Chris Thorpe gives an overview of the capital v revenue battle lines.
When running a business and looking at which expenses to set off against turnover to calculate taxable profits, it’s important that those expenses should be revenue in nature – rather than capital. It sounds obvious but there are several grey areas where it is anything but obvious whether the subject of expenditure was revenue or capital in nature.
Repairs
An oft-encountered issue, especially with regard to property, is whether a repair is revenue (as repairs are) or whether it is an improvement (i.e., a capital expense). Generally, if a replacement is made of a part of an asset, it will be regarded as a repair and thus allowable for income tax (Samuel Jones v. CIR (1951) 32 TC 513). If, however, a replacement represents the whole (or a substantial part) of the asset, then it will be capital (Bullcroft Main Collieries v O’Grady (1932) 17 TC 93). Initial repairs to a recently-acquired asset will generally be considered as a capital outlay – in the case of a second-hand ship being bought (Law Shipping Company Ltd v. IRC (1923) 12 TC 62), before it could be made seaworthy, a significant amount was spent to make it ship-shape – i.e., it is effectively an extension of the purchase price (which will, of course, be a capital expense). In contrast, initial repairs to remedy wear and tear on an asset which is already operating will be considered revenue and thus allowable (Odeon Assoc Theatres Ltd v. Jones (1971) 48 TC 257).
It is possible that, over time, technological changes mean that an improvement is actually just bringing something up to date, in which case HMRC will accept that this is a simple ‘like-for-like’ replacement and not an improvement (HMRC manual BIM46925). The common example is that of double-glazing replacing a single-glazed window; whilst on the face of it an improvement, it is accepted these days that double-glazing is the norm and not an improvement.
Software
Another area where there might be some question mark over the revenue or capital divide is software. Generally, if a lump sum is paid for the use of software, HMRC will regard that as a capital outlay unless it has an expected economic life of less than two years. The creation of a website, for example, which HMRC considers analogous to a shop window (HMRC manual BIM35815). However, if regular payments are made (like a rental), then it will be treated as revenue expense spread over the useful life of the software. The then Inland Revenue produced their views on the matter 30 years ago in the Tax Bulletin Issue 9F (November 1993).
If it is capital?
Then capital allowances will be available for plant and machinery, writing off 18% or 6% of the cost each year over the useful life of the asset. Up to £1million of capital expenditure can be written off each year through the Annual Investment Allowance; for companies, an additional first-year allowance known as ‘full expensing’ is available for many new and unused plant and machinery (though not cars) bought between 1 April 2023 and 1 April 2026.
For other assets, the expenditure on costs and improvements can be deducted from the disposal proceeds for capital gains tax purposes.
The guiding principles
There have been umpteen cases throughout the last century trying to give clarity on this matter. HMRC manual BIM35901 tries pulling all the threads together and suggests looking at the nature of what is being bought and aspects such as: involving recurring payments (a ‘once and for all’ cost is likely to point to a capital outlay); the object and whether it gives ‘enduring benefit’; the acquisition, improvement or disposal of an asset will be capital; and if it’s a tangible asset, is it stock in trade, a fixed asset or is it a short-life tangible asset?
Practical tip
Careful analysis of a purchase of questionable status should always be made. Just because a client calls something a ‘repair’ does not mean you should automatically assume it is allowable as a revenue expense, for example. Ask for more detail wherever possible to help you decide whether it is capital or revenue.
