PROFIT AND a man is engaged in business, his profits for the year are the excess of his receipts from his business during the year over his outlay for his business ; the difference between the value of his stock and plant at the end and at the beginning of the year being taken as part of his receipts or as part of his outlay, according as there has been an increase or decrease of value. Such is the definition of profits as given by Professor Marshall in his Principles of Economics. It cannot, however, be adopted in its entirety, when considered from the legal point of view, in respect of the profits of companies. This was decided by Mr. Justice Farwell in Bond v. Barrow Hematite Steel Co., who in that case quotes and considers the definition. The learned judge gives as a reason for not adopting the definition the fact that the phrase therein, " stock and plant," includes both fixed and circulating capital—fixed capital being that " which exists in a durable shape and the return to which is spread over a period of correspond ing duration ;" circulating capital being that " which fulfils the whole of its office in the production in which it is engaged, by a single use." All the legal authorities agree, in the opinion of Mr. Justice Farwell, " that circulat ing capital must be kept up." On the other hand, according to Lord Justice Lindley, in Venzer v. General and Commercial Investment Trust, fixed capttal may be sunk and lost and yet the excess of current receipts over current payments may be divided. [See CAPITAL.] A depreciation in circulating capital must therefore be made good before the balance can be arrived at which is intended to represent profit, and out of which the dividends will be paid. Nevertheless, " there is no hard and fast legal rule on the subject," said the Master of the Rolls in In re National Bank of Wales ; "it may be safely said that what losses can be properly charged to capital, and what to income, is a matter for business men to determine, and it is often a matter on which the opinions of honest and competent men will differ." It is expressly provided in the Companies Acts that dividends shall not be paid out of capital, but this does not mean that capital, if lost, must be made up. A company may carry any balance it has to the credit of its profit and loss account to a suspense account or to reserve, and if the assets subsequently increase in value the amount neither has been nor will be part of the capital (Bond v. Barrow Hematite Steel Co.), and so may ultimately be distri buted as profit. According to Lee v. Neuchatel Asphalte Co., there is nothing in the Companies Acts to require a company to keep the value of its capital assets up to the level of its nominal capital, provided that dividends are only paid out of profits and not out of capital. This does not mean, however, that no company whatever which owns wasting property, such as a mine or patent, need ever create a depreciation fund. If the company was primarily formed to work that property, then undoubtedly, as a general rule, it need not set apart a sinking fund to meet the depreciation. On the other
hand, it would doubtless be improper for a company to purchase out of capital the last two or three years of a valuable patent for example, and to distribute the whole of the receipts in respect thereof as profits without replacing the capital expended in the purchase. But whether or no, in a particular case, a sinking fund should be established is a question which the Court will decide only upon the facts of that case. If, however, the general capital property of a company should rise in value, that increased value cannot lawfully be treated as a profit and made available as a fund for dividends (Salisbury v. Metropolitan Rail. Co.).
This question of profits came before the Court in a case (Davison v. Gillies) wherein it was claimed that a tramway company was improperly paying dividends before repairs had been provided for. The Master of the Rolls having decided that profits in connection with that case meant "net" profits, proceeded as follows : " What are net profits ? A tramway company lays down a new tramway. Of course the ordinary wear and tear of the rails and sleepers, and so on, causes a sum of money to be required from year to year in repairs. It may or may not be desirable to do the repairs all at once ; but if at the end of the first year the line of tramway is still in so good a state of repair that it requires nothing to be laid out on it for repairs in that year, still, before you can ascertain the net profits, a sum of money ought to be set aside as representing the amount in which the wear and tear of the line has, I may say, so far depreciated it in value as that that sum will be required for the next year or the next two years. Take the case of a warehouse. Supposing a warehouse-keeper, having a new warehouse, should find at the end of the year that he had no occasion to expend money in repairs, but thought that, by reason of the usual wear and tear of the warehouse, it was 131000 worse than it was at the beginning of the year, he should set aside X1000 for a repair or renewal or depreciation fund before he estimated any profits ; because, although that sum is not required to be paid in that year, still it is the sum of money which is lost, so to say, out of capital, and which must be replaced. I should think no commercial man would doubt this is the right course—that he must not calculate net profits until he has provided for all the ordinary repairs and wear and tear occasioned by his business. In many businesses there is a regular sum or proportion of some kind set aside for this purpose. Shipowners, I believe, generally reckon so much a year for depreciation of a ship as it gets older. Experience tells them how much they ought to set aside; and whether the ship is repaired in one year or another makes no difference in estimating the profits, because they know a certain sum must be set aside each year to meet the extra repairs of the ship as it becomes older. There are very many other businesses in which the same thing is done."