Determining whether losses derive from property trading or property letting has always been a contentious issue. In a recent income tax case of Re Albermarle 4 LLP (TC/2011/02843 published on 8 February), the First-tier Tribunal found that losses, claimed by members of an LLP, arose from the purchase and sale of property and could therefore be offset more favourably against general income.
In arriving at their decision the FTT explored the reasons why the property had been acquired and whether there was sufficient evidence to support the ‘trading loss’ claim. The case provides some useful reminders of the key aspects which practitioners should consider when reviewing the trading status of a property business, and the use of losses.
The facts of the case
The property transactions which were the subject of the appeal relate to the purchase and sale of three commercial properties (formerly Kwik-save Stores) by an LLP during the period April 2005 to 2011.
The LLP members consisted of two married couples – Mr & Mrs Ellis, and Mr & Mrs Wallis – together with a corporate member. All the parties had also been members of other LLPs carrying out other property activities under the “Albermarle” banner. These LLPs usually involved 20-50 members where property was usually acquired with existing tenants and then held longer term. These differed from the ‘Kwik-save’ LLP arrangements where vacant property had been acquired for a specific purpose.
The LLP members contended that at the time the properties were acquired (untenanted), the intention was to improve their value by securing tenants and then sell the properties within a short period of time. This intention had been clearly set out in a letter sent by Mr Ellis to the other members where a choice of either turning the properties into “Albermarles” or simply selling them and taking the profit was outlined.
The three properties were acquired for £3.7m in March 2005. The sellers entered into a one year letting agreement with the LLP to find suitable tenants.
A mortgage of £2.2m with a one year repayment term funded 60% of the purchase price with the members contributing the remainder. Due to difficulties finding suitable tenants, the mortgage repayment date was extended periodically, with the extensions contingent on personal guarantees provided by the members via Coutts Bank.
No suitable tenants were found and all the properties were subsequently sold at a loss, the final sale completing in 2011. Relief for trading losses totalling £694,584 was claimed.
HMRC took the view was that the members intentions was to hold onto the properties once tenants had been secured in order to receive rental income. The evidence was consistent with the making of a risky investment and that the lack of an intention to trade was supported by the way the activities had been presented in the LLP’s financial statements and tax returns – whereby, the properties had been shown as fixed assets, the trade described as “property investment” and the disposals shown as “disposals of chargeable assets”. In HMRC’s view, the losses were property losses which could only be carried forward and used against future property income.
HMRC raised enquiries challenging the trading losses which included a discovery assessment for 2005/06. The members argued that there was no proper basis under the statutory provisions for making the discovery amendment and the FTT found in their favour upholding this part of the appeal.
The main aspect of the case as to the nature of the LLP’s activities and the basis of the loss claim were the subject of further examination and this forms the interesting part of the decision. In particular, the factors presented by the members to support trading activity and the FTT commentary on these points and their conclusions, highlighting the key aspects in arriving at their decision.
The following points were made by the members to support their argument that these were the trading losses:
- Properties bought untenanted and empty – this supported the intention to turn the properties to profit by a sale, which contrasted with other property ventures operated through the larger Albermarle LLPs.
- Financing and personal guarantee – the short term nature of the financing arrangements and the fact that the Kwik-save transactions were the only ones in which a personal guarantee to the bank was given.
- Changes made to the assets to enhance saleability – expending funds in actively pursuing tenants for the purpose of making the properties more marketable at a profit.
- Short term letting agreement – the 12 month agreement with the sellers was indicative of an intention not to hold the properties.
- The way the properties were sold – two properties were sold in or just after auctions while the other was sold to the owner of adjacent premises. It was argued the properties were sold in a way typical of trading organisations.
While the FTT acknowledged the members had raised pertinent issues which were not inconsistent with supporting the member’s case they felt that some of these points were also were equally consistent with HMRC’s view on the member’s intentions to hold onto the property longer term. However, the consistency of the contemporaneous documents coupled with Mr Ellis and Mr Wallis’ evidence on the members intentions relating to the use of the properties were significant and the FTT felt that they outweighed the points made by HMRC in relation to the tax return entries. In particular the letter sent to members indicating a choice between the usual longer term Albermarle property transaction and the sale for profit was found to be supportive of a trading intention. Accordingly, the FTT found that the losses were trading losses and not property losses.
Why this case is important to practitioners
The case highlights many of the pertinent factors which should be considered when ascertaining whether a property business is one of investment or trading. While the majority of these were dismissed in this particular case, they are nevertheless key points which practitioners should build into their reviews when considering the nature of the property business. Some of these factors are supported by earlier court decisions and this useful case highlights a number of these.
More importantly, the existence of Mr Ellis’s letter to members coupled with complying evidence presented by credible witnesses, underlines the importance of establishing at the outset the intentions of the property owners in relation to the use of the property and making sure these are clearly documented and supported with as much evidence as possible.