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Tax Journal by Mark McLaughlin ATII TEP

Capital gains tax (CGT) broadly applies to chargeable gains arising from the disposal of assets by UK resident or ordinarily resident individuals, trustees and personal representatives. This article considers the disposal of assets by contract.Capital gains tax (CGT) broadly applies to chargeable gains arising from the disposal of assets by UK resident or ordinarily resident individuals, trustees and personal representatives. Companies are not subject to CGT, but instead pay corporation tax on chargeable gains. In each case, the date of actual or deemed disposal of an asset can have important implications. For example, it determines the correct tax year or accounting period of charge, and hence the tax rules in force and to be applied, the correct tax rate and the amounts of any available reliefs and annual exemption. This article considers the disposal of assets by contract (all references are to the Taxation of Chargeable Gains Act 1992, unless otherwise stated).

Unconditional contracts

A disposal occurs when there is a binding contract between the parties. An agreement which remains 'subject to contract' is not a binding contract (CG 25852). In addition, a contract might contain conditions, which perhaps require the parties to undertake certain actions or to perform particular obligations, but which do not prevent the contract from immediately binding the vendor and purchaser. These are called 'conditions subsequent', and although a breach of those conditions may result in an action for damages, the contract remains a binding one (CG 14271).

The general rule is that where an asset is disposed of under a binding unconditional contract, the date of disposal is the time at which the contract is made. This applies to oral agreements, even though the contract may be unenforceable (Thompson v Salah (1972) 47 TC 559)). However, following the introduction of the Law of Property (Miscellaneous Provisions) Act 1989, contracts for the disposal of land in England and Wales must be made in writing (similar requirements are understood to apply in Scotland).

The date on which an asset is conveyed or transferred is irrelevant for unconditional contracts (s 28(1)).

An exception to the general rule applies to deemed disposals where a capital sum results from the ownership of an asset, notwithstanding that the asset in question may not be acquired by the person paying the capital sum. This particularly applies where a capital sum is received in the following instances:

- As compensation for any kind of damage or injury to assets or for the loss, destruction or dissipation of assets or for any depreciation or risk of depreciation of an asset;

- Under a policy of insurance of the risk of damage or injury to assets or for the loss, destruction or dissipation of assets or risk of depreciation of an asset;

- In return for the forfeiture or surrender of rights, or for refraining from exercising rights; or

- As consideration for the use or exploitation of assets.

In those cases, the time of disposal is deemed to be when the capital sum is received (s 22).

Conditional contracts

The recent case Hatt v Newman ([2000] STC 113, ChD) concerned among other issues the date of disposal for CGT purposes, where an asset was disposed of under a conditional contract.

For CGT purposes, a contract is considered to be 'conditional' if any condition(s) must be satisfied before the contract becomes legally binding. Such conditions are called 'conditions precedent'.

If a contract is subject to 'conditions precedent', the date of disposal is the date when all of the conditions are satisfied (s 28(2)). The time of contract completion (e.g. the exchange of keys between a property vendor and purchaser) is not the material date for CGT purposes, as was illustrated in the case below.

Hatt v Newman

In Hatt v Newman, the taxpayer and his wife decided to sell a property. Contracts were exchanged for the sale on 21 February 1995, and the contractual completion date was 20 March 1995. However, completion of the contract was conditional upon planning permission being granted. Planning permission was granted on 29 March 1995, and completion subsequently took place on 6 April 1995. The taxpayer appealed against a 1994/95 CGT assessment, contending that the relevant date of disposal for CGT purposes was 6 April 1995 (i.e. in the tax year 1995/96). However, the court preferred the Revenue's argument that the contract for the sale of the property was a conditional contract, and that the disposal took place on 29 March 1995, when the condition was fulfilled.

Specific situations

(a) Hire purchase agreements

The date of disposal for CGT purposes of an asset subject to a hire purchase contract (i.e. where that asset passes from the owner for use by the hirer, and under which title may pass at the end of the contract term) is the commencement of the hire term. The full capital consideration receivable for the asset is taxable at that point (see Lyon (Insp of Taxes) v Pettigrew [1985] 58 TC 452).

If title to the asset does not pass (e.g. if the hirer does not meet the payments and the asset is repossessed), a tax adjustment may be required (s 27). Where the sums received by the vendor have been treated as capital (as opposed to income), the capital gains liability is adjusted by including as disposal proceeds only the total amount actually received from the hirer (CG 12871).

(b) Options

If a contract is conditional on the exercise of an option, the date of disposal is the time when the option is exercised (s 28(2)).

An option is an asset for CGT purposes (s 21(1)(a)). The grant of an option over a chargeable asset by the grantor constitutes the disposal of an asset (i.e. the option itself), and the grantor is chargeable to tax in respect of it. The grant of an option is not a part disposal of the asset that is the subject of the option, as the grantee has no rights over the asset until the option is exercised (Strange v Openshaw (1983) 57 TC 544).

If the option is subsequently exercised, this does not constitute a separate disposal. Upon exercise, the grant of the option and the disposal of the asset subject to the option are treated as a single transaction (s 144(2)). This single transaction is treated as occurring when the later transaction takes place, and the earlier grant of the option therefore ceases to be a chargeable occasion. Accordingly, any tax paid on the grant of the option is set-off or repayable (CG 12317).

For CGT taper relief purposes, the asset is acquired when the option is exercised, not when the option is granted.

In the case of 'cash settled' options granted after 29 November 1993 (under which the grantor is liable to make, and the person exercising it is entitled to receive, a payment in settlement of all obligations under the option) the grantor is treated as having disposed of an asset, being the liability to make the payment. The grant and disposal of the option are treated as a single transaction, taking place at the time of the subsequent disposal. The person exercising the cash-settled option is also deemed to have disposed of an asset, being the entitlement to receive the payment (s 144A).

Planning points and pitfalls

a) When selling an asset (e.g. land), an obvious way of claiming multiple CGT annual exemptions would be to dispose of the asset in two or more parts (probably to the same purchaser), over different tax years. However, there should be strong commercial reasons for disposing of the asset in this way. Multiple transactions to exploit the annual exemption are likely to be the subject of close scrutiny from the Revenue (see CG 18150-63), and are open to challenge as a tax avoidance measure.

b) A individual who is not resident or ordinarily resident in the UK is generally not liable to CGT on the disposal of an asset, except that 'temporary non-residents' are liable to CGT on assets owned prior to their departure from the UK (s 10A). By virtue of ESC D2, an individual who leaves the UK and is treated on departure as not resident or ordinarily resident is not chargeable to CGT on gains from disposals made after departure, provided that the individual was not resident or ordinarily resident for the whole of at least four out of the seven tax years immediately preceding the tax year of departure. Similar 'split year treatment' is available to individuals coming to live in the UK, where certain conditions are satisfied.

It might be considered attractive for an individual leaving the UK who satisfies the conditions of ESC D2 (or who remains non-resident for more than five tax years) to delay the contract to dispose of assets located in the UK until after departure. However, a CGT liability may still arise in the following circumstances (CG 25805):

- There was a binding agreement or contract for sale on or before the date of emigration. If a binding agreement was made prior to any formal written contract, the earlier date of the agreement is the date of disposal for CGT purposes.

- A business was carried on in the UK through a branch or agency between emigration and disposal; or

- An attempt was made to use ESC D2 for tax avoidance. In R v IRC, ex parte Fulford-Dobson ([1987] STC 344), the taxpayer's wife transferred property to him shortly after he accepted an offer to work in Germany. Four days after he left the UK the property was sold. The court upheld the Revenue's refusal to operate ESC D2 in the taxpayer's favour, on the grounds that he had attempted to use the Concession for tax avoidance.

However, a genuine postponement of the disposal by itself should not be regarded as an attempt to use the concession for tax avoidance, and should therefore not result in the Concession being withheld.

As an alternative, the individual might consider making the contract conditional (e.g. upon the exercise of an option), with that condition being satisfied following departure. However, the condition would need to be genuine, and not merely inserted to delay the disposal date.

c) As indicated earlier, the date of an unconditional contract is the date of disposal for CGT purposes. However, for CGT retirement relief purposes, Extra Statutory Concession D31 allows the date of completion to be treated as the date of disposal where, pending completion, business activities continue beyond the date of the unconditional contract. However, the date of disposal for all other CGT purposes remains the date of the unconditional contract, which may be in an earlier tax year than the date of completion.

Thus for example, if a business owner who is under the qualifying retirement relief age when the contract is made continues the business until completion in the following tax year and has reached the age of 50 by that time, ESC D31 treats the business owner as having attained the qualifying age. However, the retirement relief entitlement will be based on the lower rates prevailing in the later tax year, following the gradual phasing out of the relief up to 5 April 2003.