Wealth management update

Meaning of residence

On 19 October 2011, the Supreme Court gave its decision in the appeal made by Mr Gaines-Cooper against the earlier decision of the Court of Appeal that he was UK resident for tax purposes between the 1993/94 and 2003/04 tax years.

The case concerned the reliance of Gaines-Cooper on HMRC guidance contained in leaflet IR20, which set out the conditions that needed to be satisfied for a person to be treated as ceasing to be resident and ordinarily resident in the UK. Importantly, the guidance does not reflect the strict legal conditions (based on case law) that need to be met for a person to be non-UK resident.

The guidance was amended in 2003/04 and there were further amendments in 2009 when IR20 became guidance note HMRC6. These forms of guidance require a process of day counting, so that if a person remains outside the UK for a period of at least 183 days in a tax year and has made visits to the UK of less than 91 days in a tax year on average, he would be non-UK resident and not ordinarily resident from the day after the departure.

Gaines-Cooper argued that he had a legitimate expectation to rely upon the guidance before it was amended in 2003/04 and that the guidance before that tax year required only that he should remain outside the UK for a specific number of days. On the other hand, HMRC argued that the amended guidance did not change the principle that an individual taxpayer must sever his ties with the UK to be treated as non-resident, in accordance with the general law (unless he goes to work full time abroad). The Court of Appeal decided in favour of HMRC.

The Supreme Court has agreed with the Court of Appeal decision, in deciding that IR20 required a taxpayer to make a distinct break in the pattern of his life as well as meeting its own specific conditions for an individual to be non-resident and ordinarily resident on leaving the UK permanently or indefinitely. The Supreme Court said that, otherwise, the guidance about how to become non-UK resident was sufficiently vague that it could not be given legal effect. In consequence, HMRC decided that in this case the taxpayer's close connections with the UK, ownership of a large estate and regular trips to the UK meant he was a resident and liable for backdated tax.

This decision is important because it is likely that a number of UK-resident taxpayers have left the UK on the understanding that they have become non-UK resident and non-ordinarily resident. There may be an appeal to the European Court of Human Rights, but, failing that, this case could lead to an attack by HMRC on a large number of taxpayers who have left the UK believing themselves to be non-UK resident and non-UK ordinarily resident.

A positive comment made by the Supreme Court in this case is that taxpayers were entitled to rely on assurances given by HMRC in IR20. However, to do so, they must show that they fall within the particular circumstances described.

Updated guidance

HMRC published an updated version of the guidance HMRC6 on 27 October 2011. Most of the changes are clarifications of the previous version but there is a new example of how to calculate the average number of days spent visiting the UK after leaving to work full time abroad (which contains a material mathematical error).

There is also a change to the rules for UK individuals who leave the UK to work for European Union institutions. Such a person will remain ordinarily resident for income tax and will remain resident for income tax and capital gains tax in any year in which they make any visit to the UK (even if those visits are within the usual limits).

CGT principal private residence relief

In a recent case heard in the First-tier Tribunal, AJ Clarke v Revenue & Customs (TC01461), it was decided that where a taxpayer occupied two houses as his consecutive residences for short periods, he was entitled to claim PPR relief from capital gains tax on the disposal of both of the properties, even though the purchase of the properties had been funded by a 12-month business loan and there was no evidence of any correspondence being sent to either of the properties.

The taxpayer moved out of the matrimonial home due to a breakdown in his relationship with his wife and purchased a second property, which he moved into immediately. That purchase was funded by a 12-month business loan. The taxpayer sold that property about eight months later and moved into his mother's home while he built a new property in the garden of the matrimonial home. He moved into that property shortly afterwards for two years, following which he moved back to the matrimonial home and sold the other property a few months later.

The reasons why main residence exemption was given for the two disposals was that there were genuine family reasons that required the taxpayer to move away from the matrimonial home and that the moves into each of the other two properties had been intended by the taxpayer to be permanent.

Cases such as this on PPR relief are useful because each case will turn on its own facts and many advisers may be concerned that occupation of a series of properties, each for a relatively short period, may not meet the requirement of 'permanence' for the relief to apply.

Home loan schemes

HMRC has updated its guidance relating to home loan schemes (also known as double trust schemes). There are a number of variations of home loan arrangements but the common theme is that a taxpayer sells his main residence to an interest in possession settlement, on terms that allow the purchase price to remain owing to the taxpayer. The taxpayer then gives away the benefit of the debt to a second settlement from which he is excluded as a beneficiary. The result was that the taxpayer could effectively give away his house but continue to live there, with a reduction in the value of his estate chargeable to inheritance tax.

This type of arrangement led to the introduction of the pre-owned asset income tax regime, to catch arrangements that were technically outside the scope of the reservation of benefit rules for inheritance tax (and other arrangements). Essentially, HMRC's opinion is that home loan schemes are caught by the reservation of benefit rules. As a result, the pre-owned assets charge will not apply to these arrangements.

HMRC says that, if the taxpayer is paying income tax on the understanding that the POA rules have applied to the arrangement, the taxpayer should continue to pay the income tax, because, if HMRC is correct, all of the income tax that has been paid may be reclaimed, irrespective of any time limits for repayment.

The guidance issued by HMRC has been amended a few times. Initially, in 2005, HMRC set out its view that, if the debt within this arrangement is repayable on demand, there will be a reservation of benefit in that debt until such time as the trustees call in the loan, but if the debt is only repayable after the death of the life tenant the scheme would not be caught as a gift with a reservation. However, HMRC now believes that the scheme is a pre-ordained series of transactions and is therefore caught as a reservation of benefit by the principle contained in W T Ramsay v IRC [1981] 1 AER 865.

If HMRC's current view is correct and there is a reservation of benefit in the house, that may not be the end of the story because there may not necessarily be a reservation of benefit in the debt, which would mean that the debt would be an 'excluded liability' with the result that the POAT rules would apply to part of the value of the house and the reservation of benefit rules would apply to the remaining value.

The guidance is unclear because HMRC appears to accept that point but adds that, if there is a reservation of benefit in the loan but not the house, there will still be a POAT charge on the house while the debt remains outstanding. Presumably that POAT charge will only apply to the surplus value, in excess of the value of the debt.

The revised guidance on HMRC's view does not give confidence because of this uncertainty and because HMRC has previously changed its opinion on a couple of occasions and could change it again.

It is also unsatisfactory for a taxpayer to have to pay income tax just in case HMRC is correct.