Work in progress valuation must fairly reflect profits; no universal rule fixes direct cost or on-cost method

Valuation of work in progress for income-tax purposes is a fact-specific exercise governed by ordinary commercial accounting practice and whether the resulting figure fairly reflects profits. The direct cost method and the on-cost method are not universal rules of law, and neither can be applied mechanically in every case. On the facts discussed, the on-cost method was said to produce an inflated and unrealistic valuation because slack business conditions caused a larger share of overheads to be attributed to work in progress. The assessment therefore turned on whether the chosen method fairly stated taxable profits for the relevant years.

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Issues: Whether the special commissioners erred in law in applying the on-cost method, instead of the direct cost method, for valuing work in progress in computing taxable profits for the relevant years.

Analysis: The valuation of work in progress for income-tax purposes was treated as a matter to be decided on the facts of the particular case, having regard to ordinary commercial accounting practice and whether the resulting figure was fair. The Court held that it was wrong to elevate either the direct cost method or the on-cost method into a universal rule of law. The proper inquiry was whether, on the evidence and figures of the case, the chosen method fairly reflected the profits for the relevant years. On the facts, the on-cost approach produced an inflated and unrealistic figure because the business was operating at a slack level, so that a larger share of overheads was attributed to work in progress merely because less work was being done.

Conclusion: The decision of the special commissioners was wrong in law, and the appeal was dismissed.

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