The Special Commissioners had decided that only the net depreciation charged in the accounts should be added back under the UK equivalent of Section 81(2)(f) TCA97 as in their view only the net depreciation had been charged to the profit and loss account. The Inland Revenue disagreed and argued that the gross depreciation, i.e. the amount per the fixed assets note, should be disallowed as being of a capital nature.

On 12 April 2005 Lightman J in the UK High Court reversed the decision of the Special Commissioners. In his view, the company had expensed through its profit and loss account a sum representing the gross depreciation and the closing stock credit was not equivalent to the carry-forward or deferral of costs. It was noted that the company’s profit and loss account stated its profits after charging the gross amount of depreciation and that the tax computation had shown a £3,039,000 credit separately. Parliament had made special provision for depreciation by way of capital allowances and in Lightman J’s view ‘it is … not to be expected that Parliament intended that (save as expressly provided) any sum deducted in respect of depreciation should avoid being added back merely because it was reflected as an item of cost in the figure shown for stock.’ There was no evidence to suggest that it would be in accordance with generally accepted accountancy practice to deduct only a net sum.

The Special Commissioners’ decision had also applied to the facts of a Scottish case concerning William Grant & Sons Limited. That case was heard in May 2005 by the Court of Session in Scotland. As these cases are test cases the expectation is that the decision of Lightman J will leapfrog the Court of Appeal and will next be heard in the House of Lords.

This decision might surprise many people as the Special Commissioners’ conclusion, that only the net depreciation had been charged in the companies’ profit and loss accounts, might instinctively seem to be correct given that in most situations the stock is valued at cost. One can only speculate what the High Court decision might have been if the company had been able to disclose the net depreciation in its profit and loss account note or had disallowed only the net depreciation in its tax computation.

This decision could be applicable in Ireland, although, whether or not Irish Courts would form the same view as the UK High Court remains to be seen. Irish manufacturing companies using plant and machinery and that reflect an element of depreciation in closing stock valuations may need to consider the amount of depreciation being added back in their corporation tax computations.