29th September 2022
The question of whether a property is held as an investment or as a trading asset is essential to the property owner as it will affect their tax treatment and any tax liability arising.
There are a number of factors to consider in determining whether a property is held as an investment or for trading but the starting point is the original intention when buying the property. The distinction is usually relatively straightforward: a person buying property to let out long term will be making a property investment, whereas someone buying a property to refurbish and sell will most likely be trading as a property trader.
The tax treatment can however sometimes be less clear in practice and, as there is no statutory definition of what constitutes a trade, it will be necessary to consider case law established by the Courts. HM Revenue & Customs use the ‘badges of trade’ to identify whether a trade exists. There are nine badges of trade that have developed from case law and it is important to look at these in the round. Some of the badges that carry greater weight for property businesses are profit seeking motive, frequency of transactions, length of ownership, nature and modification to the property and source of financing.
Why does it matter if the property is held as investment or trading?
- For individuals – property traders will be liable to income tax and Class 4 national insurance (NIC) on profits arising on property disposals at an income tax rate of up to 45% (40% after April 2023) and NIC at 2% (from November 2022) for an additional rate taxpayer. An investor, on the other hand, will be subject to capital gains tax (‘CGT’) on the same disposal of the property at 20% or 28% depending on whether it is a residential property. Accordingly, there could be a considerable difference in the tax liability between the two
- For companies – Although corporation tax applies at the same rate, which is currently 19%, on a chargeable gain arising on the disposal of an investment property or trading profits arising on the disposal of trading stock, the method of calculation of the chargeable gain or trading profits, utilisation of losses and reliefs available can lead to different tax outcomes
- There are some favourable tax reliefs and exemptions that can apply on the sale of shares in a trading company, such as:
- Substantial Shareholding Exemption (“SSE”), which can exempt a company from corporation tax on the chargeable gain arising on the disposal of an interest in a trading company; and
- Business Asset Disposal Relief (“BADR”), which can reduce the CGT rate payable by an individual to 10% on the capital gain, up to a lifetime limit of £1m, arising on the disposal of shares in a trading company.
SSE and BADR only apply where certain conditions are met and will be covered in future articles in this series.
One key thing to do is to keep good documentary evidence (such as Board Minutes) as this is the clearest way of showing intent. Such evidence should be put in place at the time the property is acquired and every time there is a change in the circumstance which may lead or cause someone to question the nature of the activity. A change in the circumstance can, in some scenarios give rise to a tax charge e.g. where there is an appropriation of a property from trading stock to investment so it is important to obtain advice from your tax advisor.