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HMRC internal manual

Business Income Manual

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HM Revenue & Customs
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Business successions: cost of stock acquired as part of the acquisition

There is specific statute and case law governing the tax treatment of stock. This tax treatment may mean that a tax computation adjustment is needed to the value of the stock used in the accounts. Comprehensive guidance on stock valuation at discontinuance of a business is at BIM33450. See the flowchart (Word 25KB).

Both the vendor and the purchaser use the fair value of the stock in their accounts

No tax computation adjustment is necessary. This will often be the case where the vendor and purchaser agree the value before the sale, whether or not the sale value specifies an amount for the stock.

 

Purchaser uses a fair value of stock which differs from the value in the sale agreement

A tax computation adjustment is necessary when the sale agreement specifies an amount for stock but that differs from the fair value used in the purchaser’s accounts. The value that is allowable for tax purposes is the amount actually paid, which is the value in the sale agreement.

If the fair value of the stock is more than the amount paid then the purchaser’s account will be showing a higher opening stock value than they actually paid. An add-back in the tax computation is necessary. The add-back should be made when the stock is used or sold, so may have to be spread over more than one accounting period, e.g. the stock cost in the sale agreement was £100 but the fair value was £150. When it is sold for £200 the profit and loss account will show a profit of £50. To reflect the true profit on sale (£200 - £100 paid) the tax computation would need an add-back of £50.

If the fair value is less than the amount paid for the stock then the account will be showing a lower opening stock value. A deduction for the difference between the value paid and the fair value will be due. This should be made in the first accounting period.

 

The case law which leads us to these principles is summarised below

Where a value for stock is specified in the sale agreement and it has not been manipulated artificially then that is the value to use. Craddock v Zevo Finance Co Ltd [1946] 27TC267 established that the courts should be slow to interfere with a commercial bargain (for instance see Viscount Simons at page 287) and they should do so only where the sale is not by way of trade or is an illusory or colourable or fraudulent transaction (Lord Wright at page 290).

Sharkey v Wernher [1955] 36TC275 established that where trading stock was disposed of not by way of trade the correct procedure is to bring in the amount which would have been obtained if the stock had been sold in the ordinary course of trade, that is, market value. (See now S172B Income Tax (Trading and Other Income) Act 2005 and S157 Corporation Tax Act 2009 which give statutory force to the principle established in this case.)

Petrotim Securities Ltd v Ayres [1963] 41TC389 was a case where the disposal of the company’s stock in trade to its parent company at undervalue was considered to be an illusory or colourable transaction not by way of trade and this justified the substitution of the market value for the sale price in Petrotim’s accounts. Note that market value was also substituted as the purchase cost in the accounts of the other party to the transaction in Ridge Securities Ltd v CIR [1963] 44TC373.

Jacgilden (Weston Hall) Ltd v Castle [1969] 45TC685 and Skinner v Berry Head Lands Ltd [1970] 46TC377 show that whether or not a transaction is by way of trade or is fraudulent, illusory or colourable is primarily a question of fact for the Tribunal. In Jacgilden (Weston Hall) Ltd a property dealing company bought a property from one of its shareholders. For the freely negotiated, but bargain price the company tried to substitute a market value figure as the cost of the stock. In rejecting the company’s argument, Plowman J said:

‘(The Commissioners) were entitled to conclude that the transaction with which they were concerned ……..was not a gift or a sale by Mr Rowe to the Company at undervalue, but a purchase by the company of trading stock at a price which had been fairly negotiated between Mr Rowe and the vendors. The Sharkey v Wernher line of authority has never, so far as I am aware, been applied to a case where the price at which the property passed had been negotiated as a fair and proper price, and because it is an exceptional line of authority, I think the Courts should be slow to extend it.’

In contrast in Berry Head Lands, Goff J was able to overturn the Commissioners’ conclusion because the irresistible inference from the primary facts - a sale at an enormous undervalue to the parent company with the onward conveyance of the property to a third party on the same day - did not support the Commissioners’ conclusion that the sale was by way of trade. He concluded that market value should be substituted.