A look at pre-letting expenses and the issue of whether repairs are a capital or revenue expense
Profits from UK land or property are treated, for tax purposes, as arising from a business. The broad scheme is that rental business profits are computed using the same principles as for trades (ITTOIA 2005, s 272). Expenses are allowable if they are incurred ‘wholly and exclusively’ for the rental business.
If a property is let at less than the full commercial rent, any expenditure relating to that property will normally fail the ‘wholly and exclusively’ test. Although, strictly, no expenditure on such properties is admissible as an expense of the rental business, expenses can be deducted up to the amount of rent derived from that property.
Usually a rental business begins when letting first commences.
Allowable revenue expenditure incurred before the rental business begins can be relieved under the ICTA88/S401 or ITTOIA05/S57, provisions for pre-trading expenditure. Relief is only due if the expenditure:
Thus, for example, council tax on a property could be allowable under the above rules if it is due before the property is first let, provided the property was acquired solely for the purposes of the rental business. However, the relief is not allowable if the council tax was paid on the taxpayer’s own private residence before the property was let (as it would be the taxpayer’s own expense).
Qualifying pre-letting expenditure is treated as incurred on the day on which the taxpayer first carries on their rental business. So, any repairs carried out before the letting starts can still be deducted from the first year’s gross rents.
Pre-letting expenses have been challenged successfully by HMRC in Law Shipping Co Ltd v CIR 12 TC 62. Pre-letting expenses were disallowed on the key point that a ship was bought in a defective state and could not be used until the repairs had been undertaken.
This can be contrasted with the expenditure in Odeon Associated Theatres Ltd v Jones 48 TC 257, where the dilapidated state of cinemas was due to the accumulation of repairs in wartime (and just after) when building work was not permitted to be carried out. The courts allowed the deduction.
Although both companies purchased assets in poor condition, there were key differences between the two cases:
The following factors should be considered: