RLA : RPI : Brown's conversion

News from the Residential Property Investor, the bi-monthly magazine for RLA members

other artilces from the April / May 2001 issue

Brown's conversion - April / May 2001

Budget measures intended to encourage conversion of properties into residential use come with numerous caveats, warn Direct tax Lakshmi Narain and Michael Ussher, tax and VAT specialists with the accounting firm Baker Tilly.

Landlords may have been cheered by some aspects of this year's Budget, especially the granting of 100 per cent capital allowances on the cost of converting space above shops into residential accommodation.

But enthusiasm for this particular relief is likely to be muted by the serious limitations attached. Certainly, it will enable some property owners and occupiers to claim up-front tax relief on the whole of their capital spending on the renovation or conversion of vacant or underused space above shops and other commercial premises so as to provide flats for rent. But the scheme is intended to focus only on properties in traditional shopping areas.

The Inland Revenue has explained that to qualify the property must have been built before 1980 and must not have more than five floors in total (including accommodation in the roof, but excluding any basements). Further, it must originally have been constructed so that the floors above the ground floor were primarily for residential use. The ground floor may have originally been intended for residential, commercial, or mixed use.

Further, at the time conversion work starts, the whole or the greater part of the ground floor must be rated (in England and Wales) as:

A1 - broadly speaking, retail shops;
A2 - financial and professional services;
A3 - food and drink;
B1 - offices not in A2, research and development and industrial processes which can be carried out in residential areas; or
D1(a) - medical and health ser vices, such as doctor's surgeries and dental practices.

The scheme is intended to cover the same types of property in Scotland and Northern Ireland under corresponding ratings legislation.

Conditions continue to flow the upper floors must have been either unoccupied, or used only for storage, for at least one year before the conversion work starts. The qualifying expenditure will be apportioned if only part of the upper floors satisfy this test.

There are also specific conditions as to the flats produced. In particular, the conversion must take place within the existing boundaries of the building. While extensions will qualify if they are required only to provide access to the flat or flats, conversions which form part of a larger development, will not qualify. Each new flat must be self-contained, with external access separate from the ground floor premises, and must have no more than four rooms, excluding kitchen and bathroom and small areas such as cloakrooms and hallways. Finally, there will also be limits to exclude high value flats from the scheme.

The relief will be based on those for capital allowances for industrial buildings (IBA), but with various simplifications and modification: there will be no recovery of allowances if a 'balancing event' takes place more than seven years from the time the flat is completed and suitable for letting. In this regard 'balancing events' can include transfer of the relevant interest in the flat to another person, the granting of a long lease in the flat for a capital sum, or the flat ceasing to be let, or held out for letting. The allowances will not, however, be transferable to a purchaser.

Before rushing out, you should note that expenditure will qualify for the new 100 per cent capital allowances not from Budget day but as and when legislation on the matter receives Royal Assent. As we may be faced with a general election and a truncated Finance Act, these proposals may end up being deferred until the autumn.

The Budget also confirmed a number of the changes in VAT which had already been set out by the Chancellor in his pre-Budget statement. The main changes affecting residential property are introduction of a reduced rate of 5 per cent for certain renovations and conversions, and an extension in the application of the zero rate.

The VAT rate will be reduced to 5 per cent for the cost of renovating dwellings that have been empty for three or more years, of converting a residential property into a different number of dwellings (converting a house into flats), of converting a non-residential building into a dwelling or number of dwellings and of converting a dwelling into a care home or for another relevant residential use or into a home in multiple occupation. All of the above changes will come into effect on the day after Royal Assent.

They are all welcome developments and reduced the rate to the lowest permitted under EU rules. However, there is still a discrepancy between the VAT rate applicable to conversions costs, 5 per cent, and that applicable to the costs of constructing of new dwellings, which remains zero. Additionally, the new reduced rate is likely to be restricted to construction services themselves and will not extend to the services of professionals such as architects. VAT on professional fees is usually recoverable on the construction of new dwellings, but will remain unrecoverable for most renovated properties other than when the conversion is from a commercial to a residential property and the subsequent supply is itself zero rated.

Additionally, the zero rating schedule will be extended to include relief for renovated homes that have been empty for 10 years. This is a significant extension of the current relief which stipulates the property must not have been used for residential purposes since the inception of VAT in 1973. It will, however, still be possible to use the old relief in instances where commercial properties which may have been in use within the last 10 years are being converted for residential purposes.

The change in the zero rating will be effective from 1 August 2001.

Although all the changes are welcome there still remains a VAT advantage in constructing new residential properties on green field sites rather than brown field ones. Hopefully future Budgets will extend existing reliefs to put both on the same footing, although it is always possible that this may be done by raising VAT rates on new developments.

other artilces from the April / May 2001 issue