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  • Property Investment v Trading – The Facts…

    Much of the tax information available in relation to property is aimed Buy to Let (“B2L”) property investors. A B2L investor will acquire a property, hold it for perhaps a few years, harvesting the rents and hopefully benefitting from some capital appreciation.

    However, the UK tax system, is not focused on the underlying asset – there is not one flat rate of tax and set of rules, that applies to property. This is the same position as for disposals of shares or, more recently, cryptocurrency.

    It is what one does with the asset that drives the tax analysis.

    As such, the tax position will be different if our property holder is acquiring properties – sticking in a new bathroom and kitchen, a quick lick of paint and selling it. This would be property development which is a type of trade.

    Further, the tax position will be different if someone is simply buying and selling parcels of land without doing much else. This is known as property dealing and is also a trade. However, the availability of certain reliefs, eg Business Property Relief (“BPR”) is unlikely to be unavailable.

    Property investment v trading; FAQs

    How does one determine what is a trading or investment activity?

    It is the thought that counts. Or more accurately, it is the intention that counts. The recording of that intention can be critical if HMRC come knocking on the door one day.

    In any dispute of this nature, a taxpayer’s chances of victory will depend on the quality of their evidence.

    It is important to note that one cannot have an indeterminate status – it must be fish or fowl. This was demonstrated in Simmons v IRC [1980].

    One myth that clients are often under is that obtaining planning permission is a key event that will turn a property investment in to a property development. This is not the case. HMRC accepts that merely obtaining planning and carrying out infrastructure work is, not in itself, sufficient to make a land holding a trading transaction.

    Myth busting: HMRC accepts that merely obtaining planning and carrying out infrastructure work = not in itself sufficient to make a land holding a trading transaction.

    So where a family has say, inherited some farmland, they have held it a few years and are not looking at obtaining planning permission for houses with the view to sell to a developer – this is not, in itself, indicative of a trading transaction.

    That said, intentions can change. What was an investment can turn in to a trading transaction where the intention changes. HMRC, rather grandly, refer to this as a ‘supervening’ trade.

    An example from case law is where a taxpayer purchased a substantial residential property plus grounds at auction, with a view to living there. However, his wife pointed out that the house was rundown, isolated, near a rubbish dump, and too far from their place of work.

    Not a great purchase!

    As such, he therefore obtained planning permission for redevelopment and sold the land to a developer. HMRC challenged the case. However, it was accepted as ‘not trading’ because his change of intentions had been clearly recorded.

    Again, contemporaneous evidence is key.

    Badges of trade

    Please note that this is not a group of mercantile woodland creatures. We are talking ‘badges’ and not ‘badgers’. There is no ‘r’.

    This is where an accountant’s eyes will glaze over. ‘Oh no, badges of trade. Did them when I was a student.

    However, for a tax adviser, it is useful to look at these from time to time however. Indeed, we have found cause to look at these in quite detail at these in relation to cryto-currency clients to determine whether he was trading or not.

    This goes back to what I said earlier. It is not the asset, it’s what you do with it.

    I’ve listed out the Badges of Trade – result of a Royal Commission in the 1950’s I believe

    The badges of trade were discussed in a property context in the case Marson v Morton

    • Nature of asset
    • Circumstances in which acquired
    • Duration of holding
    • Improvements
    • Business history
    • Plan for the property
    • Circumstances of sale
    • Nature of finance [Not in the original list]

    However, I don’t propose going through these now. I am trying to keep you conscious.

    An interesting case – Terrace Hill (Berkley) Ltd [2015]

    I would like to talk about an interesting case. In tax terms, it was quite a recent one too. Rather unusually, it was also doubly fortuitous to the taxpayer.

    The Taxpayer had used a capital loss scheme… and, surprisingly, this seems to have worked!

    As such, the taxpayer tried to use this engineered capital loss against the capital gain they had made on the sale of a property.

    However, HMRC did not go down without a fight.

    Having licked their wounds on the scheme, they said. ‘OK, you’ve created your capital loss but, and what a stroke of misfortune, your gain is a trading one and not a capital one. So you can’t offset it’

    So what, broadly, were the circumstances?

    The property in question was acquired in 2000. It was an office block, a tired one, but it was in Mayfair. It had sitting tenants.

    Once the leases had expired, the property was demolished and replaced with a new building

    The taxpayer was a SPV and owned the property in a JV:

    o The taxpayer was part of a development group
    o JV partner = experience of letting offices and access to finance

    Construction of a new building was completed Sept 2003 and the space was let substantially by Sep 2004.

    The property was then sold in July 2005

    HMRC argued it was a trading receipt. They also argued that a £1m penalty should apply due to the negligent filing position taken on the tax return. Ouch! Not that they were bitter about the capital loss scheme or anything.

    HMRC relied on:

    o Terms of JV agreement
    o Communications – including a representation made to bank that would be sold as soon as possible.

    The FTT decided that the case was finally balanced

    However, perhaps somewhat surprisingly, the Taxpayer won. The key factors in this decision were:

    • ‘impressive’ witness evidence – consistent / credible story;
    • the property was shown in the accounts as an investment;
    • that the sale was driven by lower than expected rental yields
    • that a capital allowance claim had been made
    • that the documentation generally docs pointed towards investment rather than a trading venture;
    • Attractive unsolicited offer

    It is interesting that the FD had made a representation to the bank in order to get funding. This representation was that the property would be sold ‘as soon as possible’. HMRC had viewed this as a significant piece of evidence pointing to trade. However the tribunal said that this was a means of obtaining short term finance and “Not… a particularly serious deception”. So, there you have it, authority to lie to your bank!

    Additionally, the FTT was also quite damning regarding HMRC’s pursuit of the filing penalty as well. Their view was that, even if the taxpayer had been wrong, they would have not enforced the penalty.

    Trading – what is development?

    As stated above, trading could be divided in to two different limbs:

    • Development; and
    • Dealing

    So, firstly, what is development? Is there a nice juicy definition to get our teeth into?

    It just so happens that it there is. This is defined as “the carrying out of construction works on land’

    As importantly, it is not:

    • Carrying out Infrastructure works
    • the obtaining of planning permission

    There is some commentary in the Business Income Manual (BIM60806). Firstly, that ‘whether land has been developed is a question of fact’ and “in the absence of other factors obtaining planning permission will not constitute land being developed…”

    The Manual also provides many other examples with which it is worth familiarising one’s self with.

    Land Dealing; The Facts

    This brings us neatly on to what is land ‘dealing’

    It is essentially the buying and selling of land but without any development work being undertaken on the planning. Note that this could include a case where the owner of the land has obtained planning permission as this does not constitute construction work.

    Implications – property investment v trading

    Primarily, the main implication will be that the shareholders of a trading company will benefit from tax reliefs.

    For CGT purposes, the shareholder of an unquoted trading company will obtain Entrepreneurs’ Relief.

    For Inheritance Tax (“IHT”), a shareholder might obtain Business Property Relief (“BPR”) on their shareholding. One main exception to this is where the activity is ‘dealing’ which is excluded from the definition.

    If you have any queries on property investment v trading then please get in touch. You may also find our property disposal tax reliefs article of interest, our capital allowance tax relief on property article and our capital gains tax allowances article of interest. You can also read all articles about property tax here on our website.