by Charles Yorke and Jason Shaw - Allen & Overy LLP
At a time of increasing disputes involving accounting evidence, this case debunks a number of assumptions about the approach taken by both HMRC and the First-tier Tribunal. HMRC do not always instruct their own employees as their expert witnesses. The fact that an approach has been audited by one of the Big 4, or is even supported by all of them, is not enough. The Tribunal is far more interested in a clear and logical analysis of the standards themselves. The quality of the analysis presented by an expert will be crucial: Ball UK Holdings v HMRC  UKFTT 457.
We have seen many tax cases concerning questions of accounting over the past few years. There have been 12 since the beginning of 2015, more than in the previous ten years put together. The accounting question in this case is a simple one: should the appellant have prepared its statutory accounts in US dollars or in pounds sterling. That turned on whether the taxpayer applied FRS23 correctly. Avoidance was allegedly involved, but that is not the focus of this article. It may or may not have affected the outcome. The case is interesting because of HMRC’s choice of expert witness, and also because of the comments made by the Tribunal about how it approaches accounting evidence.
HMRC’s expert witness
HMRC normally instructs one of its own employees as expert witness on accounting matters. Rightly or wrongly, there has historically been an assumption that a Tribunal would generally prefer the evidence of one of the Big 4 firms over an HMRC employee.
Here, however, HMRC instructed David Chopping who is the head of Moore Stephens’ Audit Technical Department, and of the ICAEW’s Technical and Practical Auditing Committee.
Mr. Chopping has been instructed by HMRC at least twice before: recently in Smith and Nephew Overseas Ltd v HMRC  UKFTT 151 (TC), and a few years earlier in Fidex v HMRC  UKFTT 212 (TC). Out of over 25 cases involving expert accounting evidence heard over the past 15 years, these are as far as we are aware the only three occasions in which HMRC have not instructed one of their own employees to act as expert witness on accounting issues. Even so, advisers need to treat HMRC using external accounting expertise in the future as at least a realistic prospect now.
What does it mean to be GAAP compliant?
The first question addressed by the Tribunal was whether a taxpayer has to prove it applied GAAP correctly, or merely that it had adopted a reasonable interpretation. The application of GAAP is not, and has never been, black and white. Drawing up accounts involves judgement. The judgement is to be exercised by management of the company, and not by the auditors, and in doing so management can do no more than prepare accounts on the basis of a reasonable interpretation of the relevant standards.
The courts have accepted that where there are a number of GAAP compliant approaches that can be taken, a taxpayer is free to adopt any of them (see Johnston v Britannia Airways  STC 763 and more recently Versteegh Limited v HMRC  UKFTT 642 (TC)).
In this case, the appellant argued that, in preparing GAAP compliant accounts, a taxpayer merely has to adopt a reasonable interpretation of the accounting standards. Each interpretation that is reasonable would be GAAP compliant.
The Tribunal disagreed. It drew a distinction between interpreting the standard, which must be done correctly, and applying that interpretation to a given set of facts which involves judgement and so does permit a number of reasonable approaches.
In practice, there may be some doubt about the correct interpretation of a given standard. If there is, then the job of the expert is to give his or her opinion to the Tribunal on the merits of each possible interpretation. It is then the job of the Tribunal to decide on a balance of probabilities which of those interpretations is or are correct. It is not enough for an expert to merely say whether a given interpretation is a reasonable one: a reasonable interpretation may be found on a balance of probabilities not to be correct. The expert must instead explain why he or she considers that his or her interpretation is correct.
The Big 4
In practice it seems to be that both taxpayers and advisers have assumed that HMRC would find it difficult to win a dispute on an accounting point against an expert from one of the Big 4 firms of accountants.
Greene King v HMRC  UKFTT 385 (TC) is the case that first suggested that this might not always be the case. The Tribunal found for HMRC even though the appellants’ accounts had been audited by one of the Big 4. However, on a closer reading it is apparent that the audit partner was not an expert witness, he was a witness of fact. This is an important distinction, and quite rightly the Tribunal acknowledged that his evidence concerned “what was done, and why it was done” rather than whether it was GAAP compliant. The appellant’s expert witness was a director employed by another firm outside of the Big 4.
Greene King was therefore not a case where HMRC won an accounting dispute “against” one of the Big 4. Ball UK Holdings Ltd is. The appellant’s accounts were audited by one Big 4 firm. The appellant instructed two partners from another Big 4 firm as expert witnesses. There was also a report prepared by a third Big 4 firm agreeing with the appellant’s position.
The Tribunal accepted that all of these accountants had agreed with the appellant. It nevertheless preferred Mr. Chopping’s evidence, concluding that just because a number of accountants take one view of an accounting standard does not make it GAAP compliant. It is interesting to note that the Tribunal was willing to prefer HMRC’s expert evidence notwithstanding the apparent support for the appellant’s approach from three of the Big 4.
This may well be because the expert witnesses were both from only one of those firms. The Tribunal did not infer anything about the correctness of their expert evidence from the fact that the appellant’s accounts had been audited by another firm and approved by an accounting opinion from a third. In the absence of cross-examination by the Tribunal of the audit partner and of the author of the accounting opinion, this meant nothing more than two other individuals agreed with the expert evidence. This does not make general acceptance. The Tribunal inferred very little therefore from the audit and the existence of the accounting opinion.
Instead, the case simply turned on whether the Tribunal preferred the evidence of HMRC’s expert (the head of Moore Stephens LLP’s Audit Technical Department and of the ICAEW’s Technical and Practical Auditing Committee) or the appellant’s experts (lead of the KPMG accounting advisory services team and an IASB practice fellow). Each of the experts was clearly highly regarded in their profession. As such, all the Tribunal could do was evaluate the evidence presented on its merits.
An analytical approach
The Tribunal took little from the position taken by one of the appellant’s experts that his interpretation was GAAP compliant because it had been adopted by all of the Big 4. The expert supported this position by reference to the Big 4 manuals.
The Tribunal conceded that the Big 4 manuals could be helpful: “…
[W]here the meaning of an aspect of an FRS is unclear, the generally accepted interpretation of that part of the FRS may be apparent from the Big 4 manuals, particularly if they are consistent with each other on the point. Nevertheless, where the FRS is clear the Big 4 manuals do not override it.”
However, rather than simply relying on the Big 4 manuals, the Tribunal was clearly looking for analytical evidence justifying the interpretation taken primarily by reference to the words of the relevant standards, supported by the context, the spirit and purpose of the standards and the background notes and basis of conclusions. HMRC’s expert evidence was accepted because this was the approach taken by their expert.
What does this mean?
− Tax advisers should not assume that accounting advice from one of the Big 4 firms cannot be challenged by HMRC. Here, the appellant’s accounting was supported by three of the Big 4 firms. Generally one would have thought that such a position would be unassailable. This case goes to show that it may not be.
− If you do not understand or are not persuaded by the accounting advice you have received, do not be surprised if you cannot persuade HMRC that it is correct.
− The same goes for litigation. Disputes about accounting will be heard by a Tribunal Judge at the First-Tier Tribunal, one or all of whom will be a tax professional. The best way to stress test your expert’s evidence is to keep testing it until you understand it and are persuaded by it.
− Managing your expert will be key – it will be important to make it clear from the outset that his or her role is to give an opinion on what is the correct way to interpret the standards. The opinion should be analytical by reference to the standards themselves and their supporting notes.
− Evidence of what the Big 4 manuals say, and of the approach generally taken by accountants, will be helpful to some extent, but evidence of this nature should not supplant the analysis.
This article was first published in Tax Journal, 14 July 2017 (see www.taxjournal.com), and it is reproduced with kind permission of the publishers Tolley. All rights reserved.