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Malcolm Finney explores a popular and important topic for many TaxationWeb visitors in relation to property taxation. 

Background

The manner in which property is owned impacts upon its tax treatment.

This article looks at some of the issues involved.

Legal v Beneficial

English law recognises two forms of ownership, namely, legal ownership and beneficial ownership.

For UK tax purposes it is beneficial ownership which is important.

If an individual “X” is shown as the registered owner of shares in company ”C” then, prima facie, dividends paid on those shares belongs to “X”. However, if “X” has executed a declaration of trust in favour of individual “Y” then for tax purposes it is “Y” who is the beneficial owner of the shares and thus any dividends paid belong to “Y” not “X”, and the income tax liability thereon is that of “Y” not “X”. [Although one does need to beware the 'Settlements anti-avoidance provisions' - Ed.]

“Y”, in this example, is said to be the beneficial owner whilst “X” is the legal owner.

In many cases the legal and beneficial owner of property are the same; thus, in the above example "X" may be shown as the registered owner of the shares in "C" but may also be the beneficial owner thereof.

Beneficial ownership

Beneficial ownership of property may be held either as joint tenants or as tenants in common.

The key consequences of beneficial ownership as joint tenants are that:

• on the death of one of the joint tenants that joint tenant’s interest in the property passes automatically by survivorship to the remaining joint tenants irrespective of any will the individual may have made.
• the joint tenants have an equal right to income arising from the property.

The key consequences of beneficial ownership as tenants in common are that:

• on the death of one of the tenants in common that tenant in common’s interest in the property passes according to that tenant’s will (or intestacy in the event of no will). The above survivorship rule does not apply.
• ownership, and rights to income are not necessarily equal. (Nor does the proportion of ownership have to be the same as the proportional right to income).

Of the two forms of beneficial ownership, in general, that of tenants in common offers greater flexibility from a tax planning perspective. However, if beneficial ownership has initially been structured in the form of joint tenants, such ownership structure is not fixed for all time. A change from joint tenants to tenants in common can easily be achieved by the act of severance; this simply involves a joint tenant writing to the other joint tenant(s) giving notice that he/she wishes to hold his/her interest as a tenant in common. The recipient’s acquiescence is not required.

Following severance, for the party serving the notice the principle of survivorship will then no longer apply to his/her interest in the property. No tax implications arise from the severance.

Probate

Whilst as a general statement, the tenants in common form of ownership is preferred for tax purposes there may be other reasons why joint tenancy is to be favoured.

Ownership as joint tenants does mean that on the death of one of the joint tenants that individual’s interest in the property passes automatically to the surviving joint tenant and probate is not required; in essence, the joint tenant’s interest in the property is not regarded as part of the individual’s estate on death for probate purposes (although it is included as part of the deceased’s estate for inheritance tax purposes). The surviving beneficial joint tenant thus has immediate access to the whole of the property. This may be particularly important with respect to cash. A bank account held by husband and wife as beneficial joint tenants may be accessed immediately following the death of one of the tenants; no probate is required and no “freezing” of the account occurs.

Similarly, where the matrimonial home is owned as joint tenants by husband and wife, on the first death the surviving spouse inherits the deceased’s spouse’s interest automatically (under the survivorship rule) and there is no necessity to include the interest in the home in any will; supplying the death certificate to Land Registry will allow the deceased’s name to be removed from the Land Register.

Inheritance tax

Matrimonial home

However, it still may not be appropriate in all circumstances for the matrimonial home to be held as joint tenants. For example, if one of the spouses has been married before and has children from that marriage it may be that on this spouse’s death the spouse would wish their interest in the home to pass to their children and not the surviving second spouse. This is only achievable if the home is owned as tenants in common in which case interests may pass by will (and not survivorship). It may also not necessarily be inheritance tax efficient if the bulk (or all) of the first spouse’s estate on death passes to the surviving spouse. In this case the nil rate band of the first spouse to die could be “wasted”; or at least this was the position pre 9th October 2007.

Effective 9th October 2007, FA 2008 has introduced the transferable nil rate band between spouses (and between civil partners) which enables the surviving spouse to make use of the unused element of the nil rate band of the first spouse to die. Thus, if for example, the first spouse to die left all their estate to the surviving spouse (thus not using any of their nil rate band) on the death of the surviving spouse the latter would be entitled to twice the amount of the nil rate band on death.

Pre the above date, to try and stop the first spouse’s nil rate band from being wasted on death it was quite common for a so-called nil rate band discretionary trust to be, or have been set up in the will of the spouse, into which was transferred the amount of the then nil rate band. This “amount” could, and often was, constituted by the testator’s interest in the matrimonial home. Following the introduction of the transferable nil rate band between spouses (not co-habitees) it is no longer necessary for spouses to utilise the nil rate band discretionary will trust (thus also generally removing the need for tenants in common form of ownership) as in the past although the position is different for those couples who are not married. It may also still be relevant in other circumstances even for spouses and civil partners.

From the surviving spouse’s perspective, it is perhaps of greater comfort to know that 100% of the matrimonial home is owned following the death of the first spouse as opposed to only 50% with the balancing 50% owned by a discretionary trust or possibly the children (step-children perhaps) absolutely.

Buy to lets

Income tax

In the case of buy to lets the need for 100% ownership, as just mentioned, may be somewhat less important; as the property is not the matrimonial home but an outright investment.

Special rules apply to the income tax treatment of income arising from property held by spouses or civil partners in their joint names (whether held as joint tenants or tenants in common).

Any income arising from the property held in joint names is treated as income to which the husband and wife are entitled equally. They are thus treated as each being entitled to 50% of the income arising from the property. Thus rule applies even if in fact the spouses contributed to the purchase of the property in unequal proportions.

For example, if a husband and wife purchase a buy to let for £200,000 with the husband contributing £150,000 and the wife contributing £50,000, for income tax purposes each spouse will still be treated as entitled to one half of any rental income.

It is, however, possible for this rule to be displaced.

Where the spouses do not wish to be subject to income tax on an assumed 50:50 split, they can make a declaration of their respective beneficial interests in the income and the property from which the income arises, provided that the beneficial interests of the spouses in the property correspond to their beneficial interests in the income. Thus, in the above example, the spouses could make a declaration under which the rental income is to be split 75:25 in line with their respective ownership proportions. However, it is important that the ownership proportions reflect reality i.e., if the above declaration is to be made then the spouses must own the property 75:25 which would mean ownership as tenants in common.

It is not possible for the declaration to decree that the income from the property is to be shared between the spouses in a different proportion to that of the ownership. (For example, the declaration in the above example cannot specify a property split of, say, 80:20 to reflect the ownership of the property with an income split of, say, 60:40).

To be effective for income tax purposes notice of the declaration must be given to HMRC within a period of sixty days from the date of the declaration and must be on the prescribed form (Form 17 here ). The declaration then has effect for income arising on or after the date of the declaration.

On the other hand, it may be that the automatic assumption of equal split of income between spouses can in fact be used as part of tax planning. For example, the husband purchases a buy to let in his sole name. As a 40% taxpayer he is exposed to this rate of tax on the rental income. His wife has no income. The husband, however, may not wish to transfer any significant part of the real estate to his wife but would like to reduce his income tax liability on the rental income.

The husband could therefore enter into a declaration of trust under which he transfers a 1% beneficial interest in the property to his wife; he thus retains 99% beneficially of the property. No declaration is made i.e., no Form 17 is lodged with HMRC. As a consequence, under the above rule, each spouse will now be subject to income tax on 50% of the rental income. The husband will have effectively reduced his income tax liability on the rental income (as 50% is allocated to his wife) whilst he still retains the bulk (99%) of the property.

Capital gains tax

The capital gains tax rules are in line with income tax treatment outlined above.

Thus, property in the joint names of husband and wife will be assumed (in the absence of other evidence) to be held equally beneficially. Any gain arising on a disposal of the property (e.g., gift or sale) will thus be apportioned accordingly.

However, property may be held in unequal proportions if this reflects the true facts. Thus, for example, property may be purchased with the husband contributing 80% of the purchase price and the wife the balancing 20%. Beneficial ownership for capital gains tax purposes will accordingly be 80:20 (even though in the absence of a completed Form 17 (see above) any income arising from the property will be split 50:50) and any gain arising on a disposal of the property (e.g., gift or sale) will be apportioned correspondingly (i.e., 80:20).

Non-UK domiciled but UK resident individuals

Various issues may impact on the non-UK domiciled individual which are of no consequence to the UK domiciled.

Perhaps the main one to note relates to the inheritance tax position where the marriage comprises one UK domiciled and one non-UK domiciled individual. Should UK property be owned by such spouses as joint tenants then as stated above, on the death of one spouse the surviving spouse automatically inherits. If the first spouse to die is the UK domiciled spouse exempt inter-spouse transfers (to the non-UK domiciled spouse) are restricted to a lifetime allowance of £55,000; any excess may qualify as a potentially exempt transfer but a possible inheritance tax liability still lurks.

Ownership as tenants in common, whilst not resolving this potential tax liability, does permit the spouse to direct by will who should inherit in order to try and mitigate future UK tax (be that capital gains or inheritance tax) liabilities.

Summary

• Ownership of property under English law may take the form of legal and/or beneficial ownership.
• The latter is important for all UK tax purposes.
• The two forms of beneficial ownership are the joint tenancy and tenants in common. Under the former, interests in the property on death pass automatically to the survivor. Under the latter, the interest of the deceased may be directed by will or the intestacy rules.
• There are pros and cons (tax and non-tax) of each form of beneficial ownership and the better option will depend upon all the surrounding facts, including the domicile and residence status of the spouses.
• The key point to note is that positive action should be taken with respect to structuring property ownership and the tendency to fall into joint tenants, often by default, should be avoided

The above article is in part based on the author’s book “Wealth Management Planning: The UK Tax Principles”, former “Book of the Month” on taxationweb, and published by John Wiley & Sons Ltd in December 2008 - see here at TaxBookshop.com 

Malcolm Finney runs Pythagoras Training and may be contacted on malcfinney@aol.com He also heads up TaxationWeb's Tax Clinic