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HMRC internal manual

Business Income Manual

Specific deductions: provisions: allowability for tax: accuracy

The inclusion of a provision in accounts is not conclusive that it is an allowable trading deduction. For tax the provision must be estimated with sufficient accuracy. Case law shows that the factual accuracy of a provision, like any other entry in accounts, is a matter to be determined by the tribunal (see Owen v Southern Railway of Peru Ltd [1956] 36TC602).

Although factual accuracy is a matter for the tribunal, Johnston v Britannia Airways Ltd [1994] 67TC99 shows that the opinion of accountants is relevant as to factual accuracy. The decision in the case of Herbert Smith v Honour does not mean that HMRC has no right to enquire into the factual accuracy of entries in company accounts that have been signed off by the directors and auditors.

HMRC has an explicit right to enquire into any tax return to check that it is correct and complete. For pre SA periods the Inspector had to be satisfied that a return was correct and complete before making an assessment. Usually the only way to check that a return is correct and complete is to look at the underlying evidence.

It must be accepted that sometimes absolute accuracy is impossible, so that there is no single right figure. Directors and business proprietors have a responsibility when preparing accounts to make judgements, and there will often be a range of possible answers within which their own business expertise will be the main factor in deciding the final answer. What we expect them to do in arriving at an estimate is to exercise their judgement in a reasonable manner, taking into account the information reasonably available to them and other relevant factors including their own business expertise. If they have done this, and arrived at a result that accords with the requirements of GAAP, then HMRC is not entitled to substitute a different figure just because an alternative view is possible.

In Owen v Southern Railway of Peru Ltd [1956] 36TC602 the whole provision was disallowed after the House of Lords had decided that it was too inaccurate to stand. However Lord Radcliffe made it clear that this was because any examination of factual accuracy would require a remission to the Commissioners (now the FTT), in effect starting the appeal all over again, with no guarantee that a more accurate method would emerge. The House of Lords was not prepared to take this course, which in any case neither side had asked for.

Whether entries in accounts accord with GAAP is, so far as relevant to the computation of taxable profits, a question of fact for the FTT. If there is a dispute on this issue the FTT would expect to hear expert accountancy evidence, as the Commissioners did in Johnston v Britannia Airways [1994] 67TC99. Whatever certificates or reports appear on accounts are not conclusive as far as the computation of taxable profits is concerned.

Whether provisions and other estimates included in accounts are sufficiently accurate is ultimately a question of fact for the FTT, to be determined by them after considering all of the relevant evidence. This means that it is in the first instance a matter for HMRC Officers, in the course of any enquiry they make into a return, to consider the accuracy of provisions and other estimates. You may wish to ask what factors the directors or business proprietors took into account in arriving at the figure, and what information was available to them.

In practice you should not regard inaccuracy as grounds for disallowing the whole of the provision. Instead a more accurate estimate based on the facts should be proposed. Our view is that it will nearly always be possible to arrive at a sufficiently accurate estimate. Advice from an HMRC compliance accountant should be taken in appropriate cases.

The allowability of provisions is subject to the overriding capital/revenue distinction.