In April 2012 the capital allowances rules changed again – Louise Barth, Head of Capital Allowances at Altus Edwin Hill considers the key points and dispels some of the misconceptions surrounding this complex area of property tax.
Don’t let these new rules catch you out! The long term aim of HMRC is to get both buyer and seller to agree the amount for fixtures within the sale agreement on all purchases. Once we are through the transitional period it will be mandatory to pool the allowances even if the seller has not claimed. Failure to address the issue of capital allowances early on could affect exit strategies, capital values and scupper any chance of all future owners from ever making a claim. Early action can also provide opportunities to negotiate with the seller or alter the structure of the purchase vehicle. Both of which could increase the value of allowances, either by quantum or the rate of tax on which the relief is claimed.
One such structure that has proved to be particularly tax efficient is the Limited Liability Partnership (LLP). LLP’s are usually associated with firms of professionals but LLP Investment Vehicles are also popular with groups of small investors, often high net worth individuals who want shares in the larger commercial properties in a market dominated by established investment houses and institutional property funds.
The benefits of LLPs claiming capital allowances
Purchasing property in this way gives investors access to the potential returns from the larger lot sizes, along with the ability to shelter tax from the income and increased capital values that they can generate. UK property is still considered a safe bet – less volatile than stocks and shares and with better yields than banks and building societies. Capital values, in the doldrums since before the fall of Northern Rock in 2008, are showing some signs of recovery.
LLP’s holding investment property, operating like a company and governed by company law are treated as a partnership for tax purposes. The day to day affairs of the partnership is handled by a nominated administrator who is responsible for compiling the Partnership Tax return. Capital allowances are claimed on the capital assets or fixtures, inherent within most commercial properties such as lifts, air-conditioning, heating and electrical systems etc. They will be claimed within the LLP’s tax return instigated by the administrator. The members are notified of the net profits or losses generated by the LLP after capital allowances. Each member is liable for their own tax under the self-assessment rules based upon their share in the LLP. A £500,000 capital allowances claim provides a total cash saving of £225,000 to a 45% tax payer; £27,000 of that in year 1.
The LLP may only intend to hold the property in the short term but in a rising market it makes sense for the LLP to claim the allowances for a host of reasons.
Firstly it is an effective way of reducing the ‘after tax’ cost of purchasing property because capital expenditure is not in itself an allowable deduction in calculating trade profits. Capital allowances are given instead to cover the ‘cost’ of depreciation.
Secondly when it is time to sell the property the LLP can keep the allowances claimed thus far and pass on the remainder to the new owners by simply inserting the correct clauses into the sale agreement. In many instances the LLP can keep all the allowances, providing there are profits to offset them against.
Thirdly, so long as the property is sold at a profit, the capital allowances claimed will not affect the base cost or disposal proceeds of the property for CGT purposes. There are specific provisions within the CGT legislation that deals with this interaction.
Lastly its worth noting that tax savings can still be made even when there are losses in the LLP because members can claim loss relief by offsetting these losses against other income or profit depending upon whether they are individuals or corporates.
It’s not too late to revisit historic purchase expenditure or review the capital allowances position on a current deal.