Section 1
The Valuation Office Agency's (VOA) technical manual used to assess Capital Gains and other taxes.
1.1 General
Income Tax is, broadly speaking, a tax on all income the source of which is situated in the United Kingdom, or which is received by individuals who are residing in the United Kingdom. Income Tax is not a permanent tax which is levied until repealed or amended by subsequent Act of Parliament. It remains in force for one year only and has to be re-imposed annually by the Finance Act that stipulates the basic and higher rates of the tax for that year together with other variations, allowances and reliefs.
1.2 Method of assessment
Income may be generated in differing ways, some only after expenditure (e.g. on trade stock), some may involve risk so that expenditure may exceed income in some years, some may be irregular (e.g. incomes of authors). Conversely some income may be generated without expenditure, risk or irregularity, (e.g. interest from Building Societies). These different sources of income were classified in the Income and Corporation Taxes Act 1988 (ICTA 1988) (this followed similar provisions from earlier Acts) under various Schedules, each Schedule being subject to special rules regarding the assessment of the income to which it applies. These Schedules are now repealed for income tax purposes, although Schedules A and D remain for corporation tax purposes.
1.3 Tax law rewrite project
The aim of the Tax Law Rewrite Project was to rewrite the United Kingdom’s primary direct tax legislation to make it clearer and easier to use, without changing the law. The project has resulted in income tax legislation being divorced from corporation tax and is now enacted in:
- The Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003) is effective from April 2003
- The Income Tax (Pay as You Earn) Regulations 2003 (SI 2003 No. 2682) is effective from April 2004
- The Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005) is effective from April 2005
- The Income Tax Act 2007(ITA 2007) takes effect from 6 April 2007
ITEPA 2003 imposes charges to income tax on employment income (parts 2 to 7); pension income (part 9); and social security income (part 10). This replaces Schedule E.
ITTOIA 2005 imposes charges to income tax on trading income (part 2); property income (part 3); savings and investment income (party 4); certain miscellaneous income (part 5). This replaces Schedule F and for income tax purposes only, Schedules A and D.
ITA 2007 covers a miscellany of provisions.
The ‘administrative’ self-assessment rules in the Taxes Management Act 1970 are unchanged by the rewrite project.
1.4 Schedules and cases
The Schedules set out in s.15 to 20, ICTA 1988 are shown below to assist in understanding the historic background, as follows:-
Schedule A - applied to income accruing from ownership of an estate or interest in land, eg rent (replaced for income tax purposes by ITTOIA 2005, but still applicable for corporation tax);
Schedule B - applied to income derived from the occupation of commercial woodlands but was abolished from 6 April 1988;
Schedule C - applied to income from interest, dividends and annuities received from the Government or public bodies (including foreign states); Schedule C was repealed from 1996-97
Schedule D - is divided into six “cases”:-
- case I applies to income from a trade
- case II applies to income from a profession or vocation
- case III applies to income from interest, annuities, annual payments and discounts, not taxed at source
- case IV applies to income from overseas securities
- case V applies to income from overseas possessions and pensions
- case VI applies to other income not falling under any of the foregoing cases and not charged under any other schedule
Replaced for income tax purposes by ITTOIA 2005, but still applicable for corporation tax.
Schedule E - applied to income from offices, employments and pensions. This was replaced by ITEPA 2003 from 6 April 2003;
Schedule F - applied to income from dividends and other distributions by companies. This was repealed by ITTOIA 2005. For Income Tax this type of income is now within Part 4, ITTOIA 2005 and for Corporation Tax, company distributions remain in Part VI, ICTA 1988.
It was for the convenience of assessment that income was classified in Schedules. However, it should be borne in mind that Income Tax is the same tax no matter on what class of income it may be levied. For example, a person may be in receipt of rents from property (part 3, ITTOIA 2005 [former Schedule A]) and may also be receiving a substantial income from either a trade or profession (part 2, ITTOIA 2005 [former Schedule D]). The portion of gross income accrued from rents which is liable to tax is determined in accordance with the rules in part 3, ITTOIA 2005. The exact sum on which the profits of the business, trade or profession, are assessed to tax is determined by the rules in part 2, ITTOIA 2005.
1.5 Independent taxation
Since the introduction of independent taxation on 6 April 1990 all individuals, whether married, in civil partnership, or single, are independently assessed to income tax. Prior to that date the income of a married woman was generally treated as if it were part of her husband’s income.
1.6 Tax year
The Income Tax year is from 6 April in one calendar year to 5 April in the subsequent calendar year, and that year is technically known as the year of assessment being identified by the two years in which it falls, eg 2006/2007.
1.7 Taxable income
The total income assessed in accordance with the Income Tax acts detailed in 1.3 above, less annual payments and allowances, which are not subject to Income Tax, is known as the taxpayer’s taxable income. The taxable income will be less than, and may substantially differ from, the taxpayer’s actual total income in the year.
1.8 Allowances and reliefs
There are various allowances and reliefs which can be deducted from an individual’s income to arrive at the taxable income. These are set each year and included in the Finance Act which puts into law the statements made by the Chancellor of the Exchequer in the Budget.
1.9 Rate of tax
Income tax is charged either at the starting rate, basic rate or higher rate, depending on the level of taxable income. In 2006/2007 the rates are: Starting Rate : 10%; Basic Rate : 22%; Higher Rate : 40%.
1.10 Self assessment
Self Assessment (SA) was introduced for individuals, trusts and partnerships in 1996/97.
Under the SA system taxpayers are, in principle, responsible for the calculation of their own tax liability and the submission of that calculation to HM Revenue & Customs.
Personal taxpayers can comply with the self assessment requirements by either
- Including a calculation of tax liability in their tax return, or
- Filing the tax return only (at an earlier date) so that HMRC can do the calculation and advise the taxpayer of the amount to pay
In very general terms HMRC may query a taxpayer’s self assessment by opening an “enquiry” into the tax return. Apart from the discovery of incomplete disclosure, or fraud, an enquiry into a return cannot be opened more than 12 months after the last filing date unless the return is filed late in which case the time limit is 12 months from the date of actual filing. The last date for filing Income Tax returns is the 31 January following the end of the year of assessment (eg. for the tax year 2006/2007 the last filing date is 31 January 2008).
1.11 Further information
The calculation of tax is a complex subject. HMRC issue various leaflets explaining most aspects of Income Tax. Details of these leaflets and HMRC’s published internal guidance manuals may be obtained from their web site: http://www.hmrc.gov.uk/
1.12-19 Reserved
1.20 General
A company resident in the United Kingdom is chargeable to corporation tax on all its profits. A company not resident in the United Kingdom is chargeable to corporation tax only if it carries on a trade in the United Kingdom through a branch or agency, and broadly such a company is chargeable only on the profits which relate to that branch or agency.
Generally speaking, profits and income for corporation tax purposes are computed under the same schedules and rules as for income tax.
1.21 Rate of tax
Corporation Tax is levied at a single rate on the chargeable profits of all companies, except those companies whose profits do not exceed a certain level (which is varied from time to time). These companies are charged at a lower rate known as the “small companies rate”. In 2000/2001 the full rate of tax is 30% and the small companies rate is 20% with a lower starting rate of 10% for companies with profits up to £10,000 in that year.
Marginal relief is available for companies whose profits exceed the small companies limit but do not exceed an upper threshold. This relief is calculated by reducing the corporation tax liability at the full rate by a fraction of the difference between the profits and the upper threshold.
1.22 The tax year
Unlike an individual taxpayer a company may set its own date from which the accounting year may commence. This is known as the “Accounting Period”
1.23 Self assessment
Self Assessment (see paragraph 1.9) was introduced for companies in the 1999/2000 tax year.
The last date for filing Corporation Tax returns is 12 months after the end of the accounting period.
1.24-29 Reserved
1.30 General
The need for a valuation of a property for the purposes of calculating an individual’s taxable income or a company’s taxable profits can arise in a variety of ways. The following paragraphs describe the main occasions when HMRC may require valuation advice.
1.31 Income from property;
(Schedule A for Corporation Tax and Part 3, ITTOIA 2005 for income tax purposes)
HMRC may on occasions require advice from the DV on the amount of a premium received by the taxpayer or the value of works carried out by the tenant. The circumstances when advice may be required are rare and HMRC will in each case explain the reason for the request.
An example of such a request would be to calculated a deemed premium in accordance with S.34(2), ICTA 1988 which says:
“Where the terms subject to which a lease is granted impose on the tenant an obligation to carry out any work on the premises, the lease shall be deemed for the purposes of this section to have required the payment of a premium to the landlord (in addition to any other premium) of an amount equal to the amount by which the value of the landlord’s estate or interest immediately after the commencement of the lease exceeds what its then value would have been if those terms did not impose that obligation on the tenant.”
Wording to similar effect, although not identical is within S.278, The Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005).
If any difficulties arise the DV should seek advice from CEO Technical Centre.
1.32 Income from a trade or profession etc
(Schedule D for Corporation Tax or Part 2, ITTOIA 2005 for Income Tax)
When a taxpayer is trading or dealing in property valuations may be required to enable the Inspector to determine the profits. The circumstances when valuations may be required are explained in detail in Part 4 of this Section.
1.33 Income from employment etc
(ITEPA 2003 & former Schedule E)
The main occasions when valuations may be required for Employment Income purposes are when:
- a property is transferred to or from an employee or director other than at market value
- accommodation is provided for an employee or director by their employer.
The valuations required for Employment Income purposes are explained in detail in Part 5 of this Section.
1.34 Income from dividends/distributions etc
(former Schedule F)
When a distribution is made by transferring a property to or from a member of a company valuations may be required to determine both the recipients liability to income tax under Part 4, ITTOIA 2005 and the company’s corporation tax liability.
The circumstances when valuations may be required are explained in detail in part 6 of this Section.
1.35 Allowances
Valuations and apportionments may also be required to determine the amount of allowances that can be deducted from a taxpayer’s income or a company’s profits to arrive at the taxable income/profit. The circumstances when valuations and apportionments may be required are described in detail in Section 3.
1.36-39 Reserved
General
1.40 Circumstances when valuations required - overview
The need for a valuation for the purposes of assessing Income or Corporation Tax under Schedule D may typically arise in the following circumstances:
- When the Inspector considers that the acquisition and disposal of a property by an individual or company constitutes a trade of property dealing (see paragraph 1.41-42 )
- When a builder constructs or transfers a house for their own occupation (see paragraphs 1.43-44)
- When a developer claims that a property held as trading stock has fallen in value (see paragraphs 1.45-47)
- When a company receives a payment under a mining lease or agreement which relates both to mineral royalties and other matters (see Section 2)
1.41 Property dealing - General
Individuals or companies who trade in property are liable for income or corporation tax on their profits. In certain circumstances, individuals or companies who are not in business for the purpose of trading in property may enter into a transaction which amounts to ‘property dealing’. If so, then the profit realised on such a transaction will be chargeable to income or corporation tax under Schedule D, rather than being treated as a capital gain.
An example of the type of situation that may arise is where a taxpayer enjoys a tenancy of a house under a long lease at a low rent. The taxpayer enfranchises and in order to fund the enfranchisement disposes of the property freehold with vacant possession in a “same day” transaction. It might be thought that in the normal run of things the gain made by the taxpayer is a capital one and, on the assumption that the property was the taxpayer’s principal private residence relief would be available under ss 222 and 223 TCGA 1992. However, where the freehold was not acquired with the intention to retain but to sell at a profit the Inland Revenue may argue that this constitutes property dealing. If so then the difference between the value of the taxpayer’s tenancy and the value obtained on the sale with vacant possession (net of costs) would be taxable as income under Schedule D.
1.42 Property dealing - basis of valuation
Valuations will usually be required to be on the basis of normal open market value for Revenue purposes. Should any other basis be appropriate the Inspector will specify the requirements in the originating instructions.
1.43 Builders - Houses for own occupation - General
A house built by a builder for his own occupation and so used does not become stock of his trade. The only adjustment for Income Tax purposes in such a case is the disallowance under s.74 (b) ICTA 1988 of the cost of construction.
On the other hand a house built and offered for sale by a builder in the ordinary course of his business is trading stock. The taking of such a house for private occupation is treated as a sale at market value for Income Tax purposes following Sharkey v Wernher (36 TC 275).
In practice many cases fall between these two extremes and are dealt with by determining the extent to which the house and land should be regarded as trading stock. For example a private residence built on land held as trading stock may give rise to an adjustment in respect of the land alone.
1.44 Builders - houses for own occupation - basis of valuation
DVs may receive one of two requests from Inspectors in relation to the above problem. Firstly the Inspector may request the DV’s opinion of the open market value of the property which should be taken as being the normal Revenue basis of valuation (see Section 7). Secondly the Inspector may request the DV to obtain an estimate of the cost of building the property in order that the liability under Schedule E can be assessed in respect of the difference between the amount paid by the taxpayer to the company for the property and the actual cost to the company of constructing the property.
1.45 Developers - stock-in-trade - overview
In the preparation of Company accounts the determination of profit in an accounting year requires the matching of costs with related revenues. The cost of unsold or unconsumed stocks and work in progress will have been incurred in the expectation of future revenue, and when this will not arise until a later year it is appropriate to carry forward this cost to be matched with the revenue when it arises; the applicable concept is the matching of cost and revenue in the year in which the revenue arises rather than in the year in which the cost is incurred. If there is no reasonable expectation of sufficient future revenue to cover cost incurred (eg as a result of deterioration, obsolescence or a change in demand), the irrecoverable cost should be charged to revenue in the year under review. Thus, stocks and work in progress normally need to be stated at cost, or, if lower, at net realisable value.
It should be noted that there are specific rules for the valuation of trading stock on the discontinuance of a trade in ss.100-102 ICTA 1988.
1.46 Developers - stock-in-trade - requests from inspectors of taxes
A DV may be requested to provide valuation advice where a taxpayer claims that an interest in land or buildings has a value lower than its historic cost. The most common example will generally be where land purchased with hope value subsequently did not ‘live up to expectation’ or where a property is purchased at the top of the market prior to a slump or decline in demand. The items are treated individually and losses in one section of a developers land bank may not be set off against gains in another section for the purposes of stock valuation.
1.47 Developers - stock-in-trade - basis of valuation - net realisable value
Provided the basis of valuation of stock-in-trade and work in progress adopted in the accounts conforms to recognised accountancy practice and does not violate the taxing statues, it may be accepted as valid for Income Tax or Corporation Tax purposes. This follows the decision in Ostime v Duple Motor Bodies Ltd (1961, 39T.C.537),
The Revenue generally accept the basis as laid down in the Statement of Standard Accounting Practice No 9 of September 1988 which was issued by the Accounting Standards Steering Committee.
The normal basis of valuation is cost or net realisable value, whichever is the lower; each item of stock being valued separately. Details of the basis are contained in the RICS Red Book Practice Statement 21. There are three differences between a normal Revenue valuation and the net realisable value required for trading stock purposes:
- It is necessary to consider the ‘expected sale price’ of the relevant stock in the condition in which it is expected to be sold in the traders ‘normal selling market’
The identification of the traders normal selling market may not be straightforward and ideally should be decided jointly by the Inspector and DV together but the final decision rests with the Inspector. Knowledge of the previous trading activity of the company should be pooled and consideration must also be given to what might have been realistic on the specific land being considered. Evidence may have to be sought from the taxpayers regarding their past trading activities in the years leading up to the valuation date.
The difficulty can be seen in an example where the item of stock is bare land. One type of trading activity might involve site assembly and obtaining planning consent before selling on to a developer. An alternative trading activity is where the company also carries out the development, lets the newly completed development and only sells once it has become an income producing investment. Thus the ‘condition in which it is expected to be sold in the traders normal selling market’ is quite different in each case.
- From the expected sale price it is necessary to deduct the costs incurred in getting the stock into a marketable condition. Costs of completing a development will include the cost of building work, professional fees, site works, finance charges etc. However no allowances are to be made for developers risk or profit as would be done in a residual valuation
- The costs of marketing, selling and distributing the stock will also be deducted. These would not usually be reflected in a normal open market valuation
If there is any dispute over the basis of valuation the DV should consult the Inspector and seek advice from CEO.
1.48-1.49 Reserved
1.50 Circumstances when valuations required - General
The need for a valuation for the purpose of assessing Employment Income will usually arise in the following circumstances:
- when a property is transferred to or from an employee or director other than at market value. (See paragraphs 1.51-53)
- when an employee or director is provided with accommodation by their employer (see paragraphs 1.54-56)
1.51 Transfers not at market value - General
A charge to Income Tax may arise when a property owned by an employer is transferred to an employee or director for a consideration less than its market value.
In such cases the Inspector will normally contend that the employee or director is liable for Income Tax on the difference between the consideration paid and the market value of the property.
A liability to tax may also arise when an employee or director transfers a property to their employer for a consideration which is greater than its market value.
1.52 Transfers not at market value - basis of valuation
The liability to tax will in most cases arise under s.62, The Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). ITEPA 2003 replaced s.19 ICTA 1988 (Schedule E) from April 2003. Subsection 62(2)(b) explains that ‘earnings’ includes “any gratuity or other profit or incidental benefit of any kind obtained by the employee if it is money or money’s worth”. ‘Money’s worth’ is defined in s.62(3) as something that is “(a) of direct monetary value to the employee, or (b) capable of being converted into money or something of direct monetary value to the employee.” The ‘money’s worth’ basis of valuation to be adopted in cases where the property has been transferred to an employee or director should be the price at which the transferee could have sold the relevant interest in the property at the date on which it came into their possession, provided that the sale was subject to the retention by them of whatever rights of occupation they enjoyed against their employer immediately before the transfer. (Guidance on the interpretation of rights of occupation can be found in the Inheritance Tax Manual, Practice Note 3).
This basis, which is derived from case law, differs from the open market value as applied in other revenue cases in that the ‘money’s worth’ basis hypothesises a sale by the actual taxpayer rather than by a hypothetical vendor. In practice this will produce the same valuation as the normal basis except where the property has special value for the actual taxpayer. For purposes of s.62, ITEPA 2003 that special value must be disregarded, for example, where the taxpayer was previously a protected tenant normal investment value should be adopted rather than a “tenant purchaser” bid.
In exceptional cases HMRC may seek to assess the benefit received by the employee under s.203, ITEPA 2003 (or prior to April 2003 under s.154 ICTA 1988), where the cash equivalent of an employment related benefit is to be treated as earnings. In circumstances where the benefit consists in the transfer of an asset and the asset has been used or has depreciated since the person making the transfer acquired or produced it, the cost of the benefit is deemed to be the market value of the asset at the time of transfer. In such cases the normal revenue basis of ‘market value’ should be adopted but if any difficulties arise advice should be sought from CEO Technical Section.
1.53 Transfers not at market value - interaction with capital gains tax
If a property has been transferred by an employer for less than its market value the Inspector will also compute the capital gain on the disposal made by the employer using market value in accordance with s.17(1)(b) TCGA 1992. In the past, if there was a charge under the former Schedule E, the consideration actually paid was usually treated as the disposal proceeds for CGT. This practice was withdrawn for disposals taking place on or after 6 April 1995.
If in any case the differing bases of valuation for CGT and Income Tax should give rise to different figures this must be clearly pointed out to the Inspector.
1.54 Provided accommodation - general
Under sections.97-113, ITEPA 2003 (formerly in s.145 ICTA 1988) an employee may be liable to a charge on living accommodation provided for their use by their employer. S.105, ITEPA 2003 provides for a charge based on the ‘annual value’ of the accommodation (or, if greater, the rent paid by the employer) less any rent paid to the employer by the employee. ‘Annual value’ is defined in s.110, ITEPA 2003 (formerly s.837 ICTA 1988) as the “rent which might reasonably be expected to be obtained on a letting from year to year if the tenant undertook to pay all the usual tenant’s rates and taxes, and if the landlord undertook to bear the costs of the repairs and insurance, and other expenses, if any, necessary for maintaining the subject of the valuation in a state to command that rent.” However, in practice, HMRC adopt the Gross Value of the dwelling for rating purposes in the 1973 Valuation List as being the ‘annual value’. An explanation of the use by HMRC of the Gross Value is given in their Employment Income Manual at EIM11432.
In addition to the charge under s.105, if the cost of providing the accommodation exceeds £75,000, there may be an additional charge under s.106, ITEPA 2003. This additional charge is based on a percentage of the amount by which the cost of providing the accommodation exceeded £75,000. The cost of providing the accommodation is defined as the sum of acquisition cost and expenditure on improvements. However, in certain circumstances (s.107, ITEPA 2003) the charge is based on a percentage of the market value of the property rather than the cost of providing the accommodation.
1.55 Provided accommodation - advice required by inspector
Inspectors may require advice on:
- The Gross Value that would have been attributed to the property had domestic rating and the 1973 Valuation List been continued. Such requests are only likely to arise where the provided accommodation comprises a dwelling that has been constructed, created, or substantially altered after 31 March 1990, when domestic rating was abolished
- The market value of the property for the purposes of an additional charge under s.106, ITEPA 2003
1.56 Provided accommodation - basis of valuation
Market value for the purposes of the additional charge under s.106, ITEPA 2003 is defined in s.107(3) as “ the price which the property might reasonably be expected to have fetched on a sale in the open market with vacant possession.” In estimating market value no reduction is to be made for an option in respect of the property held by the employee, a person connected with the employee, or a person involved in providing the accommodation.
1.57 Provided accommodation - interest to be valued
The interest to be valued in cases where a market value for s.106 is required is the interest held by the person supplying the accommodation for the employee, but it will also include other superior interests in the property held by a relevant person (for example the employer where they are not the employees immediate landlord) or other connected persons. Where there is more than one interest to be valued the interests should be regarded as merged.
1.58-59 Reserved
(former Schedule F)
1.60 General
HMRC may seek the assistance of DVs in cases arising out of company distributions as defined in s.209 ICTA 1988. Such references will be clearly marked as being required in order to quantify a liability under the distribution provisions. For Income Tax, distribution provisions are in Part 4, Chapter 3, The Income Tax (Trading and Other Income) Act 2005. HMRC may also seek the assistance of DVs in connection with the establishment of the company’s liability under s.419, ICTA 1988; and, more rarely, may require assistance in connection with the establishment of liability under s.418 (see 1.61 below).
1.61 Basis of valuation
In cases arising out of s.209, ICTA 1988, where a market valuation is required the DV’s valuation should be on the basis of normal open market value for Revenue purposes (see Section 7).
Exceptionally in a case arising out of a distribution within s.418, ICTA 1988 where a property has been let by a close company (s.414 and s.416) to a participator (s.417) at a rent which is apparently below market rental level, HMRC may ask the DV to provide an opinion of the “annual value” (as defined in s.837, ICTA 1988 - see paragraph 1.54).
1.62-69 Reserved
1.70 General
All cases involving valuations required for income and corporation tax should be dealt with in accordance with the procedures and time limits applicable in CGT cases (see Section 6).
1.71 Inspector’s request for a valuation
In all income and corporation tax cases the Inspector’s request for a valuation should be made by memorandum and not on a CG20 form. The Inspector will in each case explain the reason for the request but if there is any doubt the DV should clarify the position with the Inspector.
If any difficulties are encountered regarding the valuations required or the basis of valuation the DV should seek advice from CEO
1.72 Unagreed valuations
If it is not possible to reach agreement on the valuation required the case should be dealt with as set out in Section 6, Part 5 recognising that references for resolving disputes will be to the General or Special Commissioners and not the Lands Tribunal.
1.73 Appeal cases
Appeals against assessments to income and corporation tax are made to the General or Special Commissioners. If a valuation cannot be agreed the DV may be required to give evidence and defend the valuation as an expert witness before the Commissioners.
If a hearing before the Commissioners becomes necessary the Inspector is required to refer details to their appropriate Head Office Technical Division who will then request CEO to authorise the DV to appear as the Inspector’s expert witness. Instructions on how to proceed will then be issued by CEO.
If a request to appear as an expert witness is received direct from the Inspector it should be submitted to CEO, and the Inspector notified of the action taken.
1.74-79 Reserved
1.80 Introduction
A new tax relief for gifts of real property to charities was introduced by S.97 Finance Act 2002. This amended S.587B & S.587C ICTA 1988 by extending the existing tax relief on disposals of investments to include land. The relief applies to Income Tax or Corporation Tax and is available to individuals or companies on the disposal to a charity of a beneficial interest in a ‘qualifying interest in land’. It applies to land located in the UK when disposals are not at arm’s length.
For a disposal that is a gift, the relevant amount of any deduction to tax is the market value of the interest in land at the time when the disposal is made, or in the case of a disposal at undervalue, the difference between the market value and the consideration paid.
‘Qualifying interest in land’ means freehold interest or a leasehold interest which is a term of years absolute (in Scotland, an owner’s interest or a tenant’s right over or interest in a property subject to a lease).
For the relief under S587B to apply it is necessary to dispose of the whole of the beneficial interest in a qualifying investment (which includes qualifying interests in land) to a charity. The granting of a lease does not transfer the whole of the owner’s beneficial interest but there is provision in the legislation that treats the granting of a lease as such a transfer.
Entitlement is subject to the donor obtaining certification by the charity acquiring the interest.
There is no entitlement to relief if there is a ‘disqualifying event’. This circumstance is where a donor or person connected with him becomes entitled to an interest or right in relation to all or part of the land, otherwise than for full consideration, within a relevant period (5 years from the 31 January following the year of assessment). For example, a lease-back on favourable terms.
This relief is in addition to the long established no gain/no loss Capital Gains treatment of gifts to charities at S.257 TCGA 1992.
1.81 Advice required by inspector
Inspector’s may require advice on:
- The market value of the freehold or leasehold interest at the date of disposal
- The market value of the premium on the grant of a lease, having regard to the actual lease terms
- In the circumstances where there is a potential ‘disqualifying event’, the Inspector may need an opinion on whether the terms of the lease-back or other entitlement is at market value
1.82 Valuation considerations
The ‘market value’ should be determined on the same basis as for Capital Gains cases.
For a joint disposal of the interest under one contract, it is not considered appropriate to make any discount for undivided share ownership.
1.83 Procedure
The Inspector will usually require a ‘negotiated’ opinion of value. Requests for assistance from the Inspector will be in memo form setting out the facts and valuations required (CG20 is not to be used because this relief does not apply to Capital Gains Tax). Comprehensive information regarding the interest and any lettings is to be obtained by the Inspector and included in the submission to the DV (see 10.5 below). It is anticipated this will, in most cases, be sufficient for the DV but if further information is required the parties can be approached directly.
An inspection should be made before entering negotiations although this can be dispensed with if the returned value appears acceptable after an initial desk-top appraisal. When necessary, the inspection should be arranged with the acquiring charity. The charity may be aware of the need for a valuation because of the requirement for certification by them. In theory the valuation could be relevant to them but this is unlikely in practise, so the Inspector will not normally invite the charity to be party to the negotiations. Discretion as to the reason for inspection should be maintained by the DV.
Reports to the inspector should be in memo form, although VO1171 may be used as a guide, ensuring no reference is made to CGT. If the DV’s opinion differs from that returned but is within a range that has no tax effect, the DV should report indicating that ‘no question need be raised on the valuation returned’.
A ‘post transaction valuation check’ service is available. Such cases should be given priority as far as practical, so as to assist taxpayers in meeting their SA filing date (see Section 6.128)
Subject to the above, the cases should be dealt with in accordance with the same procedures as Capital Gains Tax cases (see Section 6). Unagreed procedure will similarly follow that for CGT, but if an appeal hearing is ultimately necessary this will be at the General Commissioners rather than the Lands Tribunal.
1.84 Information to be provided by inspector to VOA
- A statement that the valuation requested is required for the purposes of determining relief under S587B/C ICTA 1988
- Whether a ‘negotiated’ or ‘not negotiated’ valuation is required
- Whether request is for a PTVC
- Taxpayer’s name & address
- Name, address, telephone number and reference of person with whom negotiations are to be conducted
- Date of disposal (the valuation date)
- Name, address & telephone number of charity acquiring the land (to assist making an inspection, if necessary)
- Description of property to be valued
- Sufficient information to identify the property, and in cases involving undeveloped land, provide a suitable plan
- Is the interest freehold or leasehold?
- If leasehold provide the date of commencement of lease, term, rent at valuation date, dates of rent review, liability for outgoings including repairs, any restrictive covenants, a copy of the lease if available
- If the property is let at the valuation date, provide full details of the lease(s) or tenancy as described in (11) above
- The valuation offered and a copy of any valuation report obtained
- Cost & date of acquisition of the land and details of any improvements made
- Details of any consideration received by the donor. Consideration may include the proceeds of a sale to the charity at undervalue or the value of a lease granted to the charity on beneficial terms. In the case of a lease on favourable terms provide full details of the lease as described in (11) above
- Details of any interest in the property subsequently received by the donor or any connected person that you consider could potentially amount to a disqualifying event within Section 587C(8) ICTA 1988. If this involves a lease on apparently favourable terms provide full details of the lease as described in (11) above. Make clear to the valuer if you require an opinion on whether the interest (such as terms of the lease-back) was for full consideration or not
- If applicable, the amount by which the valuation offered could be reduced without there being any effect on the amount of tax payable
- Any other papers or information that may be relevant to the valuation offered
1.90 Introduction
Schedule 15 (Sch. 15) of the Finance Act 2004 introduced new provisions for charging Income Tax on ‘pre-owned assets’ (see paragraph 1.91 below), commencing in the tax year 2005-6. The legislation provides that a pre-owned asset may either be charged to Income Tax or, alternatively, a taxpayer may make an election to bring the pre-owned asset within the scope of the Inheritance Tax Gifts with Reservation (GWR) procedures. (The GWR rules provide that if an individual disposes of property by gift but retains some element of benefit from it, such as continued occupation, the property is deemed to remain in their estate for Inheritance Tax purposes - see IHT Manual para. 4.36.)
The Government felt it necessary to introduce this legislation as several complex and sophisticated tax avoidance schemes (mainly involving the family home) had evolved in order to try and avoid the GWR rules contained in s102 FA 1986. Judicial challenges had been mounted against a number of these schemes, notably in Ingram v IRC (1999) and IRC v Eversden and Another (2003), and adverse decisions in these cases had obliged the Revenue to amend the provisions of s102. However, a number of other schemes remained untested and it was felt more wide reaching provisions were required. The Sch. 15 provisions now catch most of these schemes by imposing an Income Tax charge on the pre-owned asset unless the taxpayer elects to bring the property within the GWR rules.
1.91 What are pre-owned assets?
The pre-owned assets legislation applies not only to land and buildings but also to chattels and other assets. However, the VOA will generally only be concerned with the charge on land and buildings.
For land and buildings to be regarded as a ‘pre-owned asset’ the following must apply:
a. an individual taxpayer must occupy the land in question either alone, or with another person or persons,
b. either the ‘disposal condition’ or the ‘contribution condition’ must be met, and the disposal must not be an excluded transaction or exempt.
The ‘disposal condition’ (in para. 3(2) of Sch. 15) is satisfied if at any time after 17th March 1986 (the date that IHT was introduced) the taxpayer owned an interest in the land in question and has disposed of all or part of their interest in the relevant land. The condition can also be met if at any time after 17th March 1986 the taxpayer owned an interest in other land, disposed of all or part of their interest in that land, and then another person has applied the proceeds of that disposal towards the acquisition of an interest in the land in question (This prevents the disposal condition being avoided by the recipient of a gift subsequently acquiring a new property in which the taxpayer has never owned an interest).
The ‘contribution condition’ (in para. 3(3) of Sch. 15) is satisfied if at any time after 17th March 1986, the taxpayer has directly or indirectly provided any of the consideration given by another person for the acquisition of either an interest in the relevant land, or in other property, the proceeds of the disposal of which were applied by another person towards an acquisition of an interest in the relevant land. The contribution condition does not rely on the taxpayer having previously had an interest in the land in question or some other property.
1.92 Excluded disposals
Disposals that are excluded from the charge to tax (under para. 10 of Sch. 15) include:-
- The disposal of the taxpayer’s whole interest in the property made at arm’s length with either an unconnected party or on terms that might be expected to be made in an arm’s length disposal. The disposal can be made subject to the retention of rights by the taxpayer providing that any rights are expressly reserved. (The fact that the taxpayer expressly reserves rights on the disposal will mean that the property will be caught by the GWR rules.)
- The disposal was to the individual’s spouse, or to a former spouse, under a court order.
- The disposal was into a trust in which the individual’s spouse (or former spouse, under a court order) has an interest in possession.
- The disposal was a disposition falling under s11 IHTA 1984 (disposition for maintenance of family).
- The disposal is an outright gift to an individual and is for the purposes of IHTA 1984, an exempt transaction by virtue of section 19 (annual exemption) or section 20 (small gifts).
1.93 Computation of Income Tax charge
The relevant provisions for computing the Income Tax charge on land can be found in para. 4 of Sch. 15 and will be based on the “appropriate rental value”, for the period in question, less the amount of any payments, in pursuance of any legal obligation, made by the taxpayer to the owner of the land in respect of their occupation of the land.
The “appropriate rental value” is defined in para. 4(2) of Sch. 15 as being
R x DV |
V |
|
Where: R is the “rental value” of the relevant land for the period in question, DV is the value, at the valuation date, of either the relevant land; or, where other land was originally disposed of, the proportion of the value of the relevant land which can reasonably be attributed to it (or, where the contribution condition applies, the proportion of the value of the relevant land which can reasonably be attributed to the consideration provided by the taxpayer.) and V is the value, at the valuation date, of the relevant land. |
“Rental value” is defined in para. 4(3) of Sch. 15 as being “the rent which would have been payable for the period if the property had been let to the chargeable person at an annual rent equal to the annual value”.
The “annual value” of the relevant land is defined in para. 5 of Sch. 15 as being “the rent which might reasonably be expected to be obtained on a letting from year to year if :
- the tenant undertook to pay all taxes, rates and charges usually paid by a tenant;
- the landlord undertook to bear the costs of the repairs and insurance and the other expenses (if any) necessary for maintaining the property in a state to command that rent.
This definition is virtually identical to the definition of ‘gross value’ contained in Section 19(6) of the General Rate Act 1967, which was the basis of valuation for the purposes of the 1973 Valuation List.
The “value” for “DV” and “V” is the price which the property might reasonably be expected to fetch if sold in the open market at that time; but that price shall not be assumed to be reduced on the ground that the whole property is to be placed on the market at one and the same time (para. 15 of Sch 15).
1.94 Valuation advice that may be required
Requests for advice are likely to involve valuations to enable the Inspector to calculate “R”, “DV” and “V” in order to apply the formula at 1.93 above. Regulations are now in force stipulating there will be a 5 yearly cycle of valuations – i.e. if the first valuation date is 6 April 2005 for a particular property; valuations will not be required again until 6 April 2010 (provided the taxpayer continues to derive benefit from the property). In the intervening years the agreed valuations will be carried forward without any adjustment for inflation.
The valuation date for assessing “R”, “DV” and “V” will be 6 April for the tax year in question or, if later, the first day of the taxable period for which the property in question first becomes chargeable (ie. the date the taxpayer first occupies the property if this occurs during the tax year).
When estimaing “R” it is anticipated that one area of difficulty may be with regard to the repairing and insuring provisions of the definition in para 5 of Sch 15. In practice the taxpayer will often be responsible for some repairs and insurance and great care will need to be applied when adjusting the terms of the actual occupation to accord with the statutory definition. Any matters of difficulty in this respect should be referred to SVT Policy & Professional Team
When estimating “DV” it is anticipated that one area of difficulty may be the need to have have regard to the avoidance scheme initially utilised. Paragraph 1.97 below gives some examples of the most popular schemes, namely: the lease carve out – Ingram Scheme (examples 10-13); the settlement on interest in possession trust – Eversden scheme (examples 14-16); the lease reversionary scheme examples 17-19), and; the double trust scheme (example 20). To assist in co-ordinating details of advice given in respect of these schemes spreadsheets have been set up in the market Information folder on the R Drive in respect of the Ingram scheme and lease reversionary scheme and caseworkers should complete these spreadsheets each time values are agreed or advice is provided.
1.95 Valuation of chattels
As indicated in paragraph 1.91 above, the pre-owned assets legislation also applies to chattels. Shares Valuation will be providing advice on the valuation of chattels for these purposes. Because of the difficulties involved in assessing a rental value for a chattel, the “R” element, in the formula set out at 1.93 above, has been replaced with “N” when calculating the appropriate amount for chattels. “N” is defined as “the amount of interest that would be payable for the taxable period if interest were payable at the prescribed rate on an amount equal to the value of the chattel as at the valuation date”. Regulations have recently come into force stipulating the “prescribed rate” will be 5%.
1.96 Routing of requests for advice
Most requests for valuation advice will be routed via HMRC(IHT) and it has been agreed that these will be sent to SVT Policy & Professional Team, who will then instruct caseworkerss as to the valuation requirements.
If a case is received from any other source and the caseworker should immediately forward details (i.e. advice sought, who has requested the advice and their reference and contact details) to the SVT Policy & Professional Team and take no further action until further instructions have been received.
1.97 Examples
Introduction
Blackacre is a large, individual house situated in the outskirts of a market town.
The the value of the freehold interest with vacant possession, as at 6th April 2005 is £750,000; whilst the rental value, calculated in accordance with para 5 of Schedule 15, has been agreed at £21,000 per annum, as at the same date.
The following examples identify instances where Schedule 15 applies and, where there is a charge to income tax, outlines the approach to be taken to the valuations. In all instances A is assumed to have originally held the freehold interest with vacant possession
Gift or sale of whole
Example 1
In April 2000 A conveyed Blackacre to his daughter, Miss B. A continues to live there.
While A continues to live there, the property is subject to a gift with reservation for inheritance tax (see s102 IHTA 1984). There will be no charge to income tax under schedule 15 (para 11(5)(a). It is immaterial whether Miss B lives there or not.
Example 2
In April 2000 A conveyed Blackacre to his daughter, Miss B. A continues to live there but, as at 6th May 2005, is paying Miss B a rent of £21,000 per annum. Miss B is responsible for all repairs and insurance.
Because A is paying a market rent for his occupation, there is no reservation of benefit (para 6(1)(a) Schedule 20 FA 1986), assuming A has continued to pay a market rent throughout his period of occupation There will be no charge to income tax under schedule 15 (para 11(5)(d). It is immaterial whether Miss B lives there or not.
Example 3
In April 2000 A conveyed Blackacre to his daughter, Miss B. A continues to live there but, as at 6th May 2005, is paying Miss B a rent of £15,000 per annum. Miss B is responsible for all repairs and insurance.
Because A is not paying a market rent for his occupation, there is a gift with reservation for inheritance tax (see s102 IHTA 1984). There will be no charge to income tax under schedule 15 (para 11(5)(a). It is immaterial whether Miss B lives there or not.
Example 4
In April 2000 A sold Blackacre to his daughter, Miss B, at full market value. A continues to live there.
Because this was an outright sale there will be no transfer of value for inheritance tax There will be no charge to income tax under schedule 15 (as the transaction comprises an excluded transaction (para 10(1)(a) schedule 15). It is immaterial whether Miss B lives there or not.
Gift or sale of undivided share
Example 5
In April 2000 A conveyed Blackacre into the joint names of himself and his daughter, Miss B. A continues to live there but Miss B lives elsewhere.
Because Miss B does not occupy the property, her share is subject to a gift with reservation for inheritance tax (see s102 IHTA 1984). There will be no charge to income tax under schedule 15 (para 11(5)(a).
Example 6
In April 2000 A conveyed Blackacre into the joint names of himself and his daughter, Miss B. A continues to live there but Miss B lives elsewhere. As at 6th April 2005, A is paying Miss B a rent of £10,500 per annum, for her share of the property. Miss B is responsible for half of the repairs and insurance.
Because A is paying a market rent for his occupation, there is no reservation of benefit (para 6(1)(a) Schedule 20 FA 1986), assuming A has continued to pay a market rent throughout his period of occupation There will be no charge to income tax under schedule 15 (para 11(5)(d).
Example 7
In April 2000 A conveyed Blackacre into the joint names of himself and his daughter, Miss B. A continues to live there but Miss B lives elsewhere. As at 6th April 2005, is paying Miss B a rent of £7,000 per annum, for her share of the property. Miss B is responsible for half of the repairs and insurance.
Because A is not paying a market rent for his occupation, there is a gift with reservation for inheritance tax (see s102 IHTA 1984). There will be no charge to income tax under schedule 15 (para 11(5)(a).
Example 8
In April 2000 A conveyed Blackacre into the joint names of himself and his daughter, Miss B. Miss B paid full market value for her share. A continues to live there but Miss B lives elsewhere.
Because this was an outright sale there will be no transfer of value for inheritance tax. The transaction is not an excluded transaction (para 10(1) schedule 15); however, as the transaction took place prior 7th March 2005, there will be no charge to income tax.
Example 9
On 16 March 2005 A conveyed Blackacre into the joint names of himself and his daughter, Miss B. Miss B paid full market value for her share. A continues to live there but Miss B lives elsewhere.
Because this was an outright sale there will be no transfer of value for inheritance tax. The transaction is not an excluded transaction (para 10(1) schedule 15) and because the transaction took place after 7 March 2005, there will be a charge to income tax.
The tax charge for 2005-6 will be based as follows;
£318,750*
£21,000 x £750,000
= £8,925 per annum will be taxable
*This represents the value of Miss B’s half-share with a 15% deduction to reflect fact A is in occupation
Lease carve out – the Ingram Scheme
Example 10
In April 1998 A transferred the property to a nominee, who then granted A a 20 year lease of the property at a peppercorn rent. The encumbered freehold interest was then gifted to A’s daughter, Miss B
Because the transfer was affected prior to 9th March 1999, the arrangement is not caught by section 102A Finance Act 1986 and there is no gift with reservation for inheritance tax. Unless A makes an election before 31st January 2007, for the arrangement to be treated as a gift with reservation, there will be a charge to income tax.
The tax charge for 2005-6 will be based as follows;
£400,000*
£21,000 x £750,000
= £11,200 per annum will be taxable
*This represents the value of the freehold reversion, i.e. deferred 13 years
Example 11
In April 1998 A transferred the property to a nominee, who then granted A a 20 year lease of the property at a peppercorn rent. The encumbered freehold interest was then gifted to A’s daughter, Miss B. A died on 7th April 2006. A has not made an election for the arrangement to be treated as a gift with reservation
Because the transfer was affected prior to 9th March 1999, the arrangement is not caught by section 102A Finance Act 1986 and there is no gift with reservation for inheritance tax. A has not made an election for the arrangement to be treated as a gift with reservation and his personal representatives are not empowered to make such an election. Accordingly, there will be a charge to income tax.
The tax charge for 2005-6 will be calculated as in Example 10 above.
Example 12
On 22nd April 1999 A transferred the property to a nominee, who then granted A a 20 year lease of the property at a peppercorn rent. The encumbered freehold interest was then gifted to A’s daughter, Miss B.
Because the transfer was affected after 9th March 1999, the arrangement is caught by section 102A Finance Act 1986 and the arrangement will comprise a gift with reservation for inheritance tax, there will be no charge to income tax.
Example 13
In April 1998 A transferred the property to a nominee, who then granted A a 20 year lease of the property at a peppercorn rent. The encumbered freehold interest was then gifted to A’s daughter, Miss B. In 2004 A became aware of the pending legislation and started paying his daughter a rent of £15,000 per annum for the benefit of the lease. A is responsible for all repairs and insurance
Because the transfer was affected prior to 9th March 1999, the arrangement is not caught by section 102A Finance Act 1986 and there is no gift with reservation for inheritance tax. Unless A makes an election before 31st January 2007, for the arrangement to be treated as a gift with reservation, there will be a charge to income tax even though he is paying a rent. This is because the rent is less than the market value, calculated in accordance with para 5 of Schedule 15.
The tax charge for 2005-6 will be based as follows;
Open market rental value £21,000
Less passing rent (adjusted to accord with para 5) - £17,000
£4,000*
*. Even though the net value is less than £5,000, this does not fall below the De Minimis limit of £5,000 (para 13), as the rental value of the relevant land exceeds this figure.
£400,000*
£4,000 x £750,000
= £2,133 per annum will be taxable
*This represents the value of the freehold reversion, i.e. deferred 13 years
Settlement on interest in possession trust – Eversden scheme
Example 14
On 29 September 2002, A transferred 95% of his interest in the property to a settlement for the benefit of his wife for her life. On her death the property passes to a discretionary trust, of which he is one of the potential beneficiaries. He remains in occupation of the property, together with his wife.
Because the transfer was affected prior to 20th June 2003, the arrangement is not caught by section 102(5A) Finance Act 1986 and there is no gift with reservation for inheritance tax. Because A’s wife is still in occupation of the property there is no charge to income tax, as the arrangement is an excluded transaction under para 10(1)(c) of schedule 15.
Example 15
On 29 September 2002, A transferred 95% of his interest in the property to a settlement for the benefit of his wife for her life. On her death the property was to pass to a discretionary trust, of which he is one of the potential beneficiaries. He remains in occupation of the property; however, his wife moved into a nursing home in January 2003, where she died in February 2005.
Because the transfer was affected prior to 20th June 2003, the arrangement is not caught by section 102(5A) Finance Act 1986 and there is no gift with reservation for inheritance tax. Because A’s wife’s interest in possession came to an end in her lifetime (when she moved into the nursing home), the arrangement is not an excluded transaction, because of para 10(3) of schedule 15 and a charge to income tax will arise, unless A makes an election before 31st January 2007, for the arrangement to be treated as a gift with reservation for inheritance tax .
The tax charge for 2005-6 will be based as follows;
£712,500*
£21,000 x £750,000
= £19,950 per annum will be taxable
*This represents the value of the 95% share disposed of. No deduction has been made for the fact the share represents a fractional interest.
Example 16
On 29th September 2003, A transferred 95% of his interest property to a settlement for the benefit of his wife for her life. On her death the property passes to a discretionary trust, of which he is one of the potential beneficiaries. He remains in occupation of the property, together with his wife.
Because the transfer was affected after 20th June 2003, the arrangement is caught by section 102(5A) Finance Act 1986 and the arrangement will comprise a gift with reservation for inheritance tax, there will be no charge to income tax.
Lease reversionary scheme
Example 17
On 22nd September 1998, A granted a 999-year lease to his daughter, Miss B, but this is not to take effect until 2018. He continues to occupy the property.
Because the transfer was affected prior to 9th March 1999, the arrangement is not caught by section 102A Finance Act 1986 and there is no gift with reservation for inheritance tax. Unless A makes an election before 31st January 2007, for the arrangement to be treated as a gift with reservation, there will be a charge to income tax.
The tax charge for 2005-6 will be based as follows;
£400,000*
£21,000 x £750,000
= £11,200 per annum will be taxable
*This represents the value of the 999 year lease
Example 18
In April 1998 A granted a 999-year lease to his daughter, Miss B, but this is not to take effect until 2018. A died on 7th April 2006. A has not made an election for the arrangement to be treated as a gift with reservation
Because the transfer was affected prior to 9th March 1999, the arrangement is not caught by section 102A Finance Act 1986 and there is no gift with reservation for inheritance tax. A has not made an election for the arrangement to be treated as a gift with reservation and his personal representatives are not empowered to make such an election. Accordingly, there will be a charge to income tax.
The tax charge for 2005-6 will be calculated as in Example 17 above.
Example 19
On 22nd April 1999 A granted a 999-year lease to his daughter, Miss B, but this is not to take effect until 2019. He continues to occupy the property.
Because the transfer was affected after 9th March 1999, HMRC is of the view this arrangement is caught by section 102A Finance Act 1986 (although this scheme has never been subject to litigation) and the arrangement will comprise a gift with reservation for inheritance tax, there will be no charge to income tax.
The double trust scheme
Example 20
On 22 April 2003, A sold his house to a trust fund of which he is the life tenant for £500,000. The trustees did not pay the purchase price but gave A an IOU instead. A then made a gift of the IOU (the outstanding purchase price) to a second trust for the benefit of his children. He remains in occupation of the property.
As A is still occupying the house as the life tenant of an interest in possession trust the exemption in paragraph 11(1) of Schedule 15 would appear to prevent the charge from applying. However, the value of the property in the estate will be reduced by the debt now owned by the trustees of the second trust in the scheme. i.e. the house is now worth £750,000 and the debt is valued at £500,000, only the net value of £250,000 would be chargeable to inheritance tax. The exemption in paragraph 11(1) is restricted to the value of the relevant property that exceeds the amount of the excluded liability – in this example £250,000. The remaining part of the house will be subject to the charge for income tax, which will be calculated as follows:
£500,000*
£21,000 x £750,000
= £14,000 per annum will be taxable
- This represents the value of the IOU