Taxation in Capital and Revenue Expenditure in the UK - Term Paper Example

TAXATION IN CAPITAL AND REVENUE EXPENDITURE IN UK 0- INTRODUCTION Career in taxation refers to dealing with complex tax laws; keeping up to with changes in taxation laws and their implications; devising taxation strategy for clients business to ensure that taxes are paid in the most efficient manner along with taking benefit of the exemptions (Kessler, 2012). Taxation career is regarded as among high level of complex dealings and as a result receiving high rewards. The complexity in taxation lies in many aspects. For instance, distinction of expenditure as capital or revenue is among the most discussed ones. Another aspect that calls for considerable assessment for gaining tax relief includes the capital expenditure that can be accounted for eligible of capital allowance or not. Hence, career in taxation involves accurate distinguishing knowledge about the tax laws applicability and enables business to gain the tax relief. 2.0- CAPITAL VERSUS REVENUE EXPENDITURE Capital expenditure refers to the expenses incurred for the acquisition (purchase or improvement of an asset) for improving the productivity of business. The revenue expenditure, on the other hand, refers to expenses incurred for day-to-day business operations. It also accounts for the expenses for the repair of the property. To mention, this repair shall not result in the improvement of the assets such as increased production etc. Revenue expenditures are applied to profit derived in income statement and hence provide tax relief for the respective period. Capital expenditures, on the other hand are moved to balance sheet and hence do not provide tax relief. It is also be regarded as tricky domain where as certain capital expenditure can fetch some tax benefit as capital allowance. However, there are limited options for the purpose and benefit is usually not immediate (Bradford, 2009). 2.1- SEGREGATING REVENUE AND CAPITAL EXPENDITURE Segregating capital and revenue expenditure is much easier said than done. There is no simple rule of thumb that guides segregation. Further this segregation is merely dependent on the relevant facts at the time of expenditure incurred; mainly linked to the expenditure circumstances and finally the nature of trade. Moreover, expenditure can be regarded as capital expense in one trade and revenue expenditure in other trade (HRMC, 2012a). 2.2- RISK AREAS OF INCORRECT SEGREGATION OF REVENUE AND CAPITAL EXPENDITURE Areas where error may result in segregation of expenditure as capital or revenue one as identified by HM Revenue & Customs (HMRC) department include following (HRMC, 2012a): Record keeping Acquisition, improvement and alteration of assets Legal and professional fees Finance costs IT costs Corporate intangible assets However, identification of possible risks of incorrect assessment of expenditure as capital or revenue and solution to mitigate those risks has also been guided in the tool kit by HMRC. 2.3- CASE LAWS FOR CAPITAL OR REVENUE EXPENDITURE Various cases have been filed against the confusion of capital and revenue expenditure. Lord Reid in case of Strick v Regent Oil Co Ltd ([1965] 43TC1) referred to the difficulty in assessing the reason behind the justification having different relevance to different cases. Lord Reid further referred to reasons behind such difficulty is attempting to perceive literal meaning from case decisions instead of exploring the context within which such decision was made (HRMC, 2012b). 2.3.1- A lease of land is a capital asset (Strick v Regent Oil Co Ltd [1965] 43TC1) The mentioned case highlighted to the precision of the nature of trade specified. The retailer leased land to Regent Oil against lump sum premium set against expected sale of fuel amount. Station was sub leased by Regent Oil to retailer back with binding for a period of three days less than time it was originally leased. The agreement had covenants binding on retailer for taking up oil from Regent Oil. The decision abided premium payment as lease with reason that there was no trade activity and payments were for acquisition interest in land; hence shall be accounted as capital expenditure (HRMC, 2012c). 2.3.2- Not confined to one-offs, can and does recur (Vallambrosa Rubber Company Ltd v Farmer [1910] 5TC529). As against the perception that capital expenditure occurs once in long time whereas the revenue expenditure occurs more frequently. The case of (Vallambrosa Rubber Company Ltd v Farmer [1910] 5TC529) held that capital expenditure can have recurrence of payments. Vallambrosa Rubber Company Ltd in a newly owned rubber plant incurred expense of revenue nature for investment in portion of land that was not generating rubber for trade. It argued one time investment can only be referred as capital expenditure. The case declared all such investment as capital expenditure as improving the state of estate (rubber land) will increase productivity and hence, non referable to profit (HRMC, 2012d). 2.3.3- Other cases Other cases such as Tucker v Granada Motorway Services Ltd [1979] 53TC92 referred to object of expense (HRMC, 2012e); expenditure on the exclusivity of ties (HRMC, 2012f) etc all declared various aspects that forced changing treatment of expenditure as capital or revenue expenditure. Further in case of Heather v P E Consulting Group Ltd [1972] 48TC293 mainly held for expenditure on intangibles, it was stressed that declaration of expenditure as capital or revenue expenditure is more case law than accountancy (HRMC, 2012g). 2.4- COMMENTS Based on the discretion and mainly with respect to the decisions for various cases discussed above it raises certain questions. For instance, business that faced verdict to change the expenditure treatment must have had tax consultant that directed such treatment. Therefore, raises call for the clarity in stated and practiced laws. Moreover, those businesses that did not face any court hearing related to expenditure treatment can also be questioned for the validity and accuracy of treatment to their financials. Hence, there shall be more clarified and rigid rules ensuring similar treatment of all cases; thereby leaving no areas of concerns about the performance of other businesses. 3.0- CAPITAL EXPENDITURE Upon declaring expenditure to account as capital expenditure, the assessment requires to explore if the stated expenditure is eligible for the tax relief as every capital expenditure cannot be straight directed to profit accounts for tax relief. Capital allowance refers to those expenditures incurred on assets that decreases tax bill applicable to business (GOV UK, 2012). Capital allowances are facilitated to all forms of businesses that are eligible for corporate tax. Purpose of capital allowance is to facilitate tax benefit by decreasing the value of an asset (falling under the category of definition of an asset) purchased and owned for being used in business; also subject to certain conditions. The reduced value is applied to profit for reducing taxable income. For instance, capital allowance cannot be claimed on asset that has been acquired for buying and selling as part of trade in business (HRMC, 2012h). 3.1- ACCOUNTING TREATMENT STANARDS AND ELIGIBILTY CRITERIA Accounting Treatment for the expense incurred that are to be allocated in capital or revenue expenditure for tax purpose is referred as ‘subsequent expenditure’. It is component of FRS 15 ‘Tangible Fixed Assets’. It is also provided in detail in   in IAS 16 ‘Property, Plant and Equipment’ (3). The stated standards entail the details of accounting treatment for scope, objectives, initial measurement, revaluation, depreciation etc for the tangible fixed assets that include property plant and equipment. Subsequent expenditure is a component of the initial measurement part of FRS 15 (Barlow, 2011). Expenditure can only be capitalized according to FRS 15 under three given below three conditions (Barlow, 2011): In case subsequent expenditure increases the value of fixed asset over and above it’s already assessed state. In case the subsequent expenditure incurred for the component of the fixed asset replacement or restoration once it has completed its useful life and has been treated separately for the depreciation purpose from the asset. In case subsequent expenditure causes the overall refurbishing of the asset that revives the economic benefit provision capacity of asset equal or above the level that has already been consumed. 3.2- EXPENDITURES ELIGILE FOR CAPITAL ALLOWANCE As stated earlier all expenditures are not eligible for the capital allowance. Furthermore certain building-related capital expenditures are only accounted for the benefit of capital allowance. List of such capital expenditures, though not limited to, include: plant machinery, research and development ; gifts of equipment to charity; certain fixtures (integral features) in buildings; conversion cost or renovation of empty flats above commercial premises qualifying for the flat conversion allowance; business premises renovation; mineral extraction allowance; patent allowance etc. Moreover, these allowances are increasingly facilitated for the first year in order to encourage business to increase efficiencies in certain areas. For instance, installing water efficient technologies or adopting energy efficient products such as cars with very low carbon dioxide emissions etc are all offered 100% first year allowance under Enhanced Capital Allowance (ECA) other than temporary first year allowance (HRMC, 2012i). 3.3- CAPITAL ALLOWANCES ON PLANT AND MACHINERY  Capital expenditure to be eligible for the capital allowance under property plant and equipment are faced with an issue to meet following criteria: Asset must have been acquired in against of this expenditure. Also, the expenditure must also be wholly or partly for business use. If the asset is partly for the business than capital allowance can also be only claimed for the part being used in business. Moreover, asset to claim capital allowance must also not be on lease (allowed only in certain circumstances). However, it can be claimed on asset that is owned by business and leased to someone or some business. Asset to be eligible for the capital allowance must not of kind that gets used up in trade (buy or sell). The final sale for instance in case the asset have completed the useful life etc is other case. At the instance of sale, capital allowance must have been adjusted. Moreover, it shall also not be consumed as a component in producing the product or service that business by or sell. The (expected) life of an asset shall be at least two years. 3.4- CASE LAWS FOR CAPITAL OR REVENUE EXPENDITURE Employee and office holders are also facilitated for the various capital allowances against the plant property and equipment. For instance, if an employee uses personal property such as conveyance for business purpose can claim capital allowance. The eligibility for claiming capital allowance requires that employee is not paid with business mileage or paid amount is less than the maximum than tax benefit offered etc. However, capital allowance for assets that either has been used to replace the asset that was not earlier claimed for allowance or cost of the equipment is too small; then employee can charge whole cost of such (inexpensive) items in the year of expense incurred than claiming capital allowance. Hence, various allowances can be claimed to the property plant and equipment under Writing-down allowances (WDA), Annual Investment Allowance (AIA); 100% first-year allowances (FYA) etc (HRMC, 2009) etc. 3.5- CALCULATION FOR CAPITAL ALLOWANCE Allowances are calculated based on the rate specified in law for the respective asset under specified title. For instance, expense incurred on equipments pooled up to £70,000. Based on the law, this expenditure can be claimed upto £50,000 under Annual Investment Allowance (AIA). Moreover, for the remaining amount business can claim 20% writing-down allowance and take the tax benefit of £54,000 against the taxable income of the current year. Further, the remaining capital expenditure of £16,000 shall be accounted in the next financial year. Hence, upon testing eligibility the based on the rates given benefit of capital allowance are achieved by business under various titles. 3.6- COMMENTS Discretion for the capital allowance for various capital expenditures is though beneficial in all. However, there are certain concerns such as rate of allowance being similar to all businesses does not seem to be justified. For instance, considering the capacity of small sole proprietor and big corporation that is never similar. Hence, first year 100 percent allowance available to big corporations can be considered an extra benefit that can furthers strengthen corporation’s capacity. However, small businesses get more vulnerable to muscles of corporations. Further, the rate shall be varied based on overall capacity of business to encourage number of businesses than assets class and to cater the monopoly of certain businesses. Moreover, such discretions and varied ways to gain the tax benefit can only be suggested in a comprehensive plan by expert tax advisor that is usually beyond the capacity of small businesses to hire. Hence, again seems to benefit big business than small entrepreneurs. 4.0- CONCLUSION Career in taxation is lucrative field as it rewards tax consultant higher with growing capacity to suggest avenues to business in exploiting greater efficiency in tax payment. Drafting the basis of discretion of capital and revenue expenditure first and then eligibility of capital expenditure to fetch capital allowance has been discussed along with cases that affect and change treatment in this report. It is concluded that benefit of tax is facilitated in different ways to encourage tax payment and business growth but at the same time there remains an addressed area of benefitting small and big business equally that in turn strengthens the muscles of big corporation and increases vulnerability of small businesses. Hence, it requires developing some balance based on scale business than asset classes. List Of References Barlow, E. (2011). ‘Tips and Techniques to Manage Asset Accounting Activities to Stay in Compliance with IFRS’. GRC 2011, Available from http://www.serioconsulting.com/pdf/FI-AA_Compliance_with_IFRS.pdf [Accessed 26 December 2012] Bradford, S. (2009). ‘Capital v Revenue Expenditure and Associated Relief’. Tax Insider, Available from http://www.taxinsider.co.uk/368-Capital_v_Revenue_Expenditure_and_Associated_Relief.html [Accessed 26 December 2012] GOV UK. (2012). Capital allowances. Available from https://www.gov.uk/capital-allowances [Accessed 26 December 2012] HRMC. (2009). Capital allowances for employees and office holders. Available from http://www.hmrc.gov.uk/helpsheets/hs206.pdf [Accessed 26 December 2012] HRMC. (2012a). Capital v Revenue Expenditure Toolkit. Available from http://www.hmrc.gov.uk/agents/toolkits/capital-v-revenue.pdf [Accessed 26 December 2012] HRMC. (2012b). Capital/revenue divide: tax cases and summing up: making sense of the various decisions. Available from http://www.hmrc.gov.uk/manuals/bimmanual/bim35901.htm [Accessed 26 December 2012] HRMC. (2012c). Capital/revenue divide - intangible assets: Exclusivity ties - acquiring an interest in land. Available from http://www.hmrc.gov.uk/manuals/bimmanual/BIM35560.htm [Accessed 26 December 2012] HRMC. (2012d). Capital/revenue divide: general themes: recurrence. Available from http://www.hmrc.gov.uk/manuals/bimmanual/BIM35305.htm [Accessed 26 December 2012] HRMC. (2012e). Capital/revenue divide: general themes: emphasis on what the expenditure achieves. Available from http://www.hmrc.gov.uk/manuals/bimmanual/BIM35320.htm [Accessed 26 December 2012] HRMC. (2012f). Capital/revenue divide - intangible assets: Exclusivity ties - reimbursed repairs, etc. Available from http://www.hmrc.gov.uk/manuals/bimmanual/BIM35555.htm [Accessed 26 December 2012] HRMC. (2012g). Capital/revenue divide: the rôle of accountancy: the weight to place on accountancy evidence. Available from http://www.hmrc.gov.uk/manuals/bimmanual/BIM35210.htm [Accessed 26 December 2012] HRMC. (2012h). Capital allowances: the basics. Available from http://www.hmrc.gov.uk/capital-allowances/basics.htm [Accessed 26 December 2012] HRMC. (2012i). First year allowances for water efficient technologies. Available from http://www.hmrc.gov.uk/capital-allowances/fya/water.htm [Accessed 26 December 2012] Kessler, J. (2012). Taxation of Non-Residents and Foreign Domiciliaries, 11th edn. London: Key Haven Publications. Read More