Renewals Expenditure: Alive And Kicking?

Lee Sharpe considers whether the cost of replacing freestanding items such as fridges or washing machines, which used to be claimed as a ‘renewal’, is still allowable. 

The following article comes with a health warning: it is precisely at odds with HMRC guidance. 

Regular readers will know that we have previously distinguished between HMRC’s guidance, and what the law actually says. They are not always the same thing. Sometimes it is helpful to the taxpayer simply to go along with the guidance, when it suits. Then again, there are times when you just have to put your foot down.  

It is a very old tax treatment that has largely fallen into disuse since the advent of capital allowances, and in particular the generous first year or annual investment allowances for eligible fixed assets, except perhaps in one specific area, namely part furnished residential properties.

The legislation forbids a capital allowances claim on fixed assets used in a dwelling. In a commercial building, desks, tables, central heating and many other items are generally eligible for tax relief through capital allowances, but not so in a dwelling (ignoring the special regime for furnished holiday lettings). 

However, HMRC recognises that there is nevertheless significant expenditure in residential properties on assets such as furniture, kitchen equipment and the like. 

For fully furnished properties (broadly those where a tenant does not have to supply his own furniture in order to live comfortably in the property), the wear and tear allowance provides a useful alternative. It is 10% of the rental income – after deducting any costs that are normally borne by the tenant. It is fairly generous and simple to operate, and quite popular. It is meant to cover the cost of mending or replacing furniture, white goods and similar. 

Part-furnished properties are ineligible for wear and tear allowance. The cost of maintaining or repairing an asset is pretty much always allowable. But the cost of replacing an asset outright is a capital expense and not generally given as a deduction from rental profits, except under certain circumstances.

The renewals basis allowed the landlord to deduct the cost of replacing an asset on a ‘like for like’ basis. The cost of acquiring the first washing machine was not deductible, but the cost of replacing it was. If you bought a much better washing machine, then the improvement was not deductible – until you replaced the asset again, to that higher standard.

So, for landlords of only part-furnished residential properties that couldn’t claim wear and tear allowance, the renewals basis was very useful. I say was…

In December 2011, HMRC published a consultation on withdrawing several tax concessions – helpful tax treatments operated informally by HMRC to benefit taxpayers but that had no legislative force – from 2013/14. They had been around for years but in one of those glorious tax cases that suited just one taxpayer but cost everybody else, they were held to be unlawful. HMRC could ignore the issue no longer; they had to go (although some might disagree that they had no choice).

The consultation is at www.hmrc.gov.uk/budget-updates/06dec11/withdraw-tech-note.pdf‎. When ‘consulting’ on the withdrawal of the renewals basis concession, the document said:

“The Income Tax (Trading and Other Income) Act (ITTOIA) 2005 section 68… gives a renewals allowance for the replacement of trade tools…If the taxpayer’s qualifying activity is an ordinary property business or an overseas property business CAA 2001 s 35(2) denies capital allowances for qualifying expenditure incurred in providing plant or machinery for use in a dwelling-house. In such cases, relief will be available either under ITTOIA 2005 s 68… or, for furnished lettings, under the wear and tear allowance at Sections 308A to 308C ITTOIA 2005” (emphasis added).

I actually rang the HMRC officer named in the guidance, to check that s 68 had sufficient scope to cover white goods, a chaise longue, etc., and was told that if it were not, it would be changed. Fair enough, I thought. If only…

However, many colleagues were concerned that the renewals basis would not apply. To rub salt into the wound, HMRC also published new draft guidance in its Business Income manual on repairs, and the example “Refitting a Kitchen” at the draft new BIM46911 (www.hmrc.gov.uk/briefs/income-tax/draft-guidance.pdf) caused me concern, since I expected the guidance to say, “…but don’t worry, because Sophia can always claim the renewals basis for her free-standing fridge”. Alas, no.

So I contacted HMRC again, just to be sure. At which point I was advised by a brace of officers that s 68 would not cover renewing washing machines or furniture, and wasn’t really up to covering much more than small, frequently-replaced items such as the odd piece of cutlery or perhaps a teapot. 

This was not good. When I pointed out that I had previously been assured that the effect of the abolition of the concession would be negligible, they replied that they’d had no idea there were so many part-furnished properties, and interested parties had not identified a significant risk. To which ‘interested parties’ had they been speaking, I wondered?

ITTOIA 2005 s 68, as originally set out (abridged):

Replacement and alteration of trade tools

1. This section applies if—

        a. expenses are incurred on replacing or altering any tool used for the

                purposes of a trade...

2. In calculating the profits of the trade, a deduction is allowed for the expenses…

3. In this section “tool” means any implement, utensil or article…(emphasis added)

Section 272 confirms that this applies equally to property businesses. So if I can replace the word “trade” with the words “property business”, then why is a washing machine not a “tool” – or at least an article – used in a property business? Where does it say that the tools must be small, frequently replaced or of low cost? The section might be headed “tools” but the definition seems much wider (in fact, the title is a throwback to much older legislation, and it has been used to claim for far more than “tools” in the normal sense). 

If we review the advice in the 2011 consultation, it said quite clearly: 

“..for… expenditure incurred in providing plant or machinery for use in a dwelling-house… relief will be available either under ITTOIA 2005 s 68 or, for furnished lettings, under the wear and tear allowance”

Now, we might not be sure that a washing machine is a tool, or an article, but it’s clearly a machine: the clue’s in the name.

Interestingly, when HMRC updated its Business Income manual for real in December last year, “Refitting a Kitchen” did not make an appearance.

Practical Tip:

I think that the renewals basis is alive and kicking, and that it never actually went away for residential properties (or anywhere else). 

The idea that a landlord of a part-furnished dwelling can claim for repairing a fridge, but not for replacing it, seems quite ridiculous. I believe that the legislation still allows renewals claims to be made. 

But HMRC has not publicly backtracked on its earlier guidance, so any renewals claims made after the beginning of the 2013/14 tax year should be made carefully, with full and accurate disclosure, so HMRC cannot attack the treatment years down the line. However, this is a course of action which taxpayers and advisers must appreciate carries risk.