As the UK Finance Bill 2021 grinds its way through Parliament, one group at least has special reason to cheer – the owners of commercial buildings which are leased to tenants. Under a Government amendment filed at the report stage of the Bill, commercial landlords have been brought in from the cold to enjoy the fruits of ‘super deduction’ – the eye-catching capital allowances scheme announced in this year’s Budget by Chancellor Rishi Sunak, which will allow companies to offset 130 percent of capital expenditure against their corporation tax. It also applies to another first year allowance, the 50 percent special rate pool.
The amendment specifically relates to ‘background plant and machinery’ – the embedded assets in a building that help it to function, which includes lifts, heating and ventilation systems, to pick three common examples. The trouble is these were excluded in the first drafting of the Bill, and Steven Bone, a director at professional services firm Gateley Capitus, says: “What this meant is that despite all the great media headlines on Budget Day, only occupiers would be able to claim for all the sorts of normal plant machinery that you’d find in buildings – and landlords wouldn’t.”
Theories as to why landlords were effectively excluded vary from conspiracy to cock-up. Steve Watts, a tax partner specialising in real estate and construction at BDO, says: “We don’t believe that property lessors and landlords were specifically targeted to be excluded from the rules but that they were caught by the general leasing exclusion that applies – it may have arisen simply as a result of a drafting oversight.”
Bone says the direct reason is that the allowances are First Year Allowances which have their own set of esoteric rules which exclude leased assets. Yet it didn’t make logical sense, says Bone: “The Chancellor wanted an investment led recovery, and spend by landlords, presumably, is as good as spend by anybody else?” In any case, he says, HMRC indicated that the exclusion was deliberate, and so it’s fair to assume the subsequent u-turn on this part of the legislation is the result of successful lobbying.
Tim Sarson, a tax partner at KPMG, says: “As things stood, what would be the incentive for me to spend money on fitting out buildings, particularly given the pandemic and the fact that lots of people are refitting buildings for hybrid working? Why do it now, why not wait two years until the tax rate is higher, when I will get higher tax relief? So to me, I think this is just a sensible levelling of the playing field and ensuring that you’re not disincentivising the kind of behaviour that you would want to encourage.”
The benefit of the new allowance will apply to every kind of commercial building where a lease is involved, including offices, retail and other uses, and will mean that the owners will be able to claim tax relief at an effective rate of 24.7 percent. One specific set of beneficiaries, according to Sunil Sharma, head of Capital Allowances at Moore Stephens, are companies that opted for a “propco/opco” structure, where the property assets sit in one company and are leased to an operating entity. “This is a common structure for capital intensive industries such as hotel operators and care home businesses,” says Sharma.
What remains excluded from the new temporary allowances, in spite of the efforts of the Finance and Leasing Association, among others, are leased plant and machinery that are not tied to buildings, especially in sectors such as the construction industry, as well as commercial vehicles. Stephen Haddrill, director general of the FLA, had argued that many companies will be reluctant to make large capital purchases in the wake of the pandemic, and that giving super-deduction and special rate allowances to those leasing equipment would be an effective way to boost economic recovery; but this plea appears to have fallen on deaf ears.
Tim Sarson thinks that would have set a significant precedent. “Capital allowances have always been about capital expenditure,” he points out. To give a super deduction on assets paid for on operating leases would require different legislation. “I can see compelling arguments for why it would be a good idea and a good incentive, but it would be quite a big departure.”
In any case, for landlords who are undertaking or planning fit-outs or construction projects, timing will be an important issue in whether they can claim the temporary allowances. “The rules are that you need to have contracted for this spend after the announcement,” says Sarson. “And I know from talking to companies in the utilities industry, for example, that lots of major capital expenditure is committed years and years ahead of schedule. So the key question will be what counts as the contract?”
This point is also highlighted by Steve Watts. “As the amendment relates to expenditure on background plant and machinery within buildings it is possible that even though capital expenditure may be incurred by companies during the two-year period, this may be under a contract that was entered into prior to March 3 and therefore, only qualifies for capital allowances at the normal rates.”
The extent to which the extension of super-deduction to landlords of leased buildings will provide economic stimulus and help the commercial property sector get back on its feet is hard to quantify. It could even nudge some financial directors to decide they’d rather build and own a commercial unit than lease one, says Sharma.
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But ‘super’? Is Rishi Sunak’s tax break really as generous as it first appeared? Steven Bone says: “By announcing in advance the 25 percent corporation tax rate in a couple of years’ time, the Chancellor essentially made it inevitable that you had to start giving relief at that rate now. Otherwise, companies might think well, we’ll just hold on a couple of years, and then we’ll get relief at 25 percent. It does mean that for these two years, they will get that relief at 25 percent, but they will only be paying tax at 19 percent – so that is definitely positive.”