England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL
(TAX AND CHANCERY CHAMBER)
THE HON MR JUSTICE DAVID RICHARDS
[2013] UKUT 165 (TCC)

		Royal Courts of Justice Strand, London, WC2A 2LL
		10/05/2016

Lord Justice Floyd:

1. This is an appeal from a decision of the Upper Tribunal, Tax and Chancery Chamber (constituted by Mr Justice David Richards, as he then was) released on 9 April 2014. It raises issues as to the interaction between two forms of relief against capital gains tax, namely Enterprise Investment Scheme ("EIS") relief and taper relief, in a case in which the asset disposed of has been used for both business and non-business purposes ("a mixed use asset"). The taxpayer claims that, in the case of a mixed use asset, he can direct his claim to EIS relief to that part of the gain which is referable to its non-business use, leaving the part of the gain which is referable to its business use to take greater advantage of the more generous taper relief applicable to disposals of business, as opposed to non-business, assets.
2. HMRC decided that Mr Stolkin was not entitled to apply his EIS relief in this way. Mr Stolkin therefore appealed to the First-tier Tribunal (Judge Nowlan and Sheila Cheesman) ("the F-tT"). In a decision released on 24 November 2011, the F-tT allowed his appeal. HMRC appealed to the Upper Tribunal, which allowed HMRC's appeal. Permission to appeal to this court was granted by Kitchin LJ, on the papers, on 15 May 2015.

The facts

3. I can take the facts from the judgment of the Upper Tribunal:

"The tax return of the taxpayer respondent, Mark Stolkin, for 2005/06 included chargeable gains in respect of several properties. Some of the properties had been used wholly for business or wholly for non-business purposes but two of the properties were mixed-use properties. The two mixed-use properties were Flat 3, Observatory Gardens, London W8, of which the taxpayer owned 50%, and Lanterns Court, Millharbour, London. The un-tapered gain resulting from these disposals was £11,374,910. The taxpayer made a claim for EIS relief in the sum of £3,499,999, and it is agreed that the claim was valid and the relief was due. In his tax return, the taxpayer divided the gain arising on the disposal of the two mixed-use properties between business and non-business use in accordance with the statutory provisions dealings with taper relief. He sought to apply EIS relief against the full amounts of the non-business gains on the two properties, so eliminating those gains as chargeable gains in that year of assessment, and applying taper relief to the business gains, so far as not relieved by the balance of the EIS relief."

4. Appended to the statement of agreed facts which was before the F-tT was a comparative calculation of the tax payable on the taxpayer's approach and HMRC's approach respectively. The taxpayer's approach first applied the EIS relief to notional business and non-business elements of the gain on the two mixed use assets, ensuring in each case that the non-business element of the gain was wholly eliminated by the EIS relief. Although EIS relief was also claimed against the business element of the gain, it eliminated only 50% of the gain in respect of Observatory Gardens and about 4% of the gain in respect of Lanterns Court. The remainder of the gains on the business elements of these two properties were thus available for taper relief at the more favourable rate for business use.
5. By contrast, HMRC's approach first applied the EIS relief (in the total amount claimed by the taxpayer for that asset) to the gains on the mixed use assets, without any prior sub-division into business and non-business use. The balance of the gain was then, and only then, separated into business and non-business elements in the proportions claimed by the taxpayer. This meant that not all of the balance of the gain was able to benefit from the rate of taper relief for business use.
6. The difference in the two approaches was substantial: some £481,000.
7. Before turning to the decisions of the F-tT and the Upper Tribunal, I must set out the legislative framework.

Capital gains tax

8. Capital gains tax is governed by the Taxation of Capital Gains Act 1992 ("the TCGA"). It is charged on "chargeable gains computed in accordance with this Act and accruing to a person on the disposal of assets": see section 1 (1). Section 2 (1) provides that a person is chargeable to capital gains tax "in respect of chargeable gains accruing to him in a year of assessment", whilst section 2 (2) provides that the tax is charged "on the total amount of chargeable gains accruing to the person chargeable in the year of assessment" after deducting allowable losses.

EIS relief

9. EIS relief was introduced by the Finance Act 1995, and the detailed provisions are to be found in Schedule 5B of the TCGA. It is not an absolute relief. It operates to defer chargeable gains accrued in one year to a subsequent year of assessment. A person qualifies for EIS relief if investment is made within a qualifying period in shares meeting the conditions of the Enterprise Investment Scheme. Accordingly, for a person who makes a valid claim to EIS relief which extinguishes what would otherwise be a chargeable gain in the year of assessment, there is no charge to capital gains tax in that year. Similarly, where the EIS relief goes to only part of the gain, the chargeable gain which accrues to him in the year of assessment is limited to the balance of the gain. The part of the gain which is relieved by the EIS relief is deferred and does not fall within the provisions of sections 1 and 2 of the TCGA.
10. EIS relief may be claimed in respect of the gain arising on the disposal of any type of asset. Further, and in contrast with the situation for taper relief, in EIS relief there is no distinction between assets held for business or non-business purposes. When a taxpayer makes a claim to EIS relief he is able to choose the particular gains arising on the disposal of particular assets against which he wishes to claim the relief. It therefore made sense for a taxpayer who had both business and non-business assets to claim EIS relief against non-business assets. In this way he would be able to maximise the taper relief which he could claim on the business assets.
11. Paragraph 1 of Schedule 5B to the TCGA explains that:

"(1) This Schedule applies where-

(a) there would (apart from paragraph 2(2)(a) below) be a chargeable gain ("the original gain") accruing to an individual ("the investor") at any time ("the accrual time") on or after 29th November 1994;

(b) the gain is one accruing either on the disposal by the investor of any asset or …;

(c) the investor makes a qualifying investment; and

(d) the investor is resident or ordinarily resident in the United Kingdom at the accrual time and the time when he makes the qualifying investment and is not, in relation to the qualifying investment, a person to whom sub-paragraph four below applies."

12. The conditions for making a "qualifying investment" are set out in sub- paragraph (2) of paragraph 1 of Schedule 5B. Paragraph 2 of Schedule 5B provides:

"(1) On the making of a claim by the investor for the purposes of this Schedule, so much of the investor's unused qualifying expenditure on the relevant share as-

(a) is specified in the claim, and

(b) does not exceed so much of the original gain as is unmatched,

shall be set against a corresponding amount of the original gain.

(2) Where an amount of qualifying expenditure on the relevant shares is set under this Schedule against the whole or part of the original gain-

(a) so much of that gain as is equal to that amount shall be treated as not having accrued at the accrual time, but

(b) paragraphs 4 and 5 below shall apply for determining the gain that is to be treated as accruing on the occurrence of any chargeable event in relation to any of the relevant shares."

Taper relief

13. Taper relief was introduced by the Finance Act 1998. It operates to reduce the amount of chargeable gains accruing in the year of assessment by applying a percentage relief to the relevant gains. The governing provisions are contained in section 2A of, and Schedule A1 to the TCGA. These provisions distinguish between chargeable gains on the disposal of a business asset and those accruing on the disposal of a non-business asset. The precise percentages are not material but it is clear that the scale of relief in the case of business assets is considerably more generous than that for non-business assets.
14. Section 2A(3) provides:

"Subject to the following provisions of this Act, a chargeable gain is eligible for taper relief if –

(a) it is a gain on the disposal of a business asset with a qualifying holding period of at least 1 year; or

(b) it is a gain on the disposal of a non-business asset with a qualifying holding period of at least 3 years."

15. Section 2A(7) introduces Schedule A1. It is to have effect "for the purposes of this section". Paragraph 1 of Schedule A1 provides that:

"(1) Section 2A shall be construed subject to and in accordance with this Schedule.

(2) The different provisions of this Schedule shall have effect for construing the other provisions of this Schedule, as well as for construing section 2A."

16. The important provisions for the purposes of this appeal are those dealing with mixed use assets which are contained in paragraphs 3 and 9 of Schedule A1. It is sufficient to refer to paragraph 3, which deals with the case of separate periods of business and non-business use. Paragraph 9 deals with the case where there is mixed use at the same time, but it does so by treating the percentages as if they were periods and then applying paragraph 3. Paragraph 3(1) first deals with pure business assets:

"(1) Subject to the following provisions of this Schedule, a chargeable gain accruing to any person on the disposal of any asset is a gain on the disposal of a business asset if that asset was a business asset throughout its relevant period of ownership."

17. Paragraph 3(2)-(5) concerns assets which have been used for business purposes for parts of the period of ownership and for non-business purposes for other parts of such period:

"(2) Where –

(a) a chargeable gain accrues to any person on the disposal of any asset,

(b) that gain does not accrue on the disposal of an asset that was a business asset throughout its relevant period of ownership, and

(c) that asset has been a business asset throughout one or more periods comprising part of its relevant period of ownership,

a part of that gain shall be taken to be a gain on the disposal of a business asset and, in accordance with sub-paragraph (4) below, the remainder shall be taken to be a gain on the disposal of a non-business asset.

(3) Subject to the following provisions of this Schedule, where subparagraph (2) above applies, the part of the chargeable gain accruing on the disposal of the asset that shall be taken to be a gain on the disposal of a business asset is the part of it that bears the same proportion to the whole of the gain as is borne to the whole of its relevant period of ownership by the aggregate of the periods which –

(a) are comprised in its relevant period of ownership, and

(b) are periods throughout which the asset is to be taken (after applying paragraphs 8 and 9 below) to have been a business asset.

(4) So much of any chargeable gain accruing to any person on the disposal of any asset as is not a gain on the disposal of a business asset shall be taken to be a gain on the disposal of a non-business asset.

(5) Where, by virtue of sub-paragraphs (2) to (4) above, a gain on the disposal of a business asset accrues on the same disposal as a gain on the disposal of a non-business asset –

(a) the two gains shall be treated for the purposes of taper relief as separate gains accruing on separate disposals of separate assets;

but

(b) the periods after 5th April 1998 for which each of the assets shall be taken to have been held at the time of their disposal shall be the same and shall be determined without reference to the length of the periods mentioned in sub-paragraph (3)(a) and (b) above."

Order of claiming reliefs

18. In Daniels v HMRC [2005] STC 684 the special commissioner decided that a claim for EIS relief lay in respect of a gain before the application of taper relief. He said:

"… The available deferral relief is to be deducted from the chargeable gains accruing in the year of assessment before taper relief is applied. In a sentence, this is because taper relief only applies to chargeable gains that the 1992 Act treats as accruing in the particular year of assessment."

19. Before the Upper Tribunal the taxpayer did not suggest that this decision was incorrect. The Upper Tribunal held that it was correct, and there is no appeal from that aspect of the decision.

The decision of the First-tier Tribunal

20. At paragraph 11 (and again at paragraph 22) of their decision the F-tT said that they considered the dispute to be finely balanced. They inclined to the view that, purely as a matter of interpretation of the wording, the respondents had the stronger case. However they considered that this construction had anomalous consequences.
21. The F-tT thought that there was force in the argument that paragraph 3(5) only treated the two gains as separate gains accruing on separate disposals of separate assets "for the purposes of taper relief", and thus that the taxpayer could not seek to allocate EIS relief to the gain on the deemed non-business asset when making his EIS claim. However there were two qualifications, in the view of the F-tT, to the significance of this point. The first qualification was that it could be said that, as it was only in the context of the taper relief claim that the division into separate assets had significance, the allocation of the EIS claim to the non-business asset was "for the purposes of taper relief". The second qualification was that paragraph 3(2) did not contain the same qualification as to purpose as paragraph 3(5). Paragraph 3(2) was therefore of general application, and not limited to taper relief. This construction did, however, leave the F-tT in some doubt as to what paragraph 3(5) achieved. It is no longer advanced by the taxpayer.
22. These considerations led the F-tT to the interim conclusion that the wording was not entirely clear. The anomalous consequences, in their view, were these:

i) The taxpayer was able to choose to allocate his EIS claim against a non-business asset, leaving a gain on a separate business asset to be greatly reduced by the generous measure of taper relief. If that were so, it was odd that the same did not apply to a mixed use asset.

ii) The F-tT compared two cases. In the first, the taxpayer disposed of two adjacent houses, one of which was used for business and one which was not. In the second he owned a single title to the same two houses. It was curious that these two substantially identical examples should be treated differently for taper purposes. It was also curious that the second taxpayer could avoid the consequences of HMRC's construction by effecting a part disposal of the asset, so as only to dispose of the non-business part, followed, a day later, by the residue comprising the business part.

The decision of the Upper Tribunal

23. The Upper Tribunal Judge first set out the proposition derived from Daniels v HMRC concerning the order of claiming reliefs (cited above) and continued:

"25. On this basis, the taxpayer's claim fails, unless he can point to a statutory authority, applicable to claims for EIS relief, for treating the single gain arising on the disposal of a single mixed-use asset as two gains arising on the disposal of two assets, referable to the asset's business and non-business use.

26. No such authority exists in the provisions for EIS relief or generally in the provisions for the identification and computation of chargeable gains. The taxpayer submits that this is nonetheless the effect of paragraphs 3 and 9 of schedule A1 which, he submits, apply not only for the purposes of taper relief but also for the purposes of claiming EIS relief."

24. At paragraphs 32 to 37 of the decision, David Richards J explained why he did not consider that paragraphs 3 and 9 of Schedule A1 had any application outside the provisions for taper relief. His reasons, in summary, were:

i) The restricted ambit of the deeming provisions was clear from their context and by express provision. The entire contents of the schedule were to do with taper relief. Section 2A(7) and paragraph 1 of Schedule A1 made the limited purpose of the provisions of the schedule expressly clear.

ii) If it had been intended on the introduction of taper relief in 1998 to alter the existing provisions for EIS relief so as to allow the disposal of a single asset to be treated as the disposal of two separate assets, it would have been done in terms.

iii) The distinction between paragraphs 3(2) and 3(5) did not assist the taxpayer. They took effect together for the purposes of taper relief alone.

iv) Notwithstanding the fact that the taxpayer's purpose in seeking to allocate EIS relief to the non-business part of the gain was made in order to take better advantage of the taper relief provisions, the question was whether there was any basis for applying EIS relief in this manner, and there was not.

v) The F-tT's view that it would be odd not to allow mixed use assets to be treated in this way when the taxpayer could elect to claim EIS relief on separate non-business assets, and the other suggested anomalies pointed to by the F-tT, might assist if there was any real ambiguity in the legislation, which there was not.

The arguments on appeal

25. In his submissions on behalf of the taxpayer before us, Mr Michael Sherry accepted that the provisions of paragraph 3 of Schedule A1 do not apply outside the context of taper relief. He submitted that, on the taxpayer's approach, the statutory hypothesis contained in that paragraph is given effect to only for the purposes of calculating taper relief. He drew attention to the fact that that paragraph did not only divide the gain in respect of the disposal of a mixed use asset into its business and non-business components; it went further and deemed there to be two separate assets and two separate disposals. Once that hypothesis was applied, it was necessary to calculate the gain for the purposes of taper relief on each of the separate notional assets. Where, as here, there was also a claim to EIS relief, it was still necessary to know how much of that relief is to be applied to each of the two notional assets for the purposes of calculating the taper relief. HMRC's approach failed to give full effect to the statutory hypothesis.
26. Mr Sherry submitted in summary that the taxpayer's approach to the computation did no violence to the scheme for EIS relief, and did not alter the quantum of the EIS claim. It was consistent with Daniels v HMRC in that it applied EIS relief and taper relief in the correct order once the notional split into distinct business and non-business assets had been applied. It was consistent also with Parliament's intention evident from the way in which the scheme operates for assets which are used wholly for business and wholly for non-business purposes.
27. Ms Nathan for HMRC submitted that the Upper Tribunal judge was right for the reasons he gave. The taxpayer's approach necessitated applying the deeming provisions outside the scope of taper relief, when it was clear that this was not the legislative intention. Looking at the matter from the perspective of EIS relief, it was clear that there was nothing in the scheme for that relief which allowed the taxpayer to split up assets notionally according to their use. Although the relief could be applied to the "whole or part of the relevant gain" (paragraph 2(2) of Schedule 5B), that was not the same as what the taxpayer sought to do here, which involved dividing the gain between the two different types of use.

Discussion

28. It is now common ground that the application of the deeming provisions of paragraph 3 of Schedule A1 is confined to the purposes of taper relief. I agree with the Upper Tribunal judge that this was clear from section 2A(7) and paragraph 1 of Schedule A1, as well as from the terms of paragraph 3, all of which must be read as a coherent whole. The question, therefore, is whether the taxpayer's approach to computation involves an attempt to use the deeming provision beyond the purposes of taper relief.
29. I fully accept that the taxpayer's approach has no impact on the amount of EIS relief which he can claim to relieve his chargeable gains. Both computations recognise that the taxpayer's claim to EIS relief is valid, and the same amount of relief is given in both computations. However, whilst the use of the deeming provision has no impact on the calculation of EIS relief, it is indisputable that, in the taxpayer's computation, it is used in the application of EIS relief, so as to produce separate net gains in respect of notional business and non-business assets.
30. I do not think that the taxpayer's approach is based on a correct interpretation of how the EIS and taper relief provisions are intended to operate. One must start with the overall charging provision, section 2. The tax is chargeable in respect of chargeable gains accruing in the year of assessment. The effect of a valid claim to EIS relief is that, to the extent of that claim, gains are deferred and do not accrue in the year of assessment. Thus when section 2A says that chargeable gains are reduced by applying taper relief, it is the gains accruing in the year of assessment to which the relief is applied, and those gains are those which appear after the application of EIS relief.
31. Paragraph 3(2) of Schedule A1 provides that where a chargeable gain accrues on the disposal of any asset, a part of the gain is taken to be a gain on the disposal of a business asset and a part of the gain is taken to be a gain on the disposal of a non-business asset. In the statutory context in which it appears, the chargeable gain which is to be divided according to business and non-business use is the gain accruing in the year of assessment, which, in a case where EIS is claimed, is the gain after the application of EIS relief.
32. Paragraph 3(3) then explains how the gain is to be divided up in accordance with the proportions of business and non-business use. When the chargeable gain has been divided up in this way, paragraph 3(5) provides that, for the purposes of taper relief, the two gains shall be treated as separate gains accruing on separate disposals of separate assets. It remains the case that it is the net gain after the application of EIS relief which is divided into two separate gains for the purposes of taper relief.
33. I think Mr Sherry reads too much into paragraph 3(5) when he suggests that it requires the original, real, disposal to be treated as two separate notional disposals of two separate assets, which are then eligible for the application of EIS relief. The deeming provision of paragraph 3(5) merely allows the separate gains from the disposal of the mixed use asset to be fed back into section 2A for the calculation of taper relief. It does not go any further than that. Indeed, in my judgment, to adopt Mr Sherry's approach would not be consistent with Daniels v HMRC because it would start the process of applying taper relief before, and not after, the EIS relief has been applied.
34. The taxpayer's approach also finds no support in the EIS provisions in Schedule 5B. Those provisions provide no basis for a notional sub-division of an asset into business and non-business uses at the stage of the application of EIS relief. The provisions operate on disposals of real assets. It is possible, of course, to seek relief against only part of a gain. But this does not assist the taxpayer in the present case. He wishes to be in a position selectively to apply EIS relief to gains on separate notional business and non-business assets. There is no basis in the EIS provisions for doing so.
35. I would draw this together as follows. EIS relief applies in priority to taper relief. The first task in the case of a mixed use asset is to calculate the overall gain on the sale of the real asset and apply EIS relief to calculate the gain which accrues in the year of assessment. It is to the net gain that taper relief applies. The net gain must be divided according to the proportions of business and non-business use. At that stage the taper relief is to be calculated on the basis of the fiction that there have been separate disposals of separate assets giving rise to separate gains, applying the provisions of section 2A. This does not mean that there are deemed to be separate disposals of separate assets at the earlier, EIS stage.

Conclusion

36. For the reasons I have given, if my Lord agrees, the appeal will be dismissed.

Lord Justice Sales

37. I agree the appeal should be dismissed for the reasons given by Floyd LJ.