One of the terms used regularly in relation to property tax is ‘capital vs revenue’. The distinction is important because revenue costs generally qualify for tax relief when working out your taxable profit each year.
On the other hand, additions or improvements to the property – capital expenses – don’t get tax relief until the property is sold, when they’re deducted from the cost in working out Capital Gains Tax.
So how do you distinguish between the two? Will something like a kitchen refit get tax relief? Well, it depends. If there is an element of ‘improvement’, the expense is capital. If you’re simply modernising or repairing the kitchen, the expense is revenue.
The main tax cases in this area both involved factories:
Bullcraft Main Collieries Ltd and Samuel Jones & Co were two separate businesses. Both had factories with chimneys which were in such bad condition that each had to be demolished and replaced with a new one. In both cases, a new chimney was built while the old chimney was still in use, as the factories needed to keep operating.
In the Samuel Jones case, the cost was allowed as a repair. The chimney was an integral part of the factory building, the replacement stood in the same location and more or less the same format. Therefore, it was deemed that replacing the chimney was a repair to the building as a whole.
In the Bullcraft case, the chimney stood apart from a colliery but was connected by underground pipes. The new chimney was slightly taller and 50% wider than the old chimney. It was held that the replacement chimney was a new asset in itself, rather than a repair to the old chimney, and therefore no tax relief against income was due on the expense.
Therefore, in working out whether an expense is capital or revenue, it is necessary to consider whether the entire asset (capital) or a part of the asset (revenue) is being replaced.
Repairs can often be substantial and will still be allowed as a revenue expense. An example might be the replacement of a roof on a rental property, where the entire asset is the building, and the roof is a part of the building rather than an asset in itself. Even though this might cost many thousands of pounds, it’s still a repair, and tax relief is given against rental income. HMRC also accept that replacing old items with the modern equivalent is not an improvement, but a repair, and therefore an allowable expense. The example they give is replacing single glazed windows with double.
So back to the kitchen refit. Using the logic of the Samuel Jones and Bullcroft cases, the kitchen is obviously part of the house and not the entire thing. So even if the whole kitchen is replaced, the expense is tax deductible. However, if the work extends beyond replacement so that the kitchen is actually being improved – for example, it could be made bigger, or appliances installed which weren’t previously there – then it’s no longer simply a replacement or repair. The improvement counts as a capital expense and the cost will be deducted from the sale price when the house is eventually sold, rather than saving you tax in the year the work is carried out.
And where, as is often the case, there’s a mix of the two, then the revenue portion is allowable, and the capital portion isn’t.
Simple, isn’t it?