by Jimmy James
So it has arrived at last! — And it’s all about money … If you are involved in property then read on.
On December 4 1989 a Capital Allowances Bill was introduced into the House of Lords, consolidating all the earlier legislation since 1968.
Did you know that every Finance Act, with the exception of those in 1969, 1973 and 1977, altered capital allowances in some way? This has meant that not only is case law difficult to interpret but the legislation has spanned the last 22 years like crazy paving. No wonder specialists have had to be employed!
Of course the case law will not be repealed by the new Act, and will continue to confuse many on both the taxpaying and the Inland Revenue side. As a result it will pose continuing problems for commissioners and judges alike at an increasing number of appeals. But how will the new legislation affect the taxpayer? And how will it benefit the property industry?
To answer these questions one needs to go to the root of why capital allowances are there in the first place. Simply put, they are there to provide two things:
(a) an incentive, via tax relief, to invest in “good” things like plant, industrial buildings, hotels, enterprise zone buildings, ships, certain houses, mines, agricultural buildings, forestry, dredging and scientific research; and
(b) to provide a mechanism whereby the cost of these assets could be deducted from tax bills as they diminished in real value owing to obsolescence.
In reality the incentive aspect has been paramount since the war, as capital allowances have almost invariably been greater year by year than the loss in commercial value: motor cars form the only major exception to this.
How successful has the legislation been in supplying the incentive? In my opinion, not very!
Surely the essence of an incentive is that it should be understood by the layman and not need translation by experts. But how can this simplicity be achieved, with a new Capital Allowances Act of over 170 pages, 167 sections and schedules? This is then compounded by a prevailing wish by some in the inspectorate to resist allowance claims even when they are based upon published commissioners’ and court decisions. I have heard inspectors use the words, “The judge was wrong”, when referring to earlier precedent. Taxpayers have even been driven to litigate (successfully) in bona fide commercial finance leasing transactions, such as the Ensign Shipping case(*).
Gone, it would seem, are the days when many inspectors would search for an even-handed interpretation of the law. This has been replaced with the “maximum tax collection” approach which frequently chooses to ignore precedent decisions. This results in the taxpayer having to preplan capital allowance claims for a major project where large sums of money — perhaps millions of pounds — are at stake in the grey area of the meaning of “plant” or its valuation. This plan is prepared with an eye to possible litigation, and if thoroughly done will show the inspector that the taxpayer’s case is likely to succeed at appeal. As a consequence, better negotiations result.
These complexities, however, frequently go a long way in destroying the incentive sought by the legislation’s root purpose.
Having spread some doubt as to whether the Bill will precede a simpler Act, or a period of much-needed certainty, let us look at the situation (with slightly jaundiced eyes) from the property industry’s point of view by concentrating on those provisions which may be of principal interest.
First, this legislation is designed as a consolidating Act, not as fresh legislation. What this means is that it brings into one place all the existing enactments while, it is to be hoped, ironing out all the earlier conflicts that inevitably seep into scattered legislation.
The principal sections that interest the property industry are:
The enterprise zone legislation continues to confuse many. It is notable that the consolidation has not dealt with the ambiguity currently existing over plant fixtures within commercial buildings — should they receive 100% allowance or a mere 25% pa? The Inland Revenue have said that, by concession, the 100% allowance will be granted to plant built in under the first building contract by the original developer, but that this will not apply to any subsequent fitting-out — the allowances on these will be reduced to 25% pa. What a pity the Revenue research did not go so far as reading the cases of Schofield v R & H Hall [5] STC 353 and Stokes v Costain Property Investments [1984] 1 WLR 763. In the former it was decided that an item could be both plant and an industrial building and in the latter that plant fixtures were part of the realty. This of course makes the “concession” unnecessary and entitles, as a matter of law, enterprise zone allowances to fitting-out works whoever installs them, provided that they are part of the realty.
This aspect is bound to be appealed as many EZ projects are built on a shell-and-core basis.
In addition to the above the principle of the valuation of the land element as a deduction from the EZA claim is still not spelt out in the legislation, relying in section 150 upon a re-enactment of section 77 in the old Capital Allowances Act 1968. This states that a “just apportionment, properly attributable” shall be made. My practice have just completed a two-year negotiation with the Inland Revenue on this subject which has culminated in the Valuation Service producing internal guidelines to be followed, we are informed, by a revised set of procedures for income tax inspectors’ procedures early this year.
The provisions concerning industrial buildings and hotels are essentially unchanged, although one must say that they are very under-exploited. Long-term finance through the markets is always a useful tool for developers, but hotel owners rarely maximise their plant allowances (they could be, say, 60% of cost) because the easy way out is to rely merely on the industrial allowance of 4% pa. What a waste of money!
Fixtures in buildings are still governed by a re-enactment of what was Schedule 17 to the 1985 Act — a more difficult piece of legislation is hard to imagine! In essence this results in leaseholders being able to claim allowances and permits capital allowances to be left at various points in leasehold chains. In other words, we can plan with whom to leave the allowances in certain property joint ventures.
Purchasers of property should understand that when they buy buildings the allowances may have been stripped out.
Non-property finance leases provide-tax-based “cheap finance” for the installation of plant in buildings or the undertaking of tenants’ fitting-out works. This facility was recognised in the 1985 Finance Act and is re-enacted in section 58.
Finance leasing of this type is becoming a major tool in the long-term financing — ie up to 25 years — of major projects. It is also used extensively to re-finance, off balance sheet, trading developers’ unsold building stocks.
The ability to set allowances in buildings off against profits of any kind is maintained in section 145.
The rather unexciting assured tenancy allowances continue, although it is difficult to see how a 4% pa allowance is going to give anybody incentive in this sector. Of course in 1982 when these were introduced the allowance was at a worthwhile 75%.
Capital allowances within existing buildings still remain a rich source of tax relief for many. The conclusion of our two-year-long negotiation with the Inland Revenue establishes a base system of valuation in a hitherto uncharted area.
There are still a number of “tax exhausted” companies (ie they do not pay tax because of other charges against profits) around, who do not make use of these substantial allowances. Acquisitions can, therefore, be moulded so that these allowances can be made to work for their living. Some of these arrangements use the subsidies and contributions provisions and I am pleased to see that these remain unchanged from the CAA 1968 within their new sections 153 and 154.
So, finally, what is the verdict? Although the new Bill is over-complex there continues to be a vast sum of capital allowance money available to be used by investors and trading developers (no, this is not a misprint), provided they are preplanned at the projects’ inception.
(*) Ensign Shipping Co v IRC (1928) 12 TC 1169
