The Supreme Court (SC) has decided on an interesting case that all lower courts had found in favour of the taxpayer, Smith & Williamson, a firm of accountants and wealth advisors (S&W).  The SC also found in favour of S&W.

The holding company of a group of companies that formed the S&W corporate group established an employee benefit trust to hold options for employees of other companies within the corporate group to acquire shares in the S&W holding company at a specified price at certain future points in time.  The corporate group used international accounting standards to prepare their accounts and these standards (IFRS 2), similar to UK specific standards (FRS 26), required that the employing companies charge their P&L with notional costs for the options granted to the employees.  This notional cost was determined by reference to the fair value of the options granted.  As the subsidiary employing companies were not charged by the parent holding company for the options granted the notional costs were considered capital contributions of the parent company to its subsidiaries i.e., being further equity financing of the subsidiaries, though no money changed hands.

HMRC contended that since these were notional charges that no deduction for corporate tax was allowed and that the charges also related to capital items as the other side of the accounting entry was to capital contributions and therefore any deduction for the notional costs should be disallowed in the computation of taxable profits.

The SC didn’t agree with HMRC and found:

1. That there is no law requiring adjustment of the employing companies accounts to exclude the notional charges from computation of taxable profits and that corporation tax legislation requires companies to follow generally accepted accounting practice,
2. That the accounting standard (IFRS 2) was relevant to computations of taxable profits for corporation tax as the standard sought to preserve the integrity of both the balance sheet and income statement (profit and loss account),
3. That even though the notional costs were not ‘incurred’ per se, as the holding company didn’t charge the employing companies, that the notional costs were still debited for the purposes of the companies’ trades, and
4. That the charges were not capital in nature even though the other side of the accounting entry was to capital contributions.

The decision can be found at: Commissioners for Her Majesty’s Revenue and Customs (Appellant) v NCL Investments Ltd and another (Respondent) – The Supreme Court

This is a welcome decision, that confirmed prior lower court decisions, as it helps clarify that profits calculated in accordance with generally accepted accounting practices are a solid starting point for the computation of taxable profits.  This case highlights that good accounting practices are very important when considering possible issues from tax authorities.  We are experienced with international and UK accounting standards and can advise on their implementation and effect on tax liabilities.  Please contact us if you have any questions