Tax-savvy property management
Tuesday, November 12, 2019
There’s an oft used phrase among those in the accountancy profession: that no one should ‘let the tax tail wag the investment dog’, meaning, investment decisions shouldn’t be made solely for tax reasons.
But that said, if a printer wants to survive and grow, it will need to invest in its premises, and if it follows the rules set down in law and interpreted by HMRC, much of the investment can be offset against tax. But care is needed as the rules can in places seem as clear as mud.
Understandably, firms may take the opportunity to carry out improvements at the same time as repairs – and why not? If the business is to suffer disruption, it’s better to get it all over and done with in one go. But to Helen Thornley, a technical officer at the Association of Taxation Technicians, there are distinct differences between repairing and improving business premises, each of which can have huge tax consequences.
She says: “The question of whether expenditure on a building is a repair or an improvement is a classic tax problem. Relief for building repair costs is generally given against revenue in the period that the cost is incurred; the business will receive relief relatively quickly. In contrast, money spent on improvements to premises is considered to be capital and the business will only get relief when they sell or otherwise dispose of the premises.”
Yen-Pei Chen, manager of Corporate Reporting and Tax at the ACCA, agrees. She says that essentially, replacing or fixing something to get premises back into working order is fine as repair, “but do anything further and you could stray into capital expenditure. The fact that you have a maintenance problem that must be dealt with doesn’t necessarily make your refitting costs deductible as repair”.
And she gives an example that is cited by HMRC, a shop owner who had a new front put in when they took over the site: “The replacement of a shop front would normally be deductible as revenue expenses, but the fact that the shop owner adapted the front to his specific needs makes it an improvement, and therefore capital expenditure.”
For Thornley, another way to explain the difference is to think of putting a building back into the condition that it was when originally acquired. “If the roof blows off in the night, replacing the roof will be a repair. However, if the opportunity is taken to add an extra storey to the building before putting a roof back, then there has been an improvement.” Where the situation gets muddy is where, for example, the roof is put back but with new roof lights.
HMRC will look to distinguish
Determining which is which requires the facts of each case to be considered, and Thornley says a decision from HMRC will depend on factors such as the extent of the works or whether it is possible to do something new or different with the building after the work has been completed.
And she says that there’s plenty of case law to make the point: “Consider the classic repair or improve cases of Law Shipping Co Ltd and Odeon Associated Theatres Ltd where money was spent on assets in poor condition. The question was whether the expenditure amounted to a repair or improvement.”
As she outlines in Law Shipping, an unseaworthy ship was acquired and a huge sum had to be spent before it could be brought into use. In this case “it was held that the expenditure was capital in nature, as the need for the work would have been reflected in the lower price paid for the ship.” In Odeon, however, where work was carried out to a number of dilapidated cinemas, it was held the money spent was on repairs; “the cinemas had been operating for some years before the repairs took place and the need for repair work was not reflected in the acquisition price”.
Capital allowances on capital expenditure
As both Chen and Thornley have previously noted, if a firm ends up with capital expenditure – say plant and equipment – and can’t set that expenditure against taxable profit, it may still get tax deductions in the form of capital allowances.
The key to this is the Annual Investment Allowance (AIA) which allows businesses to claim tax deductions upfront on the full amount of qualifying expenditure in the year it’s incurred. Chen says that those wanting to invest should not dawdle; the AIA was increased to £1m, up from £200,000, from 1 January 2019 but will drop back down to £200,000 from 1 January 2021.
But there are other ‘gotchas’ to watch out for according to Chen: for an item to qualify as plant and machinery, it “has to be kept ‘for permanent employment in the business’ – so, this excludes stock or expendable equipment with a life of less than two years; and function as ‘an apparatus employed in carrying out the activities of the business’ and not as part of the premises in which the business is carried on”.
This latter point is problematic, says Chen: “Whether something consists of the apparatus used in carrying out the business or the business premises is surprisingly hard to pin down in case law.”
She refers to the case of Benson vs The Yard Arm Club, where a company opened a floating restaurant on an old ship and claimed plant and machinery capital allowances on the ship, arguing that it was the restaurant’s unique selling point. “This,” she says, “was refused in the courts.
“The ship was the structure within which the restaurant business was run. In the words of the Court of Appeal judge, he could see no distinction between ‘a restaurant on the Thames and a fish and chip shop in Bethnal Green. Both act as premises in which the trade is carried on.’”
For Chen, the basic principle that should keep firms on the straight and narrow is that anything that can reasonably be expected to form part of a building – for example, walls, partitions, ceilings, floors, doors, windows and lighting – should be considered to be premises and not plant. And of course, there might be exceptions if they are moveable, and/or designed to fulfil a special function.
For a definitive list of the tax law around the kinds of assets that qualify as plant and machinery, readers should turn to sections 21 to 23 of the Capital Allowances Act 2001. It sets out a list of things which definitely are, and which definitely aren’t, plant and machinery.
Tax allowances and what can be claimed for
To reclaim some of the cost of repairs, firms need to know what the tax system actually permits. As Thornley points out, until relatively recently there were no tax reliefs for the acquisition, construction or improvement of buildings. However, she says that “since 2008 relief for what are known as integral features within the building has been available through the system of capital allowances”.
Just as with plant and machinery, the law is very prescriptive and it’s not surprising that there is a fixed list of what is an integral feature. Thornley details the list as comprising of lifts, escalators and moving walkways; space and water heating systems; air-conditioning and air-cooling systems; hot- and cold-water systems (but not toilet and kitchen facilities); electrical systems, including lighting systems; and external solar shading.
But just as some might be mistaken for thinking that this list is definitive, so the legislation steps in to confuse. Chen gives an example: “Electrical systems are not defined in legislation, so the taxman will be looking to the ordinary meaning of the term: ‘a system for taking electrical power (including lighting) from the point of entry to the building or structure, or generation within the building or structure, and distributing it through the building or structure, as required.’” Her advice is to consider what you’re putting the electrical systems in for: “If an electrical system is installed to support qualifying plant and machinery, the cost will count as plant and machinery and will be eligible for the higher plant and machinery allowances.” By extension, if it’s for another purpose it will not be eligible.
And here’s where matters get murky, suggests Thornley. “The problem is that most businesses do not spend more in a year on qualifying plant or integral features than the AIA. If they do, then any expenditure exceeding the AIA will be eligible for writing down allowances instead. For integral features, the writing down allowance is 6%, compared with 18% for most other qualifying plant.” It’s for this reason that where a business does spend more than the AIA, Thornley says it makes sense to allocate the AIA against integral features first because they get a lower writing down allowance and it takes much longer to get relief for the costs incurred.
Writing down allowances are not calculated in an intuitive way. To illustrate the point Thornley says that “firms don’t get relief for 6% of the cost each year on a straight-line basis, instead they get relief calculated as 6% of the cost that has not yet been relieved. For example, if you spend £100 and claim writing down allowances, the relief is £6 in year one. In year two, the relief is 6% of the unrelieved amount of £94 = £5.64 – and so on, with the amount of relief declining each year. At a rate of 6% it can take 20 years to get relief for 70% of the original cost of the asset, compared with six years with a writing down allowance of 18%.”
And Chen agrees, explaining that “the more integral features you can get 100% AIA on the lower your tax bill will be... Just pay attention to the dates on your invoices: you will need to identify which assets were acquired before 1 January 2019, when the AIA amount changed, and which were acquired after.”
Structures and Buildings Allowance
Readers will recall an earlier point where it was noted that improvements received no tax relief until premises were sold or disposed of.
The 2018 Budget saw the then chancellor, Philip Hammond pull a rabbit out of his hat with the introduction of the new Structures and Buildings Allowance (SBA), giving a 2% flat rate annual allowance on commercial structures and buildings over a period of 50 years. The new SBA, says Chen, “is available to offices, retail and wholesale premises, walls, bridges, tunnels, factories and warehouses – as well as renovations and conversions started after 29 October 2018”. However, she warns that buildings covered by the SBA won’t then qualify for the AIA.
The whole point of SBA is to provide tax relief for expenditure on structures and buildings which previously received no form of capital allowances.
But as Thornley points out, the relief is not necessarily instant: “Relief for construction costs are given over a period of 50 years from the date the building was first brought into use – at rate of 2% of the qualifying costs. Otherwise, relief is given from date of renovation, conversion or extension.”
It’s worth noting that SBA can also be claimed where the business acquires a property. However, the amount of expenditure eligible for write down will be determined by the history of the building. Says Thornley: “Where the building has previously been in use, then the acquiring business will take on the history of eligible costs and can keep claiming at a rate of 2% of the original cost until the 50-year period has expired. When the business acquires a new, unused property from a developer then the eligible cost for relief is the acquisition cost.”
There are exclusions to be aware of though. The cost of the land on which the building sits does not qualify for SBA, and fixtures or fittings within the building are also excluded (although it may be possible to claim capital allowances instead where these items qualify as integral features). Chen adds that to access the allowance depends on claimants having an interest in the land on which the building sits: “There are potentially complex rules around leased properties, in deciding if, and how much, of the SBA the lessor can claim.”
But on the positive side, the bar to accessing SBA is set low - and includes any trade, profession and UK or overseas property business - and where the building is in non-residential use. Even better reckons Chen, “this simple allowance is available to incorporated businesses and sole traders alike”.
Keeping good records
When it comes to tax, for HMRC, records are everything, especially when claims for a tax relief are involved. But SBA takes this to whole new level as there is, as Thornley says, “the potential for the claim to last for half a century after the building has come into use – assuming of course that both the building and the SBA are still in existence at that point”.
Where this becomes more interesting is when considering that the 2% write-down of original costs is available not just for the first owner who brings the building into use, but also any other qualifying business that subsequently acquires the building to use in a qualifying activity.
“It’s essential,” says Thornley, “to keep the allowance statement for the SBA safe. It details the date of the earliest written construction contract, the amount of the qualifying expenditure and the date the asset was first brought into use.” She says that all subsequent owners will want a copy of this statement to enable them to claim for the remaining part of the 50-year period.
The best part of SBA is that subsequent expenditure on the building, such as further renovation or conversion which is also eligible for SBA, will be subject to its own 50-year period. Depending on the amount of work done on a building over its life, Thornley says “it is possible that one or more claims for subsequent work could be running in addition to the claim for the original costs”.
But with a note of caution, she reminds that the special rate capital allowances (such as for integral features) are more favourable than the SBA; she says it is important to prepare a detailed analysis of the construction costs of the building to identify any items that will qualify for integral features instead of the SBA.
The advice is very clear. Rather than amalgamating all costs under one-line item called ‘printroom fittings’ in the tax return, firms have a much better chance of claiming capital allowances if they break down costs into specific headings: presses, lighting and electrical wiring for air conditioning, etc.
Likewise, when claiming for a revenue deduction on repairs, be prepared to back up a claim with invoices and a breakdown of the works carried out if and when the taxman asks for details.