Breeding horses was a trade, but racing them (at the time) was not. Some of her foals were sold on to third parties and the sale proceeds were quite correctly included in her accounts. Some foals she kept and trained up and raced herself.
This led to a dispute with what was then the Inland Revenue, in the shape of a tax inspector called Mr Sharkey (some people are fated by their names to follow certain careers, don’t you find?).
The dispute with the Inland Revenue went all the way to the House of Lords, and concerned what should be the tax treatment of those young horses that she had bred in the course of her trade, but then taken for her own private use. There were three alternatives before their Lordships:
· Nothing should be taxed, as nothing had been received for the horses concerned
· The cost of breeding and rearing the horses should be brought in as a receipt, so that she did not get a deduction for those costs against her trading profits when she had not in fact sold the horses concerned as part of her trade
· The market value of the horses should be treated as a trading receipt because...well, because the tax inspector said so
Those of you who are not tax specialists and therefore retain some faith in normal commercial common sense might have thought that the second of these alternatives was the obviously just and reasonable choice. The House of Lords were however successfully bamboozled by the Inland Revenue into thinking that it would be impossible to arrive at a correct figure for these costs, and went for the third option of including an imaginary profit which had not in fact been made.
Ask any businessman for the unit cost of the things he produces and he will be able to tell you exactly (if he can’t, whatever you do, don’t invest in his company because it will be on its way down the pan), but their Lordships seemed unaware of this and thus set a precedent which has been with us ever since.
I have seen the case of Sharkey v Wernher used by HMRC to create taxable profits out of thin air across a wide variety of trades. I, and most of my professional colleagues, have always thought that the House of Lords got their decision disastrously wrong, but as the highest court in the land, their ruling was binding until someone came along with the courage (and the cash) to fight the battle again all the way to the top.
In the last few years, there seemed some hope that the decision might be overturned. There has been a trend for the Courts to affirm that where accounts are prepared according to correct accountancy principles, they should be followed for tax purposes unless there is specific legislation to override the accounting treatment.
It should be remembered that the Wernher case was decided on the (wrong) assumption that market value was the correct accounting treatment. Modern accounting practice, however, is quite clear that the middle choice (of effectively disallowing a deduction for the cost of the stock item concerned) is the way to proceed.
It seemed only a matter of time before someone won a case to overturn the tyranny of this case from the 1950s.
Then came the 2008 Finance Act – possibly one of the most illiberal and draconian Finance Acts ever – which effectively made the Sharkey v Wernher decision into specific legislation, so that it can no longer be challenged on the matter of accounting principles. Even though if you prepare your accounts correctly you will not bring in the market value of the goods you take for your own use, for tax purposes you must now do so, because of Schedule 15 to FA 2008.
The fact that a bad decision of the Lords has been converted into statute law just at the point when it was looking probable that it was vulnerable and might get overturned is bad enough, but there is worse to come.
Keith Gordon, a barrister with an excellent track record of reminding HMRC of the limitations of their powers, noticed that in the parliamentary debates on the subject, Kitty Usher (the Economic Secretary to the Treasury at the time) said that the legislation had been introduced in response to representations from “the normal types of body that one would expect – the trade associations and the accountancy and legal professions” (her words as quoted by Mr Gordon in an article on AccountingWeb.co.uk).
Mr Gordon, finding this hard to believe, made a request under the Freedom of Information Act for details of which “trade associations” and “professions” had been so stupid as to act directly against their members’ and clients’ own best interests.
His request was illegally ignored by the Treasury until after the Finance Act had been safely passed, and when they were eventually forced to reply, they admitted that no trade associations had made any request for the legislation, and the only “professional association” that could be argued to have made any representations was my own Chartered Institute of Taxation – and this relied on taking remarks out of context, rather than a direct representation from the CIOT, which in fact was strongly opposed to the proposal.
This means that Kitty Usher’s justification to Parliament for the legislation was devoid of any basis in fact.
As Mr Gordon pointed out in his article, misleading Parliament is a very serious matter – those who remember the Profumo Affair will remember that what finished Mr Profumo was not that he was playing away with Christine Keeler, but that he lied about it in Parliament.
I wish Kitty Usher every success in her future career.
James Bailey
