Special Commissioner's Decision

Special Commissioner's Decision

Mere Machinery

RICHARD CURTIS reviews a recent Special Commissioners' decision that concerned the boundaries of Schedule A and Schedule D, Case VI.

SETTING THE SCENE, the appellant in this anonymised decision (see A Property Company v HM Inspector of Taxes, SpC 433) was the property owning company in the Cornwall Group.

Having sold some properties in April 1995, on 15 August 1995 the appellant agreed to lease other properties to CGI (the group parent company). On 16 August 1996, a further agreement leased the same and some additional properties to CGI. There then quickly followed a business sale agreement, whereby the appellant sold all its assets, including the leased properties, to CGP, another group company, but retained the right to receive the rent payment under the 1996 agreement, which was due on 31 August 1996. This was then followed by a share sale agreement, whereby — in September 1996 — CGI sold the shares in the appellant to another, non-group company (X Limited). The appellant's assets at that point consisted of the right to the retained rent payment, less the tax thereon and there was also an inter-group debt to be paid off out of the rent; the net value being £200,300. However, the sale price was £20 million; the reason for such a large apparent discrepancy being that X Limited intended to negate the appellant's tax liability of £37 million by a scheme that would result in an allowable deduction. The benefit would effectively have been split between seller and purchaser.

The case report does not go into details of the proposed tax scheme, other than to note that it 'did not work'. Consequently, the Revenue issued corporation tax assessments on the appellant in respect of the retained rent payment for the accounting period 25 August 1996 to 18 September 1996 or, in the alternative, for the period 19 September 1996 to 18 September 1997. (The rental payment had been deferred.)

The company appealed, arguing that this was not taxable as, at the time of receipt, it no longer held an interest in the land to which the rental income related. The appeal was settled by agreement, but the Commissioners published their interim decision relating to issues that had arisen.

The Commissioners' decisions

The agreements in 1995 and 1996 for the letting of the properties stated that rent was not receivable without the superior landlord's consent to subletting, but there appeared to be little urgency on whether this was obtained. It seemed that 'creating rent was of primary importance'. The appellant's accounting period ended on 24 August, whilst the accounts of the other group companies were prepared to 31 August.

Paying the rent on 31 August created a 'mismatch', and deferred tax by approximately the length on an accounting period. The Commissioners decided that although the leases contained the requirement for notice to be given, they held that 'in the light of the way the parties acted, the agreements were not intended to be read as containing this requirement' and thus did create 'an immediate obligation on CGI to pay rent.

The second point related to the Landlord and Tenant (Covenants) Act 1995, which introduced a new mechanism for determining the covenants that pass on the assignment or reversion of a lease. This came into force after the 1995 agreement, which it did not affect, but before the 1996 agreement. The Commissioners held that the effect of the Act was that the benefit of the covenant for the appellant to receive rent was void and passed to CGP on 16 August 1996 and the appellant had no right to enforce payment from CGI in the future. However, the appellant did have rights under the business sale agreement to receive payment via CGP; this was 'clearly not a property right, but akin to a contractual right to consideration for the sale of the assets'.

The Commissioners then considered the extent of Sch A. In their view, 'Sch A is solely concerned with estates in land' (TA 1988, s 24(6)(a)). As the appellant did not have an interest in the land during the two accounting periods of assessment, the payment could not be within Sch A. The Commissioners pointed out that the Revenue did not argue that, following the business sale agreement, CGP held its property interests as trustee for the appellant. It was added that nor was the payment of a capital nature.

The Commissioners then considered Sch D, Case VI and decided that as the rents payable under the 1995 agreement were unaffected by the Landlord and Tenants (Covenants) Act 1995, the source of income remained as Sch A and could not be taxed under that head as the source had ceased when payment was made, the appellant's appeal being allowed in principle with regard to that part. Because of the effect of the 1995 Act, the balance of the payment, relating to the 1996 agreement, had no legal connection with the land and arose from the business sale agreement and was therefore taxable under Sch D, Case VI.

Conclusion

The outcome of this case appears to be at odds with the decision in Centaur Clothes Group Ltd v Walker [2000] STC 324 in which it was stated that where 'a company which is liable to pay corporation tax is within the charge to corporation tax ... it would be an extraordinary case of the tail wagging the dog if the provisions about accounting periods, which are mere machinery, could destroy the substantive right to recover the tax'.

The Revenue says that this case 'provides clarification on Case VI of Sch D and gives us the opportunity to look at our guidance in light of this case'.

Issue: 3983 / Categories: