Giving it all away

“So you’ve just agreed Heads of Terms on the sale of that large commercial property you own in the City, that’s fantastic”.

“What have you agreed with the buyer as regards capital allowances?”

“Oh, I’ve told the other side they can have them, I’m not really bothered about them”.

Ah, OK, so did you increase the price to get any value for the allowances given away?”

“Erm… no.”

“OK, do you know the value of the allowances you’ve given away?”

“Erm… no… not really”.

Unfortunately, I have this conversation with clients and their agents more often than you would expect as many do not understand the true value of capital allowances in respect of fixed plant and machinery they/their clients own. This can result in thousands of pounds of tax relief being given away. So, what are capital allowances, how do they work, what can they be claimed on and how should they be dealt with on a sale of a commercial property?

What are capital allowances?

Businesses are not allowed to make any deduction or allowances for expenditure on capital items (such as fixed plant and machinery) when calculating their taxable profits or losses. Instead, businesses are allowed to claim capital allowances against their profits chargeable to tax to reflect the depreciation in value of the respective plant and machinery. Basically, capital allowances are a way of getting tax relief.

Claiming capital allowances is not seen as aggressive tax planning and is accepted by HM Revenue & Customs (HMRC).

Who can claim capital allowances?

Businesses carrying on a trade from their property or a property letting business can claim capital allowances but property traders cannot claim such allowances. Nor can certain non-tax payers, e.g. pension funds as they have no need to claim capital allowances.

Non-UK property investors can claim capital allowances against profits chargeable to income tax.

How do capital allowances work?

Expenditure on fixed plant and machinery that qualifies for capital allowances is, for those wanting to claim capital allowances pooled for accounting purposes. This essentially means that items which qualify for allowances at the same rate (see below) sit in a pool of expenditure which goes up as new items qualifying for capital allowances are acquired and expenditure is added to the pool or, down as allowances are claimed or possibly on the sale of plant and machinery from the pool.

Capital allowances can be claimed on fixed plant and machinery at differing rates namely 8% on integral feature fixtures and 18% on non-integral feature fixtures. This means that each year a sum equal to either 8% and/or 18% of the sum in the relevant pool can be taken from the pool and set against the relevant business’ profits chargeable to tax.

There is also an annual investment allowance (AIA) which is currently £200,000 and can be claimed in the accounting period when the relevant plant and machinery is acquired. This allowance may enable a full deduction of the cost of the said plant and machinery against the business’ profits in the year of purchase.

So by way of example –

Company A redevelops a commercial property it intends to let and as part of this redevelopment it acquires plant and machinery (that qualify for capital allowances at 8%) for £3m. Company A’s profit in the accounting period of the acquisition are £10m. Company A can claim full the AIA (£200,000) against its £10m profit and 8% of the balance of the expenditure in the relevant pool (so 8% of £2.8m (assuming the pool had no expenditure in it before the £3m)). This means that £200,000 (the AIA) plus £224,000 (being 8% of £2.8m) can be claimed against the £10m profit. Tax is, therefore, payable by Company A on £9,576,000 (being £10m less £200,000 less £224,000) at 19% (the current corporation tax rate for a UK company). Company A’s tax liability for the year is, therefore, £1,819,440 instead of £1,900,000 (being 19% of £10m) giving a tax saving of £80,560 in the relevant tax year.     

Expenditure remaining in the relevant pool(s) can then year on year be set against the company’s profits chargeable to tax and therefore can, over time, produce significant deductions against profits and tax savings.

What can allowances be claimed on?

Neither “plant” nor “machinery” is defined in the Capital Allowances Act 2001 (CAA) although there is extensive case law on these terms. Surprising to many, these terms do not just include heavy bits of industrial kit but can include items such as baths, wash basins, carpets and pictures. The plant and machinery on which capital allowances can be claimed is relatively extensive.

“Integral features” are defined in the CAA and include items such as electrical systems (including a lighting system), lifts, escalators, cold water systems and external solar shading.

How should I deal with capital allowances on a property sale?

A “property sale” can include the assignment of a lease or the surrender of a lease as well as the sale of a freehold and so should be considered in all such transactions.

Any allowances available to a seller in respect of the fixed plant and machinery being sold in a property will not automatically transfer to a buyer. A seller can by agreement pass the allowances to the buyer but my advice would always be not to do so until the value of the allowances are understood and unless, if possible, the value can be obtained for the transfer of such allowances. Consideration should be given to capital allowances at the Heads of Terms (HOTs) stage and ideally something included in the HOTs setting out what the position is as regards such allowances. This avoids arguments when it comes to drafting the sale contract which I have seen on many occasions sometimes leading the exchange or completion being delayed.

It is possible for a seller to continue to claim capital allowances in respect of the expenditure in its various capital allowances pools even after it has sold the relevant property. Capital allowances can therefore, still be valuable post the sale of the property assuming the seller can continue to use the allowances against other profits or possible group relieve them.

A capital allowances election entered into by both the seller and the buyer typically accompanied by various contractual provisions are required for allowances to transfer. It is not possible for the respective parties simply to ignore capital allowances and for a buyer to try and claim they have transferred with the relevant property. This inevitably gives the seller the upper- hand when negotiating capital allowances.

Conclusion

Capital allowances can be very valuable but all too often they are simply given away without too much thought. Getting the position right at the start of a transaction can ensure that even if the allowances do transfer, value can be extracted from purchasers for this.

Why this matters

Giving away capital allowances can, in certain circumstances lead to the loss of a significant amount of tax relief. Take the example in this article, the total allowances available to Company A could be worth circa £570,000 (at a 19% corporation tax rate). To give all or part of these allowances away without attempting to obtain some value for them is commercially nonsensical if the selling company can continue to use the allowances. Too often allowances are given away without clients or agents understanding their true worth and when this is done by agents/advisers there is a risk that this is negligent if the client hasn’t been advised at least to consider its capital allowances position before any decision is taken in respect of them.

Further reading

Tolley’s Capital Allowances