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Schedule D Cases I and II

In the recent Special Commissioner&#39s case of Silk &#45v- Fletcher (Inspector of Taxes) (1999) Mr Silk was a partner in a firm of chartered accountants. He left after five years taking his client base with him. Under a deed of partition Mr Silk agreed to purchase the book debts for bills rendered and work in progress for his client base plus his share of furniture, fixtures and fittings. He also agreed to various conditions and restrictive covenants.

As a sole practitioner his drawings exceeded net profits and he had an overdrawn capital account. The Revenue contended that 66.8% of the claim for loan interest (and finance charges) related to business purposes and the balance should be disallowed as being for private purposes under Section 74(1)(a) and (b) ICTA 1988.

The taxpayer appealed contending that:

1. His capital account was not overdrawn if it included amounts for goodwill and cumulative depreciation.

2. Although he had not specifically purchased goodwill he had by implication done so by releasing his entitlement to a partnership annuity on retirement. His capital account should be adjusted accordingly.

The Revenue contended that:

1. The taxpayer&#39s accounts had been prepared without an entry for goodwill in accordance with Financial Reporting Standard 10. Although purchased goodwill could be capitalised, internally generated goodwill could not be capitalised. The accounts could not therefore be adjusted for goodwill.

2. Where money had been earned but not received, drawings would have to be borrowed, and such loan interest was for private purposes; and the addition to the capital account for depreciation should be reduced by the excess of debtors over creditors.

It was held that:

1. The underlying reality was more important than the accounting entries. As the taxpayer had borrowed to purchase the assets under the deed of partition his capital account was overdrawn.

2. The taxpayer was entitled to a share of goodwill and he took this with him when he took his client base with him; he also took the additional goodwill relating to his own higher fee base but he did not pay for any goodwill. Therefore the goodwill was internally generated because it related to the taxpayer&#39s own clients. As no consideration had been given for goodwill, the capital account could not be adjusted.

3. To arrive at the correct amount of loan interest for business purposes the capital account was to be increased by the cumulative depreciation but reduced by the excess of debtors over creditors. Accordingly the taxpayers appeal would be allowed in part.


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