Capital allowances: cash flow benefits
Making the most of your capital
25 April 2019
If properly understood, capital allowances can bring considerable cash flow benefits for building projects
As quantity surveyors and project managers know all too well, the cost of refurbishing a property, building an extension, constructing a new build or contributing to any building project can be substantial.
Contrary to popular opinion, capital allowances relate to far more than just mechanical and electrical installations
In the UK, there is generally no relief for depreciation charged to the profit and loss account on an annual basis. However, tax relief in the form of capital allowances is available on certain elements of the capital expenditure in a building and for plant and equipment. Contrary to popular opinion, capital allowances relate to far more than just mechanical and electrical installations.
As part of a larger fit-out, for example, a company recently equipped a new research facility for which the research and development (R&D) allowances equated to more than 25% of the building costs. The cost of construction was therefore effectively reduced by around 5% thanks to the tax relief claimed.
Identifying all assets qualifying for allowances is thus an important exercise. The key reliefs available for non-residential new-build projects and how to make the most of their benefits are described below.
Figure 1 (right): Key reliefs for non-residential new-build projects
Contaminated land remediation
Expenditure on remediating contaminated land and buildings is generally not allowed to be considered as capital expenditure. However, a specific relief allows for companies only to deduct 150% of the qualifying additional remediation costs in the year that they are incurred.
Where the costs relate to a development for sale – for example, where houses are built – the relief is 50% instead, because such projects receive relief for the first 100% of the cost already. The other difference is that developers will receive the relief in the year the property is sold and not the year that the work is paid for. This effectively puts both developers and investors on an equal footing.
Qualifying costs can include employment costs, materials and subcontractors. However, to maximise this relief a detailed understanding of the contamination and the impact on any subsequent building design is required. Qualifying remediation work may include asbestos removal or the onsite treatment of Japanese knotweed.
The company claiming the relief must be subject to UK corporation tax, and usually hold an interest in the land being remediated. It is also possible for loss-making companies to claim a 16% tax credit on qualifying expenditure to improve cash flow.
A significant number of capital projects will include expenditure on an energy-saving or water-efficient plant that is eligible for 100% enhanced capital allowances (ECAs) in the year of installation. In order to qualify, the particular make and model of the product must usually be included on a technology list. Examples include:
- pipework insulation;
- refrigeration equipment;
- boiler equipment, heat pumps, radiant and warm-air heaters;
- automatic monitoring and targeting equipment;
- heating, ventilation and air-conditioning zone controls;
- technologies that reduce and monitor water consumption or improve water quality, such as grey water recycling or rainwater harvesting;
- solar thermal systems and collectors; and
- combined heat and power (CHP) schemes.
The value of the expenditure eligible for the 100% tax relief is uncapped, so this is particularly useful in a tax year with a high capital spend.
Loss-making companies can claim a tax credit, currently at the rate of 13% of the loss created by ECAs on expenditure on green technologies, which will improve cash flows. Some technologies such as CHP and waste water systems require certification by specific bodies, such as the Department for Environment, Food and Rural Affairs or the CHP Quality Assurance programme. Note that this relief will end in April 2020.
Research and development
This 100% relief is specific to businesses undertaking R&D in their properties, which can include product improvement and process improvement alike. It can be claimed on both buildings and equipment used in them in the year the expenditure is incurred. This relief is for capital expenditure on fixed assets and is often underclaimed.
There is a related relief called R&D tax credits that can be taken for eligible revenue expenditure. These can apply to construction companies and architects developing innovative construction methods.
Plant and machinery
This relief allows partial tax relief of 18% to be written down per annum on a reducing balance basis, thus spreading it over a number of years. For example, £1m of eligible expenditure is given relief of £180,000 in year 1, at 18% of £1m; £147,600 in year 2, at 18% of £820,000; £121,032 in year 3, at 18% of £672,400; and so on.
Identifying items of plant and machinery at an early stage is key to maximising tax relief. Common items qualifying for allowances are:
- manufacturing or processing equipment and storage equipment, including cold rooms, refrigeration and cooling equipment;
- displays, counters, checkouts, advertising hoardings and signage;
- white goods and sanitary ware;
- IT hardware and software and other communication installations;
- protective systems including sprinklers, surveillance, burglar and fire alarm systems;
- some moveable partitioning; and
- gas and sewerage systems that meet the requirements of the trade.
Special rate expenditure
This relief operates in the same way as plant and machinery allowances, but with a reduced level of relief – 6% – being written down each year. For example, £1m of eligible expenditure is given relief of £60,000 in year 1, at 6% of £1m; £56,400 in year 2, at 6% of £940,000; £53,016 in year 3, at 6% of £883,600; and so on.
This relief applies to expenditure on certain specified assets, as follows:
- electrical systems, including general wiring and lighting systems;
- cold water systems;
- space- or water-heating systems, powered ventilation, air cooling or purification;
- lifts, escalators and moving walkways;
- external solar shading;
- solar photovoltaic panels; and
- long-life assets, that is those with a useful economic life of more than 25 years from new; some exclusions apply.
Note that this relief was 8% until April 2019.
Annual investment allowance
The annual investment allowance (AIA) provides a 100% deduction for the cost of plant and machinery or special rate expenditure in the year the expenditure is incurred, up to a particular limit. This limit is changed regularly by the chancellor, and from 1 January 2019 to 31 December 2020 it is £1m per annum, reverting to £200,000 per annum after that date.
For expenditure in excess of the AIA, writing-down allowances are available at 18% per annum on plant and machinery and, currently, 8% on special rate expenditure. It is therefore beneficial to plan the timing of expenditure to fall within the AIA, otherwise tax relief will be far slower. One way of doing so is to ensure that expenditure qualifies for ECAs, which can be claimed in addition to the AIA.
Structures and buildings
This is a brand-new relief of 2% per annum, not to be confused with industrial buildings allowances. This applies to all non-residential structures and buildings contracts that have been agreed after 28 October 2018, where the costs do not fall under another of the reliefs detailed above. If the property is sold before 50 years of relief is taken, the balance will transfer to the new owner.
At the time of writing, primary legislation has been enacted but secondary legislation is still awaited.
Repair and capitalised revenue
The first question to ask in a refurbishment project is whether any of the expenditure would qualify as a like-for-like repair of part of an existing property, such as replacement windows; if this is the case, then it may be possible to secure 100% tax relief for such expenditure when it is incurred. However, substantial refurbishments or improvements to an asset will often be treated as capital.
It is also possible to take relief for expenditure that is revenue in nature, such as training costs or spare parts, even though it has been treated as a fixed asset in the accounts, because relief is given as the cost is written off to the profit and loss account. For example, if you capitalised training costs this may be written off over 3 years, so relief for the capitalised cost will also be taken over this time frame. To avoid deferring relief in this way, it is advisable under UK tax law to review capitalised expenditure annually. This will ensure that any capitalised revenue expenditure is transferred to the profit and loss account to take the full relief in the year that the expenditure is incurred.
It’s advisable to use a capital allowances specialist wherever possible. A detailed capital allowances claim should be done by a tax adviser rather than by completing a template issued by the client, as the provider must be registered with a body such as the Institute of Chartered Accountants in England and Wales, the Chartered Institute of Taxation, the Law Society or HMRC to comply with government money laundering regulations. Many construction firms are not registered.
A detailed capital allowances claim should be done by a tax adviser as the provider must be officially registered
The key challenge with capital allowances is staying up to date, because they can change every year. For example, the Office of Tax Simplification held a consultation in October and November 2017 on whether capital allowances should continue, but within 12 months a whole new tax benefit in the form of structures and building allowances was created. Staying informed of changes will put you in the best position to benefit from capital allowances.
Jeremy Chapman is head of capital allowances at PKF Cooper Parry