Her Majesty's Revenue & Customs v William Grant & Sons Distillers Limited (Scotland) and Small v Mars UK Limited (Conjoined Appeals)

The House of Lords held that depreciation of tangible fixed assets that has been carried forward as part of the carrying amount of unsold stock in accordance with current accounting standards (SSAP 9/12 and FRS 15) has not been deducted for the purposes of computing trading profits and therefore is not to be added back under section 74(1)(f) of the Income and Corporation Taxes Act 1988. The court applied the statutory requirement in the Finance Act 1998, section 42(1), that profits be computed on an accounting basis giving a true and fair view, subject to adjustments required by law, and concluded that current accepted accounting practice provides the proper guide to when depreciation is to be taken into account for tax purposes.

The Lords rejected the Revenue's argument that carrying part of depreciation forward as stock necessarily means the whole depreciation has been deducted (and effectively neutralised by a notional credit), and they rejected arguments that the Companies Act 1985 or any fundamental accounting principle requires treating carried depreciation as already deducted for tax. The appeals were allowed and the Special Commissioners' decisions restoring the taxpayers' treatment were restored.

This was a conjoined appeal concerning the proper computation of trading profits for tax where companies (Mars UK Ltd and William Grant & Sons Distillers Ltd) prepared accounts in accordance with current accounting standards and carried part of the year's depreciation forward as part of the cost of unsold stocks.

Background and parties:

• The taxpayers (Mars and Grant) prepared accounts under SSAP 9/12 and FRS 15 which split depreciation into (A) depreciation attributable to goods sold in the year or to non-production assets (deducted in cost of sales) and (B) depreciation attributable to production of unsold stock (carried forward in stock valuation and not deducted in that year's profit and loss account).
• The Revenue assessed that the B element should be added back in computing taxable profits under section 74(1)(f) of the Income and Corporation Taxes Act 1988.

Procedural history: The Special Commissioners allowed the taxpayers' appeals. The Revenue successfully appealed: in Mars to Lightman J and in Grant to the Court of Session (majority). Both taxpayers then appealed to the House of Lords.

Issues before the House:

• Whether depreciation carried forward as part of stock (in accordance with SSAP 9/12 and FRS 15) had nevertheless been "deducted" for tax purposes so as to require an add-back under section 74(1)(f) of ICTA 1988.
• Whether statutory requirements in the Companies Act 1985, or fundamental principles of accounting, prevented the accounting treatment adopted by the taxpayers from being recognised for tax purposes.

Reasoning:

• The House emphasised the statutory requirement in Finance Act 1998, section 42(1), to compute profits on an accounting basis which gives a true and fair view and the role of current accepted accounting practice in identifying what that basis requires.
• Accounting standards (SSAP 9, SSAP 12, FRS 15) permit carrying forward as part of stock an appropriate share of depreciation; when so carried forward that element is not an expense in the profit and loss account for that year and thus has not been deducted for tax purposes.
• The court rejected the Revenue's contention that carried-forward depreciation must be treated as deducted because it may be offset by a notional stock credit or because the Companies Act compels immediate matching; the Companies Act and its formats do not dictate timing when a true and fair view permits carrying forward.
• The House criticised reliance on the Hong Kong case Commissioner of Inland Revenue v Secan Ltd to support the Revenue's argument and preferred the view that the accepted accounting treatment should be respected unless law requires otherwise.

Relief sought: The taxpayers sought to uphold the Special Commissioners' decisions that the B element of depreciation should not be added back for tax purposes.

Appeal allowed. The House held that where part of a year's depreciation has been included in the carrying amount of unsold stock in accordance with current accepted accounting standards, that part has not been deducted in computing profits for the year and therefore section 74(1)(f) of the Income and Corporation Taxes Act 1988 does not require it to be added back. The courts should follow current accepted accounting practice in determining the true and fair view for tax computations unless a statutory provision requires a different treatment.

Special Commissioners: appeals by taxpayers (Mars and Grant) allowed; Revenue appealed. Mars: appealed to Lightman J (successful for Revenue) ([2005] EWHC 553 (Ch) is cited as an on-appeal origin). Grant: appealed to the Court of Session where the majority reversed the Special Commissioners (reported at 2005 SLT 888). Both taxpayers appealed to the House of Lords; the House allowed the appeals.