Squeezing capital claims

Capital allowances are a valuable form of tax relief available to businesses, and the only tax relief allowable on the depreciation of capital assets. Claims for tax relief on plant and machinery have been under attack over the past few years in legislative changes. However, it would appear that HMRC are still concerned about perceived losses to the Exchequer from plant and machinery allowances and so, on 31 May 2011, a consultation document was published on “Capital Allowances for Fixtures”, with responses required by 31 August.

If capital growth is a step towards economic recovery, these proposals could seriously impact on recovery. Those investing in plant and machinery will need to consider whether the proposed rule changes are a reasonable response to HMRC’s concerns because, if enacted, investors will have a limited period of time to consider whether or not they have taken full advantage of their tax relief on past expenditure. They will also need to ensure that a plan is in place to capture all future, qualifying expenditure going forward.

Ahead of the publication of draft legislation, we believe that property solicitors and their clients should have an awareness of what the changes might mean in practical terms. However, before looking at the likely impact of the changes, we will briefly review the proposals.

Proposed changes

Basically, there are three key proposals which could have a significant impact on the work of the property solicitor. These are as follows:

(1) Mandatory pooling within one or two years of incurring the qualifying expenditure on fixtures.

(2) Mandatory notice of agreed market value of the fixtures as a condition of the purchaser being able to claim capital allowances, referred to below as “record of agreement”.

(3) The minimum disposal value of fixtures covered by an election under the Capital Allowances Act 2001, s 198 (or s 199 in the case of leasehold property) to be tax written-down value.

Mandatory pooling

This is the most significant proposal; and we understand it will apply to both new expenditure and historic expenditure. This means it is possible for a fixture to cease to qualify for capital allowances if a taxpayer does not add the expenditure to a capital allowances pool within a statutory period (likely to be the same as the self-assessment time limit for amending a tax return, i.e. 12 months after the filing date).

This proposal therefore has the potential to take out large amounts of historic expenditure from the capital allowances regime permanently, denying the taxpayer and any future owner of the property the right to claim capital allowances on those fixtures.

For property solicitors, a ramification of mandatory pooling will be an immediate increase in the amount of due diligence required. However, it is important that any property solicitor understands the consequences of not obtaining full capital allowances information as part of the property acquisition, to minimise any PI risk exposure to them. If the property solicitor does not obtain sufficient information then it is possible that some fixtures will become out-of-time for a capital allowances claim before the information is subsequently obtained. Furthermore, a claim for capital allowances will be rejected by HMRC unless the full tax history is provided for the fixtures.

Record of agreement

Obtaining a record of agreement, stipulating the open market value of the fixtures, will become an essential part of the property solicitor’s actions when acting for a buyer. Without this document the buyer will be unable to claim capital allowances. Even if the buyer is a non-taxpayer, a record of agreement will be necessary in order for a future owner of the property to make a claim.

Where the solicitor is acting for the seller, an understanding of the importance of the record of agreement to the purchaser will be essential if delays to the conveying process are to be avoided.

Minimum disposal value

This proposal, if it is carried through into legislation, will be of major significance to property sellers who have claimed capital allowances, and buyers who want to claim allowances.

For the seller, if the minimum disposal value of the fixtures is to be tax written-down value (TWDV), then obviously the seller will need to know the tax written-down value of the fixtures. This will necessitate that more detailed records of the fixtures are maintained by sellers than is currently the case with many property investors.

The necessity to establish TWDV of the fixtures has the potential to slow down the conveyancing process if the seller has not been tracking the allowances claimed. If the TWDV is not established it has potential issues for both sides. The buyer’s solicitor will need to be aware that the elected amount should not be below TWDV and therefore must seek to verify the amount. Failure to do so could result in lower capital allowances for the purchaser by default.

For the property solicitor acting for the seller, they will need to be aware of this requirement as a s 198 election could be invalidated if the disposal value is fixed below TWDV of the fixtures, thus subjecting clients to a potential HMRC clawback of tax saved.

Transaction matrix

The matrix below seeks to summarise the potential implications for property solicitors and their clients from the proposed changes to the rules for fixtures.

Recommendation

Having examined the consultation document thoroughly, but more specifically with the benefit of having attended the working groups convened by HMRC, we believe the proposed changes have the potential to not only increase the complexity and uncertainty surrounding fixtures even further, but also, in future, could deny allowances to many legitimate taxpayers. Scotland has seen a level of growth over a number of months, mainly through the private sector but, with HMRC further restricting the tax relief in this way, could see a stalling of investment by the private sector.
As can be seen above, the proposed changes to the rules for fixtures will mean property solicitors having to adapt their services to meet the new requirements to avoid loss of tax relief to their clients and potential negligence suits. The new legislation will become effective from April 2012 and our recommendation is that all property solicitors consider the implications of these proposals and plan to revise their procedures before the legislation takes effect.