HMRC Consultation on Capital Allowances and Fixtures: the good, the bad and the ugly

On 31 May 2011 HMRC published a consultation document proposing changes to the capital allowances regime in relation to fixtures. Broadly the consultation proposed the following:

• a time limit for pooling expenditure on plant and machinery, including fixtures;
• a requirement for the buyer and seller to agree and notify HMRC of the amount of the sale price attributable to fixtures;
• a minimum value which can be adopted for an election under section 198 Capital Allowances Act (“CAA ”) being the tax written down value (“TWDV”) of the asset; and
• improvements to section 197 CAA, the anti-avoidance rule, to prevent the acceleration of capital allowances on fixtures by artificial arrangements.

These proposals will have a significant impact on the hotel and leisure industry. The consultation ended on 31 August 2011. Below is an outline of the proposals made by the consultation and reactions to those proposals.

Time limit on pooling expenditure

The legislation currently allows expenditure on fixtures to be pooled at any time, provided that the fixture is still owned and used in the business. In the hotel industry, it is common practice for expenditure to be pooled a number of years after the hotel has been purchased. As a ‘fixture heavy’ business, late fixtures claims are more favourable as the owners argue that they are not bound by the value they originally attributed to the fixtures and it also can be difficult to establish the fixtures on which the seller claimed allowances and the proportion of their cost that has already benefited from the relief as many years may have lapsed since the acquisition.

If the current proposals are accepted, hoteliers will have to pool their expenditure on fixtures within a short period of time after the acquisition of the hotel in order to qualify for capital allowances (1 or 2 years has been proposed). It is anticipated that the buyer will notify HMRC of pooling through the existing self assessment process.

The new mandatory pooling requirement would apply to both expenditure incurred on second hand fixtures (whether or not the previous owner claimed capital allowances) and to new fixtures purchased by the current owner. The Government is also seeking views on whether businesses should be required to pool historic expenditure incurred on fixtures before any legislative changes take effect. Therefore a purchaser of fixtures will need to ensure that it notifies HMRC of expenditure on fixtures within the required time limit or lose the ability to claim allowances.

Reaction

The reaction has been mixed. There is sympathy with the mischief that HMRC are trying to address in relation to second hand fixtures and this is considered a welcome change. However in relation to new fixtures these proposals would be problematic. For a long term project where capital expenditure is incurred over several years it would be difficult to allocate such expenditure to particular fixtures and periods. Parties have suggested for second hand fixtures a notification period of two years following the end of the accounting period in which the acquisition occurs and for historic fixtures a period of three years from commencement.

Agreement of sale price attributed to fixtures

The Government believe that in order to make the fixtures rules work in the future, it is essential that sellers and the buyers have a common understanding at the time of sale (or reasonably near thereto), of how much of the sale price relates to fixtures. Therefore the Government propose that there would be a new requirement for the seller and the buyer to agree the part of the sale price apportioned to the fixtures and jointly notify their agreement to HMRC with their respective tax returns, within a similar timescale to the mandatory pooling requirement described above.

Unlike the current section 198 procedure, this new rule would require the apportionment to be on the basis of market value and is intended to be mandatory as a pre-condition for allowances on second hand fixtures in all cases.

Reaction

The response to this proposal has been negative as HMRC has failed to appreciate the practicalities of entering into a record of agreement “near to the time” of sale. Capital allowances are not a priority at the time of sale and the supporting information is not always available at this point. As there is no legal requirement to determine the market value of fixtures within the property being sold, the buyer and seller to formally agreeing the market value of the fixtures will involve a great deal of work and expense (especially if the buyer and seller’s valuers disagree with one another!).

An alternative suggestion made by interested parties has been to amend section 185 CAA 2001 to make it clearer that the evidential burden is on the claimant to demonstrate that he is not claiming capital allowances in excess of the past owner’s disposal value. This would be in line with the recent judgement of the First Tier Tribunal in Mr & Mrs Tapsell & Mr Lester (as partnership “The Granleys”) v HMRC [2011 UKFTT 376 (TC)].

Section 198 election

Currently, the seller and the buyer can elect to fix the apportionment of the sale price of fixtures as low as £1. This is typically used to ensure that the allowances are retained by the seller although the asset has been transferred to the buyer where the buyer has no use for or will not adequately value the benefit of capital allowances or where it is difficult to carry out an analysis to determine the original cost or TWDV of specific assets. The Government fears abuse and believes that the unrelieved expenditure should be transferred with the asset and therefore proposes that the minimum amount that may be fixed as the price incurred on the provision of the fixture would be the TWDV of the fixture in the hands of the seller. This may trigger a potentially difficult and costly analysis of the make up of the pool of expenditure.

Reaction

This proposal has provoked the most severe reaction among the responses. Interested parties have strongly opposed the introduction of a TWDV basis for the apportionment of a section 198 election. There is fundamental disagreement with the notion that a party who no longer holds the underlying asset should not be able to retain the allowances. If a seller and buyer agree that the seller should retain the right to claim allowances, and the seller has incurred qualifying expenditure on the fixture then there is no reason why it should not be able to continue to claim capital allowances.

Section 197 CAA – the anti avoidance rule

Section 197 CAA applies where the actual disposal value of any plant and machinery is less than its TWDV and the disposal event is part of, or occurs as a result of, a scheme or arrangement the main purpose of which is the taxpayer obtaining a tax advantage. The effect of section 197 CAA is to substitute the TWDV for the actual disposal value.

The Government is proposing to make it clearer that these provisions will be triggered in all circumstances where capital allowances on fixtures are accelerated by a balancing allowance, as a result of an artificial scheme or arrangement which is tax driven.

The Government has recognised that these improvements to section 197 CAA may not be necessary if, as proposed above, a section 198 election cannot be made at a value lower than the seller’s TWDV and therefore the suggested improvements are only relevant to the extent that it decides not to change the section 198 election provisions.

Reaction

The reaction to this proposal, which is somewhat vague, is confusion. It is not clear what the underlying policy purpose of this proposal is and therefore it is difficult to suggest alternatives or assess the merits of the proposal. More details need to be provided as to what identified abuse is being targeted.

The Way Forward

The consultation has now closed and we are waiting for HMRC to provide a summary of the responses to the consultation, which we understand will be published on 6th December. HMRC are convening a small working group of interested parties to discuss the proposals and their potential impact. Resulting draft legislation will be published on 6th December 2011 and included in the Finance Bill 2012.

CMS Comment

If the proposal to make allowances for historic expenditure conditional on pooling within a limited timescale, businesses should investigate possible entitlement to allowances before the deadline to avoid missing out on allowances.

On the sale of a hotel including fixtures, the buyer and the seller will need to agree the sale value of the fixture in order for the buyer to claim capital allowances in relation to the cost of the fixtures. Additional obligations will need to be included in the sale contract to ensure that the parties enter into the record of agreement. The question remains as to what happens if the seller and buyer cannot agree on the market value apportionment? It is also not clear how this impacts on the existing section 198 election.

The proposed changes to section 198 will undoubtedly increase the administrative burden on sellers in a number of cases and will require a reappraisal of how hotels are marketed in terms of their tax attributes as well as eliminating one possible avenue for tax planning where a purchaser is tax exempt (e.g. REIT) or has no current use for the allowance (very highly leveraged or carry forward losses available). It must be reiterated that in practice, section 198 elections are mainly made as sellers do not have the records to support a higher allocation.

As suggested, the change in the minimum amount for a section 198 election may prove to be unpopular with buyers and sellers as it does not allow the parties to allocate the allowances to the party to whom they are most valuable and could affect the pricing of deals going forward.

Before these proposals become law you may wish to claim all available capital allowances now where you have not already done so. You may also wish to consider intra group property transfers utilising section 198 elections to lock in capital allowances claims on a future sale to a third party.