The Commissioner of Excess Profits
Tax, West Bengal Vs. The Ruby General Insurance Co. Ltd.  INSC 39 (24
AIYYAR, T.L. VENKATARAMA BHAGWATI, NATWARLAL
CITATION: 1957 AIR 669 1957 SCR 1002
Excess Profits Tax--Insurance
company--Premium receiptsReserve for unexpired risks on pending
Policies--Whether "accruing liability"--Whether could be deducted as
a debtExcess Profits Tax Act, 1940 (XV of 1940), ss. 4, 6, rr. 1, 2 of Sch.
II--Indian Income--tax Act, 1922 (XI Of 1922), s. 1O(7), r. 6 of the Sch.
The respondent was a company carrying on
life, fire, marine and general insurance business, and the question for
determination related to the assessment of excess profits tax on its income
other than life insurance. The method adopted by the company with respect to
fire insurance policies was that while the premiums received were all of them
included in the assets of the year, a portion thereof, 40 per cent., was
treated as reserve for unexpired risks on the outstanding policies, and shown
as a liability. The appellant, the Commissioner for Excess Profits Tax, claimed
that the sum set apart as reserve for unexpired risks was liable to be deducted
under r. 2 of Sch. II of the Excess Profits Tax Act, 1940, from out of the
capital employed in business for that year. The respondent, while maintaining
that all the premiums received must be treated as capital under r. 1 of Sch. II
to the Act, contended that the provision for unexpired risks was only a
contingent liability and that a liability under a contract of insurance where
under risk had not materialised could not be held to be a debt and was
therefore not an accruing liability within r. 2 of Sch. II to the Act.
Held, that the reserve liability for
unexpired risk, unlike borrowed money and debts, cannot be treated as part of
the real trading assets of the business so as to have an effect on the running
of the business or the earning of profits, and consequently, as it cannot be included
as capital under r. i, it cannot be deducted as an accruing liability within r.
2 of Sch. II of the Excess Profits Tax Act, 1940.
Sun Insurance 0Office v. Clark, (1912) A.C.
443 and Southern Railway of Peru Ltd. v. Owen, (1956) 2 All E.R.
Northern Aluminium Co., Ltd. v. Inland
Revenue Commissioners, (1946) All E.R. 546 and Inland Revenue Commissioners v.
Northern Aluminium Co. Ltd. (1947) 1 All E.
R. 608, relied on.
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 12 of 1955.
Appeal from the judgment and decree dated
September 10, 1953, of the Calcutta High Court (Original Side) in I. T. Reference
No. 8 of 1947.
C. K. Daphtary, Solicitor-General for India,
G. N. Joshi and B. H. Dhebar, for the appellant.
K. P. Khaitan, Rameshwar Nath, S. N. Andley
and J. B. Dadachanji, for the respondents.
1957. April 24. The Judgment of the Court was
delivered by VENKATARAMA AIYAR J.-This appeal raises a question of importance
as to whether amounts shown by an insurance company as reserves for unexpired
risks on pending policies are liable to be deducted under r. 2 of Sch. II to
the Excess Profits Tax Act (XV of 1940) hereinafter referred to as the Act.
The respondent is a company carrying on life,
fire, marine and general insurance business, and the present dispute relates to
the assessment of excess profits tax on its income from business other than
life insurance for the chargeable accounting periods ending December 31, 1940,
and December 31, 1941. To appreciate the contentions raised, it is necessary to
state that the policies of insurance with which these proceedings are
concerned, are, unlike life insurance policies, issued in general for short
periods or ad hoc in relation to a specified voyage or event. To take the most
important of them, fire insurance policies, they are issued normally for one
year, and the whole of the premium due thereon is received when the policies
are actually issued. In any given year, while the premiums due on the policies
would have been received in full, the risks covered by them would have run only
in part and a, part will be outstanding for the next year. The companies have
to prepare annual statements of profit and loss for the purpose of ascertaining
their profits and distributing their dividends. They have also to prepare
revenue statements to be sent to the authorities under the provisions of the Insurance
Act, 1938. The method 1004 adopted by the respondent in preparing the above
statements has been that while the premiums received are all of them included
in the assets of the year, a certain proportion' thereof, usually 40 per cent.,
is treated as the reserve for unexpired risks, and that is shown as a
liability. To take a concrete example, if in the year 1939 the respondent
issued annual fire insurance policies and received a sum of Rs. 1,00,000 as
premiums thereof, the whole of it would be shown as income in the statement for
the year 1939, and a sum of Rs. 40,000 will be shown as a reserve for unexpired
risks. In the profit and loss statement, the former will be shown as part of
the assets and the latter as liability, and it is only the balance that will be
included in the net profits. In 1940, the policies issued in 1939 would all of
them have expired, and the sum of Rs. 40,000 shown as reserve in 1939 would be
treated as -part of the assets in 1940. There will, of course, be fresh
policies issued in 1940, and in the statement of that year, the premiums
received on those policies would be shown as part of the income, and 40 per
cent. thereof would be set apart as reserve for unexpired risks. This' method
of account keeping is what is 'usually adopted by insurance companies, and is
in accordance with well-recognised and approved practice of accountancy.
Now, the question is whether in the
illustration given above, the sum of Rs. 40,000 which is set apart in 1939 as
reserve for unexpired risks is liable to be deducted under r. 2 of Sch. II to
the Act from out of the capital employed in business for that year, which
would, of course, include the whole of Rs. 1,00,000 received as premiums. The
contention of the appellant is that if all the premiums received are to be
treated as capital under r. 1, Sch. 11, then the sums which represent the
outstanding liability in respect of the unexpired period of the policies-in the
illustration given above, Rs. 40,000-should be deducted as a liability under r.
2 of Sch. II. The respondent, while claiming that all the premiums received
mu-,it be treated as capital, maintains that the provision for unexpired risks
is a contingent liability, and that that 1005 is not within r. 2 of Sch. II.
The Tribunal decided the question against the respondent, but on reference
66(1) of the Indian Income-tax Act read with
s. 21 of the Act, the High Court of Calcutta answered the question adversely to
the appellant, but granted a certificate under s. 66-A, and that is how the
appeal comes before us.
The relevant statutory provisions may now be
Under s. 4 of the Act, the charge is on the
" amount by which the profits during any chargeable accounting period
exceed the standard profits ". I Standard profits' are defined in s. 6,
sub-s. (1), and the respondent having exercised his option under the second
proviso thereto, they have to be calculated "by applying the statutory
percentage to the average amount of capital employed in the business during
such chargeable accounting period Schedule II enacts rules for the
determination of the average capital employed.
Under r. 1(c), the capital employed will
include the value of all assets "I when they became assets of the business
Rule 2(1) enacts that any borrowed money and
debts shall be deducted from out of the value of the assets. There is a further
provision in r. 2(1), which is what is material for the purposes of the present
appeal, and it runs as follows:
" The debts to be deducted under this
sub-rule shall include any such sums in respect of accruing liabilities as are
allowable as a deduction in computing profits for the purposes of excess
profits tax ; and the said sums shall be deducted notwithstanding that they
have not become payable." For this clause to apply, two conditions must be
satisfied. The sums to be deducted should be allowable as a deduction in
computing the profits for the purposes of the Act, and further they should be
in respect of accruing liabilities. Rule 1 of Sch. 1 enacts that, " The
profits of a business .......... during any chargeable accounting period .......
shall, subject to the provisions of this Schedule, be computed on the
principles on which the profits of a business are computed for the purposes of
income-tax under s. 10 of the Indian Income-tax Act, 1922." 1006 Section
10(7) of the Indian Income-tax Act provides that, " Notwithstanding
anything to the contrary contained in sections 8, 9, 10, 12 or 18, the profits
and gains of any business of insurance and the tax payable thereon shall be
computed in accordance with the rules contained in the Schedule to this Act."
Rule 6 of the Schedule provides:
"The profits and gains of any business
of insurance other than life insurance shall be taken to be the balance of the
profits disclosed by the annual accounts, copies of which are required under
the Insurance Act, 1938, to be furnished to the Controller of Insurance after
adjusting such balance so as to exclude from it any expenditure other than
expenditure which may under the provisions of section 10 of this Act be allowed
for in computing the profits and gains of a business." It is common ground
that the statements furnished to the Controller of Insurance by the respondent
for the relevant periods did disclose 40 per cent. of the premiums received as
reserve for unexpired risks on the outstanding policies and that the same has
been treated as a liability in its profits and loss statements and allowed in
the assessment of income-tax. Thus, one of the conditions required by r. 2 has
been satisfied. The whole controversy between the parties relates to the other
condition whether the reserve of 40 per cent. can be regarded as a sum in
respect of accruing liability. The contention of the learned Solicitor General
is that it must be so regarded, and his argument in support of it may thus be
stated: A contract of insurance is complete as soon as the policy is issued.
From that time, the risk begins to attach to it, and there is a liability
incurred. Rule 2 does not require that the liability should have actually
accrued; it is sufficient that it is accruing.
Liability under a policy must be held to be
accruing so long as the policy is in force, because it can ripen into actual
liability at any time during the life of the policy on the happening -of the
specified event. When the assessee shows a certain amount as the value of that
1007 liability,-it is a sum in respect of an accruing liability and must be
deducted under r. 2.
In support of this contention, the decision
in Sun Insurance Office v. Clark (1) was relied on. The facts of that case were
as follows: A fire insurance company which had been following the practice of
entering in its annual statements 40 per cent. of the total premium receipts as
reserve for unexpired risks claimed a deduction therefor in the assessment of
its annual profits. The validity of the claim having been disputed, the
question as to its admissibility was referred to the decision of the court.
Bray J., who heard the reference, held that the amounts reserved for unexpired
risks should be deducted firstly on the ground that the premium which had been
paid in respect of a risk for a whole year could not be said to have been
wholly earned, when a portion of the period covered by the policy was still to
run, and that the reserve therefore was not income earned, and secondly and in
the alternative, on the ground that as the premium had been received burdened
with a liability which had been only partially discharged in the year of
account, the portion of the liability still outstanding should be valued on the
analogy of unpaid price due in respect of property purchased and included in
the trading assets. This decision was taken in appeal, and was reversed by the
Court of Appeal, the learned Judges holding that though the reasoning of Bray J.
was sound, the question was concluded against the assessee by the decision of
the House of Lords in The General Accident Fire and Life Assurance Corporation
v. McGowan (2 ). The case came on further appeal before the House of Lords
which agreed with Bray J.that the deduction was admissible, and distinguished
the decision in The General Accident Fire and Life Assurance Corporation v.
McGowan (2 ) as one turning on the facts of that case and as not laying down
that, as a matter of law, the deduction could not be made. Lord Haldane stated
the ground of his decision thus:
".. ...... the case is analogous to one
in which if goods are bought their value cannot be treated as (1)  A.C.
443; 6 T.C. 59. (2) (1908) 5 T.C. 308.
1008 profit without deducting the value of
the liability to pay for them which the buyer has incurred." Lord
Alverstone expressed the reasoning on which he based his conclusion as follows:
"Premiums are not profits or gains, they
are receipts which must be brought into account and out of which, after proper
deduction for losses, profits will accrue." Lord Atkinson also rested his
decision on the same ground, and observed:
" That case (Gresham Life Assurance
Society v. Styles) (1) clearly decided that the receipts of a business are not
in themselves profit and gains within the meaning of the Income Tax Acts, but
that it is what remains of those receipts after there has been deducted from
them the cost of earning them which constitute the taxable profits and gains.
Now what is the service which a Fire Insurance Company renders to each insurer
in consideration for the premium it receives ? It is only, by rendering this
service in each case it earns these receipts. The service consists in
indemnifying the insurer against loss by fire during the continuance of his
policy......... Yet until that time has expired the service for which the
Company has been paid has not been completely performed. If the accounts of the
Company are to be rendered before the date of expiry, then some division of the
premium must be made, and the proportion to be appropriated to the service
which is to be performed thereafter. I think the description 'unearned premium'
which has been used to describe this latter portion is a very appropriate and
accurate description." It is also material to note that one of the
authorities relied on for the Crown was the decision in Scottish Union and
National Insurance Company V. Smiles (2) wherein, discussing how the reserve
for unexpired risk in fire policies is to be dealt with in computing the
profits, the Lord President observed:
" Seeing that fire insurance policies
are contracts for one year only, the premiums received for the year (1) 
A.C. 3o9. (2)  2 T.C. 551.
1009 of assessment, or on an average of three
years, deducting losses by fire during the same period and ordinary expenses,
may be fairly taken as profits and gains of the Company without taking into
account or making any allowance for the balance of annual risks unexpired at
the end of the financial year of the Company." Referring to this and to
another decision, Lord Haldane observed that they " are not, when
carefully examined in the light of what appears to be the true principle,
reliable as authorities for the proposition which would run counter to the practice
and good sense of the commercial community." On the strength of the
observations quoted above, the argument has been advanced by the learned
Solicitor-General that the obligation which an insurance company contracts when
it issues a policy is to be treated, in computing its profits for the purposes
of taxation, as a liability in praesenti. Mr. K. P. Khaitan, learned counsel
for the respondent, disputes the correctness of this contention. He argues that
whatever the position under the English law, a contract of insurance is under
the Indian Contract Act merely a contingent contract, that until the event
specified in the policy happens, there is no enforceable liability, and that
accordingly unexpired risks in pending policies cannot be treated as present
liabilities. He also urges a further contention based on the history of the
enactment of r. 2 of Sch. II to the Act. That rule as originally passed
mentioned only borrowed money and debts, and it was by s. 10 of the Excess
Profits Tax (Amendment) Act (XLII of 1940) that accruing liabilities were
brought within that rule.
And when they were brought in, they did not
come as something independent of and distinct from borrowed money and debts.
They came in under a provision, which enacted that the debts to be deducted
under the rule included sums in respect of accruing liabilities. Relying on
this circumstance, counsel for the respondent contends that however liberally
the expression " accruing liabilities " might be construed, it cannot
be interpreted so as to take in liabilities which do not bear the character of
debts, and that a liability under a contract of 130 1010 insurance where under
risk had not materialised, cannot be held to be a debt, and is therefore not an
accruing liability within the rule. In support of this position, he relies on
the decisions in Webb v. Stenton (1) and Israelson v. Dawson (Port of
Manchester Insurance Co., Ltd., Garnishees) (2).
In Webb v. Stenton (1), the question was
whether a sum which was payable to the judgment-debtor under a trust deed but
which had not become due could be attached in the hands of the trustees as a
debt owing or accruing within 0. 45, R.
2 of the English Rules of Practice. In
holding that it could not be, Lindley L.J. observed:
" I should say, apart from any
authority, that a debt legal or equitable can be attached whether it be a debt
owing or accruing; but it must be debt, and a debt is a sum of money which is
now payable or will become payable in the future by reason of a present
obligation, debitum in praesenti, solvendum in futuro. An accruing debt,
therefore, is a debt not yet actually payable, but a debt which is represented
by an existing obligation." Israelson v. Dawson (Port of Manchester
Insurance Co., Ltd., Garnishees) (2) was again a decision on 0. 45, R. 2, the
Court holding that the amount which became payable under a policy as the result
of the accident specified therein having occurred was, nevertheless, not a debt
which could be attached under this rule, before the compensation had been
determined by the arbitrator in accordance with the conditions of the policy.
The argument of the respondent based on the
above decisions is that until the risk specified in the policy materialises
and, consequent thereon, the compensation payable thereunder is ascertained,
there is only a contingent liability and not a debt, and that such liability is
not within r. 2 of Sch. II to the Act. In answer, the learned Solicitor-General
contends that the decisions quoted above are not in point, they having been
given on a different statute, that the decision in (1) (1883) 11 Q.B.D. 518,
527. (2)  1 K.B. 301.
1011 Sun Insurance Office v. Clark(1) which
dealt with the question of assessment for purposes of taxation was directly
applicable, and that according to that decision, the amounts reserved for
unexpired risks would be sums in respect of accruing liabilities.
That a contract of insurance is a contingent
contract does not admit of argument. That is so under s. 31 of the Indian
Contract Act, and that is also the law in England where it is termed "
conditional contract". (Vide Pollock on Contracts, 13th Edn., p. 222).
This, however, is not material for the purpose of the present discussion which
is how such contracts are to be dealt with in assessing, the taxable profits of
an insurance company. That is a matter which must be determined on the
provisions of the taxing statutes and their application to the facts found with
reference to the particular assessment. And it is in this view that the
decision in Sun Insurance Office v. Clark (1) becomes important. Now, what is
the ratio of this decision? The law is well settled that a liability which is
purely contingent cannot be allowed as a deduction in computing the profits of
a business. And in holding that unexpired risks in respect of pending policies
could be estimated and deducted out of the gross premium receipts, the House of
Lords must be held to have decided that the obligation of an insurer under such
risks was a liability in praesenti.
Reference might be made in this connection to
the recent decision of the House of Lords in Southern Railway of Peru Ltd. v.
Owen (2). There, the appellant Company operated a railway in Peru under a
statutory scheme under which its employees were entitled to receive from it a
lump sum payment on retirement, death or other termination of service. The
Company claimed that it was entitled to value this liability in accordance with
"accountancy practice" and to deduct the same from out of its annual
profits. And support for this contention was sought in the decision in Sun
Insurance Office v. Clark (1). In rejecting this claim it was observed by the
House of Lords that the accountancy valuation was not necessarily the correct
(1)  A.C. 443; 6 T.C. 59. (2)  2 All E.R. 728.
1012 valuation for purposes of income-tax,
and that the real point for decision was whether the claim was to be regarded
as an -essential charge against the trade receipts during the year. In
distinguishing the decision -in Sun Insurance Office v. Clark (1), Lord Oaksey
made the following observations, which are pertinent to the present discussion:
" Reliance was placed, during the
argument, on Sun Insurance Office v. Clark (1), in which this House held that a
percentage of the premium income of an insurance company might be deferred as a
receipt to a future year because it was paid as consideration for future
liability, but the principle of that decision is not, in my opinion, applicable
to the present case. The premium income was only deferred and would suffer tax
in a future year, whereas, in the present case, if the appellant is permitted
to deduct compensation, Which it has not paid and which it may never have to
pay, that compensation will escape tax altogether.
There is, in my opinion, a fundamental
distinction between a contingent liability and a payment dependent on a
contingency. When a debt is not paid at the time it is incurred its payment is,
of course, contingent on the solvency of the debtor but the liability is not
Similarly, the liability in Sun Insurance
Office v. Clark (1) was not, in my opinion, contingent but remained in force
throughout the period of the insurance, though payment in pursuance of that
liability might, or might not, have to be made." The decision in Sun
Insurance Office v. Clark (1) and the observations in Southern Railway of Peru,
Ltd. v. Owen(1) quoted above do support the contention of the appellant that in
computing the profits of an insurance company for purposes of income-tax, the
unexpired risks are to be treated as a present liability.
But even so, on the footing that r. 6 in the
Schedule to the Indian Income-tax Act has adopted the law as laid down in Sun
Insurance Office v. Clark (1), the question still, remains whether unexpired
risk in an outstanding policy is an accruing liability within r. 2 of Sch. II
to the Act.
It is contended for the (1)  A.C. 443:
6 T.C. 59. (2)  2 All E.R. 728.
1013 appellant that if that liability is a
present liability for purposes of assessing the taxable profits for purposes of
income-tax, it must logically be the same for purposes of excess profits tax,
and must therefore be deducted under r.
2 of Sch. II to the Act. That would be so, if
the scheme and framework of the Excess Profits Tax Act were the same as those
of the Income. tax Act. But the fact is that the Excess Profits Tax Act
differs, in material respects from the Income-tax Act, and the principles
applicable in the assessment of profits under s. 10 of the latter enactment
cannot necessarily be held to be applicable in the ascertainment of the capital
employed under rr.1 and 2 of Sch. II to the former Act. The object of the
Excess Profits Tax Act is to tax profits of a business when they overflow a
certain level. That level is determined thus: A certain period called the
standard period is taken; the capital invested and the profits made in the
business during that year are ascertained, and the standard profits are worked
out in relation to those two factors. Then, the capital actually employed in
business during the chargeable accounting period is ascertained. If the capital
is the same as that employed in the standard period, then there is no further
problem; but if it is more, then the standard profits are increased, and if it
is less, they are reduced pro tanto. Thus, the whole scheme of the Act is to
tax profits above a certain level, and that level will move upwards or
downwards as the capital employed may be more or less. It is this that
constitutes the distinguishing feature of the Excess Profits Tax Act, and it is
the determination of the capital actually employed in business that forms one
of the most important and arduous tasks in the ascertainment of taxable profits
under the Act.
Rule 1 of Sch. II to the Act enumerates three
categories of properties, which are to be included in the computation of
capital. It is to be noted that this rule does not adopt any legalistic or
conventional notion of what is technically termed 'capital'; but it proceeds on
a factual basis to include whatever is utilised in business, :whether it be
tangible property or intangible 1014 property. The object of the provision is
clearly to confer a benefit on the assessee by enabling him to retain at least
in part the profits realised by him by investment of additional capital. Then
there is r. 2, which provides for certain deductions being made out of capital.
Omitting for the present "accruing liabilities", which form the
subject of the present controversy, the other two items mentioned therein are borrowed
money and debts, and the reasons for their exclusion from capital falling
within r. 1 would appear to be this: Money borrowed and debts incurred for the
purpose of the business must have been utilised in it, and would be included in
the capital employed as defined in r.
1. The policy of the law being to give some
relief to an assessee who invests additional capital in his business, the
reason of it requires that that should be limited to capital contributed by the
assessee himself. Otherwise, the benefit intended to be given to him might be
abused, and the object of the legislation defeated by large scale employment of
borrowed capital. Borrowed money and debt are therefore to be deducted out of
what is capital within r. 1.
We now come to the expression "accruing
What does it precisely import ? To decide
that, we must have regard to the scope and purpose of rr. 1 and 2 of Sch. II to
the Act and to the context and setting of the expression.
It has been already pointed out that the
object of the Act is to tax profits which overflow a certain line indicated by
what is termed " standard profits ", that the location of that line
varies with the capital employed, that the scheme of r. I is on a factual basis
to treat as capital all assets tangible and intangible which are thrown into a
business and contribute to the earning of profits and to exclude there from
under r. 2 that part of it which came in as a result of borrowing. Now,
obviously. a deduction under r. 2 can only relate to what is capital under r.
1, and that must be a really profit-earning asset, whether tangible or not-.
Borrowed money to be deducted under r. 2 is
money borrowed for the purpose of the business, and which has gone to swell the
capital under r. 1. That is also the position as regards debts. And 1015
accruing liabilities which are liable to be deducted under r. 2 must also be of
the same character as borrowed money and debts with which they are associated
on the principle of noscitur a sociis. They must be such as can be said to have
been utilised in the business and formed part of the really effective trading
assets during the chargeable accounting period.
If that is the correct approach, as we
conceive it is, the question to be considered is neither, on the one hand,
whether the liability amounts in law to a debt-for if it is capable of being
utilised in business and is so utilised, it will fall under r. 2, even though
it is not strictly speaking a debt; nor, on the other hand, whether it is a
liability which has been treated as one for the purpose of assessing
income-tax. In assessing income from business under s. 10 of the Income-tax
Act, what is allowed as a deduction is any liability incurred solely and
exclusively for the purpose of the business, and when that has not matured, its
value is to be determined according to rules of accountancy and deducted. But
when a deduction is claimed under r. 2, what has to be seen is whether the
obligation is such that it could be regarded as an asset used in the business,
such as could conceivably contribute to its profits. If that is not
established, then it cannot be included as capital under r. 1, and cannot be
deducted there from under r. 2 as an accruing liability. It should not be
overlooked that a deduction under s. 10 of the Income-tax Act and that under r.
2 of Sch. 11 to the Act proceed on totally different lines and have different
objects in view. Under s. 10, the deduction is claimed by the assessee, and
that has the effect, when allowed, of reducing the taxable profits. Under r. 2,
it is claimed by the department, and if allowed, it will enhance the liability
of the assessee by reducing the capital under r. 1. Incidentally, how
inappropriate the principle laid down in Sun Insurance Office v. Clark (1)
would be if it is applied for determining the question of capital employed in
business for the purpose of Excess Profits Tax Act will be seen from (1) 
A.C. 443 ; 6 T.C. 59.
1016 the fact that one of the grounds on
which the decision therein was based was that 40 per cent. of the premiums
received and set apart as reserve for unexpired risks was unearned income, and
could not therefore be regarded as profits for the purpose of the Act. If that
were the true position under the Excess Profits Tax Act, then the reserve could
not be included in the capital of the business, and, indeed, that was one of
the contentions urged by the learned Solicitor-General. But that was not the
stand taken by the department before the Tribunal and that is directly opposed
to the plain language of r. I of Sch. II, under which all the premiums thrown
into the business would be capital employed in the business. That clearly shows
how unsafe it will be to adopt the principles laid down for the purpose of
assessing business profits under the Income-tax Act to a determination of the
question of the capital employed under the Excess Profits Tax Act.
In this view, is the reserve for unexpired
risks an "accruing liability " within r. -2 ? The decision in. Sun
Insurance Office v. Clark(1) that it should be allowed as a deduction was based
on two grounds. One was that it should be regarded as " unearned income
", and for the reasons already stated, it cannot avail when the question
is one of determining capital under the Act. And the other was that the reserve
represents a liability in the nature of unpaid price of property included in
the trading assets. But apart from the fact that we have to strain the analogy
in applying it to the present situation, can that liability be held to be of
the character contemplated by r. 2 ? Can it be said that the reserve for
unexpired risk was, like borrowed money and debt, part of the real trading
assets of the business ? The answer must clearly be in the negative. The
reserve liability could not factually be said to have contributed to the
running of the business or the earning of profits. It was some. thing in the
air, and could have had no effect in the working of the concern, during the
chargeable accounting period. It cannot therefore be held to be an is accruing
liability " within r. 2 of Sch. 11 to the Act.
(1)  A.C. 443; 6 T.C. 59.
1017 A case very much in point is the
decision in Northern Aluminium Co. Ltd. v. Inland Revenue Commissioners(1).
There, the question arose whether a
conditional liability under a contract was an " accruing liability "
within the corresponding provision in the English Excess Profits Tax Act. The
facts were that on December 16, 1939, an agreement was entered into between the
Ministry of Aircraft Production and a company engaged in manufacturing
aluminium products and supplying them to manufacturers of aircraft for the
Government, wherein it was provided that the prices which the latter was then
charging to its customers should be reduced for the period July 1, 1939, to
June 30, 1940, and that the amount by which the prices paid to the company were
in excess of the reduced prices should be paid by the company to the Ministry.
The agreement further provided that negotiations should be started not later
than June 30, 1940, for determining the rates to be charged for the periods
following June 30, 1940. The agreement was, in fact, concluded only on October
12, 1942, whereby the prices to be charged by the company were fixed for the
years 1941, 1942 and 1943. In accordance with the agreement entered into on
October 12, 1942, a sum of pound 2,743,469 was repaid by the company to the
Ministry in 1943 being the difference between the price paid by the customers
and that fixed in the agreement. This amount was actually allowed as a
deduction in the assessment of the business income for purposes of income-tax,
and the dispute related to the question whether it could be deducted in
assessing the excess profits tax as an "accruing liability" of the
company for the chargeable accounting period which was January 1 to December
31, 1941. It was held by the Court of Appeal that there was, in fact, no
agreement between the parties during the chargeable accounting period, and that
therefore no liability was incurred. In the alternative, it was held that even
if the agreement dated December 16, 1939, could be construed as amounting to a
conditional agreement for the period subsequent to June 30, 1940, the
obligation created thereby could not be (1)  1 All E.R. 546, 554.
1018 regarded as an accruing liability within
the rule in question. Lord Greene M.R. stated the reason thus:
" A purely conditional liability, which
may or may not mature, is not one which falls within that language, for this
reason: Quite apart from the actual words, it would be contrary to the whole
conception underlying these capital provisions because a purely conditional
liability, which may or may not eventuate, is not a thing which affects a
company's capital position, any more than a conditional receipt can affect its
capital position. A receipt which may or may not be received, according as some
event does or does not happen, is not a thing with which you can earn profits.
It is the possibility of earning profits on your real capital that these
capital provisions are concerned with. Therefore, in my opinion, even if one
could spell such a hypothetical and conditional contract out of these words,
the result would not give rise to an accruing liability within the meaning of
the section. " This decision was taken in appeal to the House of Lords and
was affirmed. Vide Inland Revenue Commissioners v. Northern Aluminium Co. Ltd.
This decision establishes that a conditional
liability under a concluded contract-it is on that footing that the second
point arose for decision-was not an accruing liability for the purposes of the
Excess Profits Tax Act, as the same had no effect on the actual capital
position of the company, and the fact that it was allowed for purposes of
income-tax did not affect the position under the Excess Profits Tax Act.
The learned Solicitor-General sought to
distinguish this decision on the ground that it did not relate to an insurance
business, whereas it was contended that Sun Insurance Office v. Clark (2 )
directly dealt with the question now under consideration whether reserves for
unexpired risks in pending policies were liabilities which could be deducted.
We do not see how it makes any difference in the construction of r. 2 of Sch.
II to the Act that the liability sought to be deducted arises under an insurance
policy and not under some other contract.
(1)  1 All E.R. 608. (2)  A.C.
443; 6 T.C. 59, 1019 We are of opinion that the principles laid down in
Northern Aluminium Co., Ltd. v. Inland Revenue Commissioners (1) and Inland
Revenue Commissioners v. Northern Aluminium Co., Ltd.
(2 ) are applicable to the decision of the
present case, and that a contingent liability in respect of unexpired risk is
not an "accruing liability" within r. 2 of Sch. II to the Act.
The decision appealed from is correct, and
this appeal must accordingly be dismissed with costs.