Simplification of the computations. This CIOT paper identifies areas of unnecessary complexity in IBA computations and suggests an alternative simpler basis for IBAs. It was submitted to HM Treasury, the Inland Revenue and representatives of the three main political parties on 15 October 2001. We have argued elsewhere for capital allowances to be given on all commercial buildings. The present paper assumes that allowances continue to be given for industrial buildings only (including qualifying hotels and sports pavilions) and deals with computational problems.
The computation of IBAs
At present, it is necessary to compute IBAs separately for each item of qualifying expenditure - or at least for the expenditure incurred on each industrial building in each accounting period. This can lead to enormously detailed computations in cases where a company has many industrial buildings and incurs expenditure on extensions and alterations from time to time.
On the purchase of a building second-hand, the purchaser has to ascertain the history of qualifying expenditure on the building and the residue of each item after the sale to him/her. This can present considerable practical difficulties.
These complications are largely a consequence of the straight line basis on which qualifying expenditure is written off under the IBA rules.
There is the further complication that the purchaser’s qualifying expenditure cannot exceed the original qualifying expenditure on construction, alteration, etc. It is appreciated that the vendor’s balancing charge on sale cannot exceed the allowances given, but the balance of the sale proceeds gives rise to a capital gain, subject to rollover relief.
A pooling basis for IBAs
The IBA computations would be simplified considerably if, as a first step, all expenditure on one and the same building was pooled and the whole of the purchase price of a second-hand building (excluding any amount attributable to the value of the land on which it stands) qualified for IBAs.
If the expenditure on a particular building is to be pooled, then it seems inevitable that the reducing balance basis will have to apply. It then becomes necessary to determine the appropriate rate of writing down allowances. This can be chosen so as to preserve:
· the current 25 year writing off period, which implies a rate of approximately 10%; or
· the same net present value of the present 4% straight line allowances, which implies a rate of approximately 6%, which is the rate applicable to long life assets under the plant and machinery rules.
It is suggested that industrial buildings should be dealt with on the same basis as long life assets. In the case of a building occupied by the person claiming allowances for the purposes of a trade, the computations could be simplified further by including expenditure on the building in the long life assets pool relating to that trade.
The change to a reducing balance basis would, however, mean that allowances on a second hand building acquired within the present 25 year period would be given at the same rate as applies for expenditure on the construction of a new building. Also, balancing charges, and corresponding allowances to a purchaser, could arise after the end of the present 25 year period.
An essential quid pro quo would be that the purchaser’s qualifying expenditure would not be restricted to the original qualifying expenditure on construction etc.
Thus, the sale and purchase of a second hand building between unconnected third parties would follow the present treatment of machinery and plant:
· the vendor would bring the disposal value of the building (see below) into his/her capital allowances computation;
· the purchaser would get allowances on the price paid, excluding the land element, even if greater than the original construction cost.
These differences between the proposed reducing balance basis and the present straight line basis would no doubt be reflected in the purchase price.
Ascertaining the purchase price of a second hand building
In practice, there is usually one price for the land and the building standing upon it. This has to be apportioned for tax purposes between land and building. A similar problem arises in relation to fixtures. The general rule is that the apportionment is to be made on a just and reasonable basis even if the contract specifies an apportionment, since the land and the building will be acquired together as “one bargain” (s562 CAA 2001). The apportionment must be the same for both purchaser and vendor. In the event of a disagreement, the matter can be referred to the Commissioners (ss563, 564 CAA 2001).
The parties may determine, by joint election, the amount apportioned to fixtures (s198 CAA 2001), but that amount must not exceed the vendor’s qualifying expenditure (s198(3)(a)). It is for consideration whether the vendor’s disposal value for an industrial building should continue to be effectively restricted under s320 CAA 2001 where it exceeds his qualifying expenditure. The same question arises in relation to fixtures, and if there was no restriction of the disposal value under s62 CAA 2001, the restriction under s198(3)(a) would not be required.
We suggest that the parties should be able to make an election determining the amount to be apportioned to an industrial building and that this amount should not be restricted in the way it is for fixtures. Given the right to make such an election, the parties would, in practice, be able to ensure that the vendor’s disposal value does not exceed his/her qualifying expenditure if that was thought appropriate. The requirement to make an election, and the agreed value, could be specified in the purchase and sale contract and would apply without restriction. Where necessary, the purchase consideration as a whole could be adjusted accordingly.
The amounts determined under both elections could be subject to the just and reasonable requirement.
In the case of a trading concern, the tax computations should follow the accounts. Where the building is occupied by the purchaser for the purposes of its trade, the amount relating to the building will be depreciated in the accounts. This is the amount which ought to qualify for IBAs, without restriction to the vendor’s qualifying expenditure. In the case of an investment property, however, depreciation will not normally be written off in the accounts.
In cases where the Revenue do not accept the accounting treatment, and in the case of investment properties, the matter will, where necessary, have to be referred to the District Valuer. It is hoped that the number of references to the District Valuer would be kept to a minimum.
Periods of non-qualifying use
In the case of an investment building, the combined effect of ss309(1)(c) and 336 CAA 2001 would mean that a writing down allowance would have to be computed, but it would not actually be given in the Schedule A computation. It would affect the written down value carried forward to the next period. A permanent note of the allowances computed but not given would have to be kept in order to compute any balancing charge arising on a subsequent sale of the building. However, it would not affect the purchaser’s entitlement to IBAs. These complications would not arise if all commercial buildings qualified for capital allowances.
A simpler alternative would be simply not to compute allowances for the period of non-qualifying use. This would mean that allowances covering the whole of the qualifying expenditure might eventually be given despite the period of non-qualifying use, but only if the building was in qualifying use at some future time.
Where a building which has been occupied for the purposes of a trade is let, the following rules should apply:
1. If the building remains an industrial building and the trade continues, capital allowances should be given as though no change had occurred, but the taxpayer should have the option of including the Schedule A profits from the letting in the profits from the trade;
2. If the building remains an industrial building but the trade ceases, then the market value of the building should be brought into the capital allowances computation for the trade and that same value should be used for subsequent Schedule A computations;
3. If the building ceases to be an industrial building, then the market value of the building should be brought into the capital allowances computation for the trade.
Where an industrial building ceases to be an industrial building but continues to be occupied for the purposes of the same trade - eg by reason of being converted into office accommodation - there should be no adjustments to the capital allowances computation. Indeed, we think that if it is not possible to extend IBAs to all commercial buildings, then at least all commercial buildings occupied for the purposes of a qualifying trade (as defined in s274 CAA 2001), should qualify. The management of a trade is at least as important as the carrying on of the physical activities of that trade. If certain trades are to be favoured, then all commercial buildings occupied for the purposes of those trades should qualify for IBAs. The provisions of s283 CAA 2001 would then become obsolete.
Relevant interests, leases, etc
The existing rules would remain, including those relating to the realisation of capital value (ss327 - 331 CAA 2001).
Qualifying hotels and sports pavilions
We envisage that they would be dealt with on the same basis as industrial buildings.
It is suggested that the new rules should apply to buildings constructed or acquired on or after the start date, with existing buildings being left on the old basis. However, there should be an election to bring the written down value of an existing building into the new system. It is for consideration whether the election should be on a building by building basis or whether only one election should be available for all buildings held by the taxpayer or the group of which a taxpayer company is a member.
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