HM Revenue and Customs v William Grant & Sons Distillers Ltd Small (HM Inspector of Taxes v Mars UK Ltd
| Jurisdiction | UK Non-devolved |
| Judge | LORD HOFFMANN,LORD MANCE,LORD NEUBERGER OF ABBOTSBURY,LORD HOPE OF CRAIGHEAD,LORD WALKER OF GESTINGTHORPE |
| Judgment Date | 28 March 2007 |
| Neutral Citation | [2007] UKHL 15 |
| Date | 28 March 2007 |
| Docket Number | No 6 |
| Court | House of Lords |
[2007] UKHL 15
Appellate Committee
Lord Hoffmann
Lord Hope of Craighead
Lord Walker of Gestingthorpe
Lord Mance
Lord Neuberger of Abbotsbury
HOUSE OF LORDS
Appellants:
William Grant & Sons
Colin Tyre QC
Graham Aaronson QC
(Instructed by McGrigors, Edinburgh)
Mars UK Limited
Graham Aaronson QC
(Instructed by Dorsey & Whitney)
Respondents:
HM Revenue & Customs
Colin Campbell QC
Miss Jane Paterson
(Instructed by Solicitor to HM Revenue & Customs, Edinburgh)
Small (HM Inspector of Taxes)
David Milne QC
Rupert Baldry
(Instructed by Solicitor to HM Revenue & Customs)
My Lords,
The method of computing trading profits for the purposes of income and corporation tax has been settled for many years. First you compute the profits on a basis which gives a true and fair view of the taxpayer's profits or losses in the relevant period. Then you make any adjustments expressly required for tax purposes, such as adding back deductions which the taxing statute forbids. The classic formulation of this method is by Sir John Pennycuick V-C in Odeon Associated Theatres Ltd v Jones (1970) 48 TC 257, 272-273 and it has now been codified in section 42(1) of the Finance Act 1998:
"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 shall give a true and fair view involves the application of a legal standard, the courts are guided as to its content by the expert opinions of accountants as to what the best current accounting practice requires. The experts will in turn be guided by authoritative statements of accounting practice issued or adopted by the Accounting Standards Board, which are given statutory recognition by section 256 and paragraph 36A of Schedule 4 of the Companies Act 1985.
The dispute in these appeals concerns the computation of the trading profits of Mars UK Ltd ("Mars"), which makes confectionery and pet food, and William Grant & Sons Distillers Ltd ("Grant"), which makes Scotch whisky, in the years ending 28 December 1996 and 28 December 2002 respectively. There is no dispute that the profits stated in their accounts have been computed on a basis which gives a true and fair view. In each case, in accordance with current accounting standards, certain deductions have been made for the depreciation of fixed assets. But section 74(1)(f) of the Income and Corporation Taxes Act 1988 provides that in computing profits for tax purposes, no sum shall be deducted in respect of "any sum employed or intended to be employed as capital in…the trade". Although the language is by no means clear, this has always been taken to prohibit deductions for the depreciation of capital assets: see Robert Addie and Sons v Solicitor of Inland Revenue (1875) 2 R 431. Any sum which has been deducted for depreciation in the computation of profits must therefore be added back. The question is to identify which sums have been so deducted.
In order to find the answer it is necessary to examine the methodology employed by Mars and Grant in making their computations. This followed the relevant accounting standards. First, Statement of Standard Accounting Practice ("SSAP") 12, which was in force in 1996 when the Mars accounts were drawn up, states in paragraph 2 of its Explanatory Note:
"Virtually all fixed assets have finite useful economic lives. In order for the financial statements to reflect properly all the costs of the enterprise it is necessary for there to be a charge against income in respect of the use of such assets. This charge is referred to as depreciation…"
Paragraph 16 of SSAP 12 states:
"The accounting treatment in the profit and loss account should be consistent with that used in the balance sheet. Hence, the depreciation charge in the profit and loss account for the period should be based on the carrying amount of the asset in the balance sheet, whether historical cost or revalued amount. The whole of the depreciation charge should be reflected in the profit and loss account."
In 1999 SSAP 12 was replaced by Financial Reporting Standard ("FRS") 15 (Tangible fixed assets). Paragraph 77 clarified and refined the requirements of paragraph 16 of SSAP 12:
"The depreciable amount of a tangible fixed asset should be allocated on a systematic basis over its useful economic life. … The depreciation charge for each period should be recognised as an expense in the profit and loss account unless it is permitted to be included in the carrying amount of another asset."
Pausing at that point, the effect of these standards is that the depreciation deducted in the profit and loss account for a given period should correspond with the depreciation shown in the balance sheet as having occurred over that period, "unless it is permitted to be included in the carrying amount of another asset". What is meant by this exception is best explained by reference to SSAP 9 (Stocks and long-term contracts), which dates back to 1975 and was adopted by the Accounting Standards Board. Explanatory note 1 sets out the relevant general principle:
"The determination of profit for an accounting year requires the matching of costs with related revenues. The cost of unsold or unconsumed stocks will have been incurred in the expectation of future revenue, and when this will not arise until a later year it is appropriate to carry forward this cost to be matched with the revenue when it arises; the applicable concept is the matching of cost and revenue in the year in which the revenue arises rather than in the year in which the cost is incurred."
This fundamental principle is given effect by taking the revenue which has arisen in the relevant year and deducting from it only those costs which are attributable to those sales. These costs may have been incurred in the year in question, or they may have been incurred in earlier years and carried forward, in accordance with the general principle, to be matched with the related sales when they occur. The costs of stocks which remain unsold at the year end are not deducted for the purpose of computing the profit in that year but are carried forward to be matched against the revenue from their sale in future years.
SSAP 9 then specifies what should be regarded as the cost of stocks. Paragraph 17 says that it includes not only the cost of purchasing the materials but also the "costs of conversion". That is defined to include costs "specifically attributable to units of production" such as direct labour and expenses and also "production overheads" which are incurred "in respect of materials, labour or services for production, based on the normal level of activity, taking one year with another". Paragraph 20 specifically provides that such overheads should include the depreciation of assets "which relate to production".
SSAP 9 therefore demonstrates that when paragraph 77 of FRS 15 lays 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 makes an exception for a case in which depreciation is "permitted to be included in the carrying amount of another asset", that is 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 are sold in a future year.
Both Mars and Grant prepared their accounts in accordance with these standards. They divided the depreciation which occurred during the year or was carried in the opening stock figure into two parts, which I shall call A and B. A was the depreciation in fixed assets which related to the production of goods sold during the year or in assets which were not used for production at all. B was the depreciation in fixed assets which related to production of unsold stocks. They deducted A from the year's revenue and carried B forward as part of the cost of unsold stocks.
Thus the Grant profit and loss account showed "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). The Mars accounts were less explicit. Note 5 said that profit on ordinary activities before taxation was stated after charging "depreciation on tangible fixed assets" and then gave a figure for A and B together. But Note 10 said that depreciation of £3,039,000 (B) had been "included in the stock valuation" and there is no dispute that the figure for "Cost of Sales" in the profit and loss account included A but not B.
My Lords, so far there is no dispute between the parties. The expert accountants on both sides were agreed that this 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. And on these admitted facts, I should have thought that it was plain and obvious that, as only A has been deducted, section 74(1)(f) does not require B to be added back.
The Revenue submit, however, that whatever the methodology described by the accounting standards may be, the taxpayers must be deemed to have deducted both A and B and then added a sum equal to B back into profits in some other...
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