For seven years, our husband and wife clients have traded in partnership from two freehold fast food outlets several miles apart. One of the shops has two flats above it. Taxable business profits average £100,000 p.a. and these are divisible equally between the partners.
The clients are considering an offer of £900,000 for the business and all the premises, which they would use to fund a new restaurant venture.
For seven years, our husband and wife clients have traded in partnership from two freehold fast food outlets several miles apart. One of the shops has two flats above it. Taxable business profits average £100,000 p.a. and these are divisible equally between the partners.
The clients are considering an offer of £900,000 for the business and all the premises, which they would use to fund a new restaurant venture.
The long lease for the new restaurant will cost £300,000 and the development costs will be £200,000. It is envisaged that the new venture will be in a limited company, due to the uncertainty of how long the existing partnership will continue and the retention of favourable taper relief available to the partners. Work will commence on the restaurant in late 2005 and trading should start in June 2006. The client is concerned that there will be no VAT or capital allowances reliefs until trading commences — the partnership trade (which may well overlap with the new venture) will obviously not be using the assets which are part of the restaurant.
Taxation readers' views would be appreciated on the following points.
- First, if the client decides not to sell the partnership immediately, are there any opportunities to claim earlier relief for costs associated with the restaurant before it begins trading?
- Secondly, the general advice given is to incorporate the restaurant and keep the existing partnership trade separate. Should this be reconsidered?
- The problem of incorporating the existing partnership and the new venture in one limited company is that the client intends to focus only on the new restaurant venture in the future and a part sale of the new company in, say, 2006-07 would appear not to be tax-efficient.
Any other comments from readers on the most tax and VAT advantageous way of structuring the businesses, especially taking account of any overlapping period of trading, would be gratefully received.
Query T16,708 — Fast feeder.
Reply by New Road:
I assume that the restaurant and fast food businesses will be different trades. That means that the restaurant will be subject to the commencement rules if it is held within a partnership.
Based on the facts as we have them, the first year of tax will be 2006-07. Any pre-trading expenditure and pre-trading capital expenditure will qualify for relief or for capital allowances on the first day of trading, giving the relief against the 2006-07 profits. Any excess of capital allowances or expenditure will be set against other income, including the fast food outlet. However, if the two businesses are running concurrently, it does not seem to matter against which of those profits the allowances and reliefs are set.
It would be possible to sell the fast food business and then incorporate the restaurant business using one of the reliefs available, remembering that stamp duty land tax will be based on the value of any land transferred, although it might be possible to retain the lease in the partners' name and grant a sub-lease to the restaurant.
Answering the specific questions: first, I cannot see a way of using reliefs for income tax or corporation tax until the trade commences whether in a company or not. If the restaurant is set up in a partnership, the activity should be covered by the current VAT registration so that input tax could be claimed back. A company could register as an intending trader.
Secondly, it is possible to keep the existing partnership trade separate from the restaurant trade for income tax even if within the same partnership. I have seen partnerships with more than one trading account several times. In fact, if HMRC see the two businesses as different, there will be a need for separate tax computations. Such a separation does not exist for VAT where persons are in business.
Thirdly, incorporating the existing partnership means that the company will sell the fast food outlets' trade and assets. There will be no sale of part of the company. Depending upon the method of incorporation, the company may have acquired those assets at current market value so that any gain will be small. The shareholders' taper clock will have started again, but since the only asset is the new business nothing stands by that.
An alternative approach will be to set up the restaurant within the partnership, sell the fast food outlets and then incorporate the restaurant.
Finally, or perhaps firstly, Fast feeder should check what reliefs are being lost if the transactions go ahead as currently planned — the time cost might be outweighed by any additional legal and other professional costs of rearranging the transactions. After all, not all of the fit-out costs will qualify for capital allowances.
Reply by Southern Man:
Starting with basics, the costs associated with the restaurant before it starts trading will be capital or revenue. Unless eligible for capital allowances, capital costs cannot be set against the business profits of either the existing or new businesses. The only potential relief for the capital cost of the new lease would seem to be by way of rollover relief from the sale of the existing business. The fast food business is worth £900,000. We do not know its original cost or valuation, but as the whole of the sale proceeds will not be reinvested in new qualifying assets (presumably only £300,000 for the long lease), any relief is likely to be minimal. It should also be noted that taper relief is given after rollover relief, which can lead to substantial increases in the total taxable gain when the disposals of both old and new assets are taken into account.
The only way that relief for 'revenue' development costs could be obtained prior to the restaurant starting to trade would be if this were part of the existing 'fast food' trade.
Having said that, it does occur to me that if the fast food business is not sold until later, funding will be required for the new restaurant. Subject to there being capital invested in the business, the partners could borrow money which would be eligible against the 'old' partnership profits, which would allow them to withdraw capital from that business to fund the new venture. (See HMRC's Business Income Manual at BIM45690 et seq.) If this is not possible, any interest will have to be claimed under the pre-trading expenditure rules.
There seems little point in incorporating the present business. The taper relief 'clock' will have to restart and if, on a sale, the purchaser only wants to buy the business rather than the company, there could be 'double tax' implications. It is tempting to think that bundling the two businesses within one limited company will assist in the deduction of 'new' expenses against 'old' profits. However, the same rules will apply here as if the business is carried on outside of a company. Are they parts of the same business or two different ones? I must admit that I have always found the case law on this subject a little confusing. In Maidment v Kibby & Kibby [1993] STC 494 the owners of a fish and chip shop who acquired a second shop five miles away were held to have continued and enlarged their trade. However, in that case the two businesses were of the same type and there are earlier cases — such as Laycock v Freeman Hardy Willis 22 TC 288 and Gordon & Blair Ltd v CIR 40 TC 358 — which point the other way. This may be academic because as long as both are either within or outside of a limited company (and subject to the division between husband and wife), any loss of the new business should be able to be set against the profits of the old in the same year or carried back under the 'early years' rules.
Fast feeder mentions possible overlapping accounting periods and it would be as well to ensure that the losses, capital allowances or pre-trading expenses of the first accounting period of the new business fall timeously in relation to the existing accounting periods and tax years to ensure the maximum and earliest set-off of relief.
VAT treatment will depend upon the trading format. If as a partnership, the existing registration will be applied. If within a limited company, then a separate registration would be required. I would guess that the turnovers of both businesses exceed the annual limits, so there should not be a problem with aggregation issues. Perhaps on a relatively minor point, presumably the flat lettings are in joint names. VAT will not be chargeable on the rents, but the VAT on expenses could be reclaimable under the partial exemption de minimis rules.
