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Working Capital

This article first appeared in the June 2012 edition of Property in Practice, the magazine of the Law Society’s Property Section (


As the ‘Capital crimes’ article in the March 2012 issue of Property in practice highlighted, from April this year, conveyancing solicitors should take care not to inadvertently overlook a valuable tax relief: plant and machinery capital allowances.


The basic rule, for income and corporation tax, is that “capital” expenditure incurred on building or buying commercial premises, whether by an investor or an owner-occupier, cannot be written-off for tax. Instead, capital allowances are given at various rates, from 100% down to 8% per annum.


Capital allowances are not a ‘scheme’ or ‘loophole’, but simply good practice tax compliance (that is, tax ‘housekeeping’). They apply long-standing rules which grant owner-occupiers and property investors tax relief for expenditure on so-called “plant” and “machinery” in new or second-hand commercial property. The definition for tax purposes includes many standard fixtures, such as mechanical and electrical services, furnishings, and fittings.


The value arising depends upon the business tax rate and the type of property (some properties being more plant-rich than others). However, the tax savings are generally substantial; typically, in the order of 5-10% (and sometimes as much as 25%) of the expenditure incurred. Particularly plant-rich properties include offices, care homes, pubs, restaurants, hotels and motor dealers.


Traditionally, on the sale of a property, the capital allowances would transfer by default from vendor to purchaser, calculated by means of a “just and reasonable” (that is, market value) apportionment under section 562 of the Capital Allowances Act 2001 (CAA 2001), capped at a maximum of the capital allowances qualifying expenditure originally claimed by the vendor. The purchaser could chose whether and when to claim them – potentially many years later.


The aim of an apportionment is to allocate the purchase price to reflect the value that each constituent part makes to the whole. This means splitting the price between qualifying plant and machinery, and non-qualifying land and buildings (for example, the ‘bricks and mortar’).


An apportionment is a specialist tax valuation using a methodology published by the Valuation Office Agency, which may be checked by both the agency and HM Revenue and Customs (HMRC). Despite common practice, it is not appropriate to simply enter an allocation into the sale and purchase agreement (Fitton v Gilders & Heaton (1955) 36 TC 233 and Tapsell (Mr & Mrs) & Lester (Mr) (trading as “The Granleys”) v HMRC Commissioners [2011] UKFTT 376 (TC)).


Therefore, because the tax position could be sorted out laterby the accountant, little attention has been paid in the past to capital allowances during the conveyancing process. However, this should all now change.


New Rules – From 1 April 2012

Traditional practice should now change, with new rules introduced by the Finance Act 2012. These took effect from 1 April 2012 (for companies) and 6 April 2012 (for sole traders, partnerships and so on). They will then be tightened further from 1 and 6 April 2014.


The initial change is that, where the vendor has claimed plant and machinery allowances for fixtures, the purchaser will only be able to claim capital allowances for those fixtures when one of two things happens within two years of the transaction completion date, either:


  1. an election under section 198 of CAA 2001 (or section 199 for leases); or
  2. an application to the Tax Chamber of the First-tier Tribunal for an independent determination.


This is called the “fixed value requirement”. Without a valid election or tribunal determination, the purchaser will never be able to claim any capital allowances for those fixtures. And to make matters worse, if the property subsequently changes hands again, nor will any future owner. This will have severe irrevocable tax consequences and is expected to adversely affect the future market price of affected properties.


These new rules are an issue best dealt with during transaction negotiations, or the outcome will be far more uncertain, difficult and costly to resolve.

Section 198 Elections

A CAA 2001 section 198 election allows the vendor and purchaser to negotiate a value for the plant and machinery transferring between them – the “disposal value”. There are various tax-technical requirements involved in making a valid election.


The government’s intention is that any section 198 election amount should ideally reflect a market value apportionment. However, the parties are free to agree a lower amount, for example, £1 (in which case, the vendor would keep all the tax relief, despite selling the property, and the purchaser would effectively get nothing).

Tactically, it is generally in the interests of vendors to seek to agree as low an election as possible in an effort to avoid a claw-back of allowances already claimed, and to keep the benefit of future allowances. However, for purchasers, the situation reverses, such that an election at anything less than the vendor’s full  original claim amount is generally inadvisable unless adequate compensation is received elsewhere in the deal.


A fundamental point is that an election is not mandatory. Consensus will ordinarily be in both parties’ interests, and the government’s hope is that an election will become a standard part of all commercial property sale and purchase agreements. However, it is only suitable if the proposed election amount is fair. If not, then the option of a tribunal determination exists, as discussed below.


Indeed, HMRC has formally put on record that the freedom to elect for less than market value should not be seen as detracting, in any way, from the underlying statutory right of either party to insist on a just and reasonable apportionment. So if, for example, the vendor is not playing ‘fair’, and tries to impose a lower value on the fixtures than would result from an apportionment, then the purchaser is entitled take this into account in the price offered for the property, or simply seek a determination from the tribunal.


Tribunal Determination

As an alternative to entering into a section 198 election, either party may unilaterally refer the matter to the First-tier Tribunal for an independent determination. The tribunal is, of course, obliged to apply statute, which should, in the majority of cases, result in most or all of the allowances transferring to the purchaser.


HMRC has indicated that a tribunal application and hearing is not something that should be feared, nor should the time and cost involved be prohibitive.


Importance of Adequate Capital Allowances Due Diligence

These rules only apply to fixtures upon which the vendor has claimed capital allowances. It is therefore vital, at the pre-contract stage, to establish the capital allowances history of the property as far as possible. This can be complicated. In practice, vendors may have claimed on some assets but not others, and records may be poor. Indeed, it is common for smaller owner-managed businesses to have failed to claim any allowances at all.


Solicitors will be aware that that the Commercial Property Standard Enquiries (CPSE.1) form includes capital allowances questions. Only a few of these focus on plant fixtures and are, therefore, of wider application and more important than others. However, responses from vendors are often unhelpful, unclear or incomplete.


Far more attention will now need to be paid to obtaining meaningful replies (having taken specialist tax advice, as appropriate). The more information the purchaser can obtain, the easier it will be to protect his position. Purchasers’ solicitors may also wish to specifically advise vendors that the purchaser will be relying on the answers given in order to claim tax relief. Vendors may thus be prompted into treating the issue with due consideration.


New Rules – From April 2014

From April 2014, the rules are being toughened so that, where the purchaser wishes to claim allowances, they will need the vendor to ‘pool’ the expenditure (that is, formally notify the expenditure to HMRC in a tax return), even where the vendor has never claimed any capital allowances (but could have done). This is called the “pooling requirement”. This does not apply if the vendor could not have claimed because the business is not within the charge to tax (for example, pension funds or charities), or if the fixtures in their hands did not qualify for allowances.


Where the 2014 rules apply, the vendor will, before the purchaser can claim, need to go through the motions of claiming capital allowances. This involves quantifying and notifying the qualifying expenditure to HMRC, but not claiming any tax relief, and then agreeing to pass this on to the purchaser.


If the expenditure has not been pooled by the vendor, then the purchaser has no right to apply to the tribunal for a determination, so is effectively disempowered. In practice, this mandatory pooling is likely to introduce additional cost (no doubt at the purchaser’s expense), disagreement and delay. If it is not dealt with during the transaction, it is likely to be practically impossible, or prohibitively expensive, to resolve.

Action Needed

For every £500,000 of expenditure, between £25,000 and £50,000 (and as much as £125,000) of tax can be at stake. Failing to apply the new rules properly will prove costly to purchasers – even potentially damaging the market price of affected properties – and, therefore, potentially their advisers. There are two key commercial issues for solicitors.


First is risk management. Most advisers carrying out conveyancing will probably not consider that they should be intimately familiar with the detailed capital allowances rules. However, in practice, it has not generally been the case that a capital allowances specialist or tax adviser has routinely been consulted during deals. In such circumstances, conveyancers are likely to be the only professionals in a position to advise on capital allowances, and find themselves expected to ensure that their clients properly understand the implications of anything they agree, or fail to do. We have already seen, in an expert witness capacity, a number of cases where fee disputes and professional negligence actions have arisen against conveyancing advisers over their handling of capital allowances during transactions. Without considerable care under the new rules, the likelihood and severity of this is expected to greatly increase.


Second is additional fee income. Where solicitors are sufficiently confident about how the detailed tax rules work, they can, of course, charge for providing advice in the normal way. Alternatively, if they involve a capital allowances specialist, they can charge a liaison fee or enter into a fee-sharing arrangement (where appropriate, and disclosed in advance to the client). This option can also provide real benefit to clients, helping them to understand their position and the information needed as the basis of any election negotiations, or to file before the tribunal. Sound advice should pay for itself many times over.


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Tags for this article: capital allowances, solicitors, conveyancing, plant, machinery, fixtures, Finance Act 2012, fixed value requirement, section 198 election, mandatory pooling, pooling requirement, due diligence, CPSE1

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