Herbert Smith (A Firm) v Honour (Inspector of Taxes)
| Jurisdiction | England & Wales |
| Judgment Date | 12 February 1999 |
| Date | 12 February 1999 |
| Court | Chancery Division |
Chancery Division.
Lloyd J.
Edward Walker-Arnott, senior partner, Herbert Smith, for the taxpayer.
Nicholas Warren QC and Rabinder Singh (instructed by the Solicitor of Inland Revenue) for the Crown.
The following cases were referred to in the judgment:
BSC Footwear Ltd v Ridgway (HMIT) ELRTAX[1972] AC 544; 47 TC 495
ECC Quarries Ltd v Watkis (HMIT) WLR[1977] 1 WLR 1386
Edward Collins & Sons Ltd v IR Commrs TAX(1924) 12 TC 773
Gallagher v Jones (HMIT); Threlfall v Jones (HMIT) TAXELR[1993] BTC 310; [1994] Ch 107
IR Commrs v Gardner Mountain & d'Ambrumenil Ltd TAX(1947) 29 TC 69
Johnston (HMIT) v Britannia Airways Ltd TAXTAX[1994] BTC 298; 67 TC 99
Minister of National Revenue v Anaconda American Brass LtdELR[1956] AC 85
Odeon Associated Theatres Ltd v Jones (HMIT) WLRTAX[1971] 1 WLR 442; 48 TC 257
Owen (HMIT) v Southern Railway of Peru Ltd ELRTAX[1957] AC 334; 36 TC 602
Whimster & Co v IR Commrs TAX(1925) 12 TC 813
Willingale (HMIT) v International Commercial Bank Ltd ELR[1978] AC 834
This was an appeal by a firm of solicitors against a decision of the special commissioners upholding the Revenue's refusal to allow provision to be made in the firm's accounts for tax purposes for rent which would have to be paid in the future in respect of premises which it planned to vacate and which it was unable to dispose of to its advantage.
Until December 1990 the solicitors, Herbert Smith ("the firm") occupied premises in four locations ("the old premises"). On 26 January 1990 a contract which the firm had entered into for a lease of new premises in a single location ("the new premises") became unconditional and the lease of the new premises was entered into on that day. The whole of the firm's operation was transferred to the new premises by 1 January 1991.
The accounts for the year to 30 April 1990 ("the basis period") were prepared on the basis that it would not be possible to sublet the whole of two out of the four old premises at rents sufficient to cover outgoings. The firm's lease of one was not due to expire until 2008 and had upward-only rent reviews in 1993, 1998 and 2003. The lease of the other was due to expire in 1992. No rent was due in respect of the two remaining leases after the buildings were vacated and £750,000 was received on the disposal of the lease of one of them. No separate cash fund was set aside for the purpose of covering the liability for the excess rents.
The firm contended that the accounts had been drawn up on a true and fair basis in accordance with prevailing accountancy practice and the inspector was bound to accept a tax computation based on them.
The fundamental accounting principles applicable here were set out in a Statement of Accounting Practice ("SSAP2") issued in 1971 by the then Accountancy Standards Committee, in particular, the "accruals" or "matching" concept which required revenue and associated costs to be dealt with in the same accounts and the "prudence" concept, which required provision for all known liabilities (expenses and losses), either known with certainty or estimated in the light of the information available.
The special commissioners took the view that the expert evidence disclosed no unanimity among accountants as to the correct form of accounts. They decided that revenue and costs had to be matched when earned or incurred. While the making of provision accorded with the fundamental principle of prudence, that principle did not overcome the principle developed in the authorities that where commercial accounts anticipated a loss, those accounts were not conclusive for tax purposes. The special commissioners held that the future rents should have been charged as they fell due against the firm's income in periods starting with the date of the move.
The Revenue contended that there was a rule of tax law that neither profits nor losses could be anticipated and that, if on their true analysis, the accounts prepared in accordance with accepted principles of commercial accounting involved such anticipation, they could not be used for tax purposes but had to give way to a calculation eliminating anticipation.
Held, allowing the firm's appeal:
1. There was no rule of law that expenses or losses could not be anticipated. Such a rule would be inconsistent with the generally accepted principles of commercial accounting in very many cases, since it would disallow any provision made in accordance with the principle of prudence.
2. Having found that the evidence showed that the making of provision for excess rents in future years was required by generally accepted principles of commercial accounting as a matter of prudence, the special commissioners' conclusion that the accounts should not be accepted for tax purposes was not justified: Gallagher v Jones (HMIT); Threlfall v Jones (HMIT) TAX[1993] BTC 310distinguished.
By originating motion pursuant to the Taxes Management Act 1970 section 56ATaxes Management Act 1970, s. 56A (as substituted by SI 1994/1813 with effect from 1 September 1994), the taxpayer appealed to the High Court against the following decision of the special commissioners (Mr PMF Horsfield QC and Mr Theodore Wallace, sitting in private) released on 16 September 1997.
1.1 The appellants, a well-known firm of solicitors ("the firm"), claim that they are entitled, in calculating their profit for tax purposes in respect of the accounting period of 12 months to 30 April 1990 ("the basis period"), to charge against their receipts for the basis period the whole of a provision made in their accounts in respect of certain rents payable by the firm in subsequent years. The Revenue take the view that the whole of the provision for future rent cannot be treated as a charge in the basis period and have raised two assessments based on this view which are subject to this appeal.
1.2 The principal facts giving rise to the appeal are set out in a statement of agreed facts and can be shortly summarised as follows:
(2) Until December 1990 the firm occupied premises in four locations ("the old premises").
(3) On 26 January 1990 (during the basis period) a contract which the firm had entered into for a lease of new premises in a single location ("the new premises") became unconditional and the lease of the new premises was entered into on that day. The intention was to transfer the whole of the firm's operation to the new premises and there was no intention to re-occupy the old premises. The transfer to the new premises was complete by 1 January 1991.
(4) The accounts for the basis period were prepared on the basis that it would not be possible to sublet the whole of two out of the four old premises at rents sufficient to cover outgoings. The leases of these two premises ("OP1" and "OP2") were onerous in the context of the 1990 letting market. The firm's lease of OP1 was not due to expire until 2008 and had upward-only rent reviews in 1993, 1998 and 2003. The lease of OP2 was due to expire in 1992. No rent was due in respect of OP3 and OP4 after the buildings were vacated and £750,000 was received on the disposal of the lease of OP3. A schedule of the relevant leases was attached to the statement of agreed facts.
(5) Note 9 to the firm's accounts for the basis period shows a net sum of £4,761,258 (being the total provision against future rents of the old premises of £5,511,258 less the £750,000 received for OP3) as being charged against profits. The sum of £5,511,258 was the excess of future rents etc. payable in respect of the old premises over the estimate of the future rents receivable in respect of the old premises (the "excess rentals").
(6) No separate cash fund was established by the firm for the purpose of settling the liability for excess rentals.
(7) In the event, the assumptions as to the timing and quantum of rentals to be received from the old premises made in calculating the excess rentals proved to be over-optimistic. It was assumed that by the end of 1992-93 the whole of OP1 would be let, yielding, as regards the basement, £90,000 per annum and, as regards the rest of the building, £1,691,950 per annum. In the event lettings were not achieved at these levels and further substantive charges were made in the accounts in subsequent years.
(8) A chronology produced at the hearing and not disputed indicates that, although the provision in the accounts for the basis period was calculated as from 31 December 1990 (i.e. from the date on which relocation of the firm's operations was completed), the valuer's letters quantifying the provision were dated 8 February 1991. The accounts were approved on 22 May 1991.
1.3 The statement of agreed facts was enlarged in the following material respects by evidence in chief (which we accept) given by Mr J D Mullins, a chartered accountant, who is the firm's head of finance and administration.
(2) The firm's management committee made the decision to move to the new premises in the autumn of 1989.
(3) Contracts for the lease of the new premises were exchanged at Christmas 1989.
(4) At the time when the decision to move was made, it was anticipated that the old premises would be let on terms which would involve no loss and that a larger premium could be obtained on OP3.
(5) The property market "dived" in 1990 and by the summer of 1990 it was apparent that the market was "sticky".
(6) Mr Mullins also confirmed that since 1979 the firm had had its accounts audited on a "true and fair" basis.
2.1 The documentary evidence in the case consists of a bundle of correspondence and internal memoranda provided by the firm by way of agreed discovery and a statement of expert accountancy evidence from Mr P J Oliver, a recently retired partner of Deloitte and Touche, with supporting appendices. Only a small number of the documents in the bundle were relied on by the parties and these were put to Mr Mullins in cross...
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