Tax issues: Your questions answered - part 2

John Whiting John Whiting answers more of your tax problems

In the second instalment of our Ask the Expert series about tax, John Whiting, of the Chartered Institute of Taxation (CIOT), answers your questions.

Here, he deals with queries including those about about capital gains tax (CGT), pension tax, tax exemptions, dealing with HM Revenue & Customs (HMRC), VAT and the tax implications of living abroad.

CAPITAL GAINS TAX Q1. We have lived in this property for 21 years. Seven years ago we converted the middle and top floors into separate accommodation and let them. Then we lived in the bottom part. Only two thirds of the property would be liable for capital gains if we sold, but would there be a time factor in that only seven years appreciation should considered for capital gains? W. Bishop, Lancashire.

I assume you are thinking of selling the whole property.

What have you actually done to it in the interim - have you actually converted it into three separate dwellings? How is the property now assessed for council tax?

The point being that if you have had it as a single property, but let out parts of it, then it will still count as a single residence on which you make a gain, which then has to be apportioned.

If you are now selling three separate properties, that would get us to a different calculation.

Assuming it is still essentially a single property, relief is limited to that part of a dwelling house which has been used as its owner's only or main residence.

Relief is not normally available for a part of the dwelling house which is let. There is an exception where the letting has been to a lodger - the rent-a-room relief - but that will not apply here.

Apportionment will be of the overall gain made, comparing proceeds with cost and taking into account improvements still reflected in the state of the property on sale. That will probably give the following (assuming you sell now):

  • 1/3rd of the gain as tax exempt, assuming it is 1/3rd that you have occupied
  • 2/3rds chargeable, but 14/21st of that exempt to reflect when you occupied it, and then another 3/21st exempt to reflect the "last three years' ownership" exclusion, leaving only 4/21st x 2/3rd of the gain as taxable
  • There would then be a further exemption of up to £40,000 as the "letting exemption".

Which might mean not much gain left to actually tax!

Q2. I had bought a house in my sole name (there is a small mortgage left) in 1997 and lived there with my mum and dad and brother until 2004. I then moved into a flat (also in my sole name - mortgage free) with my wife and kids. My mum/dad/brother/sister-in-law and three kids still live in the house bought in 1997. My questions are as follows:
  • Both properties are owned by me and I pay all tax and bills and have considered the house as main residence. If I sell the house, will I be able to nominate this as my principal house to avoid CGT?
  • The house has been extended to create another house in 2005 on the corner plot and if this is sold separately while keeping the original house, what are CGT implications?
  • If I was to transfer the flat to my wife, can I then claim that although I do not live in the house, it is my main and only house and escape CGT liabilities?
  • If my wife then sells flat, can she claim this to be her main home and escape CGT liabilities? Also, am I correct that this will not incur inheritance tax for my wife? Bhavin Patel, Wanstead.

If you actually live in two houses, in principle you should have nominated, within two years of getting the second property, which one would count as your main residence and so be CGT-free.

Reading a tax return Plenty of help can be found on the HMRC website

HMRC may accept a late notice if you tell them now but I suspect they would normally argue your house was your main residence from 1997-2004 and your flat after that.

In any case, if you only lived in one property at any one time, that property would be your main residence at that time.

If you sell the house, the gain would be part chargeable to CGT and part exempt.

You look at:

The whole period of ownership (say 13 years)

  • The period you had it as your main residence (seemingly seven years)
  • You also count the last three years of ownership as residence
  • So (7 + 3)/13ths of the gain is exempt, the rest (3/13ths) is chargeable.

You may have your CGT annual exemption available and if the house was owned jointly with your wife, the gain would be split between the two of you and you would both have a CGT annual exemption if it has not already been used.

Creating another property and selling it basically is treated as selling part of the original property. So you would be treated as selling a part-exempt, part chargeable, asset.

However, the fact that it was built after the house was probably no longer your main residence will complicate matters and may mean it is mostly a chargeable gain.

You and your wife are only allowed one CGT-free main residence between you, so transferring the flat to her as you suggest does not really help your CGT position.

Q3. Can you explain further the situation surrounding the CGT that coalition minister Danny Alexander has legally avoided? I have two houses, one I have lived in for 24 years and a second that I inherited (actually I inherited half and bought out my brother for his half) from my parents. Both houses have increased in value over this time. If I sell them both within three years of each other, can I avoid paying any CGT. Are there any complications to this? Malcolm Heron, Eastleigh.

As you are presumably aware, you are allowed one "CGT free" house as your main residence.

If you have two houses which are both your residence at some point, you should formally elect which is to be regarded as your main residence, though in the absence of this, HMRC would no doubt accept your long-term house as your main residence.

That means your second house will be liable to CGT when sold. What is possible is to change your main residence - to nominate the second property as your main residence for a spell.

That is achieved by giving notice to HMRC and later switching back.

It will not mean the second house is fully outside the CGT net but it will be a start as when you sell it the gain is apportioned over the period when it was your main residence (say three months) and when it was not (say 10 years or whatever).

That gives a small portion that is CGT free. But what makes it better is that having been your main residence, you are also currently entitled to the last three years' ownership as deemed residence.

So that gets us to three years and three months as CGT-free, and seven years chargeable - rather better.

And if you let the property out, that can get you a further CGT exemption, up to another £40,000.

Meanwhile, opting that your first house is not your main residence for a spell exposes that to some CGT but either that would be small or it might be covered by the '"last three years" exemption if the timing was right.

Remember, you do need to have lived in each property at some point. If a property was rented out throughout the period of ownership, no formal notice of main residence can be made.

Q4. When I lived in the UK I had a property rented out, though not my main residence. Now I live abroad permanently, and still have the rented out property in the UK. When I sell it what tax will I have to pay? Paul Davies, Pattaya, Thailand.

CGT basically applies to someone who is resident in the UK, so if you are resident abroad you can sell assets in the UK CGT-free.

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Anyone living outside the UK will also need to check the tax rules in their place of residence of course”

End Quote John Whiting

There is one tripwire designed to stop people popping out of the UK for a short period.

If you come back and you have been out of the UK for fewer than five complete tax years, then gains made in your period of absence are taxable when you return. But it sounds as if that will not apply to you.

Anyone living outside the UK will also need to check the tax rules in their place of residence of course.

Q5. We currently own our house outright and would like to move. We are fortunate in having significant funds available so that if a mortgage is added we could move without selling our current property immediately and also be in the position of cash buyers. When we sell our current house after moving I understand that there is a three year window before we would become liable for CGT. If for some reason we chose not to sell our house (e.g. rent it out) would CGT be based on the day we bought it (1988) or the day we moved out (say 2010)? Paul Saunders, Thame.

You are right that you have a three-year window - the last thee years of ownership of your main residence is treated as if you were still living there whatever happens and so will not cause a CGT problem.

If you decided to keep the house for a long period, in due course when you sold it there would be a capital gain based on the difference between your sale price and original cost in 1988, which would be partly taxable.

The gain you make would be allocated on a time basis between the period it was your main house, plus the last three years, and the rest of the period of ownership.

The chargeable gain could be further reduced by up to £40,000 if you let the property out.

Q6. Last year I moved from my main residence of seven years into another property I own. I have let my other property for one year but now I have decided to sell it. Is there any CGT to be paid on my previous main residence? Katie Dincer, Abridge, Essex.

If you lived in both properties at the same time, then you should in strictness elect with HMRC which of your two properties is your main residence (and hence in principle CGT-free) within two years of getting the second property.

To Let signs Being a landlord has its own tax issues

It depends on the detail here, but generally your first property would be CGT-free provided you sell it within three years of moving into the second property.

See some of my other CGT answers.

Q7. If you have property outside Europe and want to sell the property and bring the money to UK to buy a house, is there any tax to paid on? The amount is less than £100,000. Saeed, UK.

The first point is that if you are resident and domiciled in the UK, you are liable to CGT on sales of assets anywhere in the world.

Domicile is basically the place you regard as your ultimate home - you normally takes your parents' domicile when you are born but you can change during life.

If you are not domiciled here, you are liable to CGT on overseas assets if you bring the proceeds into the UK. There is no tax to pay on bringing the money into the UK as such.

Q8. I have been living outside the UK now for 15 years but still own a home there. For that period I have allowed family members to "house sit" and help with the upkeep of the property. I have made the decision to stay overseas and put the property on the market. Am I eligible for capital gains tax? If so what if any would I expect to pay on a property valued at about £100,000? Shaun Northrop, Netherlands.

CGT basically applies to someone who is resident in the UK, so if you are resident abroad you can sell assets in the UK CGT-free.

There is one tripwire designed to stop people popping out of the UK for a short period.

As in question 4, if you come back and you have been out of the UK for fewer than five complete tax years, then gains made in your period of absence are taxable when you return. But it sounds as if that will not apply to you.

Anyone living outside the UK will of course need to check the tax rules in their place of residence.

Q9. Nine years ago I purchased £15,000 worth of shares in a new start-up company. I was the fourth person to invest and the money was to be used to get the company up and running. The company started trading shortly after my investment and is making good profits and paying high dividends. The shares are now valued at £180,000. Within four years the company is hoping to list on the stock exchange and my shares should be worth anything from £400,000 to £1,000,000. For capital gains tax purposes is this investment considered private or business i.e. that of an entrepreneur? I have never been employed by the company and invested my money knowing that I could lose it all within six months if the company failed to get enough backing. Torben Rudd, Norwich.

Clearly when you sell the shares you would be liable to CGT on the gain, currently at 18%.

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We are on warning that CGT rates will change”

End Quote John Whiting

Would you be eligible for the "entrepreneurs relief" that gives a lower rate of CGT - currently 10% on the first £2m of gains?

That depends on:

  • The type of business - it needs to be a trading business
  • The length of time you have owned the shares or business - at least one year
  • How much you own - you need to own at least 5% of the ordinary share capital and that gives you at least 5% of the voting rights; and
  • You must be either an officer or employee of that company. or an officer or employee of one or more members of the trading group.

Therefore as you have never been an employee of the company, your position does not sound promising but is worth checking carefully - see HMRC's basic notes and the entrepreneur's relief help sheet.

It would be worth talking to a qualified tax adviser to be sure.

We are on warning that CGT rates will change (probably from April 2011) but that there will be "generous reliefs" for entrepreneurs. It is not yet clear what that means.

Q10. Can I give a buy-to-let flat to my son on which the mortgage has been paid, without incurring capital gains? Does he become liable to gains when he disposes of the asset? Or can he gift it away to his son and so on? G. Mann, Notts.

Gifting an asset is a disposal for CGT purposes, so giving the property to your son would mean you have made a disposal at the then market value with a potential CGT bill. There would be no stamp duty on a gift, assuming he is not taking on a mortgage.

PENSION TAX Q11. I am receiving a pension from Foresters Life, which began in November 2008. The amount is £113.71 a month. The policy was transferred from Standard Life, which I paid out of my salary on a weekly basis, but I thought this was after tax had been deducted, so why I am I paying it now? The tax amount is £22.80, which leaves £90.91, which is a bit steep. It makes me wonder if having a private pension is really worth it, when HMRC take most of it back, when it's time for an easier life. Ian Best, Wakefield.

You should have received tax relief on the pension contributions that you paid to Standard Life, so they would have only cost you the net amount after deducting tax at your top rate.

Elderly people exercise during the opening of the first dedicated pensioners playground at Hyde Park in London, May 19, 2010 Tax problems do not end when you retire

However, equally, any pension paid to you from the pension pot is taxable. This is the opposite of, say, payments into an Isa which do not attract tax relief, whereas income from the Isa is not taxable.

This sounds as if you are being deducted 20% tax - the basic rate - from the pension.

Have a look at the payslip you get and see if it says BR against the tax code. I cannot say whether this is right or not - it depends on your other income.

You are entitled to a personal allowance (£6,475, or £9,430 if you are over 65); is this being absorbed by your other income?

Bear in mind that the state pension, if you are drawing that, will mop up some of that amount. If in doubt, contact HMRC; it may be that you need to complete a form R40 to claim back some over-deducted tax.

TAX EXEMPTIONS Q12. I am full time permanent employee and in year to February 2009 I have taken a home loan. My wife and two kids (three and six years) live in the house. I would like to know whether I can have any tax exemptions. Taraka Srinivas, Dunstable.

There are no tax exemptions as such.

The main issue that you need to check up and claim is your entitlement to tax credits. I assume you are already getting child benefit.

Do make sure you have registered with HMRC (see their website) and also make sure they have the right information about yourself, including income details and childcare costs (if any).

There is a range of other benefits available depending on circumstance - again, HMRC have some help but see also the Department of Work & Pensions.

ISSUES WITH HMRC Q13. I sent off for a tax refund in March, after losing my job in February, and used a P50 form. From reading the HMRC website they said they will try to process it within 28 days. Now nearly three months on they still have not done this, and keep fobbing me off with different stories every time I ring them. They said they were waiting for some old P45s from some old employers, which I got and sent back to them, at the end of March. They are now saying that I have to wait till end of July. Is there anyway that I can speed everything up at all, as the money will come in handy. Nick Coxon, Wrexham.

Repayment delays have been a major source of complaint from both practitioners and taxpayers.

Tax form Problems with the HMRC can take a long time to sort out

HMRC are, understandably, checking repayments carefully as they have been subject to assault by fraudsters sending in bogus repayment claims.

I also know that they done a great deal to catch up the backlog and process claims, and carry out their checks, much more quickly.

At the CIOT we have been asking HMRC for guidance on how people can progress chase their claims. This lack of information is one of the greatest sources of frustration.

I did ask my contacts at HMRC for some comments. They stress that they try and deal with repayments as speedily as possible as they are well aware of the pressures for individuals. Their streaming process to prioritise repayments relies on being able to spot them as they receive them, so it is useful if claimants mark their claim clearly as a repayment, perhaps in their covering letter, and make the claim on a form, such as a P87.

You are clearly past that stage, but it is a useful message for others. It also has to be noted that this is a peak period for repayments and that pressure will ease over the next few weeks so HMRC should be making repayments more quickly as we enter the quieter months of June and July.

On your specific case, HMRC say that there still is a commitment to clear PAYE repayment claims within four weeks, so something has clearly gone awry here as the final claim support documents seem to have been sent at the end of March.

The contact centre should have referred your case back to the processing office as a matter of urgency, so you should press for urgent action given the delays to date.

If you can give me more details of your case, my contact would be interested in tracking it back to see what lessons can be learned - they are, to their credit, really trying very hard to get this issue right.

CAPITAL GAINS TAX & INCOME TAX Q14. As an employee earning approximately £30,000 a year I pay the basic rate, I think it's about 20%. I also let property but over the last couple of years I have made a loss so I have not had to pay tax on the rental income. If I had made a profit on the lettings for the last financial year for example £25,000, would that £25,000 added to my regular job earnings of £30,000 to make £55,000 thus pushing me into the higher rate tax band? Or is it treated separately? I also wanted to know about CGT. I understand that there is talk of an income tax based rate, forgetting about any taper relief. If I sold a property for say a £120,000 profit would this automatically be taxed on the higher rate i.e. at 40% or 50%, should the coalition decide to bring in income based CGT? Nick, Leeds.

Basic rate tax is indeed 20% and is charged on all your income over the personal allowance - currently £6,475.

The higher rate starts on taxable income (ie after personal allowance) over £37,400. So if your salary is £30,000 and you make letting income of £25,000 (though I hope you have noted your rental losses which can usually be carried forward and offset against future rental income) then you have total income of £55,000 and that will be taxed as:

  • First £6,475 @ nil
  • Next £37,400 @ 20%
  • Balance of £11,125 @ 40%.

We will have to wait and see what happens if the CGT rate changes, but my guess is that if the rate is tied to income tax, it would work much as with your rental income.

That is to say, it would be added to your income to use up the rest of your basic rate band before the reminder is taxed at 40% (or whatever rate is chosen).

TAX CLAIMS Q15. Having spent seven months of 2009 -2010 overseas on business can I claim tax and council tax back? Phil Cory, Pangbourne.

It will depend on your income for the year. If you have limited earnings because, say, you have been travelling, you may not have used up all your personal allowance for the year.

That might mean you are entitled to a refund. But if you worked abroad, those earnings are taxable here as you would still be UK tax resident for the tax years in question.

To get some relief from income tax you have to be outside the UK for a longer period - basically at least a full tax year - so I fear there is no benefit for you for a seven month stint.

For council tax, normally a property has to be empty for 12 months before there is exemption, but check with your local authority as there are different interpretations around the country.

INVESTMENT Q16. If you make a living solely from spread betting on the financial markets, do you have to pay any tax on any profits you make? Katy Bodmin, Halifax.

Probably yes - in that the spread better would be your trade.

The dividing line between a hobby (not usually taxable), an investment activity (usually subject to CGT) and a trade or profession (usually subject to income tax and national insurance) is a bit fuzzy in many ways.

What tips an activity into being a trade are features such as:

  • Frequency: the more often you do it, the more likely it is to be a trade
  • Motive: were you going into it to make a profit and especially a living? If so it is more likely to be a trade
  • Organisation: how serious is this, what accoutrements do you have: the more structure there is, the more likely it is to be a trade
  • The nature of the business: is it the sort of thing that is held as an investment or for personal enjoyment? Or is it really only normally dealt with as a trading activity

Of course the advantage of being assessed as trading is that at least you can offset losses.

PENSIONS AND TAX Q17. I have recently retired from full time employment and commenced taking my company pension. Due to change in circumstances I completed a tax form; I have now been advised my tax code will be 247L. The tax office has also informed me that they are holding back £4000 in case I earn more income this year. This tax code of 247L is not what I expected and because of it, my monthly pension has been reduced by £200 per month which is not what I anticipated either. As my earnings will be under £20,000 per annum and I do not plan to go back to work, can you explain why the tax office decided to provide me with this code rather than 647L? I am 58 years of age. Can you please advise if the tax office is entitled to do this and what is the best route to having the tax code of 647L reinstated ? Marianne Tunnell, Welwyn Garden City.

This is fairly silly and you should not accept it.

There are a number of ways that HMRC restrict tax codes (against an expectation of investment income as an example) but whatever number they use is invariably wrong - how do they know you are going to earn precisely £4,000 after all?

Go back to the tax office, tell them (a) that you are entitled to the full personal allowance (b) that you do not intend to earn any other money this tax year and (c) if you do sign up for another job you would anticipate having the 'BR' tax code applied against the earnings (which means that 20% would be deducted from all the earnings).

Q18. My wife and myself are both retired. I have a state pension which is taxed and my wife has a much smaller pension which falls far short for paying tax. Can I claim the balance of her entitlement, if so how and what are the pitfalls? John Wyatt, Nailsea, North Somerset.

Sadly, no. Personal allowances are personal and if you do not use it you lose it.

The only allowance that is transferable is the married couples allowance, now available only to those aged 75+.

The Conservatives have put forward an idea of allowing up to £750 of unused allowances to be transferred to a spouse but it seems that the idea is not going ahead, at least for the moment.

All you can do is make sure your wife holds any investments you have, for example that she gets any bank interest you receive so that it can be paid gross to her.

Value added tax (VAT) Q19. Under the new rules, is VAT chargeable if the supplier is based in England, the services are delivered in Ireland, but the related invoice is addressed to an office in the UK? Philip Murby, Croydon.

I assume you are asking about services (as it is these that have changed a little recently) and indeed a service that is normally liable to VAT.

It also sounds as if this is B2B - business to business - rather than direct sales to a consumer, where the rules are different.

If the UK addressee is just acting as a paymaster for the Irish company and the services really are rendered in Ireland, then you can zero rate the supply.

The Irish company would normally have to apply the reverse change to the supply when they receive it. There are a lot of "ifs" in there, though.

LIVING ABROAD Q20. I wish to understand how you become domiciled outside of the UK for tax and how long do you need to have lived outside of the UK before you no longer have to pay tax in the UK. And does living somewhere in the EU count? Trish Foster, Whitchurch.

Domicile is a funny concept - it is your ultimate home.

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You can certainly go elsewhere in the EU and establish a domicile there but it is a "sticky" concept - it is difficult to shake off!”

End Quote John Whiting

You get a domicile when you are born, normally from your parents. To change that (say from the UK to Ruritania) you have to cut most of your ties with the UK and really plant your life into Ruritania.

t does not mean you cannot visit the UK but normally someone who is really trying to show they are leaving for another country would sell up here, buy property in Ruritania, work there, pay tax there, really live there and indeed potentially plan to die there.

It is something that HMRC may challenge after a few years if they become aware that you keep coming back, that you have season ticket at your favourite Premiership football club, that you still have some business interests here etc.

You can certainly go elsewhere in the EU and establish a domicile there but it is a "sticky" concept - it is difficult to shake off!

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