Payment for Removal of Personal Obligation Not a Deduction

When a sale of shares in a company is in progress, there are often a large number of threads that have to be tied up and sometimes this leads to unintended consequences.

In a recent case, a shareholder had entered into a contractual obligation to a third party which limited his right to sell his shares, so before they could be sold he had to buy his way out of that obligation. He did so, at a cost of £17.5 million.

That done, he sold the shares for £100 million.

When he came to complete his tax return, he calculated the gain chargeable to Capital Gains Tax by deducting from the sale proceeds the cost of the shares and also the cost of securing the right to sell them.

The relevant tax law (Section 38 of the Taxation of Chargeable Gains Act 1992) states that the deduction from the sale proceeds which is permitted in order to calculate the taxable capital gain in such circumstances is:

'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, together with the incidental costs to him of the acquisition or, if the asset was not acquired by him any expenditure wholly and exclusively incurred by him in providing the asset,

b) The amount of any 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 or defending his title to, or to a right over, the asset,

c) The incidental costs to him of making the disposal.'

HM Revenue and Customs did not accept that his expenditure met the above definition and, in an argument that went to the Court of Appeal, they successfully defended their right to charge the tax without the deduction claimed. The earlier agreement was not something that affected the shares but was an agreement personal to the shareholder. Nor could it be argued that the payment in effect re-established his title over the shares which had been forgone by his earlier agreement.