Capital allowance is the deduction available to UK tax payers while computing taxable income. In UK, depreciation is not an allowable expense and its place is taken by capital allowance.

Both depreciation and capital allowance become applicable when you buy long-term assets for business purposes. Buildings, plant & machinery and furniture are examples of such long-term assets. As these assets will be used over a number of years, you cannot write their costs off as expense in the year of purchase.

Instead, the typical solution is to estimate their useful life in years, and write off a proportionate amount each year over this life time. This is what we call depreciation. In UK, however, depreciation is not allowed as a business expense.

The capital allowance system also essentially allows you to write off the cost of assets over a number of years. However, the regulations regarding capital allowance is much more complex.

For example, in the case of buildings, the entire cost of the building cannot be the basis for claiming capital allowance. Instead, you have to segregate the cost into First Fix and Second Fix costs. Capital allowance can be claimed only for the Second Fix costs.

First Fix costs include costs up to and including plastering. Second Fix costs are all the costs after the plastering stage to final finishing. These actually include innumerable items such air-conditioning, electrical fittings (but not the wiring), water supply fittings (but not the piping) and so on.

Considering that you pay for the building as a whole, computing the Second Fix costs is a complex exercise requiring special valuation expertise. The result is that many businesses do not claim the capital allowances that they are entitled to, and pay significantly higher amounts of tax than they need to.

Accountants are not typically equipped to identify and value the borderline items eligible for capital allowances.

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Capital allowances are the amounts allowed to be written off as expenses when you incur long-term capital expenditure. You cannot write off the entire cost of long-term assets (that will be used over a number of years) as an expense in the year the expenditure was incurred. The general idea behind capital allowances is that the cost should be expensed over the period the asset is used.

The Capital Allowances Act 2001 is the current legislation for capital allowances. This Act regulates capital allowances for the following types of expenditure:

• Plant & Machinery Allowances: The expenditure must be “qualifying expenditure” incurred for the purposes of a “qualifying activity” such as trade, business or profession. The types of expenses that fall under this category is extremely varied and have been sought to be listed in the Act.
• Industrial Buildings Allowances: Buildings include (i) Walls, floors, ceilings, doors, gates, shutters, windows and stairs, (ii) Mains services, and systems, for water, electricity and gas, (iii) Waste disposal systems (iv) Sewerage and drainage systems, (v) Shafts or other structures in which lifts, hoists, escalators and moving walkways are installed and (vi) Fire safety systems.
• Agricultural Buildings Allowances: Agricultural buildings include farmhouses, cottages, fences and such agriculture-related constructions.
• Flat Conversion Allowances: This has been defined as “qualifying expenditure” incurred in respect of a flat, i.e. a separate set of premises forming part of a building and divided horizontally from another part of the building.
• Mineral Extraction Allowances: Mineral extraction “consists of, or includes, the working of a source of mineral deposits.”
• Research & Development Allowances: Qualifying expenditure on research and development under the meaning given by section 837A of ICTA.
• Know-how Allowances: Qualifying expenditure on the acquisition of know-how, i.e. industrial information or techniques to assist in manufacture, processing, mineral extraction, agriculture, forestry and fishing.
• Patent Allowances: Qualifying expenditure on the purchase of patent rights.
• Dredging Allowances: Dredging generally means removal of anything forming part of, or projecting from the bed of the sea or any inland water for maintenance or improvement of the navigation of a harbour, estuary or waterway.

Assured Tenancy Allowances: Qualifying expenditure incurred on a building which is or includes a dwelling house let on tenancy.

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In other articles we have seen that when a disposal event occurs, taxpayers are subjected to a balancing charge or allowed a balancing allowance. A balancing charge involves charging back excessive capital allowances claimed and balancing allowance provides relief for claims that are short.

Capital allowances are considered excessive when the disposal value is more than the notional written down value after deducting the writing down allowances from the original cost. If the disposal value is less than the notional written down value, capital allowance claims are treated as inadequate and the shortage is made up through a balancing allowance.

The issue of disposal even becomes relevant in the above context. Disposal events are not confined to sale of an asset. Instead, all the following events are disposal events:
• The taxpayer ceases to own the asset
• Possession of the asset by the taxpayer is lost permanently
• Abandonment of an asset used for mineral exploration and access at the site where it was so used
• The asset ceases to exist
• The asset begins to be used for a purpose other than the qualifying activity
• The qualifying activity itself is discontinued permanently
• The asset is leased under a long funding lease

When a disposal event takes place, the taxpayer is required to bring a disposal value into account. The rules regarding computation of disposal value is somewhat complex; it might not be even the sale value if the sale event is considered a tax avoidance measure.

It is possible that an asset might have more than one disposal event. In such cases, disposal value needs to be brought into account only on the happening of the first event.

It is to be noted that except in the case of single asset pools, the above provisions apply to the pool total as a whole and not to individual assets.

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Businesses are able to claim capital allowances when they enter into a long funding lease for their buildings and machinery.

However, some firms are attempting to claim back twice their entitled tax relief by entering into, “contrived, circular transactions involving the sale, leaseback and reacquisition of their plant and machinery” over a period of a few weeks.

In a written statement to MPs, Treasury Exchequer Secretary David Gauke said: Legislation, which will have effect from today (Wednesday 9^th March), will be introduced in Finance Bill 2011 to confirm that lessees engaging in transactions of this type are only entitled to tax relief up to the actual amount of their expenditure on plant or machinery.”

He also explained that this legislation would be forcibly enforced so as to “protect future losses to the Exchequer”.

However, whilst some firms are over-claiming on their capital allowances, a whole host of others are completely unaware that they are entitled to claim anything. Consequently, they may be missing out on large sums of money.

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The Finance and Leasing Association (FLA) is calling on the Treasury to extend tax relief on energy efficient equipment to the asset finance sector.

The association believes that the extension would benefit small businesses and is calling specifically for the relaxation of the Enhanced Capital Allowances (ECAs) to cover energy saving equipment hire.

ECAs enable a business to claim up to 100 per cent first-year capital allowances on their spending on qualifying plant and machinery. Currently the ECAs apply to businesses that purchase equipment with a bank loan but not when that equipment is leased.

The FLA claims that if the ECA system was extended to include leasing companies, it would support investment in energy efficient companies by small businesses, because the benefits would be passed on through better commercial leasing rates.

A spokesperson for the FLA told Greenwise: “It would give the asset finance companies the scope to pass on the ECA through decreased rentals.”

It is hoped that, as well as offering small businesses increased support, the FLAs latest bid to the Treasury may highlight the many other benefits that can be gained through ECAs.

This article was written by Katie-Jill Rowland

Capital Allowance Related Posts

• Owner of Fixtures: Elections between Lessor and Lessee

  A lease can be of a building or land which is received by the lessee along with several permanent fixtures forming part of the asset. Alternatively, the lease can be an…Read more

• Enhanced Capital Allowances (ECAs)

  The purpose of ECAs is to encourage businesses to invest in environmentally friendly plant and machinery. Enhanced Capital Allowances enable a business to claim 100% first-year capital allowances on their spending on…Read more

• First Year Allowances (FYA) on Plant & Machinery

  Until April 2008, small and medium enterprises were eligible to a first year allowance (FYA) of 40 or 50 percent on plant and machinery.

   

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Every time a commercial property owner spends money buying or improving it, there is a strong chance they can offset that expenditure against profits or general income for tax purposes – a little tapped resource offered by the Inland Revenue.

Indeed, the ability to claim capital allowances on commercial properties has been available to property owners since 1878. Most people believe that their accountant have already claimed everything, yet HMRC estimates a massive 96% of those eligible for a refund have not claimed.

Aware that the process of claiming such a tax rebate is not straight forward, Short Term Asset Finance decided it time to speak to the experts and learn how advisors can start offering this service to clients.

“HMRC has made claiming very complicated” Shaun Murphy, of specialist advisors Portal Tax Claims tell me. “Most accountants simply can’t deal with it, or think they are doing it already when they’re not. There it is an enormous under tapped resource out there.”

Effectively our surveyors will do an onsite survey and identify all the inherent plant & machinery hidden which is taken for granted within the original purchase price from which our accountants will then create the accredited HMRC approved report for submission

Portal Tax Claims promises to manage every stage of a claim’s process and offers ‘a no report no fee’ guarantee.

They will look at the purchase price paid by a company for the property and in most cases claim about 25% back, offset against the company’s tax bill.

Tax Rebates can be backdated as far as 2008/2009

A trade company, Portal Tax Claims doesn’t accept business from clients direct, but insists on an introduction from an advisor, and is currently turning over 200 claims a month.

Shaun believes the 96% not claiming is down to the complexities involved in a claim and the sheer lack of public awareness.

“Think about it, all those brokers out there, they can revisit all their old clients – at no cost to their clients – and they can say ‘whatever you’ve paid for the purchase price of a building, we can get about 25% back off that purchase price to offset against your current tax bill.’

“What we do is we go back and we unlock the hidden inherent value of the purchase price.”

Portal Tax Claims are so confident they will be able to make a substantial claim, they underwrite their offer:

“If we can’t identify an additional £25,000 in unclaimed capital allowances, we will give you our report entirely free of charge. You won’t owe anyone a penny.”

Based in Rochester, the company has in excess 300 agents across the country and is forecasting substantial company growth; “we’re aiming to bring our claims up to 500 a month, we’re growing exponentially,” explains Shaun.

Portal Tax Claims take 6% for their services (as a percentage of the identified capital allowances).

The process takes an average of eight weeks to complete and six stages are involved. Introducers are notified by text message alerts every time a stage is completed, “we do our upmost to make sure the introducer is well informed and never left in the dark.”

All reports and all surveys are managed by Portal Tax Claims, and introducers are paid by automatic direct debit as soon as the rebate completes and Portal is paid.

There are five simple questions that must be answered before a claim should be made:

1. Did the property cost £200,000 or more? Answer must be Yes

2. Is the owner subject to UK tax? Answer must be Yes

4. Has the owner paid UK tax within the last two years OR likely to pay tax in the next 2 years ? Answer must be Yes.

3. Is the property owned by a charity or pension fund? Answer must be No as charities and pension funds already have separate tax breaks.

5. Has the owner made a claim before against the actual purchase price of the bulding ? Answer must be No .

Shaun describes the average claimant as being a limited commercial company, who is the owner-occupier of a property with an average purchase price of £600,000.

On average, Portal Tax Claims find £150,000 worth of capital assets, which are then used to reduce the company’s tax bill by £42,000 – provided they are a 28% corporation tax payer.

Aware that that for many brokers capital allowances is an area they are not too familiar with, the firm has spent a substantial amount of time on its website, which includes mini step-by-step video guides, power point presentations, pdfs providing FAQs, a Capital Allowance History guide; all available to download for free.

“We want out brokers to be informed, the education process is the hardest part about it, but we’re going to get there,” says Shaun smiling.

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Up to late 19^th century (1878 to be precise) there were no capital allowances.

In 1878, a “wear and tear” allowance was introduced for traders in plant and machinery by allowing them to reduce their income by the allowance amount. For mills and factories, a “mills and factories” allowance was available. The quantum of the allowance was an amount considered “just and reasonable” and tended to represent the “economic” depreciation in the value of the equipment.

A new system of allowances was introduced in 1945 to replace the above allowances. The wear & tear allowance was replaced with:

• An initial allowance of 20% on plant & machinery for the first year
• Annual writing-down allowances to represent the usage of the asset over the years; the rate was fixed by Inland Revenue and was generally 25% for plant & machinery
• A balancing adjustment when the asset was retired or sold to ensure that the total relief was equal to the actual reduction in value over the period of ownership

The mill & factories allowance was replaced by:

• An initial allowance of 10% on new buildings
• Annual writing-down allowances at 2%
• A balancing adjustment when the asset was retired or sold to make total relief equal to actual reduction in value

The building allowance was confined to industrial buildings, and shops, offices and even hotels were excluded.

An investment allowance, over and above the allowances above, was introduced in 1954 to encourage investment in industrial assets including buildings.

The system was simplified in a major way in 1971 to eliminate burdensome record-keeping and computational requirements. A further simplification in 1984 saw the elimination of initial and first year allowances, among others.

There were other changes reintroducing and withdrawing different allowances in pursuit of specific policies until capital allowances were consolidated in 1990. There was a further revision and the current legislation is CAA2001.

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