Amounts written down in the accounts in respect of repairs and improvements to a property acquired by the taxpayer, which was transferred by way of a bonus to a director, were not deductible expenses for corporation tax purposes.

The taxpayer appealed to the First Tier Tribunal against assessments in respect of accounting periods to 31 October 1998 and 1999. The issue for the Court was whether amounts written down in the accounts for the relevant periods in respect of a property and associated expenditure, where the intention was to transfer the property in specie by way of a bonus to a director, were allowable corporation tax deductions.

Facts

The company (taxpayer) handled the exploitation of image rights for Mr Lion, who was a director of the company along with his wife. The taxpayer purchased a property in September 1998 with the intention of making a payment in kind to Mr Lion by way of a discretionary bonus of the property, once the repairs and improvements had been carried out.

The purchase price of the property including associated costs was £850,000. Subsequent amounts for repairs and improvements were £750,000 bringing the total expenditure on the property to £1.6million. Mr Lion and his wife occupied the property in February 1999 while it was still owned by the taxpayer. The occupation by the directors was disclosed as a benefit P11d item for 1998/99 and 1999/00.

The taxpayer transferred the property to the directors to hold as joint tenants by way of a discretionary bonus for Mr Lion in July 1999. The property at the date of transfer was valued at £1.2million.

The accounts were prepared correctly in accordance with GAAP and the property was treated in the accounts as a current asset. The taxpayer's profits over the period were reduced by the aggregate cost of around £1.6million; £1.2 million represented the bonus (being the value of the property at the date of transfer) and the balance represented the written off costs of additions to the property.

The amount of the bonus paid to Mr Lion of £1.2million was not in dispute and correctly treated as a deductible expense by the taxpayer. The dispute brought to the Court was in respect of the costs of the additions to the property that were written off in the accounts.

Among the arguments put forward by the taxpayer was that the property was acquired on a revenue account and not capital and as such the deduction was not prohibited by section 74(1)(e) of the Income and Corporation Taxes Act 1988 (“TA”) and the relevant distinction was not determined solely by whether there had been a trading transaction. Further the accountancy treatment, while not determinative of capital/revenue distinction, was very relevant. HMRC's disagreed and stated that the case must be determined by reference to established case law and not accountancy practice. The loss in this case did not arise from the trade as the taxpayer did not deal in property. The loss was a capital loss on disposal of a capital asset.

Decision

In reaching a conclusion, the Court declared that “a judicial common sense in all aspects of the case” was adopted. The starting point was to consider the nature of the deduction sought by the taxpayer. In this case it did not relate to an expense but to the writing down of the value of an asset which was not admittedly trading stock of the taxpayer. The asset was a freehold property and so had the inherent enduring quality which led to the initial assumption that where the taxpayer's trade did not include dealing in land, expenditure on the acquisition and improvement of the property was capital in nature.

According to the Court, the fact that an asset was owned for a short period did not change the character of an asset held on a capital account to one on a revenue account. The Court considered that the loss or write down on the property was capital and this was not outweighed by the short term the property was held or the purpose for which the expenditure was incurred by the taxpayer. The purpose was to pay a bonus to Mr Lion and that payment was by means of transfer in specie of the property which was revenue to the extent of the value transferred. The loss or write down in value was capital.

It was the quality of the asset that was relevant in the current case. The status of the asset had to be determined by its own particular characteristics. The Court did not accept the taxpayer's argument that the loss or write down incurred was itself in the nature of a gift or bonus. The bonus in the case for which a deduction had been obtained was of the value of the property. It was not the loss or write down as this related to the holding of the property as a capital asset.

The loss or write down was not affected by the accounting treatment of the property as a current asset. The criteria that applied for accounting purposes which resulted in the asset being treated as a current asset was not the same as the distinction as a matter of law between capital and revenue. In this case, the relevant accounting criteria concerned the early realisation of the property and such criteria could not change the nature of the asset or be determinative of the capital/revenue question. Therefore, the accounting treatment had no affect on the Courts conclusion that the loss or write down was on capital account.

The case is available to download at http://www.financeandtaxtribunals.gov.uk/Aspx/view.aspx?id=4660