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HMRC internal manual

Business Income Manual

Capital/revenue divide: introduction: what is capital expenditure: fixed and circulating capital

Adam Smith’s definition is not a panacea

In his classic definition, Adam Smith distinguished between capital and revenue expenditure by reference to fixed and circulating capital (see BIM35010). As an example of the fact that there is no universally applicable formula, the courts have not always found this oft quoted definition to be helpful.

In Van den Berghs Ltd v Clark [1935] 19TC390 (see BIM35530) the distinction between fixed and circulating capital played some part in the Court of Appeal finding for the Revenue. In the circumstances and for the reasons he gives at page 432 Lord Macmillan (their Lordships found against the Revenue) did not find the Adam Smith definition helpful:

‘…I confess that I have not found it very helpful. Circulating capital is capital which is turned over and in the process of being turned over yields profit or loss. Fixed capital is not involved directly in that process, and remains unaffected by it. If this is to be the test, I fail to see how the appellants could be said to have been engaged in turning over the asset which the agreements in question constituted. The agreements formed the fixed framework within which their circulating capital operated; they were not incidental to the working of their profit-making machine but were essential parts of the mechanism itself. They provided the means of making profits, but they themselves did not yield profits. The profits of the Appellants arose from manufacturing and dealing in margarine.’

Lord Macmillan’s strictures are but one of many examples where judges have warned against taking a particular method of identifying the capital/revenue divide and applying it to all and sundry cases. Each of the various methods described in this guidance is useful within a limited context. None of the methods is of universal application. Out of context a method can yield incorrect results.