Introduction
Property developers often acquire land as an investment long before any serious thought is given to development. Planning permission may be obtained, architects consulted and feasibility studies commissioned, and yet the land may still be held as an investment asset for tax purposes. At some point, though, that analysis may change, and recognising when it does is one of the more important and frequently overlooked questions in property ownership and development. The timing affects corporation tax, VAT and the deductibility of expenditure, and ultimately the tax cost of the whole project.
Investment or trading stock
A company that owns land to generate rental income or long-term capital growth is not trading but carrying on a property investment business, and a disposal will normally fall within the capital gains rules. If the company instead embarks on a development with a view to selling the finished scheme, the land has ceased to be an investment. It has become trading stock, and the profits will be taxed as trading income. While the principle is simple, identifying the moment of transition is often not.
Planning permission is not the trigger
A common misconception is that obtaining planning permission automatically converts an investment into trading stock. However, while planning permission may add considerable value to a property it often remains an investment asset, and many investors obtain consent precisely in order to sell the land on at a higher price, with no intention of developing it themselves. That was essentially the position in Taylor v Good, where land bought without any trading intention did not become the subject of a trade merely because the owner later secured planning permission and sold at a profit. The grant of permission is an important fact, but rarely the decisive one.
The decision to develop is the real trigger
The real question is not whether planning permission has been obtained, but whether the owner has made a genuine commercial decision to embark on a development. Once that decision is taken, the property is no longer simply being held as an inverstment; it is being deployed in a trading venture. The courts have long treated intention as central to the distinction between investment and trade, and have made clear that an asset cannot be both an investment and trading stock at the same time.
The legislation provides no clear demarcation, so Hthe position must be inferred from the surrounding facts. The indicators commonly relied upon include:
- commissioning development designs or feasibility studies;
- entering into binding contracts with architects, contractors or suppliers;
- arranging finance specifically for the development;
- terminating existing lettings to enable construction; and
- committing significant expenditure to the project.
No single factor is conclusive. It is the overall picture that counts.The indicators commonly relied upon include:
A matter of timing
The tax consequences of the transition are likely to be significant. When a company appropriates property from its investment assets to trading stock, section 161 TCGA 1992 treats the property as disposed of and immediately reacquired at market value, reflecting the long-standing principle that appropriations are recognised at market value rather than cost. Unless an election is made, that deemed disposal can crystallise a chargeable gain before any development profit has been realised. An election under section 161(3) allows the gain to be held over and rolled into the value of the trading stock, but it must be made within 2 years of the end of the company’s accounting period. .
The change in status also affects the VAT position. Development projects involve substantial construction costs and significant input tax. Whether that input tax is recoverable, and whether VAT previously recovered is at risk of adjustment, depends on the nature of the supplies eventually made. These questions are far better addressed before work begins than after contracts have been signed.
Keep contemporaneous records
A recurring and unfortunate feature of HMRC enquiries in this area is the absence of contemporaneous evidence. Development decisions are often reached gradually rather than at a single board meeting, particularly in owner-managed companies. That is entirely understandable, but where there is no clear record of when the decision to develop was made, it will have to be inferred from later events. The result can be disputes over the timing of the appropriation, the availability of the election and the treatment of expenditure. A short board minute recording when and why the decision was taken is likely to prove invaluable if the position is later challenged.