How to reduce your tax bill
In recent years, tax relief associated with various designated incentive schemes has been phased out. This has led taxpayers to refocus and consider looking at other ways of sheltering trading and/or rental profits.
This article outlines a relatively simple, yet often under utilised way of reducing a taxpayer’s tax liability.
What is tax depreciation?
Tax depreciation is the means by which a taxpaying entity writes off its qualifying capital expenditure on plant & machinery against its profits, thus reducing its level of taxation. This claim for depreciation is generally referred to as capital allowances. The focus of this article is on the plant content within buildings in particular. It should be noted that capital allowances cannot be claimed against buildings..
How to determine the amount of capital allowances to claim
When a taxpayer identifies the qualifying plant in a building, capital allowances can be claimed from year one and for a period of eight years. Expenditure incurred on the construction or acquisition of a property can attract a substantial amount of capital allowances given that most modern buildings have a high content of plant & machinery. The proportion of the qualifying cost can vary considerably depending on the type of building, age and specification. A range of between 5% - 40% of the building cost is to be expected in the case of a new build construction, or 30% to 70% in the case of the fit-out cost of a premise. Items such as air-conditioning, elevators and alarms are examples of expenditure that may qualify for such capital allowances.
Where residential property is let fully furnished, capital allowances are available against the rental income of such properties. Again, the qualifying percentage will vary depending on the specification of the property and the level of fit-out.
Where a taxpayer, who is carrying on a trade, incurs expenditure on the provision of plant and machinery for the purpose of the trade, and the plant & machinery is in use at the end of the taxpayer’s accounting period, capital allowances are available against the taxpayer’s profits at the appropriate tax rate. The allowances are spread over eight years at a rate of 12.5% per annum. Broadly, the tax saving is taken as the allowance multiplied by the marginal rate of tax. In the case of individuals, the top income tax rate (plus PRSI & USC) can in some circumstances be up to 55% and in the case of a company, the tax rate is 12.5%. If a company is involved in letting property then the tax rate is 25% as the rental income is considered passive as opposed to trading income.
Entitlement to claim capital allowances
In the case of a taxpayer claiming capital allowances against trading profits, the entitlement to claim the allowances is relatively straightforward. Capital allowances can be claimed if the taxpayer
a) has incurred the expenditure and the plant belongs to them, and;
b) the plant is in use for the purposes of the trade at the end of the taxpayer’s accounting period.
In a case of a landlord claiming capital allowances on plant & machinery, the question of entitlement to claim depends on which party to the lease bears the burden of wear and tear on the plant and machinery. The burden of wear and tear is regarded as falling on the person who suffers the economic loss through the deterioration of the asset which cannot be made good through repairs. In addition, the entity who bears the burden of wear and tear must also be responsible for replacing the asset in the event that it is no longer in working order. Determining who has the burden of wear and tear must be established by examining the terms of the leases. Revenue has stated in a relatively recent briefing that for clarity, it should be set out in the lease which party bears the burden of wear and tear.
What a builder views as qualifying for capital allowances may not concur with Revenue’s view on the matter and some of the larger cases have been settled in the courts.
Interestingly, there is no definition of plant in the Tax Acts and thus recourse must be made to the case law which has developed. The identification of what constitutes “machinery” is relatively straightforward. It is defined in the Oxford English Dictionary as “an apparatus for supplying mechanical power, having several parts, each with a defined function”.
“Plant” on the other hand is much more difficult to define and the result has been that many cases have been referred to the courts. One key question to ask is whether the item of expenditure has a function as opposed to being a part of a setting in which business is carried on. The following are some of the items that have been held to constitute plant; moveable partitions, dry docks, and swimming pools. Whereas examples of items held not to constitute plant include, general lighting, ceilings, shop fronts, and wall & floor tiles.
Identification of plant and machinery
It is vital that when identifying qualifying expenditure on plant, consideration should be given to both tax and construction issues. This will ensure capital allowances are not under claimed, leaving the taxpayer overpaying tax. Alternatively, a taxpayer may over claim capital allowances and be liable to penalties, surcharges and interest liabilities.
This type of capital allowances has in the past not been given the attention that it deserves resulting in property owners and business in general perhaps under claiming their entitlement. If a property owner is looking for some tax relief this is certainly an area worthy of consideration.