DECISION
Introduction
1.
The Appeal is against a Closure Notice issued by the Respondents on 15
December 2011 under Paragraph 32F to Schedule 18 of the Finance Act 1998.
2.
The Closure Notice amended the Appellant’s Corporation Tax return for
the accounting period ended 31 August 2008. The effect was to increase the
Appellant’s profits chargeable to Corporation Tax from £170,789 by £187,203 to £357,992.
This resulted in additional tax payable of £58,688.90. Part of the additional
profits is an amount of £820 Value Added Tax which was claimed in error by the
Appellant in their Corporation Tax return. This addition to profits chargeable
to Corporation Tax is not in dispute and the additional tax that results is
£257.07.
3.
The Statutory Review of the HMRC Decision was undertaken on 9 March 2012
which concluded that the assessment was correct subject to a minor adjustment
(£187,163 as opposed to £187,203)
Matters at issue
4.
The core issue is whether or not the amount of £240,992.60 expended by
the Appellant is capital expenditure prohibited by Section 74(1)(f) and Section
74(1)(g) of the Income and Corporation Taxes Act 1988 (“ICTA”) from being
deducted and calculated in the profits chargeable to Corporation Tax.
Background and
Facts
5.
The Appellant is a limited liability company, Registration Number 471372
with a registered office at Bankside House, Henfield Road, Small Dole,
Henfield, West Sussex BN5 9XQ. Its principal activity is buying, developing,
managing and letting of land and buildings. The Directors are members of the
Mackley family. For the years 2007 and 2008 the Company’s turnover was £1,102,968
and £1,163,702 respectively showing a profit in each year.
6.
The works in dispute were carried out on land and buildings on the
Mackley Industrial Estate in West Sussex (“Industrial Estate”). The works were
undertaken by J T Mackley & Co Limited, an affiliated company.
7.
On 1 June 2010 pursuant to Paragraph 24(1) Schedule 18 to the Finance
Act 1998, Mr Iain Stannard, an Inspector of Taxes, wrote to the Appellant to
conduct a check on the Company’s Tax return for the period ending 31 August
2008. There followed various correspondence between the Respondents and the
Appellant’s representative and auditors, Carpenter Box LLP, regarding
expenditure at the Mackley Industrial Estate. To understand the nature of the
works, the Respondents had paid a visit to the site and reviewed various
documentation including plans, drawings and leases used to contract with the
tenants at the Industrial Estate.
8.
The Appellant’s representative provided a schedule of works undertaken
on the Industrial Estate which was agreed with HMRC. The breakdown is as
follows:
|
(a)
|
Diversion of BT
capital and other fibre-optic cables
|
£31,469.54
|
|
(b)
|
Main carriageway temporary diversion to allow the road
to be broken up
|
£23,226.88
|
|
(c)
|
Main carriageway re-laying and re-surfacing
|
£135,141.25
|
|
(d)
|
Re-site main car park and avoid a steep entrance
|
£26,777.13
|
|
(e)
|
Additional resurfacing, to road outside original scope
of works, but which were breaking up
|
£9,299.40
|
|
(f)
|
Additional resurfacing works to road outside timber
sawmills which were breaking up
|
£27,796.00
|
|
(g)
|
Reinstating footpath to main office and estate
|
£24,377.80
|
|
|
Total
|
£278,088.00
|
9.
The Respondents agreed that two of the items listed above in paragraphs
(e) and (f) are revenue items and therefore allowable deductions. The total of
these is £37,095.40.
10.
The remaining five items of expenditure (items (a) (b) (c) (d) &
(g)) totalling £240,992.60 are the disputed amounts. The Respondents submit that
they are capital not revenue payments.
11.
There is an issue relating to tenants’ contributions. The tenants at the
Industrial Estate contributed amounts to the cost of works totalling £54,649
during the accounting period ending 31 August 2008. This amount has been
included in the Appellant’s profits chargeable to Corporation Tax on its Corporation
Tax return. All adjustments to figures after the decision of the Tribunal
would be made by the parties.
The Works in Summary
12.
The works relate to the main entrance road to the estate, which was
built some 40 years previously. It was in need of repair and widening with the
increase in traffic to the estate of heavier lorries, transporters and other
vehicles, which was substantially in excess of the original weight expectations
when the road was built.
13.
In addition to the main road, the footpaths were beginning to break up.
As a result of road damage, there was a risk to under-laid fibre optic cables belonging
to British Telecom, and these had to be re-laid. The landlord felt that tenants
should contribute to the repairs given the size and budget for the work. The
tenants agreed and contribution payments were made over three instalments.
14.
As a result of the road widening, there was attendant landscaping
required. Trees had to be removed and fencing and railings installed to comply
with local authority and safety requirements. The existing car park was re-sited,
enlarged and repaired. The total works took approximately 15 weeks to complete.
During that time, access to the estate was via a temporary access road, which
was constructed for that purpose.
Evidence
15.
The Tribunal was provided with a core bundle of documents which included
three Witness Statements and a bundle of Authorities. The core bundle included
detailed plans of the work undertaken, invoices from contractors and
correspondence between the parties. Each party provided a ring-binder of Authorities.
Witness
Statements
(1)
John Mackley
(2)
Tony Mackley
(3)
Stephen Kitchener
(1) Witness Statement of John Mackley
16.
The Witness Statement of John Mackley together with the Supplemental
Witness Statement is dated 19 October 2012 and comprises approximately 28
pages.
17.
He is a director and chairman of JT Mackley & Co Limited, the
contractor, who carried out the works in dispute. He is also director and shareholder
in Hopegar Properties Limited.
18.
The Witness Statement provided a comprehensive review of the works and
expenditure.
19.
The breakdown of the expenditure and works were on the following:
(1)
Main carriageway and temporary carriageway;
(2)
Work on the front car park;
(3)
Re-instating footpaths to the main office ;
(4)
Work on the BT cable and fibre optic diversion.
20.
The Witness Statement was comprehensive in its analysis of the figures
and together with his oral evidence explained the actual expenditure in detail
with costs incurred on the individual heads of expenditure.
(2) Witness Statement of Mr Tony Mackley
21.
Mr T Mackley is a director of Hopegar Properties Limited and shareholder
in JT Mackley & Co Limited.
22.
He provided evidence on the general Industrial Estate maintenance
expenses which included grass cutting, hedge trimming, road sweeping, clearing
of rubbish, minor repairs, and general upkeep of the pond and clearing drains.
23.
He specifically commented on why the expenditure in dispute was
reflected as an expense in the accounts. He said he took the advice of Hopegar’s
accountant, Howard Pope, who confirmed that no material capital items were
included in these maintenance items and all expenditure was of a revenue
nature.
(3)
Witness Statement of Stephen Kitchener
24.
Mr Kitchener was employed from 1974 until his retirement in 2010 as a
technical designer specialising in design calculations and drawings for civil
engineering projects and temporary work.
25. He explained that the main
carriageway to the estate was breaking up and the base below the road was
becoming saturated causing the concrete slabs to move when passed over by heavy
vehicles.
26.
He agreed with John Mackley’s statement on the technical aspect of the
works. He disagrees that there was no greater functionality as a result of the
road improvements. He does agree that the road has been brought up to modern
standards.
Findings of Fact
27.
The estate has land and buildings which is serviced by a road network
connected to the highway.
28.
The estate has 67 rental units and comprises approximately 309,500
square feet. There is 1,130 metres of road. The total length of fibre optic
cable on the whole estate is 285 metres and the total length of telephone cable
is 2,100 metres. The length of diverted fibre optic and telephone cable was 143
metres.
29.
There was no written contract between the Appellant and the contractor.
They were connected companies and the work was done on a cost plus basis. Some
incidental work was undertaken by independent contractors. The works were
invoiced.
30.
The works, under five itemised heads (relating to road works, cable
works and Bankside House), are not disputed.
31.
The works were the subject of planning permission.
32.
The main carriageway was widened but this was a small percentage of the
road network.
33.
The original access road was built in the 1960s and there was a need to update,
widen and repair the current main carriageway.
34.
The Appellant received tenant contributions towards the works.
Legislation and Case Law
The
Respondents’ list of cases:
(a) Atherton
v British Insulated and Helsby Cables Limited (10 TC 155)
(b) Auckland Gas Co. Ltd v
Commissioner of Inland Revenue (73 TC 266)
(d) Moonlight Textiles
Limited v HMRC ([2010] UKFTT 500 (TC))
(e) Southern v Borax
Consolidated Limited (23 TC 597)
(f) Texas Land and
Mortgage Company v Holtham (3 TC255)
(g) Tucker v Granada
Motorway Services Ltd (53 TC 92)
(h) William
P Lawrie v Commissioners of Inland Revenue (34 TC 20)
Appellant’s list
of cases:
(1)
Highland Railway Co v Balderstone (Surveyor of Taxes) 2 TC 485
(2)
Lurcott v. Wakely & Wheeler [1911] 1 KB 905
(3)
Anglo-Persian Oil Company Ltd v Dale; Anglo Persian Oil Company v the
Commissioners of Inland Revenue [1932] 1 KB 124
(4)
O’Grady (HM Inspector of Taxes) v Bullcroft Main Collieries;
Bullcroft Main Collieries Ltd v O’Grady (HM Inspector of Taxes; O’Grady (HM
Inspector of Taxes) v Markham Main Colliery Ltd 17 TC 93
(5)
Samuel Jones & Co (Devonshire) Ltd v Commissioners of Inland
Revenue 32 TC 513
(6)
Phillips (HM Inspector of Taxes) v Whieldon Sanitary Potteries Ltd 33
TC 213
(7)
J T Hodgins (Inspector of Taxes) v Plunder & Pollak (Ireland) Ltd 1957 IR 58
(8)
Conn (HM Inspector of Taxes) v Robins Bros Ltd 43 TC 266
(9)
Tucker (Inspector of Taxes) v Granada Motorway Services Ltd
[1979]STC 393
(10) Brown
(Inspector of Taxes) v Burnley Football and Athletic Co Ltd [1980] STC 424
(11) Transco
plc v Dyall (Inspector of Taxes) [2012] STC 199
(12) Christopher
Willis and The Commissioners for Her Majesty’s Revenue and Customs TC 00479
Statute Law
S.74 TA 1988
The Appellant’s submissions
35.
The Appellant’s main submission is that the expenditure is revenue and
not capital. The Courts have used the concept of “entirety” to distinguish
between revenue repairs and capital expenditure and it is appropriate to look
at the relevant asset which is being repaired. If the entirety is replaced
then the expenditure is capital but if less than the entirety is replaced then
the expenditure is likely to be a repair. The Appellant looks at the
individual items of expenditure rather than the scheme of works or expenditure
as a whole.
36. They make the following
main points:
(1)
HMRC have accepted certain expenditures as revenue and it must follow
that either the “scheme of works” is of a capital nature or none of the
expenditure is deductible or the expenditure is revenue in nature and is
deductible.
(2)
The works undertaken and claimed as repairs are repairs. It does not
matter if they are undertaken at the same time as improvements or as part of a
project. The Appellant says that it “is not understood why a repair is any
less of a repair simply because it was undertaken at the same time as an
improvement and as part of the same project”.
(3)
The taking of the “works” collectively as a starting point is wrong. The
correct starting point is to look at why the expenditure was incurred. First,
the entirety has to be identified and the expenditure examined in relation to
the asset. Most of the expenditure incurred relates to the main carriageway not
the whole network of roads on the estate. Secondly, the nature and extent of
the work done to the asset must be examined.
37.
In undertaking works there is no requirement for works to be considered repairs
only if the same material as the original material is used. The fact that
tarmac has been used instead of concrete does not change the character of the
expenditure.
38.
In looking at apportionment, the Appellants say that the concept of
“notional repairs” (when instead of simply repairing an asset the taxpayer may
take the opportunity to buy an improved asset) does not apply on the facts.
Respondents’ Submissions
39.
The Respondents say all of the expenditure in dispute is of a capital nature
.The plans and documentation show that there has been a scheme of alteration to
the Industrial Estate and the works should be seen as a whole rather than as a
piecemeal series of individual jobs.
40.
The contention is that there is a clear scheme of alteration and the
expenses are capital in nature.
41.
The Respondents make the following point:
“That the Appellant had a desire to solve a
maintenance problem. The access road could be repaired with patch repairs but
this did not take place. The existing concrete access road was dug up and
replaced with a tarmac road. The Appellant has discharged a future recurring
revenue expenditure that would be required to patch/repair the road, by
modification of a capital asset.”
42.
That :
(a)
There has been a scheme of alterations and improvements which should be
taken as a whole.
(b)
Where a capital asset is altered or improved, the expenditure incurred
is capital.
(c)
There is no need for an acquisition or disposal of a capital asset for
capital expenditure to exist.
(d)
If the result of the expenditure is the alteration and improvement of a
capital asset then the expenditure is capital despite the motive for incurring
the expenditure.
Discussion
43.
For the purposes of this decision we shall divide the works and the
corresponding expenditure under three main headings. These are:
(1)
Road works
(2)
Cable works
(3)
Bankside House works
This is in
accordance with the way the evidence and submissions were made.
Entirety
43. The
Appellant’s main argument focuses on the entirety of the assets. To understand
this submission, it is required that the Tribunal look to identify the relevant
asset and to consider the nature and extent of the work undertaken. On the
other hand, the Respondents say that there is a scheme of works and the
expenditure was not on repairs. The work formed part of one overall project. To
find an entirety the Tribunal would look to see if the asset is complete in
itself, physically and functionally distinct and capable of separate operation.
The work done must not result in a replacement or renewal and must not change
the character of the asset. There are other relevant considerations to
distinguish revenue from capital and these are explored below.
(1) Road works
44.
The road works relates to the main carriageway and the expenditure
incurred was £135,141. There was work undertaken on the additional carriageway
leading to the timber yard entrance and the expenditure of £9,299 was allowed.
The evidence shows that the main carriageway had been damaged and was in need
of repair and widening. Various plans, diagrams, drawings and photographs showing
the entire Industrial Estate, road work, site of building and other works
undertaken, were provided as part of the evidence. This gave a helpful overview
of both the estate and the works.
45.
The work to the main carriageway involved widening and repair. It was
required because the road was old and breaking due to the impact of heavy lorries
over a period of years. The expenditure on the road can be broken down to show
money was spent on labour, plant and material (£73k) and road surfacing (£32k).
There was additional expenditure to muck away (£18k), road planing or smoothing
(£400), road markings (£1,950), landscaping (£6,000) and footpath resurfacing
(£2,300).
46.
In his Witness Statement (Paras. 24 and 25) Mr John Mackley explained
that the reason repairs were needed was because “the concrete slabs had become
loose from the sub-base in part. This caused the slabs to tilt as lorries were
driven over them”. It is this breaking up of the concrete which seems to be
the main reason why the road was in need of repair and was dangerous. The
widening of the road itself was intended to make greater room for larger,
modern lorries. The widening reflected the fact that modern lorries were
longer and heavier and Horsham District Council in August 2006 required a wider
turning radius for articulated lorries. In short, the road needed to be
repaired and updated.
47.
The entire road system on the estate is approximately 1,130 metres. The
part of the road which was involved with the works was 120 metres. The road
has been widened in parts from 6 metres to 8.6 metres. Evidence was presented
to show that the increase in the area of road was some 3% of the road network
on the Industrial Estate. The actual widened part of the road increased from
613 square metres to 816 square metres.
48.
The way the road was originally constructed meant that there was sub-base
and more concrete over the top. The concrete was in the form of slabs and
therefore lay in sections. This concrete was replaced with tarmac. In order to
lay the tarmac, it was necessary to re-lay thicker sub-base for greater load
bearing. It was decided that tarmac could be laid more easily and quickly since
concrete required a 28 day setting period and this would facilitate an earlier
completion of the work. The tenants on the estate required 24 hour access to
their properties with a minimum of disruption. A temporary access road was
needed while the work was being undertaken. It was necessary to provide safe
passage for vehicles while workers were repairing the main carriageway and the temporary
road allowed the estate to function normally while repairs were being
undertaken.
49.
The actual work which was undertaken on the main carriageway involved
several phases. First, the area which was to form the temporary road and that
part which was to be the widened part of the main carriageway were dug up and
new sub-base was laid. Secondly, the temporary road was built. This road was
tarmacked. Thirdly, the base of the widened part of the main road was installed.
Fourthly, a stretch of access road was dug up, sub-base laid, the kerb was
repaired and then a base course followed by a layer of binder course was laid.
This would have been done to an area which covered more than half of the
existing road surface area as one lorry would require approximately 5 or 6 metres
width of road. At this point all the sub-base was being put in place for the
widened permanent road. Fifthly, the temporary road was removed in part and
then what remained of the temporary road was turned into the widened part of
the permanent road and the remainder of the surfacing was completed. New kerbs
were laid to part of the road. The work was done in stages and sequentially and
this allowed the estate to function normally during the period of work.
50.
After the permanent road was completed, as a result of the widening,
some trees had to be cut down to comply with local authority and general safety
requirements. Consequently, some landscaping work, fencing and railings were
required. These were done in the final stages of the project.
51.
The technical advice indicated that when the road works were being
undertaken there was a risk of damage to certain fibre-optic utility cables.
These had to be removed to avoid problems arising from the widening of the road
and the re-laying of the footpaths. The cables were below the part of the road
which was being repaired.
52.
There were different cost categories for the work undertaken. There was
muck away cost (£18,671) which represents carting the excavated material from
the existing road and the area of temporary road to an offsite landfill. The
substantial cost on the labour, plant and materials (£72,245), is self-explanatory.
The road planing costs (£400) which is the grinding down of the sub-base where
it was uneven prior to the laying of the tarmac. The road surfacing costs
(£32,519) relates to the cost of laying the base binder course and sub-base
courses which gives the road stability and load bearing capability.
53.
In terms of contracting, the arrangements were different. It is normal
to have a written contract. However, there was no written contract between the
parties since the two companies involved were connected by family and ownership.
The contractor was therefore on a cost plus basis which is total cost plus a mark-up
of 12%. We understand that this represented commercial terms and this has not
been disputed. Time sheets and payment ledgers were kept to record the labour
and payment for the works. There is no disagreement between the parties on the
numbers involved. A breakdown of charges was provided to HMRC with an analysis
of costs showing that the re-laying and re-surfacing of the main carriageway cost
£135,141.
54.
The Appellant, on who is placed the burden of proof and who must satisfy
the standard of proof according to the ordinary civil standard on a balance of
probabilities, says that the correct approach is to identify the relevant entirety.
Once the entirety is established, the nature and extent of the work must be examined
to determine whether the expenditure is revenue or capital. The Respondents say
that the Appellant had a desire to solve a maintenance problem. The access
road could have been repaired with patch repairs but this did not take place. Rather,
the existing concrete access road was dug up and replaced with a tarmac road. In
doing so, the Appellant solved the patch repair problem of the road and what
occurred was the modification of a capital asset. They rely on the authority of
Auckland Gas Limited v. Commissioners of Inland Revenue (New Zealand) (“Auckland Gas”) and Tucker v. Granada Motorway Services (“Tucker”)
to say that such expenditure falls to be treated as capital.
55.
HMRC have accepted in their guidance the concept of “entirety” to
distinguish revenue, repairs and capital expenditure. They accept that the
replacement of an entire asset is capital but if less than the entire asset is
replaced then it is likely to be revenue expenditure. Expenditure on repairs
and maintenance of an asset would involve restoring the asset or part of it to
its original state so it performs its original function in a manner similar to
that which was intended; it is this question of degree which must be examined.
56.
The starting point is to look to identify the relevant asset. A case
which looks at the entirety is O’Grady v. Bullcroft Main Collieries Limited 17
TC 93 (“Bullcroft”). In this case, a colliery chimney became unsafe and
needed to be replaced. It was a separate structure from the other buildings of
the colliery but connected to the furnace by pipes. It was claimed that the
cost of building a replacement chimney was revenue but the Commissioners
decided it was capital. The chimney was held to be a separate entity and the
expenditure on its replacement was therefore capital.
57.
The judge in the case, Rowlatt J, said:
“Of course, every repair is a replacement. You
repair a roof by putting on new slates instead of old ones, which you throw
away. There is no doubt about that. But the critical matter is … what is the
entirety? The slate is not the entirety of the roof. You are repairing the
roof by putting new slates. What is the entirety? If you replace in entirety,
it is having a new one and it is not repairing an old one. I think that is
very largely a question of degree, but it seems to me the Commissioners have
taken the only possible view here.”
58.
The Court seems to have been influenced by the fact that a new chimney
was functionally a significant improvement on the existing chimney. It was
taller with greater dimensions and constructed of engineering brick as opposed
to the original built in common brick. It was in effect a new structure.
59.
The concept of the new structure was explored in another case. In Phillips
v Whieldon Sanitary Potteries Ltd [1952] 33 TC 213 the Court looked at the
question of entirety. The company’s factory was adjacent to a canal and had
been protected by an embankment. There was subsidence in the embankment and
water seeped into the factory. Consequently the factory suffered subsidence.
The old brick and earth embankment was removed and an iron and concrete barrier
constructed. The Judge decided that the work was of a capital nature. Donovan
J said:
“I am of the opinion that this is a clear case of
capital expenditure. I reach this conclusion taking into account the extent of
the work, the permanent nature of the new barrier, the enduring advantage it
confers upon preserving part of the fixed capital of the business, and the
contention of the Company that it was essential to enable the trade to be
carried on. It is irrelevant, in my view, in the present case to consider
whether the new barrier, in point of size or effectiveness, is or is not an
improvement on the old, and there is no finding upon that point. There can be
cases where the work done may result in no improvement, but merely reinstatement,
and yet be work involving capital expenditure on account of its size and
importance.”
60.
The case highlights the question of the “size and importance” of the
work and concludes that because of those factors it cannot be an improvement
but must be a reinstatement. In his view, the barrier itself was the entirety
and since it was replaced with a new one, the work was not repair.
61.
As in Bullcroft, it is possible for a repair which changes the
function of the capital asset to be considered as capital. In the New Zealand case of Auckland Gas the company supplied its customers through a
network of underground cast iron and steel pipes. There were several thousand
joints within the system and the pipes were made in sections of 12 or 18 feet.
The joints were fractured because of subsidence and other reasons. To deal with
the problem of leaks arising as a result of fractures in the joints, the
company adopted the technique of inserting polyethylene pipes into the existing
cast iron and steel pipes. This meant that the leaking joints lay outside of
the polyethylene pipes containing gas, which could be transmitted regardless of
the old pipes. The company claimed the cost of inserting the pipes into the old
metal pipes as revenue deduction. The Court considered it is a capital
expenditure since it was not a restoration of the gas distribution system to
its original state but rather the work changed the character of the existing
gas distribution system. The Court was not convinced by the argument that
because the overall functionality was the same that by itself is a guide for
establishing whether something is revenue or not.
62.
Lord Nicholls summarised the argument as follows:
“The objective was not borne out of a desire to
improve the distribution system or to add new or improved features. The
objective was to restore the system to its original functional and reliable
state. The method adopted, of inserting polyethylene piping, happened to be the
most cost effective and cheapest way to achieve that goal… The nature and
extent of the work carried out to the physical asset are what is determinative
of the character of the work. The fact that the method chosen is the cheapest
and most effective is neutral. It does not deprive expenditure of its capital
character. Replacing an object may be cheaper and better than patching and
minding.”
63.
The Respondents also draw reference to Tucker where the taxpayer
paid a lump sum to extinguish a recurring revenue expense. The lump sum payment
was held to be capital. It seems that the court took the view that the
expenditure was made to prevent future repairs. In this sense, the nature and
extent of the work must be examined to see if it results in a renewal,
replacement or reconstruction of the asset. The Respondents say that the work
was intended to resolve future patch repairs and therefore capital.
64.
In the Respondents’ view the main carriageway had been altered to make
it wider to accommodate heavier goods vehicles accessing the premises. This
involved the creation of a new improved carriageway. Further, the material
used for the carriageway had been changed from concrete to tarmac which
supports the view that the expenditure was capital. While this argument is
understandable the analysis must start with the question, what is the entirety?
65.
They drew reference to the case of Moonlight Textiles Limited v.
HMRC [2010] UKFTT 500 (“Moonlight”) where the Tribunal commented:
“From the plans and other documentations available
it was clear that there had been a significant improvement of the premises
through the repairs and alterations effected. The work had changed the
character of the building as a whole. It is also clear that the Appellant
Company had chosen to adapt its premises to its needs and failing compelling
reasons to contrary this would be regarded as capital expenditure as an
alteration.”
66.
The Tribunal commented:
“It was therefore clear that there had been a scheme
of alteration of the Company’s showroom and storeroom/warehouse areas and, as
such, save for those items allowed by HMRC as referred to above, the
expenditure was capital and therefore not an allowable deduction from profits.”
67.
In the Moonlight case, one point which influenced the court was
that there was no breakdown of expenditure which could distinguish between
repairs and improvements, which meant the project’s expenditure was viewed as
one undertaking. Similarly, the Respondents say that there had been a clear
scheme of alterations of the Appellant’s premises which should be taken as a
whole and therefore the expenditure falls to be treated as capital. The work
had changed the character and functionality of the road.
68.
The fact that the repairs involved the replacement or renewal of some or
part of the asset does not make the expenditure capital. This would include the
alteration or improvement with new materials. In our case, itemised invoices
were provided and show materials used and itemised the heads of work. The
expenditure was analysed by both parties and the capital element was not
allowed. The revenue expenditure was actually incurred and identifiable. On
this basis there is no case for the notional repair argument.
69.
The Tribunal finds that there was no scheme of works or expenditure as
suggested by the Respondents. It would be incorrect to import an overall
purpose of improving the site as the reason why the work was undertaken. There
were individual heads of repair relating to particular assets. The capital
portion of the expenditure was identifiable and could be separated out.
70.
In the case of Christopher Wills v The Commissioners for Her
Majesty’s Revenue and Customs [2010] UKFTT 174 (“Wills”) the Court
rejected the idea that works undertaken as part of the scheme of works has to
be all capital. In that case, the court closely examined the repairs to convert
an outbuilding into additional living space and decided that they were revenue
in nature since there was not a replacement of the whole structure.
71.
This approach is also found in the more recent case of Transco v
Dyall (Inspector of Tax) [2012] STC (SCD) 199 (“Transco”). The
Court had to consider whether there were repairs or improvements to a gas
pipeline system. Transco operated an integrated gas transportation
system across Great Britain. The cast iron pipes were liable to fracture so
the company embarked on a process of replacement by polyethylene pipes which were
inserted into the cast iron pipes. The Tribunal had to decide whether the
expenditure was capital or revenue and whether it was deductible from the
Company’s profits. The Special Commissioners decided that the expenditure was
repairs, and therefore deductible. The expenditure involved was over £100 million.
This contrasts with the Privy Council’s decision, based on not dissimilar
facts, in the case of Auckland Gas. The Court here seems to have taken the
view that there was a modernisation of the assets resulting from the
improvements. The accepted argument was that there was a network of pipes
which comprises a single asset and only parts of that network were being replaced.
72.
The Appellant draws reference to the fact that HMRC accepted that
expenditure relating to the additional carriageway and the additional
resurfacing work to a road outside the timber sawmill (£9,299 and £27,799
respectively) were revenue in nature and deductible. They says that if HMRC
are focusing on a “scheme of works” taken as a whole, then it must follow that
either the “scheme of works” is of a capital nature and none of the expenditure
is deductible, or it is revenue in nature and the expenditure is deductible.
The Revenue’s approach in drawing a distinction between expenditure on
individual items and a “scheme of works”, when all the expenditure relates to
one project, is inherently flawed. The expenditure must be either capital or
revenue, it cannot be both. HMRC’s approach may be understood if one accepts
that expenditure on capital works may include an element of revenue expenditure.
In such a case, as here, there will be a separation of the two types of
expenditure.
73.
The picture which emerges from the plans, diagrams, photographs and
various correspondences between the parties is that the road was in need of
repair and modernising. Whilst it is accepted that the widening of the road is
a capital expenditure the work on the main carriageway was to provide, not a
renewal of the entirety of the road network but the repair of part of that
network. It was intended to provide a better surface and sub-base for heavy
vehicles and a larger turning point which, after 40 years, had to be improved
to deal with heavier lorries and more frequent usage. The re-laying and
re-surfacing of the main carriageway was only part of the road network. There
is no logical basis on which one stretch of road can be the entirety given the
entire road network is joined up and forms a single whole for the entire
estate. It is the replacement of part of the entirety.
74.
The Tribunal finds that defective parts of the road were being repaired.
The older material was dug up and replaced with a more modern equivalent which
met current standards. It was a substantial repair but not if one starts with
the entirety of 1,130 metres of road on the estate as a whole. The repaired
part of the road is not meant to function separately; it is the access point
for the estate and the other parts of the road network. By its nature it is not
physically or functionally distinct; it is part of the aggregate of roads and
access on the whole estate.
75.
The Respondents have raised a question concerning the fact that
different materials were used in undertaking the repair. The question is
whether the works should be undertaken with the same material which was used in
the original road. If the purpose of the repairs is to cater to heavier
lorries and increased loads then it would be sensible to use available modern
materials.
76.
In the case of Conn (HM Inspector of Taxes) v Robins Brothers
Ltd 43 TLC 266 (“Conn”), the repairs were treated as revenue even though
different materials were used. The slate roof was replaced with one of
corrugated asbestos, the floorings were replaced with concrete in the main
shop, certain timbers were replaced with steel joist encased in oak and
overall, modern materials had been used. The result was, in substance, to
repair what was there before and the expenditure was treated as revenue. The
case takes a common sense and practical approach to the issue of revenue expenditure.
It cannot be expected that a contractor having modern and improved components
would elect to use outdated and inferior materials to repair an asset
especially where there is a legal obligation to observe current standard of
safety and repair.
77.
A similar observation was made in the case of Transco, where the
Special Commissioners acknowledged that newer and better technology may not of
itself change the character of the asset:
“The character and nature of the property possessed
by Transco has not changed nor indeed has it been materially improved.
The material used, polyethylene, is cheaper than cast iron. To adopt the words
the Lord President, what was done was a mere insertion of polyethylene pipes
into the old pipes, which were worn out or partially worn out, and renewing
them in whole or in part along the whole network. This did not alter the
character of the network.”
78.
The roads network for the Industrial Estate was built in the 1960s when
lorries were lighter and road traffic was much less frequent. Lorries now are
much heavier being in excess of 40 tonnes when fully laden and their overall
length between 16 to 18 metres. They must be able to legally operate on
commercial roads and have adequate turning circles. The main carriageway was
being repaired with modern, durable and easy to lay material which reduced the
noise levels on the estate and enhanced the road infrastructure. As pointed out
in the evidence, road building is not an exact science but the functionality of
the main carriageway is very near the same as before the works. The Tribunal,
on balance, can see no increased functionality of significance. The work was
essentially to repair the road not to produce something entirely new. The
overall effect of the work was to give the estate back a functional carriageway
at the start of the road network.
79.
In the case of Conn the Court had to address the issue of
modernising a 400 year old building. The Court observed:
“In the light of the circumstances it seems to me
that this was expenditure incurred by the Company with a view to enabling it to
continue to earn profits from its business, not by acquiring some asset for
that purpose but by putting the Company’s existing assets into a state of
repair which would enable it to continue to use that asset. No doubt in the
course of carrying out these works certain structural alterations were made, as
one would expect with any extensive repair for a building over 400 years old,
when repairs were being carried out at a time when the building techniques have
completely altered. But the fact that there were alterations in the structural
details of the building does not seem to me to be a good ground for proceeding
upon the basis that the work produced something new. On the contrary, I think
it is implicit in the Commissioners’ findings that the result of this work was
not to produce something new but to repair something which had previously
existed. Upon that basis it seems to me that there is no ground for regarding
this expenditure as a capital expenditure. It was expenditure incurred for the
purpose of enabling the Company to continue to earn profits, and was therefore
in my judgment expenditure which would properly be chargeable to income.”
80.
The idea of a modern upgrade was also approved in Auckland Gas where
the Privy Council said:
“It is often that, with improvements in technology,
a replacement part is better than the original and would last longer or
function better. That does not, of itself, change the character of the larger
object or hence the appropriate description of the work.”
81.
The Tribunal finds that upholding modern standards of road repair,
especially when required by law and the local authority does not, of itself,
make the expenditure capital.
82.
The Respondents say that using tarmac instead of concrete created a new
structure since “concrete was the material that remained available for
installation”. The important question is whether the repair results in an
asset which is changed in character. In his Witness Statement, John Mackley
explained that the concrete slabs had a tendency to become loose and broken and
that the tarmac was a more suitable option. The fact that tarmac surfacing was
used or that it resulted in additional expenditure on increased sub-base
(£4,500) does not make the expenditure capital. We know that a replacement can
be of different modern materials and components which are more suitable. The
new main carriageway was better than the old but physically, commercially and
functionally was very similar to what existed before.
83.
The Respondents have raised issue with the expenditure on the sub-bases.
The road originally had sub-base with concrete surfacing. Extra sub-base of
thickness (approximately 100-150 mm) was added. The temporary road also had an
enhanced sub-base since part of that road was incorporated into the new improved
carriageway The Tribunal accepts the evidence of John Mackley that there was no
increased functionality in having thicker sub–base. The new carriageway did
allow heavier traffic and larger lorries. It was simply betterment to part of
the road network which was not independent of the main and while that part may
have had more operating capacity and a longer life it cannot be seen as an
entirety in itself.
84.
It is possible that the road could have been patched up using tarmac for
a further 3 years but the Appellant chose not to go down that route and to
modernise and upgrade part of the road instead. The idea of creating something
better and to modern standards was also looked at in the case of JT Hodgins
(Inspector of Taxes) v Plunder & Pollak (Ireland) Ltd [1957] IR 58 (“Hodgins”)
where there was a weigh-house as part of a leather factory and where the
building was damaged and pulled down and a new one constructed on the same
site. The Court observed:
“The Company now has a weigh-house which is in good
repair instead of a weigh-house which was in danger of becoming ruinous, but
there is no suggestion that it is more convenient, more effective, or of
greater capital value, than the weigh-house would have been if it was in
thorough repair. I am unable to see that any new capital asset has been
created.”
85.
The road was repaired to standards required by the local highway
authority in having modern safety and load bearing capabilities. The evidence
supports the conclusion that the repairs were being carried out when road
building techniques and specifications had been completely altered. As in Hodgins,
there was a significant time period between when the road was built and when it
was repaired. The parties have acknowledged that repairs and maintenance were necessary
and the standard of road building had moved forward.
86.
The Respondents made two further points with regard to the re-laying and
re-surfacing of the main carriageway. The first point is that the alteration
constitutes an improvement since there is greater room for larger lorries which
are longer than those previously using the road and secondly, the Appellant had
a desire to solve a maintenance problem and so paid a lump sum to extinguish a
recurring revenue expense. The lump sum itself would be capital as indicated
in Tucker. They say that the expenditure on the main carriageway is
capital and all incidental expenditure is capital. They draw reference to Auckland
Gas where Lord Nicholls explained:
“A maintenance problem such as existed here may be
capable of being solved in more than one way. It may be solved by work which
would be regarded as a repair of the existing structure or it may be solved by
scrapping all or much of the existing structure and providing a new one. In
overall functional terms the result may be much the same in the two cases, but
that is not by itself a reliable guide. If the latter alternative is chosen,
the expenditure may well be of a capital nature.”
87.
While this observation is interesting, the purpose of the repair does
not determine whether it is capital or revenue. By repairing the stretch of
road they will avoid patching-up repairs but that does not mean that the work
undertaken would not be repairs. The Tribunal does not accept the Respondents’
argument that the road could have been patch repaired and the fact that this
was not done makes the expenditure capital. It is possible to have repairs
which obviate the need for patching-up but that does not change the character
of what was done. The character of the entirety has not been altered. A repair
by its nature means that the work is being done on part of the whole, it is not
a replacement. It would seem nonsensical if the tax system gave relief for
patching-up but not for repairs which resulted in the taxpayer not having to do
the patching up. It seems one and the same thing. It is sensible that the law
treats both activities in the same way.
88.
The Tribunal turns next to the temporary road. We understand from the
witness evidence that a temporary diversion was necessary to allow access to
the Industrial Estate. It seems to the Tribunal that the temporary road had
two purposes. First, it provided temporary access to the tenants to the estate
between January and February 2008 and secondly, it was constructed as part of
the carriageway and was so used. The temporary road had to fit the
specifications needed for the permanent road since it had to cater for 40 tonne
articulated lorries having the same axle loads as would have used the permanent
road.
89.
The temporary diversion was built to be used while the main carriageway
was being repaired. The main carriageway temporary diversion costs is put at
£23,226 which is comprised of tree stump removal (£825), muck away (£6,224),
sub-bases (£2,433), temporary surfacing (£8,545), labour (£2,156), plant
(£1,918 + £1,125 = £3,043). We know that expenditure which is incidental to
revenue expenditure is revenue. The Appellant has deducted a proportionate
part of the sub-base (£2,433) and a proportionate part of the temporary
surfacing cost (£4,718) and they have accepted that these amounts should be
treated as capital. The remaining amounts are revenue expenditure which is
incidental to the expenditure on the main carriageway.
(2) Cable works
90.
The £31,469.54 for the diversion of the BT cables and fibre optic can be
broken down into component parts. These are as follows: New cables (£6,764),
Fibre optics (£8,350), JTM labour (£13,611.93), plant hire (£1,985), and
material (£758). The cabling provides telephone and data transmission for the
whole estate and it is run under the pathway which connects to other cabling
for the rest of the Industrial Estate It was felt that repair work on the road
could damage the cables lying underneath. Further, the roots of trees which had
to be removed to make access for the temporary road could also have damaged the
cables. The appropriate way to deal with these dangers and potential problems
would be to move the cables away from the site of the works and away from tree
roots with some older fibre optic cables were replaced.
91.
The plans and diagrams provided to the Tribunal show that there is a
cable network which runs through the whole estate. The work which was done to a
small part of that network and the functionality of the cable both before and
after the work was exactly the same. The Tribunal accepts, like the road
network, that the relevant asset was the cable network for the estate as a whole.
The cable network did not operate in parts but rather was part of one whole.
92.
The witness evidence presented suggests that the movement of the cable
was necessary for the road repairs. To the extent that it was necessary for the
widening of the road, then those costs would have to be treated as capital. The
widening of the road expenditure has been accepted as capital.
93.
Let us look at the other expenditure. The first point is that the
actual movement of part of the cable does not of itself give rise to a capital
expenditure. The reason that this cannot be treated as a capital expenditure
is because there is no increase in functionality both before and after the
movement of the cable. In the case of Samuel Jones & Co (Devonvale)
Limited v Commissioners of Inland Revenue 32 TC 513 (“Samuel Jones”)
the Lord President looked at functionality. He said :
“It is found as a fact that the new chimney is not
an appreciable improvement over the old chimney. So far as function is
concerned its suitability for boiler draft is exactly the same as that of the
old chimney. No additional steam – raising plants have been installed.”
94.
The cable network provides internet and phone communication to tenants
both before and after the work was done. The Respondents say that the addition
of new fibre optic cables means that the cable network has been altered. It is
correct to say it has been altered but it has been altered in that there has
been replacement cable for existing cables. New for old. There is nothing to
suggest that the new cable does anything different to the old cable.
95.
The Appellant say that the cable was moved because it was in a
vulnerable position and could have been damaged when the road works was being
undertaken. The repairs were therefore precautionary. The Special Commissioner
in Transco recognised that the cost of precautionary work could be
revenue expenditure. He observed:
“Although some old cast iron pipes have had only
polyethylene pipes inserted into them, that has been done only where necessary
for the purpose of repair, or precautionary repair, and has not been done to
the whole network. Those considerations would point to the conclusion that
expenditure is properly chargeable as revenue expenditure.”
96.
The fact that the new cable replaced an existing cable shows only that
repairs were undertaken. New for old does not mean a capital expenditure. This
was observed in Lurcott v Wakely by Molton LJ, who said:
“Many, and in fact most, repairs imply that same
portion of the total fabric is renewed, the new is put in place of old.
Therefore you have from time to time as things need repair to put new for old.”
97.
The part of the cable which was removed and repaired did not change the
character or functionality of the system as a whole. The repairs to the cable
network were de minimis in the context of the cable network. In Auckland
Gas, the Court observed that in order for there to be a capital expenditure
the work “may readily go beyond what would normally be regarded as repair of
the entire system … the work may be of such a nature and scale as to change the
character of the existing system”. There is no evidence that the operating
capacity or the income-earning capacity of the cable network was changed.
98.
It is clear that the work which was being done did not change the entire
system but rather that part which was under or around the area of the main carriageway.
The Tribunal does not agree with the Respondents’ submission that a new asset
has been created which replaced the old asset. The moving of the asset from one
location to another does not of itself create a new asset. The installation of
new cabling was of such a minimal amount that it cannot be said that it created
a new capital asset. A cable network must be seen as a whole over the whole
estate and the part that has been repaired and/or replaced is de minimis. The
expenditure therefore would be revenue and treated as a repair.
(3) Bankside
House work
99.
The work which is considered under this heading relates to the work on
the front car park (£26,777), which is broken down into labour plant and
material of (£17,236) and surfacing (£9,541). The second set of work under
this heading is the reinstatement footpaths to the main office and estate
(£24,377).
100. The entrance to
the car park at Bankside House was moved from the north side to the east side
and the car park area was re-surfaced as it was in need of repair. The car park
is used for visitors to the Industrial Estate. The re-surfacing was needed
because the surface had become worn and damaged. The relocation of the entrance
was done for safety reasons because the entrance had a steep slope. During
periods of icy conditions it was possible for cars to slide at the front
entrance. Further, the steepness of the entrance would become even more
pronounced during the road widening and it was felt appropriate that the
entrance should be moved to a safer area. In addition, the new entrance
allowed greater visibility for drivers and pedestrians. It was decided that
any car parking spaces which had been lost as a result of the road works should
be replaced and this was confirmed by Horsham District Council in a letter
dated 27 October 1997. The car park was also extended west and south. The
Tribunal’s understanding is that there was the repairing of part of the old car
park and the creation of a new additional car park. The expenditure should
therefore be apportioned between the two undertakings.
101. It is not
disputed that the old car park was in need of repair. The cost of labour, plant
and materials relating to digging out concrete and sub-base and earth and
preparation of the surface as well as the surfacing cost relating to the laying
of the sub-base and tarmac accounted for a substantial part of the
expenditure. The new car park is larger at approximately 226 square metres.
It is estimated that 75 square metres of this related to the area of the car
park before the extension. Using this apportionment, the Witness Statement of
John Mackley states that there is a cost to the Appellant of resurfacing which
related to repairing the old car park of approximately £3,166 (75/226
x £9,541). The balance of the £6,375 relates to the work consequential on
widening.
102. The dug up area,
including the entrances, is 311 square metres. On this basis Mr Mackley
considered the cost to the Appellant of labour, plant and materials which
related to repairing the old car park surface is £4,156 (75/311
x £17,236). The balance of £13,080 relates to work consequential on the
widening. It is accepted that the widening of the car park is an improvement.
The total amount for the widening which is to be treated as capital is £13,080
+ £6,375 based on the figures provided. The cost attributable to repairing the
car park (or a portion of it) should be considered a revenue item. The amount
of £7,322 (£3,166 + £4,165) should therefore be treated as revenue.
103. In the case of Brown
v Burnley Football Club 53 TC 357, Vinelott J looked at the concept of
premises, he said:
“In my judgment, the test is equally artificial and
remote from the facts. It may be that, for instance, a sports stadium designed
and built as a single building would constitute separate “premises” and that
replacement or renewal of part, more or less extensive, would be a repair of
the premises as a whole, though it is not easy to see why, in such a case, a
car park, baths and changing rooms forming an integral part of the structure
should not be as much part of the stadium as the spectators’ seats and the
ground itself.”
104. In the same way,
the old car park is functionally and physically part of Bankside House as is
the footpath. These are appendages of the property. The original footpath had
deteriorated significantly over the years and was in need of repair. However,
there was no need to carry out works to the footpath due to the widening of the
road. It was incorporated into that project. New bollards and railings were
installed for safety reasons to protect pedestrians on the footpath and to
prevent cars jumping the kerb and running down the steep incline of the road.
A new disabled ramp was built. The cost attributable to the railings and
bollards and for the painting of these was £3,267 (marked up by 12% to £3,659)
as shown by the documentary evidence. The balance of the £24,377 which is
£20,717 (£24,377 - £3,659) relates to the repair of the footpath. The new
railings, bollards and painting would be capital. The cost of repairing the
footpath around the main office should be treated as revenue.
105. Similarly, the
cost of repairing the car park which has been put at £7,322 should be treated
as revenue expenditure. Regarding the repairs to the car park, there has been
an allocation of an amount to capital for widening. The Respondents’ argument
that a new asset has been created does not consider that the footpath and car
park are integral to Bankside House and its functionality. The Tribunal accepts
that that part of the car park which is new is capital and the cost is
apportioned accordingly. The costs relating to the old car park which has been repaired
are revenue deduction.
106. The Respondents
say that the invoice provided with regard to the work on the car park is not
sufficiently itemised and falls to be treated as capital. The Tribunal however
is willing to accept the evidence of Mr John Mackley that because the parties
were connected the work was done on the basis of a costs plus formula on
commercial terms. There has been an apportionment of the capital expenditure. The
cost of the repair work on the footpath and the car park were clearly
distinguishable from the works which could be treated as capital expenditure.
It is accepted by HMRC that where work is undertaken of a capital and revenue
nature and these are undertaken at the same time a deduction would be allowed
for the repair element.
107. The work which
was undertaken as repair can be distinguished from the work which was of a
capital nature. There should have been no dispute as to deductibility of these
costs and it is surprising that objections have been raised. The taxpayer is
allowed to deduct an identifiable proportion of the expense which is revenue.
108. The costs of the
repair of the footpath (around the main office) and repairs to the relevant
part of the old car park are to be revenue deductions. This would allow for a
subtraction from the total of the costs of the capital elements relating to the
widening, new railings, bollards and painting.
Conclusion
109. The appeal is
allowed.
110. The Tribunal
finds as follows:
(1)
There is no scheme of alteration. The expenditure, as itemised, can be
considered individual pieces of work and are allowable as revenue deductions.
(2)
The relevant entirety (the road network, cable network and Bankside
House) is the asset being repaired. The nature and extent of the work shows
that there has not been a reconstruction, replacement or renewal of the asset
or substantially the whole of the asset. The character of the assets has not
changed when the overall effect of the work is examined.
(3)
The expenditure is clearly identifiable and sufficiently itemised. The
concept of notional repairs is not a relevant consideration. It is accepted by
the Tribunal that the widening work on the road is a capital expenditure and
other expenditure directly relating to that widening would also be a capital
expenditure. These have been indicated in the decision above.
(4)
Accordingly the appeal is allowed.
111. This document
contains full findings of fact and reasons for the decision. Any party dissatisfied
with this decision has a right to apply for permission to appeal against it pursuant
to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules
2009. The application must be received by this Tribunal not later than 56
days after this decision is sent to that party. The parties are referred to
“Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)”
which accompanies and forms part of this decision notice.
DR K KHAN
TRIBUNAL JUDGE
RELEASE DATE: 1 May 2013
