Private Residence Relief – Is That ‘Settled’?

Mark McLaughlin points out that capital gains tax ‘private residence relief’ for ‘settled’ property may be more accessible than some taxpayers and their advisers might assume.         

Private residence relief (PRR) for capital gains tax (CGT) purposes is perhaps one of the few tax reliefs of which most taxpayers are familiar. This is probably because the relief is so valuable; in many cases it effectively exempts the entire gain on the disposal of a dwelling house which is an only or main residence.   

PPR applies to disposals by individuals. The relief is extended to trustees, on gains from the disposal of settled property. In the latter case, a claim for the relief is available where, during the period of ownership of the trustees, the property was a dwelling house occupied as the only or main residence of a person entitled to occupy it under the terms of the settlement (TCGA 1992, s 225). 

If those requirements are satisfied, the PRR provisions (in ss 222-224) apply to the trustees in the same way as for an individual. As indicated, the trustees must claim the relief.

The terms ‘settlement’ and ‘trust’ are often used interchangeably, as if they mean the same thing. However, a ‘settlement’ has a wider meaning, and is defined (for income tax purposes, at least) to include “any disposition, trust, covenant, agreement, arrangement or transfer of assets” (ITTOIA 2005, s 620(1)). 

By contrast, in general terms a trust is created and structured more formally, usually by a written document, either during an individual’s lifetime (a trust ‘deed’ or ‘instrument’), or perhaps on death (a ‘will trust’).

Thus (for example) an arrangement between one individual and another can be a ‘settlement’, without necessarily constituting a trust; a settlement is all that is necessary for the PRR relief applicable to trustees (in TCGA 1992, s 225) to become available.

A settlement can be useful (for example) in the context of residences occupied by family members, such as elderly parents. In Wagstaff & Anor v Revenue & Customs [2014] UKFTT 43 (TC), a gain on the disposal of a flat, which was owned by a married couple and occupied by a relative who had previously sold the property to them, was held to be eligible for main residence relief as ‘settled property’ under TCGA 1992, s 225.

In that case, the couple jointly owned a flat, which was sold during 2006/07 at a gain. The flat was previously owned by the husband's mother (Mrs W). She sold the flat to her son and daughter-in-law in February 1996 for £45,000 (i.e. an arm's length valuation). 

The sale of the flat was subject to an agreement between the parties, under which Mrs W was entitled to continue living at the property at no cost for life (or until remarriage), subject to a payment to the couple of £5,000. The agreement also provided (among other things) that Mrs W would pay all household expenditure (e.g. heat and light), and the couple would pay for repairing and decorating the property.   

Mrs W continued occupying the property until August 2005, when she suffered an accident (by falling downstairs), and needed surgery. Mrs W subsequently lived with the couple, although the flat remained available for her use. In June 2006, Mrs W moved into a new, single storey property, which was bought by the couple and occupied on the same terms under the agreement. The original flat remained empty until it was sold, with Mrs W’s agreement, in March 2007.

Husband and wife both claimed PRR under TCGA 1992, s 225, on the basis that their ownership of the flat was subject to a trust, and that the flat was settled property which qualified for relief under that section. HMRC refused the claim, and the couple appealed.

The First-tier Tribunal held that in acquiring the flat from Mrs W on terms that included the agreement, the couple assumed the role of trustees, so that they did not become at that time absolutely entitled to the flat with the exclusive right to direct how it should be dealt with. Their interest in the flat was therefore ‘settled property’ (other than property held as ‘nominees’ or ‘bare trustees’). The PRR requirements (in TCGA 1992, s 225) were satisfied. The appeal was therefore allowed.

The tribunal in Wagstaff accepted that the couple entered into the agreement for less than full consideration (i.e. £5,000). Thus there was an element of bounty in the arrangement. ‘Bounty’ has been recognised in case law as a necessary element for a settlement to exist (see, for example, CIR v Plummer [1979] 54 TC 1), albeit that the concept has mainly been relevant to the meaning of ‘settlement’ for the purposes of income tax anti-avoidance legislation (ITTOIA 2005, s 620).

HMRC noted in Wagstaff that the agreement between the parties had been prepared by a solicitor, and broadly argued that if a settlement had been intended, the agreement would have been drafted accordingly. However, the tribunal considered that the agreement (which was described as a ‘brief document’) would not necessarily specify what form of legal relations was created between the parties. The agreement was not solely determinative, i.e. it was necessary to consider from all the evidence whether the relationship between the parties was such that the couple were trustees, and the flat was settled property.

       

The existence of a legally binding agreement appears to have been an important factor in the tribunal's decision in Wagstaff. The tribunal considered that the parties intended that the arrangements under the agreement should give rise to legal rights and obligations that would regulate their relationship during Mrs W's lifetime. The tribunal described the understanding that the arrangement was legally binding on the parties as being “fundamental”.

At the time of writing, it is not known whether HMRC will appeal the tribunal’s decision in Wagstaff. HMRC might argue that an appeal is unnecessary, as the case was decided on its particular facts. 

HMRC's Capital Gains manual includes detailed guidance on private residence relief on settled property (at CG65400 onwards). Interestingly, HMRC states the following about family agreements (CG65426):

“A practical difficulty with claims under TCGA92/S225 is that often you are considering informal family agreements in which little thought has been given to the detail of the arrangements and still less to their legal effects. Often all the parties will agree it was accepted that the occupier is entitled to live in the property for as long as he or she wanted to. That is just evidence that there was a licence to occupy the property. The parties need to establish that there was a common intention that the occupier would have an interest such as a life interest in the property.”

Fortunately for the appellants in Wagstaff, in the tribunal's view the agreement provided the necessary evidence of their intention from the outset to create an interest for a relative in settled property (i.e. the flat).

Nevertheless, based on HMRC’s guidance on the subject, it seems likely that claims for PRR on settled property involving family members may be subject to scrutiny, particularly where no formal deed or agreement exists. Whilst not legally binding, HMRC’s guidance should be noted in terms of being aware of their views and approach in such cases.

The tribunal's decision in Wagstaff may be of particular interest to families with elderly relatives who are homeowners, where equity release arrangements are being considered in order to generate income for the relative. This was apparently one of the reasons for the arrangements in Wagstaff. 

However, make sure that the arrangements are sufficient to constitute a ‘settlement’ based on the facts. If in doubt, consider a formal trust arrangement instead, and always seek expert professional advice where necessary.