Much of the case law that dictates the tax outcomes on the distinction between non-deductible capital expenditure on buildings and tax-deductible repairs and maintenance expenditure are very old cases.

However, there is a recent decision from the courts involving a case over the character of building work undertaken and whether the expenditure could be apportioned between capital expenditure and repairs.

The facts concerned the AB Trust which spend $681,220.19 carrying out works on two adjacent properties at
10 Green Street. The trust undertook a programme of work that required various building consents to the existing building.

The trust claimed $408,271.35 were deductible repairs to the existing building and capitalised $272,948.84 as non-deductible capital expenditure.

The commissioner, though, contended that the taxpayer had engaged in one overall project that was capital in nature and disallowed all the repairs claimed. The commissioner also sought to impose a shortfall penalty for having taken an unacceptable tax position.

The issues for the court centred on whether the expenditure was capital in nature and whether there was one project or multiple projects that could lead to an apportionment of cost.

The taxation review authority held that the project was capital in nature which meant the character of the
disputed expenditure was also capital in nature.

It was also found that the project was undertaken as a single project and as such it was not possible to
apportion cost between component parts of that project.

The court found that the building had been extended as per the building consents and that this did not amount to a legitimate repair of the existing building.

The court relied on evidence from the engineer and plans submitted with the building consents to draw the conclusion that the work to increase the size of the building was substantial and therefore capital in nature.

The court was satisfied that the work went beyond what could be considered a repair and also believed that it was not possible to consider the work other than in the context of a single project to upgrade the building.

Interestingly, the court also found that the question of whether the work was capital in nature was such that
“No reasonable minds could differ” and in taking this view, confirmed the commissioner’s decision to impose the shortfall penalty for taking an unacceptable tax position.

This penalty was then reduced by 50% because it was the first incident of this type with this taxpayer.

The decision reinforces the need to be realistic about where the line in the sand lies with respect to claims for maintenance and also makes it clear that trying to apportion expenditure between capital and revenue where undertaken at the same time is likely to be problematic.

The imposition of the shortfall penalty, and no double use of money interest as well, means that pushing the boundaries on a repairs and maintenance claim is not without consequence if the IRD successfully challenge a claim.

The issue of claiming deductions for repairs remains fundamentally an extent and degree matter.

If expensive but legitimate repairs are genuinely required on a building it can be very helpful to retain photographs of the damage that needed to be repaired so that better context can be brought to the arguments.

The issues around remediation of leaky buildings remain a highly contentious matter.

The IRD seems inclined now to generally disallow such claims using extent and degree arguments supported by the need for betterment of building under new building codes.

Unfortunately, we are yet to see a test case on leaky building remediation.

I suspect this is because taxpayers who have had to weather the emotional and financial impact of a leaky building remediation simply have nothing left in the tank to take on a legal fight with the IRD.

Mark and his team specialise in advising on property-related transactions, valuation and restructure services, and tax planning. Withers Tsang & Co Phone 09 376 8860, www.wt.co.nz