LORD EVERSHED M.R. The question for the decision of this court may be taken as it was formulated by the special Commissioners at the end of the case stated. It is as follows : 'Whether, on the evidence, and in view of our findings, our decision that the on-cost method should be applied in arriving at the cost of work in progress for the purpose of computing the companys Case I profits was erroneous in law.' The question as formulated did not (and I will assume deliberately did not) limit the subject-matter to the companys Case 1 profits for particular years; but I wish to say at the beginning that the problem before the special Commissioners and before us should be treated as so limited. At the beginning of the case three years are referred to (though, for the purposes of this judgment and of the argument, one particularly has been mentioned), namely, the year 1951-52 and the two succeeding years. I repeat that I shall treat the question posed as relating to those three years. The special Commissioners then put a second question, to which I may make some brief allusion hereafter.
The question arises in connection with the computation of the profits of the company, Duple Motor Bodies Ltd., for the purpose of income-tax under Case I of Schedule D. Put in the language of the statute, which language is now enshrined in section I27 of the Income-tax Act, 1952, the real question to which this matter is related is : For the years in question, what were the full amounts of the profits or gains of this companys trade Before Whimster & Co. v. Inland Revenue Commissioners, the profits or gains of a trade were, I understand, ordinarily arrived at, in the case of a company such as this, by discovering what the trading receipts were for the year in question and then deducting from those receipts the proper expenses which were allowable according to the income-tax legislation. But since the Whimster case 1, it has been recognized that, for the purpose of ascertaining the full amount of the profits or gains of a trade, it is (or, at any rate, it may be) also necessary to bring into the account at the beginning and at the end respectively of the relevant period the values of the work in progress or the stock-in-trade, or perhaps both; and that such values will, again in the ordinary case, be arrived at by looking at the market value or the cost, whichever is the less. The effect of bringing these matters into the account is this, that, if at the end of the year, the value of the work in progress or stock-in-trade is shown to be greater than it was at the beginning, then, to that extent, the full amount of the profits will be increased; and vice versa if, at the end of the year, the value of such items is less than it was at the beginning.
In the present case, it is to be noted that we are here concerned not with stock-in-trade but with work in progress. The reason for that is the nature of this companys business of manufacturing motor bodies, and we were informed by Mr. Bucher in his opening that in truth the business wholly, or at any rate very substantially, consists of making these bodies to order. That being so, there would, of course, be no question of a market value for any bodies, either partly finished or wholly finished, but still on the premises of the company; and that, indeed, is so stated in the case stated, where, in the course of formulating their decision, the Commissioners say : 'It is agreed that there is no question before us of market value.' I can now state again, and more precisely, the nature of the question we have to decide, and I can further explain the reference to 'on-cost' in the question as it was posed by the special Commissioners. The problem is, in relation to the taxpayers trading for the years I have mentioned, how you should arrive at the value, at the beginning and end of the periods, of their work in progress. It appears quite clearly that in the profession of accountancy there are two methods or theories which are current, both of which appear to have their devotees. The methods or theories are known, the one as the 'direct cost' method and the other as the 'on-cost' method. The direct cost method, as the words naturally import, means that you value the subject-matter-in this case the work in progress-by looking, at the beginning and end of the relevant periods, at what has been expended on the work in progress, and expended exclusively upon it-namely, for practical purposes (or, at any rate, in this case) the cost of the materials used and the wages of the labour directly employed. The on-cost method goes further; it says that you should not exclude a proper proportion of other, more general costs of the companys business, some part of which should be attributed to the work which was in progress at the relevant dates.
When Mr. Bucher opened the case for the Crown before us, be made it plain that what the Crown desired was that we should decide this matter as one of broad principle; that of the two champions being displayed before us, we must decide as a matter of broad principle between Sohrab and Rustum. Similarly, Mr. Borneman, for the taxpayers, invited us to decide that the direct cost method was the one that, generally speaking, should receive the imprimatur of this court. In support of these views, general arguments were put before us which clearly have much force. It was said by Mr. Bucher that if you are inquiring what is the value of, say, stock-in-trade, and in the circumstances you are to arrive at it by looking at what it has cost you to produce it, then it is not realistic to exclude any part of the general costs of the companys business, and so to do simply loads those costs unduly upon the sold articles. On the other side, Mr. Borneman has said that here you are only concerned to arrive at a valuation, and in doing so-because, after all, you are merely comparing two dates-it is only necessary and only safe to look at the costs which can be certainly discovered and ascertained and that you should not go beyond that into territory which at once becomes vague and unchartered. He supports that by saying that in this case the special commissioners, having decided in favour of on-cost, were then unable to express any concluded view as to what of the possible items of indirect expenses are those which should be included.
The special commissioners were persuaded to deal with this matter as one of general principle, and they so stated; and, as a matter of general principle, they expressed their own preference in favour of the on-cost method. In so far as they did that, it seems to me inevitable that they were not deciding a question of fact but a question of law-or, at least, of mixed law and fact. I am for my part quite clear that it would be wrong for this court to deal with this matter as one of principle, and to decide now that either for all purposes of this company or, still less, for all purposes in the case of trading companies, one method is the right and proper method and the other is not. So to do would, I think, go altogether outside the function of the court, which is to decide the particular problem presented by the particular case before it. As Mr. Bucher more than once emphasized, that with which we are in the case concerned, and only concerned, is the full amount of this particular companys profit or gains for tax purposes for certain years. Moreover, to decide the matter as one of principle, one way or the other, would, I think, fly in the face of what has been found to be professional opinion among chartered accountants. I would also add that I entertain the strongest inclination that, if we were to decide now in favour of one champion rather than another, in a very short time case would arise which would show quite clearly that, on those facts, the decision of this court could not be right. I add also that if we were to decide in favour of the on-cost method as a general proposition, the result, so far as I can see, would at best be inconclusive; and certainly, if we adopted the drawing of the line which was indicated by the special commissioners and which Mr. Bucher was inclined, I think, to accept, though be thought it was wrong, we should be giving our sanction to a purely arbitrary definition of the limits of indirect costs which should be taken into account. What we have to do, I repeat and emphasize, is to apply our minds to the question of the proper way of valuing work in progress at the beginning and end respectively of the tree years with which we are concerned as it affects the profits or gains of the Duple Motor Bodies Ltd.
At this stage I will cite two statements which were cited by Singleton L.J. in Patrick (Inspector of Taxes) v. Broadstone Mills Ltd. The first citation comes from the opinion of Lord President Clyde in the Whimster case itself. It is as follows : 'In computing the balance of profits and gains for the purposes of income tax, or for the purposes of excess profits duty, two general and fundamental commonplaces have always to be kept in mind. In the first place, the profits of any particular year or accounting period must be taken to consist of the difference between the receipts from the trade or business during such year or accounting period and the expenditure laid out to earn those receipts. In the second place, the account of profit and loss to be made up for the purpose of ascertaining that difference must be framed consistently with the ordinary principles of commercial accounting, so far as applicable, and in conformity with the rules of the Income-tax Act, or of that Act as modified by the provisions and schedules of the Acts regulating excess profits duty, as the case may be. For example, the ordinary principles of commercial accounting require that in the profit and loss account of a merchants or manufacturers business the values of the stock-in-trade' - and I would add here, though it is not in the opinion, 'or work in progress' - '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.'
The second citation is a brief citation from the speech of Lord Loreburn L.C. in Sun Insurance Office v. Clark, where he said : 'An estimate being necessary'- that is, for the purpose of arriving at the value of the work in progress -'and the arriving at it by in some way using averages being a natural and probably inevitable expedient, the law, as it seems to me, cannot lay down any one way of doing this. It is a question of fact and of figures whether what is proposed in each case is fair both to the Crown and to the subject.' Founding myself upon those two citations, it seems to me that you proceed in this case and in other cases to say : What is the normal, proper accounting practice in regard to this matter, and does what is normal produce a fair result Or, if there are alternatives, which is shown on the facts of the particular case to produce the fairer result ?
With that premise, I now turn to make one or two references to the case stated. In paragraph 7, the special commissioners, who are persons of great experience, refer to certain expert evidence given, and then in paragraph (b) they say : 'On the evidence adduced before us we find-and this naturally has caused us difficulty-that the accountancy profession as a whole is satisfied that either method will produce a true figure of profit for income-tax purposes.' Mr. Bucher somewhat criticised the addition of the last four words, but I do not think that criticism is justified. If either method is a proper method for arriving at profits for general commercial purposes, then it satisfies the test which is suggested by Lord President Clyde, but, of course, it still leaves it to be debated whether, in the particular circumstances of a particular case, it is fair.
The commissioners went on : 'In this state of affairs we find that it is very much a matter of policy for the decision of the directors of a company which method should be used.' A little lower down the commissioners proceed to deal with the still more vexing problem, as they thought and as I think : If in any particular case you do choose the on-cost method, then what of the indirect costs do you include As regards that, they said : 'If the on-cost method is applied, different accountants may apply different recognized variations of this method : and, whatever recognized variation of this method is applied, the accountancy profession as a whole would not condemn any particular recognized variation as being unsound. Furthermore, we find that there is considerable scope for difference of opinion as to how a recognized variation of the on-cost method should be applied to the facts of each particular case.'
I pass at once to that part of the case in which their decision is recorded, and I will first of all read some four or five passages without comment. They begin : 'We have been asked to decide this appeal on a board question of principle, and we are going to do that, fully aware that in doing so we shall be leaving open a wide field for discussion between the parties; but we feel that, having to decide this as a broad question of principle, that is really inevitable and cannot be helped.' Then, after stating what the problem was, and referring briefly to certain arguments, they say : 'The Crown contend that some part of these overheads' - that is, the general business overheads - 'must go into the cost of work in progress. When the factory is not running at full capacity, the Crown say it is obvious that production costs more-that is, it costs more if the factory is nor running at full capacity to make a particular vehicle. That is a fact, the Crown contend, and that kind of fact ought to be reflected in the accounts, and the on-cost method does reflect that kind of fact.'
In the next paragraph they deal with the expert evidence, and as regards one of the accountants, they say : 'Mr. Clarks evidence comes really to this, that the two methods are both accepted in the accountancy profession, and that you cannot methods are both accepted in the accountancy profession, and that you cannot say there is a general opinion in the accountancy profession that the on-cost method is unsound. Mr. Clark told us that each method will produce a true view of profits for income-tax purposes' - and I emphasize the last words, to show justification for what I have already read -'and I think we might say here that we consider it important that ascertaining profits for income-tax purposes does involve ascertaining profits year by year.' I should add that it had earlier appeared to have been his evidence that although, as he stated, both methods were regarded as acceptable and proper, there seemed recently to be a swing against the on-cost method within the accountancy profession,
The commissioners they say this : 'We feel in the end that to get at the true cost of producing an article-that is the cost of making the thing-there is really something more in the cost than the mere cost of labour and the cost of the material that has gone into that particular article. It seems to us that it has really cost more to build a vehicle body than just the cost of labour and material. The object of the on-cost method-whether we are right or wrong about this-is really to get at the cost; and as we are coming down on the side of the on-cost method is appears to us that any proportion of overheads, which on that method is to be attributed to cost, should be limited to factory overheads, namely, the overheads of the place where the thing is actually being made. We realize that the expression factory overheads is rather vague; but, since we are asked to decide this matter on a broad question of principles, we feel, as we have already said, that it is inevitable that a wide field for discussion should be left open and we do not feel able to define the term factory overheads.' They conclude : 'We finish where we began, by saying we know full well that we have left a wide area open. We do not think we can help that.'
I cannot refrain from observing that it seems to me an obvious criticism of the Crowns argument that if, as a broad principle, we must give our imprimatur to the on-cost method, then, according to the special commissioners, that levels quite undecided (and they thought really incapable of decision) what are the exact items which should be included. That is not indirectly to say that I am intimating that the direct cost method is the proper method as a broad matter of principle, but it shows what has been emphasized in the passages I have voted : that the court should deal-and the court can only deal, as I think-as a question of fact and figures with the particular circumstances of particular cases, and say : On these facts, on these figures, is this way of doing it fair as between the Crown and the subject, or is that way the fair away of doing it - and I do venture most strongly to emphasize that aspect of the matter.
Vaisey J. resolved the conflict in a different sense from that of the special commissioners. Mr. Bucher somewhat criticised his judgment, because he said that the commissioners had found that it was proper accounting practice to use either method, whereas, said Mr. Bucher, what the commissioners said was that they had found that the accountants were satisfied that it was proper to use either method; but, without repeating what I have already said, in my judgment that is exactly the same thing for this purpose, having regard to the Lord Presidents opinion. I do not therefore think, if I may say so, that there is anything in that criticism. On the other hand, I agree with Mr. Bucher that for income tax purposes you cannot say : 'Well, it is a matter for the directors. If the directors had decided to adopt in a particular year or years the direct cost method, that concludes it for income-tax purposes.' The duty of the directors is to make their decision on this matter in the best interests of the company, looking at it as a business entity, and quite plainly it could not be said that their conclusion, quite properly come to as responsible for the companys management, was decisive of the matter for income-tax purposes.
I have already said more than once-and I shall be forgiven because I wish to emphasize it at strongly as I can-that I think it is wrong, and would be wrong, it as strongly as I can-that I think it is wrong, and would be wrong, to decide this matter on general principle. I base that view partly on the citations I have made from the Broadstone Mills case and also on the results it would or might appear to lead to, of which the citations from the case stated will have given sufficient illustration. I take by way of example what was said at the beginning of the Crowns contention-and I gather the special commissioners in some sense founded themselves upon this-that obviously, if you are asking how much it cost to produce something, you should not exclude altogether overheads, and it is unrealistic to do so. But the conclusion of the passage I have read seems to me to be this, that if, as the commissioners say, production is slack, it follows that the proportion of overheads attributable to the work in progress is larger, from which they apparently are led to the conclusion that the taxable profits are necessarily larger - a proposition which I venture to think is self-condemnatory.
But I return to the facts of this case. There have been exhibited certain schedules, and I will make some reference to the figures. For the first year which has been the subject of debate, ended March 31, 1951 - since, by section 127, you look at the preceding year - you find this on the figures : the work in progress at the end of the year according to the taxpayers method of computation-based, that is, on direct cost - was worth Pounds 136,000 odd; at the beginning of the same year it was worth Pounds 138,000 odd. The result is that the work in progress was 2,000 less in value at the end of the year than at the beginning, with the further result, no doubt, that the taxable profits would be reduced by Pounds 2,000. The application for the same year of the on-cost method shows that if the sums are added, at the beginning and end of each year, which the Crown suggests should be added, however arbitrarily selected from overheads - and I repeat that the Crown seem to have accepted the arbitrary selection, though they said in the plainest language in opening the case that this geographical limitation is quite wrong; but, still, adding them-the curious result is that the value of the work in progress at March 31, 1951, is not Pounds 2,000 less but it Pounds 14,000 more than it was at the beginning of the year in question. So that, according to this computation, the full amount of the profits or gains to be taxed must be increased by Pounds 14,000 instead of being reduced by Pounds 2,000 in respect of that item.
Of course, if the truth is that upon a fair view the profits were Pounds 14,000 more and not Pounds 2,000 less, then it would be unfair that the tax liability should depend upon the latter and not the former calculation. But what evidence is there to show that the right view is that work in progress should be taken in at Pounds 14,000 more at the end than at the beginning We have no idea, because there is (for example) no evidence whatever of the number of unfinished motor bodies that there were in fact on the taxpayers premises at the beginning or at the end of the ended March 31, 1951, there was a considerable slackening off of the taxpayers business. Whereas for the year ended March 31, 1950, the wages paid to labour were Pounds 534,000 odd, for the year ended March 31, 1951, it was Pounds 347,000 odd-nearly Pounds 200,000 less. I suppose that as a judge, I may take some account of the general knowledge that there has been no tendency towards a reduction in wages, at any rate on that scale, was far less work being done.
That of itself, of course, supports what I indicated earlier, that the special commissioners seemed to be basing themselves on the passage I have quoted. They were saying that because, owing to a slackening off of business, a greater share of overheads must be applied to work in progress, therefore the taxable profits of the taxpayers were greater. I add only this, that in order to arrive at the figure for which the Crown contened -namely, Pounds 14,000 excess of value of work in progress at the end as compared with the beginning-the proportion of overheads taken in as at March 31, 1950, was 27.9 per cent. of the whole, and at the end it was 40.5 per cent. The justification for these percentages has not been debated, but they make it perfectly plain that the increased value of the work in progress depends obviously on the fact that these taxpayers were doing less work.
There was before us some discussion on the matter of onus of proof, and, of course, I accept it that where the taxpayer is assessed and complains that the charge made upon him is wrong, he must show it to be wrong; but also, as we all know, and as Mr. Bucher naturally and frankly conceded, in discussing the case the onus may shift from time to time from one party to the other. In considering the proper way to formulate a conclusion here, I venture to think certain facts are relevant in this particular connection. In the first place, it is conceded by the Crown that the taxpayers, and their immediate predecessor, have been taxed upon the full amount of profit and gains, arrived at so as to include the value of work in progress calculated by reference to the direct cost method, for rather more than a generation, and throughout that period the Crown have accepted that method of arriving at the value, or the comparative value, of the work in progress, as being fairly represented by the application of the direct cost method. Further, as Mr. Bucher again frankly conceded, in the tax years with which we are concerned there was no relevant change of circumstances in the taxpayers general affairs at all. In those circumstances, I should have thought that at any rate there was some obligation upon the Crown to show why they have now come to the conclusion that the on-cost method should be adopted and the direct cost method should be discarded. What I have said perhaps supports the view that, for reasons which I assume may be quite good - at any rate, it is not a matter on which we have to express an opinion -it is thought that now is the time to strike a blow for the on-cost method in this sort of case. It also may support the view or the suspicion - which accounts for this matter of principle not having been raised before-that in the end of all (that is, over a period of years) it matters not at all which method is adopted; in the end of all, it comes to the same thing.
In the result, however, if on the figures, on the facts, on the evidence, it were necessary for this court to reach an affirmative decision, I must say I would be prepared to conclude that for these particular years and in relation to these particular taxpayers, the on-cost method me say that this is not an oblique way of saying that I am affirming the view as a matter of principle that the direct cost method is the right one. In those circumstances, I am quite content to put it in this way : referring back to the question posed by the special commissioners, I think that, in relation to the particular years and to these particular taxpayers, which is the only matter with which this case is concerned, the decision of the special commissioners was wrong in law. Having come to that conclusion I would therefore dismiss this appeal.
PEARCE L.J. I agree. There is a divergence of view in the accountancy profession as to the respective merits and defects of the direct cost and the on cost methods. The commissioners were asked by both sides to regard this case as a conflict a outrance between the two methods, and to give their verdict to the winner. We, too, have been asked to give such a verdict, but it would be wrong to lay down such a general rule as if it were a matter of law. It is a question of fact in each case to ascertain the true profit.
The result has been that the ascertainment of the particular profits for the particular year - which, after all, was the real object of the inquiry - has been a little submerged by this ideological dispute. The costing of the work in progress, though it is a necessary part of accounting both from a commercial point of view and since the Whimster case, from the income-tax point of view; yet it is only a means to the ascertainment of the profit and not an end in itself. Moreover, one year will correct the errors of another. And it would be unfortunate if dogmas of method obscured the real purpose - the finding of a fair, true and reasonable assessment of the real profit of the business for the year. Whatever the merits of the on-cost method as seen from one point of view, in a certain set of circumstances it can produce an unfair result. As the Master of the Rolls pointed out in argument, not only can it produce such a result, but that particular set of circumstances does apparently arise in this particular case.
When a factory has an idle and unprofitable year, the costing of the work in progress is inflated by the fact that it has, under the on-cost method, to bear an abnormally high proportion of the overheads during an uneconomic period. As a result, the profits are notionally increased whereas in fact there are no true profits to justify that increase. In such a case, an actual loss could be converted on paper into a theoretical and untrue profit.
Both theories rest ultimately on the fact that cost is a guide to value. When, owing to trade difficulties, cost parts company from value, difficulties arise; and it may well well be that the more realistic the costing the greater the difficulty. It has been argued that an unfair result can always be avoided by the proviso that the market value can be taken as the touchstone wherever the on-cost calculation would produce too high a figure; but here it was common ground that the market value was not appropriate to the facts of this case. Here it would seem that a substantial amount of the figure added by the on-cost method is due to lack of work in the factory. The profits are thereby notionally increased owing to that unprofitable lack of work. That result-which, owing to the general nature of the argument, had not received the prominence to which it was entitled-must be of very great importance in these assessments; and once it is fully appreciated it becomes plain, in my view, that it would be wrong in the circumstances of these particular assessments, in these particular years, to depart from the simpler, direct cost method that had always been used by this company over so many years. For that reason, and for those that have been given in greater detail by my Lord, I agree that the appeal fails.
HARMAN L.J. I, too, agree. This case has been a good illustration of the sometimes forgotten fact that an English law suit is not a moot or debate, but an attempt to arrive at a result on the facts before the court : broad academic arguments are quite unsuited to the processes of the English law.
Here, on-cost has been declared by the commissioners to have their vote as a general matter, regardless of the fact that when the details are looked into it produces an absurdity. Judged by that touchstone, the commissioners could not have come to the conclusion they did; but they were not looking at the facts, but at the theories which were so largely debated before them. The result is that, taking their eyes off the ball, so to speak, they came to a conclusion which is not, when the facts are looked at, tenable. The appeal must, therefore, be dismissed, though not quite on the ground on which the judge below dismissed it, for he decided upon the footing that the directors had the right to choose the method of costing for income-tax purposes. In fact, of course, they have the right to choose the method vis-a-vis their shareholders and for the good of the company, but it cannot be that they are the arbiters when it comes to assessing the costs from any income-tax point of view. It is, of course, well known that many things-reserves, and so on-which are not allowable as deductions for income-tax purposes are proper deductions when setting out the profits of the company. But although we do not agree with all the reasoning of the judge, we do agree with his conclusion.
Appeal dismissed with costs.
Leave to appeal to House of Lords
Refused.