(1) Cooper (HM Inspector of Taxes) v Stubbs
| Jurisdiction | England & Wales |
| Judgment Date | 30 June 1925 |
| Date | 30 June 1925 |
| Court | King's Bench Division |
No. 535.-HIGH COURT OF JUSTICE (KING'S BENCH DIVISION).-
COURT OF APPEAL.-
Income Tax, Schedule D - Profits of trade - Cotton futures.
Independently of those dealings in future delivery contracts which ordinarily form part of the business of cotton brokers in connexion with the buying and selling of actual cotton, two partners in a firm of cotton brokers undertook on their own account, over a period of years, a series of speculations by way of buying and selling cotton futures, not with a view to receiving or delivering cotton, but with a view to gaining a profit on the balance.
The Special Commissioners held, on appeal, that the individual partners did not deal in future delivery contracts so habitually and systematically as to constitute such dealings the carrying on of a trade, and that the profits arising therefrom
were accordingly not assessable to Income Tax under Case I of Schedule D. They further held that the dealings were gambling transactions and that the profits thereon were not annual profits assessable under Case VI of Schedule DHeld, (by the Master of the Rolls), that the transactions of each partner in cotton futures constituted the carrying on of a trade, and that the profits arising therefrom were accordingly assessable to Income Tax under Case I of Schedule D.
Held(by Warrington and Atkin, L.JJ.), that the finding of the Commissioners that the transactions in question did not constitute the carrying on of a trade was entirely one of fact with which the Court could not interfere, but that the profits arising from the transactions were annual profits or gains assessable to Income Tax under Case VI of Schedule D
(1)
COOPER v. STUBBS.
CASE
Stated under the Income Tax Act, 1918, Section 149, by the Commissioners for the Special Purposes of the Income Tax Acts for the opinion of the King's Bench Division of the High Court of Justice.
1. At a meeting of the Commissioners for the Special Purposes of the Income Tax Acts held on the 18th January, 1924, for the purpose of hearing appeals, Mr. Henry Stubbs (hereinafter called "the Respondent") appealed against assessments to Income Tax in the sums of £1,982, £4,200, and £4,302 for the years ending 5th April, 1921, 5th April, 1922, and 5th April, 1923, respectively, made upon him by the Additional Commissioners for the Division of Liverpool under the provisions of the Income Tax Acts.
2. The assessments under appeal were made upon the Respondent under Schedule D of the Income Tax Act, 1918, in respect of profits from private transactions in cotton futures entered into by him in the circumstances hereinafter set out.
3. The Respondent was a partner in the firm of Richard Stubbs and Company which carried on the business of cotton brokers (i.e.,selling cotton on commission to spinners and merchants and buying and selling for clients on future delivery contracts) and cotton importers (i.e., acting as merchants on their own account). In all material years up till the death of Mr. Richard Stubbs, Senior, in 1919, the partners in the firm were Mr. Richard Stubbs, Senior, the Respondent, and Mr. Richard Stubbs, Junior. After the death of Mr. Richard Stubbs, Senior, the partners were the Respondent and Mr. Richard Stubbs, Junior. On the death of Mr. Richard Stubbs, Junior, on the 2nd October, 1922, the business ceased and the Respondent retired temporarily from business. He resumed business as a cotton broker after an interval of about six months.
4. The course of business of cotton merchants in general and of the Respondent's firm was explained to us as follows:-
(a) Owing to the uncertainty of the quantity and quality of the cotton crop the price of cotton is subject to violent and rapid fluctuations. In order to protect himself against such fluctuations between the time of buying and selling or vice versa, a merchant usually effects a cover or hedge each time that he makes a purchase or sale of actual cotton.
(b) On a purchase by a merchant of actual cotton, for which he has not yet found a purchaser, the merchant effects a hedge by making a contract for the sale of the same quantity of cotton for delivery in some month in the future. Conversely on a sale of actual cotton not yet purchased the merchant effects a hedge by making a contract for the purchase of the same quantity of cotton for delivery in some month in the future.
(c) These hedging contracts are known as future delivery contracts. The future delivery contract, though differing in some important respects from the contract for the purchase or sale of actual cotton, provides for the delivery of actual cotton, but it is only exceptionally that a future delivery contract is entered into with the intention of taking up actual cotton, and it is almost invariably closed out, as explained in paragraph (d) below, by entering into another future delivery contract to cancel out with the one originally entered into.
(d) By means of these hedges at any given time the total amount of cotton bought or contracted to be bought by the merchant (whether as actual cotton or under a future delivery contract) balances his total commitments for sale of cotton (either as actual cotton or under future delivery contracts), and thus the risk of any rise or fall in the general price of cotton between the time of purchase and sale of the actual cotton is eliminated. On the subsequent sale or purchase of the actual cotton the relative hedging contract is nearly always closed out by the merchant.
(e) Future delivery contracts are dealt in on the Liverpool, New York and New Orleans cotton markets. Under the Rules of the Liverpool Cotton Association, of which the Respondent was a member, there is a provision that where purchases and sales are made between the same members of the Association for the same quantity of cotton for delivery in the same month, the contracts are closed out, and the transaction is concluded by the receipt or payment of differences. The vast majority of future delivery contracts are closed out in this way, both in Liverpool, New York and New Orleans.
(f) Besides the ordinary future delivery contracts, the Respondent's firm from time to time entered into the operation known as a straddle, which consists of entering into a future delivery purchase contract in Liverpool and a future delivery sale contract for the same amount of cotton in New York or New Orleans, or vice versa. When actual cotton was bought or sold one side of the straddle would be closed, leaving the firm with the other side of the straddle as a hedge against the actual cotton. Straddles were entered into in anticipation of subsequent transactions in actual cotton, and in some cases these straddles would be closed without any actual cotton being bought. While a complete hedge against fluctuations in the price of cotton could be effected by the ordinary future delivery contract, the straddle was useful in the import business as a protection against fluctuations in the rate of exchange and in the cost of shipping actual cotton.
(g) The firm varied their hedges frequently in consequence of fluctuations in the market: for instance, they altered a future delivery contract for one month into a future delivery contract for another month, or they sold future delivery contracts in Liverpool and bought corresponding future delivery contracts in New York or New Orleans if they thought that the course of business would make the alteration advantageous.
(h) In accordance with a common custom among cotton merchants, the firm employed an arrivals salesman to transact on the Exchange the future delivery contract business of the firm. In addition to the future delivery contracts necessary to the firm or their clients for hedging which were bought or sold on the instructions of the firm, the arrivals salesman was allowed to deal on his own initiative in future delivery contracts not required for hedging. This dealing was entered into not so much with the object of profit, as with the object of enabling the arrivals salesman to keep in touch with the futures market. All these deals were closed out at the end of the day, so that no great risk of loss was involved. It is the common practice of cotton merchants to authorise their arrivals salesman to enter into such deals. The arrivals salesman received 30 per cent. of the profits on these deals, the balance going to the firm, who bore any losses. The average number of these transactions is between 1000 and 1100 a year. The firm's profits or losses on these transactions were included in the accounts of their business.
5. We were satisfied that the Respondent's firm entered into future delivery contracts including the straddles, as a protection or hedge against their transactions in actual cotton, that these contracts formed a legitimate and in fact an essential part of their business of cotton merchants, and that the speculative deals entered into by the arrivals salesman were ancillary to this business.
6. Future delivery contracts are also entered into by members of the Liverpool Cotton Association and others, not as hedges to transactions in actual cotton, but purely as speculative transactions, with a view to making a profit on the rise or fall, as the case may be, in the market price of these contracts. Future delivery contracts entered into with this object are always closed out by entering into a similar contra contract as described in paragraph 4 (d), differences being received or paid. The profit or loss on the transaction is then ascertained. This form of transaction constitutes in our opinion nothing more or less than gambling in differences.
7. During the material years the Respondent entered into speculative transactions on his own behalf in future delivery contracts without any intention of taking up actual cotton, or of using the contracts as hedges for actual...
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