HM Revenue & Customs v Smallwood [2007] EWCA Civ 462

[2007] EWCA Civ 462Case No C3/2006/1663
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
MR JUSTICE WARREN
CH/2005/APP/0900
Venue Royal Courts of Justice, Strand, London, WC2A 2LLDate 17/05/2007
Before
LORD JUSTICE SEDLEYLORD JUSTICE CARNWATHLORD JUSTICE LAWRENCE COLLINS
Between
COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMSAppellantCHARLES ST CLAIR SMALLWOODRespondent
(Transcript of the Handed Down Judgment ofWordWave International LtdA Merrill Communications Company190 Fleet Street, London EC4A 2AGTel No: 020 7421 4040 Fax No: 020 7831 8838Official Shorthand Writers to the Court)
Mr Michael Furness QC (instructed by Her Majesty's Revenue & Customs) for AppellantMr John Watson and Miss Kate Marten (Ashurst) for RespondentHearing Hearing date : April 26, 2007
Judgment

I Introduction

[1]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.[2]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.[3]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.[4]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

[5]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”).[6]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.[7]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.[8]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.[9]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.[10]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.[11]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.[12]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.[13]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.[14]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.[15]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.[16]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.[17]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.[18]The realisation of the investment was structured in such a way as not to give rise to any balancing charge on the unit holders.[19]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

[20]I will set out the relevant provisions in full in section Vbelow, but for present purposes it is sufficient to mention the principal provisions in issue.[21]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.[22]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 …”[23]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 losses for the purposes of the Income Tax Acts.” Section 41(1) disapplies section 39(1) where the deduction takes the form of a capital allowance, but section 41(2) provides that “in the computation of the amount of a loss accruing to the person making the disposal, there shall be excluded from the sums allowable as a deduction any expenditure to the extent to which any capital allowance…has been or may be made in respect of it.”[24]The inspector of taxes disallowed Mr Smallwood’s claim for capital losses on the ground that part of the sum subscribed by Mr Smallwood for the units was expenditure in respect of which a capital allowance had been made. The Special Commissioner allowed Mr Smallwood’s appeal from the decision, and Warren J affirmed the Special Commissioner’s decision.[25]The Special Commissioner’s decision can be summarised as follows. Section 38(1) restricted sums allowable as a deduction to “the consideration…given…wholly and exclusively for the acquisition of the asset…” By reason of section 99 the relevant asset was Mr Smallwood’s holding of units in PET8, and section 41(2) did not apply to expenditure on some other asset, namely the trust’s disbursement of the subscription monies on the Property. The computation on disposals of units had to be treated in the same way as the computation on disposals of shares.[26]The words “any expenditure” within “any expenditure to the extent to which any capital allowance has been made in respect of it” in section 41(2) could only refer to expenditure comprised in the consideration given wholly and exclusively for the acquisition of the relevant asset, namely the subscription monies for his units. No capital allowances had been given in respect of that expenditure and therefore section 41(2) did not apply to exclude it from the computation of accrued losses.[27]Warren J affirmed the decision. It was the purchase of the Property which gave rise to the capital allowances and not the subscription of monies to the scheme by the unit holders. The effect of section 99 is that TCGA applies(a) as if the unit holders were shareholders, with section 38(1)(a) applying to their notional shareholding as if they had acquired their shares for a consideration provided by them equal to the amount of their subscriptions to the scheme;(b) as if the subscription monies were the property of the notional company; and(c) accordingly, as if the acquisition by the trustee of the Property were an acquisition by the notional company with section 38(1)(a) applying as if the notional company had acquired the Property for a consideration provided by it equal to the purchase price.[28]Consequently, TCGA could not at the same time apply as if the notional shareholders had provided the consideration for the Property. Accordingly, notwithstanding that in equity and for the purposes of capital allowances the actual payment was made out of assets beneficially owned by the unit holders, the fiction imposed by section 99 resulted in the actual payment being regarded for capital gains tax purposes as being made by the notional company.[29]The payment of the purchase consideration by the notional company was clearly “expenditure.” It was also expenditure in respect of which Mr Smallwood and other unit holders became entitled to capital allowances. Since the payment was expenditure and also gave rise to a capital allowance, it fell within section 39(1) in relation to the base cost of the notional company unless it could be said that section 39(1) requires that the capital allowance (or other deduction) envisaged by section 39(1) must accrue to the person making the disposal. That was not an express requirement of the subsection, and there was no compelling reason why such a requirement should be imposed. Accordingly, section 39(1) applied to exclude from the trustee’s base cost of the Property the amounts in respect of which unit holders obtained capital allowances.[30]It did not necessarily follow that section 39(1) should not also exclude those amounts from the notional shareholders’ base cost of their notional shares. But that was a most unattractive proposition and not one which was correct, because the relevant expenditure, the payment by the trustee for the Property, was not expenditure which was included within the sums which constituted the base cost of the notional shares in the first place. The money used in the purchase of the Property was, for the purposes of TCGA, treated as an asset of the notional company not as an asset of the shareholders. It could not, therefore, be treated for the purposes of TCGA as part of the consideration provided by the notional shareholders for the acquisition of their shares.[31]The expenditure referred to in section 39 which was part of that consideration was to be treated as expenditure by the notional company (for the acquisition of the Property) and not as expenditure by the notional shareholders deductible from the base cost of their notional shares. Section 99 required one to assume a state of facts inconsistent with the unit holders having provided the expenditure there referred to.[32]Section 39(1) excludes certain items from the sums allowable under section 38 as deductions in computing the gain on a disposal. That section 39(1) is drafted as an exclusion is significant. The draftsman has not provided that the amount of certain identified expenditure is to be deducted from the amount otherwise allowable as a deduction but said that certain expenditure is to be excluded from the sums allowable. The use of the word “excluded” is designed to ensure that section 39(1) only excludes things which would otherwise be included in the sums allowable under section 38. The “expenditure” which is excluded by section 39(1) must form part of the items which make up the sums the allowance of which would otherwise be permitted under section 38.[33]Section 41(2) only had the effect of re-introducing as exclusions certain amounts which would have fallen within section 39(1) apart from their exclusion by section 41(1). The words “in respect of it” at the end of section 41(2) were to be read as meaning no more than that, as a result of the very expenditure in question, the person making the disposal becomes entitled to claim a capital allowance in respect of it. A capital allowance is not made “in respect of” expenditure if that expenditure does not, itself, give rise to a capital allowance but, instead, must rely on the further use of that expenditure (in the present case its use to purchase the Property) in order to establish the capital allowance.

IV The appeal

[34]The Revenue’s argument on the appeal is that in the transparent world of income tax and capital allowances, the £9,678 was expended by Mr Smallwood himself and by nobody else. Section 41(2) operates by requiring certain expenditure to be excluded from “the sums allowable as a deduction”. In the present case, the only sum allowable as a deduction in the CGT computation is the £10,000 paid by Mr Smallwood to acquire his units. The expenditure to be excluded is “any expenditure to the extent to which any capital allowance … has been … made in respect of it”. To the extent of £9,678, the amount which Mr Smallwood subscribed for his units is expenditure “in respect of” which a capital allowance has been made. The £9,678 must therefore be excluded from the base cost, but only for the purpose of ensuring that no allowable loss arises.[35]But the question posed by section 41(2) is simply whether any part of the acquisition cost (here the £10,000) is expenditure in respect of which capital allowances were made. The expenditure which generated the capital allowances came out of the monies subscribed by the unit holders, and from nowhere else. The deeming provision in section 99(1) does not affect the simple factual enquiry in section 41(2), and the consequent need to go out of the world of CGT and into the world of income tax and capital allowances in order to answer it.[36]The only requirement is that a capital allowance has been, or may be, made “in respect of” expenditure which is deductible in the CGT computation. The words “in respect of” are wide and general. They connote no more than the existence of a nexus, or identifiable connection, between the expenditure which it is sought to deduct and the expenditure which generated the capital allowances: cfBurdett-Coutts v IRC [1960] 1 WLR 1027 at 1036-7.[37]What matters is what was actually done with the £10,000 that Mr Smallwood actually subscribed. There is no conflict with the deeming in section 99, because the provisions of TCGA which are applied by section 99 in relation to the acquisition and disposal of the notional shares include sections 39 and 41, which by their very terms require one to look outside the world of CGT and into the world of income tax and capital allowances.[38]Mr Smallwood supports the decisions below on the basis that the effect of section 99 is that the provision out of the assets of PET8 of the purchase price of the property was expenditure by the notional company on the acquisition of land and did not form part of the base cost of the units. The only sum which can be said to be a deduction in computing Mr Smallwood's loss is the sum he paid for his units and, in determining whether section 41(2) applies to reduce his acquisition cost, the only question is whether “any capital allowance or renewals allowance has been or may be made in respect of [those subscription monies]”.[39]Since the expenditure which has to be considered is the subscription price paid by Mr Smallwood for his units, it must follow that his loss can only be restricted by reference to his capital allowances if those allowances can be said to have been given “in respect of” that expenditure.[40]It is accepted that the trustee could not have incurred the expenditure on the Property unless it had been funded through the subscription monies, and that the subscription monies were provided to the trustee in order to fund that expenditure. But once one regards the unit trust as a company, it cannot be said that this is sufficient to imply that the allowances were given “in respect of” subscription expenditure.[41]Unless one either ignores the deeming provisions of section 99 or writes new words into two sections that have stood for 40 years, no distinction can be made between Mr Smallwood’s position and that of an individual who subscribes for shares in a company so that that company may incur expenditure which attracts capital allowances.[42]The overall regime for EZPUTs contemplates that the expenditure may occur up to 12 months after the subscription for units. Where the subscription for units takes place before the trustee has decided which properties it is to buy, or even whether to buy them at all, it cannot be maintained that allowances are made in respect of the amounts subscribed: still less that the subscription expenditure could be regarded as allowable for section 39(1). The mere fact that expenditure followed immediately after subscription cannot result in an entirely different construction of the two subsections.[43]The fact that Mr Smallwood who received the allowance is also the recipient of any loss is an inevitable result of the interaction between the statutory scheme for capital gains tax and the way in which capital allowances arise to a unit holder in an EZPUT.[44]The availability of the capital loss to Mr Smallwood is a direct result of the Revenue’s failure to include EZPUTs in paragraph 3 of the Capital Gains Tax (Definition of Unit trust Schemes) Regulations 1988 (SI 1988 No 266), made on the same day as the Income Tax Regulations, and providing (para 3) that a unit trust scheme which is(a) a limited partnership scheme, or(b) a profit sharing scheme which has been approved in accordance with Part I of Schedule 9 to the Finance Act 1978, shall be treated as not being a unit trust scheme for the purposes of TCGA.

V Conclusions

[45]The Finance Act 1980 introduced 100 per cent initial allowances for persons who incurred expenditure in constructing or acquiring commercial buildings or structures in enterprise zones, to encourage investment in them. Individuals wishing to invest in such buildings commonly did so through the medium of an unauthorised unit trust (an EZPUT) in order to be able to pool their investments. The trustees would then commonly incur expenditure on the building in question. Under the unit trust, each unit holder would be beneficially entitled to an undivided share of the trust assets and could therefore claim capital allowances for a corresponding share of the trustees’ expenditure on the basis that(a) he had himself incurred that share of the expenditure and(b) he was beneficially entitled to his share of the property interest acquired by the trust.[46]Unit holders were taxed on their share of the trust income and obtained capital allowances on their shares of the trust’s qualifying expenditure. At the time when PET8 was established in March 1989, the provision giving 100 per cent initial allowances for the construction or acquisition of commercial buildings or structures in enterprise zones was section 74 of the Finance Act 1980. This provision was re-enacted in section 1 of the Capital Allowances Act 1990 (“CAA 1990”).[47]This treatment was temporarily reversed for EZPUTs (in common with all other unauthorised unit trusts with UK resident trustees) with the enactment of section 39 of the Finance Act 1987, which inserted a new section 354A into the Income and Corporation Taxes Act 1970 (now section 469 of ICTA 1988), but the status quo ante was restored by Regulation 3 of the Income Tax (Definition of Unit trust Scheme) Regulations 1988, SI 1988/267 (“the Income Tax Regulations”), which provided that:
“Subject to the provisions of these Regulations, a unit trust scheme which is – (a) an enterprise zone property scheme …. shall be treated as not being a unit trust scheme for the purposes of section 354A.”
[48]The detailed conditions which an EZPUT must satisfy in order to qualify as an “enterprise zone property scheme” under the Income Tax Regulations are set out in Regulation 4. They include requirements that the contributions of participants are all to be made in the same tax year, and that the capital expenditure on the enterprise zone property is to be incurred wholly in that tax year: Regulation 4(2)(d)(i) and (ii).[49]The Capital Gains Tax (Definition of Unit Trust Scheme) Regulations 1988 (SI 1988 No 266) were made on the same day as the Income Tax Regulations, and provided (para 3) that a unit trust scheme which is(a) a limited partnership scheme, or(b) a profit sharing scheme which has been approved in accordance with Part I of Schedule 9 to the Finance Act 1978, shall be treated as not being a unit trust scheme for the purposes of TCGA. These Regulations did not apply to EZPUTs.[50]The provisions in force in 1988/9 which enabled Mr Smallwood to elect to set off his share of the capital allowances against his general income for that year were contained in section 6(2) and (5) and the proviso to section 71(1) of the Capital Allowances Act 1968. The method by which the allowances were granted was by way of discharge or repayment of tax.[51]The basic provisions relating to balancing charges, at the time when PET8’s investment in the Property was realised in January 1999, were contained in section 4 of CAA 1990. No balancing charge arose because the “relevant interest” in the Property was not sold: section 4(1)(a). Had a charge arisen, its amount would have been equal to the excess of Mr Smallwood’s share of the sale proceeds over his share of the written-down value of the Property, subject to a cap equal to the amount of the initial allowance made to him: section 4(4) and (10). The effect would have been that almost the whole of his share of the sale proceeds would have been subject to a balancing charge.[52]Although an EZPUT is set up through the medium of a trust, the trust property is not settled property for CGT purposes because the unit holders are at all times collectively absolutely entitled to the trust property as against the trustee: TCGA, sections 68 and 60(1). It follows that, special provision apart, an EZPUT would be “transparent” for CGT purposes in the same way as it is transparent for income tax and capital allowance purposes.[53]Special provision is made for unit trust schemes in Chapter III of Part III TCGA, sections 99 and following, which have their origin in section 45(8) of the Finance Act 1965 and section 93 of the Capital Gains Tax Act 1979.[54]Section 99(1) provides that:
“This Act shall apply in relation to any unit trust scheme as if – (a) the scheme were a company (b) the rights of the unit holders were shares in the company, … except that nothing in this section shall be taken to bring a unit trust scheme within the charge to corporation tax on chargeable gains.”
[55]Although section 99(3) empowers the Treasury to make regulations disapplying section 99 to schemes of any specified description, and although this power was exercised at the same time as the Income Tax Regulations were made, no steps were taken to exclude EZPUTs from section 99: see above, para 49.[56]By virtue of TCGA, section 122(1), where a person receives a capital distribution from a company he is treated as if he had disposed of an interest in the shares in consideration of that capital distribution. “Capital distribution” is defined in section 122(5)(b) as meaning any distribution from a company in money or money’s worth except a distribution which in the hands of the recipient constitutes income for the purposes of income tax. The combined effect of sections 99(1) and 122(1) is that Mr Smallwood and other unit holders who received distributions in respect of their units are treated, for CGT purposes, as having made part disposals of their notional shareholdings.[57]TCGA section 15(1) provides that the amount of the gains accruing on the disposal of assets shall be computed in accordance with Part II of the Act, and that every gain shall, except as otherwise expressly provided, be a chargeable gain. By virtue of section 16(1), “except as otherwise expressly provided the amount of a loss accruing on a disposal of an asset shall be computed in the same way as the amount of a gain is computed”.[58]The provisions relating to computation of gains are contained in Chapter III of Part II of TCGA (sections 35 to 52). Section 37 provides:
“(1) There shall be excluded from the consideration for a disposal of assets taken into account in the computation of the gain any money or money’s worth charged to income tax as income of, or taken into account as a receipt in computing income or profits or gains or losses of, the person making the disposal for the purposes of the Income Tax Acts. (2) Subsection (1) above shall not be taken as excluding from the consideration so taken into account any money or money’s worth which is – (a) taken into account in the making of a balancing charge under the Capital Allowances Act …”
[59]The consideration for the disposal is deemed by section 122(1) to be the amount of the distribution. No exclusion from the disposal consideration falls to be made under section 37(1), because no part of the disposal consideration was charged to income tax, or otherwise taken into account for income tax purposes, in the hands of Mr Smallwood. Section 37(1) is intended to avoid a double charge to income tax and CGT, and to give primacy to the income tax charge.[60]By section 38(1), so far as material, “… 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 limited 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 …”[61]Sections 39 and 41 provide: “39. Exclusion of expenditure by reference to tax on income(1) 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 the profits or losses of a trade, profession or vocation for the purposes of income tax or allowable as a deduction in computing any other income or profits or gains or losses for the purposes of the Income Tax Acts…; and this subsection applies irrespective of whether effect is or would be given to the deduction in computing the amount of tax chargeable or by discharge or repayment of tax or in any other way. … 41. Restriction of losses by reference to capital allowances and renewals allowances (1) Section 39 shall not require the exclusion from the sums allowable as a deduction in the computation of the gain of any expenditure as being expenditure in respect of which a capital allowance…is made, but the amount of any losses accruing on the disposal of an asset shall be restricted by reference to capital allowances…as follows.(2) In the computation of the amount of a loss accruing to the person making the disposal, there shall be excluded from the sums allowable as a deduction any expenditure to the extent to which any capital allowance…has been or may be made in respect of it. …(3) In this section “capital allowance” means – (a) any allowance under the Capital Allowances Act… … (6) The amount of capital allowances to be taken into account under this section in relation to a disposal include any allowances falling to be made by reference to the event which is the disposal, and there shall be deducted from the amount of the allowances the amount of any balancing charge to which effect has been or is to be given by reference to the event which is the disposal, or any earlier event. …”.

(a) any allowance under the Capital Allowances Act…

[62]Section 38(1) limits the sums allowable as a deduction from the consideration in the computation of a gain to the amount of the consideration given by the taxpayer or on his behalf. Section 39(1) excludes certain expenditure from the sums allowable under section 38, by excluding from the sums allowable under section 38 as a deduction in the computation of a gain “any expenditure” allowable as a deduction in computing income tax.[63]Since section 39(1) operates by excluding certain expenditure from the sums allowable under section 38, the excluded expenditure must be expenditure which would otherwise be allowable under section 38, and must therefore be expenditure by or on behalf of the person making the disposal, and not expenditure by a third party.[64]The general rule stated in the opening words of section 41(1) reverses the operation of section 39 where, in computing a gain, expenditure in respect of which a capital allowance is made forms part of an otherwise allowable deduction. In such a case section 39 is not to require the exclusion as a deduction of “any expenditure as being expenditure in respect of which a capital allowance … is made.”[65]But where the computation of a loss is required by section 41(2) there is to be excluded from the sums allowable as a deduction “any expenditure to the extent to which any capital allowance…has been or may be made in respect of it”. The effect of section 41(2) is to reintroduce, in the context of the computation of a loss, the exclusion from the sums allowable as a deduction under section 38 which would have been brought about by section 39(1), if section 39 had not itself been disapplied by section 41(1).[66]The reason for the general rule in section 41(1) is that in cases where the calculation results in a gain, the taxpayer is likely to have incurred a balancing charge equal to the capital allowances originally given. It would therefore be unfair to disallow the capital allowances a second time in the CGT computation. Where, however, the taxpayer does not incur a balancing charge, or the balancing charge amounts to less than the original capital allowance, there is no unfairness to the taxpayer in excluding the capital allowance (or the excess of the capital allowance over the balancing charge) from the CGT computation. If it were not excluded the taxpayer would effectively get the benefit of the capital allowance twice over, once when the asset was acquired and again when it is disposed of.[67]The qualifying expenditure was the 96.78 per cent of the subscription monies which were spent on the acquisition and construction of the Property. That money belonged to, and was expended by, the unit holders. There was no other money in PET8 apart from the sums subscribed by the unit holders. As a matter of general trust law, Mr Smallwood and the other unit holders were beneficial co-owners of the assets in the trust, and acquired them when the subscription monies were expended.[68]The effect of these sections if they stood alone would be that to the extent of £9,678, Mr Smallwood would not have been entitled to deduct that sum as consideration for the purposes of computing a loss, because the £10,000 which Mr Smallwood subscribed was expended on the Property, and a capital allowance was made in respect of that expenditure. Because it was expenditure by him, and because in terms of section 39(1) it was “expenditure…allowable as a deduction in computing…income…for the purposes of the Income Tax Acts”, it would (in the absence of special provision to the contrary) have to be excluded from his otherwise allowable base cost of £10,000, when he sold his units (i.e. his interest in the Property). The exception in section 41(1) for expenditure allowable as expenditure in respect of which a capital allowance had been made did not apply because the computation was of losses, and section 41(2) disallowed for this purpose expenditure in respect of which a capital allowance had been made.[69]To adapt the words of the Special Commissioner (Decision, para 21), in a slightly different context, that would have a “real world ring” about it, because by operation of the capital allowance rules, Mr Smallwood, as unit holder, could be regarded as having provided his share of the building and by operation of the 1988 Regulations, he qualified for capital allowances on an amount equal to his share of the subscription monies; and the disbursement of the subscription monies was in reality reflected in the value of the assets he disposed of, namely his units. If the capital allowance were not excluded the taxpayer would effectively get a loss reflecting his expenditure twice over, once when the asset was acquired and again when it is disposed of.[70]But this would give no effect to section 99. What effect does section 99 have? It provides that the CGTA shall apply in relation to the unit trust scheme as if “(a) the scheme were a company” and “(b) the rights of the unit holders were shares in the company”.[71]The effect of section 99 is that there are two levels of capital gains tax. First, gains made by the trustee in respect of trust assets are taxed as if they were gains of a company (except that the tax paid would not be corporation tax but capital gains tax). Any tax on these gains is assessed on the trustee. Second, each unit holder is treated on a disposal of his units as if they were shares in a company, his gains or losses on units being taxed as if they were gains or losses on shares.[72]It is accepted by the Revenue that the £10,000 is deemed for CGT purposes to have been spent by Mr Smallwood on the acquisition of a notional shareholding. The Revenue accepts that by virtue of section 99 the money used in the purchase of the Property is, for the purposes of TCGA, treated as an asset of the notional company and not as an asset of the shareholders. But, the Revenue says, it does not follow that for the purposes of sections 39 and 41 the capital allowance is to be treated as if it were expenditure by the notional company, because there is nothing in section 99 which requires one to assume a state of facts inconsistent with the unit holders having provided the expenditure.[73]We were referred to the judgment in Marshall v Kerr [1993] STC 360, 366 (CA), per Peter Gibson J (approved [1995] 1 AC 148, 164, per Lord Browne-Wilkinson):
“For my part I take the correct approach in construing a deeming provision to be to give the words used their ordinary and natural meaning, consistent so far as possible with the policy of the Act and the purposes of the provisions so far as such policy and purposes can be ascertained; but if such construction would lead to injustice or absurdity, the application of the statutory fiction should be limited to the extent needed to avoid such injustice or absurdity, unless such application would clearly be within the purposes of the fiction. I further bear in mind that because one must treat as real that which is only deemed to be so, one must treat as real the consequences and incidents inevitably flowing from or accompanying that deemed state of affairs, unless prohibited from doing so.”
[74]This is not a case in which it can be said that on its face the deeming provision would lead to injustice or absurdity unless given a special interpretation. What is said by the taxpayer is that its effect is that for all purposes the unit holder should be treated as a shareholder and the trust as a company. What is said by the Revenue is that it should not be interpreted to say that it applies for all purposes and to have consequences which were not intended.[75]There is no doubt that for the purposes of income tax and capital allowances the unit trust was transparent in the sense that it was the individual unit holder and not the unit trust which was the taxpayer and the person entitled to capital allowances.[76]Section 38 allows a deduction from the consideration on disposal of the amount of the consideration provided by the taxpayer. The exclusion in section 39(1) is an exclusion from the sums “allowable under section 38”, i.e. the amount or value of the original consideration provided by the taxpayer. The exclusion is that of “any expenditure” allowable as a deduction in computing income tax. The amount allowable is “the amount or value of the consideration … given by him … wholly and exclusively for the acquisition of the asset, together with the incidental costs” (section 38(1)).[77]I would reject the contention for the Revenue that the questions posed by sections 39(1) and 41(2) are simply whether any part of the acquisition cost (£10,000) is expenditure allowable as a deduction in computing income tax or in respect of which capital allowances were made, and that they are not affected by the deeming provisions of section 99; and that section 39(1) excludes for the purpose of computing the consideration given by Mr Smallwood for the purposes of section 38(1) “any expenditure” which was allowable as a deduction in computing income tax, and also that section 41(2) similarly excludes “any expenditure” to the extent to which any capital allowance has been made in respect of it.[78]Section 39(1) refers back to section 38, and section 41(2) refers back to section 39. The effect of section 99 is that for capital gains tax purposes the unit holder has acquired shares in the unit trust. The consideration is the sum subscribed. When the units are disposed of, the sum allowable as a deduction is the consideration: section 38(1)(a). Section 39(1) excludes from the sums allowable under section 38, any expenditure allowable as a deduction for income tax purposes. But such a sum has not been included (and therefore cannot be excluded) in the sums allowable under section 38, because it was not included in the consideration for the units. It also follows that section 41(2) has no application, because that section, like section 41(1), is concerned with exclusion of sums which would otherwise be allowable.[79]Consequently I do not accept the argument for the Revenue that the true question is whether any part of the consideration provided by the notional shareholders for the acquisition of their notional shares (i.e. in Mr Smallwood’s case the £10,000 which he subscribed for his units) is expenditure in respect of which capital allowances were made to them. I reach this result on a construction of sections 38(1), 39(1) and 41(2) in conjunction with section 99.[80]My conclusion is supported, but is not dependent upon, the point that if a company had invited subscriptions for shares and then used the money raised to purchase a building which qualified for capital allowances, in such a situation section 41(2) would not apply to restrict a loss accruing to a shareholder on a subsequent disposal of his shares. In such a case the expenditure on the building is not expenditure by the shareholder, but by the company. But, unlike an EZPUT, a real company is opaque for income tax and capital allowance purposes as well as for CGT purposes. The analogy begs the question of the scope of section 99.[81]Consequently I consider that the judge’s conclusion was right. This may have the result that Mr Smallwood may be the beneficiary of a double relief. It was contended on behalf of Mr Smallwood (and was accepted by the judge) that this is a logical result, because the effect of section 99 is that the capital loss realised by PET8 would be eliminated. But that is a question which is not before the court, and is unnecessary and inappropriate to decide.[82]I would therefore dismiss the appeal. I would add that we have had the benefit not only of very full and clear conclusions from the Special Commissioner and Warren J, but also of excellent and comprehensive arguments from Mr Furness QC and Mr Watson.[83]I agree. Without I hope disrespect to the excellent arguments before this court, I see this as a relatively short point.[84]I start from TCGA section 38. This is a key provision of the code, which explains how a gain or loss is to be computed for the purposes of capital gains tax. So far as is material it provides:
“(1) Except as otherwise 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 – (a) the amount or value of the consideration, in money or money’s worth, given by him or on his behalf wholly and exclusively for the acquisition of the asset,” (a) the amount or value of the consideration, in money or money’s worth, given by him or on his behalf wholly and exclusively for the acquisition of the asset,”
[85]As Mr Oliver QC said (para 19), the computation provisions are “asset specific”. In the present context of a unit trust scheme, the asset is a notional share in a notional company. That follows from section 99, by which the Act applies “as if” the scheme were a company, and the rights of the unit holders were shares in the company. In accordance with the well-established principle applicable to such statutory fictions (“the deeming principle”) – “… because one must treat as real that which is only deemed to be so, one must treat as real the consequences and incidents inevitably flowing from or accompanying that deemed state of affairs, unless prohibited from doing so.” (Marshall (Inspector of Taxes) v Kerr [1993] STC 366 at 367)[86]Section 39 must be read against that background. It provides:
“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 the profits or gains of a trade … for the purposes of income tax or allowable as a deduction in computing any other income or profits or gains or losses for the purposes of the Income Tax Acts …”
The expenditure there referred to must be expenditure which would otherwise be allowable under section 38. I agree with Warren J that: “…The use of the word 'excluded' is designed, I consider, to ensure that what is excluded is something which would, absent the exclusion, be included. In other words, the 'expenditure' which is excluded must form part of the items which make up the sums the allowance of which is otherwise permitted under s 38.” (para 43)[87]The question posed by section 39 is whether expenditure “allowable” under section 38 is to be excluded because it is “allowable” as a deduction for income tax purposes. Consistently with the deeming principle, the nature of the expenditure should be treated as the same for both purposes. On that basis the expenditure was for a notional share, not for the acquisition of property. As such, it did not qualify for a capital allowance for income tax purposes. It is therefore not excluded by section 39. Once that conclusion is reached, it is common ground that section 41 has no application. That only applies as a further qualification to the treatment of sums which would otherwise be excluded under section 39.[88]Not unusually, each side points to anomalous consequences of the opposing construction. Mr Furness refers to the unexpectedly generous tax benefit received by Mr Smallwood and those in his position resulting from the judge’s construction. Conversely, Mr Watson points to potential complications in the application of the provisions to overseas property trusts, if the Revenue’s construction is accepted. I am not persuaded that the consequences on either side lead to such absurdity or injustice as to override what would otherwise be the natural reading of the sections.[89]In summary, as Mr Oliver put it (para 21), the Revenue’s approach fails, because it “focuses on the wrong expenditure on the wrong asset”. For these reasons, which are intended to encapsulate those given by the judge, and accord with those of Lawrence Collins LJ, I would dismiss the appeal.[90]In spite of an uncomfortable sense that Mr Smallwood is doing better than he should out of the tax regime, I agree, for the reasons explained in both judgments, that the Revenue’s appeal has to fail.