Replies to Queries - 4 - Landlord's compensation

A landlord wished to sell his property, but the tenant, who was still within the agreed term of twelve months, refused to move out. The tenant finally agreed to accept a negotiated lump sum of £3,000 in order to vacate the property.

Please advise whether the landlord can claim the payment against his rental income, in view of the short term nature of the tenancy which was released.

Alternatively, assuming that this payment is capital in nature, can it reduce the chargeable gain? It must presumably fall within section 38, Taxation of Chargeable Gains Act 1992 if it is to be allowable, but I am not convinced that any of the categories of expenditure mentioned in that section actually apply here.

(Query T16,107) - L and T.

As the purpose of the payment to the tenant was to enable the property to be sold with vacant possession, no deduction can be made for it against the Schedule A pool of rents for two reasons:

The capital gains tax position does, however, seem to be more promising.

Under section 38(1)(b), Taxation of Chargeable Gains Act 1992, expenditure to enhance the value of the asset sold is deductible if 'reflected in the state or nature of the asset at the time of disposal'. The £3,000 will therefore be deductible against the gain, provided that the disposal takes place before the date upon which the lease would have expired if not terminated early as a result of the payment in question. In the light of the current state of play in Jerome v Kelly [2002] STC 609, it is unclear whether the date of disposal for this purpose is that of contract or completion. While the Revenue would almost certainly accept a deduction based on the contract date, every effort should therefore be made to achieve completion of the sale before the relevant date. - JdeS.

It is felt that 'L and T' have given insufficient information to provide a wholly meaningful answer. Is this a business or private landlord/tenant situation?

If the landlord had been a property dealer, then I would say the compensation ranks as a revenue expense. Another example might be a development involving site assembly, which frequently involves vacant possession and not just the purchase of land. For a dealing company, payment to a tenant to vacate should be allowable in full as a Schedule D, Case I deduction. An investment company would need to satisfy the stringent conditions of section 38, Taxation of Chargeable Gains Act 1992.

Generally, it may firstly be worthwhile to look at the situation from the tenant's perspective. In the case of Drummond v Austin Brown [1984] STC 321 (dealing with compensation received under the Landlord and Tenants Act 1954), it was determined that the compensation received was not taxable as a capital gain. Furthermore, as the payment was of a capital nature, neither did it need to be brought into the trading profits as a business receipt. In a nutshell, it was a free of tax payment to the tenant. Whilst not suggesting the correlatable treatment by the landlord has no tax consequence, it would appear - unless dealing is an issue - that the general prohibition under section 74, Taxes Act 1988 rules out any claim to a business expense. If we are left with the possible reduction of the capital gain, as 'L and T' presume, then the only consideration would appear to fall within the realms of enhancement expenditure under section 38(1)(b), Taxation of Chargeable Gains Act 1992. If the payment enhances the property value - being expenditure reflected in its state or nature at the time of disposal, then a claim under this section is considered appropriate. - Jim.

Extracts from further replies received:

Section 38(1)(b), Taxation of Chargeable Gains Act 1992 treats as an increment to base cost the expenditure incurred on an asset for the purpose of enhancing its value, if this is reflected in its state at the time of disposal. Clearly, the vacant possession satisfies this test because the mere expiry of the term of the lease does not mean that the tenant would have gone quietly - a court action is often necessary. - Elder.

Where a reverse premium is paid by a landlord at the inception of a lease, a deduction for the payment will be prohibited if the lease that was created as a consequence of paying the premium has already ceased when the property is sold. This is confirmed in the Inland Revenue's Capital Gains Manual at paragraph CG70851.

However, in this case the payment is made not to create a lease, but to terminate it, and so obtain vacant possession. The query indicates that the property was sold with vacant possession; therefore the consequence of the payment is reflected in the state or nature of the asset at the time of disposal. - Hodgy.

What we do not know in this case is the history of the let property. If, say, it had always been let, the whole gain would be liable to capital gains tax (subject of course to indexation allowance and taper relief) with relief being obtained for the £3,000. But what would be the position if the property had previously been the owner's principal private residence with, say, the letting only taking place within the last three years of ownership, so that the whole gain might potentially be exempt under section 223, Taxation of Chargeable Gains Act 1992? If the expenditure has been incurred simply to enhance the selling price of the property, is that enhanced element of the gain exempt? The Revenue's Capital Gains Tax Manual at paragraphs 65200 to 65271 makes interesting reading here. It would seem that the increase in the value of the property - the 'marriage value', less the £3,000 - might theoretically be subject to tax without the benefit of section 223. - Slippery Rails.

Issue: 3882 / Categories: