Mind The Surface!

• Review all repairs to property, especially work to property surfaces, for tax efficiency 

A recent case (G Pratt and Sons v HMRC (TC 1269)) has questioned whether expenses which are of replacement or re-surfacing are revenue or capital in nature. It is fair to say that the question as to whether expenditure is of a revenue (and therefore generally an allowable business expense) or capital nature is one of the longest running arguments in the UK tax system.

It is therefore no surprise that the question of repair has recently been tested at tax tribunal level once again. The case (Cairnsmill Caravan Park v HMRC TC02580) concerned the replacement of the grass surface of a caravan park with a hard-core surface. It was agreed by the First-tier tribunal (FTT) that the cost of the hard-core surface was correctly treated as revenue expenditure. The points from the decision by the FTT are set out as follows with commentary:

The Tribunal looked at the size of work compared to the size of the entirety.

[19] “The first aspect to be determined is identifying the entirety of the subject which has been repaired. In our view the entirety is the whole caravan park.”

[21] “On that view the area of the park which has been resurfaced is only a very small part of the entirety. It extends to three acres out of a total area of 51 acres.”

It was considered that the area repaired was a very small part of the whole of the caravan park.

A further point considered was durability. Does the resurfacing work make the new surface more or less durable? More durable indicates improvements, but this could not be proved.

[23] “In the correspondence between HMRC and the taxpayers’ accountants the former suggested that the hard-core surface is more durable than grass and consequently and quite simply is thus an improvement. That inference may have a superficial attraction. However, as the evidence emerged, other considerations arose. Durability seems questionable as the original grass surface had been in existence for about 50 years…Maintenance costs of the new hard-core surface are, if anything, marginally higher. The hard-core has less aesthetic appeal: it is like any hard-surfaced car park. It is not suitable as a recreational area for children. Securing a typical camping awning on a hard surface is problematical inasmuch as fixing pins cannot easily be located. This, in fact, has generated customer complaints.”

It is interesting to note that the FTT considered that the hard-core surface was in fact “less durable than grass”. Evidence showed the original surface as more durable. This highlights the importance of really understanding what work has been undertaken to be able to produce evidence of what the work was. What the values are before and after the work is also important. Producing evidence in any such debate with HMRC is essential – reasoning as to why a particular accounting and tax treatment should be adopted must be supported by evidence.

The professional work on identifying what is a repair and what is improvement should ideally be carried out in advance of the work so that full and robust evidence can be obtained.

The Tribunal looked at enhancement and improvement. The FTT decision as to how to measure the value of the work before and after the work is carried out is worthy of further review.

[24] “We do not consider that that part of the Park, ie the area allocated to touring caravans, has been enhanced or improved as a result. Also in the broader context of the Park as an entirety we do not consider that it gives rise to an improvement. In the valuations produced before and after the works were undertaken, there is no suggestion of an improvement or resulting enhanced value.”

The property owner and adviser must understand the need to consider the ability to measure the enhanced value and improvement element. The aim should be to produce evidence to quantify the lack of improvement and lack of enhanced value where the expenditure is considered to be revenue and not capital in nature.

The FTT decision was that the re-surfacing was a repair, and qualified for income tax relief.

[26] “For all these reasons we consider that the expenditure of £89,210 on re-surfacing with hard-core is a revenue expense, deductible for tax purposes. The Appeal is accordingly allowed.”

This decision could have a lot of impact - not just on caravan parks, but on all property repairs and on properties which have a variety of surfaces which need an ongoing repair programme.

It is enlightening to note the FTT considered that the evidence showed that maintenance costs of the new hard-core surface are higher to maintain than the previous grass surface. It might be questionable as to why this particular caravan park put down the hard-core as it is generally considered it did not look as good and it was difficult to secure camping awnings and it did not increase the value. However, the Cairnsmill Caravan Park did put down a hard standing and the expenditure on the re-surfacing with hard-core was allowed for tax purposes as a revenue expense.

The trap for property owners is that following the positive results in the cases of Prattand Cairnsmill, there will be an over-simplification of the view that any re-surfacing work will automatically achieve the tax advantages of being treated as a repair. There could be a ‘trap’ of not obtaining sufficient understanding, detail and evidence of the work undertaken to the surface. This will extend to any work to property which is capable of being interpreted as either ‘capital’ or ‘revenue’. The review of expenditure is something that should not be undertaken lightly.

The timing is key with regard to when the expenditure is carried out and the impact on property profit or loss. Consideration must be given to the tax position before or after the end of the property tax year. This should also be part of the whole tax planning exercise for the property owner in terms of total income (for example, where there is a 45% tax rate applied in a tax year).

The tax tip has to be to review all property repairs and improvements (e.g. re-surfacing).  The case of Pratt is a clear example of being able to establish the tax efficiency of repair costs. It is considered by many that rental income has improved, so there is cashflow to try and repair surfaces, and to make sure the surfaces comply with health and safety, etc. The tax efficiency of such work does need to be considered and planned in advance. Recent appalling weather is currently resulting in property repairs. Re-surfacing must be planned in the years ahead and maximising the tax relief will help with funding. Where a taxpayer has a property portfolio which pushes taxable income above £100,000 (so there is a loss of personal allowances), there is extra incentive to ensure that the timing of the work is carried out.