The three little pigs, a wolf, and some property tax

Once upon a time there were three little pigs, whose mother sent them into the world to seek their fortunes and build their houses.

The first little pig built his house of straw, which he acquired from a local farmer in exchange for a particular sum of money. His house was finished quite quickly and without much work.

Shortly thereafter a bad wolf of indeterminate size emerged from the woods and approached the pigs house.

“Little pig, little pig, let me come in.” quoth the wolf.

“No, not by the hairs on my chinny chin chin.”

“Then I’ll huff and I’ll puff, and I’ll blow your house in.”

Naturally the house was decimated and the pig fled to the second brother’s house. The second brother had un-milled timber from a local duck, who had grown the trees in a local wood that he managed commercially. The house took a little longer to build as it was necessary to turn the trees into usable lumber.

As the duck merely grew the wood he benefited from an income and capital gains tax exemption in respect of monies received in relation to growing timber (although this wouldn’t have applied if he milled the timber, grew short rotation coppice, or grew Christmas trees).

Given that some cost had been incurred he charged the first little pig rent. Fortunately, this benefit from rent a room relief so the first £7,500 per year was covered by the relief and didn’t give rise to any tax costs.

The first little pig had not insured his house, although as the house had been destroyed he could consider making a claim to crystalise the capital loss in order to offset it against future gains. Regrettably his tax advisor informed him that under such claims the land is valued separately from the house and as such the loss would be equal to the value of the straw, which was of course sod all and certainly less than the tax advisor’s fee.

The one day the wolf re-appeared.

“Little pig, little pig, let me come in.” quoth the wolf.

“No, not by the hairs on my chinny chin chin.”

“Then I’ll huff and I’ll puff, and I’ll blow your house in.”

Although timber is a somewhat less rubbish than straw, it wasn’t sufficient to resist the wolf’s exertions. The pigs fled to the third brother’s house.

The third pig had built his house out of stone and, although he never actively mentioned this to the other pigs, he deported himself with a slightly smug air and always seemed to look down on the other brother’s choice of building materials – even though the absence of cement, plumbing or heating meant they were technically kinder to the environment.

The second pig had insured his property and set about making a claim under his policy, provided he utilised all of the hoped for funds in the reconstruction of the property no taxable receipt would arise. But he was dismayed to find that if he used any of the insurance proceeds for other purposes, such as buying a literate spider to weave messages in the corner a sty, then a part disposal would arise and that element would, potentially, be taxable.

Naturally the third pig charged his brothers rent. Once again, the first £7,500 of this benefited from rent a room relief, as it merely applies to the use of furnished accommodation in once’s only or main residence, rather than to a specific room. Any receipts in excess of this would of course have been subject to income tax. As an alternative the third pig did have the option of deducting actually expenses from the rents received.

HMRC view the presence of more than one lodger as being a lodging business and accordingly, should be third pig subsequently sell his house the entire property would no longer benefit from principle private residence relief. Fortunately, despite recent changes, a lettings relief would be available to relieve some or all of the gain relating to the room let by the second pig (up to a maximum of £40,000 of gains).

The one day the wolf re-appeared.

“Little pig, little pig, let me come in.” quoth the wolf.

“No, not by the hairs on my chinny chin chin.”

“Then I’ll huff and I’ll puff, and I’ll blow your house in.”

The rest, as they say, is history.

But what of the wolf’s actions in this matter? Certainly, he appears to be acting of his own volition, rather than under the direction of some third party so matters of employment status appear to be irrelevant.

However, we need to give some thought to the purpose and motivation of the wolf’s actions and consider whether he is carrying on business on his own account. In considering whether activities constitute a trade, the Courts have developed a number of tests to determine whether an individual is trading, these are collectively known as the badges of trade.

Considering the badges, we see that there are frequent and similar transactions; the wolf has effectively modified the assets (being the pig’s houses and potentially, if caught, the pigs); it is reasonably safe to assume that if caught the period of ownership of the pigs would be quite short. On balance these matters point to a trading activity. That said, the badges must be considered in the round and what is uncertain is whether there is the presence of a profit seeking motive, the reasons for the acquisition and whether there is the existence of a sales organisation.

Unfortunately, we simply don’t know this from the information available and further details would need to be sought. If the wolf is merely seeking to satisfy his own nutritional requirements, then there is no trading activity. Alternatively, if we’re passing on the pigs, or refined pig products, to other parties in exchange for some form of consideration it would be quite clear that he was trading. Under these circumstances the wolf would need to register for self-assessment by the 5th of October following the end of the tax year.

So, what’s in a fable? Quite a bit of tax stuff it seems.

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