Acquisition, improvement and alteration of assets
Provides checks to make and what risks and mitigations to consider, including explanations and examples for acquisition, improvement and alteration of assets.
Risk
Capital expenditure on the purchase of assets may have been charged to the profit and loss account for example, fixtures and fittings included in repairs and renewals, expenditure on items of computer hardware included in IT costs or vehicles purchased included in motoring expenses.
Mitigation
Consider whether any items of capital expenditure on the purchase of assets might have been treated as revenue expenditure in the profit and loss account. Developments in the business, such as relocation or expansion, may suggest potential areas in which this may have occurred.
A review of accounts such as repairs and renewals, other expenses, motoring expenses for example, may reveal items of a capital nature, which are not allowable as revenue expenditure. However, a capital allowances claim may be possible.
Further information
- Business Income Manual — BIM35005 provides further guidance on distinguishing capital from revenue expenditure
- Capital Allowances Manual provides further guidance on the definition of capital allowances, how allowances are made and how to claim
Risk
When a business carries out refurbishment of an existing or newly acquired asset, such as a property, some or all of the expenditure may relate to improvement or alteration of the asset. This expenditure will normally be capital for tax purposes, but it may have been included in repairs and renewals or other profit and loss account headings in the accounts. It is not possible to treat some of the expenditure on improvements as ‘notional repairs’.
Specific attention may be required in respect of the integral features rules. See explanation below.
Mitigation
Where a business carries out work to repair or refurbish either a new or an existing asset, review the expenditure to identify any items that represent improvements or alterations rather than repairs and ensure that they are treated as capital expenditure as appropriate for tax purposes.
Explanation
A repair to an asset restores it to what it originally had been and is normally an allowable revenue expense. For example, the cost of replacing roof tiles blown off by a storm. The cost of alterations, however, are normally capital for tax purposes as they involve improving or changing an asset and so providing an enduring benefit to the business, rather than simply restoring it to its previous state. For example, extending the area of the roof or taking off the roof and building another storey.
The Business Income Manual — BIM46900 provides further guidance on specific deductions for repairs and renewals.
A repair or replacement of a part of an asset using modern materials may look like an improvement, but if the new materials are broadly equivalent to the old materials then the cost is normally an allowable expense. For example, replacing single glazed windows with double glazed windows. The Business Income Manual — BIM46925 (opens in new browser) provides further guidance on what is considered a repair.
If the work results in the renewal or replacement of an asset as a whole, then all of the expenditure incurred should be treated as capital expenditure.
The importance of good record keeping is also relevant in cases where it may be possible to apportion the total of the expenditure between capital and revenue. For example, a debit in the profit and loss account may read ‘building works’ in an amount of £100,000. However, an analysis of the detailed invoices may indicate that £40,000 was spent on an identifiable improvement of the building, which would correctly be capital in nature and the balance of £60,000 was identified as revenue expenditure. This would allow for an acceptable apportionment of the total expended of £100,000 and result in the balance of £60,000 being a revenue expense of the business as repairs.
Where the records kept do not allow for such an apportionment to be identified then all the expenditure will be treated as capital. An example of mixed expenditure could be legal fees incurred in relation to a planning permission application, part of which involves new or extended planning permissions (capital) and part of which relates to a renewal of an existing planning permission (revenue). If the invoices do not split the legal fees incurred between these two elements, then, ordinarily, all the legal fees should be treated as being capital in nature.
The possibility of expenditure on improvement or alteration should particularly be considered where a newly acquired asset is being subjected to a change of use, and therefore needs to be altered to adapt it for its new purpose.
The Business Income Manual — BIM46915 provides further guidance on improvements and alterations.
There are also special rules relating to expenditure on specified parts of buildings called ‘integral features’. The following are integral features:
- an electrical system (including a lighting system)
- a cold water system
- a space or water heating system, a powered system of ventilation, air cooling or air purification and any floor or ceiling comprised in such a system
- a lift, an escalator or a moving walkway
- external solar shading
Under these rules if expenditure on an integral feature represents the whole, or more than 50%, of the cost of replacing the integral feature, then the whole of the expenditure is to be treated as capital expenditure on the replacement of an integral feature for capital allowances purposes. No deduction is then available for the expenditure in computing the profits of the trade (except under the capital allowances rules).
The Capital Allowances Manual — CA22310 provides further guidance on expenditure on integral features for buildings and structures in relation to Plant and Machinery Allowances (PMA).
Risk
If an asset cannot be used as soon as it is acquired because of its poor condition and the purchase price was substantially reduced to reflect the need for repairs, then the cost of those repairs may be capital expenditure.
Mitigation
Identify any instances where the business has acquired an asset at a reduced cost because essential repairs are required and the business is prevented from bringing the asset into use until the repair work is done. Consider whether these repair costs should be treated as capital expenditure.
Explanation
There are circumstances in which the cost of repairs may constitute capital expenditure even though the work does not improve the asset but merely restores it to an acceptable condition.
Factors that may be relevant are, whether the:
- asset could be used in the business without being repaired
- asset could only be used in the short term as its long-term use was dependent upon the repairs being carried out
- purchase price of the asset was substantially reduced because the asset needed repairing.
Example
A business purchases a vehicle that has failed its MOT and cannot be used; this was reflected in the purchase price. Carrying out the repairs necessary to obtain a MOT certificate will not improve the vehicle. However, it will contribute to the cost of acquiring an asset of lasting benefit to the business. In these circumstances the cost of the repairs constitute capital expenditure for tax purposes and a revenue deduction is not available in computing the taxable profits. However, a capital allowances claim may be possible.
Further information
- Business Income Manual — BIM46915 provides further guidance on improvements and alterations
- Business Income Manual — BIM35450 details assets bought in a defective condition
Risk
Incidental expenditure incurred when acquiring or disposing of an asset should be treated as capital expenditure. The most common example of such expenditure is legal and professional fees incurred in acquiring or disposing of an asset. Incidental expenditure may also include the cost of such items as the transportation and installation of the asset.
Mitigation
Consider whether any incidental costs have arisen as a consequence of the acquisition of new assets or the disposal of assets. Review the profit and loss account for any such incidental costs of a capital nature and ensure that they are treated appropriately.
Explanation
Expenses incurred in the course of capital transactions are not allowable as revenue expenditure, except where incurred by a company in relation to intangible assets, where the corporate intangible assets regime may apply.
Further guidance on the corporate intangible assets regime can be found at:
- Business Income Manual — BIM35501
- Corporate Intangibles Research and Development Manual (CIRD) — CIRD10000
Costs such as Stamp Duty or legal and professional fees, for example architects’, engineers’ or surveyors’ costs, incurred when acquiring or disposing of an asset should be treated as capital expenditure.
Costs incurred in bringing a new asset into use, such as transporting it to its intended site or erecting and installing it should also be capitalised as part of the cost of the asset. However, the cost of removing trading stock, stores, equipment or plant and machinery for the purpose of relocation to new premises will generally be allowable in computing the taxable profits, where the relocation is not part of a more general plan to expand the business.
The Business Income Manual — BIM42530 provides further guidance on the removal of expenses.
Professional fees, such as legal costs, survey fees, architects’ fees, or quantity surveyors’ fees, may qualify for capital allowances as expenditure on the provision of plant or machinery if they relate directly to the acquisition, transport and installation of the plant or machinery.
The Capital Allowances Manual — CA20070 provides further guidance on professional fees and preliminaries under Plant and Machinery Allowances (PMA).