Same same, or different? The deductibility of R&M on a recently acquired asset

By Hiran Patel & Navroz Singh

Businesses and their accountants will be aware of interpretation statement 12/03 Deductibility of repairs and maintenance expenditure (IS 12/03) which provides guidance on the general principles for repairs and maintenance deductions. However, questions remained about the deductibility of expenditure on repairs to “recently acquired capital assets”. Inland Revenue has recently released draft guidance through a “Question We’ve Been Asked” (QWBA) on this specific issue: “PUB000459 Can I claim a deduction for expenses I incur on repairing a recently acquired capital asset?”

Spoiler alert – the answer is, no, you cannot! The QWBA confirms that the capital limitation rule in s DA 2(1) of the Income Tax Act 2007 prevents businesses from claiming a deduction because the expenses are of a capital nature. However, if the capital asset is an item of depreciable property, businesses may be able to add the amount of the expenditure to the cost of the asset for depreciation purposes.

So, what’s new?

Inland Revenue introduces the concept of “initial repairs” in the QWBA. Initial repairs involve work carried out on a capital asset that has recently been acquired where the expenditure is non-deductible capital expenditure. The nature of initial repairs refers to work involved to ensure that the capital asset is suitable for use as intended within a taxpayer’s business. These repairs are non-deductible, even if the same repair work incurred by a previous owner before sale, would have been deductible for that previous owner.

The QWBA includes an example of initial repairs to a commercial building complex (example four).

Example Four (replicated from PUB000459)

MetroHub Properties Ltd acquired a commercial complex comprising several separate buildings. MetroHub intended to use the complex for the purpose of deriving commercial rental income as part of its existing commercial property portfolio.

When MetroHub acquired the complex, all but one of the buildings were tenanted and producing rental income. One multi-storey building, however, had been unoccupied for years and was in a run-down condition.

MetroHub incurred expenditure in the year of purchasing the complex to repair the multi-storey building so it was in a condition for renting out. The work comprised interior cleaning, rubbish removal and redecorating, repairs to the roof, guttering and downpipes, replacing broken windows and maintaining the exterior grounds.

The repairs in this case involved initial repairs because they were required to restore and maintain the functionality of the multi-storey building to the level that MetroHub could use it for the intended purpose of leasing.

This outcome applies, even though parts of the complex are capable already of functioning as intended, and as a whole the complex could be seen as not in need of repair for that purpose.

However, in this case, the relevant asset identified for repairs and maintenance purposes as the object of the expenditure determines the relevant intended use and this is the multi-level building and its surrounding land, not the entire commercial complex.

This expenditure would be added to the cost of the asset (and in this case, subject to a 0% depreciation rate if allocated to the building structure).

While this approach is consistent with ordinary tax principles, businesses should take care when identifying the item of depreciable property. From 1 April 2024, the depreciation rate for all commercial buildings is 0%. As such, identifying the relevant asset being worked on is important in the context of residential and commercial buildings. Fortunately, we have recently written an article on the Inland Revenue guidance on identifying relevant assets.

Wait… am I no longer allowed an immediate deduction for repairs?

It is important to note that the QWBA does state that an initial repair does not include work that remedies normal wear and tear arising from a taxpayer’s use of an asset in carrying on a business. For example, if a building had been tenanted and a window broke, any expenditure incurred in replacing the window is likely to be repairs and maintenance even if it is undertaken shortly after the asset is acquired. This expenditure should be immediately deductible.

The key distinction here is whether the costs are a necessity to restore the functionality of an asset so it can form part of the business structure of the taxpayer’s income earning activity. In the window repair example above, the asset (the building) was already part of the taxpayer’s income earning activity.

If the facts in example 4 (above) from the QWBA were varied and the same costs were incurred by the previous owner, who had owned the building for 20 years, it is likely that expenditure such as interior cleaning, rubbish removal and replacing broken windows will be of a repairs and maintenance nature and immediately deductible, given the building would not be considered to be “recently acquired” (see comments below).

The QWBA accepts that expenditure can be apportioned between an initial repair and repairs for normal wear and tear. The only caveat to this is that if the normal wear and tear repair element was “simply ancillary” to an initial repair, the entire amount is treated as an initial repair and treated as capital in nature. The QWBA does not provide guidance as to what “simply ancillary” means and so the facts and circumstances of a situation must be considered.

Ok, so how long do I have to wait before all repairs are deductible?

Inland Revenue have not provided any material guidance on what comprises a “recently acquired” asset. However, the QWBA does state that shorter the time between purchasing the asset and undertaking repairs, the stronger the inferences that the repairs were needed to restore and maintain the asset’s relevant functionality to enable the business’s intended use.

We expect that Inland Revenue have deliberately refrained from providing specific criteria to prevent taxpayers from waiting until this criteria has lapsed or has been met and then undertaking repairs.

So where to from here?

The QWBA makes it clear, as is the case in all capital/revenue distinction questions, that all the facts and circumstances of the specific situation need to be considered. This includes:

• The state of repair or disrepair of the asset at the time the business acquired it;
• Whether the asset was in a fit state for use as intended in the business;
• The price of the asset or its value at acquisition* and whether this was, or can be assumed on a reasonable basis to have been, affected by the state of repair or disrepair of the asset;
• The previous use of the asset in comparison with the business’s intended use;
• The nature and extent of the repair work carried out;
• The timing of the work; and
• Whether the business has made any use of the asset before or during the period between acquisition and when the relevant work is completed.

^{*The purchase price of any secondhand asset is usually reflective of a number of factors, and this may include its state of disrepair. The purchase price would then be relevant in the context of initial repairs to the extent it is indicative of the state of the asset at the time.}

These considerations are largely consistent with the earlier general principles guidance in IS 12/03.

This QWBA is a useful reminder of complexities of the deductibility of repairs and maintenance expenditure. Next time you incur expenditure repairing a “recently acquired” asset or have any questions on repairs and maintenance deductibility, we recommend reaching out to your Deloitte tax adviser.