January 23, 1970. RUSSELL, L.J. - The appellant taxpayers trade is that of selling footwear as retailers from their many retail shops up and down the country. For the most part they acquire the footwear for their trade from the manufacturers. The question for decision concerns the correct method of ascertaining the full amount of the profits or gains of the trade of a year. Stated more narrowly, the question for determination is the correct method of ascertaining the value of stocks of footwear held by the taxpayer at January 1, 1959, and December 31, 1959, the opening and closing dates of the accounting period forming the basis of assessment. Stated yet more narrowly, the question for determination is what is the market value to be considered in the present case in applying the time-honoured formula under which, for income tax purposes, in valuing stock-in-hand at the close of an accounting period (and consequently at the opening of the next accounting period) such stock is to be brought in at cost or if the market value be lower than cost, then at that lower value.
For many years the taxpayers have kept their accounts upon a basis that has been accepted by the Crown as demonstrating the full amount of their profits or gains for the relevant periods for the purposes of income tax. But a challenge to this was made for the first time by the Crown in respect of the period of 1959. Of course in the long run, since any basis of valuation must be followed consistently, it would seem that in a broad sense it makes little difference which approach to 'market value' is adopted. But questions of tax are seldom viewed in the long run. The dispute before us demonstrates that the Crown considers it preferable to challenge the previously accepted system, while the taxpayer considers it preferable to adhere to it. Ours not to reason why; certainly not ours to explain why.
The full facts are set out in the findings of the commissioners in the stated case. I believe that for present purposes only the barest outline will suffice.
The taxpayers operate a system, to some extent flexible, by which management fix from time to time an average 'mark-up' in terms of a percentage of retail selling price : say, as an example, 35 per cent. This produces the gross profit which is a larger percentage of cost : footwear costing Pounds 35s. is aimed to sell at Pounds 5 and vice versa.
Very large stocks are carried and it is an essential part or aspect of this trade that there are sales in January and also in the summer of stock-in-hand at the end of the previous year. These sales are at reduced retail prices that will not, of course, produce the gross profit at which the percentage mark-up had been, so to speak, aimed. In valuing the stock-in-hand at December 31 (and consequently at January 1) in their accounts the taxpayers in effect job backwards from the expected (reduced) retail prices in the sales so as to produce a figure as the value of stock on which the expected (reduced) price in the sales will reflect a mark-up as previously stated : for example 35 per cent. The calculations are meticulous and detailed. The resultant values are described as replacement values the sums that the taxpayers say that they would be prepared to pay for the stock having regard to their estimates of future retail prices and their desired mark-up percentage. This seems to me a perfectly legitimate way of presenting such a companys financial situation over the years; much evidence was given before the commissioners by those of great experience in such matters to that effect, and I would not presume to criticise it. As a system of presenting accounts it was described as 'sophisticated,' a word that has in this use travelled far from its true sense. But the question for tax purposes is whether the value attributed to stock-in-hand by this method of calculation is properly to be described as market value, bearing in mind that stock is to be brought in at cost unless market value is shown to be lower. The Crown contends that market value in this context requires that the stock should be taken at the figures expected to be realised in due course on sale in the retail market. It is, of course, obvious that the taxpayers system of ascertaining replacement values will produce values lower than cost in many cases in which, according to the Crowns contention, market value is not lower than cost, and the stock must accordingly be valued at cost. Broadly speaking, the taxpayers contend that any diminution in hope of net profit on cost should be reflected in the terminal valuation, whereas the Crown contends that for income-tax purposes a valuation below cost is permissible only when sale at a figure below cost is expected.
I must say, as I did at an early stage in argument, that I have always thought that in this context market value meant the price at which the stock could be expected in due course to be sold in the market in which the trade of selling by the taxpayer was conducted. And after extensive argument I am not persuaded that my original assumption was wrong. It seems to me to be wholly artificial to speak of the values calculated in the manner stated as the market values of the stock : the taxpayers would not dream of selling in any market at those values when they aim, in due course of selling retail, at prices showing a gross profit of over 35 per cent. of those values. Nor was it suggested that there would be then available from manufacturers the equivalent of stocks-in-hand at the relevant marked down values.
In my judgment income-tax law in this regard does not march step by step in the divergent footprints of the accountancy profession. May be it would be appropriate that for tax purposes any of several methods in this connection of showing a years profits or gains of a trade should be acceptable, as may be the case when ascertaining the proper cost, and therefore value, of work in progress. But it seems to me that for tax purposes the valuation of stock-in-hand at market value if lower than cost has crystallised in a retail trade as the price fairly to be expected as the retail sale price of the goods in due course, assuming that (as here) a retail sale is still to be expected. The traders market is the retail market, and while that market exists for the goods I see no justification for turning to any other market, or for thinking that in the accustomed judicial phrase reference is made to any other market. It is said that the Crowns contention cannot be acceptable because the formula assumes a sale on a market of the whole of all stock-in-hand on the very terminal date; no such sale is conceivable in the present case of all this stock in the retail market all on one day : and indeed the figures of expected sale values put forward by the taxpayers upon which the Crown relies as showing market values are avowedly on sales spread over several months. For myself I do not see that this gives rise to a problem. It seems to me that in this context market value, though it falls to be estimated at a particular date, can quite readily refer to the price that the goods will fetch when sold in due course in the relevant market.
In my view the accepted practice of entering stock-in-hand at cost at the terminal date of the first period and the opening date of the second period arises from the fact that the expenditure has not contributed anything directly to the figures of gross profit in the first period. It is unused expenditure to be carried forward into the second period in which it is estimated that it will contribute on sale to the gross profit of that period. But if it is estimated that on sale it will not contribute to the gross profit of the second period - that is, if it is estimated that it will sell below cost - the shortfall is to be regarded in the course of stock valuation as irrecoverable and may properly be treated as a loss incurred in the first period. This I believe to be the basis of the principle that for tax purposes market value, if below cost, may be taken as the value of stock-in-hand. The principle relates to loss of all gross profit and more, and not to diminution.
The Crowns figures of valuation are based upon the taxpayers estimate of retail selling prices in due course : but they allow a deduction for salesmens commission. This, it is suggested by the taxpayers, reveals a fallacy in the Crowns approach, for, they say, all kinds of overheads, will be involved in producing these sales, overheads that will be absorbed in the mark-up involved in the taxpayerss method of valuation. I do not myself think that this shows a fallacy. Granted that market value means that which the stock is expected to produce on retail sale, it seems to me logical and reasonable to look for the money expected to reach the till as a result of sales : in effect the salesmans commission does not reach the till, though in practice he does not abstract it from money handed over the counter and pocket it before paying the balance into the till.
I have not rehearsed in detail the contentions of the taxpayers, which I am sure justify their method of presenting their accounts from year to year to shareholders and creditors, a method which no doubt they will continue to follow. They do not, however, in my judgment affect the issue, which in my view is to be decided by the view that the relevant market for present purposes is that in which the taxpayers sell and intend to sell this stock - the retail market - and the market value is the price at which in due course they expect to sell it in that market. If, of course, in a retail trade a particular line was no longer saleable in the retail market, but had to be sold in some special market, say abroad, as a lot, the market would not be the retail market : but that is not this case.
I would dismiss the appeal.
SALMON L.J. - This appeal raises the point whether or not the tax-payers audited accounts for the year 1959 disclose the full amount for tax purposes of the profits or gains for that year. It is on these profits or gains that the assessment for tax for the year 1960 has to be made : see the Income-Tax Act, 1952, section 127 (1). The statute gives no help as to how profits or gains are to be computed. In Duple Motor Bodies Ltd. v. Inland Revenue Commissioners, Viscount Simonds said, at page 746 :
'... first the ordinary principles of commercial accounting must as far as practicable be observed, and secondly ... the law relating to income tax must not be violated ... that is to say, by one means or another the full amount of the profits and gains must be determined.'
As the judge pointed out in the present case, 'profit' is an elusive concept; indeed, I suppose that few commercial questions have been so much debated or, in some cases, proved so difficult to resolve as - What is the true profit in a particular year Sometimes the problem is capable of more than one acceptable solution. Clearly the years profit depends a great deal upon stock taking and the method of valuation which is adopted. In many trades there is little room for debate about the correct method. In others, however, of which the present case is an example, the correct method is debatable and may, perhaps, be capable of different but equally valid solutions for commercial purposes. Much turns upon accountancy practice. Although this may appear elaborate and artificial to a lawyer (see Lord Simonds speech in the Duple case at page 748) it is aimed, almost always successfully, at arriving at an aspect of the truth. For upwards of 20 years prior to 1959, the eminent chartered accountants who audited the taxpayers accounts have accepted the taxpayers method described by my Lord and which I need not repeat. The auditors would certainly not have certified the accounts unless, in their view, these accounts had presented a true picture of the taxpayers profits or gains. The Crown must equally have been satisfied during all those years that the taxpayers method fairly revealed the full amount of the taxpayers profits or gains for the years in question. The findings of the special commissioners show that there are many chartered accountants who agree that this method, approved for so long by the Crown and by the taxpayers auditors, is unexceptionable. The Crown, however, claim that now, at last, they have seen the light. They have discovered that they erred for more than 20 years in accepting the taxpayers method as correctly showing the taxpayers full profits or gains for each of those lost years. They seek to challenge for the year 1959 and all succeeding years the method which for year after year they had previously agreed. I confess that I have little sympathy with the attitude adopted by the Crown. I should have thought that, in all the circumstances of this case they might well have considered it unnecessary if not undesirable to repudiate a practice which, with full knowledge of all the material facts, they had followed for so long. Moreover, it is very much in the public interest that accounts should be prepared conservatively, that the closing stock should not be overstated and the profits for the year thereby inflated. The contrary practice only too often results in the investing public being cheated. If, on the other hand, the accounts for the year are prepared so that the value of the closing stock and the amount of the profits for that year are kept down to a conservative level, no investor can be deceived and the profits for the following year will automatically be increased so that any possible loss of tax by the revenue in year A will probably be recouped in year B. This, however, cannot affect the point which we have to decide, for we are not concerned with whether the taxpayers method of stock valuation is commercially sound and gives a fair picture of their trading results over the years. This is not challenged. The question for us is whether, taking the year 1959 in isolation, as we must, the taxpayers method shows the actual amount of profit for income-tax purposes, made in that particular year.
In the Duple case the House of Lords was chiefly concerned with the proper method of valuing work in progress. What Lord Reid said at  1 W.L.R. 739, 755 may, however, be equally applicable to stock-in-trade.
'So the real question is what method best fits the circumstances of a particular business. And if a method has been consistently applied in the past, then it seems to follow that it should not be changed unless there is good reason for the change sufficient to outweigh any difficulties in the transitional year.'
In the present case we are asked to decide between two competing methods as a broad matter of principle. Should the stock be taken (1) at its cost price or at its expected net realisable resale price if that price falls below cost (as the Crown contend), or (2) at its cost price or at replacement price in a notional market which would show an arbitrary profit calculated by the taxpayers if such replacement price is lower than cost (as the tax-payers contend). There appears to be some difference of opinion between accountants in deciding which of these two methods should be followed. I am tempted to echo what Lord Reid said in another context, at page 753 : '... if the accountancy profession cannot do that, I do not see how I can.' I feel, however, reluctantly driven to the conclusion that, in the present case, there is 'good reason for the change sufficient to outweigh difficulties in the transitional years,' because the method consistently applied prior to 1959, however commercially sensible it may be and however true the picture it gives of the taxpayers trading results over the years, does not for the year 1959, taken in isolation, accurately reproduce the profits or gains of that particular year as is required for the purpose of income-tax. The method adopted must, for tax purposes, be not only consistent over the years but must produce the full profits or gains for each year.
I think that it is important to remember that in dealing with stock-in-trade we are not concerned with the valuation of an asset in a balance-sheet. Nor are we attempting to assess the real value of the stock-in-trade to the taxpayer. Our task, so far as the closing stock is concerned, is to quantify a notional receipt in a profit and loss account according to an accountancy practice long recognised and accepted by the courts :
'... the value 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' :
See-the judgment of the Lord President, Lord Clyde, in Whimster & Co. v. Inland Revenue Commissioners, which has been approved and followed, without question, by the House of Lords ever since 1925.
No doubt it may seem strange, as Lord Simonds pointed out in the Duple case, that the closing stock should be treated as a receipt, and illogical, as Lord Reid pointed out in the same case, that it should be marked down when the market price falls but not marked up when the market price rises. However strange or illogical the practice may appear, it is, I think, founded on sound commercial experience and good sense. Naturally all money spent in buying stock-in-trade is entered on the expenditure side of the profit and loss account and all money realised by the sale of stock-in-trade appears on the revenue side of that account. If in year A there had been heavy buying and, at its end, there remained a substantial amount of stock, it would give an entirely false picture of the years trading results were the existence of the closing stock to be ignored in the profit and loss account. The amount spent in acquiring it would appear as an item of expenditure much of which would apparently (but not really) have been wholly lost. Thus the figures for year A would be falsely depressed and those for year B falsely inflated. It is for this reason that closing stock in year A is normally entered in the years profit and loss account as the notional receipt of an amount equal to its cost. The same figure is carried forward into year B as opening stock; it is the first item on the expenditure side of that years profit and loss account. Thus this stock is treated, in effect, as not having been bought in year A or in preceding years but in year B. Accordingly, the profit or loss in year A is not affected by the amount which has been spent in buying the closing stock. The profit or loss on that stock is left to fall in year B, in which year it will presumably be made. The only exception to that rule is an exception made in favour of the taxpayer. If, at the end of the year, the market price of the closing stock can be shown to have fallen below the cost price, the stock is taken into the account at the market price and thus the loss is anticipated. To that extent, the taxpayer is relieved from paying some of the tax he would otherwise have had to pay in respect of year A. If, on the other hand, there had been a rise in the market price of the stock at the end of year A, the rise is ignored and the stock is still taken into account at cost price. It is a cardinal principle of accountancy practice and of our tax law that, whilst provision may be made in the trading accounts for expected losses, profits must not be anticipated. No tax is chargeable on a profit until that profit has been achieved. It is, I think, important to realise that so far the only concession made by the courts to the taxpayer in this filed is that the taxpayer is allowed to anticipate in year A a loss he expects to make in year B on his closing stock for year A by reason of a fall in the market price of that stock at the end of year A.
'The rule cost or market value is not a substantive rule of law : it is a means of enabling the taxpayer to anticipate a loss by bringing expected loss into account.'
Per Lord Reid in the Duple case, at page 756. It has never yet been held that the taxpayer may anticipate in year A a diminution of the profits which he may have hoped to make in year B on the closing stock for year A by writing down his closing stock for that year below its cost price. Commercially, and for the purpose of his internal account, it is conceded that it may well be wise for him to do so. I find it difficult, however, to see how, if challenged, he can obtain any tax concession for year A on this basis, although no doubt ordinarily the tax position would adjust itself in year B. Taking year A in isolation, as I think we must, it would follow that if the taxpayers are right, a taxpayer whose normal rate of profit is, say, 50 per cent. could write down his closing stock in year A below its cost price because he anticipates making only 45 per cent. profit in year B as a result of a fall in the market at the end of year A. He would thus show an anticipated loss on that closing stock whereas, in fact, he expects it to show a handsome profit. On the present state of the authorities and indeed on principle, it is, in my judgment, ordinarily permissible to enter stock in a profit and loss account at less than cost price for tax purposes, only if its net realisable resale price is less than its cost price. The question as to what items (if any) of indirect selling costs can properly be deducted from the expected resale price in order to arrive at the net realisable resale price of the closing stock was not fully explored before the commissioners, nor was it argued before the judge or in this court. Therefore, like the judge, I express no view upon this point, which will have to be agreed or decided later.
It follows from what I have already said, that I cannot accept the taxpayers contention that the words 'market price' in the time-honoured phrase 'cost or market price, whichever is the lower' ordinarily refer to the price in the market in which the goods were bought for resale -certainly not in the case of a retail taxpayer.
I am conscious, however, that there are many businesses in which manufacturers hold considerable stocks of commodities such as steel, tin, tobacco, tea, rubber, and so on which are used in the course of manufacturing goods for sale. The market prices of some of these commodities fluctuate violently. There is no material before me to show how such stocks are dealt with in the profit and loss account when the market in which the stocks were bought has fallen by the end of the accounting period. I doubt whether the resale price of the commodities in question is the true criterion because the manufacturer has no intention of reselling them except as part of a manufactured product. In such cases 'the market price' may well be the price in the market in which the commodities were bought. Such businesses are, however, very different from that with which we are concerned in the present case and, as Lord Reid pointed out in the Duple case, at page 755 : 'the real question is .... what method best fits the circumstances of a particular business ?'
The taxpayers contention that they may, for tax purposes, enter their closing stock in their accounts below cost price at a market price which would show them a gross profit of 37.19 per cent. is beset with difficulties. To begin with there was certainly no market in which they could have acquired the goods at such a price. Clearly the goods could not have been bought from manufacturers or wholesalers at such a price. Equally clearly, no other retailers nor the taxpayers themselves for that matter would have sold at those prices when they could obtain much higher prices in their own shops. What the taxpayers are attempting to do is to enter the stock at what they argue would be its value to them in a notional market which can have no existence in reality.
It also seems to me to be very difficult to accept that none of the closing stock was worth more to the taxpayers than a price which on resale a would show them a profit of 37.19 per cent. They were in 1959 most experienced and carried on their business with the highest degree of efficiency; their budget forecasts and estimated resale prices are agreed to have been prepared with meticulous care and remarkable accuracy. It cannot really be doubted that they at all times realised that, at the end of the year, they would be left with about one-third of the total stock carried during the year and that of this remaining stock a certain proportion would fail to achieve a gross profit of 37.19 per cent. No one suggests that when the taxpayers bought their stock, they were unable to form an accurate estimate of what that proportion would be and by how much it would fall short of a profit of 37.19 per cent. Accordingly, the taxpayers contention that their closing stock can be written down below cost price to provide for a 'diminution in expected profit' runs into the initial, and, to my mind, insuperable difficulty (apart from all the others) what at all times the taxpayers realised that it would not achieve an overall profit of 37.19 per cent. They did not at any time in year A expect it to sell for more than the price it would realise in year B.
I would, accordingly, dismiss the appeal.
MEGAW L.J. - The crux of the case, as I see it, is the meaning to be given to the phrase 'market price' or 'market value' in the judicially created formula which has for so long been accepted. It was first stated by the Lord President, Lord Clyde, in Whimster & Co. v. Inland Revenue Commissioners, in these words :
'..... the ordinary principles of commercial accountancy require that in the profit and loss account of a merchants or manufacturers 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 the cost or market price, whichever is the lower, although there is nothing about this in the taxing statutes.'
The Lord Presidents 'market price' has in later cases been silently transmuted into 'market value.' 'Price' and 'value' have different meanings, though in a given case the price of an article and its value may well be identical. For the moment, I shall assume that 'market price' means 'market value.'
I do not think that the method of valuing stock for which the taxpayers contend can be regarded as an assessment on the basis of market value. Their business is retail trade. They have the goods in order to sell them at retail. The price at which the goods might be bought and sold on the wholesale market is not relevant. The taxpayers own the goods in question. They are not going to buy them. They are going to sell them. In any event, in order to justify a figure as being market value, there must be an assumption, based on reason, that someone would be prepared to sell and that someone else would be prepared to buy the goods in question (that is, goods of the same quantity, quality and description) at or about the relevant time at the price in question. Here the evidence of the taxpayers themselves, as shown in paragraph 9 of the case stated, precludes any such assumption.
The method of valuing the stock for which the Crown contends is not subject to that objection. There is an assumption, based on reason, and indeed accepted by both parties, that the goods in question will hereafter be sold in the market - the retail market - at the prices which, subject to deduction of salesmens commission, the Crown asserts to be the relevant market value.
The Crowns contention involves this : that when one seeks to ascertain the market value of goods remaining in stock in this business at December 31, 1959, for the purposes of ascertaining the profit or loss of the business for the year 1959, it is appropriate to take as being such value the price which is expected to be realised in a sale in, say, the summer of 1960, or, it may be, even later.
Of course, no one would suggest that the market value of stock-in-hand on December 31, 1959, could sensibly be assessed as nil because the day happened to be a Sunday or holiday when no goods could be sold at retail. Nor could the market value normally be taken as being represented by the possibly vary low price which would be obtainable on a forced sale basis, flooding the market in order to dispose of the whole of the stock within a few days or a few weeks after December 31. That would be right only if there were some real business necessity for dealing with the goods in that way. 'Market value' on a particular day is, I believe, not necessarily to be confined to actual or notional transactions on that precise day. It may properly relate, and in this case I think does properly relate, to what is going to happen in a real market on a future date. How far in the future one may look depends upon the ordinary course of the business with which one is concerned, in respect of goods such as those whose market value falls to be ascertained : here, the stock-in-trade at the end of the year.
What, then, is the position where, as here, in the ordinary course of business, the most profitable method and the normal method of disposal of stocks-in-hand on December 31, 1959, involves the selling of them, or some of them, at special bargain sales, weeks or months after the relevant accounting year has ended There can be no doubt that this sensible method of doing business will involve expenditure which is properly referable to the stock thus to be sold. The goods have to be kept in store or on the shelves. They presumably are insured, at a cost. There may well be expenditure in advertising specifically to attract the public to buy these goods from the previous years stock at the bargain sales. All this expenditure is incurred in 1960 for the purpose of securing the market price on 1959s leftover stock. Is it right to ignore such expenditure in assessing the market value of the goods at December 31, 1959 For it is ignored if one takes the market value simply as being the price which will be obtained at bargain sales in January or July or October, 1960, less salesmens commission.
It is here, I believe, that the word 'market' comes in, whether it is associated with 'price' or with 'value.' The price which will be realised on a sale of the stock in July, 1960, may not represent 'the value' simpliciter, of the stock at December 31, 1959, unless deduction is made for the expenses necessarily to be incurred between December 31, 1959, and the date of the sale of those goods. But the price which will be realised does represent the market value of the stock at December 31, 1959, if it is in the ordinary course of the business that the stock-in-hand at the end of the year should be dealt with in that way. Perhaps it was because of this conception that the Lord President used the words 'market price' rather than 'market value.'
If this were wrong, it would mean that the Crowns method of computation is wrong, because it would not give effect to the true market value of the stock at December 31, 1959. But it would not make the taxpayers method right. The taxpayers sought to refute the Crowns method by the argument that it did not make allowance for overhead expenditure; but they did not contend, as I understand, even as an alternative, that the Crowns method would be correct, provided it made such allowance. Hence, if the Crowns method is wrong, the consequence is, not that the taxpayers method is right, but that there is here no scope for the alternative of market value at all. So the taxpayers would be left simply with the stock being taken at cost.
I confess that, for myself, with all respect, I do not see any really acceptable or logical basis for a differentiation being drawn between the salesmens commission and the other overhead expenses. The latter, I think, were rightly disregarded. But the Crown has made this concession.
I agree that the appeal should be dismissed.
Appeal dismissed with costs.
Leave to appeal granted.