Ostime (Inspector of Taxes) v Duple Motor Bodies Ltd [1961] UKHL 6

House of Lords
Between
Ostime (Inspector of Taxes)AppellantDuple Motor Bodies LtdRespondent
It is Ordered and Adjudged, by the Lords Spiritual and Temporal in the Court of Parliament of Her Majesty the Queen assembled, That the said Orders of Her Majesty's Court of Appeal of the 18th day of March 1960, in part complained of in the said Appeals, be, and the same are hereby, Affirmed, and that the said Petitions and Appeals be, and the same are hereby, dismissed this House: And it is further Ordered, That the Appellants do pay, or cause to be paid, to the said Respondents the Costs incurred by them in respect of the said Appeals, the amount thereof to be certified by the Clerk of the Parliaments.Ostime (Inspector of Taxes) v. Duple Motor Bodies Limited, Commissioners of Inland Revenue v. Duple Motor Bodies Limited (Consolidated Appeals).

HOUSE OF LORDS

OSTIME (Inspector of Taxes)

v. DUPLE MOTOR BODIES LIMITED

COMMISSIONERS OF INLAND REVENUE

v.

Viscount Simonds Lord Reid Lord Tucker Lord Hodson Lord Guest

DUPLE MOTOR BODIES LIMITED

[Consolidated Appeals]

Tuesday 28 th March, 1961.

Viscount Simonds

My Lords,These appeals cannot, in my opinion, be sustained. They relate to assess- ments made upon the Respondent company to income tax under Case I of Schedule D of the Income Tax Act, 1952, for the years of assessment 1951-52, 1952-53 and 1953-54 and to profits tax for the chargeable accounting periods between the 1st April, 1950, and the 31st March, 1952. The same questions arise in regard to all these assessments and it will be sufficient to take a single example, namely, the assessment to income tax for the year of assess- ment 1951-52. In that year the Respondent company were assessed to income tax in respect of their trade of motor body builders in the sum of £250,000. They appealed to the Commissioners for the Special Purposes of the Income Tax Acts, who upheld the assessment but stated a Case for the opinion of the Court. The case came before Mr. Justice Vaisey, who reversed the determination of the Commissioners. His decision was affirmed by the Court of Appeal.The question at issue between the parties was as to the correct method of ascertaining the cost of work in progress in order to determine the full amount of the profits or gains of the company's trade, and I will state at once the question as formulated in the Case Stated. It was:
" 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 company's Case I profits was erroneous in " law. "
This question was followed by another, which, in the view that I take, does not arise. If it did arise, I do not think that there are materials which enable your Lordships to answer it.My Lords,it must be apparent that, before your Lordships can answer the question whether it was erroneous in law to apply the " on cost " method for the purpose indicated, you must be told precisely what the " on cost " method is. I doubt whether at the end of two days' discussion it is possible to form any clearer idea of it than that it is at least something different from the " direct cost " method about which there is no less difficulty of definition It was significant that learned counsel, after arguing strenuously in favour of the " on cost " method, invited your Lordships to assist the Crown by saying in what that method consisted In these circumstances I would myself be content to dismiss this appeal upon the single ground that the Case Stated does not formulate a question which the Court can properly answer. I will, however, state certain further facts and make some observ- ations upon them in deference to the arguments that we have heard.The Respondent company was incorporated in July, 1946, and took over the business of a company which had been incorporated in 1919. Its business is that of building to order bodies for different types of road vehicles, mostly motor coaches. As the business is almost entirely that of building bodies to order, very few finished bodies are included in work in progress at the end of an accounting period. The business is seasonal, the busy season ending about the end of June. The turnover of the business was over £1,000,0002per annum in the years 1948 to 1954. Upon these facts the question arises how for tax purposes (income tax or excess profits tax) the cost of work in progress consisting of motor bodies is to be ascertained.I have referred to the two methods, " direct cost " and " on cost ", and note that the company and its predecessor had since 1924 been assessed on the former method until the assessments were made which are now in dispute. As these words are labels invented by accountants to describe two different methods, I will try to explain them, with the proviso that no explanation is precise or satisfactory. Before doing so, it is proper to say—it is indeed implicit in what I have said—that it is common ground that some value must be attributed to work in progress, and that in ascertaining that value two considerations must be borne in mind, first, that the ordinary principles of commercial accounting must as far as practicable be observed and, secondly, that the law relating to income tax must not be violated : see Whimster & Co. v. Commissioners of Inland Revenue, 1926, S.C. 20 : that is to say, by one means or another the full amount of the profits or gains of the trade must be determined.It is perhaps easier to say what the " direct cost " method means than the " on cost " method. By that I mean that there appears to be less vagueness in the definition of that method. In the instant case it seems that the Respondent company has included nothing more in " work in progress " than wages and material directly attributable to that work. But that is by no means the end of the matter. For the company in the course of the case has conceded that other items of expenditure might well be included. " Direct " cost " therefore remains an imprecise term The question of " on cost " method presents far greater difficulties. Let me cite some passages from the Case Stated." There are several different ways of applying the On-Cost method. " Indirect expenditure is quite commonly divided by Cost accountants " into headings of: —( a ) Factory Expenses ; ( b ) Office Expenses ; ( c ) " Selling Expenses ; ( d ) Dispatch and Financial Expenses." It is a common, but not universal, method of applying On-Cost " method to include in the cost of Work-in-Progress a proportion of " either all the Factory Expenses or of some only of them, and to " exclude the other headings of indirect expenditure.
" If the On-Cost method is applied, different Accountants may apply " different recognised variations of this method ; and whatever recog- " nised variation of this method is applied, the Accountancy profession " as a whole would not condemn any particular recognised variation as " being unsound. Furthermore, we find that there is considerable scope " for difference of opinion as to how a recognised variation of the On- " Cost method should be applied to the facts of each particular case."
My Lords,what a prelude is this to asking the Court whether the decision of the Commissioners that the " on cost " method should be applied in arriving at the cost of work in progress in the present case was erroneous in law! I could understand it better if the question were whether the direct cost method could properly be applied. But it would not be much better. The consideration of this problem undoubtedly presents something of a dilemma. The practice of accountants, though it were general or even universal, could not by itself determine the amount of profits and gains of a trade for tax purposes: see, for example, Minister of National Revenue v. Anaconda American Brass Ltd. [1956] AC 85 at p. 102. On the other hand, it was the basis of President Clyde's decision in Whimster's case that the ordinary principles of commercial accounting require that in the profit and loss account of a manufacturer's business the values of the stock-in-trade at the beginning and 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. It is for this reason that stock-in- trade (and work in progress also, though nothing is said of this in Whimster's case) is brought into account. If this is so, regard must be paid to account- ancy principles also in ascertaining what that cost is, subject always to the condition that taxing statutes must not be violated. As to this let me cite some further passages from the Case Stated.3" Both methods are recognised by the Accountancy profession as " correct accountancy ...." Professional Accountancy opinion is rarely static on questions of " this kind : we find that up to fairly recently the weight of Accountancy " opinion was in favour of the On-Cost method, but that now the trend " in the profession is slightly away from this method.
" 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."
The final sentence is perhaps open to criticism, but I take it to mean that either method shows the full amount of the profits and gains of the trade, and I see no impossibility in this when I remember how elaborate and artificial are the methods of accountancy. The important thing is that the method which is in fact adopted should not violate the taxing statute. Different results may be reached by different methods, neither of which does so.My Lords,a first principle of tax law is that the taxpayer in ascertaining his profit is entitled to debit his expenditure in the year of assessment unless it is excluded by section 137 of the Income Tax Act, 1952. And this is so although the whole of that expenditure may not bear fruit in that year : see, for instance, Vallambrosa Rubber Co., Ltd. v. Farmer, 5 T.C. 529. In other words, it is no ground for refusing a deduction in one year that the expense may be recoverable in another. Put in yet another way, the Crown is not entitled to anticipate a profit which may or may not be made, as it might do if too high a value were put on stock-in-trade or work in progress. This principle must be harmonised with another, which I have already mentioned, namely, that at any rate some value must be placed on these things. That is recognised by the so-called " direct cost " method even if it is confined to the cost of labour and material. But the danger of putting too high a value on stock-in-trade is also recognised, for, whatever method is adopted, the trader is by any theory of accountancy allowed to value it at cost or market value, which I take to mean market value at the end of the accounting period. This is of greater significance in the case of work in progress than of stock-in-trade. Counsel for the Crown admitted that the market value of an unfinished motor body made to order might be negligible but that, nevertheless, that value might be taken. Of this the Respondent company may yet, I suppose, take advantage. They could not be blamed for doing so if the co-called " on cost " theory is pressed to a manifestly unfair conclusion.My Lords,I think that in this dilemma the prevailing consideration must be that the taxpayer should not be put to any risk of being charged with a higher amount of profit than can be determined with reasonable certainty. He may concede that stock-in-trade and work in progress must for tax pur- poses be regarded as a receipt. Upon that professional accountants appear to be universally agreed, though it might not be at once obvious to the layman. But this concession should not be pressed beyond the point at which the profession is widely, if not universally, agreed, and I should, therefore, if I had to choose (which I have not) between two vaguely defined methods, choose the " direct cost " method as the less likely to violate the taxing statute. I should be supported in this choice by the reflection that, if the cost is put at too low a figure, the error will be made good to the advantage of the Crown in the following year.Another consideration that weighs with me is this. I recognise the force of the contention that, if the cost of work in progress cannot be ascertained with accuracy, at least the attempt should be made to be as accurate as possible. But against this I put at least two powerful considerations. The first is that it is undesirable to indulge in what is no better than guesswork though it may be described as an intelligent estimate, and it appeared to me that a large part of the suggested apportionment of overheads to stock-in- trade and work in progress was the wildest guesswork. It may be from the commercial point of view a desirable practice. But it is a very different thing to impose it upon a trader whether he wants it or not. It is not only4unreliable for the purpose of ascertaining the year's profit. It is also an elaborate and costly practice if carried to its logical conclusion. And I see no reason why, once embarked on, it should not be carried to its logical conclusion. There appears to me to be no distinction, except perhaps of convenience, between the many varieties of cost which the exponents of one" on cost " system or another advocate.A second and more powerful reason, which the case under appeal illustrates, is that an attempt to get as nearly as possible an accurate estimate of cost may, if it means the consistent application of a theory of costing, lead to what from the taxing point of view is an absurd conclusion. That is not too strong a word. For here, as was well pointed out by the Master of the Rolls and Lord Justice Pearce, the value of the work in progress at the end of the relevant year was £2,000 less than at its beginning if the " direct cost " method is adopted, whereas according to the " on cost " method it was not £2,000 less but £14,000 more. This difference is due to little else than the fact that the overheads had to be distributed among a smaller number of articles so that each of them bore a greater proportion of such costs. An idle and unprofitable year thus increases for tax purposes the value of the work that has been or is in course of being done. Counsel for the Crown did not shrink from this conclusion and accepted my suggestion that, if owing to a prolonged strike little work was produced, the weight of all the overheads would have to be thrown upon that little. The only course then open to the trader would be to take market value as the test. This, I have pointed out, is an invitation that may be accepted.My Lords,in my opinion this is fundamentally wrong. Stock-in-trade and work in progress are brought into account because, fictitiously but as a matter of plain common sense, they are treated as a receipt of the year's trading. The words "receipt" and "realised profit" were often on counsel's lips in regard to them. My Lords, I would say, nevertheless, that it is something remote indeed from common sense to say that for taxing or any other purpose an inflated value is to be given to stock-in-trade or work in progress because a slump in trade has reduced the articles between which overhead costs can be apportioned. The asset regarded as a receipt is not more valuable nor is a greater profit realised.For the reasons that I have given I reject the so-called " on cost " method as a method which can be imposed on the taxpayer. If in any particular case there is in the opinion of the Crown some item of expenditure beyond wages and cost of material which ought for tax purposes to be attributed to stock-in-trade or work in progress and there is a dispute about it, that can be settled in the ordinary way. But I will add, in order to show how impossible it is to lay down any universal or even general rule, that it may be equally open to the taxpayer in special circumstances to show that something less than the cost of material and wages should be taken as the value of work in progress or stock-in-trade.I would dismiss this appeal with costs.

Lord Reid

My Lords,The Respondents build bodies for motor vehicles : generally these are motor coach bodies built to order for individual purchasers. This case arises out of assessments to income tax in respect of that trade for the years 1951/52, 1952/53, and 1953/54. At the end of each accounting period the Respondents had in their possession a number of unfinished bodies on which work was proceeding and which are referred to as work in progress. Admittedly sums representing work in progress at the 'beginning and end of each period must be taken into account in computing the profits of the period for income tax purposes. The question at issue in this appeal is the principle by reference to which sums representing work in progress must be determined.5In the Case Stated by the Special Commissioners it is said: " 2. The questions for our determination were :—" (1) whether, in arriving at the cost of work in progress for " the purpose of computing the profits of the Company for Income " Tax purposes, the cost of direct materials and labour only " (' Direct Cost ') should be taken into account or whether there " should be added to the Direct Cost a proportion of indirect " expenditure (' On-Cost '); and" (2) if On-Cost was to be taken into account what items of " indirect expenditure fell to be included therein." It was common ground that there was no question of market value " of work in progress as it could not be regarded as saleable in its " unfinished state.. . . . . .
"5. We were asked in the first instance to decide as a broad " matter of principle whether the Direct Cost method or the On-Cost " method was to be applied in ascertaining the cost of Work-in-Progress " for the purposes of computing the Case 1 profits ; and on this basis " we were asked to consider the accounts for the year to March, 1951, " as an example."
The findings in the Case Stated may be more easily understood if I first set out what I believe to be the background of this matter. It appears that at one time it was common to take no account of stock-in-trade or work in progress for income tax purposes, but long ago it became customary to take account of stock-in-trade, and for a simple reason. If the amount of stock-in-trade has increased materially during the year, then in effect sums which would have gone to swell the year's profits are repre- sented at the end of the year by tangible assets, the extra stock-in-trade which they have been spent to buy; and similar reasoning will apply if the amount of stock-in-trade has decreased. So to omit stock-in-trade would give a false result.It then follows that some account must be taken of work in progress. Suppose that the manufacture of an article was completed near the end of an accounting period. If completed the day before the date the article if not already sold has become stock-in-trade, if completed the day after that date it was still work in progress on that date. It could hardly be right to take that article into account in the former case but not in the latter. I do not know when it became customary to take into account work in progress, but it appears that that has been customary for many years, and it is not disputed that at least in all ordinary cases that must now be done.Then the question is what figure should be taken to represent the stock-in- trade. If it consists of articles bought for resale the answer is obvious—the price the taxpayer paid for them or their cost to him. If market value were taken that would generally include an element of profit, and it is a cardinal principle that profit should not be taxed until realised: if the market value fell before the article was sold the profit might never be realised. But an exception seems to have been recognised for a very long time: if market value has already fallen before the date of valuation so that at that date the market value of the article is less than it cost the taxpayer, then the taxpayer can bring the article in at market value, and in this way anticipate the loss which he will probably incur when he comes to sell it. That is no doubt good conservative accountancy but it is quite illogical. The fact that it has always been recognised as legitimate is only one instance going to shew that these matters cannot be settled by any hard and fast rule or strictly logical principle.The earliest authority dealing with this matter on general lines appears to be Whimster & Co. v. Commissioners of Inland Revenue (1925) 12 T.C. 813. The opinion of Lord President Clyde has always been followed and Lord Sands's opinion is also instructive. It is not disputed that the principles there expressed apply both to stock-in-trade and work in progress. But there was no discussion there as to the meaning of " cost ", and that is the problem that now confronts your Lordships.6Broadly speaking, the direct cost method only takes account of money spent solely for the purpose of or in connection with the manufacture of the particular goods, whereas the on cost method treats as an additional part of their cost proportions of various overhead expenses or of money spent in connection with the manufacture of those goods and also of others. The main elements in direct cost are labour and materials, though there may be others, and the method can be applied with a large degree of accuracy, but, as will appear in a moment, there is great uncertainty attaching to the on cost method.The findings of the Special Commissioners with regard to these methods are long and elaborate, and I shall try to present them fairly in summarised form. Both methods are recognised by the accountancy profession as correct accountancy. Professional opinion is rarely static on such questions. The on cost method is used for most taxpayers (it is not said whether any of them object to this). There are several different ways of applying the on cost method : different accountants apply different recognised variations of it. Whatever recognised variation is applied the accountancy profession as a whole would not condemn it. And within any particular recognised variation there is considerable scope for difference of opinion in its applica- tion to the facts of a particular case. The Commissioners quote from a booklet issued by the Institute of Chartered Accountants in England and Wales:
" 107. No particular basis of valuation is suitable for all types of " business but, whatever the basis adopted, it should be applied " consistently."
The present Respondents have used the direct cost method since 1924.There is one finding of the Commissioners which rather puzzles me. " The " Accountancy profession as a whole is satisfied that either method will " produce a true figure of profit for Income Tax purposes ". This cannot mean that, taking a particular business in a single year, either method will produce a true figure: the methods will produce very different figures of profit and both cannot be true figures of profit for the same year. It may mean that, applied consistently over a period of years, both methods will for the whole period produce the same aggregate profit, and that appears to be approximately true. Or it may mean that one or other method will produce a true figure depending on the nature of the business, and that seems to accord with the " Recommendations " of the Institute.Normally a court attaches great weight to the view of the accountancy profession, though the court must always have the last word. But here the findings which I have summarised show that that assistance is not available on the issue which your Lordships have been invited to consider. The Commissioners state that they were asked to decide between these methods as a broad matter of principle, and your Lordships were also invited to take that course. But I find that very difficult: if the accountancy profession cannot do that I do not see how I can. The most I can do is to try to bring common sense to bear on the elements of the problem involved in this case on the assumption, which I am entitled to make, that common sense is the same for lawyers as for accountants.The Appellant first submitted an argument which, if sound, would carry him a long way, indeed it would carry him further than he wanted to go. It was based on an assumption that expenditure shown in a profit and loss account can all be divided into manufacturing and selling expenditure and that the manufacturing expenditure can and should be attributed entirely to goods manufactured or partly manufactured during the year of account. If that were so it might follow that you should allocate that expenditure between all those goods: if you refuse to allocate any of it to that part of the goods still unsold (stock-in-trade) or still unfinished (work in progress) you over- load the goods already sold with more than their share and so reach a final figure less than the true profit.But the assumption is wrong. It has long been established that you are entitled to include in expenditure for the year all business expenses in that year not excluded by the old Rule 3, now section 137 of the Income Tax Act,71952, whether or not they can be attributed to the production of goods in that year. It matters not that certain expenditure may have proved abortive or may have been spent solely with a view to production and profit in some future year and have no relation at all to production during the year of account. This was settled as long ago as 1910 in Vallambrosa Rubber Co., Ltd. v. Farmer, 5 T.C. 529, a decision often followed and never questioned. Expenditure which it is permissible to include in the account is the whole general expenditure during the period, and it can only be said to have been spent to earn the profits of that year in the sense that it was all spent during that year to keep the business going and that during that year the business yielded the profit shown in the account.So the question is not what expenditure it is proper to leave in the account as attributable to goods sold during the year, but what expenditure it is proper in effect to exclude from the account by setting against it a figure representing stock-in-trade and work in progress. You must justify what you seek to exclude in this way as being properly attributable to and properly represented by those articles.I said that the Appellant's argument would carry him further than he wants to go. It appears from the Case Stated that expenditure is commonly divided by cost accountants into factory expenses, office expenses, selling expenses, and dispatch and financial expenses. The Special Commissioners held that only factory overheads should be taken into account and the Appellant supports their decision. I can see reasons why, in principle, selling and dispatch expenses should be excluded. But why exclude office and financial expenses? Some part at least of these may well have been closely associated with production. The Commissioners do not give any reason for including factory overheads and excluding the rest, and indeed they say that they do not feel able to define the term " factory overheads ". I am not surprised. I can see that if you are going beyond direct cost there may be good practical reasons for drawing a line somewhere—going beyond it may be laborious and lead to insignificant results. The line may be drawn differently for practical reasons in different cases. But it would be impossible to say as a matter of principle that factory overheads must be brought in and others left out, and quite impossible to say so as a practical criterion if we do not even know how to define factory overheads.One can imagine many cases which would not fit any hard and fast rule or general principle. Suppose a new model is to be brought out which it is hoped to sell in large numbers over a period of years. Much preliminary work must be done before production starts, some of which might be " factory " overheads ". For costing purposes I suppose that would be regarded as attributable to the new articles. But it is not so easy for income tax purposes. To begin with, preliminary work done in a previous year cannot be attributed to work in progress at the end of the next year. It went into the previous year's account and that is an end of it. And whether done in a previous year or in the same year it was done partly with a view to producing articles already in course of manufacture at the end of the year and partly with a view to producing an unknown number of similar articles in future years. How much of it is to be attributed to the work in progress? As a practical matter some solution would no doubt be found. On principle the question seems insoluble.It appears to me that we must begin at the other end and simply ask what in all the circumstances of a particular business is a figure which fairly represents the cost of stock-in-trade and work in progress. One thing clearly emerges as approved by the accountancy profession—whatever method is followed it must be applied consistently. I accept that. So the real question is what method best fits the circumstances of a particular business. And if a method has been applied consistently 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 cases where the on cost method has been consistently followed in the past there may or may not be good reason for changing now. There might perhaps be good reason for a change in a particular case in the other direction. But I can8find nothing in the Case to justify such a change in the present case. That is not to say that every item in these accounts is in its proper place. It emerged that the cost of power used in making the unfinished bodies ought to have been but was not included in the cost of work in progress, and there may be other particular items in the same position. But I find nothing in the Case to support the Commissioners' decision to bring in whatever may be included in " factory overheads ".I am confirmed in this opinion by a consideration which greatly influenced the Court of Appeal. One of the findings in the Case is:
" ( g ) One result of the On-Cost method is that the cost of Work-in- " Progress varies with the rate of production. If a factory is not working " at full capacity, the cost of Work-in-Progress computed by this method " is higher than if the factory is working at full capacity. On the Direct " Cost method the cost of Work-in-Progress is not affected by the rate " of production."
That means that for a year in which trade is slack the profits for income tax are inflated by the on cost method because an unusually large proportion of factory overheads is attributed to work in progress at the end of the year and its " cost " is therefore greater than it would have been if the factory had been busy. In costing for some purposes this may well be right, but it seems difficult to justify for income tax purposes. In many cases it must clearly be wrong if the whole year is taken as a unit. Suppose that the factory was losing money in the early part of the year but was busy in the latter part when the work in progress at the end of the year was in produc- tion. It could not be right to say that the " cost " of that work in progress should be increased because of something that had ceased to have any influence before that work started. I would not go so far as to say that this consideration condemns the on cost method in every case. No doubt all these methods have their weak points. But this does, to my mind, make it more than ever necessary to find good reason for adopting the on cost method in any particular case.One answer for the Appellant was: Well, if the taxpayer does not like this inflated ' cost " he can always elect for market value under the rule cost or market value whichever is the lower. I am not satisfied that " market " value " in its ordinary sense can be applied to work in progress. 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. The taxpayer must be able somehow to do that in relation to work in progress, but it may be that some modification of the rule will have to be applied if the taxpayer can show that he has probably already incurred a loss in con- nection with his work in progress. In any case this is not, to my mind, an adequate answer to the difficulty.The question stated in the Case is whether the Commissioners' decision that an on cost method should be applied in this case is erroneous in law. I would answer that question in the affirmative on the ground that the facts and findings set out in the Case do not justify requiring the Respondents to change from their present practice of using the direct cost method. I am therefore of opinion that this appeal should be dismissed.

Lord Tucker

My Lords,I agree that these appeals should be dismissed for the reasons stated in the Opinion of my noble and learned friend, Lord Reid.

Lord Hodson

My Lords,I also agree that these appeals should be dismissed for the reasons stated in the Opinion of my noble and learned friend, Lord Reid.9

Lord Guest

My Lords,The contest between two different methods of costing for the purposes of income tax can seldom be resolved in the abstract by the courts. It is only when these methods are applied to the facts of a given case that the courts can give a satisfactory decision. But one essential factor which must be known is what is involved in each of these different methods The Special Commissioners in the present case upon the invitation of parties attempted to decide as a question of principle between the " direct cost " method and the " on cost " method in relation to work in progress. They favoured the " on cost " method. They then proceeded to decide what items of expenditure were involved in the " on cost " method. This was, to my mind, the wrong approach to the question and putting the proverbial cart before the horse. They ought first to have decided what items of expenditure were included in the " on cost " method and then to have approached the problem of whether this method was the proper method of costing work in progress in the Respondents' factory. The Court of Appeal declined to treat the matter as one of principle, and for my part I think they were quite right to decline to do so. The Court of Appeal, however, while affirming the decision of Vaisey, J., did not approve of his ground of judgment, and again I think that the Court of Appeal were right. Vaisey, J. considered that as the Directors of the Respondent company had elected to adopt the " on cost " system in the preparation of the company's accounts and as both the " direct cost " and the ' on cost " method were recognised by the accountancy profession as correct accountancy, the " direct cost " method was the proper method to apply. It can never rest with the taxpayer to decide upon what principle his income is assessed for tax purposes. The Directors' decision can never be decisive of the matter for income tax purposes (see Patrick v. Broadstone Mills Ltd., 35 T.C. 44). The assessment, in addition to being consistent with normal accounting practice, must be made according to the provisions of the Income Tax Acts.The Court of Appeal held that on the facts and figures the " on cost " method produced an unfair result and the " direct cost " method was the right one to apply. In these circumstances the burden is on the Crown to show that the " direct cost " method is not in accordance with the rules of the Income Tax Act, and as we were informed that the Crown has for a period of about fifty years accepted the " direct cost " method, and as this is the first case in which they have sought to set up the " on cost " method as opposed to the " direct cost " method, this burden is a heavy one.The proper approach to the matter was given by Lord President Clyde in Whimster & Co. v. Inland Revenue Commissioners, 1926 S.C. 20 ; 12 T.C. 813:
" 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 prin- " ciples of commercial accounting, so far as applicable, and in con- " fortuity 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 merchant's or manufacturer's 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 cost or market price, whichever is the " lower; although there is nothing about this in the taxing statutes."
10This statement of the law has in many subsequent cases been approved and was in particular approved in Minister of National Revenue v. Anaconda American Brass Ltd. [1956] AC 85 . The question is, therefore, whether the " direct cost " method is inconsistent with the ordinary principles of commercial accounting or is not in conformity with the rules of the Income Tax Acts.The " direct cost " method only takes account of wages and materials in ascertaining the cost of work in progress. The " on cost " method seeks to add to the figure arrived at by the " direct cost " method something in name of what may be compendiously called " overhead expenses ". The principle upon which the Crown contend for the " on cost" method was stated by Mr. Bucher as follows: -
" Where expenditure in the year includes expenditure on goods not " sold during the year, this expenditure must be eliminated in order to " get the true manufacturing cost of the goods sold during the year. " The expenditure so to be eliminated is the total of all expenses which " are incurred for the purpose of producing unsold goods and which " would be factors in consideration of the market value of unsold goods."
This statement makes it clear that the Crown are not so much interested in altering the method of costing work in progress as making an alteration in the deductible expenses in the company's accounts. It is at once obvious that by adding a sum in name of overhead expenses to the cost of work in progress, the Crown are pro tanto reducing the expenditure which would otherwise appear on the debit side of the accounts. The principle contended for is no justification, in my view, for adopting the " on cost " method in relation to work in progress. No other justification in principle was put forward for the " on cost " method. Moreover, the " on cost " method, in my view, offends against the rules contained in section 137 of the Income Tax Act, 1952. whereby the deductible expenses include all expenses wholly or exclusively laid out for the purposes of the trade. The adoption of the " on cost " method involves the recharging of the taxpayer by the disallow- ance of items of expenditure which are otherwise deductible under section 137. It is a familiar principle of income tax law that the expense lies where it falls, that is, in the year in which it was incurred (see Vallambrosa Rubber Co., Ltd. v. Farmer (1910) 5 T.C. 529, Lord President Dunedin, at page 534). By a circuitous method the Crown are attempting to disallow an expense which is otherwise deductible under section 137. It is no justification, in my opinion, for allocating various items of expenditure contained in the accounts and relating them to the cost of work in progress on the plea that the expenditure is indirectly referable to the production of the work in progress. In The Naval Colliery Co., Ltd. v. Commissioners of Inland Revenue, 12 T.C. 1016, Rowlatt, J. at p. 1027, said:
" Now, one starts, of course, with the principle that has often been " laid down in many other cases—it was cited from Whimster's case, " a Scotch case—that the profits for Income Tax purposes are the receipts " of the business less the expenditure incurred in earning those receipts. " It is quite true and accurate to say, as Mr. Maugham says, that receipts " and expenditure require a little explanation. Receipts include debts " due and they also include, at any rate in the case of a trader, goods " in stock. Expenditure includes debts payable ; and expenditure incurred " in repairs, the running expenses of a business and so on, cannot be " allocated directly to corresponding items of receipts, and it cannot be " restricted in its allowance in some way corresponding, or in an endea- " vour to make it correspond, to the actual receipts during the particular " year. If running repairs are made, if lubricants are bought, of course " no enquiry is instituted as to whether those repairs were partly owing " to wear and tear that earned profits in the preceding year or whether " they will not help to make profits in the following year and so on. " The way it is looked at, and must be looked at, is this, that that sort " of expenditure is expenditure incurred on the running of the business " as a whole in each year, and the income is the income of the business " as a whole for the year, without trying to trace items of expenditure " as earning particular items of profit."
11It is the expenditure of running the business as a whole in each year which is to be looked at, not the expenditure related to any particular item of profit. If, of course, any expenditure can be directly related to work in progress, then this would fall to be added to the cost on the " direct cost " method. But no such question arises in this case.In considering whether the " on cost " method is a proper method I am influenced by a reflection of some of the absurd results which would follow from the adoption of this system. If the overhead expenses are to be allocated to the work in progress, it will follow that if trade is slack during any given year, a greater proportion of the overheads will be allocated to the work in progress, and as the cost of the work in progress is to appear as an item of profit, this will swell the profits of the business. So tills absurd result will follow, that when trade is slack the trader's profit on the goods sold will be low as his expenses are high, but his profit in respect of work in progress will be increased. I cannot think that a method which leads to these absurd results is in accordance with the principles of income tax law or, I may add, with common sense.I turn now to the direct cost method which is limited to the cost of labour and materials. Have the Crown shown that this method is either inconsistent with the ordinary principles of commercial accounting or not in conformity with the rules of the Income Tax Acts? The Commissioners have found as a fact that the " direct cost" method is recognised by the accountancy profession as correct accountancy and that it will produce a true figure of profit for income tax purposes. This method, therefore, satisfies Lord Clyde's first test. It is said that this method, like the " on cost" method, offends against the principles enshrined in section 137 of the Income Tax Act, 1952. But according to the decision in Whimster the cost of the work in progres must be ascertained, if it is lower than the market value. Work in progres is a receipt of the business as a result of work done during the year. The " direct cost " method ascertains the amount which the production of work in progress has actually cost. It does not, in my view, offend against Lord Clyde's second test.The Crown have failed, in my opinion, to show that the " on cost " method is of universal application. The Commissioners say that the accountancy profession is divided upon the question as to which is the proper method. The Crown have also failed to show that in order to conform with the rules of income tax law the " on cost" method must be employed. Their appeal must therefore fail.Upon what is the proper method of costing to adopt in this case I need say no more than this, that upon the facts and figures the Respondents' profits have, in my opinion, been correctly assessed by the application of the " direct " cost " method.I would dismiss the appeal.

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