Claiming deductions for repairs and maintenance
Tax Alert - August 2010
With the removal of the ability to claim depreciation on buildings from the 2012 income year, taxpayers should scrutinise repairs and maintenance more closely to ensure they are claiming a deduction where appropriate to do so. The rules for repairs and maintenance haven’t changed since 1994 but it is an area which can be difficult and a fine line is often trodden between what is a deductible repair and what is a non deductible improvement.
There is no specific provision within the Income Tax Act 2007 (the Act) providing for repairs and maintenance to be deducted. Instead the question of deductibility is covered by the general deductibility rules subject to it not being “capital” in nature. In determining whether expenditure is “capital” in nature, it is necessary to refer to a large body of case law precedent which provides guidance on the matter.
We would expect Inland Revenue to publish a new interpretation statement on repairs and maintenance at some stage in the future. Until they do however, we have a rather dated 1994 policy which doesn’t take into account important case law since it was issued, a 2000 interpretation statement on dairy farming which refers to repairs and maintenance in the context of dairy equipment and more recently the 2010 interpretation statement regarding residential rental properties which does include some relevant commentary. The Policy Advice Division of Inland Revenue has, however, published some guidance on repairs and maintenance in the guide accompanying the budget announcements.
The current approach established is two-stage as follows:
- Identify the relevant asset to which the test of repair or replacement is being applied. Is the item that is being repaired or replaced part of a larger asset, or is it a single asset?
- Ascertain the nature, extent and cost of work undertaken. This will involve determining whether the work remedied wear and tear which is generally deductible or whether the asset has been improved or otherwise substantially changed (generally nondeductible).
As a general rule, expenditure that merely restores an asset to its original condition on purchase is likely to be deductible, but things begin to get a bit cloudy where new technology or new improved materials are used to restore the asset. Provided the work does not alter a substantial part of the asset, such expenditure may still be deductible. However a desire to solve a maintenance problem is not inconsistent with carrying out work of a capital nature. Expenditure on renewal, replacement or reconstruction of a substantial portion of the asset which goes beyond repair, will be classed as being capital in nature and non-deductible.
In the context of a building, repairing or replacing something which forms part of a building should be deductible provided it does not substantially alter or improve the value or function of the building.
These general rules help provide a methodology as a starting point but each case needs to be considered based on its own facts in light of all the surrounding circumstances. This is not always easy in practice.