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Jennifer Adams warns of unexpected tax consequences for homeowners when selling their only or main residence in some cases.
HMRC are increasingly contending that the disposal of a principal private residence (PPR) is, in reality, a trading disposal. This article looks into why HMRC is taking this stance with particular consideration of the recent tax case of Regan and Anor v HMRC.
Conditions for PPR relief
The claim for PPR relief (TCGA 1992, s 222(1)) is arguably one of the most valuable reliefs available to any UK taxpayer. However, it must be remembered that there are conditions that must be fulfilled in order for a claim to be valid, broadly that:
- there needs to be a capital gain made on sale;
- the property must have been the individual's only or main residence; and
- the property must not have been purchased for the sole reason of making a profit.
Income tax treatment of transactions generally takes precedence over CGT treatment (TCGA 1992, s 37(1)), and at 28% the CGT higher rate is much lower than the income tax higher and additional rates. It is therefore no wonder that HMRC are looking at property transactions in more detail.
One area of interest is where a taxpayer buys a property, renovates it and then lives in it for a period before selling and buying another property to renovate, and so on. HMRC are contending that these owners are, in fact, ‘serial developers’ engaged in a trade (i.e. property development) and therefore liable to income tax and National Insurance contributions on the profit rather than being able to claim PPR relief for CGT purposes. This situation is particularly prevalent in areas where, because of the limitation of building land, bungalows are being purchased and then converted into houses. After conversion the owner moves in with his family, waits a few months or possibly a year (the longer the better) before selling and moving on to another property to undertake a similar conversion.
For the purposes of determining whether a property transaction constitutes trading, HMRC are looking to see whether the transaction has been as a result of an ‘intention to trade’, which is a usual determination as to what constitutes any trade - property development or otherwise. There is no definition in the legislation; HMRC rely on the ‘badges of trade’ as a starting point.
The ‘badges of trade’ are not found in statute, having been developed by the courts over a number of years. The first six ‘badges’ were collated and published in a 1955 Royal Commission report on the taxation of profits and income. The Commission used previous judicial decisions to identify the six, this number having now increased to nine following rulings in subsequent tax cases.
HMRC guidance lists these ‘badges’ in its Business Income manual (at BIM20205). Interestingly, the first listed ‘badge’ shown is profit-seeking motive - an intention to make a profit supports trading, but by itself is not conclusive”.
‘Not conclusive’ has been proven in many tax cases, e.g. in Marson v Morton  STC 463, where the judge declared that the ‘badges…. are in no sense a comprehensive list of all relevant matters, nor is any one of them so far as I can see decisive in all cases. The most they can do is provide common sense guidance to the conclusion which is appropriate’.
The importance of ‘motive’
The recent tax case of Regan and Anor v HMRC  UKFTT 569 (TC) http://www.bailii.org/uk/cases/UKFTT/TC/2012/TC02247.html underlines the importance of being objective in looking at the motives for acquiring the properties and of assessing all the circumstances surrounding the transaction without putting a disproportionate emphasis on individual factors, such as that the fact that the owner of the properties was a builder. It therefore follows that any taxpayers who are builders should keep their own residences, and any building work carried out on them, entirely separate from their building trade. Mr Regan was a part-time builder.
In fairness to HMRC, the living arrangements of Mr Regan were not straightforward, as he had bought, lived in and sold four different properties over a period of seven years; two properties had been renovated before he moved in. So when 95 Rowan Avenue was sold, HMCR contended that the sale was actually a trading transaction. Mr Regan countered by saying that the sale was of his PPR and as such not taxable or indeed, declarable.
In determining the case the tribunal used the original six ‘badges’ as a starting point namely:
Both the taxpayers and HMRC made submissions about the nature of the disposal of the property based on the ‘badges’ and it was concluded that, on balance, the disposal was not a trading transaction.
Having decided that the transaction was not trade, the tribunal then went on to consider whether the property was Mr Regan’s PPR. The tribunal decided that ‘residence’ should be determined based on the quality of the occupation not the quantity (i.e. length) of the occupation. As Mr Regan had occupied the property for nine to ten months the tribunal ruled that the property was more than a ‘temporary place of occupation, but where they lived’ and as such was their residence so PPR could be claimed.
The tribunal went further, commenting that that permanence or continuity should not be overstated, and that, following Moore v Thompson  STC 170, an occasional or short residence in a place can make it a residence, but that the important question was one of fact and degree, i.e. the quality and not merely the length of the occupation.
Another interesting aspect of this case is the evidence HMRC put forward in their assessment of the PPR position. In deciding whether to bring the case before the tribunal HMRC considered a number of points such as:
they stated that their records held a different address and it was to that other address that they had sent notice to submit a tax return (however, Mr Regan was able to produce HMRC correspondence which had been sent to him at 95 Rowan Avenue during the period);
Mr Regan’s name was not on the electoral register for that address. Mr Regan stated that he had no interest in politics so had not registered to vote. The tribunal decided that the electoral register details were irrelevant to the question of whether Mr Regan was living there;
there was no evidence of credit arrangements being entered into from that address. However, Mr Regan countered this by saying that he did not have any credit arrangements whilst he was living at the property. The tribunal decided that the absence of credit arrangements was irrelevant;
in a point that indicates the depth HMRC go to in collating facts before bringing them to the tribunal – HMRC produced evidence that Mr Regan used a date stamp belonging to another property on his private correspondence. HMRC said that its use was evidence that he did not live at 95 Rowan Avenue. Mr Regan countered by saying that the date stamp was used because he opened correspondence at the second address, and the tribunal accepted his reasoning. Furthermore, they said that the use of the date stamp was irrelevant as the dates shown to be used fell within the last three years of ownership (the case being heard before the reduction in PPR final period exemption to 18 months); and
the enquiry was started as a result of information gained by HMRC whilst undertaking an enquiry into the tax return for a company of which Mr Regan was a director. Mr Regan was asked to provide various documents relating to that enquiry, and it was as a result of this that HMRC asked for details relating to the sale of 95 Rowan Avenue.
The Regan case is further proof of the importance of retaining documentation. The outcome of this case obviously was not determined by this one factor, but it did help that Mr Regan was able to supply HMRC correspondence to 95 Rowan Avenue (although it must be unusual for anyone to keep HMRC letters for more than six years).