Defining "profits" for British income tax purposes: A contextual study of the depreciation cases, 1875-1897

Accounting Historians Journal, The, Jun 2002 by Lamb, Margaret

Abstract: Seven British income tax disputes over depreciation (1875-- 1897) are analyzed in this contextual study. The legal cases reveal how uncertainty over meanings for "depreciation," "profits," and "capital" reflected social and political tensions which had commercial accounting implications. Case analysis yields evidence of how judicial support reinforced the Inland Revenue's technical authority over a competing tax administration institution and enabled its modern regulatory control over taxpayers to be constructed. The British example illustrates the ways in which technical and administrative practices may emerge from the contestation of meanings that takes place both in a wide political context and within particular institutional settings.

INTRODUCTION

This paper is a contextual study of seven British income tax cases reported between 1875 and 1897. Each case concerns a dispute between tax officials and taxpayers over the treatment of depreciation in the calculation of taxable profits. Not only does the problem of "depreciation" represent a significant theme in early income tax history, but the tax treatment of depreciation is a focus of accounting historians as an influence on the development of commercial accounting practices. In 1881, the Coltness case established the leading tax principle that amounts incurred in the acquisition of a capital asset, even when allocated over the useful life of the asset, are not deductible in computing the profits of a trade [Tiley and Collison, 1999, p. 427]. Cases before 1881 reveal the development of the judicial principle, and cases after 1881 reveal how distinctive tax rules were applied.

The purpose of the paper is to consider how the decisions in the tax depreciation cases affected tax practice and an emergent accounting measurement practice. In these cases, we find evidence of how the Inland Revenue used the support of the courts to reinforce its regulatory control over taxpayers and technical authority over a competing tax administration institution, the local General Commissioners of Income Tax. In addition, the cases provide evidence of alternative meanings for and measurement practices associated with "depreciation," "profits," and 11 capital." As Parker [1994] points out, the meanings of these words for other purposes were unsettled and changing in this period. No consensus existed that depreciation was a measure of the cost or valuation of the economic benefits of tangible fixed assets consumed during an accounting period, and, as such, that depreciation represented a writing off of capital in the annual calculation of profits. An analysis of the institutional politics of the tax depreciation cases also lends support to an explanation why the judiciary abjured precise definition of "profits" for income tax or dividend distribution purposes. Judges left themselves flexibility to change regulatory concepts of calculation when judicial definitions were abstract and not defined in much detail. Thus, they were better able to avoid the creation of regulatory conflicts between income tax and other areas of their jurisdiction. The paper concludes that, with judicial support, the Inland Revenue was able to construct de facto regulatory control of the income tax. Judicial decisions reinforced taxing practices based on writing, interpretation, and examination of texts, and extended calculation. Such practices formed the basis for the disciplinary power of the modern Revenue and supplanted taxation based on the exercise of sovereign power.

The political, legal, and institutional context for the tax depreciation cases is developed by reference to related cases and documentary sources, including reports of Parliamentary Select Committee (SC) and Commissioners of Inland Revenue (CIR). In the depreciation cases themselves, we can find evidence concerning processes of accounting for taxable profits, as well as "the court's narration of ... particular accounting principle[s] buried in the dicta" or to be inferred from other details [Mills, 1993, p. 766]. Close examination of court judgments and consideration of the wider context suggest how the courts might have intervened to support particular social, political, or economic outcomes [French, 1977; Reid, 1987; Bryer, 1998].

Hopwood and Johnson [1986] challenged accounting historians to study accounting practices in the social, economic, and institutional contexts in which they operate, and Hopwood [1983] urged researchers to explore how accounting shapes the way in which organizations function. Taxation is an arena for accounting that has not been studied in much detail from these perspectives. A few studies [Preston, 1989; Boden, 1999] research taxation as a social and institutional practice, but modern practice is their focus. Lamb [2001] begins to redress the taxation gap in the "new accounting history" literature [Miller et al., 1991] with a study of accountability in mid-9th century British tax assessment practices. The present paper continues this analysis of accountability in the late 19th century. It is also a response to calls for more studies of accounting and the law [Bromwich and Hopwood, 1992; Freedman and Power, 1992]. It considers "issues such as how and why accounting and the law intersect, whether this is due to certain fundamental limits that law encounters in seeking to regulate certain practices, and what happens to both accounting and law when such intersections take place" [Miller and Power, 1992, p. 230].