HM Revenue and Customs v William Grant and Sons Distillers Ltd; Small (Inspector of Taxes) v Mars UK Ltd
| Jurisdiction | England & Wales |
| Judgment Date | 08 March 2004 |
| Date | 08 March 2004 |
| Court | Special Commissioners |
special commissioners decision
Dr Nuala Brice & John Walters QC
Graham Aaronson QC, instructed by Messrs Dorsey & Whitney Solicitors, for both Appellants
David Milne QC and Rupert Baldry, instructed by the Solicitor of Inland Revenue, for both Respondents
CORPORATION TAX - treatment of depreciation in stock - in preparing the financial statements gross depreciation was shown and then reduced by the amount of depreciation in stock leaving net depreciation - net depreciation was deducted in arriving at the accounting profits and depreciation in stock was capitalised - when adjusting the accounting profits for tax purposes only net depreciation was added back; the depreciation in stock was carried forward and deducted from profits in the year in which the stock was sold - the Inland Revenue argued that in each year the gross depreciation should be added back for tax purposes - whether, in making the tax adjustments to the accounting profits, gross depreciation should be added back - no - or whether net depreciation should be added back with the depreciation in stock being added back in the year in which the stock was sold - yes - appeal allowed - Income and Corporation Taxes Act 1988 section 74TA 1988 s 74(1)(f)
1. Mars UK Limited (Mars) appeals against part of an assessment for the year ended 28 December 1996. The disputed amount is £1,969,335.76 and was assessed because the Inland Revenue were of the view that cumulative depreciation in stock up to 31 December 1996 should be brought within the charge to tax for that year.
2. William Grant & Sons Distillers Limited (William Grant) refers a question to the Special Commissioners for determination in connection with the subject matter of an enquiry into their return for the year ended 28 December 2002. The question is whether, for the purposes of corporation tax, the gross amount of depreciation is required to be added back in arriving at taxable profits or whether only the net amount (after adjusting for depreciation included in opening and closing stock) is to be disallowed.
3. We were informed that these appeals were in the nature of test cases and that there were thirteen other companies with similar issues.
4. Section 74 of the Income and Corporation Taxes Act 1988 (the 1988 Act) provides:
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74 General rules as to deductions not allowable
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(1) Subject to the provisions of the Tax Acts, in computing the amount of the profits to be charged under Case I or Case II of Schedule D, no sum shall be deducted in respect of- …
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(f) … any sum employed or intended to be employed as capital in, the trade .... .
5. As from 6 April 1999 section 42 of the Finance Act 1998 (the 1998 Act) provided:
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42 Computation of profits of trade, profession or vocation
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(1) For the purposes of Case I or Case II of Schedule D the profits of a trade … must be computed in accordance with generally accepted accountancy practice, subject to any adjustment required or authorised by law in computing profits for those purposes. …
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(3) This section applies to periods of account beginning after 6 April 1999.
6. For completeness we set out the charging provision relative to Case I of Schedule D (part of section 18 of the 1988 Act):
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18 Schedule D
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(1) The Schedule referred to as Schedule D is as follows-
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SCHEDULE D
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Tax under this Schedule shall be charged in respect of -
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(a) the annual profits or gains arising or accruing-
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(i) to any person residing in the United Kingdom from any kind of property whatever …
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(2) Tax under Schedule D shall be charged under the Cases set out in subsection (3) below, and subject to and in accordance with the provisions of the Tax Acts applicable to those Cases respectively.
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(3) The Cases are- Case I: tax in respect of any trade carried on in the United Kingdom or elsewhere …
7. We have adopted three definitions agreed by the expert witnesses. "Gross depreciation" is the gross amount of the charge for depreciation calculated for the year on fixed assets. "Depreciation in stock" is that element of depreciation on fixed assets that is included in the carrying amount (or value) of unsold trading stock in a company's balance sheet at the end of the year. "Net depreciation" is the gross depreciation charge after adjustment for depreciation in stock.
8. In preparing their financial statements both Appellants included in the cost of unsold trading stock the overhead costs incurred in producing the trading stock. At the end of the year depreciation on manufacturing fixed assets was treated as an overhead cost, capitalised and included in the carrying value (i.e. the balance sheet value) of closing stock and carried forward to the next year. The gross depreciation was debited in the profit and loss account followed by a simultaneous credit to the profit and loss account to adjust for the capitalisation of the depreciation in stock. The other side of the double entry dealing with this adjustment was a debit to the carrying value of closing stock (thereby increasing that carrying value by the amount of depreciation in stock). The amount of the final accounting profits was calculated by deducting net depreciation and not gross depreciation.
9. Because section 74(1)(f) of the 1988 Act prohibits, for tax purposes, the deduction of sums employed as capital in the trade, and because depreciation in respect of fixed assets is a deduction in respect of capital, the accounting profits shown in any trader's profit and loss account (although they are computed in accordance with generally accepted accounting practice) have to be adjusted for tax purposes by cancelling the deduction for depreciation. This cancelling is known as "adding back". In preparing their tax computations the Appellants added back the amount of net depreciation but did not add back the amount of depreciation in stock; depreciation in stock was carried forward and effectively added back in the year when the stock was sold.
10. The Inland Revenue accepted that both Mars and William Grant had computed their accounting profits in accordance with generally accepted accounting practice. However, they argued that gross depreciation, including depreciation in stock, had been deducted in the accounting period and so should be added back in the accounting period. The Appellants argued that the depreciation in stock had not been deducted from the accounting profits and so it was wrong to require it to be added back to the accounting profits for tax purposes.
11. Thus the issue for determination in the appeals was whether the amount representing depreciation in stock should be added back in the accounting period.
12. Oral evidence was given on behalf of Mars by Mr Richard Collier-Keywood, the Head of Tax at PricewaterhouseCoopers LLP (PricewaterhouseCoopers) who advised Mars. A witness statement by Ms Linda Bacon, a Financial Controller and later Finance Director of Mars, containing evidence on behalf of Mars, was not objected to by the Respondents and so was admitted in evidence at the hearing. Oral evidence was given on behalf of William Grant by Mr Ewan Henderson, the Group Tax and Finance Manager of William Grant.
13. Expert evidence on behalf of both Appellants was given by Mr Peter Holgate. Mr Holgate is a Fellow of the Institute of Chartered Accountants; a member of the Accounting Standards Board's Urgent Issues Task Force; a member of the Financial Reporting Committee and Research Board of the Institute of Chartered Accountants of England and Wales; and a member of the International Accounting Committee of the Consultative Committee of Accountancy Bodies. Between 1984 and 1986 he was the Secretary of the United Kingdom Accounting Standards Committee which set accounting standards including SSAP 9 and SSAP 12. Mr Holgate heads the United Kingdom Technical Department at PricewaterhouseCoopers which department is principally concerned with advising the firm and its clients on technical accounting matters.
14. Expert evidence on behalf of the Inland Revenue was given by Mr Thomas Charles Carne, the Advisory Accountant to the Board of Inland Revenue. Mr Carne is a Chartered Accountant and spent nine years in private practice and industry before joining the Inland Revenue in 1978. He then spent seven years as an Accountancy Advisor/Investigator in Enquiry Branch after which he took up the position of Accountancy Advisor to International Division. He spent six years there before taking up his present position.
15. After both experts had prepared their reports they met on 20 November 2003 to discuss their areas of agreement and disagreement. They then produced a joint report dated 4 December 2003 which was also before us.
16. From the evidence before us we find the following facts.
Mars
17. Mars is a subsidiary of Mars Incorporated (Mars Inc), a United States company. Mars Inc determines the worldwide policy for group activities and local management implements those policies. Mars manufactures and sells food for human consumption (especially confectionery) and pet food. The internal structure of Mars consists of a number of units which operate independently of each other although all activities are reported as a single business for statutory reporting purposes.
Mars - financial reporting
18. The financial reporting procedures followed by each unit are described in the Mars Finance Manual (the Manual) which all units in all territories must follow. The Manual recognises that Mars Inc is privately owned but nonetheless requires that United States Generally Accepted Accounting Procedures (US GAAP) are followed. All levels of the organisation must conduct their financial activities according to properly approved and written policies and...
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