Meg Saksida highlights why it is important to know the difference between a property developer or a property investor.
For more in depth discussion on this important area of property taxation, please see our recently updated guide, 'Property Investment v Property Trading'. New 2023/24 edition available - Save 40% today!
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Different behaviours cause different taxation consequences. For example, the disposal of one antique table at a gain would cause a taxpayer to be charged to capital gains tax (CGT), an antique table being a chargeable asset for CGT purposes. However, if the same taxpayer set up an antiques shop and traded as an antique dealer, every antique table they sold would be the turnover of a trader and the profits would be chargeable to income tax.
Given that the highest tax rate for disposing of tables for CGT is 20% and the highest rate for taxing a trade in income tax is 45%, there is a significant difference and a huge incentive to get it right.
So which is it?
When considering the sale of one antique or the trading of many, the difference is reasonably easy to ascertain. However, with property, whether the taxpayer is developing or investing is not such a straightforward distinction, although profits from furnished holiday lets are treated as a trade for all taxes except National Insurance contributions (NICs) and inheritance tax.
Generally, if the taxpayer is holding the property for a long-term increase in capital, whether let or not, they are likely to be a property investor. On the other hand, if the property is bought with the intention of a short-term renovation or build, to subsequently dispose of it at a gain, it is likely to indicate a trade. The taxpayer's intentions at the time of the purchase are paramount. In Azam v CRC [2011] UKFTT 50 (TC), HMRC found the taxpayer’s intentions at the time of the purchase of the properties in question were more important than what actually occurred.
What’s the difference?
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Profits and losses
If the individual is not a property developer but is simply holding the property for the rental income or the capital increase, any gains will be charged to CGT. Gains will be reportable and payable 60 days after the completion of the sale, and a self-assessment tax return detailing the sale will also be required by 31 January in the year following the end of the tax year the disposal is made in.
The CGT rates will be 28% for a residential property (10% if business asset disposal relief (BADR) is available), with a £12,300 annual exempt amount (reducing to £6,000 from 6 April 2023). If a loss arises, this can only be carried forward for use against a future gain made by the same taxpayer.
If the individual is a property developer, so buying and selling the properties for short-term gain, the profits are chargeable instead to income tax. When the individual is classified as a trader (whether a sole trader or partnership), all profits are chargeable to non-savings income and will be charged at either 20%, 40% or 45%.
If a trading loss is made in the year, the amount to be taxed in the computation is nil. A note of the loss will be made and, depending on the wishes of the trader, this loss can be relieved in different ways:
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Firstly, the trader could set the losses off against other or general income earned in the year. This would require a claim.
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The trader could set the losses off against other income earned in the preceding year. This would also require a claim. Either or both of these two claims could be made in any order.
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If the loss is unable to be relieved as above, the loss could be set against the individual’s capital gains.
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Finally, losses can be carried forward and set against future trading income (from the same trade only); again, this will require a claim but tends to be made only if the above claims have already been made.
If the developer is a company, corporation tax will be in point. Profits from the trade will be chargeable to corporation tax at 19% (25% from April 2023) and profits will need to be extracted at a tax cost too. This means if the property is an investment rather than a trade and is likely to make a gain, it will probably be worth the taxpayer holding the property in their own name rather than through the company.
Losses, however, offer a number of options. The losses may be:
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Offset against total profits in the current period (total profits here refers to net income and gains before deducting qualifying charitable donations);
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Offset against total profits in the previous 12 months; or
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Carried forward and set against total profits of a later accounting period.
As can be seen, the CGT rates of a sale are significantly lower at 28% than the rates of up to 45% through income tax. Although a company has a lower rate at 19%, the profits need to be extracted, which tends to attract an additional (up to) 45% or 39.35% (if dividend) tax charge.
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Other issues
Further, if the individual taxpayer is a trader, NICs will also need to be paid, increasing the cost further.
However, although the investor path may appear better for CGT than income tax, it may also be necessary to contemplate the impact on IHT.
IHT considerations
For IHT purposes, if the business is trading and not ’wholly or mainly‘ dealing in land, as long as the ownership conditions have been satisfied, the business should be eligible for business property relief (BPR) at 100%, saving IHT at 40%.
For property developers, they must ensure that the properties are in stock rather than in fixed assets and ready to be re-sold and not held for investment purposes. The increase in the value of the properties should be from building, additions, renovations etc. and not from simply holding the property or from the addition of planning permission which would indicate investment and not be eligible for BPR.
How do we know?
Unhelpfully, there is no definition of ‘trade’ in the legislation. There are, however, the ’badges of trade’ that were identified in 1955 in a Royal Commission report on the taxation of profits and income, and which have subsequently been augmented by case law over the years. HMRC’s Business Income manual, BIM2020, gives nine badges of trade with links to further information on these. They are:
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Profit-seeking motive (supports trading but not conclusive on its own).
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The number of transactions (the more transactions, the more likely the entity is trading).
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The nature of the asset (is the asset able to be manipulated for an enhanced sale value?).
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The existence of similar trading transactions (is the trade similar to one that exists already?).
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Any changes to the asset (has the asset been repaired or improved to increase the probability of a sale?).
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The way the sale was made (was it typical of trading, i.e., advertised and subsequently sold or was it a ’fire sale’ with no choice?).
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The source of finance (borrowed money only able to be repaid as a result of the trading?).
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The interval of time between purchase and sale method of acquisition (the quicker the turnaround, the more likely it is to be trading).
Practical tip
It is not always clear whether the individual or company is trading or investing. Although the badges of trade are helpful, it is always recommended that a tax adviser be consulted to ensure an independent and more accurate view, and as the taxpayer’s intention is important, sufficient proof should be kept if this is to be relied on.
