Taxpayers tend to assume that all the land they sell with their home will be free of CGT, but that is not always the case, as Andy Keates explains.
This article looks at the case of married couple Billy and Hazel Ritchie (TC05911), who made a number of mistakes when they sold their home and associated land for £2m in January 2007.
In 1987 the Ritchies purchased around 0.7 hectares of land, on which they planned to build a house. The land included a sizeable shed, which Billy used as a garage, domestic storage and to keep the equipment for his hobby of competitive ploughing. Billy used this land and shed from 1987 onwards. In 1995, they moved into their newly built home and Billy continued to use the shed, which was around 85 metres from the new house.
Billy and Hazel were also joint partners in takeaway business. When they sold their home and the associated land they paid the funds into their partnership bank account.
The Ritchies submitted their personal and partnership tax returns through their accountant Victor Weir. Because he was inexperienced in matters of capital gains tax, Weir recommended Billy to take advice from Clive Russell, a retired tax inspector who practised as a tax consultant.
Billy told Russell about the total land area but did not mention the pre-occupation period between 1987 and 1995, and Russell failed to ask. Russell told Billy that based on what he had told him, full private residence relief (TCGA 1992 s 222) ought potentially to be available.
Billy reported back to Weir that there would be no CGT liability, and Weir filed the couple’s self-assessments tax returns, making no mention of the disposal.
In May 2010 HMRC wrote to Weir asking about the introduction of £2m of partnership capital. Weir replied outlining the circumstances of the sale. HMRC responded by issuing assessments for gains totalling £442,640 each, under the discovery provisions in TMA 1970 s29.
The Ritchies appealed and eventually the case arrived at the First-tier Tribunal (FTT), where these two issues were considered:
- Was there actually a chargeable gain to assess, or was all the gain covered by private residence relief?
- Did HMRC have any right to issue CGT assessments, since the normal time limit of four years had elapsed? HMRC would need to show they could utilise the extended time limit of six years given by TMA 1970 s36.
These two issues are interdependent: if the Ritchies won on either, the outcome of the other would be irrelevant. HMRC needed to win on both.
The capital gain
The FTT made a ruling of fact that land of 0.699 hectares (ha) was sold. Since this exceeds the 0.5ha of land which is automatically allowed as the “permitted area” to be exempt from CGT, it was necessary to decide how much larger was the “area required for the reasonable enjoyment of the dwelling-house... having regard to the size and character of the dwelling-house”.
But what exactly was the ‘dwelling house’? HMRC had been advised by the District Valuer that the house, with a gross external area (GEA) of 311 square metres, was comparable to local properties, so the Ritchies’ property did not require more than 0.5ha of land. The Ritchies argued that the shed also formed part of the dwelling house, raising the GEA by around 150 square metres, necessitating a larger permitted area and invalidating the District Valuer’s comparisons.
It was clear Billy used the shed as part of his dwelling house – and had done even before the house was completed. The FTT ruled as fact that the shed was part of the dwelling and that the permitted area was 0.6ha out of the total 0.699.
Apportioning the gain
During the period from 1987 to 1995, the Ritchies did not own a dwelling house, so for that period none of the land qualified for private residence relief. HMRC argued for a straight time-apportionment of the gain, but the FTT ruled that a more nuanced approach should be taken, since the bulk of the rise in value took place after the period of non-occupation, i.e. when the house was fully constructed.
This approach was permitted by TCGA 1992 s224(2), allowing a “just and reasonable” apportionment, and was achieved by looking at the purchase costs of the land and its rateable value immediately following the construction of the house in 1995. This gave rise to a gain of £9,100 relating to the pre-occupancy period (considerably less than the £630,000 which HMRC’s method would have given).
The chargeable gain which should have appeared (but did not) on the Ritchies' self-assessments was judged to be £92,985 each.
The normal assessing limit would have required the tax assessments to have been made by 5 April 2011. HMRC was relying on TMA 1970 s 29(4) (assessment to recover tax lost to the Exchequer) and TMA 1970 s 36 (extended time limit of six years rather than four); both require HMRC to show that either the taxpayer or someone acting on his behalf has been careless in making returns.
The FTT considered whether the conduct of each of the parties involved could be termed careless.
Billy and Hazel Ritchie were not careless: Billy sought professional guidance from Weir and Russell. He had failed to mention to Russell that they had owned the land for seven years before they occupied the house, but why should he have grasped the relevance of that fact? While he took Russell’s advice to have been more robust than it was, reporting back to Weir simply that there was no gain to assess, that was essentially what he thought he had been told.
Weir, however, was careless. While he did the right thing in referring Billy to an adviser with more experience in CGT, he neither accompanied him to the meeting, briefed Russell beforehand nor followed up for confirmation of the advice.
According to the tribunal notes: “A simple phone call... would probably have sufficed to show that Russell’s advice... was more nuanced than that which Billy had told him and may not have been based on complete information.”
Russell too was careless. He ought to have sought more facts, which would have revealed to him the need for time-apportionment. Also, he should not have allowed Billy to believe that he did not need to disclose the gain, and the relief being relied upon, in his return.
The conditions were satisfied for HMRC to issue tax assessments using the extended time limits of TMA 1970 s 36.
This was nominally a win for HMRC, in that both issues were resolved in their favour. However, the final CGT computation came out better for the Ritchies than might have been the case if they had originally submitted complete and accurate tax returns. If Weir had filed a self-assessment return on the basis used by the FTT it is highly unlikely HMRC would have agreed with it!