For tax purposes, assuming that grandpa’s spade was an asset used in a trade, the cost of the new handles and blades would have been allowed as repairs, but if instead you had chucked away the old spade and bought a new one, that would have been capital expenditure on a new asset, not a repair to an existing one.
The distinction becomes important where significant sums of money are involved, because whereas repairs can be treated as an expense and deducted from the profits of the business, capital expenditure is either not deductible at all (until you sell the asset, when it may be allowed against the capital gain) or only deductible at a slower rate, such as where it attracts capital allowances at 20% of the cost per year.
This article looks at the distinction between repairs (which can be treated as an expense against the profits of the year) and capital expenditure on replacing or improving an asset. It is relevant to both trading businesses and to Buy to Let landlords.
What is a Repair?
We all know what “repair” means. Unfortunately, for tax purposes, there are some expenses that we would call “repairs” in everyday speech but which are treated as capital expenditure for tax purposes:
“The Entirety”
This is a doctrine that has grown out of a number of tax cases concerning expenditure on dilapidated assets of a trade. Essentially, what it says is that if a “repair” involves replacing the “entirety” of an asset, then that is a capital cost of acquiring a new asset, not a repair to an old one.
The leading cases on the subject both concern factory chimneys. In both cases, the old factory chimney was in such bad repair that it had to be replaced with a new one, but in one case (Bullcraft Main Collieries Ltd v O’Grady) the chimney was a separate structure, connected to the factory building by flues, whereas in the other (Samuel Jones & Co (Devondale) Ltd v CIR), it was part of the factory building itself.
In both cases, because the factory could not be left to lie idle while a new chimney was constructed, the new chimney was built and put into operation before the old one was demolished, but in the Bullcraft case, it was held that the cost was capital (because the “entirety” of the chimney was a separate structure to the factory, and it had been entirely replaced) whereas in the Samuel Jones case, the cost was allowed as a repair (because the chimney was an integral part of the factory building, and the factory was the “entirety”, not the chimney).
HMRC tend to be a little over-enthusiastic in applying the “entirety” doctrine – in a recent case I dealt with, the fascia boards on a building were replaced, and the inspector tried to disallow the cost on “entirety” grounds, on the basis that all the fascia boards were replaced – this was an absurd argument, as in this case the “entirety” was clearly the building itself, not the fascia boards attached to it, but it took some time to persuade her of this fact.
Improvements
An improvement is not a repair for tax purposes. If you had replaced the old wooden handle of grandfather’s spade with a state of the art carbon fibre one, you would no longer have the same spade, and HMRC would deny you a deduction for repairs.
The distinction between repairs and improvements is not always an easy one to make. HMRC used to argue, for example, that replacing old single glazed windows with double glazed ones was an improvement and thus a capital cost, but they had to concede eventually that this was merely using modern materials to effect a repair. Mind you, they are not averse to arguing the other way if it suits them:
The Weekend Retreat
My client (this is a real case) bought a weekend retreat in a famous seaside resort. He spent thousands of pounds on doing it up – it had not been touched since the 1950s and so he installed a state-of-the-art modern kitchen, period fireplaces (marble), and so on. The property was never let, so there was no rent against which to deduct the cost of repairs, but if there had been, I am sure HMRC would have said that these costs were capital expenditure on improvements and as such could not be deducted from the rent.
In my client’s case, however, when he came to sell the property, he claimed the costs as “improvements” to the property, which could be deducted from the capital gain on the sale – he had a “main residence” elsewhere so the sale was not exempt from CGT. HMRC then decided those costs were in fact repairs and so not deductible from capital gains. When it was pointed out that, for example, a wartime “utility” kitchen had been replaced with a steel and marble masterpiece straight out of the pages of “House and Garden”, the inspector wrote back saying “one kitchen is much like another”.
Repairs to Newly Acquired Assets
If you buy an asset to use in your trade, or a property to let as a landlord, you may decide to spend some money on refurbishing it before you bring it into use, or in the case of a buy to let, before you let it out.
There is a common misconception (particularly among buy to let landlords) that expenditure before the asset is used, or before the property is first let, is capital and not deductible as repairs.
This is not the case. Provided the expenditure passes all these tests, it can be treated as a repair:
The asset was fit for use before you spent the money
The price you paid for it was not significantly reduced because of the state it was in (a price reduction is not “significant” if, for example, a property was somewhat cheaper merely because it was in need of routine maintenance such as painting)
The expenditure was on restoring the asset to the good condition it had once been in, not on “improving” it.
“Notional Repairs”
There used to be an Extra Statutory Concession for landlords, whereby if instead of repairing a property you decided to improve it (for example, instead of repairing the old sun lounge, you tore it down and put in a new conservatory), you could not deduct the whole cost but you could deduct the notional cost of repairing the old sun lounge. Unfortunately, this was withdrawn in 2001 when the new rules for property income were introduced.
Other Deductions
Although the new spade you bought to replace grandfather’s old one was not a “repair”, you might nevertheless get a deduction for it under different legislation – as a “renewal” – but that will be the subject of an article in a future edition of Tax Insider.
