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Plant and Machinery Allowances - Common Misconceptions

This article appeared in The Tax Journal (the "non-taxing weekly for top professionals") on Monday, 22 January 2007.

 

Although capital allowances are a routine aspect of tax compliance, our specialist capital allowances experience, gained both in the accountancy and surveying professions, has revealed that common misconceptions and areas of difficulty still exist.  In this article, we will discuss some of the real life examples seen in practice that have resulted in missed opportunities to claim tax relief.

Interaction with capital gains tax

Perhaps the most frequent effect of a misconception that we see in practice is where capital allowances are not claimed because of the mistaken view that any tax saved by claiming allowances will later be cancelled out by an increased chargeable gain (if, of course, the property is ever sold).  This is not true.

 

On the contrary, even if expenditure has attracted capital allowances, that does not prevent its deduction in a capital gains computation, so claiming capital allowances cannot create or increase a chargeable gain.  This is confirmed by s 41(1) of the Taxation of Chargeable Gains Act 1992, supported by HMRC’s published instructions on capital gains.

 

This misconception perhaps arises because intuitively it would appear that these rules mean tax relief is being given twice.  Special rules do exist where there would be a capital loss on disposal.  These prevent expenditure on assets that have qualified for capital allowances being deducted in calculating a capital loss.  However, in practice although this may apply to chattels it rarely applies to fixtures in buildings, which typically appreciate in value with the land and buildings of which they are part.

Contract allocations

We commonly see price allocations written into agreements for the purchase and sale of property.  These are primarily agreed for the purpose of stamp duty land tax (SDLT), but are frequently also intended to be used for capital allowances purposes.  However, there are problems with this approach. 

Influence of SDLT

Firstly, for SDLT purposes it is necessary to split the consideration between expenditure on:

 

• land, including fixtures (which is potentially subject to SDLT) and
• non-land assets, such as chattels and goodwill (which are not subject to SDLT)

However, for capital allowances purposes the allocation should be between expenditure on:

• assets that qualify for capital allowances, such as plant and machinery (including fixtures and chattels) and
• assets that do not qualify for capital allowances such as land and buildings.

 

So it is immediately apparent that the assets required to be valued for capital allowances purposes are different to those to be valued for SDLT.  Consequently, SDLT and capital allowances valuations should be different in most cases.

Requirement for ‘just and reasonable apportionment’

Secondly, as described in our  previous article, although vendors and purchasers may jointly elect to agree a disposal value for fixtures under s 198 of the Capital Allowances Act 2001 (hereafter CAA 2001), in the absence of such an election a ‘just and reasonable apportionment’ is required by s 562 CAA 2001.  This statutory requirement to prepare a ‘just and reasonable apportionment’ always operates by default and there is an established specialist methodology for doing this. 

 

It is therefore easy to see how arbitrary contract allocations are unlikely to be ‘just and reasonable’, particularly if imprecise terminology is used, such as ‘fixtures and fittings’, as mentioned in our previous article.  Therefore, the HMRC capital allowances and SDLT instructions make clear HMRC’s view that agreements of this nature may not be reasonable and could well be an area of enquiry.  Furthermore, for capital allowances purposes at least, there is long established authority that HMRC and the Courts are not bound by contract allocations (Fitton v Gilders & Heaton (1955) 36 TC 233).  These are therefore ineffective in practice and do not provide the protection often imagined.

 

To achieve accuracy in tax returns different apportionments should normally 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 apportionment, as described in our last article, or alternatively a valid s198 election should negotiated and submitted, together with corresponding clauses in the purchase agreement.  However, this of course still requires care, including conducting adequate pre-contract capital allowances due diligence (for example, using the British Property Federation endorsed ‘CPSE.1’ capital allowances questions drafted several years ago by us on behalf of the London Property Support Lawyers Group).

Allocation not the vendor’s prerogative

Another common experience of ours is that it is often thought that a vendor may unilaterally decide upon a disposal value (for example using tax written down value).  This is again mistaken.  It is of course possible for a vendor and purchaser to negotiate and jointly agree to an approach like this, but only if a valid s 198 election is submitted by both parties (which is subject to various conditions).  If an election is not submitted, then the default ‘just and reasonable apportionment’ provision applies to calculate both the vendor’s disposal value and the purchaser’s claim, which should be the same amount (subject to a maximum of the original cost claimed by the vendor).

Investment properties

We have heard it said that it is not possible to claim plant and machinery allowances for properties held as an investment.  This is easily cleared up by examining s 15 CAA 2001, which includes “an ordinary schedule A business” (i.e. property investment) in the list of permissible qualifying activities for capital allowances purposes.

 

It has also been said that claiming capital allowances will reduce the market value of property.  This is again not true as capital allowances are not taken into account when property is valued for commercial or accounting purposes.

Residential properties

It is relatively well known that s 35 CAA 2001 prevents expenditure on plant and machinery from qualifying for capital allowances if the asset is to be used in a ‘dwelling-house’ (defined by HMRC as a building, or part of a building, which is a person’s home) in connection with a qualifying activity which is either:

• an ordinary Schedule A or overseas property business (i.e. property investment) or
• ‘special leasing’ (i.e. hiring out plant otherwise than in the course of another qualifying activity). 

However, less well known is that this restriction does not apply in three main circumstances:

Firstly, where plant is used for furnished holiday lettings, or in a dwelling-house in connection with a qualifying activity which is not a property business or special leasing (for example, a trade).  So where a trader’s premises include living quarters, such as accommodation at a pub or hotel, there is no requirement to restrict allowances. 

 

Secondly, HMRC accepts that some multi-occupation buildings are not ‘dwelling-houses’, such as nursing homes, hospitals, university halls of residence, or prisons. 

 

Thirdly, a block of flats is not a dwelling-house, although the individual flats may be.  This means that capital allowances may be available for plant in communal parts of the building, like reception desks and lifts, and for other plant and equipment serving common parts like fire and security alarm controls, and plant room central heating boilers.

Other reasons why claims are not always made

In practice, we have seen many instances where the full amount of capital allowances have not been claimed, or no claim has been made (particularly for acquisitions of second-hand properties).  There are various reasons for this.

 

It is sometimes said that claiming capital allowances is just a cash flow exercise.  Whilst there may be an element of truth in this, any deferral of tax is always valuable and many properties are held for a long time, resulting in a significant real term erosion of tax through inflation.  Furthermore, it is not uncommon for plant and machinery fixtures to be stripped-out during regular refurbishment projects, or for entire buildings to be demolished because they have become obsolete.  In these circumstances the tax savings arising through capital allowances become permanent because the disposal value required is normally nil or a nominal amount (e.g. scrap value).  Also, it is becoming increasingly common for vendors to market property for sale ‘without the benefit of capital allowances’ and enter into a s 198 election with the purchaser to avoid a clawback of allowances already claimed (i.e. by electing at tax written down value) or to retain all the allowances if, for example, the purchaser is a pension fund (i.e. by electing at a low amount like £1).

 

For new-build or refurbishment construction projects capital allowances are typically claimed for obvious chattels, such as fittings and furnishings like office desks and chairs, or beds in a hotel.  This is because their cost is readily identifiable from supplier invoices.  However, capital allowances claims can more easily be missed for fixtures like sanitary appliances, hot water and heating installations, ventilation and air conditioning installations, electrical installations and lifts etc.  This is because these fixtures are often capitalised as ‘land and buildings’ in the accounts, rather than as ‘furnishings, fittings and equipment’.  Furnishings fittings and equipment are generally recognised as plant and readily identified as such in the tax return and it is sometimes then thought that everything that can be claimed has been claimed.  However, for fixtures posted to land and buildings it is not always apparent that a capital allowances claim is possible and claims are missed.  Nor, without capital allowances specialist surveying assistance, is it particularly easy or cost effective in practice to identify the cost of those qualifying fixtures and agree the amounts with HMRC in the event of an enquiry.

 

For purchase of second-hand properties it is similarly not always realised that capital allowances claims are possible, or it is wrongly thought not be worthwhile, because of the reasons given above.  As capital allowances are also not widely understood by all of the parties involved in transactions (including taxpayers and the professionals advising them like surveyors and solicitors) and accountants are often not always closely enough involved during contract drafting and negotiations it can be difficult for them to protect their client’s interests and maximise the allowances available.

Remedying missed capital allowances claims

The good news is that if capital allowances claims are missed, it is possible to remedy the situation.  There is a normal two year window from the end of an accounting period for a company to make or amend a capital allowances claim.  However, if this deadline is missed, depending on the circumstances it is still possible to claim the allowances in a later period’s return, as long as the assets are still owned in that later period (i.e. the plant has not been stripped-out, or the building sold).  Or in exceptional circumstances, and subject to various conditions, it may be possible to make an ‘error or mistake claim’ within six years of the end of the accounting period of the return when the expenditure on plant was incurred.

 

Although expenditure incurred recently is easiest to review and often generates the largest tax saving (e.g. within the last six years, because records are normally retained for at least that long), it is in principle possible to go back indefinitely and remedy missed claims (for example, based on limited information we have successfully recently agreed claims on property portfolios for expenditure incurred back to the early 1980’s). 

Conclusion

This article has highlighted and hopefully answered some of the most common capital allowances misconceptions seen in practice that prevent taxpayers from taking up valuable opportunities to claim capital allowances.  The key message is that although capital allowances due diligence and claim preparation can be difficult and time consuming, with effort making a claim can be very worthwhile.

 

 

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