Capital/revenue divide: the role of accountancy: generally accepted accounting practice
As discussed at BIM30510, the starting point in computing taxable profits is accounts prepared in accordance with generally accepted accounting practice (GAAP).
The treatment in the accounts does not, however, determine the question of whether expenditure is capital or revenue. For accountancy purposes the important issue is not whether the expenditure is capital or revenue. For accountants the main question is when expenditure is consumed and, therefore, when it must be charged to the profit and loss account.
Not every expense that is properly charged in the profit and loss account according to GAAP is deductible for Income Tax. For example under GAAP a deduction is required for the cost (capital expenditure) of depreciation. For tax purposes depreciation is not an allowable deduction in computing trade profits.
The following expenditure is not deductible:
- on capital account or in connection with capital incomings or disposals (see BIM35030),
- of a revenue nature incurred for non-business purposes (see BIM42100 onwards),
- incurred in earning income of another period (see BIM31095 onwards),
- relating to a source of non-trading income; for example rent or rates on sub-let premises the income from which is assessable as property income (see BIM42100 onwards), and
- specifically disallowed; for example entertaining (see BIM45000 onwards).
If an expense is deductible in the computation of trading profits, the allowance may not be foregone in favour of an alternative deduction. This follows from the decision in Wilcock v Frigate Investments Ltd  55TC530. A property dealing company failed in its attempt to have bank interest deducted, under the rules in force at the time, as a charge on income, and so available as a deduction from total profits from all sources, instead of as a deduction in computing its dealing profits.
At page 123B of Threlfall v Jones and Gallagher v Jones  66TC77 (cases concerning the application of GAAP to payments due under certain leases) the Master of the Rolls, Sir Thomas Bingham, expanded on the application and the developing role of commercial accountancy:
‘Subject to any express or implied statutory rule, of which there is none here, the ordinary way to ascertain profits or losses of a business is to apply accepted principles of commercial accountancy. That is the very purpose for which such principles are formulated. As has often been pointed out, such principles are not static: they may be modified, refined and elaborated over time as circumstances change and accounting insights sharpen. But so long as such principles remain current and generally accepted they provide the surest answer to the question which the legislation requires to be answered…
Given the plain language of the legislation, I find it hard to understand how any judge-made rule could override the application of a generally accepted rule of commercial accountancy which (a) applied to the situation in question, (b) was not one of two or more rules applicable to the situation in question and (c) was not shown to be inconsistent with the true facts or otherwise inapt to determine the true profits or losses of the business.’
Thus where you have an accepted rule of commercial accountancy that:
- applies to the situation, and
- is not one of two or more equally applicable rules, and
- is consistent with the established facts and is not inappropriate to determine the true profits
then you must follow it unless there is specific legislation to the contrary.
See generally BIM31000 onwards for the interaction of tax on trade profits and accountancy.