Capital vs revenue expenditure
Knowing whether business expenditure is revenue or capital is essential to the preparation of correct accounts and tax returns, but it is sometimes difficult to decide what is the right treatment. HM Revenue and Customs (HMRC) has recently updated its guidance on the most common errors.
First the basics: revenue expenditure is deductible in computing taxable profits; capital expenditure is not deductible, but it may qualify for capital allowances. Currently up to £500,000 a year of capital expenditure on plant and machinery (not cars) qualifies for the annual investment allowance and is deductible in full. This allowance will fall to £200,000 a year from 1 January 2016. Capital expenditure that is over the limit, and also the cost of buying most cars, qualify for writing down allowances at 8%or 18%.
Identifying revenue costs
Establishing the precise nature of expenditure is therefore essential. The key is to keep full and accurate records of each item of expenditure, what it is for and the circumstances in which it was incurred, especially where it is part of a bigger project. This will allow identification of all revenue costs that arise in conjunction with capital expenditure so that they can be deducted correctly. Conversely – and this is what concerns HMRC – we will be able to ensure your tax return does not claim any impermissible costs.
Refurbishment of property is one area that HMRC looks at carefully. The general rule is that the cost of repairs is revenue expenditure, but improvement and alteration are treated as capital costs. Work on a building may include both types of expenditure, so your records need to be detailed enough to make an apportionment, and to determine the nature of capital expenditure so that the correct rate of writing down allowance can be claimed.
Legal and professional fees are another area that can attract HMRC attention. The cost of acquiring an asset or other advantage of enduring benefit to the business is capital, but many people also overlook the fact that the cost of an unsuccessful attempt to acquire an asset is also capital. Such abortive expenditure cannot be added to the cost of any asset and so it may be charged to the profit and loss account. However, it is not deductible as revenue expenditure, nor can it qualify for capital allowances.
Also featured in HMRC’s updated guidance are the costs connected with the structure of a company or partnership, including incorporating a sole trader business. Such costs are treated as capital costs, but expenditure on recruiting a new partner is generally revenue. Training courses for a proprietor or partner are capital if their purpose is to acquire new skills, but they are revenue items if the aim is to update expertise that they already have.
Whether the cost of acquiring a computer software licence is revenue or capital depends on the expected useful economic life of the software. Under two years economic life and it is a revenue cost, but if it is more than two years, the expenditure should be capitalised. A sole trader or partnership will then be able to claim capital allowances, but for a company it may fall within the intangibles regime. Expenditure on website development also requires careful analysis.
We can help you categorise your expenditure correctly so please contact us.
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