Creaking At The Seams?

Creaking At The Seams?

PHILIP McNEILL and SARAH McNEILL ponder principal private residence relief in a changing climate.

CAPITAL GAINS TAX was not designed to penalise people of modest income on the sale of their home. Yet, as witness the case study which follows, the complexity of the system, coupled with changes in patterns of lifestyle, can bring more people within range of CGT than might be supposed. Just as importantly, once in the system, it can be difficult to get out.

Dickensian plot?

A widow stands to lose her home to pay an incorrect tax bill — the plot of a Dickensian novel, you might think. In fact, this is a real case from TaxAid, the charity which promotes public understanding of tax matters and provides free tax advice to people in financial need. Faced with a completely unexpected CGT bill for £9,000 on the sale of a flat in which she used to live, Mrs Y phoned TaxAid. She was threatened with court action if the amount was not paid immediately. Her sole income was incapacity benefit. She had no savings or assets. The only way to pay the CGT bill would be to sell the home where she now lived with her son and family.

How had the position arisen? Mrs Y had bought a flat about six years ago and lived there for a few months before moving out for family reasons. She then let the flat to her son and family to help cover the mortgage.

A few years later, following the break up of a relationship, Mrs Y wanted to move back into her flat. She also considered selling it with a view to buying a house big enough for herself, her son and his family.

She took professional advice. Her accountant knew that to buy a big enough property she would need to reinvest all the proceeds from the sale of the flat. Mrs Y was advised that no tax would be due. The flat was sold. Computations were submitted to the Revenue.

The Revenue issued a CGT bill. Mrs Y went back to her accountant, who checked his file and changed his mind: the original claim had been incorrect. The Revenue had pointed out the error, and its calculation was correct. The tax was due.

At this point Mrs Y contacted TaxAid.

Quantity and quality

How did the facts of Mrs Y's case match tax law? First of all, TCGA 1992, s 222 gives relief for the disposal of, or an interest in, a dwelling house which is, or has been at any time in the taxpayer's period of ownership, his or her only or main residence.

The Inland Revenue Capital Gains Manual at para CG64441 provides a useful guide as to what constitutes a residence. It says: 'the test of residence is one of quality rather than quantity of occupation'. It quotes Mr Justice Millett from Moore v Thompson [1986] STC 170: 'it is clear that the Commissioners were alive to the fact that even occasional and short residence in a place can make it a residence; but the question is one of fact and degree for the Commissioners'. This position is reaffirmed in Inland Revenue Interpretation 75.

In Moore v Thompson the decision went against the taxpayer, who was renovating a farmhouse while living in a caravan which was not connected to mains services. It was considered that the taxpayer's visits were too 'sporadic and occasional' to constitute residence. Furthermore, the farmhouse was derelict and neither it nor the caravan was ever a dwelling-house capable of being regarded as a main or only residence.

The character of residence is further illustrated in Goodwin v Curtis [1998] STC 475. The taxpayer sold a nine-bedroomed farmhouse after occupying it for 32 days. The timescale alone was not the deciding factor in the case, however. Rather it was clear from the outset that the taxpayer had not intended to occupy the farmhouse as a permanent residence. Due to changes in personal circumstances, he instructed agents to sell the property before the purchase had actually been completed. The taxpayer had also completed the purchase of another property within two days of occupying the farmhouse, moving into this property on the sale of the farmhouse.

It was held that the farmhouse was not the taxpayer's residence. He had merely been in temporary occupation. A nine-bedroomed house was 'not suitable for a single man'. It was 'a stop gap measure pending completion of his purchase of somewhere else to live'.

The quality/quantity question was also considered in Frost v Feltham [1981] STC 115. Here the question was, could a second property be the main residence and qualify for mortgage interest relief? Spending only 'several days' a month was considered sufficient in this case to establish a main residence. The question could not be determined solely on time spent in each property.

In conclusion, one is looking for a degree of settled occupation. To be a home, one might expect the intention to be to occupy it on a permanent basis, coupled with a period of actual occupation. The use of the property as a home is likely to be evidenced by the location of one's personal belongings, use of the address for correspondence, as well as actual occupation. Just having the intention to occupy is unlikely to be convincing. (See Inland Revenue Capital Gains Manual at para CG64466.)

On the facts of Mrs Y's case, her flat was a residence. One further point needs to be considered, however. Was it the only residence?

One or more residences?

S 222(5) provides that where there is more than one residence, an election can be made by the taxpayer within two years to choose which residence is the one to which the relief shall apply. If the taxpayer fails to do this, the decision will be made by the Inland Revenue.

However, even a minimal tenancy, such as a weekly rent with negligible capital value, can create the need for an election. (See Tax Bulletin 13, October 1994 and Inland Revenue Capital Gains Manual at para CG64473.)

One note of comfort is that Extra-statutory Concession D21 allows a late election where a taxpayer has two residences, one of which has negligible capital value. A late election will be accepted if the taxpayer was unaware that an election was needed and makes one within a reasonable time of becoming aware of the need for an election.

In TaxAid's review of Mrs Y's case, it appeared that for the initial period when she occupied the flat, there was no other property. In the subsequent period she occupied another property under licence. Overall therefore, residence, albeit for only a few months, was established. As a final point, Mrs Y was not caught by the TA 1988, s 776(9) anti-avoidance provisions relating to development gains and purchases with a view to gain.

Benefits of PPR

Once the right to private residence relief had been established, Mrs Y also benefited from:

With Mrs Y's flat, letting relief helped. S 222(4) gives relief against the letting period gain of the lower of £40,000 and the amount of gain covered by the private residence relief. This latter includes the last 36 months.

The effects of this for Mrs Y were dramatic. The combined effect of actual residence for a few months, plus letting relief, was to take out of the calculation the gain arising during a period of up to six years and eight months. So in Mrs Y's case no CGT was due after all.

Collection procedures

But for Mrs Y, the story had already moved on. Seeing no other way to pay the CGT bill, Mrs Y had put her home on the market. To avoid an imminent surcharge, another £500 to an already impossible bill, and feeling pressurised by the continuing threat of court proceedings, Mrs Y then paid the tax by taking out a loan she could afford to service for perhaps two months. As a result of the stress, she collapsed and was admitted to hospital for a brief period.

The problem was finally resolved when Mrs Y confirmed detailed facts about occupation and the available CGT exemptions were explained. She was then able to contact an Inland Revenue enquiry centre near her home and ask for the help of a CGT expert. The official accepted the case as outlined by TaxAid and pulled out all the stops to help Mrs Y prepare an amended return which showed no CGT was due. The tax which had been paid was refunded.

Too complex

In the light of the cases considered above, it may perhaps be felt that the CGT régime is showing some signs of strain. The case from TaxAid illustrates quite dramatically that ordinary domestic circumstances can bring CGT into consideration. A complex interaction of reliefs may need to be claimed even, as in this case, to establish that no tax is due. The reliefs were too complex for Mrs Y to realise what information was not correctly presented in her original return and, perhaps, too complex for the Revenue easily to assist an unrepresented taxpayer.

Mrs Y's story makes unhappy reading, but it has an optimistic postscript in that the relationship between the taxpayer and the Revenue was restored.

Philip McNeill MA (Cantab), FCA, CTA is a helpline adviser and website editor for TaxAid. Sarah McNeill MA (Cantab), PhD has collaborated on a number of professional publications.

TaxAid is holding a conference 'Tax-traps for the unwary small property investor' in central London on Friday morning 25 February 2005. The speakers will be Gerry Hart, Chris Jones, Chris Whitehouse and Dean Wootten. They will cover pre-owned assets, inheritance tax, maximising private residence exemption, buying to let, tax efficient disposals, stamp duty land tax and VAT. Further information is available by e-mailing: conf@taxaid.org.uk or telephoning Catriona on: 020 7803 4950.

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