The High Court upheld a decision of the special commissioners ((2005) Sp C 509) that the Taxation of Chargeable Gains Act 1992, s. 41(2) did not operate to restrict the allowable losses accruing in respect of a taxpayer's units in an enterprise zone unit trust (‘EZPUT’) when he disposed of the units since the sum subscribed by the taxpayer for the units was not expenditure in respect of which a capital allowance had been made.

Facts

In March 1989 the taxpayer invested £10,000 in an EZPUT, known as PET8 in the Isle of Dogs Enterprise Zone. The trustee of PET8 spent the moneys subscribed by the taxpayer and by other subscribers on land and buildings. To the extent that those moneys were spent on buildings, as distinct from the sites of those buildings, 100 per cent first year capital allowances were obtained. The effect of the Income Tax (Definition of Unit Trusts Schemes) Regulations 1988 (SI 1988/267) (‘the 1988 Regulations’) was that the taxpayer, as unit holder, obtained his share of those capital allowances amounting to £9,678. He claimed those allowances and they were set off against his general income for 1988–89.

Nearly ten years later the property in PET8 was realised and in the tax years 1998–99 and 1999–2000 the taxpayer received distributions of £5,000 and £125 in respect of his units. Those distributions fell to be treated for capital gains tax as part disposals by the taxpayer of his units. But for TCGA 1992, s. 41(2), those part disposals would have given rise to allowable losses in the taxpayer's hands. However, s. 41 made provision for the amount of any losses accruing on the disposal of an asset to be restricted by reference to capital allowances and, by s. 41(2), excluded from the sums allowable as a deduction any expenditure to the extent to which any capital allowance or renewals allowance had been or might be made in respect of it. The taxpayer appealed against the Revenue's amendment of claims for capital losses arising in the years 1998–99 and 1999–2000.

The taxpayer contended that s. 41(2) did not operate to restrict the losses accruing to him since the expenditure he incurred in subscribing for his units in PET8 did not give rise to capital allowances. The expenditure which gave rise to the capital allowances was his share of the expenditure by the trustee of PET8. The Revenue contended that s. 41(2) operated to restrict and eliminate the losses that would otherwise accrue to the taxpayer, because to the extent of £9,678 the expenditure which he incurred in subscribing for his units in PET8 was expenditure ‘in respect of which capital allowances were made within the meaning of the subsection.

A special commissioner allowed the taxpayer's appeal, concluding that the words ‘any expenditure’ in the expression ‘any expenditure to the extent to which any capital allowance . . . has been or may be made in respect of it’ in s. 41(2) should be interpreted as referring to expenditure comprised in the consideration given wholly and exclusively for the acquisition of the relevant asset, i.e. the £10,000 given by the taxpayer for his units. Capital allowances were not given in respect of that expenditure. Thus s. 41(2) did not apply ((2005) Sp C 509). The Revenue appealed to the High Court.

Issue

Whether TCGA 1992, s. 41(2) operated to restrict allowable losses that would otherwise have accrued when the taxpayer disposed of the units because part of the sum subscribed by the taxpayer for the units was expenditure in respect of which a capital allowance had been made.

Decision

Warren J (dismissing the appeal) said that TCGA 1992, s. 39 excluded certain items from the sums allowable by s. 38 as deductions in computing the gain on a disposal. In an ordinary case, that provision gave rise to no difficulty. A taxpayer would purchase an asset out of his own money for a price. The sum allowable under s. 38 was, prima facie, the amount of the purchase price and that sum was set against the amount of the disposal consideration when he subsequently sold the asset. The payment of the purchase price was clearly expenditure by the taxpayer and was, ex hypothesi, expenditure allowable as a deduction for the purposes of s. 39(1).

In the present case, since TCGA 1992 applied to the acquisition of the property by the trustees as if the scheme were a company, it applied, in particular, as if the subscription moneys provided by the unit holders were assets of the notional company; and it also applied as if the trustees’ acquisition of the property were an acquisition by the notional company, in respect of which the purchase price given fell within s. 38(1) as consideration given by the notional company.

That was so notwithstanding that the actual payment made by the trustees was out of the money subscribed by the unit holders (the scheme having no other assets), money which, apart from the world of CGT, belonged beneficially to the unit holders. On a disposal by the trustees of the property, TCGA applied as if the disposal were by the notional company. The amount of the consideration given for the acquisition fell within the sums allowable under s. 38(1) in computing the gain on that disposal, subject to TCGA 1992, s. 39 and 41.

The result was that: (1) there had been a payment by the trustees in consideration of the purchase of the property; (2) that payment was made out of the subscriptions of the unit holders to the scheme; (3) so far as the taxpayer was concerned, 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 (4) TCGA 1992 applied as if the scheme were a company so that that payment represented consideration given by the notional company under s. 38 for the property and not consideration given by the unit holders. So far as s. 39(1) was concerned, the expenditure giving rise to the capital allowances available to unit holders was not excluded from the sums allowable as a deduction in computing the gain accruing to unit holders on distributions from the scheme. It was the purchase of the property which gave rise to the capital allowances and not the subscription of moneys to the scheme by the unit holders. The payment of the purchase consideration by the notional company was clearly ‘expenditure’ in respect of which the taxpayer and other unit holders became entitled to capital allowances. Thus it fell within s. 39(1) in relation to the base cost of the notional company unless it could be said that s. 39(1) required that the capital allowance (or other deduction) envisaged by s. 39(1) must accrue to the person making the disposal. But, since that was not a requirement of the subsection, s. 39(1) applied to exclude from the trustees’ base cost of the property the amounts in respect of which unit holders obtained capital allowances.

As regards TCGA 1992, s. 41(1), the first part of that subsection was an exclusion from an exclusion: it said that s. 39(1) should not require the exclusion from the sums allowable as deductions in the computation of gains of any expenditure which attracted a capital allowance or a renewals allowance. However, if the computation ignoring that exclusion resulted in a loss, then the second part of s. 41(1) provided that the loss was restricted by reference to such allowances as provided by s. 41(2).

Section 41(2) then provided that in the computation of the amount of a loss there was 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’. Section 41(2) only had the effect of re-introducing as exclusions certain amounts which would have fallen within s. 39(1) apart from their exclusion by s. 41(1). Section 41(2) was not a free-standing provision of wider extent, in relation to capital allowances and renewals allowances, than s. 39(1).

In particular, the words ‘in respect of it’ at the end of s. 41(2) were to be read as meaning no more than that, as a result of the expenditure in question, the person making the disposal became entitled to claim a capital allowance in respect of it. A capital allowance was not made ‘in respect of expenditure if that expenditure did not, itself, give rise to a capital allowance. Instead, it was 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.

Chancery Division. Judgment delivered 6 July 2006.