CAPITAL ALLOWANCES FORFLATS ABOVE SHOPS

(“Flat Conversion Allowances”)

David Gibbens for NAEPP, 2009

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Copyright © NAEPP 2009

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Disclaimer

The National Association of Empty Property Practitioners (“NAEPP”)is an unincorporated association run by and for empty homes practitioners. Neither NAEPP nor any individual author identified in this work is a legal or accountancy practice or practitioner and nothing in this work should be construed as legal, financial or other professional advice. NAEPP has taken reasonable steps to ensure that the information contained in this work is correct but neither NAEPP nor any identified individual author will be liable for any loss or damage arising directly or indirectly from the possession, publication, or use of or reliance on the contents of this work. NAEPP and any identified author furnishes this work in good faith without express or implied warranty. If the information or advice you are seeking would have a material impact on your actions you must seek competent professional advice from a solicitor, accountant, financial advisor or other qualified expert.

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BACKGROUND

• Included in Budget 2001• In effect since May 11th 2001• Based on recommendation in Rogers

Report (Towards an Urban Renaissance)• Offers tax concessions for LOTS schemes: • Refurbishment /conversion of empty

space above shops into flats for rent

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TAX ISSUES• All qualifying expenditure tax-deductible• Can claim 100% in 1st Year• Can claim up to 25% in subsequent years

(“writing down allowance”)• Have flexibility to claim over time• The higher the tax rate the more you gain• If you don’t pay tax – you won’t benefit (eg

charitable RSL)

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EXAMPLE£100k flat conversion above shop:

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Tax rate on income against which allowance claimed

Additional Income

40p (top rate income) £40,000

30p (top rate corporation)

£30,000

20p (standard income) £20,000

(Note: these rates may not be up-to-date)

INEFFICIENT USE OF ALLOWANCE

Year 1 Allowance Claimed

Tax saving

Income taxed at 40p

£20,000 £20,000 £8,000

Income taxed at 20p

£35,000 £20,000 £4,000

Totals £55,000 £40,000 £12,000

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Total capital allowance available of £40,000Claimed as 100% allowance year 1

EFFICIENT USE OF ALLOWANCE

Year 1 Year 2 Year 3

Income taxed at 40p £20,000 £20,000 £20,000

Allowance claimed £20,000 £10,000 £10,000

Tax saving £8,000 £4,000 £4,000

Income taxed at 20p £35,000 £35,000 £35,000

Allowance claimed £0 £0 £0

Tax saving £0 £0 £0

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Example: total allowance available of £40,000Claimed as 50% in year 1, 25% in years 2&3

Total tax saving = £16,000 (vs. £12,000)

HOW DO YOU QUALIFY?“QUALIFYING PERSON” INCURRING

“QUALIFYING EXPENDITURE” ON

“QUALIFYING FLATS” WITHIN A

“QUALIFYING BUILDING”

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“QUALIFYING PERSON”You must• Have incurred the expenditure• Have the “relevant interest” in the flat• “Relevant Interest” = the interest

(freehold, leasehold) held when expense incurred

• Can sell a different interest (eg freeholder sells leasehold of up to 49 years)

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“QUALIFYING EXPENDITURE”

Capital expenditure including:• Conversion costs (new walls, services, doors,

windows etc.)• “capital repairs” – repairs which include

improvements, or required when building was bought

• Costs of accessRepairs are tax-deductible anyway

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NON-QUALIFYING EXPENDITURE

• Acquisition Costs• Extensions except for those required to

gain access to upper floors• Provision of furnishings, chattels• If part of a “larger scheme of development”

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“QUALIFYING BUILDING”• Ground floor authorised for (specified) business

use• Storeys above ground floor originally for use

primarily as dwellings • No more than 4 storeys above ground floor• Construction completed before 1st Jan 1980;

extension completed by 31st Dec 2000.• Upper floors empty for over a year

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GROUND FLOOR ISSUES (1)

• A1, A2, A3, B1 or D1(a) use classes• = retail shops, financial/professional services,

sale of food or drink, other offices, medical and health services

• = “high-street” uses

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GROUND FLOOR ISSUES (2)

• What about basement/semi-basement situations?– Common sense will prevail

• Authorised = “approved” for use – what if no planning permission (pre 1948)?– Based on business rating

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UPPER FLOOR ISSUES• Deciding original use must be matter for

common sense. Fireplaces?• Some business use permissible in original use

of upper floors• Attics not counted unless lived in• May be already converted

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EMPTINESS• An empty flat or space used only for storage• If part-empty, allowance pro-rated• How do you prove a flat is empty? No

specified standard of proof.

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PROOF OF EMPTINESS

• For VAT purposes (Notice 708):“If you hold a letter from an Empty Property Officer certifying that the property has not been lived in for X years, you do not need any other evidence. If an Empty Property Officer is unsure ….he should write with his best estimate.”

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“QUALIFYING FLAT” • Suitable for letting as dwelling• Held for the purpose of “short-term letting”• Accessible without going through business

premises• No more than 4 rooms• Not a “high-value” flat• Not part of a scheme for high-value flats• Not let to a “connected person”

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DEFINITIONS (or not) - 1

“Suitable for letting” (after conversion)• not defined: fitness standard; HHSRS?• OK if flat empty provided “actively marketed”• Can be unsuitable between lettings (how long?)

“Short-term letting” • means less than 5 years; includes: • AST with fixed term < 5 years; • statutory periodic tenancy following fixed term• full assured periodic? – not clear

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DEFINITIONS (or not) - 2

“Held for the purpose of” – relates to end use of flat

“Room”Excludes kitchens and bathrooms, closets,

cloakrooms, hallways < 5sq.M.Through rooms and “kitchen-diners” will

count as one room

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DEFINITIONS - 3“High-value flats” - depends on “notional”

rent if let furnished on AST

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1 or 2 rooms £150 pw*

3 rooms £225 pw*

4 rooms £300 pw*

(*= these figures subject to change – check hmrc site for latest figures)

BALANCING ADJUSTMENTS – CONTINUING TO QUALIFY

Apply if you no longer meet qualifying criteria egyou dispose of the relevant interestthe flat is no longer a qualifying flat orthe building is no longer a qualifying buildingYou are likely to have to repay most of the money. But this only applies for 7 years.

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FLEXIBILITY

• You can’t dispose of relevant interest – but you can sell another interest including long leasehold up to 49 years

• So freeholder could claim capital allowance and still sell upper floors to RSL on 29 year lease (TSH) AFTER COMPLETION

• Or long-leaseholder of upper floor could sell shorter lease to RSL

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Incurring expenditure

• Charitable RSL could not afford to incur expenditure on conversion (as don’t pay tax)

• So to reap benefits, owner would have to do work and RSL would have to reimburse via lease premium.

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EH?(some of this is technical!)

“Where the relevant interest is leasehold and it is extinguished by the person acquiring another interest, which is reversionary on it, the interest into which the leasehold merges becomes the relevant interest”

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DOES IT WORK?

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SORT OF• Survey gathered 216 replies• 19% from the South West (highest %)• Only 7 out of 216 managed by RSLs• 29% said FCAs had no influence• 28% said FCAs “very influential”• 59% would have done it anyway• (41% wouldn’t, presumably)• Little clustering (= regeneration)

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LOCAL AUTHORITIES

• (only) 10 LA’s interviewed.• None featured FCA’s in their toolkits, even

where LOTS was important• “would have liked signposting and promotion

by government”

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HOW CAN WE USE IT?• Non-charitable RSLs paying tax on

surpluses can benefit directly How do we encourage this?

• What partnerships can we establish?• How could charitable RSLs benefit?• How do we publicise it? • How do we work with financial advisers ?

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WISH LIST• Pro-active RSL?• Market-renting?• Sub-market renting for Homeless Households?• Good developer ready to do deals with RSLs• Ditto – willing to lease to Councils• Full package for owners – design, financial

advice, builders all on board

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GRANT AND LOAN ISSUES

• Grant will reduce capital costs• Therefore tax relief will be lost• Means inefficient use of grant• Therefore loans definitely preferable• This applies to both SHG and Private Sector

Renewal grant

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Grant / Loan Example – no grant

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Cost £100,000Grant £0

Cost after Grant £100,000Tax rate 40p in £

Capital Allowance £40,000Net Cost to developer £60,000

Net cost to HMRC £40,000

Grant / Loan Example –grant

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Cost £100,000Grant £30,000

Cost after Grant £70,000Tax rate 40p in £

Capital Allowance £28,000Net Cost to developer £42,000

Net cost to HMRC £28,000