BIM35455 - Capital/revenue divide: tangible asset: asset bought in a defective condition: the court’s view

Unseaworthy ship contrasted with useable cinemas in need of repair

The courts gave contrasting decisions in two cases involving the purchase of assets in need of repair.

In the case of The Law Shipping Co Ltd v CIR [1923] 12TC621 the company bought a second hand steamship, 'Duns Law', at a date when its four-yearly Lloyd’s survey was overdue; exemption of the survey was granted pending completion of a voyage that was about to begin. Six months later the survey was made resulting in significant expenditure. The company admitted that part was capital but claimed the majority as repairs. The Special Commissioners only allowed the part of the repairs that was applicable to the period during which the company owned the ship. The Court of Session upheld the Commissioner’s decision. Lord President Clyde at page 626 explained that the capital cost of the ship was not restricted to the cost of acquisition from the previous owner but included the costs of making the ship seaworthy:

It is obvious that a ship, on which repairs have been allowed to accumulate, is a less valuable capital asset with which to start business than a ship which has been regularly kept in repair. And it is a fair inference that the sellers would have demanded and obtained a higher price than they actually did, but for the immediate necessity of repairs to which the ship was subject when they put her in the market…Again, when the purchasers started trade with the ship, the capital they required was not limited to the price paid to acquire her, but included the cost of the arrears of repairs which their predecessors had allowed to accumulate; because, while their own trading with her would - in ordinary course - provide a revenue out of which the repairs incidental to such trading would be met, it would be unreasonable and abnormal - in any commercial sense - to saddle such trading with the burden of arrears of repairs incidental to the trading of their predecessors from which the purchasers derived no benefit.

In Odeon Associated Theatres Ltd v Jones [1971] 48TC257 the company carried on the trade of cinema owner and operator. During the Second World War the company purchased a number of theatres. Evidence was given that the purchase price of these theatres was not affected by their state of repair. From the beginning of the war until the early 1950s theatre building was prohibited, as was decorating and repair work except for a small amount of essential maintenance, which was inadequate to keep the theatres in a proper state of repair. The company carried out the accumulated repairs and claimed the full costs. The Special Commissioners found that the expenditure was properly charged to the company’s profit and loss account in accordance with the principles of sound commercial accounting. Nevertheless the Special Commissioners disallowed the costs as 'deferred repairs' following Law Shipping.

The High Court and the Court of Appeal found for the company. The Court of Appeal distinguished Law Shipping on the following grounds:

1. The purchase price of the ship was substantially less than if it had been in a fit state of repair.
2. The ship could not continue as a profit-earning asset without being repaired shortly after acquisition.
3. No evidence in Law Shipping that on sound commercial accountancy principles the deferred repairs could be charged as revenue expenditure. In Odeon, Salmon LJ says at page 283 “… I should be very surprised if there had been any such evidence “

Whereas in Odeon:

• The purchase price of the cinemas was not depressed by their condition.
• The cinemas could and were used in the ‘as acquired’ condition.
• Accountancy evidence figured large.

Again you see the courts coming to opposite conclusions in cases where at first glance the facts seem to be the same but on deeper examination important differences emerge. This again shows the importance of establishing all of the facts before entering into argument.