Practical guide: capital allowances for commercial property

Introduction

You run a manufacturing company that is in the process of purchasing a factory from a competitor. The property is 20 years old and the agreed purchase price is £1.5 million. You want to know what tax relief will be available on the purchase. Once purchased, there are also plans to extend the factory to create office space at a cost of £300,000, and the company will spend approximately £50,000 fitting out the extension.

Capital allowances

When it comes to the purchase or construction of commercial property, the cost must be split into its component parts to ascertain what capital allowances might be available. The land on which the factory sits does not qualify for capital allowances and so will receive no immediate tax relief.

The cost of the land will obtain tax relief when it is sold, by deducting it from the sale proceeds received.

This leaves the cost of the building and any fixtures attached to it, both of which can qualify for allowances if certain conditions are met, but at different rates. Let’s take a look at both.

Structures and buildings

Following the introduction of the structures and buildings allowance (SBA) in 2018, the cost of physically constructing or extending a commercial building will now qualify for allowances. The SBA is a new type of allowance separate from writing down allowances or the annual investment allowance.

The general conditions for claiming the SBA are detailed in CA90100 but, broadly, allowances will be available where a non-residential building that is used for a business purpose is constructed after 28 October 2018.

The SBA is given on a straight line basis over 33.3 years, which equates to a flat rate of 3% per annum on the qualifying expenditure incurred. Where a building is constructed from scratch the qualifying expenditure will be the capital expenditure incurred. Where a building is purchased second hand, the buyer will take on the residue of the seller’s qualifying expenditure.

Example. If, hypothetically, the seller of the factory had incurred £100,000 qualifying expenditure three years ago, you would be able to claim allowances at 3% of the seller’s expenditure, i.e. £3,000 per annum, for the remaining 30-year period.

In order for a purchaser to continue claiming where the seller left off, the seller must provide an allowance statement detailing the amount of qualifying expenditure on which allowances have been claimed.

Fixtures

In contrast to buildings which have their own special allowance, expenditure on fixtures are subject to the better-known plant and machinery allowances. They are, therefore, potentially eligible for the annual investment allowance (AIA), the new full expensing first year allowance, and writing down allowances.

Fixtures are defined as plant or machinery that is so installed or otherwise fixed in or to a building as to become, in law, part of that building. Fixtures therefore cover items such as toilets, sinks, signage, fitted kitchen units etc., as well as the integral features of lighting and electrical systems, cold water systems, central heating systems, lifts and solar panels. Integral features fall into the special rate pool, while other fixtures fall into the main rate pool. When a building is constructed from scratch it will be relatively easy to identify the cost spent on fixtures. However, what about when a property is purchased and a single price paid for the building. Is it still possible to claim allowances on fixtures?

S.198 election

Whenever a commercial property changes hands, the subject of fixtures must be addressed between the buyer and seller. Even though one price is being paid for the property, it is still possible to allocate an element of the purchase price to reflect the cost of the fixtures attached to the building.

Example. You and the seller agree that 10% of the purchase price would be a fair reflection for the fixtures, therefore £150,000 of the £1.5m is eligible for capital allowances. The agreed price is documented in a fixtures election under s.198 Capital Allowances Act 2001.

AIA v full expensing

As expenditure on fixtures falls into the category of plant and machinery allowances, both the AIA and full expensing could be available, both of which provide capital allowances of up to 100%. But which is better?

The AIA gives 100% tax relief on up to £1 million of expenditure on plant and machinery, subject to some exclusions, and can be used for both new and second-hand items. When an asset is sold on which the AIA has been claimed, the sale proceeds fall into a pool. Full expensing is a first-year allowance which gives 100% tax relief on main pool items of plant and machinery, and 50% tax relief on special rate pool items. In contrast to the AIA, there is no limit on the amount of expenditure incurred, but it only applies to new and unused items.

When an asset is sold on which full expensing has been claimed, the sale proceeds fall into their own single asset pool and therefore a balancing charge equal to (100% or 50%) of the sale proceeds will arise. As a balancing charge arises on the disposal of full expensing items, it would be preferable to claim the AIA where both the AIA and full expensing are eligible on the same item of expenditure, e.g. where the assets cost less than £1 million.

Full expensing applies to purchases on or after 1 April 2023. It was initially meant to be temporary until 2025/26, however at the 2023 Autumn Statement it was made permanent.

Applying to your situation

The extension will be eligible for the SBA. The £300,000 will receive capital allowances of £9,000 per annum (3%) over the next 33.3 years. The £50,000 spent on fixtures for the extension will also qualify, and be eligible for both the AIA and full expensing. As we have seen, where both allowances are available it would be preferable for you to claim the AIA, especially if any of the fixtures are integral features and fall into the 50% special rate pool.

The purchase price of the factory, i.e. £1.5 million, will not be eligible for the SBA as it was constructed prior to 29 October 2018. However, it has been agreed that £150,000 of the purchase price is attributed to fixtures and therefore capital allowances can be claimed on this amount. As the fixtures are not new and unused, first-year allowances under full expensing are not available, although the AIA will be available to allow relief at 100%.

Clawback

It is often thought that by entering into a s.198 election and allocating an element of a property’s purchase price to fixtures, it will reduce the capital gains base cost commensurately, e.g. in your case reduce the base cost by £150,000 to £1.35 million. This is incorrect. There is no clawback for fixtures allowances and the full £1.5m will be available to set against any future sale proceeds. However, there is a clawback under the SBA. When a property is sold, the total of the SBA claimed is added to the sale proceeds received, thereby clawing back the tax relief.