New Clause 8

Finance Bill – in a Public Bill Committee at 3:00 pm on 25th June 2009.

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Private residential exemption from capital gains tax

‘(1) Part 7 of TCGA 1992 is amended as follows.

(2) In section 222(5) (relief on disposal of private residence) leave out paragraph (a) and insert—

“(a) the Commissioners must notify, in writing, the individual of the notice requirement in paragraph (aa),

(aa) the individual may include that question by giving notice to the inspector within six months from the date on which the notification under paragraph (a) was received but subject to a right to vary that notice by a further notice to the inspector as respects any period beginning not earlier than six months before the giving of the further notice,”.

(3) Insert after section 223(2)—

“(2A) Subsections (1) and (2) do not apply where an individual has varied a notice under section 222(5)(aa) to the effect that an individual’s previous main residence has been redesignated as their main residence.”.

(4) The amendments made by this section have effect for the tax year 2010-11 and subsequent tax years.’.—(Mr. Browne.)

Brought up, and read the First time.

Photo of Jeremy Browne Jeremy Browne Shadow Minister (Treasury)

I beg to move, That the clause be read a Second time.

New clause 5 was pretty straightforward, because I think everyone is able to grasp the difference between 40p a mile and 45p a mile. I am afraid that new clause 8 is rather less straightforward. It seeks to deal with what has been an extremely topical issue over the past few months, namely eligibility for capital gains tax on second residences.

The new clause does not refer to the practice of which many members of the public strongly disapprove, which is the very narrow issue of Members of Parliament designating one property as a second residence in order to claim their additional costs allowance and designating another property as a second residence for the purposes of capital gains tax compliance with HMRC. That is legal, although, people feel that in most cases it is morally dubious, at best. However, that is not the central thrust of new clause 8.

The new clause would amend the Taxation of Chargeable Gains Act 1992. When I looked into the issue—with some assistance—it proved to be rather more complicated than it first appeared. The new clause centres on sections 222 and 223 of the 1992 Act. Section 222 identifies what constitutes the principal residence and what constitutes other residences for the purpose of eligibility to pay capital gains tax. The section includes a requirement for a person to inform HMRC which residence is their principal residence, as well as other requirements relating to, for example, married couples and the consistency of their declarations on which residences are designated in which category.

Section 223 deals with the amount of relief and the rules whereby people can qualify for it. It is worth bringing one point in particular to the attention of the Committee, because some Members may not be aware of it. Under one of the provisions, if a second property is sold within three years of it becoming a second property, there is no eligibility for capital gains tax in that period. For example, somebody who has a single home may want to buy a bigger house in the next street, because they have an expanding family. They move swiftly to buy the house before they have sold their existing property, because the house is on the market and they are happy to pay the asking price. They do not have the time to make a chain arrangement, but they are fortunate enough to have enough money to support two mortgages for an interim period. My understanding is that the original property is not considered to be a second home for the purposes of eligibility for capital gains tax during that period.

The housing market may be picking up a little, but I think that people in areas where it is hard to sell properties would feel aggrieved if they had to pay substantial capital gains tax on a property that was only a second property in a technical sense, but that had been the family home until they moved. I understand the argument for having that three-year period, but many people might think that it is quite a long time; perhaps we could discuss what is an appropriate period. There is a problem in that, although the present system is reasonable in the circumstances that I have just described, it allows quite a lot of creativity and flexibility where people do not have those sorts of arrangements and where they own multiple properties.

I declare an interest, because I own two properties, but I have not flipped between the two for the purposes of my additional costs allowance, and I have never sold a property in my life. I have bought two, but I have not sold any, so I have never paid capital gains tax on any property transaction. I hasten to add that, rather than seeking to avoid it, I have not realised any capital gain.

What am I trying to do in the new clause? I am inserting two new paragraphs. The first is on the subject of the first part of my speech: the requirements to report to HMRC which property is the main home and which is the second home. At the moment, the requirements are not sufficiently prescriptive so there is, therefore, room for doubt and for people to be caught out unwittingly or to bend the rules in a way that we would disapprove of.

New section 222(5)(a) requires HMRC to write to the individual to inform them of the requirement to declare which property is their main property and, by implication, which is not their main residence for the purposes of tax. New paragraph (aa) reduces the two-year period to six months from the date on which the notification from HMRC is received. People moving house have many concerns—making sure that they have their council tax and utility bills right and so on—so some leeway in registering the change of status is reasonable, but two years is excessive; six months would be sufficient. Under my proposal, for the first time, HMRC would be obliged to write to the person from whom it required the information, so people would not be caught out unwittingly. I can imagine circumstances in which people would not realise that they were required to submit the information and I would not wish them to incur the wrath of HMRC unwittingly.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster 3:15 pm, 25th June 2009

I congratulate the hon. Gentleman on putting his case pretty clearly. The rules are couched in that way, first, to avoid added bureaucracy—he has started down that path and I suspect that we will hear more about the bureaucratic necessity for an individual or HMRC to get in touch—and, secondly, to recognise that people’s lifestyle changes over time, perhaps because of getting divorced, splitting up and so on, and it is not necessarily easy to say that that will be within six months or twelve. The three-year rule means that one does not have to worry about changes in circumstances or have to investigate an individual’s intention at a particular time in their life. While perhaps an over-long period for the hon. Gentleman’s liking, a three-year period is clear, and enables matters to be managed with clarity and with as little bureaucracy as possible.

Photo of Jeremy Browne Jeremy Browne Shadow Minister (Treasury)

I am grateful for that intervention, because it allows me to clarify a point that I probably did not explain well enough the first time. Two separate points are being conflated. One is the three-year rule, which I mentioned earlier, and the other is the period in which people are not eligible to pay capital gains tax. I cited the example of somebody moving within their neighbourhood while still retaining ownership of the first property for an interim period.

The point that I was making before I gave way was about the two-year period during which HMRC ought to be notified of which property is the principal residence. We do not want it to be unclear which property is the main residence. If it was unclear, there would be an incentive for the individual to claim that whichever house they were selling and realising a capital gain on was their principal residence at that point. Many people would feel that that was unreasonable.

As I understand it, my new clause states that the individual must inform HMRC which property is the principal residence, unlike the current wording, which seems to say that the individual may inform HMRC—there is ambiguity. Trying to frame the new clause has been difficult because the current rules are somewhat ambiguous. Trying to amend a rather fluid and hard-to-pin-down arrangement is not easy. That fluidity and the difficulty in pinning it down make the rules open to abuse and, if I am being generous, broad interpretation, particularly by accountants, which means that the spirit of the rules can be infringed, even while abiding by the letter of the law.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

As Conservative Members are not whipped in Committee these days, it is always interesting to hear an argument before making a decision. I am not sure what nut the hon. Gentleman is trying to crack. I have experience of the previous recession, which was not as bad as the one we are in now. The house in which I was living fell considerably in value. When I had to move to a different part of the country, I could not afford to sell the first house at a loss, so I had to wait for it to come back up in value. Under the hon. Gentleman’s proposal, I would have been penalised for that.

Photo of Jeremy Browne Jeremy Browne Shadow Minister (Treasury)

There are two sections, both of which I will explain. If I do not explain the whole picture, there is a danger that someone as open-minded as the hon. Gentleman may not fully realise the merits of my case. I do not say that in a sneering way at all. The hon. Gentleman is one of the few Members whose vote is unpredictable on this Committee. Many Members could ask themselves why they bother to turn up at all because they vote as instructed. [Interruption.] I will not be tempted down this route. I suspect that few members of the Committee find slightly laughable the ritual of one side voting one way and the other side voting the other. As I say, the hon. Member for Wellingborough is commendably open-minded in many of his views.

I realise that people’s circumstances change, that they get jobs in different parts of the country, and that they get divorced and married. All those changes happen all the time. We all know that the rules are trying to establish that one’s principal residence is not eligible for capital gains tax, but subsequent residences are. If that were not the case, one could, as an investment decision, accrue many different properties and not be eligible for capital gains tax on them when they are sold, whereas that individual would be eligible for capital gains tax if they had chosen to invest in something other than property.

We know what we are trying to achieve. In each individual case, one can recognise, in most instances, what is an appropriate interpretation of the law and where the rules are being bent. The difficulty is trying to frame in legislation—no doubt the Government have faced this difficulty—the wording that prevents people from treating the law in the opposite way to which it was intended but does not inadvertently trap people whose behaviour is entirely proper and in line with that just mentioned by the hon. Gentleman. That is the difficulty that I face. I hope that everyone is facing it because we all need the incentive to get this right.

The first part of the new clause is the requirement for people to inform HMRC which is their principal residence. Without that information, it is impossible to draw any further conclusions. That is what I was talking about a moment ago. The second part is to see how we can tighten up the rules on what has now widely become known as “flipping”. At the moment, when someone redesignates a property, they can claim that for a three-year period, they are not eligible for capital gains tax. That point came up earlier when I talked about the safeguard that is in place for somebody who has moved within their neighbourhood from what is essentially one first home to another first home, but who, for an interim period, owned two properties. The safeguard, which prevents that person from being eligible for capital gains tax, means that individuals can “flip”—to use the new jargon—the residence and, therefore, qualify for  the three-year exemption. They qualify even though the property was always their second property. They are being advised by accountants that that is an appropriate way to avoid capital gains tax, or a portion of it, on what was always a second property. That is hard to define. I propose that if people flip to a property and then flip back to the principal property, they would not then be eligible for the three-year period. It is still difficult because somebody with multiple properties who sells them on a rotating basis might be able to stay one step ahead of the tax man in terms of their tax liabilities. It is difficult to frame a law that would stop them from doing that. However, they should not be able to flip from their main property to the second one and back again in a way that enables them to qualify for a benefit that social attitudes would deem to be inappropriate and against the spirit of the law.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster

Although I admire what the hon. Gentleman is trying to achieve—albeit with the caveats that I mentioned earlier—has he not summed up the problem? He might be able to stop somebody who has two properties from being able to flip, but he cannot stop the serial property owner who, through a buy-to-let operation, can flip through several properties. Such people just have to ensure that in any three-year period they do not designate the same property as the primary property more than once. The proposal is fine for the average person, but it could be used as a charter for buy-to-let operators and allow them to avoid tax.

Photo of Jeremy Browne Jeremy Browne Shadow Minister (Treasury)

That is an entirely fair point. However, the people the hon. Gentleman describes avoid tax at the moment so I would not be making the situation any worse. This is a probing amendment.

Photo of Jeremy Browne Jeremy Browne Shadow Minister (Treasury)

It is a probing new clause. I readily accept that getting the detail of such a proposal right would be difficult for anybody in Opposition, or indeed for the Government. However, it would be negligent of us not to explore this issue to see if the law can be improved.

The problem is similar to the inheritance tax argument with which we are familiar. The people who plan ahead and employ decent accountants can avoid paying a tax that those who do not plan ahead and do not use accountants do not avoid paying, even if their circumstances are the same. People think that unreasonable. It does not require a particularly sophisticated accountant to advise people to redesignate their properties to reduce substantially their capital gains tax liability in a way that goes against the spirit of the law. Such revenue is lost to the Exchequer and could have been used on debt repayment, schools, hospitals, police and so on.

People who own one property or who do not own any property think it reasonable that capital gains tax should be paid on the sale of a second property. They feel that the system that allows people to pick and choose whether they pay tax on a large proportion of their capital gain on a second property is unreasonable and ought to be more effectively policed. That is why we tabled the new clause. This is an important subject and I look forward to the contributions of the Minister and other hon. Members.

Photo of Greg Hands Greg Hands Shadow Minister (Treasury)

This has been an interesting and entertaining debate so far. I congratulate the hon. Member for Taunton on tabling the amendment and on floating an interesting suggestion.

We have three broad areas of concern. First, some of the consequences of the proposal might not have been fully thought through. It sounds as though the hon. Gentleman would not disagree with that. Secondly, it will increase bureaucracy, particularly because of the number of additional letters. It sounds as though HMRC would have to send out a letter on the completion of any property transaction. If the problem is as big as he suggests—and perhaps it is—that might be reasonable. However, we should not underestimate the bureaucracy involved. At the same time, there would be an obligation for people to write to HMRC to detail any change in what they perceive as their residence. That might also be reasonable, but I fear that we would be adding a great deal of bureaucracy without knowing the size of the nut that we are trying to crack.

I also have a couple of concerns about the drafting, but I am getting more and more confused. I have spoken to two bodies that have concerns about the new clause, but they cannot agree between them what the problems are. Therefore, I will not discuss the drafting because it is likely to make us even more confused.

We are broadly sympathetic to the hon. Gentleman’s intention to prevent the flipping of properties for capital gains tax purposes, seen most notably recently in the case of Members of Parliament. However, the measure will affect many thousands of people—it is hard to tell how many—beyond MPs. Care is needed when making tax policy such as this. We would want to see far more extensive study of the impact of the proposed changes before we felt able to give our support. The status quo, as he pointed out, provides protection for those selling properties where, for example, they have ended up owning two properties at the same time due to a delay in the sale. It seems reasonable to have some protection for those who end up holding both properties, especially in the current climate.

My hon. Friend the Member for Wellingborough referred to the last recession. In the current climate there is likely to be a fair number of stalled property chains where people have ended up having two principal or primary residences. I do not think that the new clause is intended for them. It also might penalise people who end up selling homes or their principal or primary residence twice in the same year. I do not believe that that happens terribly often but I am sure it does happen, and we would not want to penalise that. We have sympathy with the motives and intention but want to see more study. We are not actively able to support the new clause at the moment but would like to see more intensive study carried out by HMRC, if this is perceived as a serious and widespread problem.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury 3:30 pm, 25th June 2009

I begin by congratulating the hon. Member for Taunton on so ably and frequently deputising for the hon. Member for Twickenham who is the lead name for the new clause. I am sure that it is not his fault that the drafting is technically deficient. For the record, as the hon. Member for Hammersmith and Fulham made some comments about this, the new clause refers to  part 9 of the Taxation of Chargeable Gains Act 1992 when part 7 is intended. It also purports to amend a provision—section 222(5)(b) of the Act—that was repealed in 1996.

Photo of Greg Hands Greg Hands Shadow Minister (Treasury)

I thank the Minister because I was also told that. However, I went back to the new clause and it clearly states part 7, it does not mention paragraph (b) but does mention paragraph (aa). Will he clarify? I was given the same information—that there was a drafting error—but, when I checked, there did not seem to be one.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

I am certainly advised that the new clause is technically deficient along those lines. I will investigate again and see whether that matter has been cleared up. I hope to go on to explain the other reasons that the new clause does not work as intended.

Photo of Greg Hands Greg Hands Shadow Minister (Treasury)

Is the Minister saying that he did not check that himself?

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

I am beginning to wish I had never introduced this part of my speech. [Laughter.] Let me make a bit of progress.

Photo of Greg Hands Greg Hands Shadow Minister (Treasury)

I am concerned because the Minister, in explanation, criticised the new clause for mentioning part 9 of the Taxation of Chargeable Gains Act 1992. It is clear in front of us that there is no mention of part 9. The new clause does in fact refer to part 7, which is the point I was making. It appears to be drafted correctly. Where does it say part 9?

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

I stand corrected on that point. Perhaps the new clause has gone through modifications. There are other reasons why it should not become part of the Bill and I hope to describe them.

I do, however, welcome the opportunity to discuss private residence relief in the capital gains system as an issue more generally. It might be helpful briefly to outline to members of the Committee how the relief operates, although I think that a number of our colleagues understand it perfectly well.

In general, individuals who own more than one residence pay capital gains tax on their second home, but not on their main residence. They can choose which is their main residence and notify HMRC. Any residence that has been at some point a main residence receives relief from capital gains tax for the final three years of ownership.

The relief has been in place since the introduction of capital gains tax in 1965. The only significant change to it has been the extension of the relief for the final period of ownership of a property which has at any point been a main residence. That period was initially one year. It was extended during housing market downturns from one year to two years in 1980, and from two years to the current three years in 1991.

The system currently has a number of features. It is straightforward to operate, as it allows individuals to take the initiative in notifying HMRC of any change of their main residence. It allows people to move residence as and when they see fit, and it also means that individuals who move houses during a housing market downturn—for  example, to find work—but have difficulty in selling their old house in a reasonable period of time, do not have to pay a capital gains tax charge. However, as hon. Members have pointed out, the very flexibility of the system has meant that some people have been able to reduce their CGT liability by flipping their nomination of main residence between different properties.

The new clause seeks to address some of the perceived problems with the current system, and I have sympathy with the aims of the new clause, even though I do not believe that it achieves those aims. First, it would require HMRC to contact all those who have more than one residence to tell them to nominate their main one. Although I can see that that might reduce the scope for abuse in some cases, it would mean practically that HMRC would need to monitor the movements of every person in the country who owned more than one property, including landlords of buy-to-let property, to check where they were spending their time. That would be administratively impossible. HMRC has neither the power nor the resources to carry out such a task. It is also, arguably, far too intrusive into people’s lives.

Photo of Jeremy Browne Jeremy Browne Shadow Minister (Treasury)

I take the Economic Secretary’s point that what constitutes a main property can be hard to define—and Members of Parliament may have discovered that—and even harder to police. However, although people would accept that point, they may still have reservations about a situation where someone’s circumstances have not changed, but they still flip the designation because of tax liability considerations, not because they are suddenly spending more nights in one property than they were before. If they are going to designate a main property, they should, many people believe, stick with that as their designation unless there is some reason to change it to some other designation.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

Again, I have sympathy with what the hon. Gentleman says, but there are real practical difficulties involved in establishing main residence.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

Perhaps HMRC might consider contracting out such an enforcement process and the checking mechanisms that are required to a media organisation with experience in this area.

Photo of Ian Pearson Ian Pearson Economic Secretary, HM Treasury

I will not pursue the line of argument suggested by my hon. Friend. The new clause would, as the hon. Member for Taunton recognises, oblige everyone who owned more than one home to nominate their main residence within six months of HMRC contacting them to ask for a nomination. The new clause does not specify a time limit within which HMRC is to contact home owners, and so set off the process, so it could have the effect of extending the total period for which a nomination may be made. It would also be an additional burden on home owners who at present, as has been pointed out in the debate, “may” contact HMRC, but are not obliged to do so when there are changes in the homes that they own and occupy. I can see there are arguments for reducing the period during which a change in nomination can be made. However, new clause 8 on its own would not deal with the problems; it would need to be part of a much wider package of measures to do so.

The third reason why I think that new clause 8 does not work is that it would deny any relief from capital gains tax for someone who moved their nomination of main residence to another property and then moved it back to the first property. Again, I can see the problem that the hon. Member for Taunton is trying to solve, but that approach would capture some people who have moved residence for reasons other than to reduce their CGT liability.

For instance, suppose that someone occupies two homes and has nominated the home where they spend most of their time as their main residence. They then move away to work and as a result their second home becomes, in fact, their main residence and they vary their nomination accordingly. If, because of a change in circumstances, they then shifted their main residence back to their first home, a switch of nomination to reflect that reality would mean that they would receive no relief from CGT on either of the properties under the new clause.

Therefore, there are some real difficulties in the detail of what the hon. Gentleman is proposing. However, he raises some important points about the abuse of private residence relief, which need further consideration. This is a complex issue, but the new clause would create the type of difficulties that I have outlined. On that basis, I ask him to withdraw the new clause.

Photo of Jeremy Browne Jeremy Browne Shadow Minister (Treasury)

I never pretended that new clause 8 was a perfect blueprint for administering this difficult area of taxation and I am grateful to everyone who assisted me in making it as close to perfection as it ended up being; if it had been left to me, it might have been a lot further away from perfection. This is a difficult area and trying to amend all the previous Acts of Parliament that we are discussing is obviously difficult, for Ministers as well as for other MPs.

However, I think that the point that I sought to make remains a valid one. That point is that people should expect to pay CGT on the capital gains on properties beyond their first property. Furthermore, a system that is as open to avoidance as the current system is becomes discredited. As a result, the people who pay CGT are, as often as not, the people who are least effective at working their way around the system. Compare their position with that of people who are least eligible to pay the tax. If that happens it is unfortunate, because it discredits the tax system as a whole and people feel that they are not being treated fairly.

What I was seeking to do in new clause 8 was to suggest a possible improvement. I hope that the Minister and other members of the Committee will see merit in exploring this area further, to see where the law can be improved. However, having had a useful conversation, I beg to ask leave to withdraw the new clause.

Clause, by leave, withdrawn.