Podium case: Capital v revenue, the enduring debate

By Angus Isherwood and Hiran Patel

The distinction between capital and revenue expenditure is crucial for those carrying on a business, and how they treat certain costs for tax purposes.

Under general principles, expenditure incurred in deriving income is generally deductible, subject to some exclusions, including to the extent that the expenditure is capital in nature. The boundary between capital and revenue expenditure is not codified by statute. Instead, it has been shaped by a long-standing and settled body of case law. Cases testing the boundaries of the distinction rarely appear before the courts, making the recent judgment of Podium Investments Limited v Commissioner of Inland Revenue an important and timely reminder of the principles that govern the capital/revenue distinction.

The deductibility of expenditure on repairs and maintenance (R&M) relating to assets is predominantly a question of whether the expenditure is revenue or capital. The leading Privy Council decision in Auckland Gas Co established a two-step approach for distinguishing between repairs (revenue) and replacement (capital) expenditure. First, the taxpayer must identify the asset that is being repaired or worked on. Second, they must consider the nature and extent of the work done to that asset. If the work changes the character of the asset or improves it, the expenditure will generally be capital rather than revenue. Inland Revenue’s recent guidance on R&M expenditure reinforces that both assessments are highly circumstantial on the facts of a given case.

Podium’s 2-million-dollar problem

Podium Investments Limited (Podium) undertook substantial construction work on its mixed-use commercial building after a report found that the building’s hollow floors posed an earthquake risk under the New Building Standard (NBS). The work followed the departure of the building’s longstanding retail anchor tenant and the signing of a new lease with a replacement tenant, which required Podium to undertake seismic strengthening works to achieve a specified NBS rating.

The construction work was completed in two stages. The first involved the installation of a new glass façade and a range of other refurbishments including upgrades to lighting, air conditioning, a new lift and stairs, and the addition of an atrium. The second round of work was focused on seismic strengthening of structural deficiencies, specifically the repair of a defective beam in the building’s carpark and the addition of fibre-reinforced plastic strengthening to the hollow floors.

Initially, Podium applied for a binding ruling from Inland Revenue to confirm whether the total expenditure of $13.7m on all construction work was deductible, which was subsequently denied. Interestingly, by the time Podium’s case was heard by the Taxation and Charity Review Authority (the Authority), only the expenditure on the ground floor glazing and seismic works remained in dispute, a fraction of the total amount spent (approximately $2m).

So - was the expenditure capital or revenue?

Based on the evidence before it, the Authority found that both the glass façade and the seismic strengthening work were an integral part of a larger capital project to modernise the building in the hopes of finding a new tenant. The Authority also held that, considered separately from the wider construction project, both sets of work were capital because they changed the character of the building. Consequently, the Authority denied Podium deductions for both amounts of expenditure.

The High Court was tasked with determining whether the Authority was correct to categorise the disputed expenditure as capital rather than revenue. Following the same two-step test from Auckland Gas Co, the High Court upheld the Authority’s findings on all four issues in dispute.

The Judge considered that both the glass façade and seismic works could not be separated from the overall capital project, which was intended to convert the building into “a seismically compliant, desirable office building with functional design and cohesion.” Notably, individual work does not become capital merely because it is carried out at the same time as a larger capital project. Instead, there must be a sufficiently close connection between the two. A similar case, Colonial Motor Co was referred to in the judgment, involved a similar set of circumstances; seismic strengthening was carried out alongside general construction work, and the Court held that there was a single project to transform a derelict warehouse into a functional office block. 

Even assessed on a stand-alone basis, both sets of work went beyond remedying defective components and were found to improve the character of the building. The new glass façade was considered functionally and aesthetically superior to the façade it was replacing (noting that modern building standards required strengthened glass to be used), and the seismic work provided a major structural improvement to the function and safety of the building. The High Court therefore found that the work done significantly altered the character of the building.

Principles to take home

Considering the facts at hand, it is unsurprising that the Court found the construction undertaken by Podium changed the character of its building. What makes the present case particularly interesting is not the outcome itself, but the Court's discussion of when work forms part of a wider capital project.

Summarising the key legal principles for the deductibility of R&M expenditure:

• When identifying the relevant asset, work that forms part of a wider project may take its character from the project as a whole. If the overall project reconstructs, renews or substantially replaces the asset, the expenditure will generally be capital. Whether particular work forms part of that wider project depends on whether there is a sufficiently close connection between them. Commercial objectives and timing may be relevant, but neither is determinative.
• Moving to the second stage of the assessment, replacement of a component part will generally be considered a repair of the larger object. The exception is if the new component part differs from the damaged original in a way that changes the character of the asset, by improving or enhancing it. The Court also reaffirmed that if the asset was purchased in a defective state, expenditure incurred to bring it to a suitable condition for its use will generally be capital as the costs are not related to remedying wear and tear.

To conclude, the distinction between capital and revenue expenditure is a fine one. There is no concrete definition for what constitutes a close connection to a larger project, or when work will go beyond a mere repair to change the character of an asset. Ultimately, it is the Courts that continue to define the boundary through the cases that come before them, and the Podium Investments Limited case is a timely reminder of how the principles are applied in practice. With the removal of tax depreciation on commercial buildings from the 2024/25 income tax year onwards, the capital/revenue distinction in relation to work on commercial buildings will become more important – we may see more taxpayers trying to argue the boundaries of these principles to ultimately seek to claim a deduction (as if the works are capital, they are depreciated at 0%). An alternative option for taxpayers who have made capital improvements to a building after 22 May 2025 is to claim an investment boost deduction.

If you are looking for advice on whether your R&M (or any other type of) expenditure will be deductible, or if you have any questions about Podium Investments Limited, please contact your usual Deloitte advisor.