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Published: Fri, 02 Feb 2018
Tax & Capital Expenditure
Fred runs a small chain of high street launderettes: the
business has an annual turnover of 6 million and assets of 4 million. The
number of employees varies between 40-60 people during the year. Fred is
planning a new venture: an environmentally friendly laundry service for working
parents which he intends to house in a specially designed building. The project
will use the latest technologies for rainwater harvesting, water conservation,
solar powered lighting and energy efficient boilers. Other equipment including
washing machines and drying racks (which may or may not be moveable) will be
sourced from Fred’s normal suppliers.
Fred expects to need numerous expensive
consultants, who will advise on the most appropriate equipment, design the
building and assist with the planning enquiry. You have been engaged as freds
planning director, and he he shown you his draft of the business plan for the
green laundry. You are surprised to see that Fred has shown ‘nil’ for all costs
relating to the building, the specialist equipment and the professional fees.
When pressed about this he explains that he thought that our tax system was
designed to subsidise this kind of capital expenditure.
Structure: Introduction,Legal Rules and Authority
has a chain of high street launderettes with an annual turnover of 6 million
and assets of 4 million with number employees 40 to 60. The new venture
involves environmentally friendly laundry service for working parents. This
needs a specially designed building. The project will use the latest
technologies for rainwater harvesting water conservation, solar powered
lighting and energy efficient boilers. He plans to use existing suppliers to
supply washing machines and drying racks fixed and movables.
planning director is needed to plan and control the project which would involve
seeking advice from different consultants. The business plan prepared by Fred
shows nil costs for the building, specialist equipment and the professional
fees under the a misconception that the tax system was designed to subsidise
this kind of capital expenditure.
business could be classed as a small to medium size business considering the
level of turnover which is (6million), assets (4 million) and number of
employees (40-60). It is not clear from the question whether the building he
is in the Enterprise Zone or not however assuming it is then it could qualify
for 100% Capital Allowances on this building. Thereafter the annual allowance
of 4 per cent would be available for this building and 25 per cent for plant
present the business plan does not take into account any costs relating to the
building or its refurbishment costs. It needs to take into account the initial
cost of the building plus the costs, which he is going to incur in converting
it into an environmentally friendly launderette. This obviously means use of
most water efficient and energy saving boilers and washing machines. The Inland
Revenue has introduced various capital allowances schemes since 1997 to
encourage investment by particular type of business and in particular type of
assets. Although the capital expenditure itself would not be allowed as a
deductible expense from his trading profits but the capital allowance can be
deducted from the profits thus writing off the capital cost of the assets.
Capital allowances take the place of depreciation, as depreciation is not an
allowable deduction for the tax purposes. This must be taken into account while
building up a business plan for his new venture.
the first year allowance would allow to set bigger proportion of the capital
expenditure on assets which could be set against the trading profits of that
period. This will free some of the vital cash flow needed for the first crucial
months of the business when business is still in its infancy and not a lot of
cash coming in.
business plan must show the original cost of the building and plant and
machinery with related cost added to it. The business plan must show the fees
for the architects, consultants and other professionals. It should also take
into account when it has to pay its customers and when it expects its customer
to pay. This will also then show how much money has been injected in this new
venture and whether the business is going to need any borrowing from the bank
to fund all the planned special features to make the specially designed
should also show how and when Fred expects business to start to breakeven and
make profit. First few months are undoubtedly going to be loss making and it is
more than likely that the venture would make a loss in the first year and the
capital allowances will increase that loss if claimed in that year. However,
the loss can be carried forward to subsequent years and set against the profits
for those years.
regard to washing machines and drying racks are treated as plant and machinery
and eligible to claim First Year Allowance of 50% . Also the nature of
business which Fred is claiming to be environmentally friendly then undoubtedly
he will be using energy saving equipments. The Inland Revenue has started a
scheme from 1 April 2001 whereby small and medium size businesses can claim 100
per cent First Year Allowances if they invest in energy saving plant and
machinery. This scheme is referred to as the Enhanced Capital Allowances
Scheme. The same rules apply if the business invests in water efficient plant
and machinery. If the washing machines used in the business are water efficient,
if Fred is marketing his business as environmentally friendly then he would
have to use such as Boilers and Washing machines anyway, then these would
qualify for 100 per cent First Year Allowance. The allowance is also given on
water efficient / conserving machinery and equipment such as water meters,
leakage detection equipments and efficient taps. Fred will be allowed to
include other cost to it such as installation of various equipment in the
launderette as well as costs of altering the building to install energy
efficient equipment. Fred will have to claim the enhanced first year
allowances in the same way as capital allowances through his corporation tax
year allowances can be used to reduce the corporation tax by setting all the
above allowances against the taxable profits. The reduction in the tax on
trading profits will help Fred with his cash flow and fund the business. If the
business does pay tax in the first year it would most definitely help to claim
all these allowances specified above.
Industrial building and equipments are classed as fixed assets. Equipments such
as washing machines and drying racks treated as plant and machinery and will
depreciate through wear and tear, building will appreciate provided it is
maintained properly. A plant is defined as ‘ whatever apparatus is used by a
business for carrying on his business, not his stock but includes all goods and
chattels, fixed or moveable which is kept permanently for his business’.
has a specific function within the business, but a building only provides a
setting. Plant is moveable but building is immovable. Building includes
mains services of water, electricity, gas and sewerage systems. Therefore when
the building is being designed for this specific purpose then expenditure on
the provision of mains services will be regarded as part of the cost of the buildings
and will not qualify for capital allowances. The expenditure on apparatus to
provide electrical light or power, hot water, central heating, alarm and
sprinkler systems would qualify for capital allowance. Fred needs to consider
the building regulation will have to be complied with which requires Fire
regulations and Health and Safety Act.
Architect, a builder and other related professionals need to be provided for in
the business plan.
assets used in the business do depreciate due to wear and tear arising from
their use however it is not an allowable deduction from the business’s profits
for income tax purposes. However, there are certain types of fixed assets which
are eligible to claim relief in the form of capital allowances.
expenditure is not deductible as day to day trading expenses from the revenue
of the business however the taxable profits are then reduced by capital
allowances. These capital allowances are only available on certain assets and
governed by Capital Allowances Act 2001. These allowances are available to
companies, sole traders and partnerships on plant and machinery and treated as
day to day running expense of the business in the accounting period they are
In order to claim
Capital Allowances on an expenditure incurred in buying an asset, that asset
must be a qualifying asset. It is irrelevant how that purchase is funded, loan
or bank overdraft; however interest on such funding is an allowable expense.
If the asset
bought by the business qualifies for the capital allowance then it will be
claimed in the form of ‘Writing Down Allowances (WDA). WDA of up to 25% of
qualifying expenditure in the first and subsequent years is available. A
qualifying expenditure consists of original cost after any allowances already
given. Theses allowances can be claimed in part or in full by sole traders and
If a plant and
machinery is bought by a small or medium size business during July 1998 to July
2000 then it would qualify for an enhanced first year writing down allowance of
40% of the cost provided the turnover of the business is not over 11.2 million,
assets of the business are not more than 5.6 million and business has less
than 250 employees.
The rates for
Capital Allowances for 2004/2005 are 50% allowances can be claimed on the
qualifying fixed assets bought by a small business. This allowance is available
for the first year. Similarly, a medium sized business can claim 40% capital
allowance in the first year on qualifying fixed assets. The Writing down
Allowances are still at 25%.
When a business
sells the asset which it no longer needs, there will be a balancing charge on
the difference between the sale proceeds and the written down value. This
usually equals to the amount of the actual depreciation. On the other hand if
that fixed asset is sold for less than its current written down value then
there will be a ‘balancing allowance’ which would be available as a way of
granting relief. It should be noted that a balancing charge cannot be more than
the amount of allowance given. Also if the business makes any profit on the
sale of those assets then it would be liable to capital gains tax.
A 100% First
Year’s Allowance is available on expenditure by small companies on information
and communication technology equipment in the four year period from 1 April
2000 to 31 March 2004. It is also available on car which electrically propelled
or does not emit more than 120 gm CO2. The year in which a business ceases to
trade no First Year Allowance or Written Down Allowances are given in that
final period of account. Each asset is deemed to be sold on the date when the
business stops trading.
It is possible for
a business to make an election to treat an item as Short Life asset provided
that the asset is disposed of within four years of the accounting period in
which it was bought and a balancing charge or allowance is made on its
disposal. In case of assets bought on Hire Purchase, these are treated as being
purchased outright for the cash price. Therefore the buyer is eligible to claim
the capital allowance on the cash price from the date when the agreement
In a case of big
companies such as Glaxo or Orange Plc they are likely to have several items of
plant and machinery. Then allowances are given by reference to a ‘pool’ of
expenditure. The reason for that is the assets in the pool are treated as one
asset. If one asset in the pool has been sold then the sale proceeds of threat
item is deducted from the written down value of the pool. Generally, this
adjustment is known as ‘balancing adjustment. This also allows to have smaller
amount of capital allowances in later years. A balancing charge only arises if
the assets in the pool are sold for more than the written down value of the
There are two
sources of the rules on what qualifies as plant and machinery. These rules help
decide whether or not the plant in question is eligible for capital allowances.
Statute gives list of items which does not qualify as plant but does not give a
comprehensive list on what does qualify. Certain items such as thermal
insulation and computer software are specifically defined as plant by statute.
Also there is ample case law which illustrates how certain items have been
accepted as plant.
Expenditure on a
building as well as any asset which is incorporated in a building and therefore
forms a part of that building does not qualify as expenditure on plant.
Therefore walls, floors, mains services waste disposal systems are classified
as buildings and not plant. On the other hand heating systems, lifts, sound
insulation provided mainly to meet the particular requirements of the trade,
partition walls, where movable and intended to be moved are classed as plant.
On a sale of a
building, the vendor and the purchaser have an option to enter into a joint
election to decide how they wish to split the sale proceeds between the
building and its fixtures. The anti-avoidance rules set out in the Act ensure
that the capital allowances are given on a fixture do not exceed the original
cost of the fixture. In practice the sale is designed in such a way that
majority of plant and machinery which is built on site or fixed to the factory
floor is taken out to avoid the possibility of these becoming a part of a
building rather than a plant. Also if the business has spent money on
structures or on works which involves alteration of land then that expenditure
does not qualify as expenditure on plant.
on assets are available in the year the asset is bought and also through out
the period that asset is owned by the business.
As there is no
statutory definition of plant and machinery, one has to look at the case laws
to see how they are defined. But there are certain items whose expenditure are
specifically allowed, for example, those incurred by traders complying with
fire regulations, heat insulation in industrial buildings, meeting safety
requirements for sports grounds. Under the Capital Allowances Act 2001 certain
expenditure on buildings is not allowed to be treated as plant or machinery.
However the Act does give a list of items of expenditure which is generally
accepted as plant and machinery and therefore qualifies for the capital
The definition of
plant posses a problem, because it is difficult to decide the ‘apparatus’ which
is used in a business to carry out normal business activities and then
distinguish it from the ‘setting’ in which it is carried on. It then follows
that if an assets is such that it becomes part of the settings, then such an
asset would not qualify for allowances unless such items of assets are treated
as part of the building itself and not as plant, for example, if the asset in
question is an industrial building. The Act gives some lee way for a business
for which atmosphere or ambience is important then the expenditure could
qualify for capital allowance. The expenditure on shop fronts, flooring and
suspended ceilings does not qualify for capital allowance. However, lifts and
central systems are treated as plant, but basic electricity and plumbing
systems are not.
If an asset is
used for private purpose by a sole trader or by a partner in a business then
that asset is treated as a single asset pool. Application of this rule is not
extended to cover the directors of family companies. In a capital gains tax
calculation, capital allowances are not deducted from the cost of an asset but
it is taken into consideration while calculating capital loss.
Case Law – Advantages of Capital Allowances
expenditure is not deductible as day to day trading expenses from the
taxable profits of the business however the taxable profits are then
reduced by capital allowances
- In the
first year of a new business when money coming in to the business is
limited, a 100 per cent capital allowance helps with the cash flow to fund
allowances can be used to create a loss and then can be carried forward to
set against the profits in the subsequent years. This is particularly
helpful especially when there are no profits to set the loss against and
therefore effectively wasting it.
allowances help to reduce the tax bill so that the money saved can then be
used reinvest in the business
Disadvantages of Capital Allowance
depreciation, a capital allowance is not deductible every month and
therefore a business has to wait until the end of the year to use these
allowances against the profit for the year
per cent allowance is only available in the first year and only on certain
specific items and if the equipment needed for the business is not on the
Inland Revenue’s list then it does not qualify for the allowance
annual capital allowance either on industrial building or plant and
machinery are claimed on straight line or reducing balance method as
required by the Inland Revenue and the business does not have a choice of
The following case law analysis shows how courts to define plant for capital allowances
In a recent case Alan
Shove (HMIT) v Lingfieldpark 1991 Limited An artificial race track was installed at the race track which was held to
be part of the main premises and therefore did not comply with the requirements
of section 24 of the Capital Allowances Act 1990. Similarly,
in Fred’s business specific design which would become part of the building
would not qualify for the capital allowances.
In Yarmouth v
France plant referred to a horse and defined as ‘whatever apparatus is used by a
businessman for carrying on his business: not his stock in trade which he buys
or makes for sale; but all goods and chattels, fixed or movable, live or dead,
which he keeps for permanent employment in the business’ by L J Lindley. However, the washing machines which are not his stock in
trade and drying racks which are fixed which he is going to use permanently in
his business would be treated as plant and therefore qualify for capital
A Function test
was applied in later cases which made a distinction between those plant which
were actively used in business (qualifying) and those setting in which the
business was carried on (non-qualifying).
In the Schofield
v R & H Hall case, the cost of a concrete grain silos was allowed because apart from storing
grain they were designed to make the process of unloading and distribution more
efficient. The cost of making building more energy and
water efficient would qualify for enhanced capital allowance under the Inland
In Munby v
Furlong case, a barrister was allowed the cost of his textbooks in his law library. His
argument was that, plant includes tools of trade which are used everyday in the
course of their profession. It is not just confined to physical things. His
argument was upheld.
In IRC v
Barclay Curle & Co Limited the cost of dry dock was held to be plant. It was considered to be an
apparatus for carrying on the business and not premises in which the business
was carried on. However in Benson v Yard Arm Club Limited a ship
owner used his ship as a floating restaurant which did not qualify for capital
allowance. He argued that it should be treated as plant because the ship was
used to conduct the business from.
In Jarrold v
John Good & Sons Ltd movable office partitioning was allowed because it was not
regarded as part of the setting in which the business was carried on.
was held in St John’s School v Ward that prefabricated building were not regarded as plant for school because the
structures did not form an active part of the trade but it only acted as a
In Dixon v Fitch’s Garages Ltd the taxpayer claimed that a concrete canopy over a petrol service station
was a plant. However, it was considered to be part of the setting in which the
trade was being done and therefore rejected.
In Brown v Burnley Football and Athletic Co Ltd it was
held that a football club’s spectator stand was not considered to be a plant as
it did not perform any function in the actual carrying out of the club’s trade.
In CIR v Scottish and Newcastle Breweries Ltd , light fittings, décor and
murals in licensed premises and hotels were held as plant. These items created
an atmosphere conducive to the comfort and well being of the customers.
the other hand in Wimpy International Ltd v Warland the
company owned and managed a chain of fast food restaurants and wanted to claim
capital allowances in respect of a number of items of expenditure.
court held that in order to decide what is allowable and what is not it is
important to apply two tests: the premises test and the business use test in
this case. Accordingly, under the first test, those things which become part of
the building cannot be considered as plant unless of course the premises
themselves are plant. Therefore, an attractive floor provided in a restaurant
which has a main purpose of making the restaurant attractive to its customers
is not enough to make it a plant. It functions as premises and its cost does
not, therefore, qualify for capital allowance. On the other hand, if we apply
the second test to the items which are not part of the building then, it qualifies
as a plant provided that item is used in the course of the business and is not
part of business’s stock in trade.
light fittings are classed as general chattels and therefore these did not
become part of the premises. In addition to this, it was held that the light
fittings had a specific function which was unique to the trade as it was
important to have certain volume of light in a fast food restaurant and
therefore Wimpy being fast food restaurant it had a same importance.
In Cole Brothers Ltd v Phillips general lighting in a department store was distinguished from special display
lighting and held that general lighting is not plant but it is merely a
setting. However, special display lighting was held to qualify as a plant.
Leeds Permanent Building Society v Proctor had Free-standing decorative screens installed in the windows of their
premises. The Inland Revenue allowed these as plant for capital allowances
purposes. The reason was the main function of these decorative screens was to
attract more customers and had nothing to do with the setting in which the
society’s business was carried on.
In Carr v Sayer it was held that a building which is built for a particular trade do not
qualify as plant, hence quarantine kennels which were immovable did not
was held vitally important what the taxpayer did, and not how he funded that
transaction and bought those assets, so was the decision in Barclays
Mercantile Business Finance Limited v John Mawson
analysis and discussion of variety of case law demonstrates how Inland Revenue
distinguishes what does and what does not qualify as plant. It seems obvious
that if the asset is used in business on a day to day basis then it is more
than likely to qualify as plant and hence would qualify for capital allowances.
Inland Revenue have stated that expenditure on the provision of mains
services to buildings such as electrical wiring, cold water piping and gas
piping are part of the cost of the buildings and therefore qualify for capital
allowances. Similarly, expenditure on apparatus and alterations to existing
buildings which could be classed as incidental to the installation of plant or
machinery also qualifies for capital allowances.
Fred will not have any problems claiming capital allowance on
industrial building which is specifically designed for environmentally friendly
launderette. The energy saving and water efficient equipment would qualify as
plant for capital allowance. On the basis of case law it may be possible to add
the cost of electrical wiring, cold water and gas piping etc to the cost as
they would be apparatus which are used in the day to day activity of the
business. It may be that the Inland Revenue would apply a function test to
these items to see which ones qualify. The case law analysis shows that Fred
would be allowed to claim capital allowance on light fittings and perhaps
drying racks and all such other items which do not become part of the building
because light fittings are chattels and not part of the building. The reason
being they fulfilled the specific function of the business as drying racks and
lighting are essential to the launderette.
- 1. BPP Study text
‘Advanced Taxation (FAs 92)’ pages 94 to 97
- 2. Tolleys Tax
Guide by Arnold Homer and Rita Burrows published by Tolley pages 380 to 396
- 3. Business law by
Scott Slorach and Jason Ellis published by Blackstone press pages 171 to 175
- 4. Lawtel. For
- 5. Inland Revenue
- 6. page
33 to 38 The Taxation of unincorporated businesses, Tax planning ACCA open
learning Resource book published by ACCA
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