Developing property can be an excellent way to build wealth, but flippers should be aware of a couple of tax hazards. They all boil down to whether you are treated as trading or investing. If you are deemed an investor, then you pay capital gains tax on your profits; if you are a trader, then you pay income tax. The higher rate of income tax is 45% plus national insurance of 2%, and if your total income is around the £100,000 mark, your margin rate of tax can be 62%. Capital gains tax currently has a maximum rate of 28% and has annual exemptions [although these are falling].
So obviously, flippers generally prefer to be treated as investors and HMRC prefers them to be treated as traders. In reality, the taxpayers decide when they complete their tax return, and its up to HMRC to challenge this later. However,, if HMRC successfully challenges this, there are penalties and interest to deal with.
One other overlooked wrinkle is the CIS scheme. The CIS scheme was created to deal with the construction industry’s cash economy. If you engage a subcontractor unless they have a gross payment certificate, then the business that engages them should deduct tax from their payment at either 30% or 20% and pay this over to HMRC. If you are deemed a trader developing a property, you are caught within the CIS scheme and should register and deal with your sub-contractors under these rules.
There is a horror story case involving a taxpayer, the Parkinson case. They engaged a subcontractor and failed to deduct the 30% tax from the payment. Many years passed before HMRC caught up with this. The amount of tax that should have been deducted was only £800, but the penalty issued to the developer was £31,000! A costly mistake.
So, it is essential to know whether you should treat yourself as a trader or an investor. The things that HMRC considers when deciding the status of a developer are as follows
Profit Motive – are you looking to make a profit in a short amount of time and extract, or are you investing for the long term
Finance – is the development financed by a mortgage or a bridging loan?
Frequency – how often are you buying and selling property
Duration – how long do you hold the property
Amount of work – is there a lot of work, or is it a small amount to quickly increase the value?
About the Author
Jason Seagrave is the founder of Seagrave French and has been advising business clients for 35 years. He is never happier than when helping ambitious clients transform their businesses.