Embedded Capital Allowances

Capital allowances for business properties

While nearly all accountants who deal with business tax computations are familiar with capital allowances in general, allowances for commercial property fixtures are becoming increasingly specialised. Important modifications took effect in 2008, 2012, and 2014, and as the regulations get more complex, it’s impossible for any corporate tax counsel to keep up with all of the nuances.

Help is available in a variety of forms, but there are a few crucial points that all accountants and tax consultants should be aware of if they have customers who own (or are considering purchasing) commercial properties. The writers of this article summarise the key concepts that all such practitioners should be aware of in order to defend their clients’ interests.

Value

The first step is to recognise that capital allowances for commercial properties can be extremely valuable. There are numerous variables here, but tax relief may be available for between 15% and 45% of the cost of a property. A simple warehouse will be at the lower end of the scale, whereas a care home or upscale hotel may be near the top.

For a company paying 19 percent corporation tax, a £1 million property could result in tax savings ranging from £28,500 (£1 million x 15% x 19%) to £85,500 (£1 million x 45 percent x 19%). Individuals paying 45 percent income tax could save up to £200,000 in potential savings. There will be exceptions on both ends of the savings’ spectrum.

Because these are significant sums for any client, it is the tax adviser’s clear duty to ensure that the tax relief is not lost due to negligence or an incomplete understanding of the relevant statutory rules.

Fixtures

The value of the allowances comes from fixtures in the property.

The key point here is to recognise that the term “fixture” has a technical meaning for capital allowances purposes (CAA 2001, s. 173). Crucially, the meaning is different from the concept of “fixtures and fittings” as used for accounting purposes.

The technical capital allowances definition is that a fixture is “plant or machinery that is so installed or otherwise fixed in or to a building … as to become, in law, part of that building …”.

As a result, the term “plant or machinery” encompasses tables, chairs, computers, automobiles, and many other items, but none of these are fixtures. The latter term only refers to plant or machinery that is permanently attached to the property, such as toilets, lifts, and general lighting.

This distinction has a wide range of practical ramifications. The most important is to recognise that capital allowances claims cannot be made solely on the figures in the accounts for “fixtures and fittings.”

Assume, for example, that a nursing home has an addition. The costs of the beds and tables will be recorded as “fixtures and fittings,” but the costs of the toilets, lifts, and lighting will be recorded as “additions to property” or under some other heading. If only the items classified as fixtures and fittings are included in the capital allowances claim, the claim will be far less than it should be.

Sale and purchase agreement

When purchasing a home, the same principle applies. The sale and purchase agreement may differentiate between different categories, such as £800,000 for property, £200,000 for goodwill, and £30,000 for fixtures and fittings. The buyer will almost certainly attempt to claim plant and machinery allowances for the £30,000 cost of the fixtures and fittings. That’s fine in and of itself, but it can’t be the end of the storey! The main capital allowances claim will be within the £800,000 limit: not all of this amount will qualify, but a significant portion will. (However, as discussed below, specific steps will be required to ensure that these more valuable allowances can be claimed.)

Time Limits

For capital allowances, time limits work differently.

If a property was purchased (say) 15 years ago and allowances were not claimed at the time, it is not possible to go back and re-open the computations for that year. What is possible, however, is to include any qualifying expenditure in the current year (or into any year that is still open under normal self-assessment principles).

However, there are several caveats to this principle.

First, the person must still own the items in question at some point during the chargeable period for which the claim is made (see section 58(4) CAA 2001). As a result, no claim can be made for the period following the sale of the property.

If a property is being renovated, extreme caution must be exercised. Assume, for example, that a property purchased in 2003 came with a boiler that was replaced in 2010. Because no claim can now be made for the original boiler, tax relief is no longer available. It will be necessary to determine whether the new boiler’s cost was capitalised (in which case allowances may now be claimed) or was written off as revenue expenditure (in which case, of course, no claim may be made).

Another limitation is that no claim for either annual investment allowances (AIAs) or first-year allowances (FYAs) will be permitted for delayed claims, i.e. where the expenditure is first included in capital allowances computations in a year later than the year in which it was actually incurred. This is due to the limitations imposed by sections 51A(2) CAA 2001 (for AIAs) and 52(2) CAA 2001. (for FYAs). As a result, the claim will only be for writing-down allowances.

Capital Gains Tax

The fact that allowances for fixtures in a property are claimed does not imply that there will be a higher capital gain on sale (TCGA 1992, s. 41). So, if a property is purchased for £600,000 and sold for £800,000, the gain (in simple terms) will be £200,000, regardless of whether allowances are claimed and the value of those allowances is retained at the point of sale. (The situation becomes more complicated if the property is sold at a loss.)

Changing rules-2008

The rules for claiming plant and machinery allowances underwent several significant changes in 2008, some of which continue to raise significant practical issues today.

Since the implementation of AIAs, most businesses have been able to claim accelerated allowances for the majority of qualifying expenses. Following some eye-wateringly complex transitional rules in previous years, the annual limit for such AIAs is now set at £200,000. AIAs are subject to various restrictions (for example, they are not granted for automobiles), and the £200,000 must be divided among various entities as specified in the legislation (e.g. group companies).

The concept of “integral features” was also introduced from 2008. This broadened the range of assets qualifying for capital allowances. In particular, it meant that cold water systems, general lighting and general electrical wiring all started to qualify for capital allowances on pretty much a routine basis. This cut-off date (expenditure incurred from 1 or 6 April 2008 for corporation tax and income tax respectively) remains significant today, as the buyer of a commercial property needs to know whether or not the vendor has been able to claim allowances for any given fixture. If the person who is today selling an office block bought it in 2007, the current buyer can be reasonably certain that the outgoing owner was not able to claim for the general lighting and wiring costs, for example. This can have a big impact on the claim that may be made today.

Changing rules 2012-2014

Finance Act 2012 (FA 2012) introduced some important new legislation, now at s. 187A and 187B of CAA 2001. These changes – applying from April 2012, but to some extent deferred to April 2014 – again have critical implications for the buyer of a property.

In brief, a buyer normally has to jump through two hoops before claiming capital allowances for fixtures in the property. As these hoops necessarily involve action by the vendor, it is vital to consider them before the sale and purchase agreement is signed off.

Pooling requirement

The first is the so-called “pooling requirement” (section 187A(4) of the CAA 2001). Essentially, this means that the vendor must pass the value of the property’s fixtures through his (or her) capital allowances computations before transferring any such value to the buyer. An example will help to demonstrate this:

Example:

Jack purchased a restaurant in 2010 for £450,000 and will sell it to Jill in 2018 for £480,000. Because the business was a failure, Jack generated no taxable profits and was unconcerned about capital allowances.

A review reveals that Jack could have claimed £160,000 for property fixtures. Although he does not require the allowances, Jack must include the full £160,000 in his capital allowances computations and then agree to a transfer to Jill in order for Jill to be eligible for the valuable tax relief.

If Jill only becomes aware of this after the purchase agreement has been signed, Jack will have no interest in cooperating and may refuse to pool the qualifying expenditure. Jill will then have no legal hold over Jack, so will miss out on the tax relief.

Fixed Value requirement

The second requirement introduced by FA 2012 (the “fixed value requirement” at s. 187A(5) CAA 2001) is that the parties sign a fixtures election (under s. 198 or sometimes s. 199 of CAA 2001) to determine a value at which the fixtures will pass from one party to the other for capital allowances purposes. More on this later, but in the preceding example, the parties may agree to transfer the fixtures for the maximum amount allowed, £160,000.

Furthermore, the FA 2012 rules do not apply to fixtures for which the vendor was unable to claim (e.g. general lighting costs incurred before April 2008). The buyer can still make a claim for these, in addition to any figures in the fixture elections.

The FA 2012 rules also include a snare for unwary vendors. This appears to be an innocuous remark in section 187B(6) CAA 2001, which states that the pooling and fixed value requirements have no bearing on the vendor’s disposal value.

Example

Romeo owned a restaurant, which he is now selling to Juliet. The facts are the same as in the case of Jack and Jill above, except that Romeo has a profitable business and has claimed full relief (via annual investment allowances) for the qualifying expenditure of £160,000.

Juliet will be unable to claim for the cost of the fixtures if no fixtures election is signed or if the election is found to be invalid for any reason. Nonetheless, Romeo will be subject to a balancing charge of up to £160,000 – a disastrous outcome for both parties! With a valid election, one of the parties would have received the full amount of tax relief or (more likely) agreed to share it in some way.

The fixtures election

To avoid the scenario in the second example above, the s. 198 (or s. 199) election must be done carefully, and the detailed conditions for the election are set out in s. 201 CAA 2001. A common mistake is to forget that the election can only cover fixtures in the above-mentioned sense. If the election purports to include tables and chairs, for example, it may be declared invalid, with disastrous consequences as previously described.

The election determines an amount that will only be treated as the transfer value of the fixtures to which it relates for capital allowances purposes. There are two key points to consider here. First, this has no bearing on the commercial apportionment of the “fixtures and fittings” and the property. Second, the figure in the election does not have to be “reasonable” in any way; within certain parameters, the parties can negotiate the figure however they want, and it will be binding on HMRC. Understanding what types of negotiations are possible is critical to defending the client’s interests, whether buying or selling.

Commercial property standard enquiries (CPSEs)

The solicitors acting for the buyer will normally raise CPSEs, the last section of which is concerned with capital allowances. Most solicitors, however, will make it clear in their engagement terms that they do not wish to be responsible for capital allowances matters, so the buck may well stop with the accountant or tax adviser.

The CPSEs are problematic in various ways, not least because they include an ambiguous question about former claims by the vendor. Furthermore, the CPSE replies rarely provide sufficient information to determine the best way forward, and often need to be challenged. Given the amounts at stake (even, and indeed especially, if the CPSE replies purport to say that no or few allowances are due) it may well be worth getting specialists involved in reviewing the replies received from the vendor’s side (and indeed in formulating the replies if acting for the vendor).

Valuation

In some circumstances, it will be essential to have a valuation of the property and of the fixtures it contains. This is not something that most accountants are professionally qualified to do, so specialist valuers will need to be engaged as appropriate.

A valuation will generally be necessary, for example, if the vendor owned the property before 2008 and/or if the vendor has not yet made a full capital allowances claim.

The capital allowances history of previous owners is one key factor that may determine whether or not a claim is possible (s. 185 and s. 562(3) CAA 2001). This may involve digging up Land Registry records and/or Companies House accounts, and understanding the implications of both.

Different issues also arise, for example, where leases are granted (s. 183, 184 CAA 2001), where there are connected parties (s. 214 CAA 2001) or where the property is a dwelling-house, albeit perhaps with communal elements for which a claim may be possible (s. 35 CAA 2001).

Dealing with capital allowances without a detailed understanding of the underlying complexities is, of course, unlikely to lead to the best outcome for the client. But ignoring the potential claim (a much more common scenario in practice) is equally unacceptable for the client and risky for the adviser.

Capital allowances are an extremely valuable relief and can reduce your tax liabilities substantially yet are often missed. Early and specialist advice is key and the cost of obtaining this advice is normally greatly outweighed by the potential tax savings.