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Replies to Queries - 2 - Big tax, little profit

25 September 2002
Issue: 3876 / Categories:

In 1991 a lease for a property was acquired for £20,000. This property was used in a rental business giving about £5,000 of income per year. The lease expired in 1998 and the property reverted back to the landlord.

We have been informed by the Inspector that, as this is a contract with less than 50 years to run, it is a wasting asset (section 46, Taxation of Chargeable Gains Act 1992). Thus, when the property reverted back to the landlord, the lease value is nil and thus the residue of allowable expenditure for capital gains purposes is nil.

In 1991 a lease for a property was acquired for £20,000. This property was used in a rental business giving about £5,000 of income per year. The lease expired in 1998 and the property reverted back to the landlord.

We have been informed by the Inspector that, as this is a contract with less than 50 years to run, it is a wasting asset (section 46, Taxation of Chargeable Gains Act 1992). Thus, when the property reverted back to the landlord, the lease value is nil and thus the residue of allowable expenditure for capital gains purposes is nil.

No allowance is to be given against the income of the rental business as sections 37 and 38, Taxes Act 1988 relate to premiums paid on the granting of a lease. In this case the payment was not to the landlord for the granting of a lease, but was for the acquisition of an existing lease.

It appears inequitable that £20,000 was paid to acquire £35,000 of income, yet the Inspector is refusing any allowance, either capital or revenue, in respect of this expenditure. Do readers consider that some allowance is available, or is the Inspector correct?

(Query T16,081) - Highwayman.

 

The Inspector is telling nothing but the truth, but not quite the whole truth. It is absolutely right that the £20,000 paid for the assignment of the tail end of an existing lease is entirely a capital payment and there is no relief for it against income. It is also absolutely right that the tail end of a lease is a wasting asset and, once it has expired, the cost has evaporated and there is no capital loss. On the figures given, that certainly seems harsh - the only solution is to be fully aware of it in advance and to build the unfairness into either the rent that is charged to the tenant or the decision to make the investment or not.

The small detail that is missing - that may not now be particularly helpful - is the permitted deduction of an element of the premium which was paid on the grant of the lease, if it was originally a short lease when granted. This is fairly well known. If the grantee of a ten-year lease pays a premium of £100,000, the landlord is assessed on 82 per cent of it in the year of the grant and the tenant can deduct £8,200 for each year of the lease from Schedule A or Schedule D income derived from ownership of the lease.

What is slightly less well known is the provision in section 37(4), Taxes Act 1988 that transfers this deduction with the lease on an assignment. 'The person for the time being entitled to the head lease' may deduct an element of the original premium paid by the original grantee. This means that the £20,000 actually paid is not deductible at all, but some fraction of an amount payable by someone else - which might be a lot more or a lot less, or nothing - is deductible.

This may not help in this case for three reasons. First, it may now be hard to find out what the original premium was. Secondly, the deductible amount may be very small - if the lease purchased was the tail of a 40-year lease, or a lease granted with a small premium, the deduction would be insignificant - or nil if it was a long lease, or without any premium at all.

Third, the deduction is allowed as an expense ('additional rent') year by year, so it should have been included in the accounts and returns for the years from 1991 to 1998. Most of those are now out of time for an error or mistake claim if no additional rent was claimed.

So, in conclusion, this is one of those unfair 'tax nothings' for which you get no relief, and you need to be aware of it from the outset in order to take the tax consequence into account in planning your commercial transaction. - Leyborne.

 

Unfortunately, the short answer is that the Inspector is correct with one possible qualification.

If the landlord had granted the lease after 3 April 1963 and had charged a premium, he would have been taxable on a proportion of the premium under what is now section 34, Taxes Act 1988. The original lessee would have become entitled, under what is now ibid., section 37, to be treated as having paid rent of an amount equivalent to the figure on which the landlord was taxed, spread over the whole period of the lease.

If, for example, the landlord received a premium of £30,000 for granting a 21-year lease in 1977, the amount taxable would have been £30,000 x 60 per cent = £18,000. Spread over 21 years this would give relief of £857 a year. For Schedule A, this entitlement is under section 37(4), Taxes Act 1988, and for Schedule D, Case I or II it is under section 87(2), Taxes Act 1988.

An assignee of the lease becomes entitled to the same deduction for the remainder of the lease. As 'Highwayman' does not mention such a deduction in computing the taxable rent of £5,000 a year, it seems likely that either the lease was granted before 1963 or no premium was charged.

Capital payments are not relieved unless there is specific provision, as in the Capital Allowances Act 2001. It is inequitable but, as Mr Justice Rowlatt said in Cape Brandy Syndicate v Commissioners of Inland Revenue (1921) 12 TC 358 at 366, 'there is no equity about a tax'. - The Captain.

Issue: 3876 / Categories:
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