Capital Gains & Other Taxes Manual - Section 3 - Part 3 : Approach to Apportionments

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3.30 General

3.31 The Formula Approach

3.32 Effects of the Application of the Formulae

3.33 Valuation of the Bare Site

3.34 Replacement Costs

3.35 Adjustment of Replacement Costs for Depreciation

3.36 Cases of Doubt or Difficulty

3.37-39 Reserved

Part 3 : Approach to Apportionments

3.30 General

Apart from the special provisions for Mineral Extraction Allowances the CAA 1990 does not specify any method of apportioning the price paid for a property between qualifying and non-qualifying expenditure. The only requirement is that it should be a ‘just apportionment’.

In accordance with the decision in Salts v Battersby the underlying aim of any method of apportionment should be to apportion the purchase price in proportion to the values of the constituent parts that go to make up the property. The DV should seek to arrive at the contribution that each part of the property makes to the value of the whole. It is considered that a just apportionment will in the majority of cases be achieved by applying the formulae set out in the following paragraph. However, the DV should always stand back and carefully consider whether the answer produced is reasonable in the particular circumstances of each case. A consistent approach should be maintained whether the apportionment is for the purpose of a capital allowances claim or a balancing adjustment.

3.31 The Formula Approach

Depending on which allowances are being claimed, it may be necessary to apportion a purchase price either between the land and the building or between the land, the building and the qualifying items of plant and machinery:-

a) For the purposes of Enterprise Zone Allowances, when it is necessary to simply apportion a purchase price between the qualifying building (including all plant and machinery) and the non-qualifying land, the approach should usually be to apply the following formula:

Apportioned value of the building =

Purchase price X (A ÷ (A+B))

Where
A = The replacement cost of the building
C = The bare site value

b) For the purpose of Plant and Machinery Allowances, when it is necessary to apportion a purchase price between the qualifying items of plant and machinery and the non-qualifying building and land, the approach should usually be to apply the following formula:

d) When Industrial Buildings Allowances are being claimed it may be necessary to arrive at a separate value for the building excluding the items of plant and machinery on which Plant and

Apportioned value of the Plant and machinery =

Purchase price X (A ÷ (A +B+C))

Where

A = The replacement cost of qualifying items of plant and machinery

B = The replacement cost of the whole building excluding qualifying items of plant and machinery

C = The bare site value

c) For simplicity the above formula can be abbreviated to the following:

Apportioned value of the Plant and machinery =

Purchase price X (A ÷ (B+C)

Where

A = The replacement cost of qualifying items of plant and machinery

B = The replacement cost of the whole building including plant and machinery

C = The bare site value

d) When Industrial Buildings Allowances are being claimed it may be necessary to arrive at a separate value for the building excluding the items of plant and machinery on which Plant and Machinery Allowances are being claimed. The approach should usually be to arrive at the plant and machinery value as above and then, applying the same principles, to arrive at the apportioned value of the building as follows:

Apportioned value of the building =

(Excluding Plant and Machinery)

Purchase Price x (B ÷ (A + B + C))

A = The replacement cost of qualifying items of plant and machinery

B = The replacement cost of the building excluding the qualifying items of plant and machinery

C = The bare site value

3.32 Effects of the Application of the Formulae

The following examples illustrate the practical effects of applying the different formulae set out in paragraph 3.31 above:-

a) Example 1

A taxpayer acquires a new property which qualifies for Enterprise Zone Allowances. The property is purchased for £10 million, the estimated replacement cost of the building is £6 million and the value of the bare site is £2 million.

Apportioned value of the building:

£10 Million x ( £6m ÷ ( £6m + £2m) ) = £7.5m

As can be seen, the apportioned value of the building is £7.5 million compared with it’s cost of £6 million. Had the taxpayer chosen to purchase a site and erect the building himself then he would of course only be able to claim allowances on the cost of constructing the building. The downside, from the taxpayer’s point of view, is that the apportioned value of the disallowable land element is higher than the bare site value. The difference between the total of A + B in this example, that is £8 million, and the purchase price of £10 million broadly speaking represents the developer’s profit. The developer has created the property by combining the land and building and the effect of the formula is to apportion that profit between the two elements that go to make up the property.

b) Example 2

This example is to illustrate the effects of the formula in a situation that has arisen in some cases as a result of a fall in the property market. In this example the taxpayer has again acquired a new property which qualifies for Enterprise Zone Allowances. The estimated replacement cost of the building is again £6 million and the value of the bare site is £2 million, but the purchase price is only £7.5 million.

Apportioned value of the building:

£7.5 Million x ( £6m ÷ ( £6m + £2m) ) = £5.625m

As can be seen, the apportioned value of the building is reduced below its replacement cost and the apportioned value of the non-allowable land element is of course also reduced below the bare site value.

c) Example 3

This example is to illustrate the effect of the formula for arriving at the plant and machinery value on the acquisition of a building that is say 20 years old. The total replacement cost of the building is £6 million, the replacement cost of the qualifying items of plant and machinery is £1.5 million and the bare site value is £2 million. The purchase price, as the building is now 20 years old, is however only £5 million.

Apportioned value of the Plant and Machinery:

£5 Million x ( £1.5m ÷ ( £6m + £2m) ) = £937,500

As can be seen, the apportioned value of the plant and machinery is £937,500 compared with it’s replacement cost of £1.5 million, reflecting the fact that its value will be less due to its age. That value, however, is probably considerably higher than the original cost of the plant and machinery 20 years ago.

Even though we are dealing with an ageing building, the replacement costs used in the formula are not written down because the obsolescence factor is reflected in the purchase price. The effect of the formula is therefore to reduce the value of the plant and machinery in the same proportion that the purchase price bears to the total of the replacement cost of the whole building and the bare site value. The effect of the formula is also to write down the values of all the elements of the property, including the land. Although land does not of course depreciate in value with age the bare site in this case is encumbered by an ageing building. The full bare site value is not actually realisable because it would not be economic to demolish the building until it’s value was exhausted.

d) Example 4

The final example assumes a new property which qualifies for Industrial Building Allowances and includes qualifying items of plant and machinery. It is acquired for £10 million, the replacement cost of the building (excluding the plant and machinery) is £4.5 million, the replacement cost of the qualifying items of plant and machinery is £1.5 million and the bare site value is £2 million.

Apportioned value of the Plant and Machinery:

£10 Million x ( £1.5m ÷ ( £1.5m + £4.5m + £2m) ) = £1.875m

As can be seen, the value of the plant and machinery in this example is higher than its cost. Like in the very first example, the total of A + B + C on the bottom line in the formula are less than the purchase price. The effect of the formula is therefore to apportion the element of developer’s profit on a pro-rata basis between the three elements of the property.

The apportioned value of the building, excluding the plant and machinery, is then calculated in the same manner.

Apportioned value of the building:

£10 Million x ( £4.5m ÷ ( £1.5m + £4.5m + £2m) ) = £5.625m

Again it can be seen that the effect of the formula is to increase the apportioned value above the cost.

3.33 Valuation of the Bare Site

The bare site value, for use in the apportionment formulae described in paragraph 3.31 should be taken as the open market value of the actual site as at the date of purchase of the property making the following assumptions:-

  • The site is cleared of all building and external works.
  • Access and services are available up to the actual boundary.
  • Planning permission is available for the existing type of development. (If the bare site would have a higher value for an alternative type of development it is necessary to consider whether this is reflected in the purchase price being apportioned. If it is, then it should be reflected in the bare site value).

Any reclamation works which have been carried out on the site which permanently enhance the value of the land (eg. removing underground obstructions or treating contamination) should be reflected in the valuation of the bare site.

The valuation of the bare site should normally reflect the circumstances existing at the date of valuation except when the purchase price being apportioned reflects Enterprise Zone benefits even though the Enterprise Zone status has expired at the date of purchase (see para 3.4). In such cases to achieve a ‘just apportionment’ the bare site value should assume the benefits of Enterprise Zone status as they are reflected in the purchase price.

The interest to be valued will be the interest actually acquired. If the interest is long leasehold at a ground rent then it is necessary to take account of the ground rent payable when considering the bare site value.

3.34 Replacement Costs

The replacement costs for use in the apportionment formulae described in paragraph 3.31 should be taken as the estimated cost of replacing the building if work had commenced at the appropriate time so as to have the building available for occupation at the valuation date (ie. the date of purchase). The replacement cost should include:-

  • The cost of external works but not reclamation works which permanently enhance the value of the land.
  • An addition for professional fees.
  • An addition for finance charges.

If, due to the use of modern materials and building techniques, the cost of erecting a modern substitute building (of the same gross internal area) would be less than the cost of erecting an identical replacement building then the cost of or modern substitute should be adopted.

3.35 Adjustment of Replacement Costs for Depreciation

As explained in paragraph 3.32 above the replacement costs used in the formula are not usually depreciated because any obsolescence is reflected in the purchase price and through the application of the formula this is then reflected in the apportioned values of the elements of the property. However, when a building is near the end of its life the purchase price may reflect substantial redevelopment value. In such circumstances the buildings obsolescence may not be truly reflected in the purchase price and the application of the formula will over state the value of the building and items of plant and machinery. Clearly, if the purchase price is based largely or wholly on the value of the land then the obsolete nature of the building will not be reflected in that price. In such circumstances it may then be necessary to adjust the replacement costs to allow for obsolescence.

3.36 Cases of Doubt or Difficulty

In any cases which give rise to doubts or difficulty concerning the approach to an apportionment the advice of CEO should be sought via the RD/CV(S), at an early stage.

3.37-39 Reserved

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