A business which spends money on capital assets for use in its business cannot claim a tax deduction for that expenditure. Instead a tax relief called a capital allowance may be available for certain types of expenditure.
The aim of capital allowances is to give tax relief for the reduction in value of certain capital assets used by a business, by letting the business write off the cost of the assets over a number of years against the taxable income of the business.
Buildings themselves do not usually qualify for capital allowances but they will contain items of plant and machinery such as lifts, heating systems, air conditioning and sanitary fittings which may qualify for allowances.
Availability of capital allowances can be an important consideration on the sale or purchase of a commercial building.
Plant and machinery allowances
Writing down allowances are available in respect of expenditure on certain types of plant and machinery. Details of what constitutes plant and machinery can be found in HMRC guidance.
Writing-down allowances are annual allowances that a business can claim to reduce or 'write down' any remaining balance of capital expenditure on plant and machinery that the business has not already claimed a capital allowance for, referred to as a 'pool' of 'unrelieved' expenditure.
You apply writing down allowances to the sum of the following:
- any residual capital expenditure balances carried forward from previous years
- added to the balance of any new capital expenditure in the accounting period after you have claimed any other more advantageous allowances (such as the annual investment allowance – see below)
- less the proceeds of equipment you have disposed of or sold.
There are two different rates of capital allowance – the main rate of 20% (which will be reduced to 18% from April 2012) and the 'special pool' rate of 10% (which will be reduced to 8% from April 2012).
Most plant and machinery will fall within the main pool. However, certain assets in a building are designated as 'integral features' and qualify for allowances at the lower special pool rate if expenditure was incurred in respect of them on or after 1 April 2008. The following are designated as integral features:
- an electrical system (including a lighting system),
- a cold water system,
- a space or water heating system, a powered system of ventilation, air cooling or air purification, and any floor or ceiling comprised in such a system,
- a lift, an escalator or a moving walkway,
- external solar shading.
Certain other assets with a working life of over 25 years are designated as 'long-life assets' and qualify for allowances at the special pool rate.
There are special capital allowance rules for cars. There are also special rules which enable an election to be made in respect of assets with an expected useful life of less than 4 years (short life assets) which enable the full benefit of the allowances to be obtained more quickly.
Annual investment allowance
Businesses can claim an annual investment allowance for capital expenditure incurred on most items of plant and machinery. The annual investment allowance gives 100% capital allowances on expenditure up to £100,000 in the accounting period. Businesses which are members of a group of companies only get one annual investment allowance for the whole group. The annual investment allowance is due to reduce to £25,000 from April 2012.
Enhanced Capital Allowances
Enhanced capital allowances give 100% capital allowances on certain designated energy-saving and environmentally beneficial plant and machinery.
There are two categories of plant and machinery which currently qualify for ECAs:
- energy-saving plant and machinery; and
- water conservation plant and machinery.
Qualifying items are set out on a government website about enhanced capital allowances.
The equipment purchased will only qualify if it is unused and not second hand equipment. So in a property purchase if assets are acquired from the seller with the property they will not qualify for this relief as they are second hand. However, if you build or refurbish a building using designated equipment the 100% allowances should be available.
For further details of enhanced capital allowances see OUT-LAW guide to enhanced capital allowances.
Enterprise zone allowances
100% capital allowances used to be available (especially in the 1980s and 1990s) for expenditure on industrial buildings in designated 'enterprise zones'. This type of allowance in respect of the cost of the buildings is not available for any expenditure incurred from April 2011.
In the 2011 budget the creation of some new enterprise zones was announced. Businesses in some of these zones will qualify for 100% capital allowances in respect of expenditure on plant and machinery. 100% allowances will not, however, be available in respect of expenditure on the cost of buildings themselves (other than on plant and machinery, such as a lift, which is a part of the building).
Industrial Buildings Allowances (IBAs)
Industrial buildings allowances (IBAs) used to provide capital allowances for construction costs of specific types of buildings used for a trade such as factories and offices. However, IBAs are no longer available.
Business Premises Renovation Allowance
Business Premises Renovation Allowance (BPRA) is designed to encourage conversion and renovation of empty business properties in specified 'assisted areas'. BPRA provides a 100% tax relief to property owners on money spent on conversion or renovation works on a building.
For more details see Out-Law guide to Business Premises Renovation Allowance.
Capital allowances on a property sale or purchase
When a property is sold, if the seller has been claiming capital allowances in respect of plant and machinery within the building, it will need to work out what part of the sale proceeds are attributable to the assets which qualified for allowances. This figure will need to be brought into the seller's capital allowance computations.
Similarly a buyer which is hoping to claim allowances in respect of plant and machinery in a building will need a figure on which to claim allowances.
The general position for working out the amount of sale proceeds of a building which relate to assets qualifying for allowances is to carry out a just and reasonable apportionment.
However tax legislation also enables the parties to enter into an election (a 'section 198 election') to fix the value at whatever amount they choose, within certain parameters. It is normal to make the election at either tax written down value or at £1 per pool of assets.
Electing at tax written down value means the seller won’t suffer a clawback of any allowances already claimed, but will cease to be able to claim further allowances in respect if its expenditure on the assets. The buyer will be able to obtain allowances and effectively steps into the seller's shoes.
By contrast, an election at £1 means that the buyer will not be able to claim any allowances in respect of the acquisition of the building and the seller will continue to get the benefit of unclaimed allowances.