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Capital allowance: A capital way of cutting your tax bill

The UK’s system of Capital Allowances tax relief was largely introduced as a post-1945 measure to stimulate reconstruction and represents valuable tax savings on commercial property expenditure.

Fixed plant and machinery has been the key focus, as in the construction of a dealership where typically 20% of the construction cost may qualify as tax relief – making appreciable savings.

Any buildings expenditure on a dealership will include elements that qualify for tax relief, whether it is a new build, refurbishment, or even the purchase of an existing property where allowances have not previously been claimed.

The range of items is extensive and includes much of the fit-out, such as heating, air-conditioning, kitchens, toilets, office fittings, security systems, and showroom display fittings.

Purchases of dealerships

In a purchase of an existing dealership where the previous owners did not make claims for allowances – which in the past was not uncommon – the price may be apportioned to separate the fixed plant items and may result in around 15% of the land and buildings figure being treated as tax relief.

Notably this has no impact on Capital Gains Tax when the building is re-sold in the future. Allowances are not lost with time and any past expenditure may be reviewed for its tax relief content even from 10 or more years ago.

Proposed tax relief changes

In late December 2007 the Treasury published its proposals based upon its consultation “Business Tax Reform – Capital Allowances”.

The result from the perspective of the motor retail sector is good news, with a welcome expansion of the amount of expenditure that in a construction or refurbishment after April 2008 will qualify for tax relief. The Treasury’s views now undergo further consultation and so some amendment is possible – but we can be reasonably confident that most of the measures will become enacted in this year’s finance bill.

The coming changes to the capital allowances system were heralded in last year’s Budget with the announcement of the phasing out of industrial buildings allowances which will affect car repair workshops and will no longer be available. This was, however, a limited benefit compared to workshop components such as ramps and tool systems, which will continue to be tax relieved.

#AM_ART_SPLIT# Trade related plant

The intention of the Treasury proposals is primarily to influence design and specification decisions towards a more sustainable approach. Plant and machinery allowances were until now all claimed at a rate of 25% per annum.

The changes will divide the pool of allowances in a building into two tiers. Integral features, specifically heating, air conditioning, lifts, escalators, cold water systems and electrical systems, will be written down at 10% per annum on a reducing balance. All other fixed plant items will be treated as trade related fixtures and have a 20% per annum rate of claim.

A key result of the two-tier system is an increased focus on Enhanced Capital Allowances (ECA) which offer a 100% first year allowance on low carbon emission/energy saving equipment. In other words, some parts of the integral features can in tax terms become upgraded from a 10% to a 100% rate of claim.

This principally affects heating and air conditioning. Henceforth, in any new project it will become important to consider this at an early planning stage, with the mechanical and electrical consultants being asked to specify qualifying items where possible.

The inclusion of entire electrical systems for tax relief is a new departure as previously only parts would be expected to be allowable. The particular intention is to encourage the use of ECA qualifying lighting systems.

Environmental features

This is a new concept introduced within the Treasury’s consultation and may become the most controversial. It extends to brise soleil and ventilated facades and if the current proposals are not amended, these will now become tax allowable on the same basis as integral features. In recent years the former has become a frequent design addition to dealerships to reduce the solar gain in summer and its inclusion will now be encouraged. Obviously, the inclusion of either becomes an early decision in the design process.

Investment allowance

To be introduced in April 2008, the annual investment allowance will replace the previous first year allowances for small and medium businesses. This is a new flat rate deduction of £50,000 for all businesses incurring expenditure on most types of plant and machinery in that financial year. This is an across-the-board simplification and inevitably is less likely to particularly benefit larger businesses. There will also be various restrictions to reduce abuses such as fragmentation of companies.

A notable benefit is that the taxpayer can determine which items are included within the AIA claim and thus it should usually be applied to integral features that attract the lower 10% rate of claim.

#AM_ART_SPLIT# Getting the best

The outcome of the Treasury consultation on capital allowances is to encourage a more sustainable approach to buildings by way of tax relief incentives. However, it will only be effective if due consideration is given while at the design stage and the project team is engaged in seeking to optimise savings.

If the potential tax relief savings are calculated early in the project then this may be a way of extending the budget to set a higher specification overall and potentially achieve an upgrade in the energy performance certificate asset rating.

The outcome could be a double benefit with both lower running costs and possibly a useful future sales point in an increasingly energy conscious world when the building is sold.

Energy performance certificates inevitable

During 2008 Energy Performance Certificates (EPCs) will become a compulsory requirement for new build projects, and sales or lettings of commercial buildings.

There is some debate on the practicality of the timescale as there are currently few assessors to undertake certifications.

Nevertheless, the UK has limited time to comply with European legislation and so EPCs will become inevitable. Initially, they are likely to be viewed as more bureaucracy – but the intention is to influence behaviour through market forces. A commercial building can have an asset rating for its energy performance of A to G – in a similar fashion to the labelling of domestic appliances – with C being the expected median of most new buildings.

Unlike the system being introduced on residential properties the certification of a commercial building is a much more technical exercise requiring a high level of understanding of construction methodology.

A great deal of information has to be assembled which is then processed by a complex software programme to generate the asset rating. The time commitment on the part of the surveyor is considerable and so fees are expected to be from several thousand pounds upwards, depending on the size and complexity of the property.

Further information on the EPC implementation timescale may be found at www.diag.org.uk. What we may see when EPCs are commonplace is that in some sectors – for example, offices – a potential tenant may be influenced by a higher or lower EPC rating in buildings being considered as it indicates a differential in running costs.

It is less likely to envisage this affecting the motor sector, although it is becoming apparent that more and more businesses see adopting a sustainable approach to their buildings procurement as an important component of their corporate social responsibility policy.

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