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Capital Tax Review by Matthew Hutton MA, CTA (fellow), AIIT, TEP

Matthew Hutton MA, CTA (fellow), AIIT, TEP author of Capital Tax Review, comments on the Special Commissioner’s decision in Henke and another v HMRC.

Context

The matters for consideration in this case involved both the validity of assessments made by HMRC and the substantive issues of deductible expenses, the size and location of the ‘permitted area’ and whether an apportionment was required to exclude relief for the period before the house became Mr and Mrs Henke’s main residence.

Henke and another v HMRC: the facts

On 25.8.82 Mr and Mrs Henke jointly purchased a freehold plot of land comprising 2.66 acres. They subsequently built a house on the land which became their main residence in June 1993. In July 1995 they obtained planning permission for two dwelling-houses to be built in front of their house. On 15.10.99, ‘plot 1’, an area of 0.54 acres, was sold for £171,000 and on 15.3.01 ‘plot 2’, an area of 0.54 acres, was sold for £230,000, and houses were built on both plots.

On 15.4.00 Mr and Mrs Henke, in accordance with their usual practice, completed Forms R40 for 1999/2000. Each ticked Box B, which contained the words ‘Tick this box and we will send you a form R40(CG) to complete’, to indicate that they had disposed of assets for more than twice the annual exempt amount for CGT purposes, and submitted their forms. As Mr and Mrs Henke received no response from HMRC, they telephoned a separate tax office for advice and were supplied with Forms SA108. Mr and Mrs Henke duly completed Forms SA108 showing that plot 1 had been sold for £171,000 and claiming that full relief was due under TCGA 1992 s222.

Following an exchange of correspondence relating to the status of Forms R40, on 25.7.01 HMRC wrote to Mr and Mrs Henke stating ‘Our enquiry into your tax affairs for the year 1999/2000 should have been opened properly and in line with our best practice. Unfortunately this did not happen ... A legal enquiry does however exist’. On 26.1.02 Mr and Mrs Henke submitted Forms R40 for 2000/01, together with completed Forms SA108 showing the disposal of Plot 2 for £230,000, divided equally between them and claiming full relief under s222. HMRC issued self assessment returns to Mr and Mrs Henke for that year which they duly submitted on 9.12.02 and on 4.2.03 HMRC issued a notice of enquiry into those returns.

On 28.10.03 HMRC wrote to each appellant indicating that enquiries into their Form R40 had been completed and enclosing notices of assessment for 1999/2000 each showing assessable capital gains of £60,449 on the disposal of plot 1 and tax payable of £18,579.60. On the same date HMRC wrote to each appellant indicating that enquiries into their tax returns for 2000/01 had been completed and concluding that a chargeable gain arose on the sale of Plot 2 as main residence relief did not cover the whole of the gain. For Mr Henke the amendment to his return resulted in an increase in tax due of £24,910.80 with an amended self assessment of £24,258.80 tax due. For Mrs Henke, the amendment resulted in an increase in tax due of £24,446.40 with an amended self assessment of £23,794.40 tax due. On 18.11.03 Mr and Mrs Henke appealed against the notices of assessment for 1999/2000 and the enquiry conclusions for 2000/01.

The decision: SpC (John Clarke)
Determinations on each of the issues were made in principle. The final figures were to be agreed or determined.

(1) On the question of the validity of the assessments for 1999/2000 and the enquiry into the 2000/01 returns, Mr Clarke found that Mr and Mrs Henke did not make ‘returns’ for 1999/2000, as Form R40 was only a form to claim a repayment of income tax and did not constitute a return and similarly merely submitting the Form SA108 did not amount to a return (applying Osborne (decd) v Dickinson (Inspector of Taxes) [2004] STC (SCD) 104). He interpreted the position as involving an enquiry into Mr and Mrs Henke's tax affairs as a result of the claims made in the Forms R40 and the information subsequently provided by them (in the SA108 pages) as to their capital gains disposals. Thus the enquiry was into the R40 repayment claims, and the implications for those of the capital gains which HMRC considered them to have made. The correspondence generally did not relate to a ‘claim’ for relief under TCGA 1992 s222. However, in the absence of a return, TMA 1970 s29(1) permitted an assessment to be made without the need to consider s29(2) or (3); it was simply necessary for an officer of the Board to ‘discover’ that (in the present case) chargeable gains which ought to have been assessed to CGT had not been assessed. Although the correspondence did not refer to the assessments as discovery assessments, nor did they refer to the loss of tax, they were properly made pursuant to TMA 1970 s29, and were therefore valid discovery assessments.

It followed from the conclusions in respect of the 1999/2000 assessments that Mr Clarke also found that the Forms R40 and the accompanying SA108 pages for 2000/01 did not constitute ‘returns’ for that year. Mr and Mrs Henke did not make returns for 2000/01 until 9.12.02. Notice of the enquiry was issued on 4.2.03, which was within the enquiry window applying under TMA 1970 s9A(2)(b). There was no difficulty with the fact that there might have been prior discussions about the disposal; the enquiry could only be into a ‘return’, and events before the return was issued could not be taken into account. The enquiry was properly closed pursuant to TMA 1970 s28A. Therefore the amendments to Mr and Mrs Henke's returns for 2000/01 on the conclusion of the enquiry were validly made.

Mr Clarke expressed concern at the unsatisfactory way in which HMRC had dealt with the whole subject of the 1999/2000 capital gains. Forms R40 were not suitable for taxpayers with more substantial capital gains. Where the taxpayer had ticked the relevant box, that should result in an immediate request for further information. If the gain was likely to be substantial, the proper course would be to issue a SA return to the taxpayer, rather than attempting to deal with the matter by using Form R40(CG).

(2) As regards the allocation of allowable costs, the conditions for a part disposal were clearly met on each disposal. TCGA 1992 s42 governed the attribution and, where appropriate, the apportionment of expenditure in relation to part disposals. S42(4) made it clear that an apportionment was not to be made where on the facts the expenditure was wholly attributable to what was disposed of, or wholly attributable to what remained undisposed of. What that meant in the present case was that, unless any of the expenditure on building the house and its garage could be regarded as having been reflected in either or both of plot 1 and plot 2, it could not be taken into account under s38 as an allowable deduction in computing the gains on the sale of those plots. Preferring not to give a general ruling as to deductibility (so as to avoid the possibility of further disagreement between the parties), Mr Clarke agreed most of the categorisations of costs listed in the schedule to the statement of facts not in dispute and confirmed that all the expenses that might be deducted from the sale proceeds of plot 1 or 2 would be subject to indexation allowance.

(3) The ‘permitted area’ test in s222(1)(b) was to be applied by reference to what was required in the circumstances prevailing at the time of the disposal, and was an objective one. There were two distinct tests for a house and a garden. In relation to a house, the test for only or main residence was ‘at any time’. For land, the test was whether it was a garden or grounds at the time of disposal. If a house ceased to be an only or main residence, the garden would not qualify. If both house and garden met the respective tests at the time of disposal, the grounds would qualify whatever their previous use. Mr Clarke held that in the present case the permitted area was on both occasions 0.82 of a hectare (2.03 acres) and the apportionment of the sales proceeds of the plots sold should be on the basis of the respective areas of the non-exempt and the exempt areas.

(4) On the issue of the period of ownership and main residence relief, Mr Clarke held that, as Mr and Mrs Henke did not own the house until 1993 but had owned the land (as legal owners and beneficial joint tenants of the freehold) since 1982, an apportionment was required under TCGA 1992 s223(2) to limit the relief because they did not meet the ‘throughout the period of ownership’ condition in s223(1). The Parliamentary intention behind the legislation was clear; there was to be only one period of ownership of the single asset consisting of the land and any buildings which might be erected on it during that period. Where, as in the present case, land was held for a period and subsequently a house was built on it and occupied as the individual's only or main residence, an apportionment was required.

(Henke and Another v Revenue and Customs Commissioners 2.5.06 SpC 550 reported at [2006] STI Issue 28)

Comment

The procedural aspects of this case are curious to say the least. The main point obviously is that, to secure finality once the twelve month enquiry window has passed, it is essential to submit a self-assessment return by the due date of 31 January following the end of the tax year.

An interesting point arises in relation to garden or grounds. The decision in Varty v Lynes (1975) 51 TC 419 makes it essential not to have disposed of the house at the time of the disposal of any part of the garden or grounds on which it is hoped to secure s223 relief. In that case the court said obiter that even if the property was sold as a whole, but prior to sale the taxpayer ceased to occupy the house, no relief would be due in respect of the garden. (The Revenue stated that they would not pursue the obiter dictum, unless the garden had development value (CCAB statement TR 211 June 1976). However, in Tax Bulletin Issue 12 (August 1994) page 148, they said that they had received advice that such an argument was misconceived and would not be applied.)
Consider the situation where at the time of the disposal of the house and garden together, say, the taxpayer has ceased to occupy the house, in particular, in reliance on the ‘last 36 months’ rule given in s223(2)(b)? While strictly speaking it would seem that no relief is due on the garden, HMRC’s statement on the obiter dictum in Varty v Lynes should ensure that HMRC will accept that relief is due on the garden or grounds, even where there is development value.

More generally:

(a) A possible argument arising from the different treatment of the (i) house and (ii) garden or grounds under s222 is that the limitation for husband and wife living together applies only to (i) and not (ii). Would it therefore be open to have a house owned jointly with up to 0.5 of a hectare of garden owned by husband and up to 0.5 of a hectare owned by wife (all within the basic permitted area), so as to get automatic exemption on one hectare?

(b) The fact that the test for garden or grounds is applied at the date of disposal should mean that one disregards other areas of land owned by the taxpayer but not then in use as garden or grounds, obviously taking into account at each part disposal the footprint of the house within the basic permitted area. Assuming then a case of say a 2 hectare garden with development value, could successive part disposals be made out of a 0.5 hectare area with the land in use as garden or grounds and the balance over 0.5 hectare owned not so in use at that time (e.g. licensed to the next door neighbour as a vegetable plot or to the nearby school as a playing field), so as to be sure of successive 100% relieved disposals? That is, the traditional HMRC argument on a part disposal out of more than the basic permitted area (‘it can’t be required for the reasonable enjoyment of the house because otherwise you wouldn’t have disposed of it’) wouldn’t apply?! But I can see an interesting argument here based on the wording and interrelationship of subsections (2) – (4) of s222 in the context of s 222(1)(b).


Matthew Hutton MA, CTA (fellow), AIIT, TEP
October 2006

More Information

The above article has been taken from Matthew Hutton’s Capital Tax Review, a quarterly update for professional advisers of private clients. For more information, visit http://www.taxationweb.co.uk/books/capital_tax_review.php.

About the Author

Matthew Hutton is a non-practising solicitor (admitted 1979), who has specialised in tax for over 25 years. Having run his own consultancy (latterly through Matthew Hutton Ltd) until 30th September 2000, he now devotes his professional time to writing and lecturing.