A recent tax appeal raised an interesting question about whether a transaction could be cancelled so it effectively meant it never happened in the first place.

The issue came up after a commercial property owner, Arshad Mahmood, mistakenly believed no capital gains tax (CGT) would be due when he transferred properties to a company owned by his wife.

After HMRC opened an enquiry, Mr Mahmood and Rajay Khan Properties Limited (RKP) agreed to “rescind” the handover by transferring the properties back to Mr Mahmood.

However, the First-tier Tax Tribunal (FTT) has now ruled Mr Mahmood couldn’t unwind the transaction for CGT purposes, and so the tax liability remained.

Background to the Arshad Mahmood v HMRC tax appeal

In November 2016, Mr Mahmood transferred 10 commercial properties he owned to RKP, a company wholly owned by his wife. Mr Mahmood didn’t report this on his tax return because he didn’t believe there was any taxable gain.

But HMRC said any capital gain should be calculated based on a consideration equal to the market value of the properties, because the disposal was to a connected person.

The tax body issued a closure notice resulting in extra tax of £303,476. It also charged Mr Mahmood a penalty of almost £82,000 (27% of the extra tax) for providing an inaccurate tax return.

In the meantime, Mr Mahmood and RKP agreed to unwind the transfer by handing the properties back to Mr Mahmood in early 2019. Mr Mahmood accepted the CGT spouse exemption wasn’t available because the properties were transferred to a company owned by his wife, rather than being handed directly to her.

The arguments over the property transfer and CGT

Mr Mahmood appealed both against the amendments made by the closure notice and against the penalty. He said the transfer of the properties had been rescinded and so no taxable disposal had taken place. With the closure notice, he argued it didn’t validly impose any tax liability on him because HMRC hadn’t made the required changes to his tax return.

HMRC defended the legitimacy of the closure notice and the resulting tax imposed on Mr Mahmood. However, it asked the tribunal to reduce the amount of the tax charge from £303,476 to £36,316 for the following reasons:

  • To reflect an updated, reduced valuation of the properties of £544,750.
  • To allow expenses of £352,068 when calculating the capital gain.
  • The property wasn’t residential and so the tax rate should be 20% instead of 28%.
  • To allow property expenses of £8,239 to offset income tax liabilities on the rental income.

And, in line with the reduction to the tax, HMRC said the penalty should be cut to around £9,800 (27% of the revised tax).

The First-tier Tax Tribunal

The tribunal had to decide:

  • Whether, as a matter of law, it was open to Mr Mahmood and RKP to rescind the transfer of the properties because of their common mistake regarding the tax consequences. And should the transaction therefore be treated as never having taken place for CGT purposes?
  • If so, were the parties mistaken as to the tax consequences and was the transfer properly rescinded?
  • What action should HMRC take on completion of their enquiry into a person’s tax return so a tax liability arises?
  • Did HMRC take the actions required of them?

As far as the penalty was concerned, Mr Mahmood didn’t challenge this other than on the basis no tax was due. The penalty therefore stood or fell in line with the tribunal’s decision on the tax liability.

The appeal ruling

The FTT concluded the reversing of the handover of the properties didn’t mean the original transfer could be treated as if it hadn’t taken place.

That transfer was therefore a disposal by Mr Mahmood for capital gains tax purposes and should be treated as having taken place for a consideration equal to the market value of the properties.

The tribunal ruled the closure notice issued by HMRC in April 2020 was valid. And it said the notice was all that was needed to amend Mr Mahmood’s tax return.

Tribunal judge Robin Vos added: “The amount of the amended self-assessment should however be reduced to £36,316 to reflect the reduced amount of the gain, the lower tax rate of 20% and HMRC’s acceptance that the property expenses claimed are allowable. The associated penalty should accordingly be reduced to £9,805.32.”

Our advice for taxpayers about property transfers

The rules can be confusing. There are many misconceptions about various reliefs, one of them being the spousal exemption. So, it’s important for you to get tax advice before going ahead with any planning.

It’s incredibly difficult to get transactions set aside once they’ve been implemented, so it’s worth spending some time and money getting professional advice before any paperwork is put in place.

Trying to carry out your own planning without specialist guidance is often false economy. The rules are a minefield, and it’s easy to misunderstand or misapply them, which can result in large tax liabilities.

What can accountants learn from the Arshad Mahmood v HMRC tax case?

The tribunal decision isn’t a surprise given the interspousal relief only applies to individuals, not to entities owned by the spouses.

It’s easy for clients to misunderstand the rules and to press ahead in the belief that if it all goes wrong their accountant will sort it out. But once a transaction has taken place, it’s very difficult to convince a court to unwind it.

And while it’s not always possible to prevent clients from “doing their own thing”, it’s important to make sure they understand they should take advice before changing anything legally. Otherwise, it could prove costly in terms of tax.

Property transfer tax advice

For expert advice on property transfers and other tax issues, talk to our team on 07813 434195 or email stephanie.churchill@churchilltaxation.co.uk

We can also help with HMRC tax enquiries and investigations. Plus, we offer a tax expert witness service.

Steph Churchill

Stephanie Churchill

Managing director & co-owner of Churchill Taxation