Alan Pink looks at three situations where property tax can be reduced by careful consideration of the timing of expenses.
Timing is very important in a number of situations. Consider stand-up comics, like Bob Monkhouse, of whom the following reminiscence is related: ‘when I was young, I told everybody I wanted to be a comedian when I grew up, and they laughed at me – they’re not laughing now! ‘. Or, Tony Hancock, in Hancock’s Half Hour, describing a passionate affair in his long distant past, where he met the young lady in ‘The Café de la Belle Marguerite – Chiswick ‘.
In both of the above gags, the essential skill is in delivering the last part, represented by the words after the hyphen, after exactly the right pause for effect.
Similarly, in property tax, the time when you do something can make a permanent difference to how much money HMRC receives at your expense. I’d like to look at three specific typical situations where you can make a lot of difference to your tax liability by careful consideration of timing.
1. Repairs or improvement?
One of the enduring puzzles or, if you prefer it, injustices in tax is the distinction between ‘revenue‘ expenditure and ‘capital‘ expenditure. Normally speaking, the first is allowable against tax, and the second is a ‘nothing‘; that is, it is an item of expenditure which is incurred purely for business purposes, but which doesn’t reduce your income tax on the profits of the business.
A classic example of this is the distinction between repairs and improvement of a rental property. Repairs, refurbishment, and redecoration are all generally speaking fully allowable against the rents of the year concerned in computing profits chargeable to income tax. Improvements to property, by contrast, are disallowable, and may possibly never get any kind of tax relief, depending on the circumstances.
This puzzling distinction is crucially important, obviously, when you consider that every £1 you spend on repairs, etc., can cost you as little, after tax, as 55p because of the tax relief; whereas £1 spent on capital improvements can end up costing you precisely the same amount, i.e. £1.
Let’s take an example to illustrate:
Example 1: Contrasting tax treatment
Mr Emir buys two town centre hotels, ‘The Imperial’ and ‘The Russell’. Both are returning very low profits, for a number of reasons; predominant amongst which, in Mr Emir’s opinion, is the dilapidated state of the buildings, which means that the fussier sort of guest is not going to want to stay there.
In the case of The Imperial hotel, Mr Emir adopts a ‘root and branch‘ approach, shutting the hotel for three years and basically gutting the place. The result, following the comprehensive refurbishment, is effectively a new hotel – particularly as far as the interior is concerned.
Next door, at The Russell hotel, the approach taken is completely different. The hotel continues to be let to members of the public, but a gradual process of redecoration and marginal improvement of (e.g. bathroom) facilities takes place. Obviously, the result of this different approach is that the refurbishment of The Russell hotel takes a lot longer. However, the £1 million which Mr Emir spends on The Russell hotel gets full tax relief, on the basis of what is now quite an old tax case concerning Odeon Cinemas.
In that case, some fairly extensive improvement/refurbishment expenditure (on cinemas which fell to rack and ruin during the war) ended up being allowed for tax purposes against the annual profits because firstly, the cinemas continued to be used and open to the public during the refurbishment, and secondly, this was a gradual process rather than resulting in substantially new properties.
Looking at the situation of The Imperial hotel, with a long closure and a radical transformation of the interior, HMRC would be likely to argue, successfully, that all of the expenditure was ‘capital‘ and, therefore, not allowable. Without tax relief, the expenditure on The Imperial hotel would, therefore, be almost twice as much, allowing for tax, as that on The Russell hotel.
2. Choose your tax rate!
The above example, which relates to hotels, is an example of the taxation of trading profits; but the same principles can, of course, be applied to the rental landlord.
Similarly, a landlord needs to give consideration, in some circumstances, to the precise period in which expenditure is incurred, as in the following example.
Example 2: Timing to best advantage
Laurence Medici is an investment banker, who has accrued a pretty massive bonus for his investment performance in the accounting year of Florence Bank plc ended on 31 December 2018. He receives this bonus on 30 April 2019, and his basic salary is such that all of it is chargeable to tax at the top rate of 45%.
By spending the bonus on a much-needed refurbishment program of his privately-owned property portfolio, he ensures that his income from rents, which would otherwise have borne tax at his top rate, is correspondingly reduced in that year. In this way, the expenditure receives full relief at that top rate of 45% - whereas deferring the refurbishment program to the following year might mean that the expenditure receives relief at the lower rate of income tax.
3. Property management companies
Any landlord will tell you that a property portfolio doesn’t run itself. For many landlords, looking after the portfolio is nearly a full-time job – or even more than a full-time job in some cases.
Consider the following example, where there is an important element of timing difference in the way the resultant tax liability is controlled:
Example 3: A family affair
George owns a fairly sizeable property portfolio, which is his sole source of income and supports his family, comprising his unmarried partner, Tracy, and their 20-year-old son, Chuck.
Because of the fact that George and Tracy aren’t married, he’s in difficulties about sharing out the income by transferring an interest in the property to Tracy (and the same problem applies, of course, to any transfer to Chuck), which is that the transfer would trigger any inherent capital gain that exists in respect of the property.
Instead, George sets up a property management company, Dragon Investments Limited, which he and the other two members of his household own shares in. This company charges George for the management of the properties, which, being a full-time job, is a reasonably substantial charge of £80,000 (nb any charge which was much higher than this would run into difficulties, making the company registrable for VAT).
On the basis that this is an allowable expense for tax purposes because the amount of the charge is justified by the work which the individuals (directors of the company) put into managing the portfolio, the result is that the £80,000 charge reduces the profits which would otherwise have been chargeable to income tax on George at 45%, and instead pays only 19% tax in the limited company. The profits of the company can then be paid out as dividends, including a reasonably substantial dividend to both Tracy and Chuck, using their dividend allowances, personal allowances, and lower rates of income tax to reduce the overall tax burden.
What’s more (and this is where the timing point comes in) the property rental accounts can include an accrual for the charge which the company is going to make; hence getting relief in the earlier period for a charge which the company may not make until a later period.
