BIM35115 - Capital/revenue divide: basis of computation: approach to establishing profits

The starting point for the tax computation

In the case of Beauchamp v F W Woolworth plc [1989] 61TC542 the company took out two loans of 50 million Swiss francs each from consortia of Swiss Banks. Exchange controls in force at the time restricted consent to loans that had a minimum life of five years. On eventual repayment the loans gave rise to an exchange loss of £11.4 million. The courts considered that borrowing a definite sum for a fixed five-year term was not part of the company’s day-to-day activities but an increase of its capital and the exchange loss incurred in connection with it was accordingly not allowable. Lord Templeman described the general approach to calculating income tax profits at page 574C of 61TC. He makes it clear that the computation should exclude expenses of a capital nature:

My Lords,…(what is now ICTA88/S1)… directs …that income tax shall be charged in respect of profits described in Schedule D set out in (what is now ICTA88/S18). That section directs…that tax shall be charged in respect of the annual profits arising or accruing to any person…from any trade. The expression 'profits' is not defined, and there is no express provision for the deduction of the expenses incurred in earning profits, but it is only possible to arrive at the computation of the profits of a trade after setting against the receipts the expenditure necessary to earn them according to the ordinary principles of commercial accounting…The expression 'annual profits' confirms that income tax is to be charged on profits of an income nature as opposed to capital profits…Moreover, by what is now ICTA88/S74 (1)(f)), in computing the amount of the profits of a trade, no sum shall be deducted in respect of any sum employed or intended to be employed as capital…It follows that while expenses incurred in earning profits may be deducted for the purposes of assessing income tax on the profits of a trade, such expenses as may be incurred in respect of capital transactions are not so deductible…The question which arises in the present case is whether an expense or loss was incurred by a trader in earning profits, or was incurred in the course of a capital transaction.

To determine whether a loan or other similar liability is capital you should apply the approach described in BIM39510 (which deals with foreign exchange gains and losses).