Industrial Allowances

Industrial Allowances

Decontaminate And Be Damned

KEVIN SLEVIN finds that the relief for contaminated land does not do exactly what it says on the tin.

THIS ARTICLE IS about a really good tax break for companies; a measure full of potential to help change the face of our towns and cities. Indeed, it also applies to qualifying expenditure incurred in the countryside. There are, however, problems with the measure, not least being that it does not quite do 'what it says on the tin'.

Readers who do not usually advise companies should not stop reading at this point. This tax break is almost revolutionary in its effect and it is therefore important that all those involved in tax should be aware of its availability. Indeed, it is not an exaggeration to say that such can be its value, it might well be worth incorporating a business to take advantage of this tax break. Why, though, should this tax break not apply to unincorporated businesses in any event? Read on and perhaps you will be encouraged to start a campaign to extend the law.

As seems to be the case with most tax breaks, nothing is simple. It is not that complicated, but it certainly is not simple. The many pages of detailed legislation are set out in FA 2001, Sch 22. The number of tax professionals who are not familiar with this relief is probably due to the fact that the label on the tin is, to say the least, misleading. More importantly, anyone opening the tin may find the contents do not spread as far as they had hoped. Thoughtlessness on the part of the draftsman has led to a misunderstanding or, in some cases, no understanding whatsoever.

What does the tin say?

The reason why this tax break does not feature more highly on the list of topics to discuss with company clients is that the legislation effectively disguises its potential impact by using what can best be described as a code word, which seemingly only a limited number of people crack. The tax break in question relates to 'buildings', but the word used in the legislation for buildings is 'land'.

The draftsman proceeded on the basis that if he used the word 'land', any reader of the legislation would have the decoding device to hand. It is found in the Interpretation Act 1978, because the definition of land found in Sch 22 para 31 is far from enlightening. All that subparagraph (1) states is that 'land' means any estate, interest or rights in or over land. However, the Interpretation Act 1978 states that in any Act, unless the contrary intention appears, words and expressions are to be construed according to Sch 1 thereof. Sch 1 states:

Despite the legislation in question being structured in accordance with the modern day tax law rewrite style, the draftsman chose not to refer to 'land or buildings'. Instead, he labelled the relief as though it only relates to land. Could it be that it was thought that the use of the phrase 'land or buildings' might create too much interest and lead to a drain on the Exchequer? All kinds of companies might claim to take advantage of the legislation if they could tell at a glance it related to their situation. Who knows, there might have been such a surge in the level of incorporations to exploit the potential for this tax break, if it were fully understood. Indeed, if recent events relating to small companies and the nil rate of corporation tax are anything to go by, a surge in claims following this article might result in the Chancellor having to clamp down on those who are eligible. On reflection, maybe it was a good idea to keep most taxpayers in the dark as to their entitlement with a view to reducing the likelihood of its sudden repeal.

Getting back to the first point of this article, is it not time that tax legislation was always drafted so that reference to the Interpretation Act 1978 would not be necessary? It would still be available as a safety net, just in case the draftsman made a mistake but, apart from this fallback role, surely we should not have a need built into the legislation drafted under the tax law rewrite style for automatic reference to the Interpretation Act. 'Crazy' is the word that springs to mind. For the avoidance of doubt, 'land' does not always include 'buildings' for taxation purposes. For example, TCGA 1992, s 152 rollover relief provisions treat land and buildings as a separate asset (but that is perhaps a separate story).

The second issue is trickier to deal with. To say the legislation does not work is an overstatement, but to say that it fails to provide the intended relief in a large number of instances is by no means an exaggeration. Sadly, I believe the legislation to be fundamentally flawed, or perhaps I should say contaminated. In effect, this measure positively discriminates in favour of certain activities.

Experience suggests that wherever positive discrimination is pursued as a policy, it means that negative discrimination lurks close by in the shadows. Before we look at the discrimination, let us look at one aspect of the tax break in question.

What tax break?

Where all the necessary conditions are met, an eligible company is given statutory authority to make fictional entries on its self-assessment return. In short, a claimant company having incurred a particular type of capital expenditure (see below) can:

There are all sorts of conditions, but think about this brief summary for a moment. It is quite incredible. I have got former clients who have served time in jail as a result of having been found guilty of adopting this approach well before FA 2001 was introduced. Are they now to be viewed as having to pay the price that history repeatedly shows far-sighted individuals have to pay for being ahead of their time?

In summary, Sch 22 allows wondrous things to happen but only if the conditions are met and the correct expenditure is incurred. Neil Beaumont, in his article 'Our Green and Pleasant Land', see Taxation, 25 September 2003 at page 694, highlighted the detailed provisions of this tax break and, therefore, I will not comment in any detail thereon in this article, other than to say the focus of Neil's article was remedial expenditure on contaminated land and buildings, whereas this article focuses solely on remedial work to buildings or structures.

What discrimination?

We have a system, the upshot of which is that Company A may incur identical expenditure to Company B, but the tax break is only available to one of them. The outcome depends on the activities to be carried on in the buildings that companies have acquired. Does the list of excluded activities include the usual 'suspects' such as farming companies, property development companies, bankers and other financial companies? The answer is 'no', as all such companies can claim the tax break in question if they comply with the conditions thereof, even though their activities are 'excluded activities' for the purposes of the various enterprise measures such as the enterprise investment scheme, venture capital trusts, the enterprise management initiative and the corporate venturing relief for companies.

Which then are the companies that are discriminated against? The answer is that any company which acquires a building for use in a manufacturing or processing activity is prevented from enjoying this tax break. To be a little more precise, any industrial activity described as a 'qualifying trade' in CAA 2001, s 274 will debar the company from enjoying this particular tax break, although there are rules for mixed-use buildings. Thanks to the special extension of industrial buildings allowance to accommodate the hotel industry, buildings such as old office blocks acquired for conversion to a hotel will normally be excluded.

So what is all the fuss about?

The Urban Task Force recommended that the Government introduce a tax break for remedial costs to encourage regeneration of cities and major towns.

The Government's response is to be found in FA 2001, Sch 22. In essence, where a company incurs capital expenditure on a building (and yes, the tax break extends to expenditure on any land or any estate or interest or right in or over land as stated in Sch 22 para 31 but the focus here is on buildings) and the building is to be used for a purpose qualifying under the industrial buildings allowances régime (either by the acquiring company or by a tenant thereof) so that the expenditure will result in an entitlement to the four per cent industrial buildings writing-down allowance, the tax break designed to subsidise the contamination expenditure will not apply.

The reason for this is to be found in Sch 22 para 1(4). It excludes capital expenditure in respect of which an allowance has been, or may be, made under the enactments relating to capital allowances. Who would argue that an entitlement to industrial buildings allowances does not fall within this exclusion? Presumably no-one would.

The following Example demonstrates the position.

Example

XYZ (2006) Limited acquires a building and immediately spends £200,000 paying contractors to remove asbestos and other substances capable of causing harm. It intends to use the building to manufacture components used to make the latest robots which it sells throughout the world. Here, the only available claim relating to this capital expenditure will be the industrial buildings writing-down allowance at the annual flat rate of four per cent.

There being a lot a demand for the company's product, XYZ (2006) Limited is a highly profitable company paying tax at 30% and, as a result, its tax bill will be reduced under the industrial buildings allowances régime by £2,400 for each year for 25 years (four per cent of £200,000 = £8,000 @ 30% = £2,400). Note that this amounts to 1.2% of the capital outlay.

Had XYZ (2006) Limited not used the building for a manufacturing process but, instead, leased it for use by the proprietor of an amusement arcade or, indeed, used it for other activities not attracting industrial buildings allowances, the tax break available to the company for the accounting period in which the £200,000 expenditure was incurred would amount to £90,000 as follows:

Capital expenditure £200,000

Capital expenditure deemed to be

Revenue expenditure (Sch 22) £300,000

Consequent reduction in corporation

tax @ 30% £90,000

In effect, therefore, the cost of remedial work (£200,000) is reduced by a tax subsidy of £90,000, i.e. 45%, in this scenario compared to a reduction £2,400, i.e. 1.2%, under the industrial buildings allowance régime. The latter does, though, recur for a total of 25 years.

The comparison set out in the above example is brutally crude but commercial life is just that. How many companies would not opt for an immediate subsidy of 45% for the accounting period in which the expenditure was incurred rather than an annual entitlement to a tax break equal to 1.2% of the expenditure? Yes, it is true that industrial buildings allowances cease to be clawed back after 25 years whereas any relief given under Sch 22 will ultimately be clawed back if the building is sold at any time. The enhancement expenditure allowable under Sch 22 is not also allowable for capital gains tax purposes when the building is ultimately disposed of. Most companies would regard sacrificing the industrial buildings allowance as a small price to pay for gaining an immediate subsidy of, say, 45%. Companies falling into the 32.75% marginal rate of corporation will enjoy an even larger subsidy, up to a maximum of 49.125%.

Expressed in terms of an immediate 'capitalised value', the 25 years worth of writing down allowances at the rate of £8,000 a year (with the assumed consequent tax saving of £2,400 a year), these allowances are worth in the region of £30,000. Compare this to an extra £90,000 cash in the bank. Which would you choose if you had a choice?!

Change the law

The change required in the law is simple. The taxpayer should be given the option of either claiming industrial buildings allowance or claiming relief under Sch 22 when both potentially can apply. Sch 22 para 1(4) which prevents capital expenditure from qualifying where an allowance has been, or may be, made under the enactments relating to capital allowances should be capable of being overridden by an election in the case of expenditure on industrial buildings. One of the advantages of this self-assessment system is that such choices are left to the taxpayer and create little or no administrative burden for the Revenue. The taxpayer company will have a lot to consider before making an election to sacrifice the industrial buildings allowances, not least of which will be the likely period of ownership, given the ability to dispose of a lesser interest in an industrial building without triggering a balancing charge.

However, what I am suggesting is that companies should have a choice. Unless the Chancellor wishes to discriminate against the industrial sector of the British economy, this provision should be revised, and revised soon.

Kevin Slevin CTA (Fellow), ATT, TEP is a tax partner with the Bristol based chartered accountants Solomon Hare LLP. He can be contacted on 0117 933 3147; e-mail: kevin_slevin@solomonhare.co.uk.

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