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It is by no means unusual to come across a situation where a private company is occupying its trading premises either by way of a formal lease or informal licence granted by the freeholders, who are directors. Considerable sums can be spent by the company on what appears in the balance sheet as leasehold improvements. If not reimbursed by the owners, is there not a taxable benefit in kind, subject also to Class 1A National Insurance contributions? If so, is the quantum of the benefit equivalent to the increase in the value of the freehold reversion created by the works?
It is by no means unusual to come across a situation where a private company is occupying its trading premises either by way of a formal lease or informal licence granted by the freeholders, who are directors. Considerable sums can be spent by the company on what appears in the balance sheet as leasehold improvements. If not reimbursed by the owners, is there not a taxable benefit in kind, subject also to Class 1A National Insurance contributions? If so, is the quantum of the benefit equivalent to the increase in the value of the freehold reversion created by the works? Is it a legitimate defence to contend that the expenditure has had no effect on the capital value of the property?
(Query T15,819) – GDA.
Surely 'improvements' enhance the value of the director's property. Construction works would retain their value on expiry of a short lease. In any case, it is the incurring of expenditure which matters rather than its efficiency.
In the absence of a formal agreement or board minutes, it is uncertain whether the terms at commencement of the letting could be said to impose on the company tenant an obligation to carry out work on the premises, as envisaged by section 34(2), Taxes Act 1988, with a consequential income tax liability on notional rent for the owners. This could be significant if no money rent is specified.
Section 154 is the general charging provision for directors' benefits. Section 156(2) measures the cost of a benefit as the amount of any expense incurred in connection with its provision. In English land law, anything annexed to land or a building becomes an integral part of it as regards ownership, so it does not seem possible to regard the leasehold improvements as constituting the transfer of an asset for which market value would be relevant. The value of premises is immaterial. It is the cost to the company which has to be taken as the measure of the directors' benefit.
To escape interest and penalties for past under-declarations, the directors' loan accounts could be debited now (see Loose Ends, 'Making good a benefit in kind', in Taxation, 27 February 1992 at page 531). – Elder.
There is a VAT aspect to this question. Whilst there should be no problem for a business in recovering input tax incurred on routine maintenance of a property, which it occupies under an informal agreement with a director, there could be one with capital expenditure. Many 'leasehold improvements' will have little or no ongoing value in an industrial context: work in adapting the fabric or altering the layout of the building for the purposes of the business occupying it may be irrelevant to the next user.
However, suppose a property was bought by a director, substantially improved at the expense of the occupying company and then sold on for a substantial capital gain. VAT recovered by the company on the cost of the improvement work would represent a significant saving to a director not registered for VAT in his or her personal capacity, or if the sale was not opted to tax. If Customs realised what had happened, they would obviously query it.
It is not usually practicable to move businesses in and out of premises merely to shelter VAT recovery, and there may be other tax considerations which inhibit the idea. However, suppose a director's pension fund or the partners in a professional partnership own the property occupied by the business. Neither is likely to be registered for VAT. The arrangements are probably informal and the principals in the business will take it for granted that it should pay for the improvements.
Common sense suggests a written agreement under which an initial rent is determined and the business is made responsible for all expenditure on the property as required for its purposes. A board minute might usefully record the normal commercial rent payable for such a property at the time, and the reduction in the rent due to the business assuming liability for repairs. However, do not build into the agreement a rent reduction or a rent-free period in return for a formal obligation of the business to carry out improvements. See Notice 742 Land and Property for the possible consequences.
Although, for arrangements not at arm's length, a formal lease and security of tenure may be unnecessary, it seems to me that something in writing is needed in order to confirm the basis for VAT recovery. Board minutes setting out the reasons for major expenditure as it occurs would also be sensible as evidence of why it was necessary for the purposes of the business. – A St John Price.
Extract from reply by 'Barham':
If occupation by the tenant is informal, either for free or on a periodical rent, the exact nature of the works is of interest.
(a) Are they wholly or partly detachable? It may be that they can be lifted and removed or sold by the company at the end of the lease or when they have outlived their usefulness. To that extent, they are like freestanding assets of the company, and the raison d'être of this query dissolves.
(b) Do they impart lasting value to the property or do they benefit only the tenant's business? They may be of no value to the freeholder, but allowed to the tenant, on condition that they are eventually cleared away. One can hardly take an enrichment from something that yields no value.
However, any acceptable and enduring improvements that stay embedded in the property must be accounted for, but the process is not automatic. Initially they are capital expenditure by the company, shown as improvements on its balance sheet. They remain company property and there is no transfer to the freeholders until it is shown in the company's books. This would be rent in kind, emerging either at the end of the lease, as part of the surrender, or during it at such times and in such amounts as it is transferred from asset account to rent paid account. Or if the company makes no book entries in respect of a transfer of the value, but simply surrenders the improved property at the end of the lease, the freeholders make a capital gain of the (then) value of the improvements.
