Lee Sharpe looks at some recent cases covering when a taxpayer loses their deposit on a property.
It is common for brand new developments to require would-be investors to fund a deposit towards the build – typical in ‘off-plan’ projects. These may be high-risk ventures, and it is not unusual for the investor to lose their deposit. HMRC will typically reject any claim for tax relief. But is this always the correct treatment?
This article considers some case law from the last few years that may appear inconsistent, but which may nevertheless offer the investor some hope of a tax relief claim in the right circumstances.
Background
TCGA 1992, s 144 (‘Options and forfeited deposits’) broadly sets out, amongst other things, that:
- the abandonment of any option (other than specified in TCGA 1992, s 144) by the person for the time being entitled to exercise that option shall not constitute the disposal of an asset by that person; and
-
the section also applies to a forfeited deposit of purchase money or other consideration money for a prospective purchase or other transaction which is abandoned as it applies in relation to the consideration for an option which binds the grantor to sell and which is not exercised.
So, aside from a few narrow exceptions, a forfeited or abandoned deposit on a purchase should be treated as if it were a forfeited or abandoned option to purchase, and not give rise to an allowable capital loss because capital gains tax (CGT) law deems there to have been no disposal.
HMRC’s Capital Gains Tax Manual likewise states (at CG12390 and CG12340):
‘A forfeited deposit of purchase money, or other consideration money for a prospective purchase or other transaction which is abandoned, is dealt with in the same way the consideration for an option which is not exercised” (it does not amount to a disposal, so cannot give rise to a capital loss).
Case law would appear largely to back this approach. The broad logic is that payment for an option to purchase an asset acquires a valuable legal right but not any part of the asset itself. If the purchase completes, then the cost of the option to purchase will be added to the cost of the asset. If not, the legislation blocks the forfeiture or abandonment of the option from counting as a disposal for CGT.
Hardy v HMRC
In Hardy v HMRC (heard latterly at the Upper Tribunal under Hardy v HMRC [2016] UKUT 0332 (TCC)), the taxpayer had placed a 10% deposit of £72,000 on an off-plan purchase, with the balance payable within a few days of substantial completion of the building. The taxpayer had intended to fund a good proportion of the balancing amount by selling two investment properties but was unable to do so in time for the completion deadline; the seller was allowed under agreed terms to rescind the contract but keep the taxpayer’s deposit. The Upper Tribunal agreed with HMRC that the taxpayer’s deposit was a part-payment of the purchase price of the property rather than the acquisition of contractual rights under the contract but either way, as a forfeiture by the taxpayer, it did not give rise to a disposal.
This finding appeared to conflict with the older Court of Appeal case Underwood v HMRC [2008] EWCA Civ 1423, which held that such contractual rights might themselves comprise assets for CGT purposes.
Lloyd-Webber v HMRC
In Lloyd-Webber v HMRC [2019] UKFTT 717 (TC), the Lloyd-Webbers contracted to buy two villas in a large development for a combined price of $26 million. The developments proceeded and the taxpayers made stage payments exceeding $11 million. But the global financial crisis intervened and the developer was unable to continue to finance the entire development. The taxpayers arrived at substantial deficits of roughly £3 million each, which they, in turn, claimed as capital losses.
Both the taxpayers and HMRC agreed that the Hardy case, which might otherwise be binding as an Upper Tribunal case, had failed to consider the above point in Underwood, which carried more precedential authority as a judgment from an even higher court. This, in turn, allowed the First Tier Tribunal to find that “the payments made by the taxpayers under their initial contracts were for the acquisition of contractual rights, the only asset they actually acquired”, and the Lloyd-Webbers had in fact made allowable capital losses on those rights.
Note that both the taxpayers and HMRC had already agreed that the Underwood case should override Hardy; also, the judge in Lloyd-Webber offered little about why Underwood should override Hardy. HMRC did not appeal; but that does not mean that HMRC agreed with the outcome.
Drake v HMRC
In Drake v HMRC [2022] UKFTT 25 (TC), the taxpayer again made an ‘off-plan’ contract, paying a 20% initial deposit on a £2.2 million lease premium. However, the taxpayer failed to make a subsequent 10% stage payment, which amounted to a repudiatory breach, thereby losing their deposit. The taxpayer hoped to rely on the Underwood and Lloyd-Webber cases, to claim relief for capital losses.
HMRC now argued that the old appeal case of Underwood should not be followed, that Hardy was, in fact, good law and should be binding on the First Tier Tribunal in Drake; the taxpayer should not be allowed to claim a capital loss on the initial deposit.
Alas, the judge accepted that key issues in the Underwood case were not sufficiently aligned with the circumstances in Hardy and Drake as to override Hardy. The Drake tribunal concluded that it was “regrettably unable to follow the First-Tier Tribunal in Lloyd-Webber” and that Hardy remained precedential for the present case, and Drake’s claim for capital losses should be disallowed accordingly.
However, the judge in this latest case also made some important points:
-
While he felt that he had to follow the ruling in Hardy, he was not persuaded that the judge in Hardy had been correct to say that contractual rights to acquire land were not CGT assets.
-
Even if he were wrong on that, Drake must still be denied capital loss relief because the legislation decreed that forfeited deposits of purchase money were not disposals for CGT purposes.
-
But the Lloyd-Webber case was not about a forfeited deposit – it was the developer who had failed the contract, not the Lloyd-Webbers – so TCGA 1992, s 144 (7) did not apply to them.
Where does this leave property investors?
The relationship between Hardy, Lloyd-Webber and Drake warrants further exploration, likely in the courts. While there may be some argument for denying tax relief for a deposit that a taxpayer forfeits through their own action or inaction, it cannot be right that taxpayers should be denied relief where completion fails due to the seller. It seems that the judge in the Drake case had real concerns about the logic behind Hardy, even though he felt he had no choice but to follow it.
The idea that an investor might put up (say) roughly half the cost of a property as a ‘prospective purchase’ but get no CGT relief, even though performance was frustrated by the vendor, seems quite offensive. HMRC seems to have walked back from the helpful approach in the Lloyd-Webber case. But can HMRC be persuaded otherwise?
Property investors who have lost money through vendor insolvency, for example, might seriously consider making a corresponding capital loss claim, subject to careful advice and disclosure in their tax returns. Under general self-assessment rules, a capital loss should be claimed within four years of the tax year of disposal. Further flexibility may be available where the taxpayer is in a position to argue that their CGT asset (their contractual rights) have ‘become of negligible value’.
Even where the property investor has abandoned the deposit themselves, there may still be merit in pursuing a capital loss claim of sufficient substance – again, subject to careful consideration and appropriate disclosures. Simply put, a 20% deposit feels like more than just an option to buy.
Conclusion
Drake should not be the last word in this rag-tag thread of tax cases. The rationale behind important concepts underpinning the CGT regime deserves more clarity, and taxpayers need more tax cases, or better guidance or legislation (or even all three), to secure fairer and more consistent outcomes.
