With many landlords considering converting commercial premises to residential ones, Nathan Robinson highlights the importance of capital allowances and why both clients and owners of law firm premises should identify any unclaimed expenditure before it’s too late.

Since the global pandemic began, working from home has become the norm for most businesses across the UK. This has presented opportunities for commercial landlord and investor clients that are seeking the best return on investment for their properties, with many deciding to convert commercial units to higher yielding residential ones. However, when changing a property’s function there are a few key factors that owners need to take into consideration to avoid losing out financially.

What’s changed?

In the past 18 months many businesses had to take the unenviable decision to send their work force home for an unforeseen period of time with the result that working patterns have changed – probably for good.

The knock-on effect of empty city centres had also changed how commercial property is used as well as the supply chain of commercial buildings which rely on  ‘city footfall’.

Case study

Imagine your client is a large company which has owned an office building since 2006 when it was purchased for £2 million. The building comprises six floors and is rented out to three other companies with a combined rent of £600,000 per year.

The pandemic has turned this picture upside down – there may be very few people in the building, yet both tenants and owners have seen productivity remain high without staff being in the office.

It’s now 2022, and all of the tenants in the building approach the owner for new arrangements. Likely requests include the following:

  • “We need to downsize – as our workforce is now 100% digital, we only envisage five members of staff a day in the office; therefore, we are terminating our lease”.
  • “With flexible working we only need one floor as opposed to two”
  • “We need to watch our cashflow and whilst we want to stay here we can only justify it if we can negotiate terms”

In addition to this the landlords themselves are likely considering their options. Regardless, all of these will have the same potential outcome – the landlord will have to change the building’s ‘commercial to residential split’ in order to maintain rents or face selling it altogether.

Change of use

Let’s assume that the owner of the building opts for a ‘commercial residential split’ where a 50/50 split is created amongst residential and commercial. After the change, the owner agrees to review the capital allowances position following advice from their solicitor and they are disappointed to learn that relief has been lost.

This is because residential use, even if rent is received, is limited to plant and machinery located in communal areas such as stairwells and landings only – not the dwellings themselves. The bottom three floors (which are still offices) are exempt, as there is a qualifying activity going on in them, but a big portion of relief will be gone.

The financial position

Using the numbers in the case study above, here is how change of use pre- and post-Covid-19 could catch out you or your clients in the future:

 Pre-COVID-19:

  • 100 per cent of the £2 million building was comprised of commercial units
  • the capital allowances exercise identified 20% of the purchase price in qualifying plant and machinery
  • the allowances identified were £400,000
  • the property owned via a limited company at 19% therefore, total relief available via allowances equalled £76,000

 Post-COVID-19:

  • 50 per cent of the £2 million building is now comprised of commercial units
  • only £10,000 of qualifying expenditure can be identified in communal areas
  • capital allowances identified remain at 20% in parts of the building still used for commercial use
  • allowances identified are £210,000
  • property owned in a limited entity at 19% therefore, total tax relief available via allowances equals £39,900

Whilst £39,900 is still a saving, it shows that altering building uses is great for addressing income yields but can have knock-on effects with regard to tax relief. Therefore, you should always review capital allowances prior to a change of use to avoid losing money.

Of course, some businesses have seen a huge demand for more staff on-site and huge expansion over the past 18 months. Some clients in the manufacturing industry, for example, may have expanded/moved to new premises due to increased workload. This, again, is a key moment for clients to consider where things stand in relation to the tax relief available, not only for the property they are leaving, but for the property they are buying.

In April 2014 the Finance Act 2012 brought into force new changes whereby both the buyer and seller needed to enter into an agreement via a ‘section 198 election’ in respect of what allowances were being passed over, if any.

Questions that are now raised as part of the contract are as follows:

  • How has the property been treated in relation to capital allowances to date?
  • If allowances have been claimed, how were they claimed and when?
  • Is the vendor willing to assist the purchaser in reviewing a claim for themselves post completion?

This is where 95% of client claims can be lost, but with the correct support and legal advice, it doesn’t need to be this way.

To find out more information visit www.catax.com.

 

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 Nathan Robinson is a Regional Development Director in the commercial property team at specialist tax relief consultancy, Catax. Nathan adds significant value to Catax’s partners and its clients, with all things connected to capital allowances.

During his career, Nathan has delivered an ‘end-to-end’ proposition for his clients – from identifying opportunities for claims to building surveys. Nathan has also become a trusted partner to accountants and law firms alike, particularly in the area of section 198 election negotiations and historical property acquisitions.