No Yuppies Allowed

ALLISON PLAGER produces a potted guide to the new 100 per cent capital allowances on expenditure on converting business properties into flats.

AS PART OF its drive to aid urban regeneration and solve the ever-growing housing problem, the Government in its Spring 2001 Budget introduced 100 per cent capital allowances for expenditure on renovating or converting space above shops and other commercial premises into flats for letting. This generous relief will enable property owners and occupiers to qualify for immediate tax relief on their capital expenditure in refurbishing former residential space over shops. Prior to the introduction of this relief, they received tax relief only on capital gain on the disposal of the property.

It is worth noting that the new legislation will enter the Capital Allowances Act 2001, and so is written in the tax law rewrite style. It should therefore be straightforward and easy to understand.

The new legislation is found under clause 67 of, and Schedule 19 to, the Finance Bill 2001, and brings it into the Capital Allowances Act 2001 as new sections 393A to 393W. The rules have been based on the industrial buildings allowances.

Section 393A states that allowances will be available to the person who incurred the expenditure and owns the flat. A flat is defined as a dwelling which:

• is a separate set of premises;
• forms part of the same building as the business;
• is divided horizontally from the other part of the building.

There are conditions attached to the expenditure, and these are described in section 393B. Not surprisingly, the expenditure must be of a capital nature incurred on or in connection with the conversion or renovation of part of a qualifying building into a qualifying flat. Expenditure on capital repairs related to that conversion may also qualify.

However, allowances will only be available where the building was unused or used only for storage for at least one year immediately prior to the commencement of the conversion. So there is no point in kicking out Uncle Herbert who lives over the chip shop, doing a quick refurbishment, letting out the flat to new tenants in order to claim the 100 per cent capital allowances – it will not work!

Not all types of expenditure will qualify for the relief. Examples of non-qualifying expenditure include:

• outlay in connection with the acquisition of land or rights in or over land;
• the cost of building an extension, unless it is to provide access to the flat;
• the development of land next to the flat;
• the provision of furnishings or chattels.

Finally, as mentioned earlier, the costs of repairs are allowable as capital expenditure as long as they would not be allowed as a deduction in calculating the Schedule A profits.

Before a building qualifies for allowances, it must meet all the following four conditions:

• All or most of the ground floor must be authorised for business use, i.e., under a town and country planning order.
• When the building was constructed, the floors above the ground floor must appear to have been primarily created for residential accommodation.
• There must be only four storeys in addition to the ground floor (not including attics).
• The building must have been originally built and completed before 1 January 1980, and any subsequent extensions must have been completed by the end of December 2000.

There are also a number of conditions that the converted flat must meet before it qualifies for allowances. It must, for instance:

• be in a qualifying building;
• be suitable for short-term, i.e., not more than five years, letting as a dwelling;
• be possible to gain access independently of the ground floor business;
• not have more than four rooms, excluding a kitchen, bathroom and closet or cloakroom of less than five square metres;
• not be a high value flat (as defined in section 393E), or be created as part of a scheme involving the creation of one or more high value flats;
• not be let to a person connected to the person who incurred the expenditure in the conversion.

Section 393D(4) states that if a qualifying flat has a period of being temporarily unsuitable for letting, it will not cease to be qualifying during that period.

The meaning of notional rent is set out in section 393E. It is the rent that could reasonably be expected for the flat on the relevant date assuming that the conversion has been completed, and let furnished. The relevant date is that when expenditure on conversion work is first incurred. There is a table setting out notional rent limits, and this is reproduced below. The limits are set at a very low level, particularly for London and the Home Counties.

The person who incurs the expenditure in renovating a flat has the relevant interest in the flat. Where that person has more than one interest in a flat, and one of the interests is reversionary on all the others, then the reversionary interest is the relevant one. Furthermore, if the relevant interest is one in the leasehold, and this is extinguished on the person acquiring an interest which is reversionary on it, then the merged interest becomes the relevant interest.

The 100 per cent capital allowances are given to the person who incurs the expenditure in relation to renovating the flat, but there is no compulsion for the claimant to take the full amount. A reduced amount can be claimed. The allowances will only be given on a qualifying flat, and will not be made if the person incurring the expenditure sells his interest before the flat is suitable for residential letting. Allowances which have been already given can be withdrawn.

Writing down allowances will be due to the person who incurs the expenditure on a qualifying flat, provided that the person has a relevant interest and has not granted a long lease, that is one that exceeds 50 years, of the flat out of the relevant interest.

If a balancing event takes place within seven years of the time when the flat was first suitable for letting, then a balancing adjustment will be made in the normal way, subject to specific relevant conditions. Section 393N lists balancing events for the purpose the new relief and these are clearly intended to sweep up all possible eventualities. They are as follows:

• the relevant interest in the flat is sold or (by virtue of section 573, Capital Allowances Act 2001) otherwise transferred into new ownership;
• a long lease is granted out of the relevant interest in return for a capital payment;
• where the relevant interest is a lease, that lease ends;
• the person who incurred the expenditure dies;
• the flat is demolished or destroyed;
• the flat ceases in another way to be a qualifying one.

A table in the legislation shows balancing events and the proceeds for each event. After seven years, no balancing adjustments will be applicable and the relief cannot then be recaptured on a sale. Note that there is no provision for any transfer of allowances to a new owner if a balancing event does occur in the initial seven-year period.

The legislation also covers the rules for writing off qualifying expenditure (sections 393Q, R and S), making apportionments if sums relate partly to non-qualifying assets (section 393U), and the termination of leases (section 393V). There is also a definition of the meaning of lease for the purposes of the relief. It is defined as an agreement for a lease, or any tenancy, but it does not include a mortgage.

It all looks pretty simple, a consequence no doubt of having been written in the tax law rewrite style to fit the new Capital Allowances Act 2001. In essence, as long as the relevant interest is satisfied, and the flat complies with the rules for qualification, the allowances are there for the taking. Much was made by the Opposition in Standing Committee debating the Bill of the maximum of four floors, and whether the ground floor would always be obvious. Having read the legislation, for once, Dawn Primarolo's response that it will largely be a matter of common sense seems fair.

There are, however, some potential oddities. For instance, the business has to be on the ground floor only, and cannot be spread up to the next floor. Although in many areas this will not signify, some shops (and there is no reason why they should be particularly upmarket) will take up two floors, and still have potential accommodation on the remaining one, two or three floors. While the Government's intended aims of regenerating urban areas and encouraging affordable rented accommodation are laudable, the legislation is rather narrow.

There does not appear from the legislation to be a deadline for the new relief, but as with all good things, it might be wise to act now, or at least consider acting soon, rather than leaving it.