Capital or revenue expense?

Trustees of a settlement giving a life interest to A with remainder to A’s children have acquired a property intended to provide the trustees with rental income for the benefit of A. The Trustees took a loan at commercial interest rates secured on the property and other property held by the Trustees to pay the purchase price. Is the interest payable on that loan a capital or revenue expense for trust account purposes (not for tax purposes) or partly one and partly the other. If the Trustees have a discretion to exercise in how the interest is treated what factors should or may they take into account in exercising that discretion?
The property is a shop with residential accommodation above which, with the aid of a further loan, will be converted into two residential units. The property is in poor repair and some of the borrowed funds will be used to remedy the existing disrepair and to refurbish the whole building. The same questions posed above for interest on the monies borrowed to purchase apply to the further loan to carry out improvements and repairs.

Even where trustees have the power to allocate any expenditure between income and capital, I would normally treat loan interest as an income expenditure (unless there are particular circumstances that would deem this unfair/inappropriate).

The purpose of the loan is to improve the trust assets to enable them to generate a greater income level than they would if they remained in their “unimproved” state. Why then should not income bear some of the cost involved (being the interest charged on the loans).

Paul Saunders FCIB TEP

Independent Trust Consultant

Providing support and advice to fellow professionals

In the absence of provision in the trust deed the general rule is that expenses of a recurrent nature must be borne by income whereas expenses incurred for the benefit of the whole estate must be borne by capital.

Interest (a recurrent expense) on borrowings incurred to acquire, repair and/or refurbish property from which rental income is to be generated (which is primarily if not wholly) for the life tenant’s benefit I would suggest be charged against income.

The actual costs of acquisition, repair and/or refurbishment is chargeable against capital. Under general law, expenses against income can only be made where the expense is wholly and exclusively for income.

Malcolm Finney

Thank you for a clear explanation.