Capital thinking

The Finance Act 2012 (FA 2012) has fundamentally changed the landscape of capital allowances, and placed a much higher significance on the role of the conveyancing solicitor in ensuring this important tax relief is not lost at the point of sale. As of 1 April 2014 (for corporation tax) or 6 April 2014 (for income tax), the issue of capital allowances relief must be raised by the acting solicitors on every commercial property transaction. In this article, I explain the steps that the solicitor should be taking throughout the purchase or sale of a commercial property to either maximise the tax relief available or ensure that the maximum allowances possible can be claimed.

It is essential that the seller is engaged as early as possible in the process; they need to be made aware of the potential benefit of claiming capital allowances and determine their availability

What are capital allowances?

Capital allowances are available to any person or company incurring capital expenditure by buying commercial property. Commercial property owners are entitled to claim capital allowances on certain purchases or investments. This means that a proportion of the cost can be deducted from their taxable profits.

While accountants will often deal with capital allowances with regards to items such as IT equipment and furniture, claims relating to the intrinsic fabrication of the building (for example, heating installations, lighting and air-conditioning units) – often where more valuable tax relief lies – are typically left unclaimed.

Leaving the evaluation of capital allowances until after the property has changed hands is no longer an option; the issue must be dealt with at the pre-contract stage. Failure to do so is likely to lead to difficult discussions at a later stage when it becomes apparent that clients have missed out on a significant tax-saving opportunity.

While the implications for not giving competent advice are serious, acting in accordance with the new guidelines can be relatively straightforward, provided they are adhered to carefully.

Dealing with capital allowances within sale and purchase agreements and responses to property enquiries should be nothing new for commercial property solicitors. In 1997, a formal procedure was introduced to clarify the availability of capital allowances, by way of the ‘section 198 election’ (Capital Allowances Act 2001 (CAA 2001), section 198). This was later accompanied by the introduction of standard questions regarding the relief, within the Commercial Property Standard Enquiries (CPSE.1).

The introduction of the CPSE.1 was intended to bring about a higher level of transparency and uniformity in how prior capital allowances claims were dealt with at sale. Unfortunately, due to the lack of consequences for sellers, purchasers and solicitors alike, explicit references to actual capital allowances claims made by prior owners were in the minority, thus rendering the replies largely meaningless.

How has the legislation changed?

The fixed value requirement, introduced in April 2012, necessitates that the part of the purchase price attributable to fixtures within a property must be fixed by a strict deadline from the date of completion. Failure to do so will effectively destroy value within the property.

The requirement must be met whenever a relevant disposal event takes place. This will include the majority of, but not all, transactions, and is limited to the following:

• the market value sale;
• the capital sum paid for lease; and
• the sale of property following discontinuation of business.

The values are often expected to be fixed via a section 198 election. When an owner comes to sell their commercial property, the solicitor, working in conjunction with their accountant, will need to establish a “fair value” for the inherent fixtures. A section 198 election (or a section 199 election for long-term leases) will then need to be made, using this “fair value”. If this is not completed within a two-year window, the purchaser’s claim to capital allowances in the future will be blocked. Both the current purchaser and all subsequent purchasers will lose their right to claim.

In rare cases, where it is not possible to fulfil the fixed value requirement, the disposal value statement requirement may apply.

This is intended to cater for situations that fall outside of the normal disposal events.

The fixed value requirement must be met in addition to the mandatory pooling requirement for all commercial property transactions carried out from April 2014. The introduction of the mandatory pooling requirement dictates that a purchaser is unable to claim any capital allowances on fixtures within a property, unless the seller has first made provision for the costs, and then a disposal value, in their tax computations.

There is no requirement for the seller to actually write down the allowances within their tax return, but they must be added to the relevant pool and disposed of to the purchaser. The pool is the total amount of qualifying expenditure that has yet to be offset against taxable profits.

The requirements mean it is important for capital allowances to be addressed prior to the property disposal; therefore, solicitors acting on behalf of either seller or purchaser need to follow specific procedures to secure the tax relief. Below, I outline the steps solicitors need to take.

Acting for the purchaser

The changes introduced by the FA 2012 have brought about new restrictions on the purchaser when considering future tax relief. If the availability of capital allowances is not dealt with and agreed upon prior to exchange of contracts, there is a strong possibility that tax relief will be lost for both the new owner and all future owners, too.

It is essential that the topic of capital allowances is raised as early in the transaction as possible. This will allow sufficient time for the necessary discussions to take place between the seller, their accountants and their capital allowances advisers. Obtaining a full response to question 32 of the CPSE.1 (version 3.4) should be sufficient, although in practice, it is likely that further enquiries will need to be raised.

Once a response has been received, the appropriate steps that a practitioner should take, either where the seller has claimed capital allowances or where they haven’t, are outlined below. However, seeking the assistance of a capital allowances specialist before you go any further is strongly recommended.

Where the seller has claimed capital allowances

Step 1: Request full details of which fixtures have been claimed on, 

Step 2: Negotiate the level of capital allowances that are to be passed to the buyer. If an agreement cannot be reached, then it may be necessary to proceed to a first-tier tax tribunal. However, in practice, due to the cost, time and involvement required, this should be considered a last resort.

Where the seller has not claimed capital allowances

Step 1: Establish whether or not the seller was eligible to claim. Should the seller be a non-taxpaying entity (such as a charity or pension fund), the new requirements may not apply.

Step 2: If the pooling and fixed value requirements do apply, as they will in most cases, it is in the purchaser’s best interests to enter into a bilateral agreement with the seller. This will enable the purchaser to enjoy the benefit of the unclaimed capital allowances disposed to them by the seller.

Acting for the seller

While a set of conditions have been imposed on the purchaser, it is also vital that the seller is made aware of their entitlement to claim capital allowances prior to the exchange of contracts and ultimate disposal of the asset.

It is essential that the seller is engaged as early as possible in the process; they need to be made aware of the potential benefit of claiming capital allowances and determine their availability as a matter of urgency.

These investigations will typically lead to a discussion between the client and their accountant. Hopefully, it can then be established which fixtures within the property have been subject to capital allowances claims, and the current residual value of those claims. While an accountant may assure their client that full claims have been made, a forensic review by a capital allowances specialist can confirm to a client that their tax position is secured.

Once it has been determined that all available allowances have been pooled appropriately, a section 198 election should be entered into by both parties. This will stipulate how the remaining pool is to be allocated – either retained in full or part by the seller, or entirely transferred to the new owner.

The final allocation of allowances will be a matter of negotiation in most circumstances. For this reason, it is important to consider to which party the allowances are most valuable. As capital allowances are offset against taxable profits, the rate of income tax / corporation tax (and in some cases, capital gains tax) may have a bearing on which party has the most to gain from utilising the relief.

In some situations – for example, where the purchaser pays a higher rate of tax – it may be agreed that allowances are transferred to the new owner in return for an increase in the sale price.

Replies to CPSE.1 (version 3.4)

The changes introduced in the FA 2012 have necessitated a revision of the capital allowances section of the CPSE.1. Below, I list the questions relating to mandatory pooling and fixed value requirements, and how you can best approach them.

32.3 If you have not pooled any expenditure on plant or machinery fixtures:

(a) will you do so if the buyer asks you to?

The solicitor will need to consider their client’s intention with regards to what are, at present, unclaimed allowances.

For example, is it desirable for the current owner to retain the allowances, and will there be a tax liability to offset them against? Conversely, is a consideration available from the purchaser in return for the benefit of allowances being passed to them? If so, this may be something that will need to be discussed and explored further.

(b) if so, by when?

If the decision is made to pool the allowances, it must be completed while the seller’s tax return for the year of disposal remains open for amendment.

(c) if not, why not?

If the seller does not want to pool the allowances, a reason should be provided. Unless there is an explicit reason preventing the allowances from being identified, the seller will typically be willing to co-operate.

32.4 If you bought the Property and cannot pool any expenditure on plant and machinery fixtures:

(a) please provide the name and contact details of everyone who has owned the Property since April 2014;

This is important because it will establish whether or not there has been a ‘past owner’ – that is, someone who was eligible to claim allowances and owned the property post-April 2014. The mandatory pooling requirement will only apply in situations where there has been a ‘past owner’.

(b) please provide evidence that the most recent previous owner who was entitled to claim allowances pooled any expenditure on plant and machinery fixtures? Please answer the supplementary questions in enquiry 32.9 in respect of that previous owner’s expenditure.

Following on from 32.4(a) above, this query aims to confirm that the past owner has pooled any available allowances as required. 32.9 requests further detail of this expenditure.

32.10 Please provide the name and contact details of your capital allowances adviser. Please confirm that we may make contact with him/her in order to obtain information about the matters dealt with in this enquiry 32.

In line with the increased focus on capital allowances, it is now expected that the seller will provide the contact details of a capital allowances adviser acting on their behalf. This will ensure that all parties are aware of the property’s current capital allowances position, and maximises the chance of a successful claim being identified.