Property income and trading income are taxed under different provisions of the tax code. This can sometimes have practical implications for the taxpayer, particularly in terms of how losses can be offset against profits and gains. However, determining whether income relates to property or a trade is not always straightforward, despite a significant body of case law in this area.
In the recent case of Julian Nott v Commissioners for HMRC, the First Tier Tribunal (“FTT”) considered whether income from letting furnished holiday cottages was property or trading income. In doing so, they set out some general principles to apply to determine the nature of the income.
Facts
Mr Nott rented out cottages on his estate as holiday accommodation. The cottages were typically let for two weeks at a time and were provided with some services, including a cooked breakfast at an additional charge and limited weekly cleaning, as well as recreational activities on the estate.
Mr Nott had filed his 2009-10 tax return on the basis that losses incurred in renting the cottages were trading losses which could be set off against his general income for tax purposes for 2009-10 and subsequent years for Class 4 National Insurance purposes.
HMRC opened an enquiry into the return, claiming that the losses from the cottages were property losses and that the use of losses was therefore restricted.
Law
The starting presumption is that income derived from the exploitation of property should be taxed as property income. However, in some cases the taxpayer may be able to show that the activities giving rise to that income constitute a trade and should therefore be taxed as trading income.
HMRC's guidance in their Property Income Manual is that letting activity "will only constitute a trade where the owner remains in occupation of the property and provides services substantially beyond those normally provided by a landlord”. HMRC go on to give an example that running a bed and breakfast or hotel will constitute a trade.
However when the FTT questioned whether this “occupation plus services” test is the correct statement of the relevant case-law, HMRC submitted that they in fact ask two questions to identify the true derivation of income. The first of these is "what is the activity giving rise to the payment?" and the second is "what are customers paying for - the use of the land or a package of services forming part of a trade?”. The FTT found that this test broadly reflects the correct legal position.
Therefore, whether or not the owner occupies the property and whether the services he provides are substantial are not determinative factors in themselves. However, looking at the services provided with a property will be relevant in determining what the customer is paying for – unless substantial services are provided, the customer is probably paying for use of the property itself. Equally, the occupation of the property’s owner will be relevant in that a property owner who gives up occupation of his property in return for payment is likely to be generating property income rather than operating a trade.
The FTT also considered whether section 10 of Income Tax (Trading and Other Income) Act 2005, which provides that commercial occupation of land in the United Kingdom is to be treated as a trade, applied in Mr Nott's case. On the face of it, this provision sounded promising for Mr Nott but the FTT found that section 10 applies only in narrow circumstances and where the taxpayer is in actual occupation of the land (which Mr Nott was not).
Decision
The FTT considered whether Mr Nott had been in occupation of the cottages and whether he had provided sufficient services to customers to be operating a trade. The FTT did not regard the legal basis on which customers occupied a property or the length of their occupation to be material factors in determining whether there was a trade.
The FTT found that, for the services to displace the presumption that the income was property income, the services provided needed to be sufficiently substantial to convert what was being sold into a package of services of which the accommodation enjoyed by guests or customers is only a part.
The FTT decided that the services provided by Nott were not sufficiently substantial because they were largely consistent with those usually provided by a landlord. For example, Mr Nott provided some recreational facilities on the estate, including a pool house and guided tours. The FTT found that these were features intended to increase the attractiveness of the Units for letting rather than additional services. The breakfast and daily cleaning offered for a fee were also found to be insufficient to change the income into trading income.
Mr Nott had argued that the accommodation he provided was essentially the same as that provided by a B&B and it is easy to have sympathy with this argument, given that the only material difference appears to have been that each cottage was self-contained rather than being a room in a building. However, the FTT found that it was confusing to describe the cottages as a B&B and that customers would not have characterised them as such. The FTT also found the view expressed by HMRC in their manual that B&Bs constitute a trade may be unduly simplistic so it is conceivable that income from a B&B could be property income in any case.
Implications
The decision in this case follows previous case law which requires the services provided as part of a property letting to be very extensive before they can convert property income into trading income.
The FTT acknowledged that it was difficult to find clear principles in case law on the correct treatment of income derived from exploiting property, although they did seek to do so. They also noted that dividing lines between various types of rental accommodation have become increasingly fluid. For example, there are hotels which provide very little in the way of additional services and others which have self-contained properties within their grounds available to rent together with the provision of extensive services and extras.
The judgment in this case is useful in setting out the relevant case law and the FTT’s view of the principles which can be derived from it. However, the decision shows that subtle distinctions in the type of accommodation; the services provided with it and the owner’s occupation can affect the treatment of income from property for tax purposes.
For further information, please contact Nigel Popplewell.