Garner (Her Majesty's Inspector of Taxes) v. Pounds Shipowners and Shipbreakers Limited and One Other Action

The House of Lords held that the sum of £399,750 paid for an option was the full consideration for the grant of the option and could not be reduced by a subsequent payment of £90,000 made by the grantor to third parties to procure release of restrictive covenants. The court construed the Capital Gains Tax Act 1979, holding that the £90,000 was not deductible from the consideration under section 32(1)(a) or (b) because the obligation to procure releases was not expenditure "wholly and exclusively" incurred in providing the option nor expenditure reflected in the state or nature of the option at the date of disposal. The court distinguished Randall v Plumb and analysed the operation of sections 19, 27, 32, 40(2) and 41 of the Act of 1979 in relation to valuation of consideration and contingent liabilities.

This case concerned the tax treatment of a payment made to a grantor in return for an option to purchase land which was never exercised. By agreement dated 9 September 1988 Mowat Group plc paid £399,750 for an option from the company. The agreement included an obligation on the company to procure releases of certain restrictive covenants; the company later paid £90,000 to obtain releases and retained the £399,750 after the conditions in clause 1.3 were fulfilled, but Mowat did not exercise the option.

The revenue assessed the company to corporation tax on the basis that the consideration for the disposal of the option was £399,750. The company sought by appeal to reduce that consideration by reference to the £90,000 expenditure either by treating the £90,000 as part of the consideration (valuation adjustment) or as deductible expenditure under section 32(1)(a) or (b) of the Capital Gains Tax Act 1979. The general commissioners allowed the company the deduction under section 32; Carnwath J rejected the section 32 argument but treated the £90,000 as reducing the consideration; the Court of Appeal allowed the revenue's appeal. The company appealed to the House of Lords.

The main issues were (i) whether contingent obligations or contemporaneous obligations to incur expenditure should be taken into account in valuing consideration for the grant of an option having regard to sections 40(2) and 41 and authorities such as Randall v Plumb, and (ii) whether expenditure of £90,000 was "expenditure wholly and exclusively incurred in providing the asset" or "expenditure ... for the purpose of enhancing the value of the asset" within section 32(1)(a) and (b).

The House of Lords concluded that the £399,750 was an unambiguous sum paid for the option and that payments made by the company to third parties to obtain covenant releases did not reduce the value of that cash consideration. The obligation to procure releases was not a precondition to exercise of the option and so was not expenditure "wholly and exclusively" incurred in providing the option nor reflected in the option's state or nature at disposal; therefore section 32(1)(a) and (b) did not permit deduction. The court accepted earlier authorities where contingencies directly affected the value of consideration but distinguished them on the facts. The court observed that if the option had been exercised and the land sold the expenditure might be deductible from the sale proceeds, so the decision did not necessarily produce an irrecoverable tax "black hole."

Appeal dismissed. The House of Lords held that the £399,750 was the full consideration for the grant of the option and the £90,000 paid by the company to procure covenant releases could not be deducted from that consideration under section 32(1)(a) or (b) of the Capital Gains Tax Act 1979, nor could the cash sum of £399,750 be reduced by subsequent payments to third parties; the obligation to procure releases did not alter the value of the option at the date of disposal.

General Commissioners for Portsmouth allowed the company's appeal (finding the £90,000 deductible under section 32). On appeal Carnwath J (High Court) rejected deduction under section 32 but treated the £90,000 as reducing the consideration. The Court of Appeal allowed the revenue's appeal. The company appealed to the House of Lords which dismissed the appeal.