Election Fever

Election Fever

DAVID YOUNG and DAVID WHISCOMBE present some notes on main residence elections.

IT HAS ALWAYS puzzled us that the plural of mouse is mice, the plural of louse is lice, but the plural of house is houses. Perhaps we should not be surprised; the only thing with more inconsistencies and vagaries than the English language is our tax legislation. It is therefore entirely unsurprising that the legislation which covers the tax relief on private residences should be full of strange quirks and complications.

In these notes, we shall look at one small area: the making of an election to decide which of two or more residences should be treated as someone's main residence for the purposes of capital gains tax.

Begin at the beginning

As always we need to start with the legislation. Section 222(5), Taxation of Chargeable Gains Act 1992 states:

'So far as it is necessary for the purposes of this section to determine which of two or more residences is an individual's main residence for any period —

' (a) the individual may conclude that question by notice to the Inspector given within two years of the beginning of that period but subject to a right to vary that notice by a further notice to the Inspector as respects any period beginning not earlier than two years before the giving of the further notice.'

It might reasonably be supposed that the words '… within two years from the beginning of that period …' relate back to the phrase '… for any period' in the first part of the section. In other words, that an election can be made at any time, subject to a limitation that its retrospective effect cannot be for a period in excess of two years.

This reasonable supposition would be wrong. Mr Justice Vinelott decided in Griffin v Craig-Harvey [1994] STC 54 that the provision actually means that any election must be made, if at all, within two years from the start of the period when it first becomes necessary for the Inspector to decide which of two or more residences is the taxpayer's main residence.

For example, Robert, who has lived in his house in London since 1986, purchases a country cottage in the Cotswolds as a second home in September 2004. He can make an election at any time up to September 2006 to determine which of the two should be treated as his main residence. If he has not elected by September 2006, relief will be given in respect of whichever of the properties is as a question of fact the main residence. Readers may have a vague feeling that in the absence of an election, the Revenue has a right to determine (subject to appeal) which is in fact the main residence. That used indeed to be the case: the determination right perished with the introduction of self assessment.

Subtle difference

It should be noted that the legislation refers to a person having two residences. This is not quite the same as owning two properties. There are still advisers around who labour under the dangerous misapprehension that a house bought as an investment asset and which has never been the owner's own residence can somehow be made the subject of an election, so as to secure some element of relief. This is definitely wrong. But by the same token, it is not the acquisition of property that triggers the start of the two-year period; but the acquisition of a second residence. Thus, if Robert were to let his country cottage as a holiday home for a year until September 2005 and only then start to use it as his own residence, he would have two years to September 2007 to make the election.

The time limit may be extended if Extra-statutory Concession D21 applies. This would be of no help to Robert. Rather it would apply where a taxpayer has two residences, but his interest in one of them is of little or no capital value, for example a flat rented on a weekly rent. In such circumstances, a taxpayer may fail to appreciate that he will be treated as having two residences and may be unaware of the need to elect. Where this applies, the concession allows the election to be made within a 'reasonable time' of the taxpayer becoming so aware.

Robert is not obliged to nominate as his main residence a dwelling which actually is his main residence. If there were such a requirement, the election would be largely otiose: but the election only comes into play if he has in fact two residences. Some explanation is needed here. At one extreme, a cottage in the country that is fully furnished, where some of the owner's treasured possessions are kept and which the owner visits every weekend as an escape from his stressful life as a City lawyer is pretty clearly a 'residence' in respect of which an election would be competent. At the other extreme, a seaside flat that is left vacant for the winter months, let out for much of the summer, and visited by the owner only for his summer holiday once a year probably falls short of a residence of the owner. Essentially, the meaning of 'residence' is not very different from 'home': it therefore follows that an election can be made only by a person who can fairly be said to have two or more homes.

Fresh opportunity

Another point to be noted is that a fresh opportunity to elect arises on every occasion on which the number of residences alters. This will be the case if, in our example above, Robert buys a third property and uses it as a residence. He can elect within two years of the purchase and use of the third property.

It is sometimes assumed that the acquisition of a new residence simply affords the opportunity to elect in respect of that new residence. This is not so: there is no limitation on the new election. This can give rise to unusual opportunities. For example, let us assume that Robert has his two residences but has sadly overlooked making any election. One way of creating a fresh opportunity is, as we have seen, to acquire a third residence; but that may be an expensive solution.

Another way would be for Robert to let out his cottage for say six months. The cottage would thereupon cease to be his residence. When the lease came to an end and the cottage again became his residence, there would be another new period during which Robert had two residences and a fresh opportunity to elect would arise. Indeed, if Robert had previously made an election, it would automatically lapse when he reverted to the sad state of having only one residence. When he again started to have two residences, he would have to re-elect within two years if he wanted to restore the status quo , as the old election would not revive automatically. If letting out his cottage is uncongenial and buying a third residence seems costly, Robert might instead consider renting a further property under a lease, but not under a licence to occupy, and occupying that property too as a residence. This would enable him to elect for one of his other properties from that date.

Another misapprehension concerns the location of the property. Sometimes it is assumed that only United Kingdom properties may be the subject of an election. But in fact the legislation says nothing of the kind. An election may apply equally to the Spanish villa or the Bavarian schloss .

Make an election

The availability of this election is a useful tool for tax planning. Usually it is preferable for the property with the largest potential gain to be nominated. But it may be years before that property is sold, so sometimes it is better for the property which is most likely to be sold first to be the subject of the election. The problem is that reliable crystal balls are in short supply; a decision has to be made within the two-year time limit if the election is to be validly made; and an election (or non-election) that seems like a good idea at the time can turn out to be a bad guess. Can anything be done to remedy the situation?

The answer is — perhaps. It is possible at any time to vary an election but this variation can only apply for a period beginning two years before the date of the variation notice. An election can only be varied if it has been made in the first place; so the very first fundamental rule that should be drummed into every tax adviser's head is that a client must always be advised to make an election whenever he comes to have two residences. This is the case even when you want the relief to attach to the property that is as a matter of fact the main residence and would therefore get the relief automatically. The point is that an election, once made, can always be varied if the facts change.

This provides the opportunity for a piece of tax planning which is, unusually, laid out in the Revenue's own manuals (see Capital Gains Manual at paragraph CG64512). Fortunately since this does not involve employment or financial instruments, the Revenue will not have to disclose the promotion of the scheme to itself .

Variation

Suppose Jennifer has had two residences for a number of years: a flat in town and a house in the country. She has nominated the flat as her main residence expecting that it will have the larger gain and will probably be sold first.

However, she decides that country life is not for her and wants to sell the country house. She is facing a full gain on the sale, subject only to the possibility of some non-business asset taper relief and her annual exemption.

Because she has made the election, she can vary it from a date two years before the variation. The effect is that the country cottage will become her (deemed) main residence from that date. However, at the same time her London flat would cease to be her residence, so she would lose relief for the same period on that property.

The solution is as follows. On 1 September 2004, Jennifer varies the nomination to make the country property her main residence from that date. A week later on 8 September 2004, she changes the notice again to restore her London property as her main residence. She has lost only one week of exemption on her London flat but now the country property has been her (deemed) main residence at a point during her period of ownership. This means that the last 36 months of ownership are treated as being part of her occupation as her only or main residence. She has sheltered three years of her period of occupation at a cost of relinquishing only one week of her exemption on her London flat. If at some time the property has been let out, the benefit of the election is even more startling, for as well as unlocking relief attributable to the last three years of ownership there may well be additional relief under section 223(4) .

There is no requirement that the properties must still be owned at the time when the election is made. Thus even if country property has already been sold before it occurs to anyone that capital gains tax is payable and some planning might be advisable, it is not too late. This is subject to the two-year time limit for the variation. So if the property has been sold two years or more before the question comes to be addressed, the variation cannot be made.

The variation, like the election itself, must be made formally in writing but there is no statutory form. It must be signed by the individual, not an agent and, in the case of joint owners who are husband and wife, must be signed by both parties. A husband and wife can by statute only have one main residence for both, so both need to agree which is to be nominated. This can give rise to some interesting issues.

Whose residence?

It is not difficult to envisage circumstances under which a property is a residence of one of the spouses but not of the other. This might be the case where the main family home is in the country, but the husband, for example, works in town all week and has a flat in town, returning to the family home at the week-end. It might well be that the wife has seldom or never set foot in the flat. Any election to nominate the flat as main residence must apply to both husband and wife, and be made by them jointly.

So is it possible in this case for the wife to nominate what is palpably not a residence of hers? We think the answer must be yes, though it is not easy to force such a conclusion from the legislation. Incidentally, a similar difficulty may arise if no election is made, for it then becomes necessary to decide which property is as a matter of fact the main residence of the couple, rather than of each of them individually. In theory, this could cause difficulty if as a matter of fact the main residence of the husband is different from that of the wife.

However, in practice it will be unusual for a 'man and his wife living with him' to have different main residences (although not, perhaps, impossible) and the question does not seem to cause practical difficulty.

More commonly, a husband and wife may each own a residence on marriage, so that the couple have two residences after marriage: a (joint) election may be made to nominate one as the main residence of the couple and the time limit for doing so runs from the date of marriage.

By contrast, if the couple forgo the commitment of marriage and simply cohabit, they will each be able to continue to benefit from main residence relief on the one property that each owns. Whether an election needs to be made to secure this result is unclear. If Mr X and Miss Y use Mr X's house as their main residence and Miss Y's cottage as a second home, it may be advisable for each to nominate the property that he or she owns to be treated as main residence.

Although the Revenue takes the view that a property occupied under licence is not treated as a 'residence' for capital gains tax purposes, it is by no means clear that Miss Y occupies Mr X's property only as licensee, and vice versa . If either has contributed directly or indirectly to the cost of the other's property, whether by sharing mortgage payments or by funding substantial work on the property or even perhaps by their own labour in respect of such work, it is quite possible that an equitable share in the property will have been acquired.

The most pragmatic solution would seem to be for both Mr X and Miss Y to avoid the difficulty by assuming that each does acquire an interest in the other's property and each, therefore, nominating the property he or she owns as the main residence.

One could so easily be demoralised that such abstruse issues arise from just two subsections of a single section that probably affects more taxpayers than pretty well any other provision. Perhaps the philology of the English language is not so difficult after all.

David Young is an associate director and David Whiscombe a director of Berg Kaprow Lewis Tax Consultants, tel: 020 8922 9317.

Issue: 3971 / Categories: