Capital Allowance in the Construction Industry - Part I

Capital Allowance for RICS APC Candidates – Part I

A guide to understanding and claiming capital allowances for construction professionals

Capital allowances are a form of tax relief that allow businesses to deduct the cost of certain assets from their taxable profits. They are especially relevant for construction professionals, who may incur significant expenditure on plant and machinery, fixtures and fittings, and other qualifying assets. In this blog post, we will explain the current legislation, the difference between capital and revenue expenditure, the principles of taxation, the capital allowances legislation, and the process of claiming capital allowances. We will also refer to the RICS guidance notes and the UK laws that apply to this topic, as well as provide some real-life examples.

The following topics are discussed within this blogpost:

• Current legislation

• Capital and revenue expenditure

• Taxation

• Capital Allowances legislation

• Claiming capital allowances

• Plant and machinery

1        Current legislation

The current legislation that governs capital allowances is the Capital Allowances Act 2001 (CAA 2001), which consolidates and simplifies the previous laws on this subject. The CAA 2001 sets out the rules for determining whether an asset qualifies for capital allowances, the types and rates of allowances available, the methods of calculating and claiming allowances, and the special rules for certain industries and activities. The CAA 2001 is updated regularly to reflect changes in tax policy and practice, and the latest amendments can be found on the legislation.gov.uk website.

The RICS guidance note on capital allowances, which is part of the RICS Valuation - Global Standards 2017 (the Red Book), provides a summary of the main provisions of the CAA 2001 and the relevant case law. It also gives guidance on how to value qualifying assets, how to apportion the purchase price of a property between land and buildings and fixtures and fittings, and how to deal with capital allowances issues in property transactions. The guidance note is intended to assist RICS members who are involved in capital allowances matters, either as valuers, advisers, or expert witnesses. [1]

A real-life example of the current legislation in action is the case of SSE Generation Ltd v The Commissioners for HM Revenue and Customs [2019] UKUT 0332 (TCC), which concerned the eligibility of hydroelectric power stations for capital allowances. The Upper Tribunal held that the power stations were plant and machinery for the purposes of the CAA 2001, and that the expenditure on them was not excluded by the rules for buildings or structures. The Tribunal also held that the power stations were not integral features of the buildings or structures in which they were installed, and that they were not fixtures that had become part of the land. Therefore, the expenditure on the power stations qualified for capital allowances at the main rate of 18%. [7]

2        Capital and revenue expenditure

Capital expenditure is the money spent on acquiring or improving fixed assets, such as land, buildings, plant and machinery, and intangible assets, such as goodwill, patents, and trademarks. Capital expenditure is not deductible from the taxable profits of a business, but it may qualify for capital allowances, which reduce the taxable profits by a percentage of the cost of the assets.

Revenue expenditure is the money spent on the day-to-day running of a business, such as wages, rent, utilities, and raw materials. Revenue expenditure is deductible from the taxable profits of a business, as it represents the cost of earning the income.

The distinction between capital and revenue expenditure is not always clear-cut, and it depends on the facts and circumstances of each case. The general principle is that capital expenditure is incurred for the purpose of creating or enhancing an enduring benefit or advantage for the business, whereas revenue expenditure is incurred for the purpose of consuming or using the benefit or advantage in the course of the business. However, there are many exceptions and nuances to this principle, and the courts have developed various tests and criteria to help determine the nature of the expenditure.

The RICS guidance note on capital and revenue expenditure, which is part of the RICS Property Taxation Guidance Note 2018, provides a comprehensive overview of the relevant case law and HMRC guidance on this topic. It also gives examples of common types of expenditure and how they are treated for tax purposes. The guidance note is intended to assist RICS members who are involved in property taxation matters, either as advisers or as expert witnesses. [6]

A real-life example of the capital and revenue expenditure distinction is the case of The Commissioners for HM Revenue and Customs v The University of Edinburgh [2019] UKUT 0150 (TCC), which concerned the deductibility of the costs of repairing and maintaining historic buildings. The Upper Tribunal held that the costs were revenue expenditure, as they did not result in any significant improvement or enhancement of the buildings, but merely restored them to their original condition and utility. The Tribunal also held that the costs were not capital expenditure by analogy, as they did not fall within the scope of the CAA 2001 or any other statutory provision that treated them as such. [8]

3        Taxation

Taxation is the process of imposing and collecting taxes from individuals and businesses by the government. Taxes are compulsory payments that are not directly linked to the benefits or services provided by the government. Taxes are used to fund public expenditure, such as health, education, defence, and infrastructure, as well as to redistribute income and wealth, to influence economic behaviour, and to regulate social and environmental issues.

The main types of taxes that affect construction professionals are income tax, corporation tax, capital gains tax, value added tax, stamp duty land tax, and business rates. Each type of tax has its own rules, rates, thresholds, reliefs, and exemptions, which are determined by the government and the Parliament. The tax system is administered by HM Revenue and Customs (HMRC), which is responsible for collecting and enforcing taxes, as well as providing guidance and assistance to taxpayers.

The RICS guidance note on taxation, which is part of the RICS Property Taxation Guidance Note 2018, provides a general introduction to the UK tax system and the main types of taxes that affect property transactions and ownership. It also gives guidance on how to calculate and report taxes, how to deal with tax disputes and investigations, and how to plan and structure tax-efficient property deals. The guidance note is intended to assist RICS members who are involved in property taxation matters, either as advisers or as expert witnesses. [6]

A real-life example of taxation in practice is the case of Project Blue Ltd v The Commissioners for HM Revenue and Customs [2018] UKSC 30, which concerned the application of stamp duty land tax (SDLT) to a complex property transaction involving a sale and leaseback arrangement and a sharia-compliant financing structure. The Supreme Court held that the transaction was subject to SDLT at the higher rate of 15%, as it involved the acquisition of a chargeable interest in land by a company that was not acting in the course of a property rental business. The Court also held that the transaction was not exempt from SDLT by virtue of the alternative property finance rules, as they did not apply to the particular type of financing structure used in this case. [9]

4        Capital Allowances legislation

Capital allowances legislation is the part of the CAA 2001 that specifies the types and rates of allowances that are available for different kinds of qualifying assets. The main types of allowances are:

• Annual Investment Allowance (AIA), which allows a 100% deduction of the cost of plant and machinery (excluding cars) up to a certain limit per year. The current limit is £1 million for expenditure incurred between 1 January 2019 and 31 December 2021, and £200,000 for expenditure incurred before or after this period. [2]

• First-Year Allowance (FYA), which allows a 100% deduction of the cost of certain energy-efficient or environmentally friendly plant and machinery in the year of purchase. The current list of qualifying assets can be found on the HMRC website. [4]

• Main Rate Allowance (MRA), which allows an 18% deduction of the cost of plant and machinery (excluding cars) on a reducing balance basis per year. This applies to assets that do not qualify for AIA or FYA, or that exceed the AIA limit. [2]

• Special Rate Allowance (SRA), which allows a 6% deduction of the cost of plant and machinery (excluding cars) on a reducing balance basis per year. This applies to assets that are classified as integral features of buildings or structures, such as electrical systems, heating systems, air conditioning systems, and lifts. It also applies to cars with CO2 emissions above 110g/km. [3]

• Structures and Buildings Allowance (SBA), which allows a 3% deduction of the cost of construction or renovation of non-residential buildings or structures on a straight-line basis per year. This applies to expenditure incurred on or after 29 October 2018, and the building or structure must be brought into use for a qualifying activity, such as a trade, a profession, or a property rental business. [1]

The RICS guidance note on capital allowances legislation, which is part of the RICS Valuation - Global Standards 2017 (the Red Book), provides a detailed explanation of the types and rates of allowances, the qualifying criteria, the calculation methods, and the claim procedures. It also gives guidance on how to deal with capital allowances issues in property valuations, such as the interaction between capital allowances and market value, the allocation of purchase price between land and buildings and fixtures and fittings, and the impact of capital allowances on rental income and yields. The guidance note is intended to assist RICS members who are involved in capital allowances matters, either as valuers, advisers, or expert witnesses.

A real-life example of the capital allowances legislation in action is the case of The Commissioners for HM Revenue and Customs v SSE Generation Ltd [2019] UKUT 0332 (TCC), which we have already mentioned in the section on current legislation. In addition to determining the eligibility of hydroelectric power stations for capital allowances, the Upper Tribunal also determined the rate of allowance that applied to them. The Tribunal held that the power stations qualified for the main rate allowance of 18%, rather than the special rate allowance of 6%, as they were not integral features of buildings or structures, and they were not fixtures that had become part of the land. Therefore, the expenditure on the power stations was subject to a higher rate of relief than the expenditure on the buildings or structures that housed them. [7]

5        Claiming capital allowances

Claiming capital allowances is the process of reporting and deducting the cost of qualifying assets from the taxable profits of a business. The process involves identifying the assets that qualify for capital allowances, determining the type and rate of allowance that applies to them, calculating the amount of allowance that can be claimed, and submitting the claim to HMRC. The process may also involve keeping records of the assets, pooling the assets into groups, allocating the purchase price of a property between land and buildings and fixtures and fittings, and agreeing the value of the fixtures and fittings with the seller or the buyer.

The RICS guidance note on claiming capital allowances, which is part of the RICS Valuation - Global Standards 2017 (the Red Book), provides a step-by-step guide on how to claim capital allowances, as well as the common pitfalls and challenges that may arise. It also gives guidance on how to deal with capital allowances issues in property transactions, such as the use of elections and statements, the transfer of allowances between parties, and the impact of capital allowances on the sale price and the stamp duty land tax liability. The guidance note is intended to assist RICS members who are involved in capital allowances matters, either as valuers, advisers, or expert witnesses.

A real-life example of claiming capital allowances is the case of Tower Radio Ltd v The Commissioners for HM Revenue and Customs [2016] UKFTT 0160 (TC), which concerned the claim of capital allowances for the installation of radio masts on the roofs of buildings. The First-tier Tribunal held that the radio masts were plant and machinery for the purposes of the CAA 2001, and that the expenditure on them qualified for capital allowances at the main rate of 18%. The Tribunal also held that the radio masts were not fixtures that had become part of the land, and that they did not belong to the owners of the buildings, but to the taxpayer who had installed them. Therefore, the taxpayer was entitled to claim capital allowances for the radio masts, regardless of the terms of the leases or licences that granted them access to the roofs. [10]

6        Plant and machinery

Plant and machinery is a broad term that covers any assets that are used for carrying out the business activities, such as equipment, furniture, vehicles, computers, etc. Plant and machinery can qualify for either annual investment allowance (AIA), first-year allowance (FYA), or writing down allowance (WDA), depending on the type and cost of the asset. AIA allows businesses to claim 100% of the cost of qualifying plant and machinery up to a certain limit (£1 million for the tax year 2020/21). FYA allows businesses to claim 100% of the cost of certain energy-efficient or environmentally friendly plant and machinery, regardless of the limit. WDA allows businesses to claim a percentage of the cost of plant and machinery that does not qualify for AIA or FYA, over a number of years.

As a RICS APC candidate, you should be familiar with the criteria and rates for claiming plant and machinery capital allowance, as well as the methods and sources for identifying and valuing the eligible assets. You should also be aware of the implications of plant and machinery capital allowance for property transactions, such as the need to obtain a section 198 election or a section 562 statement to transfer the entitlement between the seller and the buyer. You should refer to the RICS guidance note on Plant and Machinery Valuation for Financial Statements (1st edition, 2018) and the HMRC Capital Allowances Manual for more details and examples. [11], [12]

7        Conclusion

In conclusion, capital allowances play a crucial role in providing tax relief for businesses, particularly for construction professionals who often incur significant expenditure on various assets. This blog post has provided an in-depth exploration of several key aspects related to capital allowances, including the current legislation outlined in the Capital Allowances Act 2001, the distinction between capital and revenue expenditure, taxation principles, and the specifics of capital allowances legislation. Real-life examples, such as the SSE Generation Ltd case, have been cited to illustrate the practical application of these concepts. Moreover, the process of claiming capital allowances has been detailed, emphasizing the importance of correctly identifying qualifying assets and navigating the associated procedures. Additionally, the significance of plant and machinery in capital allowances has been highlighted, with reference to relevant RICS guidance notes and HMRC resources. Overall, this comprehensive examination serves to enhance understanding and awareness of capital allowances, empowering professionals to effectively leverage tax relief opportunities within their business operations.

8        References

1.      Capital Allowances Act 2001. Available at: https://www.legislation.gov.uk/ukpga/2001/2/contents

2.      HM Revenue and Customs. Capital allowances for plant and machinery. Available at: https://www.gov.uk/capital-allowances

3.      HM Revenue and Customs. Structures and Buildings Allowance. Available at: https://www.gov.uk/guidance/structures-and-buildings-allowance

4.      HM Revenue and Customs. First-year allowances for energy-saving products. Available at: https://www.gov.uk/guidance/energy-technology-list

5.      RICS. Valuation - Global Standards 2017. Available at: https://www.rics.org/globalassets/rics-website/media/upholding-professional-standards/sector-standards/valuation/valuation-global-standards-2017-rics-red-book.pdf

6.      RICS. Property Taxation Guidance Note 2018. Available at: https://www.rics.org/globalassets/rics-website/media/upholding-professional-standards/sector-standards/valuation/property-taxation-guidance-note-1st-edition-rics.pdf

7.      SSE Generation Ltd v The Commissioners for HM Revenue and Customs [2019] UKUT 0332 (TCC). Available at: http://www.bailii.org/uk/cases/UKUT/TCC/2019/332.html

8.      The Commissioners for HM Revenue and Customs v The University of Edinburgh [2019] UKUT 0150 (TCC). Available at: http://www.bailii.org/uk/cases/UKUT/TCC/2019/150.html

9.      Project Blue Ltd v The Commissioners for HM Revenue and Customs [2018] UKSC 30. Available at: https://www.supremecourt.uk/cases/uksc-2016-0192.html

10.   Tower Radio Ltd v The Commissioners for HM Revenue and Customs [2016] UKFTT 0160 (TC). Available at: http://www.bailii.org/uk/cases/UKFTT/TC/2016/TC04929.html

11.   RICS (2018) Plant and Machinery Valuation for Financial Statements. 1st edition. RICS guidance note. London: RICS.

12.   RICS (2019) Depreciation of Plant and Equipment Valuations for Financial Statements. 1st edition. RICS guidance note. London: RICS.