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A farming partnership for whom I act, recently constructed two new farm buildings. These were constructed alongside two existing buildings which were in a very dilapidated condition.
The partners considered that it would be less expensive to construct new buildings rather than repair the existing ones. They also had the benefit of being able to use the old buildings until such time as the new ones were ready for occupation.
A farming partnership for whom I act, recently constructed two new farm buildings. These were constructed alongside two existing buildings which were in a very dilapidated condition.
The partners considered that it would be less expensive to construct new buildings rather than repair the existing ones. They also had the benefit of being able to use the old buildings until such time as the new ones were ready for occupation.
I claimed 95% of the cost of the new buildings as repairs and agricultural building allowances on the remaining 5% — there being some element of improvement.
The Inspector is contesting this apportionment on the grounds that the expenditure is mainly of a capital nature, because brand new buildings are concerned.
Against this, I have pointed out to him that the total accommodation is the same now that the old buildings have been demolished, but this argument does not appear to influence his opinion.
I wonder what other Taxation readers would do?
(Query T16,589) — Fairfax.
Reply by Belgravia
It may be that Fairfax has been visited by the ghost of Extra-statutory Concession B4. This obsolete concession permitted a deduction (for Schedule A purposes) for capital expenditure which saved the estimated cost of repair that would otherwise have been required. It was abolished for the tax year 2001-02 onwards. There is no other obvious explanation for the suggestion that the expenditure on the farm buildings in this enquiry is other than capital expenditure and not a repair.
Though not a tax case, Lurcott v Wakeley [1911] AER 41 still provides the most succinct summary of the boundary of what could constitute as a repair. Lord Justice Buckley said (page 49):
'Repair is a restoration by renewal or replacement of subordinate parts of the whole. Renewal as distinguished from repair is reconstruction of the entirety, meaning by the entirety not necessarily, but substantially, the whole of the subject-matter under discussion.'
The doctrine of what constitutes the entirety was taken into tax case law in the two famous cases, Samuel Jones & Co (Devondale) Ltd v CIR [1951] 32 TC 513 and O'Grady v Bullcroft Main Collieries Ltd [1932] 17 TC 93.
In the former case, the cost of replacing a factory chimney with a new chimney (with no significant improvement) was allowed as a repair, whereas in the latter case another chimney was replaced by another on a different site (with an element of improvement) and this was held to be capital expenditure.
The distinguishing feature being that in the former case the chimney was part of a larger entirety (a factory) whereas in the latter case the chimney was the entirety. The emphasis on the lack of improvement element may be less relevant today in view of the Inland Revenue's admission that certain improvements necessitated by technological advances or building regulations might be ignored (see the Inland Revenue's Tax Bulletin, June 2002 regarding double glazing).
There is nothing in the facts presented by Fairfax that suggests that the farm buildings are part of a larger entirety. Certain specialised farm buildings that perform a function as part of a process might — just — have this quality (for example, buildings for battery hen egg production often have to be constructed in a particular way to meet the requirements of equipment within and outside the building). Even if, on a true and fair view for accounting purposes (with FA 1998, s 42 in mind), the expenditure is accounted as a repair, this cannot over-ride the entirety principle. — Belgravia.
Reply by JdeS
Case law suggests that there may be two problems here, first, there is an admitted element of improvement, and, second, that the form of replacement opted for took the form of new construction rather than refurbishment with modern materials.
With regard to the former, it was held in Thomas Wilson (Keithley) Ltd v Emmerson [1960] 39 TC 360, that the retained engineers' solution to a dangerous premises problem, increasing the head height of the top floor and its cubic content by a third, constituted an improvement rather than a repair, even though there had been no change in the floor area.
This has to be contrasted with Conn v Robins Bros Ltd [1966] 43 TC 266, in which the renovation of the interior of an old building with modern materials was held to constitute a repair.
On the second issue, reference may be made to Curtin v 'M' & Co Ltd [1960] IR 97, where the demolition of all but two outside walls of a three-storey building and its replacement by a modern two-storey one, fell to be looked at as a whole and hence had to be regarded wholly as capital expenditure, even though there was a substantial repair element which the judge at first instance had been minded to accept as revenue expenditure.
The fact that the new buildings were, in Fairfax's case, alongside the old, rather than on the same site, would serve to emphasise the capital nature of the expenditure under both heads.
However, assuming Fairfax has drawn up the accounts in accordance with generally accepted accounting practice (GAAP), the question does then arise as to whether, under FA 1998, s 42(1), case law should prevail?
This is the normally accepted view, as expressed by Lord Justice Peter Gibson and Lord Justice Carnwath in Barclays Mercantile Business Finance Ltd v Mawson [2003] STC 66. But Lady Justice Arden's dissenting judgment in CIR v John Lewis Properties plc [2003] STC 117 may be interpreted as offering some support to the contrary view. — JdeS.
Reply by Edmund.
Is the expenditure of a capital or revenue nature? The general rule is that expenditure on additions, alterations, expansions and improvements are capital, but the cost of repairs (i.e. the restoration of a building to its original condition) is allowable. This is modified so that the cost of abnormal repairs to a building when originally purchased (and likely to be reflected in the purchase price) in order to put it into condition so that it can be used for the purpose of the trade, will be capital (see Law Shipping v CIR 12 TC 621).
The essential feature in this case is that the buildings have been replaced, rather than the old buildings restored, and this immediately suggests capital treatment. Relevant case law includes the two 'factory chimney' cases which illustrate the importance of the concept of whether the 'entirety' of the asset is being replaced, or whether the replacement is of only a part of the 'entirety' so that it may be argued that the expenditure is a repair when seen in the context of a greater 'entire asset'. Both cases involved replacement of factory chimneys which had become old and dangerous.
The first, O'Grady v Bullcroft Main Collieries Ltd [1932] 17 TC 93, found that the expense was capital as the chimney being replaced was the 'entirety' and was not part of a larger asset. The new chimney was also slightly taller and considerably wider than the old one. Whilst this is also indicative of capital improvement, no allowance was made for the 'repair element' as it was found that the whole was a replacement of the 'entirety' of the asset. The second case, Samuel Jones & Co (Devondale) Ltd v CIR [1951] 32 TC 513 concluded that the expenditure was an allowable repair, because the chimney was only a part of the factory which was considered to be the whole asset.
Fairfax may recall a recent Revenue statement that the cost of replacing single-glazed windows by modern double-glazed equivalents will be allowed as a repair, on the basis that this is often the most economical solution. However, the 'entirety' in these cases will be the building as a whole and a replacement of a window will be seen as a repair to the building as a whole.
Unless the buildings being replaced are part of a larger asset, then it is difficult to see any merit in Fairfax's argument that the expenditure is revenue in nature.
Having considered the nature of the expenditure, it is worth recalling that the starting point for the tax computation is the profit shown by the accounts. Following FA1998, s 42, accounts are required to be prepared in accordance with generally accepted accounting practice. This applies for all accounts prepared for Schedule D, Case I and Case II and, by extension, for Schedule A purposes.
The Revenue in a series of tax bulletins, culminating in Tax Bulletin 53 (June 2001), and in paragraph BIM42215 of its Business Income Manual, has given it's views where revenue expenditure has been deferred by being posted to the balance sheet, for example as a fixed asset, or as a prepayment. The conclusion is that the expenditure is only allowable for tax as it is debited through the profit and loss account. For example, this may occur when the expenditure is amortised or depreciated. This is a logical extension to the rule established in a series of recent cases (e.g. Gallaher v Jones [1993] 66 TC 77, Johnson v Britannia Airways Ltd [1994] 67 TC 90 and Herbert Smith v Honour [1999] 72 TC 130) that accounting practice is paramount in establishing taxable profits.
We are not told how the expenditure has been accounted for in Fairfax's case, but unless it has been debited to the profit and loss account in the proportion claimed, it cannot be allowable as repairs in the tax computation. If the expenditure is of a revenue nature, but has been capitalised, only the depreciation element can properly be claimed.
In conclusion, it seems doubtful that any of the expenditure is allowable as repairs. Fairfax is advised to analyse the expenditure carefully to maximise any part which may be qualify for plant and machinery allowances, and accept that agricultural buildings allowances apply for the remainder.
