Revenue Law
Tutorial 4
1. Explain the general approach to deductions when calculating profits of a trade, profession or vocation outlined in Usher’s Wiltshire Brewery Co Ltd v Bruce; and explain the special significance of ss 33 and 34 IT(TOI)A 2005.
Usher’s Wiltshire Brewery v Bruce: business profits are calculated by deducting from any receipt any deduction general accounting practice would make, unless specifically prohibited by statute.
Note: below cases show trend to give due weight to general accounting practices
Spending aimed at future receipts:
Vallambrosa v Farmer (Court of Session): expenditure can be deducted in the current year, even though it aimed at producing receipts in a future tax year.
Facts: TP owned a rubber plantation, which was cultivated on a rota basis as rubbers only yield after 6 years. Claimed deductions for expenses incurred on all 7 patches. Allowed
“Rules and Cases … are only guidelines, because the real point is, what are the profits and [expenses] of the business?”. Lord President thought doing otherwise would result in an absurdity
But, Gallagher v Jones: expenditure in the current tax year can’t be deducted, if it’s so artificially premature that general accounting practice would spread deductions over later periods, then those deductions must be spread.
Facts: TP engaged in 3 two year contracts of which payments were heavily front loaded to produced a loss that the TP wanted to set off against income from earlier years.
Taxpayers cannot be taxed on accounts that ‘give a completely misleading picture of their trading results…’
General statutory prohibitions: general in the sense that every item of expenditure needs to be tested against them.
S33 ITTOIA: no deduction allowed for trade expenditure of a capital nature
S34 ITTOIA: no deductions allowed for
Expenses not wholly and exclusively for the purpose of trade
Losses not connected or arising out of that trade
If an expense is incurred for more than one purpose, any identifiable part can be apportioned if wholly and exclusively for the purpose of trade
S32: applies to professions and vocations
(rationale: capital expenditure is merely changing the ‘form’ of capital held by the business, so it is not really ‘lost’ as an expense)
S33: distinguishing income from capital expenditure
Vallambrosa: court originally suggested simplistic test. Single payment was capital, series was revenue.
British Insulated v Atherton: rejected the simplistic test as determinative. More importantly, looks at the purpose ➔ was the purpose of spending to acquire an asset with enduring nature?
Pitt v Castle Hill Warehousing: looks at “the manner in which what the money is spent on is to be enjoyed”, but may be redundant at there is a purpose test already.
Mallett v Stavely Coal: expenditure to get rid of a fixed asset is also capital
Facts: TP ran a colliery, paid sums to get out of long term contracts of 17 and 22 years
“by this payment out-and-out they freed themselves from what was a capital liability”
Tucker v Granada: expenditure to improve fixed asset is also capital, but this is distinct from ‘maintaining’ or ‘repairing’ an asset.
“money spent on getting rid of a disadvantageous asset as a capital expenditure and, secondly, to regard money spent on improving the asset, or making it more advantageous, as capital expenditure…”
Background:
Granite Supply Association v Kitton: costs incidental to acquiring, getting rid of, or improving an enduring asset also seen as expenditure of a capital nature
ECC Quarries v Watkis: money spent for a capital purpose (acquiring, getting rid of, improving) a benefit of an enduring or fixed capital nature, is capital expenditure even if that purpose is not achieved.
Countess Warwick Steamship Company v Ogg: where TP contracts to acquire capital, payment to be released from the contract is also of capital nature. Here TP paid a sum to buy a ship, and upon realizing it will make a loss paid another sum to terminate the contract. Both sums held to be of capital nature.
Time threshold to be ‘enduring’
Hinton v Maden & Ireland: period of intended ownership needed to make an asset fixed is a matter of degree (“degree of permanence…”). Here knives with average use life of 1 year deemed ‘fixed’. Can be seen as rough minimum.
Royal Insurance Co. v Watson: spending with dual purpose, both capital and revenue one, seems to be non-deductible under s33, if capital purpose was a substantial one.
Expenditures resulting in acquiring, getting rid of, or improving enduring items, but without that being a purpose.
Lawson v Johnson Matthey Plc: if no capital purpose, mere incidental effect does not make expenditure one of capital nature.
Stone and Temple v Waters: but Lawson was distinguished here, can be a partial purpose.
Even if a TP’s main purpose is preserving his business, an acquisition/disposal/improvement of fixed assets which actually matters to the taxpayer, as distinct from being a ‘point of indifference’, is capital expenditure, because that is now at least a substantial part of the purpose.
Therefore: it is better to maximize expenditure nature of any expense. E.g. 10k lease with nominal payment is regarded as capital, while same amount spread evenly would be considered revenue (Bolam v Regent Oil, principle further developed in Regent Oil v Strick)
S34: determination
Strong & Co v Woodifield: must be for the purpose of making profit. Here damages paid to an aggrieved customer was not deductible as not for the purpose of making profits.
British Insulated v Atherton: expenditure need not be aimed at a direct and immediate profit, can be indirect. Must be “voluntary and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business…”
Mallalieu v Drummond: “wholly and exclusively”
Sole purpose of the expenditure must be for the business (trade, profession, vocation). There must not be even a small different private purpose.
Provided there was a sole purpose, does not matter if venture has non-business effect
‘subconscious purpose test’ ➔ here a lawyer cannot deduct expenses for business dress as there was a ‘subconscious, private, non-business purpose of preserving warmth and decency’.
Note: so interpretation of s34 is quite restrictive.
Test also applies to partnerships
MacKinley v Arthur Young: applies the subconscious purpose test, if any one partner has a non-business purpose for an expenditure, then not deductible.
Even if the partner which has a private purpose has no direct say in making the expenditure
Here there is a sub-conscious purpose of providing a new house even though the partner did not want to move.
Apportionment. There has been debate on whether a single item of expenditure can be apportioned so that one part is ‘wholly and exclusively’ for the business. Court accepted this in some cases
Traditionally, the courts did not accept apportionment in some cases, discussed in Roger Kerridge "Deductibility of Expenses for Schedule D Income Tax - The 'All or Nothing' Rule". But s. 34(2) ITTOIA 2005 now makes clear that apportionments can be made.
Recoverable Expenditures
2. (a) T, a barrister, purchases a wig and gown for court use. Can T deduct this expenditure in calculating the profits of her profession?
Need to consider s33 and 34.
S33. Apply British Insulated v Atherton. T has acquired assets of some degree of permanence. A gown and wig would be expected to last several years. So it has passed the threshold and can be considered a capital asset.
Either way, also falls under s34, as purpose was not wholly and exclusively or the business
Mallalieu v Drummond: a case with similar facts. Held that the barrister had a ‘subconscious’ purpose of maintaining ‘warmth and decency’ in buying court attire.
b) T has also just purchased computer equipment for her chambers costing £20,000. Can T deduct this cost in calculating her profits?
T is a barrister, so this is an expenditure of a capital nature, under s33. Pitt v Castle Hill considers the manner of which the asset is enjoyed. The computers are not sold for profit, but kept to assist the generation of profits.
Also British Insulated v Atherton, computers have a long period of permanence.
However, court realised that depreciation is a genuine business cost and deductible. Capital Allowances Act 2001 allows capital allowances for certain types of assets. They are an important qualification to s. 33: although you can’t deduct the cost of capital assets at purchase, you can now sometimes deduct that cost later, in stages.
Plant and Machinery
“The first £500k of expenditure in a year on the provision of plant and machinery (excluding a car) by a trade, profession or vocation is 100% deductible that year; provided a claim is made in the tax return.” This is due to be £200k in future tax years.
Therefore, the above sum is wholly deductible.
Munby v Furlong: the courts have given ‘plant’ a wide meaning, beyond its natural meaning, to cover virtually any equipment used in a business, even items used intellectually like law books
S71 CAA 2001: buying computer software or license to use it, is acquisition of plant even if nothing physical was obtained.
3. "Partners" are a firm of solicitors. Recently the firm decided that too much of its partners' time was being wasted in commuting, and so it decided to hire chauffeur driven cars to take its partners to and from work, in the hope that they could do some of their paperwork while travelling in the cars. Will expenditure on the cars be deductible in computing the profits of the firm for income tax purposes?
S33: British Insurance v Atherton: they are hired cars, so permanence would depend on the length of the contract. Pitt v Castle Hill the manner of enjoyment. Cars are provided for transportation, but unsure. A look at s34 would be more relevant and conclusive.
S34: expense has to be wholly for the purpose of the business. Strong v Woodifield test seems to be arguable. Intended to save time from commuting and hope partners can do paperwork in the cars. Could argue that it is aimed at making a profit – maximising billable hours generated indirectly British Insulated v Atherton ‘… on the grounds of commercially expediency and to facilitate carrying out of the business’.
However, it is likely that there is also an unconscious and private motive of providing personal transport. Mallalieu v Drummond. This is also practically impossible to apportion, unless the court accepts that salary of chauffeur be left out, but then needs to prove that chauffeur hire is for the purpose of making a direct/indirect profit.
There is no capital allowance for cars by 51 CAA 2001.
Submission: no likely deduction.
However, there are specific rules regarding travelling expenses:
Newsom v Robertson: no deduction for travelling from home to workplace,
Only travel between two workplaces can be regarded as wholly for the purpose of the business.
Home as workplace? No, it is not a workplace just because work is done there is which could have been done at the normal workplace.
Horton v Young: if a home is also his work base, the cost of travelling from home to other work sites will be deductible, and the cost of journeys back again.
Jackman v Powell: a home is not a work base simply because accounting and paperwork are done here, if all other business activities – making contracts, buying, and selling etc. are carried on at another location.
Samadian v R&C Comrs:
Even if the home was a work base,
Only reductions to irregular locations journeys, called ‘itinerant’ work journeys, are deductible
Regular location journeys were said to involve private purpose to maintain a home separate from work, but this reasoning is hard to understand provided the home is already a work-base.
Freedman and Loutzenhiser suggest this was a policy decision: to bring the self-employed in line with the rules for employment income.
4. T is a professional solicitor. For the last year he has travelled once a week from his home to series of evening law seminars and back, attendance being to improve his ability as a solicitor. Is he entitled to deducted the travelling expenses incurred in calculating the profits of his profession?
Can cost of seminar tickets be argued under s33 that travelling to conferences is an ‘improvement’ of his ability as a solicitor, so a capital receipt? Does seem absurd.
Travel expenses not deductible. General rule in Newsom v Robertson that no deduction to travel from home to a workplace or vice versa. However, there are cases particularly on travelling to conferences:
Bowden v Russell & Russell: expenditure on travelling to attend a business conference can’t be deducted, if there is a social or tourist purpose, because it’s not wholly and exclusively for the purposes of the business. Registration fees for conference are deductible though.
But, Edwards v Warmsley Henshall: if attendance is solely for business purposes, attaching social or tourist engagements, does not make the expenditure no-deductible.
Then any extra motive needs to be investigated.
5. T is a leisure services tycoon. He has recently bought Royals Football Club. T paid £1,000,000 for the stadium. T has spent £100,000 in the building of executive boxes, where there were previously none, in the main stand. It was also known at the time of the purchase that the whole of one other stand would have to be rebuilt immediately: T has accordingly spent £250,000 in doing this. Finally, he has spent £20,000 having dangerously old fencing replaced. Discuss the deductibility of this expenditure.
Repairs and maintenance of capital assets are not of a capital nature. Expenditure on repairs and maintenance of fixed capital assets is deductible
Repairs contrasted with improvements.
Repair contrasted with replacement
O’Grady v Bullcroft Collieries: TP was a colliery proprietor, and built a new chimney to replace and old dangerous one. Held replacing a capital asset in its entirety is not a repair to it, it is buying a new one.
Contrast, Samuel Jones v IRC: also a chimney, but held it was repair of a larger unit: the factory itself.
There is no clear test, Brown v Burnley acknowledges difficulties and reviews authorities:
‘Repair is restoration by renewal or replacement of subsidiary parts of a whole.’
‘Renewal, as distinguished from repair, is reconstruction of the entirely, meaning by the entirety not necessarily the whole but substantially the whole subject-matter under discussion’
Replacement spread over years
Repair and improvement combined
Highland Railway Co v Balderston: where a capital asset is repaired with a component which is not a mere equivalent (iron rails replaced with steel rails), but an improvement, only the excess paid, over what would have been paid for a mere equivalent, is capital expenditure within s33.
Facts: the replacement of the component “would not alter the character of the line”, obiter.
Capital assets bought in a state of disrepair:
Law Shipping Co: where a capital asset is purchased already in a state of disrepair, expenditure for repairing the asset is not deductible. Capital expense by s33.
Here TP bough second-hand ship, and had it repaired. Held a capital expenditure.
Rationale: buying a second-hand item and doing it up, is regarded as essentially the same as buying a brand new one.
BUT, Odeon Associated Theatres Ltd v Jones: above rule only applies where, at the date of the purchase, repairs were seen as necessary to make the asset properly functional, otherwise a deductible revenue expenditure.
“1) there, at the date of purchase, the repairs were in contemplation as being necessary shortly after the time of purchase in order to make the asset a profit earning asset, whereas the assets here were serviceable profit earning assets, potentially for several years, at the date of purchase. 2) there had been a substantial reduction in the purchase price because of the disrepair, whereas here, there was none.”
“Since distinction 2 follows distinction 1 naturally, as a matter of ordinary commercial reality, distinction 1 is the distinguishing factor”
Replacement and alteration of tools
Repair vs Reinstatement: the latter is capital
Application:
£1mil for stadium, is this deductible?
By s33, this is purchase of a fixed capital asset thus not deductible. This is not a business running cost, but a conversion of capital from cash to asset. BI v Granada purpose test.
£100k for building executive boxes.
Mallet v Stavely Coal: Capital spending includes acquiring, disposing, and improving capital. This is a clear improvement as opposed to repairs, Tucker v Granada.
£250k for rebuilding the whole of one stand. This is a difficult issue, as there are two ways to look at this.
Looking at the stand as an asset on its own. The whole stand has been replaced. O’Grady v Bullcroft held that replacing an asset in its entirety is the same as acquiring a new o, so a capital expenditure by s33.
Looking at the stand being part of an overall larger unit: the stadium. Then there is a repair expenditure is usually deductible, but the rule in Law Shipping Co has a self-qualification.
Law Shipping v IRC: you can’t deduct expenditure when you buy an item already needing repairs. Buying a second-hand asset and repairing it is the same as getting a new one
Odeon v Jones: however, the above rule only applies where repair was needed immediately in order to use theasset.
An argument the TP should used I that the test should be applied to the stadium, given that it was purchased as a whole.
The distinguishing point in Odeon was that the asset could have been used immediately without being repaired straight away. Arguable that you can use the overall asset w/o repairing, and it is possible to rebuild one stand at a time a use the rest later. (had the repair plan been done in stages spread over several years, it would more likely be deductible as revenue expenditure Rhodesia Railways)
There is no clear legal test for looking at this. However, a similar case would be Brown v Burnley concerning a football stand. The stand was viewed as an item on its own. However, architecture of each stand varies so decision open to judgement of court or tribunal.
Either way decision (chimney cases O’Grady and Samuel Jones)
Replacing dangerous fencing
Same process as above. But given that fencing was dangerous, this would likely invoke the Law Shipping Rule. Not deductible.
6. T is a professional accountant. She hosts an annual Christmas dinner for the directors of major corporate clients as a goodwill gesture. Is she entitled to deduct the expense of this in calculating the profits of her profession?
Spending money on entertainment or hospitality is considered non deductible. This used to be deductible but parliament took the view that the provisions were being abused, so took away.
S45 ITTOIA: the general rule is that there is no deduction for entertainment, any form of hospitality or gifts.
S57A ITTOIA now says a trader can deduct any reasonable cost of food and drink for himself while travelling in his trade.
Food costs themselves are of a deductible nature
Either trade is itinerant, or the journey is not a regular one
Incidental food costs
7 T trades as proprietor of a country public house. Each year he gives to his regular customers a calendar bearing the name of the pub on each page, together with scenes of the local countryside, costing £9:50. Is he entitled to deduct the cost of these in calculating his trading profits? As a goodwill gesture, he also provides free drinks for the evening to the winner of the weekly darts tournament in the pub, which usually costs him around £25 each time. Is he entitled to deduct the cost of these drinks in calculating his profits?
s 45 ITTOIA 2005: The general rule:
s 46 ITTOIA 2005: Two exceptions for entertainment.
“Case A”: either sale at a discount, or free samples, for public advertising purposes, where the taxpayer’s business is selling that kind of entertainment.
“Case B”: in-house entertainment, for employees, or primarily for them, is deductible
s 47 ITTOIA 2005: Four exceptions for gifts.
“Case A”, again covers sale at a discount, or free samples, for advertising, where the taxpayer’s business sells the item.
“Case B”, is where the gift incorporates a conspicuous advertisement for the business; unless
the gift is food, drink, tobacco or a token or voucher exchangeable for goods, or
the cost of the gift, added to other gifts to the same person, goes beyond £50 in the tax year.
“Case C”, again covers gifts to employees, or primarily aimed at them.
“Case D”, allows gifts to charities, and some other good causes.
Associated Newspapers v Flemming: Case A exceptions for both entertainment and gifts (discount or free samples) is only applicable to potential customers, not business suppliers.
Application:
Calendar: Here there is a gift, so s47 exceptions may apply. Case B allows a gift that incorporates a conspicuous advertisement for the business. Has to be smaller than £50, and cannot be food, tobacco or token for goods. ➔ Submit: calendar should be deductible, only £9.50 per tax year.
Round of drinks for winners: This is probably entertainment or hospitality, not a gift. S46 exceptions looked at. Case A allows giving away free samples for what you usually sell for advertising purposes. Case A (s2(2)) requires that advertisement made to ‘public generally’. This likely means advertising to potential customers of the business. Size of advertising depends on size of business. ➔ Submit: deductible as prize intended to attract customers.
8 T is a professional film actress. She was advised by her agent that her career would only really take off if she had cosmetic surgery on her nose to improve her camera profile. She reluctantly had the operation at a cost of £3,000. Is she entitled to deduct this expenditure in calculating her profits?
Norman v Golder: The general rule is that medical expenses are for health purposes, not deductible, even if to treat a work-related injury or to enable a return to work.
Murgatroyd: TP could not deduct cost of private care, even though free NHS care was available, because he needed to continue his work where there is a telephone. Held not deductible because he claimed only a 60% deduction, so must have been a dual purpose. Harsh decision and questionable reasoning.
Application:
There seems to be no health reason here, so Prince v Mapp could be applied. However, the courts could use the agument that there is also a subconscious purpose of enhancing beauty, so not wholly for business purposes Mallalieu v Drummond. This depends on evidence
S33 could be improvement of capital, the human body regarded as an asset. This is legally possible but the Revenue will not likely use it.
One foreign jurisdiction: Holliwood, California allows cosmetic surgery to be deductible.
9 T trades as a wine merchant. In this tax year warehousemen have stolen £500 worth of drink, and the assistant manager has disappeared with £80,000 of the funds of the business. Is any deduction available in calculating the profits of the trade?
Last year he entered as a receipt the amount of £10,000 due to him from a customer for the supply of a consignment of wine. The debt has not been paid, and the customer has this year become insolvent. The taxpayer has been told by the customer's accountant that he can only expect to receive £1,000 in respect of the debt. What is the implication for computation of the taxpayer's trading profits?
Non expenditure reductions for individual losses during the year (not overall loss at year’s end).
S34(1)(b) ITTOIA losses by a trader can only be deducted if they are connected to arise out of the business. (This is separate from an expenditure as provided by s34(1)(a)).
Allen v Farquharson: There might be some overlap between (a) and (b), and an individual might fall within both. But generally they are distinct. Expenditures (a) cover payments, while losses (b) covers involuntary reductions in the value of assets held. E.g. lost, destroyed, stolen.
Beauchamp vWoolworth: cannot be losses to assets of a fixed capital nature by s33.
Theft
Bamford v ATA: petty thefts by junior employees are deductible, but large frauds by senior executives are not. Reasoning was not very convincing, but an alternative theory is that big losses are of a capital nature so not deductible.
Insured/indemnified losses:
A loss of a revenue nature will be deductible, but any compensation has to be entered as a receipt, which will then cancel it out
S. 106 ITTOIA 2005 ensures that even if insurance or indemnity compensation is received in the form of a capital payment, it still cancels out the revenue loss, in the case of trades. s. 95 applies the same rule to professions and vocations.
Bad debt:
On the earnings basis, they are entered as a receipt straight away. However, because payment is no longer possible, s35 allows the TP to make a deduction of bad debts that cancels out the receipt you already made for the full amount. Here there is a deduction for £9k.
S32 also applies to professions and vocations.
