CA11800 - General: Definitions: When capital expenditure is incurred
CAA01/S5
The normal rule is that expenditure is incurred on the date on
which the obligation to pay becomes unconditional.
A person buying goods is legally required to pay for them on
delivery unless there is a special agreement as to terms of
payment. If the buyer is legally required to pay on delivery the
obligation to pay becomes unconditional when the goods are
delivered.
If goods are sold subject to reservation of title (a Romalpa
contract, see
CA11700) the obligation to pay becomes
unconditional when the goods are delivered. The supplier has then
fulfilled his or her part of the contract. This means that the
buyer incurs capital expenditure as soon as the goods are
delivered.
The date on which the obligation to pay for an asset becomes
unconditional and the date on which the purchaser is legally
required to pay for that asset may not be the same. For example,
the sales agreement may require payment to be made within four
weeks of delivery. If so the obligation to pay becomes
unconditional on delivery but the purchaser is not legally required
to pay until four weeks after delivery.
There is an exception to the general rule. If there is a gap
of more than four months between the dates on which the obligation
to pay becomes unconditional and the date on which payment is
required to be made the expenditure is not incurred until the date
on which payment is required to be made.
Example 1 Bob buys a car for £15,000. Under
the contract he has to pay £12,000 when he takes delivery of
the car and £3,000 one month later. Bob takes delivery of the
car on 24 May. His obligation to pay for the car becomes
unconditional on 24 May. He is legally required to pay for the car
in two instalments - £12,000 on 24 May and £3,000 on 24
June. Both payments are required to be made four months or less
after the date on which the obligation to pay becomes
unconditional. Bob therefore incurs expenditure of £15,000 on
24 May when he takes delivery of the car and his obligation to pay
becomes unconditional.
Suppose that Bob buys the car for £15,000 from his
brother. Under the contract he does not have to pay for the car
until he has had it for six months. He takes delivery of the car on
24 May and his obligation to pay for the car becomes unconditional
then. He is not legally required to pay for the car until 24
November, which is more than four months after the date on which
his obligation to pay for the car becomes unconditional. He does
not incur his expenditure of £15,000 on the car until 24
November, the date on which he is legally required to pay for it.
If some of the expenditure is required to be paid more than
four months after the date on which the obligation to pay becomes
unconditional and some is not, split the expenditure. The part of
the expenditure which is required to be paid four months or less
after the date on which the obligation to pay becomes unconditional
is incurred on the date on which the obligation to pay becomes
unconditional. The rest is incurred on the date on which payment is
required to be made.
Example 2 As in example 1 above Bob buys a car for
£15,000. Under the terms of the contract he has to pay
£12,000 one month after delivery of the car and the balance of
£3,000 five months after that. He takes delivery of the car on
24 May and his obligation to pay becomes unconditional then. He is
legally required to pay:
- £12,000 on 24 June, and
- £3,000 on 24 November.
The first payment is due four months or less after his
obligation to pay becomes unconditional but the second one is not.
He incurs expenditure of £12,000 on 24 May and £3,000 on
24 November.
A
milestone contract is a contract that satisfies
the following conditions:
- The asset which is being constructed under the contract becomes the property of the purchaser as it is being constructed;
- Payment becomes due as and when agreed stages of the work (`milestones') are satisfactorily completed.
Milestone contracts are often found where there is a large-scale
construction project for buildings or for major items of machinery
or plant such as oil pipelines. In a milestone contract the
obligation to pay normally becomes unconditional when an architect
or engineer who has inspected the work done issues a certificate.
In a milestone contract, the asset becomes the property of
the purchaser as it is being constructed. The obligation to pay for
a part of the asset that has been completed becomes unconditional
when the work is certified.
If the part of the asset, which has been completed, becomes
the property of the purchaser before the end of the chargeable
period and the work is certified before that accounting date the
normal rules about when expenditure is incurred apply. This means
that the expenditure is incurred when the work is certified. If the
part of the asset which has been completed becomes the property of
the purchaser before his accounting date and the work is certified
within one month of that accounting date the expenditure which is
certified is treated as incurred on the accounting date. If the
part of the asset, which has been completed, becomes the property
of the purchaser before his accounting date but the work is not
certified until more than one month after that accounting date this
special rule does not apply. The expenditure is incurred when the
work is certified.
There are anti avoidance provisions. They apply where both
the following conditions are satisfied:
- The obligation to pay an amount of expenditure under an agreement becomes unconditional at an earlier date than would be the case in a normal commercial contract.
- The sole or main benefit that might be expected to be obtained from A is that the expenditure would be treated as incurred in an earlier chargeable period or basis period.
The legislation applies to both initial and supplementary
agreements. In deciding whether a contract is a normal commercial
contract you should find out what the normal practice is for making
contracts for the type of asset concerned and compare it with that.
Where the above conditions are satisfied the general rule
does not apply. The expenditure is treated as incurred on the date
when payment is required to be made.
Example 3 Brian draws up his accounts to 31 July.
On 4 July 2004 he orders a sloop for delivery on 15 August.
Normally payment would be due on delivery and so the expenditure
would not be incurred until 15 August 2004. The expenditure would
be incurred in Brian's accounts year ended 31 July 2005. However,
Brian makes an agreement with the supplier under which payment is
due in full (and so the obligation to pay becomes unconditional)
when the order is placed but the supplier allows a credit period of
six weeks. This means that if the normal rules applied the
expenditure would be incurred on 4 July 2004, which is in Brian's
accounts year ended 31 July 2004. If the anti-avoidance legislation
is applied the expenditure is incurred on 15 August 2004, in the
accounts year ended 31 July 2005.
You should only consider applying the anti avoidance
provisions if the amounts involved are substantial. You should
consult CT&VAT (Technical) before you attempt to apply them. In
your submission you should state the reasons given by the taxpayer
for entering into the contract within rather than a normal
commercial contract.
A contract may let the purchaser retain part of the purchase
price (
a retention) until certain conditions are
satisfied. The obligation to pay the part of the purchase price
that is retained does not become unconditional until the condition
that gave rise to the retention is satisfied.
The rules about when expenditure is incurred do not apply to
the following:
- expenditure incurred before a trade begins (IBA, know how, machinery and plant, MEA, patents). Expenditure incurred before a trade begins is treated as incurred on the first day of trading.
- expenditure still to be incurred under a hire purchase etc contract at the time when the asset is brought into use. Expenditure still to be incurred under a hire purchase etc contract at the time when the asset is brought into use is treated as incurred on the date on which the asset is brought into use.
- buildings and structures bought unused (ABA, ATA and IBA). Expenditure incurred on the purchase of an unused building or structure is deemed to be incurred on the date on which the purchase price becomes payable.
- an additional VAT liability or rebate. An additional VAT liability is incurred and an additional VAT rebate arises on the last day of the relevant VAT interval.
