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Business Income Manual

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Capital/revenue divide: introduction: marginal cases

In borderline cases the courts have held that a useful test is to consider the practical and business effect of the expenditure rather than carry out a detailed analysis of the legal rights secured or surrendered as a result. This approach was first clearly articulated in a dissenting judgement in an Australian case. Australian cases are not binding on UK appellate bodies but the particular judgement has been quoted with favour all the way up to the House of Lords. There is no reason to doubt that this approach is one that will be followed by UK courts. The Australian case in question was Hallstrom’s Proprietary Ltd v The Federal Commissioner of Taxation, 72CLR634. The appellant company manufactured refrigerators using patents held by a rival company that were about to expire. The rival company applied for an extension of its patent and the appellant incurred costs opposing such extension. The High Court in Australia held that the expenses were of a revenue nature and not capital. Dixon J, in his dissenting judgement held that the expenditure was of a capital nature (72CLR649):

‘What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.’

In Strick v Regent Oil Co Ltd [1965] 43TC1 Lord Wilberforce approved Dixon’s approach in Hallstrom’s (see BIM35560), saying at page 54H to page 55C:

‘In the course of the numerous decisions, which have distinguished between capital and revenue expenditure in relation to widely different trades and varying circumstances, certain ‘tests’ have emerged. These may be useful, so long as it is recognised that they have emerged a posteriori from the facts of a given situation and that they may not always be suitable as guiding lines in other situations. I begin by asking two questions, which may be said to be generally relevant: what is the nature of the payment, and for what was the payment made? These together with a third question, namely, how that for which the payment was made was to be used, were stated by Dixon J. in his classic judgement in Sun Newspapers Ltd v Federal Commissioner of Taxation 61CLR337. There are, he said, at page 363

“three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.”

I may add to this another statement by the same learned Judge in the later case of Hallstrom’s Pty Ltd v Federal Commissioner of Taxation 72CLR634, at page 648

“What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process.”’