Capitalising on tax allowances to maximise property returns

Posted On Sunday, 16 April 2006 02:00 Published by eProp Commercial Property News
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What are Capital Allowances?
Capital allowances are a relief from income tax and are based on the capital expenditure incurred on the provision and installation of certain fixed assets in a building that suffer wear and tear, as well as on various types of properties, including certain industrial buildings and hotels.

Richard BlakeleyAlmost all commercial property owners and investors who incur capital expenditure are entitled to claim capital allowances either by purchasing or refurbishing an existing property, by carrying out alteration or extension works or by developing a new building, but many fail to realise their full entitlement or even claim at all, ultimately resulting in a loss of significant tax savings.

Capital allowances in some form are available in virtually every property used for business.  Whilst there are many types of tax allowances on property expenditure including Wear & Tear Allowances on Machinery, Plant, Implements, Utensils and Articles; Hotel Allowances; Industrial Buildings Allowances and Urban Development Zones, in our first article we touch on the subject of Wear & Tear / Depreciation Allowances on machinery and plant.

Every building contains fixed assets, which qualify for wear and tear allowances, such as air-conditioning equipment, hot water installations, lifts, escalators, carpets, furniture and fittings, to name a few.  However, less obvious assets may also qualify, for example, emergency lighting, fire alarm systems and security equipment.

Expenditure on assets qualifying as “machinery, plant, implements, utensils and articles” can be written-off over approved and agreed periods in accordance with Section 11(e) of the Income Tax Act No. 58 of 1962.  The claim for depreciation is to represent such sum, as the Commissioner thinks “just and reasonable as representing the amount by which the value of any machinery and plant etc, used by the taxpayer for the purposes of his trade are diminished by reason of wear and tear”.

Qualifying assets within hotels and industrial buildings may be eligible for Special Depreciation Allowances under Section 12C, where expenditure may be written-off over 5 years (20% per annum) on a straight line basis.

Who can Claim?
To qualify for capital allowances the person or company claiming must:

• Be a taxpayer.

• Incur capital expenditure.

• Use the plant and machinery in the course of a trade, including the letting of property.

• Demonstrate ownership of the assets.

Capital allowances are available on real estate expenditure only when property is held for investment purposes or owner-occupation.  They are not available on trading stock.


Achieving a Successful Claim
Although it sounds straightforward, we would emphasize that the valuation of plant and machinery is not an exact science capable of accurate prediction.  It is a complex “balancing” exercise involving many variables.

The process is further complicated by the fact that there is currently no satisfactory legal definition of “plant”.  There are substantial “grey” areas and achieving a maximised claim requires detailed research and analysis, identification of every allowable item and “on-cost” and skilled negotiation with the Receiver of Revenue.


The Value of Allowances
Allowances upon expenditure incurred on purchased properties are normally valued as an apportionment of the price paid with regard to The Income Tax Act No. 58 of 1962, Sections 11(e)(vii) or 12C(2) as appropriate.  However in certain circumstances, where the previous owner has made a claim, entitlement may be restricted.

As a general guide, depending upon specification, between 11% - 21% of the purchase price of a typical low rise office park could be made up of fixed assets qualifying for wear and tear allowances, with between 14% - 24% on high rise offices, and between 14% - 19% on suburban strip shopping centres.

As an example, an air-conditioned office building purchased for R100 million may have assets qualifying for capital allowances at an apportioned cost of say R20 million.  As an illustration this could be written down against tax by R3,200,000 each year for the first five years.

With the current tax rate on companies of 29%, the saving to the investor's tax bill will be R928,000 in the first year alone, with an overall saving in the first five years of R4,640,000 in this example.

If this property was purchased off an 8% yield, it will be equivalent to only 5.68% after 29% tax.  Capital allowances relief of R928,000 in the first year has the effect of increasing the net yield to 6.61%.

Plant and Machinery Allowances are also available on expenditure incurred on the refurbishment or extension of an existing building or on the construction of a new building and should include costs associated with, and incidental to the installation / provision of qualifying items of plant and machinery.

The allowances are available over agreed and approved write-off periods, on a straight-line basis in accordance with Section 11(e) of the Income Tax Act No. 58 of 1962 and having regard to Practice Notes 15, 19 and 39, typically over periods of between 5 and 12 years.  Where assets qualify for Special Depreciation Allowances (S12C), i.e., where they are used in the course of a qualifying industrial trade, or by a hotel keeper, etc, they will be available over a 5 year write-off period on a straight-line basis.

In addition to Plant and Machinery (Wear and Tear Allowances), Industrial Buildings Allowances may be available to the purchaser of the relevant interest in a used qualifying industrial building or where expenditure is incurred on the refurbishment or extension of an existing building or on the provision of a new building.

Allowances are also available on the appropriate proportion of capital expenditure on a qualifying hotel, where the qualifying hotel is being used by the taxpayer in the course of the trade of a hotelkeeper (or leased to a hotelkeeper).

Issues Affecting Capital Allowances Claims
Capital allowances claims should be submitted to SARS with the Tax Returns and will therefore need to undergo the scrutiny of the Receiver of Revenue.

For a maximised claim to be successfully agreed with the Receiver, it is essential that the computation is prepared in accordance with the relevant statutes, and that the principles evolved from precedent case law are correctly applied.

The computation must also take into account current SARS practices and procedures and must be prepared so that all the figures are correctly analysed and presented in an appropriate format.

There are potentially four levels of interrogation that a claim may be subjected to:

• The Receiver will consider whether an item is “plant” or machinery and determine the legal basis of the claim.

• The Receiver may address the basis of land valuation used in determining the claim.

• The Receiver may also audit the rates and quantities in the analysis and the balance between “non-qualifying” and “qualifying” expenditure.

• The Receiver may consider whether the “write-off” / depreciation periods used are reasonable and in line with current practice.

Recoupment
Upon disposal of a property the Income Tax Act No.58 of 1962 section 8 (4) requires that where an asset is sold for a figure in excess of its tax value, wear and tear allowances previously claimed are to be recouped.  The recoupment will be equal to the sale price less the tax value, however it cannot exceed the value of the deductions previously claimed.

Case law suggests that the sale of land and buildings are the sale of one asset, and therefore if a property is sold at a price exceeding its purchase price, any allowances previously given will be fully recouped.  Additionally, apportionments made to reduce potential recoupment of allowances are not justified, unless such apportionment is stated in a sale agreement and agreed by both parties.

From a tax perspective, it is therefore beneficial for the seller to apportion the purchase price within the sale agreement to the relevant asset classes.  Without such an apportionment SARS can apply a reasonable value to the assets sold in determining the recoupment.

Therefore, in order to suffer no recoupment the sale agreement should apportion the purchase price as follows:-

• Fixed assets within the property qualifying for wear & tear allowances.  The sale price should equal the tax written down value (the disposal value).

• Land and buildings (excluding aforementioned fixed assets) is to equal the remainder of the purchase price.

From a tax paying purchaser’s perspective, the apportionment to qualifying fixed assets should be as high as possible as they will be entitled to allowances on that portion.  It is therefore important during the negotiation process to identify whether a claim has been made, and which of the parties are likely to gain the most benefit from the available allowances.

Conclusion
We estimate that less than 15% of purchasers who acquire existing commercial property (whether offices, hotels, nursing homes, shopping centres etc.) actually claim their full and proper entitlement to capital allowances on fixed machinery and plant.

The main reason why capital allowances are usually missed or undervalued, is that it requires a specialist property valuation as well as an understanding of both tax and legal requirements, which is a combined skill beyond the scope of almost every accountancy and quantity surveying practice.

• As a property owner, or consultant to a property investor, always consider capital allowances as they are a valuable tool, and a successful claim can substantially improve cash flow by increasing the property’s net yield.

• Whether on a purchased property or a property development, always obtain a forecast of the value of allowances from a specialist, if only to make comparison to the level of allowances you may already be claiming.

• Never discount historical expenditure that has not yet been the subject of a capital allowances claim.  In many cases allowances will not be lost, only deferred, providing the assets are still owned.

About The Author
Richard Blakeley DipSurv MRICS and Michael Robinson BSc MRICS are partners of PJB, a UK based international firm of Capital Allowances and Depreciation Consultants.

The partners of PJB have experience in capital allowances dating back to 1977 and have worked in countries as diverse as the UK, South Africa, Australia, New Zealand, Singapore, Malaysia and the Netherlands.

 

 

Last modified on Sunday, 25 May 2014 16:12

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