Private residence relief: The trading trap

By | 18 July 2015

The capital gains tax (CGT) relief on disposal of a private residence (TCGA 1992, s 222) is one of the most well-known tax reliefs available. This is no doubt due to the large number of home owners who claim the relief when moving house at various points in their lives.

Some individuals move house more than others. It may be tempting to buy a run-down house cheaply, renovate it, live there for a while and sell it for a profit. This process may then be repeated for subsequent houses, with the individual seeking to claim private residence relief on each sale.

However, the question arises whether HM Revenue and Customs (HMRC) may seek to challenge private residence relief claims in such circumstances. For example, is the individual actually trading as a property developer? If so, private residence relief will not be available, and the profits of the trade will be liable to income tax (and normally National Insurance contributions) instead.

Is it a trade?

The question of what constitutes a trading activity for tax purposes can be a difficult one to answer in practice. ‘Trade’ is simply defined as including ‘any venture in the nature of trade’ (ITA 2007, s 989).

The lack of legislative guidance has resulted in extensive case law on the subject over the years. The Royal Commission for the Taxation of Profits and Income in 1955 identified certain ‘badges of trade’, using previous case law about what constitutes a trade. Subsequently, in Marson v Morton [1986] STC 463, a total of nine badges were identified.

A detailed analysis and discussion of the ‘badges of trade’ and case law on what amounts to trading is outside the scope of this article. However, HMRC has published detailed guidance on the badges of trade in its Business Income manual (at BIM20200 and following), including HMRC’s interpretation of them and relevant case law. HMRC summarises the nine badges as follows (at BIM20205):

  1. Profit seeking motive;
  2. The number of transactions;
  3. The nature of the asset;
  4. Existence of similar trading transactions or interests;
  5. Changes to the asset;
  6. The way the sale was carried out;
  7. The source of finance;
  8. Interval of time between purchase and sale; and
  9. Method of acquisition.

However, case law indicates that the badges of trade should be used with caution. For example, in Marson v Morton, it was pointed out that the badges “…are not a comprehensive list and no single item is in any way decisive. I believe that in order to reach a proper factual assessment in each case it is necessary to stand back, having looked at those matters, and look at the whole picture and ask the question – and for this purpose it is no bad thing to go back to the words of the statute – was this an adventure in the nature of trade?”

A similar approach of “…standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole” was approved in Hall v Lorimer [1994] STC 23.

Not out of the woods

Even if the individual is not trading, that is not necessarily the end of the story. The private residence relief provisions include an anti-avoidance rule (TCGA 1992, s 224(3)), which can deny or restrict the relief in certain circumstances.

This provision bites broadly if a house (or an interest in it) is acquired wholly or partly for the purpose of realising a gain from its disposal. It also applies to any expenditure after acquiring the house for the same purpose.

HMRC guidance (at CG65230) states: “If an argument can be sustained that an individual has acquired a dwelling house wholly or partly for the purpose of realising a gain from its disposal, then a charge to tax on trading income will take priority over an assessment to Capital Gains Tax. So it is rare for the first part of TCGA 92/s 224(3) to be applied.”

Nevertheless, HMRC may use the anti-avoidance rule as an alternative to a tax charge on trading income in appropriate cases. If it does apply, the whole of the gain arising from the disposal of the house (including any garden or grounds) will be excluded from private residence relief.

In addition to the above anti-avoidance rule for CGT purposes, there are income tax anti-avoidance provisions regarding ‘transactions in land’ (ITA 2007, Pt 13, Ch 3). However, those provisions are prevented from applying to a gain which is exempt from CGT under the private residence relief legislation, or which would be exempt but for the application of the above anti-avoidance rule in TCGA 1992, s 224(3) (ITA 2007, s 767).

The transactions in land provisions are complex, and are considered by HMRC only in relatively limited circumstances. Those rules are therefore beyond the scope of this article.

Partly successful

The line between private residence relief and an income tax charge as trading income can be a fine one. The tax treatment will depend on the facts and circumstances of each particular case. It is possible that an individual will be able to successfully claim private residence relief on one property, but not on another.

In Hartland v Revenue & Customs [2014] UKFTT 1099 (TC), the appellant operated a plant hire business on a self-employed basis. From 2000 onwards, he also undertook minor repair work to domestic properties owned by his customers.

In January 1996, the appellant bought a property (WV) for £70,000. He extended the property, and sold it on 26 January 2000 for £181,000. Two days later, the appellant bought another property (PC) for £200,000. He sold that property on 25 July 2002 for £550,000. On 23 September 2002, the appellant bought another property (GC) for £170,000, and subsequently sold it on 27 February 2004 for £625,000. In the meantime, on 5 January 2004 the appellant bought a further property (NH), which was in a poor state of repair, for £335,000. He offered it for sale for £975,000 between 1 September and 1 December 2005.

HMRC issued a discovery assessment for 2002/03 and amended the appellant’s 2003/04 tax return, on the grounds that property transactions undertaken by the appellant amounted to ventures in the nature of trade. The appellant appealed. He asserted that all four properties were, successively, his homes; that he bought the properties to live in them; and that the properties were not assets in which he was trading. He therefore argued that there was no income tax due on the profit on the property disposals, and that no CGT was due because of private residence relief (although he accepted that certain other transactions he entered into at or about the same time were undertaken in the course of trade).

The First-tier Tribunal (FTT) considered it necessary to view the transactions in respect of PC (sold in July 2002) and GC (sold in February 2004) in the context of the appellant’s successive property purchases followed by their subsequent redevelopment, in some cases extending to demolition and replacement, and then immediate or almost immediate sale. The FTT referred to Marson v Morton and the ‘badges of trade’ mentioned above. However, instead of examining the badges of trade one-by-one, the FTT (following the approach in Hall v Lorimer [1994] STC 23) stood back from the facts and considered the overall picture.

The FTT also applied principles established in other cases (Leach v Pogson (1962) 40 TC 585 and O’Kane & Co v CIR (1920) 12 TC 303), and accepted that the appellant acquired PC (and WV) with a view to making it his home, and concluded from the evidence that the profit on disposal was neither a trading profit nor a chargeable gain (because of private residence relief). By contrast, the FTT held that the appellant’s acquisition, demolition, rebuilding and sale of GC were undertaken in the course of a property development trade. The evidence showed that he sold it almost as soon as the works were completed, and there was no evidence that he ever lived in it. The appellant’s appeal was therefore allowed in part.

Practical point

The appellant in Hartland accepted that his dealings in respect of NH (before he took it into personal ownership) and other land and property were carried out in the course of trade. This case was decided on its own specific facts. However, it perhaps serves as a useful reminder to existing or aspiring property developers to keep such activities entirely distinct from transactions in respect of their only or main residences; the availability of private residence relief on the latter could well depend on it. A limited liability partnership or company could perhaps be considered for any property development activities, particularly where the distinction between property acquired for development or as a residence would otherwise be difficult.

The above article was first published by Tax Insider (February 2015) (www.taxinsider.co.uk).