The complication of tax simplification

Updated comment on the future for capital allowances, and the due diligence that will be needed

19th March 2012 | Lois Stirling

Following our online article in November looking at the implications for solicitors of the consultation, “Capital Allowances for Fixtures”, the draft legislation has now been published. The draft legislation is much preferable to the proposals set out in the consultation document, but still throws solicitors to the forefront of ensuring that a client’s tax relief is not lost.

The new rules

The draft legislation contains new rules affecting the entitlement to capital allowances for fixtures, which will commence on 1 April 2012 for corporation tax and 6 April 2012 for income tax.

In summary, these new rules will require that in order for a purchaser of a property to claim capital allowances in respect of the fixtures within the property, the seller must have claimed (pooling), and the value (fixed value requirement) be agreed between the seller and purchaser. Simple, you would think, but please read on.

The pooling requirement

What this means is that when a purchaser acquires a property on or after the commencement date, any seller who could have claimed capital allowances must have pooled the expenditure in order that the purchaser can claim capital allowances. This pooling requirement (PR) also applies to previous owners, other than the seller, where the previous owner has sold the property on or after the commencement date.

However, where the purchaser acquires the property within the transitional period, there is no PR. This means that if a seller who could have claimed capital allowances but does not make a claim sells the property before the end of the transitional period, the purchaser will still be able to claim capital allowances.

The transitional period for corporation tax will be from 1 April 2012 to and including 31 March 2014, and for income tax from 6 April 2012 to and including 5 April 2014.

The fixed value requirement

If the PR is met, the purchaser will then need to satisfy the fixed value requirement (FVR). To satisfy the FVR, the seller or previous owner must have fixed the disposal value of the fixtures by entering into a joint election under CAA 2001, s 198 or 199. The election must be completed within two years of the date that the purchaser acquired the property, and a copy of the election must be jointly submitted by both seller and purchaser to HMRC in order that the purchaser can claim capital allowances. Therefore, s 198 elections should become as important to purchasers as they currently are to sellers.

Previously, if a purchaser could not claim, allowances may have been ignored, but do this following the new changes at your peril.

The FVR will apply even where the purchaser is not able to claim capital allowances. Therefore, all purchasers must enter into a joint election when the seller has claimed capital allowances. Otherwise, a future owner of the property will not be able to satisfy the FVR and, therefore, will not be able to claim capital allowances in respect of the fixtures.
However, if the seller is unable to claim capital allowances, there will be no FVR in respect of that sale of the property as the seller is not able to enter into a joint election.

Unlike the PR, the FVR will apply in the transitional period. Therefore, the purchaser must satisfy the FVR in the case of any purchase after the commencement date, if the seller or previous owner has claimed capital allowances. However, the FVR will not apply in the case of any previous owner who has sold the property before the commencement date.

The draft legislation includes the provision for extending the scope for making an election under s 198 to include the situation where the seller has discontinued the qualifying activity and then sold the fixtures.

The disposal value statement requirement

There will be certain situations where an election is not possible under the legislation. So a catch-all clause has been included to cover any disposal event for plant and machinery not covered by the proposed new legislation. In these cases the FVR is replaced by the “disposal value statement requirement” (DVS).

The DVS requires that the seller or previous owner makes a written statement of the disposal value brought into account within two years of the seller or previous owner ceasing to own the plant and machinery. Any purchaser of the property will then need to have obtained a copy of this written statement in order to be able to claim capital allowances.

Tribunals

The legislation envisages there may be times when contract parties are unable to agree a value for the fixtures. Currently, only the purchaser can only make an application to the tribunal, but the legislation is being amended to enable either party to do so. This will enable the purchaser who is not able to claim capital allowances to protect the entitlement to capital allowances for a subsequent owner of the property.

The application to the tribunal must be made within two years from the date that the purchaser acquired the property. The amount fixed by the tribunal will then be treated as fulfilling the fixed value requirement even though the decision of the tribunal is reached outside the two year time limit. Alternatively, provided the application to the tribunal is made within the time limit, a s 198 or 199 election can be executed at any time up until the tribunal reaches its decision or the application is withdrawn.

Some examples of how the new rules would take effect

PROPERTY HISTORY	POOLING REQUIREMENT	JOINT ELECTION OR STATEMENT	POSITION OF CURRENT OWNER
Example 1: Property is built by developer and acquired by pension fund in 2008 which then sells to current owner in June 2012	None – pension fund not able to claim capital allowances	Not required – pension fund has not made a claim	Unrestricted claim based on an apportionment of the price paid to the pension fund
Example 2: Property funded by investor in 2009 and claim made for capital allowances before sale to current owner in June 2012	Investor has pooled qualifying expenditure	Section 198 election required as investor has made a claim – no claim by current owner or subsequent owner without election	Claim based on elected amount. If parties cannot agree value then application to tribunal within two years of transaction date
Example 3: Property developed and sold in 2011 by developer to investor who sells in June 2012 without making a claim	None – No pooling requirement for sales within transitional period	Not required – investor has not made a claim	Unrestricted claim based on an apportionment of the price paid to the investor
Example 4: Property developed and sold in 2011 by developer to investor who sells in May 2014 without making a claim	Investor required to pool expenditure on fixtures in order that current owner or subsequent owner can claim. Expenditure can be pooled within self-assessment time limit	Section 198 required between investor and current owner in order that current owner or subsequent owner can claim. No election possible unless investor pools the qualifying expenditure.	Current owner acquires after transitional period – no claim by current owner or subsequent owner unless pooling requirement is met. Application to tribunal not possible as previous owner has not made a claim.
Example 5: Investor buys property in 2011, contributes fully to the cost of the air-conditioning system installed as part of a full refurbishment carried out by the tenant, before selling in June 2014 without making any claims	Pooling requirement applicable to the fixtures acquired with the property and remaining after the refurbishment, but not applicable to the new air conditioning system	Section 198 required between investor and current owner in order that current owner or subsequent owner can claim on the fixtures acquired by the investor. No election possible unless investor pools the qualifying expenditure	Current owner is able to make an unrestricted claim on the air conditioning system as the investor had no entitlement to claim other than under s 538 – contribution allowances
Example 6. Property is funded by a REIT in 2011 and then sold in May 2014	No pooling requirement as the REIT follows the “shadow” regime	No joint election or disposal value statement is applicable	The current owner adopts the TWDV of the REIT

In the above examples the current owner is assumed to be an investor who will claim capital allowances.

Due diligence

The draft legislation is much preferable to the proposals set out in the consultation document, as the pooling requirement only arises when there is a change of ownership, and there is no time limit for a taxpayer to make a claim. However, it may well have been the prospect of a flood of capital allowances claims inundating HMRC that really prompted a rethink of the earlier proposals.

It can be seen from the examples given in the earlier table that the new rules could give rise to a multitude of different outcomes, depending on the specific circumstances of each transaction. This will definitely lead to an increase in the level of due diligence necessary to establish the capital allowances entitlement of the current owner. It should be noted that when the pooling requirement has been satisfied, the onus is on the taxpayer to prove whether a fixed value requirement or a market value notice requirement is applicable and to provide HMRC with the relevant document. Therefore, the purchaser’s solicitor will need to ensure at the time of purchase that the right document is acquired or valuable tax relief will be lost.

So, there will be an increase in the amount of due diligence that a taxpayer will need to carry out before submitting a capital allowances claim on secondhand fixtures, which rests mainly with the solicitor. Apart from establishing whether the entitlement to capital allowances is capped by a disposal value of a previous owner, claimants will now also need to prove that entitlement has not been lost due to the pooling requirement not having been met.

Furthermore, due diligence should be carried out by the purchaser before acquisition and not when the tax return for the relevant chargeable period is being prepared. Failure to consider the capital allowances position before exchange could lead to a loss of entitlement. The capital allowances legislation is set to become even more complicated. Whilst the pooling requirement will not apply during the transitional period, purchasers must be mindful of the fact that where the seller has claimed allowances, either the fixed value requirement or the disposal value statement requirement will need to be met.

Sellers who have claimed allowances need to be as mindful of the need for joint elections to provide tax certainty under the new rules as they are under the current regime.

The property market needs to familiarise itself with these changes as soon as possible and certainly before April 2014. There is likely to be some level of complacency, with conclusions that nothing really changes until April 2014. But the message must be that there is an element of urgency as transactions taking place from April 2012 will affect those following April 2014.