01 October 2018 by Russell Cockburn
Examining the oft-overlooked tax treatment of short life assets, and the complexity of tax relief for property investors
I have recently dealt with a few cases where businesses have spent significant amounts of money on small tools, computer equipment, furniture and miscellaneous office equipment, or similar, and the question arises about how they should be treated for accounting purposes?
One option open to businesses is to elect for such items to be ‘pooled’ on an annual basis and then to claim short life asset capital allowances treatment for them within the capital allowances regime. This system permits such items to be written off for tax purposes over a relatively short period of time (effectively a maximum of 8 years) and hence accelerate the capital allowances/depreciation tax relief on them.
Where, for example, a company has a policy of writing off such items over, say, a period of three to four years, then the tax relief can in effect be gained in line with such a policy, provided that HMRC accepts that the policy is reasonable and achieves a fair result. After all, this only represents a timing difference.
What the issue comes down to is the expected effective useful life of the asset for the business and, particularly, whether the company has a fixed asset register tracking system in place that would enable the short life assets elections to be tested by HMRC in a compliance check if necessary.
The latter is often the main difficulty. Some businesses make the point, quite validly, that the additional record-keeping and data capture requirements can prove too onerous when compared with the expected additional and accelerated tax relief that can be obtained.
My response, however, is usually to point out that in these days of electronic record keeping, the instigation of such a detailed asset-tracking control system should not prove too problematic and that the accelerated tax relief may well prove worthwhile.
“Achieving an agreement will entail discussion and some negotiation with HMRC about the accuracy of the company’s record keeping and asset-tracking systems”
Short life asset elections are a part of the capital allowances regime, which can often be overlooked and yet can provide a very useful method of dealing with such items. It is in fact a lot more flexible than it at first seems and with a little effort will often prove a very worthwhile addition to the capital allowance computations for a business.
An alternative method may also be to seek an agreement with the company’s HRMC customer relations manager, where expenses below a certain ‘expense tolerance’ threshold can simply be charged to a profit and loss account.
Achieving such an agreement will entail discussion and some negotiation with HMRC about the accuracy of the company’s record keeping and asset-tracking systems, to satisfy it about the level of expenditures appropriate in the specific case. In particular, the expected useful life of the assets in questions will need to be agreed in advance. Here the concept of durability will come into play.
There is unfortunately very little guidance on this and general accounting treatment will have an important part to play.
There was one case many years ago, Hinton (HM Inspector of Taxes) v Madden and Ireland Ltd: HL 16 Jul 1959, which indicated that where, in the context of the particular business in question, an asset’s value is capable of lasting only three years, then it could be treated as having only that degree of useful life and written off as such – even though the specific items in question (in this case, ‘cobblers lasts’), could physically last much longer than this.
“There is little guidance on the concept of durability and general accounting treatment will have a part to play”
Although the case is very old, it can still be used as authority for arguing that where, in the context of a particular business, certain assets will indeed have a very short useful expected life, then they may well, on agreement with HMRC, be suitable for write off via the profit and loss account on an agreed ‘just and reasonable’ basis.
Clearly, such an approach should not be taken for assets that are definitely and technically capital in nature without the prior agreement of HMRC, but in a few cases I have seen, such expense tolerances were agreed by customer relations managers without too much hassle.
Indeed, such an approach can often provide a very straightforward and simple approach to dealing with what can otherwise be annoyingly large total expenditures on small items eminently suitable for such tax deductions treatment.
With the advent of the interest tax relief restriction from April 2017 for property investors, many buy-to-let property owners have been looking at incorporating their ‘businesses’ as an alternative means of mitigating the impact of those new provisions. After all, given the impact of the restrictions can be a loss of 25% tax relief on interest payments, incorporation is a not-unattractive proposition for some.
The strategy is not as easy to implement as some advisers seem to have been suggesting over the past couple of years and unexpected capital gains liabilities might well arise on the incorporation if HMRC were to refuse to grant eligibility for the relief provided by section 162 of the Taxation of Chargeable Gains Act 1992.
Some advisers adopting a more cautious approach, including myself, have advised clients that they should approach HMRC, under the non-statutory clearances mechanism, for their advanced agreement that the capital gains tax relief would indeed be available in their particular circumstances.
The Elizabeth Moyne-Ramsay judgment from a couple of years ago indicated that a significant level of involvement personally with the business – at least 20 hours per week – will be expected by HMRC and this is not an easy threshold for a small buy-to-let landlord to cross.
However, life may well be about to get significantly more difficult for such business clients and their advisers, and indeed their level of risk as a result may well make them reconsider this strategy – HMRC has recently announced that it will no longer provide such advanced clearances for these cases.
No real reason seems to have been offered for this change of approach, but the lack of such a facility may well introduce a level of increased risk that many will find unacceptable. It was very useful to be able to offer such business owners a level of ‘protection’ and reassurance about what remains a relatively controversial strategy from HMC’s perspective.
Personally, I have a worrying suspicion that the tax authorities may well in future consider imposing a higher rate of corporation tax on such businesses, which are simply letting residential properties.
It has been done before and could be an attractive policy decision for the government; that is, allow many businesses to incorporate and then hit them with a much higher rate of corporate tax. After all, disincorporation relief was withdrawn from this year as well, so extracting oneself from such a corporate structure may not be as easy in the future as the past.