The distinction between capital and income is one of the most fundamental issues in the tax code, but it can be extremely complex to interpret in practice. A recent dispute in Wensley Stock v Neal [2026] EWHC 1823 (Ch) is a good example of how nuanced the issue can be. This is especially so in cases involving trusts, where the question turns on the characterisation of receipts related to contractual rights and the exploitation of intellectual property. It is also a reminder of the extent to which tax disputes involve detailed engagement with general law.

The parties agreed that the royalties were, fundamentally, “income” subject to income tax, but this was not the end of the matter. A trust’s “accumulated or discretionary income” is subject to tax at the “special” trust rate (45%) under sections 479 and 480 of the Income Tax Act 2007. The meaning of “income” in this context is taken to refer to the character of funds received by the trustees as a matter of trust law, which, in turn, raises difficult issues of interpreting a trust deed and relevant legal authorities.

Background

The Reverend Wilbert Awdry first published Thomas the Tank Engine in 1946. It was the start of a much-loved series of children’s books featuring the eponymous character and friends, which he continued to publish over almost four decades. The works themselves remain popular and have spawned spin-offs, including television adaptations and merchandise.

A settlement was created by the Reverend Awdry for the benefit of his grandchildren as an accumulation and maintenance trust. Some years earlier, the Reverend Awdry had entered into a deed of assignment that transferred all copyrights to his publishers in exchange for a stream of royalties covering the same term. He now (equitably) assigned half of the royalties as the trust property.

Until the beneficiaries came of age, the trust deed conferred on the trustees a discretion to apply the “income” from the beneficiaries’ share of the trust property for their maintenance, education, or benefit. Any unapplied income could be invested and the “income thereof” added to the trust fund. The beneficiaries became entitled to the income at the age of 21 and absolutely entitled to the capital of their share in the trust fund at the age of 45.

The dispute

The trustees were concerned about whether the royalty payments should be classified as income or capital for trust law purposes, which would affect their ability to distribute it. They brought a Part 8 claim in the High Court with an independent third party and HMRC acting as defendants, given the tax implications that would follow if the funds were found to be “income”.

Mr Justice Richards observed that the dispute raised two distinct issues:

1. The “true construction” of the settlement, which involved “an objective determination of Reverend Awdry’s intention from a combination of the words used in the Settlement and surrounding circumstances”.
2. Given that subjective intention would not necessarily be determinative, it was also necessary to establish whether any relevant trust law principles should displace this construction.

The court noted that the wording of the settlement “read in any straightforward manner” was clear. The trust deed made a distinction between the royalties and the income generated from the investment of the royalties. The royalties themselves and the contractual right to receive the royalties seemed to be treated as the settlement’s capital, while the investment income alone was treated as income.

This appeared to be supported by what could be deduced about the Reverend Awdry’s intentions and the effective administration of the trust in practice. For example, treating the royalties as income would reduce the importance of the “watershed moment” when the beneficiaries turn 45 and become entitled to the capital. The beneficiaries, if the amounts were income, would already have been entitled to receive the royalties since the age of 21.

Accordingly, the royalties should be considered capital unless some other rule required a different interpretation.

The trust law authorities

The focus therefore turned to whether any principle of trust law could displace this analysis. The parties identified several possible arguments.

One of these was a line of cases concerning the royalties payable under mining licenses, which have historically been considered capital rather than income. These cases seemed to draw a distinction between the characterisation of royalties depending on whether they were generated by the settlor’s own exploitation of an asset, in which case they would be income, and other cases in which they would be capital. This authority had been applied to royalties payable in relation to the publication of written works in the Scottish case of Davidson’s Trustees v Ogilvie (1910) SC 294.

Mr Justice Richards rejected the argument that these authorities were helpful since he considered that they were “concerned [only] with seeking to divine the intention of a testator/settlor in circumstances where that intention was otherwise unclear”. This was not the case here and did not establish any rule in trust law about whether or not royalties should be considered as capital.

The court turned to a line of “income stream cases” which derive from the ambiguous decision in Crawley v Crawley (1833) 7 Sim 426. Crawley had been variously interpreted in a complex line of authorities as requiring that any income element must be “the fruit of some other capital asset” and, specifically, a capital asset within the settlement. The court assessed the different arguments and reasoned that the best argument would be that the royalties are “most naturally analysed as ‘fruit’ of the [Thomas the Tank Engine] copyrights”. The copyrights were not within the settlement, and, on that basis, it would point towards the royalties themselves being the capital within the settlement, and not income.

Finally, the court considered the case of PL Travers Will Trust v HMRC [2014] SFTD 265, which concerned the tax treatment of royalty payments under the will of PL Travers, author of the Mary Poppins series. This had found that part of the receipts from the author’s copyrights had been income but only in relation to a specific period in which the trustees had been responsible for the exploitation of the copyright. This was not the case here.

Conclusion

The court determined that the royalties constituted capital for trust law purposes, which is perhaps unsurprising given the interpretation of the trust deed. The case nonetheless emphasises the potential complexity that even this most apparently simple concept can have in practice.