UK Tax Bulletin
May 201439 Offices in 19 Countries 2 squiresanders.com
Current Rates:................................................................................ Latest rates of inflation and interest
IHT : Deduction of Liabilities:................................................ The new rules on deduction of liabilities
Penalties:........................................................................................HMRC might have a new approach
Reasonable Excuse:............................................................................ More on "insufficiency of funds"
CGT : Private Residence Relief:.............................................................. Is the property a "residence"
IHT : Omission to take Pension Benefits:........................................................More judicial guidance39 Offices in 19 Countries 3 squiresanders.com
Latest Rates of Inflation and Interest
The following are the current rates at May 2014
Current Rates May 2014
Retail Price Index: April 2014 255.7
Inflation Rate: April 2014 2.5%
Indexation factor from March 1982:
to April 1998
to March 2014
to April 2014
Not yet published
Interest on overdue tax
Interest on all unpaid tax is charged at the same rate.
The formula is Bank base rate plus 2.5% which gives a present rate of 3%.
There is one exception: Quarterly instalments of corporation tax bear interest at only 1.5%.
Interest on all overpaid tax is payable at the same rate.
The formula is Bank base rate minus 1% but with an overriding minimum of 0.5% which applies at the
Official rate of interest
To 6 April 2014: 4%
From 6 April 2014: 3.25%39 Offices in 19 Countries 4 squiresanders.com
IHT : Deduction of Liabilities
It may be remembered that one of the changes in 2013 was a restriction to the deduction of liabilities
for inheritance tax purposes. This issue seems to be causing widespread problems.
The general rule in Section 162(4) IHTA 1984 is that where a liability is charged on particular property,
the liability reduces the value of that property for inheritance tax purposes.
However, last year this rule was modified and a deduction now depends on how you spend the
borrowed money. If you borrow money to invest in business property (or agricultural property) which
qualifies for 100% relief, a deduction will no longer be allowed for such borrowings against other assets.
The borrowings can only be deducted from the assets which were acquired with the money. The effect
of this is to eliminate any effective deduction for the borrowings.
Another new rule applies to liabilities which have been incurred to finance property which is excluded
from inheritance tax. (This will mainly affect non doms, because it is comparatively rare for UK
domiciled individuals to have excluded property.) So borrowing money charged on a UK property and
depositing that money abroad will disqualify that borrowing from any deduction against the UK property.
It is perhaps arguable that if an individual borrows money charged on his UK property and that money
is merely sitting in a bank account outside the UK pending investment, the borrowings have not been
incurred to acquire or finance excluded property. However, HMRC take the view that the money on
deposit is excluded property, the borrowing was incurred directly or indirectly to acquire the deposit so
it is therefore disqualified.
One can understand the logic behind the proposals but I can see serious practical difficulties here. The
fact that HMRC may not allow a deduction for a liability does not mean that the liability does not exist.
Accordingly, a situation could easily arise where somebody has a net estate of zero because he has
significant debts. If you ignore the debts he would have a substantial chargeable estate on which IHT
would be payable. This is a pure fiction; the estate is zero and although HMRC can have a deeming
provision to create a tax liability, there is no deeming provision to provide the money to pay it.
An amendment was made so that the new rules only apply to loans taken out after 5 April 2013. That
was obviously welcome but unfortunately it applies only to loans taken out to acquire business property
or agricultural property – it does not apply to loans attributable to financing the acquisition (or
enhancement) of excluded property. Accordingly, all those foreign domiciled individuals who (years
ago) reduced the value of their UK property by loans will find that the loans are now disqualified from
an inheritance tax deduction and the gross value of the UK assets is now exposed to inheritance tax.
The retrospective nature of these provisions creates a significant problem for people who have had
settled arrangements for many years (including trustees who may now be unexpectedly exposed to the
ten year charge) and some serious attention will now be necessary to reconsider all those
arrangements.39 Offices in 19 Countries 5 squiresanders.com
The case of Gardiner v HMRC TC 3550 is interesting on a number of levels. It also seems to give a
clear indication about HMRC's approach in penalty cases. Mr Gardiner and his family entered into a
tax scheme to shelter a capital gain they had made on the disposal of some shares. The details do
not really matter but it seemed to have similarities with the case of Drummond which the Court of
Appeal held was ineffective. As a result of the Court of Appeal's decision, the taxpayer accepted that
the tax was due and paid up.
However despite the fact the taxpayers took detailed professional advice and it needed the Court of
Appeal to determine whether the scheme worked, HMRC argued that the taxpayers had been
negligent in submitting their tax returns on the basis that it did work. Accordingly they imposed
The argument of HMRC was very similar to that in Litman v Newall, that no reasonable person could
have concluded that the arrangements were carried out properly and that the weaknesses were such
that they should have been appreciated by the taxpayer.
This argument puts the taxpayer in a very difficult position. How far is the taxpayer expected to
understand a complex arrangement and how obvious do the weaknesses in the scheme have to be
(both technically and by way of documentation), for them to be exposed to a penalty. And what if he
does have concerns about the technicalities and the documentation and makes specific enquiries of
the advisers who assure him specifically that everything is OK.
I don't not need to put too many eyes of newts and toes of frog into my cauldron to foresee that if the
taxpayer is supposed to fulfil some conditions (like carrying on a trade or working for a specific number
of hours) and he knows he has not done so, then the risk of a penalty arises. I have a feeling we are
going to see a lot more of this argument.
However, the most extraordinary thing about the case of Gardiner is how this point ever got to Court at
all. HMRC were claiming that the taxpayer had been negligent and therefore liable to a penalty. The
onus of proof was on them - but they did not put forward any evidence. The Tribunal naturally allowed
the taxpayers appeal.
I simply cannot understand this. You can understand an unrepresented taxpayer turning up to the
Tribunal not appreciating that the onus of proof is on him and being unclear about the nature of
evidence. But surely not HMRC. How can they take the taxpayer to the Tribunal (at considerable
expense) and then adduce no evidence at all in support of their allegation.
It is not as if this is the first time. In the case of Trustee of the de Britton Settlement v HMRC TC2524
HMRC imposed a penalty for the late submission of a tax return and pressed the penalty to the
Tribunal but without any evidence whatsoever in support of their case. It is hardly surprising that the
penalty was set aside by the Tribunal in that case as well. Given that costs are not awarded to the
Appellant before the First Tier Tribunal, this approach imposes a serious burden on the taxpayer which
is surely wrong.39 Offices in 19 Countries 6 squiresanders.com
Reasonable Excuse : Insufficiency of Funds
In the January 2013 Bulletin I made reference to the case of Stephen Brand v HMRC TC 2434 in which
the Tribunal took a sympathetic view of the financial situation of Mr Brand and concluded that the
insufficiency of funds which caused him to be late in making payment was attributable to events outside
his control. This is important because in the penalty regime set out in the Finance Act 2009, the
following phrase appears a number of times:
“An insufficiency of funds is not a reasonable excuse unless attributable to events outside
the person’s control”.
HMRC take the view that cashflow problems are part of the normal cycle of business which need to be
managed as part of the day to day operations. However, they acknowledge that there can be
unforeseeable events outside the taxpayer’s control that will create a severe cash shortage which
cannot be managed.
This issue arose again this month in the case of Anaconda Equipment International Limited v HMRC
TC 3521. The company’s business was the manufacture of conveyor systems and engineering
equipment for the construction trade. The company seemed to be managing their cashflow position
but their bank had reduced their overdraft facility by two thirds and insisted on a further monthly
reduction. This made their cashflow position significantly worse and they had no alternative but to
refinance – and that obviously took a little while. In addition, the company lost two big clients which
accounted for approximately 67% of their turnover.
HMRC said that the taxpayer was a habitual late payer with a history of poor compliance, but the
Tribunal looked at this appeal on its merits.
The Tribunal concluded that the reduction in turnover and the substantial reduction of the overdraft
facility were events entirely outside their control and constituted a reasonable excuse for the late
By a strange coincidence, a week later the case of Paragon Precision Engineering Limited v HMRC TC
3542 was published. This involved an appeal on the same grounds – an insufficiency of funds.
However, this was much more difficult because it was a VAT case, and the rule for VAT is considerably
worse. Section 71(1)(a) VAT Act 1994 says:
“An insufficiency of funds to pay any VAT due is not a reasonable excuse”.
There is nothing here about events outside the taxpayer’s control. Accordingly, this looked completely
hopeless. However, the taxpayer had an argument based on proportionality. They claimed that the
Tribunal could strike down penalties which were clearly out of all proportion to the default. This
approach has previously been supported by the Upper Tribunal who said that in appropriate cases it is
possible to conclude that the penalty is so disproportionate that they would be entitled to substitute their
own view of what is fair for the penalty which Parliament has imposed. However, this power should
rarely be used because “the Tribunal should show the greatest deference to the will of Parliament
when considering a penalty regime”.
Applying this to the circumstances of Paragon, the Tribunal did not think that the penalty was
disproportionate - but they suspended their decision for 21 days to give the taxpayer the opportunity to
provide further evidence regarding their financial affairs to demonstrate the lack of proportionality.
We may never know whether they were able to do so - but the mere possibility opens up an interesting
further defence to the taxpayer in what looked like a hopeless case.39 Offices in 19 Countries 7 squiresanders.com
CGT : Private Residence Relief
The recent case of Iles v HMRC TC 3565 is another case in the series involving the Principal Private
Residence exemption. It is well known that the capital gains tax exemption is given for the only or main
residence and the usual area of challenge these days is not whether the property is the only residence
or the main residence; it is whether the property was a residence at all. We have been here before.
Cases such as Goodwin v Curtis, Susan Bradley and David Morgan, are in complete conflict and it is
very difficult indeed to decide whether a property is “a residence” or not.
We know (from Lord Widgery in Fox v Stirk) that a residence means:
The place where a man is based or continues to live;
Where he sleeps, shelters and has his home;
Something other than temporary accommodation;
There is some expectation of continuity with a degree of permanence.
The evidence was lengthy and confusing but the key issue was that Dr Iles and her husband moved
into a small flat on 1 July which they had owned for some time. It had been up for sale and was
already under offer when they moved in and the sale was completed on 25 July when they moved out.
Before moving into the flat they lived in a detached 5 bedroomed house. When they moved out they
moved to a detached 4 bedroomed house. The obvious conclusion was that the small flat was not
intended to be a long term home.
During the 24 days they were in the flat, they had no other property which qualified as a residence so
they claimed that it was their only or main residence and qualified for the relief.
The Tribunal was not over impressed with some of the evidence, but the bald facts were enough to
preclude them for relief. The Tribunal found that none of the relevant conditions were satisfied and
although they did not have anywhere else to live during those 24 days, it was only temporary
accommodation and they did not have a sufficient degree of permanence, continuity or expectation of
continuity to justify describing it as a residence.
This was hardly a surprising result but the case does cover the key principles for the relief and is a
worthwhile read on that account alone.
I do not know what is happening with the proposals about CGT for non residents, which includes some
unspecified changes to this relief – so maybe all this uncertainty will not matter any more.
IHT : Omission to take Pension Benefits
The case of Parry (Mrs Staveley’s Personal Representatives) v HMRC TC 3548 confirms and clarifies
some inheritance tax issue surrounding pension benefits.
Mrs Staveley was terminally ill and she transferred substantial funds to her personal pension plan from
which she was entitled to draw pension benefits. She did not do so and died six weeks later. The
pension fund monies were paid out to her sons without any charge to inheritance tax.
HMRC drew attention to Section 3(3) IHTA 1984 which says that where the value of a person’s estate39 Offices in 19 Countries 8 squiresanders.com
is diminished and the value of another person’s estate is increased by the omission to exercise a right,
they are treated as having made a disposition unless it can be shown that the omission was not
deliberate. HMRC claimed that Mrs Staveley deliberately did not exercise her rights, the result of
which meant that the estate of her sons was increased and therefore this represented a chargeable
transfer by her. (This was broadly similar to the position in Fryer v HMRC (2010)).
This all sounds reasonably straightforward but actually there are some seriously difficult issues. For
example it was accepted that the transfer to the pension scheme was not intended to confer any
gratuities benefit; there needed to be a deliberate omission to diminish her estate and increase her
sons estates but the sons estates were not actually increased by her omission; and it was arguable
whether there was “an actual pensions disposition under the pension scheme” which prevented any
protection from Section 12(2B).
The Tribunal did not gloss over these points but dealt with them fully, coming to the conclusion that it
was Mrs Staveley’s deliberate intention to confer a gratuities benefit on her sons and that their estates
were increased by the omission by her of taking her pension benefits. The reasoning looks dangerous
because anybody over retirement age who has not drawn their pension could find the whole of their
pension fund vulnerable to inheritance tax because they omitted to do so.
Fortunately, Section 12 (2B) IHTA 1984 comes to the rescue as it provides that omitting to exercise
pension rights will not be treated as a disposition for this purpose if the transferor had no reason to
believe he would die within 2 years of the transfer of funds to the pension scheme.
This was of no assistance to Mrs Staveley who knew she was seriously ill but it does protect those who
might otherwise inadvertently fall within Section 3(3).
P S Vaines
Squire Sanders (UK) LLP
30 May 2014
T +44 20 7655 1780
© Squire Sanders (UK) LLP All Rights Reserved May 2014
The contents of this update are not intended to serve as legal advice related to individual situations or as legal opinions
concerning such situations nor should they be considered a substitute for taking legal advice.