Basic guide to capital allowances

The purpose of this guide is to provide a basic overview of the Capital Allowances regime that exists in the UK and its relevance to owners, occupiers and investors in Commercial Property.

The guide describes the different types of Allowances currently available, who is entitled to claim them and what they are worth.

Finally, the guide looks at the basis on which these allowances are given and in particular the different rules that exist whether developing a new property, acquiring an existing property or fitting out a property for your own occupation.

 

 

Capital Allowances are a form of tax relief given to UK taxpayers who incur Capital Expenditure on fixed assets (including parts of buildings) as defined or set out in the Capital Allowances Act 2001 (CAA2001).

This is known as the taxpayer’s qualifying expenditure.

Whilst capital (fixed) assets may be depreciated for accounting purposes, this depreciation is not an allowable tax deduction in the UK. Therefore Capital Allowances are the only means by which taxpayers receive tax relief on their long term capital investment.

In other words, whilst depreciation adjusts the taxpayer’s accounting profit it is merely a reporting adjustment. Capital Allowances by comparison reduce the taxable profits which in turn saves tax.

With regards to property and construction, the following types of assets may qualify for Capital Allowances:

  • Plant and machinery
  • Renovation or conversion of qualifying vacant commercial premises in an assisted area (areas being as defined in the assisted areas order 2014/1508)
  • Capital expenditure on research and development

 

Of these, the most common type of qualifying expenditure is that on Plant & Machinery which includes loose chattels but more often building fixtures.

For companies with insufficient profits to utilise the FYA there is the option to surrender the allowances in return for a payable tax credit. The credit is currently paid at 19% of the qualifying ECA expenditure and capped at £250,000 per tax year for each company.

Whilst this may be less than the equivalent value if the relief was to be claimed directly, it can provide a very useful cash flow benefit.

When the expenditure does not fall within the ECA regime then the expenditure must allocated to one of two pools – the Main Pool or the Special Rate Pool.

The special rate pool is for qualifying expenditure on assets such as:

  • Integral Features – which includes power and lighting installations, air conditioning, heating, ventilation, hot & cold water installations, lifts, escalators and external solar shading
  • Thermal insulation of existing commercial buildings
  • Long life assets – these are assets that have an expected economic life of 25 years (although it does not apply when those assets are installed in an office, hotel, retail shop or showroom)

The Main Pool is for qualifying expenditure on all other Plant & Machinery usually found in buildings.

From April 2012 (1st April for Corporate Tax Payers and 6th April for Income Tax Payers) special rate expenditure attracts an 8% annual WDA, given on a reducing balance basis.

By contrast Main Pool expenditure currently attracts an 18% annual WDA, again on a reduced balance basis.

Plant & Machinery Allowances are given on “expenditure on the provision of Plant & Machinery”. The particular relevance to this is that qualifying expenditure is not limited to just the cost of the asset itself but will also include directly related costs such as certain professional fees and associated builders work on a new build project

Where the project is the refurbishment or fitting out of an existing building then there is a specific section of CAA2001, section 25, that allows building works incidental to the installation of an item of Plant & Machinery to be included as part of the qualifying cost of that asset. These building works are of the type that would not qualify in a new build scenario.

Not only can the overall level of allowances be increased but decisions can be taken on the scheme design to make it more tax efficient – for example ensuring elements of the services comply with the ECA regime and so attract a 100% FYA as opposed to the much less attractive special rate pool WDA.

On any proposed new build development we, therefore, always advocate “pro-active planning” rather than “re-active reporting”.

It is very common for commercial properties to be bought and sold and this will often provide the purchaser with a significant entitlement to plant and machinery allowances. This entitlement will be on both the loose chattels and building fixtures, previously highlighted in this guide, that form part of the sale.

When an existing property is acquired, either for owner occupation or as a property investment, then the level of Plant & Machinery Allowances available to the purchaser on any fixtures will be based on the price paid for that property and will not usually be discounted in any way to reflect the age of the property.  This is in accordance with section 562 of CAA2001 and can produce a claim value of anything between 10% and 35% of the purchase price paid.

For a large UK Corporate these allowances could equate to a tax saving over time equivalent to around 6% to 7% of the price paid. For a UK resident High Net Worth Individual the saving could be closer to 12% or 13% of the purchase price

A restriction may apply, however, where the seller or a prior owner of the property has already made a claim on the qualifying assets. If they have, then the purchaser’s claim value will be restricted to the “disposal value” that prior seller brought into account for those qualifying assets when the property was sold.

Despite this potential restriction, our experience shows very few prior owners have made a claim for all the Plant & Machinery Allowances on which they were entitled and in a significant number of cases have not made any claim at all.

Detailed due diligence of past owners will need to be undertaken to establish whether any restriction does apply, This usually starts with the purchaser’s solicitor raising pre contract enquiries of the seller, but where there have been many prior owners or historic information is limited these enquiries may not be sufficient and further research could be required.

These provisions are particularly useful for landlords looking to provide an inducement to prospective tenants, to the extent that if the parties agreed the whole contribution was towards qualifying expenditure, for example new air-conditioning or carpets, then the entire inducement would qualify for Capital Allowances for the Landlord.

In contrast to Plant & Machinery Allowances, there are a number of Capital Allowances which do give tax relief on the costs of buildings and structures. One such Allowance is known as Business Premises Renovation Allowances (BPRAs).

BPRAs provide a 100% FYA or alternatively a 25% straight-line WDA on the cost of renovating or converting vacant commercial premises within approximately 2000 specially designated disadvantaged areas.

A disadvantaged area is one set out in the Assisted Areas Order 20014/1508. There is a useful post code checker which can be found at;

http://www.ukassistedareasmap.com/ieindex.html

To qualify for the relief the premises must have been vacant for at least 12 months and its last use cannot have been as a dwelling.

As you would expect, extending a building or developing land next to a qualifying building does not qualify for BPRA’s.

From April 2012, BPRAs are limited to €20m per project. This does not, however, exclude other forms of allowances to be claimed on that same project above that limit.

 

A further type of Capital Allowance potentially available on buildings and structures is known as Research & Development Allowances (RDAs).

Unlike other types of allowances RDA’s are not available to property investors but are limited to traders undertaking research and development activities that are directly related to the trade being undertaken.

If there is a sale within 5 years then some or all of the BPRA’s claimed will be clawed back, the amount clawed back being based on the sale price achieved.

Similar to BPRAs, the value of any RDAs clawed back will also be a factor of the sale price achieved but this repayment will occur should the asset be sold at any time in the future.

Surely my Accountant can advise me on Capital Allowances?

Unfortunately, whilst Capital Allowances may be a tax issue, most accountants and tax advisers are not trained in the different property, construction and legal skills needed to fully understand the issues or maximise Capital Allowance claims on property.

It is for this reason that we work closely with many accountants and tax advisers, using our expertise in this specialist area to support and complement their more general skills.

Whilst it may be the most common type of qualifying expenditure, there is actually no statutory definition as

to what constitutes Plant & Machinery for the purposes of CAA2001.

There is a dictionary definition for “machinery” and in Finance Act 1997 the Government decided to define buildings and structures and at the same time exclude anything within that definition from qualifying as Plant & Machinery.

Notwithstanding this exclusion, however, CAA2001 then went on to list over 30 headings of assets that despite being part of a building or structure could still qualify for Plant & Machinery Allowances.

These headings include, but are not limited to:

  • Air conditioning, heating and ventilation installations
  • Hot and cold water installations
  • Lifts and Escalators
  • Electrical systems
  • External solar shading
  • Data and telephone installations
  • Sanitary fittings
  • Furniture and fittings
  • Curtains and carpets
  • Signage
  • Thermal insulation added to an existing commercial building
  • Alterations to an existing building incidental to the installation of an item of Plant & Machinery
  • Removal of existing items of Plant & Machinery

As a result, there are significant elements of every commercial property that will qualify for Plant & Machinery Allowances

Qualifying expenditure on Plant & Machinery can, depending on the type of asset, attract either a First Year Allowance (FYA) and/or an annual Writing Down Allowance (WDA).

For example, a FYA of 100% is given for expenditure on energy saving and water efficient Plant & Machinery which falls within the Enhanced Capital Allowance (ECA) regime.

Further information on the specific types of assets that qualify can be found at https://etl.decc.gov.uk/etl/site/etl.htmlt .

An example of section 25 works would be the building works – lift pit, forming and trimming of holes in floors, lift shaft and associated fees - necessary to install a lift within an existing building.

As both Main and Special Rate expenditure are pooled there is generally no “balancing allowance” should a particular asset be sold for a value that is below the total allowances given.

By contrast, where a main pool asset, that has an expected economic life of less than 8 years and is not leased, an option exists to elect to treat that asset as a Short Life Asset.

The benefit of such an election is that if the asset is indeed disposed of within 8 years there is a balancing adjustment allowing any unclaimed allowances to be taken at the time of disposal. This provides a potentially significant timing advantage over the asset remaining in the Main Pool.

Although initially aimed at small businesses, every business has since April 2008 been given an Annual Investment Allowance (AIA). From April 2014 this AIA attracts a 100% allowance on the first £500,000 spent on qualifying Plant & Machinery.

As it is given on the first tranche of qualifying expenditure, the AIA can be used to claim tax relief in preference to any other available FYA or WDA. Any qualifying expenditure over the monetary limit will continue to attract Plant & Machinery Allowances in the usual way.

The obvious benefit of the AIA is assets that would normally attract either a much smaller Main Pool or Special Rate Pool WDA can, up to the set monetary limit, be claimed in full in the year of expenditure.

Whilst it may appear straight forward, claiming Capital Allowances on a new property requires careful planning with the claim being prepared in a manner that can withstand any level of scrutiny from HMRC or the Valuation Office Agency (VOA).

Our experience shows that by considering the potential Capital Allowances early in the design of a project the levels of Plant & Machinery Allowances achieved can be increased significantly – typically by up to 15%.

Whilst this research can be time consuming it is often very worthwhile, particularly if it can be established no restriction exists to the purchaser’s entitlement.

In December 2011 changes were announced following a lengthy consultation process. These changes were formally enacted in the Finance Act 2012 and, from April 2014, deny Plant & Machinery Allowances to future owners of a property where the seller of that property had not pooled their own qualifying expenditure on any plant and machinery fixtures they were entitled to claim on.

For expenditure incurred between April 2012 and April 2014 Allowances will only be denied to a purchaser on any fixtures in a property that the seller has claimed on and the parties do not agree a fixed value agreement by way of a CAA2001 s198 joint election.

Whether you own the property or simply occupy it under a lease, Capital Allowances are available on any fitting out works undertaken at the property.

As the name suggests, because these works relate to the “fitting out” of a property they do not generally include providing the shell building or structure that are unlikely to qualify for relief.

Rather, the works tend to comprise installing assets that fall within the definition of qualifying Plant & Machinery fixtures or chattels.

Indeed, our experience shows it is not uncommon for anything between 50% and 85% of any fitting out works to qualify for Capital Allowances.

As with any new build development it is essential that the claim on fitting out works is pre-planned to ensure both the maximum  level of allowances are achieved and that these allowances are claimed under the most advantageous qualifying heading.

In this respect, because fitting out works will typically be undertaken within an existing property the incidental works previously highlighted as qualifying under section 25 CAA2001 will be particularly relevant.

In situations where a person contributes towards another person’s qualifying expenditure on Plant & Machinery, CAA2001 contains specific provisions that allow the contributor to claim any allowance on which the recipient would otherwise be entitled.

If Research and Development is being undertaken then RDA’s are available on the capital expenditure associated with that Research & Development and can include the provision of any buildings or structures in which the activities are undertaken.

RDA’s attract a FYA of 100% of the qualifying capital expenditure which can often include the entire cost of constructing or fitting out a property.

 

As Capital Allowances are a tax relief their value is ultimately related to the claimant’s rate of tax - the higher their rate of tax the higher the value of any allowances to them.

What is important to remember, therefore, is that as these allowances are a tax relief, if they are to be of any value  at all, the claimant must either be making or envisage making taxable profits which they can use any allowances to shelter.

The only exception to this would be the payable tax credit available to companies on qualifying ECA expenditure previously mentioned.

Advice should always be taken when an asset on which Capital Allowances have previously been claimed, is being sold. As the allowances may have been claimed many years previously, it will come as an unwelcome surprise that some or all of these previously claimed allowances could be clawed back.

Whether this is the case will depend very much on the type of allowances claimed.

Where Plant & Machinery Allowances are concerned then if the seller has made a claim for allowances that relates to fixtures the buyer and seller should agree amongst themselves and jointly elect, under section 198 CAA2001, the value of allowances that will transfer as part of the transaction.

If the elected value is below the level of allowances unclaimed by the seller, then the seller can continue to claim the difference even though they will no longer own the property.

In terms of BPRAs, then provided the taxpayer retains the property for at least 5 years from the date the buildings are first used or the works completed (7 years if the expenditure was incurred prior to April 2012) and the property is available for use, then there is no balancing event or claw back of the allowances.

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