WHY PROPERTY KNOW-HOW IS A CAPITAL IDEA

Any solicitor dealing with commercial property transactions is now also required to know about many related issues.

Stephen Winter explains why capital allowances is one such areaCapital allowances are a form of tax relief intended to act as an incentive for business to invest in capital equipment, including commercial property.

Whereas depreciation charged to profits is not a tax allowable expense, capital allowances are treated as an expense and therefore reduce taxation.Plant and machinery is probably the most common form of capital allowance for property owners.

While even today the definition of plant remains somewhat imprecise, typical items would include air-conditioning, heating, fire alarms, furniture, carpets, curtains and even sanitary fittings.Property transactionsWhen a property is acquired, any plant and machinery allowances available to the purchaser must be valued in accordance with section 562 of the Capital Allowances Act 2001.

Essentially, this section of the legislation requires the purchase price paid for a property to be apportioned between the land, the non-qualifying building structure, and the qualifying items of plant and machinery fixtures.Similarly, when a property is sold, section 196 (1) of the Act requires the vendor to apportion the sale price to ascertain the value of any plant and machinery disposed of along with the property.So, why should capital allowances concern a solicitor? Virtually every commercial property, regardless of its age, is likely to contain a significant level of plant and machinery fixtures.

Indeed, it is not uncommon for the amount of qualifying expenditure to be a much as 20% of the purchase price paid.As the solicitor is involved in the property transaction from initial enquiry stage, often even before the purchaser's tax adviser is aware a property is being acquired, it is often the actions of this acting solicitor that will determine the level of plant and machinery allowances, if any, a new purchaser will be entitled to claim.

Problem areasThe level of capital allowances available to a purchaser will often be affected by capital allowances claimed by a previous owner.

The purchaser's entitlement to capital allowances is limited to the disposal value of the plant and machinery brought into account by the vendor or an earlier owner of the property who sold the property on or after 24 July 1996.It is not sufficient to make enquiries solely of the vendor to see whether a potential restriction applies.

If the vendor did not make a claim, but acquired the property after July 1996, then the purchaser will need to establish whether the previous owner made a claim that could restrict the purchaser's entitlement.To ensure no restriction applies, this line of enquiry must go back via every previous owner since July 1996 or until the most recent claimant is identified.

The further we move away from July 1996, the more difficult these enquiries are likely to become. Having identified whether a previous claim was made, a potential purchaser still needs to ascertain the extent of any restriction that applies.

By asking a few questions, the purchaser's solicitor is in the ideal position to ascertain the basis of any restriction.

For example, a claim may have been made by the vendor on the initial acquisition of the property, but not on any fixtures within a subsequent refurbishment, or vice versa.Acting for the vendorWhen a property is sold, it is the disposal value of any plant and machinery also sold that determines the level of any allowances that have to be repaid by the vendor to the Inland Revenue.

Therefore, there is a clear incentive on the part of the vendor to minimise the disposal value.

One such method is to insert an apportioned plant and machinery figure within the sale agreement.

However, typically these figures have no basis and go against all revenue guidelines.

But where the vendor has made a capital allowances claim, section 198 of the Act allows the vendor and purchaser jointly to elect a disposal value, irrespective of whether the purchaser is entitled or intends to make a claim.

If the rules are followed correctly, the election is also binding on the Inland Revenue.

The election, which is irrevocable, must be made within two years of the sale.

Again, solicitors acting on behalf of vendors are ideally placed to enquire whether a section 198 election is necessary.

If the vendor has claimed capital allowances but the contract does not require an election to be made, the vendor may well have to repay all past allowances claimed.Acting for the purchaserAt pre-contract enquiry stage, an acting solicitor is in the ideal position to establish any disposal value the vendor may be proposing.

Purchasers should certainly be wary of vendors who suggest inserting plant and machinery values within the purchase contract.

Not only is such a figure likely to be in the vendor's best interests, but once the purchaser agrees to a figure, he could be in breach of contract should he then attempt to challenge it.Even if the vendor has not made a claim for plant and machinery allowances when he disposes of the property, the legislation still allows him two financial years to make a retrospective claim.

To protect the purchaser's interest, it is advisable for his solicitor to insert in the sale agreement a warranty from the vendor agreeing not to make a retrospective claim.So, what are the risks? Sellers and purchasers of property rely on their solicitors to advise them of the contractual implications of entering into a property transaction.

This advice should extend to the tax considerations of the proposed agreement and therefore should include capital allowances.Where a solicitor does not provide advice on capital allowances, the client could subsequently incur significant loss, which could have been avoided, had the issues been addressed at the contract stage.

In some cases, the potential loss to an uninformed seller or purchaser could run into millions of pounds.

It is possible that the client, in such circumstances, would seek redress from his legal adviser.Here are some examples of the risks facing conveyancing solicitors.

The seller suffers significant monetary loss because: l The contract is silent on capital allowances;l The contract includes a clause on capital allowances that is ineffectual;l The sale triggers an unexpected disposal value;l The grant of option triggers an unexpected disposal value, and;l The value of capital allowances is not realised.The purchaser suffers significant monetary loss because: l The contract does not provide for a reasonable level of capital allowances;l The existence of previous election is not considered;l The purchaser is unaware that no capital allowances attach to the interest acquired;l The vendor has made an inter-group transfer before sale, and;l The value of capital allowances is not realised.That list is by no means comprehensive, and every conveyance could have unique capital allowances implications.While capital allowances on commercial property is a complex area, it is an area about which clients expect their solicitors to have a basic knowledge.

Indeed, the acting solicitor is the only professional adviser who is ideally placed to ensure that the client addresses all the relevant issues prior to any property transaction.Stephen Winter is a partner at London-based capital allowances specialists NBW Crosher & James