TRADING STOCK Whether Properties in Course of Sale by Group Investment Companies Were

TRADING STOCK – whether properties in course of sale by group investment companies were acquired by another group company as trading stock – no

THE SPECIAL COMMISSIONERS

A PROPERTY DEALING COMPANYAppellant

- and -

HM INSPECTOR OF TAXESRespondent

Special Commissioners:DR JOHN F AVERY JONES CBE

JOHN CLARK

Sitting in private in London on 9, 10 and 12 December 2003

Jonathan Peacock QC instructed by Ernst & Young for the Appellant

Philip Jones instructed by the Solicitor of Inland Revenue for the Respondents

© CROWN COPYRIGHT 2003

1

ANONYMISED DECISION

1. This is an appeal by A Property Dealing Company against a Notice of Determination of loss for the period ended 31 December 1996. The issue is whether certain properties were acquired by the Appellant as trading stock. The Appellant was represented by Mr Jonathan Peacock QC and the Respondent by Mr Philip Jones.
2. We had three binders of documents. Mr Smith of the Group’s UK Property Division gave evidence.

Agreed facts

1. There was a statement of agreed facts as follows:

(1)The Appellant” is a company incorporated in England. The Appellant is and has always been resident in the UK for tax purposes.

(2)the Appellant is a wholly owned subsidiary of the Parent Company..

(3)At the start of 1996 the Parent Company (through its subsidiary companies) owned the following properties (“the Properties”):

(1)“Northampton” owned by Subsidiary No.1.

(2)“Langham Place” owned by Subsidiary No.1.

(3)“Winchester” owned by Subsidiary No.2.

(4)“Queens Terrace” owned by Subsidiary No.3.

(5)“Park St James” owned by Subsidiaries Nos.4 and 5.

(6)“Lincoln Place” owned by Subsidiary No.5.

(7)“West Thurrock” owned by Subsidiary No.1.

(8)Hyde Park Square” owned by Subsidiary No.3.

(9)“Jarman Fields” owned by Subsidiary No.6.

(3)The Properties did not form a part of the trading stock of any trade carried on by the subsidiary companies which owned the Properties.

(4)Had the Properties been sold on 13 November 1996 a loss, for capital gains tax purposes, of about £68m would have arisen (“the Loss”).

(5)All but one of the properties were sold in the period between 18 November 1996 and 3 March 1997.

(6)On 24 December 1997 the Appellant signed a corporation tax return for the period ended 31 December 1996 (which was delivered to the Inland Revenue on 6 January 1998). This was prepared on the basis that it had acquired from its fellow subsidiaries the Properties on 13 November 1996 “as trading stock” of a trade carried on by it within section 173(1)(a) TCGA 1992 and that the market value of the Properties on 13 November 1996 be increased by the amount of the loss that would have arisen on that date for capital gains tax purposes and that the Appellant’s profits, for corporation tax purposes, should be computed accordingly. The Inspector of Taxes, in a letter dated 22 April 1998, accepted the computational entries accompanying the return as the election under section 161(3).

(7)On 31 May 2000 the Inland Revenue issued a Notice of Determination of loss for the period ended 31 December 1996 in the sum of £448,332 that did not take the Loss into account.

(8)On 5 June 2000 the Appellant appealed against the Notice of Determination.”

1. To give a more complete picture of the surrounding circumstances it should be mentioned that on 18 November 1996 other properties held by group dealing companies were also contracted to be sold to the Appellant. The Respondent accepts that the Appellant acquired them as trading stock.

Legislation

1. The legislation relevant to this case is first section 161(1) Taxation of Chargeable Gains Act 1992:

“Subject to subsection (3) below, where an asset acquired by a person otherwise than as trading stock of a trade carried on by him is appropriated by him for the purposes of the trade as trading stock (whether on the commencement of the trade or otherwise) and, if he had then sold the asset for its market value, a chargeable gain or allowable loss would have accrued to him, he shall be treated as having thereby disposed of the asset by selling it for its then market value.”

On its own this brings into charge or relieves any existing gain at the time of appropriation of an asset to trading stock. That is subject to subsection (3) which allows the taxpayer to elect that the existing gain or loss should be taken into account in computing its trading profits:

“…subsection (1) above shall not apply in relation to a person’s appropriation of an asset for the purposes of a trade if he is chargeable to income tax in respect of the profits of the trade under Case I of Schedule D, and elects that instead the market value of the asset at the time of the appropriation shall, in computing the profits of the trade for purposes of tax, be treated as reduced by the amount of the chargeable gain or increased by the amount of the allowable loss referred to in subsection (1), and where that subsection does not apply by reason of such an election, the profits of the trade shall be computed accordingly.”

Section 173(1) applies the foregoing sections where there is an intra-group transfer with the transferor company holding the asset as a capital asset and the transferee company acquiring the asset as trading stock by providing that the existing capital gain or loss arises accrues to the transferee company, which may elect under section 161(3) to treat the gain or loss as part of its trading profits. At the relevant time, it took the following form:

“Where a member of a group of companies acquires an asset as trading stock from another member of the group and the asset did not form part of the trading stock of any trade carried on by the other member, the member acquiring it shall be treated for the purposes of section 161 as having acquired the asset otherwise than as trading stock and immediately appropriated it for the purposes of the trade as trading stock.”

1. It is common ground that the Appellant made an election under section 161(3) and the effect of the legislation is that if the Appellant acquired the Properties as trading stock the Loss will be available for group relief. Accordingly the question for us is whether the Appellant did acquire the Properties as trading stock.

Contentions of the parties

1. Mr Peacock QC for the Appellant contended that the Appellant carried on an existing property dealing trade. It acquired the Properties from other group companies on 13 November 1996 and except for one of them which remains unsold, sold them all on or before 3 March 1997. As such it was, he says, a normal dealing operation and the Properties were acquired as trading stock.
2. Mr Jones for the Respondent contended that whether something was acquired as trading stock was a commercial concept in terms of Macniven v Westmoreland Investments Ltd [2001] 377, to the question of which we should adopt a commercial approach. While there is the appearance of dealing, the reality is that the Properties were being sold anyway because the Parent Company was closing down its property operations. The Appellant never had a trading purpose; it was merely carrying out the group’s purpose of disposing of the Properties and it had no purpose of its own other than to obtain the Loss in the form of a trading loss.
3. Mr Jones also contended that it was difficult for one member of a group to acquire an asset from another member of the group with a view to making a turn. Also that the section required that the two group companies act independently with their own directors.

Further findings of fact

1. It is necessary to go into the surrounding facts in more detail. In 1994 following a strategic review the Group decided not to make any further commercial property investments and to sell the whole portfolio in an orderly manner. The Parent Company’s 1994 accounts stated that the “group will continue to dispose of its property portfolio at acceptable prices.” Sales of £189.2m were made in that year. Sales continued in 1995, and in the second half of 1996 the Group board decided to accelerate the disposal programme. By the time with which we are concerned the best properties had been sold and only complicated or difficult properties remained.
2. Consideration was given to showing the property division as a discontinued business. A memorandum of 15 October 1996 from the Head of Group Accounts to the Group Finance Director explained that the accounting treatment for a discontinued business as an exceptional item required that the sale would need to take place by the first week in March 1997 and that the sale has a material effect on the nature and focus of the group. The memorandum explained that investment properties qualify as exceptional items in any case but dealing properties must qualify under the definition of discontinued business to be an exceptional item. It seems therefore that the transfer of the Properties to the Appellant made it more difficult for the Loss to be shown as an exceptional item because it required the Properties to be sold by the first week in March 1997. There is a note of an undated phone call with Ernst & Young, the group auditors, saying that they would prefer the remaining US assets to be clarified under current assets as “assets held for resale,” which implies that this treatment was not necessary to the UK assets. A memorandum was sent by Ernst & Young to the Head of Group Accounts on 11 November 1996 giving Mr Allister Wilson’s initial thoughts on the accounting issues on discontinuance. This contains the following:

“My view is that since you will have discontinued the property division, the remaining properties cannot, by definition, continue to be classified as investment properties. My preference, therefore, is to transfer the properties from the property division to Group (in order to reinforce the fact that the property division has been closed) and include them within current assets as assets held for resale.”

We assume that the reference to the transfer to “Group” refers to an accounting transfer, rather than the intra-group transfer that took place. We notice that the Head of Group Accounts had been copied a memorandum from the Financial Controller of 8 November giving details of the proposed transfer to the Appellant and it is possible that he contacted Ernst & Young following this, but this seems less likely as the focus of the Ernst & Young memorandum is on the discontinuance. Unfortunately we did not have any further evidence on this point which would have been helpful. The memorandum also states that “FRS3 does not appear to distinguish between operating and non-operating items in the case of discontinued operations” and concludes that the entire net result of the discontinuance should be shown in one place in the accounts. This seems contrary to the basis of the 15 October memorandum which was that investment properties qualified for treatment as an exceptional item in any event. Naturally we treat this advice with great respect but for tax purposes we do not think that anyone would say that on a discontinuance all fixed assets automatically become trading stock. For example, on a discontinuance of a trading business we think there is no doubt that the sale of the factory would for tax purposes be the sale of a capital asset. Accordingly, we do not consider that this advice assists the Appellant’s contention that the Properties were acquired by the Appellant as trading stock.

1. The idea of transferring the Properties to the Appellant started with a memorandum from Mr Brown of the group tax department to the Group Finance Director on 28 October 1996 (which pre-dated the accounting advice) that said “the dealing expertise of this company’s [the Appellant’s] officers would then be used to market the properties and optimise the timing and value of disposal.” The writer said

“I imagine that the discussion you would have at the Board Meeting could be summarised as follows:

▪ the intentions of the Group towards property have changed. We no longer consider ourselves property investors and instead wish to use our property dealing expertise to optimise the value/timing of disposal of our existing portfolio…”.

Mr Smith did not see the memorandum at the time but he agreed with the proposal. The Appellant has carried on business as a property dealing company since 1986 and has been in the group since 1996. It has developed and sold in phases a site near the Angel in London. The directors of the vendor companies and the Appellant at the time of the transfer consisted of Mr Smith, the Commercial Director of the UK property division, and the New Project Manager, who was not a director of three of the vendor companies. The Financial Controller of the UK property division) became a director of all of them on 20 November 1996. They were all employed by a group company. Since the “property dealing expertise” rested in the same persons as were the directors of the investment companies who were already conducting the sale of the Properties, we regard this stated advantage as window dressing by the tax department which has made us approach other statements of the Appellant’s purposes more critically.

1. The tax department originally proposed a sale of the Properties at a price which gave a guaranteed minimum margin of 10 per cent. Mr Smith and the Financial Controller substituted a fixed price. A memorandum by the Financial Controller of 12 November stated:

“It has been decided that [the Appellant] should expand its dealing activity by purchasing a portfolio of properties from other Group companies which it will then market using its dealing expertise….In the majority of cases the consideration is less than the current book value but this will enable [the Appellant] to have the opportunity to trade the properties profitably, and optimise the sales proceeds from a Group perspective….”

1. Mr Smith also said that the price at which the Appellant purchased was designed to enable it to make a profit. The Properties (plus a further property not relevant to this appeal) were contracted to be sold from the various group investment companies to the Appellant on 13 November 1996 for a total of £18,705,000. Mr Smith signed the contract on behalf of the Appellant and the Commercial Director on behalf of the vendor companies. In the absence of any evidence to the contrary we accept that the prices at which the Appellant acquired the Properties were within the range of arm’s length prices but at the end of the range designed to show the maximum profit to the Appellant. The minutes of the directors of the vendor companies attended by Mr Smith and the Commercial Director approving the contract reported that agreement had been reached following an approach from the Appellant and stated that the sale would reduce the company’s financing costs, which we understood to mean financing by intra-group loans. The same two directors in their capacity as the finance committee of the directors of the Appellant approved the purchase by the Appellant and stated that the Appellant “intends to hold the properties as part of its dealing stock and to use its dealing expertise to maximise its profits.” We make the same comment as before on the statement about the company’s dealing expertise. The parent company capitalised the Appellant so that it paid cash for the Properties to the vendor group companies.
2. On 10 December 1996 following a memorandum from Mr Smith of 29 November the board of the Parent Company resolved to discontinue the property division and dispose of the remaining properties. This was the end of a process that had been continuing since 1994. Since the Properties had been in the hands of agents and (as appears below) offers for all of them had been received by that date this seems to be a resolution that recognised an existing state of affairs rather than a new decision to discontinue the property division. The 1996 accounts include the statement that “its exit from retailing and commercial property has now been completed.” Property disposals of £167.4m were made in the year, leaving £36.2m of investment properties mainly outside the UK. Those accounts contain an exceptional item before tax of £52.3m arising from the discontinuance of the property business.
3. The Properties were sold by the Appellant in three parcels: Northampton, Langham Place, and a portfolio of the remaining properties (except for Jarman Fields, which remains unsold). Brief particulars of the progress of the sale of each of them are as follows.

Northampton

1. Northampton was put into the hands of agents on 23 May 1996. Two offers were made by 14 August 1996. The higher one of £630,000 was accepted on 21 August 1996 and a draft contract was submitted on 4 September. Negotiations took place concerning VAT resulting in the vendor company electing to waive exemption for VAT on 19 September, following which the draft contract provided for transfer of a going concern treatment. A reduction in the price to £625,000 was agreed on 20 September and the purchaser wanted a loan to cover any VAT liability, which the vendor company was not willing to give. On 6 November Purchaser No.3 made an indicative list of assets they would be prepared to purchase (see paragraph 19 below) including this property at £650,000 but no offer was made for this property. Negotiations with the former purchaser continued and on the third draft of the contract dated 12 November the name of the vendor was changed to the Appellant. A letter of the same date shows that the purchaser wanted a later completion date than 31 December which was required by the Appellant.