TMI Blog1971 (5) TMI 66X X X X Extracts X X X X X X X X Extracts X X X X ..... contended) was unacceptable in law for the purposes of section 127, even though it might be commendable as a matter of prudent accounting and might cause no loss to the revenue, taking one year with another, or whether (as the taxpayer contended) the profit figure returned was acceptable for all purposes, including the tax purposes of section 127. The facts are set out in their Lordships' opinions. F. Heyworth Talbot Q. C., C. N. Beattie, Q. C., Michael Nolan Q. C. and Denis Carey for the appellant, the taxpayers. H. H. Monroe Q. C. and Patrick Medd for the Crown. May 5, 1971 LORD REID. My Lords, the appellants carry on a very large business selling shoes by retail : they have about 790 shops. They buy their shoes wholesale. Normally they fix their selling prices by adding a mark up of about 37 per cent. to the prices which they have paid. But for various reasons such as change of fashion or severity or mildness of the weather they often find that a particular line is not selling as well as they had hoped it would. Then they have to reduce the selling price, generally in their annual sale in January. They make up their accounts on December 31, so th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on as regards stock-in-trade. If it were applied logically, stock-in-trade must always be valued at the end of the year at cost, even if it could have been bought at the end of the year much more cheaply. But for half a century at least traders have been allowed to value such stock at the end of the year at its market price or market value at that date if that is lower than the original cost price : on the other hand, the trader is not required to value his stock at market value if that is higher than the original cost. So to this extent he can diminish his profit in year one by setting against it an anticipated loss in year two. It is only an anticipated loss because the market price may move upwards before he sells the stock so that when he does sell it he gets a price equal to or greater than the original cost and so never in fact suffers any loss. If that happens the matter is put right in year two. The effect of carrying forward the stock at a valuation below cost is that in the account for year two that valuation and not the actual original cost is deemed to be the cost, and so the profit in year two is increased. That exception has been expressed by the phrase cost or m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the goods were sold. I cannot see how in such circumstances the marked reduced prices can be regarded as market prices on the date when the account was closed. But we are not looking for theoretical perfection. We are looking for a solution which is not too cumbrous in operation and which produces a reasonably fair result. I have no doubt that in many, perhaps in most, cases the Crown's method fulfils these requirements. But I am not satisfied that it does so in this case where large sums are involved in rather unusual circumstances. What we are looking for is a method of ascertaining value at a particular date where there is no market and no market price. Then one method at least would be to ask what the taxpayer will ultimately get for his stock after performing all necessary operations before it can be sold and to deduct a fair estimate of the total cost of these operations. The Crown are willing to go some distance in this direction by deducting direct expenses connected with the sale, but it seems to me that in some cases that must be insufficient. Suppose a trader had such large stocks that during the next year the chief function of his shops was to sell off this stoc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed in cost or market value, whichever is the lower. The purpose of the concession is to enable taxpayers to anticipate loss so that if the situation does not change there will be no loss in the next year, but not so that there will be a profit in the next year. It appears from the case stated that the appellants' accountant justified this method as producing a fair allocation of profits and losses to different periods. That may well be good commercial practice. It may present to the shareholders and to the public a better picture of the company's financial position as a whole than a more conservative method of writing down depreciated stock in hand. But just as the Crown's contention appears to me to allow too little latitude so this appears to me to allow too much. The question then arises whether the appellants ought to be compelled to change their present system of valuing this kind of stock. It appears that it had been in operation for at least 30 years- probably longer, but earlier records have been destroyed. The revenue were well aware of this but never objected until 1959. If they are right in now saying that the appellants throughout that period were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method because they think it gives a better picture of their results. But in my judgment this House ought to avoid if possible a decision which results in taxable profits escaping taxation. To sum up, in my view the Crown's method, though rough and ready, generally produces a reasonable result though in this case it brings out too high a figure. The appellants' method is liable to abuse but in this case it brings out a result which is reasonable and it cannot be said to conflict with any rule of law. I think the Crown are quite entitled to prevent anyone from changing to this method, but it is another matter to require the appellants to abandon it. In my judgment the disadvantages of making a change outweigh the advantages. I would therefore allow this appeal. LORD MORRIS OF BORTH-Y-GEST. My Lords, for valid and justifiable reasons the appellant company keeps levels of stock which, in relation to turnover, are very high. Experience has shown that this has been necessary so that sales should be maintained. The vagaries of the weather as well as changes in fashion and style make it impossible to predict with certainty which lines will, in a particular period, prove to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g a sum by way of net profit. Thus, if there were a mark up of 33+ per cent. a selling price of 150 would be fixed in the case of an article which it had cost the company 100 to buy. The mark up would be decided upon by the directors from time to time as the average overall margin which the company would hope to achieve : some measure of discretion in the application of the mark up as between different lines was given to the buying department. In respect of the stocks on hand at the end of a year which it was expected could only be disposed of by selling them at reduced prices the method adopted by the company for accountancy purposes has been as follows. In the first place, those reduced prices have to be decided upon. This requires the application of the skill, the knowledge and the experience of the retailer. There will be some stocks which will already be on sale at reduced retail prices and which it is expected will only be sold if retail prices are further reduced. On a consideration of all these matters figures are arrived at of the amounts which the company expects to be able to obtain for the goods, i.e., the expected retail selling prices. No question is ra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s be deducted the known or anticipated direct selling cost (salesman's commission). As this deduction is accepted by the Crown I do not find it necessary to consider the basis of it. All general items of expenditure would separately appear in the accounts. The view of the special commissioners was that the practice followed by the company produced a valuation of stock below that which the law allows for computing profits for tax purposes and that the authorities required them to adopt the basis of valuation put forward by the Crown in place of that which had been followed by the company. They regarded it as established law that in computing the profits of a trader for the purpose of assessment to income tax under Case I of Schedule D stock-in-trade could be entered at cost or market value whichever is the lower : but that it was not permissible to enter stock at a value (being below cost) which is lower than what is sufficient simply to anticipate the loss expected to be realised when the goods are sold. In carefully reasoned judgments Cross J. and in the Court of Appeal Russell, Salmon and Megaw L. JJ., agreed with the result reached by the special commissioners. It w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly arise when some express statutory direction applied which excluded ordinary commercial practice. Before the special commissioners, as the stated case records, evidence was given by two experienced and eminent accountants. One took the view that the method of accountancy adopted by the company was appropriate : the other took the contrary view. The evidence did not show that the company's method was to be recognised as being established settled commercial practice though its exponent did consider that it represented a modern and sophisticated form of accounting in contrast with that of the Crown which was stigmatised as being old-fashioned. He accepted that there is more than one method employed by accountants and traders in determining market value and he said that one well-accepted method is to take the lower of replacement price and net realisable value. He considered that the replacement price as calculated by the company produced a fair allocation of profits and losses to different periods because it fairly measured the adverse circumstances regarding the stocks held at the accounting date. The other accountant took the view that the company's method of valuation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ethod it has to be decided which of the two is the better calculated to show the full amount of profits and gains. In my view, there is (for tax purposes) an unreality in taking the calculated figures for which the company contend. They have stock-in hand at the end of a year. They have planned to have it. Most of it they expect to sell at a profit. They have vast selling organisations. Their main business is to sell. It is an accepted principle that profits are not to be taxed until they are realised. So it would not normally be fitting to enter the stock-in-trade at the figure of selling price. The figure of cost price would be more appropriate. It is an actual figure and a real figure. It may be, however, that it can be seen that some of the stock will be sold at a loss. It has been accepted that in such circumstances the selling price, if it is below cost, may be given as the figure. I agree with the view expressed by Salmon L. J. that this is in the nature of an exception or concession in favour of the taxpayer. This may well be somewhat illogical, as my noble and learned friend, Lord Reid, pointed out in Duple Motor Bodies Ltd. v. Inland Revenue Commissioners [1961] 1 W. L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... It may seem strange in the first place to start calculating a replacement price when there is neither need nor desire to replace. The company has goods which it has bought for re-sale, If it is correct that the alternative to cost price is that by way of concession to the taxpayer market price (if lower) may be taken I would have thought that in this context (the context of the time-honoured formula) market price would denote the price at which the goods held for sale would be marketed. The company are in the best position to know what such market price is. Their very business is to market their goods. The prices which they can obtain in their hundreds of shops must form the surest guide to the prices in the markets which are peopled by the persons to whom they sell. So far as any decided cases throw any light on this matter I would agree with Cross J. that though the decision of Rowlatt J. in Brigg Neumann Co. v. Inland Revenue Commissioners [1928] 12 T. C. 1191, may show that there may be some cases in which the wholesale market value may be taken as the appropriate market value the case does not establish that a retailer who on a retail sale will sell at a price above what it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the profits of their trade for income tax purposes at market values or at what the appellants have described as replacement values. The latter values have appeared in their accounts for about 30 years and these have been accepted by the revenue for income tax purposes. But in 1959 the revenue insisted that market values should be taken. The reason put forward for the change was that the valuation at replacement values was not in accordance with the principles of the Income Tax Acts. There is no doubt that the method of computing profits according to commercial accountancy practice holds some validity but the computation must not conflict with the principles of the Income Tax Act. (Duple Motor Bodies Ltd. v. Inland Revenue Commissioners [1961] 1 W. L. R. 739). It would be reasonable that a trader's stock at the relevant period should be valued at cost price. But as a concession to the taxpayer it has long been accepted that where the market value is less than cost price, then the lower figure may be taken for the purposes of valuation : see Whimster Co. v. Inland Revenue Commissioners **. This concession is really inconsistent with the principle that the computations ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ethod more fairly and reasonably represents the profit of the appellants' business and they have shown that the appellants' method is less preferable than their own. I would dismiss the appeal. VISCOUNT DILHORNE. My Lords, for some 30 years the appellants have followed the same system in valuing their stock both for determining the results of the year's working and their profits and gains for the purposes of income tax. Throughout this period the revenue have not challenged the propriety of the system but they now contend that a different method of valuation should be used ; and based on that method they have made the assessment for the year ended December 31, 1959, which is the subject of this appeal. For the purposes of their business the appellants carry very large stocks, the boots and shoes in stock at the end of the year amounting to about a third of their annual sales. The correct valuation of their stocks at the year's end is consequently of great importance, not only for the purposes of income tax but so that the company may know and its shareholders be informed, as accurately as can be ascertained, what were the profits for the year. If the sto ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to pay for similar boots and shoes. Bearing in mind the company's position as one of the largest retailers of boots and shoes in the kingdom, it is perhaps unlikely that any other retailer would at that time be prepared to buy them at a higher price. They thus contend that the highest price they would pay is the replacement value of the stock and that it is right to enter that figure in the valuation when it is less than cost. Cost or market value, whichever is the lower has long been recognised as an appropriate method for the valuation of stock but it is not the only method which may be used. Whatever method or system is used, the object must be to give as true a picture as possible of the year's working (Patrick v. Broadstone Mills Ltd. [1954] 1 W. L. R. 158, 173, per Singleton L.J.). It is, as my noble and learned friend, Lord Reid, said in Duple Motor Bodies Ltd. v. Inland Revenue Commissioners [1961] 1 W. L. R. 739, 756, not a substantive rule of law that stock must be valued at cost or market value whichever is the lower. Lord Clyde, when he said in Whimster v. Inland Revenue Commissioners [1926] S. C. 20, 25, 26, that the ordinary principles of commercial acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ean that the company will not suffer a loss on the sale. Whether or not it does so, will depend on whether the margin between that figure and the cost is sufficient to cover that part of the other expenses of the company attributable to the sale. The revenue's contention is that only if the reduced retail price less the known expenses directly referable to the sale is lower than cost, can a lower figure than cost be entered in the valuation. If the profit element is not also deducted that will prevent the company from including a figure lower than cost in cases where, if it had been deducted, they would have been able to do so. On the revenue's basis the net profit element remains included in the adjusted selling price. It is taken into account in making the valuation and, as I have indicated, may affect the entries made therein. To some extent profits which may be realised in a following year are anticipated. I cannot think that this is right. Further, if it is recognised that some expense related to the sale must be deducted from the retail price, why should the deduction be limited to only some of the expense, such as the salesman's commission ? Why should not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ths before delivery he held that the commissioners were right in holding that the cost of purchasing the cloth if ordered three months before the accounting day could be entered in the valuation as the value of the cloth if that cost was lower than actual cost. This is an instance of the cost of replacement being regarded as the value of the stock. The revenue did not appeal from this decision. Another way of arriving at the value of stock is to take the price at which it is hoped to sell the goods in the future and to deduct from that price the profit element and the expenses referable to the sale. The appellant's figures have been arrived at in this way for they deduct the mark-up. The revenue as well as the appellants start their calculations by taking the retail selling price but they deduct only a part, and it may be only a small part, of the expense and nothing in respect of profit. And this difference in the sums they deduct accounts for the difference between their figures. To my mind it has not been established that the appellants' method is wrong and I am far from satisfied that the revenue's method is right or better. The phrase cost or market v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is held by a retailer or manufacturer if it be the case that similar goods could be bought on the accounting day. True it is that wholesalers and retailers are not engaged in making articles but in distributing and selling them but that difference in function does not, in my opinion, warrant a different interpretation of the words in question. If the value of stock is its retail selling price, what justification is there for valuing it at cost ? Surely if that is its true value, all the stock held should be valued at its selling price whether that be above, below or the same as the cost. The fact that this is not done may be an indication that its retail selling price is not its value to a retailer. I do not myself regard the fact that market value if lower than cost can be entered in the valuation as something in the nature of a concession to a manufacturer or trader. If goods have dropped in value below cost at the time of valuation, to value them at cost is to over-value them. There has been a loss on those goods not then realised but which, if correctly valued, would be realised if sold on the accounting date. In Edward Collins Sons Ltd. v. Inland Revenue Commissioners ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at after making the deduction of the mark-up as the replacement value when it might equally have been called the net realisable value. Even if the revenue's method is better and more right than that of the appellants-and for the reasons I have given I do not think it is-I still would be in favour of allowing the appeal. In Duple Motor Bodies Ltd. v. Inland Revenue Commissioners * this House was asked to choose between two different methods of valuation. There, as here, there were differences of opinion between accountants. There the House expressed the view that, if a method had been applied consistently in the past, it should not be changed unless there was good reason for the change sufficient to outweigh any difficulties in the transitional year. Here, in my view, there are not good reasons for the change, but even if I accepted the revenue's contentions as good reasons for a change, I would not think they outweighed the difficulties that must ensue, which are either that the taxpayer will pay tax twice on some part of his profits or that a substantial sum will entirely avoid tax. As I see it, no question of law is involved in this case. All we are asked to do is t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsold for too long (as they may do for instance in the event of a change of fashion or unexpected weather conditions) and the retail selling price has to be marked down, then the appellants, instead of retaining the goods in their books at cost price, write them down to a figure equal to the reduced retail selling price less the mark-up. The mark-up is a percentage of the retail selling price. For convenience of illustration the mark-up has in the course of argument been assumed to be 33 1/3 per cent. though the appellants' mark-up would normally be somewhat higher. Then goods bought at 100 units of price would have initially a retail selling price of 150. But if the goods remained unsold for too long and consequently the retail selling price was reduced to 100, the goods would be written down to 66 2/3 in the appellants' books. The question is whether the appellants' system of stock valuation is acceptable for tax purposes. As it had been accepted by the Inland Revenue for many years up to 1959, it is now for the Inland Revenue to justify their rejection of it for 1959 and subsequent years. In order to do this, I think the Inland Revenue must show that the system is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting to the whole of the stocks. The total of the original retail selling prices was ? 3,668,087. The total of cost (arrived at approximately by subtracting the mark-up) was ? 2,303,925. The reduced total of expected retail selling prices was ? 3,246,272. Thus the valuation at cost was nearly ? 1 million below the total of expected retail selling prices. And yet according to the appellants' system the valuation at cost was reduced to ? 2,038,843, being approximately ? 1.2 million below the total of expected retail selling prices. (ii) Secondly, I will take the window samples which were slightly reduced in price owing to possible damage in the course of window display. The original retail selling price was ? 300,000. The original cost (arrived at as mentioned above) was ? 188,430. The expected retail selling price after reduction was ? 285,000. Thus the valuation at cost was nearly ? 100,000 below the expected retail selling price. And yet according to the appellants ' system the valuation at cost was reduced to ? 178,997, being more than ? 100,000 below the expected retail selling price. (iii) Thirdly, I will take some figures relating to the January, 1960, sale stock ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... atural course of action is to sell off these goods at a cheap price in his half yearly sales. It is there that he may make a loss. He is not vitally concerned with the wholesale price at which he might buy more of the goods, because he does not need to buy more of them and probably does not wish to do so. It he did seek to buy more of the goods, he would presumably have to order them to be made by the manufacturers and to pay at least as high a price as the original cost, unless some manufacturer happened to have manufactured in anticipation of demand and had some unsold goods for disposal at reduced prices. The Inland Revenue have taken the market value in the application of the usual formula to be the net realisable value, arrived at by subtracting from the expected retail selling price the amount of the salesman's commission. It appears from the case stated that it was suggested on behalf of the company that there might be other items of direct selling cost, besides the salesman's commission, which should be taken into account, but no attempt was made to specify them or attach a figure to them. In these circumstances I wish to reserve the question whethe ..... X X X X Extracts X X X X X X X X Extracts X X X X
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