An Englishman’s Home is his ‘Tax Exempt’ Castle – Private Residence Relief (PRR)

CardiffCastle-Exterior41-med-A0013928-1“Everyone knows” that:-

“A person’s home is exempt from capital gains tax” – SIMPLES!

Well, no actually! In law it may get up to 100% tax relief, but it remains a chargeable disposal.

Imagine:-

1. You own more than one property (including say a holiday home overseas) OR
2. You buy a property to live in, but actually live elsewhere (say in rented accommodation) OR
3. Circumstances change over your period of ownership.

Each of these (quite common) circumstances could give rise to a nasty, unexpected tax liability. We have seen a number of situations where advice has been sought ‘Just Too Late’. This can mean a relatively small outlay “saved” on proper professional advice, results in an expensive (and potentially unnecessary) tax bill – plus, on occasion penalties, for naïve belief in the somewhat misleading phrase, set out above.

Some of the benefits of this suggestion are reflected in the recent case reported below.

Private Residence Relief Claim Rejected

Private Residence Relief (PRR) can be a very beneficial relief where the conditions are met, providing for up to 100% of a gain to be exempted where a property has been a taxpayer’s main residence throughout ownership.

Of course though careers, inheritance, divorce and the general messiness of real life, things do not always quite pan out as simply as “always” living in one house. As a result, claims made perhaps in ignorance and good faith, can lead to disagreements between HMRC and taxpayers over whether, and the extent to which, properties may qualify. This can lead to appeals, so a number of cases end up being dealt with through the courts.

One such recent case was P Lam v HMRC at the First-Tier Tribunal. The case found that a taxpayer’s occupation of the property was not sufficient to meet the conditions. HMRC accepted the taxpayer had spent some time in the property whilst she was renovating it, but they argued that the nature and extent of that occupation was not enough to qualify for relief, which requires a degree of permanence.

What may be useful for taxpayers is that the Tribunal provided a list of things that the taxpayer in this case was not able to provide as evidence. Such factors therefore appear to be key in being able to prove that occupation in a property should be sufficient for the relief. This list included:

• Proof of how many days she lived in the property
• utility bills to establish the time spent there
• moving any furniture into the house
• bringing items that would have made occupation more comfortable
• providing evidence of a change of address

Taking professional advice in advance and keeping good records will certainly make matters easier in the event of an HMRC challenge into a PRR claim. Perhaps an easier route would have been to file a timely election for the relevant property to be deemed the qualifying property.

To quote an old motto, regarding getting matters in order in advance …

“A stitch in time, saves 9”.

Beware New Rules on Liquidations – HMRC Refuse to Give Clearance

As you may be aware, new rules are being introduced with effect from April 2016 as part of the Finance Act 2016.  These relate to distributions in a winding-up/liquidation and are designed to target certain company distributions in respect of share capital in a winding-up. Where a distribution from a winding-up is caught, it is chargeable to income tax rather than capital gains tax.

The rules apply where the following conditions are met:

  1. The company being wound up was a close company (or was within the two years prior to winding-up)
  2. The individual held at least a 5% interest in the company (ordinary share capital and voting rights).
  3. The individual continues to carry on the same or a similar trade or activity to that carried on by the wound-up company within the two years following the distribution
  4. It is reasonable to assume, having regard to all of the circumstances that there is a main purpose of obtaining a tax advantage.

Whether or not Conditions C or D are triggered could be a cause for some contention, and so HMRC note that they have received a number of clearance applications relating to these new rules.

In the absence of a statutory clearance procedure under the new legislation, HMRC have clarified that it is not their general practice to offer clearances on recently introduced legislation with a purpose test.  They have instead sent out a standard reply providing some examples of how they think the rules will apply.

Clearly this is a developing area and HMRC’s reaction is somewhat disappointing as taxpayers often require certainty before carrying out commercial transactions which could be caught.  HMRC have stated that further guidance will be published, however in the meantime we advise that care be taken, and seeking professional advice, as always, may save time and costs in the long run.

We would be delighted to assist if you think you may be affected by these rules and have any queries.

Careful with those Capital Gains Tax deductions

Accountants and clients used to the broad brush “commercial” approach to computing trading profits can get caught out by the different and stricter rules for calculating capital gains.

Payments which may make sense, or even be thought essential from a commercial perspective are not necessarily then allowable for capital gains tax purposes.

This is demonstrated by the recent case of J. Blackwell.  In exchange for £1m, Mr Blackwell agreed to act exclusively in voting his shareholding in BP Holdings in favour of the Taylor and Francis Group who wished to purchase BP Holdings.  Later another prospective purchaser came along for BP Holdings.  In order to extricate himself from the first agreement Mr Blackwell paid Taylor and Francis Group £17.5m which he then claimed under S38 TCGA 1992 as a deduction against his subsequent sale of the BP Holdings shares to the second purchaser.

The Upper Tier Tribunal found against him on the grounds that the expenditure was not reflected in the value of the asset disposed of to the purchaser.  Admittedly, it put him in a position to make the disposal, by releasing him from the previous restrictions, but it did not enhance the value of the shares themselves.  Similarly, the Courts held the payment did not create or establish any new rights over the underlying shares themselves.

This principle can be a factor in helping clients decide whether to accept an offer, by understanding what it would be worth after tax.  It can often be in point where a client is considering an offer from a developer for (say) housing.  On this principle, if the developer is buying a cleared site, where a bulldozer has taken down perhaps years of “enhancement expenditure” on the former trade site, then it is likely HMRC will seek to deny the cost of the previous building works, perhaps increasing the gain by a material amount.

Care in understanding the facts is crucial.

Discovery Allowed by Tribunal – N Pattullo v HMRC

The question of what constitutes a discovery remains an area of ambiguity, although recent cases tended to have sided with HMRC’s view that virtually anything can be considered a discovery.

A further recent case was heard on the subject in N Pattullo v HMRC (TC03958), although the decision in the case is unlikely to be too controversial or unexpected, especially considering the case involved an avoidance scheme.  In the current climate, the courts are tending to be reluctant to favour taxpayers in cases where they have used an avoidance scheme.

Mr Pattullo participated in a scheme which generated capital losses of around £2.6m which he reported on his 2003/04 tax return.  HMRC concluded that he had participated in an avoidance scheme and issued a notice under TMA 1970, s.20(1) requesting relevant documents.  The taxpayer did not comply with this request and instead sought a judicial review to revoke the notice, but this request was dismissed by the Court of Session in 2009.

In the meantime, the Court of Appeal had found in favour of HMRC in the case of J Drummond v CRC (2009) which involved a similar second-hand insurance policy scheme.  Therefore, HMRC raised a discovery assessment for £835.400 as they were now satisfied that his original return was incorrect.

The taxpayer appealed, arguing that there had been no discovery as no new information had come to light.  The Tribunal found that the decision in Drummond v CRC constituted a discovery as it converted a “suspicion” of an underpayment of tax into a “positive view”.  It was doubtful that a hypothetical officer would have been aware of these avoidance schemes before the Drummond case was heard.

The taxpayer made a final attempt to protect his position by arguing that the grounds of his appeal should be amended to argue that the original avoidance scheme actually worked.  This was again dismissed by the tribunal who felt that, bearing in mind there were a number of appeals on similar schemes to Drummond pending, he was trying to jump on a “bandwagon” allowing other taxpayers to argue his case for him.  They felt the amendment was too vague and dismissed the appeal.

The final decision will likely not be a surprise to many, but does highlight the current attitude of the courts to the use of such avoidance schemes, and the wide definition of “discovery” that HMRC are using.

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.

Disincorporation Relief

Background

Disincorporation Relief was introduced from 1 April 2013 and is a form of roll-over or deferral relief.

When a company ‘disincorporates’ there is a transfer of assets between the company and its shareholders.  As the parties are connected, the transfer is deemed to occur at market value for tax purposes and normally results in a Capital Gain.  Prior to the introduction of disincorporation relief this would result in a Corporation Tax charge being incurred.

Disincorporation relief enables small owner-managed companies to transfer qualifying assets so that no capital gain arises, and as a result no Corporation Tax charge is incurred.

The availability of Disincorporation Relief coincides with the introduction of other tax simplification measures for unincorporated businesses, such as the ‘Cash basis’ election and the flat rate expense allowances.

Conditions for Relief

A company and its shareholders can make a claim for Disincorporation Relief if:

  • the company transfers its business to some or all of its shareholders
  • the transfer is a ‘qualifying transfer’
  • the transfer occurs between 1 April 2013 and 31 March 2018
  • the transfer is to either a sole trader or individuals in partnership, but not to members of a limited liability partnership (LLP)

Qualifying Transfer

There are a number of conditions to be met, and each case should be considered in the light of the facts.  One of the key requirements, which will restrict the application of the relief, is that the total market value of ‘qualifying assets’ (land and goodwill) at the time of the transfer must be below £100,000.

If you would like more information on Disincorporation Relief please contact Paul Eaves on 0113 244 3502 or peaves@eavesandco.co.uk.

Principal Private Residence: The Importance of Intention

D Morgan (TC2596)

The first-tier tribunal case dealt with the taxpayer’s claim for principal private residence relief (PPR). The area of contention was whether the taxpayer’s occupation of the property was sufficient to justify its description as his residence for PPR purposes.

The key message from the outcome of this case is that, according to the tribunal, it is a taxpayer’s intention, and not the quality of the occupation, that is more important in determing whether the relief applies.

Background

The taxpayer purchased the property with the intention of moving into it with his fiancée, and making it their marital home. However, shortly before completion his fiancée broke off the engagement suddenly, giving no explanation.

The taxpayer, on the lack of evidence to the contrary, felt that his fiancée was merely having cold feet. He assumed that they would soon reconcile and she would move into his new house with him. He therefore went ahead with the property purchase and moved in.

Some weeks later it became apparent that they were not going to reconcile as she was seeing someone else. The taxpayer, whilst purchasing the property in his own name, had budgeted on his fiancée paying for groceries and household bills etc. As a result this left him in financial trouble and he had to assess his options.

After living in the property 3 months the taxpayer moved back in with his parents and rented the property out. The property was rented out for just under 5 years, at which point the taxpayer moved back in with the intention of selling the property. The property was then sold within 4 months.

HMRC assessed the taxpayer to capital gains tax on the gain, saying that the two periods he had stayed in the property had been temporary and it therefore did not qualify for principal private residence relief.

The taxpayer appealed.

Ruling

The tribunal said the case was “extremely finely balanced”. It was their view that it is not the ‘quality’ of the occupation, but the intention of the occupier that matters when determining whether or not the property is an individual’s principal private residence.

If Mr Morgan had moved into the property fully furnished, and all the bills had been addressed to him personally, and if he had already intended to let the property, then the quality of his occupation would be irrelevant.

The tribunal accepted the taxpayer’s assertion that he had hoped, when he occupied the house, that his fiancée might return. Therefore when purchasing the property he had intended for it to become his principal private residence.

After learning his fiancée would not be returning, an early repayment charge clause in the mortgage made it clear it would have been financially unviable to sell the property straightaway. Therefore the tribunal said that it was understandable that, after he found the cost of living too high, the taxpayer decided to let the property and move back in with his parents.

The taxpayer’s appeal was allowed and he was entitled to principal private residence relief.

Reynolds painting from 1776 is found to be a “Wasting Asset” – Executors of Lord Howard of Henderskelfe (dec’d) v R&C Commissioners

A recent Upper Tier Tribunal case – Executors of Lord Howard of Henderskelfe (dec’d) [2011] TC 01340 – considered the Capital Gains Tax implications of the sale of a painting by Sir Joshua Reynolds.

The painting, owned by Lord Howard, was informally lent it to a company that put it on display at Castle Howard, Lord Howard’s stately home, as part of the company’s ‘house-opening trade’.

Lord Howard died in 1984 and the painting was sold by the executors of his estate in 2001.  Throughout this period, the painting continued to be displayed by the company. The executors claimed that the painting was tangible moveable property which was ‘plant’ and therefore a ‘wasting asset’.  The result being that the gain on the sale of the painting would be exempt from capital gains tax.

The first-tier tribunal originally found in favour of HMRC, who argued that the painting was not plant because the executors did not have a business.  However, Mr Justice Morgan at the Upper Tier Tribunal found in favour of the executors, agreeing that the painting represented plant, stating, “the painting satisfied the tests as to function and as to permanence in the established test as to the meaning of plant”.

New Disclosure Campaign Targets Undisclosed Property Gains – Property Sales campaign

HMRC have announced the Property Sales campaign, a further new disclosure opportunity aimed this time at those with undisclosed taxable gains on residential property sales.

The disclosure campaign requires details of income and gains and the tax payable to be settled in full before 6 September 2013. After this date, HMRC will use the information they hold to target those who should have come forward under the campaign and did not do so.

HMRC states that reduced penalties will be levied on those who make a disclosure, but no firm details have yet been released.  At present, a penalty calculator on the HMRC website refers to a maximum penalty of 20%.

This campaign marks a further step in HMRC’s drive to get taxpayers to come forward over undisclosed income and gains, following the recent announcement of the Isle of Man Disclosure Facility, the longer running Liechtenstein Disclosure Facility, and the UK-Swiss Tax Treaty amongst others.

Principal Private Residence Relief – TC02560 Mrs Bradley

The recent tribunal case of Mrs Bradley v HMRC was regarding principal private residence relief, and in particular whether the appellant had ever ‘resided’ in the property in question.

Mrs Bradley had moved into a property which she had previously rented out after separating from her husband. After living in the property for less than a year the property was then sold and Mrs Bradley reconciled with her husband.

Prior to Mrs Bradley moving in to the property it was put on the market for sale and remained so when she moved in.  The tribunal were happy that the couple had intended to permanently separate but questioned whether she ‘resided’ there.

In line with Goodwin v Curtis the tribunal stated that in order to qualify for principal private residence relief a taxpayer must provide evidence that their occupation shows some degree of permanence, some degree of continuity or some expectation of continuity.

On the basis that the property was for sale throughout, the tribunal concluded that the residence was not intended to be permanent; had Mrs Bradley received a suitable offer for the property she would have sold sooner. The property could only ever have been a temporary home in those circumstances, and therefore it was never her residence.

The claim for principal private residence relief was denied.