HMRC tried to argue that the sale of an investment property was in fact a trading activity, to prevent the taxpayer using capital losses - and tried to impose a c£1million penalty to boot. Nick Fernyhough of RPC Solicitors explains why HMRC came unstuck in its key contentions. .
In Terrace Hill (Berkeley) Ltd v HMRC  UKFTT 75 (TC) TC 04282, the First-Tier Tribunal ("the FTT") rejected HMRC's arguments and concluded that a property developer's activity in relation to the development of an office property was an investment rather than a trading activity and allowed its appeal. The fundamental issue in the case was whether the property concerned was acquired as an investment. As this is a question of fact, the company's intention was of paramount importance, in particular, whether it intended to retain the property at the time of acquisition. The evidence provided to the Tribunal by the company's chairman was crucial in this regard, and as his evidence was accepted by the Tribunal, the appeal was allowed. The case also demonstrates the importance of contemporaneous documentation in cases where the facts are disputed by HMRC.
Terrace Hill (Berkeley) Ltd ("the Appellant") was a special purpose vehicle ("SPV") which had been formed to hold the Terrace Hill Group plc's 50% beneficial interest in a development of an office property in Mayfair known as 16 Berkeley Street ("the Property"). The development was to be undertaken on a joint venture basis with the other 50% interest being held by another SPV, Longford Business Centres (Berkeley Street) Limited ("LBC(BS)").
The Property was acquired in August 2000. The proposal was to demolish the existing building and to replace it with a grade A office property. The construction work was completed in September 2003. Whilst the dominant hope had been that the Property would be let in its entirety to one triple "A" rated tenant, the rental market declined during the period that the Property was under redevelopment. Accordingly, the building had to be let out on a floor by floor basis. The average rentals achieved were disappointing. Consequently, the investment value of the Property was diminished by the fact that some of the tenants were not of the calibre that had been hoped for. The Property was fully let by May 2005 and had been sold by July 2005.
The SPVs had utilised a 'capital loss' scheme the effect of which was expected to be that losses would be set against the gains on the beneficial interests in the Property held by the joint venture parties, which would eliminate all tax due on the disposal. HMRC challenged the arrangements and argued that each group had in fact held its respective interest in the Property from the outset as a trading asset and not as an investment. If that submission succeeded, the capital loss scheme would fail to achieve its objective and the two groups would be subject to corporation tax on their respective profits.
The Appellant's Case
While it was accepted on behalf of the Appellant that the Terrace Hill Group plc ("the Group") often had development properties on trading account and so held them when the developments had been pre-sold, the Group also held investment properties and was aiming to retain its stakes in suitable development properties as well. In evidence, the Chairman of the Group, Mr Robert Adair ("Mr Adair") said that his strategy was to retain completed developments where he anticipated good rental growth, so that the Group would have a steady net rental income. His aim, in particular, was to retain the completed development of the Property following completion. It was hoped that the retained surplus of rentals over interest and amortisation of the long-term borrowings would provide the Group with steady (and hopefully rising) income. Consistently with these objectives, the Property was always treated as a capital asset for accounting purposes by the Appellant. Capital losses were claimed and had been conceded by HMRC in relation to the plant and machinery component of the development costs.
HMRC's argued that the Appellant had always intended to sell its interest in the Property as soon as it had reached its maximum value, in other words, as soon as the development had been completed and the building fully let.
In addition, it was claimed that the potential benefit of being able to claim capital allowances, when the Property was held as an investment and the benefit of indexation on selling an investment property, were factors likely to induce the Appellant to classify the Property as an investment property rather than as trading stock.
The appeal also involved a subsidiary issue relating to a penalty of approaching £1million which HMRC had imposed on the basis that in reporting the sale as a disposal of an investment, the Appellant had been negligent.
Both parties accepted that the fundamental issue for the FTT to determine was the factual one of whether, when the Appellant acquired the Property, it intended to retain it as an investment, subject to the reality that if circumstances changed radically, the Property might have to be sold. The primary question was whether the Appellant had acquired the Property with a view to its retention.
The FTT's Decision
The FTT (Judge Howard Nowlan and Mr Julian Stafford) accepted Mr Adair's evidence that he pursued a strategy of seeking to retain developments where rental growth looked highly promising so as to maximise net rental income and reduce delays in the realisation of profits. The FTT attached some weight to the fact that Mr Adair was an accountant and that as such he was familiar with the factors that governed whether a property was rightly treated as an investment. It was significant that the Property was always treated as a capital asset for accounting purposes.
It was also significant that whenever minutes referred to the views of Mr Adair, they consistently supported his evidence that he wished to retain what he hoped was going to be a very attractive Mayfair office development as an investment. The FTT also accepted that in being the Chairman and the person responsible for advancing the fortunes of family trusts which owned the Group, it was his objectives that governed the strategy adopted by the Group.
The impressive nature of the evidence given on behalf of the Appellant coupled with the credible strategy which it was claimed was being pursued and the entirely understandable manner in which changed circumstances led to a change of plan, led the FTT to conclude that the Property was held as an investment and was rightly accounted for throughout in that manner. The penalty dropped away in the light of the conclusion reached, but the FTT did record (in case the primary decision was overturned on appeal) that there was no neglect by the Appellant in the filing of its corporation tax return. In the view of the FTT, the Appellant honestly believed that its case was correct and that its return was also therefore correct.
The appeal was determined on the basis of the cogent and credible evidence that was adduced on behalf of the Appellant, which persuaded the FTT to conclude that the Property was indeed held as an investment, notwithstanding the fact that it had been disposed of fairly soon after the refurbishment work had been completed. The case is a further reminder of the importance of careful preparation of witness statements where findings of fact are likely to be crucial to the outcome of the appeal.
Nick Fernyhough is a Senior Associate in RPC's tax disputes resolution team, with over 20 years of experience in contentious tax. He specialises in resolving complex disputes with HMRC in all aspects of direct tax and VAT. Prior to joining RPC, Nick was a member of HMRC's Solicitor's Office where he was responsible for the conduct of a number of high profile cases before the Tax Tribunals and Higher Courts.