Tax and letting surplus business accommodation

Sarah Bradford explains the tax implications of letting surplus business accommodation.

A business may receive rental income in addition to the income generated from the trade or profession which it carries on.

For example, a business that is not using all its business premises may let out the unused part to generate additional income; or the business may hold investment properties, which are let out.

From a tax perspective, not all rental income received in relation to a trade or profession is equal; depending on the circumstances, it may be taxed as trading income or as property income.

Rents from surplus trading premises

A business may not use all its business premises. For example, they may be expecting to expand and have premises that are larger than the current needs of the business to allow for expansion. Alternatively, the business may have experienced a downturn in trade and contracted with the result that the business premises are now larger than they currently require.

Where a business has surplus business accommodation that they are not currently using, it may make commercial sense to let out the unused accommodation to generate additional income and to contribute towards the running costs of the premises. In certain circumstances, it is possible to treat the income that the business receives from letting surplus business premises as a trading or professional receipt rather than as property income.

However, this can only be done where all the following conditions are met:

the let business accommodation is temporarily surplus to current business requirements;
the premises must be used partly for the business and partly let;
the rental income must be comparatively small; and
the rents must relate to the letting of surplus business accommodation only, and not to the letting of land.

It is important to note here that for the rents to be treated as trading receipts, the let accommodation must be in the same premises as are currently used for the business. If the rental income derives from separate business premises that are currently unused, the rents cannot be treated as trading income.

Where the rents from letting surplus business premises are treated as trading income, any associated expenses are likewise treated as trading expenses and are deducted in computing the trading profit, rather than being taken into account in computing the profits of any rental business that the business may also have.

Example 1: New premises for a growing business

A Ltd is a growing business and is looking to expand. They have recently moved to new business premises that will accommodate the growing business. The premises have more space than they currently require, but the company envisages that they will need the space in the next six to 12 months.

To generate some additional income, they let out the surplus accommodation, which comprises 15% of their business premises by floor area, for £500 per month. Expenses associated with the letting of the surplus accommodation are £175 per month.

The turnover of the business is £40,000 per month.

The business is able to treat income from letting the surplus business premises as a trading receipt and deduct the associated expenses in computing their trading and professional profits. All the conditions necessary for this treatment are met.

Example 2: Permanently surplus to requirements

B Ltd has experienced a downturn in business, which it expects to be permanent. To survive, the business has had to close an unprofitable division and make staff redundant. As a result, they are no longer using all their business premises and decide to let out the spare business accommodation to generate some income and contribute to costs. They let out the unused portion of the building and expect to continue to do so for the foreseeable future.

Unlike A Ltd, B Ltd is unable to treat the rental income as a trading receipt, as the conditions necessary for this treatment are not met. The accommodation is permanently rather than temporarily surplus to requirements and, as such, the rental income forms income of a separate property rental business rather than being treated as trading income. Any associated expenses are deducted in computing the profits of the property rental business, rather than in computing the trading profit.

Separate business property surplus to requirements

A business may have a separate property that is surplus to their current needs. This may arise (for example) following the closure of one site or division, or following a move to new business premises while retaining the old premises.

If a separate business property is let, any rental income is taxed in accordance with the property income rules; there is no option to treat the rental income as a trading receipt.

However, if the surplus business property is not let or (as the case may be) sublet, expenses of the unused property can usually be deducted in computing the business’s trading or professional profits. However, for this to be the case, the business must have taken on the obligations of the surplus property `wholly and exclusively’ for the purposes of the trade or profession. This test would generally be met if the business took on the lease of a property for the purposes of their trade or profession. However, it would not be possible to deduct expenses associated with a private property or a rental business property in computing the trading profit, as the `wholly and exclusively’ test would not be met.

If the property has been acquired for the purpose of the trade or profession and becomes surplus (e.g. before the end of the lease) and the property is sublet, the rents are taxed as rental income but without any deduction for associated expenses where these are deducted in computing the trading profits. Although the expenses are not incurred ‘wholly and exclusively’ for the purposes of the rental business, they can instead be deducted from the rental income rather than in the computation of trading profit if the business prefers. This may be beneficial if (for example) the business is loss-making and there is insufficient trading income against which to set the expenses but they can be utilised against the rental income.

If the expenses exceed the rental income, they can be set against the rental income in the first instance, with any excess being set against the trading income. This will prevent a loss arising on the rental business that can only be set against future rental profits. However, the expenses must be incurred ‘wholly and exclusively’ for the purposes of the trade to benefit from this approach.

Example 3: Closure of a site

C Ltd operated from three sites – in Leicester, Loughborough, and Nottingham - for many years. After a difficult period, the company made the decision to close the Leicester site, making some staff redundant and relocating other staff to either Loughborough or Nottingham.

At the time of the closure, the business was tied into the lease on their Leicester business premises for ten months. They were unable to sublet the property and continued to pay rent of £2,000 a month and business rates of £818 per month.

As the property was acquired ‘wholly and exclusively’ for the purposes of the trade, the business is able to deduct the associated expenses in computing their trading profits once it has become surplus to requirements.

Example 4: Sub-letting of old premises

D Ltd operated a shop, an interior design business, from high street premises. Following an expansion in trade, they moved to a new showroom on a nearby trading estate. The lease on the high street property had 12 months to run, and the business was able to sub-let it.

As they are no longer using the high street property for their business, the rent is taxed as rental income rather than as a trading receipt. However, the associated expenses can either be set against the rent or deducted in the computation of the trading profits. The property was rented for the purposes of the business, so the ‘wholly and exclusively’ test is met.

However, if a business retains former business premises, either by renewing the lease so that they can continue to sublet it or by failing to exercise an option to terminate after it became surplus to requirements, the associated expenses can no longer be deducted in computing trading profits.

Practical tip:

Where business premises become surplus to requirements, check whether any rental income can be treated as trading income and whether associated expenses can be deducted in computing trading profits.