Home sweet home

I OFTEN WONDER why we are treated so regularly to the joy of having clients who turn up having already caused a huge tax problem and who are then looking for their adviser to find a way out. Do these people arrive at the vet's cradling a deceased pet saying: 'I have accidentally poisoned the cat; is there anything you can do?' Or do they arrive at the dentist carrying their front teeth and asking if he can put them back in? What on earth made me choose the only profession in which clients expect us to cure irreversible damage to their position after the event?

Actually, I guess this can be one of the most rewarding things which we do, assuming of course that a solution can indeed be found!

The second residence

A very common scenario is the capital gains tax election for a second residence which was never made. Sometimes it is possible to engineer a new opportunity to make such an election, but in the straightforward case of the person who has lived for many years in one property and then bought a second property several years ago, any such simple solution is not likely to be on the cards.

Worse still, cases turn up where either or both of the properties have already been sold and thereafter the word 'tax' suddenly enters the vendor's head. And so they arrive looking for someone with a magic wand to wave over their tax return.

All is not lost

It is easy to fall into the trap of assuming that the original main residence must always be the capital gains tax exempt property, and the second home purchased at a later stage will be fully chargeable; only a capital gains tax main residence election could have provided the remedy. I am sure that this will very often be the case, as the second property might well be a holiday home, or more of an investment than a residence, but even so it will still be worth looking at the overall facts to see if a different conclusion can be reached.

In days gone by, before the introduction of self assessment it was down to the Inspector of Taxes to determine which of two or more residences was the main residence, if the taxpayer had failed to elect. There was always the suspicion, entirely unfounded I am sure, that the Inspector's determination would be on the basis of whichever produced the most tax. That system was swept away in 1996 and now, in the absence of an election by the taxpayer, he or she has to self assess any such capital gains according to the facts of the case. The Inspector's role is to open an inquiry into the self assessment return, if he or she chooses to do so, and then review the claims for main residence exemption. Of course, if it becomes apparent that there were no possible grounds for treating a property disposed of as the main residence, the question of penalties for an incorrect return will no doubt arise. So one can hardly recommend taking an aggressive view when completing the tax return.

As HMRC's Capital Gains Manual has a rather curious and somewhat sketchy set of tests for Inspectors to apply when deciding what was the main residence on the facts, I thought it would probably be worth examining the issue in more detail.

Residence or not?

The very first point to consider is whether or not the property concerned has ever counted as a residence of the taxpayer at all. This point was the taxpayer's downfall in the case of Goodwin v Curtis [1988] STC 475. He moved into a farmhouse for about one month whilst it was advertised for sale and during that time he lived and slept at the property as his only home. Nevertheless, the General Commissioners thought that there was a difference between temporary occupation of a property on the one hand, and residing at it on the other. They accepted the Revenue's contention that to qualify for relief the taxpayer had to live at a property with some degree of permanence, continuity or some expectation of continuity.

This test comes from the early cases on residence for income tax purposes in which the dictionary definition of residence was held to apply, that being 'to dwell permanently or for a considerable time, to have one's settled or usual abode, to live in or at a particular place'. The Court of Appeal upheld the Commissioners' conclusion on the basis that 'temporary occupation at an address does not make a man resident there. The question whether the occupation is sufficient to make him resident is one of fact and degree for the Commissioners to decide ... the nature, quality, length and circumstances of the taxpayer's occupation of the farmhouse did not make his occupation qualify as a residence'.

The decision seems harsh because during the one month period that was the taxpayer's only home. It was fully furnished and he had no other property available. However, like it or not, this is now a settled principle of law.

Nevertheless, I would suggest that one should not get too carried away with the concept of permanence in this context. Cases where the taxpayer has failed have been fairly extreme examples; see also Moore v Thompson [1986] STC 170 which concerned occupation of a caravan without electricity parked in the grounds of a country house. That did not qualify as a residence either, although it was occupied intermittently whilst work on the country house, which was uninhabitable, proceeded. The High Court decision clearly acknowledges that this was a borderline case and the important remark was made that 'it is clear that the Commissioners were alive to the fact that even occasional and short residence in a place can make thata residence'.

The most common circumstance in which the question of what is a residence is likely to be problematic is where a property is occupied for a few weeks whilst it is on the market for sale. It will be hoped that living at the property will be helpful to both the sale prospects and the capital gains tax position. The chances are that the former is more likely than the latter. But if there is intermittent occupation of a habitable property over a longer period of time, I would suggest that that should certainly be good enough to constitute residence at the property.

Not relevant!

It is sometimes suggested that a property overseas cannot qualify as a main residence, or even as a residence at all. I have no idea how this myth has come into circulation, but I can find nothing in the capital gains tax main residence provisions to suggest anything of the sort.

Another issue which may crop up is the council tax treatment of two UK properties held by one individual; one of those properties should qualify for a council tax discount, this being the secondary property not occupied as a main residence. Can we not therefore knock the whole problem on the head by looking at which property had the discount?

The answer is no, or at least not unless the relevant local authorities have determined the matter upon enquiry into the full facts. Their decision would certainly carry considerable weight, but quite commonly matters do not get that far. The home owner will make a statement as to which of the two properties should qualify for a discount and it might well go unchallenged. In the case of Frost v Feltham [1981] STC 115, the taxpayer gave his view as to which of two properties was his main residence but it was held that the matter has to be decided objectively. The taxpayer's view was simply his uninformed opinion which did not carry much weight on its own.

HMRC's Capital Gains Manual

HMRC's Capital Gains Manual at paragraph CG64552 lists some criteria which it says may be useful for Inspectors to apply in deciding which is the main residence.

The first of these is what address is shown on declarations made on return forms. For the life of me, I cannot see how this can be relevant. Certainly, the address which one gives to a very generous aunt who likes to send large cheques at regular intervals might be highly relevant, as one would not want her letters sitting unopened on a doormat somewhere, but the last organisation most clients want to hear from is the HMRC. I would think that the address given for tax purposes is least likely to be the main residence, but evidently HMRC hopes that the contrary will be the case.

Next on the list is the address shown on third party correspondence on the file, such as dividend warrant counterfoils. Once again, this does not in my view count for very much. It is quite usual for correspondence on investments or finances to go to an office address and not a home address at all.

Another factor listed is the security of tenure in respect of each residence. What is probably in mind here is another of the facts underlying the case of Frost v Feltham. In that case, the taxpayer was the tenant and licensee of an establishment known as 'The White Horse Inn', and he acquired a property of his own in Wales. The tenancy of the inn had endured for 17 years, but it was capable of being terminated at any time within 12 months. This was one of the key facts which led to the conclusion that the property in Wales, visited for a few days each month, was the main residence and not The White Horse Inn where he lived for most of the time.

Next on the list is how each residence is furnished. This test can certainly be helpful in some situations, although in a lot of cases it will give inconclusive results. Where it will help is if valuable possessions are to be found at one of the residences, and the other has nothing of any particular value. One would not expect a secondary residence to have an individual's most valuable possessions.

For married persons, another test is where the family spends most of its time. This is clearly a relevant issue and was one of the factors which counted against the taxpayer in the caravan case (Moore v Thompson). Although the family stayed in the caravan during some weekends, most of the time they were elsewhere.

The next factor is the residence at which the taxpayer is registered to vote. This will no doubt relate to Parliamentary elections, for which there can be only one vote per individual, and there must be a presumption that one would want to have a say in who is to be the MP for the district in which one feels the closest connections. Note that if the home owner does not even bother to get put on the local electoral role in relation to a particular property, this can count against that property being regarded as a residence at all (see Kirkby v Hughes [1993] STC 76).

The final test which HMRC have in their manual relates to the location of the individual's place of work. However, this did not count for much in the case of Frost v Feltham, and I am not sure that it will very often be of much help. Quite often, a second home is bought purely to save commuting to the area in which someone works, and so this test can quite easily go either way.

A better list?

So far, I have awarded HMRC about six out of ten for its list. Is a more helpful list to be found in any other source?

I think there probably is. A similar question will arise for council tax purposes, if the local authority decides to review a claim for a council tax discount on what is alleged to be a second home. Under Local Government Finance Act 1992, s 12 the discount applies where a property is not the sole or main residence of any individual. The official boot is on the other foot here of course, and so reverting briefly to the case of Goodwin v Curtis, one cannot imagine the relevant local authority being content to forgo full council tax liability for very long on the property which was held not to be a residence at all for the month in which it was occupied.

The key factor which the local authority will look for is which of the two properties the taxpayer intends to return to on a regular basis, or where he would live were it not for the demands of work or other commitments. This will generally, but not always, be where the taxpayer's own family also lives. In Williams v Horsham District Council [2004] EWCA Civ 39, a couple owned a property that was their usual residence for 20 years. They then moved into accommodation provided by the husband's employer for four-and-a-half years and during this time they did not spend a single night at the property they owned, even though it was only a few miles away. Visits to that property were only to clean it and maintain it. The Court of Appeal held that the accommodation provided by the employer was their main residence during this period, notwithstanding the lack of security of tenure at that accommodation, as compared with freehold ownership of their own property.

Extended holidays

The intention to return applies equally where the home owner goes away on an extended holiday or travelling expedition. If the original main residence is retained during this period and the home owner intends to return to that property after the completion of the extended break, that property will continue to be the main residence (Ward v Kingston upon Hull City Council [1993] RA 71). A recent court case established that this remains so even if all the furniture is removed while the home owner is away. Other tests which are applied for council tax purposes are as follows:

Rights of occupation

• At each residence, review whether the individual is:
  • an owner;
  • a tenant (and the nature of any tenancy);
  • a lodger; or
  • in accommodation provided with employment.
• What is his or her right to occupy a property?
• Is residence conditional, e.g. dependent on holding a work permit?

Personal ties

• At which residence is the individual registered with a doctor/dentist?
• Where are the majority of his or her possessions kept?
• Where does he or she return to during periods of leave or at the end of employment?
• What are the long-term intentions?
• Where is the individual registered to vote?
• Consider the membership of clubs and other social activities.
• Which address is used as the normal postal address?
• Which property does he or she regard as the main residence?
• How is time split between the residences?

Family ties

• At which residence does the spouse and dependants live?
• From which residence do any children attend school?
• At which residence does the individual spend time with the family?

Particular circumstances

• Merchant seamen: such individuals are not considered to be resident in a ship.
• Services personnel: these are regarded as mainly resident in accommodation provided privately rather than any service accommodation.

No election — no problem!

So long as the taxpayer can give the right answers to most of those questions, you might just be able to salvage his capital gains tax position after the disposal of a second property, even without the help of a main residence election. That, I reckon, at least makes us one up on both his vet and the dentist.

Malcolm Gunn is a tax consultant with Squire, Sanders & Dempsey; e-mail mgunn@ssd.com.

Issue: 4077 / Categories: Comment & Analysis , Capital Gains , Only or main residence