Restrictive Covenants

The taxpayer, along with other oil companies, paid lump sums to service station owners in consideration for the owners' agreement to deal exclusively with the oil companies for a fixed number of years (generally, five years, but ranging up to 20 years). The payments were fully deductible given that: the only ultimate reason for their being made was to maintain or increase gallonage; the payments would be expected to be returned "penny by penny" during the term of the agreements through increased sales (p. 266); the benefit derived "was to be used in the continuous and recurrent struggle to get orders and sell petrol" (p. 273); and they were made on a recurring basis in the sense that every five years (on average) further payments would be required in order to secure the same advantage. Because the term of the agreements were part-way between what would have been short-term (two or three years) and what would have been long-term (twenty years), the term of the agreements was a neutral factor.

Following competition among the major U.K. oil companies to have service stations distribute the companies' products on an exclusive basis, the taxpayer began entering into arrangements under which it would lease the service station from the owner for a period of up to 20 years in consideration for a nominal annual rent and a lump sum payment paid at the inception of the lease. The taxpayer in turn would sublease the premises back for a slightly shorter term for a nominal annual rent under a sublease agreement which bound the operator to purchase its petroleum exclusively from the taxpayer.

After rejecting (at p. 35) the fallacy that a benefit is "enduring" if it lasts for more than one year, Lord Reid found that the lump sum payments made by the taxpayer were capital expenditures in light of the term of the lease agreements (five years to twenty years) and because the transaction took the form of a lease and sublease, rather than a simple tie arrangement such as that considered in Bolam v. Regent Oil Co. Ltd. The lease-sublease transaction gave the taxpayer better security for the performance by the service station operator of its obligations. Lord Pearce stated (at p. 46) with respect to entering into the lease transaction that "the acquisition of such an interest in land points strongly to a capital expenditure."