Interpretation Note 74: the Deductibility of Expenditure on Repairs
09 September 2013
Posted by: Author: PwC
Interpretation Note 74, issued by SARS on 6 August 2013, is a collation of fundamental principles regarding the deductibility of expenditure on repairs (and the recoupment of such expenditure) in terms of section 11(d) of the Income Tax Act 58 of 1962 and the principles, as laid down in case law, regarding the distinctive features of a repair as contrasted with other categories of expenditure.
The Note commences with the general observation that –
‘expenditure on repairs to an asset not comprising trading stock is likely to be of a capital nature, particularly when it is not incurred at regular intervals’.
This is a puzzling proposition on several grounds.
Firstly, in the context of income tax, a repair is usually regarded as being, by definition, expenditure that is not of a capital nature, as distinct from expenditure on an improvement or reconstruction, which is capital in nature. Implicitly, however, this dictum seems to countenance that certain expenditure, though involving a repair will nonetheless be of a capital nature and – on that ground – non-deductible.
The rationale for the deductibility of expenditure on repairs
The Interpretation Note goes on to defend the proposition, quoted above, that expenditure on an improvement or reconstruction is not deductible by saying that expenditure on repairs is of a capital nature where –
‘the expenditure relates to the protection of a capital asset’.
Although the Interpretation Note cites a Tax Court decision as authority for this proposition, its validity in this form is doubtful. A repair does not ‘protect’ a capital asset in the usual sense of that word – it restores the asset to its prior condition.
Nor is it true, as a general proposition, that expenditure that ‘protects’ a capital asset is necessarily of a capital nature. For example, there seems little doubt – although there has not been a specific reported decision to this effect – that where a business employs a watchman or security guard to protect its capital assets, the wages paid to that person are not of a capital nature and are deductible under section 11(a) of the Income Tax Act.
The distinctive characteristics of a ‘repair’
The Interpretation Note goes on to affirm, in principle, the distinction between deductible expenditure on a repair and non-deductible expenditure on an improvement. The Interpretation Note, however, concedes that a repair inevitably effects a measure of improvement, in that the asset is in a better condition after the repair than before it. This paradox is a source of uncertainty in tax law. The Note goes on to quote a dictionary definition to the effect that to repair means –
"to restore (something damaged or broken) to good condition or working order”.
The Interpretation Note says in this regard that –
‘In order to determine whether an expense will constitute a repair it is necessary to establish the meaning of the word "repairs” as used in section 11(d). The Act does not contain a definition of the word "repairs” and it must, therefore, be given its ordinary grammatical meaning.’
While not wholly incorrect, this unqualified assertion of the predominance accorded to dictionary definitions is somewhat surprising in the light of the recent, seminal decision of the Supreme Court of Appeal on the principles governing the interpretation of statutes, in which the court unequivocally signalled a movement away from looking at the meaning of words, shorn of their context – which is of course precisely what a focus on the grammatical meaning of a word entails.
Thus, in Natal Joint Municipal Pension Fund v Endumeni Municipality 2012 (4) SA 593 (SCA) the Supreme Court of Appeal said that –
‘Over the last century there have been significant developments in the law relating to the interpretation of documents, both in this country and in others that follow similar rules to our own’.
The court then went on to say (at para ) that –
‘Most words can bear several different meanings or shades of meaning and to try to ascertain their meaning in the abstract, divorced from the broad context of their use, is an unhelpful exercise.’
The Interpretation Note makes no attempt to follow the approach favoured by the Supreme Court of Appeal in this case which acknowledges –
‘The stress placed in modern statutory construction on the purpose of the statute and identifying the mischief at which it is aimed ...’
The Interpretation Note cites the decision in ITC 617 (1946) 14 SATC 474 which distilled the following principles from prior case law –
- • ‘Repair is restoration by renewal or replacement of subsidiary parts of the whole. Renewal as distinguished from repair is reconstruction of the entirety, meaning by the entirety not necessarily the whole but substantially the whole subject matter under discussion.
- In the case of repairs effected by renewal, it is not necessary that the materials used should be identical with the materials replaced.
- Repairs are to be distinguished from improvements. The test for this purpose is – has a new asset been created resulting in an increase in the income-earning capacity or does the work undertaken merely represent the cost of restoring the asset to a state in which it will continue to earn income as before?’
There is established authority for all of these propositions, and they have indeed become a mantra in tax literature. However, the Interpretation Note throws no new light on the difficulties inherent in the first and third of these propositions.
The Interpretation Note cites and quotes from decisions in this regard, but without venturing a view on the criteria that characterise an entirety. This question is particularly important in the current era where, particularly in the field of computers and other electronic equipment, faulty components are seldom repaired and are merely replaced. Thus, the Note quotes from the decision in ITC 617 (1946) 14 SATC 474 in which the court considered the deductibility of various expenses incurred on a racecourse, comprising a number of buildings and a race track. In this case, the Tax Court merely asserted and concluded, without advancing reasons, that the track as a whole was the entirety and the court did not lay down any governing principles, saying merely that –
"[A]s far as the buildings are concerned the general principles applicable to the repair of each building as constituting a separate and distinct subject matter, are applicable to that particular building, whether used for one purpose, or conjointly for several purposes. In the case of the race-track or course itself the whole subject matter is to be regarded as comprising the track itself, the rails along it and the starting gates, discs indicating distances and so on.”
Maintenance as distinct from repair
The Interpretation Note goes on to discuss whether repair includes maintenance. Again, the Note takes as its starting point a dictionary definition and quotes The Concise Oxford English Dictionary to the effect that maintenance is –
‘the process or state of maintaining or being maintained’,
and that maintain means to –
"cause or enable (a condition or state of affairs) to continue, keep at the same level or rate; keep (a building, machine, etc.) in good condition by checking or repairing it regularly”.
The court cites the decision in Heerman’s Supermarket (Pty) Ltd v Mona Road Investments (Pty) Ltd 1975 (4) SA 391 (D) at 396 where van Heerden J considered the meaning of the words repair and maintenance in the context of a lease agreement and the question whether the wide dictionary meaning of the word repair was wide enough to cover maintenance. In that case, a lessor had claimed that it was liable for repairs but not for maintenance under the provisions of the lease agreement. The court held that the word repairs was capable of covering maintenance.
In Clanwilliam Municipality v Braude 1954 (3) SA 657 (C) the court expressed the view that –
‘the words "maintenance” and "repair” have "connotations which differ in accordance with the objects and circumstances to which they are applied’
Regrettably, the Interpretation Note does not explicitly make the important point that context is vital in determining meaning and that an expression, such as repair, may mean one thing in the context of tax legislation and another in the context of a contract. Nor does the Note discuss the respective spheres of application of the general deduction provisions in section 11(a) and the specific provisions of section 11(d) in relation to expenditure on repairs. Thus, in the context of repairs, does section 11(d) merely cover expenditure that would have been encompassed by section 11(a) in any event?
The Note is undoubtedly correct where it says that –
‘Expenditure incurred on maintenance will be deductible under section 11(d) provided it complies with the essential elements of a repair and the other requirements of that section.’
The distinction between repairs and improvements
The Interpretation Note distils the following principles, as emerging from case law, in regard to the fundamental distinction between deductible expenditure on a repair and non-deductible expenditure on an improvement:
- • Has a new asset been created, resulting in an increase in the income-earning capacity, or does the work undertaken merely represent the cost of restoring the asset to a state in which it will continue to earn income as before?
- Unless the structure or article on which repairs are deemed to have been done was damaged or had deteriorated, and replacement was required, no repair for the purposes of section 11(d) has taken place and no further inquiry need be made.
- Materials used for the repair need not be identical to the original materials that are being replaced. As long as the purpose of the work is to restore the asset to its original condition, as distinct from creating an improvement, the work constitutes a repair. The fact that new materials are substituted for the old at a greater cost than would have been incurred had the same materials been used is not relevant. Each situation must be decided on its own merits in order to determine whether the use of new materials is for the purpose of improvement or merely for the purpose of restoring the asset to its original condition.
- Repairs undertaken at the same time as improvements may qualify for deduction under section 11(d) if they can be clearly and separately identified from the improvements. Much will depend on the facts of the specific case and the taxpayer will bear the onus of showing that what was undertaken was a repair. In ITC 1457 (1989) 51 SATC 131 (T) the taxpayer had converted residential flats on the upper floor of a two-storey building into offices after the flats had fallen into disrepair. A quantity surveyor could identify certain of the work as repairs.
While there can be no arguing with the accuracy of this summary, it adds no new insights.
This Interpretation Note is a useful collation of long-established principles in regard to nature of a repair, but it sheds no new light on the unsettled questions in this area of tax law. The most striking omission from the Note is the failure to consider whether the principles of statutory interpretation, recently laid down by the Supreme Court of Appeal in Natal Joint Municipal Pension Fund v Endumeni Municipality 2012 (4) SA 593 (SCA) necessitate a reconsideration of the way in which the courts have hitherto interpreted the expression repair in the context of section 11(d) of the Income Tax Act.
If the principles of interpretation, laid down in that decision were to be applied in the debate as to what constitutes a repair, account would have to be taken of the internal logic of the Income Tax Act, and the underlying purpose of the distinction between expenditure that qualifies for outright deduction and that which qualifies for deduction in instalments, spread over the productive life of an asset.
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