How to reduce your tax bill
As growth has returned to the economy in recent years, taxpayers are again investing and we are seeing increasing levels of capital expenditure on plant, fixtures and fit-outs. In this issue of Private Matters, we discuss a relatively simple, yet often under-utilised, way of reducing a taxpayer’s tax liability (be it corporate or individual) by sheltering trading and/or rental profits
What is tax depreciation?
Tax depreciation is the means by which a taxpaying entity writes off its qualifying capital expenditure on plant and machinery against its profits, thus reducing its level of taxation. The focus is on the plant content contained within buildings, in particular. .
Quantum of allowances
When a taxpayer identifies the qualifying plant in a building, an immediate tax deduction is available commencing in year one for a period of eight years. Expenditure incurred on the construction or acquisition of a property can attract a substantial amount of allowances since most modern buildings have a high content of plant and machinery. The proportion of the qualifying cost can vary considerably depending on the type of building, age and specification. A range of between five per cent to 40 per cent of the building cost is to be expected in the case of new construction, or 30 per cent to 70 per cent in the case of the fit-out cost of a premises. Items such as air-conditioning systems, lifts, boilers and alarms are examples of expenditure that may qualify for such allowances.
Where residential properties are let fully furnished, 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 and machinery is in use at the end of the taxpayer’s accounting period, then wear and tear 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 cent per annum. Broadly, the tax saving is taken as the allowance multiplied by the rate of tax. In the case of individuals, the top income tax rate of 40 per cent (plus PRSI and USC) can in some circumstances be up to 55 per cent and in the case of a corporate, the tax rate is 12.5 per cent. If a corporate is involved in letting property, then the tax rate is 25 per cent, as the rental income is considered passive, as opposed to trading, income.
Entitlement to claim allowances
In the case of a taxpayer claiming allowances against trading profits, the entitlement to claim the allowances is relatively straightforward. Wear and tear allowances can be claimed if the taxpayer:
- has incurred the expenditure and the plant belongs to them; and
- 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 allowances on plant and 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 lease. Revenue has stated in their publications that for clarity it should be set out in the lease who bears the burden of wear and tear.
What a builder or non-expert views as a piece of plant may not accord to the view of the Irish Revenue Commissioners and some of the larger cases have ended up going to court for resolution.
Interestingly, there is no definition of plant in the Tax Acts and thus recourse must be had to case law on the subject, which has developed over many years. 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 capital 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 and 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, as without the combination of knowledge of both construction and tax, allowances may be under claimed, leaving the taxpayer overpaying tax or alternatively a taxpayer may over claim allowances and be liable to penalties, surcharges and interest liabilities. It is also important to quantify and review the spending early and when in progress, if possible, so that we can ensure that the construction cost documentation is drafted and collated in a manner that maximises the potential allowances, supports a robust claim, can be efficiently gathered and is supported by photographic evidence taken during construction.
We have found that these types of capital allowances have in the past not been given the attention that they deserve, thereby resulting in property owners and businesses under claiming their entitlement. If a property owner is looking for some tax relief, this is certainly an area worthy of consideration.