Steven Bone (The Capital Allowances Partnership Ltd) answers a reader query.
A company is carrying out a major fit-out to new office premises which it plans to occupy in the following year and has obtained a final quote from its builders in respect of the fit-out project. As at the year end, it has incurred fairly significant preliminary and professional fees (such as project management fees, architects and surveyor fees) in respect of the project, although the fit-out itself will not commence until the new year.
In the JD Wetherspoon tax case, HMRC has accepted that preliminary and professional fees may be apportioned between qualifying and non-qualifying expenditure on a reasonable basis for the purpose of a capital allowances claim. Accordingly, we have analysed the capital expenditure quoted between qualifying and non-qualifying expenditure and have used the ratios derived therefrom to attribute qualifying expenditure incurred on the professional fees.
The question is: can capital allowances be claimed on the professional fees in the current year, even before the fit-out project is completed?
As the company is carrying out a qualifying trade and the professional fees have been incurred and paid by the year end, the first two conditions for claiming capital allowances have been satisfied. The issue is whether the third condition - which requires that the asset must belong the person who incurred the expenditure - has also been satisfied?
Or will capital allowances be denied on the ground that 'the underlying asset (the asset created by the project) does not yet belong' to the company (since the project has not been completed). Will it make a difference if the project has not yet commenced at the date when the capital allowances claim is submitted?
The questioner is right to be concerned about an absence of ownership in the first year of the project.
Of all the criteria to be met in order to claim plant and machinery (P&M) allowances, the ownership requirement is the one which is most often overlooked. To put the question in context, let us start by summarising the rules that entitle a business to claim allowances. (All statutory references are to CAA 2001.)
The general rule, set out in s 11, is that a person must carry on a ‘qualifying activity’ (defined by s 15 and including a trade) and must incur ‘qualifying expenditure’.
‘Qualifying expenditure’ is capital expenditure on the provision of P&M wholly or partly for the purposes of that qualifying activity. It was held in Ben-Odeco Ltd v Powlson (1978) 52 TC 459 that the words ‘on the provision of’ include costs such as transport and installation, as long as they are not too remote in purpose. So it is permissible to treat associated costs, such as professional fees and a contractor’s preliminaries, as part of the cost of the P&M in question.
However, there is a second part to the definition of qualifying expenditure, which is that the person incurring the expenditure owns the P&M as a result. Furthermore, s 58(4) provides that qualifying expenditure cannot be allocated to a capital allowances pool for a chargeable period unless the person owns the P&M at some time in that period.
Ownership is therefore critical.
When the P&M will become owned by the taxpayer depends on the terms of the particular construction contract used. However, under the most widely used standard forms of construction contract, the client becomes the owner of assets either when the asset is incorporated into the permanent works (i.e. installed in the building) or when it has been paid for. The second may apply to ‘materials on-site’ not yet incorporated into the works. This is certainly the case under most contracts used for major office fit-outs. These are the Joint Contracts Tribunal (JCT) or New Engineering Contract (NEC) suites of contracts.
If the actual fitting out works have not started in the first year, then the client will not own any P&M in that year because none has been incorporated into the permanent works or paid for. The only (albeit remote) possibility is that the client might own some P&M if it has paid for ‘materials on-site’ or ‘materials off-site’ (the latter generally being particularly costly, or key, assets which it is prudent to reserve to protect the construction programme). Payments for materials off-site are unlikely for an office fit out project such as this.
Some readers may recall that s 67 contains ‘hire purchase’ provisions which deem ownership if expenditure is incurred under a contract providing that a person ‘shall or may become the owner of P&M on the performance of the contract’. However, this would not apply in the present case because s 69 provides that that s 67 does not apply to fixtures.
So, the client will need to wait until the second period when P&M is actually installed, or paid for, before it may pool qualifying expenditure and claim allowances.
In the second period (and later periods if the project spans additional years), it is normal practice to pro-rata apportion the expenditure on preliminaries and fees. The client may, in effect, apportion the relevant first year’s expenditure on those costs as part of the cost of the P&M installed in the second period. This was endorsed in JD Wetherspoon plc v HMRC [2012] UKUT 42 (TCC). In that case, the Upper Tribunal (which establishes binding legal authority) ruled that an apportionment was a reasonable, common-sense and sensible solution.
There are a couple of matters to be careful of though.
First, not all professional fees may be apportioned. It is normal practice to apportion architect’s and quantity surveyor’s fees. Additionally, in Wetherspoon it was accepted that the fees of a building control officer attending the site to check compliance with building regulations was a general overhead to be apportioned equally, and the structural engineer’s fees should be proportionally allocated to those items of expenditure that related to the alterations and amendments to the existing building.
Second, HMRC appears somewhat reluctant to acknowledge the Upper Tribunal’s binding ruling, instead placing reliance on the First-tier Tribunal (FTT), which is merely persuasive, and subject to the Upper Tribunal’s decision. The FTT concluded that a global apportionment would normally be appropriate, but commentated that it might not be legitimate in all cases and suggested that HMRC was entitled to investigate figures on a case-by-case basis to see whether a more specific basis would be appropriate and proportionate. As a result, regrettably because this ignores the binding legal precedent of a higher court, HMRC reserves the right only to accept apportionments in a limited fashion. HMRC’s Capital Allowances Manual (at CA20070) of stipulates that:
‘For most small construction projects the use of the pro rata approach will generally be acceptable ... In larger construction projects there will often be other capital allowances aspects that need to be enquired into and it may be that one aspect of a wider review of the capital allowance claim will be the treatment of professional fees and preliminaries.’ (emphasis added in italics)
Inexplicably, HMRC’s definitions of ‘smaller’ and ‘larger’ have been withheld because of exemptions in the Freedom of Information Act 2000. But it is understood that HMRC may regard a smaller project as one which is relatively modest in scale (perhaps about £100,000 in London or £50,000 elsewhere). Regrettably, experience has shown that HMRC does still routinely dispute an apportionment of preliminaries and professional fees projects. So it cannot be guaranteed in practice that it will always accept the Upper Tribunal’s ‘unhesitating’ ruling. As ever, advisers should be aware of the law, and not rely on guidance in HMRC’s manuals.
Steven Bone (The Capital Allowances Partnership Ltd) answers a reader query.
A company is carrying out a major fit-out to new office premises which it plans to occupy in the following year and has obtained a final quote from its builders in respect of the fit-out project. As at the year end, it has incurred fairly significant preliminary and professional fees (such as project management fees, architects and surveyor fees) in respect of the project, although the fit-out itself will not commence until the new year.
In the JD Wetherspoon tax case, HMRC has accepted that preliminary and professional fees may be apportioned between qualifying and non-qualifying expenditure on a reasonable basis for the purpose of a capital allowances claim. Accordingly, we have analysed the capital expenditure quoted between qualifying and non-qualifying expenditure and have used the ratios derived therefrom to attribute qualifying expenditure incurred on the professional fees.
The question is: can capital allowances be claimed on the professional fees in the current year, even before the fit-out project is completed?
As the company is carrying out a qualifying trade and the professional fees have been incurred and paid by the year end, the first two conditions for claiming capital allowances have been satisfied. The issue is whether the third condition - which requires that the asset must belong the person who incurred the expenditure - has also been satisfied?
Or will capital allowances be denied on the ground that 'the underlying asset (the asset created by the project) does not yet belong' to the company (since the project has not been completed). Will it make a difference if the project has not yet commenced at the date when the capital allowances claim is submitted?
The questioner is right to be concerned about an absence of ownership in the first year of the project.
Of all the criteria to be met in order to claim plant and machinery (P&M) allowances, the ownership requirement is the one which is most often overlooked. To put the question in context, let us start by summarising the rules that entitle a business to claim allowances. (All statutory references are to CAA 2001.)
The general rule, set out in s 11, is that a person must carry on a ‘qualifying activity’ (defined by s 15 and including a trade) and must incur ‘qualifying expenditure’.
‘Qualifying expenditure’ is capital expenditure on the provision of P&M wholly or partly for the purposes of that qualifying activity. It was held in Ben-Odeco Ltd v Powlson (1978) 52 TC 459 that the words ‘on the provision of’ include costs such as transport and installation, as long as they are not too remote in purpose. So it is permissible to treat associated costs, such as professional fees and a contractor’s preliminaries, as part of the cost of the P&M in question.
However, there is a second part to the definition of qualifying expenditure, which is that the person incurring the expenditure owns the P&M as a result. Furthermore, s 58(4) provides that qualifying expenditure cannot be allocated to a capital allowances pool for a chargeable period unless the person owns the P&M at some time in that period.
Ownership is therefore critical.
When the P&M will become owned by the taxpayer depends on the terms of the particular construction contract used. However, under the most widely used standard forms of construction contract, the client becomes the owner of assets either when the asset is incorporated into the permanent works (i.e. installed in the building) or when it has been paid for. The second may apply to ‘materials on-site’ not yet incorporated into the works. This is certainly the case under most contracts used for major office fit-outs. These are the Joint Contracts Tribunal (JCT) or New Engineering Contract (NEC) suites of contracts.
If the actual fitting out works have not started in the first year, then the client will not own any P&M in that year because none has been incorporated into the permanent works or paid for. The only (albeit remote) possibility is that the client might own some P&M if it has paid for ‘materials on-site’ or ‘materials off-site’ (the latter generally being particularly costly, or key, assets which it is prudent to reserve to protect the construction programme). Payments for materials off-site are unlikely for an office fit out project such as this.
Some readers may recall that s 67 contains ‘hire purchase’ provisions which deem ownership if expenditure is incurred under a contract providing that a person ‘shall or may become the owner of P&M on the performance of the contract’. However, this would not apply in the present case because s 69 provides that that s 67 does not apply to fixtures.
So, the client will need to wait until the second period when P&M is actually installed, or paid for, before it may pool qualifying expenditure and claim allowances.
In the second period (and later periods if the project spans additional years), it is normal practice to pro-rata apportion the expenditure on preliminaries and fees. The client may, in effect, apportion the relevant first year’s expenditure on those costs as part of the cost of the P&M installed in the second period. This was endorsed in JD Wetherspoon plc v HMRC [2012] UKUT 42 (TCC). In that case, the Upper Tribunal (which establishes binding legal authority) ruled that an apportionment was a reasonable, common-sense and sensible solution.
There are a couple of matters to be careful of though.
First, not all professional fees may be apportioned. It is normal practice to apportion architect’s and quantity surveyor’s fees. Additionally, in Wetherspoon it was accepted that the fees of a building control officer attending the site to check compliance with building regulations was a general overhead to be apportioned equally, and the structural engineer’s fees should be proportionally allocated to those items of expenditure that related to the alterations and amendments to the existing building.
Second, HMRC appears somewhat reluctant to acknowledge the Upper Tribunal’s binding ruling, instead placing reliance on the First-tier Tribunal (FTT), which is merely persuasive, and subject to the Upper Tribunal’s decision. The FTT concluded that a global apportionment would normally be appropriate, but commentated that it might not be legitimate in all cases and suggested that HMRC was entitled to investigate figures on a case-by-case basis to see whether a more specific basis would be appropriate and proportionate. As a result, regrettably because this ignores the binding legal precedent of a higher court, HMRC reserves the right only to accept apportionments in a limited fashion. HMRC’s Capital Allowances Manual (at CA20070) of stipulates that:
‘For most small construction projects the use of the pro rata approach will generally be acceptable ... In larger construction projects there will often be other capital allowances aspects that need to be enquired into and it may be that one aspect of a wider review of the capital allowance claim will be the treatment of professional fees and preliminaries.’ (emphasis added in italics)
Inexplicably, HMRC’s definitions of ‘smaller’ and ‘larger’ have been withheld because of exemptions in the Freedom of Information Act 2000. But it is understood that HMRC may regard a smaller project as one which is relatively modest in scale (perhaps about £100,000 in London or £50,000 elsewhere). Regrettably, experience has shown that HMRC does still routinely dispute an apportionment of preliminaries and professional fees projects. So it cannot be guaranteed in practice that it will always accept the Upper Tribunal’s ‘unhesitating’ ruling. As ever, advisers should be aware of the law, and not rely on guidance in HMRC’s manuals.
