Crafty renovations

A long-awaited consultation documentation relating to proposals to introduce a scheme aimed at rejuvenating business premises in designated disadvantaged areas was published by the chancellor of the Exchequer in his 2004 pre-Budget report.

The business premises renovation allowance (BPRA) will operate so as to provide 100% first-year allowances for the capital costs incurred by businesses in converting or renovating business premises in designated disadvantaged areas that have been vacant for at least a year, in order to bring them back into business use.

The proposals for the introduction of BPRA have already been the subject of a long gestation period. They were originally aired in the 2003 Pre-Budget Report and the current consultation runs until 1 March 2005. No firm date has been given in the document as to when enabling legislation will be introduced but, given the strong likelihood of a general election during May 2005, the first opportunity would seem to be either a Finance (No 2) Act 2005 or, more likely, the Finance Act 2006.

Delayed introduction

BPRA will be regarded under the European Community Treaty as state aid and, for this reason, will require prior approval from the European Commission which enforces the relevant rules and generally controls and monitors the grant of state aid.

Given this requirement to obtain prior approval, it is conceivable that the Commission could block the Inland Revenue's proposals by reaching a 'negative decision'. Alternatively, it could approve the proposals but make them subject to further amendments or additional conditions. This uncertainty means that it is currently very difficult for taxpayers to assess, with confidence, the potential impact of BPRA on their operations and to conclude how best to position themselves in order to take full advantage of it. Should, for instance, taxpayers defer major capital improvement programs until the final form of the legislation has been established? Or should the commercial opportunities in an overheated real estate market be seized without delay, regardless of the tax considerations?

BPRA will be available to individuals and companies, regardless of size, who own or lease business property in 2,000 designated enterprise areas that has been unused for at least twelve months. The scheme will operate so as to allow individuals and companies to claim tax relief on their capital spending on the renovation or conversion of the property to bring it back into business use. BPRA will, however, be a temporary provision that is expected to expire five years after the date of its introduction.

How will BPRA work?Turning to the detail of the provisions, the Government has proposed a vacant period of at least twelve months that may be proved by reference to reduced levels of business rates payable in respect of unoccupied premises. There will, inevitably, be a significant impact on businesses.

• Some businesses will, invariably, seek to structure their real estate interests in order to ensure that they are able to take full advantage of BPRA. This may well include ensuring that specific premises remain vacant for the prerequisite period to allow them to fall within the BPRA provisions.
• Significant numbers of businesses lack a cohesive and robust real estate strategy to support their commercial operations. Although real estate expenses comprise a significant component of the overall costs of a business, it is often the case that the actual real estate interests held by businesses are not wholly responsive to the specific commercial requirements of the business. BPRA could, potentially, act as an incentive for businesses in enterprise areas to review their real estate policies more objectively and be more proactive in taking steps to optimise their respective real estate holdings.

Who qualifies?

BPRA will apply to all businesses, be they investors in real estate or occupiers, and regardless of their size. The Government considers that if the provisions were made available exclusively to small and medium-sized enterprises there would be a danger that this class of taxpayer would not possess the necessary resources to take proper advantage of the opportunities available. In making available the BPRA provisions to all taxpayers, the Government is ensuring that maximum economic effect is leveraged from the BPRA proposals. It should not go unnoticed that there has already been significant interest on the part of UK and overseas property investors in disadvantaged areas and we believe this interest is likely to be further raised when the new provisions are introduced.

The BPRA provisions require the unused part of business premises to be capable of proper identification and for them to be physically distinguished. It is, for instance, not possible to claim a part of the business premises as vacant and claim BPRA in respect of that specific part. The vacant premises for which BPRA is available must be capable of separate identification and must be ring-fenced from other business premises that may be in occupation.

A fairer approach would be for the Revenue to consider the full facts and to take a pragmatic approach in line with the overall sentiments of the legislation. In our view, the hurdle for BPRA has been set at rather a high level and it is possible that a significant number of taxpayers will be prevented from taking full advantage of the provisions.

How much?

BPRA provides for 100% first year allowances for the capital costs of the renovation and conversion work, for the chargeable period in which the qualifying expenditure is incurred. Where the full amount of the claim is not made, it will be possible to carry forward the balance of any unrelieved expenditure to future accounting periods and obtain a writing down allowance on that expenditure at a rate of 25% on a reducing balance basis. In providing for a 100% first-year allowance, the effect will be:

• to accelerate the relief obtained in respect of certain buildings (for instance industrial premises); and
• to introduce a relief for expenditure in respect of, say, shops and certain commercial premises where one is not otherwise available.

In the case of landlords investing in property, BPRA is likely to mitigate any continuing taxation liabilities. Given that the level of tax arising from real estate investments in enterprise areas is likely to be substantially reduced this could well inspire landlords to offer keener lease terms to potential tenants.There are extensive provisions regarding the clawback of BPRA previously given if a balancing event occurs within seven years of the premises being used or made available and suitable for letting for business use. A balancing event includes:

• the sale of the building;
• the grant of a long lease; and
• the demolition or destruction of the building.

If the proceeds received are less than the residue of qualifying expenditure, a balancing allowance will be available. If the proceeds received exceed the qualifying expenditure then the quantum of the balancing charge is restricted to the initial allowance or the writing down allowances previously given. In order to avoid the potential clawback of allowances, it is possible that taxpayers will structure potential exits so as to ensure that a clawback does not happen. Typical approaches may include:

• Structuring sales through the disposal of the shares of an asset owning company as opposed to the disposal of the asset.
• Ensuring that a 'balancing event' does not occur until after the expiry of the seven-year period. This will necessarily entail adoption of a more structured approach to sales of business premises.

Could have done more

The concept of BPRA makes eminent sense and the Government is to be applauded for having had the political will to pursue a programme that will assist in rejuvenating some of the most deprived areas within the UK. However, given the obvious social, environmental and economic benefits to be gained from this initiative, it is debatable whether ministers should have taken a more urgent approach in order to expedite the introduction of the provisions which have now been mooted for over a year.

Turning to the draft proposals our specific concerns are as follows.

• Since approval will be required from the European Commission there will be a further period of uncertainty before the final form of the provisions can be established.
• The Revenue has sought to identify that part of vacant business premises which may qualify for BPRA in a rather unsatisfactory way. We recommend that a more pragmatic approach be taken that accommodates the specific circumstances of taxpayers and meets the overall aims of the legislation.
• The proposed period of five years for the maintenance of the BPRA provisions is considered to be too short, particularly for more extensive programmes that are being contemplated by certain property groups. In order to cater for such programs, the BPRA legislation should be maintained for a minimum of, say, seven years. Given that many of the designated enterprise areas have witnessed substantial industrial decay over a protracted period, a five year 'window of opportunity' is unlikely to be sufficient to enable some of the more systemic and deep-rooted issues to be properly addressed.
• A seven-year lock-in period for avoiding a potential balancing charge appears excessive. We consider that many investors and occupiers will find this aspect particularly stifling and recommend that it be reduced to a more reasonable length.
• The interaction of BPRA with existing tax reliefs, e.g. those for decontaminated land relief, should be given due consideration in the drafting of the legislation.

The phrase 'may you live in interesting times' is one that is most apt for UK commercial real estate.

A potent mix of BPRA, international accounting standards, corporation tax reform and the potential introduction of a UK real estate investment trust will yield some interesting results.

These proposals are welcome and we look forward with interest to their passage from consultation document into statutory provisions.

Issue: 3989 / Categories: Comment & Analysis , Business , Capital allowances