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HMRC internal manual

Business Income Manual

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Capital/revenue divide: the role of accountancy: the weight to place on accountancy evidence

The question of whether an item is capital or revenue is a question of law not of accountancy. What matters is the effect of the expenditure in question. Accountancy does not determine that effect but may be informative as to what was the effect.

Lord Denning considered the weight to be given to accountancy evidence in Heather v P E Consulting Group Ltd [1972] 48TC293 Lord Denning concluded that the issue was one of law ultimately for the determination of the court (page 322):

‘The courts have always been assisted greatly by the evidence of accountants. Their practice should be given due weight; but the courts have never regarded themselves as being bound by it. It would be wrong to do so. The question of what is capital and what is revenue is a question of law for the courts. They are not to be deflected from their true course by the evidence of accountants, however eminent.’

In ECC Quarries Ltd v Watkis [1975] 51TC153 (see BIM35325) Brightman J affirmed that accountancy evidence is not decisive, page 173D:

‘Owen v Southern Railway of Peru Ltd would seem to establish that unchallenged evidence, or a finding, that a sum falls to be treated as capital or income on principles of correct accountancy practice is not decisive of the question whether in law the expenditure is of a capital or an income nature.’

The question arises from time to time as to which, of equally valid alternatives, is the correct accountancy treatment to follow. In Johnson v Britannia Airways Ltd [1994] 67TC99 (a case concerning the treatment of provisions for maintenance of aeroplanes) the evidence showed that there were three different approaches to the particular accounting question in issue. Each of the three possible approaches was in accordance with generally accepted principles of commercial accountancy. The court decided that the taxpayer was entitled to have their profits for tax purposes determined by the approach chosen by their auditors. At page 123D Knox J said:

‘The court is slow to accept that accounts prepared in accordance with accepted principles of commercial accountancy are not adequate for tax purposes as a true statement of the taxpayer’s profits for the relevant period. In particular, it is slow to find that there is a judge-made rule of law which prevents accounts prepared in accordance with the ordinary principles of commercial accountancy from complying with the requirements of the tax legislation.’

In Herbert Smith v Honour [1999] 72TC130 (a case concerning a claim to deduct a provision for future rents payable on vacant premises) Lloyd J listed the circumstances where you should not follow accountancy for tax purpose (see also BIM35030), at page 153 paragraph 17 he said:

‘The question is, given that this is an approach developed by the courts, in what circumstances are accounts prepared according to generally-accepted principles of commercial accounting not determinative for tax purposes.’

At paragraph 21 Lloyd J went on to say:

‘In some cases accounts said to be correctly prepared according to generally accepted principles of commercial accounting are found to be based on an analysis of the factual position which is wrong in law. In such a case the correct legal analysis will override the accounts as prepared: see for example CIR v Gardner Mountain & D’ Abrumenil Ltd (1947) 29TC69 (see BIM35030). In some cases the accounts properly prepared on generally-accepted principles of commercial accounting have been found to be based on factual assumptions which are either insufficiently reliable (Southern Railway of Peru Ltd v Owen (1957) AC334, 36TC602) or simply inconsistent with the true facts (e.g. BSC Footwear Ltd v Ridgway (1972) AC 544, 47TC495). In either of these cases an approach more correctly or more reliably based on the facts will be adopted for tax purposes.’

You should therefore consider accountancy evidence to be informative but not determinative. The question capital or revenue remains a question of law not of accountancy. You should also bear in mind that accountancy has developed very considerably over the period of history covered by reported tax cases. Current accountancy practice is much more codified and standardised than was the case in the early days. There has been considerably less call in recent years for judicial intervention to determine the correct accountancy treatment.

There is also a body of statute law that requires the accounting treatment to be adopted for Corporation Tax. Under the loan relationships, derivative contracts and intangible assets regimes, accounting entries may be required to be followed in computations of income for Corporation Tax, even where those entries are of a capital nature. See BIM30515.