Capital Gains and other taxes manual

Practice note 1: valuation of interests encumbered by tenancy or licence - the nature of the encumbrance - law as at 31 March 1982

The Valuation Office Agency's (VOA) technical manual used to assess Capital Gains and other taxes.

1) The quantum of the valuation of an interest often depends materially upon whether or not, in a hypothetical sale, it could be offered with vacant possession.

2) For Revenue valuations, the material date is often a time when in fact someone was in occupation of the subject property, so the valuer cannot point to the fact of vacancy to prove that VP would have been available.

3) In the vast majority of cases there is no difficulty over the question, there being either an obviously encumbering tenancy or an owner-occupier who could clearly give VP and who does not contest it. These are the black and white cases.

4) However, there are occasions when the contrast is not so sharp and the shading between these extremes needs to be considered.

5) Anyone occupying a property in any way has some named status. The significance lies in the way and ease by which that status can be terminated without purchase, and whether the hypothetical vendor could have been expected to have obtained VP as part of the preparations for sale. One of the first things to remember is that the Revenue valuation hypothesis includes the assumption that all preliminary arrangements have been made for the sale (Duke of Buccleuch v IRC (CA)) and these would include the removal by the hypothetical vendor of any persons who could legitimately be removed without notice and without having to purchase their interest to do so. The preliminary arrangements for sale would not however extend to the extinguishment of a tenancy held by, for example, a company of which the taxpayer was a controlling shareholder (see Henderson (HMIT) v Karmels Executors (1984)).

6) Even where removal without purchase of the encumbering interest cannot be expected, there are shadings of status from the ephemeral through to more than lifelong statutory protection and it will be for the valuer to consider how the hypothetical purchaser, taking the interest subject to such encumbrance, would view the possibility of gaining early VP and how one would discount the VP value for this in making the bid.

7) The purpose of the following notes is first to help a valuer to identify the nature of such an encumbering interest and then to examine its effect as an encumbrance. The first step is to consult the Flowchart. In the boxes are the questions and the paragraph numbers containing the relevant advice. The following notes are not intended to be read as a narrative but to be used only in conjunction with the flowchart. The notes refer to the state and case law as it existed on 31 March 1982 as this is the most common valuation date in CGT cases. For an up to date summary of the law reference should be made to Practice Note 3 in the Inheritance Tax Manual.

8) These notes are not intended to be comprehensive, and it will still be necessary to refer to the relevant Acts. Furthermore it must be appreciated that instances will arise where expert legal advice is necessary; any such difficulties should be referred to CEO DVS HMRC Section if they materially affect valuation.


1. Identification of Rights of Occupation

1.1 Tenancy of Licence?

The distinction between a licence and a tenancy depends on the truth of the relationship between the parties involved, not the label which they choose to put upon it.

An occupier who does not have exclusive possession of the demised premises cannot be a tenant, and unless a trespasser, should be regarded as a licensee and the licence “path” followed on the flowchart.

The occupier who does have exclusive possession may prima facie be regarded as a tenant unless there are factors tending to demonstrate a licence, eg (a) where there has been something in the circumstances such as a family arrangement, an act of friendship or generosity or such like to negate the intention to create a tenancy, and (b) where the usual features of a tenancy (especially a fixed or periodic term) are absent.

The same considerations apply in ascertaining the occupational status of an employee occupying the premises of an employer, with one exception. Despite a fixed term and regular payment of rent an employee may be regarded as a ‘service occupier’ (a species of licensee) if either:-

a. it is essential that the employee lives in a particular dwelling to perform their duties, or

b. although not essential for the employee to live in a particular house the employee can perform their duties better by living there and it is an express term of the contract of employment that they do so.

In such circumstances the employer is regarded as retaining paramount occupation of the property.

Difficulties in distinguishing between a tenancy and a licence may particularly arise where a property is jointly occupied by two or more occupiers. Whether the occupiers together have a joint tenancy or whether they each have individual licences will depend on the particular circumstances of the case. The law on this question has been clarified by a number of cases decided since 31 March 1982. A useful review of pre 1982 cases can be found in the House of Lords decision in Street v Mountford (1984).

Cases may arise where it is not possible to determine with any certainty whether the occupier is to be regarded as tenant or licensee. Where different interpretation results in materially different valuations, DVs should submit cases for advice to CEO DVS HMRC Section. Where no significant valuation differences emerge a common-sense approach should be adopted, (eg the identification of an occupancy as being either a licence or an unprotected tenancy at will does not significantly affect the prospects for obtaining possession).

1.2 Statutory Protection

Instances where statute confers on the tenant a degree of security are as follows:-

i) Rent Act 1977

S.1 RA 1977 provides that “a tenancy under which a dwelling-house (which may be a house or part of a house) is let as a separate dwelling is a protected tenancy for the purposes of the Act”. Ss 4-16 RA 1977 provide for certain circumstances where protected tenancies will not arise; these consist of:

S.4 dwelling with Rateable Value above the relevant limit on the appropriate day, ie 23 March 1965 or the date on which it was first entered in the Valuation List, if later. The relevant limits are as follows:-

Class A

When the appropriate day is on or after 1 April 1973: RV £1,500 in Greater London, £750 elsewhere.

Class B

When the appropriate day is on or after 22 March 1973 but before 1 April 1973:

a. on that day

RV £600 in Greater London, £300 elsewhere

and b. on 1 April 1973

RV £1,500 in Greater London, £750 elsewhere

Class C

When the appropriate day is before 22 March 1973:

a. on that day

RV £400 in Greater London, £200 elsewhere

and b. on 22 March 1973

RV £600 in Greater London, £300 elsewhere

and c. on 1 April 1973

RV £1,500 in Greater London, £750 elsewhere

S.5 rent payable below 2/3 RV on ‘the appropriate day’. The appropriate day is

23 March 1965 or the date on which the hereditament first appeared in the Valuation List, if later; but if the appropriate day falls before 22 March 1973 and on that date the RV exceeded £400 in Greater London, £200 elsewhere, 22 March 1973 is substituted as the ‘appropriate day’ for the purpose of s.5. The rent payable is the whole amount paid by the tenant including rates where the tenant pays an inclusive rent. The absence of rent is not conclusive against a protected tenancy, if an adequate rent is payable but has been waived by the landlord. The rent must be expressed in money terms, even if it is paid in another form.

S.6 dwelling let together with other land (but see also s.26 RA 1977).

S.7 bona fide letting at rent which includes payment in respect of board or attendance forming a substantial part of the rent.

S.8 letting to student by specified institution.

S.9 holiday letting.

S.10 dwelling comprised in an agricultural holding and occupied by the person responsible for the control of the farming of the holding.

S.11 letting of dwellings which are on licensed premises.

S.12 letting on or after 14 August 1974 where at date of letting and at all times since (except as provided by Sch 2 para 1 RA 1977) the landlord occupied another part of the holding as his residence. See 1.3(b) below.

S.13 landlord’s interest belonging to the Crown.

S.14 landlord’s interest belonging to a Local Authority.

S.15 landlord’s interest belonging to a Housing Association etc.

S.16 landlord’s interest belonging to a Housing Co-operative.

Full protection is also excluded for tenancies falling within s.51 Housing Act 1980 (shorthold) and s.67 (lettings by servicemen), also for “assured tenancies” (s.56(5)).

1) Rent (Agricultural) Act 1976

See s.2 R(A)A 1976 for the definition of a protected occupancy. It should be noted that in certain circumstances a licence may be a protected occupancy.

2) Landlord and Tenant Act 1954

Part I applies to long tenancies of dwellings at low rents which would in other respects qualify for protection under the Rent Act. S.2 LTA 1954 specifies that ‘long tenancy’ means a term of more than 21 years and low rent means less than 2/3 x RV at the appropriate day (see 1.2.(i) above).

Part II applies to ‘business tenancies’ as defined in s.23. The business user must be significant, not incidental to residential use. Exceptions include: agricultural holdings, mining leases, on-licensed premises (other than premises where the sale of alcohol is not the major part of the business), any tenancy granted by reason of the tenant’s employment provided that, if granted after 1954, it is in writing and specifies the purpose for which it is granted. Tenancies at will are also excluded, as are most tenancies for a term certain not exceeding six months (see s.43(3) LTA 1954 as amended by s.12 Law of Property Act 1969).

3) Agricultural Holdings Act 1948 and Agricultural Holdings (Notices to Quit) Act 1977

These Acts apply to the letting of an agricultural holding, which term is defined as “the aggregate of the land (whether agricultural or not) comprised in a contract of tenancy which is a contract for an agricultural tenancy, not being a contract under which the land is let to the tenant during his continuance in any …. employment held under the landlord”. “Contract of Tenancy” is defined in s.94(1) of the AHA 1948.

S.3 AHA 1948 provides that a tenancy of an agricultural holding for a term of two years or more will not terminate on expiry of the term without due notice to quit.

S.2 AHA 1948 contains a similar provision in respect of an interest less than a tenancy from year to year (this includes a tenancy for one year exactly). Unless the letting or grant was approved by the Minister or is a mere mowing or grazing licence for part of the year, it takes effect, whether tenancy or licence, as if it were a letting from year to year and therefore termination requires a notice to quit.

It should be noted that a tenancy for a fixed term of more than one year but less than 2 years escapes protection unless it carries on without notice into a third year. For this purpose the tenancy must be treated as starting at the date of grant and not, if different, at the date from which the term is expressed to run.

The Agricultural Holdings (Notices to Quit) Act 1977 provides that notice to quit shall be effective only in certain specified circumstances (see 2.1(iv) below).

1.3 Restricted Contracts

Restricted contracts are defined in ss.19 and 20 Rent Act 1977. Broadly they include the following:-

a) any contract (provided that it does not create a protected tenancy) whereby one person grants another the right to occupy a dwelling for rent which includes a payment for use of furniture or services subject to certain exceptions defined in s.19. It should be noted that the right of occupation need not be that of a tenant; a contractual licence may be a restricted contract if it satisfies the requirements of s.19.

b) S.20 provides that any tenancy which is denied protection on account of s.12 RA 1977 (Resident Landlord) shall be treated as a restricted contract.

c) S.21 provides that any tenancy of premises where some accommodation is shared with the landlord shall be a restricted contract.

1.4 Nature of Tenancy

If it is established that a tenancy does not come within the protection of the statutes mentioned in 1.2 and is not a restricted contract it will be necessary to examine its nature before it can be established how soon the landlord may obtain possession. It will fall into one of the following categories:-

a) Lease for fixed period the period may be of any length but it must be certain.

b) Tenancy from year to year this may be expressly created but may also be inferred where a person occupies land with the owners consent and rent measured with reference to a year is paid and accepted. A yearly tenancy may therefore arise when a tenant under a lease for a fixed term holds over after expiry and continues to pay a yearly rent.

c) Tenancy from week to week (or other period less than 1 year) this may be expressly created but may also be inferred from the payment and acceptance of rent measured with reference to week, month or quarter etc.

d) Tenancy at Will this may be expressly created but may also arise where a tenant holds over with the landlord’s consent after the expiry of a previous tenancy without paying rent on a periodic basis. A tenant at will has no fixed term, but caution should be exercised in identifying a tenancy at will merely from the absence of any fixed or periodic terms; in recent years the Courts have tended to regard such arrangements as licences.

e) Tenancy at sufferance this cannot be expressly created and arises only where a tenant having entered under a valid tenancy holds over without the landlord’s assent or dissent.

1.5 Nature of Licence

Licences may be classified as bare (normally gratuitous) or contractual. The distinction depends upon whether or not they are supported by contract; a contract may be accepted to exist where supported by written evidence, but even where the original contract was merely oral it will be sufficiently evidenced by the payment and acceptance of a licence fee.

1.6 Statutory Protection for Certain Contractual Licences

Two types of contractual licence are afforded a degree of statutory protection:

i) A licence for exclusive occupation of a dwelling or part of a dwelling where the licence fee includes payment for use of furniture or services may be a “restricted contract” as defined in s.19 Rent Act 1977.

ii) A contractual licence of any duration to occupy an agricultural holding may be converted into an agricultural tenancy (see s.2 Agricultural Holdings Act 1948). Any licence however which may be regarded as an agreement for mowing or grazing only, during any specified period less than 1 year is excluded. Specific ministerial consent will also exclude a licence.

2. Security of Tenure and Recovery of Possession

2.1 Protected Tenancies

1) Rent Act 1977

S.18 RA 1977 provides that the Court has an overriding discretion in that it must be satisfied that it is reasonable to make an order for possession on the grounds either that suitable alternative accommodation is available to the tenant or that one of the first 10 cases specified in Part I of Sch 15 applies. Note especially that Case 8 applies to service tenancies, which in all other respects enjoy full protection.

It further provides that the Court must grant possession in any one of the Cases 11-18 also specified in that Schedule, as amended by s.66 Housing Act 1980.

S.55 Housing Act 1980 provides a further mandatory Case, 19, applicable only to shorthold tenancies. Ss. 56, 57, 58 Housing Act 1980 exclude assured tenancies from full protection and confer on them the security of tenure provisions of the Landlord and Tenant Act 1954 Part II subject to modifications. S.67 Housing Act 1980 provides a further mandatory Case 20, permitting certain servicemen landlords to recover possession.

Otherwise the tenancy will end only with the death of the tenant; even so, certain persons may ‘succeed’ to the protected tenancy. These consist of:-

a) surviving spouses (prior to 28 November 1980 only surviving wives), if residing in the dwelling immediately before death (ignoring temporary absence).

b) if there is no surviving spouse (prior to 28 November 1980 surviving wife) residing in the dwelling, a person who was a member of the original tenant’s family and who was residing with him or her at the time of and for 6 months prior to death. On death prior to 28 November 1980, surviving husbands can only claim under this provision.

A person who becomes a statutory tenant by succession on the death of the original tenant is known as the first successor. On the death of his first successor while still a statutory tenant, a further survivor may generally become a second successor (there are three instances were a second succession is excluded - see paras 9 and 11(1) a Sch 1 RA 1977). There can be no further transmission on the death of the second successor.

2) Rent (Agricultural) Act 1976

S.6 provides that an order for possession will only be given in Cases 1-4 in Sch 4.

3) Landlord and Tenant Act 1954

Part I provides that in order to regain possession at the end of a long lease of a dwelling at a low rent the landlord must serve notice to quit and apply for an order for possession. An order may be obtained on the following grounds:-

  • that possession is required in order that redevelopment may be carried out (where the landlord is a public body) and
  • other grounds set out in Sch 3 LTA 1954.

If the tenancy is not terminated in this way it will, unless the tenant surrenders or serves notice to quit, continue on the same terms after the expiry date until converted into a statutory tenancy on the landlord’s application.

Part II provides that in order to regain possession the landlord must serve a notice to quit, whether the tenancy is for a fixed term or is periodic. The tenant may then notify the landlord that he is not willing to give up possession and proceed to apply to the Court for a new tenancy. The landlord can only resist the application on the seven grounds provided in s.30 LTA 1954.

4) Agricultural Holdings Act 1948, Agricultural (Miscellaneous Provisions) Act 1976 and Agricultural Holdings (Notice to Quit) Act 1977

The AHA 1948 provides (see 1.2(iv) above) that notice to quit is required to terminate any letting for a term of two years or more, or one year or less (including certain licences).

The AH(NTQ)A 1977 applies to notices to quit served in the above context, and also, as required by Common Law, where the landlord wishes to terminate a periodic tenancy. It provides that the notice will, if contested, be effective only if one of the eight cases specified in s.2(3) AH(NTQ)A 1977 applies.

If a counter notice is not served, possession can be recovered from the tenant, and normally from any sub tenants also.

From 15 November 1976 a limited number of close relatives who can satisfy the Agricultural Land Tribunal as to their having been deriving their principal source of livelihood from agriculture, without being the occupier of any commercial unit of agricultural land, and as to their suitability, may be granted a new tenancy in succession to that of the deceased. There are a number of circumstances where succession is prevented (see s.18(4) 1976 Act).

2.2 Unprotected Tenancies

a) A lease for a fixed period this automatically determines when that period expires. No notice to quit is required.

b) A tenancy from year to year is determined by notice. The period of notice may be agreed by the parties but in the absence of agreement it will be half a year expiring at the end of a completed year of the tenancy.

c) A tenancy from week to week, month to month, quarter to quarter etc. may be determined on the same basis as a yearly tenancy except the period of notice (unless otherwise agreed) shall be the appropriate period expiring at the end of the relevant week, month or quarter by reference to which rent is paid. However s.5 Protection from Eviction Act 1977 requires in the case of a dwelling that the period of notice shall not in any case, be less than 4 weeks.

d) A tenancy at will may be determined by a demand for possession at any time. It automatically determines on the death of either party or on the alienation of the landlord’s interest; thus a tenancy at will does not bind the landlord’s successors in title.

e) A tenancy on sufferance may be determined at any time.

2.3 Restricted Contracts

Where the contract is for a fixed term no notice to quit is required and the licence or tenancy will come to an end at the end of the fixed term. It may be necessary to obtain a Court Order to recover possession (see 3.4) and if the contract was originally made on or after 29 November 1980 s.69(2) HA 1980 provides that the Court may stay or suspend execution of the Order or postpone the date of possession for a period not exceeding 3 months. Where the contract features a periodic term, notice to quit (see 2.2(b) ad 2.2(c) above) is required but the effect of such a notice may depend on when the contract was originally granted:-

a) If the contract was granted prior to 29 November 1980 the tenant or licensee may apply to the Rent Tribunal to extend the notice for a period of up to 6 months. Repeated applications obtaining up to 6 months security at a time at the Tribunal’s discretion may be made (ss.103-6 RA 1977). It may also be necessary to obtain a Court Order to recover possession (see 3.4) if the tenant has not quitted on expiry of the notice.

b) If the contract was granted on or after 29 November 1980, the notice to quit will take effect on the day appointed, but it may be necessary to obtain a Court Order (see 3.4) to recover possession. If so s.69(2) HA 1980 empowers the Court to stay or suspend execution of the Order so as to postpone the date of possession for a period not exceeding 3 months.

Before 29 November 1980 it was much easier to recover possession at the end of a fixed term than during a periodic term. However, if a resident landlord sought to take advantage of this by granting a succession of tenancies with fixed terms in place of a periodic term s.12(3) RA 1977 brings the resulting tenancy within full protection (see 2.1.1 above).

2.4 Licences

Licences are mere personal privileges. They do not in themselves confer any interest in the land. The privilege will therefore not usually survive alienation of the owner’s interest or death of either of the parties. Licences cannot be assigned (except in the rare instance of licences coupled with a proprietary interest in land or chattels - such licences are irrevocable.

(1) Bare licences Licences which are bare or gratuitous cannot usually be enforced against the landlord since there is normally no act of part performance to which the licensee can refer in order to render a contract enforceable. The landlord may therefore determine the licence at any time, with reasonable notice.

(2) Contractual Licences Contractual licences are always enforceable against the licenser in accordance with the terms of the contract. But as with all licences the licensor’s successors in title are not normally bound by the contract. Contractual licences may be revoked in accordance with the terms of the contract and may also be evaded by alienation of the licensor’s interest. If the parties insist that the licensor’s successors in title are bound, the DV should make a report setting out their contentions and the surrounding circumstances to CEO DVS HMRC Section.

2.5 Proprietary Estoppel

Proprietary estoppel can in certain circumstances convert licences whether bare or contractual into equitable interests and so render them enforceable against both licensors themselves and their successors in title. The estoppel arises where a licensor allows the licensee to expend a significant sum on the property other than on normal items of annual repair, in circumstances which raise a reasonable expectation that the licence will not be revoked. The Courts have in various circumstances awarded licensees a lien on the land to the extent of their outlay, a licence for life, or even the fee simple itself. If the parties allege such an estoppel exists the DV should make a report setting out their contentions and the surrounding circumstances to CEO DVS HMRC Section.

3. Valuation Effects of Subordinate Interests and Rights of Occupation 3.1 Tenancies Protected by Statute

Regard should be had to the prospects of obtaining possession by means of demonstrating to a Court that one or more of the cases for possession is satisfied. It should be remembered when valuing the landlord’s interest that whereas the tenant must be the actual tenant, the landlord is a hypothetical vendor who does not necessarily possess the characteristics of the actual landlord. Broadly the vendor would be expected to act prudently and (eg) take advantage of reasonable opportunity to advertise to purchasers the possibility of obtaining possession.

3.2 Other Occupations: Need for Notice to Quit

In order to determine periodic unprotected tenancies and restricted contracts, notice to quit must first be served. It cannot be supposed that notice has been given, at the valuation date, if in fact it had not. It should therefore be supposed that notice would be given as soon as possible by the hypothetical purchaser.

Since licences do not normally bind third parties, the hypothetical purchaser will not normally have to serve notice on the licensee.

3.3 Need for Court Order for Possession

The combined effect of the Protection from Eviction Act 1977 and Criminal Law Act 1977 is that a landlord cannot even after serving notice to quit, eject an occupier of residential accommodation (whether tenant or licensee) without in most cases, obtaining a Court Order.

Valuation of properties subject to unprotected occupations will therefore normally be based on a vacant possession value abated to reflect the need for service of notice to quit and/or the need for a Court Order to recover possession.

A pragmatic approach should be adopted and where it is reasonable to suppose that vacant possession will be readily available, for example, where the occupiers are members of the taxpayer’s household, the vacant possession value should normally be adopted, without abatement.