Garner v Pounds Shipowners and Shipbreakers Ltd (Garner v Pounds)

On the grant of an unexercised option, a fixed cash payment does not lose value as consideration merely because the grantor incurs expenditure towards a third party under an associated obligation. A contingency may affect the computation where it bears directly upon the value of the consideration, such as a contractual liability to repay it.

Under section 32(1)(a) of the Capital Gains Tax Act 1979, the deductible expenditure for a newly created option is expenditure wholly and exclusively incurred in making the grant. Section 32(1)(b) concerns expenditure on an existing asset which enhances its value and is reflected in its state or nature when disposed of. Commercial reality cannot alter the unambiguous terms of an arm's-length agreement.

A company granted an option to purchase land for £399,750. It undertook to use its best endeavours to obtain releases from restrictive covenants and paid £90,000 to obtain them. The purchaser did not exercise the option, and the Revenue assessed the company on the full option consideration.

The general commissioners allowed the £90,000 as a deduction under section 32 of the Capital Gains Tax Act 1979. Carnwath J rejected that basis but held that the value of the obligation reduced the consideration. The Court of Appeal, in [1999] S.T.C. 19, rejected both arguments and allowed the Revenue's appeal.

The central issue before the House was whether the £90,000 reduced the consideration for the option or qualified as deductible expenditure under section 32(1)(a) or (b).

1. The appeals were dismissed unanimously. Lord Jauncey of Tullichettle delivered the leading speech. Lord Slynn of Hadley, Lord Clyde, Lord Hutton and Lord Millett agreed with his reasons.

2. Per Lord Jauncey, section 40(2) of the Capital Gains Tax Act 1979 requires consideration to be brought into account without discount for postponement, irrecoverability or contingency. It permits a later adjustment where consideration proves irrecoverable. It did not affect the valuation of the fixed cash consideration received for these options.

3. A contingency may be relevant where it bears directly upon the value of the consideration. Randall v Plumb [1975] 1 W.L.R. 633 was correctly decided because the option payment there was subject to possible repayment. Its broader suggestion that every contingency outside the statutory provisions must be reflected in the consideration was too wide.

4. The £399,750 in this case was an identified cash sum given for the option. The grantor's obligation involved a probable payment of an unknown amount to third parties, rather than repayment of the consideration to the purchaser. The £90,000 payment could not alter the value of the cash received. Commercial reality, although important, could not alter the unambiguous terms of an agreement negotiated at arm's length.

5. Section 32(1)(a) did not permit the deduction. For a created option, expenditure wholly and exclusively incurred in providing the asset means, prima facie, the expenses of making the grant. Obtaining the covenant releases was not essential to exercise of the option and therefore was not expenditure wholly and exclusively incurred in providing it.

6. Section 32(1)(b) also did not permit the deduction. It applies to expenditure incurred on an existing asset to enhance its value, where that enhancement is reflected in the asset's state or nature at disposal. The option arose upon the agreement, so a contemporaneous obligation could not satisfy that provision. The releases might enhance the land, but they were not reflected in the state or nature of the option when granted.

7. Lord Jauncey also accepted that expenditure within section 32(1) must be extraneous to the asset rather than an integral part of it. He left open whether the obligation itself formed part of the asset disposed of. He observed that the £90,000 might instead be deductible, wholly or partly, on a later disposal of the land whose value the releases enhanced.

1. House of Lords: Dismissed the taxpayers' appeals unanimously and affirmed the Court of Appeal's conclusions.
2. Court of Appeal: In [1999] S.T.C. 19, rejected both asserted bases for reducing the option consideration and allowed the Revenue's appeal.
3. High Court: Carnwath J rejected a deduction under section 32 of the Capital Gains Tax Act 1979, but held that the value of the obligation should be considered when computing the consideration.
4. General commissioners for Portsmouth: Allowed the company's appeal and treated the £90,000 as deductible from the £399,750 consideration under section 32.