United Kingdom House of Lords Decisions

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Cite as: [2000] EG 62, [2000] UKHL 30, [2000] NPC 58

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Garner v. Pounds Shipowners and Shipbreakers Ltd and One Other Action [2000] UKHL 30; [2000] 3 All ER 218; [2000] 1 WLR 1107 (18th May, 2000)

HOUSE OF LORDS

Lord Slynn of Hadley Lord Jauncey of Tullichettle Lord Clyde Lord Hutton Lord Millett

OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT

IN THE CAUSE

GARNER (HER MAJESTY'S INSPECTOR OF TAXES)

(RESPONDENT)

v.

POUNDS SHIPOWNERS AND SHIPBREAKERS LIMITED

(APPELLANTS) AND ONE OTHER ACTION

ON 18 MAY 2000

LORD SLYNN OF HADLEY

My Lords,

I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Jauncey of Tullichettle. For the reasons he gives I too would dismiss the appeals.

LORD JAUNCEY OF TULLICHETTLE

My Lords,

These two appeals concern the method of computing for tax purposes the capital gain accruing on the grant of an option to purchase land which was never exercised. Although the taxpayer company has been assessed to corporation tax and the individual taxpayer to capital gains tax the relevant considerations applicable to both taxes are the same and since the two option agreements are for all practical purposes in identical terms I need only refer to the details of the grant by the company.

By agreement dated 9 September 1988 between the company and Mowat Group Plc. ("Mowat") it was stated in clause 1 that:

Clause 1.1 provided that the option should be exercisable by Mowat serving on the company's solicitors a purchase notice on any day prior to the expiry of the option period which was later defined, subject to a proviso which is not relevant to the appeal. Clause 1.2 provided that in the event of no purchase notice having been served before the expiry of the option period the agreement should cease to be of any effect whatsoever save that subject to clause 1.3 the sum of £399,750 should not become repayable to Mowat. Clause 1.3 provided that the said sum should be held by the company's solicitors as stakeholders until such time as (a) and (b) there had been executed and delivered a deed by each of two coventantees releasing two parts of the land from restrictive covenants and (c) a lease dealing with certain other rights had been granted. The sub-clause further provided:

The sub-clause then contained an undertaking by the company to use its best endeavours to secure the above releases, and continued:

Clause 1.4 provided that upon service of a purchase notice there should be constituted an immediately binding contract for the sale of the whole property for the price of £4,490,000 of which the sum of £399,750 should be taken into account as part payment.

On the date of the agreement the sum of £399,750 was paid to the company's solicitors as stakeholders and in May 1990 the company procured releases of the two restrictive covenants referred to in clause 1.3(a) and (b) on payment of £90,000. It appears that the lease referred to in clause 1.3(c) had also been granted with the result that the sum of £399,750 held by the solicitors was paid over to the company. Notwithstanding the fulfilment of the foregoing conditions Mowat did not exercise the option within the stipulated period. The revenue assessed the company to tax on the basis that the consideration for the disposal of the option was £399,750. The company appealed the assessment and has all along maintained that the payment of £90,000 made in order to obtain release of the covenants should be taken into account either in computing the consideration or as an allowable deduction therefrom. That is the issue between the parties.

The general commissioners for Portsmouth determined the appeal in the company's favour concluding that the sum of £90,000 was to be allowed as a deduction from the consideration of £399,750 pursuant to section 32 of the Capital Gains Tax Act 1979. On appeal by the revenue Carnwath J. rejected the company's contention that the £90,000 was a deduction from the consideration allowable by virtue of section 32 but upheld its contention that the £90,000 being the value of the obligation must be taken into account in computing the consideration. The revenue appealed to the Court of Appeal who rejected both arguments advanced by the company and allowed the revenue's appeal. The company now appeals to this House.

The relevant statutory provisions are all to be found in the Act of 1979 and the following matters are not in dispute. A gain accruing on the disposal of an asset is chargeable to tax. An option is an asset (section 19(1)(a)) and a grant of an option is the disposal of an asset, namely the option, unless it is exercised in which event the grant and the subsequent sale by the grantor in pursuance thereof are to be treated as a single transaction (section 137(1) and (2)). In the present case there being no exercise of the option the date of its disposal was the date of the agreement namely 9 September 1988 (section 27(1)).

Before examining the arguments advanced to your Lordships I propose to make some general observations about the terms of the agreement. The opening words of clause 1 refer specifically to the sum of £399,750 as consideration for the grant of the "option to purchase the property subject to the following terms and conditions." However, none of those conditions refer specifically to any actual or contingent alteration to the foregoing sum. Furthermore the sum was not necessarily repayable by the company if it failed to procure the release of the covenants since Mowat still had a discretion to exercise the option in that event. Conversely Mowat was not obliged to exercise the option even if the releases had been procured. In the latter event they would, as indeed happened, lose the sum of £399,750 but would incur no further liability.

Mr. Ewart for the company in a well-presented and forceful argument advanced two propositions. First he submitted that since contingent obligations which were not mentioned in section 40(2) and 41 of the Act of 1979 were to be taken into account in computing the consideration for the disposal a fortiori must the immediate obligation to procure the release of the restrictive covenants be taken into account. Any obligation undertaken by a seller to a buyer which involves payment has to be taken into account in computing the consideration for the disposal. Section 40(2) to which the sidenote reads "Consideration due after time of disposal" provides:

This subsection directs that the whole of the consideration must be brought into account at the date of disposal without any discount for deferment and without regard to the risk of any part of it being irrecoverable or of the right to receive any part being contingent. The final sentence of the subsection demonstrates, however, that the initial computation may in certain circumstances be provisional and subject to adjustment: Goodbrand v. Loffland Bros. North Sea Inc. [1998] S.T.C. 930, 933F-934A per Millett L.J. It will be seen that this subsection has no relevance to computation at the date of disposal of the consideration subsequently received by the company. Section 41 to which the sidenote reads "Contingent liabilities" provides that in the first instance no allowance shall be made in the computation for certain specified contingent liabilities but provides for adjustment of tax in the event of such contingent liabilities becoming enforceable. None of the specified contingencies are relevant to these appeals.

Mr. Ewart relied strongly on the decision of Walton J. in Randall v. Plumb [1975] 1 W.L.R. 633, in which the taxpayer granted for the sum of £25,000 an option to a company to purchase land for the sum of £100,000 if the company obtained planning permission, in which event the sum of £25,000 would be treated as part-payment of the purchase price. It was agreed that the company could demand repayment of the sum of £25,000 after the expiration of 10 years if it had not by then obtained planning permission. During the currency of the 10-year period and before planning permission had been obtained the taxpayer was assessed to capital gains tax in the sum of £25,000. The special commissioners upheld the assessment but on appeal Walton J. held that the consideration for the disposal of the option should be valued after taking the contingency of repayment into account. The legislation applicable at the time was the Finance Act 1965 and paragraph 15 of Schedule 6 thereto was in identical terms to section 41 of the Act of 1979.

Walton J. rejected, at p. 637, a submission by the revenue that since the contingency of repayment did not fall within [section 40(1)] it must be disregarded altogether notwithstanding that the taxpayer might have to repay the whole £25,000 and have no relief in respect of the tax paid. He continued:

It has not been suggested either in the Court of Appeal or in this House that Randall v. Plumb was wrongly decided and indeed on its facts I consider that it was a correct decision. However, it is distinguishable. The consideration there was not £25,000 absolute but £25,000 subject to repayment of the whole on the happening of a certain event. Thus, the contingency went directly to the value of the consideration. To have ignored it in valuing the consideration would have produced what Walton J. described, at p. 638, as "monstrous and unnecessary injustice to the taxpayer." However, this is not a case, as in Randall v. Plumb, of tax being assessed on a consideration which has been received but which may ultimately have to be repaid in whole or in part by reason of a contingent liability provided for contractually. Rather was there an immediate obligation involving probable payment of an unknown sum to third parties to procure release of restrictive covenants. The agreed sum of £399,750 has been received by the company and no part thereof has been repaid to Mowat. How can the value of a specific sum of cash paid by Mowat to the company be reduced because the company has paid another sum to a third party? In my view it cannot be. No payment by the company to a third party can alter the value of the cash sum of £399,750 paid by Mowat in terms of the agreement as a consideration for the disposal, i.e. the grant of the option.

Mr. Ewart also referred to Aberdeen Construction Group Ltd. v. Inland Revenue Commissioners [1978] AC 885 and to the well known passage in the speech of Lord Wilberforce, at p. 893, to the effect that in the taxation of capital gains "the courts should hesitate before accepting results which are paradoxical and contrary to business sense." In that case this House reached the conclusion that a sum paid to acquire the whole share capital of a company X on condition that the vendor of the shares waived a loan to X was in fact paid in consideration not only for the transfer of the shares but also the waiver of the loan. No such apportionment between the grant of the option and the obligation to obtain releases of the covenants has been here suggested so the case is relevant only to the above general observations of Lord Wilberforce. However important as commercial reality may be, it cannot be invoked to alter the unambiguous terms of an agreement negotiated at arms length. It follows that Mr. Ewart's first argument fails.

In conclusion on this branch of the case I must refer once again to the passage above cited in Randall v. Plumb where Walton J. states that unless the contingency is one expressly mentioned in [section 41] it should be taken into account in establishing the amount of consideration. In my view this proposition is too widely stated. If the contingency is directly related to the value of the consideration it may be appropriate, as it was in that case, to have regard to it in computing that value. If on the other hand it is related to matters which do not directly bear upon that value it does not follow that it must necessarily be taken into account.

Mr. Ewart's second proposition was that the sum of £90,000 was expenditure which was either wholly and exclusively incurred by the company in providing the option or expenditure similarly incurred in enhancing the value of the option, and as such deductible from the consideration for the disposal in accordance with the provisions of section 32(1)(a) and (b) of the Act of 1979. That subsection is, so far as relevant, in the terms:

a

b

Parties were agreed that on the authority of Chaney v. Watkis (1985) 58 T.C. 707 the incurring of an obligation which is capable of being valued in money could constitute expenditure for the purposes of section 32. However, they disagreed as to what was the asset which was disposed of. Mr. Ewart maintained that the option was the asset and the obligation was expenditure in relation thereto, whereas Mr. Henderson for the revenue submitted that the obligation was an inseparable part of the asset which was disposed of and was not undertaken to provide the option as a separate asset.

Assuming that the asset disposed of consisted of the option alone it was not an option to purchase land only when freed from the restrictive covenants but one to purchase land within a specified period subject to certain conditions one of which was the obligation above mentioned. However, what is important is that the implementation of the obligation was not a prerequisite of the option being exercised. If such implementation was not essential then I do not consider that the obligation could be said to be "wholly and exclusively incurred by [the company] in providing the [option]" for the purposes of section 32(1)(a).

So far as section 32(1)(b) is concerned the time of disposal of the option was, as I have stated, the date of the agreement and once again neither the obligation nor the subsequent payment of £90,000 could be said to be reflected in the state or nature of the option at that date, which was an option to purchase land at a specified price within a specified period. If the obligation was fulfilled within the period and Mowat had exercised the option the expenditure would no doubt have enhanced the value of the land which they had acquired but it would not have been reflected in the state or nature of the option itself.

Paragraphs (a) and (b) of section 32(1) are intended to deal with two different situations. Paragraph (a) relates to the acquisition cost to the taxpayer of the asset being disposed of. When there is no acquisition cost expenditure incurred in providing the asset is deductible. Since an option is created and hence provided by making a grant thereof it is the expenses of the grant which are prima facie deductible under paragraph (a): see [1999] S.T.C. 19, 28A Nourse L.J.

Paragraph (b) applies to expenditure incurred on the asset to enhance its value and reflected in its state or nature at the time of the disposal. It presupposes that the asset is in existence when the expenditure is incurred. This would cover the situation where after acquisition an asset is transformed or improved with the result that it fetches a higher price on subsequent disposal. Thus the acquisition cost is deductible under paragraph (a) and the subsequent cost of improvement under paragraph (b).

Since the option only came into existence at the date of the agreement I do not see how a contemporaneous obligation could be said to qualify as expenditure to which paragraph (b) applies.

Mr. Henderson's argument was short and simple. Since the obligation was not undertaken to provide the option but was an integral part of the asset provided by the company under the agreement it could not be both part of the asset and expenditure in relation thereto at one and the same time. The expenditure referred to in the subsection must be expenditure which was extraneous to the asset. There is a good deal to be said for the view that the obligation was part of the asset disposed of by the company and not a right independent of the option but in light of my conclusions in relation to the company's arguments I do not find it necessary to reach a conclusion thereon. I agree, however, with Mr. Henderson's contention that the expenditure referred to in section 32(1) must be expenditure which is extraneous to the asset rather than part of it.

Mr. Henderson suggested that there appeared to be no reason in principle why failure of these appeals should necessarily produce a black hole of £90,000 for the taxpayer company. I consider there to be force in this suggestion. The fact that the payment of £90,000 does not qualify as expenditure deductible from the consideration received for the option does not inevitably mean that in no circumstances can any part of the sum be taken into account in computing the consideration for a disposal. If Mowat had exercised the option and paid to the company the balance of the purchase price the company would have had strong grounds for claiming that the £90,000 was deductible in whole or in part from the consideration received for the sale of the land. The fact that the land may in fact be sold to a buyer other than Mowat should not alter the position. In either event it is the land not the option which is the asset being disposed of for the purposes of section 32(1), and it is the land whose value will have been enhanced by removal of the restrictive covenants.

For the foregoing reasons I would agree with the conclusions of the Court of Appeal and would dismiss these appeals.

LORD CLYDE

My Lords,

I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Jauncey of Tullichettle. I agree with it, and for the reasons he gives I too would dismiss the appeals.

LORD HUTTON

My Lords,

I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Jauncey of Tullichettle. I agree with it, and for the reasons he gives I also would dismiss these appeals.

LORD MILLETT

My Lords,

I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Jauncey of Tullichettle. I agree with it, and for the reasons he gives I too would dismiss the appeals.