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Are finance charges taxable investment income?

A service charge trust fund levies over £1k of interest on service charge arrears. Is it taxable?

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According to HMRC’s SAM100320:

“A property / flat management company may also be liable to income tax at the rate applicable to trusts where investment income arises on residential service charges (known as sinking funds) held in a designated account. This is a requirement of S42 of the Landlords & Tenant Act 1987.”

A service charge trust fund (per S42 of the Landlord and Tenant Act 1987) has received over £1k from finance charges imposed on arrears (in accordance with the lease).  

HMRC guidelines seem to state that investment income only is taxable. 

Would you say that a finance charge levied on arrears of service charges is taxable investment income?

Your advice would be gratefully received.

Replies (13)

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By whitevanman
20th Jun 2020 23:14

Excuse the impertinence but it is a little worrying that you quote the SAM guidance which is directed, primarily, at the clerical staff in HMRC who are responsible for setting up records on the SA system.
If you wanted to view technical guidance, it is more likely to be found in the Trusts, Settlements and Estates manual.
As ever, the correct answer will depend on the facts but my, limited, understanding is that, management companies within S42 are likely to be trusts. The annual contributions they receive are capital and not taxable. However, any interest etc received on the investment of those funds is chargeable at trust rates.
To determine whether the "finance charges" you describe, are comparable to interest or something else, you will need to know exactly what the rules, under which they are paid, say about them.
If the sums are comparable to interest, I suspect they will be taxable at the trust rates but, as I say, you will need to consider all the facts and look at the correct bit of HMRC guidance (if you are looking for their take on matters).

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By Tax Dragon
20th Jun 2020 23:55

I suspect s42 (and indeed TSEM) is a red herring. I think the question to ask is simply whether it's income. When tax-free payments are supplemented by "ex gratia" pop-ups for lateness, the top-ups have tax deducted (or used to - haven't seen one for a while) because they're classed as income.

As whitevanman says, have a look at the rules and have a look at how the charges are determined.

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Replying to Tax Dragon:
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By whitevanman
21st Jun 2020 00:12

Don't agree the red-herring comment.
S42 covers most typical, flat management etc, companies. It sets the rules. If established in accordance with S42, it is likely the entity will be a trust and the annual contributions will be capital payments to that entity (hence not taxable).
The rest follows the taxable status of the entity.

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Replying to whitevanman:
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By Steadfast
21st Jun 2020 03:04

Thanks so much for your replies whitevanman and Tax Dragon.

The TSEM Manual is keeping me up!

TSEM 5710 appears to confirm that the income is indeed taxable.

The case quoted is: Retirement Care Group Ltd v R & C Commrs (2007) Sp C 607
"Income tax – Trust income – Income on service charge monies held by trusts under s. 42 Landlord and Tenant Act 1987 – Whether ‘income to be accumulated’ within ICTA 1988, s. 686 and so liable at rate applicable to trusts" – Yes

The interest levied on the arrears is "income to be accumulated" and is therefore liable to tax. (The trustees have an implied power to accumulate this income.)

I will definitely sleep now!

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Replying to Steadfast:
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By Tax Dragon
21st Jun 2020 03:57

Income tax is a tax on income. The first question is whether it's income. That's not determined by s42 or TSEM, so I do think those are red herrings vis-à-vis that question. I'm not surprised if it is income, as it sounds, but I think you knew that already.

Question 2 is what is the rate of tax. There, s42 (and TSEM) are immediately relevant. Given that the figure has increased since your TMEs question, so the trust rate will apply to the excess over £1k, the answer to that question becomes more important. It's no longer "who cares?" (or whatever it was I said) as there will be a measure of tax relief.

I wonder whether wvm would agree with (the rest of) my response on that thread?

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Replying to Tax Dragon:
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By Tax Dragon
21st Jun 2020 04:03

Here:

https://www.accountingweb.co.uk/any-answers/service-charge-trust-fund-an...

Sorry, Steadfast, I see you did say "over £1,000" before. I either misread it then (my suspicion) or am misremembering my thought process now.

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Replying to Tax Dragon:
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By Steadfast
21st Jun 2020 16:53

Many thanks Tax Dragon. My mind's blown!

Re your Q1 as to whether it's income: It is income because Section 42 LTA 1987 contains an implied power to accumulate.
STEM5730: "If the lease specifies contributions are to be made to a service charge fund or sinking fund then an accumulation trust exists whether the funds are paid to an individual, a company, a trust or an unincorporated association."

Re your Q2: excellent question, thank you.
https://www.gov.uk/trusts-taxes/trusts-and-income-tax
Tax rates for an accumulation fund are 20% up to £1k and 45% thereafter.
(I hadn't appreciated that I thought the rate was 20% only.) So then TME's would be allowable against the taxable amount above £1k? And the effective rate could be 20% if the TME happens to match the amount above £1k?

Thanks again for all your help and thought provoking questions!

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Replying to Steadfast:
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By Tax Dragon
22nd Jun 2020 06:23

It is income because it can be accumulated (added to capital)? Weird logic. What would happen to it if it wasn't income?

However I missed that you'd called it interest - even in your sub heading (I'm not doing very well with my reading/comprehension skills on your threads!) - and as interest is income, I'm not going to argue your conclusion.

Yes, TMEs could reduce 45% to 20%. Note that the costs are grossed up, which helps.

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Replying to Tax Dragon:
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By Steadfast
22nd Jun 2020 13:36

Thanks for that. So if the grossed up TMEs are higher than the income chargeable at 45% they can be carried forward to put against future taxable income? Although, I'm guessing that can't be the case as the TME has to be exclusively incurred in relation to the income received.
PS: Not possible to have receipts that are not income as its a Service Charge Trust Fund. All the dosh collected in variable Service Charges go towards the maintenance of the structure, etc.

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Replying to Steadfast:
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By Tax Dragon
22nd Jun 2020 16:34

No carry forward, correct.

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Replying to Tax Dragon:
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By whitevanman
21st Jun 2020 23:15

Sorry, busy day and did not see this earlier (nor in fact did I see the previous thread).
I would indeed agree your comments. I think Steadfast has also, now, arrived at the same conclusion from dragging through the mire of the HMRC Trusts etc manual - not an easy feat.

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Replying to whitevanman:
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By Steadfast
22nd Jun 2020 02:14

Oh the joys of the TSEMs!

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Replying to whitevanman:
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By Tax Dragon
22nd Jun 2020 06:28

Thanks wvm. In my turn, I missed that you had commented before I replied above just now.

I need a holiday.

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