CGT v Income from trade

chappers

In the process of deciding what to do with a property I own.

In 2006 I purchased a property with a view to developing it, due to one thing and another I rented it out until October last year, when I carried out the development.
I have split the property into 3 freeholds and am now deciding whether to sell all, to rent again or to sell part.
Do you think selling all now would be classed as income from trade (income tax) or capital gain.
Just trying to work out which way to go as there is a potential gross profit in the region of £350K .
Just wanted to get some pointers as I am in the process of changing accountants (long story) and wanted to canvas their opinion against the concensus.

Cheers
gareth

SeniorSam

Your accountant can confirm that if you will be making a sale, then it will be a capital gain that you will make if sold at a higher price than purchased, less costs for development and allownaces. The rental period produced income.

Sam

Mary_Hartnell

If this is your first such venture, you are unlikely to get picked out as a trader.

You might have noticed that most of the people on the "property !!!!!!" programmes prior to 2008, would say "Well I think we will have to live in it for a bit"

Meaning, we want to be able to claim the Principle Private Residence allowances for letting out your own home, when the home gets sold (or gets stuck and has to be let until property prices revive).

bluep

Seems to me that this is more about filing risk and whether a reasonable view of the circumstances would enable you to file it as a capital gain as you have to consider not only the difference in tax rates but also the penalties situation i.e. failing to take reasonable care.

It would be relatively rare to get picked up for enquiry by local compliance in HMRC for an issue like this unless your tax return is high risk in other ways or you are dealt with by the high net worth unit. That said, if enquired into, it could be a situation where an Inspector might jump to the conclusion that you are trading - depends on the wider context, what your normal job is, whether you have done similar developments before, what you are doing now (i.e. 12-18 months afterwards when you'd be having the debate with HMRC). The fact that you have accountants might indicate that you aren't simply in a PAYE job with no other complexities? Quite often HMRC are a bit more aware of tradesman (plumbers/builders etc...) doing developments on the side i.e that could be argued as related to their main trade. Likewise if you work for a property company (or own one) but doing your own development on the side - I've seen this recently too.

I wouldn't even bother thinking of the PPR route given that you have split it into three flats - there's been a shift in how much evidence/what circumstances make such claims successful and far more focus on whether you actually lived there or are just trying to manufacture a tax relief

taxing

Hi

You bought the property with the (specific) intention of making a profit - this is an activity in the nature of a trade. It doesn't matter that it was the first time you had done this - it is the original intention that sets the outcome.

You don't say why, but I suspect you couldn't get planning permission quickly (??) so development was delayed until last year.

Wisely, you have been making an income out of the property in between times.

Given the time delay, this could be presented to HMRC as an investment 'gain' as opposed to trading income and your case might be strengthened if you sell the property with one or more sitting tenant in residence. However, there will always (always) be the danger of a challenge from HMRC and, if there is, then under the new penalty regime (now with us) this could be seen as deliberate concealment and liable to higher penalties than a careless or negligent mistake.

The new penalty regime is 'tough' and you will find that many accountants are taking a tougher line on how information is presented to HMRC - and on what they will and will not go along with...

Regards.

Mary_Hartnell

More mission creep - you can now go to jail for what you are thinking, not what you do.

bluep

taxing wrote: »

Hi

You bought the property with the (specific) intention of making a profit - this is an activity in the nature of a trade. It doesn't matter that it was the first time you had done this - it is the original intention that sets the outcome.

Not sure I quite agree that its that simple.

http://www.hmrc.gov.uk/manuals/bimmanual/BIM20205.htm

Whilst intention to make a profit is an indicator, the repetative nature of transactions is another factor to consider, as is the poster's original trade/profession, funding, manner of sale etc...

I'm not sayign that the fact pattern here doesnt point to trade, just that it isn't quite so black and white as original intention.

In terms of penalties, deliberate is a difficult one to prove unless, all of the facts point towards a certain tax treatment and it would not be reasonable to take another position of interpretation of the legislation. Failure to take reasonable care is much more likely in these kinds of cases but the best protection from that is documentating the fact pattern, technical considerations and basis for adopting a particular treatment and filing on this basis. HMRC may well take a different position on their interpretation of how the facts fit under the legislation. If of course this consideration of all the facts leads one to trading rather than CGT then you are on very shakey ground in terms of failure to take reasonable care or even deliberate understatement.

jimmo

The way that the OP phrased the question does rather imply a trading adventure from the outset and if he were to present the facts to HMRC in a similar manner then he should expect the worst.
If you buy a derelict property and pay builders to modernise it and sell up that would be one thing but I rather think buying a single property, dividing it into 3 separate units and selling them separately is quite another.
There are still lots of pros and cons here and the end result is far from certain.
However I would think that an Enquiry from HMRC (at some time) is almost guaranteed.
If the OP sells all 3 of the new properties in a single tax year and realises the anticipated profit/ gain of £350k then the sheer numbers will be sufficient trigger to justify an Enquiry.
If the OP sells only one of the new properties and declares a Capital Gain that will be a part disposal requiring an apportionment of the original acquisition price, and of the improvement expenditure, by reference to the sale price of the property sold and the market value of the part retained.
http://www.hmrc.gov.uk/manuals/cgmanual/CG12731.htm
Either way, there is ample scope for an Enquiry and, once the decision is made to open an Enquiry the question of whether this was an adventure in the nature of trade will definitely arise.

Pennywise

Sadly,you may end up scuppered by the facts and paper trail here. I don't think there's any doubt that it would be "trading" if you started the conversion when you bought it and hadn't put a tenant in. So, why the delay? If you applied for planning permission as soon as you bought it, then I think you are well and truly scuppered as that is a matter of public record on file and clearly confirms your intention at that time. Whether it's capital or trading rests basically on your intention. The fact you went onto let it doesn't take away the fact that it wasn't your original intention.

chappers

Thanks all, some really helpful stuff in the above posts but as I suspected, not a straight forward situation.

Indeed planning permission was the major hold up on the development and yes development was always my aim and so strictly speaking it is profit from trade (yes I run a building firm).
To throw a further complication into the works I am seriously considering selling two of the units and retaining one as a rental which would reduce the profit by about two thirds.
I was always under the impression I would have to bite the bullet and pay income tax, but just wanted to run it by those with better knowledge especially as being a dodgy builder the last thing I want is HMRC picking through my books, I had enough of that with Customs and Excise a few years back ( 3 investigations in 5 years due to doing a fair bit of zero and 5% rated work).
I am seeing a couple of potential accountants next week and will use some of the above information to help assess their worth.

Many thanks
Gareth

jimmo

chappers wrote: »

To throw a further complication into the works I am seriously considering selling two of the units and retaining one as a rental which would reduce the profit by about two thirds.

I am afraid you may be in for a rude awakening on that one.
As a general principle in taxation a lettings business is not trading and so the lettings business and the trade are separate entities.
When and if you sell the 2 units those sales will almost certainly generate trading income. However, when you start letting unit 3 HMRC will want to regard that as an "appropriation from stock."
In other words, you the trader will be regarded as having sold unit 3 to you the lettings man at full retail price thus generating trading income.
http://www.hmrc.gov.uk/manuals/bimmanual/BIM33630.htm
Similar principles should apply to your original appropriation from stock and subsequent appropriation to stock.
So the overall picture is.
1) You the trader bought the original property as trading stock.
2) You the trader sold the property to you the lettings man at the commencement of letting .
3) You the lettings man sold the property to you the trader at the end of the letting.
4) You the trader will sell units 1 and 2 to others and sell unit 3 to you the lettings man.
There is, however quite a bit of guidance specifically in respect of builders and developers and if you fancy a bit of homework here is the index page.
http://www.hmrc.gov.uk/manuals/bimmanual/BIM51500.htm