You should allow the normal professional costs of preparing tax
computations and supporting accounts.
In the cases of Smith’s Potato Estates Ltd v Bolland
[1948] 30TC267 and Smith's Potato Crisps (1929), Ltd v
Commissioners of Inland Revenue, 30TC267, the company in the first
case (the Estates Company - Estates) was a wholly owned subsidiary
of the company in the second case (the parent company) and was
formed to purchase and work an estate.
In computing Estates’ profits for Excess Profits Tax
[EPT] purposes the Commissioners of Inland Revenue decided that
only just over half of the estate manager’s remuneration
should be allowed. The appellants were of the opinion that if this
decision were upheld, similar decisions, which it would then be
almost impossible to resist, would be made for subsequent
chargeable accounting periods. For these subsequent periods there
would be a right to recover from the manager the additional EPT
resulting from the decisions and it was thought that the parent
company, being a public company, might be bound to exercise this
right. Such action might seriously prejudice the company's future
by causing the loss of the services of the manager. The appellants
therefore appealed against the decision to the Board of Referees,
who held that 90% of the manager's remuneration was allowable. In
conducting the appeal the Estates company incurred expenditure of
£622 on legal costs and accountancy fees.
On appeals to the Special Commissioners against an assessment
to IT under Case I of Schedule D on Estates and an assessment to
EPT on the parent company in respect of its subsidiary's profits,
the appellants contended that the expenditure of £622 was
allowable as a deduction in computing profits for IT and EPT
purposes. The Crown contended that the case was indistinguishable
in principle from Allen v Farquharson Brothers & Co [1932]
17TC59 (see
BIM37840), and that the appellants'
motive in conducting the appeal was irrelevant. The Special
Commissioners dismissed the appeals.
The Crown lost in the High Court, won a unanimous verdict in
the Court of Appeal and was successful by a three to two majority
in the House of Lords.
The company argued that if the cost of preparing its accounts
was allowable for tax purposes then the cost of the appeal to the
Board of Referees should be similarly allowable - the purpose of
the appeal, as with the drawing up of accounts, being to ascertain
the correct profits. Lord Porter began by saying that the dicta in
Strong & Co of Romsey Ltd v Woodifield [1906] 5TC215 (see
BIM37300) should not be pressed too far;
the dicta merely gave a gloss on the statutory wording. It is safer
to stick to the actual statutory words and consider if the facts in
an individual case satisfy the test imposed by what is now
ICTA88/S74 (1)(a).
Lord Porter went on to explain that accounts may be drawn up
for a variety of purposes and the costs of preparation and
agreement must be considered in the light of the purpose or
purposes served. Lord Porter gave express approval to the practice
of allowing a deduction for the costs of preparing accounts for
submission to the Revenue; costs that in strictness are not
allowable - the expense being for the purpose of computing the
profits rather than expended in earning the profits.
Lord Porter then explained why the specific costs claimed in
this case were not allowable; the costs were incurred solely for
the purpose of ascertaining a tax liability and nothing else.
Finally Lord Porter dealt with the argument that because EPT was imposed on a person only because they carry on a trade the costs of dealing with matters arising must be trade expenses. Lord Porter acknowledged that only a trader is liable to pay EPT, but it is not payable by the trader as a trader. The trader pays as an individual, like any other individual, tax on the sum that they have earned as a trader.
For those who do not have ready access to tax case volumes, the part of Lord Porter’s judgement commenting on Strong & Co is set out below, 30TC foot of page 287 and head of page 288:
The argument, so far, extends only to
expenditure incurred for the purpose of finding out what the
balance of profits or gains is, but, it is said, if the cost of
ascertaining that balance by making up the Company's accounts is
wholly and exclusively laid out for the purposes of its trade, so
the expense of ensuring by an appeal to the Board of Referees the
correctness of the figure reached is equally wholly and exclusively
laid out for that purpose.
The opposite view, maintained by the Crown, is
perhaps best expressed in the case of Strong and Company of Romsey,
Ltd. v Woodifield, [1906] A.C. 448, at page 453 (5TC215, at page
220), where Lord Davey says:
‘These words ... appear to me to mean for the purpose of enabling a person to carry on and earn profits in the trade’.
My Lords, that expression has often been referred to and approved, but it was used in reference to the circumstances of the case then under consideration, and I doubt if it carries the matter to a final conclusion. It still leaves open the question: What expense is incurred for the purpose of enabling a trader to earn profits? and the adoption of a phrase helpful in analysing the meaning of words in an Act of Parliament with reference to a particular set of circumstances is not necessarily either useful or conclusive in all cases. It is probably safer to retain the wording of the Act itself and, by applying it to the facts established, to discover whether the deduction falls within its terms or not.
For those who do not have ready access to tax case volumes, the part of Lord Porter’s judgement giving express approval to the practice on the deduction of accountancy fees is set out below, 30TC middle of page 288:
Regarding the circumstances which your
Lordships have to consider from this point of view, I should myself
draw a marked distinction between accounts made up on the purely
trading basis and those which are prepared for and accepted by the
Inland Revenue. If there were no obligation to ascertain and pay
either of these taxes, there would be no necessity for making up
accounts on Income Tax principles, it would suffice to make up the
ordinary commercial accounts. The computation of accounts for tax
purposes is therefore not directly associated with the carrying on
of the business. It is an obligation imposed upon the Company for
another and extraneous purpose, that is, for the purpose of
ascertaining the tax to be paid out of profits. It is not, at any
rate directly, undertaken for trade purposes but to satisfy the
Revenue authorities.
It is true that as a matter of convenience the
cost of making up accounts for the Inland Revenue is allowed by the
authorities as a deduction from profits, as is the cost of making
up the strictly business accounts of the trade, but this is not a
matter of principle but of expediency. The two duties overlap and
in practice are almost indivisible. Moreover it is of advantage to
the Revenue to have the figures required for their purposes
carefully and accurately made up. Strictly, however, I think the
expenses should be divided, and any additional cost of making up
Revenue accounts should be disallowed in determining the allowable
deduction for Income Tax purposes, but the advantages of allowing
both to be deducted as a practical measure outweigh the
disadvantages, though the result may not be strictly
logical.
For those who do not have ready access to tax case volumes, the part of Lord Porter’s judgement explaining why no deduction was due is set out below, 30TC towards the foot of page 288:
But no such illogicality has to be faced when
the sum which is alleged to be deductible is not the cost of
accountant's work ascertaining trading profits, but the expense of
an appeal to the Board of Referees for the purpose of discovering
the true measure of profits for tax purposes only. Such expenditure
is incurred directly for tax purposes and for nothing else, though
it may indirectly affect both the amount available for distribution
to the proprietors of the business and that proper to be put to
reserve.
This is the conclusion which I should have
reached if left to determine the question unassisted and
unembarrassed by authority. It remains to be determined whether
your Lordships' decisions in previous cases throw doubt upon this
view.
For those who do not have ready access to tax case volumes, the part of Lord Porter’s judgement explaining why the restriction of EPT to traders does not make the cost of computing the tax an allowable deduction is set out below, 30TC foot of page 289 and head of page 290:
So far as Income Tax is concerned there is
direct authority in the High Court in Allen v Farquharson Bros. and
Co. (see BIM37840),
that the cost of opposing the Inland Revenue
in a contest as to what the profits of a business are, is not
deductible. But it is said that case merely followed Strong v
Woodifeld (see BIM37300),
and in any case Excess Profits Tax differs
inasmuch as it is imposed on a trader only and therefore the cost
of ascertaining it is part of the trade. I do not accept this
contention. It is true that a trader only is liable to pay it, but
it is not payable by him as a trader. He pays as an individual,
like any other individual, tax on the sum which he has earned as a
trader.
‘To my mind’, said Lord Selborne,
L.C., in Mersey Docks and Harbour Board v Lucas (1883), 8 App. Cas.
891, at page 905 (2TC25, at page 29), ‘it is reasonably plain
that the gains of a trade are that which is gained by the trading,
for whatever purposes it is used’, and therefore what your
Lordships have to determine is whether the expense is incurred in
order to earn gain, or is the application or distribution of that
gain when earned. With all respect to the opposing view,
expenditure to ascertain the true amount of tax to be paid, whether
it be Income Tax or Excess Profits Tax, and whether successful or
unsuccessful, is, in my opinion, incurred, at any rate in part, in
order to determine the correct amount of Income Tax or Excess
Profits Tax, as the case may be, and not in order to earn gain,
even though that phrase be given a broad significance. The same
conclusion might be reached by saying, in the words of this
statute, that such expense is not wholly or exclusively laid out
for the purposes of trade. It is in truth partially, if not wholly,
laid out in order to discover what sum is to be paid to the Crown
out of the profits or gains, which have already been earned and
computed.
