Contractual Obligations

JEREMY DE SOUZA, consultant to White & Bowker, reflects on the Court of Appeal's decision in Jerome v Kelly.

A TAXPAYER CONTRACTED to sell farmland. but before completion transferred interest in it to an offshore trust. It was held that the entire capital gains tax disposal under the contract was made by the taxpayer and there was no disposal bt the trustees

On 16 April 1987, Mr and Mrs Michael Jerome and Mr Oliver Jerome contracted to sell 13.2 acres of farm land to a developer, Conder. This land appears to have included 0.9 acres in the ownership of Mrs Philbrow, which was transferred to Mr and Mrs Jerome on 1 May 1987. The contract was not a conditional one. Under its terms, completion had to take place seven years later, but the developer could advance this event upon obtaining planning permission. In the event, the land was transferred in three tranches between 1990 and 1992.

The taxpayers did not dispute that the relevant year for accounting for capital gains tax was 1987-88, by reason of what is now section 28(1), Taxation of Chargeable Gains Act 1992. In relation to the 0.9 acres acquired by way of gift on 1 May 1987, it was common ground that the date of disposal was that date, rather than the earlier contract date.

Point at issue

At issue was the proportion of the proceeds of sale brought into charge in the hands of Mr and Mrs Jerome, who, by reason of section 60(1), had attributed to them the actions of the legal owners of record who had entered into the contract with Conder. By the time that the various completions took place, Conder was in fact out of the picture, having assigned the benefit of its contract to Crest, but nothing turned on the change of purchaser.

The reason for the dispute was that, in 1989, Mr and Mrs Jerome assigned part of their beneficial interest in the land to two Bermudan settlements established in 1988. When the contract was completed, therefore, not all of the proceeds to which the Jeromes would have been entitled in 1987 found their way to them. The Inland Revenue considered, however, that they should nonetheless be taxed on the basis that, at the relevant 1987 dates, they had been entitled under the contract with Conder to all of the monies in question.

Earlier decisions

The Special Commissioner found in favour of the Revenue, seemingly on the basis that the legal owners of record conveyed the land to Conder's assignee under a contract entered into by them and that section 60(1) had the effect of attributing their actions to those for whom they were the bare trustees at that time.

Mr Justice Park reversed her decision on the basis that section 28(1) was inserted in 1971 to shift the tax point from completion to contract, but that completion had to have taken place before section 28(1) came into play. At the date of completion, the beneficial owners standing behind the legal owners included the Bermudan trusts, the trustees of which, being offshore, were not chargeable to capital gains tax.

Judgment in the Court of Appeal

On 20 December 2002, the Court of Appeal restored the decision of the Special Commissioner on the following basis:

• under the general law laid down in Lysacht v Edwards [1876] 2 Ch Div 499, a contracting purchaser acquires an equitable interest in the land;
• when part of the beneficial interest in the land was transferred to the Bermudan settlements, it was subject to that contractual obligation;
• section 28(1) only applies to disposals 'under a contract';
• the only contract ever entered into was that of 16 April 1987, for which the actions of the legal owners were attributed to the taxpayers as beneficial owners under section 60(1); but
• with regard to the land received by way of gift on 1 May 1987, by reason of Kirby v Thorn EMI [1987] STC 621, the taxpayers' ownership could not be backdated before their acquisition of it; and
• sections 21(1) and 22(1) could operate where section 28(1) did not.

The effect of section 28(1) was, in consequence, stated to be:

' where the owner of an asset contracts to convey or transfer it, and the contract is subsequently completed, the disposal of the asset for capital gains tax purposes takes place when the contractual obligation is created and not when it is performed.'

Comment

Underlying this whole problem is the fact that, when somebody contracts to sell an asset, his 'full' ownership goes into limbo, but that the purchaser does not acquire that status, i.e. 'full' ownership, until completion. While Mr Justice Park concentrated on the latter, the Court of Appeal focussed on the former. It is a difficulty which is not confined to sales for capital gains tax purposes. The courts have also been troubled with this issue in other contexts, not least stamp duty, for decades.

The Court of Appeal may well have been conscious that tax avoidance was involved. The original contractual obligation was an extraordinary one and there cannot have been many like it. Indeed, Mrs Philbrow's position was particularly strange. Had her beneficial interest been bound by the contract made on 16 April 1987, she would presumably have been taxable on the gain realised by her donees, in the same way that they were liable for the gains accruing to their donees. A double taxation situation would thereby have resulted.

Potential double taxation

Indeed one of Mr Justice Park's concerns was that, in the events which had happened, part of the gain made by the Bermudan trusts was brought within the scope of capital gains tax under what is now section 87, Taxation of Chargeable Gains Act 1992. Indeed, any subsequent copier of the Jeromes would have found that the current section 86 and 87 régimes might well create a double taxation position. The Court of Appeal did not address the double taxation issue, which clearly arises if Mr Justice Park's formulation is (as it has held) incorrect.

The Appeal Court has, however, arrived at a formulation which brings section 28(1), Taxation of Chargeable Gains Act 1992 into operation only retrospectively. Completion remains a prerequisite to liability and failed contracts are not brought into charge pro tem.

Consistent?

There is one final oddity. If section 28(1) only operates in relation to a contracting vendor, presumably the same also applies to a contracting purchaser. Had Conder not been a trader in land, would the end result of this have been the absurd position that, when Crest completed as assignee, Conder would have been treated for capital gains tax as having a type of acquisition which it never made?

If this is indeed the case, the question must then be asked as to how this proposition is consistent with the analysis by Lord Justice Chadwick in relation to the completion of an option by an assignee of the grantee in Mansworth v Jelley [2003] STC 53. His formulation was agreed to by Lord Justice Jonathan Parker, who gave the leading judgment in Jerome v Kelly.

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