Germany: 049. Distinguishing Construction Cost From Repair And Maintenance Expense

Last Updated: 20 May 1996
KPMG Germany Webpage
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The Federal Tax Court rendered a series of decisions in 1995 dealing with the distinction between construction cost (must be capitalised) and repair and maintenance expense (fully deductible when incurred) (see in particular BFHE 177, 454 of 9 May 1995 and BStBl II 1996, 132 of 19 September 1995).

Maintenance expense covers regular repair and maintenance costs. With respect to a building, such costs are necessitated by normal use. They include expenditure for the replacement of existing fixtures and equipment such as replacement of windows or installation of a new heating system. It generally makes no difference whether the newly installed facilities are materially superior to the ones they replace as long as the new facilities are reasonable from a contemporary point of view. Construction cost is expenditure for goods and services used to create an asset or to extend or materially improve an existing asset. These definitions apply for both commercial and tax accounting.

Any increase in the usable space of a building constitutes an extension, no matter how little additional space is gained or how little the change cost. The same applies if elements not originally present are later added. If a building is improved, however, this only constitutes construction cost if the improvement is major as compared with the original condition of the asset.

An exception to the above rules applies for recently purchased used buildings. If, during the three years following the purchase, expenditure for work nominally constituting repair and maintenance expense is disproportionate to the price paid for the building (more than 15 % of the purchase price), then such expense may be classified as construction cost if it results in significant change in the nature of the building or the uses to which it can be put or a significant extension of its useful life compared with the condition of the building at the time of purchase.

An exception also applies for repair work which is interconnected with or inseparable from construction work. Such work is treated as construction work in its entirety, even if certain parts, taken in isolation, would otherwise have been repair work.

It is also clear that all work performed on a building which is so dilapidated as to be unusable in its present condition constitutes construction work because the result of such work is to create a new asset, namely a usable building in place of an unusable one. However, the general rule is that, even in the case of extensive renovation and modernisation work, the various types of work carried out must be individually categorised (under the above rules) as repair/maintenance or construction-improvement-extension. The tax authorities were not successful in arguing that, in effect, construction and modernisation work can, outside of instances of complete unusablility, be so extensive as to warrant treatment of all work as construction work. The Federal Tax Court held that each item of work performed must be analysed individually and repair expense separated from construction cost by estimate if necessary.

Lastly, the Court dealt with the issue of lavish modernisation of old buildings. Here the Court wished to apply a concept of reasonable replacement expenditure in light of contemporary standards ("zeitgemaesse substanzerhaltende Erneuerung") to determine when a building had been so significantly improved that the related cost must be capitalised.

This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.

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