Author: Julian Lewis
This article first appeared in issue 282 of the Property Law Journal, published by Legalease Ltd.
A Business Premises Renovation Allowance (BPRA) is available pursuant to a special regime that allows building owners to claim enhanced capital allowances on expenditure, that is incurred on unused commercial buildings to bring them back into commercial use.
They have three functions:
However, as discussed in more detail later, there has been surprising little uptake in BPRAs. At a time when high streets are suffering and government is keen to do what it can to revitalise town centres, it is encouraging that the duration of the scheme has been increased. Could the government close some of the restrictions that apply to BPRAs to encourage their use? We will look at that shortly, but first a recap of the BPRA rules.
How do BPRAs work?
BPRA is a form of capital allowance given at a rate of 100% of qualifying expenditure. As the top tax rate for individuals is currently 50%, an investor may effectively save up to 50% of the qualifying expenditure that they incur. Further, where the BPRAs arise in connection with a real estate business, they may be capable of being offset against an investor’s general income by way of sideways loss relief. However, the starting point is to determine which expenditure qualifies.
Qualifying expenditure Qualifying expenditure is expenditure incurred on:
Other than the overuse of the word qualifying by the parliamentary draftsman, what one can immediately notice from this is that qualifying expenditure is limited to the cost of works to refurbish an existing building. It does not include the cost of acquiring or extending the building, or developing adjacent land, or the cost of plant and machinery (although plant and machinery allowances may be available in respect of these costs).
Qualifying building A qualifying building is all or part of any building that:
A disadvantaged area is simply part of an area designated by government as disadvantaged. In practice, this currently covers large parts of the north and central England, Scotland and Wales and all of Northern Ireland. However, as mentioned later, the disadvantaged area map is to be redrawn from 1 January 2014 and this may have an effect on whether certain expenditure may qualify for relief.
In many cases it will be obvious whether a building is unused for a period of time but use does not equal occupation. For example, BPRA may not be available in respect of a building that has been used for storage within the last 12 months. The cost of any unused building in a disadvantaged area may be relatively small and this should enable a large proportion of expenditure incurred in connection with an acquisition and renovation project to qualify for BPRA.
Qualifying business premises
After renovation is completed, the building must constitute qualifying business premises; in short, it must be a building which is either used or let for the purposes of a trade, profession or vocation, or as offices and is not used as a dwelling. Hence, to date, it has been relatively straightforward to purchase an empty office block in a disadvantaged area, convert it into a hotel, which is let to a hotel operating company, and claim BPRA. It is important, however, that the hotel, once completed, is let rather than operated for the purposes of sideways loss relief (see below). Luckily, a number of ‘disadvantaged areas’ are in places which are both attractive to business and/or leisure visitors such as Birmingham, Liverpool and Newcastle.
Also, as mentioned above, the cost of converting an office building into a hotel is high, compared with the costs of the acquisition of the building. For example, it would be possible to acquire a dilapidated, unoccupied office building for a low capital value and spend a large sum of money converting it into a branded hotel such as ‘Hampton by Hilton’, ‘Travelodge’ or ‘Holiday Inn Express’. As such, approximately 75% or more of the combined project capital costs of the acquisition and renovation may be able to qualify for BPRA. Hence, BPRA has proved attractive to hoteliers. BPRA is also an attractive tax shelter for high earners. Assuming 80% of the project costs qualify for BPRA at 50%, a 50% rate tax payer investing in a project will be entitled to £40 for every £100 invested in the year in which they made that investment. If the development project is highly leveraged, interest costs will also be used to shelter income from the charge to taxation. This will reduce the property rental business profits to the business and enable more losses derived from BPRA to qualify for sideways loss relief.
What are the pitfalls?
In order to claim BPRA it is essential that all of the above criteria are met and, in case of challenge, that suitable evidence is produced to convince a sceptical HMRC official.
Hence, if anyone is buying a building with a view to claiming BPRA as refurbishment expenditure, they should satisfy themselves that the building has been vacant and not used (even for storage) for at least one year. We would recommend that one of the documents that the seller is required to hand over at completion, in addition to the usual transfer of assignment, is a statutory declaration or affidavit from a director of the seller confirming all relevant details.
In carrying out an assessment of a capital expenditure project which relies on BPRA, it is clearly essential to ensure that the expenditure qualifies for the relief and, therefore, we would recommend that specialist advice is sought to ensure that there is a proper understanding of the expenditure that will qualify for BPRA and that which may only qualify for standard capital allowances.
As the capital allowances arise in connection with the real estate business, as opposed to a trade, sideways loss relief is available to the extent that the loss is attributable to capital allowances. Normally, in the letting of the property to a hotel, initial rental receipts may be low, interest expenses may be high and so it is possible that a substantial part of BPRA generated from the expenditure incurred in connection with a hotel may be set against the investor’s general income by way of sideways loss relief.
BPRA can therefore prove a very effective and favourable tax shelter currently available to high earners. Enterprise zone allowances offered a similar rate of allowances to BPRA, but ceased as from April 2011. The enterprise investment scheme offers only 30% income tax relief; and investment via pension schemes is capped at £50,000 a year. The recently announced seed enterprise investment scheme potentially offers greater relief. However, the underlying investments may be riskier and the financial limitations may make the scheme less attractive than BPRA. Other types of tax-based investments available in the marketplace that may be challenged by HMRC for that reason are likely to carry a large amount of risk.
So what about the future?
BPRA was due to expire in 2012 but the period in which BPRA is available has now been extended until 2017. However, there are several proposed limitations on relief in the future. First, the exclusions from the definition of qualifying trade have been extended so that businesses in financial difficulties do not qualify, although in practice this may not be too great a concern. Second, as mentioned earlier, the existing definition of disadvantaged areas will be replaced with effect from 1 January 2014. Accordingly, care will be needed to ensure that any expenditure to be incurred on a site which is to cease to be in a disadvantaged area should be incurred before 2014, although the re-designation of disadvantaged areas may give rise to new opportunities for expenditure to be incurred on projects from that date. Perhaps the most fundamental change is that there will be a cap on qualifying expenditure at €20 million for each project.
Also, there is the spectre of a change to the rules concerning sideways loss relief for real estate transactions. HMRC launched a consultative document on 4 July 2011 concerning what it perceived to be the exploitation of sideways loss relief for tax avoidance purposes. The Institute of Chartered Accountants in England and Wales (ICAEW) and the Chartered Institute of Taxation (CIOT) responded to this and HMRC has yet to take any action. It is hoped that the government would aim to direct any changes it made to the existing sideways loss relief regime to prevent genuine tax avoidance rather than simply limit or abolish sideways loss relief altogether; any blanket amendment to the sideways loss relief regime may prejudice schemes like BPRA which simply seek to rely on government-approved tax reliefs to support the renovation of key areas of the UK.
The Treasury’s Budget 2011 policy costings estimated that in 2009-10 around 300 companies and unincorporated businesses claimed expenditure of around £90 million. Thus, it came as something of a surprise when the relief was extended for five years in this year’s budget. The total impact on tax revenues during the period of the extension was estimated by the Treasury to be only £90 million.
The figures on BPRA claims suggest that the government is not expecting significant advantage of the relief to be taken, despite the obvious attractions. Quite why this is the case given the cessation of enterprise zones and the attractiveness of the relief (especially when utilised in properly structured leveraged transactions) is unclear. To date the relief (at least in relation to structures intended to provide investors with tax sheltering opportunities) has been focused, we believe, almost exclusively on the branded hotel sector. It may well be that the opportunities for further development of branded hotels in the relevant areas is limited. The question that then arises is what other sectors would benefit from the use of the relief. The answer is limited to those sectors that fulfil the following criteria:
Perhaps there are not many sectors that can fulfil these criteria. The one that clearly can but which is excluded is residential investment and lettings.
Why not ‘residential’? As the detailed analysis above demonstrates, the allowance cannot be utilised for projects for conversion from commercial to residential use. This seems like a huge wasted opportunity. With the well publicised housing shortage and the growth in demand for rental property, given the difficulties of obtaining mortgage finance, allowing BPRA to be claimed for residential conversions could provide a huge boost to brownfield residential conversions whilst helping also to stimulate the construction sector. One could envisage a thriving subsector of the residential letting market, with investors acquiring redundant city centre office buildings and, with the assistance of BPRA, converting these to over seven-year residential investments potentially targeted at key workers. Such a course would be most welcome and would seem to accord well with government policy on both regeneration and encouraging house building.
Julian Lewis (email@example.com), partner, Fladgate LLP