The following is a statutory analysis of the position when a lease of land is granted for a premium. We have already seen how this works in previous articles on the Lease Premium Rules. The first article was about how the rules operate to modify the capital gains treatment of the landlord, and the second article concerned how the landlord could use these rules to his advantage in claiming tax relief for the property.
However, these two articles raise some important questions concerning the nature of the premium and how it is taxed. Why should a landlord receiving a premium be taxed under the capital gains legislation, and a property trader be taxed under the income tax rules? More importantly:
“How does this result come about under the legislation?”
We shall discuss this more fully below.
In the following discourse we shall use the term “CGT” for capital gains tax, to denote the tax payable by both individuals and corporates on their capital gains. Similarly we shall use the term “income tax” to denote the tax payable on income, or revenue profits.
Strictly, UK companies pay corporation tax on both income profits and chargeable gains – however, the convention we adopt makes the following discourse easier.
Landlords pay CGT and traders pay income tax
This is the short answer.
- Landlords hold the property as an investment. This is therefore a capital asset and so it is taxed under the capital gains legislation, in particular under TCGA 1992;
- Property traders hold the property as trading stock on revenue account. Therefore this must be taxed under the income tax provisions.
While this is correct, there are a number of subtle points that need to be negotiated in the legislation to reach this conclusion. We shall come to the startling conclusion that technically, the capital gains legislation isn’t restricted to capital assets, but can even cover revenue items. How is this possible?
Granting a lease constitutes a (part) disposal
We saw this in our previous articles, when we stated that a landlord who grants a lease for a premium is subject to CGT. Of course, the Lease Premium Rules may modify this position if the lease is a short one, but the basic starting point is that this is a CGT event.
The actual legislation is to be found in TCGA 1992 Schedule 8 paragraph 2(1):
“Subject to this Schedule where the payment of a premium is required under a lease of land, or otherwise under the terms subject to which a lease of land is granted, there is a part disposal of the freehold or other asset out of which the lease is granted.”
So this is a part disposal of an asset and as we all know, the capital gains legislation is concerned with disposals and part disposals. TCGA 1992 Schedule 8 paragraph 2(2) even goes on to give instructions as to how to calculate the gain:
“In applying section 42 to such a part disposal, the property which remains undisposed of includes a right to any rent or other payments, other than a premium, payable under the lease, and that right shall be valued as at the time of the part disposal.”
Note the words of the legislation. The statute doesn’t explicitly state that the person granting the lease has to be a landlord in the sense of a person who is holding the property long term to make a “living off the rents”. All that is required is a lease to be granted for a premium – this encompasses the case where a property developer or trader is the “landlord”.
So does this mean that property traders also pay CGT? Does the fact that the grant of a lease constitutes a part disposal, mean that the premium is a capital sum, and therefore subject to the CGT regime?
The premium doesn’t have to be a capital sum
Let us have a closer look. This is the definition of the term “premium” in TCGA 1992 Schedule 8 paragraph 10(2):
“In this Schedule “premium” includes any like sum, whether payable to the intermediate or a superior landlord, and for the purposes of this Schedule any sum (other than rent) paid on or in connection with the granting of a tenancy shall be presumed to have been paid by way of premium except in so far as the other sufficient consideration for the payment is shown to have been given.”
Note that the definition makes no mention of the words “capital” or “income” or “revenue” – there is nothing to indicate the nature of the payment. It is simply a sum payable on granting a lease.
So the question whether it is a capital or revenue amount must be determined on general tax principles.
So everything’s fine for our property trader. The premium is on revenue account, so can’t be taxed under the CGT legislation, because the CGT legislation only applies to capital sums. It is only when the landlord holds the property as an investment that CGT applies.
But is this really the case?
What does the capital gains legislation actually say?
First we shall look at the basic charging provision in TCGA 1992 s 1(1):
“Tax shall be charged in accordance with this Act in respect of capital gains, that is to say chargeable gains computed in accordance with this Act and accruing to a person on the disposal of assets.”
So the key words are: “chargeable gains”, “disposal” and “assets”. We shall look at these in reverse order.
“Assets” and “disposals” are defined in TCGA 1992 s 21. Assets are “all forms of property”, wherever situated, and includes1:
- Options, debts and incorporeal property;
- Any currency apart from sterling; and
- Any form of property created by the person disposing of it, or otherwise coming to be owned without being acquired.
So land is an asset, and this includes a leasehold as well as the freehold.
The word “disposal” is not explicitly defined. The relevant statutory provision simply states that a disposal includes a part disposal2. And a part disposal is given by the following, rather lengthy passage3:
“there is a part disposal of an asset where an interest or right in or over the asset is created by the disposal, as well as where it subsists before the disposal, and generally, there is a part disposal of an asset where, on a person making a disposal, any description of property derived from the asset remains undisposed of.”
No extra clue as to what “disposal” means in these lines. Accordingly, the word must be given its natural meaning.
Finally, the expression “chargeable gain”. This is defined in TCGA 1992 s 15(2):
“Every gain shall, except as otherwise expressly provided, be a chargeable gain.”
This last is an extremely important definition. Note what it doesn’t say. It doesn’t say that the gain must be of a capital nature, even though the phrase “capital gains” was used in the opening words of the legislation. There is no reference to the tax only being applicable where a capital sum has been received. There are other situations where the legislation requires a capital sum before tax is charged4, but not in the most basic situation of all, the disposal of an asset. All that is needed is:
- An asset – such as a piece of land – no mention whether the land is held as trading stock or for an investment;
- A disposal – such as when the land is sold or a lease granted (the latter being a part disposal, as we have seen); and
- A gain on the disposal – not a capital gain, but simply a gain.
So does this mean that the property trader has to pay CGT after all?
No it doesn’t. Although the sale of trading stock is caught by the words of the legislation, TCGA 1992 s 37 provides that:
“There shall be excluded from the consideration for a disposal of assets taken into account in the computation of the gain any money or money’s worth charged to income tax as income of, or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts.”
This covers both individuals and companies. Trading companies pay corporation tax, but they are covered by the words:
“…or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts.”
The definition of the phrase “Income Tax Acts” is given in the Interpretation Act 1978 s 5 Schedule 1:
“The Income Tax Acts” means all enactments relating to income tax, including any provisions of the Corporation Tax Acts which relate to income tax.
“The Corporation Tax Acts” means the enactments relating to the taxation of the income and chargeable gains of companies and of company distributions (including provisions relating to income tax);”
The net effect of this is that TCGA 1992 s 37 provides the way out. Anything taxed as income cannot be taxed again under the capital gains legislation.
So, that’s okay then. Well, not quite. We need to check that our property trader is in fact taxed under the Income Tax Acts.
What do the Income Tax Acts say?
We have a property trader who has made an income gain on the disposal – or to be more precise a part disposal of an asset.
This is what the corporation tax rules say5:
“The charge to corporation tax on income applies to the profits of a trade.”
And this is what the income tax rules say6:
“Income tax is charged on the profits of a trade, profession or vocation.”
And what are profits? This is an accounting term, as stated in the legislation7:
“The profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in calculating profits for [income/corporation] tax purposes.”
And then there follows a whole raft of rules as to what can and cannot be included – the most important being the general exclusion of both capital receipts and capital expenses8.
So, if the premium is income and is recognised in the accounts, it is taxable under the income tax rules. And because it is taxed as income, it cannot be taxed as capital, because of TCGA 1992 s 37.
So we are home and dry.
What have we learnt?
If anything, this should show the importance of statute law. Of course, we knew from the beginning what the answer was going to be. It sounds so obvious that an investor pays CGT and a trader pays income tax. It was comforting to actually find this confirmed in the legislation.
So why did we bother to look in the legislation at all?
Well, was it so obvious that the capital gains legislation – or to be more precise, the Taxation of Chargeable Gains Act 1992 – can, in theory, tax asset disposals that constitute trading transactions? What about the result that this statute doesn’t actually tax capital gains, but chargeable gains? Which are simply gains.
Most importantly, how do you know that the next time you come across a situation that is “obvious”, it turns out not to be the case? This is why it is so important to look at the legislation – it is the source of our tax law, and the starting point for the answers to any tax question.
- TCGA 1992 s 21(1). ↩
- TCGA 1992 s 21(2). ↩
- TCGA 1992 s 21(2)(b). ↩
- For example, where capital sums are “derived from assets” under TCGA 1992 s 22. This doesn’t require there to be a buy-sell transaction, and covers situations such as where an insurance payout is received for a building falling down. ↩
- CTA 2009 s 35. ↩
- ITTOIA 2005 s 5. ↩
- ITTOIA 2005 s 25(1), CTA 2009 s 46(1). ↩
- ITTOIA 2005 ss 33, 96; CTA 2009 ss 53, 93. Note that this is a general exclusion. Capital allowances are specifically allowable, and for companies, the rules for corporate debt, intangibles and derivatives specifically state that all capital amounts are to be taxed as income. ↩
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