Capital is not defined in statute and the meaning has been discussed on numerous occasions in numerous, quite often, high profile cases. Let’s have a look at one of them.
This is a quote from Viscount Haldane in John Smith and Son against Moore when he said, ‘It is not necessary to draw an exact line of demarcation between fixed and circulating capital.‘
We probably wouldn’t use the phrase circulating capital. We’d probably use stock and trade now. Since Adam Smith drew the distinction, which has become classical, economists have never been able to define much more precisely, what the line of demarcation is. Adam Smith described fixed capital as what the owner turns to profit by keeping it in his own possession. With circulating capital, that’s what he makes profit of by parting with it and letting it change masters.
What exactly is capital expenditure?
Here’s a famous quote from Viscount Cave in Atherton and British Insulated and Helsby Cables. ‘When an expenditure is made with a view to bring into existence an asset or an advantage for the enduring benefit of a trade, There is very good reason for treating such an expenditure as properly attributable not to revenue, but to capital.‘
Those words resonate still, ‘Bringing into existence an asset or an advantage for the enduring benefit of a trade.’ Now we interpret that as looking at the effect of the expenditure or, if it’s aborted, what would have been the effect. If to acquire, dispose of, or modify a capital asset, then that is going to be capital, but notice that maintenance of capital assets will always be revenue.
Lord Denning in the famous Heather and PE Consulting Group case made a wonderfully clear observation about the distinction between the two. In many cases, the answer is easy, but in others, it is difficult.
The difficulty arises because of the nature of the question. It assumes that all expenditure can be correctly put into one category by the other, but this is simply not possible. Some cases lie on the border between the two, and this border is not a line clearly marked out. It is a blurred and undefined area in which anyone can get lost.
Different minds may come to different conclusions with equal propriety. It is like the border between day and night or between red and orange. Everyone can tell the difference except in marginal cases, and then everyone is in doubt.
Whether an item is capital or revenue is a question of law to be determined in the light of the facts of an individual case. There is no single test. The authorities by which we mean the case law identify the approach and the relevant factors.
The question is not to be determined by accountancy evidence, which has been at least historically informative but not determinative. We need to note that there is a growing body of statute law which requires the accounting treatment to be adopted for tax purposes, examples including corporate intangibles.
Some areas of difficulty in practice exist. For example, the replacement of an entire asset. That is generally capital. If you knock down and build a new garage, that’s not a repair.
Another concept absolutely critical in determining our thinking is the concept of the entirety of the asset. Here we can see two important cases. The first is Bullcroft and the second is Samuel Jones. Like a lot of these tax cases, they point in different directions.
In Bullcroft Main Collieries, they had a chimney which was separate from the factory. When they knocked it down and rebuilt it, that was held to be capital because the chimney, of itself, was the entirety of the asset.
In Samuel Jones, where the chimney was attached to the factory, it was integrated with the factory. Therefore, when that was knocked down and rebuilt, the entirety of the asset was not the chimney, it was the factory, and so they were allowed the expenditure as a repair.