A Question for you

System
System Posts: 100,537 🤖 Admin 🤖
edited June 9 in General accounting discussion
I have a question and would like your opinions on this please.

I have a client who is in a partnership. They run a physiotherapy centre and the partnership owns the building (by way of mortgage) and they charge 3 business for rents and upkeep. I propose to do the following:

The income is to be split as follows:

1/3rd = rents
2/3rd = service charges (these are for the general upkeep of the building, electricity, wages etc).

On the tax return I propose to put:

Rents to schedule A income; and
Service charges to trading income.

The 2 partners run their own Ltd Co's within the partnership.

The service charges comprise the provision of various equipment for 3 business, the provision of a receptionist, the provision of payroll services, the provision of repairs and renewals. Essentially, the same services as a serviced office for example.

There are genuine reasons why I am asking this question which I will go into when I have your thoughts. I do have have an answer but it is one of those that is "open to interpretation" and I'd like to hear others "interpretation" before I explain why I am asking the question.

Kind regards
Steve

Comments

  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:A Question for you

    Hello Steve,

    I specialise in property tax and would agree with your treatment though I agree with you that it is an extremely grey area.

    If the service charges merely consist of re-charged utilities then this would be deemed to be rental income and taxed under schedule A. I think you can argue that the service charges are trading income because of the setup of the partnership. Clearly you can see that the partnership has been set up and the 2 partners have their own businesses operating within the partnership. This gives rise to a "trade" and as such should be taxed under schedule D1. The Revenue would also argue this case as there are potential Class 4 issues here, which I am interpreting from your post that you are taking into account. Class 4 is not payable on rental income and as such a lot of people would argue (quite rightly in some circumstances) that service charges are schedule A. In some circumstances they are part of schedule A but in this case there is a clear case for arguing the services charges are trading income.

    Another aspect concerns CGT and the business asset taper relief (which may be a thing of the past).

    Susan.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:A Question for you

    Thank you for your reply Susan.

    As I mentioned in my original post, there are 2 partners within this "property" business. One of the partners has another firm of accountants who do his tax return.

    The other firm has quite categorically disagreed with my treatment of the service charges. He said that they should be schedule A. I do agree that they should be schedule A IF they are just recharges for heat & light bills/utilities. However, the property partnership provides a receptionist who answers the telephone, who makes and books appointments, whose wages are recharged to the individual companies within the service charge. The property partnership own equipment which is in the 3 treatment rooms and pay all the repairs/renewals/maintenance costs. All the fixed assets are paid by the property business so I worked on the assumption that the partnership was trading in much the same way as a firm such as Regus who provide serviced offices. The same principles still apply.

    The accountant was very adamant I was wrong. However, I don't think he understood quite what the service charges represented. I was also at a loss as to why he said the client's trading loss could not be offset against his other income?????

    You are right about my thought process in terms of Class IV & CGT issues.

    To be fair, I do think this is one of those many "grey areas" which is open to interpretation.

    Thanks for your input.

    Steve
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:A Question for you

    As I mentioned I deal with property tax but not in practice. I have confirmed today with a CTA qualified tax adviser that your argument to treat the service charges as trading income and tax them under Sch D1 rules is plausible. The reasons he cited were:

    The set-up of the partnership and the intention as to the trading of the partnership.

    That there are two income streams - one from the trade itself being the provision of serviced rooms and the rentals.

    He said that in the event of an enquiry the Revenue would almost certainly expect to see the partnership with two tax streams (schedule A and Schedule D1 which you have done).

    When I worked in practice I found that sometimes accountants dealing with the same client often disagreed, especially when it came to VAT issues.

    Susan.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:A Question for you

    Thanks for that Susan. I appreciate your input.

    Kind regards
    Steve
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:A Question for you

    Steve

    You are right to treat the services as trading income and the rent as rental income but I am not sure you are going to get away with the split of 1/3rd rent 2/3rds services.

    HMRC are likely to argue that the rental element of the income is the predominant source, with ancillary services being relatively minor. What would the market rent be for the property without any of the services being provided? Would it really be 1/3rd?

    If you want to quote a tax case to the 'other' accountants then I believe the two income stream principle is established in the case of Fry v Salisbury House Estate Ltd.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:A Question for you

    Hi Dean,

    I've been waiting for your response - thanks for your input.

    The 1/3rd 2/3rd split is within the legal agreement drawn up by the lawyers on inception of the partnership. The rooms themselves which they let out are very small rooms (no bigger than, say, a GP's room in a surgery). The actual building, however, is quite large.

    The accountant was ranting to me that the legal agreement bears absolutely no significance to the partnership split?? I was completely at a loss as to why he said this. The split is in the legal agreement and this is the reason why we have used those splits. I think the accountant was saying that the legal agreement bears no significance to tax legislation - which is fair enough but I cannot argue with a legal document which the partners have drawn up. In the event of an enquiry then we would refer the inspector to the agreement.

    Dean, thank you for giving me the case law - this is ideally what I was looking for. I have written to the accountants giving a detailed description of what the service charges are actually made up of and I have printed off your post in the event he comes on the telephone again firing on all cylinders!!

    Thanks again dean.

    Best wishes
    Steve
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:A Question for you

    No worries.

    Proper legal agreement will certainly help here but, just as an example, if I sold my house and got the solicitors to draw up an agreement stating that £20k was for the building and £180k was for fixtures and fittings then that would hold no weight.

    Obviously a very different situation here, but it is just something to bear in mind.
  • System
    System Posts: 100,537 🤖 Admin 🤖
    Re:A Question for you

    HMRC would try and argue the ratios in which the charges/rents have been split but on the face of it I doubt there would be much recourse.

    I have to say the knowledge demonstrated on these forums by Dean Shepherd and, you, Steve is exemplary - I have been reading some of the answers posted by you both in response to questions and it is reassuring to know that you are both on hand to answer questions. I have returned to work after a career break and have decided to complete the final stage of AAT before I embark on either a chartered accountancy course or follow the tax route. What routes have you both taken?


    Susan.

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