Unused compensation for damaged property – is tax payable?

Your trading premises suffered structural damage, for which you were compensated by your insurer before any repairs were made. But you didn’t use all the money – do you need to pay tax on it?

Compensation for loss of profits will be taxable in the same way as trading income and compensation for loss of equipment tends to be dealt with under capital allowances (CAs) rules. For building damage, these are capital transactions and will fall within the capital gains tax (CGT) rules.

There are special rules that will allow you to defer, or even avoid CGT on the compensation payment. Exceptions from CGT apply when money received is:

• Fully used to repair/restore the damaged building.
• Partly used to repair/restore the damaged building. The used part will be small compared to the total amount of compensation, and wasn’t “reasonably required” for the works.  
• A small amount, compared to the value of the building.

So, if you received a compensation payout, and didn’t fully use it, you may decide to take advantage of one of these exceptions, to avoid or defer CGT until it’s time to sell the property.

But there might be a better option. If could actually pay to accept the capital gain, if it’s not much greater than your annual CGT exemption. You can defer, but it might be more tax-efficient not to.

The rule is, as always, do not simply go with what looks instantly more financially attractive and take great care when you’re crunching your numbers. Get advice and guidance from a chartered accountant, too. For optimised tax planning, it’s about seeking out which option suits you best, thinking creatively and pragmatic decision-making.

For help with business or personal tax planning, call Figurit (formerly known as Lansdell & Rose) on 020 7376 9333 or complete the form below.