Phasing Out of the Industrial Buildings Allowance

FACT

In the 2007 budget by Gordon Brown, it was announced that the Industrial Buildings Allowance (IBA) was to be abolished by the 2010/11 financial year. This was a considerable blow for the hotel sector as it substantially reduced the amount of tax relief made available for hotels.

IBAs were introduced by the Income Tax Act 1945 to encourage post-war reconstruction by productive industry, but at that time Hotels were specifically excluded. Legislation to give IBA on capital expenditure when constructing hotels was only introduced in 1978.

The legislation was intended to encourage the holiday trade. Allowances are given for expenditure incurred on or after 12 April 1978 on constructing hotels that are deemed to be qualifying hotels in respect of IBA - other hotels do not.

Expenditure incurred on acquiring a hotel on or after 12 April 1978 does not qualify for IBA even if the hotel is a qualifying hotel unless the hotel was constructed on or after 12 April 1978. For example, the Lytham hotel was constructed in the 1920s. It satisfies the conditions for being a qualifying hotel. If Richard buys the Lytham hotel in March 2004 Richard cannot claim IBA because the hotel was constructed before 12 March 1978.

A hotel has to be in a building of a permanent nature to be a qualifying hotel. It must be open for at least four months in the season that runs from the beginning of April to the end of October. This rules out hotels like a hotel that caters for skiers and is open only in winter.

These are the other conditions to be satisfied before the hotel can be a qualifying hotel:

• when the hotel is open in the season it must have at least 10 letting bedrooms,
• the sleeping accommodation must consist wholly or mainly of letting bedrooms, and
• the services provided for guests must normally include the provision of breakfast and an evening meal, the making of beds and the cleaning of rooms.

HMRC regard the ‘meals test’ as satisfied where the offering of breakfast and dinner is a normal event in the hotel’s carrying on of its business. HMRC do not regard it as satisfied where the service of meals is exceptional, for example, if either breakfast or an evening meal is available only on request.

HOW

The allowance was to be phased out gradually over a number of years, by reducing the % of the relief by 1% each year. See the table below:

  * where purchased by second or subsequent owner before 21 March 2007.

In order to prevent businesses manipulating transactions to accelerate relief before 2010/11, balancing adjustments or recalculations of allowances on the sale of an asset (or other balancing events) were abolished for any event occurring on or after 21 March 2007 to 2011. However, where the adjustment arose as a result of an unconditional contract which was agreed and signed before 21 March 2007 (and not varied in a significant way thereafter), balancing adjustments are allowed.

For Instance, prior to Budget 2007, when a person sold an industrial or agricultural building within 25 years of first use, there was a balancing adjustment (giving rise to either a charge or an allowance) based on any difference between the residue of qualifying expenditure (RQE) and the proceeds from the event. The person acquiring the building would then be entitled to a recalculated written down allowance, based on the expenditure that had not yet been written off (taking into account the balancing adjustment) divided by the remainder of the 25-year period. For example, if the remainder of the 25-year period was 10 years and the RQE after the sale was £10,000, the buyer would be entitled to a recalculated WDA of £10,000/10 = £1,000 p.a.

However after 2007 the buyer now effectively ‘stands in the seller’s shoes’ claiming the same allowance as the seller had previously.

EFFECT ON HOTEL SECTOR

The effect of this change to the Hotel Sector was significant, reducing the second-hand value of some hotels as purchasers considered the impact of the reduction in allowances available on the overall cost of using the hotel over their intended period of ownership. The decision had a particularly marked impact in the hotel sector where the capital value of buildings was particularly high relative to earnings. As well as seeing a drop in hotel values, hotel owners have seen a drop in their profits as this relief has been phased out.

Anyone acquiring a second hand hotel after 20 March 2007 is still able to claim IBAs until they are phased out but the amount of expenditure on which they are claimed is restricted to the tax written down value of the building to the previous owner prior to the sale.

There has also been a dramatic effect on new builds. For example a hotelier building a new hotel for £20 million will see an increase in tax of nearly £2 million over the next ten years as a result of these changes. Also, big organisations looking to invest are finding hotel acquisitions less attractive.

However on the other side of the coin, many hotels on which these allowances are claimed will have appreciated in value to in excess of their written down value for tax purposes. On sale of such assets a balancing charge will now NOT arise to claw back allowances already claimed although there will, of course, be tax to pay if capital gains are realised.

So for example, if you were to sell your hotel that cost £1,000,000 and the written down value over 10 years after you bought it was £600,000, previously a balancing charge would have arisen of £400,000 to claw back the allowances already claimed and tax would have been due. However balancing charges no longer exist.

CURRENT POSITION

We are now in year 2009/2010 therefore the 2% rates is applicable, reducing to 1% after April. So if you are still claiming allowances at the 4% rate STOP!

Also, in light of these changes it is now more important than ever to maximise plant and machinery allowances, for most Hoteliers this will be the only way of obtaining any tax relief for expenditure on property.

If you would like further information on any of our articles feel free to contact us at the office.