Enter Your E-mail

Tolley's Practical Tax by Arthur Sellwood

Arthur Sellwood takes a fresh look at the taxation implications.In the past – especially perhaps, when capital profits were not taxable at all – the Revenue were only too anxious to discover ‘badges of trade’ in isolated or infrequent transactions and thus to have such transactions designated as trading profits, which were fully assessable to tax. They should not, therefore, feel unduly aggrieved where a taxpayer uses a similar line of approach to gain an advantage by turning what might seem to be a capital loss into a trading loss in order to use a relief provided in the legislation.

Where a person incurs a capital loss, it is not normally available for relief against other income. Similarly, where a member of a group of companies incurs such a loss, it is not available for allowance as group relief against the profits of other group companies.

Special rules for transfers into and out of stock

It is provided in TCGA 1992 s 161(1) and s 161(2) that, if a person transfers an asset which he acquired otherwise than as trading stock into a trade carried on by him, he is to be treated as having disposed of it at its market value and as having made a capital gain or loss accordingly. In the same way, if he appropriates an asset out of trading stock for any other purpose, either while his trade still continues or on its cessation, he is treated as having acquired the asset at that time for a consideration equal to the amount brought into his accounts at the time of his appropriation of the asset.

A right is, however, given by s 161(3) to elect that, where the person is chargeable to income tax on the profits of the trade under Schedule D Case 1, the market value of the asset, for the purpose of computing those profits, should be reduced by the capital gain otherwise assessable or increased by the capital loss allowable. This means that the capital gain or loss is effectively converted into a trading profit or loss.

These rules are applied by s 173 to transfers into or out of trading stock by one member of a group of companies to another.

A tax-planning opportunity

As might have been expected, the availability of this statutory right of election could be seen as an opportunity for tax-planning which might escape being blocked by the Ramsay principle. It might have been expected also that the use for this opportunity could be found in cases involving assets of high value, such as real property and stocks and shares. In 1982, two cases, which were eventually heard together in the higher courts, although one was concerned with property and the other with shares, found their way into the Chancery Division.

In Coates v Arndale Properties Ltd [1984] STC 637 the taxpayer was a property dealing member of a group of companies. Another company in the group had a property, the market value of which showed a loss of over £2,000,000 on its acquisition cost. This property was assigned to Arndale Properties Ltd, which passed it on to an investment company in the same group and purported to make an election under the predecessor to the section referred to above – which would have had the effect of turning what would have been a capital loss into a trading loss. The Revenue claimed that Arndale had not acquired the property as trading stock and treated the election as ‘invalid’. The General Commissioners accepted the company’s claim and the Revenue appealed and argued that, under the new approach signified by the Ramsay decision, this avoidance scheme should be nullified. The Commissioners’ finding and decision was upheld in the High Court but overturned by the Court of Appeal, whose decision was affirmed in the House of Lords. In the principal judgment, Lord Templeman agreed that there were sound commercial reasons for converting the capital loss into a trading loss, but said that Arndale never had any intention of trading with the property which could not, therefore, be said to have been transferred into trading stock.

In the other case, Reed v Nova Securities Ltd [1985] STC 124, the taxpayer company had traded in securities and shares for some years, before it was acquired by the well-known Littlewoods Group. Littlewoods had sustained losses in a German venture, which it arried on through a subsidiary called Medaillon. After acquiring Nova Securities Ltd, it sold the shares in Medaillon and that company’s book debts to Nova. That company made an election to have the shares and debts regarded as having been transferred into trading stock at their original cost and then to have disposed of them at a substantial loss, which it claimed to be a trading loss. The Revenue resisted this, but the company’s claim was upheld by the Commissioners and in the Chancery Court and the Court of Appeal, although in the latter court, Lord Justice Lawton delivered a dissenting judgment. When the case came before the House of Lords, it was said by Lord Templeman that the Revenue could not complain that a taxpayer had obtained an advantage by availing itself of the opportunity which the legislation offered. He also said, however, that for an asset to be trading stock it had to be of a kind which was sold in the ordinary course of the company’s trade and must have been acquired for the purposes of that trade with a view to profit. The House of Lords upheld the decisions of the lower courts with regard to the debts, but overturned their decision on the shares. It was said that no reasonable body of commissioners could have concluded that the company had acquired the shares as trading stock and that this acquisition had no commercial justification.

A more recent case

In 2003, a case came before the Special Commissioners under the title ‘A property-dealing company v Inspector of Taxes’ SpC 360. The taxpayer company belonged to a group, whose parent company owned a number of properties through its subsidiaries. The group decided to cease investing in commercial property and to sell off its entire portfolio via the taxpayer, a dealing company. This company made an election to treat the properties as having been acquired as trading stock, so that any losses could be regarded as trading losses for the purpose of group relief. On an appeal against the Revenue’s determination, which did not take the losses into account, the Commissioners held that the properties had not been acquired as trading stock. Under the more succinct title of New Angel Court Ltd v Adam, the High Court held that the Special Commissioners had correctly directed themselves in law and that they were entitled to look at the intention of the group of companies as a whole and to conclude that the properties were disposed of as capital assets. The company’s appeal was therefore dismissed.

New Angel Court Ltd v Adam [2004] EWCA CV42 went to the Court of Appeal in March 2004. The company’s claim that they had sustained a trading loss of £68,000,000 on properties acquired from other group companies as trading stock, had been dismissed by the Special Commissioners and the High Court, but this decision was now overturned by the Court of Appeal. It was said that TCGA 1992 s 173(1) did not require fiscal considerations to be taken into account. The point to be considered was whether the acquisition of the properties had a trading purpose. It was considered that the assets, which had been acquired by New Angel Court, were of a kind sold in the ordinary course of its trade and that they had been acquired for the purposes of that trade. The properties were therefore to be regarded as having been acquired as trading stock. Lord Justice Parker, who gave the judgment of the court, with the other members of the court concurring, repeated what Lord Templeman had said in Reed v Nova Securities Ltd, to the effect that the legislation had given corporate taxpayers the opportunity to convert capital losses into trading losses and that the Revenue could not therefore complain if the taxpayer took advantage of this opportunity to reduce his tax. The judge took the view that, in deciding whether the assets had been acquired as trading stock, fiscal considerations should be set aside, leaving the question of whether there was a legitimate trading purpose to be considered as one of fact. In asking whether the acquisition of the asset has a trading purpose, it should be said that TCGA 1992 s 173 does not require the absence of fiscal considerations so much as the presence of a trading purpose. A trading transaction may be dictated entirely by fiscal considerations without losing its character as a trading transaction.

Lord Justice Parker accepted that the Special Commissioners had correctly directed themselves in asking the question whether the taxpayer had acquired the assets as trading stock, but had then erred in law in making further contrary findings with regard to group purposes. They were wrong to have found that the group purpose of disposing of the properties for fiscal reasons somehow negated the existence of the trading purpose. With regard to the judgement in the High Court, Lord Justice Parker disagreed with this where it had been said that the fact that there is profit or some conceivable reason for the transaction does not necessarily mean that the properties were acquired as trading stock.

Lord Justice Parker concluded by saying that he was satisfied that the taxpayer company had acquired the properties as trading stock and that the requirements of Lord Templeman in Reed v Nova Securities Ltd had been met. He therefore decided the appeal in favour of the taxpayer.

March 2005

ARTHUR L H SELLWOOD

This article was first published in ‘Tolley’s Practical Tax’ on 29 March 2005, and is reproduced with the kind permission of LexisNexis Butterworths.