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Saving tax on renovations

Practices need to invest in their premises to grow and if the rules are followed, much of the investment can be offset against tax

Understandably, businesses may take the opportunity to carry out improvements at the same time as repairs. But to Helen Thornley, a technical officer at the Association of Taxation Technicians, there are distinct differences between repairing and improving business premises, each of which can have huge tax consequences.

She says that “the question of whether expenditure on a building is a repair or an improvement is a classic tax problem. Relief for building repair costs is generally given against revenue in the period that the cost is incurred. In contrast, money spent on improvements to premises is considered to be capital and the business will only get relief when it sells or otherwise disposes of the premises.”

Yen-Pei Chen, manager of Corporate Reporting and Tax at the ACCA, agrees. She says that essentially, replacing or fixing something to get premises back into working order is fine as a repair, “but do anything further and you could stray into capital expenditure”.

And she gives an example cited by HMRC – a shop owner who had a new front put in when he took over premises: “The replacement of a shop front would normally be deductible as revenue expenses, but the fact that the shop owner adapted the front to his specific needs makes it an improvement, and therefore capital expenditure.”

HMRC will look to distinguish

Determining which is which requires the facts of each case to be considered, and Thornley says a decision from HMRC will depend on factors such as the extent of the works or whether it is possible to do something new or different with the building after the work has been completed.

And she says that there’s plenty of case law to make the point: “Consider the classic repair or improve cases of Law Shipping Co Ltd and Odeon Associated Theatres Ltd where money was spent on assets in poor condition. The question was whether the expenditure amounted to a repair or improvement.”

As she outlines in Law Shipping, a ship was acquired which was not seaworthy and a huge sum had to be spent before it could be brought into use. In this case “it was held that the expenditure was capital in nature, as the need for the work would have been reflected in the lower price paid for the ship”. In Odeon, however, where work was carried out to a number of dilapidated cinemas, it was held that the money spent was on repairs, as “the cinemas had been operating for some years before the repairs took place and the need for repair work was not reflected in the acquisition price”.

Capital allowances on capital expenditure

If a practice ends up with capital expenditure – say plant and equipment – and can’t set that expenditure against taxable profit, it may still get tax deductions in the form of capital allowances.

The key to this is the Annual Investment Allowance (AIA) which allows businesses to claim tax deductions upfront on the full amount of qualifying expenditure in the year it’s incurred. Chen says that those wanting to invest should not dawdle; the AIA was increased to £1 million, up from £200,000, from 1 January 2019 but will drop back down to £200,000 from 1 January 2021.

But there are other “gotcha’s” to watch out for according to Chen: for an item to qualify as plant and machinery, it “has to be kept ‘for permanent employment in the business’ – so, this excludes stock or expendable equipment with a life of less than two years; and function as ‘an apparatus employed in carrying out the activities of the business’ and not as part of the premises in which the business is carried on”. This latter point is problematic, says Chen, as “whether something consists of the apparatus used in carrying out the business or the business premises is surprisingly hard to pin down in case law”.

She refers to the case of Benson v The Yard Arm Club, where a company opened a floating restaurant on an old ship and claimed plant and machinery capital allowances on the ship, arguing that it was the restaurant’s unique selling point. “This,” she says, “was refused in the courts – the ship was the structure within which the restaurant business was run. In the words of the Court of Appeal judge, he could see no distinction between ‘a restaurant on the Thames and a fish and chip shop in Bethnal Green. Both act as premises in which the trade is carried on.’”

For Chen, the basic principle that should keep practices on the straight and narrow is that anything which can reasonably be expected to form part of a building – for example, walls, partitions, ceilings, floors, doors, windows and lighting – should be considered premises and not plant. And of course, there might be exceptions if they are moveable, and/or designed to fulfil a special function.

Tax allowances and what can be claimed for

Integral features

To reclaim some of the cost of repairs, practices need to pay attention to what the system permits. As Thornley points out, until relatively recently there were no tax reliefs for the acquisition, construction or improvement of buildings. However, she says that “since 2008 relief for what are known as integral features within the building has been available through the system of capital allowances”.

Just as with plant and machinery, the law is very prescriptive and there is a fixed list of integral features. Thornley says it comprises lifts, escalators and moving walkways; space and water heating systems; air-conditioning and air-cooling systems; hot- and cold-water systems (but not toilet and kitchen facilities); electrical systems, including lighting systems; and external solar shading.

And here’s where matters get murky, suggests Thornley. “The problem is that most businesses do not spend more in a year on qualifying plant or integral features than the AIA. If they do, then any expenditure exceeding the AIA will be eligible for writing down allowances instead. For integral features, the writing down allowance is 6 percent, compared to 18 percent for most other qualifying plant.” It’s for this reason that where a business does spend more than the AIA, Thornley says it makes sense to allocate the AIA against integral features first because they get a lower writing down allowance and it takes much longer to get relief for the costs incurred.

And Chen agrees, explaining that “the more integral features you can get 100 percent AIA on, the lower your tax bill will be… Just pay attention to the dates on your invoices: you will need to identify which assets were acquired before 1 January 2019, when the AIA amount changed, and which were acquired after.”

Structures and Buildings Allowance

Budget 2018 saw the then Chancellor, Philip Hammond, pull a rabbit out of his hat with the introduction of the new Structures and Buildings Allowance (SBA), giving a 2 percent flat-rate annual allowance on commercial structures and buildings over a period of 50 years. The new SBA, says Chen, “is available to offices, retail and wholesale premises, walls, bridges, tunnels, factories and warehouses – as well as renovations and conversions started after 29 October 2018”. However, she warns that buildings covered by the SBA won’t then qualify for the AIA.

The point of SBA is to provide tax relief for expenditure on structures and buildings which previously received no form of capital allowances.

Keeping good records

When it comes to tax, for HMRC records are everything, especially when claims for a tax relief are involved. But SBA takes this to a whole new level as there is, as Thornley says, “the potential for the claim to last for half a century after the building has come into use”.

Where this becomes more interesting is when considering that the 2 percent write down of original costs is available not just for the first owner who brings the building into use, but also any other qualifying business that subsequently acquires the building to use in a qualifying activity.

Parting advice

The advice is very clear. Rather than amalgamating all costs under a one-line item called “practice fittings” in the tax return, practices have a much better chance of claiming capital allowances successfully if they break down costs into specific headings – veterinary tables, lighting and electrical wiring for air conditioning, for example.

Adam Bernstein

Adam Bernstein is a freelance writer and small business owner based in Oxfordshire. Adam writes on all matters of interest to small and medium-sized businesses.

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