Granddad’s axe, like Trigger’s broom in ‘Only fools and horses’, may have had umpteen new handles and a few new heads but it remains the same implement. That underlines one of the basic principles of repair and replacement: you can replace part of an item, or indeed a building, but so long as you don’t change its nature that will usually count as a repair.
Repair or improvement?
Thinking of the broom, replacing the head with a mop would change its nature completely and count as an improvement. Where small items are concerned the distinction makes little difference but if, say a recovery truck has its car-carrying body replaced by a crane that is a significant change.
For most small or medium-sized businesses, the distinction is of little importance at present because there is a 100% annual investment allowance for expenditure up to £500,000; but that allowance is due to be reduced to £25,000 from 1 January 2016.
Replacements in buildings can also be problematic, because replacing parts of integral features such as heating, lighting, ventilation and water systems or machinery such as lifts and escalators cannot be counted as a repair if the cost of the replacement is more than 50% of what it would have cost to replace the entire feature (not the building, just the particular piece of equipment, e.g. a lift).
So if the annual investment allowance applies does that mean it doesn’t matter how you classify expenditure on repairs or replacements? Absolutely not: HMRC still expect you to put the right claim on your return and you will need to take account of all expenditure on an asset should you sell it. If you claimed a capital allowance, such as annual investment allowance, you could end up paying more tax on disposal because sale proceeds may be taxable to the extent that they exceed expenditure that hasn’t already been given a capital allowance.
But if the expenditure was counted as a repair the expenditure doesn’t affect the capital allowances you claim or any balancing charge on disposal.
Problems with improvements
The essence of a repair is that it should normally do no more than restore the asset to its full working order, but this can be difficult to assess when the materials required are no longer available or no longer meet modern standards. So if your property’s single-glazed windows need to be replaced because their wooden frames have rotted you don’t have to settle for direct like-for like replacements, but can fit standard UPVC double-glazed units instead. The basis for this is that HMRC accept that if the part being replaced was the norm, or industry standard when it was originally fitted, your replacement can be of the current standard which, in our example, would mean a normal double-glazed unit.
If you choose to upgrade to a higher standard but a repair was already needed you should be able to claim the cost of like-for-like replacement as a repair and only have to treat the additional cost as attributable to improvement.
Take care too with assets that need renovation when you buy them. If the asset, be it a building or piece of machinery, is not fit for use when you buy it, any cost of making it serviceable must be counted as an improvement. You may still be able to claim annual investment allowance instead of a repair.
Practical Tip:
Don’t forget about capital gains tax (CGT). If a cost is disallowed for income or corporation tax purposes but the asset is chargeable to CGT, remember to keep a record of that improvement expenditure as it will be deductible as part of the CGT base cost when you come to sell it.
