England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
ON APPEAL FROM THE SPECIAL COMMISSIONERS

		Royal Courts of Justice Strand, London, WC2A 2LL
		06th July 2006

Mr Justice Warren

Introduction

1. This is an appeal from the decision of the Special Commissioner, His Honour Stephen Oliver QC, dated 3 November 2005.
2. The issue before Mr Oliver, and before me, is whether section 41(2) Taxation of Chargeable Gains Act 1992 ("TCGA") operates to restrict allowable losses that would otherwise have accrued in respect of Mr Smallwood's units in an enterprise zone property unit trust ("EZPUT") when he received distributions in respect of those units, giving rise to a deemed disposal under section 122 TCGA. The central question is whether part of the sum subscribed by Mr Smallwood for his units is expenditure in respect of which a capital allowance has been made in such a way as to fall within section 41(2) in computing Mr Smallwood's loss on such disposal.
3. In brief, Mr Smallwood invested £10,000 in March 1989 in an EZPUT known as PET 8 in the Isle of Dogs Enterprise Zone. The trustees of PET 8 immediately spent the subscription of Mr Smallwood (and those of other subscribers) as they were obliged to do by the terms of their trust on land and buildings known as No 2 Harbour Exchange ("the Property"). To the extent that the money was spent on buildings, in contrast with the land, 100% first year capital allowances were obtained by Mr Smallwood and other unit holders. Mr Smallwood's share of those allowances amounted to £9,678, each unit holder being entitled to an allowance equal to 96.78% of his subscription. Mr Smallwood claimed this allowance which was set off against his general income for 1988/89.
4. Nearly 10 years later, the trustees realised a substantial consideration in respect of a realisation of the Property, that realisation being effected by a fairly complex set of transactions designed to avoid bringing about any balancing charges. In the tax years 1998/99 and 1999/2000, Mr Smallwood received distributions of £5,000 and £125. These fell to be treated for capital gains tax ("CGT") as part disposals by Mr Smallwood of his units. But for the provisions of section 41(2) TCGA, those part disposals would have given rise to allowable losses in Mr Smallwood's hands.
5. Mr Smallwood contends that section 41(2) does not operate to restrict the losses accruing to him whereas HMRC contend that it does. Mr Oliver found in favour of Mr Smallwood. HMRC now appeal against his decision. Although the tax at stake for Mr Smallwood is modest, the case raises an important point of principle relevant not only to him but also to other subscribers to PET 8 and to other EZPUTs. It has been agreed by the parties that each side will bear its own costs of this appeal regardless of the outcome. HMRC appear by Mr Launcelot Henderson QC; Mr Smallwood appears by Mr John Watson, solicitor advocate, of Ashurst.

The facts

6. Before me there is an Agreed Statement of Facts and Issues (the "Agreed Statement") which was also before Mr Oliver. I take the following facts from that Agreed Statement.

PET 8

7. PET 8 is an EZPUT which was formed in 1989 to invest in the Property. Subscriptions were invited by Property Enterprise Managers Limited (the "Manager"), the promoters and managers of the trust. The trustee would spend the money subscribed on the Property.
8. The original trust was effected by a trust deed dated 5 April 1989 and entered into between Midland Bank plc as trustee and the Manager. It seems from a subsequent deed dated 20 June 1989 that the trust was in fact constituted on 31 March 1989 but it is agreed that for present purposes nothing turns on this. In relation to the original trust deed, it should be noted that Clause 1 declares that the Property is to be held "upon Trust for the Members in accordance with the terms of the Principal Trust Deed". The Principal Trust Deed for this purpose is a master trust deed dated 25 October 1983 as subsequently amended by supplemental trust deeds dated 22 January 1985 and 24 December 1986 (the "Principal Trust Deed").
9. The subscribers for units in PET 8 (including Mr Smallwood) paid their subscription monies into an account of which the trustee had control. These monies, totalling £81,786,000 (the "Subscription Monies") were paid on or before 31 March 1989, when the trust closed.
10. On 31 March 1989 the trustee of PET 8 took an assignment from Globebuy Ltd. of that company's rights under a development agreement which it had previously entered into with Charter Group plc (the "Developer") and Charter Group Developments plc ("CGD"), a company in the same group as the Developer. Under the arrangements to which the trustee then became party:

a. the Developer was obliged to carry out and complete or procure that CGD carried out and completed the construction of the building at No.2 Harbour Exchange;

b. as soon as practicable following the date of practical completion of the works (and in any event on the Developer itself receiving a headlease for 200 years less two days of the Property from the London Docklands Development Corporation under an agreement between the Developer and that corporation) the Developer was to grant to the trustee an underlease of the Property for a term of 200 years less three days (the "Underlease");

c. immediately following the grant of the Underlease, CGD was to take one or more 25 year sub-underleases of the Property from the trustee at a rack rent. The purpose of this was to provide a rental yield for those parts of the building which did not already have a commercial tenant; and

d. in return for the grant of the Underlease and completing the works, Globebuy Ltd was to pay the Developer an aggregate purchase price of £81,786,000 by 31 March 1989.

In consideration of the assignment the trustee covenanted with Globebuy Ltd by way of indemnity to observe and perform all the covenants and obligations on the part of the purchaser contained in the development agreement.

11. The execution of the contracts and the payment of the Subscription Monies to the Developer satisfied the requirement in clause 2 of the Principal Trust Deed that the trustees should apply the whole of "the Deposits" on the acquisition and development of the Property.
12. The trustee paid the Subscription Monies to the Developer on completion on 31 March 1989. The Developer refunded to Globebuy Ltd payments previously made by Globebuy Ltd under the development agreement.
13. Since the parties made an election under section 37 Finance Act 1978, by virtue of which the Underlease would be regarded as the "relevant interest" in relation to the expenditure on the building, the entire purchase price (save for that part which was attributed to the site) was eligible for capital allowances.
14. Mr Smallwood subscribed for 10 units, each with a nominal value of £1,000. Mr. Smallwood paid his £10,000 subscription by cheque. The monies he subscribed formed part of the Subscription Monies and were applied by the trustee as described above.
15. Mr Smallwood claimed and obtained relief for capital allowances in the sum of £9,678. It is uncertain in which year he obtained that relief but the parties are content to proceed on the basis that it was claimed against his general income for 1988/9.

The realisation of the Investment

16. On 28 January 1999 the trustees granted a sub-sub-underlease of the Property for the whole of the then unexpired term of the Underlease (less a nominal reversion) to Hammerson (2 Harbour Exchange) Limited at a premium of £43,417,749 plus VAT, subject to and with the benefit of the then existing occupational sub-underleases. Since the grant of the sub-sub-underlease was not a disposal of the relevant interest in the Property for capital allowances purposes, there was no balancing charge on the unitholders. The freehold interest in the Property was also sold. The Underlease was retained by PET 8.
17. On 26 February 1999, Mr Smallwood received a capital distribution of £5,000 on his units. By virtue of sections 99 and 122(1) TCGA Mr Smallwood is to be treated as if he had disposed of an interest in the units in consideration of that capital distribution which represented some 97% of the then value of the units. By application of the part disposal formula in section 42 TCGA, and without regard to any limitation which may be imposed by section 41(2) TCGA, Mr Smallwood incurred a capital loss of £4,804. There was a further part disposal in 1999/00 giving rise to a capital loss on the same basis of £61.

The statutory framework

18. I now turn to the statutory framework of capital allowances and CGT so far as relevant.

The capital allowances provisions

19. The Finance Act 1980 introduced 100% initial allowances for persons who incur expenditure in constructing or acquiring commercial buildings or structures in enterprise zones, to encourage investment in such zones.
20. Individuals wishing to invest in such buildings commonly did so through the medium of an unauthorised unit trust – an EZPUT – in order to be able to pool their investments. The trustees would then commonly incur expenditure on the building in question. Under the unit trust, 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 trustees' 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 the Finance Act 1987, unitholders were taxed on their share of the trust income and obtained capital allowances on their shares of the trust's qualifying expenditure. This reflected the reality of the beneficial ownership and resulted in complete transparency or "look-through" for the purposes of capital allowances.
21. Section 39 Finance Act 1987 introduced a new income tax regime for unauthorised unit trusts and their unit holders. This regime is now found in section 469 Income and Corporation Taxes Act 1988. In effect, the trustees are taxable on the income of the unit trust and are regarded as the persons to whom capital allowances are to be made. The effect of that in relation to EZPUTs was to prevent the 100% capital allowances from flowing through to the unitholders and thus to remove one of the main attractions to investors of investing in EZPUTs.
22. Representations to the Commissioners of Inland Revenue resulted in special income tax treatment being afforded to EZPUTs and to certain other arrangements (charitable unit trust schemes, limited partnership schemes and certain profit sharing schemes). The treatment was afforded by the Income Tax (Definition of Unit Trust Scheme) Regulations 1988 (SI 1988/267) ("the Income Tax Regulations") which provided that the excluded schemes are to be treated as not being unit trust schemes for the purposes of what is now section 469 ICTA. One condition for a scheme to qualify as an EZPUT for the Income Tax Regulations, found in Regulation 4(2)(d), is that contributions of participants are all to be made in the same tax year (and none in any subsequent year) and that the capital expenditure on the enterprise zone property is to be incurred wholly in the tax year in which the participants make their contributions.

The CGT provisions

23. Although an EZPUT is set up through the medium of a trust, the trust property is not settled property for CGT purposes since the unitholders are at all times collectively absolutely entitled to the trust property as against the trustees. Accordingly, it might be thought that the trust has no CGT implications. That is not so, however, because there are special provisions which apply to unauthorised unit trust schemes including EZPUTs.
24. In particular, section 99 TCGA provides in subsection (1) as follows:

"This Act shall apply in relation to any unit trust scheme as if –

(a) the scheme were a company,

(b) the rights of the unit holders were shares in the company…"

25. The effect of this is that the trustees pay CGT on any gain realised by the unit trust in respect of the trust property and the unitholders pay CGT on any gains realised by them on their units. The position is analogous to that of a UK company and its shareholders, save that the trustees pay CGT rather than corporation tax on chargeable gains.
26. At the same time as the Income Tax Regulations were made, regulations were also made for CGT purposes; these are the Capital Gains Tax (Definition of Unit Trust Scheme) Regulations 1988 (SI 1988/266) ("the CGT Regulations"). They exclude limited partnership schemes from the statutory treatment under section 99. However, neither EZPUTs nor charitable unit trusts were included in the CGT Regulations. The reasons for the difference between the two sets of Regulations are not known by me, although it is clear that those differences were not simply an oversight.
27. It is elementary that CGT is charged on the amount of chargeable gains pursuant to section 2(2) TCGA; that the amount of a gain is to be computed in accordance with Part II TCGA (see section 15(1)); and that every gain is a chargeable gain save as otherwise expressly provided (see section 15(2)). Since the amount of a gain needs to be expressed as a sum of money, consideration for an acquisition or disposal which is not expressed in money terms has to be valued (and where it cannot be valued, market value is substituted under section 17(1)(b) TCGA).
28. Under section 37 TCGA, there is excluded from the consideration for a disposal any money or money's worth which is income for income tax purposes of the person making the disposal. Such of the consideration as is not excluded then remains to be brought into account in computing the amount of the gain.
29. Section 38 provides that the "sums allowable as a deduction from the consideration [ie the disposal consideration] in the computation of the gain…. shall be restricted to" the items listed in paragraphs (a) to (c). Paragraph (a) is "the amount or value of" the consideration for the acquisition and paragraph (b) is "the amount of any expenditure" on enhancement. The reference to the disposal consideration is clearly to the amount of that consideration: section 38(1) refers to sums allowable as a deduction from the allowable sums (ie amounts of money) in contrast with section 37(1) which refers to exclusion of certain money or money's worth from the consideration.
30. I make these detailed points about sections 37 and 38 because the structure of those provisions may have some bearing on the meaning of "expenditure" in section 39(1), a matter to which I will come in due course. But before turning to sections 39 and 41, I need to say some more about section 99.
31. First, there has been a debate before me about the extent to which section 99 goes. It is common ground that the correct approach to a deeming provision is that stated by Peter Gibson J giving the leading judgment in the Court of Appeal in Marshall v Kerr [1993] STC 366 approved by Lord Browne-Wilkinson in the appeal to the House of Lords: see [1995] 1 AC 164:

"For my part I take the correct approach in construing a deeming provision to be to give the words used their ordinary and natural meaning, consistent so far as possible with the policy of the Act and the purposes of the provisions so far as such policy and purposes can be ascertained; but if such construction would lead to injustice or absurdity, the application of the statutory fiction should be limited to the extent needed to avoid such injustice or absurdity, unless such application would clearly be within the purposes of the fiction. I further bear in mind that because one must treat as real that which is only deemed to be so, one must treat as real the consequences and incidents inevitably flowing from or accompanying that deemed state of affairs, unless prohibited from doing so."

32. It is worth noting that the House of Lords reversed the Court of Appeal in the light of the new arguments presented by Mr McCall QC on behalf of the Crown. Lord Browne-Wilkinson quoted Peter Gibson J's conclusion as follows:

"If the trustee of the varied trusts is to be treated as if the personal representative's acquisition of the assets the subject of the instrument had been the trustee's acquisition….. one must surely, unless prohibited from doing so, also treat Mrs Kerr as never having acquired or disposed of those trust assets."

33. Lord Browne-Wilkinson agreed that that was correct on the argument presented to the Court of Appeal, but he also accepted Mr McCall's new argument. It was, he agreed, in that case, necessary first to identify what was the property settled by the arrangement under consideration and then to ask the question, "Is there anything in section 24 which requires one to assume a state of facts inconsistent with Mrs Kerr having been the settlor of the property so identified?" I will need to return to this aspect of the decision later.
34. Mr Henderson emphasises that the fiction imposed by section 99 applies to the whole of TCGA including the computation provisions of sections 37 to 41. He says that section 39 expressly takes one into the world outside TCGA by referring to the income tax allowances, in particular into the world of equity and capital allowances where the subscribers are, and are viewed as, the beneficial owners of the subscription monies and then of the Property which they own in undivided shares.
35. Since TCGA applies as if PET 8 were a company, it is appropriate in my view to imagine a notional company taking the place of PET 8. PET 8 is not, of course, a legal person, although the trustees will have their own (corporate or individual) legal capacities. But the effect of section 99 must be that the trustees acting as such are to be treated as such a notional company for the purposes of TCGA.
36. Similarly, since TCGA applies as if the rights of the unitholders were shares in the notional company, it follows that the unitholders are to be treated as shareholders. This is why, as is common ground, section 122 TCGA applies on a distribution of assets from PET 8 to the unitholders. There is, it is true, nothing express in TCGA which states that the notional shares have been acquired by the unitholders let alone that the unitholders are to be treated as having made such an acquisition for an amount equal to their subscriptions. It is, however, in my judgment a necessary consequence of section 99 that this treatment is to be afforded if sensible effect is to be given to the statutory fiction; so that the notional shares are indeed to be treated as having been acquired for an amount equal to the subscription monies.
37. A further consequence of the statutory fiction is that TCGA applies as if the assets of PET 8 were assets of the notional company. Accordingly, in relation to the purchase of the Property by the trustees of PET 8 out of the subscription monies which they had received, TCGA applies as if the notional company had acquired that Property.
38. In particular, section 38 applies as if the purchase price provided from the assets of PET 8 was consideration given by the notional company for the acquisition by it of the Property. It must follow that that purchase price is not, for the purposes of section 38 or any other provisions of TCGA, consideration given by the notional shareholders (ie the subscribers to the scheme). Nor is it, for the purposes of the TCGA, consideration for an acquisition by the notional shareholders of their notional shares.
39. The same analysis would apply where the trustees of a scheme spend subscription monies to enhance the value of an asset which is a scheme asset. The spending of the money is "expenditure" within section 38(1)(b) being expenditure by the notional company not expenditure by the notional shareholders. It forms part of the notional company's base cost for the property, not part of the notional shareholders' base cost of their notional shares.
40. I turn now from section 38 to sections 39 and 41. It is important to note that they are part of one code of computation of gains and losses. They should be construed together and made to mesh sensibly so far as possible. In this context, I should mention one aspect of the Decision delivered by Mr Oliver.
41. In paragraph 11 of the Decision, Mr Oliver states that 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 be allowable as a deduction under section 38. However, Mr Oliver nonetheless reached the contrary conclusion in relation to section 41(2). Mr Henderson agrees with that conclusion on section 39 and says that logically it follows that the same must be said for section 41(2). Mr Watson disagrees with that conclusion on section 39 and says that the capital allowances afforded to Mr Smallwood do not result in any deduction from his base cost of his units but that they do result in a deduction from the base cost of the trustees for the Property. Although disagreeing about the correct result, both of them say that the half-way house reached by Mr Oliver is not a sustainable position and that the result should be the same in relation to both sub-sections. They say this not because the view which each of them espouses on section 39 supports the conclusion which he asserts on section 41(2) but because they both perceive a genuine logical difficulty in reaching differing conclusions on the two sub-sections. Accordingly, if I were against one of them on section 39, each would accept that the same conclusion follows through to section 41(2). I agree with that approach for reasons which will, I hope, become apparent.
42. Section 39(1) is of wider application than section 41. The former deals with many different sorts of deduction and is not restricted to capital allowances and renewals allowances, although the wording is wide enough to cover them without expressly referring to them as such. In contrast, sections 41(1) and 41(2) are restricted to capital allowances and renewals allowances. It is, in my view, essential, therefore, to examine in the first place the effect of section 39(1) if it stood alone.
43. Section 39(1) is a provision which excludes certain items from the sums allowable under section 38 as deductions in computing the gain on a disposal. That the provision is drafted as an exclusion is significant. The draftsman has not provided that the amount of certain identified expenditure is to be deducted from the amount otherwise allowable as a deduction but has said that certain expenditure is to be excluded from the sums allowable. The use of the word "excluded" is designed, I consider, to ensure that what is excluded is something which would, absent the exclusion, be included. In other words, the "expenditure" which is excluded must form part of the items which make up the sums the allowance of which is otherwise permitted under section 38.
44. In an ordinary case, this provision gives rise to no difficulty. Typically, a tax-payer will purchase an asset out of his own money for a price. The sum allowable under section 38 is, prima facie, the amount of the purchase price and that sum is set against the amount of the disposal consideration when he subsequently sells the asset. The payment of the purchase price is clearly expenditure by the tax payer and is, ex hypothesi, expenditure allowable as a deduction for the purposes of section 39(1). To the extent that an income tax deduction is obtained, the amount so allowed is to be excluded from the sums which would otherwise be allowable under section 38. It is an exclusion from the sums allowable under section 38 of part of the very monies which were comprised in those allowable sums.
45. In the present case, however, a more subtle investigation needs to be made into the meaning of the word "expenditure" in section 39(1). This is because the fiction imposed by section 99 applies only for capital gains tax purposes and not for the purposes of income tax or capital allowances. Questions arise about the nature of the relationship between the expenditure mentioned in section 39(1) and sums from which the amount of that expenditure is to be excluded.
46. In the present case, the payment by the unitholders of their subscription monies to the trustees of itself had no consequence for income tax or capital allowances. Those monies (and the Property which was purchased with them) remained in the beneficial ownership of the subscribers and the income tax and capital allowance provisions recognise that beneficial ownership and "look through" the trustees. The payment of the purchase price for the Property by the trustees was, as a result of this "look through", a payment, for the purposes of income tax and capital allowances, by the unitholders with the result that it was the unitholders, including Mr Smallwood, who became entitled to claim capital allowances. Further, were it not for the fiction imposed by section 99, the position would be the same for capital gains tax since the ordinary rule is that nomineeship and bare trusteeship is ignored under section 60(1).
47. However, for capital gains tax purposes, the fiction imposed by section 99 results in the unitholders having acquired notional shares in consideration of their subscriptions. Focusing on Mr Smallwood, he obtained, for £10,000, units in the scheme and his rights fall to be treated as though they were shares in the notional company. On each distribution to him from the scheme, there was a deemed disposal of his notional shares under section 122. Section 38 applies as if his subscription for his units was consideration for his notional shares and the amount of that subscription (£10,000) falls within the sums allowable in computing the gain on that deemed disposal (applying the part disposal rules, of course) but subject to sections 39 and 41.
48. Since the TCGA applies to the acquisition of the Property by the trustees as if the scheme were a company, it applies, in particular, as if the subscription monies provided by the unitholders were assets of the notional company; and it also applies as if the trustees' acquisition of the Property were an acquisition by the notional company, in respect of which the purchase price given falls within section 38(1) as consideration given by the notional company. This is so notwithstanding that the actual payment made by the trustees was out of the money subscribed by the unitholders (the scheme having no other assets), money which, apart from the world of capital gains tax, belonged beneficially to the unitholders. On a disposal by the trustees of the Property, TCGA applies as if the disposal were by the notional company. The amount of the consideration given for the acquisition falls within the sums allowable under section 38(1) in computing the gain on that disposal, again subject to sections 39 and 41.
49. The result of all this is that (i) there has been a payment by the trustees in consideration of the purchase of the Property (ii) that payment was made out of the subscriptions of the unitholders to the scheme (iii) so far as concerns Mr Smallwood, a capital allowance of £9,678 became available to him because, in equity, he remained the beneficial owner of his subscription and beneficial co-owner of the Property and (iv) TCGA applies as if the scheme were a company so that that payment represents consideration given by the notional company under section 38 for the Property and not consideration given by the unitholders.
50. What, then, in this fictional world, to the extent but no further than section 99 imposes a fiction, is the effect of the reference to "expenditure" in section 39(1)?
51. Mr Henderson submits that, to the extent that the subscription monies provided by Mr Smallwood were used to acquire the Property and also attracted capital allowances (ie 96.78% of the subscription), they would fall to be excluded from Mr Smallwood's base cost of his units under section 39(1) subject always to the provisions of section 41. He says, correctly, that the subscription monies have in fact been used to acquire the Property and have in fact resulted in Mr Smallwood obtaining a capital allowance. Although it was the trustees who effected the purchase, they did so with money belonging beneficially to the subscribers and the Property itself is held in trust for the subscribers. He says that, out of the actual expenditure given by Mr Smallwood for his units, that part which has attracted a capital allowance has in fact reduced his own taxable income and therefore falls to be excluded under section 39(1) as "expenditure allowable as a deduction…" within the subsection. His focus is on the money subscribed rather than the purpose of its subscription. With that focus, the "expenditure" referred to in section 39(1) is simply a reference back to such part of the consideration referred to in section 38(1)(a) or such part of the expenditure as is referred to in section 38(1)(b) as is utilised in a way which attracts a capital allowance available to Mr Smallwood. On this footing, it would be appropriate to read "any expenditure allowable…." as meaning "any part of the consideration within section 38(1)(a) or of the expenditure within section 38(1)(b) applied so as to be allowable….".
52. Mr Watson submits that that approach is wrong and fails to give full effect to the statutory fiction imposed by section 99. According to his approach, the amounts attracting the capital allowances available to unitholders are to be excluded from the trustees' base cost on their own disposal of the Property and not from the base cost of the unitholders' notional shares. He reaches this result adopting an apparently literal approach to sections 38 and 39. Since the Act applies as if the scheme were a company, there are two levels at which the situation must be viewed. First, the Act applies as if the unitholders were shareholders who acquire their shares for their subscription. Further, since the Act applies as if the scheme were a company, the assets of the scheme (ie the subscription monies received) prior to the acquisition of the Property must be treated as assets of the notional company for the purposes of the Act. Secondly, because of that treatment, the Act applies as if the acquisition of the Property were made by the notional company and as if the consideration for its acquisition were made by the notional company out of its own assets.
53. Thus, when the trustees come to sell the Property, the base cost of the Property in the hands of the trustees is the consideration given by them for it; and section 38 applies as if the price paid by them was consideration given by the notional company. But any part of that consideration which is expenditure which attracts a capital allowance is excluded under section 39(1). In fact, 96.78% of the trustees' actual expenditure did attract a capital allowance, albeit one available to the unitholders rather than the trustees. In this context, Mr Watson reads section 39(1) as being satisfied when expenditure by one person falls within section 38 in relation to an asset whilst at the same time giving rise to a deduction in computing the taxable profits of another person.
54. The fact that, in the world of capital allowances, the Property was acquired, beneficially, by the unitholders and the consideration for its acquisition was given by them, does not detract from the fact that, in applying section 38(1), the Act applies as if the consideration had been given by the notional company. Section 39 (which like the rest of the Act applies as if the scheme were a company) then excludes such part of the consideration (ie consideration falling within section 38(1)(a)) as attracts a capital allowance from the allowable deduction in computing the gain. Mr Watson's focus is therefore not merely on the expenditure as a sum of money but is also on the nature of the expenditure. It is the very act of paying for the Property which is the making of the expenditure and which attracts the capital allowances. In contrast, such act of paying is not expenditure in relation to the disposal of the notional shares because the payment of the subscription monies did not give rise to any capital allowance: it was only the subsequent payment of the purchase price for the Property which did so and that is a different expenditure. As Mr Watson puts it, the capital allowance was obtained not because of the payment of the subscription monies to the trustees but because of the acquisition of the Property by the trustees. What is more, since the Act is to apply as if the scheme were a company, that expenditure is not part of the consideration which falls within section 38(1) in relation to a disposal of the notional shares.
55. In support of his conclusion, Mr Watson draws attention to the position which would obtain in the case of an actual company carrying out a similar transaction. In such a case, an investor acquires shares for his equity contribution which would form his base value for his shares. The company, in applying the equity contribution by purchasing, for instance, a building, acquires the building with a base cost equal to the purchase price. Let it be supposed that the company obtains a capital allowance in respect of its expenditure on the building. It is quite clear that, on a disposal of the building by the company, such part of the purchase price as attracted a capital allowance will be excluded under section 39(1) from its base cost of the building under section 38; and it is quite clear that there will be no exclusion from the base cost of the shares of such part of the expenditure on the property as attracted the capital allowance. Since section 99 says that the Act is to apply as if the scheme were a company, Mr Watson says that the same consequences should follow for the scheme as follow for the company.
56. Further, he points out that Mr Henderson has to identify the payment made by the trustees for the Property with at least part of the unitholders' subscriptions: unless he does that, the payment by the trustees (which is what Mr Henderson needs to identify as the expenditure within section 39(1)) does not fall to be excluded at all, because it is never included within section 38(1) in relation to the acquisition of the notional shares in the first place. But if that is a correct approach in the present case, Mr Watson says it is also the correct approach in the case of an actual company. In other words, if it is permissible to trace the actual application of funds in the case of a scheme, it should be possible to do so in the case of a company. The result of Mr Henderson's argument, he says, would be, in the company example given above, that the expenditure giving rise to the capital allowance for the company is to be excluded from the shareholder's allowable expenditure, a result which everyone accepts cannot be correct.
57. Mr Henderson's response in relation to Mr Watson's submissions is this. (It is a point he makes principally in relation to section 41(2) on which his submissions focused rather than in relation to section 39(1) which I am now addressing, but the same point can be made). It is that the expenditure to be excluded must be expenditure by or on behalf of the person making the disposal. Expenditure by a third party will not, he says, be relevant. This is really a reiteration of the point that to be excluded by section 41(2) (or section 39 I would add) the expenditure concerned has to be part of the sums expended by the person making the disposal: one cannot exclude something which, absent the exclusion, would not be included in the first place. Mr Henderson submits that that limitation is satisfied on his approach because Mr Smallwood's share of the expenditure on the buildings was, through the transparent medium of the scheme, expenditure by him. In contrast, he submits that the expenditure attracting Mr Smallwood's capital allowance was not expenditure by the trustees but expenditure by Mr Smallwood.
58. Mr Henderson says that this analysis also provides the answer to Mr Watson's submissions based on the position of a real company. The Crown agrees that section 39 and section 41(2) would not apply to restrict an allowable loss accruing to an actual shareholder. But the reason that they accept this is that the expenditure on the building is, in equity and for the purposes of corporation tax and capital allowances, as well as for the purposes of capital gains tax, not expenditure by the shareholder but expenditure by the company.
59. Mr Watson responds to that by saying that Mr Henderson, in order to reach the conclusion which he does, has to imply into section 39 (and the same goes for section 41(2)) words to the effect that the benefit of the tax deduction or capital allowance must accrue to the person making the disposal. There is no warrant, he says, for such an implication.
60. In my judgment, Mr Watson's submissions are to be preferred and, so far as concerns section 39(1), my judgment is that the expenditure giving rise to the capital allowances available to unitholders is not excluded from the sums allowable as a deduction in computing the gain accruing to unit holders on distributions from the scheme. I reach this conclusion essentially for the reasons given by Mr Watson. I should however put one element of my decision in my own words.
61. It is unquestionably the purchase of the Property which gives rise to the capital allowances and not the subscription of monies to the scheme by the unitholders. Without the subscription the purchase could not, of course, have been made; but it is the actual purchase which gives rise to the capital allowances.
62. For capital gains tax purposes, the Act applies as if the scheme were a company and as if the rights of the unitholders were shares in the company. Applying that fiction, the Act applies:

a. as if the unitholders were shareholders with section 38(1)(a) applying to the notional shareholding as if they had acquired their shares for a consideration provided by them equal to the amount of their subscriptions;

b. as if the subscription monies were property of the notional company;

c. accordingly, as if the acquisition by the trustees of the Property were an acquisition by the notional company with section 38(1)(a) applying as if the notional company had acquired the Property for a consideration provided by it equal to the purchase price (if this were not so, there would be no available base cost at all, a proposition which is clearly wrong).

63. Since the Act applies as if the Property had been acquired by the notional company and as if the notional company had provided the consideration, it follows that the Act cannot at the same time apply as if the notional shareholders had provided the consideration. It also follows that the Act is to apply as if the actual payment made by the trustees to purchase the Property were made by the notional company and not by the notional shareholders. Accordingly, notwithstanding that in equity and for the purposes of capital allowances the actual payment was made out of assets beneficially owned by the unitholders, the fiction imposed by section 99 results in the actual payment being regarded for capital gains tax purposes as being made by the notional company.
64. The payment of the purchase consideration by the notional company is, in my judgment, clearly "expenditure"; at least, I can see no reason for reaching a contrary conclusion. It is also expenditure in respect of which Mr Smallwood and other unitholders became entitled to capital allowances. Since the payment was expenditure and also gave rise to a capital allowance, it falls within section 39(1) in relation to the base cost of the notional company unless it can be said that section 39(1) requires that the capital allowance (or other deduction) envisaged by section 39(1) must accrue to the person making the disposal. In my judgment, that is not a requirement of the subsection. It is certainly not an express requirement and I see no compelling reason why such a requirement should be imposed. Accordingly, I consider that section 39(1) applies to exclude from the trustees' base cost of the Property the amounts in respect of which unitholders obtained capital allowances.
65. It does not necessarily follow that section 39(1) should not also exclude those amounts from the notional shareholders' base cost of their notional shares. But that is a most unattractive proposition and not one which I think is correct. It is not correct, in my judgment, because the relevant expenditure, that is to say the payment by the trustees for the Property, is not expenditure which is included within the sums which constitute the base cost of the notional shares in the first place. The point here is that the money used in the purchase of the Property is, for the purposes of the Act, treated as an asset of the notional company not as an asset of the shareholders. It cannot, therefore, be treated for the purposes of the Act as part of the consideration provided by the notional shareholders for the acquisition of their shares. The position is no different from that which would apply in the case of an actual company as explained above.
66. This result is consistent, in my judgment, with the approach to deeming provisions explained by Peter Gibson J in Marshall v Kerr (the relevant passage being set out at paragraph 31 above). Because the consideration referred to in section 38 is treated as if it had been given by the notional company, so too the expenditure referred to in section 39 which is part of that consideration is to be treated as expenditure by the notional company (for the acquisition of the Property) and not as expenditure by the notional shareholders deductible from the base cost of their notional shares. One might ask the question (cf the question posed by Mr McCall referred to by Lord Browne-Wilkinson at [1995] 1 AC 165B) "Is there anything in section 99 which requires one to assume a state of facts inconsistent with the unitholders having provided the expenditure there referred to?" to which my answer is "Yes there is". It is inconsistent with section 38(1) to assume such a state of affairs when that section clearly treats the consideration for the Property, of which the expenditure referred to in section 39(1) forms part, as having been provided by the notional company and not by the unitholders.
67. In the light of those conclusions, I can deal with section 41 relatively shortly particularly as it is common ground that it would be illogical to reach different conclusions in relation to sections 39(1) and 41(2). In the first place, I should say that there is nothing in section 41 which leads me to a different conclusion in relation to section 39(1) from that which I have already reached.
68. Next, it should be noted that the first part of section 41(1) is an exclusion from an exclusion: it says that section 39(1) shall not require the exclusion from the sums allowable as deductions in the computation of gains of any expenditure which attracts a capital allowance or a renewals allowance. However, if the computation ignoring that exclusion results in a loss, then the second part of section 41(1) provides that the loss is restricted by reference to such allowances as provided by section 41(2).
69. Section 41(2) then provides that in the computation of the amount of a loss there is to be excluded from the sums allowable as deductions "any expenditure to the extent to which any capital allowance or renewals allowance has been or may be made in respect of it". Reading the second part of section 41(1) and section 41(2) together, I consider that section 41(2) only has the effect of re-introducing as exclusions certain amounts which would have fallen within section 39(1) apart from their exclusion by section 41(1). It is not the case that section 41(2) is a free-standing provision of wider extent, in relation to capital allowances and renewals allowances, than section 39(1).
70. In particular, the words "in respect of it" at the end of section 41(2) are to be read, in my judgment, as meaning no more than that, as a result of the very expenditure in question, the person making the disposal becomes entitled to claim a capital allowance in respect of it. A capital allowance is not made "in respect of" expenditure if that expenditure does not, itself, give rise to a capital allowance but, instead, it is necessary to rely on the further use of that expenditure (in the present case its use to purchase the Property) to establish the capital allowance.

Conclusion

71. For these reasons, I agree with Mr Oliver's conclusion on the effect of section 41(2) and dismiss the appeal of HMRC.