Under the UK tax system, 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 18% and the 'special pool' rate of 8%.
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 8 years (short life assets) which enable the full benefit of the allowances to be obtained more quickly. For assets purchased before April 2011, the election can only be made in respect of an asset with an expected life of less than 4 years.
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 £200,000 a year. Businesses which are members of a group of companies only get one annual investment allowance for the whole group.
The amount of the annual investment allowance changed several times between 2008 and 2016.
Enhanced Capital Allowances
Enhanced capital allowances give 100% capital allowances on certain designated energy-saving and environmentally beneficial plant and machinery.
There are three categories of plant and machinery which currently qualify for ECAs:
- energy-saving plant and machinery;
- environmentally beneficial plant and machinery (including water conservation plant and machinery); and
- low carbon cars and low carbon refuelling stations.
Qualifying items of energy saving plant and machinery 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.
There are now over 40 new enterprise zones benefiting from business rates reductions and a simplified planning process. Businesses in some of these zones 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).
For more information about enterprise zones see the government's enterprise zone website
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 which constitute fixtures for land law purposes, 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.
If the buyer is to be able to claim allowances in respect of machinery and plant in the property 'which constitutes a fixture', tax legislation requires the parties to enter into an election (a 'section 198 election') to fix the value at whatever amount they choose, within certain parameters or to apply to the Tax Tribunal for a value to be determined.. 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.
From April 2014 a buyer of a building is only able to obtain capital allowances if the seller has 'pooled' its expenditure on the fixtures for capital allowance purposes in a chargeable period when it owned the property. Pooling means adding the expenditure to the seller's capital allowance pool – although the seller does not have to have claimed a writing down allowance.
The pooling requirement is in addition to the requirement to have fixed the value of the fixtures by entering into a section 198 election or getting a determination from the Tax Tribunal.
The pooling requirement will not be an issue where the seller has been claiming all the allowances it was entitled to claim, as it will have already pooled the expenditure in order to claim the allowances. However, buyers will need to take particular care if the seller has not claimed allowances. Buyers may also want to investigate whether the seller has claimed all the allowances it could have claimed.
If the seller has not claimed all the allowances it could have claimed, the buyer will need to ensure that the seller agrees in the sale documentation to pool its expenditure. If the seller is not entitled to allowances, perhaps because it is a non-taxpayer, such as a pension fund, the last owner of the property who was entitled to claim allowances (and owned the building at some time after April 2014) would have had to have pooled the expenditure in order for the allowances to be available to a subsequent buyer.
Buyers will therefore need to find out about the seller's capital allowance position as early as possible, so that the necessary steps can be taken to preserve the capital allowances. Otherwise valuable allowances can effectively be lost and cannot be claimed by anyone.
It is important that non-taxpayers, such as pension funds, pay attention to the capital allowance position and obtain the necessary information when they buy properties, even though they themselves cannot claim allowances, so that they can preserve the value of the allowances (and thereby increase the value of the property) for future buyers.
Capital allowances and leases
When a lease is granted, allowances in relation to the fixtures within the building will remain with the landlord, unless the lease is granted at a premium and an election (a 'section 183 election') is made for the allowances to pass to the tenant. However, tenants will usually be able to claim allowances in respect of expenditure they have incurred on items qualifying for allowances as part of their fit out of the premises. Any contribution by the landlord to the fit out of the property needs to be carefully structured so as not to prejudice the availability of allowances for the tenant.