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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 some valuation difficulties facing taxpayers when calculating the pre-owned assets income tax charge.

Context

The joint paper (referred to below as COP 10) submitted to HMRC in July 2005 by the CIOT, STEP and the Low Incomes Tax Reform Group contained some questions on valuation, to which HMRC responded (see also CTR Issue 13 Item 6).

Reg 4 of the March 2005 regulations provides that, in relation to land and chattels, valuations should be done every five years.

What happens if the taxpayer moves in that five year period?

According to HMRC, the rental value of the new property is taken.

Example 1

A gives £300,000 cash to his son in April 2000. Son uses all the cash to purchase a house and contributes none of his own funds. A occupies the house within seven years – say in April 2002. He therefore, satisfies the contribution condition and is within POA. The house is worth £500,000 on 6.4.05 and the rental value is £25,000. A therefore, pays income tax on £25,000 for 2005/6. Son sells the house in June 2006 and purchases with the proceeds a property worth £300,000, which is occupied by A. The rental value of this property is £15,000. A now pays income tax on £15,000.

Valuation problems with home loan schemes

Example 2

In 2003 B sells his house to an interest in possession trust for himself for £900,000, with the purchase price left outstanding as a debt repayable on his death. In 2003 B gives away the debt to a trust for his children. Assume that B is caught by POA and the debt is an excluded liability within para 11(7). The debt has interest rolled up. The house is worth £1 million on 6.4.05. How is the debt valued?

There are at least three possibilities:

1. The face value of the debt excluding interest – hence £900,000. In these circumstances B would pay income tax on 90% of the open-market rental.

2. The commercial value of the debt, bearing in mind it is not repayable until after his death. This might be, say, £600,000. B would then pay income tax on 60% of the open market rental of the property.

3. The face value of the debt plus rolled-up interest – say £150,000. B would then pay income tax on 100% of the open market rental of the property.

How is the debt valued?

HMRC state that the third answer is the correct one, but suggest that B only needs to value the debt and rolled-up interest on 6.4.05. Subsequent accrued interest in the intervening period is ignored until the next fifth anniversary date. If the debt is repaid in part during the five-year period, the lower outstanding amount at date of repayment including accrued interest still owing is taken.

Home loan schemes: the effect of electing into GWR

Suppose a married couple (H and W) decide to avoid POA on a home-loan scheme by making an election under para 21. The intention is that they then fall within the GWR rules and, therefore, POA is not payable. H dies 10 years later. His share passes to W under the terms of the property trust. Suppose 90% of his share is subject to the debt.

In these circumstances HMRC say that there is no spouse exemption on the part subject to the debt, with the effect that there is an immediate IHT charge on H’s death equal to the value of the debt with no IHT deduction. The trustees of the property trust need to find cash to pay that IHT, which may involve selling the house. It might be argued against HMRC that the spouse exemption is available on the entire value of the house including the debt element, because the deceased’s share as a matter of fact passes to the surviving spouse under the terms of the property trust, as IHTA 1984 s18 requires. However, anyone making an election should consider HMRC’s view carefully. (No final decision should be made about whether to elect until later this year - or just before 31.1.07.)

(Tax Adviser Feb 2006 p26, article by Emma Chamberlain)

Comment

In Example 1, what would happen if say the initial gift made by Father to Son in April 2000 was of £200,000 and, following the purchase of the replacement property in June 2006, Son ‘repaid’ Father with the surplus £200,000 received on sale of the original property? The answer, of course sadly, is that, so long as Father continues to occupy the replacement property, POA applies: the fact is that once the initial contribution has been made, repayment of the amount given ‘cuts no ice’. This is consistent with the HMRC view that the contribution condition is breached by a loan ‘on commercial terms’. Clients need to be warned …!

On the final issue, it seems hard to appreciate what is the technical basis behind HMRC’s position, understandable though it may seem in principle. However, I understand that HMRC are very definitely sticking firm to their view that the spouse exemption does not apply in such circumstances.

Matthew Hutton MA, CTA (fellow), AIIT, TEP
March 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.

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