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The need for a valuation for the purposes of assessing Income or Corporation Tax under Schedule D may typically arise in the following circumstances:
- When the Inspector considers that the acquisition and disposal of a property by an individual or company constitutes a trade of property dealing (see paragraph 1.41-42 ).
- When a builder constructs or transfers a house for their own occupation (see paragraphs 1.43-44).
- When a developer claims that a property held as trading stock has fallen in value (see paragraphs 1.45-47).
- When a company receives a payment under a mining lease or agreement which relates both to mineral royalties and other matters (see Section 2).
Individuals or companies who trade in property are liable for income or corporation tax on their profits. In certain circumstances, individuals or companies who are not in business for the purpose of trading in property may enter into a transaction which amounts to 'property dealing'. If so, then the profit realised on such a transaction will be chargeable to income or corporation tax under Schedule D, rather than being treated as a capital gain.
An example of the type of situation that may arise is where a taxpayer enjoys a tenancy of a house under a long lease at a low rent. The taxpayer enfranchises and in order to fund the enfranchisement disposes of the property freehold with vacant possession in a "same day" transaction. It might be thought that in the normal run of things the gain made by the taxpayer is a capital one and, on the assumption that the property was the taxpayer's principal private residence relief would be available under ss 222 and 223 TCGA 1992. However, where the freehold was not acquired with the intention to retain but to sell at a profit the Inland Revenue may argue that this constitutes property dealing. If so then the difference between the value of the taxpayer's tenancy and the value obtained on the sale with vacant possession (net of costs) would be taxable as income under Schedule D.
Valuations will usually be required to be on the basis of normal open market value for Revenue purposes. Should any other basis be appropriate the Inspector will specify the requirements in the originating instructions.
A house built by a builder for his own occupation and so used does not become stock of his trade. The only adjustment for Income Tax purposes in such a case is the disallowance under s.74 (b) ICTA 1988 of the cost of construction.
On the other hand a house built and offered for sale by a builder in the ordinary course of his business is trading stock. The taking of such a house for private occupation is treated as a sale at market value for Income Tax purposes following Sharkey v Wernher (36 TC 275).
In practice many cases fall between these two extremes and are dealt with by determining the extent to which the house and land should be regarded as trading stock. For example a private residence built on land held as trading stock may give rise to an adjustment in respect of the land alone.
DVs may receive one of two requests from Inspectors in relation to the above problem. Firstly the Inspector may request the DV's opinion of the open market value of the property which should be taken as being the normal Revenue basis of valuation (see Section 7). Secondly the Inspector may request the DV to obtain an estimate of the cost of building the property in order that the liability under Schedule E can be assessed in respect of the difference between the amount paid by the taxpayer to the company for the property and the actual cost to the company of constructing the property.
In the preparation of Company accounts the determination of profit in an accounting year requires the matching of costs with related revenues. The cost of unsold or unconsumed stocks and work in progress will have been incurred in the expectation of future revenue, and when this will not arise until a later year it is appropriate to carry forward this cost to be matched with the revenue when it arises; the applicable concept is the matching of cost and revenue in the year in which the revenue arises rather than in the year in which the cost is incurred. If there is no reasonable expectation of sufficient future revenue to cover cost incurred (eg as a result of deterioration, obsolescence or a change in demand), the irrecoverable cost should be charged to revenue in the year under review. Thus, stocks and work in progress normally need to be stated at cost, or, if lower, at net realisable value.
It should be noted that there are specific rules for the valuation of trading stock on the discontinuance of a trade in ss.100-102 ICTA 1988.
A DV may be requested to provide valuation advice where a taxpayer claims that an interest in land or buildings has a value lower than its historic cost. The most common example will generally be where land purchased with hope value subsequently did not 'live up to expectation' or where a property is purchased at the top of the market prior to a slump or decline in demand. The items are treated individually and losses in one section of a developers land bank may not be set off against gains in another section for the purposes of stock valuation.
Provided the basis of valuation of stock-in-trade and work in progress adopted in the accounts conforms to recognised accountancy practice and does not violate the taxing statues, it may be accepted as valid for Income Tax or Corporation Tax purposes. This follows the decision in Ostime v Duple Motor Bodies Ltd (1961, 39T.C.537),
The Revenue generally accept the basis as laid down in the Statement of Standard Accounting Practice No 9 of September 1988 which was issued by the Accounting Standards Steering Committee.
The normal basis of valuation is cost or net realisable value, whichever is the lower; each item of stock being valued separately. Details of the basis are contained in the RICS Red Book Practice Statement 21. There are three differences between a normal Revenue valuation and the net realisable value required for trading stock purposes:
- It is necessary to consider the 'expected sale price' of the relevant stock in the condition in which it is expected to be sold in the traders 'normal selling market'.
The identification of the traders normal selling market may not be straightforward and ideally should be decided jointly by the Inspector and DV together but the final decision rests with the Inspector. Knowledge of the previous trading activity of the company should be pooled and consideration must also be given to what might have been realistic on the specific land being considered. Evidence may have to be sought from the taxpayers regarding their past trading activities in the years leading up to the valuation date.
The difficulty can be seen in an example where the item of stock is bare land. One type of trading activity might involve site assembly and obtaining planning consent before selling on to a developer. An alternative trading activity is where the company also carries out the development, lets the newly completed development and only sells once it has become an income producing investment. Thus the 'condition in which it is expected to be sold in the traders normal selling market' is quite different in each case.
- From the expected sale price it is necessary to deduct the costs incurred in getting the stock into a marketable condition. Costs of completing a development will include the cost of building work, professional fees, site works, finance charges etc. However no allowances are to be made for developers risk or profit as would be done in a residual valuation.
- The costs of marketing, selling and distributing the stock will also be deducted. These would not usually be reflected in a normal open market valuation.
If there is any dispute over the basis of valuation the DV should consult the Inspector and seek advice from CEO.