What constitutes a settlement for the purposes of CGT Principal Private Residence relief?

 In Tax

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Case Summary from LawSkills | Private Client specialist trainersWagstaff v HMRC [2014] UKFTT 043 (TC)

The Appellants in this case challenged HMRC’s assessment to capital gains tax (CGT) in relation to the gain they made on the sale of a property they owned. In spite of the fact that none of the documentation relating to their ownership of the property mentioned the word ‘trust’ anywhere, the Appellants argued they were in fact trustees of the property who could claim Principal Private Residence (PPR) relief in relation to their sale of the property. The Taxation of Chargeable Gains Act 1992 (TCGA) includes provision for trustees of property to claim relief from a CGT charge on its disposal in certain circumstances. That PPR relief could apply to this case, however, will challenge the perceptions of many as to how a trust might be created, and is a salutary reminder to professionals that a client’s particular circumstances should always be considered.

The facts

Mrs Wagstaff sold the flat she had owned and lived in for several years (the Flat) to her son, Stephen Wagstaff and his wife Victoria (the Appellants), on 6 February 1996. It was accepted by HMRC that the price paid was an arm’s length price. The sale was, however, subject to the terms of an agreement between the parties also made on the date of the sale and transfer (the Agreement). Under the terms of the Agreement, Mrs Wagstaff was entitled to continue living in the Flat at no cost for the remainder of her life, or until her remarriage, in return for a payment to her son and his wife of £5,000.

Mrs Wagstaff continued to occupy the property until 2005. She had knee replacement surgery that year, returning to the Flat a short time later. Unfortunately, within a few days she fell, injuring herself badly, and had to be readmitted to hospital. After spending several weeks there, she went to live with the Appellants pending the arrangement of more suitable long term accommodation. The Flat remained available for her use, her furniture and belongings remaining in situ, until she moved into a single storey home bought for her use by the Appellants. The Flat then remained empty until it was sold by the Appellants with her agreement, by way of an arm’s length third party transaction, on 16 March 2007.

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The First Tier Tax Tribunal hearing the case reproduced the four short clauses of the Agreement in full in their judgement:

“1.          In consideration of the sum of £5,000, the [Appellants] allow [Mrs Wagstaff] to reside at the property at no cost for the remainder of [her] life or on remarriage of [Mrs Wagstaff] whichever shall happen first.

2.            [Mrs Wagstaff] shall pay all common household expenditure including council tax water rates gas electricity telephone television licence and/or rental agreement contents insurance food.

3.            [The Appellants] will pay for the cost of the building insurance ground rent and service charge and for decorating and repairing the inside and outside of the property.

4.            All items of personal use and the contents of the property belong solely to [Mrs Wagstaff].”

The Agreement was signed as a deed, recording Mrs Wagstaff’s sale of the Flat to the Appellants, that it was intended to be legally binding and that it was entered into to regulate the occupation of the Flat by Mrs Wagstaff.

The purpose of the Agreement was to give security to Mrs Wagstaff’s continued occupation of the flat and to ensure that she could use and enjoy it without interference or interruption from the Appellants. Mrs Wagstaff’s son had noted in correspondence that in signing the Agreement he and his wife had forfeited the right to let or dispose of the Flat. As a consequence, it had only been sold once Mrs Wagstaff was no longer able to live in it and with her consent.

The law

The CGT provisions relating to the disposal of a private residence can be found in ss. 222-226 TCGA. Principal Private Residence (PPR) relief is introduced in s.222:

“(1) This section applies to a gain accruing to an individual so far as attributable to the disposal of, or of an interest in – (a) a dwelling-house or part of a dwelling-house which is, or has at any time in his period of ownership been, his only or main residence…”

And s.223 introduces the amount of the relief:

“(1) No part of a gain to which s.222 applies shall be a chargeable gain if the dwelling-house or part of a dwelling-house has been the individual’s only or main residence throughout the period of ownership, or throughout the period of ownership except for all or any part of the last [18 ]* months of that period.”

*This period is being reduced from 36 to 18 months by s. 54 Finance (no.2) Bill 2014 (not yet enacted), with effect from 6 April 2014.

PPR relief can also apply to a property held by trustees; this is provided for by s.225 TCGA as follows:

“Sections 222 to 224 shall also apply in relation to a gain accruing to a trustee on a disposal of settled property being an asset within section 222(1) where, during the period of ownership of the trustee, the dwelling-house or part of the dwelling-house mentioned in that subsection has been the only or main residence of a person entitled to occupy it under the terms of the settlement”.

The meaning of a settlement for the purposes of TCGA is defined in s.68 of that Act:

“In this Act, unless the context otherwise requires, “settled property” means any property held in trust other than property to which section 60 applies (and references, however expressed, to property comprised in a settlement are references to settled property).”

S.60 TCGA, mentioned in the definition of settled property, deals with property that is held by a person as nominee for another or as trustee for another absolutely entitled to the property as against the trustee: such property is treated as vested in the beneficiary rather than in the trustee. S.60 did not apply to the circumstances of this case, so the s.68 definition of ‘settled property’ fell within the ambit of the Tribunal’s considerations.

The submissions

HMRC submitted that the Appellants acquired full legal and beneficial ownership of the Flat on 6 February 1996 and immediately granted Mrs Wagstaff a ‘lease for life’ under the Agreement they entered into on the same date. HMRC further argued that the Agreement did not fetter the Appellants’ right to dispose of the Flat, although they could not sell it with vacant possession because of Mrs Wagstaff’s rights under the Agreement. It was their contention that the Appellants were therefore absolutely entitled to the Flat, subject only to those rights, and the Agreement did not give rise to any trust. HMRC therefore concluded that the Appellants were not trustees and the Flat was not settled property for the purposes of s.225 TCGA.

The Appellants, in turn, argued that HMRC’s conclusions might be appropriate where a lease for life was granted at full market value, but in the present case the consideration specified under the Agreement was nominal only, significantly below the level of a reasonable market rent. The Appellants therefore contended that in purchasing the Flat from Mrs Wagstaff and immediately granting her for nominal consideration the right to occupy the Flat for life or until remarriage, they had subjected their interest in the Flat to a trust, in respect of which the Flat was settled property.

The decision

The Tribunal accepted that the Agreement was entered into for less than full consideration. They also confirmed their understanding that the basic wording of the Agreement did little more than record the Appellants’ instructions to the solicitor to draft a document that would provide a legal basis for Mrs Wagstaff’s continued occupation of the Flat. It did not necessarily specify the nature of the legal relationship being created between the parties. The Tribunal did not, therefore, regard the Agreement as ‘solely determinative’ of the relationship created; they would have regard to all the evidence available on this matter.

The Tribunal then confirmed their understanding that the TCGA definition of ‘settled property’ would apply to the PPR relief provisions in the Act, including s.225.

HMRC had argued that the circumstances of this case did not satisfy the three certainties required to constitute a valid trust – the certainties of object, subject matter and intention to create a trust. The Tribunal first made it clear that they believed there was no question that the first two certainties had been met. The only certainty that remained to be considered was the question of whether there had been an intention to create a trust.

The Tribunal cited (inter alia) Snell’s Equity, 32nd Edition, para 22:

 “No particular form of expression is necessary for the creation of a trust if, on the whole, it can be gathered that a trust was intended.”

What the Tribunal found to be clear from the Agreement was that the parties intended that the arrangement into which they were entering should give rise to legal rights and obligations that would regulate their relationship during Mrs Wagstaff’s lifetime. They found that in parting with ownership of the Flat, Mrs Wagstaff was to an extent placing herself in the hands of the Appellants, but only on the basis that they accepted particular legal obligations towards her. The Tribunal continued:

“[Mrs Wagstaff’s] position vis-à-vis the Flat was to be secure against any eventuality, something that would not necessarily be guaranteed by a purely contractual relationship in the form of the Agreement but which would be better protected if the Appellants in entering into the arrangement were accepting the obligations ordinarily associated with a trust and the role of trustee.”

The Tribunal concluded that this relationship was accepted by all concerned, as evidenced by the way in which the Flat was dealt with once it was no longer suitable accommodation for Mrs Wagstaff. With her agreement, the Appellants acquired new accommodation for her and sold the Flat.

The Tribunal decided, having reached these conclusions on the circumstances of the case, that in acquiring the Flat on terms which included the Agreement, the Appellants were assuming the role of trustees and did not become absolutely entitled to the Flat, with the exclusive right to direct how the Flat should be dealt with. The Appellants’ interest in the Flat was therefore ‘settled property’ within the meaning of s.68 TCGA.

The Tribunal had not heard any argument from HMRC that the requirements of s.225 had not otherwise been satisfied and, on that basis, PPR relief under this provision was available to the Appellants.

Practice points

  • This case confirms that for the purposes of s.225 TCGA, allowing PPR relief to apply to settled property in certain circumstances, it is the definition of ‘settled property’ found in s.68 TCGA that should be applied. Other definitions, found in other taxing statutes, are not to be used in this context.
  • The practitioner should note that the evidence of intentions available to the Tribunal in this case was critical to its outcome. Indeed, evidence has proved decisive in many PPR relief cases. Clients should be encouraged to gather and keep as much evidence as possible of their intentions, of their residence in a property and the like.
  • It is advisable that documents prepared for clients make it very clear on their face when an express trust is being created.
  • Practitioners should be aware that a trust may be created even where the word ‘trust’  has not been used. All the circumstances of an agreement made by a client, on which advice is being sought, should be considered. The fact that the client believes his actions have created a trust, or a different kind of legal relationship, will not necessarily be conclusive of how the legal position will be interpreted by the courts.
  • Whilst the conclusion reached by the Tribunal was helpful to the Appellants in this particular case, it is vital that practitioners bear in mind all possible tax implications relevant to their clients. An agreement entered into now, creating a settlement of this kind, would fall within the relevant property regime for IHT purposes and could give rise to an immediate IHT charge.

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