BIM35330 - Capital/revenue divide: general themes: the doctrine of the ‘entirety’

Repair involves replacement - but what is the entirety?

When subject to detailed examination, most repairs are found to involve the replacement of defective parts but the replacement of old parts with new ones does not make the expenditure capital. The courts have used the concept of the ‘entirety’ to distinguish revenue repairs from capital expenditure. If the entirety is replaced then the expenditure is capital. If less than the entirety is replaced then the expenditure is likely a repair. The issue very much revolves around matters of fact and degree as is demonstrated by the cases below.

In Bullcroft Main Collieries Ltd v O’Grady [1932] 17TC93 the colliery chimney which carried away the smoke and fumes from the furnaces became dangerously unsafe. The chimney was a structure quite separate from the other surface buildings, connected to the furnace only by the flues. The company constructed a new chimney on a site nearby. The new chimney was admitted to be an improvement over the old. The old chimney had been replaced, not repaired, and the company claimed an allowance based on the estimated cost of a like for like replacement. The Special Commissioners decided that the cost of replacing the chimney was capital.

The High Court concurred with the Specials. At page 101 Rowlatt J explains that every repair involves a replacement but the critical question is what is the ‘entirety’. Replacing the entirety is not repairing the old, but having something new:

Of course, every repair is a replacement. You repair a roof by putting on new slates instead of the old ones, which you throw away. There is no doubt about that. But the critical matter is…what is the entirety? The slate is not the entirety of the roof. You are repairing the roof by putting in new slates. What is the entirety? If you replace in entirety, it is having a new one and it is not repairing an old one. I think that it is very largely a question of degree, but it seems to me the Commissioners have taken the only possible view here.

The case of Samuel Jones & Co (Devonvale) Ltd v CIR [1951] 32TC513, provided a contrast to Bullcroft. The company carried on a trade of paper processing. The company’s factory chimney was situated in the middle of the factory in a block of buildings containing furnaces and steam boilers. The chimney was old and had become unsafe. A new chimney, which was not an improvement, was built close to it. The flues were extended and connected to the new chimney. The old chimney was demolished. The Special Commissioners regarded themselves as bound by Bullcroft. They decided that the cost of the new chimney was capital expenditure. But they decided that the cost of removing the old chimney was getting rid of an encumbrance and was revenue.

The Lord President decided that the whole of the expenditure was admissible. The new chimney was physically, commercially and functionally an inseparable part of an entirety. The entirety was the factory. The chimney was doubtless an indispensable and integral part but nonetheless one of many subsidiary parts of a single industrial profit-earning undertaking.

The courts used the ‘entirety’ approach in Margrett v The Lowestoft Water & Gas Co [1935] 19TC481. The company had an old reservoir, which was of an open type. The old reservoir was beyond repair. A new covered type on a site some distance away replaced the old reservoir. The General Commissioners held that it was partly a renewal and allowed an amount, to be agreed by the parties. Finlay J thought that the reservoir was more clearly a separate and distinct thing than the Bullcroft chimney. He said that the Commissioners had erred in law because there was no evidence upon which they could arrive at their conclusion. At page 488 Finlay rules out the possibility of a deduction for notional repairs; what the company would have spent restoring the reservoir to original performance if they had not decided to have a new one:

I think that the expenditure on the new reservoir was a perfectly simple example of capital expenditure and was not in any sense expenditure upon repairs. If they had repaired the old reservoir they would have incurred a certain amount of expense, but it seems to me that that does not make it possible to dissect the capital sum which they spent upon the new reservoir and to say that that amount which would have been spent in repairing the old reservoir can notionally be treated as being a sum expended for repairs. The answer is that that is not what happened. They have chosen not to repair the old but to build a new reservoir, and that is just capital expenditure.

Further light on the 'entirety' concept was given in Phillips v Whieldon Sanitary Potteries Ltd [1952] 33TC213. The company’s factory was adjacent to a canal and had been protected by an embankment. The embankment suffered from subsidence. Water seeped into the factory. As a result of colliery workings the factory also suffered from subsidence. The old brick and earth embankment was removed and an iron and concrete barrier constructed. The General Commissioners decided that this was a replacement and a proper deduction. Donovan J reversed the decision, explaining at page 216 that a finding that something was a replacement and not a new asset was inconclusive of the issue, capital or revenue:

That decision is one of fact, and I cannot interfere with it if there is some evidence to support it…to say that something is a replacement and not a new asset tells you nothing which enables you to conclude whether the expenditure involved was of capital or revenue. Supposing the whole factory wall had fallen into the canal and had to be rebuilt, would the cost of the new wall be revenue expenditure merely because the old wall had been replaced? Clearly not. I cannot, therefore, accept as evidence justifying the Commissioners’ decision the mere fact that the new barrier replaced the old. Before me, however a new point was taken, namely that the construction…was a repair…and therefore allowable (under what is now ICTA88/S74 (1)(d)).

What is the premises entirety is a question of fact and degree calling for, at times, fine judgement. It does not have to be the physical whole of the trader’s site. The work undertaken can be of sufficient scale and importance to be capital. In Whieldon Sanitary Potteries, Donovan J reviewed the Bullcroft and Samuel Jones cases and explained the meaning of 'premises' in this context at page 219:

In my judgement, the 'premises' for the purposes (of what is now ICTA88/S74 (1)(d)) may sometimes be the whole of the trader’s business premises and may sometimes be a specific building forming part of these premises. Thus, if a factory window were blown out and had to be repaired, it would be obviously wrong to argue that as the entirety of the window had been restored it was not a repair to the premises. In such a case the 'premises' would be the entire factory, in relation to which the window would be a repair and nothing else. But if, for example, a retort house in a gasworks was destroyed and had to be rebuilt, one would hardly call that a repair to the gasworks. The size of the retort house would compel one to regard that as the premises; and since it had been replaced in full it could not be said to have been repaired. These examples illustrate what I think is the truth, that there is no one line of approach to the problem which is exclusively correct. In some cases it will be right to regard the premises as the entire factory, and in others as some part of the factory. Whichever alternative is the right one to adopt will depend upon the facts of the particular case. Rowlatt J, took the view…(in theBullcroftcase)...that he must regard the chimney itself as the premises, or, as he described it, the 'entirety', and I would respectfully agree with him.

The Court of Session took the view...(in theJonescase)...that the whole factory must be regarded as the premises. The difference thus exhibited is not a difference of law, but of the right conclusion of fact to be drawn in particular instances…

…Having regard to the size and importance of the new barrier in relation to the factory as a whole, I think it is proper to regard the barrier itself as the premises…and as the barrier is a new one I cannot regard it as a repair to the old...

Apart from this, there is always the question whether, although a particular expenditure may come within the deductions impliedly allowed by (what is now ICTA88/S74) it is inadmissible because it is of a capital nature…

I am of the opinion that this is a clear case of capital expenditure. I reach this conclusion taking into account the extent of the work, the permanent nature of the new barrier, the enduring advantage it confers upon preserving part of the fixed capital of the business, and the contention of the company that it was essential to enable the trade to be carried on. It is irrelevant, in my view, in the present case, to consider whether the new barrier, in point of size or effectiveness, is or is not an improvement on the old, and there is no finding upon the point. There can be cases where the work done may result in no improvement, but merely reinstatement, and yet be work involving capital expenditure on account of its size and importance. This, I think, is such a case,…

You see that Donovan took the view that the barrier itself was the entirety (the premises). Since the barrier had been replaced with a new one, the work could not be regarded as a repair. You should also note that Donovan considered that there can be cases where the work done does not result in any improvement, merely reinstatement, but is nonetheless capital because of its size and importance. In the Auckland Gas case (see BIM35470) Lord Nicholls gives recent support for this line of argument.