The fanfare surrounding the announced ‘super-deductions’ was somewhat soured for property investors, in reading of a restriction on ‘leased’ plant and machinery. Here we set out why for some investors, there is still a way to benefit from these generous temporary tax reliefs.
Investing in property – who benefits
Within the draft legislation, HMRC included the restriction under general exclusions for any plant or machinery which is leased. Under IRFS16:9 a lease is defined as a contract or part of a contract, that ‘conveys the right to control the use an identified asset for a period of time in exchange for consideration.’ This has led industry commentators scrabbling to see what this actually means for investors in property. To date, only adhoc guidance has been provided by HMRC, which has provided some clarity, but there are still gaps and the hope is further detailed guidance will be provided, although with the rules applying to expenditure from 1 April 2021, it is far from ideal.
Here we set out how this draft legislation applies to different investors in property.
The owner occupier & tenant fit out
The general principle of claiming these temporary first year allowances (FYAs), as with standard capital allowances, is that entitlement arises as a result of incurring capital expenditure, owning a relevant interest in land and those qualifying fixtures are then used for a qualifying business activity.
Single purchased equipment is straight forward to identify and capture; the challenge will be for any building works which consists of expenditure on fixtures that qualify for different rates of capital allowances. For example, an electrical lumpsum cost can contain both fire alarm expenditure, which qualifies for the main pool super-deduction (SD) and general lighting which would qualify for the special rate (SR) allowance. Furthermore, builders work in connection, such as ceiling works, could then be apportioned across both pools.
The exception is where a landlord is to provide a capital contribution towards the tenants fit out works, the tenant will then need to net off the contribution in calculating their available claim. Under the capital allowance legislation, it is the landlord who is deemed to have incurred the contribution expenditure and who has the potential to claim the temporary FYAs. Landlord and tenants may need to consider as part of the lease negotiations, who is best placed to incur the expenditure within the leased demise.
This is where it starts to get more complicated. It will firstly depend on how the expenditure is to be structured, which party is to incur the expenditure and the contractual arrangements that sit alongside.
For example, a hotel development which is undertaken under an opco propco structure, will be restricted on claiming the SDs and SR allowance, to the extent the ‘control’ of those fixtures have been passed to the opco. The question of ‘control’ is key, which under IRFS16 defines, as the use of an identified asset where a customer has the right to obtain substantially all of the economic benefits from its use of the asset, through the period.
Management contracts would seem to offer a greater opportunity for the ‘control’ of assets to be retained by the landlord over a lease, but each contract would need to be considered. Where there is no underlying leasing of the qualifying fixture and the control is solely retained by the operator, then claiming the SDs and SR allowance would still be possible.
The property investor
Under the traditional model, a property investor typically looks to grant the use of space to a tenant in return for a rent. The ‘leased’ plant and machinery restriction is most certainly in play and needs to be considered on a case by case basis.
The critical question to ask is to establish the level of ‘control’ that exists for each fixture. For a multi-let office for example, those fixtures installed within the contracted leased office space will be excluded from claiming SDs and SR allowances, but the landlord will still be able to claim the standard allowances including the annual investment allowance. For those fixtures which are within the control of the landlord, whereby the tenant is merely given ‘rights’ of use under the contract, then the landlord is not regarded as ‘leasing’. This will apply to those landlord fixtures within the common areas, such as plant room, corridors and lift lobbies which would still qualify for the SDs and SR allowances, but will however, be subject to understanding each contractual arrangement.
For build to rent and student accommodation, plant and machinery within the flat demise was already restricted under the capital allowances legislation, by the residential dwelling restriction under section 35 of the CAA 2001. Investors in this sector, as with standard capital allowances, can claim the SD and SR allowance on those assets that are deemed within the landlord common area demise.
Single let properties, however, will appear excluded even where the landlord has joint control over the whole building. It is worth noting that these temporary FYAs do not apply to second-hand acquisitions, unless the property is acquired unused from a developer.
Whilst the SDs and SR allowances can be criticised for not going far enough, the underlying objective of this temporary tax relief give away is to encourage investment. Providing both businesses and property investors with the opportunity to claim significant tax relief in bringing forward certain capital investment over the next two years.
There was always going to be a need for the government to rebalance the books however, and this will come about by the increase in corporation tax, rising from 19% to 25% from 1 April 2023. So now is the time to early tax plan for any property expenditure over the next two years, to ensure where possible, this accelerated temporary tax relief is obtained to help mitigate the increasing tax costs to come.