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HMRC internal manual

Business Income Manual

Tax and accountancy: timing of receipts and expenditure: accountancy practice and case law developments

Over the years the Courts have been concerned with the time at which profits are to be brought into charge to tax, and a number of judge-made principles have emerged. But in more recent years they have become increasingly reluctant to discern judge-made tax principles which override generally accepted accounting practice. This trend began even before the introduction of the statutory requirement for taxable profits to be computed in accordance with GAAP, subject to adjustment for tax rules or principles which differ from the GAAP treatment.

What is, or is not, generally accepted accounting practice is a question of fact not law. Furthermore the Courts have recognised that accounting practice evolves over time. In principle, therefore, it is possible for a modern Court to come to a different decision from one taken in the past on the sole grounds that the accounting treatment has changed. This is because two cases can be distinguished on the basis of their accountancy facts, even though the other facts may be identical. The Courts therefore have proceeded to ensure that the law does not become tied to out-dated accountancy practice and to decisions taken where judges were forced to take a view of commercial practice in the absence of any accountancy evidence at all.

In Odeon Associated Theatres Ltd v Jones [1971] 48TC257 the courts were concerned with the accounting treatment of deferred repairs of a property transferred from one group member to another. Salmon LJ said at page 281B that:

‘In solving this question as to what is the true profit: …first… the ordinary principles of commercial accounting must, as far as practicable, be observed, and, secondly,… the law relating to income tax must not be violated… that is to say, by one means or another the full amount of the profits or gains must be determined.’

In the last thirty years three important cases have been decided. See Threlfall v Jones and Gallagher v Jones [1993] 66TC77, (the judgment in the Court of Appeal) Johnston v Britannia Airways Ltd [1994] 67TC99, and specifically on the timing of receipts, Symons v Lord Llewellyn Davies’ Personal Representative and Others [1982] 56TC630.

These cases were concerned, not with whether an item of income or expenditure is ever taxable or deductible, but when. In particular the Courts:

  • emphasised that the taxable profits should not be computed on a basis divorced from the principles of commercial accountancy. Nolan LJ said in Threlfall at page 128I:

‘With great respect I would suggest that this might equally be described as a re-statement in a particular context of the statutory rule … that tax shall be charged “on the full amount of the profits or gains of the year”-no more and no less. But whatever the content of the expression “the principles of income tax law” may be I conclude as did Pennycuick J., that the law does not enable or require us to ascertain the profit of a trade on a basis divorced from the principles of commercial accountancy’.

  • were especially unready to override accounting treatment which in commercial terms is the only treatment. In Threlfall the Master of the Rolls said at page 123B that:

‘…the central issue is at root a very short one. The object is to determine, as accurately as possible, the profits or losses of the taxpayers’ businesses for the accounting periods in question. Subject to any express or implied statutory rule, of which there is none here, the ordinary way to ascertain the profits or losses of a business is to apply accepted principles of commercial accountancy. That is the very purpose for which such principles are formulated. As has often been pointed out, such principles are not static: they may be modified, refined and elaborated over time as circumstances change and accounting insights sharpen. But so long as such principles remain current and generally accepted they provide the surest answer to the question which the legislation requires to be answered. As Pennycuick V.-C. pointed out in Odeon Associated Theatres Ltd, different considerations arise where there is no accounting evidence or where there are two or more principles either or any of which is generally accepted. But those considerations do not apply here. The authorities do not persuade me that there is any rule of law such as that for which the taxpayers contend and the judge found. Indeed, given the plain language of the legislation, I find it hard to understand how any judge-made rule could override the application of a generally accepted rule of commercial accountancy which (a) applied to the situation in question, (b) was not one of two or more rules applicable to the situation in question and (c) was not shown to be inconsistent with the true facts or otherwise inapt to determine the true profits or losses of the business.’

In Britannia Mr Justice Knox said at page 123E that:

‘The court is slow to accept that accounts prepared in accordance with accepted principles of commercial accountancy are not adequate for tax purposes as a true statement of the taxpayer’s profits for the relevant period. In particular, it is slow to find that there is a judge-made rule of law which prevents accounts prepared in accordance with the ordinary principles of commercial accountancy from complying with the requirements of the tax legislation.’

The judge in the Britannia case was not implying a new departure on issues like the capital/revenue borderline. But in the field of timing the cases do signal a substantial increase in the influence of accountancy.