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It is a basic rule of taxation that capital expenditure on the cost of constructing or acquiring a building, or any other asset, is not allowable as a deduction when calculating the taxpayer’s taxable income or profit. To provide a measure of relief for the depreciation of capital assets, certain classes of property and assets, including buildings, plant and machinery and mineral deposits qualify for capital allowances. These allowances are calculated as a percentage of the capital expenditure and are set against the income or profit figure. Although primarily aimed at providing relief for the cost of these depreciating capital assets, in some instances allowances are also designed to encourage investment in particular types of assets.
If capital expenditure is incurred on purchasing a property or properties, where part of the expenditure qualifies for allowances of one sort or another, and part does not, then it is necessary to apportion the purchase price between the qualifying and non-qualifying elements. DVs may be asked to provide advice on any such apportionments.
The capital allowances relating to property on which the advice of the DV may be required are:-
- Industrial Building Allowances (including qualifying hotels).
- Industrial/Commercial Buildings (including qualifying hotels) situated within Enterprise Zones.
- Plant and Machinery Allowances.
- Scientific Research Allowances on plant and machinery and buildings used for such research.
- Mineral Extraction Allowances.
- Agricultural and Forestry Buildings Allowances.
The following paragraphs (3.3-3.7) give a brief explanation of each of the above allowances except Mineral Extraction Allowances which are explained in more detail in Part 2.
A taxpayer may be able to claim Industrial Building Allowances (IBA) on expenditure incurred on the construction of an industrial building or structure (including qualifying hotels), on the cost of purchasing such a building or structure before it is first used, or on the cost of purchasing a used industrial building or structure. Only “buildings” will be referred to hereafter but buildings should be read as including structures.
The definition of ‘industrial building’ is set out in Section 18 CAA 1990, and of ‘qualifying hotel’ in Section 19 CAA 1990. Section 18 lists the purposes for which a building must be used if it is to qualify as an industrial building. The section also provides that a building used or used partly as a dwelling house, retail shop, non-qualifying hotel or office is not an industrial building, unless the construction costs of the non-qualifying part are 25% or less of the total construction costs for the whole building. Any expenditure incurred on the acquisition of land or rights in or over land does not qualify for allowances (Section 21 CAA 1990).
In the past IBA has been available as an initial allowance and as writing down allowance.
Initial allowance was provided at a higher rate, between 20% and 100%, and broadly speaking, was available for the year in which a new building was constructed or in which an unused building was purchased. At present initial allowances are available only where the construction expenditure is incurred in an enterprise zone (see para 3.4 below). Writing down allowances are given each year, provided that the building continues to be used as an industrial building, on 4% of the qualifying expenditure per annum (25% in an enterprise zone), calculated on a straight line basis.
Within Enterprise Zones, IBA is available not only for expenditure on industrial buildings and qualifying hotels but on all commercial buildings. A taxpayer may be able to claim an initial allowance on expenditure incurred on the construction of a qualifying building, on the costs of purchasing a new unused building, or, subject to certain conditions, on the cost of purchasing a used building within 2 years of first use. Land in an enterprise zone is treated no differently than land elsewhere, IBA is not available on expenditure incurred on its acquisition.
If a taxpayer is entitled to allowances, they may claim either an initial allowance of 100% of the qualifying expenditure, or, if they prefer, a smaller initial allowance with a writing-down allowance of 25% per annum based on the remainder (calculated on a straight-line basis). If capital expenditure has been incurred on assets which, as a matter of fact, are both items of plant and represent part of the construction costs of the building (for example built-in heating and ventilation systems) the claimant may claim either plant and machinery allowances or industrial buildings allowances, but not both.
In certain circumstances, Enterprise Zone Allowances (as IBA in Enterprise Zones is sometimes known) may still be claimed even though the designation of the zone has expired. Allowances are available for expenditure incurred in the 10 years following the end of the life of the zone providing that the construction expenditure was incurred under a contract entered into during the life of the zone.
CAA 1990 includes provisions which exclude from the price paid for a property any increase in its value attributable to arrangements containing a provision which has an artificial effect on the price. (Section 10(D) CAA 1990, inserted by FA 1995). These provisions also apply to IBA claims outside enterprise zones, but in practice they are only likely to be encountered on schemes within the zones where 100% initial allowances are available.
A taxpayer may be able to claim allowances on capital expenditure incurred “on the provision of machinery or plant” where that machinery or plant belongs to him and is used, or is deemed to be used, for his trade. (Section 22 and Section 24 CAA 1990). This may include the purchase of a building containing plant and machinery.
There is no definition of ‘machinery or plant’ in the Taxes Acts but the meaning of ‘plant’ has been considered in numerous cases before the Courts. One principle that has emerged from these decisions, is that it is a question of fact and degree as to whether any particular asset is machinery or plant and that this question is to be addressed by considering:
- the nature of the asset,
- the nature of the trade in which it is used,
- the way in which the asset is used in the trade.
One of the earliest cases in which the meaning of plant was considered, and a case which set out the tests which are still considered to be applicable, was Yarmouth v France (1887) 19QBD 647. Lindley LJ defined plant as including:
‘Whatever apparatus is used by a businessman for carrying on his business, not his stock in trade which he buys or makes the sale; but all goods and chattels fixed or moveable, live or dead which he keeps for permanent employment in his business’.
From this and subsequent cases on the meaning of ‘plant’ it is considered that for an asset to be plant it must:
- not be stock in trade,
- not function as the premises in which or on which the trade is carried on, and
- be used for the purposes of the trade.
From 30 November 1993, FA 1994 amended CAA 1990 to provide statutory support for the Revenue’s view of what constituted the boundary between plant, and buildings and structures. (Section 83(7) and Schedule AA1 CAA 1990). The Schedule provides that expenditure on buildings and structures is generally not expenditure on machinery and plant. The Schedule includes two Tables and in Column 1 of each Table the items which are specifically excluded from being machinery and plant are set out. Items in Column 2 of the Tables are assets which, following Court decisions and long standing Revenue practice, may be plant, depending upon the facts of the case.
It should be noted the definition of machinery and plant for Revenue purposes is very different to that used for rating.
If a taxpayer is entitled to machinery and plant allowances, they may claim a writing down allowance on the qualifying expenditure at the rate of 25% per annum, calculated on a reducing balance basis.
A taxpayer may be able to claim allowances on expenditure incurred, broadly, on scientific research carried on in connection with a trade. This may include expenditure on constructing or purchasing a building or on providing machinery or plant for such purposes. Any expenditure incurred on the acquisition of land or rights in or over land does not qualify for SRA (Section 137(2) CAA 1990).
If a taxpayer is entitled to SRA they may claim a deduction of 100% of the qualifying expenditure. The taxpayer must take the full deduction in the year for which it is available. The deduction cannot be deferred to later years; no writing down allowance is available.
A taxpayer who has a ‘major’ interest in agricultural land may be able to claim allowances on expenditure on farm houses, farm buildings, cottages, fences and other works (eg drainage). The buildings must be used for husbandry on agricultural land. Broadly speaking, a major interest is a freehold or a leasehold interest, together with their Scottish equivalents.
If a taxpayer is entitled to agricultural building allowances they may claim writing down allowance on the qualifying expenditure at a rate of 4% per annum, calculated on a straight line basis. If the expenditure is on a farm house, allowances are only given on one-third of the expenditure (or less than one-third if the accommodation and amenities are out of due relation to the nature and extent of the farm).
From 1988, income from commercial woodlands was progressively removed from the scope of income and corporation tax. Until this time forestry building allowances had been available to set against income from forestry land. No relief has been available since 5 April 1993.
Balancing adjustments are a feature of each of the allowance codes described above, although the details vary between allowances. The aim of a balancing adjustment is to ensure that the seller of an asset has received an amount of allowance that fairly reflects the actual depreciation or appreciation between acquisition and disposal.
The need to make a balancing adjustment may be triggered by various events, with the most common being a sale of the asset by the taxpayer. A balancing adjustment may take the form of either a balancing charge (essentially an addition to the taxpayer’s income or profits effectively giving rise to a repayment of some or all of the allowances received) or a balancing allowance (essentially a further allowance of some or all of the original qualifying expenditure that remains unclaimed at the date of the sale).
For IBA, and for ABA (provided that the buyer and seller have elected for there to be a balancing adjustment), the total allowances available are limited to the original cost of the building etc regardless of the number of owners and the intervening purchase and sale prices.
To establish the IBA or ABA balancing adjustment to be made, it is necessary to determine the sum received by the vendor for the assets on which the allowances are being claimed. Broadly speaking, if this sum is greater than the amount of expenditure on which allowances have yet to be made to the vendor, then it will give rise to a balancing charge, but if it is less, it will give rise to a balancing allowance. From the vendor’s point of view it is therefore usually preferable to attribute a low figure to the qualifying assets, but of course if the purchaser intends to claim allowances then they may wish to attribute a higher figure.
For IBA and ABA the balancing adjustment will affect the amount on which the purchaser may claim allowances. If there is a balancing charge it will increase the amount, but if the vendor receives a balancing allowance the figure on which a purchaser can claim allowances will be reduced.
Generally speaking, machinery and plant allowances are not calculated on each individual item separately. Instead, for a particular business, the expenditure on all but a few specified classes of assets will be pooled, and writing down allowance given based on the total value of this pool, after adding any new expenditure and subtracting any sale proceeds for assets disposed of. Thus, for a continuing business, balancing adjustments will usually only arise when the disposal proceeds in a particular year exceed the amount in the pool, or on the disposal of one of the few classes that are not pooled.
For machinery and plant, the allowances due to the purchaser are usually limited to what was paid for the asset by the purchaser, rather than to the original cost of the asset, if this is different. In some circumstances, particularly where the cost of machinery and plant is determined by apportioning the total cost of an appreciating building, this may result in allowances being given on more than original cost.
The Inspector will normally seek the advice of the District Valuer whenever a claim for capital allowances is based on the price paid for a property and it is necessary to apportion the purchase price between qualifying and non-qualifying expenditure.
In such cases it is still the responsibility of the Inspector to decide:-
Whether or not a taxpayer is entitled to claim allowances.
Which buildings or items of plant and machinery qualify for allowances.
However the District Valuer or Regional Building Surveyor may provide any factual advice requested (eg. on the use of a particular building or the construction or function of an item of plant) to assist the Inspector, in making the above decisions.