[2011] UKFTT 50 (TC)

TC00928

Appeal number TC/2010/04516

INCOME TAX – losses from activities related to eleven properties purchased by Appellant and subsequently let – Appellant contending that properties were purchased with the intention of being sold at a profit within a short period, and were let temporarily when it became apparent that a deterioration in the property market made sale at a profit temporarily impossible – whether losses were a “trade loss” (Income Tax Act 2007 s.64) or a “loss in any trade” (former Income and Corporation Taxes Act 1988 s.380) – in the circumstances of the case, no 

FIRST-TIER TRIBUNAL

TAX 

	MS PARVEEN AZAM		Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

                     TRIBUNAL: Dr Christopher Staker (Tribunal Judge)
			         MR NIGEL COLLARD (Tribunal Member)

Sitting in public in Brighton on 13 December 2010

Mr Peter Clarke for the Appellant 

Mr Brian Lamb for the Respondents

DECISION

Introduction
1.	The Appellant appeals against amendments made by HMRC to her self-assessment returns for the years ended 5 April 2007 and 5 April 2008. 
2.	The Appellant’s tax return for the year ended 5 April 2007 included a claim for losses amounting to £23,208, of which £12,043 was claimed against general income for the year, with the balance of £11,165 being carried forward against future profits.
3.	The tax return for the year ended 5 April 2008 included a claim for losses amounting to £8,143 which were claimed against general income for the year.
4.	On 23 October 2009, HMRC opened enquiries into both of these returns.  On 12 May 2010, HMRC issued closure notices in respect of both years, concluding that the Appellant’s activities giving rise to the claimed losses “amount to a UK property rental source and not an adventure in the nature of trade as a property dealer/developer”.
5.	HMRC does not dispute the amount of the losses that the Appellant claims to have sustained.  HMRC also does not seek to dispute that the losses claimed arose in connection with the Appellant’s activities in relation to certain residential properties purchased by the Appellant from 2002.  
6.	The Appellant claims that she purchased the properties with the intention of reselling them for a profit within a short period.  However, she says that, due to market conditions, she found herself in a position where she would be unable to sell them except at a loss, and that she therefore rented them out on short term leases while waiting for residential property market conditions to improve.  She says that it was always her intention, and remains her intention, to sell the properties quickly at a profit as soon as she is able to do so, but that until now she has been unable to do so.  She argues that her activities therefore constitute trading in real estate, and that the losses are accordingly trade losses.  These contentions have not been accepted by HMRC.
7.	It is common ground that if the losses sustained by the Appellant are trading losses, they can be claimed against general income.  It is also common ground that if the losses are not trading losses they cannot be claimed against general income.  The Appellant’s position is that the losses were trading losses.  The HMRC position is that the properties were acquired and held by the Appellant for purposes of rental income.
8.	The sole issue that the Tribunal has been asked to determine in this case is whether the losses sustained by the Appellant in the course of her activities relating to the properties amounted to a “trade loss” within the meaning of s.64 of the Income Tax Act 2007, or a “loss in any trade” within the meaning of former s.380 of the Income and Corporation Taxes Act 1988.  If they are, HMRC has not disputed the calculations in the Appellant’s self-assessments for the relevant years.  If they are not, the Appellant has not disputed the calculations in the closure notices. 
The hearing
9.	The Appellant was represented at the hearing by Mr Peter Clarke.  HMRC was represented by Mr Brian Lamb.  The Appellant attended and gave evidence, and was examined, cross-examined, and asked questions by the Tribunal.  The Tribunal heard submissions and arguments from Mr Clark and Mr Lamb.  The material before the Tribunal included a joint bundle of documents, a legislation and authorities bundle, and a skeleton argument for HMRC.
The evidence and arguments of the parties
10.	In her evidence in chief, the Appellant said as follows.  She has bought properties since 2002.  They are all in Newcastle.  Her intention from the outset was to buy property and sell it for a profit, and this was her intention at the time of purchase of each of the additional properties. However, the downturn in the Newcastle property market came quicker than she expected. She bought the properties at a high price, and then the financial crisis came and the market deteriorated.  Thinking that this would not last long, she bought more properties.  Since purchasing the properties, she has been unable to sell any of them, since she would make a loss if she did, and would be unable to repay the loans obtained for their purchase.  The cost of financing the properties has been high.  She was able to get finance because she had a good track record with the bank, and a large deposit, having obtained loans from friends and family.  Her previous accountants did not advise her properly as to the different tax treatment for rental income, and income from buying and selling property.  She has students renting the properties. She could probably have got higher rent with other tenants but then she would need to give longer notice.  She has rented to students with one month’s notice so that she could sell the properties quickly with vacant possession.
11.	In cross-examination, the Appellant said as follows. She has never sold any of the properties. At the beginning there was some word-of-mouth interest, but potential purchasers thought that the price was too high.  She would have made a loss if she had sold the property then. At one point she gave instructions to sell a property to an estate agent, and accepted an offer, but later this fell through. When asked how she knew that potential purchasers could not get loans, she said that the people who were interested in buying the property did not have the necessary track record to get mortgage finance. She said that as the financial crisis came, people were having problems. When asked whether she had people attempting to get mortgages to buy the properties, she answered that there was one person who could not get finance. She said that the property was not on sale with an agent. When asked whether she therefore just assumed that everyone would have the same problem, she said that there were other similar properties at lower prices, and that she could not sell at a lower price as this would mean selling at a loss. It was put to her that the finance must have been very expensive, and she was asked whether she never needed to sell one property even at a loss to deal with this. She answered that that she could not pay the loans off if she sold at a loss and that selling at a loss would have been no use.
12.	In re-examination the Appellant said as follows. She was able to get mortgages because she made sure mortgage payments were never late and did not want a bad track record. She was in a financial mess now and was relying on the property market recovering significantly. 
13.	In response to questions from the Tribunal, the Appellant said as follows. She purchased her first property in 2002. She purchased at a higher price than she should have because she was too eager to get started.  She did not think that the Newcastle residential property market was in difficulty in 2002 when she purchased the first property, but that the difficulties came in the next 2 to 3 years, in about 2004/05.  By then she had three or four properties. She had anticipated that she would keep the properties for about six months before selling them. She bought the last property in 2006 because the price was very low.  When asked how long the period was between buying the first property and getting students in, she said that this happened very quickly, perhaps within 4 to 6 weeks, after basic repairs and maintenance, as she needed the rental income to service the debts. She has had students in all of the properties.  A member of her family collects the rents and does maintenance. When asked what her involvement is in the properties, she said that she pays the mortgages, and deals with problems with the students, when rent has not been paid or to arrange with her handyperson for repairs to be done.  She also deals with an agency to get more tenants, who are generally foreign students.  When asked whether in 2002 she had had previous experience buying and selling property, she said that when she was in her teens her parents bought and sold property and dealt with students. She said that she went on seminars and courses, such as on how to bid at an auction. She said that while she made a mistake at the beginning by buying property at too high a price, she had learned from her mistake.
14.	The submissions made on behalf of the Appellant included the following.  
15.	The HMRC case is based on the fact that the Appellant initially returned income from these activities as rental income until the 2006/07 tax year, and that nothing had changed subsequently. What had changed was that the Appellant had changed tax advisers, and her new adviser realised that her intention from the beginning had been to trade in property.  The number of properties purchased was larger than usual for a buy to let operation.  The way in which the properties were financed was expensive, and suitable only for a short term basis. The mortgages were interest only mortgages, and deposits were financed by loans from family and friends. This made the cost of borrowing very high. No one would finance properties in this way if their aim was to rent them out. The Appellant intended to hold the properties for a short period and sell them.  In the end, she did not sell them, but that was unexpected. The cost of borrowing would have been minimal if the property was sold on quickly.  The appellant has undertaken a number of training courses on buying and selling real estate, for instance on how to buy below market value and sell at a profit.  
16.	Contrary to what HMRC argued, it was said on behalf of the Appellant that there was nothing illogical in the fact that the Appellant continued to buy additional properties despite the downturn in the market, and despite her inability to sell her existing properties.  It was said that the Appellant’s course of action was wise, and was consistent with a pound cost averaging strategy.  The following hypothetical example was given.  A person spends £100 to buy 100 shares at £1 each. The average cost is £1 per share. The price then drops to 50p per share.  The person then spends another £100 and acquires 200 shares at 50p each. The buyer now has 300 shares for a total price of £200, an average of 67p per share.  The price then drops to 25p per share.  The person spends another £100 and acquires 400 shares at 25p each.  The buyer now has 700 shares for a total price of £300, an average of 43p per share.  In this example, the price only needs to rise above 43p per share for the buyer to make a profit on the whole deal. 
17.	The property market moves slower than some other forms of traded assets, and therefore this kind of strategy could take longer, possibly many years. Newcastle was one of the areas worst affected by the downturn in the property market. The Appellant made mistakes and did not see the downturn coming, but her intention was always to make a profit by buying and selling property. It is irrelevant that she has not yet sold any. It is the HMRC position that she needs to sell in order to be trading. That would mean that if she sold one of her properties at a loss, she would damage herself financially but would convince HMRC that she was trading in property. It would be unrealistic and unfair to require her to do that. The Appellant must decide for herself when to sell on her own assessment of when there is a profit to be made. The question whether the Appellant is trading in property or not must depend on her intention. The question cannot be based on whether she is getting an income from the property, as there is none:  she is making a loss. The financial arrangements show that she is not in it for anything else other than to sell the properties.
18.	The submissions of HMRC included the following.  The Appellant had two sources of income: a beauty salon, and the property activities.  It is not in dispute that, until the 2006/07 tax year, the income from the properties was always returned as letting income. The HMRC enquiries were opened on 23 October 2009 as a result of the different tax treatment claimed by the Appellant’s new tax advisor.  The evidence is that the properties were not put with an agent, that they were not being actively marketed, that there was no evidence of improvements being carried out, and that repairs were no more than a landlord would undertake for tenants.  When asked during her evidence what she did for the properties, the Appellant indicated that she paid the mortgages and acted as the landlord. The income was letting income. There is no evidence that any trade in property existed. The burden of proof is on the Appellant to displace the correctness of the closure notices, and the Appellant has not discharged this burden. 
19.	Further submissions in reply on behalf of the Appellant were as follows.  There is no statutory definition of “badges of trade”. The Appellant was making a loss on the properties, and she would eventually go bankrupt if she did not sell the properties. There is no such thing as a “buy to let” mortgage, and the expression means merely that the mortgages are “interest only”.  If there is no profit in letting the properties, the Appellant must have been in it for another purpose and the only purpose could be buying and selling the property. The Appellant may have made a mess of the venture but this does not change the characterisation. The fact that the properties were not placed with an agent is not significant.  Within the Asian community in Newcastle, if someone wants to buy a property, word spreads like wildfire.  The Appellant did not have the properties on offer as the price she needed was too high. The burden of proof is on HMRC to establish what it alleges in the closure notices.
The Tribunal’s views
20.	The Tribunal has considered all of the evidence before it as a whole.  Omission of any detail in this decision does not mean that it has not been considered.
21.	The issue for decision by the Tribunal is whether the losses sustained by the Appellant in the course of her activities relating to the properties amounted to a “trade loss” within the meaning of s.64 of the Income Tax Act 2007, or a “loss in any trade” within the meaning of former s.380 of the Income and Corporation Taxes Act 1988.
22.	The Tribunal finds that the burden of proof is on the Appellant to displace the figures contained in the closure notices.  The standard of proof is the civil standard of a balance of probabilities.  That is to say, the Tribunal must determine whether it is more likely than not that the losses were “trade losses”.  It is emphasised that a finding in favour of one party on a balance of probabilities does not imply that the other party is necessarily being deliberately untruthful or deceitful.  
23.	In Marson (Inspector of Taxes) v Morton [1986] STC 463, 470, Sir Nicolas Browne-Wilkinson V-C said that:
It is clear that the question whether or not there has been an adventure in the nature of trade depends on all the facts and circumstances of each particular case and depends on the interaction between the various factors that are present in any given case. The most that I have been able to detect from the reading of the authorities is that there are certain features or badges which may point to one conclusion rather than another. ... For convenience I will refer to them in a moment. But I would emphasise that the factors I am going to refer to are in no sense a comprehensive list of all relevant matters, nor is any one of them so far as I can see decisive in all cases. 
He then proceeded to set out nine “badges of trade”, after which he added at 471-472 that:
I emphasise again that the matters I have mentioned are not a comprehensive list and no single item is in any way decisive. I believe that in order to reach a proper factual assessment in each case it is necessary to stand back, having looked at those matters, and look at the whole picture and ask the question—and for this purpose it is no bad thing to go back to the words of the statute—was this an adventure in the nature of trade? In some cases perhaps more homely language might be appropriate by asking the question, was the taxpayer investing the money or was he doing a deal?
24.	Similarly, in Salt v Chamberlain [1979] STC 750 at 760, Oliver J said: 
In particular, I doubt whether the question whether in any given case a person is or is not carrying on a trade is capable of solution by the application of a logical progression of propositions culled from decided cases. The question is, I think, one of overall impression. Some of the difficulties of definition are referred to in the judgment of Rowlatt J in Graham v Green (Inspector of Taxes), and it is not, I think, helpful to seek to define or confine the term 'trade' by reference to the status of the taxpayer or the subject-matter of the transactions. As Lord Wilberforce said in Ransom (Inspector of Taxes) v Higgs [1974] 3 All ER 949 at 964, [1974] 1 WLR 1594 at 1610, [1974] STC 539 at 554, ‘... everyone is supposed to know what “trade” means: so Parliament, which wrote it into the law of income tax in 1799, has wisely abstained from defining it.’
25.	To the extent that they are helpful, the Tribunal must treat any consideration of the “badges of trade” identified in Marson v Morton as subject to these reservations.  These “badges of trade”, briefly stated, are:
(a)	whether the transaction in question was a one-off transaction; 
(b)	whether the transaction in question in some way related to the trade which the taxpayer otherwise carries on; 
(c)	whether the transaction was in a commodity of a kind which is normally the subject matter of trade and which can only be turned to advantage by realisation; 
(d)	whether the transaction was carried through in a way typical of the trade in a commodity of that nature;
(e)	the source of finance of the transaction;
(f)	whether the item which was purchased was resold as it stood or whether work was done on it or relating to it for the purposes of resale;
(g)	whether the item purchased was resold in one lot as it was bought, or whether it was it broken down into saleable lots;
(h)	whether the purchaser’s intentions at the time of purchase were to hold the object indefinitely, albeit with an intention to make a capital profit at the end of the day, or whether there was an intention to resell in the short term rather than the long term; and
(i)	whether the item purchased either provided enjoyment for the purchaser (for example, a picture) or pride of possession or produced income pending resale.

26.	In relation to the last of these “badges of trade”, it was said in Marson v Morton at 472: 
But in my judgment in 1986 it is not any longer self-evident that unless land is producing income it cannot be an investment. The legal principle of course cannot change with the passage of time: but life does. Since the arrival of inflation and high rates of tax on income new approaches to investment have emerged putting the emphasis in investment on the making of capital profit at the expense of income yield. For example, the purchase of short-dated stocks giving a capital yield on redemption but no income has become commonplace. Similarly, split level investment trusts have been invented which produce capital profits on one type of share and income on another. Again, institutions now purchase works of art by way of investment. In my judgment those are plainly not trading deals; yet no income is produced from them. I can see no reason why land should be any different and the mere fact that land is not income-producing should not be decisive or even virtually decisive on the question whether it was bought as an investment.
27.	Although the utility of these “badges of trade” must be approached with caution, the Tribunal has considered their applicability to the evidence in the present case.
(a)	None of the properties have yet been sold by the Appellant.  There has therefore been no sale transaction, one-off or otherwise.  However, some eleven properties have been bought, so that the purchase transactions are not merely one-off. 
(b)	Each of the transactions for purchase of property may be considered related to each of the other transactions for purchase of property, but these transactions are unrelated to the trade which the Appellant otherwise carries on, which is a beauty salon.
(c)	Real estate is a commodity of a kind which can be the subject matter of trade, but which is at least equally commonly the subject-matter of investment.  It is not a commodity which can only be turned to advantage by realisation, since it can also generate rental income, or a capital gain on an investment. 
(d)	As no property has yet been sold by the Appellant, it cannot be said that any transaction has yet been carried through in a way typical of the trade in a commodity of that nature.  The purchase of properties, followed by tenanting them for several years, is not typical of a trade in real estate.
(e)	The Appellant has argued that the properties have been financed by means that would make sense only if the Appellant intended to turn the properties over quickly.  The Tribunal does not have sufficient details of the financing of the properties to enable it to determine whether it accepts that this is the case.  The Tribunal does however accept that the Appellant’s activities in relation to the properties are generating a loss (see paragraph 5 above), and accepts that losses cannot continue to be sustained indefinitely.  
(f)	There is no evidence that the Appellant has undertaken significant improvements to the properties.  On the evidence, the Tribunal finds that there is no evidence of works beyond repairs that would be normal for rental properties.  
(g)	There is no evidence that the Appellant has intended to resell the properties otherwise than in the same lots in which they were bought.  There is no evidence for instance, of an intention to sub-divide properties or to convert houses into flats. 
(h)	The Appellant’s intention at the time that she purchased the properties was the major issue in contention between the parties.  The Appellant’s evidence is that in relation to each of the properties, her intention at the time of purchase was to resell the property for a profit within a short timeframe of about six months.  HMRC suggests that her intention from the beginning was to rent the properties out.  This issue is considered further below.  
(i)	The properties did produce rental income pending any resale, although insufficient income to generate an overall profit from the activities as a whole.

28.	As to the issue of the intention of the Appellant, in Marson v Morton it was said at 471 that “as far as I can see, this is in no sense decisive by itself”.  On the other hand, Simmons (as liquidator of Lionel Simmons Properties Ltd) v Inland Revenue Commissioners [1980] STC 350 at 352-353 suggests that intention at the time of purchase is of importance.  It was said by Lord Wilberforce in that case that:  “Trading requires an intention to trade; normally the question to be asked is whether this intention existed at the time of the acquisition of the asset”.  This was said to be subject to the reservation that the intention at the outset was capable of change:  “the company, in whatever character it acquires the asset, may reserve an intention to change its character. To do so would, in fact, amount to little more than making explicit what is necessarily implicit in all commercial operations, namely that situations are open to review.” 
29.	In Simmons, Lord Wilberforce said at 355 that “Frustration of a plan for investment, which compels realisation, even if foreseen as a possibility, surely cannot give rise to an intention to trade”.  Similarly, at 356, Lord Salmon said that “An investment does not turn into trading stock because it is sold”.  The Tribunal accepts that as a matter of law, the converse is also true.  Trading stock does not become an investment merely because prevailing market conditions prevent it from being sold for want of purchasers. 
30.	For the Appellant it is argued that she cannot have bought the properties with the intention of renting them, because she is making a loss.  The Tribunal does not accept this logic.  It is said that she cannot sell the properties because she initially made a mistake by paying too much for the initial property, and then failed to foresee the downturn in the market.  The fact that rental activities are running at a loss might equally be explained on the basis that the Appellant may have misjudged the rental market. 
31.	For the Appellant it is argued that she envisaged at the time of purchase of each of the properties that the property would be sold at a profit within a space of about 6 months.  She says that when she bought the first properties, she made a mistake by paying too much, and that she was therefore not able to resell in the short term at a profit.  Her evidence is that within the space of 4 to 6 weeks she brought students in as tenants.  The Tribunal considers that even if it were to accept this evidence, it would conclude on the basis of the evidence that it must have become apparent to the Appellant that she would not be able to resell the properties for a profit within a short term of about 6 months.  The first properties were bought in 2002.  The Appellant’s evidence is that the downturn in the Newcastle property market did not come until sometime later, in about 2004/05.  The Appellant’s inability to sell the first two properties within a short term of about 6 months therefore cannot be attributed to the downturn.  If her inability to sell them quickly arose from having paid too much, the Tribunal considers it probable that she realised at that time that she would have to keep the properties for a considerably longer period of time until gains in the market allowed her to sell at a profit.  The Tribunal finds on a balance of probability that at the latest by the time that she brought in the first students as tenants, several weeks after she bought the first properties, she realised that the properties would have to be rented out for a significant period before they could be sold.  The Tribunal finds on a balance of probability that by then at the latest it was her intention to keep the properties as rental properties for an undefined period, possibly with a longer term aim of selling them for a capital gain.  
32.	The Appellant says that she paid too much for the first properties, but that she subsequently learned from her mistakes.  The Tribunal does not accept this.  She has now purchased eleven properties, the last of which was acquired in 2006.  She has not sold any of them.  If it had always been her intention to sell the properties within a period of about six months, then it is clear either that she has continued to repeat the same mistake, or that it was not in fact her intention to sell the properties within a short period of about six months.  The Tribunal accepts that the pound cost averaging method (paragraph 16 above) may be a valid financial strategy, but, as the Appellant’s representative effectively conceded (paragraph 17 above), this methodology may take many years to succeed in the case of residential property.  Even if the Appellant’s initial intention in 2002 was to sell properties quickly for a profit, the Tribunal finds on a balance of probabilities that her intention rapidly changed (paragraph 28 above).  The Tribunal is satisfied on a balance of probabilities that at the time of purchasing the subsequent properties, she was aware that she would have to rent the properties out for at least some years, possibly with the longer term aim of selling them in order to realise a capital gain.
33.	The Tribunal adds for completeness that it also does not exclude the possibility that it was from the beginning the intention of the Appellant to rent the properties, possibly with the longer term aim of selling them in order to realise a capital gain.
34.	The Tribunal finds that the nature of the Appellant’s own activities in relation to the properties, as described by her in her evidence, are consistent with those of a landlord. 
35.	Looking at the evidence overall, the Tribunal is not satisfied on a balance of probabilities that the Appellant is engaged in a trade in property.  The burden of proof is on the Appellant, and having failed to discharge this burden, the Appellant’s appeal must be dismissed. 
Conclusion
36.	For the reasons given above, the Tribunal dismisses the appeal.
37.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  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.

Christopher Staker

TRIBUNAL JUDGE
RELEASE DATE: 14 JANUARY 2011