[2009] UKFTT 312 (TC)

TC00256

Appeal numbers : TC/2009/12495 & TC/2009/12496

CGT – applicability of business asset taper relief to business in receipt of property income and assessable to tax under schedule A – jurisdiction of the Tribunal and applicability of principles of estoppel and legitimate expectation

FIRST-TIER TRIBUNAL

TAX 

	
	MR MERVYN GWILLYM JONES and
	MRS ANNETTE ELIZABETH SOUTHAM	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

TRIBUNAL: 	   Michael Connell (Judge)
Derek Robertson (Member)

Sitting in public in Colwyn Bay on 22 September 2009

Mr Bates of Philip Bates & Co Ltd and the Appellants

Catherine Douglas and Philip Jones, Appeals Officers, Appeals Unit, NW & Midlands
HM Revenue & Customs for the Respondents

© CROWN COPYRIGHT 2009
DECISION

Introduction

1.	Mervyn Gwillym Jones and Annette Elizabeth Southam (the Appellants) appeal against Notices of Closure dated 22 July 2008 for the year ended 05 April 2006 and HM Revenue and Customs’ conclusion, following its enquiries, that property at 29 Bath Street  Rhyl sold in November 2005 was not a business asset attracting business asset taper relief for capital gains purposes.

2.	The Appellants jointly held the property which was given to them in 1984 by their mother and was sold to an unconnected third party in November 2005 for £190,000.00.

3.	Throughout the period the property was owned by the Appellants it was let out as fully-furnished small bedsit flatlets which produced rental income for the Appellants.

4.	Taper relief was introduced for individuals in respect of disposals on or after 06 April 1998 and replaced indexation allowance which was frozen at 05 April 1998.  Disposals on or after 06 April 1998 of assets held before that date still qualified for ‘frozen’ indexation allowance and therefore, as in this case, the capital gain on disposal qualifies for both indexation allowance and taper relief.

5.	Taper relief proportionately reduces a chargeable gain that would be brought into the charge to tax.  The calculation is based on the qualifying period (ie the number of complete years [up to a maximum of 10] an asset has been held after 06 April 1998).  Business assets qualify for a greater reduction than non-business assets.  The qualifying period is increased by one year (the bonus year) on disposal of a non-business asset that was held on 17 March 1998.

6.	The property at 29 Bath Street was held on 17 March 1998 and sold in November 2005 – the holding period was therefore 7 years and, in the case of a non-business asset, an additional bonus year is allowed - making 8 years in total. HMRC contend that the property was a non-business asset and, as such, non-business asset taper relief is due. Non-business asset taper relief for 8 years is 70%, which means that capital gains tax is charged on 30% of the gain.

7.	The Appellants contended that the property was in fact a business asset and that business asset taper relief was applicable.  Taper relief due for a business asset is 75%, thus resulting in 25% of the gain being chargeable.  The Appellants contended that HMRC was wrong not to allow business asset taper relief.  

8.	HMRC opened an enquiry into the individual 2005-06 Tax Returns of Mrs Southam and Mr Jones with regard to the capital gain declared and, following its enquiries, issued a Closure Notice under the provisions of sections 28(1) and (2) Taxes Management Act 1970 amending the Appellants’ self-assessments by applying non-business taper relief to the gain arising from the disposal of 29 Bath Street.  The Closure Notice stated that the sum returned as partnership profit was actually land and property income and that the net chargeable gain that arose on the disposal of 29 Bath Street resulted in an increase in tax due of £9,127.64 for Mr Jones and £6,624.80 for Mrs Southam.

Relevant law

9.	The principal legislation relevant to the appeal is as follows:

(i)	section 2A Taxation of Chargeable Gains Act 1992 which provides that, as outlined above, a higher rate of taper relief is available in respect of business assets as opposed to non-business assets

(ii)	paragraph 5(1A) Schedule A Taxation of Chargeable Gains Tax Act 1992 (as amended by Section160 Finance Act 2003) which provides that ‘asset was a business asset at that time if at that time it was being used wholly or partly for the purposes of a trade carried on ...’

(iii)	section 15  Taxes Act 1988 Schedule A which states that annual profits from property are assessed under schedule A

(iv)	section 18(4) Taxes Act 1988 (Schedule D), which states that if a tax is chargeable under any other Schedule, that Schedule takes priority.  These provisions are repeated in Section 4(1) of the Income Tax (Trading and Other Income) Act 2005

(v)	section 9(A) Taxes Management Act 1970 which provides for the opening of an enquiry

(vi)	section 28(A) (1) & (2) Taxes Management Act 1970 which provides for the closure of an enquiry

10.	Rental income is charged to tax under Schedule A pursuant to Section 15 ICTA 1998 as referred to above for the period 1995-6 to 2004-5.  A charge to tax under Schedule A has priority over a charge to tax under Schedule D (Section 18(4) ICTA 1998).  For 2005-6 onwards the relevant provisions for taxing income from property are contained in the Income Tax (Trading and Other Income) Act 2005. 

11.	On the basis of the above legislation, HMRC contended that the income received by the Appellants from the furnished bedsit flatlets was letting income and not trading income and that accordingly business asset taper relief was not applicable.

Correspondence between HMRC and the Appellants

12.	HMRC contended that the property at 29 Bath Street was let residentially as bedsits/flats and was therefore letting income.  The Appellants’ accountant, Philip Bates & Co Ltd, contended that the letting income was derived from a trade and that business asset relief was due.  They said it had previously been established that ‘the scale of our clients’ operation of flat letting qualified as a trade and your file will contain correspondence regarding the matter.  Profits have continued to be taxed as a trade and Class 4 National Insurance has been paid.  Consequently a trade has been carried on and, in accordance with the Finance Act 2003, and amendments to the definition of a ‘business asset’ for taper relief purposes, where a disposal occurs after 05 April 2004 and at that time it was being used wholly or partly for the purposes of a trade carried on by an individual the disposal qualifies for Business Asset Taper Relief’. 

HMRC responded that ‘tax on the exploitation of land within the UK is chargeable to tax under Schedule A (section 15 ICTA 1988) not Schedule D (under which profits from a trade, profession or vocation are charged).  Receipts from land are considered an investment activity, not a trade, and this is so even where the scale of the activity and/or degree of organisation involved amounts to a full-time activity …’.

13.	The Appellants’ accountants were unable to find their old correspondence file which they said contained correspondence which would confirm that the Appellants’ business had been taxed as a trade.  They were however able to provide two letters from the Appellants’ previous accountant, Simon Wilson FCA, who had dealt with HMRC at the time.  The letters dated 31 January 1994 and 14 February 1994 were addressed to Mr Jones and said that HM Inspector of Taxes had agreed that ‘your furnished letting income would be treated as earned income where it is in the nature of a business (as in your personal case)’.  Because, according to the Appellants’ accountants, HMRC had themselves deemed that the property letting constituted a trade, the income derived from the trade had been subject to Class 4 National Insurance contributions.  

A further letter from Mr S Wilson dated 23 November 2007 was also produced in evidence at the hearing.  In the letter Mr Wilson said he was surprised to hear that the Inland Revenue had challenged the Appellants’ assessment under Schedule D rules because he said it was the Rhyl Inspector of Taxes that originally ruled that this was Mr Jones’ and Mrs Southam’s legal taxable status.  He said that when he took over the Appellants’ affairs in 1987 or thereabouts he discovered that income was being taxed under Schedule D despite, in his view, being principally ‘rental income’.  He said he had raised the issue with the Rhyl Tax Inspector firstly as a matter of principle and also on the practical point that, in his view, the Appellants should not have been paying both Class 2 and Class 4 National Insurance contributions on their income.

14.	It appears that Mr Wilson’s files had been destroyed in 1990 or thereabouts and that therefore he was unable to produce any copy correspondence from the Inspector of Taxes.  In his letter of 23 November 2007, he recalled that his file included a letter from the Inspector stating emphatically that the decision that the Appellants’ income was trading income and not rental income had come from the ‘highest Revenue authority and could not appealed against … and covered a great many similar businesses in the North Wales area’.  In his letter, Mr Wilson added that, from memory, the Inspector’s rationale was, inter alia, that:

(i)	although the source of the income was from rent, this was in fact providing fully furnished small bedsit flatlet facilities in the same nature as a boarding house or hotel [which would be taxed under Schedule D].  The tenants were principally short-term, either transient workers or otherwise homeless persons contracted with and paid for by Social Services

(ii)	the Appellants themselves attended to all business matters – taking on tenants, collecting rent, cleaning all common parts, repairs and replacements, health and safety maintenance of external areas, gardens, yards etc

(iii)	the North Wales coastal area covered by the relevant Tax District have a great many such businesses and the local Revenue office had sought clarification from ‘Somerset House’ which had agreed with its ruling – and that the decision to tax income as trading income followed consultation with the local Owners’ Association

Mr Wilson said the Revenue had decided that the activities (especially when providing the main or only income of the owners) were in the nature of a trade/business and therefore earned income and had to be taxed accordingly.  He added that, although the correspondence had been lost, tax records and partnership accounts still existed to support the facts but, prior to self-assessment, the Appellants’ business was not only taxed as a trade under Schedule D but also assessed to Class 4 NIC as earned income and that this was primarily at the instigation of HMRC.  He said that old ‘assessments’ would also confirm that, as the income had been deemed to be earned income, in Mr Jones’ case, he had been entitled to retirement annuity relief.

15.	HMRC responded by referring to the Inland Revenue’s Property Income Manual [PIM4300] which provides that ‘significant services over and above those which would usually be provided by a landlord to a tenant would be expected for the whole activity to be regarded as a trade’.  The Inspector said that the level of services provided by the Appellants was a question of fact and may have changed over the years and that what had been decided at some time in the past did not ‘fix’ the tax treatment in later years, regardless of any possible subsequent changes.

The Inspector requested full details of the services provided by the Appellants to their tenants and copies of the relevant tenancy agreements. 

16.	The Appellants’ accountants replied that :

(i)	over the previous 10 years substantial additional work had been undertaken to the property (eg fire doors, smoke alarms and other work relating to compliance with relevant regulations - eg houses in multiple occupation).  Appropriate licence applications and regular inspections had been undertaken to comply with electrical and gas certification and Mr Jones had undertaken works of repair and redecoration where necessary

(ii)	the tenants held under standard Assured Shorthold Tenancy Agreements

(iii)	each bedsit  was largely self-contained, with shared bathroom facilities.  The Appellants maintained these facilities and the common areas

(iv)	29 Bath Road (and other properties owned by the Appellants) were the only source of earned income for Mr Jones and represented the bulk of income of Mrs Southam

17.	HMRC confirmed their views that:

(i) 	no evidence had been provided to suggest that services had been rendered beyond those which a landlord would normally be expected to undertake in normal course of conducting a rental business.  A letting activity would only constitute a trade where the owner remained in occupation of the property and provided services over and above those usually provided by a landlord

(ii)	whereas, in the case of a hotel or perhaps the provision of bed and breakfast accommodation, the occupier of the room does not acquire any legal interest in the property.  In the case of a student let, the tenants have an element of security of tenure and the income is derived from a trading activity and not from the provision of furnished accommodation

(iii)	referring to the case of Griffiths HMIT v Jackson 1983 56TC583, although the scale and extent of a letting business may be such that it constituted a full-time activity for the proprietors, it did not necessarily render the activity chargeable as a trade

(v)	HMRC could not comment on the correspondence or discussions that had taken place with the Inspector’s predecessor at the Rhyl Tax Office – (although the Inspector subsequently confirmed that, following a search, he had not been able to find any pre-assessment correspondence which may have assisted the Appellants)

18.	HMRC subsequently issued a formal Notice of Completion of Enquiry, determining that the sum returned as partnership profits was in fact land and property income and that a net chargeable gain of £33,476.00 had arisen on the disposal of 29 Bath Street.  The Appellants’ self-assessments were amended to reflect this. 

19.	The Appellants’ accountants notified HMRC of their clients’ appeal against the enquiry conclusions and Closure Notice, reiterating that, by denying business asset taper relief, their clients were suffering ‘a monumental injustice’ in that ‘HMRC have accepted, indeed directed, that a trade has been conducted for many years but now seek to deny business asset taper relief on the eventual sale of an asset when the tax payers are seeking to retire’.

20.	The Wales Capital Gains Tax Specialist Compliance Team reviewed the case but rejected the Appellants’ assertions that their partnership income should be treated as trading income, which it said was not supported by any specific evidence and that Mr Wilson’s letter provided only general comment not backed up by any factual information.  HMRC contended that relevant case law (eg Salisbury Estates Ltd v Fry (1930 157 C266) and more recently Griffiths v Jackson) reinforced HMRC’s interpretation of how letting income should be taxed and that HMRC’s practise in this regard had not changed over the years.  HMRC’s instructions and the Property Income Manual and guidance in the old IR150 provided clear guidance and no evidence had been produced to show why the Appellants’ income should not be treated and interpreted in accordance with the guidance provided.

Hearing submissions

21.	At the hearing of the appeals, HMRC summarised :

(i)	a ‘business asset’ is defined at paragraph 5(1A) Schedule A1 TCGA 1992 which, broadly speaking, provides that to qualify as a business asset the asset must be in use for the purposes of a trade.  HMRC submitted that, in this instance, the property was not in use for the purposes of a trade and therefore it did not qualify as a business asset

(ii)	it is established law that property rental does not fall to be regarded as a trade.  HMRC referred to the case of Griffiths v Jackson. This case had come before the High Court of Justice Chancery Division and the point at issue was whether a business of letting furnished rooms and providing services amounted to the carrying on of a trade.  The tax payers were practising accountants who mainly let furnished rooms to students and other short-term occupiers.  The General Commissioners had originally held that the income was trading income, taxable under Case 1, Schedule D.  The Crown appealed and Mr Justice Vinelot found in favour of the Crown, saying ‘it is a cardinal principle of United Kingdom tax law that income derived from the exercise of property rights properly so called by the owner of land … is not income derived from the carrying on of a trade.  The words I have cited come from a speech of Lord MacMillan in Salisbury House Estate Ltd v Fry at page 329’

(iii)	although the Appellants’ accountants had returned the income as partnership income for a number of years, this could not alter the principle that the letting of property does not amount to a trade, [irrespective of whether the Inland Revenue had previously directed that such activity should be treated as a trade]  

(iv)	the relevant legislation dictates that income (from property) is assessed under Schedule A and does not amount to a trade.  HMRC referred to the comments of Justice Vinelot in Griffiths v Jackson, who said “it is a peculiar feature of UK tax law that the activity of letting furnished flats or rooms whilst it may be a business, and in this case a demanding and a time-consuming business, is not a trade …  This income is not earned income and (the Appellant) is not entitled to capital allowances and to roll-over relief where capital gains tax purposes afforded to a person carrying on a trade …  The principle is now too deeply embedded in the law to be altered except by legislation”

22.	In their closing submissions, Mr Bates of the Appellants’ accountants said they accepted that the Appellants’ partnership perhaps had unusually been taxed as a trade but that they wished to emphasise that this was not by accident but at the Revenue’s direction, both pre and post self-assessment.  They said this critically affected the Appellants’ applicable capital allowances.  They maintained that, if it was accepted by the Revenue that the Appellants’ business was a trade for all previous years, given that there had been additional trading activities by Mr Jones in the carrying out of his business, then the partnership business must clearly have retained its status as a trade.  He contended that the rules of natural justice would be breached and the Appellants would suffer serious losses to their retirement funding.

23.	Mr Bates drew the tribunal’s attention to the wording of Section 160 (1) of the Finance Act 2003 in which it says ‘the asset was a business asset at that time if at that time it was being used wholly or partly for the purposes of a trade carried on by … an individual or a partnership’.  He then referred to the documentation contained in the Appellants’ submitted Schedule of Evidence.  These included the 1995/96 partnership assessments, provisional Income Tax computations and accounts for the year ended 05 April 1995 and similar documentation with regard to the year ended 05 April 1996 and 05 April 1997, all of which confirmed payment of Class 4 NIC contributions and retirement annuity claims and showed that the partnership was being treated as a trade.  Mr Bates said it was his clients’ contention that the situation which had prevailed from 1995 continued until beyond 2005/06 when 29 Bath Street was disposed of.

24.	Mr Wilson gave evidence to the Tribunal confirming that the Appellants had previously been his clients.  He said that when he looked at their files he was surprised to learn that their business was being treated as a trade.  He said he took this up with HMRC and they replied with their reasons.  He had been unable to locate copy correspondence from HMRC but recalled them saying that the tax treatment of his clients’ business had been cleared by ‘Somerset House’ and that, on that basis, he had advised his clients accordingly (with regard to rules applicable to capital loans, voluntary contributions etc).  He said he provided the appropriate computations and it was the Inland Revenue, not he, who had made the decision as to how the Appellants should be taxed.  This was prior to self-assessment.  When self-assessment changes came into force in 1994/95 Mr Wilson said he felt obliged to query the position again with HMRC, who responded that they should continue as before.  Mr Wilson said that he volunteered to HMRC that his clients’ business income should be treated as rental income – but it was HMRC who were emphatic that the Appellants’ partnership income was trading income, which they said was fairly standard practise for similar businesses in the area.  Mr Wilson said he was very concerned to get this right otherwise he and his firm could have been criticised.  Mr Wilson said he checked the position both before and after self-assessment and could not see what more he could have done.

25.	Mr Jones also gave evidence to the Tribunal.  He said that, whilst working in the partnership business, his working week was from 08.00 am until 06.30 pm 5 days a week and that eventually he had to sell 29 Bath Road because the time he had to devote to the business was too much for him.  He confirmed however that he had not provided any other services beyond the collection of rents, repair works, redecorating, window cleaning, washing of curtains etc.  He had not for instance provided any services which might commonly be provided by an hotelier – eg food and refreshments.  Mrs Southam also gave evidence to the Tribunal reiterating much of what her brother had said, also confirming that she had not undertaken any additional services.

26.	In response to questions put to a representative from HMRC, the presenting officer was unable to explain why the Appellants’ business had previously been treated as a trade or what circumstances had changed for the purposes of treating the partnership income as rental profit, other than to say that decisions in that regard had been made prior to the introduction of Schedule A tax and the previous treatment of business income did not necessarily fix the rate was taxed in subsequent years.

Conclusion

27.	For the years up to 2004/05 letting income from land and property was automatically assessed under Schedule A.  Since  2005/06 the Schedule A classification has been removed for income tax purposes and letting income is now taxed pursuant to Section 264 of the Income Tax (Trading and Other Income) Act 2005, whether furnished or unfurnished. Generally speaking however, the taxation rules follow the previous Schedule A rules in respect of rents received from property.

28.  	Section 268 of ITTOIA 2005 states that income tax is charged on the profits of a property business.  The Act also states that a person’s UK property business consists of a business which is carried on for generating income from land which means ‘exploiting an estate interest or right over land as a source of rents or other receipts’.  The only occasion on which property income is treated as earned income is when the income derives from the commercial letting of furnished holiday accommodation which satisfies certain requirements (Income Tax Act 2007 section 127).

29.	The relevant legislation and case law - ie Salisbury House Estate Ltd v Fry and Griffiths v Jackson – clearly show that annual profits from property have always been assessed under the rules applicable to Schedule A income and not under Schedule D, as a trade.  The relevant legislation at the time of the decision in Griffiths v Jackson was Section 67(1) of the Income & Corporation Taxes Act 1970.  The current provisions now appear at Section 15 of the Income & Corporation Taxes Act 1998.  The principles however have remained unchanged.  Sometimes, if the owner provides services and the services are separately charged or the receipts can otherwise be apportioned in part to the provision of those services, any profit derived in that regard would be taxable as profits of a trade.  Otherwise, irrespective of whether the tax payer is carrying on the business of letting furnished rooms and irrespective of whether it is a demanding and time-consuming business, it is not a trade and is taxable under Schedule A.

30.	The Appellants’ partnership accounts and Mr Jones’ personal assessments for the year 1995/96 and 1996/97 clearly show that income from 29 Bath Street was treated as trading income and taxed accordingly.  Indeed, the point was not disputed by HMRC.  Accounts for tax years both prior to and subsequent to this period were not produced but it was not in dispute that the partnership had always been treated (ie both pre and post the introduction of self-assessment in 1996/97) as in receipt of trading income and not income from property.

31.	The Appellants agreed with HMRC that the business income, if reviewed and assessed under current tax legislation, would be treated as income from property and not as trading income.

32.	The Appellants said that initially at least, although “the source of income was from rents, this was in fact providing fully furnished small bedsit flatlet facilities, in the same nature as a boarding house or hotel.  These were principally provided on a short-term basis, either to transient workers in the area or otherwise homeless persons contracted with, and paid for by, the Social Services … the Revenue decided that these activities, especially when providing the main or only income of the owners, were in the nature of a trade/a business and therefore earned income …” – (Mr S Wilson FCA letter dated 23 November 2007).

33.	HMRC was not able to proffer a view as to why the income had previously been treated as trading income, save to say that “the level of services provided by the Appellants to their tenants may well have changed over the years.  That it was deemed at some time in the past that a trade was being conducted does not ‘fix’ the tax treatment regardless of any subsequent changes” – (HMRC letter dated 20 March 2008).

34.	The Appellants’ argument was that HMRC were effectively estopped from denying the manner in which the Appellants’ trade had previously been taxed and that they should be taxed under Schedule D as a trade, with the result that Business Asset Taper Relief was applicable.  

35.	Copy Tenancy Agreements supplied by the Appellants to HMRC, although not seen by the Tribunal, were described as ‘fairly standard Assured Shorthold Tenancy Agreements.  The duration of the tenancies ranged from 6 months to 8 or 9 years’.  There was therefore some evidence or basis on which it is possible to reconcile the fact that the partnership income may have been correctly taxed in the years 1995/96/97 and in some subsequent years but was not correctly taxed in the later years of the partnership.  It is clear that the rental income produced by the furnished bedsits/flatlets was income from land and property and not trading income and that consequently 29 Bath Road was not a business asset to which Business Asset Taper Relief would apply.

Decision

36.	There has to be a clear and unambiguous representation by the Revenue upon which the Appellant has relied before it can be held that it is unfair for the Revenue to undertake its tax collection obligations under legislation.  Where substantive unfairness is alleged, it is necessary to show that the tax payer has relied on an inconsistency prejudicial to him.  Whether such a situation prevailed from 1995/96 – 2005 during which the nature of the business activity of the Appellants may have changed, is questionable.  Whilst HMRC accepted self-assessments submitted by the Appellants for a number of years, mere inaction on the part of the Revenue is not sufficient for the purposes of establishing estoppel.  Additionally, there is authority for the proposition that a decision on one tax could not settle anything more than the bare issues of that one liability and could not create an estoppel in relation to the succeeding year or in a different tax.  

37.	In any event however, there are long-standing authorities for the proposition in relation to direct tax matters that there is no estoppel against the Crown.  in any event, the jurisdiction of the Tribunal is confined within the boundaries prescribed by statute and cannot of its volition extend to matters of equity falling outside its own competence and within that of the courts.  Nowhere in primary or secondary legislation is there any provision for estoppel, or legitimate expectation.  The principle of estoppel is ordinarily of no application in the field of revenue law because the Revenue do not normally stand in the same position to a tax payer as one party to a commercial transaction stands to another.  Tax assessments are governed by statute which lays down regulations and a codification on which assessments are made.  Where questions of unfairness or legitimate expectation arise, these issues can only be reviewed through the courts rather than a tribunal.

38.	The Tribunal accordingly dismisses the appeals of both Appellants and determines that the sum returned as partnership profit on the sale of 29 Bath Street was actually land and property income and that the net chargeable gain that arose on the disposal of the property resulted in an increase in tax due of £9,127.64 for Mr Jones and £6,624.80 for Mrs Southam.

39.	The Appellants have a right to apply for permission to appeal against this decision pursuant to Rule 39 of The Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber) which accompanies and forms part of this decision notice.

MICHAEL CONNELL

TRIBUNAL JUDGE

RELEASE DATE : 18 November 2009