TRADING STOCK – property acquired as private residence – change of intention to use as trading stock – not demonstrated – error or mistake claim for relief on loan interest payments fails – appeal dismissed.
JOINT OWNERS – property in joint ownership – whether owners assessed for tax in equal shares in respect of the rents derived from letting the property – rental receipts paid to one of the joint owners – other joint owner surrendered her entitlement to the rents – determination that assessment for tax be against the joint owner in receipt of the rents.
THE SPECIAL COMMISSIONERS
Mr STANLEY E N KINGSAppellant
- and -
RICHARD L KING Respondent
(H M INSPECTOR OF TAXES)
Mrs MARILYN J KINGSAppellant
- and -
CHRIS BARKER Respondent
(H M INSPECTOR OF TAXES)
Special Commissioner: Michael Tildesley
Sitting in London on 26 and 27 November 2003
The Appellants appeared in person
Mr Death for the Respondents
© CROWN COPYRIGHT 2004
1
DECISION
The Appeal
1.The Appellants are appealing against the following decisions of the Respondents:
~ The refusal of a claim to error or mistake relief under section 33 of the Taxes Management Act 1970 covering the tax years 1992-93 to 1995-96 (Appeal 1).
~ Assessments of income tax on income from UK land and property in the following amounts (Appeal 2):
1992-93£2,880
1993-94£2,880
1994-95£2,815
1995-96£2,880.
~ Discovery assessment for 1996-97 (Appeal 3).
~ Amendments to self assessments as follows (Appeal 4):
1997-98£3,152.81
1998-99£3,610.85
Appeals 1 to 4 relate to Mr Kings.
~ Assessment of income tax on income from UK land and property in the following amounts (Appeal 5):
1996-97£696
1997-98£1,300
1998-99£108
Appeal 5 relates to Mrs Kings
2.At a preliminary hearing Mrs Kings consented for her appeal to be heard before the Special Commissioners. A direction was made by the Special Commissioner to consolidate the appeals of Mr and Mrs Kings and hear them together.
The Issues
3.Mr Kings was involved in the business of renovating houses and selling them on at a profit. In 1989/1990 he experienced financial difficulties due to the recession in the housing market and rising interests rates. Mr and Mrs Kings decided to move out of their private residence, 19 Hillside Way, and live in 24 Harborough Road North, which at the time was being renovated for sale. Initially 19 Hillside Way was put on the market for sale but after not finding a buyer the house was rented to tenants. Mr and Mrs Kings took out a new mortgage from the Leeds and Holbeck Building Society secured against 19 Hillside Way enabling them to discharge Mr Kings’ overdraft with the Midland Bank.
The principal issues to be decided are:
Whether the property at 19 Hillside Way became part of the trading stock of Mr Kings’ business. If yes the interest paid on the Leeds and Holbeck mortgage secured on the property is an allowable expense of his trade. If no, only a proportion of the interest is allowable against the rental income.
Whether the rental receipts from 19 Hillside Way should be charged to tax on Mr Kings alone or shared equally between Mr and Mrs Kings.
4.The issues specific to the Appeals are as follows:
Appeal 1
The error or mistake claim concerns the interest paid on the mortgage with the Leeds and Holbeck Building Society in the tax years 1992/93 to 1995/96. The matter in dispute is whether the interest payments qualify for relief in Mr Kings’ trading accounts. In order for them to qualify, 19 Hillside Way must become part of the trading stock of Mr Kings’ business.
Appeal 2
This Appeal relates to the rents received from 19 Hillside Way between 1992/93 to 1995/96. The first question is whether Mr Kings is assessable for tax alone on the whole of the rents received or whether the assessment should be shared equally between Mr and Mrs Kings. The second question is what, if any, loan interest relief is available against the rental income.
Appeal 3
This relates to a discovery assessment for tax against the rents received for 19 Hillside Way in 1996/97. The assessment also includes tax charged on pension income (£385) which is not in dispute.
Appeal 4
This relates to the Respondents’ amendments to Mr Kings’ self assessments for tax for the tax years 1997/98 and 1998/99. The matters in dispute concern the tax charged on the rental income and loan interest relief in relation to the property at 19 Hillside Way.
Appeal 5
This Appeal relates to whether Mrs Kings is chargeable to tax on a 50% share of the rental receipts from 19 Hillside Way between 1996-97 to 1998-99.
The Evidence
5.Mr and Mrs Kings gave evidence before me. Three bundles of documents were presented in evidence plus Mr Kings’ bank statements and cash book.
6.Mr Kings was a partner in an engineering business for 20 years. The partnership ended in 1985 when he was bought out by his partner for £45,000. On 7 February 1985 Mr Kings started work with “Safetymate” as a salesman. He did not find this employment satisfactory particularly working anti-social hours. Mr Kings, therefore, decided to find gainful work which would not take him away from his family in the evenings and at weekends. He embarked upon a house renovation business with the capital he acquired from the dissolution of the partnership.
7.Mr Kings’ strategy was to buy bungalows which required modest alterations, such as redecoration, new kitchen and bathroom. On 14 May 1985 Mr Kings bought a bungalow at 1 Bishops Drive for the sum of £20,050 which was renovated and resold for £32,000 yielding a profit of £6,413. On 24 January 1986 he purchased 35 Canons Walk for £18,500 which was sold for £34,500 producing a profit of £5,720.27. Bretton Close was purchased on 3 July 1986 for £27,001 and sold for £38,500 with a profit of £2,317.54. Mr Kings then bought Bilbury Crescent for £24,000 on 17 November 1986 which he sold for £38,950 with a profit of £7,555.54. On 27 April 1987 37 Whitelands Road was acquired for £31,000, reselling at £45,900 yielding a profit of £9,832.29. On 4 June 1987 Mr Kings purchased 42 Greenhills Road for £32,500 which he sold on for £50,750 at a profit of £7,387.62. During this period of two years Mr Kings bought six properties which yielded a total profit of £39,224. He spent £26,008 on renovating the six properties. The average renovation cost per property was £4,335.
8.By the end of 1987 Mr Kings was finding suitable properties hard to come by. He took employment with Warley Painters from 12 November 1987 to 31 December 1987 to keep his head above water. On the 2 February 1988 Mr Kings purchased 24 Harborough Road North for £42,500 which was by far his most ambitious project. The property was in total disrepair and needed underpinning before the renovation could start. Mr Kings intended to convert it from a bungalow to a dormer bungalow with two bedrooms upstairs which required Mr Kings “to rip the property to pieces just leaving the external walls in place”.
9.Mrs Kings, in the meantime, had been working as a team leader/ secretary for the Nationwide Building Society. She started her employment in 1986 and remained there until 1992 when she was made redundant. On 4 July 1988 Mr and Mrs Kings bought 19 Hillside Way as their private residence for £87,000. The purchase was funded with £63,000 equity from their former home at 18 Barnstable Close and a £24,000 mortgage from the Nationwide Building Society. The house was owned jointly between Mr and Mrs Kings.
10.Mr Kings’ business, however, was starting to experience difficulties. He was allowed an overdraft facility of £75,000 with the Midland Bank to complete the project on 24 Harborough Road. However, the project was taking longer than originally anticipated because of the subsidence problem. Also the interest charges on the overdraft had increased considerably from 4.5% to 15%. Mr Kings was paying charges of 4% above the base rate. The overdraft stood at £55,506. 64 on 1 January 1989 reaching £84,828.08 by the end of 1989. Mr Kings stopped employing casual labour on the conversion of 24 Harborough Road and tried to do all the work himself. In May 1989 Mr and Mrs Kings put their home, 19 Hillside Way, on the market for £175,000. In June 1989 the asking price for the house dropped from £165,000 to £150,000 and thereafter to £140,000. However, the housing market was flat. The property itself was in need of renovation and its warm air central heating system was perceived to be a disadvantage in a sluggish market. The option of selling 24 Harborough Road North was not viable because the renovation work had not been completed.
11. In August 1989 Mr Kings was called into the Midland Bank to discuss his overdraft. The Bank Manager advised Mr Kings that he was under pressure from Head Office to control strictly loans secured against property because of the fall in the housing market and the unprecedented interest rises. Mr Kings offered the equity in Hillside Way as additional security but the Bank Manager was reluctant to take a second charge on the property and more interested in the shares (£18,000) owned by Mr Kings. He did not want to give up the shares because they were “a sort of pension for old age”. To relieve some of the financial pressures Mr Kings took employment with Persimmon Homes on 1 September 1989 using his wages to pay the charges on the overdraft. Towards the end of 1989 Mr Kings deposited a share certificate to the approximate value of £5,000 with the Midland Bank as security. Mr Kings also in 1989 started business as a kitchen equipment dealer which effectively ceased in 1991, although a claim for a trade loss in connection with this business was made in his accounts ending 31 October 1993.
12.Mr and Mrs Kings decided to seek the advice of a Financial Adviser from Market Square Financial Services, Towcester. They were advised to rent out Hillside Way and obtain an £80,000 mortgage from the Abbey National on the equity of the property. The anticipated rent would pay for the interest charges on the mortgage which would repay the overdraft. Mr and Mrs Kings considered this to be the best option because it would maintain the status quo until the expected upturn in house prices. However, they did not find this to be easy decision to make, particularly as they had a ten year old daughter at the time. 19 Hillside Way was a much bigger house and the renovation work on 24 Harborough Road was not complete.
13.Countrywide Residential found tenants (Mr and Mrs Potter) on a shorthold assured tenancy for 19 Hillside Way. The Nationwide Building Society, the mortgagor for the property, consented to the tenancy which commenced on 1 March 1990 when Mr and Mrs Kings moved into 24 Harborough Road North. Mrs Kings informed the utilities, the bank, the local authority, Inland Revenue, doctors and employers of the change of address.
14.The securing of the mortgage from the Abbey National on 19 Hillside Way was proving problematical. Although Mr and Mrs Kings got to the point of a mortgage offer, they were unable to meet the Abbey National’s criterion about last two years trading. Later on in 1990 Market Square Financial Services brokered a mortgage with the Leeds and Holbeck Building Society for £95,000. This was achieved with the help of John Strange, Accountants, who provided evidence of projected annual earnings of £28,000 for Mr Kings. The earnings were based on the rental receipts for 19 Hillside Way and Mr Kings’ income from the subcontract work with Persimmon Homes. In December 1990 Mr and Mrs Kings realised that the £95,000 would not discharge the overdraft with the Midland Bank, so Mrs Kings secured an additional advance of £6,000 on the Nationwide Mortgage which was transferred to 24 Harborough Road North.
15.On the 9 January 1991 Frank Jones & Harley, solicitors for Mr and Mrs Kings received £94,995 from Leeds and Holbeck Building Society, split between two accounts in the respective sums of £28,500 and £66,495, and £30,000 from the Nationwide Building Society. The existing mortgage in the sum of £23,003 with the Nationwide Building Society secured on 19 Hillside Way was redeemed. This left a balance of £100,953. 67 after deduction of legal fees which was transferred into Mr Kings’ account with the Midland Bank. On 11 January 1991 Mr Roberts, Corporate Banking Manager for the Midland Bank, acknowledged receipt of the £100,953.67 and advised Mr Kings that the overdraft facility had been cancelled and the bank had surrendered the deeds for 24 Harborough Road North. Mr Kings was also invited to contact Mr Randle, the Enterprise Manager at the Kingsthorpe Branch to discuss his ongoing needs.
16.The mortgage with the Leeds and Holbeck Building Society was secured on 19 Hillside Way. The repayment period was 25 years. The mortgage was interest only at a variable rate, although the rate of interest was set at 1% above the normal rate. The amount of advance in the mortgage included an amount of £28,500 by way of excess advance referred to as the “deferred account”. Under the terms of the mortgage the Society suspended payment or interest thereon in respect of the “deferred account” during the first two years of the mortgage.The £30,000 mortgage with the Nationwide Building Society was secured against 24 Harborough Road North.
17.19 Hillside Way remained for sale until the summer of 1991. The bundle of documents contained an advert of Taylors Estate Agents dated 25 April 1991 which advertised a sale price of £130,000 for 19 Hillside Way. In the meantime the first tenants, Mr and Mrs Potter vacated the property overnight in early November 1990. At which time Field Lettings took over responsibility for handling the letting of 19 Hillside Way. On 1 December 1990 Mr and Mrs Hughes became the new tenants paying £500 a month in rent. Sometime in 1991 Mr Kings assumed responsibility for managing the tenancy. A new agreement was struck with Mr and Mrs Hughes dated 20 December 1991 which turned out to be invalid. The tenancy of Mr and Mrs Hughes proved very troublesome to Mr and Mrs Kings. Mr and Mrs Hughes acquired sitting tenants’ rights. The neighbours of 19 Hillside Way complained to Mr Kings about nuisances allegedly committed by Mr and Mrs Hughes. Mr Kings experienced delays with the payment of rent and encountered considerable difficulties in entering the property to carry out improvements. Mr and Mrs Hughes vacated 19 Hillside Way of their own accord on 30 August 1998 just prior to the court hearing brought by Mr Kings for possession of the property. In view of their experiences, Mr and Mrs Kings declined to take on further tenants and eventually sold 19 Hillside Way on 28 July 2000 for the sum of £145,000.
18.Between 1989 – 1999 Mr Kings carried out a range of improvements to 19 Hillside Way which cost £14,901 in materials. The schedule of works were as follows:
Year of Work / Description of the Works / Cost of Materials (to the nearest £)1989 / Fit new kitchen / 3,800
1989 / Fit new bathroom suite and toilet / 650
1989 / Fit dado rail/skirting and cornices to lounge / 110
1989 / Artexing ceilings – whole house / 475
1990 / Removal of rear window in lounge –replace patio door / 375
1990 / Fit louvred window boards / 750
1990 / Wrought iron balustrade on flat roof / 240
1990 / New boiler fitted / 1,065
1990 / Rebuild garden wall by garage / 78
1990 / Pull out old flower bed bricks and lay to lawn / 280
1991 / Renew flue to heater / 18
1991 / New flat roof / 1,600
1991 / Fitting wall lights annex / 68
1995 / Front elevation –pitched roof / 485
1995 / Rewire lights / 79
1997 / Renewal facia boards / 103
1997 / Renew bird trap on soil pipe / 29
1998 / Renewal of window catches/stays / 19
1998 / Replace all internal doors / 240
1998 / Replace all door furniture / 91
1998 / Taps/plumbing equipment en suite / 148
1998 / Wiring of en suite / 450
1999 / Central heating / 2,250
1999 / Knock out airing cupboard and build en suite, sink, shower & shower cubicle / 1,500
Total / 14,901
19.Mr Kings said he financed the improvements with a £5,000 overdraft facility with the Midland Bank and with other funds which were paid into his account with the Midland Bank. The bank statements revealed the following credit entries:
Date / Credit Entry4.3.1991 / £1,837.62
13.8.1991 / £14,000 capital invested in business
26.7.1996 / £10,375 (£10,000 invested by Mrs Kings by advance on the Nationwide mortgage on Harborough Road North.
27.11.1996 / £4,616.04 (lump sum pension from Sun Alliance of £3,941.25)
20.The rent received from the letting of 19 Hillside Way was paid into Mr Kings’ account with the Midland Bank. Mr Kings paid the monthly sum for the mortgage with the Leeds and Holbeck Building Society by standing order from his business account.
21.Mrs Kings kept the books for Mr Kings’ business as “he was not au fait with paper work”. She recorded the details of Mr Kings’ income and expenditure in a “Simplex” book from April 1981 to March 1992 and thereafter on a computer spreadsheet. The books were forwarded annually to Mr Kings’ Accountants to enable them to prepare the accounts for submission to Inland Revenue.
22.On the page headed 1988/1989 in the “Simplex book” there were three “post it notes” addressed to John, ( John Strange of Smith Starmer and Hart, Mr Kings’ Accountants). The note relating to the Leeds and Holbeck mortgage read:
“Mortgage Leeds and Holbeck mortgage on 18 Hillside Way a/c 3330547600 is not MIRAS eligible. The loan is for £67,265,000 advanced 9 January 1991. Interest charged 31.12.91 £8,831.88. Monthly payments:
£858.01 – June
£774.59 – September
£718.56 – November
£693.36 – December onwards
This is partly catered for by the renting out of the property due to the climate we cannot sell at £450 per month. New advance 9.1.91 at £28,500, interest charged £3,742.05, a/c no 3330547611, again Leeds & Holbeck”.
23.Mr Kings’ Accountants, Smith Starmer and Hart, submitted his income and expenditure accounts to the Inland Revenue. In the years ending 31 October 1988 and 1989 bank charges and interest were declared as expenses. In the year ended 31 October 1990, the income from rental receipts for 19 Hillside Way was not declared and there was no deduction claimed in respect of bank charges and interest. Also the October 1990 statement referred to the transfer of work in progress to own use to the value of £96,160. This entry referred to the transfer of 24 Harborough Road North from Mr Kings’ business. There was no entry in the October 1990 statement transferring 19 Hillside Way into Mr Kings’ business. The income and expenditure accounts submitted for the years ending 31 October 1991 to 31 October 1994 made no reference to the rental income and deductions in respect of loan charges and interest. The 1994 return was submitted by Moore Stephens, Chartered Accountants, which had taken over Smith Starmer and Hart.