LORD GREENE, M. R. - For the purposes of this judgment the following short statement sufficiently explains the facts of the case. Previously to the year 1933, the appellant company had advanced to a Finnish company (whose whole issued share capital belonged beneficially to the appellants) sums amounting to $319,690. The Finnish company had been formed by the appellants for the purpose of manufacturing and supplying to the appellants the wood pulp required by them in their business of manufacturers of newsprint. In the absence of any finding to the contrary, it must be assumed that these advances were repayable on demand. In these circumstances the two companies entered into an agreement for funding the outstanding indebtedness. This agreement was dated November 11, 1933, but it operated in effect as from January 1, 1933. Its essential terms may for present purposes be thus summarised : (1) The Finnish company agreed to issue to the appellants 680 notes (which were freely assignable) of Pounds 500 each, amounting in all to Pounds 340,000, that is, Pounds 20,400 more than the Pounds 319,600 outstanding in respect of principal; in other words, these notes were to be issued at what is commonly called a 'discount' of 6 per cent. (2) The notes were to bear interest at 1 per cent. above the lowest discount rate of the Bank of Finland during each year, but in no case higher than 10 per cent. per annum. (3) The notes were to be repaid as to Nos. 1 to 100 on November 15, 1933, and thereafter as to twenty-nine notes in consecutive order of numeration on April 6 in each following year. (4) Each notes was to be redeemed at a premium of 20 per cent. if in the next year before the year of its redemption the net profits of the Finnish company reached a specified level.
There is no suggestion that this agreement was other than a bona fide commercial transaction. The business object is it is apparent from the terms of the agreement and the circumstances in which the appellant company owned all the shares in the Finnish company affect the situation one way or another, once it is conceded that the making of the agreement was a perfectly bona fide affair. One or two points may here be noted. The rate of interest provided for by the notes is on the fact of it what appears to be an ordinary commercial rate - in fact it worked out at about 5 per cent. during the years in question. The provision for repayment of the first hundred notes on November 15, 1933, that is four days after the date of the agreement, was a natural condition to be imposed by the appellant in the circumstances. They were consenting to the funding of a loan which was repayable on demanding by making it repayable over a period of twenty years. The immediate payment of the first hundred notes left 580 to be redeemed in annual batches of twenty-nine, a process for which twenty years would be required. In is not unnatural that the appellants should have stipulated for payment down of a substantial amount.
The secretary of the appellants, Mr. Lanktree, gave evidence which was accepted by the Special Commissioners to the effect that, as to the repayment of the advances, the appellants had always had in mind 'the element of risk which might arise through trouble between Finland and Russia.' In view of the manner in which that apprehension has justified itself, it can scarcely be suggested that on a contract for funding a loan at a reasonable commercial rate of interest the appellants were taking excessive precautions by insisting on the notes being issued at a discount and redeemable at premium. It is stated in the case that the interest, discount and premiums taken together represented a return of about 7 3/4 per cent. on the amount outstanding. The fact that such a calculation can be made is, of course, no justification for asserting that the discount and the premium ought to be treated as income for the purposes of the Income Tax Acts. Whether they should be so treated is the question which arises for decision. The Special Commissioners answered it in favour of the appellants, holding that these amounts were capital sums. Macnaghten, J., took the opposite view and reversed their decision.
It is sometimes said that the question whether a receipt is to be regarded as capital or as income is to be answered by the terms of the contract as properly interpreted in the light of all admissible extrinsic evidence. In some cases this is no doubt so. Examples are to be found in two cases which were cited to us. In a scottish case, Inland Revenue Commissioners v. Nelson & Sons, Ltd., a loan was made to an Indian company repayable in ten years or earlier on the happening of certain specified events, with a power to the company to repay one-tenth of the principal on three months notice, the rate of interest being 3 per cent. The agreement provided (and this is the important matter) that, on payment of the principal sums or any part thereof, there should be paid a premium varying with the date on which such principal sums or any part thereof should become payable. From this it appears that the amount to be paid by way of premium must have been calculated by reference not to any element of capital risk but to the period of the loan whatever it might turn out to be, a circumstance which prima facie at any rate, stamped the premium with a revenue character. The Lord President in his judgment placed great reliance on the fact that the rate of interest (3 per cent.) was for a loan of that character a remarkably low one He also pointed out that, under the power given to the borrower to make yearly repayments if it had been exercised, the lenders would have received in the form of interest plus premium a return varying between five and something over 5 1/2 per cent., and this, he said, could only be regarded as a reasonable return on the capital lent. He also pointed out that there was no resemblance between the case before him and that of a debenture issued at a discount. The case before him turned on 'the specialities of the contract' and forms a good example of case where the contract itself gives the answer to the question. The other example is Ruskin Investments, Ltd. v. Copeman, a recent decision of this Court. There the argument on behalf of the taxpayer was that the transaction was one of purchase and not of loan, and the judgments of Scott, L.J., and myself are devoted to an examination of this question. It was not seriously suggested that if that were not so the profits in question would be anything but income. The loan was a loan at interest, and the assignment of the ground rents was to operate as satisfaction of both principal and interest. In these circumstances it would have required some courage to argue that the value of the ground rents ought not a be treated as being made upon of the principal advanced, plus interest. This again was a case where the answer to this particular question was to be found in the contract itself.
But in many cases mere interpretation of the contract leads nowhere. If A lends B Pounds 100 on the terms that B will pay him Pounds 110 at the expiration of two years, interpretation of the contract tells us that Bs obligation is to make this payment; it tells us nothing more. The contract does not explain the nature of the Pounds 10. Yet who could doubt that the Pounds 10 represented interested for the two years The justification for reaching this conclusion may well be that, as the transaction is obviously a commercial one, the lender must be presumed to have acted on ordinary commercial lines and to have stipulated for interest on his money. In the case supposed the Pounds 10, if regarded as interest, is obviously interest at a reasonable commercial rate, a circumstance which helps to stamp it as interest.
In Howard de Walden (Lord) v. Beck, the appellant became entitled to receive sets of promissory notes, payable without interest at three monthly intervals the consideration moving from the appellant was an amount which represented the present value of the promissory notes calculated in the case of one set of notes on a 4 per cent. basis and in the case of the other sets at a rate approximating to 4 per cent. Wrottesley, J., pointed out that the documents threw no light on the problem whether or not the difference between the present value and the nominal amounts of the notes represented capital or income. Nor did he find any assistance in the surrounding circumstances. He rejected the view that the appellant had purchased an annuity (a view which was not pressed by the Crown) and held that the appellant had stipulated for the return of his capital. This at once stamped the transaction as one of loan, and one that basis it does not seem to have been seriously argued that the difference between the present and the nominal value of the notes ought not to be regarded as interest. It is to be noted, (I) that the contracts did not in terms provide for payment of interest; (2) that 4 percent. was a reasonable commercial rate. These facts led really as a matter of common sense to the inference that the 4 per cent. was interest.
A rather different case is that of a money-lender who stipulates for payment by instalments of a sum very much larger than that which he lends. From a business point of view the excess, one would have thought, is referable largely, if not mainly, to capital risk. So long as the money-lender is carrying on his business this is immaterial, since he will be assessed under Case I of Schedule D. It is part of his business to take capital risks. But in Bennett v. Ogston the money lender had died, and the question arose in relation to instalments collected by his administrator. The substantial argument for the administrator was that, as the money-lender had been taxed under Case I, the assessment for the last year of his life must be taken as covering the amounts got in by his administrator. Once this argument was rejected (as Rowlatt, J., rejected it), it does not seems to have been seriously argued that the difference between the amount of the loan and the amount of the instalments did not represent interest. As Rowlatt, J. Says (15 Tax Cas., at p. 378) : 'Each of these instalments is found in the case to contain principal and interest and we know of course, that it is so, and we are familiar with the way in which these instalments are broken up into principal and interest.' On this basis the insurance against capital risk was provided for by means of a high rate of interest; and, where this is the case, interest it is, and not capital. In saying that the case was one of interest, Rowlatt, J., apparently based himself on the well-known practice of money-lender, and if the deceased had been alive he would no doubt have admitted that the fixed the amount of instalments by reference to an interest table, a circumstance which would be sufficient to stamp the whole excess as interest. Moreover, under Section 8 of the Money-lenders Act, 1927, a money-lender is bound to supply to the borrower a signed statement showing the amount of principal and the rate per cent. per annum of interest charged. In such a statement the excess would necessarily appear as interest.
The position is more complicated when A lends Pounds 100 to B at a reasonable commercial rate of interest and stipulates for payment of Pounds 120 at maturity of the loan. In such a case it may well be that A requires payment of the Pounds 20 as compensation for the capital risks : or it may merely be deferred interest. If it be proved that the former was the case by evidence of what took place during the negotiations it is difficult to see on what principle the Pounds 20 ought to be treated as income. In the absence of such proof, what inference ought to be drawn Something may, perhaps, depend on the length of time for which the money is lent. If the period is short it is perhaps easier to treat the Pounds 20 as deferred interest. The longer the period the greater the element of risk, and if it was (say) ten years, the probability that Pounds 20 was not intended to be deferred interest would seem to be greater. A good example of the difficulty is to be found in the contract of loan which used to be made on a gold basis when the currency had left, or was expected to leave, the gold standard. In such contracts the amount to be repaid was fixed by reference to the price of gold ruling at the repayment date, and if the currency depreciated in terms of gold, there was a corresponding increase in the amount of sterling to be repaid at the maturity of the loan. It could scarcely be suggested that this excess ought to be treated as income when the whole object of the contract was to ensure that the lender should not suffer a capital loss due to the depreciation of the currency. I refer to these problems, not for the purpose of attempting to solve them, but in order to show that there can be no general rule that any sum which a lender receives over and above the amount which he lends ought to be treated as income. Each case must, in my opinion, depend on its own facts and evidence dehors the contract must always be admissible in order to explain what the contract itself usually disregards, namely, the quality which ought to be attributed to the sum in question.
I will now consider the case of an ordinary issue of debentures by a limited company. If the credit of the company is good and the security an ample one, the issue can be made at per at a normal reasonable rate of interest. If the companys credit and the security offered are exceptionally good, the issue can be made at a premium. In such a case the calculation of the rate of interest which the subscriber will receive on the capital which he invests is a simple matter. It will be less than the nominal rate : but this does not entitle the subscriber to avoid taxation on the difference between the nominal rate and the actual rate. He is taxed on what he in fact receives. The premium which he pays is capital. He pays it because the security which he pays is capital. He pays it because the security which he is getting is expressed in terms of capital. Such a company, however, may prefer to issue its debentures at per but at a lower rate of interest. Here the excellence of the security is expressed in terms of interest. Here the excellence of the security is expressed in terms of interest. The subscriber receives less interest but does not pay a premium. Actuarially the result is the same in both cases; but the subscriber pays less tax in the latter case than he does in the former because his income is less. Now let me take the opposite case where the credit of the company and the security which it offers are not such as to enable it to offer its debentures at par at a normal rate of interest applicable to sound securities. The object of the company is to make its issue attractive, and various alternatives are open to it. It may make the issue at per but give a high rate of interest. Here the defect in the security is expressed in terms of interest. The whole of the interest is unquestionably income and is taxable as such, although the high rate of interest is in part attributable to the capital risk. Another course which the company may take, and for commercial reasons probably will take, is to fix the rate of interest at a more normal level and make the issue at a discount; or it may make the issue at per and offer a premium or redemption; or it may combine both methods. Here the defect in the security is expressed in terms of capital. I venture to think that no business man would regard the discount or the premium as anything but capital matters. In each case the result is the same - the subscriber is paying for a more or less hazardous investment less than the figure at which it is to be redeemed, and in exchange has to be content with a lower rate of interest. Another way of making good the defect in the security would be for the company to take out a guarantee policy - a practice which was common in the days of the Law Guarantee Trust and Accident Society of unhappy memory. In such a case the issue might be at par. The subscriber would by paying more for a safer investment than he would have paid if the guarantee policy had not been taken out. No one would suggest that the premiums paid by the company were part of subscribers income. Yet the policy would be playing exactly the same part as would have been played by a reduction in the issue price or the offer of a premium on redemption, or a combination of the two. The amount by which the issue price falls short of par or the redemption price exceeds par can, of course (as has been done in the present case), be reduced to terms of income if anyone chooses to make the calculation : and this is often done by a stock-broker advising a client, particularly when the redemption date is drawing near. But this does not mean that these amounts are income. If they were income, and taxable as such when received on redemption, it would appear to follow that, in the case of a debenture issued at a premium and redeemable at par, the amount of the premium ought to be treated as an income loss. A premium on redemption and a premium on issue are in their nature precisely the same, and come into existence for the same reason, namely the desire to express in the former case the greatness, in the latter the smallness of the risk in terms of capital rather than in terms of interest.
I have for simplicity considered only the case where the variations in issue price and rates of interest are due only to differences in the security offered. This, of course, is not necessarily always the case. The precise terms of an issue may be affected by a variety of other considerations, the taste of the market, the terms of previous issues by the company, the political or international situation, the expectation of changes in money rates, the instability of the currency, etc. But these matters do not affect the principle. It is perfectly true that a company may be able to obtain subscribers by issuing debentures at par at a high rate of interest just as well as it can by issuing them at a lower rate of interest below par or with a premium on redemption. The two methods are, however, essentially different, although actuarially they will normally produce the same result. But, for income-tax purposes, the result is, I think, different according as the company chooses the one method rather than the other. The Crown is, in my opinion, bound by the companys choice and cannot go behind it. The Inland Revenue authorities have never sought to tax the amount by which the redemption price of debentures exceeds the issue price. We were informed by the Solicitor-General that these amounts are regarded, not as income but as capital sums which the company bears in consideration of the risk attaching to the investment which is borne by the investor. In my opinion, this view is undoubtedly correct. IN passing I may point out that the reason given by the then Solicitor-General in Wilson v. Mannooch, for not claiming tax on discounts or premiums in the case of debentures, was quite different from that given by the present Solicitor-General in the present case.
I can find no ground for distinguishing the present case from that of an ordinary issue of debentures by a trading company. If at the date of the agreement the appellants had lent to the Finnish company a sum of Pounds 319,600 to be secured by an issue of notes at ninety-four, repayable over twenty years at 120 and bearing interest at a rate fixed by reference to bank rate in the usual way, the Revenue authorities would not have claimed tax on the discount or the premium. The element of capital risk was quite obviously a serious one, and the parties were entitled to express it in the form of capital rather than in the form of interest if they bona fide so chosen. It is said, however, that there is a difference between the case of a security issued for a present loan and that of a security issued to cover an existing loan. This argument found favour with Macnaghten, J., but with all respect to him I cannot follow it. The parties to the transaction, faced with an existing debt which the Finish company was obviously not in a position to repay there and then, did what is effect amounted to writing down the capital value of the debt which, by the terms of the agreement, was now to be repaid over a long period of years, bearing interest in the meantime at a normal commercial rate. I can see no difference between writing down the capital value of a new debt, which is what is done where a company makes an ordinary issue of debentures at a discount or repayable at a premium. Moreover it is quite common for a company to issue debentures as security for an existing loan. This is often done in the case of a companys bankers who call for security, and also not infrequently under schemes of arrangement when debentures are issued to existing creditors of the company. In such cases circumstances may well call for a writing down of the value of the debts.
An additional argument was presented on behalf of the Crown to the effect that the difference between the price at which the notes were issued and the redemption price, or at any rate the difference between the issue price and the nominal par value of the notes, was income from 'discounts' within the meaning of paragraph (b) of rule I to Case III. But in my opinion the word 'discounts' in that paragraph does not cover such a case as the present. I agree with what was said by Rowlatt, J,, in National Provident Institution v. Brown (88 L.J.K.B., at p. 1206;  2 K.B. at p. 506) : 'It is clear that it is not every difference in amount between a sum payable in future and the same sum represented by cash down which is an annual profit or gain by way of discount, even though popularly the word discount may be used to describe it.' It was conceded (and in my opinion rightly) that in the case of a debentures the difference between issue price and redemption price when received by the holder is not income form 'discounts within the meaning of the paragraph. It is impossible to suppose that the Legislature intended to include under the one word 'discounts' two such entirely different commercial transactions as the discounting of a bill of exchanger or a Treasury bill (which normally are short-dated and carry no interest) and subscription for debentures issued at a discount. The issue of debentures or other obligation by companies was unknown in 1805 when 'profits on discounts' were for the first time expressly subjected to income tax (45 Geo. 3,c, 49, s. 93, Sched. D. Case III. r. 2). In National Provident Institution vo. Brown (90 L.J.K.B., at p. 1024;  I.A.C., at p. 254), Lord Summer says that there is no restriction of the word discount in the statutes to transactions in use in the years 1842 - he might have said 1805 - and that the rule relates to profits on all discounts from whomsoever made. This observation does not, on all discounts from whomsoever made. This observation does not however, throw much light on the question whether any particular transaction is one of discount within the meaning of the rule. If the case of the debenture fell under the word 'discount' it would follow from the National Provident case that profits realised by selling debentures on the market would be taxable as income, as well as those made by an original subscriber who holds his debenture until maturity. The storm which would be aroused in the City of London if this were found to be the law is perhaps the best proof that it cannot be the law since it shown at once the fundamental difference from the business point of view between the case of the debenture and the case of the discounted bill. It is conceded that the word would not cover the 'discount' in the case of a debenture issued at a discount' and, as I have already said, for present purposes I can see difference between that case and this. In the discounting of bills of exchange, exchequer bills, etc., the discount is the reward, and in the normal case (since such bills do not as a rule carry interest) the only reward, which the person discounting the bill obtains for his money. Lord Summer pointed out in National Provident Institution v. Brown, that in the case of a 'discount' two economic elements are present, one the value of the usufruct foregone, as measured by interim interest, and the other the risk that the money will never be repaid at all. He says further (90 L.J.K.B., at p. 1025;  2 A.C., at p. 255) : 'There is nothing to show that under this section profits or discounts have to analysed into a return for the use of money by way of income and a possible accretion to capital.' If I may add may own gloss on this latter observation, if the bill of a solvent debtor is discounted at a low rate and the profit from the discount is regarded as interest, it seems logical to regard as interest also the profit from the discount where the bill of a debtor in poor credit is discounted at a high rate. In the former case the capital risk is very small, or perhaps negligible, and, in the case of a Treasury bill, to use Lord Sumners words, reaches its vanishing point. In the latter case the capital risk in terms of interest it must normally be so treated and no apportionment can be made.
It is interesting to see the official reasons given by counsel for the Crown in the National Provident Case for distinguishing the profit made on Treasury bills issued at a discount and 4 per cent. Victory Bonds issued at eighty-five. The latter, said counsel, 'were an investment at the market rate of interest. The increased amount receivable when drawn of payment of par .... is an additional capital sum bargained for to meet the probable fall in capital value likely to take place under present conditions.'
It may be convenient to sum up my conclusions in a few propositions. (I) Where a loan is made at or above such a reasonable commercial rate of interest as is applicable to a reasonably sound security there is no presumption that a 'discount' at which the loan is made or premium at which it is payable is in the nature of interest. (2) The true nature of the 'discount' or the premium (as the case may be) is to be ascertained from all the circumstances of the case and, apart from any mater of law which may bear upon the question (such as the interpretation of the contract), will fall to be determined as a matter of fact by the Commissioners. (3) In deciding the true nature of the 'discount' or premium, in so far as it is not conclusively determined by the contract, the following matters together with any other relevant circumstances are important to be considered, namely, the term of the loan the rate of interest expressly stipulated for, the nature of the capital risk, the extent to which, if at all, the parties expressly took, or may reasonably be supposed to have taken, the capital risk into account in fixing the terms of the contract. In this summary I have purposely confined myself to a case such as the present where a reasonable commercial rate of interest is charged. Where no interest is payable as such, different considerations will, of course, apply. In such a case, a 'discount' will normally, if not always, be a discount chargeable under paragraph (b) of rule I to case III. Similarly, a 'premium' will normally, if not always, be interest. But it is not necessary or desirable to do more than to point out the distinction between such cases and the case of a contract similar to that which we are considering.
For these reasons I am of opinion that the Special Commissioners came to the right conclusion and that their decision ought to be restored.
MACKINNON, L.J. - I agree. I had written a short judgment, but after doing so I read the judgment just delivered by the Master of the Rolls with pleasure and admiration, and as a result I have consigned my efforts to the waste paper basket.
DU PARCQ, L.J. - I have also had an opportunity of reading and considering the judgment which has just been delivered by the Master of the Rolls. I have to say that I agree with it and have nothing to add to it.
Leave to appeal to the House of Lords