Dilapidations - Not as taxing as you might think
By Emily Martin
Dilapidations are breaches of conditions under a lease of property to repair a building. Such breaches can take many forms, but redecorating, replacing carpets, or repairing a broken window are some common examples.
Over recent years, it has been reported in the press that the number of claims served by landlords against tenants has been on the increase. This comes as no surprise when considering the climate of the commercial property market during this period. With little capital available for large-scale redevelopments, landlords are adopting a more cost-conscious approach to re-conditioning their premises. Smaller repairing and decorating works have become more favourable, with landlords increasingly looking to seek compensation from tenants. This has led to the dramatic rise in the use of dilapidation schedules.
Provisions for Dilapidations
A schedule of dilapidations can be issued by a landlord at any time during a tenancy and up to several months after the end of the agreement. Typically a tenant would be advised to make a dilapidation provision within their profit and loss account so to make a consideration for the future cost of the schedule.
If a tenant has made a provision for future dilapidations, then there is an opportunity to claim deductions for tax purposes when the provision is made. This is because the provision itself is made in anticipation of future expenditure on the repair of the premises. If the tenant meets the following criteria as outlined under the Financial Reporting Standard 12, then the provision will be a specific provision.
• The entity must have a present obligation as a result of a past event (this is most likely to be a contractual obligation)
• It must be probable that a transfer of economic benefits will be required to settle the obligations
• A reliable estimate must be made of the amount of the obligation
The property in question must also be used for business purposes and the lessee must be responsible for repairs to the property and have an obligation to deliver the property in the state in which it was at the beginning of the lease. If these conditions are met then the tenant may be eligible to take tax deductions for the dilapidations provision, reducing their taxable profit.
The provision attracts a different tax treatment depending on whether the provision is a general provision or a specific provision. A tax deduction is not allowed for a general provision, but may be allowed for a certain proportion of a specific provision.
The dilapidations to be carried out may cover a variety of works, which for tax purposes may be either capital or revenue in nature. Some examples of capital works include:
• the cost of rebuilding the leased premises, or
• the cost of re-instatement of any portion of the leased premises which has been demolished by the lessee, or
• the cost of the demolition of any structure which the lessee has added.
Expenditure on dilapidations that are deferred repairs is allowable as a deduction to the extent that the cost would have been allowable if the repairs had been carried out during the term of the lease.
Under Corporation Tax Act 2009, section 53, the proportion of the specific provision that relates to works that are capital in nature will not be deductible for tax purposes. However, a full deduction can be taken for the remainder of the provision.
The capital proportion of the provision made, as established, is not tax deductible. Nevertheless, once the lease terminates and expenditure is actually made on capital then a proportion of this may qualify for capital allowances under Capital Allowances Act 2001.
Timing and Adjustments
If a dilapidations provision has been made
Where a dilapidations provision has been made, the amount that is assigned to the revenue works is tax deductible as and when the provision is taken. A provision will be deductible provided that:
• the profit would not be adequately stated if the obligation was not taken into account;
• a provision is made within the accounts; and
• a sufficiently reliable figure has been adopted.
This means that, upon the end of the lease when the final works are carried out and the actual cost for these works is known, it is likely that an adjustment will need to be made. If the provision was in excess of the actual expenditure, then the difference is added back to the taxable income and taxed in the year of the works. If there is an under provision, then the excess actual expenditure is allowable for tax as a deduction within the year.
Where a tenant has previously only set up a general provision, Bourne has experience in valuing the dilapidations that will be required at the end of the lease, in order to provide the necessary basis for treating part of the general provision as a specific provision. This figure can be backdated and a catch-up deduction taken in the earliest open tax return.
So, despite the actual cost of dilapidations occurring within a relatively small time period at the end of the lease term, it is possible to take tax deductions far in advance of the expenditure being incurred, establishing a potentially valuable timing benefit.
If no dilapidations provision has been made
If no provision for dilapidations is made, then relief for the expenditure will be given when the actual expenditure is incurred. Where expenditure is incurred on dilapidations only at the end of the lease, then the relief will be given at that point.
Therefore with the different treatments that can apply it is worth considering what approach to adopt in respect of potential dilapidations under a lease.
Bourne Business Consulting LLP specialises in asset taxation, including related matters such as dilapidations. If you have any queries regarding this topic or any other asset taxation issues, please do not hesitate to contact us.
Emily is a manager at Bourne Business Consulting LLP with over four years of experience working as a specialist in tax depreciation on diverse projects such as maximising claims for land remediation relief and maximising research and development expenditure on the purchase of R&D facilities.