clr/1987/1987_3_2160.pdf

(1)and 13(c)—Gratuity byacompany limited bysharestothewidow ofitsManaging Director—In thecircumstances, itwasreasonably open tothe Commissioner to disallow the deduction Taxation— Income tax— Goods lostdunng Turkishinvasionof Cyprus — Sellers waived theirright toclaim thepnce — Whether suchawaiverconstitutesagift of a capital nature or a trading receipt — In the circumstances reasonably open to the Commissioner to treat it as a trading receipt — The British Mexican Petroleum Company Ltd ν Jackson, 16Τ C 570 distinguished 5 The applicants, who are a private company of limited liability, pray for a declarationto the effectthatthedecisionoftheCommissioner ofIncome Tax regardingthecomputationoftheirchargeable income fortheyears 1975

(74)to 1979

(78),and the noticeof tax payable, issuedon theyearof assessment 1979

(78), isnull and void and of no effect whatsoever 10 Goods of the value of £15,996 00, which had been ordered by the applicants were unloaded at Famagusta harbour onthe 29th June, 1974 A billdatedthe 14thJune, 1974, whichwouldmatureonthe 1stOctober.1974 was drawnandacceptedbytheapplicantsforthepayment ofthevalueofthe goods phis bank charges The goods were lost by reason of the Turkish Invasion 15 At theendof 1974,thevalueofthesegoodsappeared inthe booksofthe applicants as purchases though the goodswere not included in their closing 2160 nn 3CX.R. 5 VaMOsEUadcsUd.v.R«pHbUc stockintradeforthatyear. Inthereturnsfortheyear 1975,theauditorof the applicants reported that the sellersof the goods Rosenthal had waived their claimforthevalueofthegoodsandbecauseofthishecreditedtheirvalueto the trading and profit and loss account for the year that ended on the 31st December,

1. However, applicants' tax consultant was of a different view. His opinion wasthattheequivalent amountofthedebtowedbytheapplicantsandwhich had been waived bythe sellerswasnota receipt of the trade but a gift and, therefore, a receiptofa capitalnaturenotliabletoincometax. 10 Inearly 1975Mr.VassosEliades,the Managing Directorof theapplicants, died and the company made to his wife a death gratuity of £15,
2. -This amountwascharged totheaccountsof thecompany fortheyear
3. The questions thatpose for decision inthepresent case are the following two: 15 (a) Whether the respondent's decision to disallow as a deduction the gratuityof£15,000.-paidtothewidowofthedeceasedManagingDirectorof thecompanywasreasonably open tohim,and (b)Whetherthe decision ofthe Commissioner totreatthe debtwaivedby thesellersasareceipt oftradewasalsoreasonably open tohim. 20 25 30 Held, dismissingtherecourse:

(1)What deductionsare allowed underthe Law are specified in section 11

(1)of the Income Tax Laws, which include, amongst others, outgoings and expenses wholly and exclusively incurred in the production of income. Section 13(e) of the Income Tax Laws further providesthatno deduction shallbe allowedinrespectof any disbursements orexpensesnotbeingmoneywhollyandexclusivelylaidoutorexpended for thepurposesof acquiringthe income.

(2)Thefact thatthepaymentofthegratuitywasmadeinaccordancewith the provisions of the memorandum of the company does not render automaticallysuchpayment anallowablededuction forincometaxpurposes ifitcould notbe treatedassuch undertheprovisionsof therelevant Income TaxLaws.

(3)The payment of thegratuitycouldbe allowed asa deduction onlyifit couldbeconnected withthebettercarryingonofthetradeorbusinessofthe companyandwiththe earningofitsincome. 35

(4)Inthecircumstancesofthecaseandasthisisafamilycompany,itcould reasonably be inferred that the payment was made in order to fulfil the shareholders'desireforafinancialassistancetothewidowandnotinorderto enable the company to carry on its trade or business for (he purposes of earningitsincome. 2161 VassosEllades Ltd.v. Republic

(5)There isnodoubt thatthesellersofthegoodswaivedtheirrighttoclaim thepricebecausetheapplicant company wasdoingbusinesswiththem.

(6)ItisunreasonabletopermittheapplicantcompanytorecordinUsbooks asaliability the sum of £15,996.- and not to include in itsstock intrade the goodsforwhichsuchliabilitywasincurred.Theentriesmadeoriginallybythe auditorofthecompanywere rightly madebyhimanditwasreasonably open to the respondent to treat the waiver of the debt asa trading receipt and 5 decide on it accordingly. Recoursedismissed. No order astocosts. 10 Casesreferredto: TheBritish Mexican Petroleum Company Ltd. v.Jackson, 16T.C.570; Adamtsas Ltd. v. TheRepublic

(1977)3C.L.R.

1. Recourse. Recourse against the income tax cu>be»!iitiiiL& laised on 15 applicants for theyearsofassessment 1975-
2. M. HadjiChristofis. for theapplicants. A.Evangelou, Senior Counsel of theRepublic with M. Photiou, forthe respondents. Cur. adv. vult. 20 DEMETRIADES J. read the followingjudgment. By means of thepresent recourse theapplicants,whoareaprivatecompany of limitedliability,prayforadeclarationtotheeffectthatthedecision ofthesecondrespondent,thatistheCommissionerofIncomeTax (hereinafter referred to asthe «Commissioner»), contained in his 25 letters to the applicants dated the 11th February, 1981 and the 13th April, 1981,regarding the computation of their chargeable income for theyears 1975

(74)to 1979

(78),andthenotice oftax payable,issuedintheyearofassessment 1979

(78),iswrongand, therefore, nulland void andof no effect whatsoever. 30 The company derives its income from manufactured goods whichitimports.Oneof itssuppliersareMessrs.RosenthalGalsU. Porzellan A.G. (hereinafter referred to as «Rosenthal»), who, according to the facts submitted by the applicants, manufacture crystalandporcelain products. 2162 35 3 C.L.R. V a s s o · Ellades Ltd.v. Republic Demetriades J. Iliefactsot the caseare inbrief, the following. Goods of the value of £15.996 00.which were ordered by the applicants to Rosenthal arrived in Cyprus and were unloaded at Famagusta harbour on the 29th June. 1974 Abilldated the 14th 5 June.

1. which would mature on the 1stOctober. 1974, was drawnandaccepted bytheapplicantsforthepayment ofthevalue ofthegoodsplusbank charges Before thegoods,however, were cleared from customs, the second round of the Turkish invasion started, as a result of which Famagusta was occupied by the 10 Turkish Forces and the goods were lost At the end of
2. the value of these goods appeared in the books of the applicants as purchases though the goods were not included in their closingstock intrade forthat year. Inthe returns for the year
3. the auditor of the applicants reported that 15 Rosenthal had waived their claim for the value of the goods and 1iecauseofthishecredited theirvaluetothetradingandprofit and !<*ssaccountfortheyearthatendedonthe31stDecember, 1975 However after theCommissionerexaminedtheaccountsofthe applicants and raised certain queries with regard to the losses 20 allegedly suffered by them dunng 1975, the applicants called in Mr Phanos lonides, a Tax Consultant, to advise them in collaboration with their auditor. His opinion, which he also communicated to the Commissioner by his letter dated the 27th June, 1977 (see Appendix 1 to the Application) was that the 25 equivalent amount of the debt owed bythe applicants and which had been waived by Rosenthal was not a receiptofthe trade but a girt and, therefore, a receipt of a capital nature not liable to income tax By his letter dated the 11th February,
4. which was 30 addressed to Mr. lonides and which is Appendix 3 to the Application, the Commissioner rejected the contention of Mr. lonidesregardingthismatter Onthesamedaythe Commissioner, who apparently had completed by then the examination of the accounts of the applicants for the years 1975 to 1978, 35 communicated to the auditor of the applicants his decision by letter of even date and he attached to it the amended computationsofthelossesoftheapplicantsforthesaidyears.Mr. lonidesthen, onbehalf oftheapplicants,byletterdatedthe26th February, 1981, objected against the amended computation of 2163 Demvtrlade· J. Vaasos Eliades Lid. v. Republic

(1987)theirlossesand withregard tothismatterhereiterated theclaimof theapplicantsthatRosenthal,bywaivingthedebt,hadmadeagift to them not liable to income tax. ThestandtakenbytheCommissionertotheviewsexpressedby Mr. lonides in his objection appear at p. 2 of the third document 5 (letterdatedthe 13thApril,1981)appended totheopposition, the relevantpart of which reads:«Buteven ifweassume-justforthesakeofdiscussion -that in 1974therewasanalleged liabilitytotheSuppliers,then we see in 1975 that such liability does not exist; and since this 10 liabilityhad been recorded,itwillhavetobetransferred tothe credit side of the profit and loss account as it was correctly done bythe company's auditor. Inthiscase itwaspointed out that '7Tieonlypossible method ofdetermining the liability, seems tobe by takingthe amount which ultimately proved to be the actualliability'. The actual liability in the case of Vassos Eliades Ltd isNiland therefore the whole amount of £15,996 should be credited to the company's profit and loss account.» Inearly 1975 Mr.Vassos Eliades,the Managing Directorof the applicants,diedandthecompanymadetohiswifeadeathgratuity of £15,000.-. This amount was charged to the accounts of the company for the year 1975. Theclaimoftheapplicantsforthededuction ofthisamountwas 25 discussed between the Commissioner and the auditor of the applicants and the former atfirst decided toallow,asa deduction, the sum of £5,000.-. Later on, and after the examination of the returns of the applicants was completed and the amended computation of losses, to which I have earlier referred, were 30 communicated by the Commissioner to the auditors of the applicants, itappeared that the Commissioner disallowed wholly as a deduction the gratuity to the widow of the late Managing Directoroftheapplicants. Mr.lonides,byhisletterdatedthe26th February, 1981, also submitted objection with regard to this 35 matter. Thesubjudice decisionwascommunicated tothecompanyby means of a letter dated the 13th April, 1981, against which the presentrecoursewashied. 2164 15 20 3 C.L.R. Vassos B l a d e s Ltd.v. Republic Demetriades J . The applicants abandoned their claim which was originally raisedintheseproceedingsthatthefuneral expensesfortheburial of their Managing Director was deductible. The Commissioner also stated that the preliminary point which he raised in his 5 opposition,namelythattherecoursewasfiledprematurely,could notstandandheabandonedit. Havingsaidthis,Ifind thatthequestionsthatposefordecision inthepresentcasearethefollowingtwo: (a)whethertherespondent'sdecisiontodisallowasadeduction 10 the gratuity of £15,000.- paid to the widow of the deceased ManagingDirectorofthecompanywasreasonably opentohim, and (b)whether thedecision oftheCommissionertotreatthedebt waived by Rosenthal as a receipt of trade was also reasonably 15 opentohim. Inowcometothefirstquestionthatposesfordetermination. Theapplicant company isafamily company, theshareholders of which were the deceased Managing Director, hiswidowand theirtwosons.AfterthedeathoftheManagingDirectortheBoard 20 ofDirectorspassedaresolutionforthepaymentofthegratuityf« thewidow.Thisresolutionwastakenbyvirtueoftheprovisions A paragraph (p)of clause3 of theMemorandum ofAssociation c thecompany,whichreadsasfollows: 25 30 «Tomake donations and givesubscriptions to any object likelytopromotetheinterestsoftheCompany,andtogrant bonuses,gratuitiesandpensionstoofficersorex-officers and employees or ex-employees of the Company, or their dependents or connections and to endow, support and subscribetoanyeducational,socialorcharitableinstitutionor societycalculatedtobebeneficial tosuchperson.» Asitappearsfrom theletteroftherespondent, datedthe 13th April, 1981, the amount of £15,000.- was not treated as an allowabledeductionbecauseitwasnotpayabletotheheirsofthe late Managing Directorbut to a particular person, hiswife, and, 35~therefore,itrepresentedapersonalgifttoherbythecompany. Counselfortherespondentsubmittedthatthiswasonlyoneof the factors taken into consideration by the respondent when deciding that the payment was a voluntary one and not an 2165 Demetriades J. Vassos Eliades Ltd. v. Republic

(1987)expense whollyand exclusively incurred fortheproduction ofthe company's income. What deductions are allowed under the Law are specified in section 11

(1)of the Income Tax Laws, which include, amongst others,outgoingsandexpenseswhollyandexclusivelyincurredin the production of income.Section 13(e) of the IncomeTax Laws further provides that no deduction shall be allowed in respect of any disbursements or expenses not being money wholly and exclusively laidout orexpended forthe purposes ofacquiring the income. 5 On thispoint counsel forthe applicant company submitted that the payment of the death gratuity was made for the sake of preserving for the company itsgood name as an ideal employer, a fact which would enable the company to look forward to securing the services of well qualified men in its employment, 15 particularly in executive posts, who no doubt would regard such payment as an additional advantage of their employment. He further submitted that the payment was made pursuant to the powersgiven tothe companybyitsmemorandum and inorder to preserve the goodwill and reputation of the company, as a good 20 employer and, therefore, it was made for the purposes of the company's trade and as such it is an allowable deduction from. profits. ; The fact that the payment of the gratuity was made in accordance with the provisions of the memorandum of the 25 company does not render automatically such payment an allowable deduction for income tax purposes if it could not be treated as such under the provisions of the relevant Income Tax Laws. Having given the matter due consideration Ihave reached the 30 conclusion that thepayment ofthe gratuity could beallowed asa deduction onlyifitcouldbeconnected withthebettercarrying on ofthetrade orbusinessofthecompany andwiththeearningofits income. Inthecircumstances ofthecaseandasthisisafamilycompany, 35 it could reasonably be inferred that the payment was made in order to fulfil the shareholders' desire for a financial assistance to the widowand notinordertoenable thecompanytocarryon its trade orbusinessfor the purposes of earning itsincome. 2166 10 3 C.L.R. Vassos Eliades Ltd. v. Republic Demetriades J. Therefore, I am of the view that itwas reasonably open to the respondent totreat the payment of the gratuity as not deductible and there isnojustification tointerfere with such a finding. Thefactthatwhen reachinghisoriginaldecisionthe respondent 5 decided to make an allowasnce of £5,000.- from the sum of the gratuity, against which the applicant had objected, does not preclude him, during the re-examination of the case and in the correct application of the provisions of the Law, to disallow the whole amount of the gratuity as a deduction. The reference by 10 counsel fortheapplicanttoothercaseswheretherespondent had made concessional allowances of certain amounts of death gratuitiesforincome taxpurposes isnotevidence byitself leading totheinevitableconclusion thattherespondent wasbound,inthe circumstances of this particular case, to accept finally part of the gratuity in question as deductible if it otherwise was not 15 deductible. I now come to the second issue raised in the present proceedings. Counsel for the applicant company argued that the relevant entries in the accounts of the company by its auditor in respect of the amount concerned were wrongly made in that the 20 waiver of the debt was entered into the relevant accounts as a trade receipt, whereas it ought to have been entered as a capital receipt, because such waiver was made by Rosenthal as a gift to the applicant company for reasons independent and irrelevant from the transaction out of which the debt arose. 25 The said contention of counsel was based mainly on the authority of The British Mexican Petroleum Company Limited v. Jackson, 16T.C.570,onwhichMr.lonidesbasedhisargumentin trying to persuade the Commissioner that he was «vrong in his approach to the matter inissue.The reasons for disagreeing with 30 the said approach areto befound inthe Commissioner's letterof the 13thApril, 1981,which reads:«Permit me to disagree withyou thatthe facts of this case are identical inallrespectswiththe U.K.caseBritishMexican Petroleum CoLtd v. Jackson. 35 In the case mentioned by you the company could not continue toperform itsobligation underthecontractsand the realisable value of its assets were not sufficient to meet the claim. Undoubtedly -as itwas held -a verybad bargain had been made and thattoomuch hadbeen charged. 2167 Demetriades J. Vassos Eliades Ltd. v. Republic

(1987)The two suppliers of the British Mexican Petroleum (The Andrew Weir and Co Ltd and the Husteca Co Ltd) by releasingthedebthadadistinctpurpose,apurposenamelyto givetheCompanyreliefbyineffectgivingthemnewcapital; and this,obviously because, the whole votingpower of the 5 British Mexican Petroleum was in the hands of these two Suppliers. These two Suppliers could have wound up the Company and certainly no profit would have been madein thewindingupandthedebtwouldthen disappear. AlltheabovefactsdonotexistinthecaseofVassosEliades 10 Ltdandtherefore, therecanbenocorrelationbetweenthese twocases. It is also important to mention that in the case British MexicanPetroleumthegoodswerepurchasedandtheunsold goodswereincludedinthecompany'sclosingstockandthat 15 there was a legal obligation on the part of the company to meet its liability. In our case, however, the goods never reached the company's warehouse and there wasneithera purchasenoraliability;andthegoodswereneverincludedin thecompany'sclosingstock. 20 Butevenifweassume-justforthesakeofdiscussion-that in1974therewasanallegedliabilitytotheSuppliers,thenwe see in 1975 that such liability does not exist; and since this liabilityhadbeenrecorded,itwillhavetobetransferredtothe credit side of the profit and lossaccount asitwas correctly 25 donebythecompany'sauditor.» Ontheotherhand,counselfortherespondentreferredbyway ofuseful guidance tothecaseofAdamtsasLtd. v.TheRepublic,

(1977)3C.L.R.181,where(atp. 195)thefollowingarestated: «Directingmyselfwiththesejudicialpronouncements,and 30 havinginmindthelongcorrespondenceexchangedbetween theliquidatorandtheinsurancecompany,Ihavereachedthe conclusion thatthe insurance company, inspiteof whathas beensaidthatitwasanexgratiapayment,itwasapaymentor apartpaymentforpartofthegoodswhichwerelootedbythe 35 Turksduringtheinter-communaltroubles. There isnodoubt thatthepaymentwaseffected because the company in question was doing business with the said insurance company and, therefore, inmyviewitisatrading 2168 3 C.L.R. 5 Vassos EHades Ltd.v. Republic Demetriades J . receipt,thatistosay, apaymentbytheinsuranceasamatter of business.Forthesereasons, Ithinkthatthe Commissioner rightly treateditasatradingreceiptandliabletotax.I, would, therefore,dismissthiscontentionofcounselfortheapplicant, because thesaid sum of £4,000.- wasthe receipt fromthe tradewhich hadbeen carried onby the company.» I have considered very carefully the authorities cited andthe contentionsputforward bycounsel and I havenodoubtthatthe waiverofthedebt was madebyRosenthalbecause theapplicant 10 company was doing business with them. Itis unreasonable to permittheapplicantcompany torecord initsbooks asaliability the sum of £15,996.- andnotto include initsstock intrade the goods for which such liability was incurred. Theentries made originallybytheauditorofthecompanywererightlymadebyhim 15 anditwas reasonably opentotherespondenttotreatthewaiver of thedebtasatradingreceiptanddecideonitaccordingly. I treatthepresent cdse, OH itsOwnparticularcircumstances,as distinguishable from thefacts and circumstances of The British MexicanPetroleum CompanyLimited, case,supra. 20 Foralltheforegoing reasons,thepresentrecourse failsanditis dismissed accordingly. Costsoftheseproceedings tobepaidby theapplicants. Recoursedismissedwith costsagainstapplicants. 21Θ9