Cost of release from agreement over shares not tax deductible

Section 38(1)(b) of the Taxation of Chargeable Gains Act 1992 provides: “(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 . . . (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 . . .”

Mr Kevin Prosser, QC, and Mr Charles Bradley for the taxpayer; Mr Michael Jones for the Revenue.

Lord Justice Briggs said that in 2006 the taxpayer paid £17.5 million to be released from certain obligations he had undertaken in 2003 in relation to his shares in Blackwell Publishing (Holdings) Ltd. Shortly thereafter he disposed of those shares for a little over £100 million. He sought to deduct the £17.5 million under section 38(1)(b) of the 1992 Act in computing his capital gain on the disposal of the shares. The Revenue refused to allow the deduction.

Looking more closely at section 38(1)(b), it was common ground that the taxpayer paid the £17.5 million for the purpose of enhancing the value of the shares in his hands. However, the Revenue submitted that the £17.5 million was not expenditure incurred “on” the shares, nor expenditure reflected in the “state or nature” of the shares at the time of the disposal. Nor was it expenditure incurred by the taxpayer in “establishing, preserving, or defending his title to, or to a right over” the shares.

The parties recognised that section 38(1)(b) really fell into two limbs, the first requiring both expenditure “on” the asset and expenditure that was reflected in the state or nature of the asset at the time of its disposal, and the second limb being a freestanding alternative, namely expenditure incurred in establishing, preserving or defending title to, or to a right over, the asset.

But the fact that they constituted alternative means of establishing the condition for deduction imposed by section 38(1)(b) meant that a reliable interpretation of section 38 required both to be kept in mind together, rather than viewed in entirely self-contained compartments.

It needed also to be borne in mind that section 38 applied for the purpose of computing both gains and losses on the disposal of assets, and that “assets” were defined in the widest terms by section 21 of the 1992 Act as extending to all forms of property, including incorporeal property generally, but also chattels, such as works of art.

Generally speaking, the Capital Gains Tax legislation, and concepts, phrases and words used in it, were to be given a broad commercial interpretation, and common sense ought to prevail if a narrow juristic, mathematical or technical interpretation would conflict with it.

The question whether the payment made for release from the applicable contractual obligations had affected the “state or nature” of the shares did not depend on whether the expenditure affected their value.

The state or nature of the shares was to be identified for the purposes of section 38(1)(b) by reference to the rights and obligations which those shares conferred or imposed on a shareholder pursuant to the applicable articles of association, and the state or nature of the asset was unaffected by the making or subsequent discharge of the relevant agreement because it was a purely personal agreement between the taxpayer and a third party.

The agreement imposed inhibitions on the taxpayer’s exercise of his rights as a shareholder, but the nature and state of the asset constituted by the shares remained the same throughout.

It was not uncommercial to apply a juristic analysis of the intangible asset constituted by shares in a company for the purpose of ascertaining its state or nature at any particular time; and to draw a distinction between the rights and obligations conferred and imposed by the shares themselves and personal undertakings by a shareholder to a third party which might restrict the exercise of those rights was both businesslike and legally correct.

Moreover, the £17.5 million payment had nothing to do with the taxpayer’s title to the shares, or his title to rights over the shares, for the purposes of the second limb of section 38(1)(b). It was a payment to discharge personal obligations or to buy back rights that had been entered into or conferred upon the third party by the relevant agreement. The rights within the agreement were personal rights of the third party over the taxpayer, not rights of the taxpayer over the third party.

It was also correct to have confined the concept of the “establishment” of title in section 38(1)(b) to making good or proving or clarifying the existence of a right, something entirely different from acquiring such a right.

Accordingly, section 38(1)(b) of the 1992 Act did not apply to the case.

Lord Justice Longmore and Lord Justice Patten agreed.

Solicitors: GRM Law; Solicitor, Revenue and Customs Commissioners.