My client is disposing of its interest in a land complex in the east of England. The holding structure is unimportant, except that the disposal mechanism involves the sale for a nominal amount of the shares in a company which is a limited partner of the partnership. The general partner will be sold a few years down the line, and £x million will be injected into the partnership by the purchaser to settle intra-group debt. There are various warranties and indemnities being negotiated as part of the transaction.
My client is disposing of its interest in a land complex in the east of England. The holding structure is unimportant, except that the disposal mechanism involves the sale for a nominal amount of the shares in a company which is a limited partner of the partnership. The general partner will be sold a few years down the line, and £x million will be injected into the partnership by the purchaser to settle intra-group debt. There are various warranties and indemnities being negotiated as part of the transaction.
Within the agreements, it states that any payments under the tax deed will be deducted from the sale proceeds of the shares in the limited partner. With consideration for the shares only being £1, any payments required will therefore lead to 'negative proceeds' for the shares, i.e. the vendor will effectively be paying to sell the shares.
The question is what would be the tax treatment, for both parties, of these negative proceeds? Will the vendor have a capital loss and purchaser a negative cost of investment? Will the payment/receipt be deemed to be a tax nothing, i.e. no relief whatsoever, either on the capital or revenue account, for both parties, which would be good for the purchaser and bad for the vendor?
(Query T16,014) - Eades.
In principle, under the Taxation of Chargeable Gains Act 1992, it may be possible both to obtain a capital loss for the receipt of negative consideration following a warranty claim, under a combination of sections 49(1)(c), 49(2) and 38(1)(b); and, despite the inference from the opening words of section 38(1), to have a 'minus' acquisition price. Although the latter usually arises through the transmission of probate values for inheritance tax under section 274, Taxation of Chargeable Gains Act 1992, the formulation of ibid., section 272(1) is sufficiently similar to the old Estate Duty formulation for a negative value to be permissible, as happened in the case of a lease in Re Brand [1945] N Ir 1.
But the Revenue is likely to latch on to the fact that the inherent nature of the shares sold, i.e. the indirect link to the limited partnership, is not such that a warranty liability in excess of £1 would come within the wording of section 38(1)(b), Taxation of Chargeable Gains Act 1992. Commercially, a warranty liability in excess of the gross consideration cannot be justified. From the vendor's point of view, therefore, such an arrangement is best avoided.
It seems possible, however, that the vendor may be anticipating receiving more money back from the project through the unwinding of the intra-group debt. In these circumstances, the warranty liability may operate to reduce the loan recoveries. It is a question of fact, albeit one in which drafting may play a part, whether this is the case: see EV Booth (Holdings) Ltd v Buckwell [1980] STC 578. In these circumstances, there would be no capital loss to the vendor because, under section 251(1), Taxation of Chargeable Gains Act 1992, the loans would not be chargeable assets in the hands of the vendor unless (as seems unlikely) they had been structured as 'a debt on a security' within the definition in ibid., section 132(3)(b).
In the hands of the purchaser, however, the assigned debt would be a chargeable asset and any reduction in the acquisition price, as against par value, would be taken into account when the debt was realised. The purchaser's advisers may, therefore, have taken the view that they have better prospects of success by contending that a negative purchase price (created by the subsequent warranty claim being set against the share price) is not permissible under the opening words of section 38(1), not least because of the lack of underlying commerciality. - JdeS.
Any payments under the tax deed will result in a revised capital gains calculation under section 49, Taxation of Chargeable Gains Act 1992. The Inland Revenue's Capital Gains Tax Manual (at paragraph 14807) states that section 49 can only reduce the gain to nil, i.e. a capital loss cannot be created. The legislative basis for this is not clear, nothing in the legislation specifically prevents any section 49 adjustments from turning a capital gain into a capital loss.
A payment received by the purchaser under the deed will represent a capital sum derived from an asset assessable under section 22, Taxation of Chargeable Gains Act 1992.The asset is the target company's rights under the contract. These will be acquired without any payment of consideration and by way of a bargain otherwise than at arm's length. The rights are therefore acquired at nil cost under ibid., section 17. Any payment received by the target company under a warranty or indemnity is therefore pure gain. In practice, the Revenue permits the purchaser to reduce the purchaser's acquisition cost by the amount received. Any excess over the acquisition cost is treated as taxable (Capital Gains Tax Manual at paragraph 13043).
It would, however, be commercially unusual for the consideration to become negative as a result of subsequent payments. In most cases, payments under warranties and indemnities are subject to an overall cap of a specified monetary amount or the level of overall consideration. - Ian.
