11.1 FUNDAMENTAL REFORM
The Government continues to use tax as a lever to encourage particular activities or behaviours. Businesses as well as individuals benefit from the tax reliefs offered. Capital allowances are an obvious example of how substantial (sometimes 100%) tax relief on expenditure can positively affect investment decisions made by businesses.
The potential for significant reform to capital allowances was however raised in the consultative document of August 2002 on Corporation Tax reform. Broadly speaking, the possibility of aligning accounting and tax practice in respect of capital expenditure was discussed, meaning the possible abolition of capital allowances – as we know them. That hasn't happened – but still could. There was silence however in the Budget speech and surrounding documents.
11.2 ANTI-AVOIDANCE – BALANCING EVENTS
A particular anti-avoidance measure that was first announced in the pre-budget report of 2002 will, however, be implemented.
It seems that some businesses have attempted to exploit the capital allowances rules by entering into artificial transactions which depressed the market value of their qualifying assets on a sale. The effect of this device was to accelerate the remaining capital allowances on those assets, so that the businesses could obtain a tax advantage. The new anti-avoidance legislation blocks this device by denying a balancing allowance if the proceeds from a “balancing event” (such as a sale) are less than they would otherwise have been as a result of a tax avoidance scheme.
The new rules apply to capital allowances for:
- industrial buildings;
- mineral extraction;
- flat conversions;
- agricultural buildings; and
- assured tenancies.
The new legislation was announced by the Chancellor and published last year at the 2002 Pre-Budget Report. It applies to events occurring on or after 27 November 2002.
Capital allowances allow the costs of capital assets to be written off against a business's taxable profits. They take the place of depreciation charged in the commercial accounts, which is not allowed for tax.
The recent attempts to exploit the capital allowances rules were seen in relation to Industrial Buildings Allowances. These allowances can be claimed at 4% a year on the “straight-line basis” on the capital expenditure on the construction of buildings or structures used for the purposes of manufacturing, processing and certain other specified trades. The disposal of an industrial building triggers a balancing event. Where the market value of the building is less than its written down value for tax, an extra allowance, called a balancing allowance is made in respect of the difference (i.e. that extra fall in value) to the person making the disposal.
The recent exploitation device sought artificially to depress the market value of a property to obtain an accelerated balancing allowance.
The new legislation blocks this device by denying the business a balancing allowance in cases where the proceeds are less than they would otherwise have been, as a result of a tax avoidance scheme. The counter-measure has a deterrent effect because any subsequent capital allowances claim by the purchaser would be limited to the amount the purchaser had actually paid (just as it would have been had a balancing allowance been made to the vendor).
11.3 ANTI-AVOIDANCE – 100% 1ST YEAR ALLOWANCES ON QUALIFYING I.T. EQUIPMENT
In addition to the measure outlined above there was recent activity in connection with the 100% first year allowances for qualifying IT equipment. This relief was only available in respect of expenditure incurred up to 31.03.03. A press release of 26 March 2003 made it clear that:
“Legislation will be included in Finance Bill 2003, which will apply to expenditure incurred on or after 26 March to counter avoidance by individuals attempting to exploit 100% rate of capital allowance available for expenditure on information and communications technology. The legislation will prevent first year allowances being available to anyone who exploits software or software rights by the granting of rights to use, or otherwise deal with, that computer software.
The change will not affect small businesses claiming 100% allowances where they have invested in information and communications technology for bona fide use in their own business”.