Repairs upheld against capital challenge
Works carried out to a site yard were a tax-deductible revenue cost and not, as HMRC claimed, a capital cost that improved a fixed asset for which no capital allowances were available.
Steadfast Manufacturing and Storage Limited (Steadfast) leased a factory and yard. Before and after the works in question were carried out, the whole of the yard was used to unload articulated lorries, move those lorries, and provide trailer storage.
Before the works were undertaken, the yard’s surface was in poor condition. Certain areas had become unstable and were unsuitable for use by forklift trucks, although they were used when necessary to turn the trailers for articulated lorries.
The works carried out
The yard had previously been repaired twice a year by patching with gravel. However, as this patching became less effective it gave rise to health and safety concerns and the taxpayer concluded that the yard should be resurfaced.
The works were undertaken as a single project. The scope of the works included removing the surface area of the yard, levelling the sub-surface to accommodate run-off for top water and infill, and resurfacing with reinforced concrete. A drainage channel was also added between the factory and the resurfaced area.
The cost of the works was approximately £74,000. The cost to replace the entire site would have been approximately £6.5m.
HMRC disallowed expenditure
HMRC disallowed the amounts spend on the yard as a deduction as it considered the expenses to be capital in nature. It amended the company’s corporation tax assessment, increasing it by £13,428.20.
Steadfast appealed against the closure notice [TC07770].
The FTT had to decide whether the expenditure amounted to a replacement of the yard, (a non-deductible capital expense), or a repair (a deductible revenue expense).
HMRC put forward several arguments as to why the expenditure should be considered to be capital, including:
- The size and importance of the yard to the site meant that, although the works only related to part of the whole asset, they could be regarded as being of sufficient scale and importance to be capital.
- Steadfast gained an enduring advantage because there would be no need for further repairs for potentially 20 years; Steadfast could have continued to repair the yard with gravel as it had done in the past.
- The extent and permanence of the works completed were such that they preserved part of the fixed capital of the business.
- In the alternative, the works amounted to an improvement of the yard.
Reduced need for repairs
As to HMRC’s argument that the works were capital in nature, because there would be no need for further repairs for potentially 20 years. The FTT noted that a reduced need for repairs does not of itself make expenditure capital. In this case, the reduction in need for repairs was an inevitable result of repairing the yard completely, rather than in patches.
In order for the work to be capital, a reduced need for repairs would have to result from bringing something new into existence that had an enduring benefit to the business, which was not the case for Steadfast’s yard.
The FTT agreed with the taxpayer that there had not been a renewal or reinstatement of the entirety of the yard as the sub-surface had not been replaced.
The FTT also found that there had been no improvement in the yard compared to its original condition, and that the works only returned the yard to its previous standard. There had been no increase in the size of the useable area and no increase in loadbearing capacity of the yard.
The additional drainage channel had been a minor addition to the works, with no evidence that it made a substantial difference to the yard or the factory.
The appeal was allowed.
It is best left to HMRC’s Business Income Manual to summarise what happened in this case: “What is and what is not capital expenditure has taxed the minds of judges, tax advisors, revenue officials, business people and others for more than two centuries. No one has produced a single simple test that will determine the issue in all circumstances.”
Indeed, HMRC’s arguments in this particular appeal fell short, with the works deemed to be revenue in nature and so it was an allowable expenditure.