Tax Residence – An Interesting Break

Tax Residence continues to be an interesting area – and an active one for HMRC challenge.

Having burned many years of their own guidance in taking Gaines-Cooper to the highest court in the land – thereby ignoring their own ‘safe haven’ guidance in IR20, HMRC have made another challenge in the case of James Glynn.  In this case, HMRC HAVE LOST, [at least at the First Tier Tribunal].  The verdict of the judges, over a lengthy(?) day hearing was [simplifying] that the taxpayer had done enough to demonstrate a ‘definite break’ in lifestyle, so was entitled to look at a ‘day counting’ approach to tax residence.

Interestingly, the long memories of HMRC appeared to consider the idea of ‘available property’ relevant – a concept which had been abolished, but is now re-emerging in the new statutory tests.

Pleasingly, the judges looked at the case based on its specific facts.  They took into account factors such as social life, family and religious tradition, changes in business and investment interests, the conduct of the taxpayer’s wife and her charity work etc., – in fact the whole picture of his lifestyle.  This resulted in the conclusion that Mr Glynn had deliberately altered his lifestyle to such an extent that there was a ‘definite break’.

Again, hopefully this gives clarity taxpayers can depend upon.  Further the court went on to say that the fact that part of the motivation was tax avoidance was irrelevant, because the question of motivation should not have an impact on what is (especially under the new statutory rules) a question of fact.  Often the question of fact may not be an easy one, but one to be weighed in the balance, based on the complete picture.

Lessons to be learned include:

  1. The importance of reviewing all the facts and assembling appropriate technical arguments.
  2. The great depth to which HMRC went in investigating detailed elements of the taxpayer’s lifestyle.

Private Residence Relief Denied – Dream House but not the same Dwelling House

Background

In this recent case, the taxpayer Paul Gibson purchased a property called Moles House for £715,000. Mr Gibson decided to demolish the original house (referred to by HMRC as Moles House One) so as to build his dream family house in its place for him and his partner (referred to as Moles House Two.) Demolition and complete reconstruction of the house was deemed as more cost effective than renovating and extending the existing structure.

Following financial difficulties due to the expense of the project and relationship problems, it was decided that the ‘new house’ would be sold upon completion. When the house was sold in February 2006 for approximately £1.5million, the capital gain on the sale of the property was not reported in Mr Gibson’s 2006/07 tax return assuming Private Residence Relief was due under TCGA s.222. HMRC opened an enquiry into that return and issued a closure notice that brought the capital gain on the house into charge as well as subsequent penalties. Mr Gibson appealed against the rejection of PPR and the 50% penalty imposed.

First-tier Tribunal Decisions

The main points considered for whether Private Residence Relief was due in this case were:

1.)     Did Moles House Two constitute the same ‘dwelling house’ as Moles House One according to its ordinary meaning under TCGA s.222(1)?

  • The FTT noted that if an existing dwelling house was fundamentally remodelled and renovated it would still be classified as the same dwelling house.  They considered whether a house that was demolished and reconstructed in order to achieve the same end as remodelling the existing house by a more cost effective means should also be regarded as the same dwelling house.
  • However, the Tribunal Judge ruled that the words of ‘dwelling house’ need to be given their ordinary meaning. ‘Dwelling house’ refers to the building itself rather than to the land. If one house is completely demolished and a new house is built in its place, then the new house is not the same ‘dwelling house.’
  • Mr Gibson’s case was weakened by the fact that the two houses were built out of different materials and it was not built on the same foundations; it wasn’t considered as the same house physically.  Perhaps the outcome would have been different if the materials from Moles House One were recycled and used to build Moles House Two in the same plan as before?  His case was also weakened by his own reference to Moles House Two as the ‘new house’ in his testimony.

On the grounds of the meaning of ‘dwelling house’, Moles House Two was found to be a different dwelling and Mr Gibson would not to be entitled to Private Residence Relief unless he had resided in the new dwelling. 

2.)     Was Moles House One and subsequently Moles House Two the individual’s only or main residence throughout the period of ownership?

  • HMRC argued that a dwelling house must be physically occupied by the individual during their period of ownership for it to be their only or main residence and for relief to apply. The intention to occupy a dwelling house but having to sell it for unforeseen reasons does not qualify the individual for relief.
  • It was accepted by all parties that Moles House One had been Mr Gibson’s main and permanent residence.
  • It was only revealed during the course of the court proceedings that he had ‘lived’ in Moles House Two following its completion. However, Mr Gibson had only ‘camped’ at Moles House Two during the process of the sale and had not occupied the reconstructed property at any other time prior to his decision to sell it. He had also testified that permanent residence in the property was not possible before the construction of Moles House Two was complete.
  • Occupation of a property does not equate to residence unless it becomes a person’s home.

As the newly constructed house was not considered as the principal residence of Mr Gibson, the claim for PPR was rejected on this point too.

Despite Mr Gibson’s appeal being rejected in its entirety, if a couple of circumstances had differed slightly in this case then the outcome may have been different.  The intricate facts of each case are vitally important and taking advice before undertaking transactions can allow the position to be considered and, perhaps corrected, in advance.

HMRC Wins Cotter Appeal on Tax Collection – But Still Hope For Some Taxpayers

The verdict of HMRC’s appeal to the Supreme Court in Cotter v HMRC has now been released.  The case concerned procedural matters as to whether a claim for loss relief was included on a return and therefore under which regime HMRC could raise an enquiry.  Whilst this sounds dull, HMRC publicity is announcing at as a victory over “tax avoidance” enabling it to collect an extra £500m.

The Supreme Court found in favour of HMRC in the case of Cotter. However, it was on a very narrow point and  hope remains, following the verdict, for taxpayers who calculated their own tax liabilities.

Background

The taxpayer, Mr Cotter, filed his tax return for the 2007/08 tax year on 31 October 2008.  He did not make a claim for loss relief and left HMRC to calculate the tax.

In January 2009, Mr Cotter’s accountants wrote to HMRC enclosing a “provisional 2007/08 loss relief claim” with amendments to his 2007/08 tax return.  They stated that no further tax would be due for 2007/08 but did not provide a tax calculation.

HMRC amended the return and opened an enquiry into the return but refused to give effect to any credit arising from the loss relief claim.  They held that the claim had not been made in a return and as such were not required to give effect to the claim until the enquiry was closed.

HMRC eventually issued legal proceedings for collection of the tax at the County Court, and a series of cases ensued.  In February 2012, the Court of Appeal found in favour of Mr Cotter, finding that HMRC would have to raise an enquiry under Section 9A of TMA 1970, thus giving Mr Cotter the right to appeal and postpone the tax until resolution.

Supreme Court Decision

The Supreme Court found that where the taxpayer had included information in his tax return that did not feed into the year’s calculation, it did not mean that HMRC were obliged to give effect to it. The tax return form includes other requests for information which do not impact on the income tax chargeable for the year, and as such the word “return” should refer to “information in the tax return which is submitted ‘for the purpose of establishing the amounts in which a person is chargeable to income tax and capital gains tax’ for the relevant year”.

As Mr Cotter had not calculated the tax due, HMRC were not required to include a claim for 2008/09 loss relief in the 2007/08 assessment.

However, Lord Hodge noted that “matters would have been different if the taxpayer had calculated his liability to income and capital gains tax by…completing the tax calculation summary pages of the tax return”.  By including a calculation with the tax return, the calculation then becomes part of the self-assessment and must be enquired into under section 9A.  “The Revenue could not go behind the taxpayer’s self-assessment without either amending the return or instituting an enquiry under Section 9A of TMA”; with either option providing the taxpayer with an opportunity to appeal.

It is also worth noting that Lord Hodge suggests that HMRC could remove uncertainty in the tax return by highlighting which boxes are not deemed relevant to that tax year’s calculation.

Conclusion

We now have an interesting situation whereby HMRC have won their appeal on Cotter, but the verdict may not have the level of impact that HMRC were hoping for, as taxpayers who calculated their own tax liabilities ought, from reading the case, to be able to use the decision to their advantage.

It remains to be seen how HMRC will seek to apply the decision to such cases, and whether they will update their tax return forms as suggested by Lord Hodge.

Taxpayers who may be affected by the decision should take further advice before surrendering to a new HMRC demand which may not be valid.

Bank Settlement – Wholly and Exclusively

The recent tribunal case of Mr Vaines v HMRC (TC02965) dealt with whether a deduction from trading profits was allowed under the ‘wholly and exclusively’ principles, for an out of court settlement of a bank claim relating to a previous trade.

If the claim was not settled the taxpayer could be made bankrupt thus preventing him from continuing in his current trade.

Background

The taxpayer, Mr Vaines, was a member of Harrmann Hemmelrath LLP, a German law firm with offices in London, until 31 December 2005.

The taxpayer subsequently became a partner in Squire Sanders & Dempsey.

On 27 October 2009 the taxpayer made an amendment to his tax return for 2007/08, claiming a deduction of £215,455 against his professional income from Squire Sanders & Dempsey.

The deduction claimed was for a payment made to a German bank, under an agreement made by a number of individuals who were connected with his previous law firm, Haarmann Hemmelrath.  The firm had ceased to trade and owed approx. €17m to a number of German Banks.

The taxpayer believed that the risk of challenging the banks through the German courts was unacceptably high; as if he lost he would be made bankrupt.

If made bankrupt he would lose his current position as partner at Squire Sanders & Dempsey.

Following negotiations with the bank, he agreed to pay them €300,000 (£215,455) in full and final settlement of all claims.  This was paid in January 2008 (tax year 2007/08).

An amendment was made to his 2007/08 tax return and a deduction from his professional income from Squire Sanders & Dempsey claimed.

HMRC denied a deduction primarily on the basis that the payment was not wholly and exclusively for the purposes of his trade.

HMRC’s Arguments

HMRC argued that the deduction should not be allowed for three reasons:

  1. Mr Vaines did not carry on a profession or a trade as an individual,
  2. If he did carry on a trade individually the payment was not wholly and exclusively for the purposes of the trade as it also enabled him to avoid bankruptcy and preserve his reputation, and
  3. If it was wholly and exclusively, it was capital and not revenue expenditure and therefore no deduction was allowed

Tribunals Conclusions

1. Trading as an Individual

 HMRC had tried to rely on a case that predated self-assessment. However this case was found to be superseded by ITTOIA s.862, which states that members of an LLP are treated as carrying out the trade and not the partnership itself.

The tribunal therefore dismissed HMRC’s argument that Mr Vaines did not carry on a trade in his own right.

2. Wholly & Exclusively

The tribunal held that as a matter of fact the purpose of Mr Vaines making the payment was to preserve and protect his professional career or trade.

With this in mind the case of Morgan (Inspector of Taxes) v Tate & Lyle Ltd (1955) states that ‘money spent for the purposes of preserving the trade from destruction can properly be treated as wholly and exclusively expended for the purposes of the trade’.

As a result they found that the payment to the Bank was wholly and exclusively for the purposes of his trade.

3. Revenue or Capital?

The final consideration was whether the payment was revenue or capital.  HMRC contended it was capital and therefore no deduction was allowed.

Mr Vaines argued that no asset or enduring advantage was brought into existence by the payment made to the Bank and as a result it was a revenue expense.

He relied on Lawrence J in Southern (HM Inspector of Taxes) v Borax Consolidated Ltd (1940) where he stated;

‘..if no alteration is made in the fixed capital asset by the payment, then it is properly attributable to revenue’ and ‘it appears to me that the legal expenses which were incurred…did not create any new asset at all but were expenses which were incurred in the ordinary course of maintaining the assets of the Company, and the fact that it was maintaining the title…does not, in my opinion make it any different’

The tribunal found that as the payment was to preserve and protect his professional career or trade it must follow that it is a revenue and not capital payment in line with the case above.

Decision

As a result the appeal was allowed and the payment found to be wholly and exclusively for the purposes of his trade.