[2010] UKFTT 92 (TC)

TC00403

Appeal number: SC/3007/2008

Income tax-Sch D-computation of profits-section 42 FA 1998-generally accepted accounting practice-whether accounts prepared in accordance with accounting standards

Income tax–section 29 TMA 1970-discovery-whether negligent conduct if accounts not prepared in accordance with generally accepted accounting practice

LONDON TRIBUNAL CENTRE

LESLIE SMITH

- and -

THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE AND CUSTOMS

Tribunal:CHARLES HELLIER (Chairman)

JOHN CHERRY

Sitting in public in London on 30 November, and 1, 2 and 3 December 2009

David Southern, for the Appellant

Barry Williams of Local Compliance, Appeals and Review Unit, for the Respondents

© CROWN COPYRIGHT 2010

1

DECISION

1. Introduction

  1. These appeals relate to the accounting practice adopted in drawing up the appellant’s trading accounts. HMRC say that it was wrong. As a result they say that the taxable profits of the business were misstated for a number of years.
  2. HMRC say that, in adopting this practice, the appellant's accountants were negligent and accordingly that they are entitled to raise assessments outside the usual limits.
  3. Terminology: throughout this decision we refer to the year ending on 5 April 2001 as the "2001" year rather than the 2000/2001 year, and similarly for other years.
  4. On 14 January 2003 HMRC opened an enquiry into the appellant's 2001 tax return. This enquiry was opened within the time limits in section 9A TMA.
  5. On 21 October 2004 HMRC wrote to the appellant indicating that they intended to enquire into the 2002 return. This was not an enquiry which could be pursued under section 9A TMA because under section 9A(2) such an enquiry had to be opened before 1 February 2004.
  6. On 13 December 2005 HMRC issued an assessment for 2002 in reliance on section 29 TMA assessing additional profits of £200,000.
  7. On 2 February 2006 HMRC issued a closure notice in respect of 2001. This amended the 2001 return to reduce the assessable profits of that year by £105,483.
  8. Also on 2 February 2006 HMRC issued assessments in respect of the years 1998, 1999, and 2000. These assessments were made in reliance on section 29 TMA, and, for 1998 and 1999 HMRC say they could be made outside the six-year time limit imposed by section 34 TMA by reason of section 36 TMA. The operation of section 29 and section 36 was dependent upon there having been negligent conduct of the taxpayer or a person acting on his behalf. HMRC’s contention is that the actions of the appellant's accountants constituted negligent conduct.
  9. On 26 February 2008 further assessments were made in respect of the 1994 1995 and 1996 years, again in reliance upon sections 29 and 36. In those years the appellant's accountants were different from those who had acted for him in the later years.
  10. On 30 April 2007 HMRC also issued a penalty determination in reliance on section 95 TMA for each of the years 1998 to 2002, on the basis that Mr Smith had negligently delivered incorrect returns. These determinations were withdrawn at the start of the hearing before us. Mr Williams said that the respondents accepted that even if Mr Smith's accountants had been negligent, as they alleged, such negligence did not translate into the negligence of the taxpayer which was necessary for such a penalty and negligence by Mr Smith himself was not alleged.

2. The Law

  1. Section 42 FA 1998 provides in relation to the years 1998 to 2002 that:

"(1) For the purposes of Case I or II of Schedule D, the profits of a trade, profession or vocation must be computed on an accounting basis which gives a true and fair view subject to any adjustment required or authorised by law in computing profits for those purposes."

  1. Subsection (3) provided that section 42 applied to periods of account beginning after 6 April 1999. By section 45 FA 1998 a period of account was any period for which accounts were drawn up. Mr Smith's accounts were drawn up to 5 April from 31 March 1998 onwards. Section 42 therefore applied to the computation of Mr Smith's profits in respect of the years ending 5 April 2001 onwards (his year to 5 April 2000 having begun on, and not after 6 April 1999).
  2. After 2002 section 42 was amended so that it required computation in accordance with "generally accepted accounting practice" rather than to give a true and fair view. Dr Southern accepted that for present purposes there was little difference between the tests given the definition of generally accepted accounting practice in section 836A TA 1988.
  3. Before FA 1998 the case law made it clear that profits and losses of a business for tax purposes were those determined on "the correct principles of the prevailing system of commercial accounting" (see Pennycuick V-C in Odeon Associated Theatres v Jones 48 TC 257 at 273, and Bingham MR in Gallagher v Jones 1990 3S TC 537 at 554). In most cases it seems to us that there will be little or no difference between profits ascertained in accordance with the FA 1998 standard and that previously applicable. That is because (as we later find) accounts will not show a true and fair view unless they are prepared on the principles of the prevailing system of commercial accountancy. There may, however, have been cases where there were two or more ways in which a particular item could properly be accounted for in accordance with such a system: in such cases the courts might, before FA 1998, have been able to determine which was the "correct" principle to be applied. But it seems to us that the scope for such interference by the courts after FA 1998 is more restricted. After FA 1998 if “an accounting basis” has been used which produces accounts which give a true and fair view, such a basis may be thrown out only by an "adjustment required or authorised by law", and such words do not in our minds encompass judicial selection of one of a number of properly applicable bases each of which are found to produce a true and fair view.
  4. Although, for reasons which will follow, it seems to us that in Mr Smith's case the "correct principles of prevailing commercial accountancy" relevant to the determination of his true profits in the years up to 2001 were the same as those which were required to be applied to produce accounts which gave a true and fair view in the years after 2001, we set out briefly below our conclusions on the cases cited to as. If we are wrong in our appreciation of the effect of section 42 FA 1998, and the principles of those cases are applicable to the computation of Mr Smith’s taxable profits after the coming into effect of section 42, this summary also guides our steps in relation to that later period:
  5. there is no judge-made rule which overrides the application of a generally accepted rule of commercial accounting which (a) applies to the situation in question (b) is not one of two or more rules applicable to the situation in question, and (c) is not shown to be inconsistent with the true facts or otherwise inapt to determine the true profits of the business (see Bingham MR in Gallagher at 556);
  6. where there are two or more accepted rules or methods applicable to the situation, the courts (or tribunal) may determine which is the best, correct or proper method (Johnstone v Britannia Airways Ltd [ 1994] STC 763 -- see in particular page 783, and Odeon at 273G). This principle seems to us to explain the judgement of the House of Lords in Willingdale v International Commercial Bank Ltd 52 TC 242 in which the method on which the bank’s accounts were drawn up was not the only method which was in accordance with sound principles of commercial accountancy (see Lord Fraser at 272B, and Lord Keith at 280B) with the result that the Courts were able to chose the alternative, and in their view, better method;
  7. adjustments must be made to those profits as specifically required by statute.
  8. Dr Southern drew our attention to the following cases.
  9. In Johnson v WS Try Ltd 27 TC 167, Lord Greene said in 1946 at page 181:

"a trader is not entitled to say: you must not tax me on these debts because I have not yet received payment. You can only tax me when I have received payment. The Legislature says: no, it is ordinary commercial practice in calculating your profits to bring in debts which are owing to you in connection with the business: therefore you are bound to bring in debts which are owed to you on the same basis as if they were receipts, ... but I venture to think in one sense that it is an anomaly, because it is a departure from what I have always understood to be the fundamental conception of income tax legislation -- that you should ascertain your profits in reference to your receipts. The reason why that exception is broadly in is that it is in accordance with ordinary commercial practice to treat debts in that way."

And at page 182: “ in the case of items which are broadly analogous to debts, it no doubt would be better finance not to bring them into account as if they were trade debts, but I can see nothing to prevent a Board of Directors making a fair estimate of what they are going to receive under an undoubted right which has accrued. That would be brought in as an estimate, though I do not suppose wise directors would bring it into account unless there was some compelling reason”

and at page 185: "... money must not be taken as being, so to speak, in hand until all the conditions necessary to earn it have been fulfilled. Delivery was a necessary condition for the appellant company to … be paid. It was not until the gear was delivered by the subcontractors that the right to payment became fixed, and, therefore a matter which could be treated in the ordinary way as a trade book debt.

  1. JP Hall & Co. Ltd V Commissioners of Inland Revenue 12 TC 382 concerned whether profit should be taken on the delivery of gear or in the period in which the contracts were made for its delivery. Lord Sterndale MR said: “... the short and simple answer ... is that his profits were neither ascertained nor made at the time that these two contracts were concluded. There are any number of contingencies that might have happened, by which the profit would not have turned out what it appeared on the face of it when the contracts were made. Any number of complications might have occurred that might have caused quite a different result to have accrued from these two contracts. I think that the Respondents did what was right in the way they carried his profits into their account: it is the ordinary commercial way of making up accounts, and in my opinion it is the right way, and the other would be the wrong way because the other would be carrying into the accounts as profits of one year the estimated profits which would accrue in subsequent years that might perhaps never be made at all."
  2. It seems to us that these judgements evince no principle relevant to the recognition of revenue or assets in Mr Smith's business which overrode the principles of prevailing commercial accountancy. Indeed in each case the court was applying the principles of commercial accountancy prevailing at the relevant time.
  3. In the remainder of this decision we used the phrase "generally accepted accounting practice" or GAAP to mean the generally accepted rules of prevailing commercial accountancy practice.
  4. Section 29 TMA 1970 provides so far as is relevant:

“(1) if an officer of the Board or the Board discover, as regards any person (the taxpayer) and a year of assessment --

(a) that any income which ought to have been assessed to income tax ...[ has] not been assessed or

(b) that an assessment to tax is or has become insufficient ...

the officer...may, subject to (2) and (3) below, make an assessment in the amount, or the further amount, which ought in his opinion to be charged in order to make good to the Crown the loss of tax.

“…(3) where the taxpayer has made and delivered a return under section 8 or 8A of this Act in respect of the relevant year of assessment, he shall not be assessed under subsection (1) above --

(a) in respect of the year of assessment mentioned in that subsection; and

(b) in the same capacity as that in which he made and delivers the return,

unless one of the two conditions mentioned below is fulfilled.

“(4) The first condition is that the situation mentioned in subsection (1) above is attributable to fraudulent or negligent conduct on the part of the taxpayer or a person acting on his behalf.”

The second condition is not relevant to this appeal.

  1. Section 34 TMA provides that no assessment may be made later than five years after 31 January next following the year of assessment to which it relates. But that section is subject to later provisions of the Act. Included in those provisions is section 36 which provides that

"[(1)] an assessment on any person ... for the purpose of making good to the Crown a loss of income tax ... attributable to his fraudulent or negligent conduct or the fraudulent or negligent conduct of a person acting on his behalf may be made at any time not later than 20 years after 31 January next following the year of assessment to which it relates.”

negligent conduct

  1. No direct authority was offered to us on the meaning of these words in the context of ss 29 or 36. Before 1989 the statute permitted extended assessment where there was fraud, wilful default or neglect. The change from "neglect" to "negligent conduct" may be significant. Neglect may be taken to refer only to an act of omission; negligent conduct may also embrace an undesired action.
  2. Normally “negligent conduct” may be abbreviated to "negligence". But the draughtsman has not used the word "negligence”. That suggests to us that the concept is not limited to tortious negligence and is not intended to be a term of art. Instead the words should be taken to have their ordinary meaning. The Shorter Oxford Dictionary defines negligent as "inattentive to what ought to be done; failing to take proper necessary or reasonable care".
  3. We were referred to the dictum of Alderson B in Blyth v Birmingham Water Works Co (1856) 11Ex 781: "negligence is the omission to do something which a reasonable man, guided upon those considerations which ordinarily regulate the conduct of human affairs, would do, or doing something which a prudent and reasonable man would not do."
  4. It seems to us that a person who acts for another person as an accountant and tax adviser should reasonably be expected to show the normal competence associated with the proper discharge of the duties of an accountant and tax adviser. The failure to do what an ordinarily competent adviser would do is failure to do what ought to be done. The failure to do those things which a reasonable man guided by the considerations which would ordinarily be expected to arise from such a relationship would do, would fall within Alderson B’s dictum. Such a failure seems to us to be a failure to take proper or reasonable care. It would thus be negligent conduct on either of the formulations above. This is not the same as saying that because a person is a qualified accountant he is to be expected to display by virtue of his training and qualification a greater standard of care; it is saying that because of the role he occupies he should reasonably be expected to display the kind of care which a person in that role would ordinarily display.
  5. If a taxpayer asks his teenage son quickly to run up some accounts from the cash book in return for extra pocket money of £20, it would not be reasonable to expect compliance with GAAP (and the failure to submit proper accounts would be down to the negligent conduct of the taxpayer in selecting and instructing the preparer). But a professional accountant engaged to prepare accounts and submit tax computations would in our view reasonably be expected, because of the circumstances of his engagement, to prepare and submit accounts which complied with section 42 FA 1998 -- accounts which showed a true and fair view. A failure to submit such accounts would therefore be negligent conduct in the absence of facts which took that relationship out of the ordinary.
  6. It seemed to us that there might be another way of putting this. We had no evidence about the contract between Mr Smith and his accountants Maynard Heady, but it is likely that contract contained express or implied terms obliging his accountants to take reasonable care to ensure that Mr Smith's accounts as submitted to HMRC were such as to comply with section 42 -- in other words to ensure that they showed a true and fair view. The breach of a contractual duty so to do would in our view be properly termed negligent conduct whether or not it was a breach of any wider duty. That is because it will be the failure to do something which a reasonable man in the circumstances of that contract would do.
  7. Dr Southern says that the standard against which conduct must be judged is that of the reasonable man, not that of the reasonable chartered accountant. Negligence, he says, in this context is not adopting an accounting practice on which opinions may differ, but making an obvious and significant arithmetical error in the accounts or adopting an accounting policy wholly outside the realm of commercially acceptable accounting practice. It seems to us that, attractively as this submission is put, it elides two separate questions: the first is what is the nature of what a reasonable man in these circumstances would have done, and the second is whether it was done. The answer to the first is governed by the circumstances in which the activity is performed. In our view where a professional firm is formally engaged then unless there are special circumstances (such perhaps as an instruction to do it quickly and on the cheap) the reasonable man would have taken care to submit accounts prepared under GAAP which showed a true and fair view, and the answer to the second depends upon whether or not they did show such a view: if they contained a significant arithmetical error or if they were prepared on the basis of accounting policies or practice which were outside the realm of commercially accepted accounting practice they would not show a true and fair view. If they were prepared on the basis of an unusual accounting practice but one within the realm of what was generally accepted they would show a true and fair view.

discover

  1. We were referred to Lord Denning's dictum in Parkin v Cattell (1971) 48 TC 462 at 474D:
  2. "the word "discover" simply means "find out". ... an Inspector of taxes "discovers" (that income has not been assessed when it should have been), not only when he finds out new facts which were not known to him or his predecessor, but also when he finds out that he or his predecessor drew a wrong inference from the facts which were then known to him: and further, when he finds out that he or his predecessor got the law wrong and did not assess the income when it ought to have been."
  3. In Hankinson v HMRC TC00319, the tribunal approved the test for discovery propounded by the Special Commissioner in Corbally-Stourton v HMRC [2008] UKSPC SPC00692, saying: “Thus we consider the relevant test to be that the officer must have evidential basis beyond mere suspicion in order to arrive honestly at the conclusion that, on balance, there is an insufficiency. The test is subjective, in that the officer must have satisfied himself that this is the appropriate conclusion.” The cases show that that conclusion must be one which newly arises.

3. The Evidence And Our Findings of Fact