A. Over the years, the courts have interpreted the legislation dealing with trade profits to mean that if a deduction is allowed when applying the ordinary rules of accountancy – it is allowed unless expressly prohibited by legislation: –
- As explained in HMRC guidance at BIM42051 in computing trade profits, a two-stage process is followed:-
- First, ascertain the profits of the trade for the period concerned, computed in accordance with generally accepted accounting practice.
• Second, adjust those profits in accordance with any tax rules or principles which differ from the accountancy principles.
Tax law provides that ‘UK GAAP’ means “generally accepted accounting practice in relation to accounts of UK companies (other than IAS accounts) that are intended to give a true and fair view” (ITA 2007, s. 997(2)(a)). It is provided that the term has the same meaning for individuals and other entities as it does for companies (ITA 2007, s. 997(2)(b)).
The meaning of “True and fair view” and “Accounting standards” are explained in detail by HMRC at BIM31020.
If therefore you have included a deduction for the payment within GAAP compliant accounts, the next point to consider is the statutory rules that permit deductions as detailed at BIM42070 , and those that prohibit or restrict deductions, please see BIM42060.
It is worth pointing out that generally, permissive rules take priority over prohibitive rules, with some notable exceptions as listed at BIM42080
Prohibitive rules include where capital expenditure is denied a deduction in calculating the profits of a trade by S53 CTA 2009 .
In the case of ECC Quarries Ltd v Watkis [1975] 51TC153 costs laid out in an attempted capital transaction that proved to be unsuccessful did not change in nature because of the failure to complete. The abortive expenditure was, in the face of unchallenged accountancy evidence, treated as capital, HMRC’s commentary is at BIM35325.
Within HMRC guidance at BIM45851 they provide their view that the loss of stock in trade or of cash in hand by fire, burglary, theft or employee negligence is in the ordinary course of events an allowable deduction.
As a general rule, it may be said that goods become part of stock not earlier than the time at which ownership passes to the purchaser, and not later than the time at which the purchaser obtains both ownership and possession.
In this instance ownership and possession was never achieved which therefore rules out the expenditure being recognised as stock and a deduction being allowed as a theft of stock. Can therefore an attempted purchase of stock, stock that never existed, be treated as a revenue expense?
The significance of the accountancy treatment in recognising a debit as required by IFRS2 was prevalent in the Supreme court ruling in the NVL Investments case and it may be that GAAP will again be significant here. A report on the case is at Press Summary (supremecourt.uk)
Alternatively, other than for the purposes of the wholly and exclusively test, should less significance be given to the fact it was the director’s intention to make a purchase of stock, after all the stock was a fiction. In other words, is it the case that this was not an abortive purchase of stock, rather it was simply theft of cash in hand through fraudulent actions, within which the director unwittingly played a pivotal role in the deception.
FRS102 defines cash as “cash in hand and demand deposits”. Does this loss of funds from the company’s current bank account therefore fall into HMRC’s view at BIM45851 that the loss/theft of cash in hand is an allowable deduction. The link aside from ACCA provides FRS102’s definition of cash ACCA Global.
Whichever view is taken, if the payment was found not to be capital expenditure, no restriction is proper under S53 and we then consider the wholly and exclusively rule at S54 (1) CTA 2009 which states that:-
In calculating the profits of a trade, no deduction is allowed for–
(a) expenses not incurred wholly and exclusively for the purposes of the trade, or
(b) losses not connected with or arising out of the trade.
The question is, therefore, was the payment made in the normal course of trading, was it exclusively incurred for the purposes of the trade or was there any other motive or purpose that denies the test being met.
Wholly and exclusively aside, there does not appear to be any reliable source we can point to in arriving at a conclusion on the correct treatment of the loss and therefore a view will need to be taken based on the circumstances and facts of each individual case.
If a deduction is claimed, I suggest a full record of events, including a police report etc is retained. Any subsequent recovery of funds would be treated as taxable income.
