Is it possible to claim losses for capital gains tax (CGT) purposes on forfeited deposits? The FTT has considered this question once again in Drake v HMRC [2022] UKFTT 25 (TC). Unfortunately for the taxpayer, the FTT departed from the approach adopted in Lloyd-Webber v HMRC [2019] UKFTT 717.
The FTT held that Hardy v HMRC [2016] UKUT 0322 (TCC) was not per incuriam and as such it is legally binding. Given this, the FTT determined that no asset was acquired when the contract for the grant of a lease was entered into. When the contract was repudiated, no asset was disposed of. Therefore, there was no allowable loss for CGT purposes.
This case is important because it shows a different approach from the more recent case law. As a result, practitioners cannot depend on the Courts to ignore Hardy in favour of a more generous approach going forward. Care should be taken when drafting contracts where it may be possible to draft around this specific issue.
Background
In July 2014, the taxpayer entered into an agreement for a lease under which at completion he would be granted a lease of a property in return for a premium of GBP 2.2m. A non-refundable 20% deposit was payable on the date of the contract and a 10% stage payment was payable one year later. These were advance payments of the premium. The appellant defaulted on payment of the 10% payment. The vendor, therefore, considered that the contract was repudiated. It never completed, and the taxpayer never took possession of the lease.
The question before the FTT was whether the taxpayer had an allowable loss for CGT purposes equal to his lost deposit.
Law on Forfeited Deposits
The law on this particular subject is relatively contained and can be boiled down to a few sections/cases. Despite this, it is not straightforward.
The arguments as to why the forfeited deposits should be treated as allowable losses boil down to the following questions:
- Does the taxpayer acquire an “asset” as defined when entering into these types of contracts (namely contracts for the grant of a lease or for the sale of land)?
- If there is an asset, is that asset disposed of when the contract is repudiated?
- Assuming yes, is the loss an allowable loss?
Legislation
The key legislation is found in the Taxation of Chargeable Gains Act 1992 (“TCGA“). The sections to look out for are the following (to skip straight to the case law click here):
For the meaning of “assets” and “disposals” section 21 TCGA:
21 Assets and disposals
(1) All forms of property shall be assets for the purposes of this Act, whether situated in the United Kingdom or not, including (a) options, debts and incorporeal property generally, and
(b) … and
(c) any form of property created by the person disposing of it, or otherwise coming to be owned without being acquired.
(2) For the purposes of this Act–
(a) references to a disposal of an asset include, except where the context otherwise requires, references to a part disposal of an asset, and
(b) there is a part disposal of an asset where an interest in right in or over the asset is created by the disposal, as well as where it subsists before the disposal, and generally, there is a part disposal of an asset where, on a person making a disposal, any description of property derived from the asset remains undisposed of.
For the specific section on forfeited deposits, section 144 TCGA:
144 Options and forfeited deposits
(1) Without prejudice to section 21, the grant of an option, and in particular—
(a) the grant of an option in a case where the grantor binds himself to sell what he does not own, and because the option is abandoned, never has occasion to own, and
(b) the grant of an option in a case where the grantor binds himself to buy what, because the option is abandoned, he does not acquire,
is the disposal of an asset (namely of the option), but subject to the following provisions of this section as to treating the grant of an option as part of a larger transaction.
(2) If an option is exercised, the grant of the option and the transaction entered into by the grantor in fulfilment of his obligations under the option shall be treated as a single transaction and accordingly—
(a) if the option binds the grantor to sell, the consideration for the option is part of the consideration for the sale, and
(b) if the option binds the grantor to buy, the consideration for the option shall be deducted from the cost of acquisition incurred by the grantor in buying in pursuance of his obligations under the option.
(3) The exercise of an option by the person for the time being entitled to exercise it shall not constitute the disposal of an asset by that person, but, if an option is exercised then the acquisition of the option (whether directly from the grantor or not) and the transaction entered into by the person exercising the option in exercise of his rights under the option shall be treated as a single transaction and accordingly—
(a) if the option binds the grantor to sell, the cost of acquiring the option shall be part of the cost of acquiring what is sold, and
(b) if the option binds the grantor to buy, the cost of the option shall be treated as a cost incidental to the disposal of what is bought by the grantor of the option.
(4) The abandonment of—
(a) a quoted option to subscribe for shares in a company, or
(b) a traded option or financial option, or
(c) an option to acquire assets exercisable by a person intending to use them, if acquired, for the purpose of a trade carried on by him,
shall constitute the disposal of an asset (namely of the option); but the abandonment of any other option by the person for the time being entitled to exercise it shall not constitute the disposal of an asset by that person.
…
(7) This section shall apply in relation to a forfeited deposit of purchase money or other consideration money for a prospective purchase or other transaction which is abandoned as it applies in relation to the consideration for an option which binds the grantor to sell and which is not exercised.
Caselaw
Hardy v HMRC
The facts of Hardy are almost indistinguishable from the facts in Drake so it is worth considering this decision and the reasoning of the UT in some detail.
In short, the taxpayer had entered into a contract for the purchase of an off-plan leasehold property which did not complete. 10% of the contract price was required to be paid on the date of the contract. That 10% deposit would be credited against the purchase price on the date of completion. The benefit of this contract was unassignable.
The FTT decided that the taxpayer had not acquired an asset through the exchange of the contracts or through the satisfaction of the conditions as to the construction of the house because the transactions never took place. The loss of the deposits was therefore not capable of being allowed against chargeable gains in the same year.
The taxpayer appealed to the UT arguing that when he entered into the contract, he acquired valuable contractual rights which were an asset. When the contract was rescinded the rights were extinguished resulting in a loss of the forfeited deposit.
The UT considered this appeal by addressing the three above questions and concluded as follows:
- “Assets” for CGT purposes is widely defined in section 21 TCGA, and can include contractual rights; however, it is necessary to carefully analyse the contractual rights in question to establish whether or not they are in fact “assets”. What the taxpayer had acquired was the right to obtain specific performance of the vendor’s obligations to convey legal title to the property in the event that he complied with his obligations. The asset in question, which is the land, is not acquired or disposed of until completion takes place. It does not make a difference if one is looking at the buyer’s beneficial ownership of the land or the buyer’s contractual right to obtain specific performance. If completion fails, there is no disposal of acquisition of this asset.
As an additional point, the UT noted that it would not have made a difference if the rights had in fact been assignable as this does not affect the fundamental point as to what the “asset” is. - If the UT was wrong, and there was an asset, the UT had to address whether or not there was a “disposal” within section 24(1) TCGA. If there was, then it was necessary to consider whether that was excluded by section 144(7) and (4). TCGA.
The UT decided first that a forfeited deposit in these circumstances was in principle within section 144. Once within section 144, it was necessary to treat the forfeited deposit in the same way as a abandonment of an option. As such, following section 144, as the transaction was not entered into as part of the taxpayer’s trade, the abandonment of it was not a dispoal by that person.
The UT specified that the word “abandonment” does not require necessarily that the taxpayer had abandoned it in the normal sense of the word. As such, it did not matter that the taxpayer tried to prevent the forfeiture from occurring. - If the UT was wrong on both of the above points and there was a disposal of an asset, the UT went on to consider whether the loss was allowable. The UT concluded that it would not have been allowable in these circumstances becuase the deposit was not paid wholly and exclusively for the purchase of the contractual rights. There was a dual purpose in that it was also a part-payment of the purchase price of the Property.
It is worth noting that points 2 and 3 are obiter.
Lloyd-Webber & Anor v HMRC
A criticism of Hardy is that it did not consider the decision of the Upper Tribunal in Underwood v HMRC [2009] STC 239 as noted by the FTT both in this case and in Lloyd-Webber & Anor v HMRC [2019] UKFTT 717 (TC).
Given this, it was common ground before the FTT in Lloyd-Webber that Hardy was per incuriam and as such not binding on the FTT.
As a result, it was not disputed that assets were acquired in Lloyd-Webber in the form of the contractual rights and that there was a disposal of those rights when they were released in accordance with the contracts in that case.
The FTT, therefore, focused on whether the test in section 38 TCGA was met and as such whether the payments were wholly and exclusively for the purchase of the contractual rights. In their view, it was after taking an objective approach and having regard to all the circumstances. The payment was made for the acquisition of contractual rights – the only assets actually acquired.
The FTT also considered that taking this approach was consistent with the wider scheme of the TCGA.
Underwood v HMRC
This case is somewhat complicated and it is not exactly on point, so I don’t think it is worth going into too much detail. What is worth taking away from this Judgement of the Court of Appeal is that in the context of certain contracts, there were contractual rights that were separate assets from the property itself.
Analysis
With this background the FTT undertook an interesting analysis of Hardy asking itself the following questions:
- What was the ratio of Hardy and Underwood?
The ratio of a decision is its legal basis.
Hardy decided that no allowable loss arises for capital gains purposes where a deposit for acquisition of a property is lost due to the taxpayer’s defaulting on his own obligations to make full payment. The UT primarily decided this on the basis that the taxpayer had no relevant asset.
Underwood decided that where a taxpayer has two contracts with the same person – one to sell and one to re-purchase the same land – and settles those contracts by payment of the net excess of the re-purchase price over the sale price, no allowable loss for CGT purposes arises as there is no disposal of the land. - Does Underwood render Hardy per incuriam?
Whilst it was common ground in Lloyd-Webber that Hardy was per incuriam, and whilst the parties in this case had agreed it was, the FTT considered that this was not enough to assume that it was in fact per incuriam. After considering submissions by the parties on the point, the FTT concluded that to the extent that Underwood contradicts Hardy, it is obiter so would not render Hardy per incuriam. In any event, the statements in Underwood do not address the key issue in Hardy as to whether contractual rights under land contracts are capital gains assets. - Is Hardy binding authority in this case?
Given what had been concluded, Hardy is binding authority.
The taxpayer’s repudiatory breach, therefore, did not constitute a disposal of an asset for CGT purposes.
The FTT did conclude that even if it were wrong on its analysis of Hardy, on the basis of sections 144(4) and 144(7) TCGA, a forfeited deposit of purchase money does not constitute the disposal of a CGT asset.
What can we take from this case?
It will be difficult to rely on the reasoning in Lloyd-Webber after this case given what the FTT has said. Of course, this is only a decision of the FTT so it is not binding precedent, but it will give HMRC a leg to stand on in arguing these cases.
As such, in negotiating these contracts, the best option may be to try to structure the financing so that these pre-payments are not structured as deposits.
If anything in this blog post was of interest to you or if you feel that you or a client has an issue that this case touches on, please feel free to contact me using the information here.