Tax impact of repairs and improvements

In this series of articles, Cameron Kotze – the Tax Partner at Ernst and Young – discusses some topical tax issues for our readers.

THE normal test to determine whether an expense incurred is tax deductible is to ask whether the expense is incurred in the production of income and if it is of a capital nature or not. Apart from this test, the Income Tax Act allows specific deductions in section 17 which may widen or narrow the deduction available to taxpayers.Repairs or maintenance expenses are only one of those for which there is a specific rule to bear in mind when determine the taxable income of a taxpayer.The first thing that needs to be established is whether the expense is a repair or an improvement.Repair expenses are tax deductible in the year incurred, whereas improvement expenditure may not be tax deductible at all.This aspect of the law has been the subject to many tax cases where taxpayers claimed expenses as repairs and the Receiver of Revenue was of the opinion that the expenses were not repairs because the Income Tax Act does not define what a repair is.The guideline the tax courts rely on to determine whether an expense is a repair or an improvement is that a repair is ‘renewal by replacement of a subsidiary part of the whole thing’.Therefore, a substantial restoration of a building or a vehicle can never be a repair.Furthermore, the voluntary use of improved materials to “effect the repair” can never be a repair.The tax courts have ruled that the redecoration of a building for aesthetic reasons is also not a repair for purposes of the Income Tax Act.It follows from the above wording that for an expense to be a repair, the condition of the asset has deteriorated due to use over time or has been damaged due to some event like an accident.The cause that requires the expenses to be incurred to restore the asset to it original state is not really relevant.The tax courts have also distinguished repairs from improvements by looking at the extent of the expenses that are required to restore the asset to its original condition.Where substantially the whole asset must be reconstructed the expense is usually regarded as an improvement and not a repair.The expense incurred to restore the roof of a building has been held by the tax court to be an expense incurred in respect of a subsidiary part of the building and therefore it was considered to be a repair and not an improvement.One of the requirements of the Income Tax Act regarding the tax deductibility of repair expenses is that they must be incurred in respect of property that is occupied for purposes of trade.The courts have interpreted this as meaning that the expenditure must have been incurred ‘for purpose of enabling the person to carry on and earn profits in the trade’.Therefore, repairs to a vacant property at the end of the lease period as a result of the treatment of the property by the tenant prior to the owner taking residence will not be tax deductible because the repair expenses are not incurred in respect of property occupied for purposes of trade.The court considered the fact that the expenses were incurred in respect of the use of premises during a period in respect of which income was received but concluded that the property was, at the time the expenses were incurred, not occupied for purposes of trade.To optimise your tax position where assets are repaired or renewed, careful panning should be done to ensure you maximise your tax deduction.The cash effect of having a tax deduction for repairs is effectively 65 per cent of the cash outlaid but if the expenses are considered by the Receiver of Revenue to be a renewal and not a repair, the cash effect of the expense is the actual amount paid to effect the renewal.* Should readers have queries, they are invited to send them to cameron.kotze@za.ey.comApart from this test, the Income Tax Act allows specific deductions in section 17 which may widen or narrow the deduction available to taxpayers. Repairs or maintenance expenses are only one of those for which there is a specific rule to bear in mind when determine the taxable income of a taxpayer.The first thing that needs to be established is whether the expense is a repair or an improvement.Repair expenses are tax deductible in the year incurred, whereas improvement expenditure may not be tax deductible at all. This aspect of the law has been the subject to many tax cases where taxpayers claimed expenses as repairs and the Receiver of Revenue was of the opinion that the expenses were not repairs because the Income Tax Act does not define what a repair is.The guideline the tax courts rely on to determine whether an expense is a repair or an improvement is that a repair is ‘renewal by replacement of a subsidiary part of the whole thing’.Therefore, a substantial restoration of a building or a vehicle can never be a repair.Furthermore, the voluntary use of improved materials to “effect the repair” can never be a repair.The tax courts have ruled that the redecoration of a building for aesthetic reasons is also not a repair for purposes of the Income Tax Act.It follows from the above wording that for an expense to be a repair, the condition of the asset has deteriorated due to use over time or has been damaged due to some event like an accident.The cause that requires the expenses to be incurred to restore the asset to it original state is not really relevant.The tax courts have also distinguished repairs from improvements by looking at the extent of the expenses that are required to restore the asset to its original condition.Where substantially the whole asset must be reconstructed the expense is usually regarded as an improvement and not a repair.The expense incurred to restore the roof of a building has been held by the tax court to be an expense incurred in respect of a subsidiary part of the building and therefore it was considered to be a repair and not an improvement.One of the requirements of the Income Tax Act regarding the tax deductibility of repair expenses is that they must be incurred in respect of property that is occupied for purposes of trade.The courts have interpreted this as meaning that the expenditure must have been incurred ‘for purpose of enabling the person to carry on and earn profits in the trade’.Therefore, repairs to a vacant property at the end of the lease period as a result of the treatment of the property by the tenant prior to the owner taking residence will not be tax deductible because the repair expenses are not incurred in respect of property occupied for purposes of trade.The court considered the fact that the expenses were incurred in respect of the use of premises during a period in respect of which income was received but concluded that the property was, at the time the expenses were incurred, not occupied for purposes of trade.To optimise your tax position where assets are repaired or renewed, careful panning should be done to ensure you maximise your tax deduction.The cash effect of having a tax deduction for repairs is effectively 65 per cent of the cash outlaid but if the expenses are considered by the Receiver of Revenue to be a renewal and not a repair, the cash effect of the expense is the actual amount paid to effect the renewal.* Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com