Regent Oil Co Ltd v. Strick (Inspector of Taxes); Regent Oil Co Ltd v Inland Revenue Commissioners

[1965] 3 All ER 174

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(Judgment by: Lord Wilberforce)

Between:
And:

Court:

Judges: Lord Reid
Lord Morris of Borth-Y-Gest
Lord Pearce
Lord Upjohn

Lord Wilberforce

Subject References:
TAXATION
Deduction in computing profits
INCOME TAX
Deduction in computing profits
Capital expenditure
Premiums on grant of leases
Oil company
Tied service stations
Lease of premises to oil company for premium
Sub-lease back to proprietor at nominal rent
Covenants binding proprietor to use company's oil
Deductibility of premium in computing company's profits
PROFITS TAX
Computation of profits
Deduction
Capital expenditure
Premiums on grant of leases
Oil company
Tied service stations
Lease of premises to oil company for premium
Sub-lease back to proprietor at nominal rent
Covenants binding proprietor to use company's oil
Deductibility of premium in computing company's profits

Legislative References:
Income Tax Act, 1952 (15 & 16 Geo 6 & 1 Eliz 2. c 10) - s 137(f)

Case References:
Addie (Robert) & Sons' Collieries Ltd v Inland Revenue Comrs - [1924] SC 231; 8 Tax Cas 671; 28 Digest (Repl) 125, 348
Anglo-Persian Oil Co v Dale - [1931] All ER Rep 725; [1932] 1 KB 124; 100 LJKB 504; 145 LT 529; 16 Tax Cas 253; 28 Digest (Repl) 117, 449
Bolam (Inspector of Taxes) v Regent Oil Co Ltd - (1956) 37 Tax Cas 56; 28 Digest (Repl) 124, 479
British Insulated and Helsby Cables v Atherton - [1925] All ER Rep 623; [1926] AC 205; 95 LJKB 336; 134 LT 289; 28 Digest (Repl) 133, 499
Collins v Adamson (Joseph) & Co Adamson (Joseph) & Co v Collins - [1937] 4 All ER 236; [1938] 1 KB 477; 107 LJKB 121; 21 Tax Cas 400; 28 Digest (Repl) 120 463
Comr of Taxes v Nchanga Consolidated Copper Mines Ltd - [1964] 1 All ER 208; [1964] AC 948; [1964] 2 WLR 339
Inland Revenue Comrs v British Salmson Aero Engines Ltd, British Salmson Aero Engines v Inland Revenue Comrs - [1938] 3 All ER 283; [1938] 2 KB 482; 107 LJKB 648; 159 LT 147; 22 Tax Cas 29; 28 Digest (Repl) 120, 461
Inland Revenue Comrs v Coia - [1959] SC 89; 38 Tax Cas 334; 3rd Digest Supp
Kauri Timber Co Ltd v Taxes Comr - [1913] AC 771; 109 LT 22; 28 Digest (Repl) 114, 330
Knight (Inspector of Taxes) v Calder Grove Estates - (1954) 35 Tax Cas 447; 28 Digest (Repl) 58, 225
MacTaggart (Inspector of Taxes) v Strump - [1925] SC 599; 10 Tax Cas 17; 28 Digest (Repl) 126, 367
Hallstroms Proprietary v Federal Comr of Taxation - (1946) 72 CLR 634
Henriksen v Grafton Hotel Ltd - [1942] 1 All ER 678; [1942] 2 KB 184; 111 LJKB 497; 167 LT 39; 24 Tax Cas 453; 28 Digest (Repl) 116, 437
Hinton v Maden & Ireland Ltd - [1959] 3 All ER 356; [1959] 1 WLR 875; 38 Tax Cas 391; 52 R & IT 688
Inland Revenue Comrs v Adam - [1928] SC 738; 14 Tax Cas 34; 28 Digest (Repl) 126, 370
New State Areas v Comr for Inland Revenue - [1946] SALR 610
Ounsworth v Vickers Ltd - [1915] 3 KB 267; 84 LJKB 2036; 113 LT 865; 6 Tax Cas 671; 28 Digest (Repl) 118, 454
Rhodesia Railways v Bechuanaland Protectorate, Resident Comr & Treasurer - [1933] AC 362; 102 LJPC 62; 149 LT 1; 28 Digest (Repl) 405, 907
Roke (HJ) Ltd v Inland Revenue Comrs, Inland Revenue Comrs v Rorke (HJ) Ltd - [1960] 3 All ER 359; [1960] 1 WLR 1132; 39 Tax Cas 194
Smith (John) & Son v Moore - [1921] 2 AC 13; 90 LJPC 149; 125 LT 481; 12 Tax Cas 266; 28 Digest (Repl) 421, 1860
Stow Bardolph Gravel Co v Poole - [1954] 3 All ER 637; [1954] 1 WLR 1503; 35 Tax Cas 459; 28 Digest (Repl) 123, 476
Sun Newspapers Ltd v Federal Comr of Taxation - (1938) 61 CLR 337
United Steel Companies Ltd v Cullington (Inspector of Taxes) (No 1) - (1939) 162 LT 23; 23 Tax Cas 71; 28 Digest (Repl) 29, 129
Usher's Wiltshire Brewery Ltd v Bruce - [1915] AC 433; 84 LJKB 417; 112 LT 651; 6 Tax Cas 399; 28 Digest (Repl) 77, 293
Vallambrosa Rubber Co Ltd v Farmer (Surveyor of Taxes) - [1910] SC 519; 5 Tax Cas 529; 28 Digest (Repl) 105, 281
Van den Berghs v Clark - [1935] All ER Rep 874; [1935] AC 431; 104 LJKB 345; 153 LT 171; 19 Tax Cas 390; 28 Digest (Repl) 117, 450
Whimster & Co v Inland Revenue Comrs - [1926] SC 20; 12 Tax Cas 813; 28 Digest (Repl) 424, 944
Yarmouth v France - (1887) 19 QBD 647; 57 LJQB 7; 34 Digest (Repl) 299, 2159

Hearing date: 15, 16, 17, 21, 22 and 23 June 1965
Judgment date: 27 July 1965

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Judgment by:
Lord Wilberforce

My Lords, these appeals raise the question whether certain payments made by Regent Oil Co Ltd to dealers in petroleum products were for the purposes of income tax, in the one case, and of profits tax in the other, of a capital or of a revenue character. The issue is the same as it relates to either tax. Moreover, although there are some difficulties of detail as regards the individual payments, it is agreed that, with one exception, these are not significant. The payments were made under agreements which typically provided for (a) a lease of a filling station site by the site owner to Regent for a nominal rent but in consideration of a sum or premium, (b) a sub-lease granted on the same day by Regent to the site owner for the whole term of the lease less a few days, (c) covenants contained in the sub-lease on the part of the site owner to take the whole of his requirements of petroleum from Regent during the term of the sub-lease, (d) provisions enabling Regent to enforce these covenants by re-entry and restricting the right of the site owner to part with his garage without ensuring that the assignee was bound by the covenants. Finally (e) the sum paid for the lease was calculated by reference to the amount of petrol expected to be sold at the station over the period of the lease-at so much per gallon-with, in certain cases, provision for an extra payment if more than this was sold. There was to be no reduction in the sum if less was sold, but in one case the lease, in that event, was to be extended.

The possibly significant difference between the agreements lies in the length of the term of the lease. In most cases this was for twenty-one years, but in one case the term was ten years and in another five years. It is the nature of the sum or premium (the name does not matter) paid for the lease that is in question, Regent seeking to establish that this is revenue expenditure and so deductible before arriving at net or taxable profits.

The nature, capital or revenue, of the expenditure is primarily to be determined from a consideration of the transactions in respect of which it was made, but it is right to look at these against the general commercial background of Regent's trading business. These are explained in considerable detail in the Case Stated. The general features of the "exclusivity" war which developed in the early part of the decade 1950-60 between the major oil companies are by now well known. The lease-sub-lease transaction was a stage in the intense competition to gain or maintain retail companies payments or concessions of varying kinds as the price of tying their sites to a single supplier; in the particular case of Regent it represented a development from the granting of rebates-first paid periodically and later in lump sums-which during the relevant years continued to constitute the majority of the payments agreed to. Some of these arrangements were considered in the case of Bolam (Inspector of Taxes) v Regent Oil Co Ltd and there held to be revenue payments. In 1957-58, the first of the years whose income tax assessment is now under appeal, of the 4,886 stations at which Regent's oil was sold, 4,483 (ie, 91.7 per cent) were tied stations and of these only twelve were tied by the lease-sub-lease method. The sums paid, though in themselves considerable, were not large in relation to the total expenditure of Regent in securing solus sites, at any rate were not so large that the amount of them could support a suggestion that they exceeded normal revenue expenditure.

In the course of the numerous decisions which have distinguished between capital and revenue expenditure in relation to widely different trades and varying circumstances, certain "tests" have emerged. These may be useful, so long as it is recognised that they have emerged a posterior from the facts of a given situation and that they may not always be suitable as guiding lines in other situations. I begin by asking two questions, which may be said to be generally relevant: what is the nature of the payment, and for what was the payment made? These, together with a third question, namely, how that, for which the payment was made, was to be used, were stated by Dixon J in his classic judgment in Sun Newspapers Ltd v Federal Comr of Taxation. There are, he said ((1938), 61 CLR at p 363),

"three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment."

I may add to this another statement by the same learned judge in the later case of Hallstroms Proprietary Ltd v Federal Comr of Taxation ((1946), 72 CLR at p 648):

"What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view, rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process."

I start, then, with a consideration of the nature of the relevant payments made by Regent in the light of the criteria stated by Dixon J under para (c). This formulation is useful in pointing the distinction (as to which much discussion arose in the argument) between a premium paid for a lease-which produces an asset for future use-and rent paid under a lease which is for current use: the first being a capital and the latter a revenue payment. I find it helpful here. The distinction is clear and intelligible, and though a complication may arise where a premium or payment for an asset is made payable periodically by instalments or when a single payment is made which is, or is described as, rent in advance, that need not concern us here, for the payments were neither described as, nor were they of, this latter nature. They were lump sums, paid at the start of the transactions to procure the immediate emergence of an asset or advantage, enjoyment of which was secured for a period. They were not, and did not represent the aggregation of, current payments made for the day to day use of or continuation of an advantage. They appear at first sight to bear the character of capital payments for an asset.

The appellant taxpayers bring forward two arguments at this stage. First they say (truly enough) that the sums or premia were calculated by reference to the gallonage of petrol expected to be sold at the sites, the suggestion being that this made them resemble, or be, rebates on the price. An effective answer to this was given in the Court of Appeal where Lord Denning MR said ([1964] 3 All ER at p 27) that it confused the measure of the payment with the payment itself. A more elaborate form of the argument was that the sums were circulating capital, because Regent expected to get their money back out of current profits as sales, gallon by gallon, day by day, were made. Of course they did: many traders who lay out capital expect to get both a return on the capital and the amortization of the capital expenditure out of the profits of the periodical sales and, whether consciously or not, they calculate the amount they are willing to lay out accordingly; but the fact that they have this expectation and so calculate their expenditure does not enable them to claim that the expenditure is of a revenue character.

Then it was said that the payment, though in a sense of a "once for all" nature (in that it was a single payment for a particular advantage) was really of a recurrent character, because the necessity was evident (though the evidence is not very apparent in the case of a twenty-one year lease) that as the leases expired they would have to be renewed and fresh expenditure of the same kind incurred. Sometimes an argument of this kind may have some force: for example, in the Vallombrosa case the expenditure, though described by Lord Dunedin as "once for all", was accepted as revenue expenditure because it related to a subject-matter, namely, weeding, which in its nature "does occur every year", or in the Rhodesia Railways case ^[F8] where the expenditure related to the, obviously continuous, matter of repairs. Conversely, in other cases, the argument fails because the expenditure is clearly capital in character-as, for example, when it is on plant such as the knives in Hinton v Maden & Ireland Ltd-and mere repetition of capital expenditure cannot turn it into revenue expenditure.

There may be an intermediate situation in which the nature of the expenditure is not clear, or near the borderline, or where the possibility of recurrence may tip the scales: whether this is such a case must await an appraisal of the other factors. Subject only to this point, in my opinion at this stage the character of the payment points to capital.

Next, as regards the nature of the asset or advantage gained. There are possibly two ways of regarding this. The first is to treat the payment as made for a lease of from five years to twenty-one years, ie, for a legal estate in land; the second, which I prefer, and which fits most closely to what Dixon J said in the Hallstroms case ((1946), 72 CLR at p 648), is to treat it as made for the granting of a lease which was (as part of the single bargain) to be subject to a sub-lease containing an exclusivity covenant by the sub-lessee with provisions making that covenant effective. So regarded, the payment was for a solid recognisable asset, evidently (to my mind) of a capital nature. It was transferable, in a limited market no doubt, but in that market it was valuable: it was a source or foundation for the earning of profits, through orders for petrol to be placed under it: it can fairly be described as a piece of fixed capital which is to be used in order to dispose of circulating capital.

I find of assistance here the case, decided in 1959, of Inland Revenue Comrs v Coia where a payment was made for a tie (by way of personal covenant) for ten years. The Court of Session held that this payment was capital in the hands of the recipient. Lord Patrick said ((1959), 38 Tax Cas at p 339)-

"he parted with what I regard as a valuable asset of a capital nature, the right to obtain the supplies of fuel oils which were his stock-in-trade from such sources as he might consider most suited to the varying nature of the demands made by his customers,"

and held that the transaction should be entered in a capital and not in a profit and loss account. The character of a payment in the recipient's hands may differ from that which it bears to the maker of the payment, but here it seems to follow naturally and logically that the valuable asset given up by the garage owner was acquired by the supplier and so acquired as a capital asset. The addition in the present case of the lease-sub-lease transaction does nothing to weaken the force of this argument.

On behalf of the taxpayers it was said that we must look through the transparent form of the lease-sub-lease to some underlying commercial reality and that, having performed this penetration, we should see that this was merely part of Regent's normal marketing operations, or, alternatively, that the payments were nothing but disguised rebates. I cannot accede to this. Without embarking here on the question how far it is permissible in taxation matters to go behind the legal forms which the parties have chosen, where these forms are not a mere sham, I am satisfied that in this case form and substance fully coincide. The garage owners, so the commissioners find, desired (possibly for fiscal reasons of their own) to use the particular method of lease and sub-lease, and Regent agreed with it: the transaction, in this form, was neither a sham nor commercially unreal: it secured for the site owner a lump sum payment and it gave to Regent the tie which they desired buttressed and given efficacy by the privity of estate which the lease-sub-lease created.

This brings me to consideration of the durability of the advantage acquired. As Dixon J said ((1938), 61 CLR at p 363), when considering the nature of the advantage sought, "its lasting qualities may play a part". In English law the term most commonly employed in this part of the argument is "enduring"-ever since Viscount Cave LC in the Atherton case ([1925] All ER Rep at p 629; [1926] AC at p 213) spoke, without intending to lay down test, of "the enduring benefit of a trade". It might be enough to decide this case in favour of the Crown to say that in relation to an "asset" of so concrete a character as a lease, or as a lease accompanied by a sub-lease, at any rate when the term of the lease amounts to five years or more, the test of durability is satisfied, but I do not wish to rest on this narrow ground; indeed, I do not think that it is sound reasoning to do so. I agree entirely with Lord Denning MR ([1964] 3 All ER at p 26), that if one considers the business reality here or, in the words of Dixon J ((1946), 72 CLR at p 648), what the expenditure is calculated to effect from a practical and business point of view, the payments were made for rights (reinforced by the lease-sub-lease method) of exclusive supply of petrol to certain filling stations for periods varying from five years to twenty-one years. It is the endurability of this complex right which has to be considered, and we must squarely face the question whether such an advantage is sufficiently enduring in the context of Regent's trade to qualify as a capital asset, or whether it has such transient qualities that it ought properly to be regarded as "day to day" or "current" and, so, revenue expenditure. It seems to me an undue abstraction to segregate the leasehold or real element in this complex and to apply to it a special rule or test which may exist in relation to such assets in other contexts: and, relevant no doubt though the lease-sub-lease framework is, it requires to be demonstrated that a different endurability test is to be applied in cases where that framework exists and in cases where the advantage consists of a simple tie unsupported by it. The commercial reality is substantially the same, for it is not suggested that Regent paid any more in the lease-sub-lease cases than in those cases where there was a simple tie, or that Regent had any desire for the lease-sub-lease method: on the contrary the evidence is that Regent disliked it and that the retailers forced it on Regent. Surely, therefore, the test should be identical.

Is there, then, any line which can be drawn below which expenditure for a short term asset has, or can have, a revenue character? It is noticeable, and I think significant, that, with one possible exception, there is no authority in favour of the view that, though an advantage has been identified, expenditure to gain it should be treated as revenue expenditure because of the short term character of the asset. That one possible exception is the case of Nchanga, where the agreement was for the period of a year. Although there were other, possibly more important, considerations which led the Judicial Committee to consider the payment as having a revenue character, the contrast was pointed out ([1964] 1 All ER at p 213; [1964] AC at p 961) between the payment in question which exhausted itself and was created to exhaust itself within the twelve months period "within which profits were ascertained" and a "contractual right to last for years" payment for which may be capital expenditure. Some other cases on short term assets are of interest. MacTaggart v Strump was a case of a premium paid for renewal of a lease for five years-this was held a capital expense-which the trader would probably make good out of his profits when earned.

Inland Revenue Comr v Adam was concerned with a right for eight years to deposit earth and slag on another's land: the right was held to be a capital asset, the Lord President (Lord Clyde) considering it as equivalent to any other capital asset of a "relatively permanent character". John Smith & Son v Moore is a delusive case: it appears to involve precisely the critical area which we must consider here-namely, very short term contracts-but no clear conclusions can be drawn from the decision. The difficulties inherent in it have been so fully analysed by the Judicial Committee in the Nchanga case ([1964] 1 All ER at pp 213-215; [1964] AC at pp 962-964) and by others of your lordships that I shall not take up time by a further discussion of them. More comprehensible is Henriksen v Grafton Hotel Ltd where it was held in the Court of Appeal that a payment in respect of so-called monopoly value on the renewal for three years of a licence was a capital payment. The subject-matter of the payment there though of a special character (but what asset is not?) was in the same area as the ties in the present case, and Lord Greene MR said ([1942] 1 All ER at p 682; [1942] 2 KB at p 192):-

"The thing that is paid for is of a permanent quality although its permanence, being conditioned by the length of the term, is shortlived":

and he regarded the fact that the licence had to be renewed every three years as irrelevant-there was "a false appearance of periodicity" ([1942] 1 All ER at p 682; [1942] 2 KB at p 191) about them. Lastly, there are certain cases concerned with opencast mining: Knight (Inspector of Taxes) v Calder Grove Estates, Stow Bardolph Gravel Co Ltd v Poole, H J Rorke Ltd v Inland Revenue Comrs. In two of them the question of transience was raised and in each it was decided that once the conclusion was reached on other considerations (the validity of which need not be here considered) that the asset acquired was fixed and not circulating capital, the fact that the asset was of a transient character is irrelevant. These authorities do little more than provide illustrations of the character of various types of assets in various trades. The principle seems to emerge that if, on a consideration of the nature of the asset in the context of the trade in question, it is seen to be appropriate to classify it as fixed rather than as circulating capital, the brevity of its life is an irrelevant circumstance. But it would still be correct, in my opinion, where the nature of the asset, taken together with other relevant factors, leaves the matter in doubt, to have regard, amongst other things, to its transient character. No rule can be laid down as to a minimum period of endurance for a capital asset or a maximum permissible period for an item of stock or circulating capital, though obviously the more closely the period of endurance is related to an accounting period the easier it is to argue for a revenue character, but no doubt there is a penumbra the width of which may vary according to the nature of the trade.

I return, then, to the expenditure in this case. Here the nature of the payments-lump sums-, the nature of the advantages obtained-security in respect of the placing of orders for a period,-the substantial periods involved, the shortest being a period of five years, more than adequately establish the expenditure as made for the acquisition of capital assets. Conversely I can see no basis on which such assets can be given such a character that payments for them can be treated as revenue payments, whether as stock or as circulating capital or by any other description. To say, as the Crown does, that it has become the custom of the trade to make them, appears to me as indecisive as to say that the vast size of modern industrial enterprises, and particularly of oil companies, forces them to engage in long term contracts. All this may be true, but it is still necessary to look at the actual means adopted to conform with the custom or to secure the long term trading advantages before it is possible to attribute a capital or a revenue character to the payments. The two obvious alternatives are to offer rebates as orders are given or to offer lump sums in exchange for security for a period: the one-like rent-qualifies as revenue, the other-like a premium-as capital. As to the critical period, I can see no logical basis for saying, for example, that twenty-one, or ten years, is good enough but five or three years, is too short or for saying that five years or three years may be long enough when there is a lease and not long enough where there is merely a personal covenant, and there is nothing in the evidence in this particular case to justify these distinctions. Nor is there any factor here which enables me to relate any of the payments to an accounting period however flexibly that criterion be applied.

I must, however, say something of Bolam's case, which was concerned with ties varying from six months to six years. The decision was not the subject of an appeal: and counsel for the Crown did not seek to attack it. He made plain, however, that his acceptance of it was on the the basis that it could and should be regarded as a case of a current payment, through rebates or compounded rebates, for current enjoyment of the advantage conferred by the ties. I think that Danckwerts LJ so regarded it both when he decided the case-for he made the comparison with rent-and also in the appeal in the present case. So regarded, it falls well within the alternative formula in Hallstrom's case and I fully accept it. If it is sought to use it as authority of general application in the trade that payments for ties of six years or lesser periods are revenue payments, I cannot agree with it.

There is one other argument on which some observation is necessary, namely, that based on accountancy considerations. It was argued, generally, that an asset of this kind-a short term advantage-ought more appropriately to appear in the profit and loss account than in the balance sheet. This is, in part, to beg the question, but it may be useful to use this way of stating the issue as a cross check. So doing, I know of no reason why a short term lease, for which a sum has been paid, or the benefit of a short term covenant, should not rank as a capital asset. Of course, its value ought in prudence to be written off over its life out of revenue, and it is no doubt fiscally unpleasant for the trader that (the income tax code allowing no depreciation of such assets to be charged) he must do so out of taxed income. This taxable disadvantage, however, cannot be used as an argument against the insertion of the item in the balance sheet rather than the profit and loss account: it is merely an argument against resorting to this type of transaction.

Even if a trader prefers for reasons of his own to charge the cost of a short term asset wholly against the revenue of the year of acquisition, that decision cannot affect his liability for tax. Then, more particularly, it was said that accountancy evidence given in this actual case supported the charge against revenue; but all that the commissioners say is this:

"Auditors and accountancy advisers of Regent who gave evidence before us took the view that such payments were made to preserve turnover, that no fresh asset was acquired as a result of such payments, and that accordingly such payments were properly chargeable to revenue."

This is either irrelevant or wrong. It is irrelevant that the expenditure was made to preserve rather than to create turnover: wrong to say that no fresh asset was created; the contrary is clearly the case: this evidence does not deal with the question of transience at all. So I cannot obtain any guidance from accountancy considerations. I would add that in Bolam's case also some reliance was placed on accountancy evidence, but that evidence was inconclusive and, as I read the judgment of Danckwerts J he did not rely on it.

I come, therefore, to the conclusion that the indications derived from the nature of the payment, the commercial and legal nature of the advantage gained, and the use to be made of the advantage, all point in the direction of capital and that they do so with a clarity which is more than sufficient to countervail such slight indication in favour of revenue (and I repeat that in this case the indication is slight) as is to be derived from the possible recurrence of the expenditure.

I would dismiss the appeals.

Appeals dismissed.

Solicitors: J G Senior (for the taxpayers); Solicitor of Inland Revenue.

Wendy Shockett, Barrister.