TC00590

Appeal number: TC/2009/14704

CHARGEABLE GAINS – computation – whether certain expenses deductible in computing chargeable gain – no by TCGA 1992 ss 38 and 39 – appeal dismissed

FIRST-TIER TRIBUNAL

TAX

                                        MRS MARGARET RAHA                        Appellant

                                                                      - and -

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                                   REVENUE AND CUSTOMS               Respondents

TRIBUNAL:              Guy Brannan  (Judge)                                                                                                           John Clark (Judge)

Sitting in public at Holborn Bars, London on 15 April 2010

Mr Duncan Forbes for the Appellant

Mr Jack Lloyd, Appeals and Review Unit, for the Respondents

© CROWN COPYRIGHT 2010

DECISION

1.       This appeal raises the question whether certain expenses incurred by the Appellant (Mrs Raha) are properly allowed as deductions in computing a chargeable gain arising to Mrs Raha in respect of the disposal by her of a chargeable asset in the tax  year 2006-2007.

The Facts

2.       A bundle of documents was admitted in evidence.

3.       Based on those documents we found the following facts, which were not in dispute.

4.       Mrs Raha acquired 68 Embassy House, West End Lane, London (“the property”) in 1976 and she occupied the property as her principal private residence until 1985. Thereafter she let the property as a furnished letting until 3 April 2006, on which date her final tenants vacated the property. She decided to sell the property and the sale was completed on 1 September 2006.

5.       When she disposed of the property, Mrs Raha made a chargeable gain. In her tax return for 2006 - 07 Mrs Raha claimed certain expenses as allowable expenditure in computing in her chargeable gain. The expenses related to the period starting after the tenants had vacated the property and ending on the date when the sale of the property was completed. The expenses (disregarding certain completion costs which were not in dispute) were set out in a schedule to Mrs Raha's tax return, as follows:

"Costs of Disposal

Expenses incurred preparing flat for sale:                                       £

Water Rates                                                                                107.09

Council Tax                                                                                 418.18

Electricity                                                                                        4.38

Gas & 3 Star Contract                                                                     1.57

Ground Rent                                                                               172.10

Telephone                                                                                      67.18

Service Charges                                                                           590.56

Insurance                                                                                      152.14

Furniture Clearance                                                                      473.60

                                                                                            1996.80”

6.       After the cessation of the letting there was no rental income against which these expenses could be set. It was common ground that these expenses could no longer be set off against the earlier rental income.

7.       Mrs Raha had also claimed as allowable expenditure the fees of her adviser, Mr Forbes, amounting to £950 in respect of his subsequent work in dealing with the dispute in relation to Mrs Raha's computation of her capital gain in respect of the property.

Relevant Statutory Provisions

8.       Section 39 of the Taxation of Chargeable Gains Act 1992 ("TCGA”) provides:

"Exclusion of expenditure by reference to tax on income

(1)  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 losses of a trade, profession or vocation for the purposes of income tax or allowable as a deduction in computing any other income or profits or losses for the purposes of the Income Tax Acts and any expenditure which, although not so allowable as a deduction in computing any losses, would be so allowable but for an insufficiency of income or profits for gains ...."

9.       Section 38 TCGA provides:

“Acquisition and disposal costs etc

(1) Except as otherwise expressly 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, together with the     incidental costs to him of the acquisition or, if the asset was     not acquired by him, any expenditure wholly and exclusively             incurred by him in providing the asset,

            (b) the amount of any expenditure wholly and exclusively incurred on the asset by him or on his behalf for the purpose of          enhancing the value of the asset, being expenditure reflected in           the state or nature of the asset at the time of the disposal, and    any expenditure wholly and exclusively incurred by him in          establishing preserving or defending his title to, or to a right      over, the asset,

            (c) the incidental costs to him of making the disposal.

(2)   For the purposes of this section and for the purposes of all other provisions of this Act, the incidental costs to the person making the disposal of the acquisition of the asset or of its disposal shall consist of expenditure wholly and exclusively incurred by him for the purposes of the acquisition or, as the case may be, the disposal, being fees, commission or remuneration paid for the professional services of any surveyor or valuer, or auctioneer, or accountant, or agent or legal adviser and costs of transfer or conveyance (including stamp duty [or stamp duty land tax]) together –

            (a) in the case of the acquisition of an asset, with costs of advertising to find a seller, and

            (b) in the case of the disposal, with costs of advertising to find       a buyer and costs reasonably incurred in making any valuation         or apportionment required for the purposes of the computation          of the gain, including in particular expenses reasonably           incurred in ascertaining market value where required by this       Act."

The arguments

10.    Mr Forbes on behalf of Mrs Raha argued that the expenses referred to in paragraph 5 above were allowable under s 38(1)(b). Mr Forbes placed emphasis on the words "any expenditure". These words in his view made it clear that the expenditure in question did not have to be capital expenditure. Mr Forbes argued that the asset (ie the property) was not just bricks and mortar but "a machine". In this sense the disputed expenses were incurred to prepare the property for sale, to enhance the value of the asset and were reflected in the state or nature of the property at the time of its disposal.

11.    In relation to s 39(1), Mr Forbes argued that since there was no income at all there could be no "insufficiency of income or profits or gains".

12.    Mr Forbes also argued that his fees referred to in paragraph 7 above were allowable as incidental costs of making the disposal of the purposes ofs38(1)(c). Since they were fees incurred by Mrs Raha for the purposes of the disposal.

13.    Mr Lloyd on behalf of the Respondents (HMRC) argued that in order for paragraph 5 expenses to qualify under s 38(1)(b) the expenditure had to be both capital in nature and to be reflected in the state or nature of the asset. In order for expenditure to be reflected in the state or nature of the asset they had to be a quantifiable improvement to the asset. Mr Lloyd also argued that the paragraph 5 expenses did not constitute incidental costs within the meaning of s 38(2). The disputed expenses were not capital in nature and they were not incurred wholly and exclusively for the purposes of the disposal of the asset. Mr Lloyd argued further that the disputed expenses referred to in paragraph 5 above were, in any event, disallowed by virtue of s 39(1) since they were expenses which would have been allowable for income tax purposes but for an insufficiency of income or profits or gains. As regards the fees referred to in paragraph 7, Mr Lloyd submitted that the fees were not incurred for the purposes of the disposal but rather were incurred in relation to the dispute between Mrs Raha and HMRC as to the correct computation of the chargeable gain arising from the disposal of the property.

The decision

14.    The scheme of taxation of capital gains requires the boundary between expenses which are allowable as revenue items for income tax or corporation tax purposes, on the one hand, any expenditure which is allowable in the computation of the chargeable gain on the disposal of a chargeable asset for capital gains tax purposes, on the other hand, to be defined. Generally, as regards the taxation of income, capital expenditure is not deductible (unless otherwise specifically provided eg capital allowances) in computing income which is chargeable to tax. Similarly, for capital gains tax purposes expenditure of a revenue nature is not allowable in the computation of a chargeable gain. Sections 38 and 39 define the boundaries of allowable expenditure for the purposes of capital gains tax.

15.    In particular, s 39(1) excludes, from those sums allowable under s 38, expenditure which would be allowable in computing income.  Section 39(1) specifically provides for the case where expenditure cannot be relieved against income because there is an insufficiency of income by excluding such expenditure from s 38.

16.    We consider the disputed expenses referred to in paragraph 5 above are disallowed by virtue of s 39(1). In particular, we consider that the words "which ... would be so allowable but for an insufficiency of income or profits or gains" are wide enough to cover the case where there is no income.

17.    Although our decision in relation to Section 39(1) was sufficient to determine the appeal in relation to the expenses referred to in paragraph 5, since much of the argument at the hearing concerned s 38 we shall also briefly consider this provision. In order to be allowable under s 38 (1) (b) the expenditure must be "reflected in the state or nature of the asset at the time of the disposal." There is surprisingly little authority on the meaning of this expression. However, these words were considered by the Court of Session in Aberdeen Construction Group Ltd  v Inland Revenue Commissioners [1977] STC 302 (the point was not considered in the subsequent appeal to the House of Lords). In that case the question arose whether the waiver of a loan made by the taxpayer to its subsidiary was allowable expenditure under what is now s 38(1)(b) in respect of the computation of the gain on the disposal by the taxpayer of the shares in the subsidiary. The Court of Session held that the loan waiver was not allowable. Although the waiver enhanced the value of the shares it was not reflected in the state or nature of the shares. The Lord President (Lord Emslie) said (at p 311 paragraph a):

"The waiver of the loans may well have enhanced their [the shares’] value but what [s 38(1)(b)] is looking for is, as a result of relevant expenditure, and identifiable change for the better in the state or nature of the asset, and this must be a change distinct from the enhancement of value."

18.    Section 38(1)(b) was also considered by the Special Commissioners in F D Fenston Will Trusts v HMRC [2007] UKSPC SPC00589. In that case the Special Commissioners had to consider whether a capital contribution to a Delaware company was allowable under s 38(1)(b) in circumstances where no shares were issued. The Special Commissioners said (at paragraph 23 ):

“It is clear from the provision that Parliament did not intend that all expenditure incurred for the purpose of enhancing the value of an asset should be deductible in computing capital gains. Only such expenditure as would be reflected in the "state and nature of the asset at the time of the disposal" was to be allowed. Further, "state and nature" for these purposes must be something other than merely the value of the asset – otherwise this phrase would add nothing to the immediately preceding words. In this case the Capital Contributions did not result in any increase in the number of shares in issue, or result in any change in the rights or restrictions attaching to the shares. The only effect of the Capital Contributions was to increase the surplus of the company – which would increase the amount available for distribution to shareholders, and therefore presumably the value of the shares. We do not consider this sufficient for the expenditure on the Capital Contributions to be reflected in the state and nature of the shares, either at the time the expenditure was incurred or at any time subsequently.”

19.    In our view, the expenses referred to in paragraph 5 did not lead to any identifiable change in the state or nature of the property. The asset itself remained unchanged. Accordingly, we consider that those expenses were not expenditure within the meaning of s 38(1)(b).

20.    For completeness, as regards s 38(1)(c), we consider that none of the expenses referred to in paragraph 5 constitute incidental costs of making the disposal as defined by s 38(2).

21.    Finally, we consider that the fees charged to Mrs Raha referred to in paragraph 7 plainly did not constitute enhancement expenditure within s 38(1)(b) nor did they constitute incidental costs of making the disposal within s 38(2). In relation to s 38(2) the fees did not constitute expenditure incurred by Mrs Raha for the purposes of the disposal but rather constituted expenditure incurred in dealing with her tax affairs consequent upon the disposal and in conducting a dispute with HMRC (see Administrators of the Estate of Caton (deceased) v Couch (Inspector of Taxes) [1997] STC 970) and consequently are not allowable.

22.    For these reasons, we concluded that the appeal must be dismissed.

Evidence of Mr Garcia and Conduct of HMRC

23.    During the hearing Mr Forbes asked Mr Mario Garcia to give evidence. Mr Garcia is a Fellow of the Chartered Institute of Certified Accountants and specialises in tax matters. In the event, Mr Garcia did not in fact give evidence but rather put forward arguments in relation to s 38(1)(b) and referred to paragraph 152251 of HMRC’s Capital Gains Tax Manual, which refers to accountants’ fees in relation to s 38(2). In the event, we did not consider that Mr Garcia's submissions differed materially from those put forward by Mr Forbes. In relation to paragraph 152251 of the Capital Gains Tax Manual, the relevant paragraph simply paraphrased the provisions of s 38(2) and, in the context of the other paragraphs in that section of the Manual, could not be said to be misleading.

24.    Mr Garcia indicated that he had experience of very similar cases to that of Mrs Raha's being treated differently by HMRC. In addition, Mr Forbes indicated strong dissatisfaction at the way in which HMRC had dealt with Mrs Raha's case. We informed Mr Forbes that the Tribunal did not have jurisdiction to deal with complaints about HMRC's conduct. Such complaints had to be taken up with the Adjudicator’s Office. However, we would observe that there was nothing in the papers before us which indicated any improper conduct by HMRC. Although there were certain minor typographical errors and some errors as regards addresses, none of these errors were in any way major. We would also observe that HMRC reduced the chargeable gain reported on Mrs Raha's tax return by pointing out an error in the application of the principal private residence exemption.

Administrative Error

25.    There was one procedural point which arose at the outset of the hearing. An administrative error was made as a result of the Tribunal staff failing to take into account the Appellant’s request for an oral hearing.  The result was that Mr Forbes was put to the task of having to prepare a statement of case, which he said took him a number of hours. He asked for the Tribunal to pay his costs. In our view, although Mr Forbes had to do this, it did amount to advance preparation of his argument for the hearing, so his work was not wasted. Nor did we think there was merit in his assertion that his client's case had been prejudiced by having "revealed his client's hand" in advance of the hearing since the arguments he put forwarded were essentially those already advanced in correspondence and it is now an essential feature of the rules of civil procedure that the parties to a dispute should, as far as possible, set out their respective case in advance of the hearing. In addition, we do not think that there is any basis for the Tribunal to recompense him for the cost involved.

26.    This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

GUY BRANNAN

                                                              &

JOHN CLARK

TRIBUNAL JUDGES

RELEASE DATE: 6 July 2010