BIM31003 - Tax and accountancy: the approach to ascertaining the profits for tax purposes

The words 'the full amount of the profits or gains' have been interpreted by the Courts as requiring the consideration of 'profits' as that word would be understood in its ordinary sense in commercial life. This involves setting against the receipts of a trade etc in any given period the expenses incurred to earn those receipts. More specifically those profits are to be those calculated in accordance with the correct principles of commercial accountancy, BIM31020. That result is not, however, conclusive of the quantum of the profits for tax purposes; the Taxes Acts may still require specific adjustments.

In summary the approach is a two stage process as follows:

1. Ascertain the profits of the trade etc computed in accordance with the correct principles of commercial accountancy.
2. Adjust the accountancy profits in accordance with any tax rules or principles which differ from the accountancy principles.

This means that if there are no relevant tax rules or principles which affect a particular case, correct accountancy principles will determine the amount of the taxable profit. This two stage approach was legislated in subsection (1) of section 42 , see BIM31004. It follows on from the view encapsulated by Sir Thomas Bingham M.R. in Threlfall v Jones and Gallagher v Jones [1993] 66TC77 at page 123E:

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.

The tax adjustment in 2 above can be made in two ways:

1. under specific statutory rules, for example ICTA88/S74 (1)(a) which prohibits the deduction of expenditure which is not incurred wholly and exclusively for business purposes,

or

2. under the more general principles which are not specifically stated in the Acts but which are fundamental to the scheme of tax. Thus expenditure which is capital in nature is excluded in calculating the profits although accountancy principles may require it to be deducted in whole or in part, for example depreciation.

The over-riding requirement is that the method shall arrive at the full amount of the profits or gains of the year. In some circumstances the commercial accountancy may be otherwise inapt to determine the true profits or losses of the business and alternative computation methods are used.