Adviser Q&A: HMRC’s consultation on legislating ESC D33

What's happening?

Following the House of Lords’ decision in CIR, ex parte Wilkinson [2005] UKHL 30, HMRC has been reviewing all its concessions, and is consulting on the enactment of ESC D33 through primary legislation.

Why was ESC D33 introduced?

ESC D33 was introduced following the decision in Zim Properties Ltd v Proctor (1984) 58 TC 371. In this case, Zim Properties was selling a property, but the transaction failed to complete because the solicitors did not complete the paperwork correctly. The company received a sum of money from the solicitors in settlement of an action for negligence. The company argued that the amount received should be treated as if it were a part disposal of the property, whereas the Revenue contended that the amount received derived from the right of action (a chose in action), which was an asset separate from the property that the company wanted to sell. The High Court found that as the property was unaffected by the action, there was no part disposal, and agreed with the Revenue in holding that the company’s right to sue the solicitors was the source of the damages.

This decision meant that, in most situations, there would be no base cost attributable to the chose in action and none of the reliefs that might have been available on a part disposal of any underlying asset.

ESC D33 was introduced to address these issues, although most of the text of the concession is, as we will see, a résumé of the legal position of various types of compensation. D33, in many respects, is not really a concession at all.

What is the basic position arising from Zim and how is this treated post-D33?

Paragraphs 2 to 7 of D33 set out how the chargeable gain on receipt of a capital sum for a right of action should be calculated following the decision in Zim Properties, and do not propose any concessionary treatment. New legislation is not required, and this section of D33 (‘the strict position’) will simply form part of HMRC guidance.

Paragraphs 8 to 10 set out an alternative to the strict position set out in paras 2 to 7, where there is an underlying asset. Instead of following the principle that any proceeds relate to the chose in action, where the proceeds can be related to an underlying asset the capital gains computation can operate on the basis of a part disposal of the underlying asset. This is essentially what the company was arguing in Zim Properties, meaning that, paradoxically, HMRC is permitting a treatment it was seeking to deny through the courts.

As a result, part of the base cost of the underlying asset can be deducted from the proceeds from the chose in action. Furthermore, any reliefs or exemptions that can be attributed to the underlying asset will be available on the disposal of the chose in action.

This treatment largely follows the decision in Pennine Raceway Ltd v Kirklees Metropolitan Council (No. 2) [1989] STC 122, where it was held that compensation received from the council following the revocation of planning permission was derived from the company’s licence to conduct drag racing, rather than from the right to sue the council. This meant that part of the cost of the licence could be deducted from the proceeds from the chose in action.

HMRC takes the view in the consultation document that as D33 reflects the position following Pennine Raceway, there is no need to introduce legislation to permit this treatment.

What changes are proposed in the condoc?

Paragraph 11 looks at, for example, compensation for poor professional advice or for the misselling of financial products. Prior to January 2014, any gain on the disposal of such rights was, by concession entirely exempt from CGT. In January 2014, the concession automatically applied to compensation up to £500,000. If compensation was received above that limit, the taxpayer has to submit a claim in writing to HMRC.

HMRC takes the view that it would not be practical to legislate for this amended concession, so is proposing an absolute limit of £1m exemption. Compensation above that amount will be subject to CGT. It has sought views as to whether £1m is the right level, and whether anyone is aware of situations where taxing the excess above £1m would cause hardship.

The consultation is limited, therefore, to the quantum of the exemption, and whether £1m is a fair and reasonable limit.

How is personal compensation treated?

Paragraph 12 looks at the position with personal compensation or damages. TCGA 1992 s 51(2) exempts compensation from CGT if it is paid to the individual personally for any wrong or injury suffered. By concession, this is extended to cover payments to relatives or personal representatives for compensation for emotional stress caused by the death of another person or for the loss of financial support.

The legislation also exempts personal compensation paid to an individual for any wrong or injury suffered by someone in their profession or vocation, for example, in relation to unfair discrimination, libel or slander, or breaches of contractual duties or torts.

By concession, this is extended to cover any wrong or injury suffered by an individual in their trade or employment, and HMRC is seeking views on whether this concessionary treatment should be legislated by extending s 51. This may seem an odd question for consultation, as it seems inconceivable that any respondent would object to the extension in statute.

What about payments under warranty?

Paragraph 13 looks at the position regarding payments made under a warranty or indemnity. The principle in Zim Properties is not regarded as applying where the payment under a warranty or indemnity is made under the terms of the sale agreement. The consultation highlights one particular issue with regard to s 49(1)(c), under which no allowance is to be made in a CGT computation for any contingent liability in respect of a warranty or representation made on a disposal by way of sale or lease of any property other than land. If, after the sale, a payment is made to the purchaser under a warranty or representation, there will be an adjustment to the CGT computation. However, s 49(1)(c) does not apply to payments made under an indemnity. HMRC has proposed that this section should be extended to include indemnities.