of England from the Invasion of Julius Caesar to The Revolution in 1688 (WB Todd (ed), Indianapolis, Liberty Fund, [1778] 1983) V:545. The Liberty Fund

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AVID HUME (1711–76), the Scottish philosopher and historian, is not usually thought of as an historically important philosopher of tax law.2 Nor is he generally reckoned to raise useful questions about taxation for today’s policy-makers. These accolades are usually reserved for Adam Smith, 12 years younger than Hume and a philosopher whose reflections on tax law and policy continue to compel attention. Yet Hume yields nothing to Smith as one of the most significant thinkers of the European Enlightenment. This chapter advances an argument for a reassessment of Hume’s contribution to tax law philosophy and of the relevance of Hume’s method of ‘philosophical history’ to the ways in which we think about taxation law and policy. A younger son of a Scottish lawyer and land-owner, Hume spent his life in a series of philosophical pursuits. He said that the ‘love of literary fame’ was the ‘ruling passion’ of his life.3 He estimated, at an early age, that he could live sufficiently frugally to enable him to pursue this passion without actually earning a living. As a young man, in the late 1730s, he published anonymously the work with which he hoped to fulfil this ambition, the Treatise of Human Nature.4 An attempt to state a sceptical philosophy of knowledge, passions and morality, its reception was a huge disappointment to him. Some people read it, but not many. Convinced of its merits, he tried again, in 1748 and 1751, with two Enquiries, one on ‘human understanding’, the other ‘concerning the principles of morals’.5 These works, which restated parts of the Treatise, were somewhat more successful. But they were not what made Hume famous in his lifetime. What did that were two other endeavours, the multi-volume History of England, published between 1754 and 1762,6 and three series of short essays, 40-odd in all, published between 1741 and 1752.7 In Hume’s 1752 essay, ‘Of Taxes’,8 in other essays, in parts of the Treatise and Enquiries, and especially in the History, can be discerned the elements of a distinctively historical theory of tax law. Evidently, edition has been used in writing this chapter. It is referenced below by volume and page number (eg, ‘Hume, History, n 1 above, I:112’) and is available, complete, at http://oll.libertyfund.org/ titles/1868. 2 See, eg H Groves, Tax Philosophers: Two Hundred Years of Thought in Great Britain and the United States (DJ Curran (ed), Madison, WUP, 1974) 15, where Hume is mentioned only in passing. But see A Miller and L Oats, Principles of International Taxation, 3rd edn (Haywards Heath, Bloomsbury, 2012) 7. 3 D Hume, ‘My Own Life’ in EF Miller (ed), Essays Moral, Political, and Literary (Indianapolis, Liberty Fund, [1777] 1987) xl. 4 D Hume, A Treatise of Human Nature, 2nd edn (LA Selby-Bigge and PH Nidditch (eds), Oxford, Clarendon Press, [1739–1740] 1978). 5 D Hume, Enquiries Concerning Human Understanding and Concerning the Principles of Morals, 3rd edn (LA Selby-Bigge and PH Nidditch (eds), Oxford, Clarendon Press, [1748/1751] 1975). 6 Hume, History, n 1 above. 7 Hume, Essays, n 3 above. 8 ibid 342–48.

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Smith recognised this and sought to build on it. In a contribution to an earlier volume, I argued for the relevance of Montesquieu to Smith’s thought on tax law.9 Hume was one of Montesquieu’s earliest British correspondents and this chapter seeks to develop the discussion of Montesquieu by interrogating Hume’s own attitude to tax law. What Hume offers is a philosophical account of a people’s historical experience of taxation. He does infinitely more than this, of course, but that experience of taxation is the concern of this chapter. The hallmark of this philosophical history is its scepticism and the general implications for public finance of this approach are examined in the first section below. According to this sceptical interpretation, at the centre of a nation’s experience of taxation are lawyers and the law. Hume accordingly reflects on the function of law in relation to tax and on the nature and scope of taxes themselves. A discussion of the implications of this, the first level of a Humeian theory of taxation, forms the second section below. One function of tax law is to complement property law. The latter, for Hume, is virtually synonymous with justice. The ‘sole origin of justice’ is not ‘a simple original instinct’ of mankind but the idea of ‘public utility’.10 Tax law and property law are mutually reinforcing, the predominantly expedient quality of the former depending upon the justice manifested by the latter. Indeed, tax and property form almost a whole interlocking system of rights and obligations. An examination of this second level of the theory constitutes the third section below. English history contains examples of whole regimes broken by the consequences of heedlessness to the issues arising at each of these levels. Particular questions that emerge from the wealth of Hume’s historical illustrations— the third and final level of his theory—are discussed in the final section.

PUBLIC FINANCE IN HUME’S PHILOSOPHICAL HISTORY

Hume’s historical writing has the avowed intent of providing a non-partisan account of the political struggles of the English nation. Tax has been central to these struggles. Of the works already mentioned, the two most relevant are the essay, ‘Of Taxes’, and the History of England. The context of each is the period after the destruction of the Jacobite army at Culloden in 1746, a time of industrial and commercial prosperity in Great Britain. Many urban Scots were intent on participating in the benefits of peace and becoming increasingly concerned about fiscal burdens.11 Both the essays, of which ‘Of Taxes’ is one, and the History, were designed to provide a basis for polite, 9 J Snape, ‘Montesquieu: “The Lively President” and the English Way of Taxation’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2012) vol 5, 73, 79 ff. 10 Hume, Enquiries, n 5 above, 183, 201. 11 A Herman, The Scottish Enlightenment: the Scots’ Invention of the Modern World (London, Harper Perennial, 2001) 56.

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urbane, historically informed discussion of important issues of politics and commerce, including public finance. Reinforcing this objective is a combination of irony and sentiment. In the process, Hume educates his readers to shun idealistic and simplistic solutions to the problems of government.

Contexts, Nature and Scope The rather slight 1752 essay ‘Of Taxes’ was one of a series of essays on politics and commerce that Hume published that year.12 In it, Hume reflects, over only about six pages, on contemporary tax law thinking. Within the essay are the discernible outlines of Smith’s celebrated maxims of taxation as expounded in the Wealth of Nations (1776).13 The History, by contrast with ‘Of Taxes’, is a vast work.14 Its constituent parts divide into epochs: volumes I and II deal with the period from earliest times to the death of Richard III; volumes III and IV cover the Tudors;15 and volumes V and VI assess the Stuart kings. The whole work closes with ‘the “settlement of the crown” on William and Mary’ in 1689.16 Especially in the later volumes, state finances are a constant preoccupation, many examples being adduced to illustrate aspects of the taxation maxims discussed in the 1752 essay. Occasionally Hume invokes public finance policies overseas to underline his arguments. In the background, the Treatise and the Enquiries, as well as other essays, also supply elements of this philosophical history of taxation. The nature, extent and scope of the 1752 essay and of the History lend themselves to Hume’s interpretative purpose. The 1752 essay examines the overarching question of whether increasing taxes makes labourers work harder without demanding higher wages.17 The History encourages reflection on the tax policy issues associated with this tenet of mercantilism,18 over many centuries, and in differing constitutional contexts. The 1752 essay, to our eyes, reads like an ancestor of a well-informed opinion piece in 12

‘Of Taxes’ was originally published in 1752 (see Hume, Essays, n 3 above, xiii). A Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (RH Campbell, AS Skinner and WB Todd (eds), Indianapolis, Liberty Fund, [1776] 1979) Book V, ch 2, 825–28. See WL Taylor, Francis Hutcheson and David Hume as Predecessors of Adam Smith (Durham, NC, DUP, 1965) Pt 2, ch 6. 14 Hume, History, n 1 above. The first complete edition, published in London in 1762, consisted of six volumes. The posthumous complete edition of 1778 was made up of eight (see G Slater, ‘Hume’s Revisions of the History of England’ (1992) 45 Studies in Bibliography 130, 131 n). 15 The use of ‘Tudor’, for ‘Tydder’ or ‘Tedder’, ‘as the label for a revolutionary political epoch’, was apparently Hume’s invention (see R Tombs, The English and Their History (London, Allen Lane, 2014) 145). 16 N McArthur, David Hume’s Political Theory: Law, Commerce, and the Constitution of Government (Toronto, UTP, 2007) 114, quoting Hume, History, n 1 above, VI:530. 17 Hume, ‘Of Taxes’ in Essays, n 3 above, 342. 18 Snape, n 9 above, 85. 13

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a quality newspaper. The History does not look at all like a work on public finance law. However, as already mentioned, the legal basis of financing the state is Hume’s constant preoccupation. It is history that is ‘the great mistress of wisdom’, in this area as in others. The relationship between the History and a book of tax statutes might, ironically enough, be compared to that between a Bible and a Catechism. The former authorises prudential and moral precepts through story-telling, the latter comprises the rules themselves. Throughout, Hume seeks to popularise his thought with a polite audience. It is for Hume the philosophical historian ‘to explore, through the writing of a historical narrative, [the] philosophical, political, and moral questions that’ lie at the heart of his earlier work.19 ‘I cannot but consider myself ’, he writes, ‘as a Kind of Resident or Ambassador from the Dominions of Learning to those of Conversation’.20 The Essays and the History are each designed to demonstrate ‘the science of men united in society and dependent on each other’.21 Readers thereby assimilate many ideas of the Treatise and of the Enquiries, especially as they relate to justice, in an accessible narrative form. Hume intended, moreover, to broaden the scope and nature of historical discussion in England. Mark Salber Phillips argues that, besides being a post-1688 ‘observer’, Hume wrote ‘from an essentially postclassical vantage’.22 Not only was Hume celebrated as comparable to ‘the best writers of continental Europe or even the greatest historians of antiquity’,23 he was also regarded as extending the scope of history, ‘beyond the military and political events that preoccupied historians in the classical tradition’, to ‘manners, commerce, and the history of the arts’.24 This, together with Hume’s scepticism, meant that nineteenth century historians tended to regard the History as nearer to ‘political economy’ and to philosophy than to history.25 Four Appendices discuss commerce, manners and— significantly—‘public’ or ‘crown’ revenue(s) or ‘finances’ at various periods.26 Appendix III, for example, deplores Sir William Cecil’s 1569 proposal ‘for levying a general loan on the people, equivalent to a subsidy’.27 Evident here is Hume’s attempt to replace, in historical writing, the reproduction

19 D Wootton, ‘David Hume: “The Historian”’ in DF Norton and J Taylor (eds), The Cambridge Companion to Hume, 2nd edn (Cambridge, CUP, 2009) 447, 452. 20 Hume, ‘Of Essay-Writing’ (1742) in Essays, n 3 above, 533, 535. 21 D Forbes, Hume’s Philosophical Politics (Cambridge, CUP, 1975) 91, quoted in S Buckle, Natural Law and the Theory of Property: Grotius to Hume (Clarendon Press, Oxford, 1991) 234, 250. 22 MS Phillips, On Historical Distance (New Haven, CT and London, YUP, 2013) 62. 23 ibid, 64; Smith, Wealth of Nations, n 13 above, II 692 n. 24 Phillips, n 22 above, 64. 25 ibid 62. 26 Hume, History, n 1 above, I:160, 455; IV:354; and V:124. 27 ibid IV:361.

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of long passages and the repetition of long-held ideological nostrums, with the empirical analysis of contemporary documents.28 Hume’s sources tend, however, to be antiquarians’ printed transcriptions, not the original documents.29

Deliberative Tax Politics in Polite Society Hume’s approach is thus designed to enable people to evaluate tax law and policy through discussion. ‘Though men be much governed by interest’, he says, ‘yet even interest itself, and all human affairs, are entirely governed by opinion’.30 This echoes certain words of Thomas Hobbes in Behemoth.31 Hume deploys a secular (not, as is sometimes asserted, an ‘atheistical’) social theory.32 The ancient ‘immunity’ of the Druids ‘from wars and taxes’ awakes Hume’s concern, based as it was on the fear occasioned by ‘the terrors of their religion’.33 Yet, consistent with his secular social theory, Hume seems only moderately sceptical, not radically so.34 His scepticism extends to what he sees withal as Hobbes’ dogmatic rationalism.35 The chief exception to it, an area in which even Smith had his doubts, is commerce. Commerce, for Hume, is the source of all public utility. His viewpoint, deliberately foregrounding the present in contrast with the past, depicts a gradual awakening of commerce.36 He speaks, for example, of ‘the inaccurate genius of the old constitution’,37 in contrast to the excellence of his contemporary one.38 In the 1370s, Windsor Castle was built, not by parliamentary taxes, but by forced labour, (something) which ‘may serve as a specimen of the condition of the people in that age’.39 Fortifications, nowadays, would be constructed with cash raised by parliamentary taxes. In Georgian England, ‘the English [have] … happily established the most perfect and most accurate system of

28

VG Wexler, David Hume and the History of England (Philadelphia, PA, APS, 1979) 13, 20. Hume’s account of Cecil’s proposal relies on a printed collection of the antiquarian Samuel Haynes (c 1701–52) (see Hume, History, n 1 above, IV:361 n (App III), citing S Haynes (ed), A Collection of State Papers, relating to Affairs in the Reigns of King Henry VIII, King Edward VI, Queen Mary, and Queen Elizabeth (London, Bowyer, 1740) 518–19). 30 Hume, ‘The British Government’ (1741) in Essays, n 3 above, 51 (also, ‘Principles of Government’ (1741) in ibid 32), as cited and referenced in Phillips, n 23 above, 70. 31 M Loughlin, ‘The Political Jurisprudence of Thomas Hobbes’ in D Dyzenhaus and T Poole (eds), Hobbes and the Law (Cambridge, CUP, 2012) 5, 20, citing T Hobbes, Behemoth (F Tönnies and S Holmes (eds), Chicago, IL, CUP, [1682] 1990) 16. 32 Buckle, n 21 above, 247. 33 Hume, History, n 1 above, I:5–6. 34 Buckle, n 21 above, 247. 35 Hume, History, n 1 above, VI:153. 36 Phillips, n 22 above, ch 3; Hume, History, n 1 above, V:276. 37 Hume, History, n 1 above, V:207. 38 ibid VI:140; Phillips, n 22 above, 71. 39 Hume, History, n 1 above, II:276. 29

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liberty that was ever found compatible with government’.40 An increased sense of the utility of justice means a greater understanding of taxes over time. Generally, political discussion among merchants refines a sense of liberty. By acquiring ‘a share of the property’, traders ‘draw authority and consideration to that middling rank of men, who are the best and firmest basis of public liberty’.41 Smith praises Hume for what he regards as the latter’s unique emphasis of the point.42 Hume himself notes that ‘[t]rade was never esteemed an affair of state till the last century; and there scarcely is any ancient writer on politics, who has made mention of it’.43 Suppression of discussion is dangerous, as when, in 1674, Charles II tried by proclamation to suppress even the coffee-houses.44 With discussion comes responsibilities, though. People must be realistic. The need to reject the simplistic schemes of ‘projectors’ is illustrated by the Commonwealth.45 The Puritans had plans for simplifying and then theocratising English law.46 These misguided people, of course, abolished the Exchequer’s excellent accounting system.47 Puritan dominance of the ‘preposterous assembly’ that was the ‘Barebones Parliament’48 even made Oliver Cromwell ‘ashamed of his legislature’, an assembly fit only for ‘amusing the populace and the army’.49 Instead of simplistic projects, two questions must always be asked: with institutions, the question must be: ‘What is established?’; with policies, it must be: ‘What is best?’50 Talking about tax and tax history also tends to keep controversy away from sectarian allegiances. Hume seeks to characterise ‘the great article, on which the house of commons broke with the king’51 as being the naval tax of tonnage and poundage, rather than a rival kind of Protestantism, as favoured by modern historians.52 Nonetheless, Hume notes that, in 1629, the ‘enquiries and debates’ in the House of Commons ‘concerning tonnage and poundage went hand in hand with … theological or metaphysical controversies’.53 Sceptical as Hume was about Hobbes, this provides a point of 40

ibid II:525. Hume, ‘Of Refinement in the Arts’ (1754/1760) in Essays, n 3 above, 268, 277. 42 Smith, Wealth of Nations, n 13 above, I, 412. 43 Hume, ‘Of Civil Liberty’ (1741/1758) in Essays, n 3 above, 87, 88, quoted in Phillips, n 22 above, 88–89. 44 Hume, History, n 1 above, VI:296. 45 ibid VI:153. 46 ibid VI:4; VI:61. 47 ibid V:500. 48 ibid VI:60–62. 49 ibid VI:63. 50 ibid IV:354 (App III), quoted in A Sabl, Hume’s Politics: Coordination and Crisis in the History of England (Princeton, NJ, PUP, 2012) 1. 51 Hume, History, n 1 above, V:207. 52 B Worden, The English Civil Wars 1640–1660 (London, Weidenfeld and Nicolson, 2009) 8. 53 Hume, History, n 1 above, V:214. 41

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contact. For Hobbes, ‘[t]heological questions seep into questions of political authority’.54 Phillips highlights the fact that, to assist with discussion and reflection, Hume departs from a definition of history ‘as a narrative of public actions’ and instead catalogues opposing political views.55 This is important, as it betokens the idea of debate and deliberation, rather than rule alone, as the essence of politics. To this end, for example, Hume summarises in detail the arguments put for John Hampden MP in the 1637 Case of the Ship-money (R v Hampden).56 This imparts a humane quality to political discussions. Hume’s chief stylistic weapons, as Phillips explains, are irony and sentiment. ‘[S]entiment and irony constitute complementary movements in Hume’s construction of distance [Phillips writes]: the one bringing history forward into virtual contemporaneity, the other returning the past to a time of its own.’57 It is irony that illuminates the tax controversies of the Civil Wars. The ship-money that had helped to bring down Charles I, nonetheless built the glory of the Commonwealth’s sea-power. England’s magnificent warships, constructed with the proceeds of the tax, were more than a match for the Dutch fleet in 1653.58 By contrast, the Puritans’ efforts at government, in the ‘Barebones Parliament’, were ridiculous. Their Instrument of Government, of the same year, with its unselfconsciously ironic taxation articles,59 was ‘a motley piece’ of work.60 When the Puritans boast ‘that they had employed only four days in drawing this instrument … [t]here appears no difficulty in believing them [says Hume]; when it is considered how crude and undigested a system of civil polity they endeavoured to establish’.61 It is sympathy that invites us to commiserate with Charles I’s resentment: the failure of Parliament to vote him the duties of customs, his ‘becoming a slave of his insolent, ungrateful subjects’.62 The execution of Charles I, with which volume V closes, is a moment of real pathos.63

LAW, PREROGATIVE AND PUBLIC FINANCE

Just as lawyers have not shunned participation in England’s political struggles, so law has historically shaped political outcomes. Central to Hume’s 54 T Poole, ‘Hobbes on Law and Prerogative’ in D Dyzenhaus and T Poole (eds), Hobbes and the Law (Cambridge, CUP, 2012) 68, 86–87. 55 Phillips, n 22 above, 71. 56 Case of the Ship-money (R v Hampden) (1637) 3 St Tr 825. 57 Phillips, n 22 above, 77. 58 Hume, History, n 1 above, VI:50. 59 Instrument of Government 1653 recital 6, art 30 (reprinted in SR Gardiner, Constitutional Documents of the Puritan Revolution 1625–1660, 3rd edn (Oxford, Clarendon Press, 1906) 405). 60 Hume, History, n 1 above, VI:68. 61 ibid VI:64. 62 ibid V:211. 63 ibid V:540–42.

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contextual, deliberative, historical and realistic discussion of public finance is a conception of its relationship with law and royal prerogative and of the role of lawyers relative to each. Taxation has a number of characteristics that distinguish it from other forms of public finance. Tax law forms part of ‘the civil science’, of ‘political law’ or ‘public law’,64 promoting a public interest formed by an emerging public utility and shaped not mainly by justice but by expediency.

Law, Prerogative and Lawyers Never an advocate, Hume had nonetheless studied law, albeit unenthusiastically, for three of his teenage years.65 His emphasis on lawyers and law invites two observations. First, law and its varieties tend to be discussed by Hume in contradistinction to royal prerogative. Lawfully containing the prerogative, that is, subjecting to law the unfettered pre-eminent discretion of the monarch to act unilaterally for the public good,66 was the seventeenth century’s greatest political cause. Like Hobbes, but unlike John Locke,67 Hume evidently regarded the nature of the prerogative to be too well known to admit of comprehensive description and analysis.68 With Hobbes, but in much more detail,69 Hume accumulates instances of prerogative being relied on to levy against property in the persons, labour or other possessions70 of subjects. Like Hobbes, too, his writing is attuned to the paradox of prerogative. For Hume, as for Hobbes, ‘[s]overeign authority flows through law but prerogative power is needed to institute law’ in the first place.71 Secondly, and concomitant with the paradoxical nature of prerogative, Hume understands the importance of the precise usage of technical legal expressions to law’s effectiveness.72 In the Enquiries, having concluded, from ‘the writers on the laws of nature’,73 that ‘the ultimate reason for every rule which the laws of nature establish’ is ‘the convenience and necessities

64

See Loughlin, n 31 above, 68. EC Mossner, The Life of David Hume, 2nd edn (Oxford, Clarendon Press, 1980) 62; J Robertson, ‘Hume, David (1711–1776)’ in Oxford Dictionary of National Biography (Oxford, OUP, 2004), available at http://o-www.oxforddnb.com.pugwash.lib.warwick.ac.uk/ view/article/14141. 66 J Locke, Two Treatises of Government (P Laslett (ed), Cambridge, CUP, [1690] 1960) 375. 67 ibid, ‘Second Treatise’, ch 14. 68 But see Sabl, n 50 above, 275. 69 Poole, n 54 above, 72. 70 Hume, History, n 1 above, V:42. 71 Poole, n 54 above, 89. 72 See, eg (among many), Hume, History, n 1 above, I:60; I:458; II:30; II:90; II:206; II:297; III:4–5; III:39; III:165; III:338; IV:11–12; and V:208. 73 Hume, Enquiries, n 5 above, 29. 65

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of mankind’,74 Hume notes the importance in ‘positive law’75 of analogical reasoning and of ‘very slight connexions of the imagination’.76 Lawyers latch on to ‘[t]he slightest analogies’, he says, ‘in order to prevent that indifference and ambiguity, which would be the source of perpetual dissension’.77 It is in this way, for example, that ‘first possession, is supposed to convey property, where no body else has any preceding claim and pretension’.78 It is thus, too, that the utilitarian justification for positive law is underscored. ‘Property’, and therefore justice, does not relate to the physical resource in relation to which legal rights subsist, but to the legal rights themselves.79 This last point is consistently embodied in Hume’s account of political interactions in the History. Thus, when describing James I’s 1604 Peace Treaty with Spain, Hume recounts how ‘the king had expressly reserved the power of sending assistance to the Hollanders’.80 Again, in discussing Parliament’s voting of supply to Charles I in 1628, Hume recounts that Parliament voted tonnage and poundage ‘only for a year; and, after that should be elapsed, reserved to themselves the power of renewing or refusing the same concession’.81 Conversely, and in a different context, in 1601, Parliament granted Elizabeth I ‘a supply quite unprecedented, of four subsidies and eight fifteenths’.82 In each case, the language encapsulates the effect of the interaction relative to law.83 Parliament reserves a power from the Crown84 and, likewise, Parliament grants the Crown supply. Civil law may relate to the constitution of the state, as public law, or regulate relationships between subjects, as private law.85 Civil law, together with martial law,86 is one of two constituent categories of positive law. Elizabeth I, ruling at a period before Parliament had definitively asserted its privileges, was addicted to martial law.87 This is why Hume emphasises that the Court of Star Chamber, established in ‘the most remote antiquity’, had jurisdiction only ‘in civil matters’.88 The ‘common law’ is the form that private law takes in England and it provides a counter to public law. It is certainly true to say that Hume is suspicious of those who have denounced the common law, not

74

ibid 195. ibid 202, 308. 76 ibid 195–96. 77 ibid 196. 78 ibid. 79 Hume, Treatise, n 4 above, 310. 80 Hume, History, n 1 above, V:23. 81 ibid V:208. 82 Hume, History, n 1 above, IV:347. 83 ibid I:203. 84 ibid. 85 See, eg Hume, History, n 1 above, VI:120. See FA Hayek, ‘The Legal and Political Philosophy of David Hume’ in VC Chappell (ed), Hume (London, Macmillan, 1968) 335, 356. 86 Hume, History, n 1 above, V:181. 87 ibid IV:357. 88 ibid V:126. 75

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only Hobbes,89 but also the low-born Puritanical members of the Barebones Parliament.90 Given the distinctiveness of law and also the forms that it might take in practice, the circumstances in which it operates are crucial to its effectiveness. This is because, as mentioned, ‘prerogative power is needed to institute law’. For instance, the Commons imposed a strict requirement on Henry IV to account in 1412 but it was only the fleeting exigencies of the moment that allowed them to exercise this power over him.91 Likewise, reflecting on Anglo-Saxon England, Hume concludes that ‘in all extensive governments, where the execution of the laws is feeble … [the power of injuring other people] naturally falls into the hands of the principal nobility; and the degree of it which prevails, cannot be determined so much by the public statutes, as by small incidents in history, by particular customs, and sometimes by the reason and nature of things’.92 This infirmity of law illustrates the paradox of the prerogative referred to above. ‘The possibility of overwhelming and unconstrained force, concentrated in the sovereign’s hands, is what allows law to be law.’93 It is thus that the History authorises its prudential and moral precepts, furnishing examples of events that have drained law of its effectiveness. The cumulative effect of the prominence of laws and of lawyers, of the different forms that laws may take and of the circumstances of their creation, mean that laws invite lawyers’ manipulation. Hume does not idealise laws. He recognises the ills that they can wreak as well as the good. The particular skill of Henry VII, especially in relation to matters of public finance, was the manipulation of civil law. ‘While he [Henry VII] depressed the nobility, he exalted and honoured and caressed the lawyers [says Hume]; and by that means both bestowed authority on the laws, and was enabled, whenever he pleased, to pervert them to his own advantage’.94 Two lawyers who were particularly favoured and who assisted Henry VII in this process were Edmund Dudley (c 1462–1510) and Sir Richard Empson (c 1450– 1510). ‘By their knowledge of law [says Hume], these men were qualified to pervert the forms of justice to the oppression of the innocent; and the formidable authority of the king supported them in all their iniquities.’95 This manipulation included public law, as shown by the 1539 statute ‘by which the parliament confirmed the surrender of the monasteries’ to the Crown.96 ‘The surrender of the great monasteries was under way’, explains

89

Poole, n 54 above, 77. Hume, History, n 1 above, VI:61. 91 ibid II:347. 92 ibid I:173–74. 93 Poole, n 54 above, 95. 94 Hume, History, n 1 above, III:49. 95 ibid III:67. 96 ibid III:268; 31 Hen VIII c 13 (‘An Act for the Dissolution of Abbeys’) 3 Statutes of the Realm 733; FC Dietz, English Government Finance 1485–1558 (London, Frank Cass, 1964) I, 117. 90

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a modern historian, ‘and needed retrospective parliamentary sanction’.97 In addition to the Preamble to the 1539 Act’s mendacious and tyrannous claim that the surrenders were ‘without constraint, of their own accord, and according to due course of common law’ (Hume is paraphrasing the text here),98 ‘the two houses [of Parliament] confirm[ed] the surrenders without demur, and secure[d] the property of the abbey lands to the king and his successors for ever’.99 Henry VIII knew, says Hume, ‘that a surrender made by men, who were only tenants for life, would not bear examination; and he was therefore resolved to make all sure by his usual expedient, an act of parliament’.100 What facilitates the manipulation of laws, says Hume, are ‘inaccuracies’ in the laws and constitution. The brevity and clarity of Magna Carta 1215101 is economically praised by Hume as being ‘in opposition to the chicanery of lawyers, supported by the violence of power’.102 For many centuries, the ‘inaccuracy’ of laws, in terms of their nature and scope, had been a major obstacle to a ‘free and legal constitution’.103 Particular monarchs had themselves made guileful contributions to these ‘inaccuracies’. In a statute of 1541,104 for instance, Henry VIII introduced such ‘a confusion and contradiction into the laws’ that ‘he became more master of every one’s life and property’.105 Property, indeed, is the first casualty of such bad laws. Constitutional inaccuracies, likewise, enabled monarchs to abuse the device of the proclamation. Under the Stuarts, proclamations were used to extract forced loans from subjects.106 Moreover, the fact that the judges long held their offices ‘at pleasure’107 was sufficient to ensure that they connived at this legal manipulation.108 Thus, the judges in R v Hampden109 could be relied upon to find the tax was lawful,110 just as they had found that in certain circumstances proclamations were constitutional.111 For Hume, then, law in its varieties is central to any idea of political order. The History’s emphasis on law means, says Neil McArthur, that ‘[i]t is … not

97 MAR Graves, The Tudor Parliaments: Crown, Lords and Commons, 1485–1603 (London, Longman, 1985) 66. 98 Hume, History, n 1 above, III:269. 99 ibid III:269. 100 ibid III:269. 101 ibid I:442. 102 ibid I:445. 103 ibid V:207. 104 It is unclear what statute Hume is referring to here. 105 Hume, History, n 1 above, III:287. 106 ibid V:244. 107 See JS Hart, Jr, The Rule of Law, 1603–1660: Crowns, Courts and Judges (Harlow, Pearson, 2003) 70–74. 108 Hume, History, n 1 above, VI:493. 109 R v Hampden (1637) 3 St Tr 825. 110 Hume, History, n 1 above, V:245. 111 ibid V:296; Case of Proclamations (1610) ER 1352.

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outlandish to suggest that at least a generation of Britons gained a significant portion of their knowledge of English law from Hume’.112 We learn which laws are good and which are not from seeing how they have actually worked. They are capable of being manipulated, something facilitated by their historical weaknesses.

Taxes and Other Forms of Public Finance Hume does not himself use the language of ‘indirect’ versus ‘direct’ taxes but he does occasionally classify them in other terms. Before around 1660, subsidies and fifteenths or tenths were the main form of parliamentary taxation,113 thereafter quota taxes by assessment. Henry II was the first king to charge ‘a tax on the moveables or personal estates of his subjects, nobles as well as commons’. This tax, says Hume, becomes, ‘in following reigns, the usual method of supplying the necessities of the crown’.114 In fact, Hume notes that, when the Commons voted Charles II four subsidies, in 1663, ‘this was the last time that taxes were levied in that manner’.115 Taxation under the Commonwealth, which was idiosyncratic, included the excise originally introduced by both sides in 1643.116 The range of public finance expedients other than taxing and borrowing attests man’s ingenuity though not, alas, his prudence. Consistently with the disutility of the feudal order, public revenue under Anglo-Norman monarchs included bribes.117 In Henry VIII’s reign, it comprehended the revenue of ecclesiastical sees deliberately left vacant. Especially under James I and Charles I, public revenue included the sale proceeds of titles and of Crown lands granted away. In James I’s reign, Sir Robert Cecil ‘invented’ the title of Baronet specifically to grant it at a fee.118 At various times, public revenue has included fines,119 not least for encroachments into arbitrarily extended forest.120 Elizabeth I and Charles I took fees for granting monopolies on the manufacture and sale of even basic commodities.121 With the

112 N McArthur, ‘David Hume and the Common Law of England’ (2005) 3 Journal of Scottish Philosophy 67. 113 Hume, History, n 1 above, V:38; V:137; Smith, Wealth of Nations, n 13 above, I, 394, 394 n, on the nature of tenths and fifteenths. 114 Hume, History, n 1 above, I:374. 115 ibid VI:187. 116 ibid VI:146; MJ Braddick, The Nerves of State: Taxation and the Financing of the English State, 1558–1714 (Manchester, MUP, 1996) 99. 117 Hume, History, n 1 above, I:479 (App II). 118 ibid V:57. 119 ibid I:78; I:173; I:175 (difference between fines and taxes). 120 ibid V:236–37. 121 ibid V:231.

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counter-intuitive exception of Richard III, pre-1688 monarchs accepted ‘free’ gifts122 called ‘benevolences’ from numbers of their grateful subjects.123 Many monarchs took the benefit of the enforced public service with which some numbers of their subjects were burdened.124 Kings and queens also benefited from distraining on the goods of subjects imprudent enough to refuse the conferring of a knighthood.125 Post-Reformation, monarchs accepted payments under compositions made with Catholics.126 Not only Elizabeth I,127 but also Oliver Cromwell and the Protectorate128 benefited from a share of the treasure captured by victorious English admirals. Kings accepted tribute from lesser sovereigns, not least those whom they had vanquished. Egbert, perhaps the first king of England, took tribute from the king of Northumberland after 829 CE.129 Edward IV had the benefit of a promise of tribute from Louis XI, king of France, or so Henry VII told Parliament in 1491.130 Nor have these expedients been exhaustive. There were others, too, such as compositions with, or forfeiture of the property rights of, those ‘possessed of [former] crown-lands upon defective titles’.131 Whilst paying taxes is compulsory, the making of loans (other than forced loans) is voluntary. Public borrowing is nevertheless improvident from the state’s point of view.132 A soldier who volunteered for foreign service during Elizabeth I’s reign was not thereby being taxed.133 Neither were the Puritan supporters of Parliament who, in June 1642, carried their precious metal and plate to Parliament’s treasury at Westminster.134 Nor yet were foreign lenders to the English Crown down the ages. The payer of a forced loan was paying a tax, however, non-voluntarily foregoing interest on the sums advanced and often losing them altogether. Those pressed into military service or forced to billet soldiers were also paying a tax.135 Purveyance and pre-emption were other ‘methods of taxation, unequal, arbitrary’ and ‘oppressive’.136 Purveyance was the forced supply of provisions to the court when the monarch made a progress.137 Pre-emption was the enforced sale of goods or land to the Crown at unfavourable prices. Henry I succeeded 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137

ibid V:84. ibid V:57. ibid V:93. ibid V:230; V:232. ibid V:201; V:229; V:230; V:236. ibid IV:186. ibid VI:83. ibid I:50 (Hume dates this at 827 CE). ibid III:38. ibid V:230. Hume, ‘Of Public Credit’ (1752) in Essays, n 3 above, 349. Hume, History, n 1 above, IV:149. ibid V:383. ibid V:93; V:126; V:180. ibid IV:362. ibid II:31.

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in restraining and moderating the demands of purveyance. Hitherto, Hume tells us, farmers and their families fled into the woods on hearing ‘of the approach of the court’, rather than submit to ‘the insults of the king’s retinue’.138 Purveyance ‘had been expressly guarded against by the Great Charter itself ’139 and its levying was one of the ‘arbitrary prerogatives’ that Richard II was accused of exerting. Henry V’s revenue was so ‘slender’, however, that he had to retain it. Parliament had to submit ‘to it as a legal prerogative’, contenting itself ‘with enacting laws to limit and confine it’.140 Abolition of purveyance was finally successful under the Commonwealth,141 but there were several unsuccessful attempts beforehand.142 It is odd that to be a purveyor is now usually seen as a mark of distinction.143 Civilian service, too, could amount to a tax, as illustrated by ‘the burthen of … repairing highways … building and supporting bridges’, which the AngloSaxons equated with ‘the burthen of military expeditions’ within the trinoda necessitas.144 Much later, as mentioned, Edward III imposed a tax paid in labour in the construction of Windsor Castle. ‘Instead of engaging workmen by contracts and wages, he assessed every county in England to send him a certain number of masons, tillers, and carpenters, as if he had been levying an army.’145 The problem was with benevolences, since these were in no realistic sense a ‘free-gift’ to the Crown.146 Taxes, formerly paid to both an universal church and a national state, are now paid solely to the state and to its national church. The ancient constitution, whatever it was, did not preclude papal and other church taxes, most importantly tithes. Tithes were introduced into England, so Hume tells us, by Aethelwulf in about the year 850 CE.147 The occasion of this innovation, according to Hume, was an opportunity taken by acquisitive ecclesiastics, just at the moment ‘when a weak, superstitious prince [Aethelwulf] filled the throne’ and when his people, ‘terrified’ by the Danes, were ‘susceptible of any impression, which bore the appearance of religion’.148 During the Reformation, which was not the beginning of doubts about church taxes, Henry VIII extinguished papal taxes.149 Subsequently, Henry VIII, Edward VI and the Restoration Parliament all had crucial historical roles in shaping

138

ibid I:274. ibid II:381. 140 ibid II:381. 141 ibid VI:159. 142 ibid V:21. 143 ibid IV:272. 144 ibid I:182 (App I). This is yet controversial (see GT Dempsey, ‘Legal Terminology in Anglo-Saxon England: the Trimoda Necessitas Charter’ (1982) 57(4) Speculum 843). 145 Hume, History, n 1 above, II:276. 146 ibid V:57; V:84; V:111 n. 147 ibid I:61. 148 ibid. 149 ibid III:196; III:199. 139

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domestic ecclesiastical taxation.150 The Commonwealth simply thought tithes, some of which had ‘passed into the hands of laymen’ in the reign of Henry VIII,151 ‘a relict of Judaism’.152 Taxes are constitutional impositions of government. Otherwise, says Hume, they are ‘extortion’153 and intrinsically unjust.154 Parliamentary taxes are unquestionably constitutional, though they may not be prudent. Non-parliamentary taxes may nonetheless be lawful feudal incidents.155 Many species of feudal due emerge from the pages of the History, including ‘talliages’;156 ‘homage, reliefs [and fines], wardship’; ‘marriage’;157 leases of papal revenues; forfeitures; escheats;158 and (already mentioned) benevolences.159 Feudal dues were a customary incident of tenure.160 Custom, something for which Hume had great respect, was a good enough constitutional warrant in these cases.161 Henry I, for example, ‘was intitled to levy a tax for the marrying of his eldest daughter, and he exacted three shillings a hyde on all England’.162 Even kings were obliged to pay homage, for instance, when they had possessions within the jurisdiction of other kings.163 Edward I ‘did homage to Philip [of France] for the dominions which he held in France’.164 Fines were payable on the alienation of estates,165 although Henry VII suspended them in return for parliamentary supplies granted in 1491.166 Forfeitures were levied for treason, as in the case of Sir William Stanley, who was executed in 1494 for assisting Perkin Warbeck’s rebellion of 1492.167 Wardship was a particularly valuable feudal incident.168 Constitutional questions constantly resurfaced around tonnage and poundage and as to whether it was a parliamentary or prerogatival tax.169 Parliament voted it to Henry V for life, after the battle of Agincourt,

150

ibid VI:195. ibid III:256. ibid VI:61. 153 ibid III:444. 154 ibid V:186–7. 155 ibid II:72. 156 ibid II:77. 157 ibid I:182. 158 ibid II:78. 159 ibid III:37. 160 ibid III:196 (Statute of Uses 1536, which, inter alia, prevented avoidance of feudal dues via the device of the ‘use’, which was a forerunner of the modern trust). 161 Hume, Enquiries, n 5 above, 44. 162 Hume, History, n 1 above, I:494. 163 ibid II:89. 164 ibid II:75. 165 AWB Simpson, A History of the Land Law, 2nd edn (Oxford, Clarendon Press, 1986) 138, 211. 166 Hume, History, n 1 above, III:39. 167 ibid III:47–48. 168 ibid V:21; V:45. 169 ibid V:207. 151 152

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in 1415.170 It even did the same with both Richard III, in 1484,171 and Henry VII, in 1485.172 But it would not similarly oblige Charles I in the 1630s except on the time-limited basis already referred to. Charles II was only granted tonnage and poundage ‘during life’.173 Indeed, Charles II was in financial difficulties from the start, because he had inherited the debts of the Commonwealth.174 A tax is necessarily intended for a political purpose. Henry VII levied taxes for other reasons.175 In Henry VII’s reign, ‘parliament gave into the snare prepared for them’ by the king and granted supplies for a war against France, ‘[i]nflamed by the ideas of subduing France, and of enriching themselves by the spoils of that kingdom’.176 The purpose of fighting the French was always popular.177 The snare was that Henry had no real intention of going to war at all. He was merely raising money to satisfy his ‘ruling passion’, that of ‘avarice’.178 Such avarice, indeed, was the proximate cause of the Cornish uprising of 1497.179 Mary I, by contrast, needed to raise revenue merely to fund the Spanish monarchy, a kind of tribute demanded by her husband, Philip II.180 So did the Duke of Alva in the Spanish Netherlands in 1570.181 For her part, Elizabeth I respected the political purpose principle.182 So, oddly, did Charles I, with ship-money, although this did not do him or his tax much good.183 That a political purpose may itself be flawed is illustrated by the case of Danegelt, since the money originally offered to the Danes was a hostage to fortune. Thus, when in 1068, William re-imposed Danegelt, he incurred opprobrium because Danegelt ‘had always been extremely odious to the nation’ before its abolition by Edward the Confessor.184 It was left, so Hume says, to Henry II to abolish Danegelt once and for all.185

170

ibid II:367. ibid II:513. 172 ibid III:12. 173 ibid VI:159. 174 ibid VI:534. 175 ibid III:38. 176 ibid III:39. 177 ibid II:484. 178 ibid III:37. 179 ibid III:55–56; T Penn, Winter King: the Dawn of Tudor England (London, Penguin, 2012) 30–31. 180 Hume, History, n 1 above, III:444, 445. 181 ibid IV:155. 182 ibid IV:181. 183 ibid V:235. 184 ibid I:196; B Abraham, ‘Danegeld—from Danish Tribute to English Land Tax: the Evolution of Danegeld from 991 to 1086’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2013) vol 6, 261. 185 Hume, History, n 1 above, I:374. 171

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It is not essential that taxes are paid in cash: they may be paid in goods and services or otherwise in kind. Hume highlights the fact that the benefit to the Crown is not confined to a cash receipt, as for a forced loan where no or a low rate of interest is payable. Indeed, the History discloses that the payment of taxes in cash took a while to develop.186

Tax Law and Tax Prerogative Political law, or public law, relates to the constitution and administration of the state and therefore to ‘the relations of “politic bodies” … especially of the rights and duties of sovereigns and subjects’.187 The jurisprudence within political law is, as Martin Loughlin argues, the original civil science of Hobbes.188 In the History, Hume refers to public law and ‘political law’. Thus, contrary to Whig myth, Magna Carta ‘introduced no new distribution of the powers of the commonwealth, and no innovation in the political or public law of the kingdom’.189 Hume’s political law is informed by Hobbes, while being less all-embracing, in denying a Hobbesian ‘original contract’190 and acknowledging the reality of a pre-political justice that survived the institution of political society. Hume’s political law, like Smith’s, is relatively lightly rehearsed. It is associated by Friedrich von Hayek with Hume’s use of the expression ‘laws of society’.191 The highest achievement of political, or public, law is a ‘legal constitution’,192 one whose ‘inaccuracies’ have been removed or very nearly removed.193 As a ‘scientific Whig’194 and philosophical historian, Hume opines that ‘[i]t is ridiculous to consider the English constitution before’ the ‘Reigns of the two first Stuarts as a regular plan of liberty’.195 Whilst the constitutional element of political law relates to the ordering of political society, the administrative one regulates the provision of public goods. Whilst ‘[t]wo neighbours may agree to drain a meadow’, ‘political society’, and hence government and public law,

186

ibid I:278; I:374; I:380. Loughlin, n 31 above, 7. 188 ibid. 189 Hume, History, n 1 above, I:487; McArthur, n 16 above, 107. 190 Hume, ‘Of the Original Contract’ (1748) in Essays, n 3 above, 465. 191 Hayek, n 85 above, 356. 192 Hume, History, n 1 above, VI:38. 193 ibid V:43. 194 N Phillipson, David Hume: The Philosopher as Historian (London, Penguin, [1989] 2011) 21. 195 Hume, Essays, n 3 above, xxxviii; I:319 (irregularity of Thomas à Becket’s fate); I:469 (App II) (post-1066 constitution simply modelled on Normandy). ‘Those who, from a pretended respect to antiquity, appeal at every turn to an original plan of the constitution, only cover their turbulent spirit and their private ambition under the appearance of venerable forms’ (Hume, History, n 1 above, II:525). 187

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is needed to raise ramparts and build harbours.196 Even under the feudal law,197 the revenue of the king, and the soldiers and weapons that it buys,198 are the key to the stability of the realm. European sovereigns have generally been weak but not so a king of Anglo-Norman England, since ‘[h]is demesnes and revenue were large, compared to the greatness of his state’.199 Nonetheless, the feudal law rendered it ‘impracticable’ for a king ‘to levy taxes sufficient for the pay of numerous armies’.200 Private law, by contrast, the law that authorises by convention the enforcement of the promise to drain the meadow, or justifies and protects each neighbour’s possession of a field in the first place, is pre-political in its origin.201 Private law cannot function without political law202 yet, in preserving and promoting justice,203 private law functions as a strong bulwark to the ‘licentiousness’ and potential for ‘tyranny’204 of the Hobbesian civil science. With Hobbes, property might just become the ‘plaything of public law’; with Hume property is protected by private law.205 The primary characteristic of public law, for Hobbes, is not justice but ‘expediency’. Public law is not amenable to the same exacting rules of justice as are most areas of private law: the ‘acquired rights’ created by public law are ‘political’, and ‘it is this factor which has militated against the development of public law into a system on a par with other branches of law’.206 Public law relies on ‘reason of state’, the same reason animating the residual concept of the prerogative. While ‘[r]easons of state’ are not, as counsel argues in R v Hampden,207 ‘topics of law’,208 constitutional developments have nonetheless placed some areas of prerogative within a framework of public law. Prerogative exertions must be sparing or they may subvert the very laws that rely on prerogative for their effectiveness.209 Prerogative, as Thomas Poole writes, had various branches.210 The dispensing power, ‘by which’, as Hume described it in relation to Elizabeth I, ‘all the laws could be invalidated, and rendered of no effect’ was regarded as 196

Hume, Treatise, n 4 above, 538–39. Hume, History, n 1 above, I:362; I:455 n (citing Montesquieu). ibid I:374; II:230; Smith, Wealth of Nations, n 13 above, Book V, ch 2, 708. 199 Hume, History, n 1 above, I:298. 200 ibid I:457. 201 J Waldron, ‘“To Bestow Stability upon Possession”: Hume’s Alternative to Locke’ in J Penner and H Smith (eds), Philosophical Foundations of Property Law (Oxford, OUP, 2013) 1, 12. 202 ibid. 203 DD Raphael, Concepts of Justice (Oxford, Clarendon Press, 2001) 94–95. 204 Hume, History, n 1 above, VI:153. 205 Waldron, n 201 above, 2. 206 K Haakonssen, The Science of a Legislator: the Natural Jurisprudence of David Hume and Adam Smith (Cambridge, CUP, 1981) 102, 127–28. 207 R v Hampden (1637) 3 St Tr 825. 208 Hume, History, n 1 above, V:247. 209 ibid V:244. 210 Poole, n 54 above, 85. 197 198

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particularly objectionable.211 Expedient but unjust, the various branches of prerogative could only have been tolerated in feudal times.212 Dating at least from the reign of Henry III,213 and directly opposed to the interests of commerce because it made property ‘precarious’,214 the dispensing power was ‘a branch of prerogative, incompatible with all legal liberty and limitations’, which is why its abolition in the Bill of Rights 1689 marked ‘the acquisition of real liberty’.215 Historically, public finance was a key area in which the prerogative operated, although parts of the prerogative were also the basis for ‘the power of imprisonment’.216 Forced loans, benevolences, ‘pressing and quartering soldiers … [and] erecting monopolies’ were all, says Hume, examples of prerogative power.217 Elizabeth I exercised the prerogative to the exclusion of Parliament in matters of taxation. Altering customs duties also fell within the scope of the prerogative,218 an expedient deployed by, among others, Mary I and James I.219 Other examples of the prerogative were Charles I’s compositions with Catholics220 and his conferring of enforced knighthoods.221 Tax law, in common with public law in general, is concerned to ‘promote public interest’.222 Private law, by contrast, endures to promote the conventional interest223 that is justice. Taxation, as public law, complements the private law of ‘justice and … separate property’.224 Private and public interests, private and public law, are locked in a reciprocal relationship in which the private relies on the public for its strength and in which the public is restrained by the private. ‘Does any one scruple, in extraordinary cases [asks Hume], to violate all regard to the private property of individuals, and sacrifice to public interest a distinction, which had been established for the sake of that interest?’225 Prerogative, therefore, instantiates law. The willingness of ministers to work for the public interest is one of the greatest blessings that political society can instill. Hume regards Edward Hyde, first Earl of Clarendon (1609–74) as an outstanding example.226 Others, of earlier ages,

211

Hume, History, n 1 above, IV:363. ibid VI:472. 213 ibid. 214 ibid I:484:II:86. 215 ibid VI:476n; Smith, Wealth of Nations, n 13 above, I, 540. 216 Hume, History, n 1 above, V:126. 217 ibid V:126. 218 ibid V:126. 219 ibid V:42. 220 ibid V:176. 221 ibid V:230; V:232. 222 Hume, Enquiries, n 5 above, 192–93; D Jackson, ‘Thomas Hobbes’ Theory of Taxation’ (1973) 21 Political Studies 175. 223 Waldron, n 201 above, 11. 224 Hume, Enquiries, n 5 above, 186. 225 ibid 196. 226 Hume, History, n 1 above, VI:164, 215. 212

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such as Sir William Cecil, first Baron Burghley (1520–98), merely further the private interest of their prince,227 and in so doing, their own. The public interest is about public utility228 and it is thus ever more clearly discerned and understood over time. The same is true of justice, which concerns private utility. Justice does not evolve: it is merely more clearly perceived and valued ‘over time as its utility becomes evident’.229 Justice is best served if tax law interferes only minimally in property rights and only for the useful ends of political society. When writing analytically of property,230 Hume generally uses the idiom of ‘property in’ or ‘property of ’.231 In neither case, as has been mentioned, does ‘property’ refer to the resource itself but to rights in relation to it. Thus, when arguing with Aethelwulf for possession of the tithe, the ‘priest-hood’ claims to have inherited from ‘the Jewish law’ property in ‘a tenth of all the produce of land’.232 This right is justice, that is, property in the tithe. Like allegiance to government233 and keeping one’s promises,234 justice is an ‘artificial virtue’, one that will not last long outside political society.235 It is expressed by present convention and ‘acquires force … by our repeated experience of the inconveniences of transgressing it’.236 Property comprehends not only property in land or in chattels but in oneself.237 ‘Slavery and injustice’238 are the result when this does not obtain. This is illustrated by Hume’s paraphrase of the words of Hampden’s counsel on ‘artificial ties’:239 It was urged by Hambden’s council, and by his partisans in the nation, that the plea of necessity was in vain introduced into a trial of law; since it was the nature of necessity to abolish all law, and, by irresistible violence, to dissolve all the weaker and more artificial ties of human society.240

Justice is most plainly recognised in the understandings of commercial society. The ancient Britons, ‘whose sole property was their arms and their cattle’, perceived this only dimly.241 Likewise, the Anglo-Saxons. The subjects of one kingdom could not assist those of another against the Danes, their own property and families being exposed in their absence.242 It was 227 228 229 230 231 232 233 234 235 236 237 238 239 240 241 242

ibid IV.126. Hume, Enquiries, n 5 above, 192. Buckle, n 21 above, 265. See, eg Hume, History, n 1 above, VI:260. ibid V:195 ibid I:60. ibid VI:38. Hume, Treatise, n 4 above, 516. Waldron, n 201 above, 12. Hume, Treatise, n 4 above, 490, quoted in Buckle, n 21 above, 254. Hume, History, n 1 above, V:190. ibid VI:266. ibid V:246. ibid V:246. ibid I:5; I:175. ibid I:58.

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part of King Alfred’s achievement that he ultimately succeeded ‘in composing the minds of men to industry and justice’.243

COMMERCE, PROPERTY AND TAX LAW

The effectiveness of law, for Hume, depends on its facilitating commerce and hence maximising public utility. Legislating for raising taxes, which is not exempt from these imperatives, requires the legislator’s prudent balancing of expediency with justice. To weigh these virtues successfully in turn demands devotion to certain key principles. A discussion of the principles, which emerge from Hume’s 1752 essay, ‘Of Taxes’, forms the culmination of the fourth section below. It is necessary first, though, to deepen various aspects of the discussion so far. The role of law in facilitating commerce, taking account of the special issues raised by taxes, is discussed first. This is followed by an analysis of how parliamentary taxes may conduce to public utility better than prerogatival or feudal taxes. The elements of this discussion are then tied together, to show the precise nature of the link between property and taxation. The establishment in 1688/1689 of a British state in which liberty is seen in terms of property and the centrality of law to that liberty is to be seen as a major achievement. This forms the basis of the discussion of the principles in the 1752 essay.

Commerce and Property Positive law, as the embodiment of justice, has a pivotal role. Law is more effective in commercial societies than in feudal ones. The justifications for taxes relative to property are thus placed at the centre of public debate. Law, and the practice of law, facilitates commerce. Hume does not use the concept of ‘the market’ to denote an impersonal aggregate of economic interactions.244 Like Montesquieu, he instead focuses on individual commercial transactions underlining thereby the importance of law as regulation. When Montesquieu introduces the theme of commerce in The Spirit of the Laws,245 he does so by invoking the Muses, which emphasises the interpersonal, almost sensual, nature of commercial transactions.246 In a similar way, Hume does not refer to ‘the economy’ but only to ‘economy’ or ‘oeconomy’ as a person’s capacity for something akin to household management. 243

ibid I:70. But see, eg Hume, History, n 1 above, V:139. Montesquieu, The Spirit of the Laws (AM Cohler, BC Miller and HS Stone (eds), Cambridge, CUP, [1748] 1989) 337. 246 TL Pangle, Montesquieu’s Philosophy of Liberalism: A Commentary on The Spirit of the Laws (Chicago, IL, University of Chicago Press, 1973) 202. 244 245

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Although Hume describes William the Conqueror as ‘naturally a great economist’,247 this is to characterise William’s domineering assimilation of the kingdom to his household. Again, so Hume avers, ‘[t]he great undertakings, which … [Elizabeth I] executed with so narrow a revenue, and with such small supplies from her people, prove the mighty effects of wisdom and economy’.248 Moreover, although commentators speak of Hume as having written about ‘political economy’,249 Hume himself does not use the expression. Rather, it is commerce that he regards as the significant category. As already mentioned, King Alfred’s encouragement of ‘men of activity to betake themselves to navigation, to push commerce into the most remote countries, and to acquire riches by propagating industry among their fellow-citizens’ is what teaches his subjects ‘to respect the virtues of justice and industry, from which alone they could rise’.250 Without an abundance of these pursuits and attributes, men have ‘no aliment for their inquietude [in Montesquieu’s terms], but wars, insurrections, convulsions, rapine, and depredation’.251 The positive law that is basic to commerce embodies justice only to the extent that implementing justice is itself consistent with promoting the public interest. Property is coincident with justice and the origin of property is private utility. If resources such as land were superabundant, there would be no need for property in them, and justice would be superfluous.252 Again, property would be superfluous if resources were finite, but no-one felt any ‘more concern for his own interest than for that of his fellows’.253 Yet again, if resources became extremely scarce, and ungenerous people insisted on personal preservation to the exclusion of all others, justice and property would need to be ‘suspended’.254 In each hypothetical situation, justice would have no public utility. None of these hypotheses for Hume has been an historical reality, with the result that ‘mutual protection and assistance’255 have ensured the ‘merit and moral obligation’ of justice and property.256 Circumstances are all-important and, as mentioned, private interests are always subject to the public interest.257 Property in resources must accordingly be shaped in accordance with the latter. 247

Hume, History, n 1 above, I:221. ibid IV:373; A Smith, Lectures on Jurisprudence (RL Meek, DD Raphael and PG Stein (eds), Indianapolis, IN, Liberty Fund, [1762–1763; 1766] 1982) 266 (demesnes). 249 See, eg IS Ross, ‘The Emergence of David Hume as a Political Economist: a Biographical Sketch’ in C Wennerlind and M Schabas (eds), David Hume’s Political Economy (London, Routledge, 2008) 31, 34–35. 250 Hume, History, n 1 above, I:81; V:147; Smith, Wealth of Nations, n 13 above, II, 589. 251 Hume, History, n 1 above, I:82. 252 Hume, Enquiries, n 5 above, 183. 253 ibid. 254 ibid 186. 255 ibid 215. 256 ibid 188. 257 ibid 196. 248

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The relationship of Hume’s theory of property to his theory of taxation law is apparent next to Buckle’s elucidation of Hume’s theory of property.258 The very fact that Hume seeks to explain the individual’s duty to act justly makes him ‘a contributor to natural law social theory’.259 This duty is part of ‘the constitution of the human passions, which are themselves the mainsprings of all human action’.260 Recall here that Henry VII was ruled by the passion of avarice. Hume’s ‘central concern … is with the source of virtuous action’,261 however, and public utility is the key to the social virtues.262 Reliance on public utility avoids the need for Hume, as a sceptical social theorist, to look for ‘final causes’.263 Moreover, utility is no ‘abstract principle’, but is ‘necessarily’ reflected in social institutions, ‘because only such [practical] considerations are efficacious in ordinary life’.264 Though not a rationalist philosopher,265 Hume stresses ‘the superior rationality of human practice’, which is entirely ‘conformable’ to natural law.266 This rationality is, however, different from the expediency deployed by the sovereign. Justice is ‘founded in reason and reflection’,267 a process that clarifies the great advantages of ‘securing to people the fruits of their industry’.268 The fulfilment of promises, and hence contracts, also depends on this conception of justice, as Knud Haakonssen explains, since property in a resource cannot be transferred by delivery when that resource is distant from the transferor.269 Contract (and also inheritance) enables the transmission of rights in the creation of which the state—that is, political society—is fundamentally implicated. That Hume was a natural law social theorist of property may seem surprising to those aware of his scepticism of the syllogisms of scholastic natural law. However, as Buckle says, a number of the older readings of this scepticism are to an extent mis-readings.270 Government requires capacity to act and, according to Hume, capacity is founded more on public opinion than on interest,271 the former being essential for the promotion of utility. Opinion, as mentioned, is formed by public discussion.272 This assessment involves a rejection of Locke’s version 258

Buckle, n 21 above, ch 5. Hume, Enquiries, n 5 above, 234. ibid 235. 261 ibid 247. 262 ibid 239. 263 ibid 243. 264 ibid 254. 265 Hume, History, n 1 above, VI:153; Smith, Wealth of Nations, n 13 above, I, 16; Hayek, n 85 above, 338. 266 Hume, Enquiries, n 5 above, 255, 262. 267 ibid 270. 268 ibid 287. 269 Haakonssen, n 206 above, 29. 270 Hume, Treatise, n 4 above, 469–70; Buckle, n 21 above, 283; J Finnis, Natural Law and Natural Rights, 2nd edn (Oxford, Clarendon Press, 2011) 36 ff; Hume, History, n 1 above, IV:27 (syllogisms and artillery). 271 Phillips, n 22 above, 70–71. 272 Hume, History, n 1 above, V:248. 259 260

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of the social contract. Loughlin explains how and why Hume disagrees with Locke in this respect. Hume: argued that even if the origins of government were rooted in some notion of contract, this cannot provide the foundation for legitimate political authority since, once government is established, its will can be imposed without regard to the people’s consent. Hume’s point is that the question of the origins of government must be differentiated from that of the source of its authority. For Hume, political obligation is not grounded in contract but rests firmly on the foundation of utility.273

This is consistent with Hume’s specific disapproval of the Lockeian part of Francis Hutcheson’s theory of property.274 For Hume, the conjunction of interest and opinion which supports political society was illustrated in England by the parliamentary representation of the boroughs.275 So long as commerce was only incipient (as in Saxon times) the boroughs remained impoverished and insignificant, and it appeared ‘nowise probable they would be admitted as a part of the national councils’.276 Once the boroughs became commercial, however, the opinions of their citizens became crucially important. Positive law is thus more effective in commercial society than in feudal society. Far from being an ordering of political society, the feudal was chaotic.277 Feudal taxes are for this reason problematic. The circumstances in which taxes are levied are all-important. Unlawful impositions are, by definition, not taxes but extortion. Law and liberty are inimical to discretion and inquisition,278 and that is why taxes are obligatory rather than discretionary. The constitution improved by the events of 1688 and 1689 is one in which the removal of the inaccuracies already referred to has minimised the need for sovereign discretion.279 Chief among these inaccuracies has been the dispensing power, its continued existence incompatible with an age in which a people’s sense of justice has become clearer.280 With the progress of commerce and a sensitisation to justice, the need for taxes to be appropriately conceived and designed becomes ever greater. The History therefore directs its readers’ attention to the relationship between the justice of property and the expedient of taxation. Hume says that levying even £100,000 ‘can produce greater effects on’ Bavaria, for example, ‘than on England’,281 while he instances the Duke of Alva’s intended 1571 turnover

273 M Loughlin, Sword and Scales: an Examination of the Relationship between Law and Politics (Oxford, Hart Publishing, 2000) 170. 274 Hume, History, n 1 above, VI:533 n; Taylor, n 13 above, 151. 275 Wexler, n 28 above, 84. 276 Hume, History, n 1 above, I:164. 277 ibid V:556; Smith, Wealth of Nations, n 13 above, II, 854. 278 Hume, History, n 1 above, V:125; V:126; V:177; V:236. 279 ibid VI:166 (V:208); VI:389 (V:159; V:194). 280 ibid VI:473. 281 ibid I:184.

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tax in the Spanish Netherlands as ‘an absurd tyranny, which would not only have destroyed all arts and commerce, but even have restrained the common intercourse of life’.282 The 1752 essay, likewise, canvasses questions such as the point at which taxes become too high to bear.283 Informed discussion of this type of issue was impossible in former ages, when such levies simply had to be borne.284 Whilst Hume’s earliest readers may not have engaged, for example, with his comments on the yields from customs duties in the reign of Henry VII,285 they may well have done so with his attempts to quantify the public revenue at different periods of history.286 Early lawyer readers, including Lord Boyle of Shewalton,287 would have engaged with those tax law issues connected with major historical events. Eighteenth century readers could thus have discussed the part played by Alva’s planned tax in the 1571 revolt of the Spanish Netherlands.288 In contrast, they might also perhaps have reflected on the fact that Charles I’s ship-money was not too onerous and had beneficial long-term national consequences.289

Parliamentary and Non-parliamentary Taxation Parliamentary taxation emerges as the least-worst form of public finance.290 It is, says Hume, the ‘regular and constitutional expedient for supply.291 When isolating such taxation from the other ways of financing the state, Hume discloses some important differences between parliamentary and prerogatival and feudal levies. These cover the constitutionality of parliamentary taxes, the purposes for which the proceeds are applied, the significance of their compulsoriness and the reasonableness of tax exemptions. First, parliamentary taxes are unquestionably constitutional, whereas non-parliamentary taxes are not.292 Richard II, though ultimately deposed in 1399, was entirely innocent of imposing new non-parliamentary taxes.293 Henry VIII, by contrast, made an unconstitutional attempt to impose the

282

ibid IV:155. Snape, n 9 above, 85; Hume, History, n 1 above, III:479. 284 ibid. 285 Hume, History, n 1 above, IV:372 n; III:77. 286 See, eg ibid V:135. 287 MRM Towsey, ‘“Patron of Infidelity”: Scottish Readers Respond to David Hume, c 1750–1820’ (2008) 11 Book History 89, 90–93. 288 Hume, History, n 1 above, IV:155. 289 ibid V:235. 290 ibid V:167. 291 ibid V:167; II:106 (Edward I). 292 Magna Carta, art 12; Hume, History, n 1 above, I:443; I:470 (App II). 293 ibid II:318. 283

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non-parliamentary ‘Amicable Grant’ of 1525.294 No matter how effectual or beneficial the non-parliamentary tax may be, what will seem important to the populace will be its arbitrary unconstitutionality. Ship-money again provides an example: As England had no military force, while all the other powers of Europe were strongly armed, a fleet seemed absolutely necessary for her security: And it was obvious, that a navy must be built and equipped at leisure, during peace; nor could it possibly be fitted out on a sudden emergence, when the danger became urgent: Yet all these considerations could not reconcile the people to the imposition. It was entirely arbitrary: By the same right any other tax might be imposed: And men thought a powerful fleet, though very desirable, both for the credit and safety of the kingdom, but an unequal recompence for their liberties, which, they apprehended, were thus sacrificed to the obtaining of it.295

Here and elsewhere, Hume’s use of ‘arbitrary’ conveys the sense of a tax’s discretionary nature, for sure, but also of its non-experiential foundation and its injustice as being contrary to natural law.296 Contrariwise, the mere fact of a tax being a parliamentary one can be dramatic in its effect. Hume the scientific Whig is gleefully sceptical297 of the ancient constitution.298 He strips ‘bare the myths of the victors’ of 1688.299 While acknowledging faith in the ancient constitution has been an historical reality,300 Hume instead rests the significance of parliamentary taxes on their requirement for the consent301 of the people’s representatives and their status as ‘voluntary grants’.302 The Commonwealth therefore possessed the ability to raise taxes to unprecedented levels.303 Something of this spirit was maintained after the Restoration, given the large grant to Charles II in 1668.304 Secondly, parliamentary taxes are intended to be applied for political purposes, whereas non-parliamentary taxes may not be. Though it is far from certain that political purposes will conduce to public utility,305 yet it is perhaps more likely than not that they will do so. It was the Commons that had refused supply to Mary I and her credit was so poor that she could 294 ibid III:160; GW Bernard, War, Taxation and Rebellion in Early Tudor England: Henry VIII, Wolsey and the Amicable Grant of 1525 (Brighton, Harvester Press, 1986), passim. Hume does not refer to the Amicable Grant as such. 295 Hume, History, n 1 above, V:235. 296 ibid IV:155. 297 JGA Pocock, The Ancient Constitution and the Feudal Law: a Study of English Historical Thought in the Seventeenth Century, 2nd edn (Cambridge, CUP, 1987) 376. 298 Hume, History, n 1 above, IV:362. 299 Phillips, n 22 above, 63. 300 Hume, History, n 1 above, V:42. 301 Hume, Treatise, n 4 above, 514; P Langford, A Polite and Commercial People: England 1727– 1783 (Oxford, OUP, 1989) 31, 55. 302 Hume, History, n 1 above, VI:234. 303 ibid VI:13. 304 ibid VI:247. 305 ibid V:500.

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not borrow from Antwerp without a suretyship from London.306 This is a lesson that the Dutch had learnt by the late 1660s. ‘Though their trade had suffered extremely [in their war with England], their extensive credit enabled them to levy great sums; and while the seamen of England loudly complained of want of pay, the Dutch navy was regularly supplied with money and every thing requisite for its subsistence.’307 But obtaining this ‘extensive credit’ requires a regular constitution. In James I’s reign, the constitution ‘was … an inconsistent fabric, whose jarring and discordant parts must soon destroy each other, and from the dissolution of the old, beget some new form of civil government, more uniform and consistent’.308 Hume recounts an example of James I’s tendency to apply his revenue for private purposes: One day, it is said, while he [James] was standing amidst some of his courtiers, a porter passed by, loaded with money, which he was carrying to the treasury. The king observed, that Rich, afterwards earl of Holland, one of his handsome agreeable favourites, whispered something to one standing near him. Upon enquiry, he found, that Rich had said, how happy would that money make me! Without hesitation, James bestowed it all upon him, though it amounted to 3000 pounds. He added, You think yourself very happy in obtaining so large a sum; but I am more happy, in having an opportunity of obliging a worthy man, whom I love. The generosity of James was more the result of a benign humour or light fancy, than of reason or judgment. The objects of it were such as could render themselves agreeable to him in his loose hours; not such as were endowed with great merit, or who possessed talents or popularity, which could strengthen his interest with the public.309

A king of the mettle of Alfred might apply ‘his own revenue’ wisely,310 but unwise application is far more likely to obtain. The Commons distrusted Charles I, for instance, as to how he had spent the supplies that he had been granted.311 For all of these reasons, Hume conceives of deliberation as being crucial to supply, even though down the ages the principle has been notably traduced. ‘Parliamentary accountability’, as we would call it, is the hinge on which the conferring of terrible aberrations or great benefits can turn. Aethelwulf, a king ‘better qualified for governing a convent than a kingdom’,312 provides a ninth-century example. Lacking wise councillors, Aethelwulf is overborne by self-serving and inconsistent arguments of the clerics, who not only ‘get possession of the tythes’ but pretend ‘to

306 307 308 309 310 311 312

ibid III:443; III:445. ibid VI:207–8. ibid V:59. ibid V:136–37. ibid I:81. ibid V:270–71. ibid I:57.

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draw the tenth of all industry, merchandize, wages of labourers, and pay of soldiers’.313 On the other hand, Duke William of Normandy, as Hume relates, realised the benefits of deliberation: The states of the dutchy [ie Normandy] were assembled at Lislebonne; and supplies being demanded for the intended enterprise, which promised so much glory and advantage to their country, there appeared a reluctance in many members, both to grant sums so much beyond the common measure of taxes in that age, and to set a precedent of performing their military service at a distance from their own country.314

The benefits of a parliamentary disposition to public purposes might even facilitate a rebate from the Crown if those purposes are not in fact carried out. When Parliament granted a fifteenth to Edward IV in 1475, to fund a military expedition to France, ‘[t]he money levied by the fifteenth was not to be put into the king’s hands, but to be kept in religious houses; and if the expedition into France should not take place, it was immediately to be refunded to the people’.315 Thirdly, if parliamentary taxes are voluntary grants, then non-parliamentary taxes involve at best a fiction of voluntariness. This matters, since, for taxes to be compulsory, and therefore non-discretionary, is essential to Hume’s philosophy. He elaborates this point in relation to customs and benevolences and to the whole nature of taxation before 1688. Forced loans and monopolies were tolerated by the ancient constitution,316 even ‘though [they were] diametrically opposite to all the principles of a free government’, as being of highly questionable voluntariness.317 Benevolences are characterised by Hume in the context of the reign of Edward IV as ‘a kind of exaction, which…, though the consent of the parties was pretended to be gained, could not be deemed entirely voluntary’.318 Odd, then, that benevolences were abolished by a statute of Richard III in 1484,319 only to be reintroduced without parliamentary consent by Henry VII in 1491.320 If a levy is not compulsory, then it is not strictly a tax and the question remains whether, when exacted, it is anything other than extortion. This matters for the legal constitution and stability of property321 that for Hume is essential to the flourishing of commerce.

313

ibid I:61. ibid I:152. ibid II:484. 316 ibid V:42. 317 Smith, Wealth of Nations, n 13 above, II, 926. 318 Hume, History, n 1 above, II:484. 319 ibid II:513 (see 1 Rich III c II, 2 Statutes of the Realm 478 (‘An Act to free the subject from benevolence’)). 320 ibid III:37 (but see III:50). 321 Hume, Treatise, n 4 above, 514, 526 (latter quoted in McArthur, n 16 above, 107). 314 315

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Fourthly, parliamentary taxes are more likely to be levied for the right reasons,322 non-parliamentary taxes for the wrong ones. Parliament’s ‘privilege’ is the counterweight to the prerogative of the monarch,323 which means that, without an effective Parliament, the people’s property, both in their resources and their persons, is utterly vulnerable.324 Henry VIII threatened to take off the head of Edward Montague MP for opposing a Bill for supply in the Commons.325 Cardinal Wolsey, the Lord Chancellor, in levying the Amicable Grant, ‘plainly’ told the ‘citizens of London that: it were better … some should suffer indigence, than that the king at this time should lack; and therefore beware and resist not, nor ruffle not in this case, for it may fortune to cost some people their heads.326

For effectiveness, the legislature’s lodestar should be public utility. A sense of public utility occasionally animated Parliament in James I’s reign.327 That sense was largely absent, however, in the reign of Charles I.328 Lack of public utility, though, is not the only danger. Parliament might, as in the reign of Elizabeth I, be servile to the monarch, as when one MP claimed that ‘all we have is her majesty’s, and she may lawfully at her pleasure take it from us’.329 Moreover, the reasoning of MPs can be partisan. Members of Parliament frustrated an Anglo-Scottish union in 1604 for simple dislike of the Scots.330 They may refuse, or indeed grant, supply wilfully.331 The biggest supply to the Crown before 1660 was for war with Holland.332 During the reign of Edward IV (1461–83), Parliament scrupled ‘to grant, and sometimes refuse, to the king the smallest supplies, the most necessary for the support of government, even the most necessary for the maintenance of wars, for which the nation, as well as the parliament itself, expressed great fondness’.333 Finally, parliamentary taxes are more likely to have useful exemptions than are non-parliamentary ones. Setting aside the unconvincing Druidical tax exemption,334 Aethelwulf again provides an instance. In addition to the introduction and extension of tithes, the church succeeds in getting

322

Hume, History, n 1 above, V:160. ibid I:XII (quoting letter to Adam Smith, 24 September 1752); I:162 (App I); V:96; Smith, Lectures, n 248 above, 262. 324 This is what has lead scholars to detect precursors to game theory, or to co-ordination theory, in the History (see Sabl, n 50 above, 6–11). 325 Hume, History, n 1 above, III:472. 326 ibid III:473. See Bernard, n 294 above, 67. 327 Hume, History, n 1 above, V:86; V:137. 328 ibid V:231; V:235. 329 ibid IV:413. 330 ibid V:21–2. 331 ibid V:23; V:271 (truculent Parliament); VI:234 (Restoration Parliament). 332 ibid VI:195. 333 ibid II:491–92 (also II:484); V:500. See also V:568, noted in Smith, Wealth of Nations, n 13 above, II, 618. 334 Hume, History, n 1 above, I:5. 323

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an ill-advised Aethelwulf to agree to exempt the ‘revenues of the church … from all burthens’, even though ‘national defence and security’ make the need for taxes especially pressing.335 All in all, ‘[t]he constitution of the English government … [says Hume] may boast of this pre-eminence, that in no age the will of the monarch was ever entirely absolute and uncontrouled’.336 Edward III ‘took no steps of moment without consulting his parliament, and obtaining their approbation, which he afterwards pleaded as a reason for their supporting his measures’.337 Montesquieu, too, was worried that this constitutional understanding would be abridged under absolutism, since France might then slide into despotism.338 Absolutism as despotism is bad, says Hume, because it is ‘contrary to the tenor of all the historians, and to the practice of all the northern nations’.339

Tax Law and Property Without property, the subject’s independence is mere illusion, as Sir William Cecil’s 1569 loan proposal already referred to showed.340 However, over the long century before Charles I’s accession in 1625,341 MPs—the squires and burgesses of the kingdom—had gradually but dramatically augmented their landholdings.342 This had been possible, as his mentor Lord Kames had suggested to Hume, because of the disentailing possibilities created by the 1490 Statute of Fines.343 The accumulation of estates in the Commons became a real headache for Charles I. Moreover, without property, the Commons has nothing of its own with which to make a grant to the Crown.344 Hume ascribes this insight to (of all people) Sir Thomas Wentworth MP (1593– 1641), in 1628: These [projectors and ill ministers of state], said he, have introduced a privycouncil, ravishing, at once, the spheres of all ancient government; destroying all liberty; imprisoning us without bail or bond. They have taken from us—What shall I say? Indeed, what have they left us? By tearing up the roots of all property, they have taken from us every means of supplying the king, and of ingratiating ourselves by voluntary proofs of our duty and attachment towards him.345

335

ibid I:61. ibid II:524. 337 ibid II:273. 338 Snape, n 9 above, 86. 339 Hume, History, n 1 above, I:165. 340 ibid IV:362. 341 ibid V:188. 342 ibid V:40. 343 Statute of Fines (1490) 4 Hen VII c 24; McArthur, n 16 above, 110–12 (Lord Kames); Simpson, n 165 above, 138. 344 Hume, History, n 1 above, V:191. 345 ibid V:191; see CV Wedgwood, Strafford (London, Jonathan Cape, 1943) 66. 336

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The main characteristic of property law is justice, not expediency. This is the inverse of public law’s main characteristic. Justice is the redressing of injuries to property in resources. Distributive questions are matters, not of justice, but of benevolence.346 ‘Barbarous nations’ like the Germans (‘generous barbarians’,347 though they were) were unlikely to discern justice since their barbarous state denied them the enjoyment of anything other than ‘valour and love of liberty’.348 This long remained the plight of their descendants, the Anglo-Saxons.349 However, property formed ‘distinctions more important than those which arose from personal strength and valour’,350 since ‘power naturally follows property’.351 However, though mainly about expediency, tax law is also a matter of justice because it is intimately linked to property. People need to have ‘fixed property in … land’, says Hume.352 To the contrary, Roger Maynwaring (1589–1653), a bishop, is memorialised as arguing that property is ‘only lodged in the subject’.353 The latter was a reiteration of the feudal law that vassals have ‘a species of benefice’, rather than property as such.354 The property of vassals ‘was conceived to be [says Hume], in some degree, conditional’.355 Property rights must nevertheless be ordered and prioritised as the public interest requires.356 Tax law should not dispense with property rights but qualify and shape them. Aspects of property law may therefore consist, not of private law, but of public law. This is illustrated both by the institution of the Great Fire of London Commissioners in 1666357 and by the 1653 Instrument of Government.358 The unmitigated injustice and lawlessness of King John’s reign is the opposite of this, as illustrated by the extortion of a Jewish man’s property in his own teeth:359 King John, … [Henry III’s] father, once demanded 10,000 marks from a Jew of Bristol; and on his refusal, ordered one of his teeth to be drawn every day till he should comply. The Jew lost seven teeth; and then paid the sum required of him.360 346 Hume, Enquiries, n 5 above, 194; Taylor, n 13 above, 154. This would not perhaps have surprised Hume’s earliest readers. The mid-eighteenth century was an age of benevolence, which saw the establishment of the Foundling Hospital (supported by Handel, with performances of Messiah, and by Hogarth) and the Magdalen House (with which Fielding was involved) (see Langford, n 301 above, 142–45). 347 Hume, History, n 1 above, I:161. 348 ibid I:15. 349 ibid I:50. 350 ibid I:164. 351 ibid I:203. 352 ibid V:47–8; VI:478; VI:489. 353 ibid V:199. 354 ibid I:461; I:478 (both Appendix II). 355 ibid I:461. 356 Taylor, n 13 above, 150. 357 Hume, History, n 1 above, VI:207. 358 ibid VI:61. 359 ibid II:69. 360 ibid V:69.

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The public interest consists in public utility. Public utility is enhanced by the decline of feudal dependencies. Property, as Montesquieu thought, is the basis of liberty.361 The accumulated wealth of the Commons in the seventeenth century illustrated this too.362 Not only does the fact that ‘[t]he landed property of England was probably in few hands during [later] Saxon times’363 illustrate the absence of the vaunted Saxon liberty, but the AngloSaxon nobility was itself to become the victim of the Norman Conquest, a ‘great injustice’ of English history.364 William, Duke of Normandy, whose ambition ‘lay little under the restraints of justice’,365 ‘had rendered himself universal proprietor of England’.366 Hume attributes to Philip II of Spain a similar desensitisation to justice in the mid-1550s.367 The ostensible purpose of the 1752 essay, as already mentioned, is to analyse the mercantilist proposition that people will absorb higher taxes by working harder. Its main focus, therefore, is the overall burden of taxation on a society but it also suggests how expediency and justice may be reconciled. Hume divides taxes into consumption taxes, taxes on possessions and poll taxes. The first two may, or may not, be arbitrary, while the last are almost always so, even though their arbitrariness can be mitigated by classifying taxpayers according to social status.368 Poll taxes are freighted with threat and ‘may be esteemed dangerous’ even in the rare cases where they are not arbitrary.369 Arbitrary taxes are bad because they are uncertain.370 They are bad, too, because they produce ‘unfavourable inequality’.371 Consumption taxes on luxury goods have the ‘only disadvantage’ of being ‘expensive in the levying’,372 whilst ‘[t]axes upon possessions are levied without expence; but have every other disadvantage’.373 Although taxes ‘levied upon consumptions, especially those of luxury’ are expensive for government to levy,374

361

ibid V:235. ibid V:216; VI:289. 363 ibid I:165. 364 ibid I:196 n; I:203. 365 ibid I:225. 366 ibid I:221 (Domesday Book, ‘still preserved in the Exchequer’, is ‘the most valuable piece of antiquity possessed by any nation’ (Hume, History, n 1 above, I:221)). 367 Hume, History, n 1 above, III:445. 368 ibid III:96. 369 Hume, ‘Of Taxes’ in Essays, n 3 above, 342, 346; J Sims, ‘The Poll Taxes in Later Seventeenth Century England’ in J Tiley (ed), Studies in the History of Tax Law (Oxford, Hart Publishing, 2010) vol 4, 121. 370 Smith, Wealth of Nations, n 13 above, II, 825 (Smith’s second maxim: ‘certainty of taxation’). 371 ibid II, 825 (Smith’s first maxim: ‘equality of taxation’). 372 Hume, ‘Of Taxes’ in Essays, n 3 above, 342, 345, quoted in Taylor, n 13 above, 139; Smith, Wealth of Nations, n 13 above, 826 (Smith’s fourth maxim: ‘economy in collection’). 373 Hume, ‘Of Taxes’ in Essays, n 3 above, 342, 345, quoted in Taylor, n 13 above, 139. 374 Smith, Wealth of Nations, n 13 above, II, 896, referencing Hume, ‘Of Public Credit’ in Essays, n 3 above, 349. 362

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they are nonetheless convenient for the subject to pay.375 Whilst ‘[t]axes upon possessions are levied [by the government] without expence’,376 it nonetheless follows that, since they ‘have every other disadvantage’,377 they are inconvenient for the subject to pay. When taxation law follows these maxims, it is both expedient and less, rather than more, unjust. If it does not, then it is ‘arbitrary’ and possibly even extortionate.378

TAX, EXPEDIENCE AND JUSTICE

History, as Hume says in the epigraph, teaches those attentive to her words with examples of prudence and of morality. As the ‘great mistress of wisdom’, she prompts avoidance of the pitfalls highlighted by historical experience.379 To demonstrate the conviction with which Hume pursues this line of thought, I proceed to show how the History yields illustrations of his taxation principles. Having done so, I go on to analyse how Hume demonstrates that a prudent legislator tempers expediency with justice in order to mitigate injustice wherever possible. The arbitrariness of an imprudent legislator is then illustrated with examples of what Hume regards as the worst types of tax legislation. To end, I explain how Hume’s thinking, through historical experience and careful reflection, suggests a kind of incremental and pragmatic but nonetheless prudent and practically just style of tax legislation.

Historical Illustrations of the Maxims Hume’s historical examples differentiate prudent tax laws and ones that are not prudent because they are arbitrary. The examples in the History provided some inspiration for those used in Smith’s Glasgow jurisprudence lectures of the 1760s and in the Wealth of Nations itself, although Smith’s specific references to the History are not restricted to taxation.380 Hume’s

375 Hume, ‘Of Taxes’ in Essays, n 3 above, 342, 345, quoted in Taylor, n 13 above, 139; Smith, Wealth of Nations, n 13 above, 826 (Smith’s third maxim: ‘convenience of payment’). 376 Hume, ‘Of Taxes’ in Essays, n 3 above, 342, 345, quoted in Taylor, n 13 above, 139. 377 ibid. 378 Hume, History, n 1 above, V:236–37; VI:482. 379 Also Hume, Enquiries, n 5 above, 29, 127. 380 See Smith, Wealth of Nations, n 13 above, 247, 445, 790, 825–28. In the 1750s, Hume lived in Edinburgh, the surroundings of the city rather than the country being ‘the true Scene for a man of Letters’ (quoted in Mossner, n 65 above, 240); Smith was then Professor of Moral Philosophy at Glasgow University (N Phillipson, Adam Smith: an Enlightened Life (London, Allen Lane, 2010) ch 6). Smith possessed a copy of the History (H Mizuta, Adam Smith’s Library (Cambridge, CUP, 1967) 105).

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examples are important since they underline his belief that only history, reason and experience can bring home to us the ‘extensive utility’ of justice.381 Understanding justice, says Hume, is not a matter of revelation, but of science and experience. Hume accordingly catalogues historical infractions of the principles discussed in his 1752 essay, namely, the uncertainty of arbitrary taxes; the unfavourable inequality of arbitrary taxes, despite the historical roots of tax equality in England; the relative cheapness of collecting taxes on possessions as compared with the costs of raising indirect taxes on luxury goods; and the relative convenience of paying indirect taxes on luxury goods, as contrasted with taxes on possessions. The uncertainty of arbitrary taxation is illustrated throughout the History. The poll tax of 1381, despite being levied by Richard II with Parliament’s consent,382 was nonetheless arbitrary because it was uncertain. Though clear to the extent that it was levied at ‘three groats on every person, male and female, above fifteen years of age’, the burden of this ‘new and unusual tax’ was rendered uncertain by a mitigation provision that ‘the opulent should relieve the poor by an equitable compensation’.383 This clause, Hume concludes, ‘being so vague and undeterminate, had doubtless occasioned many partialities’.384 Another vague tax was the benevolence, its indeterminacy being illustrated by Hume’s account of the confrontation in 1525 between Cardinal Wolsey and the Lord Mayor of London over the benevolence that followed the abandoned Amicable Grant: Wolsey sent for the mayor of London, and desired to know what he was willing to give for the supply of his majesty’s necessities. The mayor seemed desirous, before he should declare himself, to consult the common council: but the cardinal required, that he and all the aldermen should separately confer with himself about the benevolence; and he eluded by that means the danger of a formed opposition.385

‘[E]xpedients very violent and irregular’, too, were the forced £60,000 loan levied by Mary I in 1555 ‘upon a thousand persons, of whose compliance, either on account of their riches or their affections to her, she held herself best assured’,386 as well as a number of subsequent impositions on merchants and yeomen, none of which measures satisfied her financing needs.387

381

Hume, Enquiries, n 5 above, 192. Hume, History, n 1 above, II:289. ibid II:289. 384 ibid II:290; VI Parliament Rolls of Medieval England 1275–1504 (Richard II, 1377–1384) (G Martin and C Given-Wilson (eds), Woodbridge, Boydell Press, 2012) 191–92, as referenced in J Barker, England, Arise: the People, the King and the Great Revolt of 1381 (London, Little, Brown, 2014) 443. 385 Hume, History, n 1 above, III:160. 386 ibid III:444. 387 ibid III:444–45. 382 383

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Perhaps the most notorious of uncertain taxes was the benevolence levied by Henry VII in 1491.388 Having previously established the non-consensual nature of such ‘gifts’, Hume does not elaborate on the ambiguous nature of the benevolence as a tax but, in underlining the injustice it caused, ironically emphasises its ‘violence’.389 The ship-money of 1634 was ‘entirely arbitrary’,390 uncertain because ‘[b]y the same right any other tax might be imposed’.391 Arbitrary and uncertain, too was the method of taxation whereby Charles I, having failed to impose a tax in 1637 upon the vintners, then banned them from selling wine.392 That ban was lifted only when they submitted to a forced loan and a composition equal to half of the duty with which they were first charged.393 It is King John, though, who is the acme of arbitrariness, ‘continually’ loading ‘the nation with arbitrary impositions’ in the years before sealing Magna Carta.394 Consistently, John has no consideration for his subjects’ property when civil war breaks out again in 1215, ‘marching through the whole extent of England, from Dover to Berwic … [laying] the provinces waste on each side of him’.395 The Anglo-Saxons, says Hume, instantiated the principle of equality of taxation in England. The problematic trinoda necessitas, mentioned earlier, provides Hume with an illustration. ‘The trouble and expence of defending the state … lay equally upon all the land; and it was usual for every five hides to equip a man for the service’.396 Even Danegelt was ‘a land-tax of a shilling a hide’.397 These observations suggest an early form of the ‘benefit principle’ but they do not imply any redistribution from rich to poor. More often than equality, indeed, the History illustrates the unfavourable inequality of arbitrary taxes. The 1381 poll tax was unfavourably unequal because it was regressive. Its leading to the ‘Peasants’ Revolt’ of that year,398 was exacerbated, according to Hume by ‘[t]he faint dawn of the arts and of good government in that age, [which] had excited the minds of the populace, in different states of Europe, to wish for a better condition’.399 In England, moreover, there had for many centuries been ‘a great inequality in property’400 and,

388 Ibid III:37 (Hume references the Latin text in Foedera, etc (T Rymer (ed), London, Tonson, 1727) 12:446–47). 389 Hume, History, n 1 above, III:37. 390 ibid V:235. 391 ibid. 392 ibid V:244. 393 ibid. 394 ibid I:428. 395 ibid I:450. 396 ibid I:182. 397 ibid. 398 Hume does not use the expression, calling it instead ‘a mutiny, which was singular in its circumstances’ (Hume, History, n 2 above, II:289). 399 Hume, History, n 1 above, II:289. 400 ibid II:524.

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with it, more ‘personal slavery’ than obtained elsewhere in Europe.401 All of this proved fertile territory for the ‘seditious preacher’, John Ball,402 whose ideas of mankind’s ‘equal right to liberty and to all the goods of nature’ ‘were greedily received by the multitude’ as ‘conformable to the ideas of primitive equality, which are engraven in the hearts of all men’.403 The mitigation provision already mentioned even made matters worse because ‘it made the people more sensible of the unequal lot, which fortune had assigned them in the distribution of her favours’.404 Disproportionate, too, in its impact was a second Marian forced loan of 1555. When the yield from Mary I’s original forced loan disappointed, ‘she exacted a general loan on every one who possessed twenty pounds a-year’.405 Its burden falling ‘heavily on the gentry … many of them [had] to retrench their expenses, and dismiss their servants in order to enable them to comply with her demands’. When the servants thereby dismissed ‘commonly betook themselves to theft and robbery’, since they lacked the resources to live, ‘the queen published a proclamation, by which she obliged their former masters to take them back into their service’.406 Conspicuous even among unequal taxes, however, was the 1491 benevolence, which ‘fell chiefly on the commercial part of the nation’, with ‘London alone … [contributing] near 10,000 pounds’.407 Hume suggests that monarchical tolerance of the inequality of benevolences was so great that not even the experiential threat of rebellion could overcome it. In 1525, Henry VIII had sought to levy an unequal and arbitrary benevolence408 when an earlier poll tax had been found to work in the accustomed arbitrary and unequal way.409 When a lawyer objected to it, on the basis that benevolences had been abolished by the legislation of Richard III’s reign, the judges held that: Richard being an usurper, and his parliament a factious assembly, his statutes could not bind a lawful and absolute monarch, who held his crown by hereditary right, and needed not to court the favour of a licentious populace.410

In context, Hume gives here yet another illustration of the taxation consequences of judges holding office at pleasure. Moreover, lawful though the benevolence had been adjudged, yet its inequality meant that, prudentially, 401

ibid II:289. Executed in 1381 (see Barker, n 384 above, 292). Of the fourteenth-century couplet, ‘When Adam delv’d and Eve span, /Where [sic] was then the gentleman?’, revived centuries later by William Morris and Edward Burne-Jones (see Barker, ibid, plate 28), Hume comments that ‘in spite of prejudice, one cannot but regard [it] with some degree of approbation’ (Hume, History, n 1 above, II:290 n). 403 Hume, History, n 1 above, II:290. 404 ibid. 405 ibid III:444. 406 ibid. 407 Hume, History, n 1 above, III:37–38. 408 ibid III:159–60. 409 ibid III:96; III:160. 410 ibid III:160. 402

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Henry VIII was unable to inflict severe penalties on those who had rebelled against it: The king, finding it dangerous to punish criminals, engaged in so popular a cause, was determined, notwithstanding his violent, imperious temper, to grant them a general pardon; and he prudently imputed their guilt, not to their want of loyalty or affection, but to their poverty.411

Unequal though they were, benevolences were not so unequal as purveyance412 and pre-emption.413 So ‘unequal, arbitrary, and oppressive’ indeed, are these that in the reign of Elizabeth I they correspond almost to (only partially compensated) expropriation: The whole kingdom sensibly felt the burthen of those impositions; and it was regarded as a great privilege conferred on Oxford and Cambridge, to prohibit the purveyors from taking any commodities within five miles of these universities.414

It may seem surprising, therefore, that Hume regards ship-money as having been ‘levied upon the people with equality’.415 Surprising, because even this could not salvage a tax regarded as obnoxious on other grounds. Further away, in time and also space, the arbitrariness of the Duke of Alva’s planned turnover tax of 1571 was manifested by its comprehending even the necessaries of life.416 Forty years later, James I prudently tried to avoid the same mistake. In the exercise of his prerogative to amend the rates at which customs duties were charged, as Hume tells the story, James set about ‘correcting its inequalities’.417 ‘Every commodity … which might serve to the subsistence of the people, or might be considered as a material of manufactures, was exempted from the new impositions.’418 The Commonwealth altered the law as it had stood ‘during the civil wars’ and prudently exempted ‘bread and flesh-meat’ from excise duty.419 The idea that consumption taxes on luxuries are expensive to levy but are otherwise capable of being good, while taxes on possessions are cheap to levy but otherwise generally bad, is illustrated only equivocally in the History. Edward IV’s levy on a tenth of rents was expensive to collect.420

411

ibid III:161. ibid IV:362; Smith, Lectures, n 248 above, 581. Hume, History, n 1 above, IV:362. 414 ibid IV:362. 415 ibid V:235. 416 ibid IV:155. 417 ibid V:41. In fact, the initiative was the inspiration of the Lord Treasurer, Robert Cecil, Earl of Salisbury (Dietz, n 96 above, II, 368–69). 418 Hume, History, n 1 above, V:42; V:126. Hume’s discussion blurs the boundary between: (i) customs, which were truly prerogatival before 1640; (ii) tonnage and poundage (to an extent, a parliamentary tax); and (iii), impositions, again a prerogatival tax (see Braddick, n 116 above, 64). 419 Hume, History, n 1 above, VI:146. 420 ibid II:484. 412 413

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The proceeds of hearth tax in the reign of Edward III (‘such ignorant times’, writes the philosophical historian) raised nowhere near as much as was expected.421 In an echo of Montesquieu,422 and no doubt suggesting to Smith ‘the frequent visits, and the odious examination of the tax-gatherers’,423 Hume adduces the example of ‘Morton’s fork’, as employed to assess and collect the benevolence of 1491: Archbishop Morton, the chancellor, instructed the commissioners to employ a dilemma, in which every one might be comprehended: If the persons applied to, lived frugally, they were told, that their parsimony must necessarily have enriched them: If their method of living were splendid and hospitable, they were concluded to be opulent on account of their expences. This device was by some called chancellor Morton’s fork, by others his crutch.424

Subsidies granted to Charles I by the 1628 Parliament were diminished by fraud that the commissioners ‘connived at’.425 That, far from being economical to collect, a poll tax may actually be dangerous is again illustrated by the 1381 poll tax. In Hume’s delicate account, what triggers the whole revolt is the slaughter of a tax-collector by an Essex blacksmith when the former has indecently and forcibly offered to prove that the blacksmith is liable for the tax in respect of his daughter.426 The idea that consumption taxes are convenient for the subject to pay, while taxes on possessions are inconvenient, is also illustrated. The only comment that Hume makes on the new salt tax introduced by Philip VI of Valois in 1346, during the 100 years’ war, is that it aroused ‘the great discontent, and almost mutiny of his subjects’.427 It nonetheless seems reasonable to infer that this is an implicit statement about the inequality of a salt tax. Such a reading is consistent with Hume’s approval of consumption taxes, not on necessities, but on luxuries. However, that even a salt tax is convenient to pay would be acknowledged by Hume on the basis of his comments in the 1752 essay.428 More significant, though, might be the nature of the commodity itself. Salt is at least an extant commodity. When, in 1340, Edward III had levied an ‘unusual tax of a ninth sheaf, lamb, and fleece’,429 in order to support his

421

ibid II:267 n; Smith, Lectures, n 248 above, 326. Montesquieu, n 245 above, 219. 423 Smith, Wealth of Nations, n 13 above, II, 827. 424 Hume, History, n 1 above, III:37–38; Penn, n 179 above, 161, 279. 425 Hume, History, n 1 above, V:202–3. 426 ibid II:290; Smith, Wealth of Nations, n 13 above II, 827 (‘odious examination’). 427 Hume, History, n 1 above, II:224. 428 Hume, Essays, n 3 above, 345; Smith, Wealth of Nations, n 13 above, II, 874. 429 IV Parliament Rolls of Medieval England 1275–1504 (Edward III, 1327–1348) (S Phillips and M Ormrod (eds), Woodbridge, Boydell Press, 2012) 267, as footnoted in WM Ormrod, Edward III (Newhaven, CT, YUP, 2011) 217. 422

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army in Flanders, it was necessary to wait until the commodity had grown before the tax could be paid.430 Accordingly: Parliament, foreseeing the inconvenience, had granted, as a present resource, 20,000 sacks of wool, the only English goods that bore a sure price in foreign markets, and were the next to ready money.431

The forced loan of the 20,000 sacks of wool432 did not much help Edward. His army’s necessity was dire and it would take time for the Crown to collect ‘such a bulky commodity’, assemble it from all parts of England and sell it abroad.433 The desirability of taxes being convenient to pay is a double-edged sword. The government’s prudential need for convenience of payment makes commercial people vulnerable. When the 1491 benevolence was collected, the reason why the merchants, and therefore the citizens of London, bore a disproportionate burden, was because they ‘were possessed of the ready money’ to pay it.434 It was with a view to ascertaining where ready money was to be found that, in 1523, Henry VIII ‘caused a general survey to be made of the kingdom; the numbers of men, their years, profession, stock, revenue’.435 Henry, so Hume tells us, ‘expressed great satisfaction on finding the nation so opulent’, whereupon he ‘issued privy seals to the most wealthy, demanding loans of particular sums’.436

Prudence, Imprudence and Extortion A prudent legislator tempers expediency with justice to mitigate injustice if possible. In Smithian terms, this is the large prudence of the prince complementing the small prudence of the merchant. ‘Legislator’ and ‘legislation’ have special meanings. ‘Legislation is not the making of laws [says Isaiah Berlin] (that would be more properly called “legisfaction”). Legislation is the translation into legal terms of something which is to be found in nature: ends, purposes.’437 Montesquieu, Hume and Smith are all concerned with discerning purposes and ends. Hume regards King Alfred’s ‘care … for the encouragement of learning among his subjects … [as] 430

Hume, History, n 1 above, II:211. ibid II:211. 432 IV Parliament Rolls of Medieval England 1275–1504 (Edward III, 1327–1348) (S Phillips and M Ormrod (eds), Woodbridge, Boydell Press, 2012) 282–84, as footnoted in Ormrod, n 429 above, 225. 433 Hume, History, n 1 above, II:211. 434 ibid III:37. 435 ibid III:147. 436 ibid. 437 I Berlin, Freedom and its Betrayal: Six Enemies of Human Liberty (H Hardy (ed), London, Chatto and Windus, 2002) 15. 431

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another useful branch of his legislation’.438 Although Alfred’s studious bent was his main motive, it nonetheless had beneficial consequences, since ‘good morals and knowledge are almost inseparable, in every age, though not in every individual’.439 Not everyone is fit to be a legislator, however.440 ‘[T]he commons came very late to be admitted to a share in the legislative power’, says Hume.441 His ridicule of the 1653 Instrument of Government illustrates this, too. The reason is that the ill-educated, those blinded by prejudice, and so forth, are incapable of discerning ends and purposes. It was only in James I’s reign that prudence became characteristic of the counsels of the Commons. They developed a Machiavellian calculation:442 The leading members, men of an independent genius and large views, began to regulate their opinions, more by the future consequences which they foresaw, than by the former precedents which were set before them; and they less aspired at maintaining the ancient constitution, than at establishing a new one, and a freer, and a better.443

The Commons’ prudence built up steadily before the Civil Wars.444 In 1640, ‘[wh]at rendered the power of the commons more formidable, was, the extreme prudence with which it was conducted’.445 Most importantly, a prudent legislator mixes expedience with justice.446 He is an architect, a designer of the edifice of the state. There is a sense in which the History, a book about the constitution of England,447 is a map of the architect’s successes and failures. Henry II’s legal reforms showed him to be a legislator of high order. Says Hume: The provisions which he [Henry II] made, show such largeness of thought as qualified him for being a legislator; and they were commonly calculated as well for the future as the present happiness of his kingdom.448

A prudent legislator knows that, since some things may be impossible to prevent, it may be wiser ‘only to regulate and moderate them’.449 With taxes, it is prudent to avoid sudden and dramatic tax increases. ‘A nation may by degrees be brought to bear a tax of 15 shillings in the pound, but a sudden and precarious tax can never be imposed to that amount, without a 438 439 440 441 442 443 444 445 446 447 448 449

Hume, History, n 1 above, I:79. ibid. ibid V:91; VI:39; VI:70. ibid I:469. ibid V:42. ibid. ibid V:214. ibid V:291. ibid I:46. ibid I:488. ibid I:359. ibid I:176.

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very visible necessity, especially in an age so little accustomed to taxes.’450 The level of customs duties in the reign of Edward VI was disutility itself.451 The examples trace an awakening of a sense of the prudent prioritisation of justice relative to expediency.452 To repeat, whilst justice does not change, its utility becomes ever more apparent and consequently more valued.453 Justice is not about economic inequalities. The whole purpose of government is ‘the equal distribution of justice, and free enjoyment of property’.454 In 1544, a London alderman called Read, having refused to pay a benevolence, ‘was inrolled as a foot-soldier in the Scottish wars and was there taken prisoner’.455 This was in negation of government’s whole purpose. That the benefit principle is expedient, as well as a matter of justice, is borne out by the fact that, in removing Aethelwulf ’s ecclesiastical tax exemptions, William required abbots and bishops ‘to furnish to the king during war a number of knights … proportioned to the extent of property possessed by each see or abbey’, under pain of exactly the same punishment inflicted on the laity.456 Not much could have been done about disparities of wealth in a system based on primogeniture, as feudalism was. Though it ‘is hurtful by producing and maintaining an unequal division of private property’, primogeniture nonetheless promotes political and social stability.457 English history has many examples of princes both prudent and imprudent in relation to taxes. Elizabeth I was extremely prudent, though tyrannous,458 which means that with her, expedience threatened to crowd justice out and therefore to minimise the role of private law in her state. Charles I was emphatically not prudent.459 Neither was James I, a would-be despot,460 who nonetheless lacked dissimulation.461 To illustrate this, Hume recounts a story told by Edmund Waller (1606–87), the politician and poet: When Waller was young, he had the curiosity to go to court; and he stood in the circle, and saw James dine; where, among other company, there sat at table two bishops, Neile and Andrews.462 The king proposed aloud this question, Whether he might not take his subjects money, when he needed it, without all this formality of parliament? Neile replied, God forbid you should not: For you are the breath of our nostrils. Andrews declined answering, and said, he was not skilled in 450

ibid I:495. ibid III:479. ibid V:181; VI:216; VI:404. 453 Buckle, n 21 above, 265. 454 Hume, History, n 1 above, I:445 (see McArthur, n 16 above, 106). 455 Hume, History, n 1 above, III:305. 456 ibid I:204. 457 ibid I:486. 458 ibid V:19; V:20. 459 ibid V:232. 460 ibid V:45. 461 ibid V:59. 462 [Presumably Richard Neile, Archbishop of York (1562–1640), and Lancelot Andrews, Bishop of Winchester (1555–1626)]. 451 452

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parliamentary cases: But upon the king’s urging him, and saying he would admit of no evasion, the bishop replied pleasantly: Why then I think your majesty may lawfully take my brother Neile’s money: For he offers it.463

Prudence is not the exclusive preserve of the modern prince.464 Egbert, in securing England as perhaps the first king of its lands, wisely allowed kingdoms subordinate to Wessex to retain their elected kings on the basis that they paid tribute to him.465 Few princes have been so prudent as William the Conqueror, in retrospect a man of Machiavellian virtuosity.466 Likewise, the ‘administration’ of Henry II was one of ‘prudence and vigour’, such that it had ‘raised his character above that of any of his predecessors’.467 Indeed, one of Henry’s achievements was to curb the church’s gathering of ‘large sums’ of money in atonement for sin, sums so large that the church ‘levied more money upon … [Henry’s] subjects, than flowed, by all the funds and taxes, into the royal exchequer’. To do this, Henry decreed that ‘a civil officer of his appointment should be present in all ecclesiastical courts, and should, for the future, give his consent to every composition which was made with sinners for their spiritual offences’.468 By contrast, King John, by the time his Treasury was lost in the waters of the Wash,469 found himself in a ‘dangerous situation’, one ‘which prudence, vigour, and popularity, might formerly have prevented, but which no virtues or abilities were now sufficient to retrieve’.470 It was John’s imprudence that meant the clauses of Magna Carta were eventually ‘calculated [both] for the interest of the barons’ and ‘of inferior ranks of men’.471 It was the barons rather than the king who evinced ‘prudence and moderation’.472 These ‘haughty nobles … even in this plenitude of power … seem to have been sufficiently careful not to diminish too far the power and revenue of the crown’.473 As descendants of the barons of 1066,474 their rank and title meant they were the mediate lords of all lands not within the royal demesnes. Such powerful exemplars of prudence, or imprudence, are the stuff of history for Hume: they furnish lessons for the great of later times. In sum, the most imprudent tax laws destabilise property, perpetuate injustice and do not therefore promote the public interest. The implication of Hume’s theory of tax law is that 463

Hume, History, n 1 above, V:60. ibid I:74. 465 ibid I:50. 466 Hume does not describe William in this way but he does ascribe to him the key Machiavellian attributes, namely, enterprise and boldness (Hume, History, n 1 above, I:225). 467 ibid I:311. 468 ibid I:312. 469 ibid I:452. 470 ibid I:430. 471 ibid I:444; McArthur, n 16 above, 105–6. 472 Hume, History, n 1 above, I:447. 473 ibid I:446. 474 ibid I:203–4. 464

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a ‘civilised monarchy’, possibly even that of 1688, might yet provide the circumstances for stable property in the context of a public interest defined by public utility.475 ‘[W]e, in this island, have ever since [1688] enjoyed, if not the best system of government, at least the most entire system of liberty, that ever was known amongst mankind.’476

CONCLUSIONS

Such is David Hume’s philosophical history of taxation in England. Its distinctive characteristic is a sceptical attempt to work out, through the writing of history, the moral, political and philosophical issues to which tax legislation gives rise. Hume is explicit that then is a function of now, and that these issues can be thrown into sharp relief by the distancing techniques of irony and sentiment. The law and lawyers are close to the centre of his approach. Taxes, in all their various forms, make particular demands on law. At the centre of property law is a utilitarian concept of justice. Tax law, whose dominant characteristic is expediency, in turn complements property law, whose defining characteristic is justice. The two mutually reinforce each other. The rights and obligations of tax law, to some greater or lesser extent, mirror those of property law. That each is not a perfect reflection of the other results from the contrasting role of justice in each system. Whole regimes, notably that of Charles I, have been broken by failing to recognise the demands imposed by this interaction. Particular dangers arise from infraction of one or more of the four elements that seek to embody this interdependency: equality, certainty, convenience of payment and economy in collection. None of these are far away from some of the most tumultuous events in the story of the English nation.

475 476

ibid V:176. ibid VI:531.

15 Reviving Capital Transfer Tax Scholarship ANN MUMFORD*

ABSTRACT Inspired by the Hayton and Tiley text, Capital Transfer Tax, this chapter reconsiders this famous twentieth century tax in four parts. First, the significance of the complicated and controversial history of the legislation introducing this tax is explored. Possible connections between this history, and some of the objections to the tax in the following years, are considered in the second part. The third part addresses perhaps the most significant legacy of this era, the case of Pearson v Commissioners of Inland Revenue. The final section weighs the Hayton and Tiley text for historical resonance, and finds there is much of modern value. Ultimately, the chapter advances the thesis that Hayton and Tiley sought to understand Capital Transfer Tax both as a product of, and a part of, the system in which it operated.

INTRODUCTION

T

HE SCHOLARSHIP OF John Tiley is enormously rich, but it is in two areas, in particular, that he developed a significant, sustained and historical perspective on policy evolution in the United Kingdom: taxation of the family, and (a famous title) ‘death and taxes’.1 This chapter will address the latter, and in so doing reconsider his text on Capital Transfer Tax.2 The primary objective of this reconsideration is to trace the continuing impact of the Capital Transfer Tax on modern political discourse surrounding the taxation of inherited wealth in the United Kingdom.

* I am enormously indebted to John Pearce for very generous comments on an early draft, and, in particular, for introducing me to the major points of reference in this area of tax law. 1 J Tiley, ‘Death and Taxes’ (2007) BTR 300. 2 DJ Hayton and J Tiley, Capital Transfer Tax (London, Butterworths, 1978).

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In substance the chapter will cast an eye back at the period 1975–86, reconsider the Capital Transfer Tax (CTT) literature from the period, and fashion an historical basis for the hybrid inheritance tax of the modern era. The period surrounding 2006–07 saw an explosion of interest in inheritance taxation legal scholarship, largely due to the impact that public discussion of this tax seemed to have on a variety of elections in countries around the world, of course including the United Kingdom.3 The economic crisis of 2008, and a momentary worry that ‘inherited wealth may not be much of a problem’,4 suppressed this interest, and the scholarly discussion of the taxation of inherited wealth has been quiet of late. Consideration of the impact of the Capital Transfer Tax on modern tax discourse, and the evolution of late-middle twentieth century tax policy into the twenty-first century, may help to inspire a post-recession discussion. This chapter is in three sections. The first section provides the background to the legislation itself, and, in particular, traces the impact of the fraught legislative process which proceeded its introduction. Wheatcroft and others were to describe the legislation as technically flawed.5 This section of the chapter will explain why, and consider the repercussions of these observations. The second section will describe some of the challenges that the CTT faced in operation. The third section will consider the first case to reach the House of Lords under CTT, and will assess the implications of this case for CTT’s legacy. These three sections will converge in a final section, which considers Hayton and Tiley’s observations on the CTT, and aims to discern which of these observation remain relevant for consideration of the modern inheritance tax. This chapter will conclude by suggesting that reconsideration of CTT reveals a number of important insights, in particular, for the significance of the relationship between capital and income taxation.

A COMPLICATED ROAD TO LEGISLATION

The Capital Transfer Tax was introduced quickly after the first of two elections in 1974, after which the Labour Party came to power. Labour were determined to introduce immediate reforms to what were perceived as existing inequalities in taxation law. As dramatic as the election had been, the

3 See, inter alia, LL Batchelder, ‘What Should Society Expect from Heirs: the Case for a Comprehensive Inheritance Tax’ (2009) 63 Tax L Rev 1; M Schürz, ‘Zu den Rechtfertigungsverhältnissen einer Erbschaftssteuer’ in HP Gaisbauer et al (eds), Erbschaftssteuer im Kontext (Weisbaden, Springer, 2013); and J Beckert, Inherited Wealth (Princeton, NJ, Princeton University Press, 2008). 4 A comment the author heard mentioned at a number of workshops held in 2008, addressing the topic of taxing inherited wealth (and organised before the economic crash). 5 GSA Wheatcroft and GD Hewson, ‘Introduction to Capital Transfer Tax’, Part 1A in The Encyclopedia of Capital Taxation: Capital Transfer Tax (London, Sweet & Maxwell, 1977).

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draft taxation legislation which quickly followed it, and which introduced the Capital Transfer Tax, was no less controversial. Indeed, as Hepker and Whitehouse were to recall in 1975, ‘[t]he publication on 10 December 1974 of the Finance Bill incorporating the CTT legislation raised the curtain on what was to become an absorbing Parliamentary drama’.6 The CTT was announced to Parliament on 26 March 1974, by Denis Healey, the new Chancellor of the Exchequer.7 Mr Healy stated that the CTT itself would not be introduced in his first Finance Bill; but, rather, in his second Finance Bill, which would follow in Autumn 1974.8 In the interim, a second election was held, producing a ‘small overall majority’ for the Labour Party.9 The Finance (No 2) Bill 1974 followed on 10 December 1974.10 This in turn became the Finance Act 1975 (on 18 March 1975), but not without opposition, described by Wheatcroft and Hewson as ‘strenuous’.11 In this process, ‘a very large number of amendments were proposed, both by the Government, which were usually adopted, and by the Opposition, which were usually not, and the Bill ultimately only passed after a “guillotine” motion had been passed by Parliament’.12 This outcome was accepted grudgingly, and led the Chief Secretary to the Treasury, Joel Barnett, to propose that ‘there is a need to look at our procedures and our way of examining Bills’.13 The impact of this process on the legislation itself, Wheatcroft and Hewson suggested, was not positive.14 The Bill, as originally proposed back in March 1974, largely was designed to enforce a tax on gifts made after 26 March 1974; replace estate duties (at a date to be clarified later); and to enforce a tax on ‘distributions from and certain other events in relation to settled property’ where these occurred after 26 March 1974.15 The tax which emerged after the second Finance Bill, however, was, Wheatcroft and Hewson explained, ‘defective in a large number of technical respects’, leading to a period of heavy revision in both the Finance Acts 1976 and 1977.16 6

MZ Hepker and CJ Whitehouse, Capital Transfer Tax (London, Heinemann, 1975) 17. Wheatcroft and Hewson, n 5 above, 1009, para A1-05. ibid. See HC Deb 26 March 1974, vol 871, cols 313–14, where Mr Healey seemed to acknowledge the controversy that lay ahead: ‘I recognise that to some who may be affected by these new tax proposals and who are unfamiliar with the way they operate in other Western countries they may seem revolutionary in the extreme. I can assure them that, while I am determined to ensure that the new taxes will be effective instruments for redistributing wealth as a means to greater justice and equality in our society, I am concerned that they should operate fairly on those affected and I will listen to any reasonable representations which will help me to secure this end.’ 9 ibid. 10 ibid. 11 ibid. 12 ibid. 13 Hepker and Whitehouse, n 6 above, 18, quoting HC Deb 4 March 1975, vol 887, c 1347. 14 Wheatcroft and Hewson, n 5 above, 1009. 15 ibid. 16 ibid. 7 8

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Hepker and Whitehouse, in another contemporary account, were more pointed in their criticisms, and suggested that ‘[i]t would be difficult to deny that some of the original provisions were imperfectly thought out and shoddily drafted’.17 They provided some context for the controversy: [the original provisions] seemed likely to produce effects which were far more drastic than the Government apparently intended. ‘At the eleventh hour …’ suggested The Times, ‘the realization is dawning that the provisions of the CTT in its present form will in practice be so vindictive that they must be fundamentally modified’.18

‘Fortunately’, Hepker and Whitehouse continued, ‘the Opposition took up the challenge’.19 They were referring to the fact that the Bill spent 160 hours in Committee, and apparently more time was allocated to the Report and Third Reading of the Finance Bill than could be recalled in the previous 50 years.20 Whilst there is a trace of political partisanship in the observations of Hepker and Whitehouse, in particular, it is instructive to consider the impact of this fraught but extensive legislative process. The deficiencies mentioned by Wheatcroft and Hewson could not help but be noticed, given the extraordinary attention focused on this legislation. Indeed, it could be suggested that this was an unusual amount of attention. The controversy could be attributed to one of two causes. First, the intensely politicised nature of inheritance taxation, generally, could provide the cause.21 Any legislation addressing inheritance taxation is likely perhaps to produce this level of controversy. Secondly, perhaps the battle over CTT simply was an extension of the intensely fought election. It became a symbol of that fight, and, given its eventual repeal, perhaps it was never able truly to overcome that symbolism. Following the election of 1974, the Labour Party also announced their intention to introduce a wealth tax.22 Had this plan succeeded, the change to the system for taxing capital in the United Kingdom would have been even more profound. As things stood, CTT, on its own, was a very significant change. This is partially because the estate duty, which CTT replaced, actually had been introduced by the Finance Act 1894, and had remained largely unchanged since then.23 By the 1970s, estate duty was an embedded 17

Hepker and Whitehouse, n 6 above, 17. ibid, citing ‘First Leader’, The Times, 22 January 1975, 17–18. ibid 18. 20 ibid. 21 See MJ Graetz and I Shapiro, Death by a Thousand Cuts: the Fight over Taxing Inherited Wealth (Princeton, NJ, Princeton University Press, 2011). 22 This history is discussed below, in the review of the research of Howard Glennerster into the aborted wealth tax. 23 Chalmers, Impey & Co, Chartered Accountants, Capital Transfer Tax (booklet on file at the British Library, General Reference Collection X.519/28616, 14 April 1975) 2. 18 19

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part of tax legal culture. Interestingly, a booklet rushed out in the aftermath of the Finance Act 1975 wryly observed that ‘[e]ven now, over 80 years after the [1894 Finance] Act, the Courts are being asked to interpret some provisions [of the estate duty]’.24 Reviewing the literature from the era reveals a sense of surprise that this interaction with an almost 80-year-old tax was to cease, and to be replaced with a new tax. There also appeared to be a realisation that the disruption that would be caused by changing this legal regime would last for a significant amount of time. Indeed, the authors of the pamphlet proceeded to suggest that ‘[i]t would seem, therefore, that it will be many years before all the provisions of the Capital Transfer Tax can be interpreted without doubt’.25 A White Paper26 set out the proposed scope of CTT, which was followed by the Finance Act 1975. The CTT elements of the Finance Acts 1975–84 ultimately were consolidated into the Capital Transfer Act 1984, which, in 1986, was replaced by the Inheritance Tax Act 1986. The legislation which effected this change, the Finance Act 1986, dramatically changed the substance of this tax.27 Inter vivos gifts, and contributions to accumulation and maintenance trusts, were free of tax once more, provided the donor survived the date of the gift for seven years. This exemption (or ‘potential exemption’ as it was described in the British Tax Reporter) extended to creation and termination of interests in possession in settled property in 1987. The British Tax Reporter described this as a substantive reversion to the old estate tax system, with a few exceptions. Although the tax was now called an inheritance tax, ‘transfer of value’ remains (to this day) the focus of the tax, and the charge itself derives from the donor’s estate. The essence of the tax, in other words, is the impact upon the donor, and not the person receiving the inheritance. What was the difference between the estate duty, capital transfer tax and the modern inheritance tax? The change from estate duty to CTT involved a shift in the essential nature of the tax, given the incorporation of an element of gift taxation. This change, however, was in response to the perceived inefficiencies of estate duty, which had been too easy to avoid. So the

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ibid. ibid. 26 Government White Paper, Capital Transfer Tax (The National Archives, Kew, PS 6501/1974, August 1974) vol I. As Glennerster explained, the government’s plan had been to publish the White Papers on capital transfer taxation, and wealth taxation, on the same day, 8 August 1974. H Glennerster, ‘Why was a Wealth Tax for the UK Abandoned? Lessons for the Policy Process and Tackling Wealth Inequality’ (2012) 41 Journal of Social Policy 233. Glennerster notes that a Green Paper was considered by the Cabinet subcommittee at the end of July 1974, where some disappointment was expressed that legislation was not expected before 1976. ‘This’, Glennerster writes, ‘was to be the high tide of optimism about implementing the tax’. After this point, it seemed that ‘[t]he government lost the initiative and the argument’. 27 British Tax Reporter (Maugham Library, Tony Arnold Collection, 2004) p 501, 101 [para 600-100]. 25

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intention was not exactly to tax gifts, but to devise legislation means for ensuring that, upon death, a tax was levied. The gift element, therefore, was in some ways a targeted anti-avoidance rule.28 Language, of course, always has played an important part in the reaction of taxpayers to charges on death.29 The reaction of tax advisors to the change from estate duty to CTT likely was driven by something more fundamental than instinctive reactions to terms like inheritance tax, estate tax, or even death tax. Whether or not such taxes apply to estates, or to their beneficiaries (an important part of the play of language in this context is whether or not the tax applies to (grieving) beneficiaries (ie through an inheritance tax), or to inanimate ‘estates’) was not solely at issue. Rather, the resistance focused on the loss of a (familiar) charge on death, and its replacement with a new, hybrid tax on death and gifts. CTT encountered several distinct challenges in its operation. One issue arose in the context of valuing unquoted shares, which was necessary for practically any transfer or transaction, in the family company particularly.30 An additional issue concerned whether a power to accumulate denies the possibility of there being an interest in possession.31 The essential charging provisions were found in sections 19–24 of the Finance Act 1975, with special provisions for settled property in Schedule 5 to that Act. The significant provisions included section 19(1), which taxed the ‘value transferred’ by a ‘chargeable transfer’.32 The key concept was a ‘transfer of value’, which, as defined in section 20(2), led to the value of as estate immediately after the disposition being less than it would be but for the disposition. The amount by which it is less (including the amount of the tax payable if it comes out of the transferror’s estate) is the value transferred by the transfer, and was liable to CTT. Excluded property was defined under section 24(1), and was not covered by the tax.33 It largely dealt with trusts, and property abroad, and was

28 Indeed, when the CTT was announced to Parliament, it was presented in this way. Mr Healy said, by way of introduction: ‘I intend to take measures to close the loopholes which prevent the estate duty from performing the role assigned to it.’ HC Deb 26 March 1974, vol 871 cols 313–14. 29 L Eisenstein, ‘The Rise and Decline of the Estate Tax’ (1955) 11 Tax L Rev 223. 30 ibid 18–19: ‘One thing which is going to increase is the number of occasions on which you will have to value unquoted shares. Of course, this has been done for the Estate Duty purposes since 1894, and for Capital Gains Tax since 1965. However, you will see that practically any transfer or transaction in shares in a family company now involves us in CTT considerations. So that it is not just on a death or where one wants to hark back to April 1965 that valuations are needed.’ 31 RM Walters, Finance Act 1978: Taxation Changes/Prepared for the Society of Company and Commercial Accountants (London, Society of Company and Commercial Accountants, 1978) para 5.3 (held at British Library). 32 Robert Dymond, Dymond’s Capital Transfer Tax (Robert Dymond, Reginald Kimsey Johns and Roy R Greenfield (eds), Oyez Publishing, 1977) 9. 33 ibid 15.

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exempted from the charge through a curious amount of legal wrangling.34 Distinctly not excluded from the charge was the family company, a clear target of the CTT. Sherring suggested that the most important reference to close and unquoted companies in the legislation was found in Finance Act 1975 section 20(4), where ‘having stated that a disposition on arm’s length terms with no donative intent is not a transfer of value, the legislation goes on to say that this does not apply to a sale of shares or debentures which are not quoted, unless it is shown that the sale was at a price freely negotiated or at a price which free negotiations might have been expected to produce’.35 Familiarities, thus, lost with the introduction of the CTT were relatively straightforward forms of mitigation and avoidance. Given the extent of avoidance at the time, these were predictable targets for the Labour Party.36 For example, the requirement that a donor should survive for seven years before the exemption would apply had little impact on avoidance, Walters explained, because many donors were careful to make gifts sufficiently early.37 This in fact was the primary reason that the CTT originally taxed all gifts, over the course of a donor’s lifetime.38 The Finance Act 1981, however, ultimately limited the accumulation period to 10 years.39 In this sense, the capital transfer tax maintained a link with the estate duty in more ways than one.

CAPITAL TRANSFER TAX: THE OBJECTIONS

The objections to Capital Transfer Tax focused, in particular, on two issues: the projected impact on family farm ownership, and the interaction with family companies. The concern over family farms occurred against the background of significant, contemporaneous research. A few years after

34 ibid 17: ‘“[e]xcluded property” therefore occupies a somewhat curious position. It is technically part of the estate while the owner of it is alive, but not such a part that its transfer out of the estate (or, if it is settled property in which he has an interest in possession, the transfer or termination of such interest) can be a transfer of value by him, and it magically disappears from the estate immediately before his death and so likewise cannot be chargeable with Capital Transfer Tax on his death.’ 35 ibid 16–17, where Dymond continues: ‘[t]he words “freely negotiated” are the most important. During the debates on the 1975 Act, it was made clear that this phrase meant that one should temporarily ignore the restrictions which the Articles of a private company place on any transfer. This is the same position which we had for estate duty. Once one accepts the idea of an open market value, one accepts the idea that there are no restrictions on the hypothetical sale which one has to imagine in order to discover the open market value.’ 36 Indeed, Walters suggested at the time that the estate tax had become known as the ‘avoidable tax’ because it was very easy to give away assets before death: Walters, n 31 above, para 1.1. 37 ibid. 38 ibid. 39 Finance Act 1981 s 93.

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its introduction, in 1978, the first report of the Royal Commission on the Distribution of Income and Wealth40 emphasised that patterns of inheritance played a major role in the patterns of wealth distribution in the United Kingdom.41 This report, by GZ Fijalkowski-Bereday, was described as a ‘pioneering study’ of the impact of patterns of inheritance on farm ownership.42 This report was received within an existing intensity of interest concerning the interaction of farming and CTT. Literature from the era reveals an overall sense of uncertainty in this area. At a minimum, there was a call then for more scholarship of this type.43 This call occurred in the context of the fact that (as of 1978) 1973 apparently was the last year that information concerning who paid death duties, and how much, was made public.44 Horsman suggested that this, combined with the fact that the opposition in Parliament then was working steadily towards the repeal of CTT, seemed to contribute to a general sense of unease about how well the tax actually was understood.45 The impact of CTT on smaller farmers was much discussed during its tenure.46 In the House of Commons debate on CTT on 5 March 1975, Mr Francis Pym, speaking for the opposition, argued that the impact of CTT on farmers would be ‘far too heavy’.47 He warned that the only option available to farmers was to ‘fragment’ a family farm, and ‘[w]ho will buy the fragments?’48 The outcome threatened, he predicted, was ‘the peasant type of agriculture which is such a problem in certain parts of Europe’.49 Other risks, he suggested, apparently included undermining the entire system of food production in the United Kingdom.50 The structure of CTT did endeavour to encompass relief that would benefit small farmers. CTT allowed relief for small business assets,51 and, as Sutherland explained, ‘UK agriculture is a collection of small businesses’.52 The challenge was that ‘“smallness” is not a universal characteristic’,53 and studies at the time revealed a considerable number of what could be

40 Royal Commission on the Distribution of Income and Wealth, No 1 Initial Report on the Standing Reference (Cmnd 6171, 1920). 41 EG Horsman, ‘Inheritance in England and Wales: the Evidence Provided by Wills’ (1978) 30 Oxford Economic Papers 409. 42 ibid. 43 ibid. 44 ibid 45 ibid 409–10. 46 See, inter alia, GH Peters and JC Eckford, ‘The Impact of Capital Transfer Tax on Agriculture: a Preliminary Assessment’ (1976) 5 Oxford Agrarian Studies 35. 47 ibid, citing HC Deb 5 March 1975, col 1609 ff. 48 ibid. 49 ibid. 50 ibid. 51 Capital Transfer Tax Act 1984 (now Inheritance Tax Act 1984) s 20. 52 Alister Sutherland, ‘Capital Transfer Tax and Farming’ (1980) 1 Fiscal Studies 51. 53 ibid.

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described as larger farms.54 Another challenge was that, even where a farm could be described as smaller, arguments supporting resemblance to other types of small businesses generally struggled, not least because (given that land is a limited resource) inheritance was virtually one of the only methods of entrance.55 The impact of CTT on family companies also was much discussed in its time. It emerged as a distinct area of professional expertise, in part due to the impact of CTT. As FA Sherring suggested in a practitioner training tape from the era, ‘[a]s you can see, the problems of the family company and its shareholders are now a specialist tax field where, even if one ignores stamp duty, a good knowledge of CTT and CGT are essential, and where regular consultation between shareholders and their professional advisers is necessary to prevent falling into tax traps’.56 Consideration of the scope of CTT helps this come into focus. Capital Transfer Tax covered transfers of capital by persons during their lifetimes and upon their deaths; and similar transactions by close companies (which were treated as ‘transfers by the individual participators in such companies’).57 Capital transferred into, and out of, settlements were also taxed.58 There were five categories of ‘chargeable transfers’ for the purposes of the tax. The first type included non-exempt transfers made after 29 March 1974.59 The following three types were assessed ‘as if ’ a transfer of value had been made, and included: transfers upon the death of a person after 12 March 1975, transfers by close companies, and when a person received a beneficial interest in settled property.60 The final category included capital distributions made after 12 March 1975 from settled property in which no interest in possession subsists (and which was not defined in the legislation).61 The CTT employed two sets, or scales, of rates, known as ‘the lifetime and the death scales’.62 The reasoning behind two different sets of scales was to encourage donors to dispose of as much property as possible during a lifetime, and not to wait until death.63 Review of literature from the era reveals the belief that this was a direct effort to redress the perceived

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ibid. ibid. 56 FA Sherring, Current Taxation Problems, Capital Transfer Tax and the Family Company: User’s Guide, 2nd edn (London, ICAEW, April 1979), 27 (audio and transcript held in the Rare Books and Music Room, British Library). 57 Wheatcroft and Hewson, n 5 above, 1010 para A1-05. See generally Capital Transfer Tax Act 1984 Pt IV (relating to close companies). 58 ibid. 59 ibid 1011, para 1A1-06. 60 ibid 1011, para 1A1-07. 61 ibid. 62 Walters, n 31 above, para 2.1. 63 ibid. 55

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failure of the Finance Act 1894. This belief was underpinned by certain, well-known touchstones in the history of the estate duty. A particularly infamous example of the apparent inequalities of the Act involved (with appropriate historic resonance) the Duke of Westminster. There were exemptions for taxpayers in the armed services, who died either on active service or because of active service. In an infamous example, the case of Barty-King,64 the Court upheld the Secretary of State’s decision that the estate of the fourth Duke of Westminster, who died in 1967, was exempt from estate duty because of a wound suffered in 1944.65 Of course, it need not have followed from this controversial decision that an entire tax was so easily avoided (especially given the disparities in influence between the Duke of Westminster and the average taxpayer), but its evocation by Walters in a discussion of (the then new) CTT indicates its symbolic place at the heart of discussions addressing why the Labour Party might have wished to reform the estate duty.

PEARSON V COMMISSIONERS OF INLAND REVENUE

As the previous sections covered the fraught road to legislation for the CTT, as well as the primary sources of objections to the tax, the purpose of this section is to consider the tax’s legacy. This is achieved through analysis of, arguably, the most famous case decided under CTT. Pearson and others v Commissioners of Inland Revenue66 was also the first Capital Transfer Tax case to be decided by the House of Lords. It addressed the issue of the treatment, for the purposes of CTT, of interests in possession. The facts concerned a transfer by the settlor to a trust, Sir Richard Anthony Pilkington, of 13,333 Ordinary Shares of 10 pounds each in Pilkington Brothers Ltd to his three children, Fiona, Serena and Julia, all of whom had reached the age of 21 by the end of February 1974.67 The majority, reversing the decision of the lower Court, held that neither Fiona (who received a later appointment in her favour) nor her sisters were beneficially entitled to an interest in possession in the settled property. Wheatcroft and Hewson explained that Lord Keith (writing for the majority): regarded it as significant that the existence or otherwise of an interest in possession forms the sole basis for determining which of the two alternative regimes of Capital Transfer Tax is to apply to particular settled property. The 1975 Act does

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Barty-King v Ministry of Defence [1979] STC 218. Under Finance Act 1978 Sch 7 para 1: Walters, n 31 above, para 4.21. 66 Pearson v Commissioners of Inland Revenue [1981] AC 753. 67 See R Dymond, Dymond’s Capital Transfer Tax (London, Oyez, 1980) 146–47 (Maugham Library, Tony Arnold Collection). 65

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not speak of discretionary or accumulation trusts; interests in possession are set on the one side, and all other kinds of interests on the other. This seemed to him to require that the concept of interest in possession should in this context be a clear and definite one.68

Under the terms of the trust, the trustees were required to hold the capital and income, and to accumulate income, upon trust for the beneficiary absolutely. The beneficiary had no right to any income as it accrued but only a right to such income as the trustees thought fit not to accumulate. Fiona therefore, the Court held, did not have an interest in possession. It is not clear at this distance whether the poor drafting of which Wheatcroft and others complained led to Pearson, or whether this is an unremarkable case, involving the kind of interpretative attention that had surrounded the estate duty for 80 years previously. The legacy of Pearson v Commissioners of Inland Revenue is that it remains the leading authority for the definition of an interest in possession.69 Pearson was also an important case involving a moment of confrontation in ‘the awkward relationship between the terminology of property law and the (legislative) terminology of tax law’.70 Murphy suggested that this involved a discourse between ‘common sense’ (ie ‘did she really have an interest’) and ‘the metaphysical discourse of Equity’ (ie ‘what is the quality of her interest’?).71 The facts had hinged upon the appointment of an interest in £16,000 to Fiona, the oldest daughter.72 The Inland Revenue had classified this appointment as giving rise to an interest in possession within the property of the trust, such that CTT was payable under Finance Act 1975 Schedule 5 paragraph 6(2).73 An additional issue was whether, every time the trustees distributed trust property within the family, CTT would be due.74 The Court held, in allowing the Crown’s appeal, that the expression ‘interest in possession’ in Finance Act 1975 Schedule 5 should be interpreted within its ‘ordinary natural meaning of a present right to enjoyment of property’.75 Thus, the beneficiaries’ entitlement to income was subject to the trustees’ power to accumulate, which meant that attaining the age of 21 did not entail any significant changes in the beneficiaries’ entitlement.76 Thus, before the appointment in her favour in 1976, Fiona was not 68

Wheatcroft and Hewson, n 5 above. HM Revenue and Customs, ‘Interests in Possession: Definition of an Interest in Possession’ in Inheritance Tax Manual IHTM16062, available at www.hmrc.gov.uk/manuals/ ihtmanual/ihtm16062.htm. 70 WT Murphy, ‘Fiona’s Fragile Possession’ (1980) MLR 712, 713. 71 ibid 713. 72 ibid. See also Pearson, n 66 above, 753. 73 Murphy, n 70 above, 755. 74 ibid. 75 ibid 754. 76 ibid. 69

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beneficially entitled to an interest in possession. Thus, the appointment had the impact of bringing FA 1975 Schedule 6(2) into effect.77 Murphy suggested that, ‘[i]f we ask in a common sense way what Fiona really had that she could call her own, we would conclude that she was completely at the mercy of the trustees’.78 This, Murphy stressed, is the entire point of family trusts, which endeavour to ensure that trusts should ‘accumulate’ until beneficiaries are ‘settled in life’, and thus in a position to claim the wealth of the trusts.79 The objective is to delay the assumption of control until a point in time when the beneficiaries are ready.80 From the perspective of tax law, the risk is that this moment may be delayed for tax motivated reasons, as opposed to the objectives of the trust. Murphy explained that the motive of the trustees is to delay the moment at which the trustees assume control until ‘the future is reasonably clear’.81 Through this delay, however, the trustees also expand their opportunities to make ‘optimum choices’ in investment, and in tax planning.82 Murphy concluded his analysis of Pearson by asking, ‘what is the relationship between the terminology of the law of property and of tax law?’83 He questioned whether it was likely that the phrase ‘interest in possession’ would be retained (as it turned out, it was), and then proposed that the real question was whether Parliament would opt for an ‘exhaustive’ rather than an ‘illustrative’ definition. The answer to Murphy’s question was that Pearson filled the gap. The case provides, for all intents and purposes, the definition of an interest in possession. Murphy indicated that the case threw up more questions than it answered; for example, ‘[i]n the tax context, is it important to attend to the realities of the trust, to the “practical results”?’84 The alternative, he suggested, was ‘a pure conceptualism, perhaps buttressed by the need for “certainty”, to continue to be acceptable?’85 The alternative won, and Pearson in many ways became the end of a conversation (as opposed to, as Murphy seemed to suspect, the beginning). Pearson is now the authority on point, although the convergence between tax, property and trusts on this point, predicted by Murphy, seems not to have occurred.86

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ibid. ibid 713. ibid. 80 ibid. 81 ibid. 82 ibid. 83 ibid 717. 84 ibid. 85 ibid. 86 For example, a major textbook on trusts writes of Pearson: ‘Whether or not an object has a vested interest has been important for purposes of taxation law’. This specification seems to single tax law out, as containing a point of interest which is not necessarily shared in an equal way by the law of trusts; James Penner, The Law of Trusts (Oxford, Oxford University Press, 2012) 82, para 3.64. 78 79

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This moment of recognition between property, trusts and tax, for which the areas of law themselves appeared unprepared, is not surprising given the significant changes which CTT introduced. The CTT encompassed several major points of reform, not limited (as discussed below) to the introduction of a unified transfer tax system, encompassing both inter vivos transfers and transfers upon death.87 This ‘unified’ system included other provisions intended to minimise the sorts of ‘distortions’ also experienced, by way of example, in the US system, which taxes gifts and inheritances separately.88 The CTT ultimately was designed to extend beyond its initial reach, and to presage deeper changes ahead for the system for taxing capital. In this, it was very much a tax of its era. The unification of systems for taxing capital also was recommended in the United States, prior to the introduction of the Tax Reform Act (TRA) 1969, by the American Law Institute (ALI).89 Other proposals by the ALI which were mirrored in the structure of the Capital Transfer Tax included the principle that capital should be ‘taxed once in a generation’, an objective which was achieved by taxing the end of an interest in possession.90 In fact, there were a number of interesting parallels between the reforms introduced with CTT, and reforms to estate and gift taxation that were introduced with the TRA 1969.91 The UK tax system did not possess a form of gift taxation, such as might be recognised in the United States, until 1974.92 Maudsley described the UK system (in comparison with the US system) as operating thus: ‘[t]he [UK] fiscal system operated with few, but very severe, taxes, and there were well-known, widely practiced, and widely accepted loopholes at least in the estate duty system—the death tax’.93 As mentioned below, there was another, deeper change anticipated for the United Kingdom. The Labour government planned to ‘equalise wealth’ in two stages: first, by the introduction of CTT, and, secondly, by the introduction of a wealth tax, which (Maudsley wrote in 1975) was expected in 1977.94 In the end, the Labour Government abandoned this plan.95 Glennerster has conducted archival research into the reasons behind this change of plan.96 His motivation for this research is described as starting from the point that, the last time a Labour government included the introduction of a wealth tax into its election platform, it abandoned the effort.97 87 88 89 90 91 92 93 94 95 96 97

Ronald Maudsley, ‘British Capital Transfer Tax’ (1975) 13 San Diego L Rev 779, 780. ibid. ibid 779–81. ibid 781. ibid 780. ibid. ibid. ibid 784. Glennerster, n 26 above, 233. ibid. ibid.

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Glennerster suggests that the reasons for this abandonment are historically significant, and indeed describes the period 1974–79 as a ‘post war break point’.98 Wages were rising at significantly lower rates than inflation, which conflagrated to significant pressure being placed on Prime Minister Harold Wilson’s government.99 As Glennerster explains, ‘[t]o win trade union agreement to some kind of wage restraint the Labour Party agreed, before the election, to introduce a range of measures that would “fundamentally redistribute income and wealth”’.100 This package was to include initiatives in pensions, child benefits and other social policy changes.101

CONTRIBUTION OF CAPITAL TRANSFER TAX AND HAYTON AND TILEY

Glennerster’s research reveals that the impetus to introduce these changes simply lost momentum. Perhaps the energy that had driven the significant changes in the field of capital taxation, for at least 10 years, was waning. Certainly, by 1974, a great deal had changed. Capital transfer tax was part of a major shift in the taxation of capital in the United Kingdom that had been occurring since taxation of capital gains was introduced in 1965.102 Before 1965, the United Kingdom had only two forms of taxation on capital: stamp duty and estate duty.103 By 1975, there were four taxes on capital: stamp duty, Capital Gains Tax, and (courtesy of CTT) a gifts tax and a tax on transfers upon death.104 Indeed, as mentioned above, at that point in time, a fifth form of taxation upon capital (a wealth tax) was anticipated as a virtual political certainty. Hayton and Tiley suggested that, ‘[i]n an ideal tax system the tax burden would be fairly shared between the different sections of the community and acknowledged to be so shared by those sections and the taxpayers would send in the tax due from them without being asked for it’.105 They continued, ‘[t]he United Kingdom has not yet achieved this ideal’.106 The CTT, they suggested, was a response to be anticipated against this background. It was, perhaps, an imperfect response to an imperfect tax structure. The challenge, Hayton and Tiley imply, is that in the midst of significant changes to the taxation of capital, the deficiencies of income taxation were insufficiently considered. 98 99 100 101 102 103 104 105 106

ibid 3. ibid. ibid. ibid. Hepker and Whitehouse, n 6 above, 7. ibid. ibid. Hayton and Tiley, n 2 above, 15. ibid.

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What is the legacy of CTT? Hayton and Tiley’s text is contemporaneous, and does not address this question. More recently, Lee argued that there were fundamental problems with the tax itself; and, indeed, that the days of the CTT ‘were not happy ones’.107 She places emphasis on accounts from the era suggesting that one reason for the CTT’s apparent, comparatively low yield was that a significant number of wealthy taxpayers may have fled the country to avoid the tax.108 The essential problem, Lee suggests, was with the lifetime transfer element of the tax. This is the point at which CTT failed, and remains an important point of reference for assessment of modern day amendments to inheritance tax. Of course, the justification for the lifetime transfer element of CTT was the need to address the ease with which a charge triggered solely by death might be avoided. And that, Hayton and Tiley argued, was the entire point, as ‘one can say that the argument for taxing capital is that a tax based on income, particularly as defined in the United Kingdom, is inequitable in that it fails to tax many receipts but taxes those it does catch at very high rates’.109 CTT, thus, made up the difference, and caught ‘receipts which had fallen through the income tax system’.110 This introduces the question of whether a revived discourse should focus not on the value of inheritance taxation, therefore, but on the challenges faced by income taxation? On this point, it is interesting to note that, in another proposal from the 1960s and 1970s, Simons investigated whether it might be possible to avoid the issue completely, by integrating, or subsuming, estate taxation within other forms of tax.111 Simons supported an integration of income, death and gift taxes, but his proposal did not receive much support.112 Unsurprisingly, the response to an approach which, amongst other issues, would eliminate a great deal of potential for instrumentalism was mixed, and ‘[t]ax scholars were sceptical of the idea that a one-shot transfer of wealth (a stock) should be mixed with the annual flow of income’.113 The importance of Simons’ investigations is that they present the possibility of side-stepping the inheritance taxation debate entirely, by effectively hiding it behind other forms of taxation. As Goldberg reminds us (in another context), sometimes the important question is the end, not the

107 Natalie Lee, ‘Inheritance Tax—an Equitable Tax No Longer: Time for Abolition?’ (2007) 27 Legal Studies 678, 680. 108 ibid 684. The question of the overall yield of CTT was addressed in Parliament in 2012: HC Deb 12 January 2012, col 390W. 109 Hayton and Tiley, n 2 above, 16. 110 ibid. 111 As related in HM Groves, ‘The Canadian Tax Report and the American Tax System’ (1968) 379 Annals of the American Academy of Political and Social Science 94, 97. 112 ibid. 113 ibid.

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means.114 If it were ever possible in the modern era of sensitivity to stealth taxation to ‘hide’ estate taxation, would the presumed attendant absence of public debate of inherited wealth represent a loss? One of the reasons that Simons’ proposal was rejected is that it did not allow the tax system to treat death as a significant, or special, event; ie it did not permit a taxpayer’s aggregated estate to be assessed at the end of her lifetime, within a rate structure that acknowledges death as a special circumstance.115 As an assessment of the economic sum of a taxpayer’s life, a capital transfer tax has a philosophical advantage, if also the challenge (for its popularity) of its burdens landing upon taxpayers still living.116

CONCLUSION

Capital transfer tax, as the 1978 Hayton and Tiley text began, was ‘a direct tax on capital’, but with a difference.117 As this chapter has explained (and indeed as Hayton and Tiley explained in the beginning of their text), it applied to inter vivos transfers made after 26 March 1974, and to transfers on death occurring after 12 March 1975.118 In this, it was a thoroughly new kind of tax. As it applied to lifetime transfers, it differed from an estate tax; and, as it focused on the decedent (and not a person inheriting an estate), it could not be called a succession duty.119 It did not apply to the entirety of a capital gain, and thus could not be called capital gains taxation, but simply because Capital Gains Tax may have applied would not have prevented CTT from applying as well.120 Additionally, CTT did not apply to ‘stationary’ wealth, so it could not be described as a wealth tax. CTT did not fit within existing intellectual categories, and appeared to create a category of its own. These points were covered in the introduction to the second edition of Hayton and Tiley’s fascinating 1978 text. Given the distinguished backgrounds of its co-authors, the text always promised to remain of historical interest. This chapter argued that the text, and indeed the capital transfer tax, should be reconsidered, for two reasons. First, the intellectual fervour

114 FT Goldberg Jr , ‘From FDR to W: the IRS as Financial Intermediary’ (2002) 29 Ohio Northern Univ L Rev 1, 28. 115 Groves, n 111 above, 97. 116 Groves relates ‘what happened next’ in his late 1960s analysis, which was, essentially, that ‘[t]he death tax in particular fell upon evil days’. It became very easy to avoid, and ‘[i]ts contribution to the revenue dwindled from small to (almost) negligible’. The worst of the ‘host of problems’ with which it was ‘beset’, however, was that ‘[a]bove all the death tax encountered stagnation in public opinion’. See ibid 16, 97. 117 Hayton and Tiley, n 2 above, 1. 118 ibid. 119 ibid. 120 ibid.

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surrounding taxation of inheritance, and striking burst of scholarship that occurred in the first decade of the twenty-first century, has quietened, struck mute by the impact of the recession. This chapter proposed that the United Kingdom’s experience with CTT did not receive the attention it deserved within that scholarship. Forging a place for CTT within this scholarship carries the potential of reviving the discourse. Secondly, the Hayton and Tiley text on CTT complements recent scholarship into the historical place of the failed introduction of a wealth tax by the same government. CTT and the wealth tax were dual parts of a single project. Ultimately, the value of considering the capital transfer tax again, on its own terms, is suggested by some of the observations offered by Hayton and Tiley. Their text sought to explain how CTT operated, and is rich in detail and illustrative examples, but they suggested that the tax could not fully be understood unless it was considered as both a product of, and a part of, the system in which it operated. It is distinct from other texts of the era, largely because it devotes few if any pages to criticism of the belaboured legislative process which produced it. Perhaps the authors felt that this territory was already well covered, as this chapter’s analysis of the writings of Hepker and Whitehouse, and Wheatcroft and Hewson, amongst others, may suggest. Their text, by comparison, delves into more fundamental questions about the nature of the relationship between income taxation and capital taxation; and, strikingly, appears to express more concern about the failure of the former than the latter. They wrote in a time when the limitations of an 80-year-old estate duty led to a radical legislative experiment. There are some interesting points to notice about this legacy. For example, the seven year survival rule was abandoned and then, ultimately, revived. Additionally, the relationships between trust law, property law and taxation law were challenged by the very first House of Lords case decided under the CTT legislation (and the case appeared to raise questions which ultimately were not answered). Perhaps the most interesting point of all to notice about this legacy, however, rests in the promise analysis of CTT may hold for consideration of the modern inheritance tax. As the pre-recession interest in inheritance taxation looks set for revival, the CTT, at the very least, sets out significant points of reference that a productive revival might consider.

16 The Tax State, Benefit and Legitimacy MIRANDA STEWART

ABSTRACT This chapter traces the discursive history of the principles of benefit and legitimacy of taxation from the late eighteenth century to the present day. Drawing on the work of scholars from Adam Smith through Richard Musgrave to public choice theorists, it is observed that the evolution of successful tax states, especially democratic states, seems to depend on both an acceptance by taxpayers of benefits derived under government and a fiscal constitution that limits taxing power. The chapter argues for a renewed focus on principles of benefit and legitimacy of taxation to fund successful democratic tax states in the global era.

INTRODUCTION “It was Alistair who said, on national television, that being a Tax Officer was the most pleasant work imaginable, like turning on a tap to bring water to parched country. It felt wonderful to bring money flowing out of multinational reservoirs into child-care centres and hospitals and social services … He sold taxation as a public good”.1

C

OLLECTIVELY, WE GIVE authority to government to levy taxation so as to provide for the public good. This chapter discusses two core principles—benefit and legitimacy—which underpin taxation to fund government. Levying taxes for public benefit is a coercive exercise of government power. In successful tax states, the coercive taxing power seems always to be constrained by a set of rules or norms which both limit and legitimise taxation. This ‘fiscal constitution’ has been crucial to the success of the tax state. While democratic limits on taxing power are not the only possibility, the slogan ‘no taxation without representation’ indicates how representative democracy developed in tandem with legitimate taxation and 1

P Carey, The Tax Inspector (New York, Vintage International, 1993) 124.

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became the dominant form of government that could be successfully funded by substantial taxation. Thus, in the words of Australian public economist John Head, this chapter seeks to link core principles of public finance to a view of a ‘good democracy’.2 The chapter does a sweeping historical discursive survey which aims to show how the ideas of benefit, legitimacy and public good in public finance developed in the context of political, economic and technological change, in the tax state over the last 250 years. The narrative focuses on two leading scholars: Adam Smith3 (of the eighteenth century) and Richard Musgrave4 (of the twentieth century), who each saw government as a joint endeavour that must be maintained, developed and funded by taxes. The chapter then proceeds to discuss in more detail some aspects of the benefit theory of taxation and the legitimacy of the taxing power of government. The theory calls for a way to identify benefit that generates the obligation to pay tax. This led to a concept of ‘public good’ which became increasingly refined in public finance. In the early twentieth century, the benefit theory also became important in international tax theory which sought to allocate taxing rights between countries. The concept of legitimacy includes not only democratic legislative limits on taxation, but new sources of legitimacy as bureaucratic government developed in the late twentieth century. Finally, the chapter turns to discuss the challenges to the democratic tax state in the context of economic globalisation. It is argued that we need to renew our focus on the benefit and legitimacy of taxation to enable funding government for public benefit in the global era.

DEVELOPMENT OF THE ‘TAX STATE’

The ‘tax state’ refers to a government dependent on and defined by its power to tax.5 We owe the concept to Joseph Schumpeter, the Austrian economist and sociologist who was briefly Finance Minister of Austria and who later moved to Harvard University in the United States. Schumpeter presented the

2 J Head, Public Goods and Public Welfare (Durham, NC, Duke University Press, 1962) 223. 3 A Smith, The Wealth of Nations (London, Methuan, [1776] 1904), available at www. econlib.org. 4 R Musgrave, The Theory of Public Finance (New York, McGraw-Hill, 1959). 5 The term ‘tax state’ is used with more precision by economic historians to refer to particular stages of development of the tax state. See, eg YC Bartolome and P O’Brien (eds), The Rise of Fiscal States: a Global History (Cambridge, Cambridge University Press, 2012); Christopher Hood, ‘The Tax State in the Information Age’ in T Paul, G Ikenberry and J Hall (eds), The Nation-State in Question (Princeton, NJ, Princeton University Press, 2003) 213.

The Tax State, Benefit and Legitimacy 485 concept of the ‘tax state’ in 1918. He argued that fiscal affairs were crucial ‘at the turning points of epochs, when old forms die off and new structures emerge, times which always involve a crisis of the old fiscal methods’ and proposed: a special field, fiscal sociology … the view of the state, of its nature, its forms, its fate, as seen from the fiscal side. The word ‘tax state’ is a child of this view.6

Early British Tax State and Adam Smith The eighteenth century has been described in recent studies of economic history as the time of the birth of the tax state. For example, Wenkai He studied England, Japan and China and traced developments through which central governments succeeded in raising sufficient revenues to govern effectively.7 He concluded that in England and Japan, a successful transformation was achieved towards centralised and effective public finance, based largely on indirect consumption taxes. In England, this was achieved in the period from 1642 to 1752 and in Japan, a century later, in the period from 1868 to 1880. In contrast, He argues that China failed to transform its public finances away from decentralised property taxes towards centralised taxes and therefore did not achieve the same level of consolidation of government power and did not become a ‘tax state’. It was in the context of a newly consolidated British ‘tax state’, which relied heavily on indirect taxes on goods, that Adam Smith developed his ideas about government, economics and taxation.8 Smith was, as is now a cliché, the ‘father’ of free market economics. A less popularised but vital contribution of Smith is that he envisaged taxation as the core funding for government. His views on the free market and the importance of taxation to fund government are not inconsistent but, rather, are necessarily interdependent. Smith observed that the state has long been financed by a combination of sources: tribute from conquered lands; the king’s domain; seignorage derived by sovereign control of currency; borrowing; and taxes extracted by compulsion from citizens.

6 JA Schumpeter (1918), ‘The Crisis of the Tax State’ in R Musgrave and A Peacock (eds), Classics in the Theory of Public Finance (New York, Palgrave MacMillan, 1954) 101. Musgrave notes that the term ‘tax state’ was coined first by R Goldscheid, State Socialism or State Capitalism (Wien-Leipzig, Anzengruber-Verlag, 1917) 98. Fiscal sociology is enjoying a resurgence. See, eg I Martin, A Mehrotra and M Prasad, The New Fiscal Sociology: Taxation in Comparative and Historical Perspective (New York, Cambridge University Press, 2009). 7 W He, Paths Toward the Modern Fiscal State (Cambridge, MA, Harvard University Press, 2013). 8 Smith, n 3 above, especially Book V, ch 1 (‘Expenses of the Sovereign or Commonwealth’); ch 2 (‘Sources of General or Public Revenue of the Society’); and ch 3 (‘Debt’).

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The domain is the land or enterprises which belong to the sovereign, from which he derived rents from lands or agriculture, or profits from the means of production such as a mine, or ‘mercantile projects’.9 Smith observed that the great European states could no longer defray their expenses from the domain. The domain would be most productively used in private hands in the market economy and the only lands that should remain in the hands of the Crown are ‘lands for the purposes of pleasure and magnificence—parks, gardens, public walks, etc, possessions which are everywhere considered as causes of expense, not as sources of revenue’.10 Smith also rejected government borrowing as an adequate source of revenue. He gave as an example, the borrowing practices of the State of Pennsylvania in the United States. He observed: [T]he unstable and perishable nature of stock and credit, however, render them unfit to be trusted to as the principal funds of that sure, steady, and permanent revenue which can alone give security and dignity to government. The government of no great nation that was advanced beyond the shepherd state seems ever to have derived the greater part of its public revenue from such sources.11

Smith concluded that government must be funded by taxes, ‘the people contributing a part of their own private revenue in order to make up a public revenue to the sovereign or the commonwealth’.12 It is then understandable that Smith paid attention to the principles on which taxation should be designed to support ‘government … of a great nation’ in his famous maxims, extracted here: I.

II.

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. The expence of government to the individuals of a great nation is like the expence of management to the joint tenants of a great estate, who are all obliged to contribute in proportion to their respective interests in the estate. In the observation or neglect of this maxim consists what is called the equality or inequality of taxation… The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person. Where it is otherwise, every person subject to the tax is put more or less in the power of the tax-gatherer, who can either aggravate the tax upon any obnoxious contributor, or extort, by the terror of such aggravation, some present or perquisite to himself…

9 ibid Book V, ch 2.1. Smith noted wryly that princes ‘have scarce ever succeeded’ in mercantile projects (Book V, ch 2.7), referring to Machiavelli’s writing about Lorenzo of Medici’s failed business ventures, and to the misadventures of the English East India Company. 10 ibid Book V, ch 2.22. 11 ibid Book V, ch 2.13 (emphasis added). 12 ibid Book V, ch 2.22.

The Tax State, Benefit and Legitimacy 487 III. IV.

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… Every tax ought to be so contrived as both to take out and to 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…13

Smith presented the maxims as general, for the design of taxes to fund the ongoing operation of all governments.14 Half a century later, John Stuart Mill extracted Smith’s principles in his own writings, described them as ‘classic’ and added his own analysis especially on equality in taxation.15 Today, tax policy-makers frequently refer to a triumvirate of ‘traditional’ tax policy principles: equity, efficiency and simplicity, which are drawn largely from Smith’s maxims. Smith applied his maxims in considering the actual kinds of tax, their impact on business, consumption and work, and modes of collection that might be adopted by the state, to an unprecedented level of detail. He was knowledgeable about the diverse types of tax applied in Great Britain, on the Continent and in the Americas. He recognised that taxation has an impact on the entrepreneurial behaviour and choices of taxpayers in the market economy and argued for the most neutral taxes. He understood that different taxes called for different mechanisms of measurement and collection and sought to articulate how these could be most effectively designed to be acceptable to taxpayers. He also recognised that these maxims of taxation require balancing in the real world. Smith’s work on taxation therefore is a link from the historical development of taxation laws and methods of collection of the eighteenth century to the successful establishment of an income tax to fund government in the twentieth century. Although he died a decade before the first English income tax of 1799 (generally recognised as the first modern income tax), his work reveals that this concept was well understood by him and others. The concepts of taxation on faculty and on profit or revenues as a flow from assets, labour or business were already established.16 Smith discussed taxes falling on ‘the private revenue of individuals’ from ‘rent, profit, and wages’, arising from land, stock (movable property) and labour, and emphasised that it was the net revenue after expenses which should be taxed.17 He was aware of the difficult issues facing tax administrators and law-makers concerning how to identify, value and tax the returns to ‘active’ business, trades and

13

ibid Book V, ch 2.25. ibid Book V, ch 2.29. 15 JS Mill, Principles of Political Economy (London, Longmans, [1848] 1909) Book V, ch 2, especially 2.1 ff, available at www.econlib.org. 16 P Harris, Income Tax in Common Law Jurisdictions (Cambridge, Cambridge University Press, 2006) 389–90. 17 Smith, n 3 above, Book I, Book V, ch 2.23. 14

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professions as well as commodities and land. Smith turned towards direct taxation as the primary foundation for funding government.18

Nineteenth Century ‘Fiscal State’: Tax, Debt and Liberalism Taxation came to be the core funding for government in the tax state. However, governments had for thousands of years borrowed money to govern. Some early forms of taxation operated as a system of borrowing. Margaret Levi explains that in the Roman Empire the sophisticated system of tax farming was ‘as much a banking as a taxing system’: tax farmers gave rulers ‘a loan secured by the revenues they then are authorized to collect from taxpayers’.19 The Venetian government ‘levied a compulsory loan on its taxpaying citizens, for which it promised each of them five percent annual interest, and allowed the “bonds” or contracts to become negotiable, thus creating a market in government debt’.20 This innovation spread to other Italian cities and across Europe. It generated a sense of ‘ownership’ of government which was perhaps a precursor to citizenship: ‘the commercial classes in those mercantile republics that pioneered these new forms of financing did end up seeing themselves as owning the government’.21 Governments, for their part, acted in ‘service and subservience to the merchant interest’ in a ‘close, even intimate, association between the state authority and the merchant interest’.22 Smith observed the importance of the ‘great mercantile families’ in republican Holland and Zeeland, who bore a substantial part of the expense of these countries but were also accorded ‘either some direct share or some indirect influence in the administration of that government’.23 At the end of the eighteenth century, some governments became indebted to an unprecedented level. Following the American war of independence, the ensuing economic crisis, the failure of salt taxes and other taxes on commodities (partly due to smuggling and enforcement difficulties) and the Napoleonic wars, Great Britain owed in excess of 200 per cent of national income—considerably greater than the levels of government debt we see arising from the recent global financial crisis.24 This massive challenge for the state was met by the end of the nineteenth century, by which time Britain had embedded the income tax, ensuring stability of government finances.

18 R Musgrave, Public Finance in a Democratic Society (Northampton, MA, Edward Elgar, 2000) vol III, 55. 19 M Levi, Of Rule and Revenue (Berkeley, CA, University of California Press, 1989) 77. 20 D Graeber, Debt: the First 5,000 Years (New York, Melville House Printing, 2011) 338. 21 ibid 339. 22 JK Galbraith, A History of Economics: the Past as Present (London, Penguin, 1987) 36. 23 Smith, n 3 above, Book V, ch 2.225. 24 M Daunton, Trusting Leviathan (Cambridge, Cambridge University Press, 2001) 47.

The Tax State, Benefit and Legitimacy 489 The successful establishment of the income tax was, in fact, linked to a reduction overall in the size of the British state. Daunton explains that acceptance of the income tax ‘rested on creating a belief that it would help to constrain the state rather than provide it with additional resources’. As there was ‘a close correlation between paying income tax and possessing a vote in parliamentary elections under the terms of the Reform Act of 1832’ this accorded nicely with the principle of ‘no taxation without representation’.25 Trust was required from two key stakeholders: lenders and taxpayers. From the capital markets, there needed to be an ability to borrow large sums that would bear interest to be gradually paid down over the long term.26 This could only be financed with a steady flow of taxation revenues and so the government also needed to gain the trust of taxpayers. The shift towards a new equilibrium in a taxing and borrowing ‘fiscal state’ also had distributional consequences. Piketty observes that ‘a government bond is nothing more than a claim of one portion of the population (those who receive interest) on another (those who pay taxes)’.27 The ‘rentier’ class and the ‘taxpayer’ class overlapped considerably during the nineteenth century. However, by the end of the century, the equilibrium began to be destabilised, as the mass of workers in the industrialising state, who paid relatively little in income taxes but numerous taxes on commodities, sought increased government expenditures and political representation. The modern liberal state of Britain, although ‘widely appraised by contemporaries’, could not be replicated elsewhere.28 However, a similar pattern emerged in a number of other European states, revealing the ‘complementarity of the modern tax system and the modern method of issuing government debt’.29 For example, in Sweden, ‘on the one hand there were income taxes and indirect taxes on monetary streams and on the other hand state borrowing was long term with a large funded debt’.30 We can also observe a gradual change in the features of tax systems during the nineteenth century. Direct taxes, in particular income tax, land and inheritance taxes, were expanded and to some extent replaced commodity taxes and

25 M Daunton, ‘Creating Legitimacy: Administering Taxation in Britain, 1815–1914’ in J Cardoso and P Lains (eds), Paying for the Liberal State: the Rise of Public Finance in Nineteenth-century Europe (New York, Cambridge University Press, 2010) 39. 26 ibid. 27 T Piketty, Capital in the 21st Century (Boston, NJ, Harvard University Press, 2014) 113; although that general statement ignores debt owed to creditors outside the country. 28 J Cardoso and P Lains (eds), Paying for the Liberal State: the Rise of Public Finance in Nineteenth-century Europe (New York, Cambridge University Press, 2010) 22. 29 L Neal, ‘The Monetary, Fiscal, and Political Architecture of Europe, 1815–1914’ in J Cardoso and P Lains (eds), Paying for the Liberal State: the Rise of Public Finance in Nineteenth-century Europe (New York, Cambridge University Press, 2010) 299. 30 L Schön ‘The Rise of the Fiscal State in Sweden 1800–1914’ in J Cardoso and P Lains (eds), Paying for the Liberal State: the Rise of Public Finance in Nineteenth-century Europe (New York, Cambridge University Press, 2010) 16.

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tariffs. A European pattern developed, ‘defined by the execution of forms of financing government activity by taxing the economy efficiently and by servicing political and social consensus’ but differences in ‘the institutional forms of how tax policies were conducted’ remained important.31

German Communal State and Finanzwissenschaft An alternative approach to financing government developed in the German states. It is well recognised that the German states were the first to expend substantial public monies on social welfare. By the second half of the century, public economist Adolph Wagner had noticed an interesting trend in public expenditures. In 1863, he pronounced a theory that became famous as ‘Wagner’s law’, connecting the rise in government spending to growth in national income: ‘the wealthier a country becomes, the more the share of public activity (and thus expenditure) will increase’.32 The economic historian Spoerer has concluded, after a detailed review of German local, provincial and federal taxation data, that Wagner made ‘a valid empirical description of the development of the public-sector share during his time’.33 As Wagner observed, expenditures on education, utilities (water, gas, electricity, sewerage), transport and welfare payments gradually increased: ‘[w]elfare cost had always been important items in municipal budgets. But whereas supporting the poor used to be discretionary, welfare support became an entitlement with the much-praised social security legislation of Reich Chancellor Otto von Bismarck’.34 This included governmentprovided health insurance in 1883, accident insurance in 1894 and old age insurance in 1889, all of which Bismarck intended ‘to take the wind out of the socialists’ sails’ and ‘to make the labourer a dependent of the state, someone who feared that he risked his pension should the socialist overthrow the bourgeois order’.35 The German states and subsequently the Reich derived substantial revenues from ownership of public utilities, railways, mines and postal services as monopolies.36 This development, like the heavy use of debt in the fiscal state, contradicted Adam Smith who had argued that governments usually failed at ‘mercantile projects’. Taxes increased but implementation of income tax was slower than in Great Britain, although German intellectuals 31

ibid 22. A Wagner, ‘Three Extracts on Public Finance’ in R Musgrave and A Peacock (eds), Classics in the Theory of Public Finance (New York, Palgrave MacMillan, 1954) 2–5. 33 M Spoerer, ‘The Evolution of Public Finances in Nineteenth-Century Germany’ in Cardoso and Lains (eds), above n 30, 103, 112. 34 ibid. 35 ibid. 36 ibid 127. 32

The Tax State, Benefit and Legitimacy 491 had given significant attention to the concept.37 In the southern states, taxes were largely indirect or on assets including land. In Prussia and other northern states, a ‘graduated capitation tax’ which was ‘halfway between a poll tax and a primitive income tax’ was dominant until the 1848 revolutions. Eventually, an income tax was established in Saxony in 1878, Baden in 1884 and Prussia in 1891. The specialist subject of public finance for ‘communal wants’ was known as Finanzwissenschaft and became well known outside Germany. For example, Irish scholar of political economy Charles Bastable discussed the German approach in his 1892 volume, Public Finance.38 Bastable explains how this ‘remarkably productive’ German scholarship placed public finance in the context of economic history and treated it as having politico-social and not merely financial aims.39 By the end of the nineteenth century, Wagner argued that taxation can become a regulating factor in the distribution of national income and wealth, generally by modifying the distribution brought about by free competition … this second, regulatory purpose to interference with the uses of individual incomes and wealth … leads to an extended, or if preferred, a second conception of taxation. This is a ‘social welfare’ concept beside the ‘purely financial’ one.40

Twentieth Century ‘Tax and Welfare’ State We should be careful not to overstate the ability or desire of nineteenth century governments, even Germany, to tax and spend for communal wants. While public expenditures in Great Britain reached 20 per cent of national income during the Napoleonic Wars, this level was brought down during the course of the century. Most governments barely reached a fiscal ratio of 10 per cent of national income. The dawn of the twentieth century saw many governments that were neither democratic nor delivering public goods on any scale for the benefit of their people. Schumpeter, writing in 1918, was concerned about the potential collapse of the tax state, not because of war but because of increasing social demands: While the tax state has been able to survive rising costs of administration and war, changing attitudes towards property and demands for social expenditures offer a more ominous signal for its future. These may generate a crisis which the tax state cannot survive.41 37 This history is traced in ERA Seligman, Progressive Taxation in Theory and Practice, 2nd edn (Princeton, NJ, Princeton University Press, 1908) 131–32. 38 CF Bastable Public Finance, 3rd edn (London, Macmillan, [1892] 1917), available at www.econlib.org. 39 ibid ch II.15. 40 Wagner, n 32 above, 89. 41 Schumpeter, n 6 above, 116.

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Yet the tax state thrived. Forty years later, the pattern appeared more in line with Wagner’s law: a growth in public expenditures, funded by taxation, consistent with growth in the size of the economy. The public power to tax and spend became a defining characteristic of democratic government.42 As the franchise expanded, the size of government expenditures and level of taxation increased dramatically. This state of affairs appeared, until the 1970s, to be compatible with continuing economic growth.43 The scholar who embodies twentieth century public finance is Richard Musgrave, who lived from 1910 to 2007. Musgrave’s research career spanned nearly 70 years from the early 1930s to 2000. He learned his public economics from the leading scholars of the previous century, in the tradition of the European social sciences; combined this with public policy experience and advice to governments; and in the last part of his career engaged directly with legal concepts of justice and constitutionalism, teaching taxation at Harvard Law School with another great American tax policy-maker and lawyer, Stanley Surrey. Musgrave did more than any other theorist in the English language to draw together the traditions of public finance in social and economic context, recognising both the German tradition of Finanzwissenschaft and the Anglo-liberal tradition inherited from Smith and Mill. Musgrave summarises the ‘tax and welfare’ story as follows: [T]he western world saw the typical state share in GNP rise from 20 to over 40 percent. In part this reflected rising military budgets, but more importantly the growth of social programs to serve the interests of lower and middle income groups. The propertied class did not dominate voting rights and, in strategic areas, even sponsored the infusion of social concern into the market system. By and large, the rise in expenditures was matched by rising tax revenue; and where instances of over-indebtedness led to fiscal collapse (typically as the product of war finance), that crisis was soon liquidated by bankruptcy and inflation. Thereafter, the capitalist system with its tax state reemerged none the worse.44

While only hinted at by Musgrave, this was hardly a smooth trajectory: it is important to remember the wars, financial depression, poverty and holocausts that accompanied the expansion of the state in general, and tax and welfare systems in particular. The changes in state and economy led to a rush of new ideas in the debate about the role of government in the economy, epitomised in the different

42 J Campbell, ‘The State and Fiscal Sociology’ (1993) 19 Annual Review of Sociology 163; A Gould and P Baker, ‘Democracy and Taxation’ (2002) 5 Annual Review of Policitcal Science 87. 43 See, eg V Tanzi and L Schuknecht, Public Spending in the 20th Century (Cambridge, Cambridge University Press, 2000); K Messere, The Tax System in Industrialised Countries (Amsterdam, Kluwer, 1993). 44 Musgrave, n 18 above, 101.

The Tax State, Benefit and Legitimacy 493 views of John Maynard Keynes and Friedrich Hayek.45 The Keynesian goal of a capitalist economy with full employment faced the challenge and effects of inflation, which Joan Robinson called ‘the great unsolved problem of full-employment policy’.46 In the first half of the century, inflation had had important redistributional effects on bond-holders; in Piketty’s argument, at least, inflation played a crucial role in ending the dominance of the rentier class, eroding their returns and eliminating much of their accumulated wealth.47 By the 1970s, it was a problem for the ordinary worker. In the tradition of Germany in the previous century, many countries, including Great Britain and also Australia, New Zealand, Canada and to some extent the United States, were ‘mixed economies’. Governments played an active and interventionist role in market activities and derived significant revenues from enterprises supplying everything from fertilizer and steel to power, rail, postal services, airlines and water facilities. Many scholars considered that high tax and expenditure levels, public ownership of enterprises and full employment were necessary for the survival of capitalist society.48 In some countries (Sweden and other Scandinavian countries in particular) the public sector came to dominate more than half of the economy. However, in most countries economic growth meant that the private sector substantially exceeded the public sector and the range of goods and services privately consumed also grew at an unprecedented speed and scale.49 Marshall and others were influential in establishing welfare policy with the main goal of social solidarity in the twentieth century.50 In the ‘golden era’ of the welfare state and unprecedented economic growth from the 1950s to the 1970s, there was a broadly accepted consensus of universal citizenship and an acceptable minimum standard of living.51 Different countries established quite different models of welfare state, including ‘insurance’,

45 See, eg N Wapshott, Keynes/Hayek: the Clash that Defined Modern Economics (Melbourne, Scribe, 2011). 46 J Robinson, ‘The Age of Growth’ (1976) Challenge (May–June) 4. 47 Piketty, n 27 above, 133. 48 See, eg J O’Connor, The Fiscal Crisis of the State (New York, St Martin’s Press, 1973); discussed in S Fedeli and F Forte, ‘Deficits, Tax Burden and Unemployment’ in F Forte, R Mudambi and PM Navarra (eds), A Handbook of Alternative Theories of Public Economics (New York, Edward Elgar, 2014). 49 E Lindahl, ‘Just Taxation: a Positive Solution’ in R Musgrave and A Peacock (eds), Classics in the Theory of Public Finance (New York, Palgrave MacMillan, 1958); Head (1962), above n 2, 114; G Colm, Essays in Public Finance and Fiscal Policy (New York, Oxford University Press, 1955). 50 T Marshall, Citizenship and Social Class (Cambridge, Cambridge University Press, 1950). 51 TI Gizelis, Globalisation, Integration and the Future of European Welfare States (Manchester, Manchester University Press, 2010) 11.

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entitlement and more targeted ‘poverty relief’ models.52 However, they all had common goals of redistribution, provision for need, and social cohesion, so that ‘a large proportion of the population supports, the political system that governs the interaction between state and society’.53 The use of progressive income taxation with increasing rates borne by both labour and capital was of central importance in funding this welfare state in many countries. In particular, many former British colonies, including the United States, and Canada, Australia and New Zealand, succeeded in increasing income taxation and establishing redistributive welfare states. Although they became self-governing at different times and in different ways, the story of development of the ‘tax and welfare’ state in each place has similarities, especially in relation to the income tax. Leading US tax scholar Seligman placed direct taxes, especially the income tax, as the ‘last step in the historical development of public revenues’.54 The intellectual lineage dating back to Adam Smith is revealed in his use of ‘revenue’ as interchangeable with ‘income’: Just as a man’s ability to support himself or his family is seen in his income or revenue, so, in the same way, it is recognized that the test of a man’s ability to support the state is to be found in this same income or revenue. From the modern point of view, it is the duty of the citizen to support the government according to his capacity to support himself.55

The emphasis given by Seligman and others to income taxation was given renewed vigour by Henry Simons in his influential 1938 text, Personal Income Taxation.56 Simons was a liberal economist who saw the progressive income tax as essential for viability of the free market. The income tax became and still remains central to funding government and to the political compromises made in the twentieth century, especially in the United States.57 In Australia and New Zealand, progressively structured taxes had already been established before the Australian federation was formed in 1901.58 The Australian colonies had turned to income, land and estate taxes to deal with fiscal crises.59 They came to the federation (which up to the last minute might also have included New Zealand) with significant sovereign debt, in contrast to the Canadian and US federations in earlier times.60 52

ibid. ibid 27. 54 Seligman, n 37 above, 8, 19. 55 ibid 18. 56 H Simons, Personal Income Taxation (Chicago, IL, University of Chicago Press, 1938). 57 A Mehrotra, Making the Modern American Fiscal State (New York, Cambridge University Press, 2014). 58 J Smith, Taxing Popularity: the Story of Taxation in Australia, 2nd edn (Sydney, Australian Tax Research Foundation, 2004) 22. 59 ibid 37. 60 M Stewart, ‘Australia’ in G Bizioli and C Sacchetto (eds), Tax Aspects of Fiscal Federalism: a Comparative Analysis (Amsterdam, IBFD Kluwer, 2011) 167. 53

The Tax State, Benefit and Legitimacy 495 An Australian land tax was introduced in 1910 and income tax in 1915, both ultimately to fund the ‘promise of a national old-age pension’ which ‘had been an important element of popular support for the Federation’.61 After the Second World War, income taxes were for the first time in history borne by the mass of the population who earned income from work not capital. Messere defines an even narrower 20 year period ‘between 1955 and around 1975’ in which ‘there was economic growth and increased standards of living in most industrialised countries and a corresponding readiness of taxpayers to accept more tax burdens to contribute to a better welfare state’.62 In this period, higher income earners, including those earning returns to capital, paid more income tax under these progressive regimes than they ever had before. However, the broad middle taxpayer base of the personal income tax was critical for expansion of the ‘tax and welfare’ state. At the same time, social security taxes on wages also funded the ‘entitlement’ or insurance model of welfare in many countries. Unlike income tax, these social security taxes were often flat rate or even regressive. Some countries, especially France, relied less on income tax and more on social security tax and the new broad-based consumption tax known as the Value Added Tax (VAT). This was also borne mostly by labour and was adopted to fund growing welfare states across Europe from the 1960s.

Fiscal Crisis and Tax Reform for Growth The ‘golden’ period of the tax and welfare state ended in the mid-1970s, although Messere notes that ‘it took another 10 years for the tax backlash to manifest itself in most industrialised OECD countries’.63 The 1970s and 1980s saw a wave of globalisation, the collapse of the gold standard and floating of currencies across many countries. Governments borrowed heavily and this combined with ‘oil shocks’ and high inflation led to fiscal crises in many countries. It became apparent that tax systems were not as robust as had been believed. Inflation became a problem for workers, as progressive taxes became increasingly heavy on middle-income earners through bracket creep, leading to political opposition. In many countries, income tax avoidance by upper and middle earners increased in response to high

61 62 63

Smith, n 58 above, 48. Messere, n 43 above, 119. ibid.

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marginal rates, often using offshore tax havens as international capital flows became easier. The neo-liberal reaction in public finance to these developments emphasised supply side effects of taxation, especially benefits of lower taxes. There were calls for lower tax rates on capital and labour to encourage investment and economic growth and a reduction in tariffs as borders were opened to trade.64 Daunton writes of the shift to the ‘enterprise’ state in Great Britain, which led to an increased focus on incentives to entrepreneurship and savings. There was increasing acceptance of inequality in income and wealth.65 An important theoretical development was optimal tax theory, which built both incentives and distribution into tax analysis and identified biases in the tax system against work, entrepreneurship and saving. James Mirrlees and Peter Diamond ‘proved’ that high and progressive personal income tax rates on work and capital were inefficient and hence rates should tend to zero at higher incomes to counter economic disincentives for work and saving.66 These theories made many assumptions that were not tested against empirical evidence until decades later, when methods improved and data became available (and Diamond, at least, has recently presented a view in support of both progressive taxation and taxation on capital).67 At a time when top marginal rates were as much as 90 per cent, optimal tax theory supported calls for dramatic reductions of taxation on capital (because of the disincentive to save and capital mobility) and on labour income (because of the disincentive to work). These economic theories and practical developments, including global tax competition, produced an unprecedented era of tax reform, led by the United States in its 1986 reform under President Ronald Reagan.68 Significant reductions in tax rates, especially of personal and company income tax (and more generally tax on capital) were enacted. These changes were often accompanied by increases in consumption taxes. There was also a push to reduce the overall level of taxes (and hence the size of the state). However, the ‘tax state’ persisted in this new form, as tax levels remained stable or even increased in many developed countries in this period. Tax bases were

64 D Swank, ‘Tax Policy in an Era of Internationalization: Explaining the Spread of Neoliberalism’ (2006) 60(4) International Organization 847. I survey these trends in M Stewart, ‘Global Trajectories of Tax Reform: Mapping Tax Reform in Developing and Transition Countries’ (2003) 44 Harvard International Law Journal 140. 65 M Daunton, Just Taxes: the Politics of Taxation in Britain, 1914–1979 (Cambridge, Cambridge University Press, 2002). 66 J Mirrlees, ‘Optimal Tax Theory: a Synthesis’ (1976) 6 Journal of Public Economics 327; J Mirrlees and P Diamond, ‘Optimal Taxation and Public Production I: Production Efficiency, II: Tax Rules’ (1971) 61 American Economic Review 105. 67 See, eg P Diamond and E Saez, ‘The Case for a Progressive Tax: From Basic Research to Policy Recommendations’ (2011) 25(4) Journal of Economic Perspectives 165. 68 See generally C Sandford, Why Tax Systems Differ (Bath, Fiscal Studies, 2000); S Steinmo, Taxation and Democracy (New Haven, CT, Yale University Press, 1993).

The Tax State, Benefit and Legitimacy 497 broadened although rates were lowered, and debt was brought under control with the increased focus on controlling deficit. Nonetheless, some have observed that the trend of growth in the size of government came to an end during this time.69

BENEFIT THEORY OF TAXATION

The theory of benefit of taxation, both as a justification for taxation, and as an explanation of how to allocate the burden of taxation, waxed and waned as the tax state developed over the 200 years surveyed above.

Early Benefit Theory Adam Smith insisted in his first maxim, extracted above, that the subjects ‘ought to contribute towards the support of the government … in proportion to the revenue which they respectively enjoy under the protection of the state’. This built on much earlier theories of benefit. In 1651, Thomas Hobbes defined the philosophical basis for paying taxes as an obligation in exchange for security under the state, in proportion to what they consumed in society.70 Sir William Petty said in 1692, ‘it is generally allowed by all that men should contribute to the public charge but according to the share and interest they have in the public peace; that is, according to their estates and riches’.71 At the time, the benefit theory was applied explicitly to support taxation in the early American colonies, such as New England: [The] duty of every inhabitant to contribute towards the support of the colony was based upon the theory of benefit received by reason of the existence of the government. The amount of the contribution was determined by the ability of the inhabitant to pay, and his ability, by the amount of land and property he possessed, while every able-bodied freeman was required to pay a specified sum as a poll tax.72

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S Peltzman, ‘The Growth of Government’ (1980) 23(2) Journal of Law and Economics

209. 70 ‘[T]he benefit that every one receiveth … is the enjoyment of life, which is equally dear to poor, and rich … when the Impositions are layd upon those things which men consume, every man payeth Equally for what he useth’: T Hobbes, Leviathan (London, Pelican Classics, [1651] 1968) available as a Project Gutenberg eBook, www.gutenberg.org/files/3207/3207-h/3207-h. htm. 71 ‘A Treatise of Taxes and Contributions’ in C Hull (ed), The Economic Writings of Sir William Petty (Cambridge, Cambridge University Press, 1899), extracted in R Musgrave and A Peacock (eds), Classics in the Theory of Public Finance (New York, Palgrave MacMillan, 1954) 66. 72 Harris, n 16 above, 176.

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A later American recognition of the benefits of government and hence of taxation is in the famous saying, ‘taxes are what we pay for civilised society’.73 Adam Smith defined the tax obligation, as did Hobbes and Petty, on the basis of an objective measure of ability to pay. Smith measured benefit by the ‘revenues’ of the taxpayer who prospered. It was assumed, apparently without needing much discussion, that those who had more in ‘riches’ benefited more under the state and should pay more in taxation. Notably, this formulation of benefit does not focus on provision of any particular service or good by the state to the individual subject, for which the individual pays. Rather, it required a contribution to taxation in exchange for the general benefit of security or prosperity under government. Adam Smith also developed a specific concept of a ‘public good’ to be funded by taxation, besides the benefit of ‘protection’ of government.74 He observed that some goods ‘though they may be in the highest degree advantageous to a great society are, however, of such a nature that the profits could never repay the expenses to any individual or small number of individuals and which it therefore cannot be expected that any individual or small number of individuals should erect’.75 Such goods included roads and infrastructure, defence and the administration of justice and, more broadly, the necessary institutions ‘for facilitating the commerce of the society’ and ‘for promoting the instruction of the people’—especially, and still relevant today, the free public education of youth.76 Smith saw the need, in his time, for increased public expenditures in all of these areas. The benefit theory was also important in the German school of public finance theory, to the extent that it referred to taxes to fund communal wants and public expenditures.

Decline of Benefit in the Nineteenth Century Liberal political thinkers in the nineteenth century, including Mill and others, in discussing fairness of taxation famously emphasised ability to pay instead of benefit. From the late nineteenth century onward, the benefit theory is frequently described as a limited, thin or out of date theory of tax justice, which is at best inadequate and, at worst, false. As David Duff observes, Seligman considered that the idea that taxes should vary according to the benefits that persons receive from government was ‘a principle

73 Compania General de Tabacos De Filipinas v Collector of Internal Revenue, 275 US 87, 100 (1922) (Holmes J). 74 I Kaul, P Conceicao, K Le Goulven and RU Mendoza, Providing Global Public Goods: Managing Globalization (Oxford, Oxford University Press, 2003). 75 Smith, n 3 above, Book V, ch 1.69. 76 ibid Book V, ch 1.130 ff.

The Tax State, Benefit and Legitimacy 499 based on “a false political philosophy” from which follows “a false political economy”’.77 Henry Simons called it ‘a significant element in a reactionary social philosophy, constructed from the gratuitous implications of laissezfaire economics’.78 What led to such a change? The first reason for the turn away from the benefit theory by the Anglo-liberal political economists, in contrast to the German scholars, was because they were not interested in a theory of public expenditures and were sceptical of government. They examined the burden of taxation separately from a discussion of what government is for, their focus on the individual and freedom from state coercion. This individualisation of the relationship of taxpayer and government differed sharply from the ‘communal’ approach of the German school. The second, related reason was the acceptance not only of the individual but of his (or her) subjective experience of happiness and exercise of choice. This found the greatest expression in Jeremy Bentham’s utilitarian philosophy, published while Adam Smith was alive.79 Bentham called the community ‘fictitious’, the sum of the individual happiness of each of its individual members, so that ‘it is in vain to talk of the interest of the community, without understanding what is in the interest of the individual’.80 While utilitarianism concerns the collective goal of the ‘greatest good for the greatest number’, it is premised on the subjective wellbeing of each individual,81 which became (and still is today) the foundation of welfare economics. The market can be theorised as consistent with subjective wellbeing, as it is assumed that the price signal in the market indicates individual choice and that individuals choose to purchase what will make them happy. In contrast, there is no price signal for government. The objective measures on which taxation must be based—income, consumption, wealth—are mere proxies for accessing subjective wellbeing. The inability to determine each individual’s subjective preferences and wellbeing without a price signal is a problem for all theories of taxation, including ability to pay. However, it was seen to deal a particular blow to the benefit theory. Bastable said in 1895, ‘The theory that taxation is the price of the State’s services, and finds its measure for each citizen in the amount of benefit received, is, as regards the latter

77 D Duff, ‘Benefit Taxes and User Fees in Theory and Practice’ (2004) 54 University of Toronto Law Journal 391. 78 Simons, n 56 above, 34, also discussed in Duff, n 77 above. 79 J Bentham, An Introduction to the Principles of Morals and Legislation (Oxford, Clarendon, [1780] 1907), available at www.econlib.org. 80 ibid I.4. 81 ibid.

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part, quite unsupported by history’.82 Supporters of a ‘benefit’ approach to public expenditures, such as Wicksell83 and Lindahl,84 struggled with this problem. How could it ever be known in what way, and to what extent, each individual subjectively benefits from government? And if this could not be measured, how could this justify the taxation burden?

Public Goods and Musgrave’s Allocation Branch Some twentieth century theorists remained interested in benefit and saw a positive general role for government that must be funded by taxation. Richard Musgrave recuperated the benefit theory, drawing on both the Anglo and German traditions of public finance.85 Musgrave established a normative framework of a government with three branches: Allocation, Distribution and Stability. He used the term ‘public’ or ‘social wants’ to be satisfied by expenditures of the ‘Allocation’ branch of government for the benefit of the public as a whole. Musgrave separated this function from the Distribution Branch, which would address tax and welfare payments to implement the (re)distribution of income or wealth between people in society. Finally, the Stabilisation Branch would address the goals of full employment and monetary stabilisation (inflation). This approach was explicitly a normative and imaginative model of government for analytical purposes; it did not purport to represent what government actually does in any taxing or spending transaction.86 Musgrave’s move to shore up the benefit theory has to be understood in the context of the US debate around taxation in the first half of the twentieth century, which focused on the progressivity of the income tax as the government’s main gesture towards distributive justice. Musgrave explains as follows: I think it useful to maintain a distinction between the problems of the Allocation Branch and those of the Distribution Branch. This, at least, is preferable to the other extreme, inherent in the ability-to-pay approach, of discarding assignment of benefits from public services and of considering the placement of the entire tax bill as a distributional problem … We may still think of the taxes of the Allocation Branch as allocated on a proportional basis, and of the tax-transfer process of the

82

Bastable, n 38 above, Book III, ch III.4.2. K Wicksell, ‘A New Principle of Just Taxation’ in R Musgrave and A Peacock (eds), Classics in the Theory of Public Finance (New York, Palgrave MacMillan, 1954). 84 E Lindahl, ‘Die Gerechtigkeit des Besteuerung’, translated as ‘Just Taxation: a Positive Solution’ in R Musgrave and A Peacock (eds), Classics in the Theory of Public Finance (New York, Palgrave MacMillan, [1918] 1954) 168. 85 Musgrave, n 4 above; Head, n 2 above. 86 As is made clear in P Musgrave, ‘Comments on Two Musgravian Concepts’ (2008) 32 Journal of Economic Finance 340. 83

The Tax State, Benefit and Legitimacy 501 Distribution Branch as providing for a proper state of distribution, defined now with reference to income left after payment of taxes to the Allocation Branch.87

The challenge remains: How can we apply the benefit theory if we do not know what is the individual’s subjective benefit from the state? Musgrave addresses this by assuming equality and assessing taxation for public goods on a ‘proportionate’ basis. Taxation for redistribution is progressive ‘with reference to income left over’ after public goods have been provided. The reliance on a ‘proportionate’ theory of taxation harks back to the language of Adam Smith who is often assumed to argue only for a flat percentage rate of taxation. However, Smith did not always intend ‘proportionality’ to mean a flat rate. In other contexts, especially housing taxation, he clearly supports progressive taxation.88 Public economists sought to refine the definition of ‘public good’ in an attempt to solve the problem of ‘price’ for the taxpayer-consumer. Samuelson established the conditions that a public good be both ‘nonrival’ and ‘nonexcludable’89 and consumed equally by all. An example is commonly given of national defence, such as a submarine purchased for the nation. Once the benefit (let’s assume for the time being) of the submarine is made available to citizen A, it must by definition also be made available to citizen B. The non-excludability of public goods distinguishes them from private goods, which are excludable and so can be priced in the market. One consequence of non-excludability is that the market will not supply the optimal level of such goods, to the detriment of all; consequently, there is a role for government to supply them. Where there are large numbers of people, so that the contribution of each individual or consumer is insignificant in relation to the total, Wicksell and subsequent writers argued that each individual would not voluntarily make any contribution to public goods.90 On the demand side, a public good is nonrival, that is, all individual consumers can access the good once produced. Samuelson described a public good mathematically as differing from a private consumption good ‘in that each man’s consumption of it … is related to the total … by a condition of equality rather than of summation’.91 Each person’s consumption of the public good (such as a submarine) is identical to the total. Citizen B not only gets the full ‘benefit’ of the submarine, but cannot reject it, even if B is opposed to this form of military spending. 87

Musgrave, n 4 above, 21–22. For example, on ‘house-rents’: Smith, n 3 above, V.2.71. 89 P Samuelson, ‘The Pure Theory of Public Expenditure’ (1954) Review of Economics and Statistics 387; P Samuelson, ‘Diagrammatic Exposition of a Theory of Public Expenditure’ (1955) Review of Economics and Statistics 350. 90 Head, n 2 above, 86, discussing K Wicksell, ‘A New Principle of Just Taxation’ in R Musgrave and A Peacock (eds), Classics in the Theory of Public Finance (New York, Palgrave MacMillan, 1958). 91 Head, n 2 above, 350. 88

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These conditions have the effect of confining the concept of a ‘public good’ to a very narrow compass. As market failure is the only justification for government provision and coercive taxation, and this only occurs in the narrow situation of the ‘public good’ defined, this narrow compass implies a narrow view of the role of government. Some argued that this narrow approach limits the explanatory power of the concept of ‘public good’ for understanding the reality of government. G Colm observed that the distinction made by Samuelson between ‘public’ and ‘private’ goods does not necessarily match the distinction between government and non-government activity.92 He explained that the interesting question we want theory to explain is ‘why in a given economic system certain activities are conducted through government, others through private agencies?’. Many publicly funded goods can be at least partly excludable. For example, the government could quite easily exclude people from use of a bridge (perhaps unless they paid a fee, or were wearing blue) and it could enforce this. Colm observed that there are also activities in the nongovernment sphere, including philanthropy or research and development, which are not able to be priced in the market. Graeme Cooper describes the narrow approach to the benefit theory that treats taxes as a pricing mechanism as follows: The image which the economic analysis suggests is that government is to be regarded as if a private enterprise selling to its citizens the benefits it controls. The government, in providing various goods and services, tries to emulate the activity of a market and so, as in a market, the choice and extent of government-provided services as well as their tax ‘price’ is tied to the expression of a desire for that service through the consumer’s willingness to pay for it.93

On this basis, the benefit theory can be applied where government ‘services’ can be charged for like market goods. However, this analogy breaks down as there is no market, and so no objective price, by definition for government as a whole. John Head observed that the utilitarian analysis of subjective well-being had since the nineteenth century ‘manifestly failed to produce meaningful results and had mainly served to divert the attention and energies of leading tax scholars away from the practical challenge of implementing tax fairness ideals in the modern democratic state’.94 However, it held sway to the extent that even Musgrave conceded that ‘[u]nless the Allocation Branch succeeds

92 G Colm, ‘Comments on Samuelson’s Theory of Public Finance’ (1956) 38(4) Review of Economics and Statistics 408. 93 G Cooper, ‘The Benefit Theory of Taxation’ (1994) 11 Australian Tax Forum 379, 414. 94 J Head, ‘Tax Fairness Principles: a Conceptual, Historical and Practical Review’ (1992) 9 Australian Tax Forum 65, 77.

The Tax State, Benefit and Legitimacy 503 to a significant degree in imputing benefits to individual taxpayers, there is no point in distinguishing between tax distributions by the two Branches’.95 Most theorists turned instead to a theory of ability-to-pay based on the objective measure of the taxpayer’s measurable income, consumption or wealth. This sounds like Adam Smith again, but with a difference: as all now accepted the subjective wellbeing of individuals as the foundation of economic theory, a fiction is also required to support ability to pay. This is the theory of declining marginal utility of income, which imputes the objective measure of income as indicating subjective happiness in receipt of the next dollar received by a millionaire compared to a pauper; the assumption is that the marginal dollar is worth less to the millionaire.96 The strictly defined economic concept of a ‘public good’ is limited in other respects. It ignores the role of government in forming consumer or citizen preferences and in constituting the market itself, so as to shape and deliver what people want in response to price signals. More fundamentally, the division of public and private in the interaction of government, society, individual, family and market is socially constructed.97 Both market and public good preferences of individuals are endogenous to the governmental, societal and economic context. The economic concept also does not address those goods that people should have but do not necessarily want (and bads that they want but should not necessarily have). Musgrave used the term ‘merit goods’ for this category of goods which government decides all people should have for their own and collective wellbeing.98 Arguably, providing people with what is good for them (and preventing them from having or doing what is bad for them) is today one of the key roles of government. It is also, of course, a key reason why people resent, resist and protest against government. Finally, the narrow theory of public goods is confused as regards redistribution. More than half of government expenditures in developed countries are on health, education and welfare that have redistributive as well as ‘public’ features. Wicksell and Lindahl suggested that distribution should be considered separately from benefit, in a prior or simultaneous redistribution function.99 This was a way to model benefit of public goods based on a tax-price, without having to deal with ability to pay. Musgrave’s distinction between Allocative and Distributive branches of government is a metaphor only, but it is important to note that he saw redistribution as being of the ‘remaining’ income after public goods were funded, thereby placing it 95

Musgrave, n 4 above, 88. SB Lawsky, ‘On the Edge: Declining Marginal Utility and Tax Policy’ (2011) 95 Minnesota Law Review 904. 97 See, eg S Boyd (ed), Challenging the Public/Private Divide: Feminism, Law, and Public Policy (Toronto, University of Toronto Press, 1997). 98 Musgrave, n 4 above. 99 Head, n 94 above. 96

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second in importance to the base level of ‘proportional’ taxation needed to fund public goods. On the other hand, legal philosophers Liam Murphy and Thomas Nagel subordinate ‘public goods’ to ‘redistribution’.100 They argue that redistribution cannot be set aside in a decision about ‘public goods’ because ‘in determining the level and type and form of financing’ of public goods, ‘we will also be determining what is left under the private control of each individual’.101 Murphy and Nagel conclude that ‘the best we can do … is to set public expenditure at a level financed by unequal contributions from individuals that come as close as possible to equalizing the marginal utility of public and private expenditure for each of them’.102

LEGITIMACY

Before considering whether, and how, benefit theory can be recuperated, let us consider legitimacy of taxation. Margaret Levi argues persuasively that successful taxation requires negotiation of a stable fiscal bargain between government and key interests.103 Levi’s theory is borne out empirically in the broad statistical analysis of Mark Dincecco who uses long-run panel data of fiscal statistics to examine the transition to a successful tax state across Europe. Dincecco shows that this transition was successful only if both fiscal centralisation and establishment of relatively stable political limits on taxing and expenditures were achieved.104 That is, taxation must be made legitimate. In the nineteenth century, the overarching narrative of limiting government, as epitomised by Great Britain, had its philosophical basis in the work of liberal philosophers including Mill and Bentham. Both utilitarian and liberal strands of thought addressed the changing role of government and taxation from a point of view of freedom of the individual from coercive government. In contrast, the Germanic concept of Finanzwissenschaft tended to treat the state as representative of the people as a whole, not as individuals. Even in the German states, however, increases in taxation led to constraints on government. Spoerer comments that ‘while the graduated income tax

100 L Murphy and T Nagel, The Myth of Ownership: Taxes and Justice (New York, Oxford University Press, 2002). 101 ibid 81. 102 ibid. 103 Levi, n 19 above. 104 M Dincecco, ‘Fiscal Centralization, Limited Government, and Public Revenues in Europe, 1650–1913’ (2009) 69(1) Journal of Economic History 48.

The Tax State, Benefit and Legitimacy 505 imposed a much higher tax burden on wealthy taxpayers, it increased their political voice enormously’ by the suffrage linking the voting power of taxpayers to the amount of direct taxes paid.105 Limits on government developed in quite different ways in different states but some kind of increased voice, or control by certain interests or taxpayers, for example through the vote, was the price of success in taxation.106 At a time of expansion of colonial power and the British Empire, after the French Revolution and the birth of the new independent nation of the United States, these ideas provided the principled support for political advocacy or bargaining to ensure legitimate government in many countries in exchange for taxation.

Benefit Theory and the Taxpayer-Voter Democracy provided an alternative mechanism for ‘pricing’ government by means of the vote. This was seized on by the benefit theorists, to support public goods theory. As a justification for broad-based taxation to fund government in general, the benefit theory requires a broad acceptance of the legal, institutional and political process of voting. Specifically, the benefit theory requires a process of decision-making about what, and how much, of each public good should be provided. Musgrave explains this function of voting: The crucial role of assigning tax-prices in this setting (a term more appropriate than that of distributing tax ‘burdens’) is to induce preference revelation by voting on tax-expenditure issues. This is essentially the spirit of benefit taxation. Ideally, the voting process would be one where all conceivable cost distributions (tax-prices payable by various individuals) would be matched with all conceivable public service programs, but this is hardly feasible. Selected expenditure and tax programs must be considered and tax programs must be expressed in terms of generally applicable tax formulae, rather than as a set of individual tax-prices.107

Governments have gone a long way down this path of disaggregating the state into separate goods and services; the modern practice for hypothecation of revenues to particular expenditures, at least in political rhetoric, continues this process. When benefit can be linked directly to specific services, a tax-price can be ascertained and this is generally accepted as an appropriate use of the benefit theory.108

105

Spoerer, n 33 above, 108. L Neal, ‘The Monetary, Fiscal, and Political Architecture of Europe’ in J Cardoso and P Lains (eds), Paying for the Liberal State: the Rise of Public Finance in Nineteenth-century Europe (New York, Cambridge University Press, 2010) 299. 107 Musgrave, n 4 above, 58. 108 Duff, n 77 above. 106

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The benefit theory also underpins development of the big ‘tax and welfare’ states of the twentieth century, which taxed workers so as to fund insurance and protection for families, disability, unemployment or old age. This was sometimes done directly with social security or insurance contributions, but the analysis holds even in countries, such as Australia or Sweden, where funding for the welfare state came out of consolidated revenue. The broad theory of benefit justified broadening the tax base to the mass of worker-voters who paid income tax, social security tax and VAT in exchange for government. Ultimately, it is a fallacy to conceive of government as an additive set of separate goods or services. Government is more than the sum of its parts. The landscape of public goods is increasingly mixed as many public goods are not exclusively ‘public’, or are provided in part by private actors and part by government, funded in part by fees or user contributions and in part by general revenues. Cooper is persuasive in stating that ‘the benefit theory is capable of sustaining a coherent tax policy framework both for taxes based on marginal benefits (such as fees and charges) and for taxes based on notions of total benefits (such as broad-based income and consumption taxes)’.109 Moreover, redistribution can only be delivered by government and it cannot have a market price—it is properly considered a ‘public good’. In contrast to the conclusion of Murphy and Nagel, it makes sense to incorporate redistribution into the benefit theory by treating the entire redistributive tax-transfer mechanism as itself a public good; this seems, in later work, to be accepted by Richard Musgrave.110 The extent of redistribution, or level of inequality, acceptable to a particular society is a political choice which requires decisions to be made by taxpayer-voters.

Public Choice and the Fiscal Constitution Decisions about taxation to fund public goods (including redistribution) must be made in a political arena bounded by a fiscal constitution.111 Economists, theorising from the perspective of the market, turn reluctantly to consider the complexities and weaknesses of non-market, political decisionmaking systems. There is little that is optimistic in the political economic literature about the ability of taxpayer-voters to deliver the optimum level

109

Cooper, n 93 above, 407. R Musgrave, The Future of Fiscal Policy: a Reassessment (Leuven, Leuven University Press, 1978). 111 See, eg V Thuronyi (ed), Tax Law Design and Drafting (Washington DC, IMF, 1998) vol I, available at www.imf.org. 110

The Tax State, Benefit and Legitimacy 507 of public goods. Head observes that just because the market ‘fails’ to provide sufficient public goods, ‘there is no guarantee that government can do better’.112 Even legal philosophers Murphy and Nagel suggest in gloomy fashion that ‘of course’ the optimum values of public and private provision ‘simply have to be guessed at by the designers of the system’.113 The view that government will fail was especially taken up by public choice theorists. In particular, Geoffrey Brennan and Neil Buchanan wrote explicitly against the Musgravian tradition of taxation to finance government, with specific reference to the developments in the 1970s, an ‘era of apparently uncontrollable budgets’.114 They also drew on deeper philosophical roots, insofar as they are concerned about lack of consent, freedom from coercion and government as Leviathan which must be constrained. Brennan and Buchanan sought to design a fiscal constitution that would limit the governmental power to tax. They contested the baseline public finance assumption that a set level of revenue is required to fund the state and that ideally this would be levied as a lump sum tax, which then serves as an analytical benchmark.115 They argued that, prior to such a baseline assumption, there must exist the ‘constitution’ under which it is legitimate for government to raise taxes at all. This has substantive implications for tax policy because ‘at the constitutional stage of decision in the Leviathan model, potential taxpayers will recognise that government may be held back in its fiscal appetites only by limits on tax bases and on allowable rate structures’.116 The concept of ‘constitutionalism’ refers to a framework of limits on public power.117 The ‘fiscal constitution’ may be established under a written or unwritten Constitution combined with a wide range of written and unwritten legal rules, institutions, norms and practices. The fiscal constitutions of successful tax states have evolved over time at national, state and local levels.118 There are many innovations, including some that have

112

Head, n 2 above, 86. Murphy and Nagel, n 100 above, 82. 114 G Brennan and JM Buchanan, The Power to Tax: Analytical Foundations of a Fiscal Constitution (New York, Cambridge University Press, 1980) xii. 115 ibid. 116 ibid 35. 117 Levi, n 19 above, 49; G Wolfram, ‘Taxpayer Rights and the Fiscal Constitution’ in D Racheter and R Wagner (eds), Politics, Taxation, and the Rule of Law: the Power to Tax in Constitutional Perspective (Amsterdam, Kluwer, 2002). 118 See, eg Smith, n 58 above; C Webber and A Wildavsky, A History of Taxation and Expenditure in the Western World (New York, Simon and Schuster, 1986); P Conti-Brown and D Skeel, When States Go Broke: the Origins, Context, and Solutions for the American States in Fiscal Crisis (New York, Cambridge University Press, 2012). 113

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been developed in recent times, such as independent fiscal councils, parliamentary budget officers and fiscal rules, that are all aimed at constraining government taxing and spending to varying degrees. They reflect a variety of visions of how to achieve legitimate democratic decisions about taxing and spending. The tax system of a country can itself be understood as ‘quasi-constitutional in nature’.119 A progressive income tax has come to perform this constitutional function in many countries, with a lineage tracing back to Adam Smith, who was greatly concerned to prevent tyranny and the abuse of power. Smith’s maxims made clear that the tax owed by each taxpayer must be certain. Certainty was Smith’s most important principle of taxation. Smith placed certainty above equity and even above efficiency. Smith also preferred direct taxes to indirect, in part to contribute to certainty. Subsequently, political liberals such as Mill argued that a more visible progressive income tax performs a critical political role as ‘a security … for economy in the public expenditure’.120 Henry Simons saw a progressive income tax as a necessary accessory of a capitalist market economy and this principle is reiterated by Brennan and Buchanan in 1981. It became clear in the 1970s that to be effective, a tax system in a liberal democracy requires a high level of trust to produce what Margaret Levi termed ‘quasi-voluntary’ compliance.121 As Levi explains, quasi-voluntary compliance ‘rests on reciprocity. It is a contingent strategy in which individual taxpayers are more likely to cooperate if they have reasonable expectation that both the rulers and other taxpayers are also cooperating. The key lies in what rules and other government officials do to create mutual expectations of tax payments’.122 Levi’s approach acknowledges the coercive power of taxation while recognising the dynamic negotiation for limits and voice in exercise of governmental power. The fiscal constitution can be conceived today as a ‘constellation of norms and practices’.123 The link between successful tax collection and trust or representation of taxpayers should not be considered simplistically. Fiscal legitimacy may be achieved through a variety of governmental processes.124 These include goals of transparency and certainty in laws but also extend to

119

Head, n 94 above, 65. Mill, n 15 above, Book V.6.1. Levi, n 19 above; V Braithwaite, Defiance in Taxation and Governance: Resisting and Dismissing Authority in a Democracy (Cheltenham and Northampton, MA, Edward Elgar, 2009); V Braithwaite and M Levi (eds), Trust and Governance (New York, Russell Sage, 2003). 122 Levi, n 19 above, 69. 123 See C Scott, ‘Regulatory Governance and the Challenge of Constitutionalism’ in D Oliver, T Prosser and R Rawlings (eds), The Regulatory State (Oxford, Oxford University Press, 2010) 16. 124 R Baldwin, Rules and Government (Oxford, Clarendon Press, 1995). 120 121

The Tax State, Benefit and Legitimacy 509 accountability of institutions and agencies tasked with fiscal responsibility to the legislature; consultation with citizens in tax law-making or procedurally fair review and appeal rules in administration; recognised expertise in fiscal policy of the Treasury and tax collection agency; or implementation of a fiscal policy that is accepted to further economic growth in the global market or that will achieve deficit reduction goals accepted as important by taxpayer-voters or other key stakeholders, such as external creditors or ratings agencies. In some respects, contemporary tax law techniques, such as general antiavoidance rules, seem to run counter to Adam Smith’s notion of certainty as a fundamental element in tax design. However, in today’s world, these ‘uncertain’ rules contribute to building legitimacy and trust in the mass of (mostly compliant) taxpayer-voters. Historical experience has shown that governments have often been able to use technology and bureaucratic techniques to overcome problems of tax compliance without directly engaging with trust, consent or representation of taxpayers. Most of these techniques require the co-operation of the legal intermediaries of the capitalist economy. In these techniques, governmental engagement is shifted away from the taxpayer-voter- towards one or other form of intermediary or agent, such as a corporation, employer or bank, or the tax profession. In sum, the concept of legitimacy is nuanced. It has layers and gradations and cannot be properly reflected in the simple binaries of government/market, public/private, voter/price or Leviathan/benevolent voice of the people. Nonetheless, in democratic tax states, the fundamental concept of legitimacy obtained by support of taxpayer-voters remains critical to success of governments in taxation.

TAX, BENEFIT AND LEGITIMACY IN THE GLOBAL ERA

So far, we have been discussing the benefit and legitimacy of taxation as if the nation-state existed in isolation. We have been used to thinking about tax law within a national frame of analysis. This ‘Keynesian-Westphalian frame’125 in Nancy Fraser’s language refers both to the national boundaries of the state at international law126 and to its economic character, especially developed during the twentieth century, which incorporates an expectation of a government which plays an active role in the national economy.

125 126

311.

N Fraser, ‘Reframing Justice in a Globalizing World’ (2005) 36 New Left Review 69. R Falk, ‘Revisiting Westphalia, Discovering Post-Westphalia’ (2002) 6 Journal of Ethics

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Globalisation has, to some degree, caused national boundaries of economies (and, less so, states) to weaken or disappear, as we become participants in global markets and we come, in some ways, to see ourselves as global citizens.127 In the 1990s, states began in earnest to construct and participate in a new global economic order facilitating trade in goods and services, global financial capital and increasing cross-border direct investment as well as increased mobility in information and some labour mobility. How does this change the way we think about benefit and legitimacy of taxation? Are these concepts useful in a global era?

Benefit Theory and Relations Between Governments The benefit theory is generally accepted where more than one government may be levying taxes or providing services. It is relied on, first, in analysing federalist structures, where taxing and spending is allocated across different local or provincial governments within a country; and second, in the international context, where taxing power must be allocated between nation-states. In a fiscal federal context, the benefit theory has been based largely on the Tiebout theory established in the 1950s about local public goods.128 Taxes and spending at the local level are linked and taxpayer-voters are assumed to be fully mobile, able to vote or exit until they obtain the mix of tax and public goods that they prefer. Thus, the tax-price can in theory be ascertained and the analogy between government and market seems plausible as local governments will compete for taxpayer-voters. Many tax policymakers conceptualise local taxes, especially property taxes, as a fee for local government goods or services. Local taxes can be justified on the basis of an obligation to make a minimum contribution to government based on prosperity or capacity, measured by local assets, echoing the early uses of benefit theory to justify taxation as a contribution to government.129 Both the benefit theory, and tax competition, are also relevant to international taxation. During the early twentieth century, as the income tax expanded on individuals and companies, tax theorists examined how to

127 W Twining, Globalisation and Legal Theory (London, Butterworths, 2000); S Sassen, Globalization and Its Discontents (New York, New Press, 1998). 128 WE Oates and RM Schwab, ‘Tiebout Model’ in JJ Cordes, RD Ebel and J Gravelle (eds), The Encyclopedia of Taxation and Tax Policy, 2nd edn (Washington DC, Urban Institute Press, 2005) 437–39; C Tiebout, ‘A Pure Theory of Local Expenditures’ (1956) 64 Journal of Political Economy 416. 129 R Bird, ‘Tax Assignment Revisited’ in J Head and R Krever (eds), Tax Reform in the 21st Century: a Volume in Memory of Richard Musgrave (The Hague, Kluwer, 2009) 441.

The Tax State, Benefit and Legitimacy 511 allocate taxing rights or jurisdiction between countries. In general, taxes were levied on the basis of tax residence or of source of income, and international tax rules were established to prevent double taxation. The concept of benefit from government became an important element in defining these tax boundaries. There was a contest between the state of ‘source’, which was in the end given priority in respect of active income from business or labour, and the state of ‘residence’, which had a residual claim and priority in respect of passive income and gains. Klaus Vogel suggests that during the nineteenth century, Georg von Schanz, an early German scholar of income taxation, proposed a concept of ‘economic allegiance’ and ‘convincingly showed that both the state of residence and the state where a direct investment is made can legitimate a tax claim on the grounds of services provided, but that the share of services provided by the source state typically is higher than that provided by the state of residence’.130 However, the opposite was adopted by the ‘Four Economists’ in their statement of international tax principles in 1923, which gave priority to the state of residence of the taxpayer.131 Richard and Peggy Musgrave (also a leading economist and Richard’s spouse), considered the application of tax policy to inter-nation equity; however, Peggy Musgrave took up this issue most substantially.132 As Kim Brooks explains, the Musgraves linked inter-nation equity in taxation, especially regarding the company tax base, to the concept of benefit: ‘the idea that the source state should be able to recover from the investor some of the costs of public goods and services from which the investor benefits (a benefit tax) and/or on the idea that the source state should be able to retain the gain associated with pure economic profits’.133

Tax Reform into the Twenty-first Century As economic globalisation gained momentum during the 1990s, the tax reform ‘decade’ that started during the 1980s continued. Fresh from success in turning around country growth performances during the 1980s,

130 K Vogel, ‘Worldwide vs Source Taxation of Income: a Review and Re-evaluation of Arguments (Part III)’ (1988) 11 Intertax 393, 395. 131 League of Nations, Economic and Financial Commission, Report on Double Taxation submitted to the Financial Committee by Professors Bruins, Einaudi, Seligman and Sir Josiah Stamp (Geneva, 5 April 1923). 132 K Brooks, ‘Inter-Nation Equity: the Development of an Important but Underappreciated International Tax Policy Objective’ in J Head and R Krever (eds), Tax Reform in the 21st Century: a Volume in Memory of Richard Musgrave (The Hague, Kluwer, 2009) 471; Musgrave, n 86 above. 133 Brooks, n 132 above, 492.

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supply-side economics continues to pursue an optimal tax mix shift towards consumption (and labour) and away from mobile capital. The shift in tax policy discourse and the recognition of increasing tax competition between states for mobile capital investment led to significant changes in tax laws. The trend of lowering tax rates on income and capital continued. More countries enacted indirect taxes such as a VAT or GST, and the rates of these taxes increased, as the world trading system took hold and reduction of tariffs began in earnest (the United States remains an outlier). In spite of continuing economic growth in many countries, there was also significant financial instability. The Asian financial crisis of 1997 caused significant havoc and governments have not yet recovered from the global financial crisis of 2008; growth has slowed across the globe. The birth of the twenty-first century saw both an intellectual push, and signs of a trend, towards smaller governments after the massive growth of the twentieth century. Tanzi and Schuknecht observe a reversal of the growth of government from 1980 onwards and they argue that it will be better for all if we reduce the size of government: [T]he industrial countries with small governments and, to some extent, the newly industrialised countries with low public spending, were able to achieve levels of socioeconomic indicators similar to those achieved by countries with much higher levels of public spending … there must be considerable scope for redefining the role of the state in industrialised countries so as to decrease public spending without sacrificing much in terms of social and economic objectives.134

Tanzi and Schuknect’s goal of ‘smaller and more efficient’ governments would, they argue, ‘provide an appropriate framework for market forces to stimulate both growth and social welfare’.135 For example, citizens ‘should be able to buy, perhaps more cheaply, some of the same goods and services now provided by the government. If the private sector provides these same services more cheaply, as it often does, then society would gain from the change. Obviously in this process the regulatory role of the state will need to become more important, better directed, and more efficient’.136 The challenge lies in the last two sentences: if the service or good is provided more cheaply and if the regulatory role of the state can become better, this may leave all better off. During the 1990s, the developed countries of the OECD began to be increasingly concerned about protecting their tax bases. The OECD sought to establish co-operation among its member states to address ‘harmful tax

134 135 136

Tanzi and Schuknecht, n 43 above, 131. ibid 132. ibid 134.

The Tax State, Benefit and Legitimacy 513 competition’ and counter tax havens.137 Early attempts at co-operation failed, although national governments slowly began to increase co-operation in tax administration and information exchange. Since the global financial crisis in 2008, governments have taken more significant steps, led by the G20, to address international mobility of economic factors that has pressured governments to engage in global fiscal competition by lowering tax rates, and to counter ‘base erosion and profit shifting’ (BEPS) as multinational companies take advantage of incoherent national tax rules in a global economy.138 In this ‘age of austerity’,139 governments constrain their budgets in ways that imply drastic reductions in the size of the welfare state, for fear that they ‘will lose the confidence of globalized financial markets’.140 Roberts argues that the reforms since the 1980s, including tax reforms, have ‘constituted a distinctive program of state renovation’, aimed not only at ‘shrinking the state but also at rebuilding government so that it would complement a liberalized and globalized economy’.141 He calls this ‘logic of discipline’ anti-democratic, constraining the influence of popular sovereignty in order to build the state so that it could do ‘tasks that must be performed properly if a nation is to survive, and thrive, in a globalized economy’.142 The move towards fiscal discipline collides with hotly contested domestic political disputes regarding the distributional impact of fiscal adjustments. Tsilly Dagan calls this the unfolding of ‘tragic choices’ for national polities.143 Yet in spite of all of these developments, tax law remains stubbornly, jurisdictionally bound to the nation-state. There is not, yet, a world tax organisation, or multilateral tax treaty that regulates tax systems globally or regionally.

Future of the Tax State The power to tax has evolved interdependently with the benefit and legitimacy of government. Similarly, the discourse and practice of taxation has developed as government and market have evolved. Theories of public goods 137 OECD, Harmful Tax Competition: an Emerging Global Issue (Paris, Organisation for Economic Cooperation and Development, 1998). 138 OECD, Action Plan for Base Erosion and Profit Shifting (Paris, Organisation for Economic Cooperation and Development, 2013), available at www.oecd.org/tax/action-planon-base-erosion-and-profit-shifting-9789264202719-en.htm. 139 F Schui, Austerity: the Great Failure (New Haven, CT, Yale University Press, 2014). 140 A Roberts, The Logic of Discipline: Global Capitalism and the Architecture of Government (Oxford, Oxford University Press, 2010) 12. 141 ibid 4. 142 ibid 12. 143 T Dagan, ‘Tragic Choices’ in Y Brauner and M Stewart (eds), Tax, Law and Development (Cheltenham, Edward Elgar, 2013).

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developed at a time when it was clear that the market was not delivering what was desired for society. Renewed concern to limit coercive governmental taxing power appeared at a time of apparently uncontrollable government spending in the 1970s. Turning to the global context, how should we think about the tax state, public goods and legitimacy?144 Globalisation requires us to rethink principles about who benefits or should benefit from government; who is owed redistribution; who bears or should bear the tax burden and who makes decisions about taxation and spending. It presents new challenges for all aspects of the debate. For example, in the discussion above, I identified the problem with a subjective perspective on wellbeing. This problem becomes even more apparent in a global context, where significant differences in public wants may exist across different countries. The international debate about equity, development and public goods may have focused (just as the domestic debate has) too much on ability to pay and not enough on the benefit of a legitimate government funded by taxation. In the context of economic globalisation, the benefit theory remains an important justification for taxation. In particular, international company taxation on foreign direct investment may be supported by the benefit theory.145 Companies are legal fictions that do not themselves ‘benefit’ from any government public goods or services. However, it is plausible that the owners or beneficiaries of capital invested through companies, in particular, non-resident individuals who invest in a jurisdiction’ have benefited from that activity in relation to the source country in exchange for services provided by it. The evidence is objective: ‘prosperity’ of the company measured by profits arising under the source country government. To return to the OECD BEPS project, we have yet to see whether this latest attempt at international tax co-operation will be successful. However, it is important to note that the BEPS project does appear to be premised on a base assumption that there is a ‘fair share’ of taxation accruing to different governments, to be defined by the international tax rules. It also appears to be assumed that multinationals must pay taxation somewhere to governments in exchange for the benefit of production, sale or generation of profit. If we take the view that the redistributive element of our tax-transfer system is a public good, then this makes the benefit theory consistent with redistributive taxes and services at the local, national or global level. How might this affect our view of international taxation? It is possible to argue 144 See, eg I Kaul, P Conceicao, K Le Goulven and RU Mendoza, Providing Global Public Goods: Managing Globalization (Oxford, Oxford University Press, 2003); G Brock, Global Justice: a Cosmopolitan Account (Oxford, Oxford University Press, 2009). 145 For an excellent discussion see R Avi-Yonah, ‘Corporations, Society and the State: a Defense of the Corporate Tax’ (2004) 90(5) Virginia Law Review 1193; D Pinto, E-commerce and Source-based Income Taxation (The Hague, Kluwer, 2002); R Avi-Yonah, ‘International Taxation of Electronic Commerce’ (1997) 52 Tax Law Review 507, 520.

The Tax State, Benefit and Legitimacy 515 that minimum level of revenue must be raised to fund a basic minimum standard of living for all individuals globally. It is often considered that the redistributive element of tax and transfers on the basis of ability to pay must be done by a central government so as to ensure a minimum standard of living across the jurisdiction, also equalising distribution between rich and poor regions.146 But this cannot be translated to the global level without considering a global government. If we ignore the benefits provided by national governments and the relation of governments to each other, we are unable to deal with this global redistributive challenge. Public choice scholars may welcome the increasing constraints imposed by the global economy on governmental ability to collect taxes; indeed, Brennan and Buchanan specifically welcomed an open economy and federalist competitive structure as having potential to constrain Leviathan.147 However, their theory assumes perfect mobility of both capital and labour. That does not currently apply in the global arena. Instead, we have high— but not complete—mobility of capital and much lower, distorted and uneven mobility of labour. Exit is not an option for most people who do not like their own state’s tax and benefit compromise. The benefit principle is a foundational principle that defines the obligation to contribute to government, in a national and a global context. I argue that the benefit theory of taxation should be recuperated in the current era, but this also requires us to develop a new theory of a fiscal constitution in the global context. Tax states must confront the challenge of sustaining the legitimacy of their respective fiscal constitutions in the context of economic globalisation. To deal with these challenges successfully will likely require significantly increased co-operation by governments in taxation. However, the prospect of increased global tax co-operation, or even revenue sharing where taxes raised in one state are distributed to another, raises many questions about how to ensure effective accountability of taxation. This brings into sharp relief the challenge of legitimacy and the dynamic and evolving process of democratic and institutional constraints on taxation.

146 147

See, eg Bird, n 129 above. Brennan and Buchanan, n 114 above, 77.