Lee Sharpe looks at the key differences between legal and beneficial ownership – a common area of confusion for property owners – and differences in the tax treatment.
I will be considering the key difference between legal ownership and beneficial ownership in this article. I will also look at why the distinction matters from a tax perspective. It is important to clarify that the term ‘legal’ owner is not to distinguish from ‘illegal’ or somehow ‘inferior’ owners; essentially, legal ownership is not so much about having special rights or advantages, but more about responsibilities. The article follows the principles of English law.
Legal and beneficial ownership
The two types of ownership are not mutually exclusive, but essentially describe different aspects of property ownership.
While the beneficial owner may often also be the legal owner, (and vice versa), this will not always be the case:
- the legal owner is the ‘official’ or ‘formal’ owner of the land/property; and
- the beneficial owner is the person with the right to use/occupy the property (without paying for it) and the right to enjoy any income, etc. derived from the property.
A person can be both the legal and beneficial owner of a property at the same time – this is very common.
Legal ownership
Legal ownership reflects who is responsible for the land/property. The parties registered under the Land Registry are the legal owners. Under English law, no more than four persons can be formally registered as the legal owners of a parcel of land/property. Those (up to) four persons are essentially equal.
Beneficial ownership
The beneficial ownership or ‘equitable interest’ in property reflects who is entitled to the benefits or fruit of the land, be it in monetary or other form. The law of equity has developed to ensure that fair outcomes are achieved.
Example: Ownership of a holiday home
Bill and Ted put up the funds to buy a holiday home in York. For whatever reason, only Bill’s name is noted in the Land Registry. Bill is the legal owner, but Ted is not too bothered by this because he knows that the law of equity will recognise that he is a co-owner and that both Ted and Bill have a beneficial interest in that property.
Furthermore, if Ted put up 2/3rds of the money for the property – i.e. twice Bill’s contribution – then the principles of equity will presume that Ted has a greater interest in the property than Bill.
So, if at some future date Bill and Ted’s holiday home should be levelled to make way for York’s new airport, it will be only equitable to assume that Ted’s greater investment at the outset will result in Ted having more of the compensation received.
Analogies
One way to look at the distinction between legal and beneficial ownership is to consider a limited company:
- the company has owners – its shareholders. If the company’s value increases significantly, so does the value of each shareholder’s interest in the company. The shareholders are broadly equivalent to the beneficial owners of land. If the company is sold or liquidated, the shareholders get the proceeds; and
- the company also has official custodians/guardians – principally, its directors. The directors have duties both to the shareholders and to others. If a legal claim is made against the company, it is primarily the directors’ responsibility to deal with it on behalf of the shareholders. The company directors are broadly equivalent to the legal owners of land.
It is, of course, very common for directors also to be shareholders – there can be an overlap between the legal responsibility, and the beneficial owners.
Another way to look at the distinction is in terms of trusts. For example, In English law, a child cannot take full legal ownership of land until reaching the age of 18. If a deceased parent’s will leaves the family home to a young child, a trustee is appointed to look after the property until the child reaches 18 years old. The trustee(s) will be the legal owner(s), whereas the child is the beneficial owner and:
- he or she may live in it – a right to enjoy or occupy the asset; and
- if the property is rented out instead, the child has the right to any income received; and
- if the property is sold, then the proceeds ‘belong’ to the child.
Tax implications
Tax is first and foremost about money. It follows that tax is primarily concerned with who has the beneficial interest in the property, in terms of:
(a) who has a right to the income – income tax follows who receives the income (or is entitled to any income arising);
(b) who has a right to the proceeds of any property disposal or part-disposal – capital gains tax (CGT) will be charged on whoever is entitled to the proceeds as beneficial owner; and
(c) who has a right to enjoy or occupy the property – inheritance tax (IHT) will also follow whoever enjoys the use of the asset (see also ‘Tax complications’ below).
Stamp duty land tax (SDLT) is more complex and that is perhaps understandable, given its origins. It can potentially apply to transfers of either beneficial or legal ownership. This is a complex area, but it is worth noting that SDLT generally applies only where the value of the interest transferred is at least £40,000.
Tax complications
Income tax
While tax generally follows who is entitled to the income, it can also follow who receives the income (albeit generally as a first step).
For example, trustees sometimes have to file tax returns and pay tax on the money they receive on trust assets, even though it will, ultimately, be paid out to the trust’s income beneficiaries. But the trustees are effectively paying the tax ‘up front’ for the income beneficiaries, who get credit on their own tax bills for any tax already paid by the trustees. There can be similar arrangements for non-resident landlords.
Capital gains tax
The above example of Bill and Ted is straightforward. But what if Ted says that his investment was only a loan to Bill, so that Bill could actually buy and own the house outright? Or, what if Ted is married, and says that his wife, Gertrude, should also be included for CGT purposes (and use her basic rate band/annual exemption) when the property is sold?
While legal ownership is relatively easy to determine, beneficial ownership can change relatively easily (or be more difficult to pin down in the first place). How the proceeds are divided by the parties is strongly indicative, of course, and HMRC’s approach in such cases can be found in its Trusts and Estates manual (at TSEM9900 onwards).
Inheritance tax
Many readers will be familiar with the ‘gifts with reservation of benefit’ IHT trap which, says that where a person gives away (for example) the family home, but retains the right to live in it, the home may be deemed never to have left that person’s estate for IHT purposes.
This reflects that the original owner may have transferred legal ownership to another party, but has retained an equitable interest – a right to occupy the property – for himself.
Practical Tip:
Legal ownership is more concerned with the responsibilities of land ownership, while beneficial ownership is about who benefits from or enjoys the use of the property. Quite rightly, tax usually follows the beneficial owner. But pinning down beneficial ownership can sometimes be problematic, particularly between co-owners and family members. It is worth keeping contemporaneous notes and documentation, in case they are needed later, such as in the event of an HMRC enquiry.
