Is the cost of repairing a charter yacht a revenue or capital expense?

Question - Is the cost of repairing a charter yacht a revenue or capital expense?

A client with a 'skippered' yacht charter business had the yacht she uses in that business subject to a survey before it was to be sold.The survey disclosed osmosis,the process by which water molecules penetrate the hull and causes blisters.The client chose to have the yacht professionally treated and repaired to make it (please excuse the pun) saleable.

Can the treatment cost be considered as a revenue expense for tax purposes?

The treatment required the yacht's removal from the water and a period of months 'drying out'. This significantly curtailed its use in the business and, as a consequence, it reduced the income that would normally have been generated.

No VAT was paid on purchase of the yacht, which was kept in the client's name, but the charter business is VAT-registered. Would the sale of the yacht be liable to VAT output tax?

Query 18,984- Mr Slocum.

Answer - Is the cost of repairing a charter yacht a revenue or capital expense?

Osmosis in severe cases can lead to leakages and in time can affect the value of the yacht. The longer the gap of rectifying osmosis can result in repair costs increasing into thousands of pounds and have the yacht out of action for longer.

Paying to treat the yacht from osmosis will restore it to its original condition and prevent further damage. Depending on the severity of the osmosis,the yacht can be out of action for long periods, having as mentioned an effect on the trade income. Treatment will also ensure that the value to the yacht is not diminished.

But whose cost is it? The yacht is owned personally and so the expenses would be a personal hit. Any costs paid by the business would be seen as a distribution of profits rather than a trade cost. I would imagine that the business already pays a rent for use of the yacht, which would be an allowable cost for the business.

Had the yacht been owned by the business I would have been inclined to treat the expense incurred as repair costs and therefore allowable as a trade expense. This is on the assumption that the yacht charter trade continues following the treatment. Any enhancement to the value of the yacht following the repair costs will not change the classification of the expense.

Cases such as Law Shipping Company v CIR 13 TC 1 and Odeon Associated Theatres Limited v Jones[1993] STC 537 can be considered. There are also the enduring benefits tests that could determine whether an expense is revenue or not.

Consideration on proportion of expenses may be required if the yacht is not used 100% for business purposes.

Paperwork on the purchase of the yacht should be reviewed as in the majority of cases the purchase of a yacht used by an EU residential will be inclusive of VAT. Yachts generally do not fall within the definition of a 'qualifying ship' and so VAT would be standard rated rather than zero rated. This point may want to be reviewed depending on the size and use of the yacht.

On reviewing the five basic conditions that are used to determine whether a supply should be vatable, two of the conditions are not met by the individual. Conditions not met by the individual are the supply is made in the course or furtherance of business and by a taxable person. Based on this I would not imagine VAT to be charged on the sale of the yacht. However, the purchaser may require evidence of its original purchase to see if any VAT was ever paid or 'deemed' to be paid.

For help on a personal tax matter, speak directly to Reshma Johar at reshma.johar@raffingers.co.uk.

Credit: Taxation