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Plant Integral Features

Plant and Machinery Integral Features

This article appeared in The Tax Journal (the "non-taxing weekly for top professionals") on Monday, 17 September 2007.

 

July saw the latest stage of the debate about the future of capital allowances and whether they are suited to the modern commercial environment, when the Government published its consultation document ‘Business tax reform: capital allowances changes’. Inter alia, this document sets out proposals to ‘modernise’ the rates of tax relief available for plant and machinery.

WHAT IS PROPOSED

 

 

Integral fixtures will include:

 

These assets comprise a substantial proportion of the cost of modern commercial buildings.

 

The Government has sensibly ruled out using the definition of ‘background plant and machinery for a building’ implemented during the Finance Act 2006 leasing reforms (SI 2007 No 303). This is because its  current intention is specifically to exclude integral fixtures from a ‘more generous’ rate of allowance and a comprehensive definition is not suited to that purpose. Furthermore, that definition includes many short-lived assets like blinds, curtains and data installations that clearly should not suffer tax relief over 30 years.

 

The capital allowances changes have been discussed generally in a previous article by Martin Wilson (Taxation, 23 August 2007) and  this article will concentrate on one of the most significant areas of change: the proposed regime in respect of fixtures.

 

WHAT IS THE CASE FOR CHANGE?

In recent years the capital allowances system has been criticised by some because of its perceived anachronistic nature and complexity. In 2002 the Government began a consultation process on the reform of corporation tax, which included proposals in relation to capital allowances.

 

The Government’s view was that:

 

 

 

 

As a result the Government floated two main ideas:

 


In March 2004 the Government announced that it had decided to retain the capital allowances system  abandoning the idea of using commercial depreciation) but released a further consultation paper in December of that year confirming it was still considering modernisation and in particular introducing a commercial buildings allowance.

 

Then came the U-turn. In March of this year the Government instead made its shock announcement that it would abolish industrial and agricultural buildings allowances (see ‘Trouble at Mill’ by Keith Gordon in Taxation, 10 May 2007) and at the same time publicised its proposals to reduce the rates of relief for plant and machinery to 20% and 10%.

 

The proposed plant regime is similar to that proposed by the Chartered Institute of Taxation (CIOT) in its response to HMRC’s December 2004 consultation. The CIOT suggested that there might be only two capital allowances pools, referred to for convenience as the ‘25% pool’ and the ‘10% pool’. However, despite the CIOT cautioning against the temptation to cherry-pick items, HMRC’s proposals differ in three significant ways:

 

 

 


The key part of the Government’s comment is the first part, that ‘the Exchequer costs are extremely high’. Put another way, whether fair or not, it has decided that granting businesses buildings allowances is not a financial priority.

COMMENTARY ON THE PROPOSALS

Reducing tax relief for plant in the general pool to 20%

It is proposed to reduce the rate of writing-down allowances for plant in the general pool to 20%. This will apply to all:

 

 

 


It is difficult to justify reducing the rate of 25% presently applying to the general pool. This currently includes assets with longer lives that will be in the 10% pool in future – the new general pool will only comprise assets with shorter lives, so there can be no justification for reducing the rate to 20%. Leaving revenue-raising reasons aside, it would seem a fairer reflection of economic depreciation to consider increasing the rate rather than reducing it.

Machinery

It is often overlooked that ‘plant’ and ‘machinery’ are different things – if they were not, the phrase ‘plant and machinery’ would not be used. According to HMRC published guidance, ‘machinery’ includes machines and the working parts of machines, and a ‘machine’ usually has moving parts. One immediate observation is that irrespective of whether they are standard fittings in ‘normal’ buildings, many of the proposed integral fixtures may include elements which are ‘machinery’, not ‘plant’ (for example, boilers, air-conditioning units, lift motors, etc). Therefore they suffer rapid wear and tear and in all fairness should benefit from much faster tax depreciation than the 30 years over which the new 10% rate would grant relief. Sophisticated modern machinery normally becomes obsolete much faster than that.

 

It may be argued in response that the subsequent replacement of, say, a boiler after ten years would be a repair of the central heating system, qualifying for a revenue deduction. However, this has two serious flaws. Firstly, it does not remedy the fact that the original boiler would still continue to attract writing-down allowances of an ever-diminishing amount long after the actual plant had been scrapped, which would not be fair or reflect commercial reality. Secondly, even if the replacement was agreed to be a repair, the cost might often be capitalised (particularly by listed companies anxious not to depress earnings). In HMRC’s view a tax deduction is only available for such ‘deferred’ repairs when they are charged to the profit and loss account. Therefore tax relief would effectively be given on depreciation – an idea which the Government has already rejected!

Broadening the definition of plant

As discussed in our back-to-basics article on plant and machinery (16 October 2006), there is currently no statutory definition of plant and machinery (although the legislation does attempt to define what is not plant). Instead plant is identified by applying principles drawn from case law. These seek to distinguish between the apparatus with which a business is carried on (which is plant) and the premises in which it is carried on (which is not plant).

 

For many taxpayers this results in a number of ‘tax nothings’ which do not qualify for relief. For example, although many mechanical and electrical services in buildings routinely qualify for capital allowances, electrical power, lighting and cold water installations often do not. The Government is considering including all of these assets within the 10% integral fixtures classification, which would be welcomed by some taxpayers.

 

However, there are many instances where these types of assets do already qualify (at 25%). For example, entire electrical installations may be plant (based on a Commissioners’ decision that this was appropriate for a new-build supermarket) and normal lighting and cold water installations qualified as plant in Wimpy International Ltd v Warland [1989] STC 273. HMRC will even accept that office fluorescent lighting often qualifies, provided that certain criteria are met. The inclusion of these types of assets in the 10% pool will leave many taxpayers worse off, particularly hoteliers and the hospitality industry, who have already been hit hard by the abolition of industrial buildings allowances (IBAs).

 


Although the Government is considering giving capital allowances for ‘green’ design features that deliver energy-saving and other environmental benefits (for example, brise-soleils and active facades), which would be welcomed, it might also have considered broadening the definition of plant to include expenditure required to meet:

 

 

 

Long-life assets

Long-life assets are plant and machinery expected to have a useful economic life when new of at least 25 years. It should be welcomed that the rate of tax relief for long-life assets is to be increased from 6% to 10%, although the main beneficiaries will be the privatised utilities, which were the original targets of this ‘windfall tax’. Perhaps this will be seen as partial compensation for the loss of IBAs for these businesses.

 

Furthermore, there is an anomaly affecting certain assets which HMRC previously routinely accepted during long-life asset discussions as having a life of less than 25 years (boilers, pumps, calorifiers, etc). The Government now proposes that they should qualify for tax relief over a period of some 30 years, which can in no way be said to reflect true economic depreciation.

Short-life assets

The proposals state, without explanation, that integral fixtures will not be eligible for ‘short-life asset’ treatment. The purpose of the so-called ‘short-life asset’ election is to accelerate tax relief where a taxpayer realises a genuine, commercial loss on an item of plant in a short period of time. The system should not arbitrarily differentiate between different types of plant. If the election continued to apply to integral fixtures, the overall effect on the Treasury would probably be minimal but for the taxpayers affected the relief would be welcome and such a move would be ‘fair’ and would reflect commercial reality. In the light of its stated aims the Government should welcome such a move. If there is a concern that the measure could be abused, the legislation should target the abuse rather than taxpayers generally.

Economic depreciation

The Government’s proposals have made repeated reference to the true or actual rate of economic depreciation for integral fixtures. However, determining this is a subjective matter that, far from being an exact science, as the Government appears to suggest, will depend on the nature of the business that owns the assets and the use to which they are put. So presumably this is the type of question that is best left to management of a business, rather than the Government and ‘a one size fits all’ approach cannot possibly determine the true rate, despite the former Chancellor’s pronouncements to that effect.

 

Furthermore, the Government’s insistence that the proposed rates are the ‘true’ ones for all businesses is at odds with the so called ‘business use test’ case law definition of plant. This considers whether the asset performs a particular function as apparatus in the context of the ‘nature of the particular trade being carried on, and the relation of the expenditure to the promotion of the trade’ – that is, whether the asset functions as apparatus in that taxpayer’s particular business (recognising that identical assets may be plant in one business and not in another). If changes are to be made, logically it seems inconsistent to consider the taxpayer’s particular business important in determining whether an asset is plant but not in establishing the tax depreciation rate to be used.

CONCLUSION

The Government likes to refer to its actions as ‘modernisation’, in the interests of fairness and commerciality. Whilst these are laudable objectives, an alternative interpretation is that property is an easy target to tax because it cannot move overseas. The Treasury expects to raise a large amount of tax from these capital allowances changes (almost exactly cancelling out the effect of reducing the full corporation tax rate) without losing many votes. It is hard to see how the changes will help the UK’s economy and international competitiveness and achieve the new Prime Minister’s stated aim of ‘encouraging growth through investment’.

 

It has been said that there will be winners and losers. But apart from the Treasury itself, it is essentially a picture of small winners and big losers.

 

In response, many businesses should consider bringing forward expenditure plans by a year and making sure all capital allowances claims are up-to-date (especially unclaimed prior years’ expenditure) without delay, to ensure that tax relief is available at the higher rate. They should also make their views known by the 19 October consultation deadline.
 

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