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Hi,
I am confused about the answer of ACCA regarding the legal fee for purchase and sale of asset and enhancement expenditure. To my knowledge, capital expenditure is not allowable and thus cannot be included in calculating trading profit. However, the below legal fee and renovation ( enhancement expenditure) are allowable. Please advise.
Question: Simon house (12/09)
Simon House purchased a derelict freehold house for £127,000. Legal fees of £1,800 were paid in respect of the purchase. Simon then renovated the house at a cost of £50,600, with the renovation being completed on 10 August 2008. He immediately put the house up for sale, and it was sold on 31 August 2008 for £260,000. Legal fees of £2,600 were paid in respect of the sale. Interest from a bank loan to finance this trade is £3,000Answer from ACCA:
Proceeds : 260,000
Cost : (127,000)
Enhancement expenditure (50,600)
Incidental costs (1,800 + 2,600)= (4,400)
Interest (3,000)
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(185,000)
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75,000This question is testing our application of the badges of trade. If a taxpayer sells a property this would usually be treated as a capital gain but clearly this property has been purchased in order to sell at a profit and therefore will be treated as trading, with all costs to do with the purchase, renovation and subsequent sale being treated as allowable expenses in calculating the trading profit on sale which is therefore charged to income tax..
Your reference to capital expenditure being disallowed in the adjustment of trading profits is correct but this is being being treated as a trading transaction not a capital transaction. If a trader had bought a property for USE within the trade then that would be treated as capital with the costs being disallowed in the adjustment of trading profit and a chargeable gain being computed on its eventual sale
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