Capital Allowances and Property-Based Incentive Schemes

Introduction

Tax Briefing 63 contained an article on the Finance Act 2006 changes to the property-based incentive schemes. Following publication a number of issues were raised in relation to the article. This article addresses those issues. Also, in response to queries received, there is an example at the end of this article illustrating the application of the various restrictions put in place affecting hotels and certain other commercial and industrial projects etc benefiting from the extended 31 July 2008 deadline.

Hotels

Write-off over 7 years/25 years

The Finance Act 2003 extended the write-off period for capital expenditure on hotels from 7 years to 25 years. However, transitional arrangements were put in place in the Finance Acts 2003 and 2004 to retain the 7-year write-off regime to cater for certain pipeline projects. These transitional arrangements ensured that where capital expenditure was incurred on a hotel project on or before 31 July 2006 and that project was the subject of a valid application for full planning permission received by the relevant local authority on or before 31 December 2004, the expenditure could be written off at the rate of 15% per annum for the first 6 years and 10% in year 7. The new 25-year write-off regime, with expenditure being written off at the rate of 4% per annum, was to apply to all other hotel projects that did not meet the transitional arrangements.

The Finance Act 2006 extended the termination date for the 7-year write-off regime from 31 July 2006 to 31 December 2006 where the existing planning application conditions were met. New transitional arrangements in relation to expenditure incurred up to 31 July 2008 were also introduced. These provided that where there is a binding written contract for the construction or refurbishment work in place on or before 31 July 2006 and where work to the value of 15% of the actual construction or refurbishment costs (as certified by the local authority) is carried out on or before 31 December 2006, 75% of the expenditure incurred during 2007 and 50% of the expenditure incurred from 1 January 2008 to 31 July 2008 can be written off over 7 years, but subject to the ceiling of the projected expenditure as certified by the local authority (see Tax Briefing 63 for full details of transitional arrangements and attached Example illustrating the application of the various restrictions). For such transitional hotel projects the 25-year write-off regime will apply to:

• Expenditure incurred after 31 December 2006 where a binding contract is not in place by 31 July 2006 and work to the value of at least 15% of the actual construction or refurbishment costs is not carried out by 31 December 2006
• Any expenditure incurred after 31 July 2008 where a project is not completed by that date.

It should be noted that no allowances are available in respect of the remaining expenditure incurred up to 31 July 2008 in excess of the 75% and 50% thresholds. It should also be noted that the availability of capital allowances is subject to the requirement that the hotel be registered by Fáilte Ireland and to the transitional arrangements that apply in relation to registration.

Registration with Fáilte Ireland

The Finance Act 2005 introduced a requirement for buildings or structures that are in use for the trade of hotel-keeping to be registered in the register of hotels kept by Fáilte Ireland under the Tourist Traffic Acts before they can qualify for capital allowances. This new registration requirement applies in respect of expenditure incurred on or after 3 February 2005, subject to transitional arrangements. These transitional arrangements are similar to those that were introduced by the Finance Acts 2003 and 2004 in relation to the extension of the write-off period from 7 years to 25 years (see Tax Briefing 60 for details). A hotel project that qualified for transitional treatment in relation to registration would not be concerned with the new registration requirement and could continue to claim capital allowances over 7 years in respect of all expenditure incurred on or before 31 July 2006. As indicated above, the Finance Act 2006 extended the period within which expenditure incurred could qualify for write-off over 7 years from 31 July 2006 to 31 December 2006 and to 31 July 2008 in certain circumstances. However, it did not extend the date from which the registration requirement would come into effect. This remains at 31 July 2006. Thus, no capital allowances will be available for expenditure incurred from 1 August 2006 unless the building or structure involved is included in the register of hotels kept by Fáilte Ireland. This is the situation even where the Finance Act 2006 transitional arrangements in relation to the extension of the 7-year regime to 31 December 2006 or 31 July 2008 are met.

Holding period/clawback of allowances

It may happen that some of the expenditure incurred on the construction or refurbishment of a hotel will be written off over 7 years with the balance of the expenditure being written off over 25 years. This has implications for the period for which the hotel must be retained by the person claiming the capital allowances and in relation to the exposure to a balancing charge. In the case of, for example, a disposal of the hotel within 7 years of the hotel being first used (or first used after the refurbishment) all of the expenditure incurred will be taken into account in calculating any balancing charge/allowance. In the case of a disposal after 7 years but before 25 years, only the allowances in relation to that part of the expenditure that is being written off over 25 years will be subject to a balancing charge.

Binding Contracts

One of the conditions for availing of the extended termination date of 31 July 2008 for some of the property incentive schemes is that a binding contract in writing, under which expenditure on the construction or refurbishment of a building or structure is incurred, must be in place for the particular building or structure on or before 31 July 2006. Clarification has been requested about certain aspects of this condition.

The extended deadline for the following buildings or schemes is subject to such a condition:

• Hotels ('accelerated' allowances only)
• Holiday Camps ('accelerated' allowances only)
• Registered Holiday Cottages
• Urban Renewal (commercial and industrial buildings)
• Rural Renewal (commercial and industrial buildings)
• Town Renewal (commercial and industrial buildings)

'Self-Construction'

Revenue has been asked for a view about the need for a binding contract in a situation where the construction or refurbishment work on a building or structure is being carried out by the site owner, being either an individual or a company. Having regard to the fact that the projects in question all relate to commercial buildings and structures, Revenue would expect that most of these are unlikely to be undertaken by one person and that they would invariably involve the engagement of third parties to carry out some, or all, of the actual construction or refurbishment work. As there is a specific statutory requirement for a binding contract in writing to be in place by 31 July 2006, Revenue will expect that, in the absence of a global contract for the construction or refurbishment of a building, individual contracts for various elements of the construction or refurbishment work will be in place by that date.

In the exceptional situations where a site is owned by an individual or company and that individual or company will use only his/her/its own employees to carry out the development, without recourse to third parties, Revenue accepts that it would not be appropriate to insist on a binding contract between the site owner and another party. In such cases, Revenue will accept that the ‘binding contract’ condition is met where the site owner, whether an individual or company, swears an affidavit stating that the entire development will be carried out by the site owner’s own employees. The affidavit should also contain a statement about the degree to which arrangements are in place to begin work on the particular project. It must be sworn on or before 31 July 2006. The employees must be employed directly by the site owner and not, for example, by an individual’s development company where the site is owned by that individual.

Parties to contract

As already stated, the binding contract must be one under which expenditure on the construction or refurbishment of the particular building or structure is incurred. It will be a question of fact in each case whether the contract meets this requirement. It is not necessary that the contract provides for investor entitlement to the capital allowances. It is sufficient that it provides for a binding commitment to the initial construction or refurbishment expenditure. The legislation is silent about the parties to such a contract. The type of contract put in place will depend on the type of project and the various parties involved in the development. It is not, therefore, possible to be prescriptive about the type of contract that Revenue would regard as satisfying the condition. Possible examples of acceptable contracts are a development agreement between a site owner and a development company that is responsible for delivering over a completed building, a building agreement between a site owner/development company and a builder or a building agreement between an investor and a development company/builder. Where there is a single global contract for a project comprising several individual buildings, the condition will be regarded as satisfied for each individual building. Where there are separate contracts for each building, for example, building agreements with each investor, and no single global contract, each building agreement will have to be in place on or before 31 July 2006.

(The above material has already been issued as e-briefs 26/2006 and 29/2006)

Documentation for investors

A copy of the binding contract or affidavit (in the case of certain ‘self-construction’ projects) should be given to the investor(s) along with any other documentation that may be required to support a claim for capital allowances in the event of a Revenue audit.

15% Expenditure incurred by end 2006

All of the terminating property incentive schemes, with the exception of the general countrywide refurbishment scheme, have a requirement for work to the value of at least 15% of the actual construction or refurbishment costs of the building or structure to be carried out on or before 31 December 2006 in order to avail of the extended deadline of 31 July 2008. Clarification has been requested as to whether the 15% condition applies to the overall project or to each individual building.

In the case of industrial and commercial developments under the various schemes and in the case of hotels, holiday camps and registered holiday cottages, compliance with the 15% requirement must be certified by the relevant local authority. It is expected that issues relating to satisfying local authorities in relation to 15% certificates in these cases will be addressed in guidelines to be issued by the Department of the Environment, Heritage and Local Government in the near future.

In cases not requiring local authority certification such as in the case of residential developments under the various schemes, Revenue is prepared to accept that the 15% condition can be applied to the overall development rather than to each individual building. Revenue will, therefore, accept that where the 15% condition is satisfied in relation to an overall development, it will be treated as satisfied in relation to each individual building comprised in the development.

It should be noted that applications for local authority certificates must be made by 31 January 2007. Local authorities are obliged to issue certificates by 30 March 2007. A local authority certificate must contain the following information:

• A statement indicating whether it is satisfied or not that work to the value of not less than 15% of the actual construction or refurbishment costs of the building was carried out by 31 December 2006,
• The actual amount of the capital expenditure incurred on the building by 31 December 2006, and
• The projected balance of expenditure to be incurred on the building after 31 December 2006.

Commencement orders signed

Following receipt of European Commission approval of the 31 July 2008 deadline extension from a State aid perspective, the Minister for Finance signed Commencement Orders on 26 June 2006 giving effect to the Finance Act 2006 changes. The Orders give effect to the changes introduced for the industrial and commercial aspects of the urban, rural and town schemes as well as to the changes made in relation to hotels, holiday cottages, third level educational buildings, park and ride facilities and multi-storey car parks.

Example Illustrating the application of Finance Act 2006 Restrictions

A builder purchases a site in a qualifying Urban Renewal area for €100,000 and constructs an industrial building on it for a cost of €420,000. The building is completed in August 2008 and, without having been used, the builder sells it to X on 1 October 2008 for €600,000 and X immediately takes it into use for the purposes of his manufacturing trade.

Construction expenditure attributable to the various periods is as follows

Year 2006: €100,000;

Year 2007: €220,000;

1 Jan. 2008 to 31 July 2008: €80,000:

August 2008: €20,000.

The projected amount of post December 2006 expenditure, as certified by the local authority, was €280,000. Therefore the combined expenditure for the period 1 January 2007 to 31 July 2008 (€300,000) must be restricted to €280,000 and the restriction (€ 20,000) must be made in relation to the period Jan. to July 2008 in priority to the year 2007. Accordingly, expenditure treated as incurred in the period Jan. to July 2008 (before the 50 per cent restriction is applied) is €60,000 (€80,000 less 20,000).

The amount of qualifying expenditure in each period after application of the 75 per cent and 50 per cent restrictions is as follows:

Year 2006: €100,000;

Year 2007: €220,000 x 75% = €165,000;

Jan. to July 2008: €60,000 x 50% = €30,000;

August 2008: Nil (outside of the qualifying period).

Total expenditure for the purposes of the numerator "C" in the formula is therefore €295,000.

The net price paid by X for relief purposes under section 279 TCA (as amended) is -

X is deemed to have incurred construction expenditure on 1 October 2008 equal to the net price paid by him, that is, €340,385, and his entitlement to capital allowances will be based on that amount

NOTE: When calculating the formula for "the net price paid" in Section 279 the numerator "C" in the formula should be the amount of construction expenditure (incurred in the qualifying period for the scheme) as reduced in accordance with subsections (5) and (7) of section 270. The denominator "C" in the original formula - now "D" in the revised formula - should include the full amount of expenditure incurred on the construction of the building or structure i.e. before any restrictions and whether or not incurred in the qualifying period for the particular scheme.