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Refurbishment Costs

Property Rental Business

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An individual has a property rental business that consisted of one residential property & one commercial property.  The residential let ceased in 15/16 & since then he has spent £40k refurbishing the property with a view to selling it imminently.

He wishes to claim the refurb costs as enhancement expenditure in the CGT comp.  However, most of these costs aren't capital in nature, they are repairs, decorating etc.  Is he instead able to claim these costs against the rent from the commercial let?  Or does the fact that the residential property no longer form part of his property rental business effectively mean that no tax relief is due on these repair and maintenance costs?

 

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Portia profile image
By Portia Nina Levin
13th Jul 2017 14:24

It depends who you ask.

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Replying to Portia Nina Levin:
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By Wall1690
13th Jul 2017 15:32

If I asked you what would your response be?

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Replying to fawltybasil2575:
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By Wall1690
14th Jul 2017 11:33

That's very helpful, thank you.

PPR is not an issue.

Do you have a link to the relevant tribunal case?

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Replying to fawltybasil2575:
Portia profile image
By Portia Nina Levin
14th Jul 2017 11:52

You're not going to get CGT relief for the costs, because of the notional trade test in TCGA 1992, s 39(2).

The case you're thinking of is Day (http://www.bailii.org/uk/cases/UKFTT/TC/2015/TC04343.html), where £1,200 of redecorating costs were allowed by the FTT. The FTT though (incorrectly) did not consider s 39(2), and HMRC did not appeal the point. It is only FTT at the end of the day though (did you see what I did there).

The costs are revenue in nature; they do not create an enduring asset, they merely restore the asset to its original state.

The asset was held for the property business. A property business exploits property, and the disposal of assets and the acquisition of new assets are legitimate purposes for such a business. It may need to restore assets to their former state before sale.

I do not see how you can say that the expenditure isn't for the purposes of the property business. It also isn't capital.

See a slightly wider set of views here though:
https://www.taxation.co.uk/Articles/2017/02/28/336081/readers-forum-prop...

HMRC are likely to resist either claim (or both claims) though.

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Replying to fawltybasil2575:
Portia profile image
By Portia Nina Levin
14th Jul 2017 14:42

Basil, s 39(2) is perfectly clear. It deems the asset to have always been held for the purposes of a trade, and denies a deduction under s 38 for any expenditure that would have been deductible in computing the profits of that trade (ie expenditure that is, by its nature, revenue expenditure).

My view is not that relief for the expenditure is denied under both CGT and IT. I believe it is allowable for IT; being revenue expenditure incurred for the purposes of the continuing property business.

That is what I would do with it in this case, with no white space disclosure.

Claiming (incorrect) CGT treatment and then making a white space disclosure is ridiculous. You're saying, "Look, I've done it wrong. On purpose!"

The only other case I'm aware of on a similar point is Raha.

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Replying to fawltybasil2575:
Portia profile image
By Portia Nina Levin
14th Jul 2017 15:43

I think you need to go away and read s 39(2) Basil. The IF in s 39(2) is a hypothetical IF, which is accompanied by a WERE (indicating the hypothetical case).

What it is saying is that IF it had been the case (ie we are assuming, irrespective of whether that is actually the case), that the properties WERE held for the purposes of a trade, then expenditure will not be deductible under s 38 to the extent that it would have been deductible in computing the profits of that hypothetical trade.

See CG14306:
https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg14306

We were told by the OP that (in their view) the expenditure is revenue in nature, rather than capital in nature. It doesn't magically become capital just because the property is being sold, as you suggest; it either is or it isn't.

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Replying to fawltybasil2575:
Portia profile image
By Portia Nina Levin
14th Jul 2017 16:05

There is no trade! S 39(2) deems there to have been a hypothetical trade in which the asset has been used.

You still haven't read the legislation properly.

Nor have you referred to the HMRC manual for which I provided a link.

You don't know what you're talking about.

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Portia profile image
By Portia Nina Levin
14th Jul 2017 16:31

From the Computer Time International decision 50TC628

Fox J in the High Court:
"Mr. Whiteman contended that the purpose of the concluding words of para. 5(2) was to ensure that a taxpayer would get a deduction either for capital gains tax purposes or income tax purposes, but not both. That intention would be frustrated in circumstances such as the present if the taxpayer was not entitled to the deduction now claimed, since as there were no trading receipts there would be no question of any deduction of the payment for tax purposes. I do not think that is correct. Where one is dealing with a non-trader, there may be deductions which are not available either for capital gains tax purposes or for income tax purposes.

In the circumstances, I take the view that this payment falls within the exclusion specified in para. 5(2) of Sch. 6 and is therefore not allowable as a deduction on the disposal. Accordingly, I allow the appeal"

Orr LJ at the Court of Appeal:
"The argument for the Appellants was that the expenditure in question was not disqualified under para. 5(2) because the payments were made with a view to disposal of the Appellant's interest in the properties, but the statutory assumption required to be made under para. 5(2) is that the interests were and had at all times been held or used as part of the fixed capital of the trade, the profits or gains of which were chargeable to income tax. In my judgment this involves that the Appellant's interest in the premises must be assumed to have been held or used as such fixed capital up to the time of the disposal of the premises."

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Replying to fawltybasil2575:
Portia profile image
By Portia Nina Levin
15th Jul 2017 10:31

You haven't bothered reading the Computer Time International decision either have you Basil.

The ridiculous point that you're still trying to make are addressed in the words of Orr LJ, which I have quoted above.

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Replying to fawltybasil2575:
By Ruddles
15th Jul 2017 21:08

Basil - your conclusion in your 4th paragraph is absurd. You're trying to apply the actual facts to a hypothetical scenario. The fact that the taxpayer in this case did not intend to carry on a business after incurring the expenditure is irrelevant.

The hypothesis at s39(2) is that the asset had been held at all times for the purposes of the assumed trade. Under that hypothesis, would the expenditure have been allowed as a revenue deduction? That is the only question to be addressed.

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Replying to fawltybasil2575:
By Ruddles
16th Jul 2017 16:06

But the rest of your post is founded upon the incorrect premise of your 4th paragraph, which makes the rest of your post incorrect.

Do you accept that s39(2) imposes a hypothetical trade, with the asset in question having been held at all times for the purposes of that hypothetical trade? If not, why not?

If you do, do you then accept that the question to be asked is - in that hypothetical trade, would the expenditure have been allowed as a revenue deduction? If not, why not?

If you do, do you think there are any further questions that need to be asked? If so, what are they?

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By Ruddles
16th Jul 2017 10:31

Sticking my oar in. I agree with Portia. Although the wording of s39(2) is not the best (I suggest that if it had had said, instead of "were", "had been" and instead of "would be allowable", "would have been allowable", it would have been crystal-clear that it was considering a hypothetical scenario). (Although of course "were" is more suggestive of a hypothetical case than "was".)

As it is, I - and HMRC - agree with Portia's interpretation. If the property had been held as a trading asset (it matters not a jot that it actually wasn't) and if, it being so held, the expenses would have been allowed as a revenue deduction, no s38 deduction.

The only question to be addressed is whether the expenditure would have been allowable as a revenue deduction in the hypothetical trade envisaged by s39(2).

It's not that hard, really.

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Replying to Ruddles:
Portia profile image
By Portia Nina Levin
16th Jul 2017 10:09

And to which the answer is, if the expenditure is on repairing the asset (hypothetically used in a hypothetical trade), then it is allowable as a revenue deduction (in computing the profits of a hypothetical trade).

If, on the other hand (and the OP suggests otherwise), it is expenditure on improving the asset, it is not so deductible, but is then clearly deductible under s 38 in computing the gain (or loss) on disposal.

That is the purpose of the test, per Orr LJ.

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Replying to fawltybasil2575:
By Ruddles
16th Jul 2017 16:24

I do not disagree that the first point to establish is whether or not the expenditure is allowable for income tax purposes. I agree that in this case it would probably not be - there being no trade or property business at the time.

But, you then have to decide whether or not the expenditure would have been allowable had it been held at all times for the purposes of a hypothethetical trade. You appear to have a remarkable insight into the situation, being able to decide that the expenditure would have not been allowed in that hypothetical trade.

Your opinion is that the purpose of the repair costs was the maximisation (sic) of a capital gain. So what? That is not enough to make the expenditure allowable in computing the gain. Unless the expenditure improved, or enhanced the value of, the property - which repair expenditure tends not to do - it is outside of s38.

I will make just two points re the FTT in Day. Firstly, it is very unlikely that they would have considered s39(2) and failed to mention it. Secondly, far more FTT cases are overturned by UTT than not. So your agreement with the FTT adds no weight to your argument. Enough said, I think.

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Replying to Ruddles:
Portia profile image
By Portia Nina Levin
16th Jul 2017 16:41

Any decision is only as good as the arguments advanced by the parties. No court or tribunal can be expected to find a right answer that hasn't been given to them in argument.

Incidentally, in the OP's case, there is a continuing property business, and the asset in question is being repaired before being sold. The adding to and disposing of assets used in such a business are legitimate purposes of such a business. Repairing an asset used in the business is a legitimate purpose of the business, whenever it is carried out.

To fail the wholly and exclusively test, there must be some purpose other than a business purpose involved. Nobody has made any suggestion as to what that purpose may be.

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Replying to Portia Nina Levin:
By Ruddles
16th Jul 2017 17:13

As ever, it pays to read the question properly (my bad). Nevertheless, if the property in question is no longer in use for the purposes of that business, I can see an argument that the repair expenditure is not W&E for the purposes of that business. But none of that really matters, in the context of s39(2).

In actual fact, FB has made a suggestion as to what that other purpose might be. But he's just guessing, as the OP hasn't told us what the purpose of the expenditure was.

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Replying to Ruddles:
Portia profile image
By Portia Nina Levin
16th Jul 2017 18:53

My point is that expenditure on repair of the asset is for the purposes of the business. It is not the case that the asset has left the property business. The property business is disposing of one of its assets. It is a cost of that disposal, but it is not a capital cost (unless there is improvement of the asset). Ergo it is incurred for the purposes of the business.

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Replying to Portia Nina Levin:
By Ruddles
16th Jul 2017 19:21

I take the point, but it is a separate argument really. And academic, given s39(2).

In any event, I think we're agreed that Basil has lost it on this occasion.

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Replying to fawltybasil2575:
By Ruddles
17th Jul 2017 06:19

"significantly HMRC have not appealed that decision"

Significantly, the amount of the expenditure was £1,200.

I know of very few people that would sell a property without giving it a lick of paint first. The fact that there was an imminent sale in this case tells us nothing. £40k suggests that more than a lick of paint was involved - nevertheless, we still don't know if what was done enhanced the value of the property.

If you are so certain that the decision in Day was correct, this makes s39(2) redundant - perhaps you should apply to have it struck from the statute books.

You are entitled to your opinion. Two eminent contributors, and the legislation, say that you are wrong.

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Replying to fawltybasil2575:
By Ruddles
17th Jul 2017 10:51

You really do talk bollox, Basil.

If you do not question my point that most FTT decisions are overturned at UTT, how on earth does that reinforce the sagacity of HMRC not to escalate a decision that they lost at FTT?

s38 does indeed refer to purpose (though I note that you conveniently fail to refer to the WHOLLY AND EXCLUSIVELY requirement - my emphasis). But it remains the fact that s38 needs to be read with s39 - which the FTT ostensibly failed to do. Which makes the FTT's decision even more unreliable. Whilst the expenditure may well have been incurred with a view to increasing the value (we still don't know if that is the case) if that expenditure falls within s39(2) then you're stuffed. I note that you refuse to answer the specific questions that I put to you above.

As I suggested in my earlier post, my opinion is that HMRC's decision not to escalate the issue had far more to do with the disproportionate costs of trying to secure a modicum of tax than the fear of UTT confirming the FTT's decision.

As for the purpose of the expenditure, you're still guessing - unless you've had a PM from the OP explaining exactly what works were carried out, the condition of the property etc etc.

To close this off - depending on the results of my enquiries as to the condition of the property, the effect of the repairs on its value etc, I might be minded to claim a deduction in the CGT comp, making appropriate reference to Day in the return. At the same time advising the client that this was an unreliable FTT decision only.

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Replying to fawltybasil2575:
By Ruddles
17th Jul 2017 14:38

Well, if you won't answer the specific questions addressed to you, you know where you can put your opinion. (Good to see that another eminent contributor disagrees with it.)

It's a rather strange conclusion to reach that because a particular section of the legislation wasn't mentioned in the case report, the Tribunal must have considered it. The fact that the provision in question lies between two others, which were considered, is neither here nor there.

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By mrme89
17th Jul 2017 14:19

Having now (sadly) read the references provided by Portia, I agree with Portia and Ruddles. Though I won't be elaborating because there is already 30 odd posts and I would just be repeating what has already being said.

And with respect, I think Basil would greatly benefit from reading the same references.

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By Tim Vane
17th Jul 2017 14:10

It's always good to follow a meaty technical discussion thread nestling between the inanities.

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By paulhammett
17th Jul 2017 14:19

Yes, Tim, I agree. I'm not sure I followed all the arguments but it has been an experience.
But is that really the end?

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Replying to paulhammett:
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By Wall1690
17th Jul 2017 14:26

So to sum up.

We establish if the costs are in fact revenue or capital.

The revenue costs can then be claimed as a deduction in the ongoing property rental accounts. Unless, we accept the argument that they can be treated as capital for the reasons outlined by Basil in which case we claim them in the CGT comp. Either way, all of £40K will obtain tax relief one way or the other?

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Replying to Wall1690:
By Ruddles
17th Jul 2017 14:43

I'm not 100% convinced that the expenditure, if revenue, could be deducted from the ongoing rental profits. But on the balance of probability that Portia is more likely than I am to be correct, I would say yes.

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Replying to Ruddles:
Portia profile image
By Portia Nina Levin
17th Jul 2017 16:02

I did say that (whilst I believe the view I have enunciated is correct) HMRC would probably resist the claim from profits.

However, where the expenditure is clearly revenue, failing the test of s 39(2), then I'd consider a claim against CGT incorrect, and destined for certain failure if challenged.

Obviously, nothing is black and white, and there may be costs that one might ordinarily argue to be revenue, but one would argue to be capital in this instance.

I think we're all agreed on that point.

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Replying to Portia Nina Levin:
By Ruddles
17th Jul 2017 16:28

Portia Nina Levin wrote:
However, where the expenditure is clearly revenue, failing the test of s 39(2), then I'd consider a claim against CGT incorrect, and destined for certain failure if challenged.

Unless you were up against a (or is it an) FTT that were unaware of the existence of s39(2) ;¬)

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Replying to Ruddles:
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By Duncan Cameron
17th Jul 2017 18:04

This presupposes that HMRC do not raise the point in their statement of case, skeleton argument or orally at the hearing.

More generally, for what's it worth, I think that you and Portia are correct and that the other point of view is fawlty.

If (a very big if) things had been organised differently, viz the vendors did not spend the £40K and instead managed to sell for £40K less than they otherwise will with the vendors spending the £40k. Then the vendors will have had, de facto, the relief sought, saved a bit on estate agents' commission. The purchasers would have a SDLT saving, get the decor they want and might possibly get an income tax deduction on the £40K. Even if Law Shipping applied the vendors would still have the first two advantages.

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Replying to Ruddles:
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By Duncan Cameron
17th Jul 2017 18:06

deleted duplicate post

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By bassanclan
18th Jul 2017 15:03

I wonder how the OP would treat the expenditure if the property doesn't sell and has to be rented out again? Will the property still be sold if the market crashes? Surely the decision to close this "part of the business" is not made until there is a signature on the dotted line.

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By Justin Bryant
18th Jul 2017 15:59

I agree the Day case is decided wrongly per the Taxation Magazine article, although there is potentially an escape route per the follow-up comment in the link below:

https://www.taxation.co.uk/Articles/2017/03/07/336118/feedback

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Replying to Justin Bryant:
By Ruddles
18th Jul 2017 16:31

Whilst it is heartening (I think) to learn that you agree with me (and Portia - heavens above) I'm not sure that the follow-up comment adds much, given the identity of the author.

Subjective though it may be, capital is capital and revenue is revenue. To suggest that expenditure that is (and is agreed to be) revenue in nature should be capitalised in the accounts in order to fit with tax rules is just wrong. I suspect that the courts would take the view that the allowability or not of expenditure, per s39, is based on the presumption that accounts are drawn up correctly. In any event, revenue expenditure that has been capitalised is still allowable as a deduction in computing taxable profits, though not necessarily all at once.

And why should repairs expenditure "inevitably" increase the value of the property? It might well do, compared to the current value of the dilapidated property. But if the repairs are simply restoring the property to its former glory, with a value commensurate with that had the property been properly maintained throughout, there is no enhancement, as required by s38.

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Replying to Ruddles:
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By Justin Bryant
19th Jul 2017 11:38

You enhancement point is clearly wrong and accounting treatment is taken into account re capital/revenue case law (HMRC certainly make a big deal of it in my experience) and I did not say it was a slam dunk (as we all know it's a grey area).

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Replying to Justin Bryant:
Portia profile image
By Portia Nina Levin
19th Jul 2017 12:04

Are you suggesting that the accounts would show something that has been sold on the balance sheet Justin?

I agree with you that not claiming the expenditure as revenue in the accounts would probably scupper any chances of getting relief for the expenditure against profits,

I think deducting the expenditure from profits though does not necessarily prevent a successful argument that some/all of it is capital.

The only question that then remains is how pre-disposed one feels to shooting one's self in the foot. IMO.

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Replying to Justin Bryant:
By Ruddles
19th Jul 2017 12:02

You clearly don't understand the meaning of 'enhancement' in the context of revenue vs capital.

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Portia profile image
By Portia Nina Levin
18th Jul 2017 17:24

Well, it looks like my first post was bang on!

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