A key tax issue for the property sector
Capital allowances are the UK’s technical name for “tax depreciation” or the amount of tax relief that can be deducted from income each year in respect of the purchase price of a property.
There are two main forms of capital allowances given on the acquisition of properties:
- Structures and Buildings Allowance
- Capital allowances for Plant and Machinery in the building
There are special rules for properties entering and leaving the ATED regime and multiple dwellings.
Structures and Buildings Allowance
In the 2018 Autumn Budget, the UK Government announced a new tax allowance – Structures and Buildings Allowance (SBA) – for the cost of new commercial buildings or converting and renovating existing commercial buildings. In June 2019, the government published the response to its Consultation Document on the allowance. Although there has been some “tinkering” to deal with concerns raised by taxpayers and professional bodies, the new rules will come in broadly as originally proposed.
To qualify for the allowance, the building on which the expenditure is incurred must be used for commercial activity, but the allowance is available for properties which are let out as well as owner-occupied ones.
The rate is 2% per year on the cost of the building but excluding the land value. At first glance, 2% doesn’t seem very exciting, but it has more impact than first appears.
Suppose a company buys an office building for £1m, of which £200k is land. Rent is £50,000 pa and interest £30,000. Corporation tax at 19% on £20,000 would be £3,800. But now there is also an SBA of £16,000 leaving taxable income of £4,000 and tax of £760. This reduces the tax bill by 80%!
The allowance is only available on expenditure incurred on constructing or altering a commercial building on or after 29 October 2018. The construction of the building must start on or after 29 October, so if work had already started before then, no allowance is available even for expenditure after that date. The allowance can be claimed from when the building comes into use.
The new SBA is different from the old Industrial Buildings Allowance (IBA) system. Under IBA only specific categories of buildings qualified. Under SBA all commercial buildings qualify; residential buildings do not. Following the consultation, it is confirmed that students and other communal residential accommodations will not qualify, but hotels and care homes will.
Allowances can be claimed during a temporary period of disuse, as long as the building isn’t used for residential purposes.
There are special rules where a person builds or buys a commercial building and grants a lease of 35 years or more where the value of the retained interest is less than one-third of the amount paid for the lease. In that case, the lessee rather than the landlord is treated as the person who owns the building and can claim allowances.
The allowance does not replace the existing allowances for fixtures in a building. The normal rates for these are 18% or 6% pa. There is also a 100% first-year allowance previously limited to £250,000 pa but now increased to £1m. These are more generous than SBA and so should still be claimed in preference.
Another benefit of fixtures allowances over SBA is that a seller of a building can by-election with the purchaser to retain not only allowances already claimed but also any future allowances. Under SBA the balance of allowances unclaimed is passed on to the purchaser. So when buying a “second hand” building which was constructed on or after 29 October 2018 the purchaser will be able to claim the SBA.
At first the above appears to mean there is no clawback of SBA on sale. But the draft legislation also provides that the capital gains proceeds on sale will be increased by allowances claimed. This means that SBA will be clawed back on sale but through the Capital Gains Tax system rather than as income. This means for individuals the lower CGT rate (20%) will apply rather than income tax rates up to 45%. It may also mean that reliefs such as rollover for replacement of business assets might be claimed.
So don’t be put off by the low 2% headline rate. This is a relief worth a look.
Capital allowances on plant and machinery
As well as the SBA explained above, allowances are also available for plant and machinery in a building. This is typically fixtures and fittings and includes items such as lifts, air conditioning and heating systems.
It has been widely published that about 90% of UK commercial property transactions do not take full advantage of valuable tax relief capital allowance claims available on plants and machinery residing within the building. To give an idea of what is available, the average estimated value of unclaimed capital allowances per transaction is reported as being £100,000.
It is unfortunate that one of the most beneficial tax claims in the UK is also one of the most overlooked. Simply put, it is such a specialised area that most accountants and solicitors only have the knowledge to scratch the surface of the potential claims available on the purchase of a new building, or even to ask the right questions at the contract stage.
At BKL, the first question we ask at the pre-contract stage is “What about capital allowances?” This ensures we always get the maximum tax relief possible for our clients.
The rate of allowances is normally 18% or 6% of cost depending on the type of plant or machinery. In subsequent years this rate is applied to the reducing balance. Under special rules applying up to 31 December 2020, a taxpayer can claim 100% of the cost up to £1m per year.
Relief is given at the highest marginal rate of tax. For an average commercial office building, the value of such allowances will vary between 15% and 45% of the acquisition price. What is even more remarkable is that these allowances do not reduce the base cost of the property for capital gains purposes – this means that the allowances are not clawed back when the property is sold.
Capital allowances can significantly increase the value of the property, as shown by this case study.
When buying a second-hand property, to claim capital allowances the vendor of the property must normally also have claimed allowances and the vendor and purchaser must make an election to transfer the allowances to the purchaser. If this isn’t done, no allowances can normally be claimed. These rules are explained in more detail in our briefing Claiming capital allowances on commercial buildings – the rules.
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