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Business Income Manual

Capital/revenue divide: intangible assets: exclusivity ties - acquiring an interest in land

Unless the trade is or includes property dealing, the costs of an interest in land will be capital expenditure.

In Strick v Regent Oil Co Ltd [1965] 43TC1 the agreements took the form that the petrol retailer, in consideration of a lump sum premium based on the amount of fuel expected to be sold, leased their filling station to Regent Oil for a term of years at a nominal rent, and Regent Oil sublet the station back to the retailer at a nominal rent for the same period less three days. The sublease contained covenants binding the retailer to take all of his fuel from Regent Oil and to continue to carry on the business at the station. The courts held that the payments were premiums for leases and, because Regent Oil did not trade in land, were therefore payments for acquiring an interest in land and so capital.

Again you see the importance of establishing the precise nature of the trade.

At page 30 Lord Reid considers expenditure on a tangible asset:

‘When one is dealing with tangible assets it is generally not very difficult to reach a decision. Things which the trader uses in his business to produce what he has to sell are part of his fixed capital and their cost is a capital outlay although their useful life may be short, as in Hinton v Maden & Ireland Ltd [1959] 38TC3911 W.L.R. 875 [see BIM35415]. Things which he turns over in the course of his trade are circulating capital and their cost is a revenue expense. The things in respect of which the Act permits allowances are fixed capital. Difficulties can arise when a capital asset is improved, e.g., in distinguishing between repairs, which are a revenue expense, and renovation, which is not…’

Lord Reid then turned to expenditure on intangible assets. At the head of page 31 he explained that this is a more difficult problem:

‘When one comes to intangible assets there is much more difficulty. To help the conduct of his business a trader obtains a right to do something on someone else’s property or an obligation by someone to do or refrain from doing something, or makes a contract which affects the way in which he conducts his business. And the right or obligation or the effect of the contract may endure for a short or a long period of years. The question then arises whether the sum which he has paid for that advantage is a capital or revenue expense.’

Further down page 31 Lord Reid distinguished regular rental payments for the use of an asset from a lump sum paid to cover several years:

‘Where the wasting asset is a right to some benefit for a period of years and the consideration given for it is the payment of an annual sum during the continuance of the right there is generally no difficulty. Rent payable under a lease or under an agreement for the hire of a machine is treated as a proper debit against incomings, and the same must, I think, apply to an annual (or quarterly or monthly) payment for a tie. The difficulty begins to arise when a lump sum is paid to cover several years. If that is so then it is not so much the nature of the right acquired as the nature of the payment made for it that matters.’

Lord Reid went on to consider the problem at length. The costs of securing the arrangements that were to last for twenty years could not be revenue. For the shorter-term arrangements (one of ten years and one of five) Lord Reid looked at the precise form of the arrangements. At page 38 he expressed his conclusion that premiums for leases of land have always been considered to be capital (except in the case of a property dealer). After acknowledging that no arguments had been put to him in relation to very short leases, Lord Reid said that he was satisfied that the expenditure on the five and ten year arrangements was capital:

‘In two of the four arrangements with which the present case is concerned (including much the largest transaction) the ties were for twenty years; in one the tie was for ten years; and in the fourth it was for five years. I would have no doubt that the lump sums paid for the twenty-year ties could not be treated as revenue outgoings even if there were no lease and sublease. These ties were not obtained in order to facilitate planned marketing, or because the appellants thought it desirable to have them. The lump sums paid for them were only paid because garage owners were in a strong bargaining position: they wanted and were able to get large sums paid immediately, and they were willing to grant long ties in return.

But with regard to the [five and ten-year arrangements] I must consider what difference it makes that the transaction took the form of a lease and sublease. This is not a mere matter of form, because this form of transaction gave to the appellants much better security for the performance by the garage owner of his obligation, and it gave to them interest in land which afforded that security. So the quality of their asset is different from what it is under the older form of tie. I have already said that all relevant factors must be considered in each particular case, and I regard this as a highly relevant factor.

Premiums paid for leases have always been regarded as capital, but we were not referred to any case where a premium had been paid for a very short lease - say two or three years - and I do not wish to decide whether even in such a case a premium would necessarily be treated as a capital outlay. But I am satisfied that the weight of this factor in the present cases is sufficient to turn the scale if otherwise there were doubt, and I would therefore hold that in each of the four cases the lump sums paid by the Appellants cannot be allowed as revenue outgoings.’

At page 46 Lord Pearce stressed that the payments were for the acquisition of an interest in land:

‘The acquisition of such an interest in land points strongly to a capital expenditure and, on the facts of these cases, dominates other indications. This indication of a capital expenditure is not diminished by the argument that the wholesalers might have obtained the substance of what they wanted by a revenue payment and without purchasing an interest in the land. They did not do so. Instead they chose to enter into these particular arrangements, which were not shams but genuine commercial transactions. They entered into them in order to satisfy insistent customers who were anxious to produce genuine transactions which would render the sums paid to them capital receipts in their hands. There seems no justification for regarding these transactions as other than in fact they were, or for treating them as anything but acquisitions of leases for premiums with the object of obtaining trade ties. The fact that they were acquisitions of leases tilts the balance in favour of regarding the premiums as capital payments.’