The ‘GAAR’ – Is this Property Tax Planning Strategy in the Spirit of the Legislation?

From July 2013, the UK tax legislation has seen the introduction of a general anti-avoidance rule.  Known as the ‘GAAR’ (General Anti-Abuse Rule), the legislation has been introduced in order to target abusive/aggressive tax avoidance schemes, on the basis that all taxpayers should pay their ‘fair’ contribution of taxes.

Published HMRC guidance clearly states the premise underlying the GAAR, by confirming that it will reject the approach taken by the Courts in a number of old cases, to the effect that taxpayers are free to use their ingenuity to reduce their tax bills by any lawful means, however contrived they may be.  GAAR is enabling HMRC to call the very spirit of the legislation into question, and giving HMRC scope to apply the new rules across a broad range of mainstream taxes. 

With the enacting of GAAR, Parliament has sent a clear message in relation to its rejection of abusive tax avoidance schemes, and this is particularly epitomised by the judgment of Lord Clyde in the Ayrshire Pullman case. He said: “taxation is not to be treated as a game where taxpayers can indulge in any ingenious scheme in order to eliminate or reduce their tax liability”.  

Finance Act 2013, s 212 provides that the GAAR will apply in priority to all other tax rules. The primary policy objective of the GAAR is to deter taxpayers from entering into abusive arrangements, and to deter would-be promoters from promoting such arrangements.  

Accordingly, Parliament has imposed an overriding statutory limit on the extent to which taxpayers can go to in trying to reduce their tax liability.  The limit is reached when the arrangements put in place to achieve that aim go beyond anything which could be regarded as a reasonable course of action. 

It will be interesting to see whether the Courts will be receptive to the GAAR being deployed as HMRC’s first argument, and indeed whether HMRC themselves will use the legislation in this manner.  This will be of particular interest where the arrangement under attack is not a contrived scheme, but merely an area of tax legislation that had previously been subject to legitimate tax planning.

What can be construed as abusive is a subjective concept.  As shown in a recently aired Panorama television programme, not everyone has the same opinion as to what can be identified as acceptable tax planning.  In broad terms, the GAAR only comes into operation when the course of action taken by the taxpayer, aims to achieve a favourable tax result that Parliament did not anticipate when it introduced the tax rules in question.

Critically, the GAAR will also need to examine whether or not the course of action taken by a taxpayer can be regarded as reasonable.  This indicates the ambiguity and somewhat subjective nature of elements of the GAAR initiative. 

A wealthy taxpayer purchases several properties over the course of a few months, then elects to make each newly acquired property his main residence, before occupying it for a short period. He avoids capital gains tax (CGT) by selling each property within three years.

The question is - do the means of achieving the substantive tax results involve one or more contrived or abnormal steps?  Buying properties that are occupied as residences, and the utilisation of main residence elections, are merely representative of the legitimate use of a relief afforded by statute, and is not an abusive arrangement.  The legislation places no limit on the number of times the election may be made; the making of such elections does not involve contrived or abnormal steps, and is not an arrangement.  Indeed, HMRC has previously indicated its acceptance of the practice of making multiple elections.

The key will be guidance from the CGT legislation and the Tribunals, particularly with regard to what can be construed as a ‘short period’. There will have to be proof of ‘the quality of occupation’ of the properties concerned, in order to substantiate the eligibility of any claim for principal private residence relief.

A case before the First-tier Tribunal (FTT) questioned the quality of occupation, and whether this amounted to ‘residence’ within the meaning of TCGA 1992, s 222(5). The case was M J and Mrs B A Harte (TC 1951). The longest period that Mr and Mrs Harte had lived in the property was three weeks, which was considered by HMRC to be insufficient.  The key point arising from the case, however, was the importance of evidence and quality of occupation.

In October 2007, Mr and Mrs Harte sold a property in Alder Grove and claimed only or main residence relief under TCGA 1992, s 222.  HMRC disallowed the claim and assessed the couple to CGT, as they did not consider the occupation was permanent enough to satisfy this section of the legislation.  The taxpayers stated that they had intended to make the Alder Grove property their home, and had lived there briefly.  Subsequently, Mr and Mrs Harte had received an offer from a neighbour to buy the property, and they decided to accept that offer. The longest period that the couple had occupied the property was three weeks. The taxpayers did not move any of their own possessions into the property, nor did they carry out any work or repairs/decoration.  Mr and Mrs Harte had spent short periods in the property to test what it would be like to live there, but it was decided by the Tribunal that periods of this nature did not amount to occupation.

The Tribunal rejected the election under TCGA 1992, s 222(5).  This rejection was not on the basis of the short period it applied to, but because there was no evidence of Mr and Mrs Harte ever occupying the property with any degree of permanence or continuity.  It could be argued that there had been an attempt by Mr and Mrs Harte, to ‘flip’ the properties they owned in order to gain CGT advantages.

‘Flipping’ is the term attached to the tax planning advantage that can be gained, where a taxpayer elects for a second home to be his or her main residence for CGT purposes (s 222(5)), then varies that election in favour of the first home a short time later.  In the absence of any definition as to what can be regarded as a ‘short time’, or indeed, what time frame can be regarded as being sufficient to demonstrate permanence or continuity of occupation, it is vital that evidence can be provided to substantiate the quality of occupation during this period.

By this procedure, the first home loses the main residence exemption for a few weeks, whilst the second home achieves at least three years’ worth of exempt gain. 

However, to be effective, both properties must be factually occupied as the taxpayer’s home, and the deadlines for making and changing the election must be met.  

Scenarios such as those illustrated in the Harte case, will have to be considered as offensive planning, which the GAAR will seek to target, and we may fully expect HMRC to deploy this legislation in the first instance in such situations.  Where, however, elections are used in accordance with the existing legislation and the quality of occupation can be sufficiently evidenced, there is no good reason why planning of this nature should be exposed by the GAAR.  

As the Harte case shows, it is essential that there is evidence of actual occupation, and that this occupation amounts to more than just a trial period or a temporary displacement from what should rightly be regarded as the principal private residence.