House of Lords
Published April 2, 2007
Commissioners of Revenue and Customs v William Grant and Sons Distillers Ltd
Small (Inspector of Taxes) v Mars UK Ltd
Before Lord Hoffmann, Lord Hope of Craighead, Lord Walker of Gestingthorpe,
Lord Mance and Lord Neuberger of Abbotsbury
Speeches March 28, 2007
Taxpayer companies that had carried forward that part of the depreciation in
fixed assets that related to production of unsold stocks as part of the cost
of unsold stocks had not infringed the prohibition in section 74(1)(f) of
the Income and Corporation Taxes Act 1988, as renumbered by section 144(2)
of the Finance Act 1994, of deductions for the depreciation of capital
assets.
The House of Lords allowed appeals by the companies, William Grant and Sons
Distillers Ltd and Mars UK Ltd, respectively, from an Extra Division of the
Court of Session (Lord Penrose and Lord Osborne, Lord Reed dissenting) (2005
SLT 888) and Mr Justice Lightman ( The Times May 11, 2005; [2005]
STC 958), each allowing appeals by the Commissioners of Revenue and Customs
against decisions of special commissioners in favour of the companies. Mr
Colin Tyre, QC, of the Scots Bar, and Mr Graham Aaronson, QC,
for William Grant; Mr Colin Campbell, QC, of the Scots Bar, Miss
Jane Paterson, of the Scots Bar, and Mr Rupert Baldry for the
commissioners.
Mr Graham Aaronson, QC, for Mars; Mr David Milne, QC and Mr
Rupert Baldry for the commissioners.
LORD HOFFMANN said that the method of computing trading profits for the
purposes of income and corporation tax had been settled for many years.
First, you computed the profits on a basis that gave a true and fair view of
the profits or losses in the relevant period. Then you made any adjustments
expressly required for tax purposes, such as adding back deductions that the
taxing statute forbade.
The method was now codified in section 42(1) of the 1998 Act: “For the
purposes of Case I or II of Schedule D the profits of a trade, profession or
vocation must be computed on an accounting basis which gives a true and fair
view, subject to any adjustment required or authorised by law in computing
profits for those purposes.”
Although the requirement that the initial computation should give a true and
fair view involved the application of a legal standard, the courts were
guided as to its content by the expert opinions of accountants as to what
the best current accounting practice required.
The experts would in turn by guided by authoritative statements of accounting
practice issued or adopted by the Accounting Standards Board: see section
256 of and paragraph 36A or Schedule 4 to the 1985 Act, as amended by
section 4(2) of, and paragraph 7 of Schedule 1 to the Companies Act 1989.
The dispute in the appeals concerned the computation of the trading profits of
Mars, which made confectionery and pet food, and William Grant, which made
whisky, in the years ending December 28, 1996 and December 28, 2002
respectively.
There was no dispute that the profits stated in their accounts had been
computed on a basis that gave a true and fair view. In each case, in
accordance with current accounting standards, deductions had been made for
the depreciation of fixed assets.
But section 74(1)(f) of the Income and Corporation Taxes Act 1988 provided
that in computing profits for tax purposes no sum should be deducted in
respect of “any sum employed or intended to be employed as capital in ...
the trade”.
Although the language was not clear, that had always been taken to prohibit
deductions for the depreciation of capital assets. Any sum that had been
deducted for depreciation in the computation of profits had therefore to be
added back. The question was to identify which sums had been so deducted.
Statement of Standard Accounting Practice 9 (1975) demonstrated that, when
paragraph 77 of Financial Reporting Standard 15 laid down a general
requirement that the year’s depreciation shown in the balance sheet should
be deducted in that year’s profit and loss account but made an exception for
a case in which depreciation was “permitted to be included in the carrying
amount of another asset”, that was intended to include carrying forward an
appropriate part of the depreciation as part of the cost of stocks, to be
deducted as and when the stocks were sold in a future year.
Mars and William Grant had prepared their accounts in accordance with the
relevant standards. They had divided the depreciation that had occurred
during the year or was carried in the opening stock figure into two parts:
one the depreciation in fixed assets that related to the production of goods
sold during the year or in assets that were not used for production at all
(A), the other the depreciation in fixed assets that related to production
of unsold stocks (B). They had deducted A from the year’s revenue and
carried B forward as part of the cost of unsold stocks.
Thus the William Grant profit and loss account had shown “Turnover” of
£137,512,000 and “Cost of Sales” of £99,340,000. The latter figure did not
include B. Note 4 to the accounts said that operating profit was stated
“after charging depreciation”. It gave the figure for total depreciation (A
and B) and deducted the figure for depreciation “included within stock” (B).
So far, there was no dispute. The accountants on both sides agreed that that
was the way the computations had been made and that the resulting statement
of profits was in accordance with the standards and gave a true and fair
view.
On those admitted facts, his Lordship should have thought that it was plain
and obvious that as only A had been deducted section 74(1)(f) did not
require B to be added back.
The Revenue, however, submitted that, whatever the methodology described by
the standards might be, the taxpayers had to be deemed to have deducted both
A and B and then added a sum equal to B back into profits in some other
character that did not affect the deduction in respect of depreciation.
A deduction of anything less than the entire depreciation in the year was
contrary to some fundamental principle of accounting or to the requirements
of the 1985 Act.
Submissions that accounts had to comply with fundamental principles of
accounting additional to the best practice of accountants had been made in
other cases and always rejected: see Odeon Associated Theatres Ltd v
Jones ([1971] 1 WLR 442) and Gallagher v Jones ([1994] Ch 107).
In the present case, the submission took the form of saying that profits had
to be ascertained by taking all the revenue received during the year,
deducting all the costs, including depreciation, incurred during the year
and making an adjustment for the difference between opening and closing
stocks, treating an increase in stock value as if it were revenue.
That was certainly one way of computing profits, and there were dicta in
earlier cases that showed that formerly judges and accountants had thought
that it was the normal and obvious way.
It might have been the only practical method when record-keeping had not been
sufficiently sophisticated to enable one to make a meaningful attribution of
costs in one year to sales in some future year.
It was not, however, the philosophy of SSAP 9, which permitted the cost of
unsold stock to be carried over into future years and set against future
sales. In that exercise, relevant depreciation was simply another cost.
The Revenue said that treating depreciation carried in stock as a cost
excluded from the current year’s computation and held back for a future
year’s computation was a category mistake. Stock was an asset that had a
value and could not be a cost.
But that seemed to his Lordship to confuse the role of stock in a balance
sheet with its role in a profit and loss account. The balance sheet was a
statement of assets and liabilities on a given date, and in that statement
stock was indeed one of the assets.
The profit and loss account, on the other hand, was concerned with revenue and
costs, and in that context, the figure for stock represented a cost that
SSAP 9 required to be kept out of the computation of profit for the year but
recorded to be carried over into the computation for a future year.
The Revenue relied on Commissioner of Inland Revenue v Secan Ltd
((2000) 74 TC 1), where Lord Millett, sitting as a judge of the Court of
Final Appeal in Hong Kong, had given a judgment with which the other members
of the court had agreed, as deciding that when a cost item like interest or
depreciation was carried forward as part of the value of stock or work in
progress it had nevertheless in some sense been deducted in the year in
which the cost had been incurred.
That seemed to his Lordship an impermissible and confusing mixture of two
different systems of computation.
There was nothing in paragraph 1(1)(b), and note (14) to Format 1, or
paragraph 18 of Schedule 4 to the 1985 Act that prevented depreciation, or
any other cost, being deducted in a subsequent year if that was calculated
to give a true and fair view of the profits.
Obviously, any reduction in balance sheet value for depreciation had at some
time to be reflected in a profit and loss account deduction, but there was
nothing to say that they had to coincide. That was not surprising when
section 226 made it clear that the overall requirement was that the accounts
should give a true and fair view.
Mr Justice Lightman and the majority of the Extra Division had been wrong to
hold that B should have been added back, and his Lordship agreed with the
lucid dissenting opinion of Lord Reed.
Lord Hope delivered an opinion agreeing with Lord Hoffmann and Lord Walker,
Lord Mance and Lord Neuberger agreed.
Solicitors: Dorsey & Whitney for McGrigors, Edinburgh; Solicitor,
Revenue and Customs, Edinburgh. Dorsey & Whitney; Solicitor,
Revenue and Customs.
