Before budgets are set, clients and asset managers should review past landlord’s expenditure to ensure it is being allocated in the most tax efficient way. Confusion can arise around the treatment of the receipt of dilapidation payments or works which may in part be recovered via the service charge. Here we explain how Capital Allowances should not be ignored in both cases.
When a tenant vacates, there are generally three scenarios that can play out:
- The tenant removes the tenant’s fixtures and the Landlord then incurs expenditure to prepare the space in advance of re letting
- The tenant pays the landlord a sum of money as a dilapidations payment in lieu of carrying out the work and the landlord undertakes the works
- The tenant pays the landlord a sum of money as a dilapidations payment in lieu of carrying out the work and the landlord does not undertake the works
For each of the above there are different tax implications. The first scenario is the most straightforward, the tenant will be able to take a revenue deduction for any repairs that it is obliged to carry out under the terms of the lease. The landlord then may incur expenditure to prepare the space for re letting and typically this will be capital works in nature and Capital Allowances can be claimed.
For the second scenario, the cost to return the space back to its original condition is passed onto the landlord. For repair works which are then undertaken by the landlord, to the extent the dilapidations payment is received, then the landlord will simply nett off the receipt and so the position is tax neutral. The difficulty can arise where the allocation of the payment is not known and a “commercial settlement” is arrived at. Here an assessment should be made as to the intended allocation of that payment to the works undertaken by the landlord. Therefore, if say the landlord incurs £200,000 on works but only receives in £50,000, if the £50,000 relates to repairs which are carried out these are netted off leaving the balance of £150,000 which will be capital and on which the landlord can claim Capital Allowances, ensuring correct allocation to the right pool.
Finally, the landlord may choose not to carry out any such works, then if the property is sold or the landlord moves in it is treated as a capital receipt as compensation for taking it back in a dilapidated state. If however, the landlord lets it out then the payment is likely to reflect the lower rent that will have been charged and could be taxed as income for lost profits.
When it comes to landlord works which are met by a service charge, then to the extent Capital Allowances can be claimed it will depend on how that payment received is to be treated for tax purposes. If the service charge sits in a holding account from which the works are paid, then the landlord will not have entitlement to claim Capital Allowances as it is deemed not to have “incurred” capital expenditure.
If however, the landlord pays for the works and the receipt of monies in from tenants is taxed as income, then the landlord will have the entitlement to claim Capital Allowances on that expenditure.
The other point to note is, if the property is only partially occupied then the landlord in any event must have incurred some of the cost of works and therefore will be entitled in any event to claim Capital Allowances on that share.
- As part of year end capex reviews consider the extent to which expenditure treated as revenue deductions will be affected by the receipt of dilapidation payments
- Often where the landlord undertakes the tenant’s dilapidation works, it forms part of a wider capital project for which Capital Allowances should be considered
- Look at how the landlord’s works are paid for and if the service charge impacts on the ability to claim Capital Allowances
- For properties not fully let, the landlord will always be able to claim Capital Allowances as not fully met by the service charge