An important distinction must be made between two different types of expenditure; capital and revenue.
Capital expenditure can be thought of as any expenditure which significantly enhances the value of the asset in question, in this case the property. Revenue expenditure can be viewed as expenditure necessarily incurred in the day to day running of the business.
Why is the distinction important?
It is important to distinguish between the two types as they have different treatments when computing taxable profits of a business. Revenue expenditure can be deducted from income of the associated year and this in turn reduces taxable profit. Capital expenditure is deducted against the cost of the asset upon its sale.
A common question is often posed on whether repair expenditure incurred before a property is let out is capital or revenue in nature.
The test to determine the answer can be explained as ‘was the property fit to be let out before the expenditure was incurred?’ If yes, then the repairs are an allowable expenditure against rental profits and revenue in nature. A lot of tax law is derived from rulings of the courts. These are looked at below.
In one case, Odeon Cinemas claimed the cost of repairs to various cinemas they had bought up after the end of the second world war and refurbished before opening them to the public again.
Although the cinemas in question were in a poor state of repair, the Court was satisfied that they were nevertheless usable, and Odeon were simply carrying out routine maintenance which had been neglected during the war. They were also satisfied that the price Odeon paid for the cinemas was not significantly lower as a result of the condition they were in.
Another case concerned a ship which was also bought just after the end of the war. It was also in a poor state, to the extent that it was classified as not being seaworthy.
When the claim for these repairs came to court, the verdict went against the ship-owners. This was because it was clear that the ship was not fit for use and the repairs were necessary before it could be used for the owner’s trade. This meant it was a capital cost and could not thus be claimed against business profits.
Before letting your property think carefully about the expenditure and the state the property is in. Further reference can be in HMRC Property Income Manual, found here.