Landlord can increase rent if tenant makes property improvements

Tenants who carry out extensive improvements to their homes lose the protection of an assured tenancy leaving the landlord open to serve notice to quit or to increase the rent.

The Court of Appeal dismissed the appeal of tenant Cherry Hughes after a Rent Assessment Committee disregarded improvements she had made when assessing rent payable to landlords Borodex Ltd under the new assured periodic tenancy which was to replace her long residential tenancy which had expired.

Discussion about the case revolved around interpretation of Schedule 10 to the Local Government and Housing Act 1989.

Lord Justice Arden said Schedule 10 to the 1989 Act contained the detailed statutory scheme to achieve the result that long residential tenancies were phased out and that tenants had the chance to become tenants in respect of the same premises under the assured periodic tenancies which had been created by the Housing Act 1988.

Sections 13 and 14 of the Housing Act conferred protection on a tenant in that:

1. The landlord could only terminate the tenancy on certain grounds
2. A tenant was able to refer the rent to the Rent Assessment Committee for determination.

The protection to a tenant provided  “any increase in the value of the dwelling house attributable to a relevant improvement by the tenant” was to be disregarded and, in defining “relevant improvement” in Section 14(3) two alternative tests were set out.

The tenant in the present case did not satisfy either test because the improvements had been carried out under the long residential tenancy and not under an assured tenancy. Provisions for rent reviews and fixing the rent often provided for a tenant’s improvements to be disregarded in the interests of fairness to the tenant.

Although there was no uniform rule on this, if improvements were to be disregarded under the new form of tenancy that the tenant now had, that result had to be achieved on the interpretation of Schedule 10 to the 1989 Act.

Counsel for the tenant had submitted that it was difficult to believe that Parliament intended to take away from tenants the right to a disregard of improvements when fixing the rent after the first year of their new tenancies and, accordingly, if there was another construction, that should in fairness to the tenant be adopted. It was not open to the court to adopt that interpretation.

The essential question was one of interpretation. The effect of paragraphs 9 and 11 of Schedule 10 to the 1989 Act in their form and context in relation to rent was clear. They provided a means of fixing the initial rent. Their function was limited to that of enabling the rent to be fixed at the outset.

Once the initial terms, including rent, were fixed, these paragraphs were spent. Schedule 10 to the 1989 Act merely applied in the period immediately after the creation of the new assured tenancies and not throughout their duration.

It was not for the court to assume that Parliament necessarily intended to produce the opposite result with regard to improvements.

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Don’t let the motive to buy property remain ambiguous

In 1972, the company acquired several properties which were let and recorded as investments in the accounts.

In 1973, a property was sold and treated the surplus as a capital gain.

HMRC challenged this on the grounds of the short period of ownership and the company agreed to tax the profit as trading income. Another small property was sold in 1978 and the surplus was treated as a trading profit in line with the earlier disposal.

In 1980 it sold the major property and treated the surplus as a capital gain.

It was held the property was trading stock even though it was accepted that it had been acquired as an investment, had always been shown as an investment in the accounts, had been held for eight years, and had produced significant rental income.

The justification was that the company had accepted that the surpluses on the two small properties were taxable as trading profits.

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Property investments do not have to generate income

Although generating income is a prime indicator of an investment, the absence of income does not prove the transaction is not an investment.

In Sir Nicholas Browne-Wilkinson said in this case: ‘It is true in the Reinhold case the Court of Session did rely on the fact that there would be income in rents as a relevant factor, and in my judgment it plainly is a relevant factor.

‘But in my judgment in 1986 it is not any longer self-evident that unless land is producing income it cannot be an investment. The legal principle of course cannot change with the passage of time: but life does.

‘Since the arrival of inflation and high rates of tax on income new approaches to investment have emerged putting the emphasis in investment on the making of capital profit at the expense of income yield.

‘I can see no reason why land should be any different and the mere fact that land is not income-producing should not be decisive or even virtually decisive on the question whether it was bought as an investment.’

In this case, Marson told an intermediary that he wanted to invest in land. The intermediary offered him a site for £35,000. The taxpayer had no idea of the timescale involved in property investment, but thought it might be one or two years. He took no legal advice nor steps to sell the land but a few months later, was approached by a potential buyer.

He sold the land and received a cheque for £70,000.

It was not until HMRC raised questions that he discovered that he had in fact bought the land for £65,000 with a £30,000 mortgage and had sold it for £100,000.

The transaction looked like trading as the land was bought with borrowed money, was held for a short period, was always intended to be held for a fairly short period, and produced no income while owned.

Nevertheless, the tax commissioners held it was an investment, which was upheld by the judge.

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How to treat more than one motive for acquiring the same property

In this case, the Court of Appeal laid down the principles to apply if a person has more than one motive in acquiring land:

• If an objective analysis shows the transaction has all the characteristics of trading, that analysis must prevail.
• If the transaction is equivocal, the subjective intention of the taxpayer must be taken into account in weighing up whether the transaction is trading or not.
• If in an equivocal case the taxpayer’s sole objective is non-commercial the transaction will not be a trading transaction.
• In all other cases the overall nature of the transaction is a question of fact to be determined by the commissioners.

The facts were Kirkham contracted to buy land to develop and applied for planning permission.

Completion of the purchase was May 1978. He used the land partly as offices and partly for business storage. He also carried out some farming.

Planning permission to build a house was granted in August 1980. Kirkham then built the house, but had never intended to live there.
The land was sold in October 1982 and the taxman argued that the initial motive to buy the land was a property trade.

Kirkham claimed he had acquired it as a capital asset for use in his business.

The tax commissioners held the site was acquired principally to provide office and storage space for the taxpayer’s business but felt that it was a trading transaction.

The Court of Appeal accepted that if the commissioners had found that the subsidiary purpose for the acquisition of the site was trading, they might  hold the overall intention was trading.

Further, even if the subsidiary purpose was trading, this could not have been implemented at the same time as providing office and storage space.

Kirkham could not develop the site without planning permission and even then could not start building until finding storage and office space elsewhere.

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A property cannot belong to a property trading business and a property investment business at the same time

This is widely considered the leading case on the difference between property investment and trading.

Simmons, a surveyor , was building a property investment portfolio which he  intended to float as a public group.

He formed a number of companies over about eight years to develop and keep one or two properties. Sometimes, properties were sold  shortly after development. The sales followed a strategy of trading up, by disposing of one property to provide funds to acquire a larger one.

The profits were credited to capital reserve.

In 1966, following the Rent Act 1965 and the Finance Act 1965, he decided that there was no future for a property investment group, sold the properties and liquidated the companies.

The tax commissioners and Court of Appeal felt that some properties were trading stock.

The House of Lords reversed the decisions, holding that deciding any of the properties were trading stock was inconsistent with the primary facts.

‘Trading requires an intention to trade: normally the question to be asked is whether this intention existed at the time of the acquisition of the asset. Was it acquired with the intention of disposing of it at a profit, or was it acquired as a permanent investment?

Often it is necessary to ask further questions: a permanent investment may be sold in order to acquire another investment thought to be more satisfactory; that does not involve an operation of trade, whether the first investment is sold at a profit or at a loss.

Intentions may be changed. What was first an investment may be put into the trading stock – and, I suppose, vice versa. If findings of this kind are to be made precision is required, since a shift of an asset from one category to another will involve changes in the company’s accounts, and, possibly, a liability to tax

What I think is not possible is for an asset to be both trading stock and permanent investment at the same time, nor to possess an indeterminate status – neither trading stock nor permanent asset.

It must be one or other, even though, and this seems to me legitimate and intelligible, the company, in whatever character it acquires the asset, may reserve an intention to change its character. To do so would, in fact, amount to little more than making explicit what is necessarily implicit in all commercial operations, namely that situations are open to review’ said Lord Wilberforce in his judgment).

Each court looked at the general investment motive of Mr Simmons  to determine the motive of an individual company in acquiring an individual property.

Also the decision to liquidate could not give rise to an inference of a trading motive as this did nothing more than put an end to Mr Simmons’s investment plans.

Frustration of a plan for investment leading to selling property, even if foreseen as a possibility, cannot be seen as an intention to trade.

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Negating a trading motive is more important than proving the transaction was property investment

A large country house where the buyer’s mother had once worked was bought on impulse at an auction in July 1959 for £5,100.

The son had not decided what to do with the property but was considering moving in but his wife did not want to live there.

Before completing the purchase, he applied for planning permission for redevelopment that was refused but granted on appeal in 1962. The following year, he sold the land to a developer for £54,000.

In the High Court Megarry J said that part of the gain was capital and part income and remitted the case to the tax commissioners to determine when trading commenced.

The Court of Appeal held that the whole of the gain was capital as there was no evidence of an appropriation to dealing stock.

This case illustrates the importance of establishing motive on acquisition. of a property.
If the taxpayer had not been able to show that he did not start with a trading motive he would undoubtedly have lost as everything else pointed to a property trading transaction.

The point is that a property investor does not have to prove a motive to the taxman, just prove that the motive was not trading.

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A single property transaction is not necessarily a trade

Reinhold bought four houses in January 1945 and sold them in December 1947.

He bought them as a property trade and told his agent to sell whenever a good opportunity came along. The properties generated no profits from rent.

In the past, Rienhold had bought and sold a hotel at a profit before completing the purchase.

The decision was buying the houses was an investment and not a trade.

Lord Keith felt that where an individual enters into an isolated transaction in property investment, the inference of trading is not to be so readily drawn in regard to a single transaction from an admitted intention to sell on the arrival of a certain pre-selected time.

‘It is not, in my opinion, enough to show that the properties were purchased with the intention of realising them someday at a profit. This is the expectation of most, if not all, people who make investments,” said Lord Keith.

‘Residential property is a not uncommon subject of investment and generally has the feature, expected of investments, of yielding an income while it is being held. In the present case the property yielded an income from rents. It is said that it yielded no profit … the intention to resell at some date at a profit is not per se sufficient in this case to attract tax.’

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Having investment property doesn’t stop you being a developer as well

Two brothers built houses to let as a pension provision. By 1939, they had built or purchased 60 houses, none of which were sold before 1947.

Between 1942 and 1948 they bought a further 239 houses cheaply because of  conditions in the Second World War.

They sold 58 of the houses they bought in wartime between 1946 and 1952.

Tax commissioners held that were property traders.

Although they originally intended to invest, this changed when they bought more houses during the war. The judgment shows that a property investor can run a rental and trading business at the same time.

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The initial purchase motive counts – not a later change of mind

A company was incorporated in 1933 and bought more than 70 acres of land on the outskirts of Hull as trading stock to develop as a suburb.

In 1935, the development was abandoned as the land had drainage problems that the developers were unable to resolve.

Some land was sold between 1936 and 1956 and the profits were treated as  income.

The land was shown as an investment in the company’s accounts and generated rental income that was generally less than expenses.

In 1961 the land was purchased by the local council.

From 1952, the company had been taxed as a property investment company.
arguing that although the land was initially purchased as trading stock, when the intention to develop was abandoned in 1936, it became an investment.

It was held that abandoning a particular project does not involve abandoning any idea of developing or otherwise trading property.

There was no evidence that the land had ever ceased to be trading stock and the sale in 1961 was a property trade.

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Selling investment property doesn’t make it a property trade

A company acquired land from three shareholders in 1898 and built five tenement blocks by 1900. The investment did not make a good return and after the First World War, the company took advantage of a general housing shortage to sell several flats and houses in the blocks to raise finance to pay back borrowings.

This left the company owning 24 flats in a poor state of repair.

The tax commissioners held the company was realising investments with the property sales and not  property trading because the company had bought a single plot and after a series of sales, still held a large part of the investment.

Selling the flats was an investment decision taken to ease a difficult financial state, not a property trade.