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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Capital/revenue divide: the role of accountancy: accountants see things differently

Expenditure on plant and machinery is normally capital (except in the case of, for example, an equipment dealer; where the plant and machinery that the dealer sells is trading stock and the expenditure on buying it is revenue expenditure). Most machinery and plant wears out or becomes obsolete. Faced with the task of preparing accounts that show a ‘true and fair view’, the accountant has to identify the period or periods in which expenditure on the asset is consumed. The expenditure consumed is usually taken to the profit and loss account as depreciation. Such depreciation is not an allowable deduction in computing the profits of a trade for tax purposes.

Accountants want to charge revenue expenses in the correct period. For example, a business may pay a year’s insurance premium in advance. If the premium was paid in the last month of the accounting period then about 11/12ths will provide cover for the next period. The accountant will exclude 11/12ths from the current profit and loss account. The 11/12ths appear on the balance sheet as a pre-payment to be deducted in next year’s profit and loss account. This treatment in the accounts does not make the expenditure capital for tax purposes. It is just the accounting mechanism adopted to ensure that the charge is made in the correct period, a timing issue.

Whether expenditure is capital or revenue is not critical for an accountant. The key issue for an accountant is when expenditure is consumed in earning profits. Thus the treatment of an item of expenditure in a business’s accounts, even when that is in accordance with generally accepted accounting practice, is no more than a relevant factor to be considered in deciding for tax purposes whether the expenditure is capital. The accountancy treatment certainly does not conclude the debate.

The fact that expenditure has been charged to fixed assets in accounts may lend support to an argument that the expenditure is capital for tax purposes, provided such treatment is consistent with generally accepted accounting practice. But where, on first principles, the expenditure is of a revenue nature then charging it to a fixed asset account does not make it capital for tax purposes. The time when any tax deduction is due is a matter on which accountancy evidence has much to say. And that is a different question.