17 January 2001
Replies to Queries – 2
Residence principle?
A client, employed in the building industry, some years ago (when newly married) purchased a run-down property. The property was initially to live in, but he also carried out improvements and then sold to move into a superior property. During a period of five years he moved house three times before he found his 'dream house'. He lived in all the previous properties with his wife whilst they both carried out the improvements. They lived in the final property for over four years.
Residence principle?
A client, employed in the building industry, some years ago (when newly married) purchased a run-down property. The property was initially to live in, but he also carried out improvements and then sold to move into a superior property. During a period of five years he moved house three times before he found his 'dream house'. He lived in all the previous properties with his wife whilst they both carried out the improvements. They lived in the final property for over four years.
Replies to Queries – 2
Residence principle?
A client, employed in the building industry, some years ago (when newly married) purchased a run-down property. The property was initially to live in, but he also carried out improvements and then sold to move into a superior property. During a period of five years he moved house three times before he found his 'dream house'. He lived in all the previous properties with his wife whilst they both carried out the improvements. They lived in the final property for over four years.
The Inspector of Taxes is of the opinion that the earlier purchases/sales were 'an adventure in the nature of trade'. Our client argues that he was doing exactly the same as many other couples do, i.e. improving their life style. Readers' observations would be appreciated.
(Query T15,737) – Bob the Builder.
The term 'adventure in the nature of a trade' is surely something of a red herring. What we are actually talking about is a transaction which has the same characteristics of a trade but which for some reason falls short of being a full-blown unquestionable trade. The normal point of contention is the 'isolated transaction'.
Take for example the case of Commissioners of Inland Revenue v Fraser 24 TC 498. This case involved the purchase and sale of three whisky lots at a profit. The transactions were substantially 'one transaction'. For that reason the transaction fell short of being an actual trade but was found to be an 'adventure in the nature of a trade' because it contained all the hallmarks of a trading transaction save the fact that it was an 'isolated transaction'.
What the Inspector needs to establish is that each property transaction bore all the hallmarks of an actual trade without actually amounting to a full-blown trade. The Inspector should be asked why he considers the transactions amounted to separate 'adventures' and not an actual trade. After all, they were repeated over a period of time. The only plausible explanation is that he already accepts they were separated over such a period of time and that they should be viewed in isolation.
The starting point must be the Inspector's own instructions which make the point that 'a single isolated transaction can amount to the carrying on of a trade for tax purposes (i.e. an “adventure”) but it is generally not easy to show that that is the case (paragraph IH126d)'. Isolated transactions have been found to be 'adventures' but generally only where there are special features present, such as the commodity dealt in or the nature of the taxpayer's regular trade (see, for example Commissioners of Inland Revenue v Fraser and Commissioners of Inland Revenue v Livingstone 11 TC 538).
'Bob the Builder' could sit down and go through the normal badges of trade to confirm whether the Inspector's argument stands up. However, in my opinion, the major pointers to non-trading transactions must be the nature of the asset (the client's own home) and the intention simply to move up the property ladder. The weight to be attached to each badge varies from case to case. It is the overall impression which counts. One cannot help feeling that the Inspector is clutching at straws. Would he have the same view if the client had lost money? He should be asked to substantiate his view drawing on relevant case law bearing in mind the note of caution recorded in his own internal instructions. I think he will struggle. – Accountax.
There are several 'badges of trade' to decide if a trade is being carried on or if there is an adventure in the nature of trade. I will not rehearse the various cases but will highlight a couple of the badges. One of the more important ones is that there should be a profit-seeking motive. The client hopes to avoid this badge by saying that he acquired the house to improve a life-style. I have some difficulty in seeing how moving into a house that was constantly under renovation improves a life-style until the house is sold to obtain funds to move 'up-market'. In other words, the client planned to buy a better house with the profits.
Another badge of trade suggests that, the more frequent the transaction, the more likely there is to be an adventure in the nature of trade. Three or four renovations in five years seems to me to be frequent.
Another badge looks to see if the transaction is similar to the individual's other activities. A builder renovating a house would seem to be involved in similar activities to his main occupation.
The Inspector seems to have a strong case to suggest that the earlier transactions were adventures in the nature of trade. 'Bob' is hoping to claim that the profits are capital profits, covered by principal private residence.
However, even if the Inspector is unable to tax the profits as being from an adventure in the nature of a trade, there is a possibility that the private residence relief is not available. The following is a summary of the Inland Revenue's views from the Tax Bulletin of August 1994. Section 224(3), Taxation of Chargeable Gains Act 1992 is designed to prevent what the Inland Revenue regards as abuse of principal private residence relief. The section applies where a dwelling-house is acquired wholly or partly for the purpose of realising a gain from its disposal. It also applies where there is subsequent expenditure on the dwelling-house wholly or partly for the purpose of realising a gain from its disposal. Where the first part of the section applies, no relief is due on any gain arising from the disposal of that dwelling-house. Where the second part applies, no relief is due on any part of the gain attributable to the expenditure.
The Inland Revenue accepts that many people who buy a dwelling-house may hope that they will eventually make a gain on its disposal. One house may be chosen over another because its value is more likely to appreciate over time. Even though these cases could possibly fall within the first part of the section, the Inland Revenue will not attempt to restrict the principal private residence relief if the house is genuinely acquired and used as a residence and the conditions for relief are met. The legislation will only be applied when the primary purpose of the acquisition was an early disposal at a profit. The same approach will be taken when considering whether a restriction of relief is appropriate under the second part of the section.
The second part of the section is, according to the Inland Revenue, more often applied than the first. It denies relief on the part of a gain that is attributable to particular expenditure, such as the renovation costs.
All in all, 'Bob' will have a more difficult task in defeating the Inspector's attempts to tax the proceeds than the Inspector will have in taxing them. – J.W.G.
For the past half century or longer, couples of modest means have grappled and climbed the property ladder by 'improving and moving'. They acquire a run-down house, the market value of which is depressed by a need of repairs, or which has room and scope for improvements (or both), and turn it into a newly decorated gem. They then use the profit on sale to move up-market to a like project and repeat the cycle. The criterion is that repairs or improvements must cost less than the resulting increase in value. Mostly they achieve that margin by using their own labour, DIY par excellence, perhaps aided by the odd specialist sub-contract to electricians, plumbers or bricklayers. Even then the cost is trimmed by acting as labourers to the specialist. Typically, four or five cycles get them their dream home, often free of mortgage.
What protects them from an allegation of trading as property developers is that they retain their regular jobs, which they need to live on, and moves between properties only occur every one or two years. Exactly the same has happened here, and the only reason for the Inspector's query is that the client is a professional builder. But he too kept his ordinary job. It is suggested that the practitioner stand firm and reject the specious allegation.
Restate the facts to the Inspector and invite his attention to the similar cases on his own files. He need only count the number of, and check, cases where there have been relatively frequent changes of (freehold or leasehold) residence over the past five to ten years. If the point takes too long to clear, ask the District Inspector to intervene. – Man of Kent.
Extract from reply by 'Lane':
This case is best approached as if there will be a hearing before Special (not General) Commissioners, although there is a good chance that the Revenue might back down at the last minute. Rather than quote reported cases, time should be spent on a detailed analysis of the facts relating to each property.
It would help to chart the levels of local prices for similar properties at each stage so as to distinguish the general uplift from any added value thought to have attached to improvements, possibly of little market significance. In particular, repairs and decorations do not imply a trade.
Editorial note. Readers were divided on this query. If the taxpayer wishes to defend his position, then facts, evidence of intentions (perhaps calling his wife as a witness) and a determination to take the case before the Commissioners will be necessary. As suggested by 'Lane', the Revenue could back down before the case went to appeal. Quoting ancient cases would seem to be of little use, but it might be instructive to review Kirkby v Hughes [1993] STC 76.
Residence principle?
A client, employed in the building industry, some years ago (when newly married) purchased a run-down property. The property was initially to live in, but he also carried out improvements and then sold to move into a superior property. During a period of five years he moved house three times before he found his 'dream house'. He lived in all the previous properties with his wife whilst they both carried out the improvements. They lived in the final property for over four years.
The Inspector of Taxes is of the opinion that the earlier purchases/sales were 'an adventure in the nature of trade'. Our client argues that he was doing exactly the same as many other couples do, i.e. improving their life style. Readers' observations would be appreciated.
(Query T15,737) – Bob the Builder.
The term 'adventure in the nature of a trade' is surely something of a red herring. What we are actually talking about is a transaction which has the same characteristics of a trade but which for some reason falls short of being a full-blown unquestionable trade. The normal point of contention is the 'isolated transaction'.
Take for example the case of Commissioners of Inland Revenue v Fraser 24 TC 498. This case involved the purchase and sale of three whisky lots at a profit. The transactions were substantially 'one transaction'. For that reason the transaction fell short of being an actual trade but was found to be an 'adventure in the nature of a trade' because it contained all the hallmarks of a trading transaction save the fact that it was an 'isolated transaction'.
What the Inspector needs to establish is that each property transaction bore all the hallmarks of an actual trade without actually amounting to a full-blown trade. The Inspector should be asked why he considers the transactions amounted to separate 'adventures' and not an actual trade. After all, they were repeated over a period of time. The only plausible explanation is that he already accepts they were separated over such a period of time and that they should be viewed in isolation.
The starting point must be the Inspector's own instructions which make the point that 'a single isolated transaction can amount to the carrying on of a trade for tax purposes (i.e. an “adventure”) but it is generally not easy to show that that is the case (paragraph IH126d)'. Isolated transactions have been found to be 'adventures' but generally only where there are special features present, such as the commodity dealt in or the nature of the taxpayer's regular trade (see, for example Commissioners of Inland Revenue v Fraser and Commissioners of Inland Revenue v Livingstone 11 TC 538).
'Bob the Builder' could sit down and go through the normal badges of trade to confirm whether the Inspector's argument stands up. However, in my opinion, the major pointers to non-trading transactions must be the nature of the asset (the client's own home) and the intention simply to move up the property ladder. The weight to be attached to each badge varies from case to case. It is the overall impression which counts. One cannot help feeling that the Inspector is clutching at straws. Would he have the same view if the client had lost money? He should be asked to substantiate his view drawing on relevant case law bearing in mind the note of caution recorded in his own internal instructions. I think he will struggle. – Accountax.
There are several 'badges of trade' to decide if a trade is being carried on or if there is an adventure in the nature of trade. I will not rehearse the various cases but will highlight a couple of the badges. One of the more important ones is that there should be a profit-seeking motive. The client hopes to avoid this badge by saying that he acquired the house to improve a life-style. I have some difficulty in seeing how moving into a house that was constantly under renovation improves a life-style until the house is sold to obtain funds to move 'up-market'. In other words, the client planned to buy a better house with the profits.
Another badge of trade suggests that, the more frequent the transaction, the more likely there is to be an adventure in the nature of trade. Three or four renovations in five years seems to me to be frequent.
Another badge looks to see if the transaction is similar to the individual's other activities. A builder renovating a house would seem to be involved in similar activities to his main occupation.
The Inspector seems to have a strong case to suggest that the earlier transactions were adventures in the nature of trade. 'Bob' is hoping to claim that the profits are capital profits, covered by principal private residence.
However, even if the Inspector is unable to tax the profits as being from an adventure in the nature of a trade, there is a possibility that the private residence relief is not available. The following is a summary of the Inland Revenue's views from the Tax Bulletin of August 1994. Section 224(3), Taxation of Chargeable Gains Act 1992 is designed to prevent what the Inland Revenue regards as abuse of principal private residence relief. The section applies where a dwelling-house is acquired wholly or partly for the purpose of realising a gain from its disposal. It also applies where there is subsequent expenditure on the dwelling-house wholly or partly for the purpose of realising a gain from its disposal. Where the first part of the section applies, no relief is due on any gain arising from the disposal of that dwelling-house. Where the second part applies, no relief is due on any part of the gain attributable to the expenditure.
The Inland Revenue accepts that many people who buy a dwelling-house may hope that they will eventually make a gain on its disposal. One house may be chosen over another because its value is more likely to appreciate over time. Even though these cases could possibly fall within the first part of the section, the Inland Revenue will not attempt to restrict the principal private residence relief if the house is genuinely acquired and used as a residence and the conditions for relief are met. The legislation will only be applied when the primary purpose of the acquisition was an early disposal at a profit. The same approach will be taken when considering whether a restriction of relief is appropriate under the second part of the section.
The second part of the section is, according to the Inland Revenue, more often applied than the first. It denies relief on the part of a gain that is attributable to particular expenditure, such as the renovation costs.
All in all, 'Bob' will have a more difficult task in defeating the Inspector's attempts to tax the proceeds than the Inspector will have in taxing them. – J.W.G.
For the past half century or longer, couples of modest means have grappled and climbed the property ladder by 'improving and moving'. They acquire a run-down house, the market value of which is depressed by a need of repairs, or which has room and scope for improvements (or both), and turn it into a newly decorated gem. They then use the profit on sale to move up-market to a like project and repeat the cycle. The criterion is that repairs or improvements must cost less than the resulting increase in value. Mostly they achieve that margin by using their own labour, DIY par excellence, perhaps aided by the odd specialist sub-contract to electricians, plumbers or bricklayers. Even then the cost is trimmed by acting as labourers to the specialist. Typically, four or five cycles get them their dream home, often free of mortgage.
What protects them from an allegation of trading as property developers is that they retain their regular jobs, which they need to live on, and moves between properties only occur every one or two years. Exactly the same has happened here, and the only reason for the Inspector's query is that the client is a professional builder. But he too kept his ordinary job. It is suggested that the practitioner stand firm and reject the specious allegation.
Restate the facts to the Inspector and invite his attention to the similar cases on his own files. He need only count the number of, and check, cases where there have been relatively frequent changes of (freehold or leasehold) residence over the past five to ten years. If the point takes too long to clear, ask the District Inspector to intervene. – Man of Kent.
Extract from reply by 'Lane':
This case is best approached as if there will be a hearing before Special (not General) Commissioners, although there is a good chance that the Revenue might back down at the last minute. Rather than quote reported cases, time should be spent on a detailed analysis of the facts relating to each property.
It would help to chart the levels of local prices for similar properties at each stage so as to distinguish the general uplift from any added value thought to have attached to improvements, possibly of little market significance. In particular, repairs and decorations do not imply a trade.
Editorial note. Readers were divided on this query. If the taxpayer wishes to defend his position, then facts, evidence of intentions (perhaps calling his wife as a witness) and a determination to take the case before the Commissioners will be necessary. As suggested by 'Lane', the Revenue could back down before the case went to appeal. Quoting ancient cases would seem to be of little use, but it might be instructive to review Kirkby v Hughes [1993] STC 76.