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4. The Capital Allowances Regime Notes

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Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

4. THE CAPITAL ALLOWANCES REGIME

1. Introduction to Capital Allowances A. Structure of the UK Capital Allowances Regime B. Introduction to UK Capital Allowances

2. Relationship with the Capital Gains Tax Regime

3. Only "Capital Expenditure" Qualifies A. Identification of "Capital Expenditure" B. Timing of the Capital Expenditure C. Allowance as an Election D. Qualifying Capital Expenditure: No Finance

4. Capital Allowances for Expenditure on "Plant and Machinery" A. The Meaning of "Qualifying Activity" B. The Meaning of "Capital Expenditure" C. The Provision of "Plant and Machinery" D. The Case Law Before 1994 E. The Case Law under the Statutory Regime After 1994

5. The Allowances: AIAs, FYAs, WDAs, Balancing Charges and Balancing Allowances, "Pooling" A. The Annual Investment Allowance (AIA) B. The First Year Allowance (FYA) C. The Writing-Down Allowance (WDA) D. Disposal Value: Balancing Allowances and Balancing Charges E. Election for No Balancing Charge or Allowance on "Succession" to Qualifying Activity F. "Pooling"

7. Miscellaneous Aspects of Part 2 CAA 2001

8. Industrial Building Allowances (Part 3 CAA 2001) - PHASED OUT APRIL 2011 __________________________________________________________________________________

1. Introduction to Capital Allowances A. Structure of the UK Capital Allowances Regime

Once it has been decided that an expense is a capital expense, it may be deducted only under the capital allowances regime or under the CGT regime, with their interaction dealt with by Section 41 Taxation of Chargeable Gains Act (TCGA) 1992, outlined below. A pure expenditure tax which did not distinguish between capital and revenue expenditure would allow a deduction of the whole cost up front,

1

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

but under the UK tax system - which distinguishes between capital and income - the rules have to be more complicated. In the UK, the availability of capital allowances is restricted to certain categories of asset:

1. Plant and Machinery

2. Industrial Buildings (Phased out as of April 2011 - Do not need to know)

There are capital expenditures not falling within any listed category e.g. commercial buildings - the definitions of allowable groups therefore becomes very important because there is no deduction for any capital expenditure not falling within one of these categories

Once it has been determined the expenditure qualifies, the allowances can then be given.

Techniques used under the Capital Allowances Act (CAA) 2001 are: o o o o o o



Annual Investment Allowances (AIAs) First Year Allowances (FYAs) Writing-Down Allowances (WDAs) Balancing charges Balancing allowances Pooling

At their most basic, the allowances operate in two main ways. The First Year (FYA) and Writing-Down Allowances (WDA) operate in the same manner that a deduction would work for trading receipts and corporate profits (whereby the expenditure on qualifying plant and machinery is simply deducted from the final taxable bill) By contrast, the Annual Investment Allowance (AIA) operates like the annual exemptions for Inheritance Tax and Capital Gains Tax i.e. a certain amount of qualifying expenditure can be "written off" (or not taxed) every year (currently £500,000) if money is spent annually. Detailed descriptions of how the allowances operate are noted later. For further reference, see the CBT hand-out provided by the Oxford University Law Faculty, as well as the Table of Statutory Provisions.

B. Introduction to UK Capital Allowances

If an asset has limited life, its value to the business will decline (with wear and tear or a change in economic circumstances) and becomes an expense in terms of accounting; the capital has been consumed In the UK tax system, capital allowances displace the deductibility of expenditure on renewals

2

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

The Capital Allowances Act 2001 is consolidating legislation, but references to "plant and machinery" means that the case law is still relevant, and this will be considered below. Part 1 Part 2 Part 3 Part 3A Part 4 Part 4A (FA 2001)

Part Part Part Part Part Part Part

5 6 7 8 9 10 11

Part 12

How allowances affect calculation Plant and machinery Industrial buildings Business premises renovation Agricultural buildings Renovation/Conversion of empty spaces above commercial premises to provide flats for rent (flat conversion) Mineral extraction Research and development Acquisition of know-how Purchase of patent rights Dredging Construction of houses to let Contributions to another's expenditure Miscellaneous e.g. partnerships

Where an allowance is made pursuant to one of the codes above, the taxpayer cannot obtain allowances under another code in respect of the same expenditure.

2. Relationship with the Capital Gains Tax Regime - Section 41 TCGA 1992

Once it has been decided that an expense is a capital expense, it may only be deducted under the CAA regime OR under the CGT regime - and this is dealt with by s41 TCGA 1992

Section 41(2) TCGA 1992 - Restriction of Losses by reference to Capital Allowances "(1) Section 39 TCGA 1992 [which deals with acquisition costs for CGT purposes]
shall not require the exclusion from the sums allowable as a deduction in the computation of a gain of any expenditure as being expenditure in respect of which a capital allowance or renewals allowance is made, but the amount of any losses accruing on the disposal of an asset shall be restricted by reference to capital allowances and renewals allowances as follows. (2) In the computation of the amount of a loss accruing to the person making the disposal, there shall be excluded from the sums allowable as a deduction any expenditure to the extent to which any capital allowance or renewals allowance has been or may be made in respect of it…" 3

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

In other words, it is not necessary to deduct from the acquisition cost of an asset (in working out the capital gain made on it for CGT purposes) any capital allowance: the existence of a capital allowance will not increase the chargeable gain under CGT by decreasing the base cost of the asset. However, this also means that a capital allowance cannot be used so as to create or increase a useful capital gains loss for CGT purposes either - Section 41 TCGA 1992 works both ways.

3. Only "Capital Expenditure" Qualifies - Section 4 CAA 2001 A. Identification of "Capital Expenditure"

Usually taxpayers will prefer expenditure to be classed as revenue so as to be used in calculating taxable profits, thus receiving essentially a 100%
allowable deduction

Capital expenditure is not deductible under either the ITTOIA 2005 or the CTA 2009, and resort must instead be made to the CAA 2001 (XReferences Notes on Deductible Expenses) This is essentially dictated by Section 4 Capital Allowances Act, which states that "capital expenditure" will not include any amount deducted in calculating the profits and gains of the trade (by virtue of ITTOIA or the CTA 2009). Importantly, in addition to the case law considered below as to how to identify capital expenditure, Section 4 CAA 2001also says that not only must the expenditure (from the payer) be capital, but the expenditure must be a capital receipt in the hands of the payee

British Insulated and Helsby Cables v Atherton (Inspector of Taxes)

The facts and decision in this case is set out in the notes on Deductible Expenses.

Viscount Cave

When an expenditure is made, not entirely once and for all but with a view to bringing into existence an asset or advantage for the enduring benefit of the trade, I think that there is a very good reason (in the absence of circumstances leading to the contrary) for treating such an expenditure as properly attributable not to revenue but to capital

Comment

Even where expenditure is not made "once and for all", if it is to secure a permanent advantage or asset for the enduring benefit of the trade, then it will normally indicate capital expenditure The principal difficulty is that many types of expenditure have an enduring effect but not all of them are in the nature of capital; a payment to get rid of an unsatisfactory employee is a revenue expense but one to get rid of a lease is a capital expense 4

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

The distinction is also difficult to draw when considering whether expenditure on an existing asset is repair (revenue) or improvement (capital) Does the expenditure maintain something in present condition or does it alter the very nature of the asset so as to bring about essentially something new?
And to what extent does the replacement of part of an asset constitute capital expenditure?

Rose v Campbell


The taxpayer's business consisted of issuing brochures to branches and decorators in order to sell wallpaper to customers; these books remained at all times the taxpayer's property The taxpayer appealed against assessment to income tax on the basis that they were entitled to investment allowances in respect of expenditure on the brochures on the ground that the books were plant Pennycuick J held that it was necessary to decide if the expenditure was capital, and then as a distinct and separate question, whether it was plant. On the facts it was held that the expenditure in question was not capital expenditure (and nor was it expenditure incurred wholly and exclusively for the purposes of the trade so as to make it revenue deductible).

Pennycuick J


The construction of the word "plant" is a matter of law; in Hinton v Maden
& Ireland the House of Lords established that a trader must establish two distinct matters: (1) is the expenditure capital expenditure, (2) is it plant?
I cannot take it as law that "a finding that the expenditure was not capital is repugnant to the finding that the books are plant" However, if expenditure on a chattel is capital then it is well on its way to being plant

[In answer to (1)] I do not think that the expenditure represented capital expenditure; the life of each brochure is only 2 years and at the end of each period the function of the book is spent - the brochures are scrapped and a new cycle begins

The cost of the books is simply an outlay incurred in selling company papers and is comparable to expenditure on sale catalogues and other advertising material Upon the view which I have expressed as to capital expenditure, the question of whether the books are plant does not arise…

It is well-established that "plant" has a very wide meaning 5

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

As Lindley LJ in Yarmouth v France said;

"It includes whatever apparatus is used for carrying on a business - not his stock-in trade; but all goods and chattels, fixed or movable, living or dead, which he keeps for permanent employment…"

The word "permanent" must be regarded as denoting nothing more than some degree of durability; and it is a question of degree in each case whether something is durable…
One must take into account all the circumstances, including the character, function and life-expectancy of the chattel, and it would not be proper to elaborate in this case…

B. Timing of the Capital Expenditure - Section 5 CAA 2001


An allowance will only be available for a chargeable period if the expenditure has been incurred in that (or a previous) period If the expenditure is incurred in a chargeable period, the allowance will become available in that period even if the purchased capital has not been brought into business in that period The expenditure is incurred as soon as there is an unconditional obligation to pay it However, as an anti-avoidance measure, if the obligation to pay arises earlier than normal commercial usage for that trade will dictate, and the only or main benefit is the bringing forward of capital allowances to an earlier period, the expenditure is treated as occurring on the later date or on which payment must actually be made (Section 5(6) CAA 2001) The case of Van Arkadie (considered below) is a case on the question of timing.

C. Allowance as an Election - Section 3 CAA 2001

It was well-established by case-law, and now codified by statute, that there is no obligation on the taxpayer to claim a capital allowance; instead he must elect to do so. This unlike deductible trading expenses (Cross-Reference notes on Deductible Expenses) which will fall to be deducted from the final corporation or income tax bill automatically. Indeed, the argument of the HMRC in Ellis v Northern Ireland Oil Refinery (below), based on a parity of treatment between the revenue and capital regime, was rejected. Section 3 Capital Allowances Act 2001 now codifies Ellis v NI Oil Refinery.

Section 3 Capital Allowances Act 2001 - Claims for Capital Allowances 6

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

Bachelor of Civil Law

"(1) No allowance is to be made under this Act unless a claim is made for it…" Ellis v BP Oil Northern Ireland Refinery Ltd

The taxpayer companies were assessed to corporation tax by HMRC, with the capital allowances treated akin to a trading expense falling to be deducted automatically. The taxpayers argued that in computing the profits, their incomes were to be reduced only by the capital allowances of which they chose to avail themselves. The Court of Appeal held for the taxpayer: "allowable" and "allowances" within the statute envisaged deductions which might be allowed but need not be taken, and so it was for the taxpayer companies to take as little or as much as the allowance as they were entitled.

Balcombe LJ

Capital allowances are only relevant to the income element of a company's profits; and relief to which the company may be entitled as a result of capital allowances has to be taken into account in calculating its income before that is aggregated with any capital gain The Crown contends that the effect of the legislation is to make a capital allowance a trading expense, which are automatically deductible in computing trading profits (Morgan v Tate & Lyle); as such the effect of making a capital allowance a trading expense is to obviate the need for a claim to the allowance and make it automatically

While a simple argument, I reject it because:

i.

The only change the legislation made was procedural or technical, not substantial

ii.

They continue to be referred to as "allowances"; an allowance carries the connotation that what is allowed should be claimed first, as was and remains the case, with income tax

iii.

The legislation does not refer to capital allowances as trading expenses. All that it does is to provide that capital allowances "be given effect by treating the amount of any allowance as a trading expense"; this seem to mean that capital allowances still need to be claimed for the purposes of corporation tax but that, when claimed, they shall (and this is the mandatory element) be given effect by treating them in a particular manner.

D. Qualifying Capital Expenditure: No Finance

The cases have also established that the capital allowances regime will not give an allowance for money spent on "financing" the purchase of plant and machinery. 7

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