What are Capital Allowances?
Capital Allowances are the main form of tax relief on UK real estate. They are used to reduce taxable profits in the UK. The more Capital Allowances that are identified, the less tax is payable to HM Revenue and Customs due to the tax relief that Capital Allowances bring.
In light of so many intricate structured tax planning schemes (such as those adopted by many multi-national companies currently in the news), it is worth noting that claiming Capital Allowances is not in any way ‘tax avoidance’; it is however, an area of relief that is often forgotten about when buying, refurbishing or selling property in the UK.
There are many forms of Capital Allowances, but for the purposes of this article, we will be considering ‘plant and machinery allowances’ (PMAs) only. PMAs, whilst not defined in legislation, are broadly ‘apparatus with which an entity carries on its trade’. Obvious examples of PMAs in the healthcare and the social care sectors might include beds, nurse call points and security installations. Less obvious examples include numerous electrical, air conditioning, sanitary and recreational installations.
Such qualifying business expenditure is treated differently from immediate ‘tax write offs’ that are normally available, for items such as rent, salaries and repairs. The Capital Allowances Act sought to recognise and grant relief for this disparity on equally business-related expenditure. The relief however, was granted over longer periods of time (rather than instantly in the year it was incurred).
April 2014 saw the most recent and significant change to Capital Allowances legislation. To put the changes into context this hypothetical case study will help.
Company (A) acquired a nursing home 30 years ago for £100,000.
At the time of acquisition, there were qualifying Capital Allowances of 20%. Therefore, over time £20,000 of tax relief was available to A. A then sold the property 10 years later to B for £500,000. Assuming no capital expenditure had been incurred in the interim, company B might have expected to also make a claim for 20% of £500,000. In this way, £100,000 of tax relief would have been available to B on the same assets used within the course of its trade as well as when A was running the home. This ‘double relief’ situation was clearly a loss in revenue to the Exchequer and was not the intention of the legislation at the time. For this reason, various amendments to legislation were introduced over time, most notably to the Finance Act in 1996. These were introduced to restrict Capital Allowances to the original cost of the asset (in this example, £20,000 as established by A).
However, the most recent change in April 2014 has had the biggest impact on rules around Capital Allowances. The change in the law required most vendors, when selling a property, to ‘pool’ their qualifying Capital Allowances – that is, to quantify and enter it into their tax records. They would then agree the appropriate figure to pass onto the purchaser in an irrevocable document called an Election. This document is appended to the tax return of both parties. Most importantly, failure to do both elements of this process would result in Capital Allowances being denied to the purchaser and every future owner of the property thereafter.
The intention was to establish a link between buyer and seller, and to restrict the relief to the original cost of the Capital Allowances over the life of the assets concerned. Its, perhaps unintended, consequence in practice was to increase the burden of due diligence when buying and selling properties, particularly when one or more of the parties involved has not sought, or known to seek specialist tax advice.
Why claim Capital Allowances?
It has never been more important to consider what relief may be available when buying a property. It’s imperative to track and record qualifying expenditure (‘pooling’) during the period of ownership and to enter into the appropriate Election when selling, to ensure the relief is fully utilised.
Considering that over 40% of the purchase price of care home typically qualifies for Capital
Allowances, it is a lot of money that could be thrown away.
Many organisations in the care sector are not claiming the level of Capital Allowances that they could be. This is most often because the legal documentation is not substantiated during the purchase process, and because items qualifying for potential relief do not get identified during the subsequent period of ownership. This is not surprising given the skill sets required to identify and track this expenditure accurately.
Our team recently reviewed the potential acquisition of a nursing home in North West
London for an operator. An initial review of the legal documentation revealed a suspiciously low claim for Capital Allowances had been made, especially for a building that was almost new.
A site investigation revealed the Capital Allowances identified had only allowed for the chattels in the property (ie the loose items of plant and equipment); no account had been made for the items fixed to the property. This is quite commonplace, as a vendor’s accountant or lawyer will simply not have (nor be expected to have) the knowledge necessary to break down a property into its constituent qualifying components. This task is made even more difficult if the property has changed hands many times over the years and documentation is lost.
As a result, additional expenditure previously missed by the vendor was identified in excess of £500,000. This was added to the vendor’s ‘pool’, enabling them to make the appropriate claim going forward. It is important to note that failure to act at this stage would have resulted in a complete loss of the £500,000 of tax relief forever.
In many cases, it takes a qualified tax consultant to have the expertise to know what sorts of assets would qualify within the boundaries of the legislation. Chartered quantity surveyors would then be qualified to estimate the cost of these assets when the original cost information is not available.
Impact over the last year
The legislative changes have necessitated a clear need to identify and document capital expenditure through the lifecycle of a property. The default situation has shifted from ‘it can wait’ to ‘zero allowances’ almost overnight. As public funding for care homes tightens and profit margins are squeezed, it has never been more important to ensure this process is carried out thoroughly.
As mentioned above, a care home being sold for £5m might have £2m of Capital Allowances available on it. The inability of a vendor (or purchaser) to identify and carry out the correct due diligence can result in the loss of these Capital Allowances forever. When considering £2m of Capital Allowances can be worth £900,000 in cash, over time, to higher rate tax payers, this can result in a significant drop in the potential re-sale value of a care home.
Even if you think there is no relief available, it is worth engaging a specialist to assess the potential relief, as failure to act will default to ‘zero allowances’ in future.
Point to note
Although these legislative changes have been significant, the legislation and supporting case law will continue to evolve. Only recently, the First Tier Tax Tribunal heard the case of Bowerswood House Retirement home in Preston, which sought to make a claim for tax relief on a conservatory and a swimming pool for Capital Allowances purposes. Whilst the details of this case are outside the scope of this article, the fact that a care provider is having a case heard at the First Tier Tax Tribunal reinforces the need to seek professional advice in the assessment and methodology adopted in quantifying the tax relief potentially available in this sector.
Peter Mildenhall is Director at CBRE Capital Allowances. Peter.Mildenhall@cbre.com