CAPITAL ALLOWANCES - 21.10.2020

Capital or revenue expenditure - the tribunal decides

The First-tier Tribunal (FTT) recently ruled on a case involving one of HMRC’s favourite battlegrounds; whether an expense was capital or revenue. What was the outcome and why might it be significant for your business?

Tax case

Steadfast Manufacturing & Storage Ltd (S) leased a factory and yard. The yard was used to unload lorries, provide trailer storage and space for maintaining vehicles. The area was last resurfaced before S occupied the property. S spent £74,000 on resurfacing without increasing the size or load-bearing capacity of the yard. S claimed the cost as a revenue expense but HMRC argued that the work was capital expenditure, essentially an improvement to the property.

What was at stake?

If it was revenue expenditure it would be deductible for tax purposes for the financial period in which it was incurred. In contrast, tax relief for capital expenditure (capital allowances (CAs)) can take decades or, as in S’s case, there may be no tax relief until the property is sold, if at all.

Trap. Not all capital expenditure qualifies for CAs. Even where they are available, tax relief as a repair may be effective sooner. More importantly, there will be no tax liability if you sell the property for no more than it cost you.

For detailed commentary on assets which qualify for CAs, visit http://www.tips-and-advice-tax.co.uk , Download Zone, year 21, issue 02

The arguments

HMRC had three arguments based on its interpretation of the law: (1) the size and importance of the yard to the site meant resurfacing was capital expenditure; (2) there was an “enduring advantage” to S because it would not need to patch the surface again for 20 years; (3) it amounted to an improvement, changing the yard’s character and improving functionality due to use of more modern materials.

The decision

The First-tier Tribunal (FTT) didn’t agree that there was an increase in the useable area or capacity. It cited comments from an HMRC officer who said that on the balance of probabilities the new surface did no “more than the previous surface did, except so far as it may not require repairs as often” . This was not enough to swing the case for S. However, the subsurface hadn’t been replaced, so the original asset (the yard) still existed. The expenditure hadn’t brought something new into existence, it renovated something already there. Plus, as the yard was only a small part of the site, the cost of repairing it was minor compared with the cost of renovating the whole site. The FTT said the expenditure would only be capital if something new and enduring was created. It was therefore revenue expenditure.

Be warned

In this case S succeeded, but the line between capital and revenue expenditure is a fine one especially if the expenditure has an enduring benefit to your business. Keep these factors mentioned in this case in mind when considering a “repair”. For example, can you prove there’s a larger asset of which this asset forms only a smaller part?

Tip. Take before and after photographs of repair work to help show that at least part of the original asset remains.

The FTT decided in favour of the company. While the expense was large it was for a repair of an existing asset and not the creation of a new one. It restored the asset to its former state but used modern materials. As revenue expenditure, tax relief is given in the financial period in which it’s incurred rather than potentially being spread over decades.

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