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HMRC internal manual

Business Income Manual

Capital/revenue divide: tangible assets: sale of trade assets (wagons): incident of trade or capital?

A good starting point in capital/revenue cases is to establish the precise nature of the trade. It is not possible to draw up lists of ‘capital items’ and ‘revenue items’ because the classification is intrinsically connected to the nature of the trade rather than the nature of the particular item involved. One trader’s purchase of a fixed capital asset may be another trader’s sale of stock.

The distinction between fixed and circulating capital was described in BIM35010 and reference made to Adam Smith’s definition. Items such as trading stock, consumable stores, debts etc are generally circulating capital. Items such as business premises, plant and machinery, goodwill etc are generally fixed capital. In most cases you will be readily able to identify if the disposal or acquisition of a particular item takes place on revenue or on capital account. To make that decision you will need to establish the precise nature of the trade. On closer examination you may find that what seemed to be the disposal of a fixed capital asset is in fact a trading transaction or vice versa.

In the case of Gloucester Railway Carriage and Wagon Co Ltd v CIR [1925] 12TC720) the company manufactured railway wagons. The company manufactured wagons in three categories:

  1. to customer specification for immediate sale,
  2. for sale under hire purchase arrangements, and
  3. for the company to keep and let out on hire.

The wagons that were let out on hire were capitalised in the company’s books and accounts; being ‘sold’ to the hiring business at a price including a calculated sum added as profit on manufacture. Year by year an amount was written off the wagons for depreciation. The company was allowed wear and tear allowance for tax purposes. The company from time to time bought in wagons and resold them. The company also sold off wagons that they had been letting out on hire.

In the later years of World War I the government prohibited wagon building. After the war, there was a shortage of railway rolling stock and demand was such that existing wagons increased in value. The company was able to make significant profits by selling wagons from its hire fleet.

The company claimed that it had sold a capital asset. The Commissioners held that the company’s business was to make a profit out of railway wagons and the income from the sale of those wagons that had been let was part of the company’s trading income. The High Court, Court of Appeal and House of Lords all upheld the Commissioners’ decision.

In the Court of Appeal, Eve J described the company’s trade and the consequences that followed at pages 746 and 747:

‘The particular manner in which the manufactured stock is dealt with whether by sale out-and-out or on a deferred payment system, or whether by retention so long as it can be retained at a profit, and by sale, when it can no longer be so retained, cannot, in my opinion, alter the true character of the company’s business. It manufactures and trades in wagons, and the methods from time to time adopted of dealing with the manufactured products are matters of domestic policy and cannot be regarded as converting stock retained for letting on hire into plant or as establishing a separate business distinct and apart from the ordinary business of the company.’

In the House of Lords, Lord Dunedin explained why the sale of hire fleet wagons was on revenue account (on page 748):

‘A wagon is nonetheless sold as an incident of the business of buying and selling because in the meantime before sold it has been utilised by being hired out. There is no similarity whatever between these wagons and plant in the proper sense…’

You should be aware that although, on the facts of this case, the courts confirmed the Commissioners’ decision, they recognised that the point was not free from difficulty. See in particular Rowlatt J’s judgment in the High Court (pages 735 to 737). The courts accepted as a finding of fact by the Commissioners that the company carried on only one business. The business being that of making a profit in one way or another out of wagons, all the wagons owned by the company, however used, remained part of the company’s stock in trade, or circulating capital. If the facts had justified the conclusion that the company was carrying on two distinct businesses, one of hiring out and the other of manufacture and sale, the decision would probably have gone against the Crown. The wagons transferred to the hiring business being then regarded as fixed capital of the business. This emphasises the importance of establishing what the trade comprises in detail.