Loan Interest or Capital Gain?

Sale of house to friend. Contract says unpaid part of price was loan, but was it part-ownership?

Didn't find your answer?

30 years ago, my client moved house and sold his former home to a friend for an agreed price of £10,000.  The friend could afford only £5,000 and client agreed to lend him the other half.  Buyer had no way of repaying this loan and client was happy to wait until the friend died or the house was resold.  They drew up a contract under which no interest would be charged during the currency of the loan, but when the house was eventually sold, half the proceeds would come to my client with £5,000 representing repayment of the loan and any excess being regarded as interest.

The friend has now died, the house has been sold for £250,000 and my client has received £125,000.  Under the contract, this is £5,000 loan repayment and £120,000 interest.  Client himself is now long retired and a basic-rate taxpayer.  £120,000 of interest in a single year will push him into higher rates in a big way.  

I think that regardless of what the contract says, the reality is that my client retained a 50% interest in the property, he let out his 50% share at zero rent for 30 years and has now sold his 50% share, making a large capital gain.  The gain will be partly mitigated by his period of owner-occupation before the original sale and by residential letting during the ensuing period.

Am I right?  HMRC always argue for substance over form - when it's to their advantage to do so.  Are they likely to agree on this one?

Replies (6)

Please login or register to join the discussion.

Portia profile image
By Portia Nina Levin
23rd Nov 2016 11:48

Remind me what the terms of the contractual arrangement entered into some 30 years ago were again.

Are you asking whether some alternative fiction can be created now?

HMRC do not argue substance over form. They will seek to tax something based on the economic reality. The economic reality should not be assessed retrospectively; it should be based on the true intention of the parties at the outset.

Maybe the effect of the original agreement is that there was a trust, and the friend was the life tenant, with your client as settlor, trustee and remainderman. Having been occupied as the main residence of the life tenant throught the trust's period of ownership, there is now a gain that is covered by only or main residence relief?

And WAKE UP!

Thanks (2)
paddle steamer
By DJKL
23rd Nov 2016 12:00

Hate to say re the tax position I would follow the actual written contract, I cannot see justification why, when the agreement is documented in writing between the parties, one can depart from said agreement; interested to hear other views.

Also not sure re letting relief when never let.

One other point, the £10,000 property circa 1986 morphing into £250,000 in 2016, where is this, as £10k seems too cheap for any London property in 1986 and cannot think of anywhere else that has gone up 25 fold over that thirty year period; Edinburgh certainly has not, nearer 15-16 max I suspect.

Thanks (1)
Replying to DJKL:
Portia profile image
By Portia Nina Levin
23rd Nov 2016 12:18

£10,000 may not have been market value in 1986, it is just what the two friends agreed would be paid.

Thanks (1)
Replying to Portia Nina Levin:
paddle steamer
By DJKL
23rd Nov 2016 12:30

Possibly.

However if an intrinsic undervalue seller ought to have known (been advised) that at day one he had a latent interest bill re half any such undervalue ,and given property was to be presumably PPR of both parties in succession appears a very poor/strange decision re tax planning; wonder who advised?

Same rough result could likely have been achieved perming price and share of gain rather than selecting a possible undervalue at the outset.

Thanks (1)
By Marion Hayes
23rd Nov 2016 12:34

If the house has now sold successfully, 100% title must have been vested in the deceased, and the original contract validated by the solicitors administering the estate. I am sure the beneficiaries of the Estate would not have turned over £125,000 lightly and I am equally sure that the Estate calculations for IHT will have accepted this as a debt.
I am sorry but I cannot see how you can even consider arguing that a successfully completed contract is other than it was.

Thanks (1)
avatar
By [email protected]
24th Nov 2016 15:43

Thank you all. There was no advice or tax planning - they cooked it up between them. Client simply found himself in a position to help a needy friend and did so, probably in a naive way.

It seems to me unavoidable that the economic reality is that the client had an interest in the house since he was to get half the proceeds when it was sold. Probably the original sale was at undervalue, but any gain at the time would have been exempt. The growth/interest has worked out at 11.2% compound per annum over 30 years, but this was never planned or specified.

There are situations where a beneficial owner hides assets in the names of nominees - spouse, children, other associates - in an attempt to avoid tax. This was the opposite - there was never any thought of avoiding tax, nor was there any expectation of spectacular profit. I'm keen to avoid any unnecessary tax now that it's run its course. Perhaps Portia's interpretation is right - that effectively there was a trust.

Thanks (0)