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HMRC internal manual

Business Income Manual

Wholly and exclusively: duality of, or non-trade, purpose: loans/advances to others: advances to secure supply of raw material

S34 Income Tax (Trading and Other Income) Act 2005

Investment of capital or an advance for purchases?

For companies chargeable to Corporation Tax, the tax treatment of loans and advances is now governed exclusively by the loan relationships regime in Parts 5 and 6 Corporation Tax Act 2009. Detailed guidance is at CFM30000. The guidance below only applies to other categories of taxpayer.

The cost of trading stock is allowable. It is a question of fact whether money was paid to acquire trading stock or (wholly or partly) for some other purpose. Where there is a non-trade purpose, the expenditure is not allowable.

In the case of English Crown Spelter Co Ltd v Baker [1908] 5TC327, the company traded as zinc smelters. The company made advances to an allied mining company which had been formed in order to supply raw materials (blende) for the smelting process. Some of the advances were against material to be delivered though not against specific parcels of ore. The allied company was placed in liquidation and was unable to meet its liabilities (or supply ore). English Crown Spelter claimed to deduct the losses suffered as bad debts arising in the ordinary course of trade, or as money spent for the purpose of their trade.

The courts held that the losses were not an allowable deduction. Bray J explained that the advances were not made against specific purchases but were in the nature of loans to assist the subsidiary who had incurred heavy expenditure in opening up their mine. On the facts established before the Commissioners, this was an investment of capital in the Welsh company and was not an ordinary trade transaction, of an advance against goods. In effect, the English company had lent money to its Welsh subsidiary and was to be repaid by future deliveries of raw materials.

If, as a question of fact, the advances had been made against specific purchases then a deduction would be due in the event of non-delivery. In the current era of ‘just in time’ deliveries it would be unusual for a trader to pay for supplies very far in advance unless there were exceptional difficulties in securing supplies.

The part of Bray J’s judgment on which the above guidance is based is set out on page 338:

`If this were an ordinary business transaction of a contract by which the Welsh Company were to deliver certain blende, it may be at prices to be settled hereafter, and that this was really nothing more than an advance on account of the price of that blende, there would be a great deal to be said in favour of the Appellants. But it is quite clear that the Commissioners have not taken that view, and it is seems to me rightly they have not taken that view. It is impossible to look upon this as an ordinary business transaction of an advance against goods to be delivered. It is really nothing of the sort. The Welsh Company [the allied, mining, company] were in this difficulty. They had great difficulties in opening their mine; they had to expend large sums of money for that purpose, and they applied to the Appellant Company - the English Company - to lend them money, and they lent them money.

Now, I can come to no other conclusion but that this was an investment of capital in the Welsh Company, and was not an ordinary trade transaction of an advance against goods. It was pressed upon me that it is quite sufficient to say that the main object of this advance was to enable the English Company to carry on their business more profitably, by being able to obtain blende. I dare say that was one of the objects, and very likely the main object; but if it really is an investment of capital, that is not sufficient. If it were sufficient, then it would apply to the £8,997 as well. Therefore it seems to me that that argument is not sound, and the only conclusion I can come to is that the Commissioners have rightly found, under the paragraph I have mentioned, that this was an employment by the Appellant Company of capital in a separate concern, and therefore cannot be allowed as a deduction from gains and profits, and so the appeal must be dismissed.’