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TaxationWeb by Sophie Hill

Sophie Hill of Tolley Tax Training examines how businesses obtain relief for expenditure on industrial buildings.In this article we will cover:

* Expenditure qualifying for Industrial Buildings Allowances (IBAs);
* IBAs for an accounting period;
* Balancing adjustments on sale;
* Allowances for the second user.

Expenditure qualifying for IBAs

IBAs are claimed by traders. Traders means sole traders, partnerships or companies. Some landlords may also claim IBAs to set against their rental income from industrial buildings.

IBAs give relief for the “depreciation” of an industrial building. An IBA is simply another form of capital allowance. Capital allowances are deducted as a trading expense to arrive at the taxable trading profit for the accounting period, so IBAs are effectively business expenses, for example:

Adjusted profit	               X

Less: capital allowances:	

   Plant & machinery	      (X)

   IBAs	                      (X)

                             ____

Trading profit	               X

                             ____

Section 274 Capital Allowances Act (CAA) 2001 tells us that a building will qualify for IBAs if it is used for either:

* Manufacturing;
* Subjecting goods to a process; or
* Storing goods or materials used in manufacturing or processing etc.

IBAs are given at a rate of 4% per annum. The 4% rate is applied to “qualifying expenditure”.

“Qualifying expenditure” is based on the construction cost of the building. Construction costs include preparing, levelling and tunnelling the land on which the building is built, but do NOT include the cost of the land itself. Architects fees are included, legal fees are not.

If the building includes parts where “non-industrial” activities are to take place (eg, offices, shops, showrooms etc), the costs of building these parts will qualify for IBAs if those costs amount to 25% or less of total construction cost. Staff welfare buildings (canteens etc) will always qualify, as will drawing offices etc.

IBAs for the accounting period

The 4% writing down allowance (WDA) is given if the building is in industrial use on the last day of the trader’s accounting period.

Note we are only interested in what the building is being used for on the last day of the period. Therefore if a trader with a 31 December 2005 year-end buys a factory for £100,000 on 31 December 2005 and uses it straight away for manufacturing or processing etc, he will get £4,000 of IBAs in the year ended 31 December 2005 to deduct from trading profits.

NEVER apportion IBAs based on how long the building has been used for in the period. In the above example, even though the building was only used for one day in the accounting period, we give the full 4% IBAs. The only time we apportion the 4% allowance is if the accounting period itself is less than 12 months.

If the building is specifically being used for a non-industrial purpose on the last day of the period (for example, the workshop may have been converted into a shop or showroom), no IBAs are available for that period.

If the building is empty and is being used for neither industrial nor non-industrial purposes, we call this “temporary disuse”. Whether IBAs are given depends on whether the period of temporary disuse was preceded by an industrial or non-industrial period. If, immediately before the building became empty, it was being used for manufacturing or processing, the empty period will count as “industrial” and IBAs will be given. Otherwise it will not and no WDAs are available.

Nowadays there are no “initial allowances” on industrial buildings. During the 1980s and early 1990s, the government gave what were effectively first year allowances to traders who incurred expenditure on industrial buildings. No initial allowances have been available since 1992/93.

Only buildings which are less than 25 years old will qualify for IBAs. Industrial buildings effectively “die” for IBA purposes on their 25th birthday (hence the rate of 4%). Therefore if the building was built and used before 1981 and the trader is buying it now, he will not get any IBAs.

Balancing adjustments on sale

If an industrial building is sold within its 25 year “tax-life”, there will be a balancing adjustment on sale.

No 4% WDAs are given in the accounting period of sale. Instead there will either be a Balancing Allowance or Balancing Charge. Balancing Allowances decrease the trading profits. Balancing Charges are effectively “negative IBAs” and increase the trading profit.

If an industrial building is sold (within its tax life) at a profit, there will always be a Balancing Charge equal to the IBAs previously given. There are no exceptions to this. Given that buildings are the type of asset that generally increase in value over time, most sales will be at a profit, and the vendor will therefore have a Balancing Charge equal to the IBAs previously claimed.

Therefore, if a factory is sold, the first thing to do is to compare proceeds with cost and see if there is a profit or loss on sale. If there is a profit, we simply work out the allowances previously claimed and that is the Balancing Charge.

Don’t also forget that where buildings are sold at a profit, a capital gain will arise. This gain will be charged to CGT for individuals and corporation tax in the hands of a company. If a replacement building is acquired, it could be possible to roll-over all or part of this capital gain.

Where the building is sold for less than its original cost and a loss arises, the way we work out the balancing adjustment depends on whether there was any non-industrial use during the period of ownership.

(a) 100% industrial use

Approach to the computation:

i. Put together a “pool” (ie, qualifying expenditure less IBAs claimed);

ii. Annual WDAs are deducted from qualifying expenditure, giving a tax written down value (TWDV) at the start of the period of sale;

iii. Deduct sale proceeds from the tax written down value and consider the result:

Positive figure = Balancing Allowance
Negative figure = Balancing Charge

Also note no capital loss is available in respect of this sale of the building as relief for the fall in value of the building will already have been given against trading profits.

Example 1

Lexis plc bought a new factory on 1 July 2000, costing £500,000. Accounts are drawn annually to 31 March. The factory was always used for manufacturing until it was sold for £475,000 on 1 January 2006.

Show the balancing adjustment for the year ended 31 March 2006.

Solution

There is a loss on the sale of the building, so we follow the approach detailed above:

                                                       	 

                                                          £

Expenditure	                                       500,000

IBAs:	

Y/e 31.3.01:  £500,000 x 4%	                       (20,000)

Y/e 31.3.02:  £500,000 x 4%	                       (20,000)

Y/e 31.3.03:  £500,000 x 4%	                       (20,000)

Y/e 31.3.04:  £500,000 x 4%	                       (20,000)

Y/e 31.3.05:  £500,000 x 4%	                       (20,000)

                                                      ________

TWDV before sale	                               400,000

Less: sales proceeds	                              (475,000)

                                                      ________

Balancing Charge	                              £(75,000)

                                                      ________

The other way to reconcile this result is to compare the cash loss on the sale of the building with the IBAs given i.e.

	

                                                          £

Loss on sale £(500,000 – 475,000)	                25,000

Less: IBAs given:	

      £20,000 x 5	                              (100,000)

                                                      ________  

Balancing Charge	                              £(75,000)

                                                      ________

Effectively too many IBAs have been given, so the Revenue will claw some back by way of a Balancing Charge on sale.

(b) Periods of non-industrial use

This is more complex.

i. Work out the total period of ownership from first use to sale;

ii. Calculate how much of this period is “industrial use”. Do calculations to the nearest month;

iii. Calculate the cash loss on the sale of the building;

iv. Calculate the loss due to industrial use i.e.

             Loss on sale      x     industrial use

                                     ______________

	                               Ownership

v. Calculate the IBAs given;

vi. Balancing adjustment =

             Loss due to industrial use (Step iv)	X

             Less: IBAs given (Step v)	               (X)

                                                     ______

             Balancing allowance / (charge)	      X/(X)

                                                     ______

Example 2

Collis Ltd draws accounts to 31 December. On 1 July 1996 the company bought a new factory for £100,000. The factory was used for manufacturing furniture apart from 1 July 2001 to 30 June 2003 when it was used as a showroom while manufacturing was carried on from rented premises. On 30 June 2006, the factory was sold.

Calculate the balancing adjustment on sale assuming that sale proceeds were

a) £150,000
b) £75,000


Solution

(a) Factory sold for £150,000

Factory sold at a profit. Therefore Balancing Charge = IBAs given.

						     WDAs (£)

In industrial use at year end	

31.12.96 to 31.12.00 inc.	

£100,000 x 4% x 5	                              20,000

	

In non-industrial use at year end	

31.12.01 & 31.12.02	                               nil

	

In industrial use at year end	

31.12.03 to 31.12.05 inc.	

£100,000 x 4% x 3	                              12,000

                                                     _______  

IBAs given	                                      32,000

                                                     _______



Balancing Charge = £32,000

                   _______

(b) Factory sold for £75,000

Factory sold at a loss. Some non-industrial use

Ownership period = 10 years

Industrial use = 8 years

	                                                £

Loss on sale  £(100,000 – 75,000)	              25,000

	                                             ________

Loss due to industrial use:	

£25,000 x 8/10	                                      20,000

Less: IBAs given (see above)	                     (32,000)

                                                     ________

Balancing Charge	                            £(12,000)

                                                     ________

Note: The loss due to industrial use (£20,000) is the amount of IBAs the Revenue will award over the life of the building. In this example, the Revenue has given too many IBAs (£32,000), so they claw back the excess (£12,000) as a balancing charge.

Allowances for the second user

Finally a brief summary of how we calculate IBAs for the purchaser of a second hand industrial building.

The 4% rate is irrelevant for a second user. Instead we calculate annual IBAs as follows:

i. Compare the original qualifying expenditure with the price paid by the new purchaser;

ii. Take the lower of these;

iii. Divide the figure at Step (ii) by the remaining “tax life” of the building. The “tax life” is 25 years less the time between the first use and the date of sale.

Example 3

Tolley plc bought a new workshop for £250,000 on 1 January 2001. The workshop is used for printing and binding tax legislation. Tolley plc has a 30 September year-end.

On 1 July 2006, Tolley plc sold the workshop to Lucy (a trader) for £156,000. Lucy draws accounts to 31 December.

Calculate the balancing adjustment on sale for Tolley plc and the annual IBA for Lucy.

Balancing adjustment on sale for Tolley plc

	                                          Qualifying exp.

	                                                £

Cost (1.1.01)	                                     250,000



Y/e 30.9.01:  £250,000 x 4%	                     (10,000)

Y/e 30.9.02:  £250,000 x 4%	                     (10,000)

Y/e 30.9.03:  £250,000 x 4%	                     (10,000)

Y/e 30.9.04:  £250,000 x 4%	                     (10,000)

Y/e 30.9.05:  £250,000 x 4%	                     (10,000)

                                                    _________ 

TWDV before sale	                             200,000

Less: proceeds (1.7.06)                             (156,000)

                                                    _________

Balancing Allowance	                             £44,000

                                                    _________

Allowances for Lucy

Lower of original expenditure (£250,000) and purchase price (£156,000) = £156,000

Tax life remaining = 25 years – 5½ years expired = 19½ years

Annual WDA = 

                 156,000	= £8,000 p.a

                ________ 

                  19½

Note: the above approach works only where there is no non-industrial use by the first user. This is therefore a slightly simplified version of the rules for the purposes of this article.

A Practice Question and Answer is provided below.

May 2006

Sophie Hill

Sophie Hill is a member of the tax training team at LexisNexis Tolley where she lectures and writes material for ATT & CTA courses, and audio visual CD ROMs for the student training market. Sophie can be contacted via the Tolley Tax Training website at www.tolleytraining.co.uk.

"LexisNexis Tolley® Tax Training" provides quality correspondence, classroom and e-training for the ATT, CTA, AIIT and ADIT examinations. In addition their e-learning package "Tolley’s Tax Tutor" is excellent preparation for anyone studying tax for any professional examination (ACCA, ICAEW, ICAS, AAT etc). For further information please click the following link: www.tolleytraining.co.uk or email your query to taxtraining@lexisnexis.co.uk

Example

Tolley Ltd commissioned the construction of a new industrial building and incurred the following expenditure in December 2005;

	                                                      £

Land	                                                   200,000

Levelling and cutting the land	                            35,000

Architects fees	                                            15,000

Legal fees	                                            10,000

Factory construction (including offices £160,000)	   600,000

                                                          ________

Total	                                                   860,000

	                                                  ________

Calculate the qualifying expenditure for IBA purposes.


Answer

	                                                      £

Construction (see Note)	                                   600,000

Levelling and cutting land	                            35,000

Architects’ fees	                                    15,000

                                                          ________ 

Qualifying expenditure	                                   650,000

                                                          ________

Note

£650,000 x 25% = £162,500

Offices cost £160,000 so they qualify as below 25%

Land or legal fees do not qualify