Property trading or investment company?

Capital Gains Tax » July 29, 2021

Why does it matter?

The distinction between trading or investing in property is crucial to a great many areas of tax law.  There are several ramifications of misclassifying an activity as trading or investing. If clients own a property investment company when the properties are sold or transferred, the gains are subject to Capital Gains Tax (CGT) at either 10% or 20%.  If clients own a property trading company, the gains on sale or transfer are taxed at Income Tax rates of 40% or 45%.

Tax consequences of property trading versus investment company

 Property Trading CompanyProperty Investment Company
Rental incomeCharged to Income Tax and Class 4 National Insurance (9%)Charged to Income Tax only
Property saleCharged to Income Tax and Class 4 National Insurance (9%)Charged to CGT (18%/28%)
Disposal of businessCharged to CGT at 10% by way of Business Asset Disposal ReliefCharged to CGT (18%/28%)
Inheritance tax treatment100% Business Property Relief, zero IHT to payIHT charged at 40% on the value of the net asset

If a person is trading in property, they will be subject to Income Tax and National Insurance on their profits (including income and gains). They will have a self-employment business which should be reported to HMRC for each year they are in business. 

A person who is trading in property may also be eligible to claim Business Asset Disposal Relief (BADR) on a part or complete disposal of their business. BADR allows gains from the disposal of a trade to be taxed at a reduced rate of 10%.  Due to this lower rate of CGT, it is common for individuals or companies to present that they are trading in property and not investing in property to try and secure preferential treatment on eventual disposal.  When a property trading business is sold, it will likely qualify for BADR whereby gains would be taxed at 10% rather than 28%.

If a person is investing in property, they will be subject to Income Tax on any rental income and CGT on any disposal of assets.

Deciding between investing or trading

In tax law, there is a definition for trading in the Income Tax Act 2007 and the Taxation of Chargeable Gains Tax Act 1992. There are further definitions of trading in the Inheritance Tax Act 1984 and Corporation Tax Act 2010. For ease, I will use the terms ‘’trade’ or ‘trading’ or ‘investment’ or ‘investing’ when referring to property trading or property investment.  I will look at the conditions for trading and investing under the Income Tax Act 2007 and Capital Gains Tax Act 1992 below.

The separation of property (and letting) income from trading income is a long established principle in UK tax law. In Salisbury House Estate Ltd v Fry [1930] 15 TC 266, ‘A landowner may conduct a trade on his premises, but he cannot be represented as carrying on a trade of owning land because he makes an income by letting it’.  This principle has often been applied by the Court, in Griffiths v Jackson [1982] 56 TC 583 ‘although property income is now computed like trading income, letting is still not trade’.

Income Tax Act 2007

Trade is defined in the Income Tax Act 2007, s 989, as including “any venture in the nature of trade”.  The interpretation of the word ‘trade’ has been left to the Court, who have developed a number of tests, commonly referred to as the ‘badges of trade’, to determine whether somebody is trading.

These ‘badges’ will not be present in every case and of those that are, some may point one way and some the other. The presence or absence of a particular badge is unlikely, by itself, to provide a conclusive answer to the question of whether or not there is a trade. The weight to be attached to each badge will depend on the precise circumstances. The approach by the Court in using the badges of trade has been to decide questions of trade on the basis of the overall impression gained from a review of all the badges.

In the table below, we have examined some of the badges of trade in the context of property businesses.


Badges of trade  
HMRC Business Income ManualCases
Profit-seeking motiveBIM20210 An intention to make a profit supports trading, but by itself is not conclusive. Evidence that the sole object of acquiring an asset was to re-sell it at a profit, without any intention of holding it as an investment, is a pointer to the conclusion that a trade is being carried on. However, the presence of a profit-seeking motive is not necessarily a decisive pointer to the existence of a trade. It is only one factor to be weighed along with all the other relevant factors. Some assets are more likely to be held as investments than others are.  ‘mere intention is not enough to invest a transaction with the character or trade’ Rutledge v CIR [1929] 14 TC 490, page 496.   ‘the question is not what business does the taxpayer profess to carry on, but what business does he actually carry on’ CIR v Hyndland Investment Co Ltd [1929] 14 TC 694
Frequency and number of similar transactions  BIM20210  Systematic and repeated transactions will support ‘trade’. A single isolated transaction can amount to the carrying on of a trade for tax purposes, but it is generally not easy to show that that is the case. The transaction, if it is to be trading for tax purposes, has to be a venture in the nature of trade.    The test to be applied is whether the operations involved in the transaction are of the same kind or character, and carried on in the same way, as those which are characteristic of ordinary admitted trading in the line of business in which the transaction was carried out. CIR v Livingston and Others [1926] 11 TC 538, at page 542.
Nature of the asset  BIM20250 Is the asset of such a type or amount that it can only be turned to advantage by a sale? Or did it yield an income? The area of difficulty concerns assets that are generally bought: as an investment that usually, but not necessarily, yields income, for example shares.  That presumption can be overturned, but there is, in practice, a greater onus on those who assert that there is a trade, than is the case with assets that are commonly dealt with by way of trade. CIR v Fraser [1942] 24 TC 498. In Rutledge, a taxpayer purchased one million rolls of toilet paper in one single transaction. He then sold them in another single transaction. This was held to be trading as there was no other justifiable reason to purchase such a large quantity of toilet paper. Rutledge v CIR [1929] 14 TC 490.  
Connection with an existing trade  BIM20270 Transactions that are similar to those of an existing trade may themselves be trading.  In Harvey v Caulcott [1952] 33 TC 159, a builder claimed that certain properties that he had built and then sold many years later were investments and not part of his trading stock.  On the facts of his case, he succeeded.  
The way the sale was carried out  Was the asset sold in a way that was typical of trading organisations? Alternatively, did it have to be sold to raise cash for an emergency?  ‘I think the test, which must be used to determine whether a venture such as we are now considering is, or is not, “in the nature of trade”, is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.’ CIR v Livingston and Others [1926] 11 TC 538.  
Financing arrangements  BIM20300 Was money borrowed to buy the asset? Could the funds only be repaid by selling the asset? If an asset is purchased using a short term loan that the taxpayer is unable to repay without selling the asset, HMRC may be able to successfully argue that the asset was purchased specifically with a view to selling it and is, therefore, a trade.  For example, in Wisdom v Chamberlain [1968] 45 TC 92, the taxpayer was held to be trading in relation to profits made from the purchase and sale of silver bullion. His normal occupation was not in that sort of activity. The purchase of the bullion was financed by loans at a high rate of interest in circumstances that made it clear that it was necessary to sell the asset in the short term, to repay the loan and eliminate the interest obligation.  

Taxation of Chargeable Gains Act 1992

A trading business as defined by the Taxation of Chargeable Gains Act 1992  is one “carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities”[1].

HMRC Guidance suggests substantial is over 20% [2]. The legislation provides that such still counts as trading if their activities “… do not include to a substantial extent activities other than trading activities”.  A business, whose non-trading activities amount to more than 20% of its total activities does not meet the trading requirement.

Balance of indicators

The indicators should not be regarded as individual definitive tests to which a 20% “limit” applies. They are factors, or indicators, that may be useful in establishing whether there is substantial overall non-trading  activity.  It may be that some indicators point in one direction and others the opposite way.

The matter should be judged “in the round” [3]. The individual indicators are turnover, asset base, expenses incurred by the company, and time spent by the business.

Summary

In summary, where clients hold properties it will be important to establish early on if they are property investment companies or property trading companies. It may be relatively straightforward to make this determination, however, in cases where it is more complex, the matter should be referred to a tax expert or the parties’ accountant who may already understand the business. The tax position on sale or transfer of the business asset could be 10% or 45% depending on the nature of the business and could significantly impact the net outcome of the financial proceedings.

[1] TCGA 1992, s 169SA, Sch 7ZA, para 1 

[2] penultimate paragraph at CG53072

[3] exors of Farmer dec’d) v IRC SpC 216

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