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

Trading profits are first computed under currently accepted accounting principles on a basis giving a true and fair view. Adjustments expressly required or authorised by tax law are then made. Accounting principles may change as accounting practice develops; an asserted fundamental rule cannot displace current standards unless it is a rule of law.

Where production depreciation is included in the carrying amount of unsold stock, it remains a cost to be charged when the stock is sold. It has not been deducted in computing the current period’s profit. A statutory prohibition on deducting capital depreciation therefore requires the addition back only of the net depreciation actually deducted during that period.

These conjoined appeals concerned the corporation tax computations of a confectionery and pet-food manufacturer and a Scotch whisky distiller. Their accounts, which gave a true and fair view, included production-related depreciation in the carrying value of unsold stock. That depreciation would be charged as an expense when the stock was sold.

The Special Commissioners held that the carried-forward depreciation had not been deducted in computing current profits. The Revenue successfully appealed in the Mars proceedings to the High Court, [2005] EWHC 553 (Ch), and in the Grant proceedings to a majority of the Extra Division of the Court of Session, reported at 2005 SLT 888. The central question was whether section 74(1)(f) of the Income and Corporation Taxes Act 1988 nevertheless required that depreciation to be added back.

1. Both appeals allowed unanimously. Lord Hoffmann delivered the leading speech. Lord Hope of Craighead agreed and added further reasons. Lord Walker of Gestingthorpe, Lord Mance and Lord Neuberger of Abbotsbury agreed with Lord Hoffmann. The decisions of the Special Commissioners were restored.

2. Per Lord Hoffmann, trading profits are initially computed on an accounting basis giving a true and fair view. Any adjustment required or authorised by tax law is then made. Courts apply a legal standard, but current expert accounting practice and authoritative accounting standards guide its content. There was no additional fundamental accounting rule requiring a different computation.

3. The applicable accounting standards matched costs with the revenue to which they related. Production depreciation attributable to unsold stock could therefore be included in that stock’s carrying amount and charged as an expense only when the stock was sold. The profit and loss accounts deducted the depreciation attributable to goods sold or to non-production assets, but did not deduct the depreciation carried in unsold stock.

4. The Revenue’s proposed analysis, under which all depreciation was deemed to have been deducted and a corresponding stock amount deemed to have been credited, impermissibly combined two different systems of computation. Stock is an asset in the balance sheet, but its figure in the profit and loss computation represents costs carried forward. A reduction of stock below cost may be recognised immediately as an expense without altering that distinction.

5. Neither Format 1 in Schedule 4 to the Companies Act 1985, nor its provisions concerning depreciation, required the balance-sheet reduction for depreciation and the profit-and-loss deduction to occur in the same year. The overriding requirement remained a true and fair view.

6. Lord Hope emphasised that accounting principles had developed since earlier authorities describing closing stock as a notional receipt credited against current expenditure. Depreciation carried forward retained its character as depreciation, but had not yet been deducted. Section 74(1)(f) of the Income and Corporation Taxes Act 1988 consequently required only the net depreciation actually deducted in computing the period’s profits to be added back.

1. House of Lords: The conjoined appeals were allowed unanimously. The decisions of the Special Commissioners were restored.
2. High Court: In the Mars proceedings, Lightman J allowed the Revenue’s appeal from the Special Commissioners: [2005] EWHC 553 (Ch). Mars appealed directly to the House of Lords under section 12 of the Administration of Justice Act 1969.
3. Extra Division of the Court of Session: In the Grant proceedings, the Revenue’s appeal was allowed by a majority. Lord Reed dissented. The decision is reported at 2005 SLT 888.
4. Special Commissioners: The taxpayers’ appeals against assessments adding back depreciation carried in unsold stock were allowed.