Refitting and renovating a practice can be a rewarding expense and good for the balance sheet too. But complex tax rules can make the investment feel more like a curse than a blessing. The problem is that quite simply, different parts of a refit will be subject to different tax rules.
To make sure that practices get the most out of the tax deductions available, good record keeping and forward planning is essential. And if refitting costs are substantial, which they are bound to be considering the scale of even the smallest practice, qualified tax advice is critical.
Repair or improvement?
Corporate reporting and tax manager at professional accounting body ACCA Yen-Pei Chen says one the first thing to get straight is whether the refitting costs relate to repair or improvement.
“The distinction might seem pedantic, but it makes all the difference. If the costs relate to repair, they are deductible as an expense from your taxable profit. If the costs relate to improvement, HMRC will consider them to be capital expenditure. As such, no deductions from taxable profit are allowed.”
Ms Chen says replacing or fixing something (such as faulty heating) to get your practice back into working order is fine as repair, but do anything further (such as building a testing room) and you stray into the clutches of capital expenditure. The fact that you have a maintenance problem that must be dealt with doesn’t necessarily make your refitting costs deductible as repair – HMRC will want to know what work actually took place.
HMRC’s manual, written to guide its inspectors as they scrutinise tax returns, gives the example of a company that needed to have its roof repaired and decided to also open up the roof area for extra office space. The fact that the roof was unsound and needed to be repaired was beside the point; the additional work that was done on the roof made what happened to be classed as improvement, not repairs.
The manual also gives the example of a shop owner who had a new shop front put in when he took over a premises. The replacement of a shop front would normally be deductible as revenue expenses, but the fact that the shop owner adapted the shop front to his specific needs makes it an improvement, and therefore capital expenditure.
Capital allowances on capital expenditure
In terms of other refitting costs – capital expenditure – Ms Chen says: “The good news is, if you can’t claim revenue deductions on your refitting costs, you may still get tax deductions in the form of capital allowances. The Annual Investment Allowance (AIA) allows you to claim tax deductions on the full amount of qualifying expenditure, up to £200,000. This is available on both plant and machinery and integral features.”
Over and above the AIA limit, lower capital allowances are available each year, on a reducing balance basis. This is currently at 18% for plant and machinery and 8% for integral features. It is for this reason that Ms Chen suggests opticians prioritise integral features (such as lighting and heating systems) over plant and machinery (such as a frame heater or an ophthalmoscope) when making AIA claims. This is because capital allowances are available at a lower rate for integral features, so the more integral features you can get 100% AIA on, the lower a tax bill will be.
As an example based on a spend of £200,000 on integral features and the same on plant, if the £200,000 allowance is assigned to the plant, the practice will see that sum get 100% of the AIA and £200,000 of integral features gain relief at 8% giving a £16,000 special rate allowance. The total capital allowances will be £216,000.
But if the £200,000 allowance is assigned to the integral features first, the practice will get £20,000 more in capital allowances because the £200,000 spent on plant and machinery will see relief of 18%, or £36,000 main rate allowance. The total capital allowances will be £236k.
Ms Chen explains that to qualify as plant and machinery, the items have to be kept “for permanent employment in the business”, which excludes stock or expendable equipment (such as cleaning equipment) with a life of less than two years. It must also function as “an apparatus employed in carrying out the activities of the business” and not as part of the premises in which the business is carried on.
“The second point needs a bit of unpacking, because whether something consists of the apparatus used in carrying out the business or the business premises is surprisingly hard to pin down in case law,” says Ms Chen.
“In one memorable case, Benson v The Yard Arm Club, a company opened a floating restaurant on an old ship and claimed plant and machinery capital allowances on the ship. This was refused in the courts; the ship was the structure within which the restaurant business was run. In the words of the Court of Appeal judge, he could see no distinction between “a restaurant on the Thames and a fish and chip shop in Bethnal Green. Both act as premises in which the trade is carried on.””
In a retail setting, the basic principle is that anything which can reasonably be expected to form part of your building – for example, walls, shelves, ceilings, floors, doors, windows, security devices and lighting – should be considered to be premises and not plant. There might be exceptions if they are moveable, and/or designed to fulfil a special function – say a drop-down vision acuity screen. If this is the case, tax advice is needed.
The UK’s tax law around the kinds of assets that qualify as plant and machinery is very specific, and sometimes counterintuitive. Sections 21 to 23 of the Capital Allowances Act 2001 sets out a list of things which definitely are and aren’t plant and machinery. So, chart projectors, testing chairs, counters and POS systems would be considered plant. But ceilings, lift shafts and immovable partitions would not. However, if your refitting costs are large enough to send you scurrying to the tax books, you may sleep better if you speak to a professional accountant or tax advisor.
Ms Chen says special rate allowances are also available on assets which are integral to building. This includes electrical systems (including lighting), cold water systems, heating systems, powered ventilation, air cooling or purification and any floor or ceiling comprised in such a system, lifts (although note that lift shafts don’t get the same treatment, above), escalators or moving walkways, and external solar shading.
“It’s interesting that electrical systems are not defined in law, so HMRC will be looking to the ordinary meaning of the term,” says Ms Chen.
She adds that it is worth considering what you are putting the electrical systems in for, because “if it’s installed purely to support qualifying plant and machinery – burglar alarms, for example – the cost of the electrical system counts as plant and machinery and will be eligible for the higher plant and machinery allowances.”
Ms Chen offers one final piece of advice. Keep clear records and separately identify each item of expenditure.
“Rather than amalgamating all your costs under a one line item called “plant” in your tax return, you will have a much better chance of claiming capital allowances successfully if you break down your costs into specific headings. Likewise, when you claim for a revenue deduction on repairs, be prepared to back up your claim with invoices and a breakdown of the works carried out if and when the tax man asks you for details.”
The tax deductions process takes some thought but get it right and expenditure becomes much less expensive.
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