Ritchie case may “shed” new light on CGT residence relief

Tue 20 Jun 2017

The multi-faceted case of Ritchie and Ritchie v HMRC doesn’t quite cover all the bases in principal private residence (PPR) relief but it does present an interesting and wide-ranging case study as it involved:
• land purchased but not immediately developed to include a dwelling;
• acquisition of the land in two tranches;
• consideration of the permitted area where the plot was greater than 0.5 hectares (ha); and
• buildings occupied with the dwelling.
There was also the issue of HMRC’s power to make discovery assessments more than four years after the end of the tax year concerned on the grounds of careless conduct by or on behalf of the taxpayers.

Sequence of events

Hazel and Billy Ritchie sold their house and the surrounding land and buildings in January 2007. The land, an area finally determined as 0.699 ha was on the site of a disused railway station and included two buildings; a small “potting shed” and a large ex-railway shed used as a garage and for general storage (“the large shed”).
1. In July 1987 The Ritchies bought the main body of the land (0.615ha) for £11,000 from the Dept. of Transport (DoT) but could not reside there because there were no buildings for human habitation on the land, so they rented an adjacent cottage (“No. 22”) and lived in that, using the sheds as garage and general storage space.
2. In 1991 the Ritchies applied for planning permission to build a house.
3. They first occupied the house (“No. 28”) in January 1995.
4. In the course of the application the Ritchies had discovered that they had not acquired all the land they understood they were obtaining: it took until 2002 before they obtained possession of the remaining 0.084ha from the Dept. of Transport, for no further cost other than legal expenses.
5. In January 2007 the land was sold in its entirety to a developer for £2m.
6. The Ritchies did not enter the disposal on their tax returns on the basis of advice received from their accountant and another specialist adviser he had referred them to.
7. HMRC came across the £2m receipt when in 2010 they made an enquiry into the Ritchies’ business and queried £2m shown as capital introduced into their business (a modest takeaway).
8. In March 2013 HMRC issued two discovery assessments to each of Hazel and Billy, both in respect of the gains realised on the disposal of No. 28.
The Ritchies appealed.

CGT liability issues

The issues that arose out of the history set out above were:
• whether the Ritchies could claim PPR relief for the whole of their period of ownership (from 1987) or only from the time when they first occupied their newly-built house (1995), and if the latter, how the gain was to be apportioned;
• whether the large shed fell within the curtilage of the house and could be said to be occupied for the proper enjoyment of the house and so qualify for PPR relief; and
• since the total area of the site exceeded 0.5ha, what proportion of that area would qualify for PPR relief.
Period of occupation for PPR relief purposes
The Ritchies’ counsel contended that they should qualify for PPR relief because they had occupied and used the large shed as part of their dwelling even at the time before they owned a house on the site and were still renting No. 22. In support of this optimistic contention Counsel argued that all the relevant past cases on this aspect of PPR had only  related to buildings occupied throughout the period of ownership and occupation of the main dwelling, there was no legal precedent on the subject and, because:
1. the large shed was still occupied and qualified for PPR relief at the time of disposal; and
2. HMRC had produced no arguments against this contention
the First-tier Tribunal (FTT) should find that the large shed and by extension the entire site, at least up to the permitted area, should qualify for relief for the entire period of ownership.
The Judges rejected this novel contention because the legislation is clear that PPR relief can only extend to land and buildings occupied at the time when there is on the site a dwelling for which the relief is given.
Having decided that the period before the house was occupied did not qualify for PPR relief the Judges considered how the gain for that period should be calculated and concluded that TCGA 1992 s 224(2) applies:
“If at any time in the period of ownership there is a change in what is occupied as the individual’s residence, whether on account of a reconstruction or conversion of a building or for any other reason, or there have been changes as regards the use of part of the dwelling-house for the purpose of a trade or business, or of a profession or vocation, or for any other purpose, the relief given by section 223 may be adjusted in a manner which is just and reasonable.”
The judges concluded that “a change in what is occupied as the individual’s residence” covered the Ritchies’ situation:
• there may not have been a reconstruction or conversion, since there was no original dwelling  but the catch-all “for any other reason” brought it within the section; and
• as s 224 requires adjustment in a just and reasonable manner it was not necessary simply to apportion the gain on a specific way, e.g. time apportionment.
In this case the Judges settled on an estimate of the amount of gain likely to have accrued on the land between the times when it was acquired and when the Ritchies first occupied the house they had built, taking the market value of the house at that point as the notional consideration and deducting the costs of the land and of construction.

The second tranche of land

This land was not purchased and its acquisition was really no more than the Ritchies making sure they got what they’d originally bargained for, so this land was treated as if it had been acquired at the same time as the original purchase.

The sheds as part of the dwelling

This aspect was unusual in that the large shed pre-dated the building of the house: such disputes usually concern outbuildings that have been constructed in the grounds of an existing dwelling, most commonly some form of accommodation for a relative or employee of the house’s owner. Counsel for the Ritchies contended that as the large shed was occupied by them as overflow kitchen and storage space, including for sports equipment as well as as a garage and workshop, and was near enough to be regarded as “very closely adjacent” (Markey v Sanders), it was necessarily part of their dwelling house. The judges accepted this contention, even though the large shed was bigger than would normally be required and was in fact also used by Billy to store his competition ploughing gear.

The permitted area

Grounds and gardens of up to 0.5ha (including the footprint of the dwelling itself) automatically qualify for PPR relief unless they are discrete from the house and not used as part of the dwelling. In this case there was some dispute over the precise extent of the land but it was more than 0.5ha. The FTT decided that the evidence pointed to the area being 0.699ha. In addition s 222 (3) allows a bigger area if that is required, “having regard to the size and character of the dwelling-house”. HMRC contended that this house was not markedly dissimilar to other houses in the area whose gardens were all much less than 0.5ha but the Judges accepted the contention for the Ritchies that the house had been conceived with the intention of enjoying the surrounding space and in particular the large shed. They found that, by their estimation, an area of 0.11 ha could be identified as not necessary for the proper enjoyment of the house out of the total of 0.699ha.
The judges rounded up the total area to 0.7ha and the non-PPR area down to 0.1ha so that 1/7th of the post-1995 gain was regarded as ineligible for PPR relief. The judges also ruled that, as between the relievable and non-relievable parts of the site it was appropriate to apportion the gain in proportion to their relative areas because the premium paid for the site represented its development value and so there was no reason to differentiate between any of its parts.
Following the two apportionments, between pre and post-1995 and the permitted area, the Ritchies had realised a gain that was not entirely covered by PPR relief. Therefore there had been an omission from each of their tax returns and the FTT had to consider whether HMRC’s discovery assessments were valid.

Discovery assessments

The rules for enabling HMRC to raise discovery assessments under s 29 Taxes Management Act 1970 for matters not properly disclosed on a return outside the normal enquiry window depend on whether the omission from the taxpayer’s return was due to careless or deliberate conduct. An assessment on any understated income or gains may be made within four years after the end of the year in question in any case where an HMRC officer discovers that there has been an under-assessment. A six year time limit from the end of the tax year in question applies if the under-assessment arose from careless conduct of the taxpayer or a person acting on his behalf (a 20 year time limit applies in the case of a deliberate understatement of income or gains). HMRC’s assessments on the Ritchies for 2006/07 were made in March 2013 and so fell well outside that four year limit.
In each case HMRC had made an initial assessment in a round sum, followed by a second assessment recalculated by the HMRC officer. The Ritchies’ counsel persuaded the judges that the round-sum assessments were not valid because assessments are required to be made to the best of the officer’s judgment. This is not to say that round-sum assessments cannot validly be made but in this case HMRC did not produce evidence to satisfy the FTT that the first assessments were valid. However, the second assessments on Hazel and Billy, were held to have been validly made.
It was not disputed that the Ritchies had failed to enter the relevant property disposal on their returns and they, and their accountant, had believed they had not had to, on the basis that they had received advice from a consultant recommended by their accountant that the entire gain would be covered by PPR relief.
The FTT decided that the Ritchies had not acted carelessly: there was ample evidence that they had taken advice from their accountant and his recommended consultant. However, Billy had seen the consultant on his own, obtained no written confirmation of the consultant’s advice and reported it orally to the accountant. The judges found that the consultant had been careless in not obtaining all the relevant facts from Billy before giving oral advice. Billy had passed on the advice orally to his accountant who then acted carelessly in that he:
• failed to take proper steps to obtain from the consultant confirmation of Billy’s oral report that there was no chargeable gain; and

• not paying attention to either the tax return guide or IR 283 Helpsheet which would have made it clear that an entry on the return was required because the area covered by the house and grounds exceeded the permitted area of 0.5ha.
The FTT held that an accountant in the business of completing tax returns for clients ought to have known of this requirement or taken steps to inform himself of the requirements before telling the Ritchies that they did not need to include any entry on their returns or explanation why no entry was made.
Therefore the assessments on the Ritchies within the 6 year time limit for carelessness were valid but the appeals were allowed with respect to the amounts of tax concerned which were significantly reduced from the original amounts.