interest on borrowing for capital expenditure purpose?

Wellydancer

hello, would anyone be able to help please. Would a loan aquired to build and start a retail shop be classed as capital expenditure for a sole trader?
Was told that interest on borrowing for capital expenditure purposes is not deductible in computing reckonable income.

Legend100

well presumably you would have used the loan to purchase capital items such as fixtures and fittings so the interest should not be expensed and should be capitalised. Effectively what this means is that you wdnt get an immediate deduction against income rather an annual write down as depreciation as the interest would be capitalised as part of the fixet asset the loan was used for

Wellydancer

Legend100 wrote: »

well presumably you would have used the loan to purchase capital items such as fixtures and fittings so the interest should not be expensed and should be capitalised. Effectively what this means is that you wdnt get an immediate deduction against income rather an annual write down as depreciation as the interest would be capitalised as part of the fixet asset the loan was used for

Thank you

Sand Wedge

If he is making monthly repayments and paying off the interest on the Loan can he not claim this as a deductible expense?

Legend100

The loan is not for working capital requirements so under ias 23 he sould be capitalising it for the purchase of his assets given that it is a start up company

Sand Wedge

He is not a company, he is a sole trader. And he can use Uk & Irish standards accounting standards instead of international accounting standards! Does this make a difference?

Legend100

standard is still the same under frs 23, the ias didnt change the matter.

This is from frs 23
[FONT=&quot]10. Borrowing costs should be recognised as an expense in the period in which they are incurred, except to the extent that they are capitalised in accordance with paragraph 11.[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]11. Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. The amount of borrowing costs eligible for capitalisation should be determined in accordance with this Standard.[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]12. Under the allowed alternative treatment, borrowing costs that are directly attributable to the acquisition, construction or production of an asset are included in the cost of that asset. Such borrowing costs are capitalised as part of the cost of the asset when it is probable that they will result in future economic benefits to the enterprise and the costs can be measured reliably. Other borrowing costs are recognised as an expense in the period in which they are incurred.[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]Borrowing Costs Eligible for Capitalisation[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]13. The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made. When an enterprise borrows funds specifically for the purpose of obtaining a particular qualifying asset, the borrowing costs that directly relate to that qualifying asset can be readily identified.[/FONT]

kluivert

i have never read such a long winded and incorrect answer .

To the OP.

To answer your question the interest on the borrowings can be offset against income.

I would advise this method over captalising the interest because it will reduce your taxable profits meaning less money to pay to the Revenue.

Legend100

not ina startup situation kluivert

if he borrows 50k for 50 k of assets, dyu honestly think the revenue will allow the full interest deduction against a potential profit. After being involved in a few revenue audits, i bet my house on it that they would not. he might be able to claim it as a charge but it is debatable

kluivert

I must be confused with something else.

He borrows 50k for 50k of assets.

The Interest charged on this loan in Year 1 is say 2k.

Are you saying that he can not include this interest in his Profit and Loss account?

Legend100

Technically no beacuse he is bringing the asset to its use (he is building the shop) and should cease capitalisation when the asset is ready for use so in that first year (lets assume it takes him a year to build it) the 2k should be capitalised from the accounting pt of view rather than the tax pt of view (claim as a charge against case 1)

kluivert

Thanks Legend.

Legend100

oh and i was going to say that i know when its only 2k you might get away expensing it as its a sole trader but i was just giving the technical answer but we dont really know the figures involved. i wdnt have a notion how much of a loan one would need to take out to build a shop so OP i suggest you discuss it with your accountant

Justintime

Legend, I'm afraid that you are not fully correct from an accounting perspective. The standard is not FRS 23 but IAS 23 and yes, IAS 23 does require the interest cost on an asset that is self constructed to be capitalised during the construction period. The local standard is FRS 15 and this alows either capitalisation of the interest cost of expensing of it to the P&L (the capitalisation of the cost is an allowable alternative). Only listed group parent companies have to apply the international accounting standards with effect from January 2005 so the OP will certainly not be applying them. In any event, it's not an accounting issue but a tax issue and the interest will be an allowable expense as incurred.

HeinekenTicket

Back up the truck legend100, you are incorrectly mixing and matching:
(i)[FONT=&quot] [/FONT]FRS 23 on foreign exchange is not the relevant ASB standard. The relevant ASB standard is FRS 15 on tangible fixed assets.
(ii)[FONT=&quot] [/FONT]There is a relevant difference between FRS 15 and IAS 23.
(iii)[FONT=&quot] [/FONT]FRS 15 permits but does not require capitalisation of finance costs (paras 19 and 20). It is therefore a matter of accounting policy.
(iv)[FONT=&quot] [/FONT]If the OP opts to capitalise finance costs under FRS 15 (which I doubt), the capitalisation process ceases in any case when the asset is ready for use. Once the retail unit is substantially ready for use, finance costs would be expensed. I doubt that the time required to get the retail shop ready for use would, in any case, be particularly long, so I wouldn’t expect the amount of finance cost to be capitalised to be very much if this accounting policy was adopted.
(v)[FONT=&quot] [/FONT]Any finance cost expensed would be claimed for tax in the usual way and the finance cost capitalised, if any, would be claimed for tax purposes through capital allowances.
(vi)[FONT=&quot] [/FONT]If the OP is preparing accounts under the IASB framework (which I doubt), IAS 23 requires capitalisation of borrowing costs for qualifying assets. Qualifying assets necessarily take a substantial period of time to get ready for use. Again, I doubt that the retail unit in question is going to take that long to get ready such that it would fall to be treated as a qualifying asset. The OP may like to clarify this – if the retail unit is being built on a greenfield site, it would obviously take longer than refurbishing a unit in an existing building.
In conclusion, unless the OP opts to (i) prepare accounts in accordance with international standards and (ii) the asset is a qualifying asset, the OP could expense the borrowing costs.
Legend, your paragraph references also suggest to me that you are looking at a version of IAS 23 that has been superseded.
I hope this clarifies.

Legend100

Yes i had been reading an un ammended version of the standard heineken, thanks for pointing it out, just saw the caveat at the end referencing the revised issue.

Apologies. would still question the full expensing of the interest on a tax view given the substance over form argument with regards to capital expenditure