Paul Blakeley examines contractual considerations to be evaluated by those involved in property sales who may benefit from capital allowances.
Much has been written on the availability of capital allowances on the qualifying assets, namely plant and machinery, in purchased property. Little, however, has been said about the vendor’s position on disposal, which may very well conflict with the purchaser’s desire to maximise his available capital allowances. In this respect the vendor and purchaser’s requirements may be diametrically opposed, in which case a mutually satisfactory contractual agreement will need to be resolved.
When a vendor disposes of a building containing plant and machinery on which he has claimed capital allowances, he may be liable to a balancing charge, or clawback, on tax relief he has enjoyed. This clawback may be reduced by writing-down, or depreciating, the value of the plant and machinery so that it is sold at a lesser cost than that at which it was purchased. It is, however, important to note that a clawback can never be more than the benefit received, even if the plant and machinery is sold at a greater sum.
On the basis that the building (and hence the plant and machinery) was acquired by the vendor after July 11 1984, and he has claimed capital allowances, then the purchaser of the building will be restricted to the disposal value of the plant and machinery on which the vendor has claimed capital allowances (Capital Allowances Act 1990, section 59(10)). This applies even where an apportionment of the purchase price of the property gives a value greater than the disposal value brought into account.
Thus, if a vendor has claimed capital allowances, the purchaser may be restricted in the quantum of his claim. The question then to be answered is: “If the purchaser is to be restricted to the disposal value, how much can the vendor reasonably bring into account and how does he ensure that the figure is enforceable?” Unfortunately, the answer to this will not be found in the legislation, other than an implied term that the vendor and purchaser should agree on the disposal value of the plant and machinery.
From the purchaser’s point of view, it is usually best that the contract of sale remains silent on the disposal value of plant and machinery. This will give the purchaser maximum scope to claim capital allowances based on an apportionment of the full purchase price, if the vendor has not claimed. If the vendor has claimed, but does not specify a disposal value, then the purchaser has the scope to minimise the restriction by assuming that the qualifying assets have been sold to him at the price paid by the vendor, which presumably was the level at which capital allowances were claimed. This is the best situation that the purchaser can expect if the vendor has made a claim.
If the purchaser enters into a contract which specifies a disposal value for plant and machinery, and it can be demonstrated that the figure is reasonable, then it is likely that it is that figure to which the purchaser will be restricted. Clearly, therefore, there is advantage to the purchaser in the contract remaining silent in such a case. If, subsequently, the vendor attempts to bring into account a disposal value at a written-down figure, then the purchaser will be able to claim to the Inland Revenue that this was not the price at which he contracted to buy. It will be more difficult for the vendor to support a disposal value less than the price paid by him if it is not agreed with the purchaser at the time of sale. This will especially be the case where a building is sold at a sum greater than the vendor paid for it.
Of course it is likely that the vendor will want to minimise the effects of any clawback by writing down the value of the plant. As already mentioned, his task will be easier if the building is sold at a sum less than its purchase price. However, in most cases where property is sold at a profit, the vendor should try to negotiate a disposal value with the purchaser for the plant and machinery on which capital allowances have been claimed, if he is to minimise clawback. The agreed sum must be written into the contract. However, on its own this is not enough, and a schedule of the relevant items of plant and machinery with their respective disposal values should be appended to the contract of sale.
There is no formula for calculating a written-down disposal value, although it must be reasonable and be capable of being supported if the vendor is to stand any chance at all in agreeing the figure with the purchaser. It is a common error for a vendor to confuse writing-down allowances on plant and machinery, which are given at 25% pa on a reducing balance basis, with depreciation. In most cases it would be unreasonable to depreciate an asset at the same rate as it is written down for capital allowances purposes. While strictly it would be correct to depreciate each piece of plant and machinery over its useful life, which might be as low as 5% pa, it is rare that an asset will be allowed to remain in a building for this period of time. Buildings are regularly refurbished and much of the plant and machinery removed well in advance of the end of its useful life. Thus, depreciation will depend on such factors as, the type of building, its trade usage, the prevailing economic conditions and the level of demand at the time.
One word of caution to vendors. If they believe that they can totally mitigate clawback by specifying a very low or even nil disposal value, then they are mistaken. That, of course, presupposes that the purchaser is imprudent enough to enter into a contract on that basis. That said – some do! But beware – the Inland Revenue is not bound to accept any disposal value just because it forms part of a signed contract. If the figure is retrospectively disputed by the purchaser, and it is deemed by the Inland Revenue to be unreasonable, then it may be disregarded. For example, an overseas client entered into a contract with a large property investment company to purchase the plant and equipment in a £7m air-conditioned office building for £1. We challenged this, on the basis that the sum was unreasonable – how much of that £1 could be attributed to individual items of plant and machinery such as the lift, air-conditioning, sanitary fittings, carpets etc? Individual items of plant and machinery were not specified and, in any event, the word machinery, which makes up a high proportion of any qualifying expenditure, was not used. The vendor was unsuccessful and, we trust, a useful lesson was learnt.
Last, but not least, a vendor should not become too paranoid about minimising clawback, especially at the expense of jeopardising a deal. It is worth remembering that in the vast majority of cases, when a property-owning vendor disposes of an asset, there will still be a pool of unused allowances on other properties held in that company or any other company within the group. If this is the case, then a clawback will not involve the vendor in writing a repayment cheque to the Inland Revenue, but merely be treated as a reduction in the size of the unclaimed pool.
It is imperative that advice be sought by both vendors and purchasers to the treatment of capital allowances before they enter into a contract. It could save future loss of tax advantage and unnecessary disappointment.
