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Living Above The Shop – Two Tax Pitfalls

Living Above The Shop – Two Tax Pitfalls

Having been made redundant from his job at the Zoo, Mr Lion decided to use his redundancy money to set himself up in business as a newsagent and tobacconist. Because he had previously been provided with living accommodation by the Zoo, he was also looking for somewhere to live.

 

He found a property that seemed ideal – a corner shop with a flat above it. The price for the freehold, fixtures, and goodwill was £200,000. Mr Lion had £100,000 cash from his redundancy, and he borrowed another £100,000 by mortgaging the shop. He paid for the stock by using his overdraft facility.

 

When he prepared his first year’s accounts, Mr Lion looked at the interest he had paid on the mortgage - £6,000. Given that half the property consisted of the flat he lived in, and that he had contributed half the purchase price from his own cash, it seemed reasonable to him to claim all the £6,000 interest as a business expense.

 

Mr Lion was upset when the Tax Inspector wrote to him saying he proposed to disallow part of the interest, because the loan had been used partly to buy the business premises, and partly to buy his home.

 

Mr Lion went to a Tax Adviser, who confirmed that the Inspector was right in principle, but managed to negotiate the following deal:

 

 

Cost of:

Business

Private

Total

Freehold

  75,000

75,000

150,000

Fixtures

    5,000

  1,000

    6,000

Goodwill

  44,000

NIL

  44,000

Totals

124,000

76,000

200,000

Percentage

 62%

38%

100%

 

So 62% (£3,720) of the £6,000 interest was allowed as a business expense.

 

So what could Mr Lion have done to get a better result? If he had bought a different kind of property, such as a pub with a bungalow next door where he planned to live, he could have asked the solicitors to separate the titles so that he bought the bungalow with cash, and, as a separate transaction, the pub with borrowed money. The borrowed money, incidentally, could have been partly secured on the bungalow if necessary – what counts is the use the loan is put to, not how it is secured.

 

In Mr Lion’s situation, because it is unlikely to be practical to separate the freehold of the flat from that of the shop, the position is more complicated, but a good tax adviser might have been able to devise a way for him to acquire the business and the flat in two separate transactions – if only he’d taken advice before he did the deal!

 

Mr Lion was in for another shock five years later, when he sold the business and the flat. He sold for £400,000, making a capital gain of £200,000.

 

Because it had been already agreed that 38% of the value in the property was his “main residence” and 62% was the business, he assumed that the CGT calculation would work like this:

 

 

Business

      62%

Home

    38%

Total

 100%

Capital gain

124,000

 76,000

200,000

Exemption for main residence

NIL

(76,000)

(76,000)

Business Taper relief (75%)

(93,000)

NIL

(93,000)

Chargeable to CGT

 31,000

NIL

 31,000

 

Once again, he got a letter from the Inspector, who agreed with the exemption for the main residence of £76,000, but explained that because part of the property (the flat) had been used for a non-business purpose, the calculation of the taper relief on the rest of the gain went like this:

 

 

Business

     62%

Non-business

        38%

Total

 100%

Non exempt gain

 76,880

47,120

124,000

Business Taper relief 75%

(57,660)

NIL

(57,660)

Non-business Taper Relief 15%

NIL

(7,068)

  (7,068)

Chargeable to CGT

 19,220

40,052

 59,272

 

Mr Lion found this hard to believe – by doing the calculation this way, his gain was £28,272 higher, which meant additional CGT (at 40%) of £11,309. He went back to the Tax Adviser, who explained that, although it was manifestly unfair, this was how the taxman interpreted the law.

 

If only Mr Lion had been able to acquire (and sell) the flat and the shop in two separate transactions, as with the pub and the bungalow described above, then all the gain on the flat would have been exempt, and all the gain on the shop would have attracted business taper relief.

Two very good reasons for keeping your home and your business separate wherever possible, and for taking good tax advice before acquiring the business in the first place!