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Replies to Queries - 2 - Cashing in on retirement

29 August 2001
Issue: 3822 / Categories:

My client, a husband and wife partnership, have traded as property developers for many years. Now both 67 years old, they have decided to retire. The only asset left in the partnership is a plot of land on which they intend to build a house for a letting income and possibly selling in a few years' time.

The land cost £75,000 two years ago. Building costs may be £100,000 with a current valuation on the completed house of £350,000.

My client, a husband and wife partnership, have traded as property developers for many years. Now both 67 years old, they have decided to retire. The only asset left in the partnership is a plot of land on which they intend to build a house for a letting income and possibly selling in a few years' time.

The land cost £75,000 two years ago. Building costs may be £100,000 with a current valuation on the completed house of £350,000.

Can I simply treat the development business as ceasing so that the house will be jointly owned as a capital asset costing £175,000 and attracting taper relief when eventually sold, or is there any scope for retirement relief?

(Query T15,866) – Heybridge.

 

I fear that the transaction will be treated as part of the trade and the profit will be charged to income tax under Schedule D, Case I without the benefit of any reliefs. There appears to be a widely held view in the Inland Revenue, perhaps unfairly, that once a builder (or property developer), always a builder. In the present circumstances, there seems little defence to this view.

Chapter 5 of Tolley's Property Taxes provides a useful résumé of the distinctions between property investment and property dealing. Amongst the badges of the latter, which is a trade, there is motive. I have little doubt that the land was acquired with a view to profiting from its resale. Where is it in the accounts? I strongly suspect as stock, again indicating the profit motive. There are other tests and 'Heybridge' should review these carefully.

It is not clear when the house building will take place in relation to the supposed cessation of trade. I imagine probably before the cessation of trade. In that case, if the trade really does cease, then one is left with the problem of what to do with it. Following the principle established in Sharkey v Wernher 36 TC 275, an asset taken from a business for own use should be appropriated at market value, generating in this case a Schedule D, Case I profit of £175,000. Bear in mind that, at this point, there are no cash proceeds to pay the tax.

An alternative might be to keep the partnership going without its former trade but now having an activity of property letting. Even so, the clients would have to be cautious about reclassifying the house from stock to fixed asset because of section 161, Taxation of Chargeable Gains Act 1992. This, in effect, deems a profit to arise under Schedule D, Case I as in the preceding paragraph.

Whilst the receipt of letting income in a continuing partnership is a characteristic of property investment (rather than dealing), it is no real defence to treatment of the ultimate gain as a trading receipt. In J & C Oliver v Farnsworth 37 TC 51 properties were built and then let for many years but the eventual sales were held to give rise to trading profits.

In the unlikely event that the Inspector can be persuaded to treat the profit as a capital gain, I do not think that the reliefs suggested will be of any value.

Retirement relief is due to be phased out completely by 5 April 2003, which leaves little scope for receiving letting income from the property. Further, retirement relief is only applicable to disposal of a business or interest in a business. At best, this is an asset used in a business; for the distinction between part of a business and an asset used in a business, 'Heybridge' should consider McGregor v Adcock [1977] STC 206 and other similar decisions. However, I do not even think that this is an asset used in a business; it is a product of the business. So, retirement relief would not be due even on a short-term sale.

The more valuable business asset taper relief applies only to assets used in a trade. Property letting may be a business but it is well established that it is not a trade. If a capital gain arises, then only the lower non-business asset taper relief could be claimed and it will take several years to accrue an amount of significance. – The Snark.

 

Because what is being extracted from the business is stock in trade, the principle in Sharkey v Wernher 36 TC 275 applies, so that a credit must be brought into the accounts represented by the market value now, not just the land and building costs. No doubt the developers are registered for VAT, possibly enhancing the extraction cost. It seems evident that building work before extraction would push up the value by the profit margin and, with rising market prices, could lead to a significantly increased exit value (estimated at £350,000, plus VAT?) as compared with the current site value, albeit with planning permission.

Quite apart from Sharkey v Wernher, section 161, Taxation of Chargeable Gains Act 1992 refers to the case where stock is appropriated from trade or retained on cessation of trade, in which event the clients will be credited with a base cost for capital gains tax matching the extraction value brought into the accounts.

Some retirement relief will be available for trades ceasing not later than 5 April 2003, but this trade has no chargeable business assets, only stock in trade (and valueless goodwill).

When the clients have withdrawn the site from the trade, they should carry out the building, maintaining the VAT records appropriate to the projected sale. Taper relief will only become available at the lower rate for non-business assets, since letting (except furnished holiday letting) is not a trade. – Bear.

Issue: 3822 / Categories:
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