Revenue & Customs v. William Grant & Sons Distillers Ltd (Scotland)

Factual and Procedural Background

Appellant Company A manufactures confectionery and pet food, while Appellant Company B produces Scotch whisky. For the accounting periods ending in 1996 and 2002 respectively, both companies prepared accounts in accordance with prevailing accounting standards. Those accounts divided annual depreciation of tangible fixed assets into two elements:

• A: depreciation attributable to goods sold during the year or to non-production assets (deducted in the profit and loss account);
• B: depreciation attributable to unsold stock (carried forward in the valuation of closing stock).

The Respondent, Defendant (the taxing authority), added back element B when computing taxable profits under section 74(1)(f) of the Income and Corporation Taxes Act 1988. The Special Commissioners allowed appeals by Company A and Company B, finding that element B had not been deducted and therefore need not be added back. On further appeal the High Court (for Company A) and the Court of Session (for Company B) reversed those decisions. The present consolidated appeals to the House of Lords are brought by Company A and Company B seeking restoration of the Special Commissioners’ determinations.

Legal Issues Presented

1. Whether depreciation included in the carrying value of unsold stock (element B) has been “deducted” in computing trading profits for tax purposes so that it must be added back under section 74(1)(f) of the Income and Corporation Taxes Act 1988.
2. Whether generally accepted accounting principles, as embodied in SSAP 9, SSAP 12 and FRS 15, are compatible with statutory requirements in the Companies Act 1985 and the tax code for computing taxable profits.

Arguments of the Parties

Appellants' Arguments (Company A and Company B)

• Their accounts, prepared in accordance with SSAP 9, SSAP 12 and FRS 15, give a true and fair view; only element A was deducted in the profit computation, so element B cannot be “added back.”
• Accounting standards expressly permit depreciation relating to unsold stock to be carried forward as part of stock cost, to be matched against revenue on future sale.
• Nothing in the Companies Act 1985 or section 74(1)(f) requires simultaneous recognition of depreciation in both the balance sheet and the profit and loss account.

Defendant's Arguments

• Under fundamental accounting principles and the Companies Act 1985, the whole annual depreciation must first be deducted; consequently an equal amount must be brought back as a credit for closing stock, meaning element B is notionally deducted and therefore must be added back for tax.
• Accepting the Appellants’ treatment creates a “category mistake,” because stock is an asset, not a cost, when valued in the balance sheet.
• The judgment in Commissioner of Inland Revenue v Secan Ltd supports the view that costs carried in stock are nevertheless deducted in the year incurred.

Table of Precedents Cited

Court's Reasoning and Analysis

Delivering the leading opinion, Judge Hoffmann held that modern accounting standards (SSAP 9 and FRS 15) require matching costs with revenues so that depreciation relating to unsold stock is carried forward as part of stock value. Consequently:

• Only element A was actually deducted in computing the year’s profit; element B was never charged to the profit and loss account.
• Section 74(1)(f) disallows deductions “in respect of capital”; because element B was not deducted, nothing in that provision mandates its addition back.
• The Respondent’s attempt to superimpose a “fundamental” accounting rule contradicts the explicit guidance of current standards and has been rejected in earlier authority (Odeon; Gallagher).
• Companies Act 1985 requirements (Schedule 4, para 18 and Note 14) do not prescribe the timing of depreciation recognition, and the overriding statutory test remains the provision of a true and fair view.
• Reliance on Secan was misplaced; the judgment does not compel treating capitalised costs as simultaneously deducted.
• The Court of Session majority erred by conflating bookkeeping entries with profit computation and by ignoring the evolution of accepted accounting practice; the dissenting opinion of Judge Reed correctly applied those principles.

Holding and Implications

HELD: Appeals ALLOWED; decisions of the Special Commissioners RESTORED.

Element B (depreciation embedded in unsold stock) need not be added back when computing taxable profits because it was never deducted. The ruling affirms that taxable profit computations must follow current generally accepted accounting practice unless expressly overridden by statute. While the decision clarifies the interaction between accounting standards and section 74(1)(f), it creates no new statutory rule; its immediate effect benefits the Appellant companies and guides future disputes on the treatment of capitalised costs.