Readers may recall from the various reports of the proceedings before the special commissioner (Dr Brice), Park J and the Court of Appeal, that the taxpayers’ dispute with the Inland Revenue in Jerome v Kelly [2004] related to an unusual form of contract for the sale of development land which was (intentionally) unconditional for the purposes of s28 Taxation of Chargeable Gains Act 1992 (TCGA1992, see box). The developers’ exit route was a provision entitling them to rescind the contract in the event of outline planning permission not being obtained within seven years. The central issue before the courts was whether the effect of s28(1) was:

(1) to create a disposal when contracts for the sale of land were exchanged (as the Court of Appeal had held); or

(2) merely to backdate the effect of completion under that contract (whenever it took place) to the date of contract in order to determine the date upon which the transaction fell to be taken into account for the purposes of capital gains tax (as Park J had said).

The House of Lords decided in favour of the latter. The taxpayers therefore won their case and did not have to account for capital gains tax (CGT) on part of the land which they had transferred to offshore trusts between contract and completion.

The current compliance Implications

The case related to transactions before the introduction of self-assessment in 1996. The question therefore arises as to how, had such a contract been entered into in 1998 and the planning application had hardly progressed at all by 2001 (the date up to which amendments may be filed to returns for that year), the taxpayers should have completed their returns (SARs) for 1998/99.

It is quite clear that, in the CGT schedule for 1998/99, which would have to be filed before 31 January 2000, no disposal would fall to be declared. It would clearly be appropriate, however, for the circumstances to be explained in the ‘white space’ box in the SAR. That disclosure should suffice to alert the inspector to the possibility of an additional disposal having to be added in later. The inspector ought, in these circumstances, to initiate an ‘enquiry’ and hold it open until the earlier of completion or 31 January 2005, the latest date upon which an assessment can be made in relation to 1998/99.

If the inspector takes that course of action and the disposal is brought into charge, the taxpayer is likely to have to pay considerably more tax than would have been the case if an alternative form of contract to the ‘unconditional’ one chosen in Jerome v Kelly had been used. Not only will interest be charged from 31 January 2000, but a series of 5% surcharges will also fall to be payable.

The downside for the Revenue

Somerset House may, however, be more concerned with the consequences of the inspector failing to spot the ‘white space’ declaration and initiate an enquiry before 31 January 2001. In that event, under the SAR rules, the inspector is debarred from doing so unless the taxpayer has been guilty of ‘neglect’. This seems unlikely because, under those same rules, taxpayers are not permitted to amend their SAR for 1998/99 after the same date. In the absence of knowledge that an acceptable planning consent will be obtained (which would be very difficult to guess), not only would they be under no obligation to submit a corrected computation after that date, but there appears to be no mechanism under which they can do so.

It follows that where a contract for the sale of land to a developer is ‘unconditional’ at the outset, the collection machinery is inequitable as far as the taxpayer is concerned and defective from the Inland Revenue’s point of view.

When is a contract conditional?

There were certainly times when the general practice was to regard contracts expressed to be ‘subject to planning permission’ as ‘conditional’, and it is possible that Lord Walker may have had them in mind when he said, in Jerome v Kelly, that s28(2) of the TCGA 1992:

… would cover many long-term contracts for the sale of land with development potential, since such contracts are often conditional on planning permission being obtained.

The strict legal position is, however, that for a contract to be treated as ‘conditional’ for the purposes of s28, the conditionality must be as to liability under the contract and not as to completion under its terms. In Lyon v Pettigrew [1985] Walton J gave as an example of the former a contract for an hotel booking if the Olympic Games were held in London.

More materially, the second scenario was held to be the case in relation to the obtaining of exchange control consent in IRC v Ufitec Group Ltd [1977], to compliance with certain terms as to building works in Eastham v Leigh, London & Provincial Properties Ltd [1971] and as to a waiver of option rights in Smith and anr v IRC [2003].

But most material in this particular context has been the indication by Jonathan Parker J in Hatt v Newman [2000] that, contrary to the assumptions before the court in that case, a ‘subject to planning’ condition was also in the second category. And, as modern contracts with developers tend to involve the payment of a large non-refundable sum at exchange, most property lawyers have been operating on the basis that this represented a correct statement of the law. It is submitted that nothing in Lord Walker’s speech should be taken as detracting from that, it being common ground throughout that the form of contract used by the Jeromes was unconditional under the above criteria.

Moreover, with the complexities of the current planning system, developers generally ask for the owner to commit their land to the project for a period of ten years or more. The consequence of a combination of the SAR surcharge regime and Hatt v Newman has, therefore, been to accelerate the change of modus operandi of vendors of developable land away from contracts which may not turn out to be conditional to a series of options.

On that basis, the lump sum paid up front is brought into charge in full as an independent (and untapered) asset on exchange under s144(1) TCGA1992. It is only when the option is exercised that that ‘disposal’ is unscrambled and the option price amalgamated into the proceeds of the sale (which will very often qualify for business asset taper relief) under s144(2).

Vendor’s recovery problem

But if exercise takes place more than five years and nine months after the end of the tax year in which the option was granted, the SAR rules will not allow the vendor to file a ‘claim’ for the cancellation of the original disposal. Although the Inland Revenue’s practice is to allow the tax already paid to be credited against that payable on the second event, it will not refund it in the event of (for instance) the vendor having emigrated.

And one for the developer too

Where land is sold under a contract which provides for an additional fixed sum to be paid to the vendor if planning permission is obtained before a specified date in the future, the purchaser has to pay stamp duty land tax on an amalgum of the price paid and the maximum sum payable if such permission is obtained.

A tax refund can be claimed if the relevant period expires without the additional payment having become due. The government has, however, introduced an amendment to the stamp duty land tax legislation in the Finance Bill currently before parliament restricting the ability of the purchaser to recover the initial overpayment of tax to six years.

Conclusion

Jerome v Kelly has highlighted the unsatisfactory nature of the self-assessment rules introduced for CGT in 1996 (and since extended to other taxes) when dealing with long-term arrangements for the purchase of development land. While the Inland Revenue may well be tempted just to plug the apparent hole in the ‘unconditional’ contract arrangements, equity demands that the equivalent positions of grantors of options and purchasers liable to pay fixed price overage should also be addressed.

Section 28 TCGA 1992

Time of disposal and acquisition where asset disposed of under contract

(1) Subject to section 22(2), and subsection (2) below, where an asset is disposed of and acquired under a contract the time at which the disposal and acquisition is made is the time the contract is made (and not, if different, the time at which the asset is conveyed or transferred).

(2) If the contract is conditional (and in particular if it is conditional on the exercise of an option) the time at which the disposal and acquisition is made is the time when the condition is satisfied.

Case references

Eastham v Leigh, London & Provincial Properties Ltd (1971) 46 TC 687

Hatt v Newman [2000] STC 113

IRC v Ufitec Group Ltd [1977] STC 363

Jerome v Kelly [2004] UKHL 25

Lyon v Pettigrew [1985] STC 369

Smith and anr v IRC (2003) SpC 388

Jeremy de Souza is a consultant at White and Bowker.  © Property Law Journal