Wednesday, April 26, 2006



Surely accountants not lawyers ought to decide what are the principles of commercial accountancy! This remark is prompted by the mess that a succession of lawyers seem to me to have made in the related cases of Small v Mars Ltd and CIR v William Grant & Sons Ltd. These both relate to the inclusion of depreciation in stock. Take William Grant for example. In the year to 28 December 2002 it depreciated land and buildings by £1.585m and plant, vehicles and casks by £5.120m, a total of £6.705m. The accounting entries were debit profit and loss account £5.010m, debit stock £1.695m and credit depreciation £6.705m.

The tax legislation disallows a deduction for depreciation in calculating taxable profits. So how much of the £6.705m was deducted in the profit and loss account and falls to be disallowed? Surely all accountants would say £5.110m. Indeed so would some lawyers. It is what the two Special Commissioners who heard the case, Dr Nuala Brice and John Walters QC thought. It is also what Lord Reed thought in a thoughtful and compelling judgement in the Court of Session. Sadly it is not what Mr Justice Lightman thought when hearing the Mars case in the High Court not what Lord Penrose and Lord Osborne thought in their majority decision in William Grant in the Court of Session. They all felt that somehow £6.705m had been deducted in the profit and loss account and therefore fell to be disallowed.

The fallacy of this view is well brought out by Lord Reed when he asks what would have happened in year 1 if no stock were sold. The profit and loss account would show a break even position but the tax computation would show £1.695m profit if his colleagues view was correct. It is difficult to see how even an eminent lawyer can justify such a result.

Mr Justice Lightman’s judgement is difficult to follow. He starts by affirming that the issue turns on whether the calculation of profits is a question of law or to be determined in accordance with current accepted principles of commercial accountancy and comes down firmly in favour of the latter. He next held that under such principles “there is no notional purchase of opening or sale of closing stock, the stock is merely carried forward”. He then somehow held that what had really happened (using the above William Grant figures for illustration rather than the Mars ones) was that as the balance sheet showed £6,705m depreciation this figure should somehow have been charged to the profit and loss account and the £1.695m credited against it to arrive at a net charge of £5.110m – so the whole of £6.75m had been deducted and falls to be added back. This seems to be a complete non sequitur. It flies in the face of both the evidence and of his own conclusion that “the stock is merely carried forward”.

Lord Penrose took as his starting point a 1925 tax case, Whimster & Co v CIR, which did not involve stock (it involved the anticipation of losses on ship charters), was decided by the Commissioners on the basis of agreed facts, and in which it does not appear that accountancy evidence was called by either side. “Arithmetically the operating profit is precisely the same as it would have been if a trading and profit and loss account had been prepared in traditional form. [by which he seems to mean if opening stock had been debited to profit and loss account and closing stock credited to profit and loss account instead of merely “cost of sales” being debited in the account]. But the omission of opening and closing stock is not simply a short cut. It reflects a difference in understanding of what is required by GAAP to arrive at a proper statement of operating profits from that which would have been reflected in accounting evidence in 1925 when Lord President Clyde went on to say [in Whimster] “For example, the ordinary principles of commercial accounting require that in the profit and loss account of a merchant’s or manufacturer’s business the values of the stock-in-trade at the beginning and at the end of the period covered by the account should be entered at cost or market price, whichever is the lower; although there is nothing about this in the taxing statutes”. At that stage in the development of accounting practice it is difficult to envisage any other approach”.

He attributes the change to computer power. “However”, he goes on to say, “it is important to note that, whatever development had taken place…the focus remains the same: adjusting for stock at the beginning and end of the accounting period at cost or market value. The alternative was, and in my view remains, important. The required adjustment has at no time been confined to an adjustment related to cost…It is clear that the net realisable value alternative involves the recognition as an expense, in a period during which the goods in question have not been sold, of costs that have not been incurred in generating the receipts of that period. That, in my view, suggests that one must be slow to reduce the issue of principle in this case to one of accounting for cost or for expense…It is immaterial that a trader…could apportion the reduction over cost headings as a matter of bookkeeping. The recognition that the corporeal stock had a value derived externally from market conditions would be an inescapable part of the process of computing the amount of the reduction.”

Most accountants would find two fallacies in this argument. Reducing stock to market value is not anticipating a loss; it is recognising that the value has fallen while the stock is being held and that fall ought properly to be regarded as a result of the activity in the accounting period of holding the stock. Secondly, reflecting that fall in value does not of itself involve recognising the stock itself as a cost or expense (or a credit) in the accounts. The basic accounting principle of matching costs and receipts requires the exclusion of costs that do not relate to the period concerned, not their initial inclusion followed by a credit to exclude them.

Lord Penrose then follows the Lightman approach of looking at the Companies Act requirement to show depreciation separately on the balance sheet and concluding from this that the balance sheet figure must have been credited to profit and loss account and part then removed by capitalising it.

He then decides that Whimster (and some later cases in which accountancy evidence was again not called) “provide support for the view, on which the Revenue relied, that there is a rule of law requiring the computation of profits for corporation tax purposes on a basis that explicitly brings into account opening and closing stock figures ascertained at the lower of cost and net realisable value. In terms of current GAAP that accounting procedure would require now to reflect depreciation applied in ascertaining stock figures to be included. To that extent there has been development of the accounting practices employed to measure stock, but no change in the asset whose cost is to be measured”.

This seems a quite extra-ordinary approach. It basically says accountants try to match costs and income. They do this by by-passing from the accounts costs that do not relate to the year. But lawyers think that is unreasonable. The accountants need to recognise both the cost of opening stock and the cost of closing stock to prepare proper legal accounts. Accordingly as, contrary to the facts, that is what William Grant ought to have done its accounts need to be rewritten to bring in opening and closing stock so that the depreciation figure in the profit and loss account conforms with that in the balance sheet and can therefore be disallowed for tax purposes.

It is likely that both of these cases will go to the House of Lords. It is to be hoped that their lordships will be convinced by the argument of Lord Reed, which is the only of the judgements that, to an accountant, accords both with the facts and with the logic of the accounting principles.

Robert W Maas

Monday, April 24, 2006



Yes, yes, yes! What a magnificent volley by Marlon Harewood to propel West Ham not only into the FA Cup Final, but also into next season’s UEFA Cup. It was the highlight of the weekend.

Indeed, the only highlight of my weekend – I seem to have spent most of it travelling. The saga began on Thursday. I had a lecture engagement in Penrith, Cumbria, a part of the country I have never visited before. I decided to stay over until Saturday. A bit of a mistake, as although Penrith claims to be a town it seemed to much more a village with very little for the visitor to do. I had planned to travel back Saturday lunchtime but decided to take an earlier train back instead. First big mistake. The timetable showed one a bit after 9.00. Unfortunately Railtrack was dong maintenance so one had to get a bus to the next station. Fair enough! But when I had gone to the station on Friday there was no indication that the bus drivers like to sleep in and that the first bus was not until 10.05. Nor was there any indication that the next station, which was about 12 minutes away by train, was three quarters of an hour away by bus! (Well at least I got to see a bit of scenery). The end result was that having left my hotel at 8.15 I was not actually sitting on a train until gone 11.00. And of course, being a weekend, rail journeys somehow take a lot longer than on weekdays – in this case five hours instead of 31/4. Which meant that I didn’t get home until getting on for 6.00pm.

Then up to Villa Park on Sunday for a 4.00pm kick off. I had to leave home about 10.15 and didn’t get back until almost 11pm. You’d think that with 20,000 odd West Ham football supporters descending on Birmingham they would lay on special trains to get them back to London ASAP. Not a bit of it. Indeed for the train from Whitton to Birmingham (a 10 minute journey) the police only let a few people on the platform per train (about a 25 minute wait for it to arrive), so that the train was half empty. Thankfully I left the ground fairly promptly. I imagine a lot of supporters had a far longer wait than me! From New Street I was lucky enough to get the 19.20 “Euston only” train, albeit that it did not actually leave until about a quarter to eight. “Euston only” in Virgin Rail terminology apparently means stopping only at Coventry, Rugby, Milton Keynes and Watford, which seems to me a novel use of language.

At least I managed to catch up on my technical reading with all that sitting around. But I haven’t had time to come up with any scintillating thoughts on tax issues, so those that have struggled through the above in the hope of finding some tax nuggets will have to wait until another day.

Robert W Maas

Thursday, April 20, 2006



How’s this for a non sequitur? Mr Rahman is the sole director of New Fashion (London) Ltd. He drew cash from the company’s bank account, purportedly in order to settle legitimate trading invoices from two other companies; Golden Tower Clothing Ltd and Dexan Fashions Ltd. HMRC had doubts about the authenticity of the invoices and had asked Mr Rahman for further corroborative evidence, which he had not provided.

The General Commissioners noted that “the question for determination was whether certain money’s drawn in cash …had been paid to Golden Tower Clothing Ltd or Dexan Fashion Ltd in settlement of legitimate trading invoices”. They said that they were not satisfied that the invoices had been issued by the two companies or that Mr Rahman had paid the money over to them.

On appeal Mr Justice Leighton held that the Commissioners applied the correct burden of proof and reached a conclusion that was clearly open to them on the facts as found by them.

Fair enough? Or is it? The only facts they seem to have found were that Mr Rahman had drawn out the money and that there was no convincing evidence that services had been provided to New Fashion (London ) Ltd by the other two companies.

So what was the conclusion that they reached on these facts? The obvious one is that Mr Rahman had wrongly diverted the money from the company and was under a duty to repay it to the company. That was the decision reached in Rose v Humbles, a decision on which HMRC have consistently relied since it was decided in 1970 to assert that such sums cannot be regarded as remuneration but should be treated as a debt due to the company.

In fact the Commissioners reached the conclusion that the money drawn by Mr Rahman was remuneration from New Fashions (London) Ltd. They do not refer to Rose v Humbles, although one assumes that HMRC drew it to their attention as it was clearly so relevant that not to have done so would have been verging on dishonesty. Nor do they refer to anything else. It is an enormous leap to assume that if a payment is not shown to be what it purports to be it must be remuneration. Surely some evidence of its nature is needed to displace the more natural explanation of diversion of funds by the odd assumption that it must be remuneration?

Robert W Maas

Tuesday, April 04, 2006



Three cheers for the Court of Appeal decision in C&E Commrs v Elm Milk Ltd. Elm Milk purchased a Mercedes company car for use by its sole director He drove 50,000 miles a year on business. The car was normally kept in a car park near the Elm Milk office and within 50 yards of the director’s home. The keys were kept in the office. The director’s wife owned a Rover which the director used for all his private motoring. A board resolution recited that the company did not intend to make the car available for private use. The insurance cover was not restricted to business use, but that was because the company had been told that it is not possible to insure a car for business use only.

The VAT legislation provides that VAT is recoverable where a car is supplied to a taxable person who “intends to use the motor car…exclusively for the purposes of a business carried on by him”. It goes on to say that a person is not to be taken to intend to use a motor car exclusively for such a purpose if he intends “to make it available…to any person (including, where the taxable person is an individual, himself…) for private use, whether or not for a consideration”.

This tiny provision has been subject to a great deal of litigation. The view of HMRC seems to be that the provision was a joke by parliament and that, although it pretends to give tax relief, it is in fact impossible ever to show that a car is intended never to be made available for private use.

In C&E Commrs v Upton the Court of Appeal said that the question had to be decided at the moment of acquisition and in that case “the car was at that moment, as a matter of fact, available for Mr Upton’s private use, however little he then had any intention of actually so using it”. It decided that as a matter of law a person is deemed to intend the natural consequences of his actions, those actions being insuring the car for private use and keeping it close by. The Court commented that it was difficult to envisage circumstances in which a car could qualify for relief other than if it were insured for business use only – which seems to be generally accepted is impossible to do

In a later case C&E Commrs v Robbins, the judge commented, “The limited, perhaps very limited indeed, circumstances in which a taxable person might be able to get through these provisions…were addressed in the Upton case…one possibility mentioned being the situation where the motor car was insured only for business use. As Mr Robbins says, that may not be a practical solution”.

The Court of Appeal in Elm Milk Ltd has held that on the facts of that case Elm Milk had established its right to recover VAT. “The prohibitions on private use was backed up by the terms of the director’s employment and the arrangements as to the location of the keys”. This was in spite of the fact that HMRC had gleefully pointed out that the director had admitted in cross-examination that if an emergency arose when his wife’s Rover was not available he might use the Mercedes. The court regarded that as de minimus. This has been a favourite argument by HMRC. In an earlier case they asked the taxpayer what he would do if his daughter was seriously injured in an accident, the company car was sitting in the street with the keys in the ignition and his own car was in the garage some distance away. I hope I am not the only one to regard such arguments as “sick” and to welcome the fact that the judge in Elm Milk were not swayed by it.

So hurrah for some commonsense at last. I believe that only one other person has succeeded in the courts in establishing a right to recover input tax – and that was a Scottish case where, my friends North of the border tell me, the judges tend to apply the law with a fair modicum of commonsense.

This area seems to be a clear case where the law is an ass. It does not help anyone for parliament to grant a tax exemption that it is virtually impossible to achieve. It does not matter whether the fault lies with HMRC for guarding the exemption was extreme zeal, with parliament for hedging it around to such an extent that it is almost impossible to meet the qualifying conditions, or with the courts for interpreting the provisions in an unduly restrictive manner. What ought to matter is that reliefs that virtually never apply not only needlessly complicate the legislation but damage the integrity of the tax system by bringing it into disrepute when taxpayers come to realise that the promised relief is a mirage.

Will HMRC take defeat graciously? I doubt it. I expect them to seek leave to appeal the decision to the House of Lords.

Robert W Maas