Capital allowances in property sales and purchases

Capital allowances is a complex subject that requires detailed consideration against the history of the property in question. Here, Ken Ross gives a flavour of some of the important points to consider when buying or selling commercial property.

Background

Capital allowances provide businesses with tax relief for the reduction in value of eligible capital assets used by the business, by allowing the business to write off the cost of the assets over a period of years against the taxable income of the business.

Taxpayers are able to claim capital allowances on plant and machinery kept for use in their business. Integral features within a building (such as lifts, heating systems and air conditioning systems) and certain fixtures (such as fitted kitchens and bathrooms) also qualify as "plant and machinery", and a taxpayer can claim capital allowances on these items if that taxpayer bought the items in question.

In order to claim capital allowances, taxpayers must group items into "pools" of capital expenditure on which the taxpayer has not previously claimed capital allowances. These pools attract different rates of allowances: most plant and machinery falls within the main pool (18% rate), but integral features and items which have a life of more than 25 years will fall within the special pool (8% rate).

Purchasing a Property

When purchasing a building, capital allowances must be identified and recorded at the point of purchase and sale of the property in question or they can be lost forever. Purchasers may only claim for integral features and fixtures for which the previous owner made a claim.

In order to be able to claim for integral features and fixtures, the purchaser must agree the value of the features and fixtures with the seller. As part of the purchase and sale negotiations, the parties require to enter into an election under section 198 of the Capital Allowances Act 2001 (known as a "section 198 election") to fix the value of the eligible assets in question, which will thereby allow the purchaser to get the benefit of unclaimed allowances. In most cases, the value of the item is the price paid for it, but if the item was a gift, or was owned by the taxpayer before it was used for the purposes of the business, then the market value of the item should be applied.

The parties will typically make the section 198 election for each pool of assets either at £1 or at tax written down value (that is, the balance of expenditure in respect of which capital allowances have not yet been claimed).

If the parties make the election at tax written down value, the seller will be unable to claim further allowances, but HM Revenue and Customs will not be able to claw back any allowances already claimed. Meanwhile, the purchaser will be able to claim future allowances which would otherwise have been claimed by the seller. However, the purchaser may only claim such allowances if the seller had added its expenditure to its capital allowances pool, when the seller owned the property. The purchaser should check whether the seller has claimed all allowances which the seller was permitted to claim: if the seller has not done so, the purchaser should ensure that the purchase contract obliges the seller to pool its expenditure, in order to preserve the capital allowances, otherwise the allowances will be lost.

If the parties instead make the election at £1, the seller will continue to benefit from any allowances which have not been claimed at the point of sale, but the purchaser will be unable to make any claims for allowances in relation to the purchase of the property.

Even if the purchaser is a non taxpayer, such as certain institutional investors, it may wish to collate relevant information in order to preserve the benefit of the allowances for an onward purchaser. That should include detailed records of the fixtures, plant and machinery within each relevant property. However, it should be borne in mind that if an asset has had capital expenditure incurred on it at any time by a person who was entitled to claim capital allowances on it, the onward purchaser will be subject to restrictions on making capital allowances claims on the asset in terms of rules introduced by the Finance Act 2012.

This article does not constitute tax advice, and purchasers and sellers of commercial property should always consider taking specialist advice when negotiating the purchase contract.