HM Revenue and Customs v Smallwood

JurisdictionEngland & Wales
CourtCourt of Appeal (Civil Division)
JudgeLord Justice Lawrence Collins,Lord Justice Carnwath,Lord Justice Sedley
Judgment Date17 May 2007
Neutral Citation[2007] EWCA Civ 462
Docket NumberCase No: C3/2006/1663
Date17 May 2007

[2007] EWCA Civ 462







Royal Courts of Justice

Strand, London, WC2A 2LL


Lord Justice Sedley

Lord Justice Carnwath and

Lord Justice Lawrence Collins

Case No: C3/2006/1663

Commissioners for Her Majesty's Revenue & Customs
Charles ST Clair Smallwood

Mr Michael Furness QC (instructed by Her Majesty's Revenue & Customs) for the Appellant

Mr John Watson and Miss Kate Marten (Ashurst) for the Respondent

Hearing date: April 26, 2007

Lord Justice Lawrence Collins

I Introduction


This is an appeal from a decision of Warren J given on 6 July 2006, in which he dismissed an appeal from a decision of the Special Commissioner, HH Stephen Oliver QC (as he then was) dated 3 November 2005.


Mr Smallwood invested £10,000 in March 1989 in an enterprise zone property unit trust (“EZPUT”) known as PET8 in the Isle of Dogs Enterprise Zone. The trustee of PET8 then spent the subscription of Mr Smallwood (and those of other subscribers), as it was obliged to do by the terms of the trust, on land and buildings known as No 2 Harbour Exchange (“the Property”). To the extent that the money was spent on buildings, by contrast with the land, 100% first year capital allowances were obtained by Mr Smallwood and other unit holders. Mr Smallwood's share of those allowances amounted to £9,678, each unit holder being entitled to an allowance equal to 96.78% of his subscription. Mr Smallwood claimed this allowance which was set off against his general income for 1988/89.


About 10 years later, the trustee realised a substantial consideration in respect of the Property, and the realisation was effected by a set of transactions designed to avoid bringing about any balancing charges.


The issue is whether section 41(2) of the Taxation of Chargeable Gains Act 1992 (“ TCGA”) operates to restrict allowable losses that would otherwise have accrued in respect of Mr Smallwood's units in the EZPUT when he received distributions in respect of those units, giving rise to a deemed disposal under section 122, TCGA, and in particular whether part of the sum subscribed by Mr Smallwood for his units is expenditure in respect of which a capital allowance has been made in such a way as to be excluded from the sums allowable as a deduction in the computation of the loss.

II The facts


PET8 is an EZPUT which was formed in 1989 to invest in the Property. The original trust was effected by a trust deed dated 5 April 1989 and entered into between Midland Bank plc as trustee and the manager, Property Enterprise Managers Ltd. Clause 1 declared that the Property is to be held “upon trust for the Members in accordance with the terms of the Principal trust Deed”. The Principal trust Deed for this purpose was a master trust deed dated 25 October 1983 as subsequently amended (the “Principal trust Deed”).


The subscribers for units in PET8 (including Mr Smallwood) paid their subscription monies into an account of which the trustee had control. These monies, totalling £81,786,000 (the “Subscription Monies”) were paid on or before 31 March 1989, when the trust closed.


As a matter of general trust law, Mr Smallwood and his fellow unit holders in PET8 were beneficial co-owners of the assets in the trust as tenants in common in undivided shares proportional to their number of units.


On 31 March 1989 the trustee of PET8 took an assignment from Globebuy Ltd. of that company's rights under a development agreement which it had previously entered into with Charter Group plc (the “Developer”) and Charter Group Developments plc (“CGD”), a company in the same group as the Developer.


Under the arrangements to which the trustee then became party: the Developer was obliged to carry out and complete or procure that CGD carried out and completed the construction of the building at No.2 Harbour Exchange; as soon as practicable following the date of practical completion of the works (and in any event on the Developer itself receiving a headlease of the Property for 200 years less 2 days from the London Docklands Development Corporation under an agreement between the Developer and that corporation) the Developer was to grant to the trustee an underlease of the Property for a term of 200 years less three days (the “Underlease”); immediately following the grant of the Underlease, CGD was to take one or more 25 year sub-underleases of the Property from the trustee at a rack rent, the purpose of which was to provide a rental yield for those parts of the building which did not already have a commercial tenant; and in return for the grant of the Underlease and completing the works, Globebuy Ltd was to pay the Developer an aggregate purchase price of £81,786,000 by 31 March 1989.


In consideration of the assignment the trustee covenanted with Globebuy Ltd by way of indemnity to observe and perform all the covenants and obligations on the part of the purchaser contained in the development agreement.


The execution of the contracts and the payment of the Subscription Monies to the Developer satisfied the requirement in clause 2 of the Principal trust Deed that the trustee should apply the whole of “the Deposits” on the acquisition and development of the Property.


The trustee paid the Subscription Monies to the Developer on completion on 31 March 1989. The Developer refunded to Globebuy Ltd payments previously made by Globebuy Ltd under the development agreement.


Since the parties made an election under Finance Act 1978, section 37, by virtue of which the Underlease would be regarded as the “relevant interest” in relation to the expenditure on the building, the entire purchase price (save for that part which was attributed to the site) was eligible for capital allowances.


Consequently the conveyancing transactions were structured so as to confer entitlement to 100 per cent first-year capital allowances on the unit holders in PET8 for the full amount of their subscription, except for the part of the purchase price of the Property which was attributable to the land (rather than the buildings on it). The percentage of the subscriptions eligible for capital allowances was agreed with the Revenue to be 96.78 per cent.


Mr Smallwood subscribed for 10 units, each with a nominal value of £1,000. Mr. Smallwood paid his £10,000 subscription by cheque. The monies he subscribed formed part of the Subscription Monies and were applied by the trustee. Mr Smallwood claimed and obtained relief for capital allowances in the sum of £9,678.


The availability of first-year capital allowances for nearly 100 per cent of their investment was one of the main attractions to investors in EZPUTs. The fiscal benefits were even greater if an individual higher-rate taxpayer borrowed most of the money needed to make the investment. The existence of enterprise zone tax benefits meant that it was usually necessary to pay a premium over ordinary market value for enterprise zone property. This in turn increased the likelihood that such property would eventually be disposed of at a loss.


On 28 January 1999 the trustee granted a sub-sub-underlease of the Property for the whole of the then unexpired term of the Underlease (less a nominal reversion) to Hammerson (2 Harbour Exchange) Ltd at a premium of £43,417,749 plus VAT, subject to and with the benefit of the then existing occupational sub-underleases. Since the grant of the sub-sub-underlease was not a disposal of the relevant interest in the Property for capital allowances purposes, there was no balancing charge on the unit holders. The freehold interest in the Property was also sold. The Underlease was retained by PET8.


The realisation of the investment was structured in such a way as not to give rise to any balancing charge on the unit holders.


On 26 February 1999, Mr Smallwood received a capital distribution of £5,000 on his units. By virtue of TCGA sections 99 and 122(1) Mr Smallwood is to be treated as if he had disposed of an interest in the units in consideration of that capital distribution which represented some 97% of the then value of the units. By application of the part disposal formula in TCGA section 42, and without regard to any limitation which may be imposed by section 41(2) (which is the issue on this appeal), Mr Smallwood incurred a capital loss of £4,804. There was a further part disposal in 1999/00 giving rise to a capital loss on the same basis of £61.

III The issue and the decisions of the Special Commissioner and Warren J


I will set out the relevant provisions in full in section V below, but for present purposes it is sufficient to mention the principal provisions in issue.


By TCGA section 99(1), the Act is to apply in relation to any unit trust scheme as if (a) the scheme were a company and (b) the rights of the unit holders were shares in the company.


By TCGA section 38(1), “… the sums allowable as a deduction from the consideration in the computation of a gain accruing to a person on the disposal of an asset shall be restricted to – (a) the amount or value of the consideration …. given by him or on his behalf wholly and exclusively for the acquisition of the asset, together with the incidental costs to him of the acquisition …”


Section 39(1) provides that there shall be excluded from the sums allowable under section 38 as a deduction in the computation of the gain “any expenditure … allowable as a deduction in computing any other income or profits or gains or...

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