What are capital allowances?
Capital allowances represent a tax relief applying to the capital cost of fixed assets. They are given in place of depreciation. They are relevant to real estate owners.
In simple terms, when an owner spends money on certain capital items, it can claim an allowance. This allowance reduces taxable profits. Accordingly, the owner has less tax to pay.
Worked cash example
For those who like to think in terms of pounds saved, here is an example:
Consider a company which has large annual taxable profits. It spends £300,000 when fitting out its property.
The £300,000 will need to be analysed to find the amount of allowances available. Depending on what the money is spent on, the allowances could be between £300,000 and £0 (see the section below for more detail on this).
If £100,000 of allowances are identified for the year, then the company's taxable profits are reduced by £100,000. The main rate of corporation tax from April 2012 is 24%. The company will therefore save tax of £24,000.
What types of expenditure qualify for capital allowances?
Allowances are available for expenditure only on certain capital items. There are different rates of allowance for different types of item.
- General "plant and machinery": This type includes a wide variety of items from the most obvious machinery, through to unexpected items such as carpets. There is no definition of plant and machinery, and so there is a lot of case law. General plant and machinery has a capital allowances rate of 18% per year from April 2012.
- Special rate expenditure including integral features and long-life assets: There is a special rate of 8% per year from April 2012, for some specifically defined items. These include electrical systems, lighting systems, cold water systems, space or water heating systems, ventilation and air conditioning installations, lifts, escalators, moving walkways, external solar shading (broadly, features integral to a structure), thermal insulation and assets which have a useful economic life of more than 25 years.
- "Green" plant and machinery: On the other hand, energy or water-saving plant or machinery attracts a much more valuable 100% first year allowance. These "enhanced" capital allowances are of interest where buildings are being built to high green standards, and also to landlords who are looking to improve the environmental rating of their existing property. Remember that, under current proposals, from 2018, landlords will be restricted in their ability to let out buildings with energy efficiency ratings less than E, and so we expect to see a significant increase in this sort of expenditure (encouraged by these generous allowances).
Structural expenditure (bricks and mortar) will not generally qualify for allowances - unless it is incidental to the installation of qualifying plant/machinery. Strengthened flooring, which is installed to support a new heavy machine, is a good example of incidental expenditure which will qualify.
Often there is a mixture of qualifying and non-qualifying expenditure within real estate. As you can see from the rates at which allowances are given, there is a strong incentive to put items into the category with the best rate. This must be done correctly, otherwise HM Revenue & Customs will challenge the analysis.
Who can claim allowances?
Allowances save tax and are therefore most relevant to tax payers. Companies, partnerships and individuals in business can all make use of allowances (whether owners or occupiers, landlords or tenants). Those who are currently loss making may still assess their allowances with a view to claiming them against future business profits.
Allowances cannot be claimed by non-taxpayers such as pension funds or charities. The value of the relief is still of importance to these entities, since allowances may be of value to future owners, and that value may be reflected in the price on sale.
A property with a high level of allowances attached to it will usually be more desirable than a property where allowances are not available (or where the data is simply not available).
Are capital allowances obtained automatically?
No. Expenditure on capital items must be identified, and the amount of allowances analysed and assessed. Values from this analysis are then inserted into the tax return.
It is far easier to identify allowances if the analysis is carried out immediately following expenditure, so that records and data are to hand, and suppliers and sub-contractors are still available to answer any relevant questions and provide missing information.
What happens to capital allowances when real estate is sold?
From April 2012, most taxpaying parties will enter an election to agree the amount of allowances to be transferred to the buyer – to avoid the value of the allowances being lost.
When should I think about capital allowances?
Please do consider allowances:
- when a new building is to be constructed;
- on a sale or purchase (including when entering an agreement for lease for a premium);
- on refurbishment/redevelopment (whether by a landlord or tenant or other occupier); and
- where 'green' improvements are to be made.