Capital Gains and Principal Residence Relief: What Makes a House?

In Lee & Another v HMRC [2022] UKFTT 175 (TC), the First-tier Tribunal (FTT) rejected HMRC's argument that a dwelling-house included the land on which it was built for the purposes of calculating Principal Residence Relief (PRR) under the Taxation of Chargeable Gains Act 1992 (TCGA) and allowed the taxpayers' appeals on the basis that "period of ownership" referred to ownership of the dwelling-house alone.

Background

In October 2010, Gerald and Sarah Lee (the Appellants) purchased a freehold interest in land for £1,679,000. Between October 2010 and March 2013, the land was redeveloped, with the original house on the land demolished and a new house built. 

The new house was completed and the Appellants took up residence in March 2013, occupying and enjoying the rest of the land as the garden and grounds of the dwelling. 

In May 2014, the Appellants sold their interests in the land for £5,995,000 and subsequently filed SATRs. HMRC enquired into the Appellants' SATRs and in September 2019 issued closure notices to the Appellants on the basis that a chargeable capital gain of £541,821 had been omitted from their SATRs. 

The decision was upheld following review by an HMRC officer who determined that the period of ownership was 43 months, being the period from the date the land was acquired in 2010 until the land was sold in May 2014. Accordingly, the amount of PRR available to the Appellants under section 223, TCGA, was only 18/43rds of the gain arising. 

The Appellants appealed, arguing that "period of ownership", for the purposes of PRR, referred to ownership of the dwelling-house concerned and not the land. Since they had lived in the house for all but four days of its existence as a "dwelling-house" and the total length of occupation was less than 18 months, the Appellants contended they were entitled to full PRR, under section 223(1), TCGA.

FTT decision

The appeals were allowed. 

The FTT considered that because there was no clear definition of "period of ownership", sections 222 and 223, TCGA, should be given a natural construction unless to do so would lead to a clear anomaly contrary to the wishes of Parliament. In the FTT's view, the natural reading of the legislation was such that "period of ownership" meant the period of ownership of the dwelling-house that was being sold and not the land on which it was built. 

While acknowledging that its decision was contrary to the Special Commissioners' decision in Henke v HMRC [2006] STC (SCD) 561, the FTT noted that in every part of the legislation, the period of ownership appeared to attach to the dwelling-house where the taxpayer may or may not reside; no mention was made to land in the context of period of ownership. Further, the FTT rejected HMRC's argument that dwelling-house should be read to include land, as the fact the definition of "land" in section 228(1), TCGA, included dwelling-houses on that land, did not mean that the converse was true and dwelling-house should be read to include the land. Rather, the fact that dwelling-house was used in the legislation meant it was capable of being treated for some purposes separately to land.

While both HMRC and the Appellants referred to various anomalies that might arise on the other's construction of the legislation, the FTT noted that the legislation relating to apportionment had always contained anomalies due to apportioning being based on time rather than on valuations at specific points in time. The FTT did not consider that the anomalies identified by the parties required the legislation to be read in a way contrary to its natural meaning and concluded that there were no compelling reasons to depart from the natural reading of the legislation that "period of ownership" referred to the period of ownership of the dwelling-house.

Comment

In departing from Henke, the FTT has left HMRC and taxpayers with conflicting authority on the proper construction of the PRR provisions. It will be interesting to see how that conflict is ultimately resolved by the Upper Tribunal or higher courts and it would not be surprising if HMRC sought to appeal this decision.

In the meantime, this decision offers taxpayers a clear advantage when calculating their entitlement to PRR on the sale of a dwelling that has been in existence for less time than the period of time they have owned the land on which it is built. 

The decision can be viewed here.