The rules for taxing spouses and civil partners are meant to be simple. And they are – deceptively so. In fact they are so simple, I have known tax advisers get them wrong. This article covers the main points relating to income tax on property owned jointly by spouses, and how to correctly notify HM Revenue & Customs (HMRC) of an effective change in the split of income.
General rules for taxing income on jointly-held assets
Tax follows beneficial ownership – who is entitled to the benefit of the property – rather than whose name is on any legal documentation, such as title deeds. So, for instance, if one person puts up 75% of the funds to buy a property, and another person only 25%, then it may be argued that the first person’s beneficial interest is as to 75% of the property.
The general consensus is that, spouses aside, income from jointly-held rental properties will be taxed by default according to the respective beneficial interests – although this can be changed if the parties so decide (albeit not retrospectively). HMRC seems to agree – see for instance their Property Income manual at PIM1030. It should be noted, however, that their Trusts, Settlements and Estates manual takes a different line (at TSEM9330), and implies that any deviation from following the underlying beneficial interest may be caught by anti-avoidance (‘settlements’) legislation.
The relative proportions of beneficial interest are not always obvious: if a brother has helped his sister to buy her house, has he simply provided a loan, or did he co-invest, expecting some kind of return – say when the property is sold? Unsurprisingly, HMRC often disagrees with taxpayers’ interpretations of who really owned what. Two recent cases, which I like because the taxpayer won, are Lawson v Revenue and Customs [2011] UKFTT 346 (TC) and Watson v Revenue and Customs [2014] UKFTT 613 (TC). Although they are capital gains tax cases, the principles are quite similar.
Jointly held vs tenants-in-common
Where two people hold property, they can hold it as ‘joint tenants’ or ‘tenants-in-common’. Joint tenants each hold the same overlapping interest, whereas tenants-in-common can split their ownership unequally if they like. By default, where spouses own property, the assumption will be that they each hold the property as joint tenants.
Basic rule for spouses
Where two spouses who are living together own property jointly, then they are deemed to have an equal interest in any investment income and be taxed on a half share each. Amongst other things, this rule does not apply to husband and wife partnerships, furnished holiday lettings (as defined), or where there are other co-investors in the property, other than the couple (the rule also does not apply where it is not a joint investment because one spouse owns the property outright).
The deeming provision is found in the tax legislation at ITA 2007, s 836. If the rule applies, the actual split of beneficial ownership (such as which spouse paid the greater deposit, took on the bigger loan, etc.), is completely ignored, by default. However, this legal presumption may be rebutted, as set out in s 837, by formally declaring an unequal split of beneficial interest.
Changing the default split – Form 17
Splitting income from joint property 50:50 between husband and wife seems relatively convenient.
But what if the wife earns £100,000 a year salary and the husband only £30,000? Clearly, the wife will pay far more tax on her rental income than her husband. This would be even more unfair if the husband’s actual beneficial share in their joint property portfolio were, say, 70% to his wife’s 30%.
Fortunately, it is possible to notify HMRC of that unequal split, using form 17 (Declaration of Beneficial Interests in Joint Property and Income) – see:
Unfortunately, the form has recently become much more difficult to complete, now that HMRC has helpfully turned it into a mini-programme which asks lots of questions before you can even see the form. But that, as they say, is progress.
Practical aspects of using form 17 – getting the procedure and paperwork right
- A Form 17 is appropriate only where the property is owned jointly between two people who are each other’s spouse and living together – because the presumed 50:50 split applies only in such cases, as explained above.
- Where property is held jointly by ‘non-spouses’, it is generally possible to change the income-sharing arrangements as and when suits. With property held jointly by spouses, however, the profit share can be moved away from the default 50:50 split only if the underlying beneficial interest is (or becomes) unequal.
- If a couple currently owns a rental property in equal shares, but now wants to change the split, actual ownership must change, as the split can only be changed to reflect the actual proportion of underlying beneficial interest each spouse holds.
- The property cannot, therefore, be held as joint tenants, (since each party has an equal interest under a joint tenancy), but as tenants-in-common instead.
- The declaration must be signed by both joint owners, and has effect from the date of the later signature, if both spouses do not sign contemporaneously.
- A couple can decide to make a declaration at any time: it makes no difference how long the spouses have owned the property, or in what proportions. HMRC’s Trusts, Settlements and Estates manual (at TSEM9858) confirms that there is no limit on the number of declarations.
- A valid declaration must be submitted so as to reach HMRC within 60 days of the later signature date. A declaration received late is invalid and has no effect. However, HMRC’s guidance (at TSEM9874) admits that the onus is basically on HMRC to prove the notice was not delivered in time. If for some reason a declaration is ‘late’, a fresh declaration may be submitted.
- A declaration will cease to have effect for various reasons – death of a spouse; divorce, or permanent separation beforehand; or where the respective underlying beneficial interest changes again. If one spouse transfers part of his or her interest to the other, then the income should revert to a 50:50 split unless the couple make a valid new declaration for that property.
- HMRC now insists on documentary evidence of the unequal beneficial ownership. Aside from the declaration on form 17, this will normally require a ‘Declaration of Trust’ which sets out the spouses’ respective interests in the property. This Declaration of Trust is a relatively simple legal document – HMRC’s guidance provides an example of a very basic declaration (at TSEM9520) (although that one is a bare trust for another party).
Practical Tip:
Form 17 is essential in order to be able to distribute profits unequally between spouses; this is underlined by the recent tax case of the unfortunate Koshals - Koshal and Another v HMRC [2013] UKFTT 410 (TC) who, in the absence of a form 17, provided plenty of evidence that their interests should not be equal – but to no avail.
It is strongly recommended that competent professional advice be sought before undertaking a Declaration of Trust.
Remember that, even for spouses who are living together, a transfer of beneficial interest from one spouse to another is a CGT disposal. Although unlikely to trigger any CGT at the time because of the ‘no gain, no loss’ transfer rules for spouses, etc., it may have consequences when the property is ultimately sold. The timing of transfers is particularly relevant where the property has at any time been one’s main residence.
