Peter Rayney reviews the capital allowances treatment of fixtures and integral features when a building changes hands.
Plant, fixtures and integral features often form a valuable part of most commercial buildings. Consequently, there are likely to be significant capital allowances at stake when a building changes hands.
Setting the scene
In most cases, various types of capital allowances would have previously been claimed in respect of qualifying plant, fixtures and integral features in the building. On the other hand, some assets or structures etc. would not have attracted any capital allowances, such as land (CAA 2001, s 24), structures listed within CAA 2001, ss 21 to 22, and so on. More recent ‘structural additions’ may have qualified for structures and buildings allowances (SBAs).
Consequently, when a property is sold, one of the challenges is to ensure that the relevant sale proceeds can be fairly allocated amongst each of the various asset groups.
From a capital allowances perspective, the default rule is for the apportionment to be made on a ‘just and reasonable’ allocation of the total sale price (CAA 2001, s 562). However, the sale of fixtures and ‘integral features’ (which include hot and cold water systems, electrical systems and lighting, and air conditioning) is subject to special rules. These special provisions apply where the seller has previously claimed capital allowances in respect of various items attached to the property. In such cases, the legislation normally requires the seller and buyer to elect to fix the relevant sale price (see below).
The disposal proceeds relating to each constituent element of the building would be determined, taking into account any values fixed by the election under CAA 2001, s 198. The appropriate disposal proceeds would then be applied against the tax written down values in the various capital allowances pools. However, the proceeds deducted are always limited to the original cost of the relevant asset (CAA 2001, s 62).
Example 1: Allocating sale proceeds for capital allowance purposes
Carson Retailers (Downton) Ltd is in the process of selling one of its freehold retail stores (which was constructed in 2009). A sale price of £4,200,000 (excluding VAT and stamp duty land tax) has been agreed.
The company has agreed with the buyer the following apportionment for capital allowance purposes:
£
Land 610,000
Non-qualifying element in property (building structure, etc.) 2,300,000
Integral features (per s 198 election) 460,000
Fixtures (plant items) (per s 198 election) 480,000
Individual items of store plant and equipment (chattels not fixed to building) 350,000
Total sale price 4,200,000
The £460,000 for integral features would be deducted against the special rate pool, and £830,000 (i.e., £480,000 (fixtures) and £350,000 (individual plant items)) would be taken to the main capital allowances pool.
Dealing with fixtures and integral features
HMRC tightened the capital allowances rules on the acquisition of fixtures in response to concerns that buyers of property were claiming excessive capital allowances. The policy intention is that the cost of a fixture or integral features is relieved only once, even where it has various owners over the course of its life.
Consequently, buyers can only claim capital allowances on fixtures and integral features acquired in a commercial property provided:
- the seller has ‘pooled’ all the relevant fixtures before the sale (or has claimed a 100% allowance) (‘the mandatory pooling’ requirement); and
- the seller and the buyer agree the ‘consideration’ value of those fixtures under an election under CAA 2001, s 198; if they cannot agree the value, the amount that is determined by the First-tier Tribunal (‘the fixed value requirement’); and
- a competent section 198 election is made (or the matter is referred to the First-tier Tribunal) within two years of the purchase being completed.
The ‘mandatory pooling’ rule only operates where the seller was entitled to claim capital allowances on its acquisition of the fixtures or integral features. The underlying purpose is to make sellers bring the fixtures or integral features expenditure into the capital allowances system and to provide a ‘traceable’ audit trail of disposal and acquisition values made by successive owners.
Under this election process, the buyer’s purchase consideration for the fixtures and integral features would mirror the seller’s disposal value for capital allowance purposes.
Mandatory pooling requirement
To satisfy the mandatory pooling requirement, the seller must have included the expenditure on the fixtures in their pool of expenditure qualifying for capital allowances (CAA 2001, s 187A).
However, the seller does not necessarily need to have claimed the relevant capital allowances.
It is therefore important for buyers to find out about the seller's capital allowance position at an early stage in the transaction. Where the seller is entitled to claim capital allowances but has not done so, the buyer must act to preserve its claim to the allowances. For example, the property sale agreement could specifically require the seller to pool its ‘fixtures’ expenditure. The ability to claim capital allowances can clearly be used as a factor in negotiating the sale price.
The pooling requirement does not apply where the seller is exempt from tax (such as a charity or pension fund) or where the seller holds the relevant property as trading stock (e.g., in the case of a property developer or dealer). In such cases, the buyer must provide written documentation to support its claim and should be able to demonstrate that a ‘just and reasonable’ amount has been attributed to the fixtures or integral features (Fitton v Gilders & Heaton [1955] 36 TC 233 and CAA 2001, s 562).
Section 198 elections and the fixed value requirement
Sellers and buyers must make a section 198 election for a buyer to claim allowances on ‘second-hand’ fixtures or integral features (unless an application is made to the tax tribunal to agree the value). The election must be submitted to HMRC within two years of completion. Once accepted by HMRC, the election becomes irrevocable. It is generally recommended that the election be agreed before the property purchase is completed!
Failure to make a valid election is likely to have disastrous tax consequences. Unless the tribunal is asked to determine the relevant value(s), the buyer cannot claim any capital allowances on the fixtures and integral features acquired with the property. This is achieved by CAA 2001, s 187A, which treats the buyer’s expenditure on fixtures as ‘nil’. Furthermore, subsequent buyers will be prevented from obtaining allowances on the property’s fixtures and integral features!
The election should specify amounts for both integral features and other fixtures. The election only applies to fixtures and does not extend to chattels. The legislation requires the relevant fixtures and integral features to be identified on an ‘asset by asset’ basis in detail. However, HMRC does accept some level of amalgamation at the ‘elemental’ level with meaningful descriptions (such as hot water system, sanitary appliances and so on). It is good practice to include the ‘agreed form’ of the election within the property’s sale and purchase agreement. The election is not required in cases where the seller cannot claim capital allowances (see above).
Seller’s capital allowances
The seller would bring in the value agreed in the election as a disposal value (or original cost, if less) in its capital allowance computation. The buyer claims the relevant allowances on the same amount.
The value(s) specified in the election effectively allocate the allowances between seller and buyer. A seller will retain all the allowances if the elected amount is (say) £1. On the other hand, the buyer will take over the allowances if the elected value is equal to the original cost of the fixtures and integral features acquired with the property. The seller would suffer a recapture of the allowances by bringing in the original cost of these items as a disposal value in its pool(s) of qualifying expenditure.
Capital gains position
The sale of the property will give rise to a capital gains disposal. Importantly, sale proceeds allocated to capital allowance assets are not excluded from the capital gains calculation.
Similarly, the full cost of assets is included even though they may have attracted capital allowances claims. There are special rules for capital loss situations.
Practical tip
Agreement of the section 198 election and related capital allowance issues should always take place as part of the pre-contract enquiries for the purchase of commercial property.
