Office to hotel conversions and the tax relief that nobody knows about

Overseas residents are visiting the UK in ever increasing numbers according to the Office of National Statistics, which is putting pressure on UK towns and cities to provide enough accommodation[1].  As a way to address this, investors and developers have been looking for new ways to bring hotel products to market and we’ve seen an increase in those looking at converting office space to hotels.

Driven by the lack of suitable, well-located land for new-build hotels, there are many benefits of developing this type of property. It’s likely that the existing building will be adequately served by infrastructure, transport links may be close by and design limitations are more readily understood, consequently allowing flexibility over room types and sizes. Locations are also usually close to city centre attractions, like restaurants, bars, shops and theatres. Furthermore, there may be fewer planning considerations, as well as existing surveys and other reports being widely available.

The tax relief you could be claiming

However, while all of these factors make offices a prime target for hotel conversions, what many in the property world are unaware of is the potential tax relief incentives available to investors on the expenditure incurred on these conversions. Savings include the purchase prices of buildings, stripping out the offices, expenditure on the new hotel fit-out, as well as the removal of asbestos in older buildings.

For example, you can claim tax relief for expenditure on items of plant and machinery (P&M) installed as part of new fit-out works or developments. Spending on P&M assets that are ‘integral’ to the building such as electrical systems, space or water heating systems, powered ventilation systems and cold water systems, is eligible for what is known as Special Rate Pool P&M allowances, which will attract writing down allowances of 8% per annum. After an indicative time period of five years, this translates to approximately 34% of this type of expenditure that can be relieved against tax and relief continues to be granted each year thereafter on a reducing balance basis.

Additionally, assets not deemed to be integral features, such as fire alarms, toilets, furniture, fittings, swimming pools and signage, also qualify for relief on expenditure. Such items qualify for what is known as Main Pool P&M, which attracts a higher rate of writing down allowance of 18% per annum. Again, after an indicative time period of five years, approximately 63% of this type of spend can be relieved against tax and continues to be granted each year thereafter on a reducing balance basis.

Supporting expenditure – including the professional fees associated with the installation of the items – may also qualify for tax relief in the form of capital allowances. A detailed analysis of expenditure should be undertaken for all but the smallest projects as, while some specific sections of legislation may apply, often the capital allowances will be determined by first principles.

As well as pools for P&M, repairs, replacement or maintenance will most likely make up a significant portion of refurbishment expenditure. Some of this can also attract revenue deductions if they constitute a ‘repair to the existing property’. This includes spending on things such as re-decorating, repairing floors and walls etc. Expenditure incurred in each accounting period relating to such things can therefore be treated as revenue deductions.

It pays to go green

Enhanced Capital Allowances (ECAs) are a form of tax relief that the government allows investors to claim against expenditure incurred on a commercial property and would be available for instance, when modernising the office structure’s energy and water systems to make the hotel energy efficient.

Tax relief of 100% could even be claimed if the energy or water saving equipment is on the UK Department of Energy & Climate Change’s ‘Energy Product Technology List’, or the Department of Environment, Food and Rural Affairs’ ‘Water Technology List’. Items on these lists include energy efficient boilers, lighting, control mechanisms, heat pumps, water efficient toilets and taps. These ECA’s are given as a 100% ‘First Year Allowance’, meaning they attract 100% tax relief for expenditure in the year that it is incurred. Alternatively, if the spending leads to a trading loss, it can be surrendered for a tax credit equating to 19% of expenditure.

Why does the government offer these incentives?

These significant savings of course beg the question of ‘what’s in it for the Government?’ Quite simply, these tax regimes have been put in place to encourage investment and stimulate growth. The Government offers these to inspire a certain type of behaviour or to incentivise investment in projects which otherwise might be economically unattractive to invest in. This is particularly true for green incentives as the UK strives to meet its targets in respect of climate change. These low-risk, high-reward savings aren’t just available in the UK either; governments in Ireland, Europe, Africa, America, Asia and Australasia also offer similar incentives to developers.

So why aren’t developers taking advantage of these savings?

Every year thousands of developers are paying more tax than they have to because they are unaware of the incentives available to them, or due to the fact that they don’t understand the complex legislation that enables them to claim. How much could a developer save when converting an office block into a hotel, equipped with the right knowledge?

We recently prepared a capital allowances analysis on a £6m office to hotel conversion. The total level of allowances identified equated to £3.15m, which translated into a £630,000 saving. Due to the presence of asbestos in the building, a further £100,000 of land remediation relief was also identified, providing an additional £20,000 tax saving in the year of expenditure.

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[1] https://www.ons.gov.uk/peoplepopulationandcommunity/leisureandtourism

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