To rent or not to rent – 
tax is the question

Paul Windsor

Paul Windsor is a partner at specialist UK real estate tax advisor WSM Property. He examines 
the tax consequences of letting those unsold developments until market conditions improve

Like the ebbing tide across the beach, the liquidity of the markets seems to have disappeared over the horizon leaving rental as the only solution for all those many unsold flats in recently completed development projects across the country. However what are the tax pitfalls of hanging on to a rental portfolio? Firstly, and most importantly it is essential to establish whether you are renting temporarily or actually converting to an investment company and the intention at this stage must be evidenced in writing.

Trading against investment
It is essential that any board has agreed and documented the strategy behind the deal when the land or property was first purchased. HMRC often ask for contemporaneous evidence as to whether the purchase is an investment or a trading asset. The asset's position when it first appears in the balance sheet will give a strong indication of the intention - stock for development or a fixed asset allocation for investment, but there are a number of other factors to consider as well. This is important as it informs the whole basis of the future tax treatment of the profits - is it to be taxed as a capital gain or is it profit from trading?

This is significant as it can lead to adoption of either capital gains or income regulations. These different rules will lead to some elements of income and expenses being taxed or relieved at different times and can prevent the granting of loss relief which might otherwise be available. In the vast majority of cases letting on a temporary basis is going to be the most likely, but it is always possible that a permanent change from trading to investment may provide an opportunity to crystallise otherwise un-relievable tax losses.

VAT HMRC are already warning house-builders faced with the dilemma of having to let unsold property to check that they are not breaking tax rules by changing the purpose of their build. Residential first time sales are generally zero rated for VAT purposes enabling the developer to reclaim construction VAT costs. The reclamation of input tax is voided if a property is built to be rented - thus potentially leaving the developer with significantly higher costs. If the intention is not changed but the property is rented temporarily the loss of VAT can be reduced. Interest should be deductible for both development and investment properties; however care must be exercised on a change of use to prevent interest unrelieved to date being "locked in" to trading tax rules and not allowable against a future capital disposal.

Entrepreneurs' relief
The recent replacement of Business Asset Taper Relief (and the effective 10 percent rate of tax) on the sale of an SPV with the new 'entrepreneur's relief', taxing up to one million pounds of gain per investor on the sale of the company at ten percent, has reduced the impact of this exit route but none the less it is an important planning tool for trading company owners. Letting the underlying assets for a few years could jeopardise the trading company status and leave the relief open to question by HMRC - potentially increasing the tax charge on the withdrawal of profits by 80 percent.

SDLT As ever with property transactions the additional cost of stamp taxes should not be overlooked if there is a transfer or deemed transfer of property for actual or deemed consideration. If a change in the type of business is inevitable, a correcting structure to mitigate the risk or impact of a change in status may be available - perhaps selling to a second 'investment' company in order to retain the trading status of the first.

So in the end what have 
we learned?
Well - don't make the obvious snap decision to let without thinking it through and taking some professional tax advice first. Every developer has different circumstances and although it is sensible to take action to minimise outgoings in the current market, it is vital that you check it out first - and don't be stuck in the sand when the tide of fresh finance comes flooding back in.