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For those about to let Income from property is usually considered not to be a trade by HMRC. KEN VOLLER wonders if they are having a change of heart.
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recent query in Taxation (“Renewal refusal” from NICked, 5 July 2012, page 21) made me sit up as it gave the impression that HMRC had completely changed their view on whether the business of letting property is a trade or an investment. NICked related the story of a client who, based only on the receipt of income from let property, had been refused an application for small earnings exception from the payment of Class 2 National Insurance contributions because the profits from the lettings exceeded the exception limits. HMRC intimated that persons in receipt of “owner-managed properties” would be issued with a questionnaire so that the department could determine whether the landlord was selfemployed for National Insurance contributions purposes. A number of replies to the query suggested that the HMRC view was wrong and that NICked should revert back to HMRC for a resolution.
The Special Commissioners decided that it was not enough to move the business from passive letting to active provision of services. This led me to wonder what was behind HMRC’s muddled thinking. Property letting is a business. For many years, HMRC would not recognise that fact and it is only since legislation introduced in 1995 (now ITTOIA 2005, s 272) that the concept of a rental business has been around. However, being recognised as a business does not make it a trading business because the
Key points National Insurance dispute. Property lettings: trade or investment? Provision of other services. Guidance states property income is not a trade. 6
income is passively received by way of an investment rather than actively received from the provision of services. In 2002, a Special Commissioners case (Rashid and Garcia SpC348) explored this point and an excellent article, “It’s my business” by Malcolm Gunn, Taxation, 8 November 2007, page 491, set out matters very clearly. I have not seen or heard anything that changes the position since and I hope that Malcolm does not mind me picking out some of the pertinent points from his article and using them here. Mr Rashid had income from four properties which were a mix of residential and commercial lettings. He wanted his property income to be treated as business income so that he would be entitled to pay Class 2 National Insurance contributions because he had had to give up other work after a heart attack. As Malcolm said in his article, “it was a nice change to have an individual arguing for a tax liability and HMRC arguing against”, but the result was that HMRC won and no contributions were payable. This was after Mr Rashid listed out in great detail all the work he did in respect of the properties, including maintenance, advertising, credit checks, cleaning, gardening and collecting the rents. Although this all took a significant amount of time each week, the Special Commissioners decided that it was not enough to move the business from passive letting to active provision of services.
Active or passive Active or passive may not be recognised in terms of property letting, but I use them to help me understand the differences between various types of letting and to decide whether there is an investment business or a trading business for National Insurance purposes. If we take two examples, we can see the difference. The first is the letting of a property where, beyond collecting the rents TAXATION 11 October 2012
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and maintaining the property as required, the landlord has little more to do. This is passive and no one, not even HMRC, would expect to charge National Insurance on the profits arising. In the second example, the landlord lives in the property that he lets. In addition to collecting the rents and maintaining the building as required, he provides meals to the tenants and laundering facilities. This is active and National Insurance would be payable. If the crossover is somewhere between these two examples, at what point does passive become active? A more recent case, Ramsay (TC1871) went beyond Mr Rashid’s situation. It concerned a large Victorian house divided into ten flats. Similar to Mr Rashid, the owners of the house spent a lot of time managing the property but, again, it was judged that this was not enough to make the business active. If the maintenance activities and size of the property in Ramsay are not sufficient to effect the change, the other aspect must be the services provided, ie, something that is beyond the mere letting. In my second example, laundering and food were provided, services that are well beyond those normally found at rental properties. We would often recognise the provision of these as being from hotels, or bed and breakfast establishments but the point is that the major part of the payment is in respect of the accommodation itself, ie, rent. Most of the time, the rent would be a short-term licence to occupy the accommodation but it is not unheard of for longer-term letting to include other services. Unfortunately, even the provision of services does not truly deal with the passive/active issue. The best example is taking in a lodger. The lodger may be treated as a member of the family, eat meals with them, and have clothes washed and ironed as part of the rent that he pays. HMRC will deal with this income under the “rent a room” provisions; the income should be disclosed on the property pages of the self-assessment return rather than selfemployment pages. None of this is conclusive because we now have at least three variables, none of which appears to be the deciding factor in determining whether there is an active business on which National Insurance will be charged. In some respects, it is like trying to describe an elephant: we know what it looks like but can we describe it to somebody who has never seen one? Despite the arguments, HMRC have stood fast and successfully resisted calls for ordinary rental income to be trading income. I am leaving aside the obvious different treatment for holiday furnished letting which is not the subject of this article.
Individual or company? Going back to the query in Taxation, this centred on the question of a charge to Class 2 National Insurance, but there might also have been the possibility of paying Class 4 National Insurance if there was sufficient profit. If we are only concerned with National Insurance, might this be a situation when the landlord should consider moving property letting into a company? I will not discuss the merits of personal versus company for property letting here, but it does raise interesting advisory opportunities. 11 October 2012 TAXATION
HMRC guidance We do not know what was behind the issue that sparked the debate in the reader’s query, but there is some guidance on the subject from HMRC. This includes the SA105 UK property notes which can be found at www.lexisurl.com/sa105n. They state categorically that the individual should “complete the UK property pages in respect of rental income and other receipts from UK land and/or property”, but complete the self-employment pages for “income from hotels and guest houses, and letting furnished accommodation in your home that amounts to a trade, for example, if you run a guest house or offer bed and breakfast, rather than just taking in a lodger”. They add that, if the taxpayer is not sure which set of pages to complete, he should telephone HMRC.
Despite the arguments, HMRC have stood fast and successfully resisted calls for ordinary rental income to be trading income. Advisers also have access to the property rental toolkit, see www.lexisurl.com/toolkitp-r. From the first page, HMRC make it clear that property income may be a business but not a trading business. For further guidance on whether the provision of services in addition to the letting might constitute a trade, we are referred to HMRC’s Property Income Manual PIM4300. This provides the department’s official view but, because referral points to head office are suggested at various points, I suspect that there is internal guidance not available to the public.
Conclusion I have no doubt that HMRC have no intention of changing their view on the nature of letting income. However, they also have a vested interest in raising revenue from as many sources as possible, even if the result might mean an overall increase in costs for chasing liabilities and the possible payment of state benefits. I would like to believe that the Taxation readers’ forum query arises from the action of an over-zealous HMRC officer. However, the reference to a questionnaire being issued suggests otherwise. On that basis, I intend to keep an eye out for other cases where income from property is treated as a trade rather than an investment. Finally, I would be interested to see the aforementioned HMRC questionnaire and would be grateful if a reader could forward a copy to me. Ken Voller FFTA ATT(Fellow) is a tax and business adviser and can be contacted by telephone: 0845 130 6380 or by e-mail: ken@tax-business.co.uk. 7