Where instead properties are held either for use in the trade, e.g. trading premises including offices, or as investment properties; those held for capital growth and/or rental income generation, these should be included on the balance sheet as fixed assets rather than stock.

Does it matter how these are classified?

Although both sit as assets on the balance sheet, the treatment of each differs slightly and in some aspects is inconsequential. However, there are certain pitfalls and subtle differences to be aware of. 

Where commercial properties are held and these are correctly classified as fixed assets, indexation allowance is available up to 31 December 2017. This allowance provides an uplift based on original cost (or March 1982 value where held prior to this date) which is used to increase the 'base cost' of the asset and therefore reduces the gain on disposal. Since the end of December 2017 no further allowance accrues under current rules and there is no hint of changes afoot in this area. However, if property hasn’t been correctly classified and is held in stock, no such allowances can be achieved.

One key point to note here is that the driver for classification is intention; what is your intention for the asset at the point you purchase it? Subsequently, does your intention change? If it does then you should look to reclassify the property at the time the intention changes.

Where there is a change of intention there is potentially tax at stake and this must be treated appropriately. This arises where the properties need to 'move up' the balance sheet; i.e. the intention has changed and a property held in stock is now going to be a fixed asset. 

A good case in point is where a developer might decide to retain a property that they have developed and rent it out because they feel it makes a good investment and generates a good return. Where such a change of intention occurs, the company effectively sells itself the property at market value and pays tax on any profit it makes on this. 

For example; a developer has bought and converted a property with the intention to sell on, with costs of £250,000. After the work is complete he decides to keep it and rent it out as the start of an investment property portfolio and at the time it is worth £300,000. Broadly speaking, the developer will need to classify the property as an investment property on their balance sheet at £300,000 and pay corporation tax on the £50,000 profit they have made on the development. In this scenario the developer should also be considering the wider ramifications in terms of their own trading status for both inheritance tax and in respect of any future plans which might result in capital gains tax on the disposal of the business.

In addition, they must also consider the VAT aspects of the project, and address any issues where VAT has been reclaimed but the property is now to be held as a residential let and the supply being made is therefore exempt. In some circumstances there are planning opportunities which, where planned and structured properly, may result in VAT still being able to be reclaimed on the project.

Intention is key

The grey area a number of people find themselves in is where they may want to sell a development, but the project doesn’t run to plan or the market shifts before the properties are sold and they are then retained for some time and rented out before a sale. Fundamentally the key point to come back to is intention, and each business owner must decide what their intention is and address actions needed where this changes.

Whilst it might be counterintuitive to move things around on the company balance sheet and crystalise tax payable without recognising any proceeds from a sale, it is important to be aware that HMRC is able to challenge the position where they feel it has not been correctly addressed. Where action is not taken in a timely manner HMRC may look to levy penalties where tax has been avoided.

We would therefore encourage all businesses who own property to undertake a review of their affairs in order to ensure that everything is in order, and to discuss with us any opportunities to minimise the impact of changes where these arise.