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BKL Tax Comments on a 'revised view' by HMRC and its impact on the CGT base cost of employee shares and capital losses in affected cases.  

Introduction

Tax professionals will not need to be reminded of the saga of Mansworth v Jelley. The broad effect of the case was that if an employee acquired shares in circumstances that a charge to Income Tax arose (principally on exercise of a non-approved share option) the base cost of the shares for CGT purposes was neither the amount charged to Income Tax nor the market value of the shares on acquisition: but the aggregate of those two amounts! This often gave rise, on disposal of those shares (which in the nature of share options often happened very shortly after acquisition) to large "windfall" CGT losses which the lucky owners have been using ever since. The anomaly identified in Mansworth v Jelley was remedied by legislation in 2003 (which in turn created another anomaly which was remedied in 2004). Nonetheless, there will be many clients who are still sitting on unused CGT losses arising from the application of the Mansworth v Jelley decision to pre-2003 share acquisitions.

Or, more accurately, the above summarises HMRC's expressed view of the effect of the case: some eminent advisers have always said that HMRC had drawn incorrect inferences from the case and that the amending legislation was unnecessary. And those eminent advisers have now been vindicated: HMRC have issued a "revised view" saying that ...er... they have been wrong all along; and that the CGT base cost of shares in these circumstances is after all the market value at the date of exercise; and by implication that all those losses on which tax relief has been given at a cost of many millions of pounds in tax revenue were spurious.

So what's the effect on taxpayers?

These fall into three main groups.

1. The first, which we suspect is vanishingly small, contains those clients who acquired shares on exercise of options before 2003 and still hold them - or have disposed of them but have yet to file tax returns reflecting the disposal. The effect on those clients is that the CGT base cost is smaller than they hitherto thought it was and thus that the gain on disposal is (or will be) accordingly increased.
2. The second group is those who have already used the losses which HMRC now say never existed. The effect on those clients is nil: HMRC cannot now re-open those past tax years and seek to use their revised practice to withdraw relief for the losses.
3. The third group is likely to be the largest: those who acquired shares as employees or directors before 2003 and have since sold them and realised capital losses which have been agreed under the previous HMRC practice but which have not been utilised in full and are still being carried forward. Are those losses at risk of withdrawal? Happily, no: since the advent of self-assessment the quantum of CGT losses is determined at the time the losses are claimed and agreed (or not disputed) - not at the time they are utilised. Where claims have been made and agreed under the old practice the losses remain available for use for the indefinite future (the "shelf life" of CGT losses being in principle unlimited).

So it is likely that for many years to come clients will be taking the benefit of CGT losses which are attributable - to be frank - to nothing more than HMRC incompetence. Good news for clients: red faces all round for HMRC.