The special commissioners decided that capital contributions made by will trustees to a company incorporated in Delaware were not allowable expenditure for the purposes of TCGA 1992, s. 38(1)(b) so that, on the disposal of shares in the company, they could not to be treated as sustaining an allowable loss.

Facts

At all material times and from a date in 1994, the trustees owned all the shares in D, a Delaware company concerned in various joint venture projects for developing property, principally in California. The trustees made capital contributions, amounting to £1,530,546 to D. D's business subsequently failed and in 1994 the trustees sold the entire share capital of D for $1. The trustees claimed to have sustained an allowable loss when the capital contributions were taken into account.

Under Delaware law, the contributions had increased the company's net assets, and thus its surplus, thus increasing the amount of funds the company could lawfully have distributed to the trustees (as stockholders) as a dividend. If the company had been dissolved immediately after such contributions had been made, the amounts the trustees (as stockholders) would have been entitled to receive as stockholders upon dissolution with respect to the shares would have been increased by the amount of the contributions assuming, in each case, that amounts would remain for distribution to the stockholders following the payment in full of the company's creditors. Therefore, the contributions would have increased the amounts that could have been distributed with respect to the shares either as a dividend or as a liquidating distribution. The trustees appealed against assessments to capital gains tax for the 1998 year. They contended that, in computing their allowable losses, the £1,530,546 paid in to D as capital contributions should be deducted as expenditure within the terms of s. 38(1)(b) of the 1992 Act. On that basis, the trust would have no capital gains tax liability for 1997–98, as allowable losses so computed would exceed chargeable gains for that year.

Issue

Whether within s. 38 (1)(b) the trustees had incurred any expenditure ‘on the asset... for the purposes of enhancing the value of the asset’, being ‘expenditure reflected in the state or nature of the asset at the time of the disposal’.

Decision

The special commissioners (Sir Stephen Oliver QC and Nicholas Aleksander) (dismissing the appeal) said that the ‘asset’ in this case was the shares which represented the interest in D of the trustees as members of D. That interest was made up of the mutual covenants contained in the ‘constitution’ of the company and the number of shares issued to the trustees was the measure of their interest in D.

The consequence of each capital contribution was to increase the net assets of D, and therefore the ‘surplus’ that was available for stockholders, either as a dividend (should the company choose to pay them) or as a distribution on the liquidation of the company. The enhancement effect was demonstrated by the increases in the surplus resulting from the capital contributions as shown in the accounts. It was self-evident that the capital contribution was incurred by the trustees, as members, for the purpose of enhancing the value of their assets. The amount contributed actually enhanced the value of the asset. The irresistible inference was that the trustees, as members, incurred the expenditure with that purpose in mind.

Although capital contributions were not unknown to English law they were unusual, whereas they were a common method for Delaware companies to raise additional capital. Although the capital contributions might have led to an increase in the ‘surplus’ of D as a matter of Delaware law, an increase in the surplus was not sufficient for the expenditure to be ‘reflected in the state or nature’ of the shares either at the time the expenditure was incurred, or at the time of the disposal.

It was clear from s. 38(1)(b) 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 those purposes had to be something other than merely the value of the asset, otherwise that 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. That was not 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.

The expenditure on the capital contributions would have been allowable had the company issued even one share, either under the then ‘pooling’ provisions in TCGA 1992, s. 104, or under the reorganisation provisions (in particular s. 128). Moreover, it was likely that the issue of one share could have been effected quite informally. However no such share was ever issued. The fact that US federal tax law might regard a share as having been issued in some circumstances for certain US federal income tax purposes, even if, as a matter of fact, no such share was ever issued was irrelevant to the application of UK tax law.

Further, it was irrelevant that s. 38(1)(b) might have no application to intangible assets if it had no application on the facts of this case. It was clear that the provisions had application in relation to land and buildings (for example expenditure on the construction of a new house on an empty plot), and the provisions were therefore not without meaning.

(2007) Sp C 589.
Decision released 7 February 2007