A lick of paint, a new carpet, a move to new premises? The day-to-day running of a business requires a certain amount of money to be spent. How does the taxman treat the money you spend? Put another way, how can you plan things in the most tax-efficient way?
Essentially, the law says that repairs to a shop are tax-deductible, while improvements are not. It unfortunately follows that the tax treatment of refurbishment work in retail premises is rarely straightforward, mainly because expenditure can attract any one of a number of different possible tax treatments.
The expenditure can fall into three categories, each qualifying for a different tax treatment.
It can be revenue, usually meaning in the context of retail premises that it qualifies for an immediate tax deduction; it can be capital on plant and machinery, qualifying for capital allowances; or it can be capital on improvements to the premises, not qualifying for tax relief at all. In practice, the expenditure is unlikely to fall wholly into any one of these categories, but will be a mixture comprising all three, making life a little difficult.
Although revenue expenditure normally attracts immediate tax relief, occasionally your accountant may tell you that you have incurred "deferred revenue expenditure". This means that the expenditure has been treated in the accounts as if it were capital expenditure - but despite this, tax law says that it is revenue expenditure. These days you will usually get tax deductions on this kind of expenditure as and when the asset in question is depreciated or amortised to the profit-and-loss account.
The distinction between capital and revenue expenditure is a grey area in tax law. The courts have held that expenditure is capital for taxation purposes if it provides an "enduring benefit" to the business. That is not a particularly helpful definition, though, as "enduring" does not mean forever; it can mean for as little as about two years.
Repairs and decoration are normally revenue expenditure. However, this is not always the case - a distinction needs to be drawn between repairs and improvements. Repairs are replacing what existed before; whereas improving is creating something superior. Remember that repairs are tax-deductible, while improvements are not.
Unfortunately, it is rare to replicate something exactly. Building materials change and the old item may no longer be available. Building practices change, so something different could well serve the same purpose at a much lower cost. For example, replacing a badly chipped carved plaster ceiling with a smooth one will be far cheaper and will require far less ongoing maintenance. Does that make it an improvement? Probably not. While alterations are normally capital expenditure, even structural alterations may sometimes be the most efficient and effective way of restoring a building to its original condition. This was held to be the case in Conn v Robins Bros Ltd, where work on a shop that was more than 40 years old, including strengthening a floor and replacing a bow front with a flush one, was held to be repairs.
What counts as repairs - or revenue expenditure - depends on the facts. Redecoration will normally be revenue. The replacement of existing counters, light fittings, etc may be revenue - but may equally be capital. Shop fronts have traditionally been dealt with on a renewals basis, the cost of replacing an existing one being revenue, but any element of improvement being regarded as capital. What counts as an improvement is normally a matter of negotiation and compromise with the tax inspector.
Special difficulties arise with repairs within the first few years after the purchase of a shop, and there are two leading cases illustrating this that have general application to all businesses considering changes.
In Law Shipping Co Ltd v CIR, a ship was bought on the high seas as it was about to start a voyage. When it entered port it was refused permission to leave until substantial repairs were carried out. The repair work was held to be capital expenditure. In effect what had been bought was a dilapidated ship and the repair work amounted to improvements to turn it into something different, namely a seaworthy vessel.
In Odeon Associated Theatres Ltd v Jones, a number of cinemas were bought during the war. Because of wartime restrictions, repairs and redecorations, which would normally be done on a regular basis, could not be carried out. When the cinemas were eventually refurbished, the Revenue unsuccessfully sought to disallow part of the cost as capital, arguing it related to dilapidation that occurred before they were bought. The case was distinguished from the Law Shipping case because there was no evidence that the lack of repairs had affected the price paid, and the cinemas had been operated as cinemas for several years since their purchase without the repairs having been carried out.
These cases represent two extremes. The principle that can be drawn from them is that if a shop or other building is bought in the knowledge that work will need to be carried out before it can be used for the purpose for which it was bought, the cost of that work will be capital. It will not be treated as a repair, it will be the improvement of what was bought. If the building is in fact used in its existing state, there will be a strong inference that the subsequent work will be on repairs - although use for a very short time might not be regarded as representative.
Conversely, if the work is carried out before the building is used at all, as will often be the case with shops, it will be very difficult to establish that the work constitutes repairs. In the case of Jackson v Laskers Home Furnishers Ltd, where a 12-month rent-free period was given under the lease of a dilapidated shop, the court had no trouble in holding that the expenditure was on improvements not repairs.
Shops can present a particularly difficult problem as, even if a shop is bought in good repair, a great deal of initial work will often be carried out on it, either to adapt it for the particular trade or to create a particular image. Adapting for an individual trade will normally be improvement. The creating of an image, such as a different colour scheme, or more modern decor, may well be repairs.
For capital items, it is necessary to distinguish between plant and building. Plant attracts capital allowances. Premises do not. Again, the distinction between the two is blurred. Broadly speaking, if something is installed because it is needed in the particular business, it is likely to be plant. If it is needed to allow the building to be used for any purpose at all, it is not plant.
In the context of a shop, counters, shelving, signs and security mirrors are likely to be plant. Machinery such as tills, security cameras, fire and burglar alarms, smoke detectors and illuminated signs also qualify for capital allowances in the same way as plant. But there are a number of difficult areas.
Lighting is not normally plant, even if specially designed for the business, but it can be plant if it has a specific purpose, such as window lighting or lights sited over counters or showcases to attract the attention of customers. In another case of interest to all businesses, Wimpy International Ltd v Warland, special lighting over the serving area of a Wimpy bar was held to be plant as it was designed to make the food look more appetising.
Electrical wiring is also a problem - it is not normally plant, as a shop could not be used at all without wiring. On the other hand, if the shop is a café, hairdressers, a radio and TV retailer, or similar business where electricity is required for trade equipment, the extra wiring to support such equipment will be plant. Again it will normally be necessary to negotiate the split between plant and premises on an item-by-item basis.
For expenditure after 29 November 1993, expenditure on fittings cannot be plant unless it falls into one of a number of tightly defined categories. Unfortunately, space does not permit these to be listed, but in a retail context, they are likely to cover virtually everything that has been traditionally regarded as plant.
From 6 April 2001, relief has been available for investment in designated energy-saving plant and machinery (heat and power systems, lighting, refrigeration, etc) that have been certified as meeting energy-efficient criteria. From 1 April 2003, relief is also available for environmentally beneficial plant or machinery.
What other tax considerations arise when planning a refurbishment? Think tax from the beginning. The contractors' bill (or the bill of quantities, as appropriate) should be as detailed as possible. Anything that is included in the specification which is specific to the trade should be separately identified.
John Hiddleston is a senior tax consultant at Chiltern Plc