For many advisers, the House of Lords’ decision in Sharkey v Wernher is a distant memory from a training course. And the facts were so obscure (concerning horses bred in a lady’s stud farm and transferred to her racing stables) that it would be tempting to overlook it. However, the case is in fact authority for a principle that has a very wide application.
According to the House of Lords, whenever a trader takes an item of trading stock for personal use, the trader is required – for tax purposes at least – to account for the profit that would have been made had the stock been sold in the normal course of business.
For example, supposing a grocer takes a £1.50 loaf out of the business for personal use (and let’s assume that the loaf cost her 80p), the grocer is required to report a taxable profit of 70p in her tax accounts.
Clients can be forgiven for not knowing the rule – after all, it makes very little sense from a policy perspective. The more sophisticated clients could even be justified in objecting to the rule, given that it contradicts both the normal rules of accountancy and the VAT treatment that would apply (assuming the stock were not, as in my example, zero-rated).
Nevertheless, the rule has been around since 1955 and HMRC will frequently adjust tax computations to reflect the rule when they spot such “appropriations”.
Since the rule comes from a decision of the House of Lords, one might think that it is pointless arguing with it. However, even House of Lords’ decisions are not immune from challenge.
In any event, their Lordships’ decision does contain one fundamental flaw. The judges said that they were trying to work out what the accountancy treatment for such a transaction ought to be – they recognised that the approach of accountants was the key to their decision. However, they did not have any formal accounting evidence before them: so they had to guess. As it happens, they got it wrong. Therefore, taxpayers have in fact been at liberty in the subsequent 57 years to reargue the point, this time with the benefit of the appropriate evidence.
The problem I find is that HMRC keep withdrawing their assessments in such cases, thereby preventing me from having my day in court. But, I can be (partially) comforted by the fact that that is only my problem: after all, it is excellent news for clients.
Keith M Gordon is a barrister, chartered accountant and tax adviser. He provides tax advice and litigation support for accountants, tax advisers and lawyers. Keith won the Chartered Tax Adviser of the Year category at the 2009 LexisNexis Taxation awards.