Clark & Anor (Executors of Peggy Eileen Clark Deceased) v Revenue and Customs [2005] UKSPC SPC00502 (27 September 2005)

                                                                                                SPC00502

INHERITANCE TAX – business relief – company actively managing properties and carrying out its own building and maintenance work – whether its business consists wholly or mainly of making or holding investments (s 105(3) Inheritance Tax Act 1984) – yes 

THE SPECIAL COMMISSIONERS

JOHN GEORGE UPFIELD CLARK and
MRS JENNIFER MARY SOUTHERN
(EXECUTORS OF PEGGY EILEEN CLARK deceased)	Appellant

- and -

HER MAJESTY’S REVENUE AND CUSTOMS	Respondents

Special Commissioner: 	DR JOHN F. AVERY JONES CBE

Sitting in public in London on 26 August 2005

John Clark, one of the executors, for the Appellant

Peter Twiddy, Assistant Director, Capital Taxes Office, for the Respondents

© CROWN COPYRIGHT 2005

DECISION

1.	This is an appeal by the executors of Peggy Eileen Clark deceased who died on 30 January 2001 against a Notice of Determination dated 7 January 2005 that the Deceased’s holding of shares in T Clark & Son Limited (“the Company”) were not relevant business property for inheritance tax purposes.  Mr John Clark, one of the Executors, who is also managing director of the Company, represented the Executors; Mr Peter Twiddy represented the Respondents.
2.	The issue in this appeal is whether the Executors are entitled to 100 per cent business relief on the deceased’s shares in the Company.  It is common ground that as unquoted shares they are relevant business property (s 105(1)(c) Inheritance Tax Act 1984) unless they are excluded by s 105(3) of which the relevant part is:
“…shares in…a company are not relevant business property if the business carried on by the company consists wholly or mainly of…making or holding investments.”
3.	Mr Clark also gave evidence.  I find the following facts.
(1)	The Company’s business derives from a partnership founded in 1895 by Mr Clark’s great-grandfather.  In the 1920s a large site was purchased in Southampton on which the Company built houses which they sold.  In the depression in the 1930s the Company bought back many of these properties because the purchasers could no longer pay for the finance on them, and it leased them back to the former purchasers.  This accounts for most of the properties that the Company owns today.  The properties suffered War damage and from lack of maintenance because the Rent Acts formerly made the rents uneconomic.  The properties still require a lot of maintenance and need refurbishing.  The Company has its own workforce and carries out building (for example building extensions) and maintenance work itself.  It currently owns 92 dwelling, 4 shops, 4 offices, 2 industrial units and 20 lock-up garages.  The dwellings are mainly let on 1-year tenancies.  The Company still has some building land but at present all its time is spent on the existing properties.
(2)	The Company has a second activity consisting of the management of 141 dwellings owned by members of the Clark family, for which it also caries out the necessary refurbishment and maintenance work.  It charges a management fee of 7.5 per cent of the rent.  
(3)	Both sets of properties require extremely active management, which is run from an office at the centre of the site.
(4)	The accounts of the Company to 31 March 2000 (the latest before the date of death) describe the principal activities of the Company as “the provision of building services and property maintenance, property management and rental.”  Until 31 March 1998 the principal activity was described as “the holding of properties for re-sale, and the letting of properties held as an investment.”  The audit report to the 31 March 2000 accounts states that the directors believe that the open market value of the properties to exceed the value shown in the balance sheet (£814,396 for “fixed asset investments,” and £203,766 for land and buildings as “tangible assets,” which may be the office) by approximately £2m.  The 2001 accounts (which are after the date of the Deceased’s death) state that the directors believe them to exceed the book value (£842,753 and £202,096 respectively) by £4m.  The detailed profit and loss account to 31 March 2000 shows a split of turnover as follows:
Building and property maintenance 	£198,637
Property management 	£39,979
Property rents	£479,079
Ground rents receivable	£955
The first two relate to the management activities for properties owned by other family members, and the last two are the rent on the Company’s own properties.  Cost of sales relating to the building and maintenance is £191,281 (from which “own repairs” of £147,370 has been deducted).  Rental property costs include the same figure of £147,370 for repairs and renewals, and other property costs of £8,247.
Administration expenses are £269,553 of which the largest element is directors’ emoluments, staff salaries, National Insurance and pensions, which total £211,958.  Establishment expenses are £19,572.
Interest paid is £20,800 of which £18,299 is bank interest and the remaining £2,501 is HP and finance lease interest.  Interest received was £753.
(5)	Mr Clark estimated (and I accept) that 75% of the directors’ time was spent on the rental activity and 25% on the building activity.  He estimated that the Company’s properties were 42% of the total properties being managed, which I believe is based on the number of properties.  
4.	Mr Clark contends in outline:
(1)	The concept of renting property being an investment activity is outmoded.  He drew attention to the mass of legislation with which landlords had to comply and emphasised the active nature of the business.
(2)	The accounts of the Company do not convey the true nature of the business and the effort required by the management and staff.
(3)	It is anomalous to treat the income from managing properties owned by the family members as a non-investment activity, while treating the same activity on properties owned by the Company as investment.
(4)	The fact that rental income is investment income for income tax is irrelevant.
(5)	Investment is a word depending on the context.  It is normal parlance to describe a trading company as investing in plant and machinery.
(6)	Relying on the approach of the House of Lords in Tootal Broadhurst Lee Co Ltd v IRC [1949] 1 All ER 261, the rental income is part of the Company’s business activities and is not investment.
(7)	The Revenue’s interpretation discriminates against letting compared to other active businesses.
5.	Mr Twiddy contends that the rental activities are necessarily investment activities.  He contends that Mr Clark is relying on cases based on other legislation, rather than the latest guidance on this legislation from the Court of Appeal in IRC v George [2004] STC 147.  The Company carries on a mixed business comprising investment and building of which the business consists mainly of holding investments.
Reasons for decision
6.	Mr Clark’s arguments were extremely well researched and attractively presented and make a serious case for rethinking the categorisation of rental activities as not being investment on the ground of the active involvement of the Company, particularly here where the Company does its own building and maintenance work and where the Company originally built the properties.  
7.	However, I consider that Tootal Broadhurst, on which Mr Clark relied heavily, is a decision in a different context.  The taxpayer, whose business was manufacturing, finishing and marketing treated cotton, woollen and other goods, had granted patent licenses to third parties relating to processes that the company had in some cases invented and in other cases purchased, and which the company either used itself or licensed others to use in connection with its own manufacturing.  The issue was whether the patent royalties was “income from investments.”  It was not in dispute that the company’s business did not “consist wholly or mainly in…the holding of investments” (similar words to those in issue here) which was the condition for including income from investments in the profits of the business for excess profits tax, with the result that if the royalties were not income from investments they would not have been chargeable to that tax.  The House of Lords decided that the royalties were not income from investments but were part of the profits of the company’s business.  As Lord McDermott put it at p 268G: 
“On the facts of the present case it is enough to say that the income in question cannot be income from investments for the purposes of the statute because it arose from a series of commercial agreements, exploiting certain proprietary rights or claims, which were entered into by the taxpayers in the active prosecution of their trade or business.”
 I bear in mind that Carnwath LJ said in IRC v George at [12] “cases relating to different taxes and different subject matter are unlikely to be helpful.”  Although the Company here carries on a building trade, the rental income is far less closely connected with that trade than the patent royalty income in Tootal.  The rental income arises from granting leases of the Company’s capital asset, rather than from the active prosecution of the building trade.
8.	Essentially Mr Clark is making an active/passive distinction that was rejected by the Special Commissioner in Martin v IRC [1995] STC (SCD) 5, of which Carnwath LJ said in IRC v George at [18]:
18. The [Martin] case also concerned the availability of business property relief, but in relation to a business of letting industrial units on three-year leases. It was argued that the landlord’s activity in managing and maintaining the properties was sufficient to take it out of the ‘investment’ category, on the basis that it was ‘active’ rather than purely ‘passive’ property investment. Mr Oliver rejected that contention. That conclusion is unimpeachable. On any view, the business was at least ‘mainly’ that of holding property for letting, and thus for investment.
While it was common ground in George that the exploitation of a proprietary interest in land for profit was an investment activity, and so the point was not actually decided, it is inherent in the decision that it was an investment activity.  I consider that I should not revisit that point as Mr Clark would like me to do.
9.	Even if I were free to do so, I consider that the Company correctly described the land as fixed assets—investments in the balance sheet, and that is how a businessman would describe it.  The rents are essentially income from ownership of property which would still arise to the Company even if someone else managed the properties and carried out the repairs and maintenance, just as rental income arises to the family members from whom the Company does this work.
10.	On Mr Clark’s other contentions, I do not consider that it is anomalous to treat the management activities, for which the Company receives 7.5% of the rent, as non-investment, and the Company’s own rents as investment.  Equating a management fee with rent is not comparing like with like.  I agree with him that income tax decisions are not conclusive, which was my reason for not following the excess profits tax decision of Tootal Broadhurst.  I also agree that the meaning of investment depends on the context.  Here the context is a reference to making or holding investments, the feature of which is making a return on capital.  As I said in George v IRC [2002] STC (SCD) 358 at [12], which was approved by Carnwath LJ in IRC v George at [12]:
“There is a spectrum at one end of which is the exploitation of land by granting a tenancy coupled with sufficient activity to make it a business, which may be activity in granting tenancies rather than activity in relation to the tenancy once granted. At the other end of the spectrum, while land is still being exploited, the element of services means that there is a trade, such as running a hotel, or a shop from premises owned by the trader.”
Here one is at the former end of the spectrum.  The Company’s maintenance activity is not the separate provision of services; it is inherent in property ownership.  As Carnwath LJ said in George at [27]:
“…I agree in general terms that property ‘management’ is part of the business of ‘holding’ property as an investment (cf Webb (Inspector of Taxes) v Conelee Properties Ltd [1982] STC 913 at 921, 56 TC 149 at 157). In the case of a building held for letting, management no doubt includes the activity of finding tenants and arranging leases or licences, and that of maintaining the property as an investment.”
11.	Having decided that the Company’s rental activity is a business of holding investments I turn to consider whether the Company’s business consists mainly of holding investments.  The same issue was considered by the Special Commissioner in Farmer v IRC [1999] STC (SCD) 321 in which the deceased carried on a farming business and also let properties on the farm.  In most years the turnover from farming was greater than the rents but the profit from the rents exceed the farming profit. Dr Brice decided that the business consisted mainly of farming, based not only on the profit but also on the overall context, the capital employed, the time spent and the turnover.  Her approach was approved by Carnwath LJ in IRC v George at [14]:  
14. Farmer and anor (exors of Farmer, decd) v IRC [1999] STC (SCD) 321 is helpful as it concerned a farm which also had let properties. In deciding that the business was mainly that of farming the business was considered in the round and the fact that the lettings were more profitable than the farm was one factor to be taken into account but not a decisive factor.’ 
I agree that the last decision (of Dr Brice) is particularly helpful, not least in its emphasis on the need to look at the business ‘in the round’. 
12.	Accordingly I look at this aspect in the round.  It is difficult to separate the activities in the accounts, particularly as the Company cannot make a management charge for its own properties and charges the maintenance work on its own properties at cost.  Mr Clark’s estimate of the directors’ and staff time spent attributes 25 per cent of their time to the building activities (which relate both to the Company’s properties and the managed properties) and 31.5 per cent to management of the Company’s own properties and 43.5 per cent to management of the properties owned by members of the family.  Another way of looking at it would be to split the 75 per cent non-building activities according to the respective rents.  Since one knows that the property management figure relating to properties owned by family members of £39,979 is 7.5 per cent of the rent, the rent for family members is £533,053.  The Company’s own rent is £479,079, which is 47 per cent, which would mean that 35 per cent (.47x.75) of management relates to the Company’s own properties.  As this is not materially different from Mr Clark’s estimate of 31.5 per cent I shall use his estimate.
13.	My attempt to show the profit for the year ended 31 March 2000 on the different activities of the Company on a consistent basis is:
Investment activities
Rents	479,079 
Repairs with mark-up	(152,970)
Other rental expenses	(8,247)
31.5% of administration and establishment expenses	(91,074)
Interest	(18.299)
Profit	208,488 

Non-investment activities
Building (including marked-up own repairs) 	351,607 
Cost of sales (including cost of own repairs)	(338,651)
Management fee	39,979 
Balance of administration and establishment expenses	(198,051)
Lease rentals	(2,501)
Profit	(147,617)
The mark-up on the cost of sales of building income in the accounts is 3.8 per cent and I have marked-up the Company’s own repairs to that the figure is comparable with the figure for repairs to the family members’ properties.  I have used Mr Clark’s estimate of 31.5 per cent of the time being spent on the investment activity to apportion the administration and establishment expenses as the largest item is salaries for which time spent is a good indicator.  I have also assumed in the Appellant’s favour that all the bank interest relates to the investment activities.  The result, however, makes little sense as the profit on the building and management activities is far too small to bear the proportion of the management time spent on it.  This suggests that the Company’s rental activity is subsidising the other activity.
14.	Although the investment activity is greater in terms of turnover and profit, it is smaller in terms of estimated time spent, but apportioning the time spent on this basis gives a large loss for the non-investment activities and so cannot be justified.  In addition, the main asset estimated to be worth at least £2.8m (ignoring the land listed as tangible assets), or £4.8m in the 2001 accounts which are shortly after the date of death, relates to the investment activity.  Looking at the position in the round, as in Martin, I have no doubt that the business carried on by the Company consists mainly of holding investments.
15.	Accordingly I dismiss the appeal and confirm the Notice of Determination.

JOHN F. AVERY JONES

SPECIAL COMMISSIONER
RELEASE DATE: 27 September 2005

SC 3044/05

Authorities referred to in skeletons and not referred to in the decision:
Cook v Medway Housing Society Ltd [1997] STC 90
Burkinyoung v IRC [1995] STC (SCD) 29
Fry v Salisbury House Estate Ltd [1930] All ER 538
Neale v Jennings [1946] 1 KB 238
Williams & Glyn’s Bank Ltd v Boland  [1981] AC 487
Marina Shipping Ltd v Laughton [1982] 1 QB 1127
Sykes v Harry [2001] QB 1014
IRC v Desoutter Bros Ltd (1945) 29 TC 155