Introduction

As a general matter of tax law, capital expenditure cannot be deducted against revenue income. Such expenditure is generally relieved only on disposal of the asset on which expenditure has been incurred.

The tax rules allow a degree of relief for capital expenditure by way of the capital allowances code. The code is notoriously restrictive when compared (for example) to accounting depreciation.

Capital allowances provide a shelter from tax by reducing (on a pound-for-pound basis) the amount of income subject to tax. For investors in UK real estate, capital allowances can shelter rents from tax. They are available to income tax payers and corporation tax payers. They are particularly attractive to additional rate (50%) tax payers. Allowances are not automatically given; a tax payer must take positive steps to claim them in his tax return.

Business premises renovation allowance (BPRA) is a fiscal incentive intended to bring derelict or unused buildings in "assisted" (formerly disadvantaged) areas back into productive use. It is intended to create opportunities for regeneration and job creation, and to reduce pressure on greenfield sites.

BPRA is "personal" to the person incurring the relevant expenditure. The benefit of BPRAs cannot, therefore, be passed on to (or inherited by) a purchaser of the building that otherwise qualifies for BPRA. A sale (for example) may impose a balancing adjustment on the tax payer, and rights to BPRA in respect of the original expenditure may then be lost forever. Timing needs careful consideration to ensure that the right person incurs expenditure.

BPRA conditions

Expenditure incurred on or after 11 April 2007 and before 11 April 2017 will qualify for the allowance. There is no monetary cap or ceiling on such expenditure.

When is expenditure incurred?

The general rule is that it is incurred on the date on which the obligation to pay becomes unconditional (irrespective of the date when payment is actually made). There are some detailed rules and exceptions (for example, around milestone contracts, options and retentions). Also, there are anti-avoidance rules to counter arrangements intended to bring forward the date on which expenditure is incurred.

Other conditions

As with all valuable tax reliefs, there are many conditions to be satisfied before the allowance is given.

1. Principal among these conditions is that the premises must be situated in one of the disadvantaged areas specified by the Assisted Areas Order 2007 (SI 2007/107).

  • See www.opsi.gov.uk/si/si2007/uksi_20070107_en.pdf for a list of such areas (which are identified on a ward-by-ward basis).
  • There are "reasonable apportionment" rules where the building is partly in and partly outside an assisted area - that part within the assisted area is eligible for BPRA.
  • The test is met where, on the date when the works begin, the premises are in an assisted area. Subsequent withdrawal of assisted area status is therefore irrelevant.

2.  A person must incur qualifying expenditure in order to claim BPRA

  • Qualifying expenditure is capital expenditure on:
  1. converting a qualifying building into qualifying business premises, or
  2. renovating a qualifying building that is, or will be, qualifying business premises, and
  3. repairs, to the extent that they are incidental to (a) or (b).
  • Excluded from qualifying is any expenditure on:
  1. acquiring land or rights in (or over) land,
  2. extending a qualifying building,
  3. developing land adjacent to or adjoining a qualifying building, and
  4. plant and machinery, other than that which is a fixture for capital allowance purposes.

3. What is a qualifying building?

  • It is a commercial building or structure in an assisted area.
  • That building must last have been used for commercial purposes but cannot have been used for anything for a period of 12 months immediately before the date on which work begins.

4. What are qualifying business premises?

  • It is a building used, or is available and suitable for letting for use, as a commercial building (i.e. one used for the purposes of a trade, profession or vocation, or as offices).
  • Dwellings are excluded, as is use for certain specialised trades.

5. In order to claim the allowance, a tax payer must have a "relevant interest" in the qualifying building at the time the expenditure is incurred. A freehold is a relevant interest, as is a lease and even a licence to occupy.

The initial allowance - and its use

There is an initial BPRA, and this is 100% of qualifying expenditure. It is given as a deduction against UK property income in the period in which qualifying expenditure is incurred. Given the generosity of the allowance, BPRA is very likely to result in a significant loss in any UK property business.

Where an investor, landlord or other person carrying on a UK property business (alone or in partnership) incurs a loss in that business in a tax year, relief is given by way of carry forward to set off profits arising from that business in later years.

An alternative way of relieving such a loss is far more valuable. As long as allowances exceed balancing charges, then a loss can be relieved against a person's general income (income from any source) of the same tax year and the following one. This is very likely to be the case in the BPRA context.

This "gateway" to relief against general income significantly enhances the flexibility of losses created by BPRA. Setting such losses against general income could create significant income tax saving - at current rates of up to 50%.

Beware the clawback!

The initial allowance is withdrawn where a "balancing event" occurs within seven years of the first use of the building.

A balancing event is any of: a sale of the building; a grant of a long lease for a capital sum; the death of the person who incurred the qualifying expenditure; the demolition or destruction of the qualifying building; the building ceasing to be qualifying business premises; and, where the relevant interest is a lease, the termination of that lease without the tax payer then acquiring the reversionary interest.

A balancing event is likely to result in a balancing charge. The effect is that there is a clawback of the BPRAs previously given. Particular care should be exercised where a lease is re-geared or varied, as this may result in a termination of the original lease - and a balancing charge will be triggered.

Any capital investment should therefore be a long-term play, with the anticipated lock-in period being at least seven years after the renovation or conversion work has been completed (extending the investment period to, say, 10 years).

Writing-down of BPRA allowances

A person entitled to claim BPRA may claim a reduced amount (i.e. not the whole 100%).Any balance of expenditure (i.e. after deducting the initial BPRA allowance actually claimed) qualifies for writing down allowances (WDAs), provided the property interest is still held, no long lease has been granted at a premium and the premises continue to be qualifying business premises.

WDAs are given at an annual rate of 25% on a straight-line basis until all qualifying expenditure has been relieved.

Topical issues for BPRA investors

A number of BPRA investors (particularly syndicates) are currently facing difficulties. Where lenders are exposed on property values, some are threatening to appoint LPA receivers to sell the property. As we have seen, a sale is a balancing event and the investor's BPRAs are clawed back. That threat seems to be used as leverage to "persuade" investors to contribute more capital (and make the lender's position more comfortable). A properly structured BPRA fund (where, for example, the relevant interest of investors is different from the interest used to secure bank lending) would avoid this issue.

  • The Supreme Court decision in the Tower MCashback case [2011] UKSC 19 has, to some commentators, created uncertainty on the availability of allowances where bank lending is used - particularly on a non-recourse or limited recourse basis, or on other "soft" terms. Can it be said, in such situations, that an investor has "incurred" expenditure when a proportion of that expenditure has been funded using bank money and the tax payer has no, or limited, economic risk? If it cannot, then the concern is that allowances would be denied.
  • HMRC has completed a consultation on introducing further restrictions on using capital allowances to set against non-rental income. Suggested approaches might be: to limit the amount of set-off to £25,000 per tax payer or to the amount of actual economic loss suffered (as determined by HMRC), or to deny relief until HMRC has blessed a claim. This might constitute a serious devaluing of BPRAs and be a serious disincentive to regeneration.