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Capital allowances

Gateley Legal

The way in which purchasers can claim capital allowance on an acquired property will soon be affected by new legislation coming into force from April 2014.

As many of you will know, it is not possible to deduct the value of asset depreciation from profits for tax purposes.  Instead, a business may use what are known as ‘capital allowances’ to take account of the loss in value of certain assets and to use this allowance to write-off the value of the asset effectively over its useful life.

While commercial buildings do not give rise to capital allowances any more, it is likely that they contain items which will qualify for such allowances.  A business may claim capital allowances of 8% on integral features (such as lifts and lighting) and 18% on other plant and machinery, both on a reducing balance basis.

When buying or selling a property, the default position is for the value of the capital assets to be apportioned on a ‘just and reasonable’ basis.  This is determined by a specialist methodology endorsed by HMRC’s Valuation Office Agency.

It is possible, however, for the parties to elect (known as a section 198 election, or a section 199 election for leases) to agree  the disposal values of any assets transferred along with the building for the purposes of determining their cost for tax purposes.  Both buyer and seller need to be careful when making such an election.

A buyer will want as high a value as possible to be apportioned to these assets.  This will allow for a greater capital allowance deduction against profits.  A seller will want to resist this and to agree as low a value as possible to maximise the retained pooled capital allowances and to minimise the risk of a balancing charge.

The election is useful by allowing both parties to agree on a negotiated position for the assets.  That said, this agreed valuation needs to be reasonable and is still open to challenge from HMRC.

How this might affect you…

From 1 April 2014, where a previous owner (and not just the most recent owner) has claimed capital allowances and the buyer wishes to claim capital allowances, a section 198 election must be made.  Clearly, this would have an effect on the value of the property to the buyer, and in turn the price available to the seller.  The election must be made within two years of the acquisition.

For the buyer to be able to claim capital allowances:

  • The past owner must have allocated its expenditure to a capital allowance pool before its disposal of the property
  • An election must be entered into on the disposal of the property, or the First-tier Tax Tribunal must determine the correct purchase price of the allocation within two years of the disposal.

Where the selling party has not been able to claim capital allowances (such as a charity or a property trader) but a previous owner has been entitled to claim, the previous owner must have satisfied both tests.  Where no previous owner was entitled to claim capital allowances, there is no requirement to satisfy these tests.

The inevitable result of these changes is that enhanced due diligence will be required by buyers to ensure that they will be able to claim capital allowances.  Going forward, it will also be almost always the case that an election is made between the buyer and the seller (whereas now it is not uncommon to rely on the statutory default position), even if a £1 apportionment is made.  There will also be problems where sellers have not previously made elections and will not be able to achieve the return on their property that they may have otherwise expected.

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