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Our client acquired the property next door to his as an investment. It had been neglected and was suffering subsidence. The property was therefore bought jointly with a friend with knowledge of the building trade who could supervise the work.
Our client acquired the property next door to his as an investment. It had been neglected and was suffering subsidence. The property was therefore bought jointly with a friend with knowledge of the building trade who could supervise the work.
The Inspector has raised an enquiry into the capital gains computation submitted with our clients' returns on the basis that some expenditure is revenue in nature and therefore to be disallowed under section 39, Taxation of Chargeable Gains Act 1992. The amounts in question are significant and, if disallowed, would produce a very high effective tax rate on the actual cash profit realised.
On the face of it, the Inspector has a point. However, we consider that he is looking too closely at the detail and missing the point of the transaction. Property is now generally regarded as an attractive investment against a background of low interest rates and a volatile stock market. Our clients bought the property as an investment, not with the intention of letting it out or of selling it as soon as the necessary works were complete. In the event, they did sell shortly afterwards, but that was a decision at the time in the (erroneous) belief that prices had peaked.
Readers' comments would be appreciated on the Inspector's attitude. Also, is there a risk that the transaction could be treated as an adventure in the nature of a trade?
Finally, is there a human rights element to the case? Denial of relief for expenses that were incurred would increase the taxable profit to something greater than the actual profit. Could this not be classed as a confiscation of property, as one could, in theory, produce a tax liability higher than the cash generated?!
(Query T16,111) - Rokerman.
There is no prospect of invoking the European Convention on Human Rights in this case. Taxation is permitted under it and if a taxpayer so orders his affairs as to end up with a larger bill than would normally be the case, that is just too bad. The Convention will not assist him. This is relevant on the facts as given because the purchasers would normally have either:
(a) purchased the property with a view to resale after repairing it, in which case the transaction would either be an adventure in the nature of trade as such or alternatively within the scope of section 776, Taxes Act 1988 - in respect of both of these, the expenditure in question would be deductible; or
(b) purchased the property with a view to it being let after the works had been done, in which case (on the view taken by the Inspector) the repairs would be deductible against the rents under the principle in Odeon Associated Theatres Ltd v Jones (1972) 48 TC 257 and therefore, as the Inspector says, disqualified as a deduction for capital gains tax under section 39(1), Taxation of Chargeable Gains Act 1992.
The application of the Odeon case is, however, dependent upon the ascertainment of the best current accounting treatment of the expenditure in question. The taxpayer's first port of call has, therefore, to be an accountancy expert witness of repute, in order to see if the presumption upon which the Inspector is acting can be refuted. - JdeS.
The Inspector cannot have it both ways. The transactions making up this operation are either all capital or all revenue. The condition at the time of purchase cannot fail to have been reflected in the price paid. The clients bought the property for its market value in its then condition, made enhancements calculated to increase its value (quite apart from the insane movement of the market in general), and then resold on what they thought was the peak. That was a straight capital gains venture.
He would have been much better advised to argue that the entire transaction is an adventure in the nature of trade, and to seek to tax the realisation surplus to income tax, because the exercise could actually be seen in that light, especially as the property was resold quickly and no attempt was made to let or use it. Had the house actually been let, the clients might possibly have set some of the work against income as repairs. But that is a choice governed by what is happening, rather than by a blanket principle. In the reported circumstances, the Inspector's claim is groundless.
There seems to be a fashion now for invoking Human Rights law, whether suitable or not, as if it were a general cure-all. In this case, no rights have been assaulted. There is simply an argument about the interpretation of facts. It is suggested that the line to take is that the works were simply to effect a marked enhancement in the property's condition, hence its market value. - Man of Kent.
Editorial note. Paragraph 136 of the Revenue's booklet IR 150: Taxation of Rents gives as an example of a capital expense 'the cost of refurbishing or repairing a property you bought in a derelict or run-down state'. This would seem to be the case here as the property 'had been neglected and was suffering subsidence'. Paragraph 154 goes into more detail: 'Repairs to reinstate a worn or dilapidated asset are usually deductible as revenue expenditure … But a change of ownership combined with one or more additional factors may mean the expenditure is capital. Examples of such factors are … the price you paid for the property was substantially reduced because of its dilapidated state'.
