Michael Upton: Capital gains tax – date of disposal and conditional contracts

Many owners of valuable assets are worried that the UK government's budget announcement on October 30 could lead to a noticeable hike in capital gains tax. As a result, those considering selling their assets are keen to know if finalizing deals before October 30 would allow them to benefit from the existing tax rates, instead of facing a potential increase after the budget is released, explains advocate Michael Upton FCI Arb.

In these situations, it's impossible to have complete certainty due to the potential for laws to change retroactively. When planning sales strategies, it's usually safe to assume that any price increases will take effect in the future. This assumption can be useful, provided that we recognize the existing uncertainty.

What options do we have to ensure that the current rates apply? According to existing law, one option may be found in section 28 of the Taxation of Chargeable Gains Act 1992. This section states that the taxable date for a sale under a contract is the date when the contract is signed, rather than the date of completion.

This means that finalizing a contract before October 30 can be a wise move. However, there are also valid reasons for not hurrying into commitments that clients may not want to take on.

One potential solution is using a conditional contract, where the sale depends on certain future events that would make the deal more appealing. A common example of this is requiring planning permission before a piece of land can be sold. However, according to section 28(2), for tax purposes, the important date for a conditional contract is when the condition is met. If that date is expected to fall after October 30, trying to finalize the deal early with a conditional contract might not be beneficial. This is because if the condition is fulfilled after the Budget announcement, the higher capital gains tax rates will apply.

That, however, relies on the interpretation of what a conditional contract is according to the 1992 Act.

Contracts typically involve mutual promises between parties, meaning that each party's obligation relies on the other fulfilling their part. If one side fails to perform, this may lead to rights of retention or cancellation. In a general sense, contracts can be considered "conditional." However, if this type of conditionality was enough to delay the relevant date for tax purposes, then the specific rules for conditional contracts would override the broader rule that focuses on the date the contract was formed. Therefore, we need to interpret "conditional" more specifically in Section 28, as noted by Russell LJ in Eastham v Leigh London & Provincial Properties Ltd., [1971] Ch. 871; see also Lyon v Pettigrew, [1985] STC 369.

The more narrow interpretation of section-28 conditionality refers to conditions that depend on an event that is ultimately beyond the parties' control, such as a decision made by a third party. A good example of this is when a land sale is contingent upon receiving planning permission: in this case, the sale is conditional for section 28 purposes. The transfer of the property won't take place until the required approval is obtained, or, depending on the wording, until the buyer confirms that the approval has been granted under acceptable terms. This type of condition is known as a suspensive condition.

A resolutive condition is different from a suspensive condition. A resolutive condition refers to a situation where an agreement can be canceled if a certain event occurs later on. This is also known as a "condition subsequent." You can find more details in Gloag, pages 273-274.

A sale that depends on an outside factor, like needing approval from a third party, can be seen as essentially the same agreement. This holds true whether the parties decide that they won't be obligated to complete the sale until the approval is granted (which is called a suspensive condition) or whether they agree to go through with the sale unless the approval is not received by a certain date (known as a resolutive condition). In essence, both scenarios can lead to a very similar outcome.

There is a perspective that a contract with a resolutive condition doesn't qualify as conditional when it comes to Capital Gains Tax (CGT). This is important to consider before the upcoming Budget because it means that signing a contract with a resolutive condition would be taxed at the current rates, rather than any new rates that might be introduced later this month.

In the case of Hatt v Newman (Inspector of Taxes), Ch.D, on January 20, 2000, which is unreported, there seemed to be a recognition of this legal perspective. Park J. in Jerome v Kelly, 76 TC 147 (Ch.D) explicitly stated that a sale with a resolutive condition should not be considered conditional according to section 28. The parties involved agreed on this matter, and the judge had no doubts about it. Later, when the case reached the House of Lords, Lord Walker of Gestingthorpe mentioned the parties' consensus that the contract was unconditional, without any indication of disagreement: [2004] 1 WLR 1409. Generally, prioritizing form over substance in determining tax obligations is not often a matter of contention, as seen in Aberdeen Construction Group Ltd. v Inland Revenue Commissioners, [1978] AC 885. The interpretation that section 28 indicates the date when a contract with a resolutive condition is completed is the disposal date stems from the idea that, formally, such a contract establishes obligations that can be annulled, while a contract with a suspensive condition keeps the situation uncertain until the future disposal date.

This topic isn't without its controversies, but it could be worth discussing in the coming three weeks.

We would like to express our gratitude to Patrick Soares from the English bar for his insightful work on these topics in his article “Cake and Eat It - Unconditional Sales Contract With Power to Rescind - Capital Gains Tax,” published in the Gray’s Inn Tax Chambers’ Review, 2011, volume X, issue 2. We highly recommend it to our readers.