Judgments - Her Majesty's Revenue & Customs (Respondents) v. William Grant & Sons Distillers Limited (Appellants) (Scotland) and Small (Her Majesty's Inspector of Taxes) (Respondent) v. Mars UK Limited (Appellants) (Conjoined Appeals)

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    32.  Lord Reed, on the other hand, said that all the accounting standards were consistent in approving the treatment of depreciation of fixed assets used in the production of stock as part of the cost of that stock, to be carried forward as an asset until the stock was sold and then charged as an expense. If a manufacturing company were to prepare its financial statements in accordance with these standards, then part of the depreciation in its fixed assets in a given year would not be included as an expense in the profit and loss account if stock remained unsold at the end of the year, but would instead be carried forward to the following year as part of the carrying value of the stock.

    "In these circumstances, the company would not have made any deduction, in computing its profits, by reason of carrying forward that part of the deprecation: on the contrary, the whole point of carrying it forward is not to make a deduction at that stage, so that the deduction can be made at a later stage, when the stock in question is sold, enabling profit to be computed on what (from an accounting perspective) is regarded as a more realistic basis."

In so far as depreciation was carried forward, it was not deducted in the computation of profit and could not therefore be "added back" under section 74(1)(f) of the 1988 Act.

    33.  The exercise which Lord Penrose described as book keeping for expense is, as the taxpayers' expert witness Mr Holgate explained in his evidence to the Special Commissioners, the day to day recording activity which is carried out by the company. It consists of the making of debit and credit entries, which then have to be analysed by the application of accounting principles when the financial statements are drawn up. That involves determining which debits are to be treated as assets and which debits are to be treated as expenses, and which credits are to be treated as liabilities and which credits are to be treated as income. The profit and loss account is concerned with income and expenses. The balance sheet is concerned with assets and liabilities. Section 228(2) of the Companies Act 1985 states that the balance sheet shall give a true and fair view of the state of affairs of the company as at the end of the financial year, and that the profit and loss account shall give a true and fair view of the profit or loss of the company for the financial year. For the purposes of Case I or II of Schedule D, too, the profits must be computed on an accounting basis which gives a true and fair view: Finance Act 1998, section 42. That much, of course, was common ground.

    34.  The difference of view in the Court of Session as to the treatment of depreciation can best be identified by referring to explanatory note 1 to SSAP 9 (Stocks and long-term contracts), as revised in September 1988, which Lord Hoffmann has quoted in para 7 of his speech. It states that the determination of profit for an accounting year requires the matching of costs with related revenues and that, where the cost of unsold or unconsumed stocks has been incurred in the expectation of future revenue in a future year, it is appropriate to carry this cost forward to be matched with revenue when it arises. The reference to cost in this explanatory note includes expenditure on items such as labour and materials which have been identified as debits in the company's book keeping. FRS 15 (Tangible fixed assets), which replaced SSAP 12 (Accounting for depreciation) in February 1999, makes it clear that depreciation will not be recognised in the profit and loss account as an expense incurred during the accounting period if it is permitted to be carried forward by being included in the carrying amount of another asset. An asset for this purpose includes unsold stock.

    35.  Those, in outline, are the accounting standards in accordance with which Grant's accounts were prepared. As to their significance in this case, Lord Reed said in para 159 that he adopted Sir Thomas Bingham MR's observations in Gallagher v Jones [1994] Ch 107, 134: the ordinary way to ascertain the profits or losses of a business is to apply accepted principles of commercial accountancy; such principles are not static, but so long as they remain current and generally accepted they provide the surest guide to the question that the legislation requires to be answered.

    36.  What then is there to prevent the profits of the company being computed according to these principles for tax purposes? In Gallagher, p 137E-F, Nolan LJ referred to the general rule that trading expenditure on revenue account is deductible in the year in which it is incurred. Nobody disputes that there is such a rule. But a rule expressed in such broad terms is susceptible to modification as accounting principles are developed and modified and, as Sir Thomas Bingham MR put it in Gallagher at p 134, "accounting insights sharpen". Is there a more fundamental rule of law to which, for tax purposes, these accounting principles must be subordinated? I do not think that it has been shown that there is any such rule.

    37.  Earlier in his opinion in Gallagher at p 136A-D Nolan LJ referred to Lord Reid's speech in Duple Motor Bodies Ltd v Inland Revenue Commissioners [1961] 1 WLR 739, 751-753. He said that he thought that it was clear that, as a matter of legal analysis, Lord Reid regarded the practice of carrying expenditure on unsold stock forward to be set against the price for which the stock is ultimately sold as involving the deduction of the whole of the expenses incurred during the accounting period but the crediting against those expenses of a closing figure for unsold stock and for work in progress as a notional receipt. That, I think, is in essence the view that was taken of this case by Lord Penrose. Giving evidence to the Special Commissioners the expert for the Revenue, Mr Thomas Carne, put it succinctly when he said that the correct view was that the gross amount of depreciation is charged to the profit and loss account with a credit for stock.

    38.  It has to be recognised that accounting principles have moved on since 1961. What may have been regarded as unacceptable then need not be regarded as unacceptable now. The golden rule is that the profits of a trading company must be computed in accordance with currently accepted accounting principles. They are the best guide as to a true and fair view of the profit or loss of the company in the relevant accounting period. Profits so computed are subject to any adjustment required or authorised by law in computing those profits for corporation tax purposes. But there is no rule of law that prohibits effect being given to what currently accepted accounting principles provide as to how a true and fair view is to be arrived at, or as to how depreciation should be treated when profit or loss for the year is being calculated.

    39.  When depreciation is to taken into account to show a true and fair view of the profit or loss for each financial year is in the end a question of timing. If, in order to show a true and fair view according to currently accepted accounting principles, part of the depreciation has in fact been carried forward, that must be treated as fact. This has two consequences. The first is that depreciation does not cease to be depreciation when it is carried forward as part of the carrying amount of stock into another accounting period. It retains its character, just like any other element of cost that is carried forward, as an expense to be set off against income in the year when the stock is sold. The second is that the amount of deprecation to be added back under section 74(1)(f) of the 1988 Act is the net amount. This is because only the net amount will have been deducted in computing the amount of the profits for the relevant period.


My Lords,

    40.  I have had the great advantage of reading in draft the opinion of my noble and learned friend Lord Hoffmann. I am in full agreement with his opinion and I too would allow these appeals.


My Lords,

    41.  I have had the advantage of reading in draft the opinion of my noble and learned friend Lord Hoffmann. I am in full agreement with his opinion and I too would allow these appeals.


My Lords,


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