Pearce v Woodall Duckham Ltd

For corporation tax, a trader may adopt a proper, commercially justified and accepted accounting basis for valuing work in progress on long-term contracts. Where the change fairly recognises profit attributable to work performed, the resulting revaluation may be brought into the trading computation, subject to prudent restrictions and the rule against anticipating profit.

Where the new basis is introduced during a year, the resulting profit element is attributable to that year, not earlier years. The relevant comparison may therefore be between closing work in progress under the old basis and closing work in progress under the new basis. The amount is a trading profit item, not a separate non-trading profit.

Woodall-Duckham Ltd changed its method of valuing work in progress on long-term contracts. It moved from a prime-cost basis to an accrued-profit basis, under which a proportion of anticipated gross margin was recognised once 25% of anticipated final prime cost had been incurred, subject to reserves and provisions.

The Special Commissioners accepted that the change was commercially justified and decided that the resulting surplus of £579,874 was not chargeable as a 1969 profit. Templeman J reversed that decision on the point of principle and remitted the matter. The company appealed to the Court of Appeal.

The central questions were whether the surplus was a trading profit for corporation tax purposes and, if so, to which year it was attributable.

1. Appeal dismissed. The order was varied so that the case was remitted to the Special Commissioners to adjust the assessments in accordance with the Court of Appeal’s judgment. The company was ordered to pay the costs, and leave to appeal to the House of Lords was granted.
2. Lord Justice Orr, giving the first judgment, held that the accrued-profit basis was an accepted accounting basis and had been adopted for proper commercial reasons. Tax consequences were not the reason for the timing of the change. A trader who could reasonably write down stock or write off a bad debt in the year of the decision could likewise recognise a fair share of the final gross margin in work in progress as the contract was performed. The 25 per cent threshold, general reserve and specific provisions supplied prudent restrictions and did not infringe the rule against anticipating profit.
3. The gross-margin element recognised on introducing the new basis could not be attributed to years before 1969 merely because the underlying work had been performed over earlier periods. It was analogous to a bad debt being recognised in the year in which it became bad. The Court distinguished Commissioner of Income Tax, Bombay v Ahmedabad New Cotton Mills Company Ltd (1929 46) Times Law Reports 68, because that case concerned correction of an undervaluation, not a change of valuation basis.
4. Lord Justice Stamp explained that the relevant trading computation could compare the closing valuation for 1968 under the old basis with the closing valuation for 1969 under the new basis. The fact that the figures were calculated on different bases did not prevent the difference from being a trading profit item. The £579,874 opening revaluation was artificial and did not represent a separate non-trading profit. Lord Justice Eveleigh agreed with both judgments.

• Court of Appeal: dismissed the company’s appeal, varied the order, and remitted the assessments to the Special Commissioners.
• High Court, Chancery Division: Templeman J reversed the Special Commissioners’ decision on the point of principle and remitted the case for reconsideration.
• Special Commissioners: reduced the assessment and decided that the surplus was not chargeable as a profit arising in 1969.