Tax Implications of Property Transactions

Part A

This essay will address the income tax and capital gains tax implications arising from exercising the options of selling a self-owned residential property, letting out the property, or gifting the property to a connected person.

1. The Option of selling the flat

If Geoff sells the flat, he would incur capital gains tax. Basic-rate taxpayers incur 18% on gains after selling property. Higher and additional-rate taxpayers incur 28%.

This tax becomes applicable when someone is not entitled to full private residence relief. Full private residence relief become applicable when they have one home and lived in it as the main home for all the time they have owned the home; have not let out part of it; have not used a part of it exclusively for business purposes; or have not bought it to make a gain. In the current case, Geoff cannot get full private residence relief when he sells the flat as he did not stay in the flat the whole time and he let it out to his friend.

While calculating the capital tax gains, Geoff can deduct costs for buying or selling the property. He cannot deduct costs such as interest on the loan he took to buy the flat.

Geoff will also incur Capital Gains Tax as he let out the flat. This amount of tax depends on the duration he lived in the flat. How much you pay depends on how long he lived in it. He will incur tax on ‘chargeable gain’, which is the gain minus any Private Residence Relief he is eligible for.

Geoff will get full private residence relief for the years he lived in the home, which the time he started living in the flat in 2007 until 2012 when he left for Milton Keyes. He will also get relief for the last 9 months he owned the home until the date of sale, even if he was were not living there at the time.

Geoff has been living away from his flat since 2012 when he left for Milton Keyes. The relief for the last 9 months before he sells the flat will apply. The only condition for getting this relief is that the flat must be the only or main residence at some point while Geoff owned it. Geoff will also get relief for up to the first 2 years that he owned the home as he lived in it as his only or main residence within the 2 years of owning the flat.

---

1. GOV.UK, ‘Private Residence Relief’ accessed on 10 December 2020 .
2. GOV.UK, ‘Capital Gains Tax rates’ accessed on 10 December 2020 .
3. GOV.UK, ‘Private Residence Relief’ accessed on 10 December 2020 >Tax when you sell your home - GOV.UK (www.gov.uk)>.
4. GOV.UK, ‘Work out your gain’ accessed on 10 December 2020 .
5. GOV.UK, ‘If you let out your home’ accessed on 10 December 2020 >Tax when you sell your home: If you let out your home - GOV.UK (www.gov.uk)>
6. GOV.UK, ‘Tax when you sell your home’ accessed on 10 December 2020 .

In case Geoff makes a loss, he can apply for reducing total taxable gains. In the current case, 2012 until 2019, he has charged £950 per month even though the market rate was at £110.

In the current case, it is an uncommercial let out to a friend. As such, there is no profit or loss. Thus, any expenses incurred can be deducted up to the value of the rent received for that property.

2. The Option of Letting out

If Geoff lets out the flat, he will pay income tax on the rent received. The rate of tax on rental income depends on your total income for the year. 20% basic rate Income Tax is applicable on total taxable rental profit, which is arrived at by deducting allowable rental expenses and personal allowance. The first £1,000 of rental income is tax-free. This is the ‘property allowance’.

Allowable expenses include the interest on the mortgage the Geoff pays to buy the flat. They can be the costs for general maintenance and repairs, utility bills, insurance, service costs, and legal and accountant fees among other things. If Geoff charges non-refundable deposits for the property, such deposits will also count as rental income. So, rental income will also include the money that is kept from returnable deposit at the end of the tenancy. However, allowable expenses cannot be full amount of your mortgage payment and other personal expenses.

As Geoff has been in employment during this financial year, he will be liable to pay tax on earnings from his total employment and rental profit minus his personal allowance for the year.

The rental income, thus, gets added to other income Geoff earns. The tax rates band in case of a standard Personal Allowance stands at £12,500.

The rental income and any other income that Geoff earns will be collectively treated as one for calculating the rental income tax.

3. The Option of gift

1. GOV.UK, ‘Examples of how to work out Income Tax when you rent out a property’ accessed on 10 December 2020 .
2. Ibid.
3. GOV.UK, Work out your rental income when you let property’ accessed on 10 December 2020 .
4. Ibid.
5. GOV.UK, ‘Examples of how to work out Income Tax when you rent out a property’ GOV.UK, accessed on 10 December 2020
6. GOV.UK, ‘Income Tax rates and Personal Allowances’ accessed on 10 December 2020

Geoff’ cousin will be treated as a ‘connected people’. The normal gift rules will apply if the property is gifted to his cousin.

Geoff will incur Capital Gains Tax on the gain when he disposes the flat. The flat is his main home that he had let it out. As such, the flat is a chargeable asset. Since the gift will be to his cousin, Geoff will need to pay Capital Gains Tax on his total gains above an annual tax-free allowance. The tax-free allowance is £12,300. So, if your gain is up to £12,300, it is tax free.

As Geoff is gifting the property to his cousin, he may not be able to may also be able to reduce tax bill by deducting losses.

Geoff will pay higher rate Income Tax if he is a higher or additional rate taxpayer. The rate will be 28% on gains from residential property and 20% on gains from other chargeable assets. If he is a basic rate taxpayer, the rate depends on the size of the gain, the taxable income and the type of the property or other assets.

The tax rates band in case of a standard Personal Allowance stands at £12,500.

If Geoff has saving interests, they are treated as tax-free allowances.

The capital gain is normally the difference between what an owner paid for the flat and what he sold it for. However, the market value will be used instead in case of gift to calculate capital gains. It is the market value at the time of gift.

Geoff must not that there will be Inheritance Tax on the gift to his cousin. Small gifts are exempted gifts. There is also no Inheritance Tax on gifts to spouses or civil partners made during his lifetime and as long as the spouse or the partner live in the UK permanently.

---

1. GOV.UK, ‘Capital Gains Tax’ accessed on 10 December 2020 .
2. Ibid.
3. GOV.UK, ‘What you pay it on’ accessed on 10 December 2020 .
4. GOV.UK, ‘Capital Gains Tax allowances’ accessed on 10 December 2020 .
5. GOV.UK, ‘If you make a loss’ accessed on 10 December 2020 .
6. GOV.UK, ‘Capital Gains Tax rates’ accessed on 10 December 2020 .
7. GOV.UK, ‘Income Tax rates and Personal Allowances’ accessed on 10 December 2020 .
8. GOV.UK, ‘Current rates and allowances’ accessed on 10 December 2020 .
9. GOV.UK, ‘Market value’ accessed on 10 December 2020 .

Other gifts will be counted towards the value of the flat. So, the cousin will be charged Inheritance Tax if the gift is more than £325,000 (in this case the value of the flat is £425,000) in the 7 years before Geoff’s death.

The ‘taper relief’ shows the sliding scale of inheritance tax. For less than 3 years, the rate stands at 40%; 3 to 4 years at 32%; 4 to 5 years at 24%; 5 to 6 years at 16%; and 6 to 7 years at 8%. For 7 years or more, the tax rate is at 0%.

If Geoff makes the gift after 7 years, the gift will not be counted to the value of the flat.

To conclude, if the flat is sold, Geoff cannot get complete Private Residence Relief as he did not stay in the flat the whole time and he let it out to his friend. Tax will be on ‘chargeable gain’. He can get relief on interest on the loan. He will get private residence relief for the years he lived in the flat and for the last 9 months he owned the home until the date of sale. He can also get tax reduction for the monthly rent charge, which was below the market rate.

If the flat is let out, the Income Tax rate will apply after deducting allowable rental expenses and personal allowance. Geoff will get the first £1,000 of rental income tax-free. He can also deduct the interest in the mortgage he has. For calculating the rate, the tax will be on earnings from total employment and rental profit.

In case Geoff gifts the property to his cousin, the normal rule of capital gains tax, as applicable in case the flat was sold, will apply. Since his cousin is a connected person, he cannot avail the deduction due to loss. The capital gain tax is on his total gains above an annual tax-free allowance. If the gain is up to £12,300, it is tax free. The tax band will be applicable depending on whether he is higher or a basic rate taxpayer. In this case, since the value of the flat is £425,000, his cousin will be charged Inheritance Tax.

---

1. GOV.UK, ‘Gifts’ accessed on 10 December 2020 .
2. Ibid.
3. GOV.UK, ‘Gifts’ accessed on 10 December 2020 .

Websites

GOV.UK, ‘Capital Gains Tax rates’ accessed on 10 December 2020

GOV.UK, ‘Current rates and allowances’ accessed on 10 December 2020

GOV.UK, ‘Examples of how to work out Income Tax when you rent out a property’ accessed on 10 December 2020

GOV.UK, ‘Gifts’ accessed on 10 December 2020

GOV.UK, ‘If you let out your home’ accessed on 10 December 2020 >Tax when you sell your home: If you let out your home - GOV.UK (www.gov.uk)>

GOV.UK, ‘If you make a loss’ accessed on 10 December 2020

GOV.UK, ‘Income Tax rates and Personal Allowances’ accessed on 10 December 2020

GOV.UK, ‘Market value’ accessed on 10 December 2020

GOV.UK, ‘Private Residence Relief’ accessed on 10 December 2020

GOV.UK, ‘Tax when you sell your home’ accessed on 10 December 2020

GOV.UK, ‘What you pay it on’ accessed on 10 December 2020

GOV.UK, ‘Work out your gain’ accessed on 10 December 2020

Part B.

In this essay, a critical analysis of the effectiveness of reform in property tax through GAAR (Section 206 of the Finance Act 2013 or FA 2013) is conducted and the essay also considers the extent to which these reforms have led to fairer system of taxation of property.

In IRC v Duke of Westminster, Lord Tomlin identified one of the founding principles of English taxation law thateverybody is entitled to order their affairs in the manner that they may be able to reduce the taxes due by them under the appropriate Acts. This derives from the principle that taxation ought to be fair and people ought to be able to organise their affairs so that they can take advantage of concessions in taxes offered to them by the relevant laws. At the same time, in IRC v McGuckian, the House of Lords explained what is called as the Ramsey Principle, which provides that whilethe right of individuals to determine their property issues is to be respected, at the same time, the government’s right to apply fair and adequate tax laws also has to be ensured. Thus, fairness in the context of system of taxation of property demands that there is a balance drawn between the rights of the individuals to organise their affairs related to their property in the manner that allows them to take opportunities for reducing their tax burdens where they can and the rights of the government to levy fair and adequate taxes.

GAAR refers to the principle of General Anti Avoidance Rule (GAAR) which becomes applicable when abuse is identified as a motive for tax avoidance.The 2013 GAAR brought forth in Section 206 of FA 2013 applies to income tax, capital gains tax, corporation tax, inheritance tax, stamp duty tax, and others. Therefore, as a reform is a wide reaching and applies to different types of taxes that are collected by the government under the umbrella of property tax. To bring it to perspective of what this essay is discussing, GAAR is meant to apply in a way that it brings about a fair regime of taxation which as per the Ramsey Principle, balances the right of individuals to determine their property with the government’s right to apply fair and adequate tax laws. What is sought to be done through GAAR is to ensure that individuals do not avoid taxes in a way that is abusive. The introduction of GAAR in Section 206 of FA 2013 was aimed at “countering the unfair tax advantages of fiscal provisions” as noted in Section 206 (1) FA 2013. Therefore, clearly there is the application of fairness principle as provided as a justification for GAAR, and this essay will discuss later whether this objective has been achieved or not.

The GAAR in Section 206 FA 2013 can be said to be resultant in a fair tax system if it allows a choice structure to the tax payer which does not unfairly allow tax evasion schemes. Thus, Part 5 and Schedule 43 of FA 2013 empowers HMRC to counteract tax arrangements that are abusive in nature. However, what is abusive is open to interpretation. In that context, it would be useful to consider a common area of abuse in that of residential property use as commercial property but depiction as residential property for the purpose of evasion of taxes.Thus, a person may evade taxes payable under the law by using their residence for business income so that Capital gains tax (CGT) is not payable on such property. There is also a practice ofsplitting land into plotsfor development so that non-taxable income is allowed under certain circumstances, like where the business of the person is not development of property under the Part 2 of ITTOIA 2005.

---

1. IRC v Duke of Westminster [1936] A.C. 1; 19 TC 490.
2. IRC v. McGuckian [1997] STC 908 (H.L.).
3. Peter Harris, ‘The Profits Tax GAAR: An Aid in the Hopeless Defence against the Dark Arts’ in Peter Harris and Dominic De Cogan (eds), Studies in the History of Tax Law Volume 8 (Hart Publishing 2017).
4. Section 206(3) FA 2013.

Theprincipal residence based tax exemptions can lead to perverse results in some cases also because of the law which allows a person to elect the principal residence site irrespective of the length of time they have lived there and availability of other residence. This is seen in the case of Ellis v HMRC.In this case, the appellant had nominated the property as main residence making them eligible for PPR relief under TCGA 1992, s 222(5)). The HMRC was of the opinion that as the property was not actually a residence as occupation was only temporary and there was another residence that was available. However, the court refused to allow the argument put forth by HMRC because the legislation allows the taxpayer to nominate from a choice of residences and the nomination was valid in the case. On the other hand, in another case, where the taxpayer moved out of the matrimonial home and lived in the new property for eight months before selling it, he was not allowed PPR relief because he referred to his property as ‘temporary’ in the application even though it was the only place of residence that the taxpayer had at the time.

What can be surmised from the above two cases is that a lot depends on how the courts interprets the provisions. Unless GAAR is intentionally interpreted, a fair property tax system may not be achieved.A report published prior to the GAAR 2013 implementation has noted the task of the courts in dealing with abusive schemes based on application of normal principles of statutory interpretation of the tax provisions which leads to uncertainty in predicting the outcome of such disputes and how GAAR targeted at abusive schemes would reduce the practice of stretched interpretation and resultant uncertainty.

1. Ellis v HMRC [2013] UKFTT 775 (TC).
2. Piers Moore v HMRC [2013] UKFTT 433 (TC).
3. Graham Aaronson QC, A study to consider whether a general anti-avoidance rule should be introduced into the UK tax system (2011) accessed
4. < https://webarchive.nationalarchives.gov.uk/20130402163458/https://www.hm-treasury.gov.uk/d/gaar_final_report_111111.pdf>

GAAR as a concept is based on the premise that the Revenue Authorities can deny to the taxpayer the tax benefits of transactions or arrangements under certain conditions. However, the problem with the GAAR 2013 is that while it prevents tax abuse it does not prevent tax avoidance.Moreover, the burden of establishing abuse is on the HMRC. On the other hand, it is said that the problem with the 2013 GAAR reform is that it defines abuse in Section 206 FA 2013 in context of intention or motive to avoid taxes, which is seen to be too broad a definition of abuse. This can be linked to another issue involved in the enforcement of GAAR which is that GAAR can achieve a reasonable tax assessment framework, if it is interpreted purposively. In tax laws, purposive approach is used by the courts to look into the intention of legislation when court considers if certain provisions are the inconsistency, absurdity, or inconvenience. The purposive approach was applied in Barclays Mercantile Business Finance Ltd v. Mawson, as per which legislation should be construed purposively and applied to the facts viewed realistically.

So the question is whether any of these arguments establish that GAAR does not lead to a fair system of taxation. To go back to the point made earlier, fairness would mean that while the taxpayer is allowed to organise their affairs in the way that allows them to take advantage of the tax concessions, the government is also given opportunity to levy adequate and fair taxes. Does GAAR achieve this?To some extent, the answer to that question can be given in affirmative because the GAAR principle in Section 206 FA 2013 does bring in certainty and reliability in how tax abuse is interpreted which earlier was done by the judiciary without statutory principles thereby leading to unreliability and uncertainty. Now the courts have a clear statutory directive that for the determination of actions as abusive, it has to be established that such actions were part of a tax arrangement, which could not reasonably be regarded as a reasonable course of conduct thus being abusive, and also that it conferred a tax advantage. Moreover, bringing in fairness to scheme, the GAAR Advisory Panel has issued guidance that taxpayers cannot indulge in inventive schemes in order to eliminate or reduce their tax liability.Coming back to the point discussed in the earlier paragraph, however, it must be noted that to the extent that judicial principles are retained as part of the GAAR, it may be said that there is still a level of uncertainty that is associated with how the judiciary may interpret abuse in terms of actions of the taxpayers. Therefore, the issue of interpretation still remains relevant to how far GAAR would be effective in creating a fairer system of taxation. To that extent, it is recommended by some that purposive interpretation should be applied in order to ensure that GAAR remains fair.

1. PwC, Removing the fences: Looking through GAAR (February 2012), accessed
2. TUC, ‘The Deficiencies in the General Anti- Abuse Rule’ accessed
3. Peter Harris, ‘The Profits Tax GAAR: An Aid in the Hopeless Defence against the Dark Arts’ in Peter Harris and Dominic De Cogan (eds), Studies in the History of Tax Law Volume 8 (Hart Publishing 2017).
4. Barclays Mercantile Business Finance Ltd v Mawson (HM Inspector of Taxes), [2004] UKHL 51.
5. Judith Freedman, ‘The UK General Anti-Avoidance Rule: Transplants and Lessons ’, Bulletin For International Taxation (IBFD June/July 2019)accessed < https://www.ibfd.org/sites/ibfd.org/files/content/pdf/The-UK-GeneralAnti-Avoidance-Rule.pdf?utm_source=twitter&utm_medium=social-media&utm_campaign=tweet-week36&utm_content=pdf/The-UK-General-Anti-Avoidance-Rule.pdf>

To conclude, while GAAR 2013 is an important reform in property tax law with implications for different kinds of property taxes, the extent to how far it is effective in bringing about a fairer system of taxation would depend on how abuse in Section 206 is interpreted by the courts. The courts can apply purposive approach of interpretation so that interpretation is done as per the intention of legislation. It is clear that GAAR never intended to prevent avoidance of tax, it intended abuse of tax. Accordingly, what is needed is that taxpayers be allowed to have freedom to arrange their financial matters so as to avoid taxes if they legitimately can. At the same time, abuse is not permitted thereby allowing state to collect taxes that are appropriate and adequate. This allows fairness but much will depend on how courts continue to interpret abuse under Section 206 as there is a possibility that wider construction of abuse may allow HMRC to raise more and more objections to tax avoidance which may not be the intention of the legislation.

---

1. HMRC, ‘General Anti-Abuse Rule (GAAR) Guidance’ , [2018] accessed
2. Peter Harris, ‘The Profits Tax GAAR: An Aid in the Hopeless Defence against the Dark Arts’ inPeter Harris and Dominic De Cogan (eds), Studies in the History of Tax Law Volume 8(Hart Publishing 2017).

Authorities

Barclays Mercantile Business Finance Ltd v Mawson (HM Inspector of Taxes), [2004] UKHL 51.

Ellis v HMRC [2013] UKFTT 775 (TC).

IRC v Duke of Westminster [1936] A.C. 1; 19 TC 490.

IRC v. McGuckian [1997] STC 908 (H.L.).

Piers Moore v HMRC [2013] UKFTT 433 (TC).

Books

Harris P, ‘The Profits Tax GAAR: An Aid in the Hopeless Defence against the Dark Arts’ in Peter Harris and Dominic De Cogan (eds), Studies in the History of Tax Law Volume 8 (Hart Publishing 2017).

Websites

Aaronson G QC, A study to consider whether a general anti-avoidance rule should be introduced into the UK tax system (2011) accessed

< https://webarchive.nationalarchives.gov.uk/20130402163458/https://www.hm-treasury.gov.uk/d/gaar_final_report_111111.pdf>

Freedman J, ‘The UK General Anti-Avoidance Rule: Transplants and Lessons ’, Bulletin For International Taxation (IBFD June/July 2019) accessed

< https://www.ibfd.org/sites/ibfd.org/files/content/pdf/The-UK-GeneralAnti-Avoidance-Rule.pdf?utm_source=twitter&utm_medium=social-media&utm_campaign=tweet-week36&utm_content=pdf/The-UK-General-Anti-Avoidance-Rule.pdf>

HMRC, ‘General Anti-Abuse Rule (GAAR) Guidance’ , [2018] accessed

PwC, Removing the fences: Looking through GAAR (February 2012),

accessed

TUC, ‘The Deficiencies in the General Anti- Abuse Rule’ accessed

Take a deeper dive into Synergy of Strategic Management and Accounting Principles for Business Enhancement with our additional resources.