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A new corporate client bought a bar/restaurant business. The purchase price was apportioned as to £100,000 for plant, fixtures and equipment, plus £80,000 'goodwill'. The vendor and the purchaser made a joint election under CAA 2001, s 198 for the plant, fixtures and equipment.
A new corporate client bought a bar/restaurant business. The purchase price was apportioned as to £100,000 for plant, fixtures and equipment, plus £80,000 'goodwill'. The vendor and the purchaser made a joint election under CAA 2001, s 198 for the plant, fixtures and equipment.
Having purchased the business, my clients did not operate the bar/restaurant as it was. They gutted the premises in its entirety, and in the process scrapped all the assets they had acquired. Over a period of almost twelve months they carried out their plans to build what is, in effect, an entirely new restaurant.
The first accounts for the company show the purchased assets as being scrapped. In the capital allowances computation we made a claim for a balancing allowance equivalent to the original purchase price of the scrapped assets.
Upon enquiry, this has been denied by HMRC on the basis that the assets were scrapped prior to the company commencing to trade. They say that no allowances are available because the purchased assets were never in use at the start of the accounting period and that the accounting period does not commence until the restaurant opens its doors for business.
The following specific questions arise.
First, when does trading commence? Is it when the refurbishment work commences, or is it the day the business opens its door for business?
Secondly, if the latter, then can it be argued that the expenditure on purchased assets should be treated in the same way as the new spend — i.e. that it is regarded as having been brought into use on the first day of trading, and then immediately scrapped?
Finally, if this argument fails, is there any other which will help the situation?
We will be grateful for readers' comments.
Query T16,693 — Scrapped.
Reply by Edmund:
In this case, we are told that the assets were scrapped prior to the company commencing to trade. HMRC take the view that no allowance is due since the assets were never in use at the start of the accounting period in which the trade commenced. This seems a spurious argument as, for plant and machinery allowances, there is no general requirement for the asset to 'be in use' in the trade. CAA 2001, s 11 sets out the general conditions as to the availability of plant and machinery allowances. Allowances are available if a person carries on a qualifying activity and incurs qualifying expenditure. Qualifying expenditure is capital expenditure on the provision of plant or machinery wholly or partly for the purposes of the qualifying activity carried on by the person incurring the expenditure and the person incurring the expenditure owns the asset as a result of incurring it. The requirement for ownership was introduced as a minor change in CAA 2001 and replaced the previous expression that the plant should 'belong' to the person. We need to go back to pre-1985 legislation for there to be a general requirement for the asset to be 'in use' for the purposes of the trade.
The requirement for the asset to be 'in use' in the trade is retained in cases where the asset is acquired on hire purchase and similar conditional contracts. The taxpayer is deemed to have incurred all the capital expenditure due under the hire purchase contract when the asset is brought into use (CAA 2001, s 67). Industrial buildings allowances rules similarly require the building to have been brought into use before allowances are due.
Whether or not a trade has started and the date of commencement, are to be determined on the facts of each case. HMRC's Business Income Manual at BIM70505 sets out the position and generally this is when the assets are put to good use. Thus, in the case of Scrapped's client, the opening of the restaurant will mark the commencement of trade. Of course, the commencement of trade will also mark the beginning of a corporation tax accounting period (TA 1988, s 12). The company's expenditure before this date will be 'pre-trading' expenditure. For the purposes of capital allowances, pre-trading expenditure is deemed to have been incurred on the first day of trading (CAA 2001, s 12).
The assets will have to be added to a pool of expenditure, which could either be the general pool or a claim could be made for the cost to be added to a separate short life asset pool. Writing down allowances are then available for every period except the 'final chargeable period'. In the case of the general pool, the final chargeable period is the chargeable period in which the qualifying activity is permanently discontinued. Thus, if the plant fixtures and equipment are added to the general pool, no balancing allowance could be claimed whilst the trade of operating a restaurant is continuing.
If an election is made to treat the expense as a short life asset, the final chargeable period is the first period in which a disposal event takes place (CAA 2001, s 65(2)).
Disposal events include where the plant or machinery ceases to exist as such as a result of destruction, dismantling or otherwise and the disposal value to be brought into account is the net amount received (CAA 2001, s 61).
Scrapped needs to set out his client's claim with care. The expenditure should be brought in to the capital allowances computation as additions for the corporation tax accounting period in which the restaurant opened. Short life asset elections should be made and the scrap value should be brought in as the disposal value and a balancing allowance claimed. HMRC should be asked for the statutory basis for their assertion that the assets must be 'in use'.
Hopefully this provides sufficient guidance to enable a successful claim to be made.
Reply by T.W.:
The query may have been provoked by claiming balancing allowances on all the plant. For example, was it really the case that all purchased assets were scrapped? No doubt furniture, crockery, etc, were, but some equipment may have been retained such as some of the cookers, dishwashers, refrigerators, washbasins, sanitary ware, fire and burglar equipment, and electrical and water systems. Why pay £100,000 and then scrap everything?
The purchased assets would form a pool, and since it is not possible to identify any individual items scrapped there would be no balancing allowances. Writing down allowances would be claimed instead. The accounts portrayal would not have been intended to reflect the tax pool.
Based on my knowledge of a similar situation, had the client owned several functioning restaurants with an obviously continuing trade, I doubt there would be a problem claiming writing down allowances on the fixtures, etc, purchased with the new restaurant. Here, I would argue that although there was no income, the trade purchased was only temporarily paused by the current owner while refurbishment was under way. Why else pay £80,000 for goodwill unless there was an existing trade that was continuing even if in a modified way? If the trade was continuing then there was a qualifying activity which would justify claiming capital allowances. Also, HMRC's Corporation Tax Manual at CT41 notes from The Centaur Clothes Group Ltd v Walker [2000] STC 324 (although concerning advance corporation tax rather than a trade) that 'being within the charge to corporation tax does not imply the existence of a source (of income)', even though a company usually first comes within the charge to tax when it acquires a source of income. So the absence of income does not necessarily mean that there was no trade or accounting period. Writing down allowances could therefore be claimed.
Extract from reply by Komemnoi & Hohenstauffen:
It is quite clear from Birmingham and District Cattle By-Products Co Ltd v CIR 12 TC 92, that business commences when the doors are opened for business. While Cannop Coal Co Ltd v CIR 12 TC 31, is not quite so clear cut on the point, this is because it related to a mining business.
Also relevant is Spa Estates v O'Hargain (1974) Irish No 15, in which the acquisition of land with planning permission was held not to be the date upon which business commenced. It follows from this that the scrapping of the old plant, etc, in the course of reconstruction means that it cannot, as a matter of fact, be said to have been brought into use on the first day of actual trading.
