This article examines the tax treatment of any such rental income received in connection with a trade or profession, and also of the deductibility of any associated expenses.
Letting of Surplus Commercial Accommodation
A business may have surplus commercial accommodation that it decides to let out. In certain situations, the rent received from letting surplus accommodation can be treated as trading income. However, this is only permitted if certain conditions are met.
The conditions are that:
• the accommodation is temporarily surplus to current business requirements;
• the premises must be used partly for business purposes and partly let;
• the accommodation is not held as trading stock;
• the rental income must be comparatively small; and
• the rents must be in respect of the letting of surplus business accommodation only.
For the purposes of satisfying the above conditions, accommodation is regarded as temporarily surplus to requirements if:
• it has been used within the previous three years to carry on the trade or has been acquired within the previous three years;
• the trader intends to use it to carry on the trade at a later date; and
• the letting is for a term of not more than three years.
If the `surplus to requirements’ test is met at the beginning of a period of account, the test is treated as having been met throughout the period of account.
Where these conditions are met, the rental income received is included in the computation of the trading profit (or loss) rather than being dealt with as part of a separate property rental business.
The above conditions mean that this treatment is only available where the accommodation that is let is in the same premises as that which continue to be used for the business. It does not apply where a separate property is let (for which, see below).
The rule that allows rental income to be included in the trading computation provides something of a simplification where the business has a small amount of surplus accommodation for a temporary period (for example a spare office as a result of contraction in the operations in the business).
It is not designed to apply to a situation where the intention is to let commercial accommodation over a longer period and business accommodation has been acquired specifically for that purpose. In this scenario, the let part would form part of a property rental business.
Where rental income is included within the trading results, any expenses incurred in relation to the let accommodation are also taken into account when computing trading profits. However, where this approach is taken, the expenses deducted in working out the trading result must not also be taken into account in computing the result s for any property rental business.
This treatment has some obvious advantages particularly if the trading result shows a loss as the rental profits are immediately relieved. A similarly beneficial result arises if the expenses associated with the letting exceed the income as the expenses are set against the trading income (giving immediate relief for the letting loss).
Separate Property Surplus to Requirements
The preceding paragraph dealt with the letting of surplus accommodation in the same premises as that used by the business. Different rules apply where a taxpayer carries on a trade or profession in which a separate property becomes surplus to their trading or professional requirements.
If the separate property is not sub-let, any expenses incurred in relation to that property can be deducted in computing the profits of the trade or profession provided that the property was acquired wholly and exclusively for the purposes of the trade or profession. This is a question of fact.
HMRC would regard this test as being met if the taxpayer entered into a lease in respect of the premises in order to use the property for the trade or profession. However, if the property was acquired with a view to sub-letting it, the test would fail.
Similarly, the expenses incurred in relation to a private property or a property forming part of the taxpayer’s rental business are not deductible in computing the profits of the trade or profession.
The ability to deduct expenses is essentially limited to the period for which the taxpayer was tied into the lease but for which the property had become surplus to requirements. During this period the expenses would be regarded as having been incurred wholly and exclusively for the purposes of the trade.
However, if at the end of the lease, the taxpayer renews the lease to enable a sub-let to continue, the expenses of the former trading property would cease to be deductible for trading purposes. The same rule applies if the taxpayer has the option to terminate the lease after the accommodation has become surplus to trading requirements, but chooses not to do so.
Where rental income is received in relation to the sub-let of a separate rental property, the rental income should not be taken into account in computing trading profits. Instead it is treated as income of the taxpayer’s rental business.
Strictly speaking, the associated expenses should not be deducted in computing the profits of the property rental business as the `wholly and exclusively’ test is not met in relation to the rental business, However, HMRC allow them to be set against the rental income such that the net rental profit is taxed as income of the property rental business.
Alternatively, the expenses can be deducted in computing the profits of the trade or profession, so that the gross rental income is assessed as income of the property rental business and relief for expenses is given against trading income.
Further, if expenses in relation to the sub-let of the surplus property exceed rental income and the expenses are set first against the rental income, the excess of expenses over rental income can be deducted in computing trading profits, as long as the wholly and exclusively test is met.
This can be very beneficial as it provides immediate relief for excess expenses (under property income rules any loss can only be set against future rental profits). However, if the taxpayer has other rental properties, it may be preferable to take all expenses into account in computing the profits of the property rental business, thereby effectively relieving the excess expenses against profits from other rental properties.
The best result will depend on the taxpayer’s particular circumstances and there is no substitute for crunching the numbers to see what works best.
The relaxations in the strict rules that require income from property to be treated as part of the taxpayer’s property income business provide a common sense approach to `accidental’ rental income acquired from letting surplus business accommodation.
The rules are more generous where the surplus accommodation is in the same property as that still used for the business. Consequently, in the event that a separate property becomes surplus to requirements, it may be worthwhile to continue to use part of it for the business, for example for storage, to enable any rental income to be brought into account in computing trading profits.
As always, the best result will depend on the taxpayer’s particular circumstances.
By Sarah Bradford