Taxation logo taxation mission text

Since 1927 the leading authority on tax law, practice and administration

Replies to Queries -- 1 -- Development dilemma

27 June 2001
Issue: 3813 / Categories:

The principal private residence of one of our clients is situated in grounds of just under half a hectare. Our client has obtained planning permission to build a dwelling in the garden and can either sell the building plot, or carry out the building work himself and sell the new property once it is complete.

He intends to continue to reside in his existing residence.

The principal private residence of one of our clients is situated in grounds of just under half a hectare. Our client has obtained planning permission to build a dwelling in the garden and can either sell the building plot, or carry out the building work himself and sell the new property once it is complete.

He intends to continue to reside in his existing residence.

The sale of the building plot should escape any capital gains tax under the principal private residence exemption, but we would be grateful if readers could comment on the tax implications of our client developing the site himself and selling the property. Our client is not a builder by trade.

We have received advice that even if our client were to develop the house himself and sell it on, then this would be totally free of tax, but we need confirmation that this is correct.

The Inland Revenue has given us the impression that the whole transaction would be free of any tax, but we would appreciate readers' views.

(Query T15,828) – Garden Builder.

 

If I went around giving the sort of advice some Revenue officials seem to give, no professional indemnity cover would be available. Perhaps I am doing the Revenue a disservice. From the comment 'given the impression', I wonder if this is a case that has been properly considered. Nevertheless, my immediate reaction would not have been to say yes. If the client follows the Revenue's impression here, I suggest that 'Garden Builder' keep a copy of the answers to Query 15,816.

The relief is governed by section 222, Taxation of Chargeable Gains Act 1992. The grounds fall within the permitted area and are being sold when the main residence is still being occupied. The problem arises from ibid., section 224. Most people know that section 224 denies relief if the property was acquired wholly or partly with the intention of making a gain, but the section goes further. It denies relief to any part of the gain that arises from expenditure incurred with the intention of making a gain. Since the house is being built with the intention of being sold at a profit, any of the profit on the house will not be exempt. Furthermore, any increase in the land value attributable to the house will also fall outside the exemption.

Inland Revenue Interpretation 75 sets out the Revenue's views on this issue. It will deny relief where there is development of the land attached to the residence. The Interpretation helpfully points out that the Revenue will generally ignore any increase in value attributable to obtaining planning permission.

In other words, selling the plot will fall within the principal private residence exemption. Building the second house will not.

I could then submit a second answer discussing whether the profit will be taxed as a trading receipt, Schedule D, Case VI or capital gain, but taxed it should be. If a proper valuation is obtained, the land could be appropriated to trading stock of the building trade, giving a tax-free disposal of the plot and this would form the basis of the cost of sales for the building trade. – J.W.G.

Unfortunately, the position is not as straightforward as 'Garden Builder' has been led to believe and it is unlikely that his client could develop a house in the garden and realise the proceeds free of tax.

Under section 222(1), Taxation of Chargeable Gains Act 1992 principal private residence relief applies to gains on the disposal of either:

(a) a dwelling-house ... which is, or has at any time in his period of ownership been, his only or main residence; or

(b) land which he has for his own occupation and enjoyment with that residence as its garden or grounds up to the permitted area.

If the client simply sells the land to a developer then some residence relief should be available, because this is a disposal of land within the permitted area which was part of the garden and was therefore used for his enjoyment with the house.

If, instead, the client builds the new house, he will not be selling his main residence as required in (a) above and neither will he be selling either just land or land and outbuildings required for the enjoyment of his house under (b) above. A new house within the grounds of his property will not qualify as an outbuilding in the way that perhaps a gardener's cottage may do, since it will not be used by staff and will presumably be of a significant size in relation to the existing property. Finally, the new property is clearly not required for the enjoyment of the existing home, as the intention is to sell it once it has been built.

'Garden Builder' should also have regard to section 224(3), Taxation of Chargeable Gains Act 1992 which says:

'Section 223 shall not apply in relation to a gain if the acquisition of, or of the interest in, the dwelling-house or the part of a dwelling-house was made wholly or partly for the purpose of realising a gain from the disposal of it, and shall not apply in relation to a gain so far as attributable to any expenditure which was incurred after the beginning of the period of ownership and was incurred wholly or partly for the purpose of realising a gain from the disposal.'

The development of the new dwelling clearly falls within the above definition. Therefore, if the client proceeds, at best he may be able to argue that the gain on the land element alone is covered by residence relief. In relation to the land element, whether sold alone or with the new property, it could be argued that much of the growth in value of the land was attributable to the expense of obtaining planning permission which itself was expended solely with a view to realising a gain from the disposal of the land. This would restrict substantially the gain covered by the relief.

The profit on the disposal of the new property is, however, likely to be taken out of capital gains tax and within the anti-avoidance provisions of section 776, Taxes Act 1988. This would mean that the gain would be subject to income tax under Schedule D, Case VI with no taper relief, capital losses or annual capital gains tax exemption to set against it. The provisions apply whenever land is developed with the sole or main object of realising a gain from disposing of the land when developed.

Whilst the tax position is clearly important and is not as 'Garden Builder' has been advised, he should of course remember to consider the commercial benefits of whether or not the further profits from the development are worthwhile. – Wentworth.

 

Has the VAT been forgotten? 'Garden Builder's' client will suffer some unless correctly advised. The main point is of course to register for VAT at an early date so as to be able to recover tax on such costs as the services of planning advisers and architects. Do not forget that this will also bring into VAT any other taxable supplies, such as bed-and-breakfast, which the client happens to be making, unless you ensure that they are in a separate legal entity.

Whilst the services of the builder will be zero rated, that will not apply to anything (such as fitted cupboards and carpets) which fails to qualify as building materials, as defined by Note (22) to Group 5 of Schedule 8 to the VAT Act 1994. That particular VAT will not be recoverable because it is denied under Article 6, Input Tax Order (SI 1992 No 3222).

The remaining VAT incurred will be recoverable against the zero-rated sale of the finished house. Possible examples are standard-rated costs in landscaping, etc. and, presumably, on 'Garden Builder's' fees. – A St John Price.

 

Editorial note. It should be noted that, under Revenue Interpretation RI 75, the Revenue only ignores cases under the second part of section 224(3) where the only relevant expenditure is incurred on obtaining planning permission or removing restrictive covenants.

Issue: 3813 / Categories:
back to top icon