Spc 00509
CAPITAL GAINS TAX – Allowable losses – Disposal of units in enterprise zone property unit trust – Capital allowances made to Appellant – Whether Appellant's allowable expenditure to be restricted by capital allowances – No – TCGA 1992 s.41(2) – Appeal allowed
THE SPECIAL COMMISSIONERS
CHARLES ST C SMALLWOOD Appellant
THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents
Special Commissioner: STEPHEN OLIVER QC
Sitting in public in London on 18 October 2005
John Watson, solicitor, Ashurst, for the Appellant
Launcelot Henderson QC, instructed by the acting solicitor and general counsel for HM Revenue and Customs, for the Respondents
© CROWN COPYRIGHT 2005
DECISION
- This appeal by Mr C St C Smallwood is against the Inspector's amendment by the Inspector ("the Revenue") of claims for capital losses arising in the years 1998/99, 1999/2000.
- The issue in the appeal is whether section 41(2) Taxation of Capital Gains Act 1992 (TGCA) operates to restrict allowable losses that would otherwise have accrued in respect of Mr Smallwood's units in an enterprise zone unit trust ("EZPUT") when he disposed of the units. The critical question is whether part of the sum subscribed by Mr Smallwood for the units is expenditure in respect of which a capital allowance has been made. If so, section 41(2) applies and Mr Smallwood's CGT acquisition costs of the units is abated by that part of the subscription monies.
- Shortly stated, the circumstances leading to Mr Smallwood's claim are these. In March 1989 Mr Smallwood invested £10,000 in an EZPUT known as PET8 in the Isle of Dogs Enterprise Zone. The Trustee of PET8 spent the monies subscribed by Mr Smallwood and by other subscribers on land and buildings. To the extent that those monies were spent on buildings, as distinct from the sites of those buildings, 100% first year capital allowances were obtained. The effect of the Income Tax (Definition of Unit Trusts Schemes) Regulations 1998 (SI 1998 No.267) ("the 1988 Regulations") was that Mr Smallwood, as unitholder, obtained his share of those capital allowances. Mr Smallwood's share amounted to £9,678. He claimed these allowances and they were set off against his general income for 1988/89.
- Nearly ten years later the property in PET8 was realized and in the tax years 1998/99 and 1999/2000 Mr Smallwood received distributions of £5,000 and £125 in respect of his units. Those distributions fell to be treated for capital gains tax as part disposals by Mr Smallwood of his units. But for section 41(2) those part disposals would have given rise to allowable losses in Mr Smallwood's hand.
- Section 41 TCGA makes provision for the amount of any losses accruing on the disposal of an asset to be restricted by reference to capital allowances. Subsection (2) provides:
"In the computation of the amount of a loss accruing to the person making the disposal, there shall be excluded from the sums allowable as a deduction any expenditure to the extent to which any capital allowances or renewals allowance has been or may be made in respect of it."
- Mr Smallwood contends that section 41(2) does not operate to restrict the losses accruing to him since the expenditure he incurred in subscribing for his units in PET8 did not give rise to capital allowances. The expenditure which gave rise to the capital allowances was his share of the expenditure by the trustee of PET8. The Revenue contend that section 41(2) operates to restrict and eliminate the losses that would otherwise accrue to Mr Smallwood, because to the extent of £9,678 the expenditure which he incurred in subscribing for his units in PET8 was expenditure "in respect of" which capital allowances were made within the meaning of the subsection.
The statutory framework : the capital allowances provisions
- By way of background Finance Act 1980 introduced 100% initial allowances for persons who incur capital expenditure in constructing or acquiring commercial buildings or structures in enterprise zones. See also section 1(1) of the Capital Allowances Act 1990 which gives initial allowances for qualifying buildings in enterprise zones – "… to the person who incurred the expenditure …". Individuals who wish to invest in these commonly did so by subscribing their monies to an authorized unit trust (an EZPUT) where they could be pooled with monies subscribed by other investors. The trustee of the EZPUT would then incur expenditure on the building in question. Under the trust deed, each unitholder would be beneficially entitled to an undivided share of the trust assets and could therefore claim capital allowances for a corresponding share of the trustee's expenditure on the basis that:
(a) he had himself incurred that share of the expenditure and
(b) he was beneficially entitled to his share of the property interest acquired by the trust.
Accordingly, prior to Finance Act 1987, unitholders were taxed on their share of the trust income and obtained capital allowances on their share of the trust's qualifying expenditure.
- Section 39 of Finance Act 1987 introduced a new income tax regime for unauthorized unit trusts and their unitholders. The effect of that provision, now contained in section 469 of the Income and Corporation Taxes Act 1988 (ICTA) in relation to EZPUTs was to prevent the 100% capital allowances from flowing through to the unit holders. The previous position was then restored by the 1988 Regulations which provide that "enterprise zone property schemes" are to be treated as not being unit trusts schemes for the purposes of section 469 ICTA. An "enterprise zone property scheme" is simply an EZPUT which satisfies the detailed conditions laid down in the Regulations. One such condition is contained in paragraph 4(2)(d) which requires that:
"The terms of the scheme secure that –
(i) the contributions of the participants are all to be made within the same tax year and no contribution to be made by participants in any subsequent tax year;
(ii) the capital expenditure referred to [on the enterprise zone property] is to be incurred wholly in the tax year in which the participants make their contributions …"
The statutory framework : the CGT provisions generally
- For CGT purposes, the basic rule governing unit trusts is set out in what is now section 99 of TCGA. This provides as follows:
(1) This Act shall apply in relation to any unit trust scheme as if –
(a) the scheme were a company,
(b) the rights of the unitholders were shares in the company,
(c) in the case of an authorized unit trust, the company were resident and ordinarily resident in the United Kingdom,
except that nothing in this section shall be taken to bring a unit trust scheme within the charge to corporation tax on chargeable gains".
The effect of section 99 is that the trustee pays CGT on any gain realized by the unit trust in respect of the trust property and the unitholders pay CGT on any gains realized by them on their units. Save that the trustee of the unit trust pays CGT rather than corporation tax, the position is analogous to that of a UK company and its shareholders. The Capital Gains Tax (Definition of Unit Trusts Scheme) Regulations 1988 (SI 1988 No.266) excluded certain schemes from the deeming provisions of section 99 but left enterprise zone property schemes within section 99.
- It follows from the statutory provisions summarized above that initial allowances for capital expenditure are given to the unit holders in an EZPUT, and not to the trustee; but that for CGT purposes an EZPUT is treated as if it were a company and the unit holders were shareholders in it.
The statutory framework : the computation of gains provisions
- Section 38(1) of TCGA deals with acquisition and disposal costs for CGT purposes. So far as is material it provides:
"(1) Except as otherwise provided, the sums allowable as a deduction from the consideration in the computation of the gain accruing to a person on the disposal of an asset shall be restricted to –
(a) the amount or value of the consideration, in money or money's worth, given by him or on his behalf wholly and exclusively for the acquisition of the asset, …"
In the present case the consideration given by Mr Smallwood for the acquisition of the asset, i.e. the units, was £10,000. However section 39(1) provides that:
"There shall be excluded from the sums allowable under section 38 as a deduction in the computation of the gain any expenditure allowable as a deduction in computing the profits or gains of a trade … for the purposes of income tax or allowable as a deduction in computing any other income or profits or gains or losses for the purposes of the Income Tax Acts …".
(Since £9,678 was allowable as a deduction in computing Mr Smallwood's general income in 1988/89, the effect of section 39(1), if it stood alone, would be to exclude that amount from the £10,000 that would otherwise be allowable as a deduction under section 38.)
- However, section 39 is in turn modified by section 41, the relevant provisions of which are for the present purposes as follows:
"(1) Section 39 shall not require the exclusion from the sums allowable as a deduction in the computation of the gain of any expenditure as being expenditure in respect of which a capital allowance … is made, but the amount of any losses accruing on the disposal of an asset shall be restricted by reference to capital allowances … as follows.
(2) In the computation of the amount of a loss accruing to the person making the disposal, there shall be excluded from the sums allowable as a deduction any expenditure to the extent to which any capital allowance … has been or may be made in respect of it.
…
(4) In this section "capital allowance" means –
(a) any allowance under the 1990 Act …
…
(6) The amount of capital allowances to be taken into account under this section in relation to a disposal include any allowances falling to be made by reference to the event which is the disposal, and there should be deducted from the amount of the allowances the amount of any balancing charge to which effect has been or is to be given by reference to the event which is the disposal, or any earlier event."
- By way of preliminary comment on the computation provisions set out above, it will be seen that the general rule stated in the opening part of section 41(1) reverses the operation of section 39 where, in computing a gain, expenditure in respect of which a capital allowance is made forms part of an allowable deduction. There is then a derogation from this general rule whether computation would result in a loss instead of a gain. The derogation is set out in section 41(2) the words of which are crucial to the construction of the present appeal.
- The reason for the general rule, it appears, is that in cases where the calculation results in a gain, the taxpayer is likely to have incurred a balancing charge equal to the capital allowances originally given. It would therefore be unfair to "disallow" the capital allowances a second time in the computation. Where, however, the taxpayer does not incur a balancing charge, or the balancing charge amounts to less than the original capital allowance, there is no unfairness to the taxpayer in excluding the capital allowance (or the excess of the capital allowance over the balancing charge) from the CGT computation. Indeed, if it were not excluded the taxpayer would effectively get the benefit of the capital allowance twice over, once when the asset was acquired and again when it is disposed of. The statutory provisions, rationalized in that way, work logically and effectively where the capital allowance is obtained on an amount equal to the acquisition cost of the asset or on expenditure incurred on the asset (e.g. where air conditioning is installed and becomes part of the asset). The problem in the present case is whether section 41(2) has that effect in a regime governed by section 99(1) of TCGA which makes a unit an asset in its own right.
The facts
- I understand that the outcome of this appeal may affect other taxpayers who have disposed of units in PET8 and other EZPUTs. The full facts are not, as I see it, strictly necessary for this decision. But in case they should become relevant, I have set them out in the Appendix to this decision.
Contentions of the parties
- The Revenue, represented by Mr Henderson QC, base their argument for the application of section 41(2) on the terms of the trust deed and the effect of regulation 3(a) of the 1988 Regulations. Under the trust deed Mr Smallwood, in common with the other unit holders, is beneficially entitled to an undivided share in the underlying assets; the result, for capital allowance purposes is that the trustees' expenditure is, to the extent of his share, Mr Smallwood's and Mr Smallwood is regarded as beneficially entitled to his share in the property interest acquired by the trustees. Regulation 3(a) gives the capital allowances to the unit holders. Hence capital allowances of £9,678 were duly claimed by Mr Smallwood and set off against his general income for 1988/89. The Revenue's argument recognizes that section 41(2), applied in the light of section 99(1), requires PET8 to be treated for CGT purposes as if it were a company and the rights of the unit holders were shares in that company. But, the Revenue say, those statutory features do not displace the requirement for the simple factual enquiry in section 41(2). That simple factual enquiry reveals that it was Mr Smallwood's expenditure that generated his share of capital allowances.
- Mr Watson representing Mr Smallwood contends that the Revenue's position directly contravenes the deeming provisions of section 99(1) which, by treating a unit trust such as PET8 as a company, requires expenditure on units to be regarded as distinct from expenditure by the trustees. In any event, Mr Smallwood's case runs, capital allowances are not computed by reference to subscription monies; Mr Smallwood's entitlement depends on the proportion of the trustees' expenditure that relates to the building, as opposed to the site. In that connection paragraph 4(2)(d) of the 1988 Regulations (referred to in paragraph 8 above), which requires that contribution and expenditure occur in the same tax year, envisages that subscription for units may be made at a time when the trustees have not decided which or precisely which properties to buy. The capital allowances resulting from the trustees' expenditure cannot therefore be said to be expenditure in respect of the unit holder's expenditure. Moreover, Mr Smallwood's case runs, if it be right that the expenditure of unit holders in an EZPUT is excluded by section 41(2) because capital allowances are obtained in respect of it, does that not also apply to subscription monies of shareholders which are spent by the company on qualifying building or plant?
Conclusions
- This appeal is concerned with Mr Smallwood's claim for capital losses arising from his disposal of units in PET8. For all purposes of CGT the units are to be treated as shares in PET8 which in turn is treated as if it were a company: section 99(1). The question is whether, to use the words of section 41(2), it is correct to exclude "from the sums allowable as a deduction", in computing Mr Smallwood's gain on the disposal of the units, "any expenditure to the extent that any capital allowance … has been made in respect of it" where that expenditure is the £9,678 incurred on the qualifying buildings.
- The expression "the sums allowable as a deduction" in section 41(2) is drawn from the opening words of section 38(1). Section 38(1) restricts the sums allowable as a deduction "from the consideration", i.e. from the consideration for the disposal of the asset, the consideration wholly and exclusively given for the acquisition of the asset. Those computation provisions, found in Part II of TGCA, are asset specific. The provisions direct the manner of computation of gains and losses accruing on each disposal of each asset of the particular taxpayer. Here, by reason of section 99(1) of CGTA, the asset is Mr Smallwood's holding of units in PET8.
- The expenditure to be excluded, by section 41(2), from the sum allowable as a deduction is, as I read the subsection in its context, expenditure that would otherwise be allowable expenditure under section 38(1) being, for example, expenditure forming part of the consideration given wholly and exclusively for the acquisition of the asset. The expenditure given by Mr Smallwood wholly and exclusively for the acquisition of the relevant asset, his holding of units, was the £10,000 of subscription monies.
- Read in isolation, it would be at least possible to interpret section 41(2) as contemplating expenditure on some other asset, such as the subsequent disbursement of part of the subscription monies on the building in the Isle of Dogs enterprise zone. That is the Revenue's reading. It has a real world ring about it because, by operation of the capital allowances rules, Mr Smallwood as unitholder can be regarded as having provided his share of the cost of the building and, by operation of the 1988 Regulations, he qualified for capital allowances on an amount equal to his share of the subscription monies; what is more, the disbursement of that part of Mr Smallwood's share of the subscription monies is in reality reflected in the value of the assets he disposed of, i.e. his units. That approach does not, in my view, accord with the approach required by the CGRT computation rules (as explained above) read in the light of the CGT deeming provisions in section 99(1). The Revenue's approach focuses on the wrong expenditure on the wrong asset.
- To give the expression "any expenditure" in section 41(2) a wider meaning such as attributing it to the EZPUT trustees' disbursement of part of the subscription monies on the qualifying building requires one to confront the problem raised by Mr Watson for Smallwood. What is the position if the expenditure is a share in a genuine company which uses the money to buy a qualifying building? That company obtains the capital allowance: why, if the expression "any expenditure" is widely interpreted, should section 41(2) not apply to abate any loss on the shares in that company? It seems to me that, once the step has been taken of treating the unit trust as a company and the rights of the unitholders as shares in that company, then for CGT purposes –but not necessarily for capital allowances purposes – the computation of gains on disposals of units must be treated in the same way as the computation of gains on disposals of shares.
- In summary therefore I construe the expression "any expenditure" in the expression "any expenditure to the extent to which any capital allowance … has been or may be made in respect of it" in section 41(2) as referring to expenditure comprised in the consideration given wholly and exclusively for the acquisition of the relevant asset, i.e. the £10,000 given by Mr Smallwood for his units. Capital allowances were not given in respect of that expenditure. Thus section 41(2) does not apply.
- For those reasons I prefer the interpretation advanced on Mr Smallwood's behalf. I therefore allow the appeal.
STEPHEN OLIVER QC
SPECIAL COMMISSIONER
RELEASED: 3 NOVEMBER 2005
Case cited in argument : Burdett-Coutts v IRC [1960] 1 WLR 1027
SC 3102/05
