Navigating capital allowances in commercial property transactions

UK businesses cannot claim tax deductions for depreciation of their capital assets but they can deduct capital allowances. Our previous article here provided a brief introduction to capital allowances. This article highlights some specific considerations for commercial property owners when dealing with capital allowances in a commercial property context. 

Plant and machinery allowances

Owners of commercial property may have claimed plant and machinery allowances on "fixtures" within their property. Fixtures are typically items that are installed in a building which then become part of that building, such as air conditioning and lighting. When the building is sold, seller and buyer can apportion part of a purchase price to those ‘fixtures’, sometimes referred to as making a capital allowances election or a section 198/199 election. The effect of not making the election is often that the capital allowances will be lost, and it is therefore in both the sellers’ and buyer’s interest to make an election. Where one is made the seller should not suffer a clawback of any allowances claimed on the fixtures and the buyer should then be able to claim allowances on the fixtures during their period of ownership.

In order for this treatment to be available the seller must have "pooled" the assets in question ie the assets must have been allocated to the main or special rate pool or a first-year allowance must have been claimed in relation to all or part of the expenditure. The parties must then meet the ‘fixed value’ requirement which requires the parties to apportion the purchase price between the property itself and that for the fixtures. This must generally be done using a section 198 or a 199 election (depending on whether the land is freehold or leasehold); simply agreeing an apportionment in the contract is not binding on HMRC. Where the parties cannot agree it is also possible to obtain a tribunal determination on the apportionment, though this is a more time-consuming and costly process.

Issues with capital allowances elections

Although agreeing an apportionment using an election has become common place in commercial property transactions there are some tricky points that are easily missed. In particular the parties should consider:

1. Value of the election: The amount included in the section 198 election is the amount that the seller is required to bring into account as the disposal value of the fixtures. This amount can be anything from £1 to the cost that the seller originally incurred on the fixtures. The lower this amount, the more beneficial the position is for the seller as this allows the seller to continue to claim allowances on the expenditure in question and restricts the amount of any future buyer’s qualifying expenditure. The parties should therefore carefully consider the value of any allowances in their respective bargaining positions as this may influence the price that can be achieved on the sale.
2. Tax exempt parties: If a seller is not within the charge to tax (such as a charity) they cannot enter into a capital allowances election. It might therefore be assumed that purchases from an exempt entity will never include capital allowances. Although this is often the case, provided a prior owner meets the pooling and fixed value requirements, it is possible that the allowances have been preserved to be passed on to a future buyer. Enquiries should therefore be made of a seller to determine the capital allowance position on the seller’s own purchase including whether an election was made at that time. By the same token, purchasers not within the charge to tax should establish their vendor’s capital allowances position and consider whether to enter into a capital allowances election to preserve any available allowances and increase the value of the property on a future sale.
3. Timeframe: Elections can be made no later than two years after a purchase has taken place. This is of course problematic if the parties neglected to consider the capital allowances position when the property was being sold. However, this time limit can be helpful on a quick sale where the capital allowances position is unclear or merits further investigation. This should be borne in mind where commercial factors do not allow sufficient time to investigate the capital allowances position on a transaction as the parties may agree to investigate the position after the sale has completed.

Final thoughts

Given the potential value of allowances and their influence on pricing a transaction, advisers and property owners alike should consider the capital allowances position as early as possible and ideally prior to entering into heads of terms. The agreement between the parties should be reflected in the sales contract, and the elections completed accurately to avoid an invalid election prejudicing the tax position. Where the position on allowances is complex or high value, specialist advice should be sought.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, January 2025