Costs of factory extension

Costs of factory extension

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My client, a manufacturing company, has paid for the construction of an extension to the factory in order to accomodate a new production line and increase capacity. The build cost represents abuot 30% of the value of the building (pre-extension) and it is thought that the value of the freehold will increase by approximately the value of the build costs. The freehold of the factory is owned personally by the director/shareholder and the company pays a market rent under a formal lease. There is about 5 years to run on the lease. The directors are considering selling the freehold with the company as a sitting tenant.

I have 2 concerns:

1. Is there a potential income tax issue for the directors i.e. the company has paid for the extension which has increased the value of the director's personal asset?

2. The company has claimed input VAT on the build costs on the basis that the expenditure is for making taxable supplies - all the company's output is and will be standard rated. The directors themslves are not VAT registered and there is no option to tax in force. Can this claim be attacked on the basis that the company incurred capital expenditure on an asset in which it has no equity?

Any thoughts on either/both of the above would be most welcome.

Regards

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Euan's picture
By Euan MacLennan
20th Feb 2013 18:16

I am no expert ...

..., but as no-one else is answering, I will have a go!

Leasehold improvements should be capitalised in the company's accounts and depreciated over the remainder of the lease, because when the lease expires, the improvements revert to the landlord director.

I can see no problem with the company reclaiming any input VAT charged for the construction of the extension.  I cannot see any income tax implication for the director, but he will be subject to Capital Gains Tax on the sale of the extended property.

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By DMGbus
20th Feb 2013 20:26

Deemed lease premium

I fully agree with Euan's analysis regarding the VAT situation.

The only area of caution that I see is the potential for there to be a "Deemed Lease Premium".

To avoid this arising  I would advise as follows:

There be NO contractual obligation for tenant to carry out the improvementsNo suspension of rent comicidental with the tenant's improvements being madeSome form of agreement be put in place that should the tenant vacate the premises then the landlord reimburse the tenant for the costs incurred

HMRC guidance is referenced PIM1211 and PIM1212 on this subject matter.

http://www.hmrc.gov.uk/manuals/pimmanual/pim1211.htm

http://www.hmrc.gov.uk/manuals/pimmanual/pim1212.htm

I have seen suggestions in the past that where the improvements have been made to an employee director's property then some benefit in kind arises, however I doubt that this applies in this instance since the alleged benefit (value of improvements) arises NOT from the employment but from the directors status as landlord - and in any case no real benefit arises if the landlord is obliged to reimburse the tenant at vacation of premises.   

 

 

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