BIM35201 - Capital/revenue divide: the rôle of accountancy: ordinary principles of commercial accountancy

True and fair view

As Lord Templeman made clear in Beauchamp v Woolworth plc (see the quote at BIM35115) there is no statutory definition of profits and there is no statutory rule for the deduction of expenses incurred in earning profits. Over the years the courts have arrived at the computation of profits of a trade after setting against the receipts expenditure necessary to earn them according to the ordinary principles of commercial accounting.

The treatment in the accounts does not determine the question of whether expenditure is capital or revenue. For accountancy purposes the important issue is not whether the expenditure is capital or revenue. For accountants the main question is when expenditure is consumed and, therefore, when it must be charged to the profit and loss account.

Not every expense that is properly charged in the profit and loss account according to the ordinary rules of commercial accountancy and UK GAAP is deductible for income tax. For example under UK GAAP a deduction is required for the cost (capital expenditure) of depreciation. For income tax purposes depreciation is not an allowable deduction in computing profits.

FA98 introduced a statutory rule that applies to any trader. You should be aware that the rule is not confined to professionals moving from the so-called 'cash basis' - see BIM74010. FA98/S42 (1) put the existing requirements derived from case law onto a statutory footing:

“For the purposes of Case I or II of Schedule D the profits of a trade, profession or vocation must be computed on an accounting basis which gives a true and fair view, subject to any adjustment required or authorised by law in computing profits for those purposes”.

The following expenditure is not deductible:

• on capital account or in connection with capital incomings or disposals (see BIM35030),
• of a revenue nature incurred for non-business purposes (see BIM42100 onwards),
• incurred in earning income of another period (see BIM31095 onwards),
• relating to a source of non-trading income; for example rent or rates on sub-let premises the income from which is assessable Schedule A (see BIM42100 onwards), and
• specifically disallowed; for example entertaining (see BIM45000 onwards).

If an expense is deductible in the computation of trading profits, the allowance may not be foregone in favour of an alternative deduction. This follows from the decision in Wilcock v Frigate Investments Ltd [1981] 55TC530. A property dealing company failed in its attempt to have bank interest deducted as a charge on income, and so available as a deduction from total profits from all sources, instead of as a deduction in computing its dealing profits.

At page 123B of Threlfall v Jones and Gallagher v Jones [1983] 66TC77 (cases concerning the application of SSAP 2 (see BIM31030) and SSAP 21 (see BIM40551) to payments due under certain leases) the Master of the Rolls, Sir Thomas Bingham, expanded on the application and the developing role of commercial accountancy:

Subject to any express or implied statutory rule, of which there is none here, the ordinary way to ascertain profits or losses of a business is to apply accepted principles of commercial accountancy. That is the very purpose for which such principles are formulated. As has often been pointed out, such principles are not static: they may be modified, refined and elaborated over time as circumstances change and accounting insights sharpen. But so long as such principles remain current and generally accepted they provide the surest answer to the question which the legislation requires to be answered…

Given the plain language of the legislation, I find it hard to understand how any judge-made rule could override the application of a generally accepted rule of commercial accountancy which (a) applied to the situation in question, (b) was not one of two or more rules applicable to the situation in question and (c) was not shown to be inconsistent with the true facts or otherwise inapt to determine the true profits or losses of the business.

Thus where you have an accepted rule of commercial accountancy that:

• applies to the situation, and
• is not one of two or more equally applicable rules, and
• is consistent with the established facts and is not inappropriate to determine the true profits

then you must follow it unless there is specific legislation to the contrary.