Capital allowances on property transactions
Capital allowances represent the tax relief available to businesses on their capital expenditure. In addition to allowances available on expenditure on purchasing assets and improving a business’s existing assets, relief may also be available for the fixtures present in buildings bought through a property transaction.
Basics – who can claim
The first step is to consider whether the business fits the basic requirements to make a capital allowances claim. To be eligible for relief, a business needs to have a qualifying activity – a trade or property business – and be acquiring an interest in the land on which the property is located. It is worth noting that the interest does not have to be freehold; leasehold interests can be sufficient but may come with some additional considerations.
When expenditure towards acquiring and improving the property is treated as revenue, for example by a property developer, capital allowances will not be in point.
Pooling and fixed value requirement
Since 2014, property purchases have been subject to the pooling requirement and fixed value requirement. These stipulate that for the purchaser to make a claim for qualifying fixtures present in the purchased property, the relevant allowances must first be pooled by the vendor, and quantum allowances being transferred fixed by use of a CAA 2001, s 198 election agreed between both parties.
If these requirements are not met, the buyer will be unable to allocate any of the purchase price to qualifying assets, even when the vendor has confirmed it has not made a prior claim. This is a key planning point for any purchase transaction.
There are, however, cases where the above may not apply and the purchaser may still have opportunity to claim.
First entitlement
The pooling and fixed value requirements apply to assets only on which the vendor was entitled to claim. For various reasons, set out in more detail below, it may be that the purchaser is the first entity with entitlement to claim on the asset. In such cases the purchaser may allocate a portion of the purchase price towards the asset.
Every asset transferred is considered individually so it is entirely possible that some assets in the property must be transferred by s 198 or lost, and others may be claimed by the purchaser without interaction with the vendor or a section 198 election.
When considering first entitlement to claim on an asset, it is important to bear in mind the asset’s full history and the entitlement of each previous owner – not just the vendor. In practice, this can make an entitlement exercise more challenging for properties that have changed hands several times. In cases of a obtaining a leasehold interest, it is necessary to consider the freeholder’s historic entitlement to the assets (if any), as first entitlement may lie with them.
The following are examples of when the purchaser may be able to benefit from first entitlement.
Vendor is not subject to corporation tax
Companies that are not chargeable to corporation tax have no entitlement or use for capital allowances. When buying the asset from such a vendor, first entitlement to all the plant and machinery fixtures within the property lies with the purchaser, assuming no owners previous to the vendor would have been entitled to claim on the assets. This will typically result in the broadest form of purchase claim, and a detailed costing exercise is often required.
Such entities typically involved in property transactions include charities and pensions.
Purchase from a developer
Not dissimilar from the previous example, a developer is likely to hold the property as stock and the expenditure incurred on the development will not be capitalised. A purchaser obtaining a new property from a developer will have first entitlement to the plant and machinery fixtures within.
Integral feature uplifts
Capital allowances legislation allocates a range of assets into various pools which are ever evolving. One such change, which still affects property transactions today, was the introduction of the integral features legislation in 2008.
The special rate pool was introduced in 2008 and offered writing down allowances at a lower rate – 8%, since reduced to 6% – intended for assets that would typically deliver value to a business’s trade for a longer period of time than main pool assets, which offer writing down allowances at 18%. For example, the heating system of a property – attracting the new lower rate of deductions – would be expected to last longer than computer equipment which remains a main pool asset.
Assets to be covered by the new integral features rules were either previously eligible for main pool allowances, or non-qualifying. For assets that had changed from non-qualifying to special rate assets, provisions were put in place so that the allowances could not be claimed until the asset was purchased by a new owner. This was presumably to prevent a surge of new claims from nearly every business in the country in 2008.
The result of all of the above is that a purchaser will have first entitlement to the integral features in the property that were non-qualifying before 2008 (known as post-commencement integral features), where the vendor owned the property before 2008.
These claims, known as integral feature uplifts, can often identify up to 15% of the purchase price as qualifying for special rate pool allowances.
Vendor has first entitlement
In some cases it may be apparent that first entitlement to claim allowances lies with the vendor rather than the purchaser, whether because of one of the previous three cases apply to them, or for improvement expenditure the vendor incurred in the course of their ownership of the building.
If the vendor is not motivated to identify the allowances, it is possible to undertake a vendor pooling exercise. This is where the capital allowances exercise is undertaken for the vendor at the buyer’s expense, identifying allowances to be claimed by the vendor and subsequently transferred to the purchaser as part of the property transaction.
If such an opportunity is identified in an upcoming transaction, it is important to include wording in the sale and purchase agreement (SPA), stipulating that the vendor will co-operate with a capital allowance exercise, and transfer the allowances identified with an s 198 election.
It is also useful to note that while the wording would need to be included before the document is signed, the analysis can be undertaken after completion, so the transaction is not onerously delayed by the capital allowances analysis. A section 198 election can be signed up to two years after the completion date.
Additional considerations
The following are some other elements that should be considered in relation to purchase claims.
Annual investment allowances
The annual investment allowance (AIA) allows a business to obtain a 100% first year allowances on up to £1m of qualifying plant and machinery expenditure – expected to drop to £200,000 in April 2023. This means the deductions for qualifying plant and machinery arise wholly in the year of expenditure, rather than being written down over time at 18% or 6%.
Transactions between connected parties
If the vendor and purchaser of a property are connected, allowances may be pooled in the vendor and transferred to the purchaser as normal, through a section 198 election. However, the integral features uplift set out above would not be available, as the opportunity to claim on the first transaction after 2008 does not apply to connected party transactions. Typically, connected party purchasers are entitled to the same allowances as the connected vendor.
The AIA is also restricted for purchases between connected parties.
Time limits
For both purchase claims and improvement expenditure, there is no time limit to identify assets which qualify for capital allowances so long as the business still owns the asset and uses it for the purposes of the qualifying activity – trade or property business. Practically, this means that even if several years have passed since a purchase of a commercial building, there may be entitlement to claim if the building and the assets that will be included in the claim still remain.
It is worth noting, however, that the AIA, like most enhanced and accelerated capital allowances, must be claimed in the year the expenditure is incurred – the year the transaction took place – in effect giving a time limit to make the claim of two years from the end of the accounting period in which the transaction completed.
Where allowances are to be transferred, the s 198 election can be signed up to two years after the completion date.
Purchase claim methodology
For capital allowances claims on improvement expenditure, identifying the appropriate cost in relation to the qualifying assets is straightforward, as invoices or other cost information will show what expenditure was incurred.
For property purchases however, it is more complicated. If a large consideration lump sum is paid for the property as a whole including all land and buildings, allocating a proportion of the payment to the qualifying assets can require some analysis.
To identify the amount to be apportioned to qualifying plant and machinery, the Valuation Office Agency (VOA) recommends this formula:
Value apportioned to plant and machinery = P x A
A+B+C
Where:
P = Purchase price of the property
A = Replacement cost of the plant and machinery
B = Replacement cost of the buildings (excluding plant and machinery)
C = Bare site land value
The above values are typically determined through a detailed valuation and surveying exercise.
Conclusion
It is hoped the above is a useful summary of the cases when a buyer may be entitled to capital allowances on their property purchase. Identifying such allowances can be complex, due to the historic entitlement conditions and valuations requirements.
https://www.taxation.co.uk/articles/capital-allowances-on-property-transactions
YesTax.Positively Better.