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Practical Advice on Capital Allowances Tips and Misconceptions


This article appeared in the Institute of Chartered Accountants in England & Wales Tax Faculty's TAXline magazine on Tuesday, 19 June 2007.

 

Having worked as capital allowances specialists for many years, our experience of the accountancy, legal and surveying professions has revealed a number of commonly-seen capital allowances misconceptions and areas of difficulty.

 

By far the most common capital allowances encountered in practice, and relevant to most commercial property investors and occupiers, are plant and machinery allowances. These are available for expenditure on business apparatus, including most moveable assets (for example, equipment and furnishings) as well as many fixtures integral within buildings (for example, lifts, sanitary appliances and fittings, hot water, heating and ventilating installations etc). This article will discuss this subject and highlight a number of practical tips.

Capital gains

The most common misconception that we see in practice is that any savings achieved by claiming capital allowances will be cancelled out later by an increased chargeable gain (if, of course, the property is ever sold).

 

That this is not true is made clear by s 41(1), TCGA 1992. On the contrary, this specifically provides that the fact that expenditure has benefited from capital allowances does not prevent its deduction in a capital gains computation. So it is not possible for a capital allowances claim to create or increase a chargeable gain (although special rules do apply where a capital loss results, which prevent the cost of assets that have qualified for capital allowances from creating or increasing a loss).

Purchase contract allocations

We routinely see purchase price allocations written into agreements for the sale and purchase of property,
typically between 'property' (or 'land and buildings'), 'fixtures and fittings' (or similar terminology) and perhaps goodwill.

 

These are normally intended to mitigate stamp duty land tax (SDLT), but are often also intended to be used for capital allowances purposes. However, there are several fundamental problems with this.

Comparison with SDLT

Firstly, contract allocations are required for SDLT because SDLT is payable on land interests (including plant and non-plant fixtures) but is not payable on non-land (for example, moveable chattels or goodwill).

 

However, capital allowances are available for expenditure that qualifies for tax relief (most commonly plant and machinery, irrespective of whether it is fixed or moveable), but are not available for non-qualifying expenditure (such as land and buildings/'premises').

 

So it can be seen that in most circumstances the valuations required for SDLT and capital allowances purposes should be different (unless no moveable assets are being acquired), because different assets are being valued.

'Just and reasonable apportionment'

Secondly, although for plant and machinery capital allowances purposes it is possible for sellers and buyers to jointly elect to agree a disposal value under s 198, Capital Allowances Act 2001 (CAA 2001), without such a formal election, the only approach permissible is a 'just and reasonable' apportionment, required by s 562, CAA 2001 (which incidentally is the same wording required for SDLT by para 4, Sch 4, Finance Act 2003). This statutory requirement always operates by default and there is a well-established specialist methodology for doing it that is endorsed by the Valuation Office Agency.

 

It is therefore clear how seemingly arbitrary contract allocations are unlikely to be 'just and reasonable' to HMRC or subsequent purchasers of property, particularly if, as we often see, legally imprecise terminology is used, such as 'fixtures and fittings' (potentially mixing land/ non-land and plant/ non-plant in one unhelpful phrase!). Therefore, HMRC's capital allowances and SDLT instructions make clear to inspectors that contract agreements may not be reasonable and could well be an area of enquiry.

 

Furthermore, it is not widely realised that for capital allowances purposes at least, there is long-standing authority that HMRC, the courts and subsequent purchasers of property are not bound by contract  allocations (Fitton v Gilders & Heaton (1955) 36 TC 233). Therefore, these are ineffective in practice and do not provide the reassurance often imagined.

Allocation not the seller's prerogative

We often see sellers of property attempting to decide unilaterally upon a disposal value (for example, by bringing into account tax written-down value), which is again mistaken. It is of course possible for a seller and buyer to negotiate and jointly agree to an approach like this, but only if a valid s 198, CAA 2001 election is submitted by both parties (which is subject to various technical conditions and not always possible, for example, if one of the parties is a real estate investment trust or outside the charge to tax,  such as by being non-resident).

 

If an election is not submitted, the statutory default 'just and reasonable' apportionment applies to calculate both the seller's disposal value and the buyer's claim in all cases (which should be the same amount, subject to a maximum of the original cost claimed by the seller). This is the only other approach possible.

The solution

To achieve accuracy in tax returns, different 'just and reasonable' apportionments should ideally be used for SDLT and capital allowances, based on independent valuations prepared for their respective purposes.

 

The capital allowances claim should be calculated using a specialist just and reasonable apportionment, or a valid s 198, CAA 2001 election should be negotiated and submitted, together with corresponding protective clauses in the purchase agreement. However, this of course still requires caution, including adequate due diligence (for example, using the widely adopted British Property Federation-endorsed 'CPSE.1' enquiries form, which incorporates capital allowances questions). It is also worth mentioning that in our view it is normally inadvisable for buyers to agree to s 198 elections.

Other reasons why claims are missed

We routinely see inadequate claims for capital allowances, or no claim made at all (particularly for acquisitions of second-hand properties). There are many reasons for this, including:

 

 

 

 

The remedy

The good news is that if capital allowances claims are missed, this may be easily remedied, with specialist knowledge.

 

It is possible to claim capital allowances in any later period's tax return based on the earlier year's expenditure, providing that the qualifying assets are still owned in the later period (ie, the plant has not been stripped out or the property sold). Indeed, with the Chancellor's recently announced plans to introduce reduced future writing-down allowances for plant there is every incentive to maximise claims for plant allowances before April 2008 to ensure that it therefore qualifies at the higher rate.

 

Although recent expenditure is easiest to review and generates the largest tax savings (for example, within the last six years, because records are normally retained for that long), it is possible to go back indefinitely and make missed claims.
 

 

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