As the property investment market matures so more people are making the switch from residential to commercial buildings. Whilst commercial property can be seen as more risky, one of the key differences is in the different tax allowances. Wear and tear tax relief is not given on commercial properties but in its place are "Capital Allowances".

Worryingly, some recent research we carried out shows that over half of commercial property owners do not claim their full entitlement of capital allowances and thus end up paying too much tax.

What are capital allowances?

There are various forms of capital allowances with the most common being given for capital expenditure on plant and machinery or industrial buildings. Plant and machinery allowances are the most frequently available form as they are present in all types of commercial property. They are not usually available on the dwelling areas of residential properties but can be claimed on, for example, lifts in common areas.

The rate of allowance for plant and machinery is 25% per annum on a reducing balance basis. This means that an investor incurring £100,000 of expenditure on plant and machinery will be able to shelter £25,000 of rental income from tax in year 1, £18,750 of rent in year 2 and so on. Over a five-year period, with income tax at 40% the actual tax savings amount to over £30,000.

The term plant and machinery encompasses a wide range of items including air-conditioning, parts of electrical installations, lifts, carpets and sanitary systems. There is, however, no actual statutory definition and so it is often necessary to refer to precedent case law in order to substantiate a claim to the tax authorities.

Industrial building allowances (IBA's) are given at 4% per annum, on a straight-line basis for 25 years from the date of first use. The building must however be used for a qualifying trade in accordance with the Capital Allowances Act 2001, section 274.

Property purchases and disposals.

When a property is acquired the Capital Allowances Act, Section 562, requires that a "just apportionment" of the price paid is carried out. This involves a separate valuation of the land, buildings and plant and machinery fixtures. These figures are then related to the purchase price by inputting them into a formula as set out in the Inland Revenue practice manuals. This will usually give a significantly higher figure than the original cost of the plant and machinery and is one of the main differences from industrial buildings allowances where the claims are restricted to original cost.

Before an "apportioned claim" can be made, however, it is necessary to research the tax history of the property. If there has been any claim for capital allowances since 24th July 1996 that requires a disposal value to be brought into account then the claim of a new purchaser will be restricted to this amount. In many situations the person selling the building will seek to avoid repaying any tax allowances claimed by means of a joint "election" with the person buying the building. If you're buying a commercial property you must, therefore, ensure that no elections have taken place between former owners on the same items of plant and machinery he is going to claim on, which can take some time to establish. This research is vital to ensure that a valid claim can be made.

Over half of buildings will have had some capital allowances claim made. Often it will be found that a seller has claimed on some but not all items of eligible fixtures. This will result in a two-stage claim, one restricted and one on an apportioned basis. An election in a contract can therefore be misleading and a purchaser should not rule out the possibility of making a higher claim until the matter has been properly looked into.

Typical ranges of plant and machinery allowances for building types, after allowing for land are as follows;

• Heated office building with lift 15 - 22%
• Air-conditioned offices with lift 20 - 30%
• Hotels 25 - 50%
• Industrial buildings 5 - 12% plus IBA's
• Retail shops 2-10%
• Refurbishment schemes and fitting out works.

These types of projects often have high levels of capital allowable expenditure; sometimes up to 80% of costs can be eligible for tax relief. In some cases structural works that are not usually allowable can be claimed under CAA 2001, section 25. For example the cost of building a new lift shaft in a nursing home would be allowed if part of a refurbishment scheme but not in a new build project.

The importance of planning ahead

Whatever the situation the early consideration of capital allowances will always pay dividends. On development projects claims can be increased by up to 20% by investigating issues such as tax efficient design, trade related plant or collating full documentation as the project progresses.

Summary

• Capital allowances were created as an incentive for businesses to invest.
• If investigated in a thorough and timely manner the tax relief's available can significantly increase the cash flows from the investment. This in turn can allow accelerated amortisation of loans or the payment of higher dividends to investors
• Around half of property owners do not maximise their capital allowances claims
• The amount that can be claimed can be affected by the actions of former owners so research is always required, ideally prior to buying the property
• Capital Allowances may have to be repaid if tax planning does not take place prior to the sale of a property
• Planning prior to refurbishing or developing a property can increase the claim by up to 20%
• Those businesses that do not exploit Capital allowances will find their payments to the tax authorities are higher than they should be!