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HMRC internal manual

Business Income Manual

Capital/revenue divide: tangible assets: acquisition of an interest in land

The cost of trading stock is revenue. But the cost of gaining access to minerals, that are to be sold in the course of trade, is capital. The day-to-day operating cost of a mine, oil well etc is on revenue account. The cost of the site and of gaining access to the minerals thereon is capital.

In Coltness Iron Co v Black [1881] 1TC287, the courts decided that the company was not entitled to deduct an estimated sum representing the cost of borings and pit sinkings exhausted during the year. The reasoning was that this was part of the cost of getting at the coal. In other words, a wasting asset cannot be written off over its life. You need to distinguish between the cost of acquiring a site and the works needed to gain access to the mineral, which are capital, and the cost of operating the mine, which is revenue expenditure. If the scale of operations is such that there is repeated capital expenditure year after year that does not make the expenditure revenue. The Lord President summarised the position at page 309:

‘Capital expended in the sinking of pits must necessarily become exhausted and lost sooner or later, and that is foreseen when the expenditure is made… A certain appearance of plausibility is given to the appellant’s argument by the great number and variety of pits sunk and worked by them. The constant employment of capital year by year in such sinking, by reason of the great extent of their business, gives to this expenditure a certain similarity to ordinary working expenses. But the likeness is merely on the surface. If a man buys an unwrought mineral field, and sinks one pit by means of which he works out all of the minerals, he has converted the dormant, inaccessible, and unproductive subject into a going mine. He has made a new subject which differs from the unwrought mineral field just as a railway or canal is a different subject altogether from what the ground on which it is constructed originally was. The miner has invested his capital in creating the subject, which consists partly of the minerals and partly of the access by which the minerals are approached and worked; but the cost of the one, equally with the cost of the other, is an employment of capital…’

This is a clear proposition. But an oil company pursued a different line, arguing that they were acquiring oil, not oil wells, by the special terms on which they took over their subsidiary. In Hughes v The British Burmah Petroleum Co Ltd [1932] 17TC286, the company’s business consisted of oil refining. For some years the company had purchased oil from a subsidiary production company. In 1928 the British Burmah Petroleum Co took over the subsidiary’s business at a purchase price which included a sum payable in shares and calculated at a fixed rate per barrel of oil by reference to the estimated future production by the subsidiary’s wells.

British Burmah contended that this transaction was merely the purchase of stock and claimed a deduction against the price obtained from oil produced by the wells in subsequent periods. Notwithstanding the special basis of purchase, Finlay J was unable to distinguish the case from Coltness at page 295:

‘It has been very well settled ever since the celebrated decision in the House of Lords in the Coltness Iron Company’s case that what one may call the prime cost of buying a mine or buying a seam of coal is capital expenditure and cannot in any form be deducted…

The principle is quite clear: if you have an expenditure of that sort, an expenditure to buy an asset of the nature of a mine or an oil well or anything of that sort, that is capital expenditure and cannot be deducted…

Now here, when the facts are looked at…£70,000 was paid…to acquire an asset in the business…to acquire oil wells,…and also the means of working the oil wells.’

Coltness and British Burmah illustrate that the cost of a natural asset yielding saleable material is capital expenditure on the right to win stock and not the cost of the stock itself. Subsequently the courts have considered several cases involving arrangements for open cast coal mining. The expenditure was recurrent in the sense that a number of sites were involved, just as Coltness had sunk a number of pits. The Revenue successfully argued that the transactions were capital.

In Knight v Calder Grove Estates [1954] 35TC447, a partnership purchased the freehold in ten acres of land for £2,000. The conveyance included covenants under which the partnership undertook after winning the coal to reinstate the land and the vendor undertook to repurchase the freehold for £500. The partnership claimed that the cost of the land was a revenue charge incurred in the ordinary course of business and that the sum received on resale was a revenue receipt. The Commissioners allowed the appeal but the court decided that the expenditure (and the receipt) was on capital account.

After quoting Lord Cave’s famous dictum from Atherton v British Insulated and Helsby Cables Ltd [1925] 10TC155 (see BIM35010) Upjohn J explained that, since the purchase was of an interest in land (and it was not part of the company’s trade to deal in land), that it was on capital account at page 453:

‘Here it is said that there is no purchase with a view to bringing into existence any asset for the enduring benefit of the trade, but it is a purely transitory purchase in order that coal may be won from that particular area and, when won, the area will go back to its normal use…I am quite unable to accept that submission

…No one suggests that the purchase of this land is circulating capital or stock in trade or anything else of that sort. It is a purchase of land for the adventure, and so, on ordinary principles, the transaction must be regarded as a capital expenditure, just as when you buy land and put a factory on it, or buy land and sink a shaft…the fact that the adventure is not likely to continue for many years is quite irrelevant.’

Note that the judge took the view that the fact that each of the open cast mines was of relatively short duration did not convert capital expenditure on the acquisition of an interest in land into allowable revenue expenditure.

The arrangements in H J Rorke Ltd v CIR [1960] 39TC194, took a different form. A coal mining company entered into arrangements with various owners of suitable land under which the company undertook to make two lump sum payments to each owner; the first for the right to enter upon the land, and the second as compensation for the diminution in the value of the land by the mining operations. The Special Commissioners held that the right of entry payments were capital and could not be allowed as deductions, but that the payments for diminution in value were of a revenue nature and allowable.

The company argued that:

  • no asset or advantage had been brought into existence for the enduring benefit of the trade, and
  • the transient and recurrent character of the operation stamped the payments as being revenue in nature.

Cross J rejected both arguments and said that the expenditure was capital, at page 207:

‘If once you accept - as I must - the distinction between buying circulating capital and acquiring rights which enable you to get circulating capital, it seems to me that these payments are marked as being of a capital nature, and, if once you find that, the fact that the trader is conducting many transactions of a similar kind cannot really make any difference.’

Again you see the distinction between the costs of stock and the costs of an asset that will yield stock.