Return of capital (ROC) refers to payments back to “capital owners” (shareholders, partners, unit-holders) that exceed the growth (net income/taxable income) of a business. Investment involves the laying down of capital, which will be used to generate more income as it is being used up. Also, any investment, no matter, how well it is maintained, has a life span and is bound to come to the end of its life cycle (i.e. a wasting asset). It therefore behoves on a prudent investor to set aside a particular percentage of the regular income generated by the investment in order to recoup the initial capital outlay. It is the setting aside of part of the investor’s regular income over the period of investment that is referred to as the return of capital.
The return of capital, otherwise known as sinking fund or accumulative rate, is being viewed by any prudent and wise investor setting it aside as the scientific doctrine of “Energy cannot be destroyed but changed or transformed”. For example, leasehold interest is a wasting asset. Leasehold interest, by its nature, is for a definite period of time after which the lessee surrenders, i.e. relinquish possession or control over the property and the property thus revert back to the lessor. At the beginning of the leasehold, the lessee must have given out a lump sum for its acquisition. The property is being used as a tool in trading, hence it is depreciating as time goes on i.e. his leasehold investment is steadily sinking (or diminishing or reducing or dropping) from its full amount at the date of acquisition, right down to zero, when the last yearly equivalent would have been expended.
Sinking fund is the monetary measure through which the investor can recover his capital at the end of his leasehold term/period thereby ensuring the re-accumulation of the initial capital sum invested in the acquisition of the property. One way for the investor to achieve this, is by setting aside and re-invest every year at compound interest, a certain portion of his profit rent. This will bring about the steady re-accumulation of the invested capital, increasing the term of the leasehold interest becomes dwindle and dwindle until the end of the investment life cycle. The major reason for establishing sinking fund is to ensure that the investment sustaining itself in order to have an unending life cycle.
Reference
Ifediora, G.S.A. (1993): Appraisal Framework. Enugu, Nigeria: Iwuba Ifediora & Associates.
Return of capital. (n.d.). Wikipedia. Retrieved June 01, 2011, from Answers.com Web site: http://www.answers.com/topic/return-of-capital-1
