Capital allowances on fixtures in properties
February 2012

Background

When a company calculates its taxable profits it is not entitled to a deduction for depreciation. Instead, it may claim capital allowances for capital expenditure on certain items (including fixtures in properties). A company may claim capital allowances of 10 per cent (reducing to 8 per cent with effect from 1 April 2012) on integral features (eg, lifts, escalators, electrical systems) on a reducing balance basis and 20 per cent (reducing to 18 per cent with effect from 1 April 2012) on other plant and machinery, again on a reducing balance basis.

Where a company wishes to claim capital allowances, its expenditure on integral features must be pooled into its special rate pool and its expenditure on other plant and machinery must be pooled into its general rate pool. Allowances are claimed on the balance of the tax written down value in the pool each year.

If a seller disposes of a property which contains fixtures upon which it has claimed capital allowances it must bring a disposal value into account. This involves the seller deducting an amount from the tax written down value of the pool equal to the purchase price attributable to the fixtures. If the disposal value is higher than the seller’s written down value in either its general pool or its special rate pool, the seller will be subject to a balancing charge. As a result, buyers and sellers often enter into a capital allowances election in accordance with section 198 of the Capital Allowances Act 2001 (s.198 election) in order to agree the amount of the purchase price that should be allocated to integral features and to other plant and machinery. In the absence of a s.198 election, the purchaser may choose to apportion a just and reasonable amount to the fixtures. This is restricted to the disposal value which the seller brings into account. However, a buyer will often not know what the seller’s disposal value is. This may therefore result in the buyer attributing a higher value to the fixtures than the amount attributed to them by the seller and consequently capital allowances being claimed by both the buyer and the seller on the same capital expenditure.

Taxpayers which incur capital expenditure on converting or renovating certain business premises located in designated disadvantaged areas which have been vacant for at least a year in order to bring them back into use are entitled to a 100 per cent first year allowance or, where the 100 per cent initial allowance is not claimed, a writing down allowance of 25 per cent of the residue of the expenditure on a straight line basis (the Business Premises Renovation Allowance). If the taxpayer disposes of the property within seven years of it being brought back into use they will suffer either a balancing charge or a balancing allowance.

HMRC announced in the 2011 Budget that it would consult on changes to the capital allowances legislation in relation to fixtures. The consultation document, which was published on 31 May 2011, expressed concerns over buyers and sellers apportioning different amounts to fixtures resulting in allowances being claimed by both the buyer and the seller on the same expenditure. In addition, concerns were raised that, as taxpayers are not required to pool their expenditure on fixtures within a specified timeframe, they could make “late” claims at a time when there would be insufficient information available to determine whether a previous owner had already claimed allowances on the fixture and written off the cost of the same. The consultation ended on 31 August 2011. Responses were published on 6 December 2011 along with the first draft of the Finance Bill 2012 which contains the proposed changes.

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Main changes

It should be noted that the new provisions do not apply where there has been no previous owner of the fixtures who was entitled to claim capital allowances. For example, if the property had been bought from the original developer of the building (who would have been trading and could not therefore have incurred capital expenditure) the new rules will not be applicable. Similarly, if the fixtures had been newly acquired and fitted by an exempt person such as a charity or a pension fund, the provisions will not apply. However, the new rules will apply if there has been a “past owner” who was entitled to claim capital allowances, even if it was not that person who sold the building to the current owner. Where there has been more than one such owner who was entitled to claim the allowances, references to the “past owner” are to the most recent one.

Where it applies, the proposed new legislation provides that if a purchaser wishes to claim capital allowances on fixtures in a property:

• the past owner must have allocated its expenditure on the fixtures to a capital allowance pool prior to its sale of the property or must have claimed a first year allowance in respect of its expenditure (the Pooling Requirement); and
• a s.198 election must be entered into within two years of the buyer’s acquisition of the interest in the property or, on application of either the buyer or the seller within two years of the buyer’s acquisition of the interest in the property, the First Tier Tribunal must determine an amount of the purchase price to be apportioned to the fixtures (the Fixed Value Requirement).

In limited circumstances (eg, where the seller has permanently discontinued its business) the Fixed Value Requirement will not need to be satisfied. Instead, the seller will be required to make a written statement specifying the disposal value of the fixtures within two years of ceasing to own them.

The revised legislation will contain a transitional period so that where expenditure is incurred on or after 1 April 2012 but before 1 April 2014 the Pooling Requirement does not need to be met. However, it will be necessary for the Fixed Value Requirement to be met in order for purchasers to be able to claim capital allowances going forward.

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Practical effect

The practical effect of the changes is to make both the pooling of capital expenditure and s.198 elections mandatory if purchasers wish to claim capital allowances.

This may cause problems for purchasers of properties after April 2014 (ie, when the Pooling Requirement must be satisfied) if the seller was entitled to claim capital allowances but chose not to and did not therefore pool its capital expenditure. In such a situation, it will be necessary for the purchaser to negotiate with the seller to require it to pool its expenditure prior to sale.

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Persons unable to claim capital allowances (including pension funds and charities

The new legislation will operate so that if a person purchases a property from a person who cannot claim capital allowances (eg, a pension fund, charity or company trading in property) the Pooling Requirement and the Fixed Value Requirement must still be met if a previous owner of the property was entitled to claim capital allowances.

In such a situation, because the seller is unable to claim capital allowances, it will not be able to either pool its expenditure or enter into a s.198 election. However, the legislation provides that these tests will be met if the relevant conditions had previously been satisfied. The previous owner that was entitled to claim capital allowances must have met the Pooling Requirement and it and the person to whom it sold the building (usually the person now selling the building) must have entered into a s.198 election in order to meet the Fixed Value Requirement. Failure to achieve this will mean that any subsequent purchasers will be unable to claim capital allowances. This may affect the purchase price that the seller can achieve for the property.

The new legislation is therefore likely to result in additional due diligence being undertaken by people purchasing from persons that are unable to claim capital allowances in order to ensure that the requirements were met and capital allowances will be available.

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Changes to the Business Premises Renovations Allowance

The Business Premises Renovation Allowance scheme will be extended by five years so that expenditure incurred prior to April 2017 which meets the relevant conditions will qualify for the allowance.

In addition, new legislation will be introduced which will provide that, if a property on which the Business Premises Renovation Allowance has been claimed is sold within seven years of it being brought back into use, the purchaser will be entitled to claim capital allowances on the fixtures within the property. The amount which the purchaser will be entitled to claim will depend upon the price apportioned to the fixtures and the seller’s tax written down value at the time of sale of the property.

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Conclusion

It will be imperative that purchasers enter into s.198 elections on the acquisition of a property if they wish to claim capital allowances.

The new legislation is likely to result in additional due diligence being undertaken by purchasers to ensure that the Pooling Requirement is satisfied. In this regard, purchasers would be advised to ensure that the sale and purchase agreement contains either a warranty that the seller has pooled its capital expenditure on fixtures in the property or an undertaking that it will do so prior to completion of the transfer of the property.

Finally, the legislation is likely to be problematic for purchasers of property from pension funds and charities. First, the pension fund or charity may not have entered into a s.198 election when it acquired the property thereby preventing its purchaser from claiming capital allowances. Second, if the pension fund or charity acquired the property from another pension fund or charity the purchaser will be required to trace back the ownership in order to determine whether a s.198 election had been entered into on any of the previous transfers.

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