Lee Sharpe considers a recent capital gains tax case that seems to have upset HMRC.
The relatively few sections of legislation starting at TCGA 1992 s 222, governing ‘only or main residence relief’ (commonly known as principal private residence (PPR) relief) have been the subject of numerous fierce debates over the years.
A series of cases culminating in a Court of Appeal hearing in 2019 has caused HMRC some serious introspection, followed by some sulky ‘reforms’ of the tax code (through FA 2020, s 24) that, despite ostensibly being aimed at making the regime fairer, somehow conspired to net around £150m per annum in additional tax revenue by 2023/24.
Unfortunately for HMRC, the adverse rulings just keep coming.
The legislation on ‘period of ownership’
The code basically starts by relieving any capital gain arising on the disposal of a dwelling house that has been a taxpayer’s PPR during their ‘period of ownership’. The relief is restricted according to various parameters, such as any periods where the dwelling house has not qualified as the taxpayer’s PPR during that period of ownership.
HMRC has long maintained that the ‘period of ownership’ commences immediately when the taxpayer acquires any interest on which expenditure might be deductible in computing a capital gain (see, for instance, HMRC’s Capital Gains Manual at CG64930).
For example, this could include acquiring an interest in the land on which a dwelling house is to be built later (or first acquiring a leasehold that is later enfranchised into the freehold). However, HMRC has also insisted that only the period in which the PPR is physically occupied as the taxpayer’s main residence will qualify as their PPR. Following HMRC’s approach, if there is a significant delay between first ‘signing contracts’ and moving into the property, PPR relief will not cover that initial phase of the period of ownership.
Case law
HMRC’s position has been supported by case law, such as Henke v HMRC [2006] STC (SCD) 561, wherein a married couple purchased a bare plot of land in 1982 but did not build a house and start to live in it until around 1993. The Special Commissioner upheld HMRC’s argument that the first decade or so of the taxpayers’ period of ownership, starting with the purchase of the land, did not qualify for PPR relief, as they did not occupy a residence there until 1993.
However, in Higgins v HMRC [2017] UKFTT 236 (TC), a case involving a delay in taking up occupation of an off-plan apartment, the First Tier Tribunal decided that the four-year interval between the taxpayer entering into the contract in 2006 and the property being ready to move into around 2010, should not make up part of Mr Higgins’ overarching period of ownership, so as to dilute the PPR-qualifying period afterwards. Rather, his period of ownership began only when the purchase finally completed.
The case went against the taxpayer at the Upper Tribunal, but in Higgins v HMRC [2019] EWCA Civ 1860, the Court of Appeal agreed with the original ruling in favour of the taxpayer, noting:
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When contracts were exchanged in 2006, Mr. Higgins’ apartment (his dwelling house for PPR relief purposes) was no more than an empty space in the tower and did not physically exist until November 2009 at the earliest; and
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it would be illogical for the relief to be unable to fully cover people buying a new-build home and waiting some considerable time between signing contracts and completion or being able to move in.
The final ruling carried some weight as a Court of Appeal case, forcing HMRC into a bout of soul-searching. Amongst other things, this resulted in a new TCGA 1992, s 223ZA, which broadly set out that a delay of up to two years between acquiring an initial interest in the land and physical occupation of the dwelling would qualify for PPR relief. However, a greater delay in moving in would mean none of the interval would qualify for PPR relief – it should be treated as ‘all-or-nothing’.
The Lees case
In Lee & Another v HMRC [2022] UKFTT 175 (TC), Gerald and Sarah Lee acquired a house in late 2010 for around £1.7m but demolished it in order to build a new house. The new property was completed on 15 March 2013 and the Lees took up residence four days later. They sold the property 14 months afterwards for circa £6m. As usual, HMRC argued that the ‘period of ownership’ had started back in 2010, on the first acquisition of an interest in the land and also that the delay in taking up occupation had exceeded two years, so the saving at (what is now) section 223ZA did not apply, and the majority of the gain on disposal was ineligible for PPR relief and therefore taxable.
The taxpayers argued that the ‘clock’ could not start until the property was capable of occupation, the broad effect being that the ‘period of ownership’ was much shorter than HMRC had arrived at and was fully covered by PPR.
In Lees, the First Tier Tribunal considered Henke v HMRC (see above) but refused it, preferring the spirit of the more recent Higgins v HMRC (see above), and found for the taxpayers. The tribunal observed that in the legislation, the period of ownership referred to the dwelling house, not mere land, and the clock should not start until the dwelling house was there to be occupied. Of course, HMRC appealed (once it had managed to calm down!).
At the Upper Tribunal, in HMRC v G Lee & Another [2023] UKUT 00242 (TCC), HMRC introduced no fewer than eight grounds of appeal, including briefly:
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The underlying asset giving rise to the capital gain was the land, so the clock must start on acquiring an interest in the land.
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A dwelling house is not capable of ownership separately from the ground on which it stands, so it is essentially subordinate to the land.
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In English law, the dwelling house is itself ‘land’, so ownership must commence when the first relevant interest in land is acquired.
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The FTT was wrong not to have followed the Henke case, particularly because, in HMRC’s eyes, the Higgins case endorsed Henke (based on an obiter dictum comment about acquiring bare land to develop).
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Numerous tax consequences would arise so mind-bogglingly awful that parliament could not possibly have intended for them to arise.
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Following the approach in Lees, when living in one eligible PPR, while owning a plot of bare land that was developed alongside and promptly occupied as a main residence, both the first PPR and the developed plot might effectively enjoy PPR relief for increased value that had accrued over the overlapping initial stage – occupation of one, and development of the other. In fact, endorsing the taxpayers’ approach meant that demolishing then replacing property might achieve more overall PPR relief than simply renovating the original!
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The legislation carefully crafted by HMRC at section 223ZA in 2020 and dealing with delays in taking up occupation would be redundant, and TCGA 1992, s 38 that deals with allowable costs might as well be cancelled.
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The long-standing anti-avoidance provision at TCGA 1992, s 224(3) (which broadly states that PPR relief will not apply where a dwelling house has been acquired with the purpose of realising a capital gain on its disposal) might not be sufficiently wide or robust as to prevent someone from masking a large gain on valuable land by building a modest dwelling on it and occupying it as a residence to access PPR relief across all of the land gain accrued.
The Upper Tribunal disagreed with or simply discounted all HMRC’s arguments (which are simplified here for brevity), dismissed HMRC’s appeal and upheld the FTT’s decision.
Conclusion
On its own, the Higgins cases represented a significant challenge to HMRC’s approach to marking the taxpayer’s period of ownership. But it now seems to have swayed the courts (at least as far as the Upper Tribunal) to reconsider what really matters for PPR relief claims and the period of ownership – the underlying land or the dwelling itself? Time will tell if HMRC is prepared to face up to the possibility that it may have been getting these cases quite wrong for all these years – or whether it decides to double down on ‘clarifying’ the legislation – all in the interests of fairness, of course.
