Private Residence Relief: Tables Turned On HMRC!

Mark McLaughlin highlights a case in which the burden of proof was on HMRC in respect of a taxpayer’s private residence relief claim. 

Individuals who dispose of a dwelling house sometimes find themselves in disputes with HM Revenue and Customs (HMRC) over whether private residence relief (PRR) is due on the disposal of the property for capital gains tax (CGT) purposes (under TCGA 1992, s 222). Numerous cases have reached the courts and tribunal over the years.

If PRR was claimed but HMRC has assessed CGT on the disposal of the dwelling house on the basis that PPR is not due, the onus is normally on the taxpayer to demonstrate that HMRC’s assessment is excessive (TMA 1970, s 50(6)). However, if HMRC has made a ‘discovery’ assessment (under s 29) outside the normal time limit for making an enquiry into the individual’s tax return, the burden of proof is on HMRC to demonstrate that a loss of tax has been brought about carelessly or deliberately by the taxpayer. This requirement can be important. 

For example, in Munford v Revenue and Customs [2017] UKFTT 19 (TC), in June 2004, the taxpayer and his wife purchased a property (‘NW11’) for £4 million. On the same day, the taxpayer purchased a property (‘SW3’) in his sole name for £1,050,000. He sold SW3 on 21 March 2006 for £2,550,000. 

The taxpayer’s tax return for 2005/06 contained no capital gains disclosure relating to the disposal, as it was claimed that he moved into SW3 on 26 November 2005 and vacated it on 7 January 2006 and that PRR applied to its disposal (elections had also been made to treat SW3 as the taxpayer’s main residence for a one week period). Subsequently, HMRC issued a discovery assessment for 2005/06, on the basis that no PRR was due. The taxpayer appealed.

In general, if HMRC wishes to dispute that PRR is due on the disposal of a property, it can open an enquiry into the taxpayer’s self-assessment return for the tax year of the disposal. The time limit for HMRC to open the enquiry in most cases is twelve months after the day on which the return was filed (TMA 1970, s 9A(2)(a)).

If the property disposal was not included on the individual’s tax return (i.e. on the basis that the entire gain was relieved by PRR), HMRC could dispute the relief by making a discovery assessment outside the normal tax return enquiry window. The ordinary time limit for a discovery assessment is four years after the end of the tax year to which it relates (TMA 1970, s 34(1)). However, if a discovery assessment is made to recover a careless loss of tax, the time limit is six years, or if the assessment is made to recover a deliberate loss of tax, it is twenty years (s 36(1), (1A)). 

In Munford, HMRC’s discovery assessment for 2005/06 was issued on 23 July 2015, i.e. outside both the normal four-year assessment time limit and the six-year time limit for a careless loss of tax. The First-tier Tribunal noted that HMRC relied upon the twenty-year time limit for its discovery assessment, which required a loss of tax to have been brought about deliberately by the taxpayer. HMRC, therefore, had to show that: (a) there was a loss of CGT; and (b) the loss was brought about deliberately. 

With regard to (a), HMRC needed to prove that the taxpayer was not entitled to PRR on SW3. However, based on the facts and evidence, the tribunal did not agree with HMRC that the taxpayer acquired SW3 as an investment property. Furthermore, HMRC had not demonstrated that the taxpayer and his wife did not occupy SW3 as their private residence. Thus, HMRC had not shown a loss of CGT on the disposal of SW3. That was sufficient for the taxpayer’s appeal to be allowed. 

However, the tribunal went on to consider whether, if there had been a loss of CGT, it was brought about deliberately by the taxpayer. The tribunal concluded that HMRC had not discharged its burden of proving (on the balance of probabilities) that the taxpayer deliberately brought about a loss of tax in relation to SW3. Accordingly, the conditions for making an extended (i.e. twenty year) time limit assessment were not satisfied.

If HMRC disputes a PRR claim, check that they are within the law for doing so. If HMRC issues a discovery assessment outside the normal time limits, be aware of the shift in the burden of proof from the appellant towards HMRC. This could make all the difference, as the tribunal indicated in the Mumford case: 

‘I should stress that my conclusion that HMRC have not succeeded in showing that [the appellant] did not occupy [SW3] as their private residence should not be taken as a positive finding that it was their private residence. Had the burden of proof been on them, it would have been necessary for the tribunal to take a very different approach to the evaluation of the evidence. It does not assist to speculate what the outcome of that process would have been.’