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TMI Blog1953 (12) TMI 21X X X X Extracts X X X X X X X X Extracts X X X X ..... ear in question. Moreover, it is claimed that no system will give the true profits of the year unless there is a valuation of stock made (either on market price or cost price) at the beginning and at the end of the accounting period; in other words, if there is a variation between the beginning and the end of the year in the amount of stock, or in its value, those are matters for consideration which are omitted to an extent if the company's method of valuation is applied. The Commissioners found (in paragraph 15 of the case) that the method adopted by the company concerning its base stock in (1)[1912] A.C. 443; 28 T.L.R. 303; 6 T.C. 59. (2)[1949] 65 T.L.R. 725; [1949] 2 All E.R. 889; 29 T.C. 387. (3)[1949] 65 T.L.R. 726; 28 A.T.C. 393. (4)[1925] 9 T.C. 520. (5)[1924] 12 T.C. 773. (6)[1921] 3 K.B. 152; 12 T.C. 382. (7)[1925] 12 T.C. 813. (8)[1921] 2 A.C. 13; 37 T.L.R. 613; 12 T.C. 266. (9)[1944] 26 T.C. 119. (10)[1951] W.N. 390; 32 T.C. 275. (11)[1934] 1 K.B. 548; 18 T.C. 280. (12)[1911] 1 Ch. 92; 27 T.L.R. 76. (13)[1924] 12 T.C. 768. (14)[1940] A.C. 463; 8 I.T.R. Suppl. 57 [1940] 2 All E.R. 76; 23 T.C. 174. its accounts is one of the methods recognized in this particular trad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f their conclusion, accepted the evidence of Mr. Robson in preference to that of Mr. Gower. That may be a fair assumption to make; but the Commissioners have already said that they accept the evidence of both, and nowhere do they say that Mr. Gower is wrong in the view he expressed that the method adopted by the company led to a distorted view of the profits in the relevant year. I mention these matters with the object of saving time in future cases. It is not that which someone says which is of importance. The court ought to have before it the findings of fact of the tribunal ; if those are clearly stated there is usually no need to set out the evidence which is given. It is not easy to state the facts in this case, which involves some technical matters, without reading a considerable part of the case itself. Paragraph 3: "At all stages in the production of yarn, quantities of cotton in various stages of manufacture are either on the machines or are waiting by each machine ready to take the place of the cotton on that machine. The cotton which is actually on the machines and undergoing process is termed fixed process stock and that which is waiting to replace the cotton on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h has been processed, is not taken into account so far as regards the trading account. It is omitted entirely, because on the company's system it is not treated as part of the stock in the ordinary sense but is said to be included in the item of "Land, buildings, boilers and fixed stock" in the balance sheet. It is not in the profit and loss account, or in the trading account. Another matter to notice is that the spare process stock which is included in the trading account is taken, not at its value, but at an arbitrary figure. The third matter of importance is the very large variation in the price of cotton which has taken place over the years. Paragraph 5(3), which I read, shows values from 12½d. a pound rising to 30d., and I think that I am right in saying that the later figures show that by the end of the accounting year the value had risen to 42d. per pound. Paragraph 6 states the practice which had been followed by the company: "(1) In all previous years of assessment the profits of the company and of its predecessor, Broadstone Spinning Company Ltd., were computed for income tax purposes according to the base stock system i.e., the fixed process st ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d that it is in the balance sheet figure of land, buildings, etc. The next four paragraphs in the case concern the witnesses who appeared before the Special Commissioners and paragraph 9 begins in this way: "....the secretary of the company attended and gave evidence before us (which we accepted) to the following effect." He said that it was essential for the economical running of a mill that the machines should always remain clothed, and he described the system of buying and selling the cotton. He said that the fixed process stock was taken into the company's balance sheet as a fixed asset and did not figure in the trading account, and that the directors of the company had always taken the view that that was the way they wished the accounts to be presented to the shareholders, it being their view that a true trading result was arrived at in that way. I think it might well be said that if one had every year the same amount of base stock and fixed process stock, and if the value of it was the same, it would not affect the position of the trading account. But if the amount changes and the value changes, the position is not the same. The secretary is further recorded a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an gather from the figures shown in the case, there have been for some years consistently rising prices for cotton. That means that if the fixed basis is followed year after year their accounts would show profits lower in amount than accounts prepared on the cost or market value basis. The record of the witness's evidence continues: "But, on the basis of the principles which those people who use the base stock method hold, there is no distortion of profits in times of rising prices." The meaning of that is that those who use this principle prefer to look on the base stock in precisely the same way as they look on the machines. In other words, they regard the cotton, the raw material, at one stage as part of their fixed capital merely because it is on the machines. It passes through the machines in the course of a few weeks and is treated just as is any other cotton That is the meaning of Mr. Robson's words, "on the basis of the principles which those people who use the base stock method hold." He added: "Business people who use the base stock method do so because they consider it an appropriate method for their particular businesses; they regard th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provided that there were no violent fluctuations in the cost of the raw material; but in time of violent fluctuations, and in particular in a time of constantly rising prices, in his view, the use of the base stock method could and did give rise to very misleading results." He said that when prices were rising continually, the accounts did not show a fair view of the position. In the present case he said that the quantity of base stock had risen and that in the period under review "the price of raw cotton had risen seriously. The cost of the 'fixed process stock' had increased during the year by something like 10+d. per pound from about 32d. per pound to about 42d. per pound. Valued in accordance with the Revenue's contention at cost, the process stock was worth £ 22,502 at the beginning of the year and £ 37,947 at the end--an increase of £ 15,445. As shown by the company's books, the increase during the year in the value of the process stock was £ 4,289. There was thus a difference of £ 11,156 which had been charged against the profits in this year." He went into further figures, and said that they pointed to the conclu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ck was not a fixed asset. It was just the same as any other cotton bought that passed through the mill and through the machines in the mill, and it ought to be treated as any other cotton was. Another witness, the principal inspector of taxes, said that efforts had been made to get everyone to adopt the system of cost or market price in regard to stock; he had gone into the position and investigated it and he had found that in the cotton trade 88½ per cent. of the spinners were now valuing process stock at cost in their books, and 11½ per cent. were adopting the base stock method, although he added, "the latter concurred in the adjustment to the cost basis for taxation purposes." There is no importance in that from the point of view of the law, but I think that it does show that on the whole it is recognized by accountants who advise trading concerns that when there are violently fluctuating prices the cost or the market value of the stock gives the more accurate result in any accounting period. The first matter for consideration is: what is fixed process stock and what is spare process stock? The answer surely is clear. They are both stock. They are so ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ke it that that was because it had been pointed out by someone, no doubt on behalf of the Revenue that the company could not well claim, even on their valuation basis, to have so much spare process cotton as 45,000 pounds at any one time. It was too much; so they reduced that figure to 23,278 pounds, and thereafter in the accounts the figure of 28d. appears against 23,278 pounds, and the balance of 21,774 pounds is taken at what is said to be the cost price of 32. 1d. a pound. I find it difficult to see any reason for putting on the spare process cotton a lower figure than cost or market price. Prices were rising all the time. When I look at D 2, which shows the figure for the end of the year, I find in the left-hand column the figure of spare process cotton is there put as 76,371 pounds. I do not appreciate the reason for that great increase. True, it is said that the mill was coming into further use, as is shown by the increased cotton on the machines in No. 1 mill, but I should not have thought that there would have been anything like that increase in spare process cotton, and indeed that seems to have been recognized, because in the broad column in the middle, in the same way a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Tax Act, or of that Act as modified by the provisions and schedules of the Acts regulating excess profits duty, as the case may be. For example, the ordinary principles of commercial accounting require that in the profit and loss account of of merchant's or manufacturer's business the values of the stock-in-trade at the beginning and at the end of the period covered by the account should be entered at cost or market price, whichever is the lower; although there is nothing about this in the taxing statutes." As I say, that has been adopted in general and it is sound in practice. The Lord President, in saying that "the ordinary principles of commercial accounting require that in the profit and loss account of a merchant's or manufacturer's business the values of the stock-in-trade at the beginning and at the end of the period covered by the account should be entered at cost or market price, whichever is the lower," was in one sense going into accountancy matters. But I venture to think that that view of his is based on general experience and common sense--one cannot get at the true position unless one takes actual figures as distinct from arbitrary fig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g and the value of the stock-in-trade at the end as two of the items in the computation." There is one other authority to which I should like to refer. Mr. King directed our attention to the Sun Insurance Office v. Clark (Surveyour of Taxes)* of which the headnote reads: "A company carrying on the business of fire insurance had made a practice of carrying forward annually, in its published accounts, as a reserve, 40 percent. of the yearly premium receipts representing estimated losses on unexpired risks, and had claimed to be assessed on this basis. It was found as a fact by the Commissioners that 40 per cent. was a reasonable and proper allowance, and the company's claim was admitted. The Crown contended that the company was not legally entitled to the allowance. Held," (by the House of Lords) "that The General Accident, Fire and Life Assurance Corporation v. McGowan notwithstanding, there is no rule of law as to the admissibility of an allowance for unexpired risks in estimating profits, but the question is one to be decided by reference to the facts in each case; and that on the facts found in this case the allowance claimed was a proper allowance to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rejected because there was no evidence that it would be a reasonable way of ascertaining what was desired. "The second method suggested in that case was that of merely taking for each year the sum total of the premiums received and the sum total of the losses paid and subtracting the one from the other, without regard to the fact that the premiums cover risks running on into subsequent years and the losses include losses arising out of contracts made in previous years. This method is of course not precise of scientific. It proceeds upon the view that when this is done for the three consecutive years indicated by the statute and the figures thus reached are averaged, a fair and reasonable conclusion is attained. This method was adopted long ago and has more than once been the subject of consideration in courts of law. I can conceive it being unfair either in the case of a rapidly increasing or of a rapidly diminishing fire insurance business. It may prove unfair in both cases. But in McGowan's case* it was not proved to be unfair. On the contrary it closely corresponded with the dividends actually distributed and was upon the facts of that case clearly the most accurate a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ne or two or three methods of arriving at the profits for the relevant period. The one which shows most accurately the position between the revenue on the one hand and the taxpayer on the other hand is the one which ought to he adopted. In other words, it is not sufficient to say that a particular system of accounting is a well recognised system of accounting and all right during normal times, if the contention on the other side is that the system does not give a true result for the particular year, the accounting year. That was the case which the Crown put forward before the Special Commissioners. It is shown by their contentions, particularly the one to which I have already referred, but the Special Commissioners, although they had this case before them for quite a long time, failed to consider that contention. I would state these general propositions: (1) One cannot arrive at the profits of the year without taking into account the value of the stock one has at the beginning of, and at the end of, the accounting year. (2) The figures for stock are just as important as any other figures. Values may have to be estimated when market price is account. (3) Stock should be taken eith ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... appeal by the company from the assessment made on them by what I may call the Gower method of assessment. The company took the view, and submitted to the Special Commissioners, that they were not bound by that method at all, and were entitled to have the figures for income tax assessed on the system which they and their predecessors in trade had used for almost 50 years. That vas the issue before the Special Commissioners. I was very much impressed by the argument of Mr. King that the only question before this court was whether there was evidence to support the findings of the Special Commissioners. If the answer to that question was in the affirmative, he submitted, then this court had no course other than to support the decision of the Special Commissioners and reverse the judgment of Vaisey J. During the argument I was at some pains to try to ascertain the real question which this court had to determine. The question formulated by the Special Commissioners on the lace of it seems complete. The question for their determination was "whether the company was entitled to have its profits computed for income tax purposes according to the base stock system." Mr. King said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ereinafter provided, on the full amount of the profits or gains or income of the year preceding the year of assessment." The Rules applicable to Cases I and II in the Income Tax Act, 1918, provide: "(1) The tax shall be charged without any other deduction than is by this Act allowed." "(3) In computing the amount of the profits or gains to be charged, no sum shall be deducted in respect of......(e) any loss not connected with or arising out of the trade, profession, employment or vocation", and "(f) any capital withdrawn from, or any sum employed or intended to be employed as capital in such trade, profession, employment or vocation." I should have thought that the true question property formulated and properly stated for the Special Commissioners was this: did the base stock method of accountancy, for which this company contends, correctly ascertain the full profits as enjoined by section 29 for income-tax purposes for the year of assessment in question? I do not think that they really answered that question. I have looked again at the evidence of Mr. Robson on which Mr. King placed so much reliance, and I had in mind his criticism of Vaisay J., ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the evidence of Mr. Robson. Perhaps I may refer to what Lord Porter said in Asia Mill Ltd. v. Ryan (H.M. Inspector of Taxes)*: "Moreover what may be prudent accountancy for a company is not necessarily the correct method of ascertaining the proper assessment for income-tax." I am bound to say that the view which I have taken of the findings of the Special Commissioners here is that they were concerned almost wholly with the first part of that sentence of Lord Porter. The base stock system is the appropriate method for this company winch it has adopted consistently for its own purposes, for company purposes; but I do not think the Commissioners have really addressed themselves to the true question in this case: did this base stock method of accountancy correctly ascertain the full profits for income tax purposes for the year of assessment? Quite naturally, all sorts of subsidiary questions thereupon arise, as, for example, did the base stock method have the effect of making deductions from profits which are expressly or by necessary implication forbidden by the Act of 1918 or any other relevant taxing statute? But if we are asked to say: That if there be evidence to ..... X X X X Extracts X X X X X X X X Extracts X X X X
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