A company which spends money on capital assets for use in its business cannot claim a UK tax deduction for that expenditure.
Instead, a tax relief called a capital allowance may be available for certain types of expenditure.
The aim of capital allowances is to give tax relief for the reduction in value of certain capital assets, by letting the business write off the cost of the assets over a number of years against the taxable income of the business.
Some buildings may qualify for new structure and buildings allowances. If allowances are not available in respect of the building itself, relief may be available for certain plant and machinery such as lifts, heating systems, air conditioning and sanitary fittings.
The availability of capital allowances is often an important consideration on the sale or purchase of a commercial building.
Plant and machinery allowances
Writing down allowances are available in respect of expenditure on certain types of plant and machinery.
Writing-down allowances are annual allowances that a company can claim to reduce - 'write down' - any remaining balance of capital expenditure on plant and machinery that the company has not already claimed a capital allowance for – this is referred to as a "pool" of "unrelieved" expenditure.
There are two different rates of capital allowance – the main rate of 18% and the 'special rate' of 6%.
Most plant and machinery will fall within the main pool. However, since 1 April 2008, certain assets in a building are designated as "integral features" and only qualify for allowances at the lower special rate.
The following are designated as integral features:
- an electrical system (including a lighting system);
- a cold water system;
- a space or water heating system, a powered system of ventilation, air cooling or air purification, and any floor or ceiling comprised in such a system;
- a lift, an escalator or a moving walkway; and
- external solar shading.
Certain other assets with a working life of over 25 years are designated as "long-life assets" and qualify for allowances at the lower special rate.
There are also special rules which enable an election to be made in respect of assets with an expected useful life of less than eight years ('short life assets') which enable the full benefit of the allowances to be obtained more quickly.
Full expensing
Companies are also entitled to a 100% first-year tax deduction for the costs of new qualifying plant and machinery. The tax relief, known as full expensing, was initially set to expire on 31 March 2026, but became permanent following a UK government announcement in Autumn 2023. A 50% first year allowance is also available for certain ‘long-life’ capital assets. There is no cap on the amount of expenditure that can qualify for relief.
Annual investment allowance
Companies can claim an annual investment allowance (AIA) of £1 million, which allows for full tax relief for expenditure on qualifying plant and machinery. Where a company is a member of a group, only one AIA is available for the group.
Enhanced capital allowances
Enhanced capital allowances give 100% capital allowances on certain designated plant and machinery. 100% allowances are available on a restricted number of items including zero-emission goods vehicles and cars with low CO2 emissions.
Enhanced capital allowances on qualifying expenditure on plant and machinery may also be available in designated freeport tax sites, investment zones and enterprise zones.
Structure and buildings allowances
Structures and buildings allowances (SBAs) give tax relief on eligible construction costs incurred on or after 29 October 2018. The relief is given at 3% a year on a straight-line basis. Structures and buildings qualifying for SBAs include: offices, retail and wholesale premises, walls, bridges, tunnels, factories and warehouses. Capital expenditure on renovations or conversions of existing commercial structures or buildings can also qualify. The allowance does not apply to dwellings or to expenditure on the land itself.
Capital allowances on a property transaction
When a property is sold, if the seller has been claiming capital allowances in respect of plant and machinery which constitute fixtures in the building, it will need to apportion part of the sale proceeds to those fixtures. Apportionment is usually made on a just and reasonable basis.
For the buyer to be able to claim allowances in respect of the fixtures, the parties must enter into an election (a 'section 198 election') to fix the value of the assets, or apply to the Tax Tribunal for a value to be determined. Generally, an election is made at either tax written down value or at £1 per pool of assets.
Electing at tax written down value means the seller won’t suffer a clawback of any allowances already claimed but will cease to be able to claim further allowances in respect of the fixtures. Going forward, the buyer will be able to claim the remaining allowances on the fixtures - effectively stepping into the seller's shoes.
By contrast, an election at £1 means that the buyer will not be able to claim any allowances in respect of the fixtures following acquisition and the seller will retain the benefit of unclaimed allowances.
In addition to an election, a buyer is only able to obtain capital allowances for qualifying fixtures if the seller has 'pooled' its expenditure on the fixtures for capital allowance purposes. Pooling means adding the expenditure to the seller's capital allowances pool – although the seller does not have to have claimed a writing down allowance.
The pooling requirement will not be an issue where the seller has been claiming full capital allowances, since pooling is a requirement for claiming allowances. As part of pre-acquisition due diligence, a buyer may seek to investigate whether a seller has claimed full allowances.
If the seller has not claimed full allowances, the buyer will need to ensure that the seller agrees to pool its expenditure. This should be detailed in the sale documentation.
The position is further complicated if the seller has not claimed allowances due to being ineligible to claim - for example, as is the case with tax exempt entities. In such circumstances, the buyer will only be entitled to claim capital allowances on qualifying fixtures if the last owner of the property who was entitled to claim allowances had pooled the expenditure to preserve the availability of allowances for future buyers.
To avoid valuable capital allowances becoming lost on a property acquisition, buyers are advised to determine the seller's capital allowance position as early as possible so that, if necessary, action can be taken to preserve the allowances.
Where the buyer is tax exempt and ineligible to claim capital allowances, they should still consider taking steps to preserve any allowances, since their availability may enhance the value of the property on a future sale.
Leases
When a lease is granted, allowances in relation to the fixtures in a building will remain with the landlord unless the lease is granted at a premium and an election is made for the allowances to pass to the tenant. Tenants will usually be able to claim allowances in respect of expenditure they have incurred on qualifying plant and machinery. Any contribution by the landlord to the fit out of the property by the tenant needs to be carefully structured so as not to prejudice the availability of capital allowances for the tenant.
