Capital gain on assignment of lease–Payment of arrears of rent made by liquidator to obtain landlord’s consent to assignment not made to enhance the value of the asset and not a permissible deduction–Even if made to preserve company’s title to the asset, payment must be excluded from computation as deductible in the normal course from profits of a hypothetical trade
This was an
appeal by an inspector of taxes, Mr Peter Kennedy Emmerson, against a decision
of special commissioners upholding a claim by the respondents, Computer Time
International Ltd, a company in liquidation, to relief under schedule 6, para 4
(1), to the Finance Act 1965 in respect of arrears of rent paid after the date
of winding-up of the company.
Mr P Gibson
(instructed by the Solicitor of Inland Revenue) appeared for the appellant, and
Mr P Whiteman (instructed by Kingsley, Napley & Co) represented the
respondents.
Giving
judgment, Fox J said that the respondent company was formed in 1969 to carry on
the business of hiring computer time. It acquired a 21-year lease of premises
in Oxford Street, London W1, at an annual rent of £16,000, and by an underlease
it was tenant of second-floor premises in the same building at an annual rent
of £19,000. The business did not prosper, and in April 1970 the company went
into voluntary liquidation. It was in arrears with its rent, and the landlord
agreed to assignment of the lease and underlease to new tenants only on
condition that the arrears were paid in full by the liquidator. On completion
of the assignments the new tenants paid the liquidator a total of £93,155, out
of which the liquidator paid the landlord £14,688 for rent arrears; of that,
£6,131 was for rent accruing due after the company was wound up. The special
commissioners allowed the company’s claim to deduct that sum in computing its
capital gains arising out of the assignments, as being expenditure incurred in
enhancing the value of an asset of the company. The Crown appealed from that
decision.
The enactments
he (his Lordship) had to construe were contained in schedule 6 to the Finance
Act 1965. Para 4 (1) of the schedule provided, so far as relevant, that sums
allowable as a deduction from the gain accruing on the disposal of an asset
should be restricted to expenditure wholly and exclusively incurred to enhance
the value of, or preserve the taxpayer’s title to, the asset. Para 5 provided:
‘(1) There shall be excluded from the sums allowable [under para 4 (1)] . . .
any expenditure allowable as a deduction in computing the profits or gains or
losses of a trade, profession or vocation. . . . (2) Without prejudice to the
provisions of subparagraph (1) above, there shall be excluded from the sums
allowable [under para 4] as a deduction in the computation under this schedule
any expenditure which, if the assets, or all the assets to which the
computation relates, were, or had at all times been, held or used as part of
the fixed capital of a trade the profits or gains of which were . . .
chargeable to income tax would be allowable as a deduction in computing the
profits or gains or losses of the trade for the purposes of income tax.’ The commissioners had held that the
liquidator’s purpose in agreeing to pay the arrears was to obtain the right to
assign the leases freed from the threat of re-entry, and that this right
enhanced the value of the leases. They decided that the payment made was a
capital payment and was not disallowed by the exclusion provisions of para 5
(2). The Crown now said (1) that though the landlord could not have sued for
the £6,131, the payment was one which the liquidator could, and did, properly
make as a payment of rent; (2) that that rent was not aptly described as
expenditure wholly and exclusively incurred to enhance the value of an asset;
(3) alternatively that the payment would, on the hypothesis stated in para 5
(2), be allowable as a deduction in computing the profits of a trade, and was
therefore not allowable in computing the gains on the disposal of an asset.
As regards the
first argument, the rent was payable in advance and was due before the beginning
of the liquidation, so that the landlord could not sue for it, but if the risk
of forfeiture for non-payment was to be removed, the rent had to be paid in
full. It must therefore have been proper for the liquidator to agree to pay the
arrears. Further, in his (Fox J’s) view the payment was a payment of rent.
Turning to the construction of para 4 (1), he did not think payment of the
arrears was aptly described as expenditure for the purpose of ‘enhancing’ the
asset’s value. No doubt, to realise the leases’ full value the arrears had to
be paid off, but that meant only that there was a liability inherent in the
asset itself. It could however be that the payment was made to preserve the
company’s title to the asset within the meaning of para 4 (1). He (his Lordship)
would assume this was so, and go on to consider the exception in para 5 (2).
This required the assumptions (i) that the lease was held as part of the fixed
capital of a trade, and (ii) that the profits and gains of the trade were
chargeable to income tax. If the lease were part of the fixed capital of a
trade, a payment of rent made in accordance with the covenants of the lease
would clearly be allowable as a deduction in computing the profits and gains.
The position would be no different if the trader got into arrears with his rent
and then, either to prevent forfeiture proceedings or as a condition of relief
from forfeiture, paid off the arrears. The payment would no doubt be one made
to protect a capital asset, but would still be deductible as a payment of rent.
In the present case the situation was more complex. The payment was made so
that the asset could be sold in circumstances in which the full amount could
not be recovered from the company by action on the covenants of the leases. He
(Fox J) thought, however, that it was still a payment of rent. For the company
it was contended that where a payment which would
of a capital interest, that payment acquired a capital quality and would not be
deductible in a trading computation. In support were cited Littlewoods Mail
Order Stores Ltd v McGregor [1969] 1 WLR 1241 and IRC v Land
Securities Investment Trust [1969] 1 WLR 604. But those cases were
concerned with the acquisition of new assets, and here no new asset was
acquired. The payment was therefore not turned into a capital payment.
Assuming that
the lease was part of the fixed capital of a trade, and having regard to his
finding that the payment made by the liquidator was a payment of rent, he (his
Lordship) thought that the payment must be one which was deductible in
computing the profits of that trade. Accordingly it fell within the prohibition
in para 5 (2) and was not allowable as a deduction. It followed that the appeal
succeeded.
The Crown made
no application for costs.
