Net accounting has always thrown up some difficult questions for taxpayers and their advisers looking to claim a deduction for something that cannot be seen on the face of the accounts. This is particularly so when an amount for which the taxpayer would like a deduction under a tax regime that follows the accounts (such as the rules in Part 3 CTA 2009 for calculating trading income or the rules in Part 5 CTA 2009 for taxing loan relationships) is netted against income not taxed on an accounts basis, such as sales proceeds for a chargeable gains asset. And this is now something the First-tier Tribunal has had to consider in two recent cases.
In the first, West Burton Property Limited v HMRC, the taxpayer sold a power station at net book value and so showed neither a profit nor loss on the sale. However, the taxpayer sought a deduction for c. £65m of deferred revenue expenditure (DRE) which had been capitalised and included in the net book value. The evidence showed that the book keeping entries used to determine the profit and loss involved crediting the relevant account with the sale proceeds and debiting the same account with the net book value of the property. The result – nil – was then recorded in the profit and loss account. For the £65m DRE to be deductible as a trading expense it needed to be an item brought into account as a debit in calculating the profits shown in the profit and loss account (section 48 CTA 2009). HMRC argued that it was not. Judge Beare disagreed. It was common ground that the nil amount reflected in the profit and loss account in respect of the sale was calculated by deducting the net book value of the power station from the sales proceeds. If the net book value had been smaller, then the profits would have been greater. So the net book value clearly was brought into account in calculating the profits, it was too narrow an interpretation to require the debit itself to appear in the profit and loss account.
Clearly this was a sensible decision. On any common sense view, the DRE had been taken into account in calculating the taxpayer’s profit and loss. However, the case of Shinelock Ltd v HMRC shows that it was rather important that it was common ground that the taxpayer’s accounts in West Burton had recorded a nil amount. Shinelock Ltd purchased a residential property for £725,000 and sold it some 5 years later for £1,030,000. It paid the difference, £305,000, to Mr Ahmed, its erstwhile shareholder. HMRC sought to tax Shinelock Ltd on the chargeable gain arising and one of the arguments run by the taxpayer was that the £305,000 was deductible as a loan relationship debit on the basis that Shinelock Ltd had agreed it would pay any gain to Mr Ahmed in return for providing some finance by way of loan and/or guaranteeing Shinelock Ltd’s bank debt. However, the question was whether a debit of £305,000 had been recognised in Shinelock Ltd’s accounts and the issue, once again, was net accounting. Here the relevant amounts were “netted and excluded”. Although the FTT was somewhat hampered by the lack of expert accounting evidence before it, Judge Zaman took a similar approach to Judge Beare noting:
“... if a net amount which is shown on the face of the accounts reflects two underlying gross amounts, both such gross amounts can be said to have been recognised (albeit that neither are shown) for this purpose. I see no reason to draw a distinction between a situation where there is then a net or loss of, say, £10 shown in the accounts and that where the gross amounts are equal such that the net amount recorded is £0. However, this is only the case provided that the net amount of £0 is actually shown on the accounts. In a situation where it is concluded in preparing the accounts that no entry needs to be made … I would not accept that the gross amounts have been “recognised””.
Unfortunately, that was the case for Shinelock. On the evidence, the FTT found that it was not the case that the accounts recognised an entry of nil, which was the result of netting the gross amounts as in West Burton, but, rather, that the amounts were simply excluded and nothing was recognised at all. Hence, the difference between nothing and nil. And a good reminder that, if you are looking for a deduction for a payment which does not appear on the face of your profit and loss account, to make sure that it is a demonstrable component of an amount which does so appear, even if that amount is nil.