How do I treat this building cost

How do I treat this building cost

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Sole trader incorporated 3 years ago. Building that business operates from still owned by the sole director/shareholder, not by the ltd co. He now plans to extend the premises using ltd co cash. Should the cost be set againt the DLA and reduce its balance? Any chance of accounting for it as tenants improvements even though ltd co does not pay rent for the property (although it does pay the business rates)?

Also, what is the VAT position (can VAT be reclaimed by ltd co if the cost is effectively being borne by the director)?

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By DMGbus
17th Jul 2013 21:27

Tenants improvements = OK and VAT = OK

"Tenants improvements" is a phrase that I sometimes see in accounts where a tenant has incurred capital costs on leasehold property that the tenant occupies.

I see no problems (subject to certain provisos).(*)

And, yes a tenant can recover VAT incurred on such costs incurred for the purposes of its taxable business.

(*) Be careful that the improvements are not treated as a "deemed lease premium" in the landlords hands.     Advisable to have a clause / agreement eradicating this possibility.  That's what I did a couple of years ago when commercial property owned by a director was improved / adapted by the Ltd Co tenant for the purposes of its business.

I have seen dissenting views on AWeb to my above opinions, but found them NOT persuasive as "tenants improvements" is a normal long established scenario, but perhaps not encountered by many accountants and tax advisors on Aweb.

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By brucklay
17th Jul 2013 14:13

Thanks very much DMGbus

Will be wary of the deemed lease premium pothole!

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By henry williamson
18th Jul 2013 12:24

The question says...

...no rent is paid. This implies that there is no lease of the land so that the Company has no ownership in the land. If that is so, the Company is not a tenant so the extension cannot be tenant's fixtures.

Moreover, by operation of Land Law, the extension will become part of the land and therefore belong to the individual as freeholder, not to the Company.

Accordingly, the funds spent by the Company should be treated as advances to the individual and be charged to the DLA, as the questioner originally suggested.

Since the individual obtains ownership of the extension, the supply is to him, not to the Company. The VAT treatment follows from this.

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By DMGbus
18th Jul 2013 20:29

Tenants improvements advice

A Google search for this well-established scenario (where I have seen tenants receive compensation from their landlord for the improvements over the past several decades) will provide many results, here's one picked at random:

http://www.kerseys-law.co.uk/content/improvements-leasehold-business-pre...

with useful extracts to support my views that there is value that accrues to the tenant - no it is NOT a dead loss to the tenant as some would suggest.  No it is not a loan or advance to a director either.   And YES the VAT can be claimed where invoiced to the VAT registered tenant.

No rent needs to be paid.

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By henry williamson
19th Jul 2013 07:59

For there to be...

...tenant's improvements to a lease there has to be a lease in the first place. 

In the case in the question the individual freeholder has apparently not granted a lease to his company so the company has no lease which it could improve and no ownership in the property.

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By brucklay
20th Jul 2013 19:06

So...more complicated than I thought
Seems like this is more complicated than I thought then. Just for info, the property is in Scotland where freehold/leasehold is not particularly applicable , although with no rent being paid I suspected that we might be on sticky wicket as far as tenants improvements are concerned.

Thanks for your comments

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By plummy1
21st Jul 2013 10:13

Capital Allowances Position.

I'm not an accountant (but nodbodys perfect) so am coming at this from a capital allowances point of view. If your client was to lease the property to the company at a fair market rate, they as an individual could claim the capital allowances on the extension to offset the tax on the income. It would also be worth investigating the capital allowances history on the original purchase in any case.

This is the structure we come across most commonly when undertaking claim for individuals who own commercial property but also have a trading company in the premises.

 

 

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By Steve Kesby
21st Jul 2013 11:13

Oh not this again

In a "normal" case (and without a recent tribunal decision) I'd agree with DMGBus and disagree with Henry.

I certainly agree with Henry that there isn't a lease, but it's implicit by the individual's and the company's actions that (a) there's a licence to occupy the land (otherwise the company would be trespassing) and (b) there's a licence to carry out works to the land from which the licencee expects to benefit.

Starting with the VAT position though, the supply is a supply of services. It doesn't need to be the owner of the land that receives a supply of construction services. The person that receives the supply is the person that orders and pays for those services.

If they then immediately donate the product of those services to the owner of the land, that's their business. In order to recover input VAT there needs to be an intention that the supply will be used by the VAT registered person for the purposes of making taxable supplies and that does seem to be the intention. If the cost of the works is more than £250,000 then CGS may apply and there will need to be a restriction for any expected private use by the owner and ouput VAT will need to be accounted for if and when the extension de facto reverts to the owner.

From an accounting perspective economic substance prevails over legal form and the economic substance is that the company has an asset.

The problem comes with the benefit in kind position, particularly in the light of the recent FTT decision on the Foxcote Court issue in Denny. To my mind, the tribunal in Denny wasn't adequately directed towards, and therefore failed to give, adequate consideration of a proper apportionment under S.204 ITEPA 2003, which is a test of purpose (rather than legal effect); the purpose in a taxpayer's mind at the time of incurring the expenditure.

If this were a whole building, I'd again look beyond a strict legal analysis, and look at the wider commercial reality that the company is spending money on premises that it intends to occupy for the purposes of its business in the safe and certain knowledge that the owner of the land will permit that continued occupation for the foreseeable future, perhaps ad infinitum.

My problem in this particular case, bogged down by the Denny decision, is that part of the building is the individuals and the company has the economic benefit of just an enlarged area. If it were a whole building, I'd argue that Denny was wrong in not considering the S.204 apportionment and that the company spent the money in order to obtain the economic benefit of the entire building.

Rather than be charged to a benefit with a Class 1A cost it might be better to extract the funds by dividend in order to carry out the works privately, register for VAT and opt to tax, charge a rent and as John says, claim any capital allowances. VAT would need to be accounted for on the office element of the proceeds of any subsequent disposal of the property.

There are then also CGT issues if the property is subsequently sold. The office bit will not get PPR (either with or without the extension). Once you start charging rent though, you will also deny that chargeable gain entrepreneurs' relief.

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Replying to SNOOPDOG:
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By henry williamson
22nd Jul 2013 12:42

@ Steve Kesby: some points to consider

1. You say it is a supply of services but an extension to a building usually involves the supply of bricks, mortar, concrete, timber, uprights, crossbeams, floorboards, plasterboard, roof tiles, guttering, drainpipes, doors, windows, locks and handles as well as consumables such as plaster, paint, nails, and screws (and possibly sealing wax and string as well). All these sound like supplies of goods. Of course, there will also be the supply of construction services to build the extension.

2. By operation of Land Law the extension becomes part of the freehold premises so that all the goods supplied for its construction become owned by the freeholder. There is therefore a supply of those goods to the freeholder. The builders use the goods supplied to the freeholder to construct an extension on his land. The construction services are therefore also supplied to the freeholder.  

3. The company does not have any ownership interest in the land because there is no lease. The company therefore does not have any ownership of anything that is attached the land, which includes the extension.

5. In contrast, the freeholder owns the land and the premises, including the extension. If the freeholder sold the land, ownership of  the premises and extension would pass with the land to the buyer. 

4. The company may have an informal, undocumented licence to occupy the premises but that does not mean it has an asset because an asset is essentially something you have beneficial ownership of such that you can sell or otherwise dispose of it and keep the proceeds. An assignable lease is thus an asset but an informal, undocumented licence to occupy is not, not least because there is nothing the licensee owns or can dispose of. There is therefore nothing that the licensee beneficially owns that it could put in its balance sheet.

5 There is room to differ over what the substance of the proposed transaction is. A reasonable view would be that the freeholder is borrowing money from his company to fund the construction of an extension to his freehold premises. On that view, the appropriate accounting treatment for the company would be to charge the funds advanced to the DLA. If the freeholder prepares accounts the treatment would be to add the cost of the extension to the acquisition cost of the land and premises.

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By brucklay
22nd Jul 2013 08:38

Thanks all

Thanks everyone for your help.

I had no idea that this was going to be such a can of worms!

Think I need to pass to someone with more knowledge than I have from my few years in industry...bit too technical for someone like me!

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By Steve Kesby
22nd Jul 2013 14:05

Henry

1. Decided VAT cases have concluded that all those things put together is a single supply of services.

2. Decided VAT cases have concluded that services are supplied to the person that procures and pays for those services.

3. Agreed.

5. Agreed. No indication is given of the likelihood or otherwise of an imminent sale, but the owner of a company acting sensibly, knowing that the property was going to be sold in the foreseeable future, would act differently I'm sure.

4. Accounting standards to not require beneficial ownership before expenditure is recognised as being expenditure on an asset. All that is required is that future economic benefit will accrue, such as having some rent-free place from which to operate the business.

5. A more reasonable view is that the company, desirous of continuing to occupy the premises that it currently has at its disposal rent-free, but wanting them to be 20% larger (and with its licensor's consent), enlarges those premises, using its own funds in order to achieve its own purposes. As I've noted the Denny decision does seem to view things differently, but that may be because of the way that it was argued.

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By FoxAccountancyServices
29th Aug 2013 08:57

This has been a really interesting read :)

There is a question here...

http://www.book-keepers.org.uk/t54794598/how-treat-a-new-car-park/

Whilst this post above doesn't really concern me, I'd be interested to hear whether this type of situation would raise an issue?  How would the company proceed for tax relief, and regards the chairman - is he receiving a benefit from the, technically free, development of his land? (if he owns a retail property, surely changing a field to a car park would benefit him long term, if he decided to sell or rent to someone else?)  I assume there would be a lease in place, as the OP mentions rent.

Looking forward to hearing views on this :)

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