Has a taxpayer been careless simply because he or she disagrees with HMRC? Peter Vaines looks at several tax cases on carelessness, personal goodwill and the definition of a dwelling.
The recent case of Richard Villar v HMRC  UKFTT 0117 (TC) considered the tax implications of a sale of goodwill by a professional person and is very helpful in clarifying the law in this area.
Mr Villar had a successful medical practice and he sold the business as a going concern to Spire Healthcare Diagnostics Limited for £1 million. Mr Villar said that the sale gave rise to a capital gain. However, HMRC argued that the payment was subject to Income Tax.
A crucial part of the HMRC argument was that the payment was mainly attributable to goodwill and they said it could not be transferred to Spire because the goodwill was personal to him.
HMRC also argued that there was no business to dispose of– it was really a payment in advance for the exploitation of Mr Villar’s professional skills for a future flow of income. In other words, it was an arrangement for Mr Villar to obtain money in capital form (taxed at 10% having regard to Entrepreneurs’ Relief), and not as income which would have given rise to rather more tax.
It is fair to say that when anybody buys a business, they are buying an income flow. They buy the business because the business makes profits and that is what provides the capital value. The purchaser may be able to exploit synergies with his own business or may feel that he has something to add to the business which will increase the profitability which makes it additionally attractive. When any business is sold, the vendor gives up the future profits which are subsequently received by the purchaser – but that does not mean every sale is therefore a sale of future income chargeable to Income Tax on the vendor. The sale of a business gives rise to a capital receipt chargeable to Capital Gains Tax.
It was said to be common ground that the sale of a business is a capital transaction. The point was that HMRC said that this was not the sale of a business because Mr Villar did not have a business to sell.
That is a tough argument because Mr Villar certainly believed that he had a business capable of sale – and he sold it. The expert valuers who valued the business thought so too. And Spire obviously thought he had a business capable of sale because they paid £1 million for it.
The Tribunal did not take long to conclude that as a matter of fact, the sale by Mr Villar was a sale of his business and that the amount received was capital.
However, that was not the end of the story because HMRC argued that even if the payment were capital, it should be taxed as income under ITA 2007 s 773 which brings into charge to Income Tax, a capital sum which is received to exploit the earning capacity of an individual in an occupation.
The FTT observed that there was no fixed intention or obligation for Mr Villar to continue to work in this way. On that basis it is difficult to conclude that the purchaser was exploiting Mr Villar’s earning capacity. In reality (and in fact) Spire were exploiting the practice (and the goodwill) that Mr Villar had sold to them.
The second condition for s 773 to apply is that one of the main objects of the arrangements was the avoidance of a liability to Income Tax. HMRC said that if Mr Villar had continued to receive the profits of his practice, they would have been chargeable to Income Tax whereas having sold the practice, he received £1 million which was chargeable to Capital Gains Tax and eligible for Entrepreneurs’ Relief. That is a substantial tax advantage – in fact a saving of the whole of the Income Tax.
However, the Tribunal found that there was no intention or desire to avoid or reduce Income Tax and, indeed, they saw no evidence that Income Tax was a matter which had been considered at all. Having regard to the huge tax saving involved, this was perhaps a view welcomed by Mr Villar, but it did not matter because the Tribunal found that Section 773 had no application in any event.
This case is important as it clarifies the tax position of goodwill of a professional practice which has certainly been the subject of controversy in the past. Unless there is an appeal (and press reports indicate there is not) this will obviously be a very helpful decision – even though decisions of the FTT have no precedential value.
There are numerous Tribunal cases dealing with penalties for carelessness. Some of them reveal matters of importance. My eye was recently taken to the cases of Negka v HMRC  UKFTT 82 (TC) and A Omar v HMRC  UKFTT 78. Both taxpayers were unrepresented.
In the first case, HMRC penalised Miss Negka on the grounds that she had been careless in connection with her tax return and deserved a penalty. This was because, although she had looked at the HMRC published materials on line, “a prudent person would have appointed a tax adviser”.
Before anybody gets too excited …. the FTT rejected this argument.
When we look at the case of Mr Omar, he was also penalised by HMRC on the grounds that he too had been careless and therefore deserved a penalty. However, we find that he was obviously a prudent person because he appointed two expert advisors. He should be OK then? Er, no. HMRC said that he was careless because: “In order to avoid being careless, he should have looked at HMRC’s published material.”
I am not making this up. Fortunately, the FTT rejected this argument too – but that should not stop us getting excited about this.
What these decisions indicate is that the (unrepresented) taxpayers were being wrongly accused of being careless (and were wrongly charged penalties) simply because they did not agree with HMRC.
It is clear that the Tribunal carries an increasing heavy responsibility to protect the taxpayer from such an approach.
Definition of a Dwelling
There are a number of Stamp Duty Land Tax issues where it is important to know whether a property is a dwelling – for example, it may determine the rate of SDLT payable from next to nothing perhaps to 15%. It may also be relevant to Capital Gains Tax charge and Inheritance Tax.
The recent case of P N Bewley Ltd v HMRC  UKFTT 65 (TC) provides some helpful guidance. The case involved the 3% SDLT surcharge in Finance Act 2003 Sch 4ZA which said that building counts as a dwelling if:
a) it is used or suitable for use as a single dwelling, or
b) it is in the process of being constructed or adapted for such use.
These words (apart from the reference to a single dwelling) are found elsewhere in the legislation – such as the definition in TCGA 1992 Sch B1 for the Non Resident Capital Gains Tax charge and for the new Inheritance Tax rules on UK residential property – and this decision may therefore be of wide application.
The key issue in this case was whether the property was “suitable for use as a dwelling”.
This is obviously a matter where judgements can differ – which is a nice way of saying that cases will arise where the taxpayer will say that a property is suitable for use as a dwelling, and HMRC will say that it is not.
The FTT took the view that a building may be capable of being a dwelling but may be unsuitable for the purpose at the relevant time. This particular property was in a poor state with radiators and pipework removed (and the presence of asbestos prevented any repairs) and they concluded that it was not suitable for use as a dwelling.
HMRC did not agree and argued that the building was suitable for use as a dwelling – which was a bit odd having regard to their guidance notes which say that a dwelling is a building which affords those who use it the facilities for day to day private domestic existence – which clearly it did not.
Anyway, the discussion contained in this judgment about the various factors to be taken into account (or not taken into account) in deciding whether a building is a dwelling, could prove rather helpful in a number of different situations and a number of different taxes.