Playing the system: Loopholes used to avoid tax

Jane Merrick and Brian Brady report on the ways politicians have maximised their allowances for houses

Dozens of MPs, including at least two cabinet ministers, have benefited from loopholes in the tax system to save themselves tens of thousands of pounds, it emerged yesterday. MPs have routinely classed their second homes as main residences to avoid paying capital gains tax (CGT) when they are sold.

The disclosure added yet another dimension to the growing scandal of the use of second-home allowances by MPs, including splashing vast sums of taxpayers' money on soft furnishings, security arrangements and trivial items of food.

Tax experts revealed yesterday that it is perfectly within the law for MPs to designate a property as a second home for the purposes of claiming up to £24,000 a year in expenses, while at the same time telling HM Revenue and Customs it is a main residence to avoid paying capital gains tax.

Any member of the public can make the same arrangement, and accountants frequently exploit this for their clients. However, the difference is that taxpayers are funding the cost of MPs' second homes.

Until last year, CGT of up to 40 per cent was payable on the profits from the sale of second homes, unless the vendor sells it within three years of moving out. Last year, a new flat rate of 18 per cent was introduced by the Chancellor, Alistair Darling. Hazel Blears is one cabinet minister who has benefited from the loophole. The Secretary of State for Communities claimed for three different properties in a single year, spending almost £5,000 of taxpayers' money on furniture in three months. In August 2004, she sold her flat in Kennington, London, when it was her second home, for £200,000 – a profit of £45,000. But it was confirmed yesterday that she did not pay CGT on the sale.

A spokesman for Ms Blears said yesterday: "Hazel complied with the rules of the House authorities and Inland Revenue. No liability for CGT arose on the sale of her Kennington flat."

James Purnell, the Work and Pensions Secretary, designated his London flat as his second home, claiming expenses of £20,000 a year, but when he sold it in October 2004, he told the Revenue it was his main home, and therefore he was not liable to pay up to 40 per cent CGT. An aide to Mr Purnell said he had sold his London flat within three years, the threshold at which CGT is payable. He added: "James has correctly followed both House of Commons and HM Revenue and Customs rules. He has not broken any rules and it is wrong to suggest otherwise."

Mike Warburton, a tax expert at Grant Thornton, confirmed that the loophole was within the law. He said: "I frequently use that in the tax planning for my clients."

One MP who did not exploit the loophole was Caroline Flint, who paid CGT on the sale of a London house even though it was classed as her main residence. "She paid CGT because she thought it was right that she should," her spokeswoman said.

The Labour MP John Mann has claimed that more than 100 of his fellow MPs from all parties have profited from the capital gains tax dodge. Mr Mann pointed out that he won a vote in Parliament ending the ability of MPs to switch the location of their second home to benefit from CGT exemption. But the new stipulation has been omitted from the new Green Book of parliamentary rules. He said: "It is absurd that MPs should get preferential treatment in this way."

There were also calls for a change in the culture of MPs which allowed them to stretch the rules as far as possible. Despite the Green Book making clear that second-home allowances must not be used to pay for luxurious items, many of the expenses that have emerged in the past few days breach the spirit of this. MPs privately claimed that the Fees Office turned a "blind eye" to exorbitant expenses claims because it was part of the culture. Newly elected MPs even have a "freshers' week" in which they are told how to play the system, said one insider.

A selection of letters to Fees Office staff, which had been marked for deletion, reveals the extraordinary methods MPs – citing destitution, "natural justice", and slum living conditions – have used successfully to urge the Fees Office to give them what they want. A fellow Labour MP took a dramatic position when he had trouble getting the Commons to pay for his £3,100 40in Sony TV in 2006. He said: "From a natural justice perspective I feel a justifiable exception would be the fairest manner to deal with the current situation."

The high-minded approach was used in several letters designed to browbeat officials. "I object to your decision not to reimburse me for the costs of purchasing a baby's cot for use in my London home," one Labour MP said in November 2004. "Perhaps you might write to me explaining where my son should sleep next time he visits me in London?" Another Labour MP wrote: "I appreciate you are under severe pressure ... but, as I explained on the phone, I am away for two weeks and I don't want to leave my family destitute."

If the pompous approach failed, many MPs relied on the pity of officials. One Tory MP justified spending over £5,000 on a new kitchen by explaining: "The work surfaces are no longer hygienic and the sink unit, which is an old brown plastic double bowl, is scratched and very ugly."

The tactic often worked. A note made by an official after a conversation with a Labour MP claiming £12,400 for work on his flat said: "Old flat. Facilities out of date. Decrepit. Health reasons. Update. Living in slum. On advice, called in contractor. Recommended kitchen and bathroom replacement."

Four to watch

Hazel Blears Communities Secretary

What they did: Sold London flat when it was a second home for £200,000, making profit of £45,000. Did she declare it as main home for tax purposes, and so avoid capital gains tax (CGT)?

What they said: A spokesman for Ms Blears said yesterday: "Hazel has complied with the rules of the House authorities and the Inland Revenue. No liability for capital gains tax arose on the sale of her flat in Kennington."

Lord Mandelson Business Secretary

What they did: Sold Hartlepool home for £205,000 in 2005, making a profit of £136,000. Did he designate this as main home at point of sale, and so avoid paying CGT?

What they said: A spokesman said that Lord Mandelson was unavailable for comment yesterday.

James Purnell Work and Pensions Secretary

What they did: Designated London flat as second home, but when he sold it in 2004, he told the Inland Revenue it was his main home.

What they said: An aide said Mr Purnell had sold the flat within the threshold at which CGT is payable. He said: "James has correctly followed both House of Commons and HM Revenue and Customs rules. He has not broken any rules and it is wrong to suggest otherwise."

Caroline Flint Europe minister

What they did: Sold her "main home" in London in 2005, and declared Sprotbrough in Yorkshire her main residence. Used parliamentary allowances for solicitors' fees when she bought a new flat. Did not exploit the CGT loophole.

What they said: "At each stage I sought advice from the House of Commons and never sought to make personal gains from public funds. I sold the London home and I paid CGT."

Top 10 scams: How to make a bundle on that other property

1. Switch second homes: buy a home in London, call it your second and claim for repairs and furnishing. Then, redesignate your family house as the second home and start claiming all over again.

2. Push costs on to the taxpayer: a second home should be the one used least, but by making your cheap pied-a-terre in London the main address you can claim liberally for the family house back in the constituency.

3. Play the market: get the taxpayer to help with mortgage charges and improvements on your second home, then sell at a profit and buy somewhere better.

4. Overcharge for repairs: after all, who's checking?

5. Tax dodge: if a second home is reclassified as a main address before it is sold, you can avoid paying capital gains.

6. Take in a lodger: this helps pay the mortgage but you won't lose out on contributions from Parliament.

7. Council tax: you can claim a 50 per cent discount on a second home, and Commons authorities probably won't know, if you don't tell them.

8. Feather both nests: claim for expenses on your second home but have the new items turn up at the first.

9. Eat for Britain: claim the full £400 for food every month at your second home – even during the holidays.

10. Claim to the max: the golden rule means many MPs cram expensive purchases into the end of the financial year to make sure they get right up to the limit of what they can claim.

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