In a case where both sides fell short, the taxpayers failed to meet the requirements to deduct enhancement expenditure in their CGT computations, and HMRC failed to raise the correct assessments.
What is enhancement expenditure?
For CGT purposes, a vendor’s cost of acquisition may be augmented by “enhancement expenditure”, which is defined in TCGA 1992 s38(1)(a): “Expenditure wholly and exclusively incurred on the asset by him or on his behalf for the purpose of enhancing the value of the asset, being expenditure reflected in the state or nature of the asset at the time of the disposal, and any expenditure wholly and exclusively incurred by him in establishing, preserving all defending his title to, or to a right over, the asset.”
Robert Sidebottom and Jane Pickett (TC06724) used to be a married couple. In 2002, they acquired Silurian Mill, a disused factory and connected land in mid-Wales. The aim was to re-develop the site for residential use and sell on for a gain.
This would involve seeking planning permission, and Sidebottom was persuaded that this would look better coming from a limited company. The couple therefore set up Mainstone Properties Ltd (MPL) in 2003: the two were equal shareholders, but Sidebottom was sole director.
Relationship with MPL
The development agreement between the couple and MPL included provisions that:
The company would “explore development potential and provide all necessary services and amenities required to obtain planning permission”
A fee of 5% of either the sales price or the independently-assessed value of the Mill (plus VAT) would be payable to MPL on sale or the receipt of planning permission.
MPL’s activities were funded by director’s loans from Sidebottom, which in turn were funded by loans (in his name) secured on properties owned jointly by him and Pickett.
It was asserted that MPL incurred £283,227 of costs in remedial work on the site. Planning consent was granted in April 2007, subject to an extensive site survey. This took over a year rather than the anticipated 12 weeks, and a £1.75million offer to purchase fell through in March 2008 owing to the delay (coinciding as it did with the financial and banking crisis).
MPL was wound up in February 2010. In March 2011, Silurian Mill was sold for a mere £400,000.
Neither Sidebottom nor Pickett notified HMRC of the disposal of Silurian Mill, or of another 2011 disposal (Hill End Farm, which they also owned jointly). It was not until 2014 that HMRC made a discovery (under TMA 1970 s29) that gains had not been assessed.
A key part of this case was establishing the correct amount of tax to assess. In February 2017 HMRC made the following assessments in respect of both Silurian Mill and Hill End farm:
Sidebottom: CGT of £26,036.54 - no enhancement deduction for the Mill
Pickett: CGT of £36,640.20 - no enhancement deduction for the Mill
Neither of those assessments took into account the enhancement expenditure the taxpayers claimed in respect of the Mill. In addition, both taxpayers were issued with penalties.
In May 2017, following their appeal, HMRC amended the assessments on the basis of Sidebottom being sole owner of Silurian Mill. The revised liabilities were:
Sidebottom: CGT of £46,996.78
Pickett: CGT of £15,705.16 (Hill End Farm only).
These revised assessments continued to take no account of enhancement expenditure, and the appeal came before the FTT.
Establishing a loss
The most important issue before the FTT was to decide whether the couple were entitled to any enhancement expenditure in principle. If so, there would be an allowable loss on the sale of Silurian Mill, which could be offset against the gain on Hill End Farm. If not, there would be gains on both disposals.
A second issue was what adjustments the FTT could make to the assessments to reflect the fact that HMRC was wrong in assessing all of the Silurian Mill gain on Sidebottom.
Much of the problem results from the manner in which MPL was wound up. Under the terms of the development agreement, the couple should have paid the company its 5% fee on obtaining planning permission, MPL’s expenditure would be reimbursed by the couple, and then the directors’ loan could have been repaid. Had this been done, HMRC conceded that they would have been entitled to claim the expenditure which would have been incurred “on their behalf”.
None of this was done. Instead the director’s loan became irrecoverable on the winding-up of MPL.
The judge found that there was a loss, but it was a loss on director’s loan account, accruing to Sidebottom as a director. He commented: “A loss on director’s loan account generates its own form of relief and it cannot be conflated with enhancement expenditure for capital gains tax purposes even if the economic consequences might be the same”.
Revising the assessments
By this stage, HMRC had acknowledged that the Mill had been jointly owned, so the assessment of all the gain on Sidebottom was in error.
Clearly it was the tribunal’s duty to reduce Sidebottom’s assessment back down to the amount assessed in February 2017 of £26,036.54. The judge had to consider whether he should at the same time increase Pickett’s assessment back to £36,640.20. HMRC would have preferred him to do this, but the judge was reluctant.
Even if the two had still been married, they would nonetheless be separate and independent taxpayers. The judge commented: “Whilst it is attractive to see increasing Ms Pickett’s tax liability as correcting the tax payable to the true amount, this would in substance be treating Mr Sidebottom and Ms Pickett as joint taxpayers where the tax can simply be shifted from Mr Sidebottom to Ms Pickett. Had [HMRC] wished to preserve their position on this point we assume that they could have done so.”
Neither Sidebottom nor Pickett incurred the expenditure, nor was it incurred on their behalf, so neither could claim it as enhancement expenditure.
Sidebottom’s assessment was reduced to the February 2017 level, while Pickett’s was left at the May 2017 level.
Where the taxpayers went wrong was in the sloppy manner in which they tried to unwind their development vehicle. Admittedly they were panicking in the midst of a financial crisis, and were suffering from poor financial support (they became customers of RBS’s notorious “Global Restructuring Group). But they failed to follow the straightforward procedural steps set out in the development agreement, which should have guaranteed them the enhancement expenditure.
Also, they might well have found HMRC slightly less confrontational if they had disclosed the gains in the 2010/11 returns rather than going through a lengthy compliance review. Who can say whether their CGT calculation would not have gone through on the nod if it had been declared correctly in the first place?