[IN THE COURT OF APPEAL.]

H. J. GREEN (INSPECTOR OF TAXES) v. J. GLIKSTEN

AND SON, LIMITED.

Revenue - Income Tax - Insurance against Fire - Loss of Stock in Trade by Fire - Insurance Money exceeding Amount at which Stock in Trade valued in Books - Inclusion of Whole in Profit and Loss Account as a trading Receipt - Income Tax Act, 1918 (8 & 9 Geo. 5, c. 40), Sch. D, Case 1.

A quantity of timber belonging to a company carrying on business as timber merchants was destroyed by fire. In the company's accounts the timber was valued at cost or market value, whichever was the lower, and for this purpose large sums were in the last two years of account before the fire written off the cost price in respect of depreciation in order to arrive at the closing stock values. The reduced sums so arrived at were adopted each year in order to arrive at the company's profits for income tax purposes. The company kept its stock in trade insured against loss or damage by fire; and for the purpose of fire insurance the stock in trade was valued at replacement value. At the date of the fire the value of the stock destroyed was very high owing to a boom, and the insurance companies paid 477,838l. in respect of the replacement value. The sum of 160,824l. was the estimated book value of the timber destroyed. This sum was brought into the company's accounts as a trading receipt, and the balance of the sum of 477,838l. (after some small deductions) was carried into the balance sheet as a reserve and was not brought into the profit and loss account:-

Held, that the company must bring the whole of the money received from the insurance companies in respect of the timber destroyed by fire into their profit and loss account as a trading receipt in order to arrive at the company's profits for income tax purposes.

Decision of Rowlatt J. [1928] 1 K. B. 475 affirmed.

APPEAL from a decision of Rowlatt J. (1) allowing an appeal from the Commissioners for the Special Purposes of the Income Tax Acts on a case stated under s. 149 of the Income Tax Act, 1918, for the opinion of the High Court.

At meetings of the Commissioners held on June 25, 1924, and April 6, 1925, for the purpose of hearing appeals, the appellants J. Gliksten & Son, Ld. (hereinafter called "the Company"), appealed against an assessment to income tax in the estimated sum of 100,000l. for the year ending April 5, 1924.

(1) [1928] 1 K. B. 475.

The company was incorporated under the Companies Acts, 1862 to 1900, on December 14, 1905, and carried on business as timber merchants at Carpenter's Road, Stratford. On August 8, 1921, a large quantity of timber stored in the company's timber yard was destroyed by fire, and in respect of this timber the company received in February, 1922, 477,838l. from various insurance companies. The timber so destroyed consisted mainly of the best class of hardwood, which was purchased by the company seasoned, unseasoned or partly seasoned, and included a large quantity of seasoned wood which was taken into stock before the war.

The company's accounts were made up to June 30 in each year, stocks being valued, following the usual practice, at cost or market price, whichever was the lower; and for the purpose of this valuation large sums were in the last two years of account before the fire written off the original cost prices of the stock in respect of depreciation in order to arrive at the closing stock values. The reduced sums so arrived at were adopted each year in order to ascertain the company's profits for income tax purposes. In respect of the stock on hand at June 30, 1921, the sums so from time to time written off the stock values amounted in the aggregate to 107,000l., and the total stock on hand was thus valued in the company's accounts at 266,831l.

For many years past the company had kept its stock in trade insured against loss or damage by fire, and had in computing its profits for income tax purposes been allowed to deduct the premiums paid by it in respect of the policies of insurance as an expense of the business. For the purposes of fire insurance the stock in trade was valued at replacement value. At the date of the fire the value of the timber of the kind which constituted the greater part of the company's stock was very high, and the company received in respect of the replacement value of the stock destroyed the sum of 477,838l. 2s. 4d. Out of this sum the sum of 160,824l. (being part of the sum of 266,831l., the value of stock on hand at June 30, 1921), estimated by the company to be the written down value of the timber destroyed, was brought in the

company's accounts for the year ending June 30, 1922, as a trading receipt.

After deducting the sum of 2485l. for law charges, the sum of 1000l. for expenses of clearing the yard and the said sum of 160,824l., the balance of the money received from the insurance companies, amounting to 313,168l., was carried into the balance sheet for the year ending June 30, 1922, as a reserve, but was not brought into the profit and loss account. The trading account for the year ending June 30, 1922, and the fire account are set out in the report of the case before Rowlatt J. (1)

Mr. F. W. Gower, chartered accountant and advisory accountant to the Inland Revenue Commissioners, who was examined on behalf of the respondent (the Inspector of Taxes), stated in evidence that in his experience as a chartered accountant, extending over twenty years, the normal commercial method of dealing with money recovered by a trader under a policy of insurance in respect of stock destroyed by fire was to include the actual amount received in the accounts as an ordinary trading receipt, in the same way as the proceeds of an ordinary sale of stock.

During the war the greater part of the company's trade consisted in supplying seasoned and specially selected timber of various kinds to Government departments and various aircraft contractors. The timber required for these purposes, being of a special character, had to be and was picked out from the company's stocks. The whole of the company's stocks of the required types of timber, such as silver spruce, mahogany, walnut and English ash, had (before the fire) been gone over in this way, and the company was at the date of the fire left in possession of such portions of these stocks as had not been found suitable for the above mentioned purposes. Since the armistice the company had done an increasing business with the motor body building and like industries, and this class of lines had led to demand for, and the company had stocked, timber of types and qualities different from those stocked by the company during and

(1) [1928] 1 K. B. 477, 478.

before the war. For this reason only a small portion of the timber destroyed by the fire had been replaced - namely, to an amount of 18,400l. or thereabouts.

At the date of the fire there was a boom which was being prolonged by the adoption on the part of the larger timber merchants of a policy of holding up stocks; the high prices obtaining at that time, and on the basis of which the insurance companies paid the company's claim, were due to this boom. The timber destroyed was of such a character that it would have been practically impossible to have put it on the market without causing a glut and destroying the market for the time being.

The Special Commissioners decided that the sum of 477,838l. recovered from the insurance companies did not represent a trade receipt, and that no part of that sum was assessable as trade profits under Case 1 of Sch. D. They expressed the opinion that the burned timber which had been replaced, which amounted in value to 18,400l., "should be brought into stock at the original cost price of the timber." On appeal Rowlatt J. held that the whole sum of 477,838l. must be brought into profit and loss account as a trade profit for the purpose of assessment to income tax.

The company appealed.

Maugham K.C., Latter K.C. and Cyril King for the appellants. The whole sum recovered from the insurance company is not a profit of the trade or business so as to be liable to income tax under the Income Tax Act, 1918, Sch. D, Case 1. The position in regard to property destroyed by fire which was insured is made clear by r. 3 (k) of the Rules applicable to Sch. D, Cases 1 and 2. The effect is that in this case the value of the timber as shown in the balance sheet cannot be treated as lost, as that amount of insurance money has been received in respect of it. Inland Revenue Commissioners v. Newcastle Breweries, Ld. (1) is distinguishable, for that was a case of a compulsory sale. The fact that the vendors could not fix the price of their rum

(1) (1927) 12 Tax Cas. 927.

or prevent the Admiralty having it did not make it other than a sale in the course of the trade.

[LORD HANWORTH M.R. It was there said that a sale in the course of trade had been prevented, and that so much capital had been extracted from the company, as in Glenboig Union Fireclay Co. v. Inland Revenue Commissioners. (1)]

The decision really turns on its being a sale. Here no such point can arise. The question here is a novel one, and is one of how a loss by fire covered by a contract of indemnity entered into in the ordinary course of business by a trading company should be dealt with, when a larger sum is received under the contract of indemnity than the value at which the property destroyed properly stood in the balance sheet. The sum received on the insurance policy is not a profit of the business, for it is not the business of a timber company to have fires. The matter is completely covered by r. 3 (k) of the Rules applicable to Cases 1 and 2, which provides that: "In computing the amount of the profits or gains to be charged, no sum shall be deducted in respect of .... any sum recoverable under an insurance or contract of indemnity." All the cases of sales depend for their decision on the fact that a sale is an incident of the trade. A fire is not.

The amount received from the insurance company in excess of the value of the property destroyed as set out in the balance sheet is a windfall not resulting from carrying on the trade. It is like a nugget of gold dug up on property of the company, and has nothing to do with carrying on the business of timber merchants.

[LORD HANWORTH M.R. Is not the true position that part of the company's circulating capital has been converted into cash and, if so, ought not the amount received to appear in the accounts as part of the circulating capital? Is not this case rather like Gloucester Railway Carriage and Wagon Co. v. Inland Revenue Commissioners? (2)]

Not everything received during a year is a profit of the year's trade. There may be windfalls. Rule 3 (k) does not provide that the insurance money should be substituted for

(1) (1922) 12 Tax Cas. 427.

(2) (1925) 12 Tax Cas. 720.

the property destroyed, but only that in so far as the loss by fire is covered by insurance, it shall not be deducted as a loss. It follows that the sum recovered has not got to be brought into account. The fact that insurance is effected in the ordinary course of business is recognized by the Crown, which makes an allowance in respect of the premises. This is the justification for r. 3 (k), and there is no reason for going beyond it. To show that the money received on an insurance policy is not profit of a trade, take the case when a shop is burned down and the owner goes out of business, and has subsequently received money under a policy of insurance of his stock in trade. In this case there is no trade being carried on when the money is received. It may be the last act of a trader to sell his stock in trade, but it was no part of the trade to have a fire.

Further, the second finding of the Commissioners was that timber replaced must go into the company's accounts and should be brought into account at the original cost price of the timber before the fire gave full effect to r. 3 (k). Thus if the whole sum of 477,838l. had been applied in replacing the timber, it would only have appeared in the account at the value at which the timber stood in the account before the fire, and the Crown would get the full benefit of a profit on the sale as though there had been no fire. That is, it is submitted, correct, and the result will be that as further parts of the sum received are applied in replacements, the timber will go into the accounts at the old value.

Sir Douglas Hogg, A.-G. and R. P. Hills for the Commissioners were not called upon.

LORD HANWORTH M.R. This case is an interesting one, and has given rise to an interesting argument by Mr. Maugham and Mr. Latter. But we have come to the conclusion that the decision of Rowlatt J. is right.

In this case we have to deal with what I may call the proceeds of a fire. The company are engaged in large business in the timber trade, and in their accounts, which were made up to June 30 in each year, the stocks were valued

at the cost or market value, whichever was the lower, and for the purposes of valuation large sums were, in the last two years of account before the fire, written off the original cost prices of the stock in respect of depreciation. A fire took place on August 8, 1921, and a large amount of the timber was burnt. The actual amount of timber which was destroyed stood, at that valuation of cost or market value, at a sum of 160,824l. The company were insured in several insurance companies, and the ultimate amount which was received from the insurance companies in respect of that timber was the sum of 477,838l. The discrepancy between the book value of the timber destroyed and the actual sum received from the insurance companies is explained in the case, which says: "At the date of the fire there was a boom, which was being prolonged by the adoption on the part of the large timber merchants of a policy of holding up stocks; the high prices obtaining at that time and on the basis of which the insurance companies paid the company's claim were due to this boom." In other words the company were fortunate, because the contract of fire insurance being one of indemnity, the timber company were able to say to the fire insurance companies: "You must give us the sum of 477,838l., because if we were to go into the market to replace in specie the timber which we have lost by fire we should have to expend that amount, although in our books we were carrying that timber at a value of 160,824l. and no more." The question arises, how the large sum received from the insurance companies ought to be dealt with in the trading account of the timber company for the purposes of income tax.

It is said on behalf of the timber company that their business is one for the buying and selling of timber, but that they do not carry on a trade in fires. They say that the misfortune which has overtaken them is one which is no part of their business, that they do not contemplate a fire in the ordinary course of business, and therefore that the large figure received from the insurance companies must be taken as an indemnity for the book value of the timber, 160,824l., and no more. And they suggest that the amount

they have received from the insurance companies beyond that figure is a windfall like a nugget of gold dug up on their premises, which is unconnected with their trade and does not fall into their trading account for subjection to income tax.

I think one must look a little more closely into the nature of the business of the timber company. We have before us an account attached to the case and set out conveniently in the report of the case before Rowlatt J. (1) On one side of the account there are the stock in trade, purchases, the charges for freight, carriage and cartage, lighterage, insurance. All those items fall rightly within the trade account. The expenses of freight for bringing fresh stock in trade to the premises of the company, and of insurance of the stock in trade in transit or after its arrival, are all items which are rightly found in the trading account as part of the ordinary business of the trader. On the other side of the account there are the sales less returns, the stock in trade, and the timber destroyed at estimated cost prices. I have examined that trading account because I think it shows conclusively, as one would expect, that insurance, whether against marine risks or fire risks, is a part of the ordinary duty of the trader in carrying on his business. It is quite true that the timber company does not trade in fires. But governed by ordinary business prudence, and mindful of the fact that untoward events take place both by land and by sea, the company takes steps to insure an indemnity being paid to them whether they lose their stocks in transit by perils of the sea or in situ on land by the misfortune of fire.

It is pointed out, and much stress is laid upon it, that the premiums paid for insurance, whether marine or fire, are proper subjects for deduction in the ordinary trade account, and attention is then called to the deductions which are allowed in computing the amount of the gains or profits to be charged for income tax. These are catalogued in r. 3 of the Rules applicable to Cases 1 and 2 under the Income Tax Act, 1918. It is true that in form that rule is negative; but, while it restricts deductions and says that no sums

(1) [1928] 1 K. B. 475, 477.

should be deducted in respect of the matters mentioned, it must be read as allowing a deduction to be made in certain other cases. The particular item to which our attention is called is r. 3 (k). Rule 3 (k) runs in this way: "In computing the amount of the profits or gains to be charged, no sum shall be deducted in respect of any sum recoverable under an insurance or contract of indemnity." As Mr. Maugham has pointed out, some explanation of those words is necessary. It seems to contemplate that there has been a loss in respect of which there is an indemnity recoverable. Therefore one must read it as prohibiting a deduction, where there has been a loss, in respect of the sum recovered in respect of that loss under a contract of indemnity. In other words, it forbids your treating as a loss a sum which in fact is recoverable under a contract of indemnity. Thus if there is a loss of 100,000l., and a portion of that sum, let us say 75,000l., is recovered under a contract of indemnity, then to the extent of that 75,000l. no deduction is to be made as on a loss, because instead of its being a loss it has been recovered under a contract of indemnity. But r. 3 (k) appears to contemplate that if, and so far as, there is a loss, and it is not recovered under a contract of indemnity, that loss would be a sum which could be deducted. I am, myself, however, unable to find in r. 3 (k) any definite ground for the determination of this case, and I think Rowlatt J. has treated the question from the right point of view.

The appellants were traders in timber; it was their business to buy and sell timber, and it was a part of their business - ancillary perhaps - to take steps to insure their trade against mischances such as perils of the sea and perils of the land. They had a certain amount of fixed capital in their business, and they had a certain amount of circulating capital employed in the purchase of stock, which is enhanced again when the stock is sold. A part of that circulating capital was invested in timber. That timber might have been sold in the ordinary course of trade, but instead of being sold it was burnt. Under a contract of indemnity, properly entered into for the purpose of safeguarding the business against

this risk, a sum has been received in respect of the timber. That amounts to a restoration to the circulating capital of a sum which had previously been invested in specie in timber. For this purpose regard must be had to the actual sum received, which is a sum received in the ordinary course of business, taking into account the ordinary safeguards of business. As Rowlatt J. says (1): "It seems to me that the respondents must account for this timber that has been destroyed by fire; they have received the money from the insurance company in place of it. .... The fact is that the respondents' business is to buy, hold and sell timber, and it is part of their business to insure timber while they have it, in order that if the timber is destroyed they may have the insurance money instead of the timber, and, in my judgment, they must treat that money in the same way as they would have treated the timber - namely, as an item in their trading account." Those are the words of Rowlatt J. I think they are right, and therefore that the appeal fails.

I would like to add one word on another topic, because it appears to me that the case is one which is clearly open to review by the Court. The Special Commissioners, somewhat curiously, appear to have made a finding which, as I understand it, appears to be in direct conflict with the evidence of Mr. F. W. Gower. Why they set that evidence out in the case, if they did not accept it, I cannot imagine. There was no evidence called on the other side, we are told, and Mr. Gower's evidence is this: "The normal commercial method of dealing with moneys recovered by a trader under a policy of insurance in respect of stock destroyed by fire was to include the actual amount received in the accounts as an ordinary trading receipt in the same way as the proceeds of an ordinary sale of stock." That is the evidence as it stands. Upon that, without any comment from the Commissioners, they say: "We are satisfied that the sum .... recovered from the insurance companies, does not represent a trade receipt." I find some difficulty in seeing what evidence there was upon which the Commissioners

(1) [1928] 1 K. B. 481.

could come to that conclusion, having regard to the evidence which they themselves have set out in the case stated. I make that observation by the way, but it certainly shows that the Commissioners have dealt with a matter of law - namely, the proper way of dealing with the insurance money in a trading account. For the reasons I have given I think that it is an ordinary item in respect of the circulating capital of the trading company which has to be brought into the trading account and dealt with at its true value, and not at an artificial value, based upon the book values of the timber actually in stock.

For those reasons I think the appeal fails and must be dismissed with costs.

SARGANT L.J. With great respect to the arguments of Mr. Maugham and Mr. Latter it seems to me that this is a very plain case. We have to consider whether in computing under the Rules applicable to Sch. D, Case 1, the profits or gains of this company, this large sum of over 400,000l. received from the insurance companies under the policies of insurance against fire, is to be taken as being one of the gains to be brought into account.

The company, trading as a timber company, in the ordinary course of business insured its timber against loss or damage by fire. The premiums were an ordinary trade outgoing, allowed for, of course, in the trading account. Fire is an event which has to be taken into account as an ordinary risk of a company of this kind, and in consequence of the insurance this very large sum was recovered. To my mind, on the face of the transaction itself, the whole of the amount so recovered is clearly an amount which ought to be brought in. It is an ordinary receipt in the sense, not that it occurs every year or regularly at stated periods, but that it is a receipt which would ordinarily be received in case the risk insured against should happen. A great deal has been made, or attempted to be made, of r. 3 (k). To my mind that rule does not affect the matter in any way. I do not think there is any real doubt about the effect of the rule. The words of the rule are: "In computing the amount of the profits or

gains to be charged, no sum shall be deducted in respect of any sum recoverable under an insurance or contract of indemnity." It seems to me that head (k) assumes that there has been a loss, and that the loss is one which is wholly or partially covered by an insurance or contract of indemnity; and the effect of the words seems to me quite clear - namely, that to the extent to which the loss is met by the sum recoverable under the contract of indemnity or insurance, the loss is not chargeable in the ascertainment of profits and balance of profits. To my mind the broad meaning of those words is, so far as it goes, rather against the appellants than in their favour because, broadly speaking, I think the words mean that the amount recoverable in such a case is to take the place of the asset lost, so far as the amount recoverable goes. What is said by the appellants is, that you must take account not of the actual sum recovered but only of the book value, in the company's books, of the timber destroyed; and that as regards any excess of the amount recovered over the book value, that is a mere windfall, and is not to be accounted for at all. I fail to follow that argument altogether. To my mind the book value of the timber in the company's books has nothing at all to do with the amount of the loss or with the amount which has been recovered in respect of the loss. The amount recovered is a gain of the company in the course of its business no less than the sale price of the timber would have been, if the timber had been sold in the course of ordinary sales during the continuance of the company's business; and in estimating the balance of the profits or gains which the company has to bring into account for the purposes of income tax, the amount of the excess of the sum recovered over the book value of the timber in the company's books has to be brought into account just as fully and completely as if there had been a sale in the ordinary course of business at that price, in which case it is conceded by the appellants that the full amount of the difference between the sale price and the book value in the company's books would have had to be brought into account. I agree that the appeal should be dismissed.

LAWRENCE L.J. I agree. The appellants contend that the difference between the book value of the timber and the amount paid by the insurance companies is not a trading receipt but is in the nature of a windfall, and in support of that contention they rely mainly upon r. 3 of the Rules applicable to Cases 1 and 2 in Sch. D. Their contention is that r. 3 (k) negatives the idea of bringing in the insurance money as one of the items of receipt, that what has to be brought in is the book value of the stock which has been burnt, and that the excess over that value is not a trading receipt and does not stand on the same footing as the proceeds of sale of the stock. In my opinion that contention is not well founded. The effect of r. 3 (k) in my judgment is that, in arriving at the balance of profits or gains there has to be no deduction in respect of a loss which is covered by insurance to the extent to which that loss is recoverable. But that in no way negatives the idea that if the true value of the stock burnt is received from the insurance companies, such receipt is a receipt in the ordinary course of the company's business. I agree, of course, that a fire is not an ordinary incident in a trading business; but if it does occur I think the receipt from the insurance company is an ordinary receipt in that it is a receipt which an ordinary trader generally stipulates for in case his stock is burnt. I agree with Rowlatt J. that the insurance money ought to be treated, for the purposes of ascertaining the balance of profits or gains, as an ordinary trading receipt in the same manner as the proceeds of sale of the stock would have had to be treated had the stock been sold.

I agree that the appeal fails and ought to be dismissed.

Solicitors: Ward, Perks & Terry; Solicitor of Inland Revenue.

H. C. G.