CLAUSE 67 AND SCHEDULE 19: CONVERSION OF PARTS OF BUSINESS PREMISES INTO FLATS
1. This Clause and Schedule provide for 100 per cent capital allowances for expenditure incurred from Royal Assent on renovating or converting space above shops and other commercial premises into flats for letting.
2. The scheme enables property owners and occupiers to obtain up-front tax relief for their capital expenditure on recycling former residential space over shops. Under the existing rules, tax relief is only given against the computation of any capital gain on the disposal of the property.
3. The scheme includes all normal conversion expenditure, and is based around existing provisions for capital investment in industrial buildings, but there are differences. In particular, no balancing charges or allowances are made provided that, throughout a period of seven years from the flat being completed and suitable for letting, it is let or held out for letting and there is no disposal event. And the allowances are not transferable to a subsequent purchaser of the interest in a flat.
4. The scheme is part of a package of measures being introduced to encourage the regeneration of urban areas.
DETAILS OF THE CLAUSE
5. Clause 67 brings Schedule 19 into effect in relation to expenditure incurred on or after the date that the Finance Act is passed.
Schedule 19 – Capital allowances : conversion of parts of business premises into flats
Part I – New Part 4A of the Capital Allowances Act 2001
6. Schedule 19 inserts the new Part 4A into the Capital Allowances Act 2001 (“CAA 2001”). Part 4A comprises new sections 393A to 393W and contains the rules for flat conversion allowances.
7. Section 393A provides for flat conversion allowances to be made under Part 4A.
8. Subsection (1) of Section 393A provides that allowances will be available if person incurs qualifying expenditure in respect of a flat.
9. Subsection (2) defines the person to whom the allowances are to be given as being the person who incurred the qualifying expenditure and who has the relevant interest in the flat.
10. Subsections (3) and (4) define what is meant by a flat, and a dwelling for these purposes.
11. Section 393B defines “qualifying expenditure”.
12. Subsection (1) of Section 393B defines qualifying expenditure. It is capital expenditure incurred on, or in connection the conversion or renovation of part of a “qualifying building” into a “qualifying flat”, or on capital repairs incidental to such conversion or renovation.
13. Subsection (2) provides that the conversion or renovation expenditure does not qualify unless the part of the building in respect of which it is incurred was either unused, or used only for storage for a period of at least one year immediately prior to the commencement of the renovation or conversion work.
14. Subsection (3) defines certain types of expenditure that are not qualifying expenditure. They comprise expenditure incurred on, or in connection with the acquisition of land or rights in or over land, the extension of a qualifying building (unless the extension is for the purpose of providing access to the qualifying flat), the development of land next to the qualifying building, and the provision of furnishings or chattels.
15. Subsection (4) defines capital expenditure on repairs for the purposes of section 393B. It comprises any expenditure that would not be allowed as a deduction in calculating the profits of a Schedule A business.
16. Subsection (5) provides for Treasury regulations to make further provision for defining expenditure that is or is not qualifying expenditure.
17. Section 393C defines a “qualifying building”.
18. Subsection (1) of Section 393C defines a qualifying building as one which meets four conditions. All or most of the ground floor must be “authorised for business use”, it must appear that when the building was erected the upper storeys were constructed primarily for use as dwellings, the building must not have more than four storeys above the ground floor, and the construction of the building must have been completed before the 1 January 1980.
19. Subsection (2) defines the term “authorised for business use”. This is done by reference to specific uses designated in the relevant ratings rules for England and Wales, Scotland and Northern Ireland.
20. Subsection (3) provides that attics are not counted when considering how many floors a building has, unless the attic has been or is being used as a dwelling.
21. Subsection (4) includes extensions as part of a qualifying building, provided the extension was completed on or before the 31 December 2000.
22. Subsection (5) provides for the definition of “qualifying building” to be amended by Treasury regulations.
23. Section 393D defines a “qualifying flat”.
24. Subsection (1) of Section 393D lists the detailed conditions that must be met by a flat in order for it to be a qualifying flat. The flat must be in a qualifying building, must be suitable for letting as a dwelling and must be held or the purposes of short-term letting. Also, the flat must have access independent of the ground-floor business element, and not more than 4 rooms. The flat must not be a high-value flat, or be part of a conversion scheme containing one or more high-value flats. And the flat must not be let to a person connected to the person who incurred the conversion or renovation expenditure.
25. Subsections (2) and (3) explain what is meant by “short-term letting, and how to calculate the number of rooms in a flat for the purposes of subsection (1).
26. Subsection (4) provides that a flat will not cease to be a qualifying flat during a period of temporary unsuitability for letting, provided that it was a qualifying flat immediately before that period.
27. Subsection (5) provides for the definition of “qualifying flat” to be amended by Treasury regulations.
28. Section 393E defines a “high-value flat”.
29. Subsection (1) of Section 393E defines a flat as a “high value” if the notional rent exceeds specific limits. These are set out in the tables in subsection (4).
30. Subsection (2) defines what is meant by the “notional rent”. It is the rent that could be reasonably expected for the flat on the “relevant date” assuming that the conversion has been completed, the flat is let furnished, the tenant is not required to make any other payments such as a premium to the landlord or anyone connected with him, the tenant is not connected with the person who incurred the expenditure on the creation or renovation of the flat, and for a flat in England, Wales or Scotland, it is let on a “shorthold tenancy”.
31. Subsection (3) defines the “relevant date” as the date on which expenditure is first incurred on the conversion or renovation work.
32. Subsection (4) sets down the notional rent limits in tabular form by reference to the number of rooms, and whether or not the flat is in Greater London.
33. Subsection (5) provides for the notional rent limits to be amended by Treasury regulations.
34. Subsection (6) applies the rules at section 393D(3) for the purposes of determining the number of rooms for the table in subsection (5).
35. Section 393F contains the general rules as to what is the relevant interest.
36. Subsection (1) of Section 393F provides that the relevant interest in a flat at the time expenditure is incurred is the interest in the flat to which the person who incurred the expenditure is entitled at that time.
37. Subsection (2) makes the general rule in subsection (1) subject to the rest of section 393F, and to section 393V, which contains special provisions in respect of the termination of a lease.
38. Subsection (3) provides that where the person who incurred the qualifying expenditure is entitled to more than one interest, and one of those interests is reversionary on all the others, the reversionary interest is the relevant one.
39. Subsection (4) provides that an interest does not cease to be the relevant interest if a lesser interest is created that is subject to the interest.
40. Subjection (5) provides that where the relevant interest is a leasehold interest, and it is extinguished by the holder acquiring a reversionary interest, the merged interest becomes the relevant interest when the leasehold interest is extinguished.
41. Section 393G provides that a person who incurs expenditure on the conversion of part of a building and who is entitled to an interest in the flat on or as a result of the completion of the conversion is treated as having had that interest when the expenditure was incurred.
42. Section 393H contains rules relating to initial allowances.
43. Subsections (1) and (2) of Section 393H provide that a person who has incurred qualifying expenditure on a flat is entitled to an initial allowance of 100% of the qualifying expenditure.
44. Subsection (3) provides that the claimant may require the initial allowance to be reduced to a specified amount.
45. Subsection (4) provides that the initial allowances is made for the chargeable period in which the qualifying expenditure is incurred.
46. Section 393I prevents an initial allowance being made if the flat is not a qualifying flat, or if the person incurring the conversion or renovation expenditure sells his interest before the flat is first suitable for letting as a dwelling. Provision is made for any allowance which has already been made to be withdrawn, and for all necessary assessments or adjustments to assessments to be made for this purpose.
47. Section 393J provides the entitlement to writing down allowances.
48. Subsection (1) of Section 393J sets down the conditions that have to be met for a person to be entitled to a writing down allowance for a chargeable period. These are that person must have incurred qualifying expenditure in respect of a flat and, at the end of the chargeable period, the person must be entitled to the relevant interest in the flat, the person must not have granted a long lease of the flat out of the relevant interest in return for a capital sum, and the flat must be a qualifying flat.
49. Subsections (2) and (3) define what is meant by a long lease. This is a lease with duration in excess of 50 years, as defined in the rules in section 38 Income and Corporation Taxes Act 1988 (“ICTA 1988), but without regard to the rule in new section 393V, which treats an new lease granted as a result of the exercise of an option to be treated as if it were the continuation of the old lease.
50. Subsection (4) provides that the person claiming a writing down allowance may reduce the amount of a claim to a specified sum.
51. Section 393K determines the amount of the writing down allowance.
52. Subsection (1) and (2) of Section 393K sets the writing down allowance for a chargeable period at 25% of the qualifying expenditure, but this is increased or decreased proportionally if the chargeable period is more or less than one year.
53. Subsections (3) and (4) provide that the writing down allowance cannot exceed the residue of qualifying expenditure on the flat. The residue of qualifying expenditure is to be ascertained immediately before the writing down allowance at the end of the chargeable period.
54. Section 393L defines the residue of expenditure as the amount of qualifying expenditure that has not yet been written off.
55. Section 393M defines the circumstances in which a balancing adjustment is made.
56. Subsection (1) of Section 393M provides for a balancing adjustment to be made if qualifying expenditure has been incurred in respect of a flat and a balancing event occurs.
57. Subsection (2) defines a balancing adjustment to be a balancing allowance or a balancing charge, and provides that the adjustment is made for the chargeable period in which the balancing event takes place.
58. Subsection (3) provides that the balancing allowance or charge is made on the person who incurred the qualifying expenditure.
59. Subsection (4) prevents a balancing adjustment being made if the balancing event takes place more than 7 years after the time when the flat was first suitable for letting as a dwelling.
60. Subsection (5) provides that where more than one balancing event occurs, only the first gives rise to a balancing adjustment. The subsequent events do not give rise to balancing adjustments.
61. Section 393N lists the various balancing events that give rise to balancing adjustments providing definitions as necessary.
62. Section 3930 lists the proceeds from balancing events.
63. Subsection (1) of Section 393O defines the proceeds to be taken into account from a balancing event. This is done by reference to a Table which lists the proceeds for each balancing event in turn.
64. Subsection (2) restricts the proceeds from the event to those received or receivable by the person who incurred the qualifying expenditure.
65. Subsection (3) defines a term, “commercial premium”, used in the Table in subsection (1).
66. Section 393P contains the rules for calculating balancing adjustments.
67. Subsection (1) of Section 393P provides for a balancing allowance to be made if there are either no proceeds from the balancing event or the proceeds are less than balance of unrelieved qualifying expenditure immediately before the event.
68. Subsection (2) defines the amount of the balancing allowance. If there are no proceeds from the event, it is the residue of any unrelieved qualifying expenditure. If there are proceeds, it is the excess of the residue over the proceeds.
69. Subsection (3) provides for a balancing charge to be made if the proceeds are more than the residue of unrelieved qualifying expenditure immediately before the balancing event.
70. Subsection (4) defines the amount of the balancing charge. It is the excess of the proceeds from the balancing event over the residue of unrelieved qualifying expenditure. If the residue is nil, the balancing charge will be equal to the proceeds (subject to the limit specified in subsection (5)).
71. Subsection (5) provides that the balancing charge cannot exceed the total of any initial allowance and writing down allowances made in respect of the expenditure and given in the chargeable periods ending on or before the date of the balancing event that gives rise to the balancing adjustment
72. Section 393Q determines when qualifying expenditure shall be treated as written off, and to what extent. These are the times and amounts specified in sections 393R and 393S.
73. Section 393R deals with the writing off of initial and writing-down allowances.
74. Subsection (1) of Section 393R provides that initial allowances, if made, are written off at the time the flat is first suitable for letting as a dwelling.
75. Subsections (2) and (3) provide that, where a writing down allowance is made, that amount written off at the end of the chargeable period. But, where a balancing event takes place at the end of such a chargeable period, the amount written off in the period is taken into account in computing any balancing adjustment.
76. Section 393S deals with treatment of demolition costs.
77. Subsections (1) to (3) provide that, where a qualifying flat is demolished and the cost is met by the person who incurred the conversion or renovation expenditure, the net cost of the demolition is added to the residue of qualifying expenditure immediately before the demolition. The net costs are those costs incurred on demolition less any monies received for the remains of the flat.
78. Subsection (4) provides that, neither the costs nor the net costs of demolition are to be treated as expenditure on any property replacing the demolished flat.
79. Section 393T gives effect to allowances and charges.
80. Subsection (1) of Section 393T applies the rules where a person is entitled or liable to an allowance or charge for a chargeable period.
81. Subsection (2) provides that, if the person’s interest in the flat is an asset for a Schedule A business carried on in the period, then the allowance is given as an expense of the business, or charge is given as a receipt of the business.
82. Subsection (3) provides that, if the flat is not part of a Schedule A business carried on in the chargeable period, any allowance or charge is given effect as if he had been carrying on a Schedule A business during the period.
83. Section 393U contains rules for making apportionments if sums relate partly to non-qualifying assets.
84. Subsection (1) of Section 393U provides that, where a sum is paid for the sale of the relevant interest in a flat and the sum relates partly to assets representing qualifying expenditure and partly to other assets, the proportion of the sum paid referable to the assets representing qualifying expenditure is found by making a just and reasonable apportionment of the total amount.
85. Subsection (2) applies this apportionment rule to any proceeds from a balancing event as it would to the sale of the relevant interest.
86. Subsection (3) ensures these apportionment rules does not affect any provisions in CAA 2001 relating to apportionments.
87. Section 393V deals with termination of leases.
88. Subsection (1) of Section 393V applies the rules in the section if a lease is terminated.
89. Subsection (2) provides that, on its expiry, a lease is treated as continuing if, and as long as, the lessee remains in possession of the flat.
90. Subsection (3) provides that a new lease is treated as a continuation of the first lease if it is granted as a result of the exercising of an option available under the terms of the first lease.
91. Subsection (4) provides that a lease is treated as if it had come to an end by surrender in consideration for the payment if, on termination, the lessor pays a sum to the lessee.
92. Subsection (5) provides that, if on the termination of a lease, another lease is granted to a different person who pays the first lessee a sum in consideration in connection with the transaction, the two leases are treated as if they were the same lease, assigned by the first lessee to the second in consideration of the payment.
93. Section 393W defines the meaning of “lease” for the purposes of Part 4A to include agreement for a lease, if the term to be covered by the lease has begun, and any tenancy. But it does not include a mortgage. The section also makes relevant provision for Scottish interests in land.
Part II – Consequential Amendments
94. Paragraph 1 includes Part 4A flat conversion allowances within the list of capital allowances covered by CAA 2001.
95. Paragraph 2 includes Part 4A flat conversion allowances within the general rules for giving effect to allowances and charges.
96. Paragraphs 3, 4 and 5 make necessary amendments to ensure the provisions regarding contribution allowances are unaffected by the introduction of the new Part 4A flat conversion allowances.
97. Paragraph 6 applies to Part 4A flat conversion allowances the rules in Section 567 that treat sales between connected persons, or sole or main benefit sales as taking place at market value.
98. Paragraph 7 excludes Part 4A flat conversion allowances from the special provisions that permit connected persons to elect for transfers of assets between them to be treated to take place at an amount that gives rise to neither a balancing charge nor a balancing allowance.
99. Paragraph 8 introduces various terms used in Part 4A into the index of defined terms in Part 2 of Schedule 1 CAA 2001.
100. Capital allowances allow the cost of capital assets to be written off against taxable profits. They take the place of depreciation in the commercial accounts, which is not allowed for tax.
101. Expenditure on dwelling houses does not normally qualify for capital allowances, and there are specific provisions to prevent allowances being made in the codes for industrial buildings, plant and machinery, and research and development.
102. The main exception relates to farmhouses and farm cottages in the rules for agricultural buildings allowances. There was also a special scheme give allowances at a rate of 4 per cent a year on the cost of constructing dwellings-houses for letting as assured tenancies. It applied to qualifying expenditure incurred between 1982 and 1992.
103. Other measures within the urban regeneration package include enhanced relief for cleaning up contaminated land, a reduced rate of VAT for property conversions, and a stamp duty exemption for properties in the most deprived wards in the UK.