DECISION
Preliminary
1.
The issue in this appeal is whether £89,210, being the cost of
resurfacing part of the area occupied by the Appellants’ business, is
deductible as a trading expense for the Year to 5 April 2009. An
area covered with grass was resurfaced with hard-core materials. HMRC argues
that it represents an improvement and as such is capital and not deductible.
The law
Income Tax (Trading and Other Income) Act 2005 (“IT (TOI) A”)
Income and Corporation Taxes Act 1988 (“ICTA”)
Case law
Rhodesia Railways Ltd v Collector of Income Tax
[1933] AC 368
Highland Railway Co v Balderston 2 TC485
Transco plc v Dyall [2002] STC (SCD) 199
Samuel Jones & Co (Devondale) Ltd v CIR 17 TC93
Conn v Robins Bros Ltd (1966) Ch 266
Lawrie v IRC (1952) SC 39
Lurcott v Wakely & Wheeler [1911] IKB 905
J B Vale v Martin Mahony & Bros Ltd [1947] IR 30
Margrett v The Lowestoft Water & Gas Co [1935] 19
TC 481
Hodgins v Plunder & Pollak (Ir) Ltd [1957] IR 58
Wynne-Jones v Bedale Auction Ltd 51 TC 426
Phillips v Whieldon Sanitary Potteries Ltd 33 TC 213
The Evidence
2.
The only witness was Mr John Dalrymple Kirkcaldy. He is senior partner
of the Appellant firm which is a family business. He confirmed the terms of
his Witness Statement (produced as Appel/1) and elaborated on it in evidence-in-chief
and cross-examination. He explained that 70% of the customers of the Park were
families with children. The rest were largely older couples. He identified an
aerial photograph of the Park (Resp/5/24). The two grey strips on the right are
the resurfaced area. The work had been completed in a short “window” of
opportunity between October 2008 and March 2009. This avoided
disruption of the business as the touring caravan area was in use only from
March to October annually. Resurfacing with grass would have proved a longer
process with some disruption of lettings to touring caravans. The site is
licensed for 300 units, both permanent (or static) and touring caravans. There
are 60 pitches for touring caravans, the rest being for static ones. 25%
of pitch fees are derived from touring caravans. The photograph shows also the
Appellants’ administrative office, the shop, the indoor swimming pool, a toilet
and shower block, and a recreational area of woodland and open ground. Of a total
area of 51 acres, 14 are woodland and open ground. Over the years the
proportion of static caravans has increased relatively. Customarily their
owners have had touring caravans and have developed an association as customers
of the Appellants. They then have “progressed” to a static caravan,
customarily bought via the Appellants. Mr Kirkcaldy spoke proudly of
various environmental awards which have been won by the Park – one sponsored by
the naturalist, David Bellamy. Later in re-examination Mr Kirkcaldy acknowledged
certain unfavourable customer reviews of the new hard surface covering the area
for touring vans.
3.
In cross-examination Mr Kirkcaldy explained that the local
authority and Tourist Board were anxious to maintain the proportion of sites
for touring caravans. He indicated that the static caravan business was
preferable from the Appellants’ viewpoint. There was no need for communal
toilet provisions. While the shop was used more by the touring caravans, it
was not a source of profit, rather a “necessary evil”. There was a greater
need for office staff resources to manage bookings for touring caravans. These
required also a 24 hour warden service. Mr Kirkcaldy explained too in
cross-examination the very favourable costs and the immediate availability as
at Autumn 2008 of the materials which were used for the resurfacing works.
4.
We considered Mr Kirkcaldy to be a credible and reliable witness
and, indeed his evidence was not controversial. On the basis of it and the
correspondence and other documents to which we were referred, we make the
following
Findings-in-Fact
1. The
Appellants are a partnership constituted by Deed of Agreement dated
3 June 1998. John Dalrymple Kirkcaldy is the senior partner of this
family firm. Its business is that of a caravan park conducted at Cairnsmill
Farm, Largo Road, St Andrews. It rents sites for static caravans and also on a
short-term basis for touring caravans.
2. The
area occupied by the Appellants extends to about 51 acres. There is an
undeveloped area of about 14 acres, accessible to all patrons for recreational
use. Of the remaining area at the material time about 27 acres were devoted to
providing sites for static caravans. These are plumbed in for water and sewage
facilities. They are in use throughout the Year. The remaining five acres
were occupied by touring caravans, which the Appellants allowed to park there
from March to October each Year. These are brief lets although some touring
caravans are, by arrangement, parked there over the winter too. Many of their
owners decide to acquire a static caravan and to lease long-term a site for it
at the Park. It is the practice of the Appellants to select long-term lessees
on the basis of an extended relationship with them over several seasons as
owners of touring caravans. They will buy their static caravan via the
Appellants. 25% of total pitch fees come from the touring caravans. A
disproportionate amount of expenditure is required in servicing the touring
caravans, including staff engaged in booking and general service facilities.
3. The
Appellants provide also shop facilities, which are used mainly by the occupants
of the touring caravans. There is a toilet block with lavatory and shower
facilities, provided primarily for the occupants of the touring caravans.
There are play areas for children on the site which are used generally,
irrespective of whether they are staying at a static or touring caravan. There
is a 24 hour warden service provided for the touring caravans.
4. Commercially
the caravan park is run as one business, and all its sources of income are
inter-related in that one entirety.
5. In
Autumn 2008 the Appellants decided to restore the surface of the pitches let
out short-term to touring caravan customers. These extend to about three acres
and are shown as two grey strips on the copy photograph (Resp/5/24). There is
an area of grass remaining between each strip but there is no grass between the
individual pitches. The grass surface had deteriorated with use over about a
50 year period before. To restore the grass surface would have required the
area to be left largely vacant for about two holiday seasons to allow the grass
surface to become re-stabilised. Instead the Appellants replaced it with a
hard-core surface, consisting of a foundation made up from a former airport
runway surface (conveniently nearby for transport purposes and which had become
available at a relatively cheap cost at that time) and a top surface of loose
gravel.
6. These
works were completed well before March 2009. This enabled the Appellants
to let out the area restored from that date for touring caravans. While the
pattern of business was maintained, it was not improved. However, the surface
now resembles a car park and is much less aesthetically and environmentally
pleasing. It is less suitable as a recreational area for children. Annual
maintenance costs are marginally more than those incurred on the previous grass
surface. Erection of caravan awnings on the hard-core surface is problematical
as securing pins cannot be readily located on hard-core. Unfavourable customer
reviews have been generated as a result of the change of surface.
7. The
cost of the surface restoration work amounted to £89,210, the deduction of
which for tax purposes from the partnership’s profit has been refused by HMRC.
8. The
value of the Appellants’ business at about 2008/2009 was in the region of £4m.
It was not materially affected by the carrying out of the re-surfacing works.
Two valuations are produced, one about one year before and the other three and
a half years later (Appel/11-14). No reference is made to the state of the
touring pitch (either before or after the carrying out of the works) as
contributing to the value of the business.
9. The
decision to carry out the resurfacing works was prompted by a coincidence of
factors, viz the unsatisfactory state of the grass surface; the
availability of suitable materials for re-surfacing at a relatively cheap price
and nearby; and the avoidance of an extended period for the re-stabilisation
of the top surface.
Submissions
5.
While the factual background to the dispute was largely not
controversial, Parties differed materially in their interpretations of the
applicable law in determining whether the expenditure was of a capital or
revenue nature.
6.
On behalf of the Appellants Mr Simpson submitted that the question for
the Tribunal to determine was whether the expenditure on the replacement
hard-core surface was capital or revenue in nature. If it were capital, then
it is not allowable: Section 33 IT (TOI) Act 2005. In distinguishing
capital and revenue, he argued, one should identify the entirety of the
subject involved. If a whole or substantial part of the entirety is
replaced, that would represent a renewal and hence capital expenditure. But if
the replacement is of less than the whole or a substantial part of the entirety,
then the next question is whether an improvement has resulted. If the entirety
has been improved as a whole, the expenditure is capital in nature. Otherwise,
it is revenue expenditure and should be allowed for business tax purposes.
7.
Had the existing grass surface been replaced by grass, then the revenue
nature of the expenditure would have passed unchallenged, Mr Simpson
continued. Clearly, where no new asset has been created, expenditure would
ordinarily be revenue in nature.
8.
Mr Simpson referred extensively to the leading case-law distinguishing
repairs and renewals. He noted the criteria formulated by Buckley LJ in Lurcott
v Wakely & Wheeler at p924, viz:-
“Renewal,
as distinguished from repair, is reconstruction of the entirety, meaning by the
entirety not necessarily the whole but substantially the whole subject-matter
under discussion. ………………………………. the test is whether the act to be done is one
which in substance is the renewal or replacement of defective parts, or the
renewal or replacement of substantially the whole.”
He noted an Irish case (consistent with UK law) viz Hodgins v Plunder & Pollak, in which expenditure on renovating a
weigh-house at a factory was allowed as revenue. The reasoning was that no new
asset had been created. He relied also on the decision in Samuel Jones
& Co (Devonvale) Ltd v CIR. There the replacement of a factory chimney
by a new chimney was allowed as a repair: the chimney was only part of the
factory, which itself was the entirety (see p99-100). That decision
contrasted with Lawrie v CIR, in which an extended roof was erected to
cover an extended building. This represented capital expenditure, which, moreover,
could not be apportioned to allow as a deductible expense a fraction
proportionate to the size of the original dilapidated roof. Mr Simpson then
referred to the recent decision in Transco plc v Dyall, a Special
Commissioners’ decision, not appealed further. The taxpayers operated a gas
transportation system across Great Britain. The original cast iron pipes were
liable to fracture. Expenditure was incurred in inserting plastic piping into
the cast iron pipes to avoid the risk of gas leakages. The Commissioners
considered that the character of the asset was not changed by the work. It
fell therefore to be regarded as a repair, and revenue in nature, rather than a
renewal which would have been capital in nature. The expenditure accordingly
was allowed. He then referred us to the decision in Highland Railway
v Balderston, the case of a railway company where heavier rails were
substituted in the permanent way, resulting in an improvement of a section of
the line, bringing it up to mainline standards. While in a sense one kind of
rail had been replaced for another, viz steel for iron rails, it
resulted in a much more valuable railway and a transformation in its nature.
That accordingly was held to be capital expenditure and not deductible. He
then distinguished from the circumstances of the present case the nature of the
expenditure in Vale v Martin Mahony & Bros Ltd. There a woollen
mill replaced its sanitary accommodation. While the original provision was
satisfactory, the new provision was an improvement. It therefore fell to be
disallowed. Finally, Mr Simpson noted Margrett v The Lowestoft Water
& Gas Co, where the replacement of an old reservoir with a new one
which was an improvement, was considered to be capital expenditure and
disallowable.
9.
The entirety in the present case, Mr Simpson submitted, was the
caravan park, extending to the entire 51 acres, including the 14 acres used as
a recreational area. The two strips affected were only a minor part. The five
acres used for touring caravans was not a separate, divisible part of the
caravan park. The business should be viewed, he submitted, as embracing its
whole activities, both the static and the touring caravans. The static caravan
side of the business was a development arising from the touring caravans. The
shop and recreational facilities served both categories of campers. Indeed,
the common facilities indicated that the entirety was the whole park.
10.
A replacement of a subsidiary part is a repair, not a renewal. The
costs of the works should, Mr Simpson argued, be compared with the value of the
whole undertaking. On these criteria the caravan park as a whole had not been
improved. There had been no significant change overall, Mr Simpson suggested.
11.
By way of a reserve argument Mr Simpson suggested that even if the entirety
were restricted to the five acres occupied by touring caravans, the three
resurfaced acres were not a substantial part. A significant grass-covered area
remained. Additionally the block containing the lavatories and shower
facilities should be added, as it served only the touring caravans.
12.
Mr Simpson then considered whether the re-surfacing had improved the
park as a whole. The re-surfacing was not a “like for like” replacement. HMRC
had argued in correspondence (Respondents 5/40 and 50) that there was a greater
durability and climatic resistance and lower maintenance costs resulting. That
was questionable. The previous surface had lasted for about 50 years. Indeed,
maintenance costs now were slightly increased. But while the hard-core
re-surfacing avoided disruption of business activities, it detracted from the
ambience and aesthetic appearance of the Park. Grass better fitted the
business’ ecological ethos. It was a preferable surface for children to use.
Furthermore, there was no evidence of an increase in the overall value of the
Park.
13.
In short the hard-core re-surfacing was the cheapest and quickest
solution for the business, but it did not produce an improvement. Accordingly
Mr Simpson invited us to allow the Appeal.
14.
In reply on behalf of HMRC Ms Shields submitted that the expenditure
should be disallowed for tax purposes. She agreed with Mr Simpson that the
first consideration was to determine what was the entirety. Thereafter,
she argued (differing somewhat from Mr Simpson) that we should consider whether
there had been the replacement of the whole or a substantial part of the
business. Here the touring pitches generated 25% of the business’ income, and
the Appellants had decided to ensure its continuance by replacing the grass
with a hard surface. They could not afford to lose income by a delay in the
availability of the pitches. Accordingly, the touring area represented the
entirety and the works were not a repair but an overhaul. In any event the
entirety had to be judged by reference to what produces income. Here the
recreational land, the swimming pool, and (for practical purposes) the shop did
not yield income.
15.
In the present case the works undertaken created a permanent and enduring
advantage for the business, Ms Shields argued. This accrued to its fixed
capital. Accordingly the works represented more than a repair in that the land
or surface had to be excavated, replaced by entirely different material, viz
hard-core, and then surfaced with gravel. In effect a new asset had been
acquired.
16.
Ms Shields then reviewed the relevant case-law which, she argued,
supported her contentions. In Phillips v Whieldon the new barrier
constructed to protect the pottery factory from flooding from the nearby canal,
represented capital expenditure. There Donovan J concluded that the importance
of the new barrier was such that it represented the premises (or entirety)
for tax purposes. Somewhat similarly in Wynne Jones v Bedale Auction
Limited Foster J considered that expenditure in reconstructing the cattle
ring in the taxpayer’s auction mart was on the facts of that case, capital
expenditure on the basis that the premises (or entirety) were the ring
itself. Ms Shields sought to derive further support from Margrett v The
Lowestoft Water & Gas Co where expenditure on a water-tower and
the construction of a new reservoir, of twice the size and with other
improvements on the previous one, was held to be capital in nature. At p488 it
is observed that while repair involves renewal, it is renewal of a part, of a
subordinate part.
17.
Ms Shields made reference also to the decisions in Rhodesia Railways
Ltd, Conn v Robins Bros Ltd, Lurcott v Wakely & Wheeler and Vale v
Martin Mahony & Bros Ltd. The decisions there, she submitted, were
consistent with her argument that the expenditure in this case brought into
being a new improved capital asset. Accordingly the expenditure should be
disallowed for tax purposes and the Appeal should be refused.
Conclusion
18.
Both Ms Shields and Mr Simpson addressed us helpfully on the case-law
cited. The distinction between capital and revenue in the context of
expenditure on repairs and renewals is essentially a question of fact. The
inference to be drawn depends on each individual case. We have recorded
Parties’ arguments on the case-law in the preceding section of our Decision.
In the abstract these summaries did not seem controversial, and we do not
propose to rehearse the substance of them again. However, we would note the
following observations in Transco:-
[79] “…
we derive the principle that the replacement of part of an asset is repair,
that that is not altered by the fact that the replacement of part is by a new
component of different materials, and that a test to decide whether there is a
repair or an improvement is whether the character of the asset is changed by
the work. Repair occurs when part of a complex whole is renewed or replaced
and renewal occurs when substantially the whole is reconstructed or when the
character of the subject-matter changes. In the present appeal the evidence
supports the conclusion that it was only small parts of the complex whole of
the network which were renewed each year and that it could not be said that
substantially the whole was reconstructed nor did the character of the
subject-matter change. It remained a pipeline throughout which gas was
transported; neither the pressure nor the capacity was materially increased.”
19.
The first aspect to be determined is identifying the entirety of
the subject which has been repaired. In our view the entirety is the
whole caravan park. The enterprise is integrated physically and commercially.
There is no physical barrier within the area of the Park, segregating the types
of custom. Commercially there are certainly two categories of customer – the
owners of fixed caravans and those owning touring caravans. However, the
touring caravan custom is the source of the sales by the Appellant of fixed
caravans and of the leases of permanent sites. Indeed, it provides a means of
filtering suitable long-term tenants from the Appellants’ point of view.
20.
Apart from the shower and toilet block which is used primarily by the
touring caravan custom, the other facilities at the Park are used, albeit to
varying degrees, by both categories of custom. The shop, recreational areas,
and the open land extending to some 14 acres or so are used by both
groups.
21.
On that view the area of the Park which has been resurfaced is only a
very small part of the entirety. It extends to three acres out of a
total area of 51 acres.
22.
The next aspect to decide is whether there has been an improvement
and, further, whether that affects the entirety as a whole. That was
the somewhat technical approach which Mr Simpson invited us to follow. We
think that this is sound-in-law, and we would refer to the observations of Lord
Carmont in Lawrie at p401:-
“The
importance of considering an entirety is, of course, with a view to determining
the character of the work done, because what might at first look like a renewal
may, when applying the matter to a larger unit, be shown to be only a repair.”
23.
In the correspondence between HMRC and the taxpayers’ accountants the
former suggested that the hard-core surface is more durable than grass and
consequently and quite simply is thus an improvement. That inference
may have a superficial attraction. However, as the evidence emerged, other
considerations arose. Durability seems questionable as the original grass
surface had been in existence for about 50 years (para 10 of
Mr Kirkcaldy’s Witness Statement – and not challenged in
cross-examination). Maintenance costs of the new hard-core surface are, if
anything, marginally higher. The hard-core has less aesthetic appeal: it is
like any hard-surfaced car park. It is not suitable as a recreational area for
children. Securing a typical camping awning on a hard surface is problematical
inasmuch as fixing pins cannot easily be located. This, in fact, has generated
customer complaints.
24.
We do not consider that that part of the Park ie the area allocated to
touring caravans, has been enhanced or improved as a result. Also in the
broader context of the Park as an entirety we do not consider that it
gives rise to an improvement. In the valuations produced before and after the
works were undertaken, there is no suggestion of an improvement or resulting
enhanced value.
25.
The most obvious advantage to the Appellants of re-surfacing in this
manner was that it avoided a serious disruption of their lettings for touring
caravans over an extended period. A “like for like” re-surfacing with grass
would not have stabilised and been suitable for use for up to two years. An
immediate contributing incentive was the availability of suitable materials
(the surface of a runway at nearby Leuchars Air-base) as a hard-core
foundation, at an attractive price, and with minimal carriage costs.
26.
For all of these reasons we consider that the expenditure of £89,210 on
re-surfacing with hard-core is a revenue expense, deductible for tax purposes. The
Appeal is accordingly allowed.
27.
Finally, we would record our thanks to both Ms Shields and Mr Simpson
for their presentation of their respective arguments and their analyses of the
authorities cited.
28.
This document contains full findings of fact and reasons for the
decision. Any party dissatisfied with this decision has a right to apply for
permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure
(First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be
received by this Tribunal not later
29.
than 56 days after this decision is sent to that party. The parties are
referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax
Chamber)” which accompanies and forms part of this decision notice.
KENNETH MURE, QC
TRIBUNAL JUDGE
RELEASE DATE: 5 March 2013
