Capital allowances on fixtures - A practical guide to the changes
Since 1985, when the special capital allowances rules for fixtures were first introduced, the intention has been that expenditure on a qualifying fixture should be written-off against taxable profits only once during that fixture’s economic life.
Thus, where a building containing second hand fixtures is sold, there are limiting provisions to ensure the new claimant’s entitlement does not exceed the disposal value which the seller is required to bring into account for those same fixtures.
Her Majesty’s Revenue and Customs (HMRC) were concerned that in practice these limiting provisions were not as robust and effective as intended.
Additionally, the absence of any time limit for new claimants to pool their qualifying expenditure meant it was sometimes very hard to establish whether a prior claim restriction applied.
Whilst these deficiencies had existed for many years, HMRC were aware of the emergence of a whole new army of capital allowances advisers actively encouraging owners to make often substantial ‘late’ fixtures claims.
HMRC were concerned about the “perceived” tax loss this was causing and have therefore introduced a set of revised rules to protect the purse of the Exchequer.
To this effect in Budget 2011 the Government announced it would consult on proposals to ensure the capital allowances rules on fixtures achieved their original policy purpose.
The principle measures HMRC were originally proposing comprised:
b) Mandatory pooling of qualifying expenditure within one or two years of incurring the expenditure
c) Mandatory notice of agreed market value of the fixtures as a condition of the purchaser being entitled to claim allowances on those fixtures
In addition, the consultation contained the proposal that the minimum disposal value of fixtures under an alternative apportionment election (within Capital Allowances Act 2001 section 198 or 199) should be the tax written down value.
HMRC issued a consultation response document on 6th December 2011 and in Budget 2102 on 21st March 2012 the final draft legislation setting out proposed changes that were then formally introduced in the Finance Bill 2012.
In a relaxation from the original proposals the new legislation allows, in specific circumstances, the purchaser to obtain a written statement from a past owner which states the disposal value brought into account to satisfy the fixed value agreement
Failure to meet this new fixed value requirement will also deny the purchaser the ability of claiming any Capital Allowances on fixtures upon which the seller, or in certain cases another past owner, has made a claim.
It will also deny allowances on those fixtures to any subsequent owner of the property.
As stated above, there will be a small number of situations where the fixed value agreement is not possible and so as an alternative, the “disposal value statement” was introduced.
An example of when this might occur is where the owner of the fixture ceases to carry on a qualifying activity without there being a sale of the fixtures at that point.
Where this occurs it will be down to any subsequent purchaser of those fixtures to obtain a “disposal value statement” from the seller setting out the disposal value brought into account for the relevant disposal event.
CAA2001 s187A (11) clearly puts the onus on the purchaser to show, if requested by HMRC, whether the fixed value requirement applies and, if so, is satisfied.
Quite naturally purchasers are now going to expect sellers to be able to provide them with all the necessary records to support any request that might be received.
Whilst the burden of proof on pooling is not a stated requirement of the new rules, HMRC envisage the situation should be relatively easy to verify and check as part of the normal pre acquisition due diligence process.
HMRC can obviously check what values have been pooled, but it is still not known to what extent they will enquire into the accuracy and validity of the amounts pooled when the allowances have not then been claimed. It is important to recognise that pooling of expenditure is very different to actually claiming of allowances.
Purchasers will no doubt make their own enquiries of sellers to ensure all qualifying expenditure has been pooled by the seller where it could have been and if not obtain an appropriate warranty or undertaking from the seller that it will be pooled in an appropriate chargeable period.
Our advice to purchasers would be to:
a) Undertake extensive due diligence of prior claims at pre-contract stage engaging experts who fully understand the issues and potential impact of both the old rules and the new changes.
b) Raise the appropriate pre contract enquiries and review the answers provided in detail. This may require the raising of transaction specific supplementary enquiries
c) From the enquiries the purchaser will be able to establish what fixtures, for the purposes of CAA 2001, are attached to the land interest they are looking to acquire. The enquiries should also help identify any restrictions that apply to any allowances claim on these fixtures.
d) Obtain the appropriate supporting documentation to identify what fixtures have been pooled/ claimed and just as importantly any that have not.
e) For those fixtures that have not been pooled/ claimed, the purchaser will need to establish whether these are now caught by the new rules.
f) Obtain copies of any previous elections relating to the property being acquired. These elections must be sufficiently detailed to identify exactly what fixtures they cover so it can also be established what fixtures they do not cover.
g) When reviewing prior claims be aware of any assets that may have been stripped out by tenants as the purchaser may no longer be entitled to make a claim on these items.
h) Purchasers also need to be aware of any fitting out works or additions undertaken by tenants who may be entitled to claim allowances on those works
i) They also need to identify any capital contributions that have been made towards tenants fitting out works and the amount of contribution allowances, if any, claimed on these payments.
j) Once the full situation has been established the Purchaser can then propose the appropriate clauses to include in the sale and purchase contract to ensure, within the context of the deal, that their interests are best protected and the maximum level of allowances they are entitled to claim are realised.
These rules are set out in s187A of CAA2001 - Effect of changes in ownership of a fixture.
These changes, which differ from the original proposals, mean the purchaser of an existing property must, subject to certain transitional provisions that existed until April 2014, satisfy the following requirements:
(a) The pooling requirement and
(b) The fixed value requirement if it applies, or alternatively
(c) The disposal value statement if it applies
Failure to meet these requirements will mean the purchaser’s qualifying expenditure for Capital Allowances purposes will be treated as nil.
This requirement only applies for sales after 1st / 6th April 2014. For such sales it means where any prior owner of the fixtures was entitled to make a claim for allowances on those fixtures, they must have quantified and pooled their qualifying expenditure, or claim a first year allowance if one is available, to enable any future owners to claim allowances on those same fixtures.
The pooling of the qualifying expenditure must be for a period in which the fixture belonged to the prior owner. Fortunately due to the time lag of tax there is an opportunity to pool the expenditure after the fixture has physically been disposed of.
Failure by the previous owner to pool their expenditure means that the qualifying expenditure by the purchaser and any future owners of those fixtures will be treated as nil, effectively removing the ability of anyone to make a claim on them.
With effect from April 2012 where a vendor has claimed Capital Allowances on a fixture, that forms part of a property transaction, then the parties to the sale will need to enter a formal agreement to fix the transfer value of those fixtures.
This agreement will usually take the form of an alternative apportionment election under the existing provisions of either s198 or s199 of CAA2001, but could take the form of a determination by the first tier tribunal if the parties are unable to agree a relevant apportionment.
In reality, we suspect the tribunal option is likely to be rarely used because, cost aside, a seller will be well aware that their interests are usually best protected if they can agree a relatively low alternative apportionment value with the purchaser during the pre-contract process – a time when they would be negotiating from a position of strength
What has not changed for purchases prior to April 2014, is the purchaser’s ability to make a claim on any fixtures not included in the “fixed value agreement”, subject to the other existing limiting rules that remain in place and are generally set out in CAA2001, Part 2, Chapter 14 s185-187.
This means, for example, where the purchaser acquires a property before April 2014 from a seller that themselves acquired it prior to April 2008 and so was not entitled to make a claim on newly qualifying integral features such as the general power and lighting installations, that purchaser will still be able to make a claim on these specific items even though they would not be included in the “fixed value agreement”.
The same would be true if a property was acquired from a non-taxpayer who had themselves acquired the property prior to April 2012 and the previous owner had not identified and claimed all of the allowances to which they were entitled.
This non-claiming of allowances is certainly not as unusual as it might first seem. A significant number of properties are owned by property traders, non-taxpayers, taxpayers with no tax capacity to utilise the allowances. Also there are taxpayers who do have tax capacity but have not been properly advised as to the allowances they are rightfully entitled to.
Overage claims on post April 2014 acquisitions.
For any purchases after April 2014, the only overage claims now possible will be on any fixtures on which the seller was not entitled to make a claim.
Therefore, in addition to instances where the seller acquired the property prior to April 2008, other opportunities for an overage claim after April 2014 might include where any entitlement is only created on the next sale. This might include, for example, where the current owner acquired a new leasehold interest with no CAA2001 s183 election, or where the fixtures were installed after the seller acquired it and by a tenant not entitled to claim the allowances themselves.
What is certainly clear is these changes will require purchasers of commercial property and their advisers, to undertake increased levels of due diligence to ensure their entitlement to allowances is not unknowingly restricted or lost completely.
Similarly, owners of commercial property and their Accountants will need to ensure systems are in place to be able to track fixtures on which a prior entitlement exists. Failure to do this means purchasers and future owners could be denied allowances on them.
In summary, purchasers need to view fixtures in a property separately based on “pockets of qualifying expenditure”. They will need to establish those where there was no prior pooling requirement, those where the value is set or limited by a fixed value agreement (or disposal value statement) and those where no prior claim entitlement existed and so a just apportionment is still possible.
Most significantly, sellers will be expected to have available chapter and verse about the fixtures in a property they are looking to sell and in particular those fixtures which have been pooled.
For those that have owned the property for many years or were not extensive with their own pre-contract due diligence at acquisition, this may prove problematic.
Where sellers are not able to provide the necessary evidence and supporting documentation expected by the seller, they will run the risk of having the sale price reduced to reflect the potential loss of allowances.
Sellers will also need to be aware of any provisions they agree to. In particular, they need to take expert advice before providing any warranty or providing any guarantee of the level of allowances available to a purchaser. If these allowances don’t transpire it could prove a very costly agreement to them!
Now they are fully implemented the new fixtures rules will add yet another layer of complexity for both purchasers and sellers which could prove very costly if not fully understood and planned for.
Both parties should therefore take expert advice as early as possible to avoid any nasty surprises that could either delay a transaction or result in a purchaser looking to reduce the purchase price to reflect the reduced level of allowances available to them.
Even worse, a purchaser who neglects to undertake the appropriate due diligence, could discover post completion they are not entitled to the level of Capital Allowances they had blindly assumed they would obtain.
We are sure it is a mistake the Purchaser will only make once!