Replies to Queries - 2 - Having your cake

Our client owns a substantial town house. It is not our client's principal private residence but is used by his limited company as an office. The building is regarded by the local council as a private residence in terms of rating, etc.

The building is let on a commercial arm's length basis to the client's unquoted trading company and the rent is determined by a surveyor. Our client does stay at the house overnight once or twice a week, as his main home is some distance from his 'office'.

If our client is to sell the building, are there any steps we can take to mitigate what will otherwise be a significant capital gain? The client would ideally prefer to reinvest the proceeds into a farm.

In our view, the town house does not qualify as a 'business asset' for rollover purposes because of the receipt of a commercial rent.

Would readers agree that our client, unfortunately, cannot have his cake and eat it?

(Query T15,941) - Heart of Midlothian.

First, let us dispose of the direct question. It is not clear why 'Heart of Midlothian' thinks that the receipt of rent precludes a claim to rollover relief. Section 157, Taxation of Chargeable Gains Act 1992 extends the prime relief for replacement of business assets in section 152 to the situation where an asset is used by the owner's personal company. Personal company, for this purpose, means a holding of at least 5 per cent of the ordinary shares by the property owner. The legislation is silent on the subject of rent. A technical note issued by The Chartered Institute of Taxation on 31 October 1991 indicated the Inland Revenue view that rollover relief may be claimed where rent is paid by a family company for use of an asset. This is now confirmed in paragraph 61260 of the Inland Revenue Capital Gains Manual.

Second, what is the asset here? In similar circumstances, many business proprietors would let the company use the property on an informal licence. However, we are told that the house is let on a commercial arm's length basis to the company and the rent is determined by a surveyor. This suggests some degree of formality and the likelihood of a lease. The client cannot therefore simply sell the house. There are two interests; his as the freeholder and the company's tenancy.

There are therefore two choices. Either the client and his company sell their respective interests to a third party at the same time or, alternatively, the client procures the surrender of the lease and then sells the unencumbered freehold.

In the former case, the company may have a gain on the tenancy which it could roll over into new assets purchased for its trade. Additionally, the client has a gain on the freehold. As demonstrated above, this can be rolled into the purchase of new assets but only if the new assets are used in a trade carried on by the same personal company which occupies the house (see paragraph 61260 of the manual again).

In the latter case, where the tenancy is first surrendered, a gain is also likely to arise in the company because the bargain is not at arm's length and the transaction is deemed to take place at market value by virtue of section 17, Taxation of Chargeable Gains Act 1992. If the client pays less than market value to the company for surrender of the tenancy, there will also be a distribution to him (which is chargeable to income tax). A gain will be realised by the client, in the computation of which any compensation (paid to the company for surrender of its tenancy) is an allowable cost. The respective gains may be rolled over as in the preceding paragraph.

In any of these circumstances new assets, purchased with the proceeds of sale of the house, must be used in the trade of the company. If the client wishes to buy a farm, this should be no problem.

If the rollover provisions prove unsuitable for any reason, the client should reflect on the availability of taper relief. Following the changes in definition of business assets in Finance Act 2000, property let to a qualifying company is a business asset for the purposes of taper relief. A qualifying company for this purpose includes any unlisted trading company. Thus property let to an unquoted trading company is always a business asset; it does not have to be the property owner's qualifying company. This anomaly arises from a combination of paragraphs 5(2)(c) and 6(1) of Schedule A1 to the Taxation of Chargeable Gains Act 1992. In the circumstances described, there is every likelihood that the let property also qualified as a business asset before 6 April 2000. If the ownership/occupation described has persisted since 6 April 1998, the qualifying holding period for taper relief will be four years on 6 April 2002, giving maximum taper of 75 per cent and an effective maximum tax rate of 10 per cent. This may be acceptable to the client before he reinvests the proceeds in a manner which does not necessarily satisfy the rollover relief provisions. Since taper relief does not apply to companies, this would dictate surrender of the tenancy before onward sale of the house.

As a final thought, has 'Heart of Midlothian' stopped to think about the income tax consequences of the present arrangement? The client might regard the town house as his property, but it appears that it is formally let to the company. When he occupies it, this must be by virtue of the company permitting him to use its tenancy. This will have Schedule E benefit in kind implications and is not an issue that the Inland Revenue will overlook.

For the same reason, I think that the client is right that the main residence relief under section 222, Taxation of Chargeable Gains Act 1992 is precluded. The client's interest is as freeholder; his occupation is of the company's tenancy. His interest is not occupied as a residence and (if he owns another house) an election under section 222(5) is not possible. - The Snark.

To qualify for full rollover relief, the old asset, in this case the town house, must have been used throughout the entire period of ownership for the purpose of the business. Therefore any thought of making it the client's principal private residence for a reasonable length of time, in order to qualify for the last 36 months of ownership exemption from capital gains tax (section 223(4), Taxation of Chargeable Gains Act 1992), should be weighed up against the apportionment of the periods of business and non-business use. However, it should be noted that if, during the period of residence the office, and therefore business, use was still relevant, then that part of the house would not qualify for the last 36 months relief.

Fortunately I can disagree with the view of 'Heart of Midlothian'. An individual can claim rollover relief in respect of the disposal and replacement by him of an asset where his personal company carries on the trade in question at the same time. Under section 157, Taxation of Chargeable Gains Act 1992 a claim for rollover relief in respect of the assets used by his personal company cannot be refused, on the grounds that rent is paid to the individual for the use of the asset. This is confirmed in the Revenue's press release dated 10 November 1981 and also in its Capital Gains Manual at paragraph 61260:

'Section 157 directs that section 152 should be read as if it said: "If the consideration which an individual obtains for the disposal of the old assets used and used only for the purposes of the trade carried on by his family or personal company … is applied by him in acquiring … the new assets which on the acquisition are taken into use, and used only, for the purposes of the trade carried on by that family or personal company …"

'The asset must be used, and in the case of land and buildings occupied, by the family or personal company only for the purposes of the trade carried on by it. Accordingly, relief is available to the individual even if rent is paid by the company to the individual for the use of the asset.' - N.K.

Issue: 3841 / Categories: