Rental income from sub-let leasehold – Reply to readers’ queries published by Taxation magazine in August 2023

Reply to readers’ queries published by Taxation magazine in August 2023

Reader’s query

Mrs O is a director and shareholder of O Ltd. She has signed a five-year tenant repairing lease on an office in her own name. O Ltd pays the rent of £1,000 a month as well as the insurance and any repair costs relating to the office.

Mrs O decided to convert the upstairs floor of the office into a residential flat. The landlord agreed that she can do this and O Ltd paid for the conversion of the upper floor to a flat at a cost of £20,000. First, should the £600 rent which is now being received for the upper floor flat be declared on Mrs O’s personal income tax return rather than the corporation tax return of O Ltd, which appears to be paying for everything? Second, if the rent can be shown on her tax return, does Mrs O owe the company £20,000 for the conversion costs? Third, is the rent of £1,000 a month paid by O Ltd allowable in the company accounts, even though the lease is not in the company’s name? Finally, is the £20,000 conversion cost a leasehold improvement and therefore not allowable in the accounts of O Ltd?

Reply to reader’s query

The answer to Landlord’s questions seems to hinge on exactly who the actual lessee is.

Scenario one. If the actual tenant is Mrs O, she is primarily responsible for the monthly payments.

The fact that her company, O Ltd, has paid for the rent, insurance, repair costs and flat conversion, whilst the lease ownership is in Mrs O’s personal name, suggest that Mrs O has received benefits in kind from the company.

The tax treatment for the benefits in kind depends on whether Mrs O has an employment (actual or deemed) with the company. If she is not (treated as) an employee, the benefits in kind are likely treated as deemed dividends received by Mrs O, which will, in turn, be subject income tax dividend rates. If she is an employee of the company, the benefits in kind must be reflected on P11D which gives to both NIC and tax implications.

Alternatively, the costs and expenses paid for by the company may be treated as director’s loan, the total amount for which needs to be reflected in the company’s accounts accordingly. If the director’s loan account is overdrawn as a result of the lease and associated costs, a s455 charge may be in view for the company at 33.75% on whatever balance that remains outstanding at the end of the accounting period.

Mrs O may be able to claim employment expenses, if she is able to prove that any of the expenses and costs incurred are necessary for her employment, and such expenses and costs are incurred wholly and exclusively for the employment.

Scenario two. If Mrs O has signed a sub-let agreement with the company, assuming consent is granted by the freeholder and all legal requirements are satisfied, the tax treatment is completely.

There is a partial disposal of the short lease for CGT and income tax purposes, which may give rise to a CGT and income tax exposure for Mrs O.

The entire £1,000 monthly rental payments should be reported by Mrs O on her personal tax return each tax year, reduced by tax allowable expenses incurred by Mrs O.

The £20,000 conversion costs fall into the category of leasehold improvements, most of which appear capital in nature, which need to be reflected in the company’s accounts accordingly. After the building works are completed, the company, as a leaseholder, has an entitlement (an intangible right) to enjoy the improvements; however, whatever have been physically installed become the freeholder’s assets.

As a result, for accounts preparation purposes, the leasehold improvements are amortised instead of depreciated. For tax purposes, capital allowance may be claimed, although it is advisable for the company to obtain an itemised invoice with detailed descriptions for each item and the associated costs.

Based on the second scenario, where Mrs O sub-lets the property to her own company, the answer to Landlord’s specific questions is as follows.

Answer to the first and third questions. The entire £1,000 monthly rent should be reported by Mrs O on her personal tax return. It appears that £600 of the £1,000 monthly rent relates to the residential flat, for which Mrs O may be treated as having received benefits in kind, although employment expense relief may be in view if all conditions are satisfied.

Answer to the second and fourth questions. The £20,000 conversion costs are incurred by the company in the capacity of a lessee. Mrs O does not appear to owe the company for the costs incurred.

This article is for general information only and should not be relied on as a substitute for specific tax advice.

This article is provided for general information only. It does not constitute tax, legal or other professional advice, and should not be relied on as a substitute for specific advice based on your particular circumstances.