But beyond that all premises, from time to time, need ongoing repairs and maintenance which clearly comes at a cost.
Tax should never be the driver behind any commercial decision. However, that does not mean businesses cannot use the tax system to lower the impact of costs that were going to be spent anyway.
This makes it particularly important to understand the tax implications of spending because the law makes very clear distinctions between ‘improvements,’ ‘alterations’ and ‘renovations’ in terms of how claims for relief are treated by HMRC.
For David Wright, a technical officer at the Association of Taxation Technicians, the pivotal question for tax is whether money spent on the premises is revenue or capital expenditure. As he outlines: “The costs of ongoing repairs and maintenance will normally be revenue, meaning they’re fully deductible in the period incurred, and the business benefits from tax relief relatively quickly.
“In contrast, if you build, extend, or make improvements to your premises, the money spent is classed as capital expenditure.” This means, as he explains, that unless you can claim capital allowances, no tax relief is available upfront for capital expenditure; you’ll also have to wait until you sell the premises to get tax relief for the costs of any additions or improvements.
To this Tim Beresford, director of capital allowance specialists, The CA4 Partnership, explains that if an item is treated as a repair, and is expensed through the company’s P&L account, then “it must be claimed as an expense in the year of expenditure rather than a future year”.
And to illustrate just how complex tax law can be, and that when it comes to property the lines can get blurred, he gives an example: replacing a boiler which is part of a larger heating system. “The boiler,” he says, “is just one part of the larger heating system and so would be considered a repair of that larger asset.”
He says that a distinction is drawn based on whether something is repaired, or whether there is an improvement or alteration to the asset or larger asset, the whole heating system in this example. So although the whole boiler is being replaced, the work would be considered a repair since the boiler forms part of a larger system.
Revenue or capital?
In principle, Wright says that the distinction between revenue and capital expenditure should be simple: work done to return premises to the condition they were in at acquisition is revenue while expenditure on enhancing them beyond that is capital.
And Beresford agrees. He comments that “a repair is a like for like repair but allowing for modern day equivalent – such as replacing single-glazed windows with double-glazed units.” But he differentiates a repair from an improvement as being where a firm goes “beyond the modern-day equivalent such a repairing a broken doorbell with a full access control videophone”.
He warns that while the rules for claiming repairs “do allow for repairing to modern-day equivalents, such as replacing fluorescent lights with LED lights, they do not extend to improvements, such as replacing worn vinyl flooring to marble tiling”.
Looking at larger-scale changes, Wright gives further examples: “Where a roof blows off and the firm pays for a like-for-like replacement, that cost should be a repair and therefore deductible for tax purposes in the period incurred. In contrast, if it decides to have the roof replaced in order to add a mezzanine, then the cost will be capital as it’s enhanced the building beyond its state when it was acquired.”
It needs to be understood that if an expense should be treated as capital, any incidental costs are also likely to be capital in nature. For instance, the cost of building an extension to the premises would be capital, and therefore so would any associated legal or planning fees.
All of this said, Beresford does make one key point: that “some companies might not, for a number of reasons, want to expense all repairs through their P&L account as it impacts on the reported profitability of the company”. In this instance those repairs can instead be capitalised and added to the balance sheet but would qualify for tax relief if they qualified for a capital allowance.
Detailed invoicing
When works are completed a single invoice might cover a range of changes such as an extension and redecorating a staff restroom. In this instance, Wright explains that the cost of the extension would be capital and, subject to the availability of any structures and buildings allowances (SBA), only recoverable when the premises are sold, but the redecoration is a repair and so can be deducted for tax purposes when incurred.
As a consequence, he advises: “Whenever building work is commissioned covering more than one task, firms should always ask for the invoices to be subtotalled by area or sub-project as appropriate.” He says that doing this will help determine what tax relief is available now and what will be treated as capital.
Beresford thinks the same and comments that firms should be “proactive rather than reactive” in this regard. His clear advice is to ensure that firms document – from the outset – not just the works, but the reason why they are being undertaken. Further, he says that “sufficient details about and breakdown of the cost of the works should be obtained while the works are being undertaken and everyone is still engaged”. Doing this after completion will be an uphill task as details and information will be that much harder to obtain from contractors and consultants who will have (mentally and physically) moved onto other jobs.
Capital allowances
Capital allowances are a tax relief that is given on certain items of qualifying capital expenditure. Beresford details here that plant and machinery allowances are the most common. But apart from pieces of machinery, he says qualifying items – known as fixtures – can include what are known as integral features in buildings.
Wright expands on the point, noting that integral features are items that, “put simply, are things ‘with which’ rather than ‘in which’ a business operates”. He says that qualifying integral features are strictly defined as electrical and lighting systems; hot and cold water systems; lifts, escalators and moving walkways; powered ventilation systems, and air cooling, heating or purification systems; and external solar shading.
He also explains that with most capital expenditure on premises, “firms often have to wait until they sell to get any tax relief. However, money spent on plant and machinery and integral features can qualify for higher rates of capital allowances, meaning they can get tax relief much sooner.”
It needs to be remembered that the cost of items classed as integral features qualifies for an annual writing down allowance (WDA) at a rate of 6%, which, says Wright, “allows tax relief based on a small amount of the asset’s cost to be claimed each year – possibly even extending past its useful life”.
However, many businesses will be able to get more tax relief sooner by claiming the annual investment allowance (AIA) against the cost of these integral features in the year they’re acquired.
In describing what AIA is, Beresford says: “AIA is a first-year allowance given at 100% of the allowed limit of expenditure on items of qualifying plant and machinery.” He adds that “since April 2023, the level of AIA has been set permanently at £1m. In other words the first £1m on qualifying plant and machinery, including any ‘integral features’ can be claimed at 100%”. It’s for this reason that he says that “at the moment the claim rates for capital allowances are relatively generous, particularly on items of plant and machinery”.
But there’s a catch to watch out for which Wright highlights: “Firms can’t claim the two allowances simultaneously – it’s a choice of either AIA or WDA in the first year.” He goes on to advise “where a business spends more than £1m on qualifying assets, it’s most tax efficient to offset the AIA against integral features first, as the WDA for ordinary plant and machinery is 18%, three times higher than those available for integral features”.
To complicate matters even further there are currently a number of other first year allowances available to businesses on the cost of new qualifying plant and machinery which also need to be considered if tax relief on any expenditure is to be maximised.
Structures and buildings allowance
It can be painful to wait for tax relief on capital expenditure on buildings and as Beresford details, expenditure on buildings does not typically qualify as plant and machinery. But there are exceptions that he mentions: incidental building works undertaken to an existing building or structure to aid the installation of an item of qualifying plant and machinery. This could involve, for example, constructing a lift shaft within an existing building to facilitate the installation of a new lift, or adding thermal insulation to an existing commercial property.
Both he and Wright also point to the SBA that was brought in from October 2018. This applies to the cost of constructing or renovating commercial premises for use in a trade; the allowance is currently 3%. The allowances can also be passed on to the next owner of a qualifying property if that property is acquired within the SBA tax life – currently set at 33 and one third years.
Wright explains that “leaseholders can qualify for SBAs on qualifying building works they pay for such as fitting out premises for their use.”
But for building owners, as opposed to tenants, Beresford considers SBA “just a timing benefit as any claim reduces the base cost of the property when it is eventually sold”.
Wright offers a further word of warning on SBA: “Firms can only get relief once, so the value of assets qualifying for plant and machinery allowances can’t also be included in an SBA claim.” It’s for this reason – the potential clawback of any capital allowances claimed – that Beresford considers “early advice should be sought to try and mitigate or avoid this”.
Common mistakes
Even before the expansion of tax law – the legislation was 5,000 pages long in 1995, but more than 20,000 now – it was easy to make mistakes when making claims. It’s not surprising therefore, that the only way to get claims right, in Beresford’s view, is to “seek specialist advice from a qualified expert who has an appreciation of both construction processes and tax legislation”.
At the other end of the spectrum, he fears that some companies assume that they are not entitled to make a claim or as he often sees, “expenditure is simply overlooked as there is no dialogue between the property and tax functions in a company”.
The lesson for him is simple: “Be proactive from the outset, and ensure the reasons why and information about the works are obtained and stored.”
Summary
Renovating or improving premises is an expensive business, but one thing is certain: taking the time to seek advice and understand the tax rules and reliefs available to businesses will help make a project less expensive overall.
