[CHANCERY DIVISION]

OCKENDEN (INSPECTOR OF TAXES) v. MACKLEY

Revenue - Income tax - Schedule D, Case V - Income from overseas possessions not remitted to United Kingdom - Bank interest on loan acquired to purchase flat in Gibraltar - Interest paid in Gibraltar out of rental income from letting - Whether interest payments deductible in computing amount of income chargeable - Income and Corporation Taxes Act 1970 (c. 10), ss. 109, 122 (1) (as amended by Finance Act 1974 (c. 30), s. 19, sch. 1, Pt. VI)

In 1975 the taxpayer, who was resident in the United Kingdom, purchased a flat in Gibraltar. The bulk of the cost of the property came from a loan from an international bank that was a resident in the United Kingdom but the loan was dealt with by its local branch in Gibraltar. The flat was furnished and let by the taxpayer through local managing agents. The rental income from the property was not remitted to the taxpayer in the United Kingdom but was used to pay the bank interest and to reduce the borrowing. The taxpayer

appealed against assessments to income tax under Case V of Schedule D, made by virtue of the provisions of section 109 of the Income and Corporation Taxes Act 1970,¹ for 1975-76, 1976-77 and 1977-78 each in the sum of £2,600 on the ground that section 122 (1) of the Act permitted the bank interest payments to be deducted from the rental for the purposes of computing the taxable income. The general commissioners upheld his appeal and reduced the assessments to agreed amounts.

On appeal by the Crown: -

Held, allowing the appeal, that for the purposes of section 122 (1) of the Income and Corporation Taxes Act 1970 "the full amount of the income" assessable to tax under Case V of Schedule D, was the full amount of the rent from the taxpayer's property in Gibraltar and that although paragraphs (a), (b) and (c) of subsection (1) permitted certain deductions from income not received in the United Kingdom, they did not include any deduction in respect of the interest paid on the loan acquired to purchase the property, that being a deduction for which no provision was made (post, pp. 790B-C,792H - 793B).

Per curiam. A consideration of the earlier legislation strongly suggests that the deductions and allowances available under section 122 (1) (a) cannot be those available under Cases I and II of Schedule D (post, p. 791B-C).

The following cases are referred to in the judgment:

Colquhoun v. Brooks (1889) 14 App.Cas. 493; 2 T.C. 490, H.L.(E.).

Littman v. Barron [1952] 2 All E.R. 548; 33 T.C. 373, H.L.(E.).

The following additional cases were cited in argument:

Aikin v. Macdonald's Trustees (1894) 3 T.C. 306.

Courtaulds Investments Ltd. v. Fleming [1969] 1 W.L.R. 1683; [1969] 3 All E.R. 1281; 46 T.C. 111.

Farmer v. Scottish North American Trust Ltd. [1912] A.C. 118; 5 T.C. 693, H.L.(Sc.).

Gresham Life Assurance Society v. Styles [1892] A.C. 309; 3 T.C. 185, H.L.(E.).

London County Council v. Attorney-General [1901] A.C. 26; 4 T.C. 265, H.L.(E.).

CASE STATED by the Commissioners for the General Purposes of the Income Tax for the Division of Shoreham.

The taxpayer, John Francis Mackley, was assessed to income tax under Case V of Schedule D for the years 1975-76, 1976-77 and 1977-78, each assessment being in the sum of £2,600. He appealed against the assessments on the ground that interest paid on a loan from the Gibraltar branch of Barclays Bank International Ltd. to assist with the purchase of a property in Gibraltar from which the income arose, qualified as a deduction for the purposes of computing his income from overseas possessions. The commissioners, allowing the appeal, held that they "were unable to accept that section 122 (1) (a) would not enable the taxpayer to make any deductions or allowances in respect of the income arising from the furnished lettings. ... Section 122 (1) (a) of the Act could only be construed as allowing the interest to be deducted from the income

1 Income and Corporation Taxes Act 1970, s. 109 (2): "... Case V - tax in respect of income arising from possessions out of the United Kingdom, not being income consisting of emoluments of any office or employment; ..."

S. 122 (1): see post, pp. 789H - 790A.

arising from the furnished lettings." They reduced the assessments for each of the years to £1,06l, £1,327 and £1,268 respectively.

The Crown appealed.

The facts are set out in the judgment.

John Mummery for the Crown.

G. R. A. Argles for the taxpayer.

NOURSE J. This is an appeal by way of case stated against a decision of the general commissioners for the Shoreham division of Sussex given on October 30, 1980. It was thought by the Inland Revenue to be a test case, and so to a limited extent it still may be, but the substantive argument of the taxpayer in this court has been entirely different from that which was advanced on his behalf before the commissioners. Shortly stated, the question for decision is whether annual interest payable by a borrower resident in the United Kingdom to a lender likewise resident on a loan obtained for the purchase of foreign residential property is deductible in computing the borrower's rental income from that property for the purposes of Case V of Schedule D. The commissioners held that it was, and the inspector of taxes now appeals against that decision.

The taxpayer is Mr. John Francis Mackley. At the end of June 1975 he was granted an overdraft facility of £13,000 by the Gibraltar branch of Barclays Bank International Ltd. at interest to be charged quarterly at 2½ per cent. above Gibraltar base rate with a minimum of 9 per cent. Security for the loan was to be by way of the personal guarantee of the taxpayer's father and an equitable mortgage over a flat, 18, Marina Court, Gibraltar, which was a property owned by the taxpayer and at which he appears to have spent some of his time. The commissioners found that at all material times both the taxpayer and the bank were resident in the United Kingdom. They also found that in August 1975 the taxpayer purchased another flat in Gibraltar, 14, Marina Court, and that the bulk of the cost of that property came from the loan made by the bank on the terms to which I have referred. Although the commissioners made no express finding to this effect, it would be unrealistic for me not to proceed on the footing that the loan was obtained for the purchase of 14, Marina Court and I propose to proceed accordingly. That property was let by the taxpayer as a furnished flat, being managed by local agents. No rental income was remitted to the United Kingdom. Instead, it was used to reduce the taxpayer's borrowings from the bank. In December 1976, 14, Marina Court was sold.

It was agreed that the rents received by the taxpayer during the period of his ownership of 14, Marina Court were income arising from a possession out of the United Kingdom within Case V of Schedule D. Is he then entitled to deduct the interest payable to the bank during the like period and to claim that only the balance is subject to income tax? The Crown's claim is founded on section 122 (1) of the Income and Corporation Taxes Act 1970, which reads as follows:

"Subject to the provisions of this section and sections 123 and 124 below, income tax chargeable under Case IV or Case V of Schedule D shall be computed on the full amount of the income arising in the year preceding the year of assessment, whether the income has been or will be received in the United Kingdom or not, subject in the case of income not received in the United Kingdom - (a) to the same

deductions and allowances as if it had been so received, and (b) to a deduction on account of any annuity or other annual payment (not being interest) payable out of the income to a person not resident in the United Kingdom, and (c) to a deduction on account of any annual interest payable out of the income to a person not resident in the United Kingdom, being interest payable before April 6, 1982 on a debt incurred on or before March 26, 1974."

As appears from that subsection as I have read it, there have been certain amendments to it made by Schedule 1 to the Finance Act 1974.

It is agreed that neither paragraph (b) nor paragraph (c) permits the interest to be deducted in the present case. On that footing the Crown's claim is a simple one. It is that "the full amount of the income arising" means what it says. In this case it means the full amount of the rents. Since the rents were not received in the United Kingdom, certain deductions are permitted. They are those, and only those, set out in paragraphs (a), (b) and (c) of section 122 (1). Although some deductions may be permissible under paragraph (a), it is clear that they do not include annual interest of any description, because paragraph (c) expressly permits the deduction of one limited category of such interest and impliedly disallows the deduction of any other.

The commissioners expressed their decision in these terms:

"We were unable to accept that section 122 (1) (a) would not enable the taxpayer to make any deductions or allowances in respect of the income arising from the furnished lettings. In our view section 122 (1) (a) of the Act could only be construed as allowing the interest to be deducted from the income arising from the furnished letting. We accordingly allowed the appeal in principle."

As that decision indicates, the burden of the taxpayer's argument before the commissioners was that the interest was deductible under paragraph (a), on the ground that it would have been deductible if the rents had been received in the United Kingdom. However, there is no express provision, either in the Act of 1970 or elsewhere, for deductions and allowances to be made against Case V income which is received in the United Kingdom.

The Inland Revenue practice in the case of a let property is to allow the deduction of certain expenses, such as rates, insurance premiums and agents' fees or commissions, all of which can, as they seem to me, be described as expenses incurred in procuring and maintaining the rents. But the practice is to disallow the deduction of interest on a loan obtained for the purchase of the property, on the ground that that is an expense incurred, not in procuring and maintaining the rents but in or towards the acquisition of the property. Seeing how the case had been argued before the commissioners, the Crown's advisers had a natural expectation that this appeal might result in their receiving more general guidance as to the correctness of the practice than was necessary for the decision of the case itself. In the event, I regret that it is not going to be possible for them to receive it. Some ten days ago the taxpayer's solicitors gave notice under R.S.C., Ord. 91, r. 4, of an intention to make on his behalf the following additional contention:

"That in order to calculate the 'full amount of the income' assessable under Case V of Schedule D (before any of the deductions or allowances as are referred to in section 122 (1) of the Income and

Corporation Taxes Act 1970 are made) it is necessary to compute such income on ordinary commercial principles, and that on such ordinary commercial principles the interest payable to Barclays Bank under the terms of the loan would be deductible in computing such income."

What happened on the hearing of this appeal was that Mr. Argles, who appears for the taxpayer, did not, as he put it, encourage me to decide the case on the ground on which it was decided by the commissioners. He has left it to me to do so if I think that that is the correct view. I am certainly not going to decide a case of this kind on a ground on which I am not encouraged to decide it. But I will say that a consideration of the earlier legislation, starting with section 100 of the Income Tax Act 1842, through which Mr. Mummery, who appears for the Crown, was good enough to lead me, strongly suggests that the deductions and allowances available under section 122 (1) (a), whatever else they may be, cannot be those available under Cases I and II of Schedule D. Accordingly, I can well see why Mr. Argles did not now encourage me to decide that interest is deductible under paragraph (a), since the main theme of his argument was that it is deductible on ordinary commercial principles, being a concept essentially applicable to trades, professions or vocations under Cases I and II.

I turn then to the additional contention, in support of which Mr. Argles' substantive argument was deployed. It will be noted that it involves deducting the interest before the full amount of the income referred to in section 122 (1) is arrived at. It was said that that is something which must be done on ordinary commercial principles, the payment of interest having been linked to the receipt of the rents so as to be part of the cost of earning them. I will assume in the taxpayer's favour, although against the submission of Mr. Mummery and with some hesitation, that the commissioners' findings do justify that linkage. On the other hand, they do not justify the view that the taxpayer was carrying on a trade of letting the flat. That point was never argued before the commissioners, and it is clear on authority that if it had been it would have failed. Mr. Argles started by referring to certain of the basic Schedule D provisions in the Act of 1970. He relied on section 108 (1) (a) (i) and (b) as together showing that the basic charge is in respect of "the annual profits or gains" arising or accruing to any person residing in the United Kingdom from any kind of property whatever, whether situated in the United Kingdom or elsewhere. Then he pointed to Case V in section 109 (2), the effect of which is to provide that tax shall be charged in respect of income arising from possessions out of the United Kingdom. He said that that provision, and also section 122 (1) and its reference to "the full amount of the income," were controlled by the basic charging provisions in section 108, with the result that section 122 (1) is in truth referring to the full amount of profits or gains. There is nothing at all in that point. All other objections aside, it is clear that Case V embraces income arising from a multitude of different varieties of possessions out of the United Kingdom. It is therefore natural for it to refer to income and not to profits or gains. The true view is that there is no conflict between any of the provisions to which Mr. Argles referred. Section 122 (1) both refers to the full amount of the income and either contemplates or provides that certain deductions can be made from it according as to whether it is or is not received in the United Kingdom.

Once you have made those deductions you have the annual profits or gains for the purposes of the basic charge in section 108.

The next step in Mr. Argles' argument was based on the proposition that the possession from which the income arose was a business of letting the flat of which the taxpayer was the proprietor. It has been settled law ever since Colquhoun v. Brooks (1889) 14 App.Cas. 493, that the income arising from a trade carried on entirely out of the United Kingdom falls within Case V. At one stage during the argument I thought it might be favourable to Mr. Argles that Case V must in practice attach only to the profits or gains of such a trade; i.e., gross receipts after deduction of all disbursements, expenses and so forth properly deductible on ordinary commercial principles. In the case of a trade of purchasing and letting flats those principles would normally permit the deduction of bank interest of the kind found in the present case. But then Mr. Mummery's review of the earlier legislation demonstrated to me that there have always been express provisions for Case V income of that kind to be computed in accordance with the rules applicable to Cases I and II. Those provisions are currently to be found in section 23 of the Finance Act 1974. In any event, as I have said, it is impossible to say that the taxpayer was carrying on a trade of letting the flat. I believe that Mr. Argles may have sought to draw some distinction between a trade and a business, but if he did so I was unable to see it. In my view it is clear that the possession in the present case was the flat. That was an asset or an investment, it does not matter which, and the rents were the income which it produced. Is there then any basis left on which the linked interest can be deducted? Mr. Argles referred me to a number of authorities on Cases I and VI. I did not find those on Case I of any assistance. Case VI is nearer the present case, because it applies to any annual profits or gains not falling under any other Case of Schedule D, and not charged by virtue of Schedules A, B, C or E; and it can include rents derived from United Kingdom property.

Mr. Argles' authority on Case VI was Littman v. Barron [1952] 2 All E.R. 548 where the House of Lords held, shortly stated, that losses sustained by a property dealer were sustained in "transactions" within the meaning of section 27 (1) of the Finance Act 1927; that the transactions were of such a nature that if profits had arisen therefrom they would have been assessable under Case VI; that the excess rents then taxable under the excess rents provisions were profits arising from transactions in respect of which the taxpayer was assessed under Case VI; and accordingly that the losses could be deducted from the excess rents under section 27. Mr. Argles relied on that case in support of his argument that the interest in this case can be deducted from the rents on ordinary commercial principles. I am afraid that it does not get him anywhere near that point, if only because it is clear that the whole case depended on the construction and effect of section 27. Further, if there is no trade, I find it difficult to see how you can talk about ordinary commercial principles in the first place. The more correct way of putting the point may be to contend that the interest is deductible on ordinary principles of good housekeeping, but that concept, however admirable, is not one within the comprehension of the Income Tax Acts.

That leaves Mr. Argles with no alternative but to return to section 122 (1) (a), although for a purpose different from that for which it was used before the commissioners. Mr. Argles said that since there is no

express provision, either in the Act of 1970 or elsewhere, for deductions and allowances to be made against Case V income which is received in the United Kingdom, therefore none can in fact be made under paragraph (a). Accordingly, he said, since it is clear that some deductions must be allowable, at least for what I have described as expenses incurred in procuring and maintaining the rents, therefore they can only be made at the earlier stage before you get to the full amount of the income. Then he said that those expenses also include the linked interest in the present case. In rejecting that argument I need only say that it cannot stand with the express permission to deduct one limited category of interest contained in paragraph (c). In the end it seems to me that the Crown's simple claim, as I have earlier stated it, is correct.

I desire to say that I have considerable sympathy with the taxpayer and those in the same position as himself, not least because it would appear likely that if the flat had been in Sussex and not in Gibraltar the recent restrictions on relief for loans for the purchase or improvement of land contained in section 19 of and Schedule 1 to the Finance Act 1974 would not have prevented the interest from being deductible, provided that the material requirements of the Finance Acts of 1972 and 1974 had been satisfied, in particular that of paragraph 4 (1) (b) of Schedule 1 to the Act of 1974, which, broadly stated, requires that a let property should normally be let at a commercial rent for more than 26 weeks in the year and when not let should be continually available to be let at such a rent. However, it is clear to me that the statutory provisions do not permit the deduction in the case of a foreign property, and that means that this appeal must be allowed.

Solicitors: Solicitor of Inland Revenue; Griffith Smith Dodd & Riley, Henfield.

[Reported by MRS. HARRIET DUTTON, Barrister-at-Law]