Substance, Form and Equity in Taxation and Accounting
| DOI | http://doi.org/10.1111/j.1468-2230.1991.tb01853.x |
| Date | 01 November 1991 |
| Published date | 01 November 1991 |
| Author | Graeme Macdonald |
Substance,
Form
and Equity in Taxation and Accounting
Graeme Macdonald
*
Introduction
Both taxation and accounting are concerned with economic transactions; both have
had to face the argument that within
their
respective domains transactions should
be analysed according
to
their ‘economic substance’ rather than their legal form.
Within the
UK
tax system the law has eschewed that doctrine until very recently,
but
in
the world of accounting it seems
to
have been embraced as
a
principle, concept
or consideration underlying accounting practice. Whether this represents a
contradiction between the practices of taxation and accounting, between lawyers
and accountants, or whether the issue is different in the two contexts, notwithstanding
the use of the same terminology,
is
considered here.
In
their professional domain
accountants have encompassed both taxation and accounting to such an extent that
it
would not be surprising
if
there was an idea shift from one
to
other. However,
like many such shifts
it
may not be wholly appropriate, or the idea itself may need
further explication.
In
particular there is the danger that substance over form is seen as a peculiarly
legal doctrine, whereas
it
will
be argued that
it
is
a general issue potentially applicable
wherever there is a rule governed activity. That being
so,
substance is not something
to
be determined exclusively by reference to legal, or for that matter economic,
characteristics; it is something which derives from the perspective of the activity
under consideration.
As
an idea, substance over form can be discussed
in
a quite
neutral sense; but its application
will
always depend on the context. Substance is
to be understood
in
the context of prior definitions or norms;
it
is not determinative
of those definitions or norms. In that sense
it
is a second order issue. Substance
over form
is
therefore not regarded here as a fundamental accounting paradigm
which can determine accounting outputs.
This paper suggests, using taxation as an example, that the doctrine of substance
over form has more than one meaning; at one level it is a legal doctrine of
construction, (or
in
more general terms it is a question of
categoridon);
at another
it
is an
equitable
concept employed by those charged with administering generalised
rules
in
a hostile environment. Taxation is a rule-governed activity; tax law represents
the
rules
by which tax policy is administered. By contrast, accounting has not always
been a rule-governed activity.
It
has been practised and only relatively recently has
that practice been regulated, latterly through accounting standards. These standards,
or rules, seek
to
administer the activity which is accounting, but they are grounded
in
an extant practice.
In
essence they seek
to
codify that practice by formalising
the consensus on best practice as rules; and they seek
to
do
so
in
an increasingly
internally
consistent way. To that end attempts have been made (notably
in
the
US)
to
formulate a conceptual framework
-
a conceptual base
to
underpin the specific
rules of individual standards.
In
so
doing, consistency
with
fundamental concepts
may
in
fact require a change
in
the detail of practice or existing standards.
It
will
be argued that the doctrine of substance over form
in
accounting has two
facets broadly similar
to
those at issue
in
taxation. One is the question of
categorisation,
the other
is
the
equitable
application of accounting rules. The problem
~~~ ~~
*Dcpartnicnt
of
Accounting
and
Finance. University
of
Kcnt.
830
Tlrc
Moclerti
Ltrw
Review
54:6
Novclnbcr
1991 0026-7961
November
I99
1
1
Subsicitice,
Fortn
arid
Equity
in
Tnscrtioti
otid
Accounting
which the issue of substance and form highlights
in
both spheres is that the two
activities
-
taxation and accounting
-
operate within and by reference
to
the existing
system of classification given by general law. Where this hinders the implementation
of tax policy then tax rules are changed
in
order to achieve the policy objective.
Similarly accountants propose
their
own rules for accounting for specific transactions
in
accordance with their perceived objective of accounting. Even then,
with
each
activity having its
own
peculiar rules, the problem of resolving ‘hard cases’ arising
from the necessarily general nature of rules still persists. As noted above, tax
administration through the legal system has long eschewed any
equitable
solution,
although, as
will
be seen, it has recently accepted
it
within self-imposed constraints.
By contrast
it
will
be argued that accounting practice has long permitted
equitable
solutions and even
with
the advent of regulation still retains that position.
Taxation
The argument over substance or form
in
tax law has arisen
in
two distinct ways:
the first
in
construing the nature
of
a
transaction, the second
in
deciding how a
transaction should have the tax rules applied
to
it.
Each approach involves different
propositions. The first, referred
to
here as the legal proposition, argues that
in
ascertaining the character of a transaction regard is to be had to what is
in
fact done
rather than
to
the label or nomenclature given
to
what
is
done. The second, the
equitable proposition, suggests that
in
taxing a transaction regard is
to
be had to
the economic effect of what has been done and tax levied by analogy
to
the tax
treatment
of
similar economic effects realised through different transactions.
Both propositions are apparent
in
the celebrated case of
Duke
of
Westtninster
v
Cornmissioners
of
Inland Revenue.‘
The significance of that case is that the two
propositions are distinguished with the legal being accepted and the equitable being
rejected. Finlay
J
had upheld the Commissioners and decided that ‘looking, not
at the form, but at the substance
of
the thing’* the receipts under deeds of covenant
were,
in
the case of servants still employed,
to
be regarded as wages.
In
so
doing
he had referred
to
a
Court of Appeal decision which had approved the proposition
that ‘the Court
will
in
each case look at
the
real nature of the transaction, whatever
may be the form
in
which
it
is expressed.’3 This decision itself followed one from
the House of Lords
in
which the Lord Chancellor had said:
looking
at
the whole nature and substance
of
the transcation (and
it
is
agreed on all sides
that we must
look
at the nature
of
the transaction
and
not
be
boutrd
by
the
mere
use
of
words)
I
cannot doubt
.
.
.
that what
is
called
an annuity in the contract
.
.
.
wcls
a
ttiodc
of
the payments
for
. .
.
a debt
to
be paid. (Emphasis added)“
The contradistinction between what is done and the label given to
it
is clearly the
issue here.
In
the
Westminster
case
the
Court
of
Appeal rejected Finlay J’s decision and
accepted the argument of Mr Wilfrid Greene that ‘when you have looked at the
whole
of
the
substance, you are still
to
look
at
it
from the point
of
view of the law
and see what
the
effect
is
as a legal relation.’5 The judge had erred
in
that he had
I
19
TC 490.
3
Pcwirr
v
Dicksorr.
14 TC
608.
626.
2
p50l.
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