A capital idea
Venture into the world of taxation and learn how capital allowances work, and there are some rich pickings for the savvy surveyor, says Ray Chidell
The past, it has been said, is a foreign country; they do things differently there. Perhaps the same could be said of taxation, with its strange practices, laws and language. But those who travel to foreign parts are often pleasantly surprised by the treasures of which they previously had little knowledge.
Why should a surveyor care about capital allowances in the first place? It comes down to yields. Capital allowances can cut the real cost of commercial buildings by up to 10% or occasionally more. Properties where the allowances are indeed valuable include hotels, pubs, clubs and restaurants; nursing and residential homes; offices; and sports centres. Allowances are not generally available for domestic properties but they are relevant for blocks of flats with communal areas.
The buyer’s perspective
For the buyer, capital allowances can simply reduce the real cost of a property.
For example, a client wishes to invest £2 million in a commercial property with a view to generating maximum rentals over a 20-year period. There is a shortlist of three properties, two of which are being sold by private property investors, with the third coming out of a pension fund.
The third property has never been the subject of a capital allowances claim. It is calculated that tax relief can be claimed, at 30%, on £400 000 of the cost, saving the client £120 000 in tax (six per cent of the cost) and increasing the percentage yield accordingly.
The seller’s perspective
Capital allowances are also of real concern when selling a property.
For example, clients have been operating a nursing and residential home as a family partnership. They have spent substantial sums on the property in recent years but the business has been losing money so the decision has been taken to sell up to repay bank borrowings. The property is valued at £1.75 million, including fixtures that cost £350 000, but that have a re-sale value of £100 000.
The purchaser is a wealthy individual, who wishes to claim income tax relief on as high a figure as possible. For tax purposes, the two parties can elect to sell the fixtures for their full historic cost of £350 000, even though they are now worth much less. The vendors will be treated effectively as having additional taxable income, but any tax charge may be wiped out by the losses incurred. Capital allowances on these fixtures are worth £140 000 to the purchaser (£350 000 at a 40 per cent tax rate).
The surveyor advising on the sale would certainly do well to highlight the fact that these allowances are available and should probably reflect the valuable tax relief in the asking price.
Tax specialists may consider the matter after the event but the surveyor should grasp the implications before the decision is made to buy or sell a property.
Capital allowances in practice
For these reasons, it is helpful for surveyors to have an understanding of at least the principles of this type of tax break. Capital allowances are simply the means by which tax relief is given for certain capital expenditure.
There are different tax regimes for various types of expenditure. The key ones for present purposes are those available for expenditure on plant or machinery (although some will also have a particular interest in allowances given for industrial or agricultural buildings). Special rules apply to ‘fixtures’ which for tax purposes are broadly defined as plant or machinery that is so attached to a building as to become, in law, part of that building.
The mechanics of how capital allowances are given are only of secondary importance for most surveyors as a claim for such allowances has to be made as part of the company’s annual tax return (or as an amendment to that return). Usually, therefore, internal or external accountants acting for the company will submit the claim. What is essential, though, is that surveyors should understand whether the allowances could have a significant impact on the value of the property being sold or bought. At the least, this will involve finding answers to the following:
- What are the items of plant and machinery on which a claim can be made in any given case?
- What claims have already been made on those items?
- How do the special rules relating to fixtures apply in any given case?
If it is necessary to apportion an overall price between capital allowances and other elements, should such an apportionment be made by reference to historic cost, current market value or replacement cost?
Each of these brings its fair share of complications, and some surveyors will decide that they do not wish to lead any capital allowances exercise. In many cases, that will undoubtedly be the correct commercial decision but that does not mean that surveyors should back out altogether.
The chances are that neither the accountants nor the lawyers will advise the client on how allowances affect the value of the property being bought or sold. Nor will they have the necessary expertise in the (frequent) cases that require valuations of property and plant.
Surveyors can legitimately ask to play only a supporting role in relation to the claim but the challenge then is to ensure that the client is receiving proper advice from someone who really understands how these allowances work. See, in this respect, the list of common fallacies (see left).
Common fallacies
The following statements about capital allowances, though commonly made by accountants and advisers, are wrong:
- Capital allowances are no more than a cash flow exercise
- The purchase and sale agreement determines the level of allowances that can be claimed
- Anything gained through a capital allowances claim will be lost when computing a future capital gain
- If the purchase price is split between land and buildings on the one hand and fixtures and fittings on the other, plant and machinery allowances can only be claimed on the latter.
For those surveyors who play a part in preparing capital allowances claims, the goal is to make that claim as high as it legally can be. Falling short will cost money for the client (and for the surveyor, if operating on a percentage). An excessive claim that is clearly wrong can, however, expose the client to the wrath of HM Revenue & Customs, followed interest charges and penalties. What qualifies as plant and machinery can cause problems. Some items (eg electrical costs, office partitions and lift shafts) will qualify in some cases but not in others.
Claims made by an owner since 24 July 1996 (when the tax rules changed) will have an impact on allowances now available. Advisers must, however, recognise the possibility that a claim may have been made for some items but missed for others.
In summary, this is not an easy area of tax law, but the sums at stake mean it cannot be ignored. Surveyors will help their clients if they flag the tax issue at the earliest stage of any proposed transaction.
Do
- Advise a purchaser client to take capital allowances into account when comparing buildings.
- Flag the potential value of any capital allowances when selling a property.
- Challenge a statement from an accountant or other adviser that the allowances are not worth claiming.
Don’t
- Dabble: much better to gain client approval for flagging the issue, and fees for advising on related valuation matters, than to pick up a PI claim for incorrect advice.
- Prepare claims that are inflated or based on an incorrect application of the law.
- Just assume that the accountants or lawyers will deal with the issue.
Ray Chidell (MA Cantab) is a tax adviser specialising in capital allowances, providing consultancy advice through his company Claritax Ltd (www.claritax.co.uk).
Trained originally as an Inspector of Taxes, he subsequently worked for 15 years in accounting practices, including six as tax partner with Mazars, Chartered Accountants.
He is author of Capital Allowances 2006-07 – available through RICS Books.
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This article appeared in RICS Business, February 2007.
