Repairs and maintenace (R&M) expenditure – capital or revenue?

The phrase ‘repairs and maintenance’ (R&M) is typically used to refer to costs for repairing, altering or maintaining a capital asset. These costs are immediately deductible if they are revenue in nature and not subject to the capital limitation.  In practice it can be difficult to determine whether costs are of a capital or revenue nature, as there is no succinct legislated provision to be ‘ticked off’.  Instead, the question is answered with reference to a considerable body of case law and the specific facts in a given scenario.

In June this year, the IRD finalised its Interpretation Statement (IS 12/03) setting out its view on what it considers the general principles for determining whether expenditure qualifies as R&M. The statement has replaced previous commentary issued by the IRD.  Although the IRD’s view has not changed in any substantial way, the latest statement is 55 pages, compared to the previous five page statement released in 1994.

Broadly, a two step process is used to determine whether expenditure is R&M.  Firstly, the relevant asset is identified.  Secondly, the nature and extent of the work is considered in the context of that asset.

As a general rule, if work carried out on an asset results in the reconstruction, replacement or renewal of the asset or substantially the whole of the asset, the cost of that work will not qualify as R&M.  However, costs to repair or maintain an asset, or restore an asset to its original condition, without going so far as to reconstruct, replace or renew it, will qualify as R&M and will be deductible.

The line between restoration of an asset versus its renewal can be difficult to identify and one of the examples provided by the IRD is of concern as it indicates that a tougher view is to be taken by them in future.

Example 23 of the Interpretation Statement involves a residential rental property in a good state of repair that was damaged in an earthquake.

To get it back to a tenantable state, the foundations are replaced, the floors reconstructed and three external walls are rebuilt and the roof replaced. The IRD considers the costs would be capital in nature as the work results in the “effective renewal” of the asset.

However, case law provides strong support for this work being revenue in nature and therefore R&M.  That case law suggests the work is to repair something that previously existed, it is not to produce something new, it does not significantly improve the asset or make it different in kind by changing its character, and thus does not increase its value or extend its useful life. It does no more than restore it to its original condition and should therefore qualify as R&M.

The Interpretation Statement sets out the current view and therefore reflects the view that can be expected to be taken by the IRD’s investigators. Unfortunately, it is a matter of opinion, not fact, as to whether it is correct.

Published Spring 2012.

Serious about your success?