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10 January 2001
Same but different
I act for a private investment property company whose corporation tax return is subject to enquiry with one unresolved area remaining.
Due to deterioration and the fact that the roofs were no longer watertight, £31,000 of expenditure was incurred on several warehouse units to remove old asbestos corrugated roofing, wall cladding, guttering and fall pipes and replace with plastic coated steel cladding, new guttering and fall pipes.
I act for a private investment property company whose corporation tax return is subject to enquiry with one unresolved area remaining.
Due to deterioration and the fact that the roofs were no longer watertight, £31,000 of expenditure was incurred on several warehouse units to remove old asbestos corrugated roofing, wall cladding, guttering and fall pipes and replace with plastic coated steel cladding, new guttering and fall pipes.
Same but different
I act for a private investment property company whose corporation tax return is subject to enquiry with one unresolved area remaining.
Due to deterioration and the fact that the roofs were no longer watertight, £31,000 of expenditure was incurred on several warehouse units to remove old asbestos corrugated roofing, wall cladding, guttering and fall pipes and replace with plastic coated steel cladding, new guttering and fall pipes.
This expenditure has been claimed as repairs, but the Inspector is seeking to disallow all the expenditure on the grounds of improvement.
Readers' views would be helpful, please.
(Query T15,734) – Allowable.
This is an old chestnut, and probably one of the biggest causes of dispute between the Inland Revenue and the profession.
The legal position is set out in section 74(1), Taxes Act 1988, which refuses deductions for:
(d) any sum expended for repairs of premises occupied, or for the supply, repairs or alterations of any implements, utensils or articles employed, for the purposes of the trade, profession or vocation, beyond the sum actually expended for those purposes;
(g) any capital employed in improvements of premises occupied for the purposes of the trade, profession or vocation.
It is plain from these extracts that the costs of necessary repairs are allowable deductions, although capital improvements are disallowed, as they would be under basic accounting principles.
Unfortunately, the Inland Revenue internal guidance (see paragraph 994 of the Inspector's Manual) is slightly different:
'Significant improvement – example
'However, where a significant improvement arises from the change of materials, the whole of the cost is capital expenditure. For example, if single glazed softwood windows are replaced with double glazed PVC windows, the improvement element normally means that the entire cost is capital expenditure.'
This is the strict guidance given on the replacement of 'the entirety' of an asset (I would recommend a thorough review of the paragraph, as this makes it plain that this statement is not absolute but should be read in the context of the expenditure) and I personally find the legal basis of this statement questionable. Individual Inspectors tend to take a more rational view, however, and are generally prepared to negotiate reasonable deductions in cases where there are income and capital elements.
The Inland Revenue accepts that, on occasion, it is necessary to include an element of improvements with any repairs. An important element on this occasion is the material – asbestos. My understanding is that it is not lawful to replace an old asbestos roof with a new asbestos roof – quite apart from anything else, nobody makes them anymore. It is unlikely that 'Allowable's' client would be permitted to repair the roof, more likely they would be ordered to replace it. To quote further from paragraph 994 of the Inspector's Manual:
'Changing technology, etc.
'Problems can arise where the asset on which the work is carried out is old. A repair or replacement of a part of an 'entirety' using modern materials may give an apparent element of improvement because of the greater durability, superior qualities, etc. of the new material. The cost is normally revenue expenditure where any improvement arises only because of new materials which are broadly equivalent to the old materials.'
This does appear to be what has happened here. Yes, there is an apparent improvement. However, this is solely because of changes in the way buildings are finished.
'Allowable' should point out to the Inspector that he has merely replaced the roof with the modern equivalent. A review of local industrial estates might be in order to compare older buildings with more recently completed ones and check the type of roof fitted.
It might also be worthwhile to obtain a quote to repair the original roof, rather than replace it. This may well show that the cost of repairs exceeds the cost of replacement, which somewhat dents the Inspector's argument.
A number of similar cases have been heard by the courts over the years. Of particular relevance here is the case of Conn v Robins Bros 43 TC 266. In this instance a 400 year old slate roof was replaced by a (modern!) asbestos roof. The Commissioners, and the High Court, accepted that this was revenue expenditure. In the judgment of Mr Justice Buckley, it is made clear that when an old building is upgraded to modern standards, such expenditure is of a revenue nature.
Hopefully, 'Allowable' will be able to agree an acceptable deduction with the Inspector - even if it has to be accepted that an element of capital improvement is involved. If not, I would recommend a trip to the Commissioners and a liberal application of common sense. – Whitehall.
I fear this grey area is becoming a shade more 'all black' as far as enquiries are concerned following the New Zealand Court of Appeal decision in support of the New Zealand Inland Revenue's disallowance in the case of Auckland Gas Co Ltd v Commissioners of Inland Revenue [2000] STC 527, if 'Allowable's' (and my) experience is anything to go by. It might be worthwhile to briefly mention the facts which appear to have aroused United Kingdom Revenue Inspectors in this area.
The company solved the problem of gas leaking from metal pipes by transmitting the gas through new plastic piping (using the old metal as a conduit). A higher pressure flow coupled by solving the leaks was achieved by the most effective and cheapest method. Although the replacement of one or more components generally amount to a repair even if, with technological improvements, the replacement parts would function better and last longer than the original, Lord Nicholls decided in the Auckland case that the replacement was of a capital nature as:
* the gas distribution was not restored to its original state;
* there was a significant upgrading;
* the old pipes no longer performed the function for which they were originally laid;
* the character of the system had changed.
In essence 'Allowable' will need to consider whether there has been an improvement to the warehouse units by replacing subsidiary parts of the whole. If no significant improvement beyond the original condition has been achieved, then a repair and allowable deduction should prevail. This entirety test is one of fact, and more information or, better still, a survey would be needed to give an informed opinion but interestingly the Inspector has not supported his opinion with any case law. Perhaps 'Allowable' might be advised to study the decisions for the disallowance of a roof replacement in William P Lawrie v Commissioners of Inland Revenue 34 TC 20 and compare the various factors in O'Grady v Bullcroft Main Collieries Ltd 17 TC 93 and Samuel Jones & Co (Devondale) Ltd v Commissioners of Inland Revenue 32 TC 513 which led to (chimney) replacements being disallowed in one but allowed in the other. – Jim.
Extract from reply by 'Wentworth':
If the properties were purchased by the company immediately prior to the expenditure, there is then a strong chance that the Inland Revenue would be successful in disallowing the expenditure as the state of repair of the properties would presumably have been reflected in the purchase price, and with leaking roofs they could not be let to generate profits (see Law Shipping Co Ltd v Commissioners of Inland Revenue 12 TC 621 and Odeon Associated Theatres Ltd v Jones 48 TC 257). As the expenditure has been treated as repairs in the accounts rather than as a capital expense, the latter case may also be referred to as giving weight to the accounting treatment adopted for tax purposes.
Editorial note. A majority of readers considered that allowance as repairs was reasonable. There is a strong element of repair from the brief facts given and the use of more modern materials does not apparently indicate any significant intention to improve, but simply to update.
I act for a private investment property company whose corporation tax return is subject to enquiry with one unresolved area remaining.
Due to deterioration and the fact that the roofs were no longer watertight, £31,000 of expenditure was incurred on several warehouse units to remove old asbestos corrugated roofing, wall cladding, guttering and fall pipes and replace with plastic coated steel cladding, new guttering and fall pipes.
This expenditure has been claimed as repairs, but the Inspector is seeking to disallow all the expenditure on the grounds of improvement.
Readers' views would be helpful, please.
(Query T15,734) – Allowable.
This is an old chestnut, and probably one of the biggest causes of dispute between the Inland Revenue and the profession.
The legal position is set out in section 74(1), Taxes Act 1988, which refuses deductions for:
(d) any sum expended for repairs of premises occupied, or for the supply, repairs or alterations of any implements, utensils or articles employed, for the purposes of the trade, profession or vocation, beyond the sum actually expended for those purposes;
(g) any capital employed in improvements of premises occupied for the purposes of the trade, profession or vocation.
It is plain from these extracts that the costs of necessary repairs are allowable deductions, although capital improvements are disallowed, as they would be under basic accounting principles.
Unfortunately, the Inland Revenue internal guidance (see paragraph 994 of the Inspector's Manual) is slightly different:
'Significant improvement – example
'However, where a significant improvement arises from the change of materials, the whole of the cost is capital expenditure. For example, if single glazed softwood windows are replaced with double glazed PVC windows, the improvement element normally means that the entire cost is capital expenditure.'
This is the strict guidance given on the replacement of 'the entirety' of an asset (I would recommend a thorough review of the paragraph, as this makes it plain that this statement is not absolute but should be read in the context of the expenditure) and I personally find the legal basis of this statement questionable. Individual Inspectors tend to take a more rational view, however, and are generally prepared to negotiate reasonable deductions in cases where there are income and capital elements.
The Inland Revenue accepts that, on occasion, it is necessary to include an element of improvements with any repairs. An important element on this occasion is the material – asbestos. My understanding is that it is not lawful to replace an old asbestos roof with a new asbestos roof – quite apart from anything else, nobody makes them anymore. It is unlikely that 'Allowable's' client would be permitted to repair the roof, more likely they would be ordered to replace it. To quote further from paragraph 994 of the Inspector's Manual:
'Changing technology, etc.
'Problems can arise where the asset on which the work is carried out is old. A repair or replacement of a part of an 'entirety' using modern materials may give an apparent element of improvement because of the greater durability, superior qualities, etc. of the new material. The cost is normally revenue expenditure where any improvement arises only because of new materials which are broadly equivalent to the old materials.'
This does appear to be what has happened here. Yes, there is an apparent improvement. However, this is solely because of changes in the way buildings are finished.
'Allowable' should point out to the Inspector that he has merely replaced the roof with the modern equivalent. A review of local industrial estates might be in order to compare older buildings with more recently completed ones and check the type of roof fitted.
It might also be worthwhile to obtain a quote to repair the original roof, rather than replace it. This may well show that the cost of repairs exceeds the cost of replacement, which somewhat dents the Inspector's argument.
A number of similar cases have been heard by the courts over the years. Of particular relevance here is the case of Conn v Robins Bros 43 TC 266. In this instance a 400 year old slate roof was replaced by a (modern!) asbestos roof. The Commissioners, and the High Court, accepted that this was revenue expenditure. In the judgment of Mr Justice Buckley, it is made clear that when an old building is upgraded to modern standards, such expenditure is of a revenue nature.
Hopefully, 'Allowable' will be able to agree an acceptable deduction with the Inspector - even if it has to be accepted that an element of capital improvement is involved. If not, I would recommend a trip to the Commissioners and a liberal application of common sense. – Whitehall.
I fear this grey area is becoming a shade more 'all black' as far as enquiries are concerned following the New Zealand Court of Appeal decision in support of the New Zealand Inland Revenue's disallowance in the case of Auckland Gas Co Ltd v Commissioners of Inland Revenue [2000] STC 527, if 'Allowable's' (and my) experience is anything to go by. It might be worthwhile to briefly mention the facts which appear to have aroused United Kingdom Revenue Inspectors in this area.
The company solved the problem of gas leaking from metal pipes by transmitting the gas through new plastic piping (using the old metal as a conduit). A higher pressure flow coupled by solving the leaks was achieved by the most effective and cheapest method. Although the replacement of one or more components generally amount to a repair even if, with technological improvements, the replacement parts would function better and last longer than the original, Lord Nicholls decided in the Auckland case that the replacement was of a capital nature as:
* the gas distribution was not restored to its original state;
* there was a significant upgrading;
* the old pipes no longer performed the function for which they were originally laid;
* the character of the system had changed.
In essence 'Allowable' will need to consider whether there has been an improvement to the warehouse units by replacing subsidiary parts of the whole. If no significant improvement beyond the original condition has been achieved, then a repair and allowable deduction should prevail. This entirety test is one of fact, and more information or, better still, a survey would be needed to give an informed opinion but interestingly the Inspector has not supported his opinion with any case law. Perhaps 'Allowable' might be advised to study the decisions for the disallowance of a roof replacement in William P Lawrie v Commissioners of Inland Revenue 34 TC 20 and compare the various factors in O'Grady v Bullcroft Main Collieries Ltd 17 TC 93 and Samuel Jones & Co (Devondale) Ltd v Commissioners of Inland Revenue 32 TC 513 which led to (chimney) replacements being disallowed in one but allowed in the other. – Jim.
Extract from reply by 'Wentworth':
If the properties were purchased by the company immediately prior to the expenditure, there is then a strong chance that the Inland Revenue would be successful in disallowing the expenditure as the state of repair of the properties would presumably have been reflected in the purchase price, and with leaking roofs they could not be let to generate profits (see Law Shipping Co Ltd v Commissioners of Inland Revenue 12 TC 621 and Odeon Associated Theatres Ltd v Jones 48 TC 257). As the expenditure has been treated as repairs in the accounts rather than as a capital expense, the latter case may also be referred to as giving weight to the accounting treatment adopted for tax purposes.
Editorial note. A majority of readers considered that allowance as repairs was reasonable. There is a strong element of repair from the brief facts given and the use of more modern materials does not apparently indicate any significant intention to improve, but simply to update.
