In the vast majority of cases, it is taken for granted that the disposal of an individual’s only or main residence is a capital transaction, and is eligible for exemption from capital gains tax (CGT) due to the availability of ‘principal private residence’ (PPR) relief. However, HMRC occasionally try to argue that the disposal is a trading transaction instead, which would accordingly be liable to income tax as opposed to CGT. It is therefore necessary to consider when HMRC might challenge such a disposal as a trading transaction, and whether such a challenge could be used more widely to prevent CGT treatment and potentially deny PPR relief on the disposal of a taxpayer’s only or main home.
In Regan & Anor v Revenue & Customs  UKFTT 569 (TC), Mr and Mrs Regan sold 93 Rowan Avenue in the year ended 5 April 2007. They claimed that the property was their home, and that there was therefore no tax liability on its disposal. However, HMRC contended that the sale of 93 Rowan Avenue was a trading transaction. HMRC also argued that even if the sale was not trading, it was liable to CGT because the property was not Mr and Mrs Regan’s only or main residence.
The tribunal in this case looked at the facts and background surrounding the acquisition and disposal of 93 Rowan Avenue. Briefly, Mr and Mrs Regan sold 91 Surrenden Road in August 1999. They stayed with friends until they bought 95 Rowan Avenue in May 2000. Mr and Mrs Regan occupied 95 Rowan Avenue until June 2003; the property was sold and subsequently demolished. In September 2002, Mr and Mrs Regan had bought 7 Woodland Drive. That property was uninhabitable at the time, and Mr and Mrs Regan spent the next two years carrying out work on it. In the meantime, Mr and Mrs Regan bought 93 Rowan Avenue in or around February 2003. Before moving into 93 Rowan Avenue, and while still living at 95 Rowan Avenue, Mr and Mrs Regan carried out some work to make 93 Rowan Avenue habitable. They moved into 93 Rowan Avenue in June 2003, and lived there until April 2004. Mr and Mrs Regan then moved into 7 Woodland Drive in April 2004. After moving out of 93 Rowan Avenue, they built an extension on the property, before finally selling it in August 2006.
Badges of trade
The first question for the tribunal to consider was whether the sale of 93 Rowan Avenue was a trading transaction. In doing so, the tribunal considered the various characteristics of a trade. These characteristics are known as the ’badges of trade’. The ‘badges of trade’ were originally identified by the Royal Commission for the Taxation of Profits and Income in 1955, using previous case law about what constitutes a trade. The Royal Commission summarised six badges of trade. Subsequently, in the case Marson v Morton  STC 463, a total of nine badges were identified. However, the tribunal in Mr and Mrs Regan’s case looked at the original six badges of trade:
1. The subject matter of the realisation;
2. The length of the period of ownership;
3. The frequency or number of similar transactions by the same person;
4. Supplementary work on or in connection with the property realised;
5. The circumstances that were responsible for the realisation; and
With regard to the first badge (i.e. the subject matter of the realisation), the tribunal considered that it was inconclusive, as land can be held both as trading stock and as an investment. On the second badge (i.e. the length of the period of ownership), the tribunal did not find the period of ownership or occupation by Mr and Mrs Regan to indicate trading or otherwise.
The third badge (i.e. the frequency or number of similar transactions by the same person) was considered to be more significant in this case, because Mr Regan was a builder by trade. HMRC argued that Mr Regan bought and sold 93 Rowan Avenue as part of his trade. Mr and Mrs Regan stated that they bought 93 Rowan Avenue because they had nowhere else to live, and also pointed out that there was no planning permission for the property at that time. The tribunal did not regard the number and frequency of transactions in this case as indicating a trade.
HMRC contended that the fourth badge (i.e. supplementary work on or in connection with the property realised) was important. They said that building an extension on the property after occupying it was above and beyond what a typical private owner would do. In other words, Mr Regan was not a typical private owner, because he was a builder. The tribunal considered whether the activity of modernising and extending a property was consistent with a trade. The tribunal held that this badge of trade was met, but said that this conclusion was hardly surprising, given that Mr Regan is a builder and the work on the property was done through his business.
On the fifth badge (i.e. the circumstances that were responsible for the realisation), HMRC argued that the disposal was in the course of a trade. HMRC pointed out that Mr and Mrs Regan owned the property for 41 months, but only lived in it for 10 months. The tribunal pointed out that in cases of doubt, the sixth badge of trade (i.e. the motive for acquiring the asset) can also be considered. The tribunal found, on the evidence, that the main motive for acquiring 93 Rowan Avenue was for Mr and Mrs Regan to have somewhere to live, which was convenient in terms of the work on the development at 7 Woodland Drive that was about to start.
The tribunal’s overall conclusion was that the various factors tipped the balance towards the disposal of 93 Rowan Avenue not being a trading transaction or an adventure in the nature of the trade. The taxpayers were therefore successful on that point.
The second question for the tribunal to consider was whether 93 Rowan Avenue was Mr and Mrs Regan’s only or main residence. HMRC argued that the property was never their ‘residence’ at all, let alone their only or main residence. HMRC also said that 93 Rowan Avenue was only a ‘stop gap’ until Mr and Mrs Regan could live in 7 Woodland Drive. The tribunal considered the meaning of ‘residence’ based on previous case law, and accepted HMRC’s point that Mr and Mrs Regan always intended to move into 7 Woodland Drive when they could do so. However, the tribunal’s view was that this intention did not disqualify 93 Rowan Avenue from being a residence.
Importantly, the tribunal considered that the issue of whether a property is, or has been, a residence is a matter of fact to be determined by reference to the quality and not merely the length of the occupation. The tribunal held that in view of the fact that Mr and Mrs Regan occupied 93 Rowan Avenue for 9 to 10 months, the property was more than a stop gap or temporary place of occupation, but was where they lived; in other words, 93 Rowan Avenue was their residence. It was held that Mr and Mrs Regan were entitled to principal private residence relief from CGT on the disposal of the property, and their appeal against the income tax assessments was therefore allowed.
Wider ‘trading’ argument?
Mr and Mrs Regan’s case is perhaps unusual, because HMRC generally tend to accept that the disposal of a residence is subject to CGT as opposed to income tax, which means that principal private residence relief will normally be available. However, it does beg the question why HMRC chose this case to argue that the property disposal was a trading transaction, and also whether HMRC could argue for income tax treatment more widely.
As with most tax questions these days, the answer is that it depends! It depends on the specific facts and circumstances. For example, the fact that Mr Regan was a builder by trade would probably have been a major factor in HMRC challenging the property disposal as a trading transaction. 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.
Aside from builders, in practice I have seen HMRC enquire into a taxpayer where the individual bought and sold a series of residences in fairly quick succession. However, the facts and the evidence in that case supported the taxpayer’s explanations as to his motives and the reasons why he had bought and lived in a succession of houses. The taxpayer had also kept evidence to support his arguments, and this is obviously an important step in terms of preventing a possible challenge from HMRC.
Finally, it is probably fair to say that generally speaking the longer a taxpayer occupies a residence, the less likely it is that the disposal of the property will be challenged by HMRC as a trading transaction. However, it is worth keeping in mind the point made by the tribunal in Mr and Mrs Regan’s case, that the issue of whether a property has been a residence should be determined by reference to the quality of the occupation, and not merely the length of the occupation. The tribunal in the Regan case commented:
“We consider that the issue of whether a property is or has been a residence is a matter of fact that should be determined by reference to the quality (and not merely the length) of the occupation.”
The above article is reproduced from ‘Practice Update’ (January/Febuary 2013), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.