Steven Bone, Director at The Capital Allowances Partnership Ltd explains the tax relief on offer under the capital allowance scheme and what it can mean for businesses…
Clients with building projects can save substantial amounts of tax by claiming capital allowances. This is tantamount to securing a Government funded discount on the overall cost of their building, which improves the financial viability of projects and ensures that build quality remains high.
What are capital allowances?
A business pays tax on its profits, ie income less expenditure. However ‘capital’ expenditure is not a tax-deductible expense. Capital expenditure is money spent with a longer-term outlook, such as constructing new buildings or extensions, or altering or fitting out existing buildings (as opposed to maintenance or repairs).
Instead, tax relief is available through ‘capital allowances’ – which are given to property investors, owner-occupiers and tenants. The most common allowance in practice is something called ‘plant and machinery allowances’. This provides tax relief when the business or investor spends money on ‘plant’ or ‘machinery’ (P&M). It does not assist for money spent to buy or alter land, or on bricks and mortar such as the substructure and superstructure (eg, walls, floors, ceilings, doors, windows and stairs).
What assets qualify as machinery or plant?
‘Machinery’ takes its dictionary meaning and most construction projects include lots of obvious machinery, such as pumps, motors, fans and the like, as well as more obscure machines such as door handles or closers with moving parts. Because these are all machinery, the money spent on them qualifies for tax relief.
‘Plant’ is more difficult to identify though. It is sometimes defined by statute, but generally by more than 100 years of case law. In essence, ‘plant’ is apparatus used in a business. The surprising thing though is that most of the assets which qualify for tax relief in buildings are standard fixtures that you would find in almost any commercial property. These include sanitary and water installations, heating, ventilation and air conditioning systems; electrical installations; lifts and conveyors; fire protection; communication, security and control systems; and many furnishings, finishes and fittings.
What types of properties benefit?
Because the definition is so wide, most commercial buildings contain P&M. However, some property types are more P&M-rich than others. For these, between 20% and 45% of the money spent can be allocated to P&M. Particularly good buildings from a capital allowances perspective are those which are fitted out to a high standard, including (amongst others):
- Hospitality – hotels, public houses, restaurants;
- Healthcare – care homes, doctors and dentists practices, veterinary facilities;
In most cases, capital allowances statute prevents tax relief being claimed for residential property. And because capital allowances are a tax relief they can only be claimed by businesses or investors who pay income tax or corporation tax. Therefore, they cannot be claimed by not-for-profit owners or occupiers, such as central or local government, charities or the like.
What is the benefit?
Capital allowances are a tax adjustment only and do not affect the market value of the property, or the business’s financial accounts.
In effect, capital allowances reduce the taxable profits of the business or investor. This saves tax at whatever tax rate they pay. For example, if a company paying 20% corporation tax spends £100,000 on P&M and claims capital allowances, this can reduce its taxable profits by £100,000 and therefore save tax of £20,000 (ie, £100,000 x 20%).
For the vast majority of businesses all (or most) of the tax savings are immediate. This is because of an accelerated capital allowance called the ‘Annual Investment Allowance’ (AIA). The AIA is available for expenditure on P&M up to an annual limit or cap, which is currently £500,000. When working out the business’s tax bill the AIA allows up to £500,000 of expenditure on P&M to be written-off for tax at 100%. In addition, certain energy-saving and water conserving or quality improving P&M qualifies for 100% relief under a scheme called ‘enhanced capital allowances’ (ECAs) – based mainly on specifying particular products listed on government websites.
To the extent that the money spent on P&M exceeds the AIA cap, or is not eligible under the ECA rules, tax relief is given over several years at either 18% or 8% a year. The 8% rate mostly applies to so-called ‘integral features’. These are the electrical system (including power and lighting); cold and hot water systems; heating, ventilation and air conditioning; lifts and escalators; and external solar shading. Other plant usually attracts the 18% rate.
Why is this relevant?
Whilst there is an old saying in tax that “you should never let the tax tail wag the commercial dog”, in any construction project there are always choices. These can affect the tax savings available to the building employer. If the client can identify ways to save tax this boosts the bottom-line and ultimately makes the project more viable. Taking an early interest in capital allowances permits the design and specification to be ‘tweaked’ to improve its tax-efficiency (for example, some floor finishes qualify for relief, whereas others do not; or ECA-qualifying assets can be chosen). It also allows the right paper trail to be put in place so the client can meet its tax obligation to submit a correct and complete tax return and avoid the time, hassle and cost of an unfavourable HM Revenue compliance check.
However, to ensure proper identification and compilation of a claim, it is often wise to obtain specialist input beyond the involvement of generalist quantity surveyors and accountants.
Steven Bone BSc(Hons) PGDip.BA FRICS ATT
The Capital Allowances Partnership Ltd
Tel: 0333 123 1203