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HMRC internal manual

Capital Gains Manual

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HM Revenue & Customs
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Capital sums derived from assets: section 22(1) TCGA 1992: contractual rights

CG12040 explains the circumstances in which a contractual right is capable of being an asset for chargeable gains purposes.

When a capital sum is received in connection with a contractual right it is essential to establish the facts in order to decide whether the receipt was derived from:

  • an asset that was the subject of the contract, or
  • the bundle of contractual rights to which the recipient was entitled under the terms of the contract, or
  • a specific contractual right that is capable of being separated out from the bundle of rights in the contract.

Completed contracts

Each of the parties to a contract will have a number of rights against the other, ie a bundle of contractual rights. In the simple case of an unconditional contract for the sale of an asset the purchaser will have the right to demand that the vendor transfers legal and beneficial ownership to him on completion whilst the vendor will have the right to demand that the purchaser passes over the sale consideration. In this type of situation where a contract is completed without modification the consideration received by the vendor will be treated as the proceeds for the disposal of the asset rather than a capital sum derived from his rights under the contract.

Modified or surrendered contracts

A capital sum received by a person because the terms of a contract to which he was a party have been modified, varied, waived, assigned, terminated, rescinded, relinquished or surrendered will normally fall to be treated as having been derived from the recipient’s contractual rights.

However, where a contract has been modified etc without the agreement of all of the parties, one party may take legal action against one or more of the others. A capital sum received in settlement of such an action may have been derived from the recipient’s right of action, see CG13015, rather than the asset that was the subject of the contract or the recipient’s contractual rights.

In O’Brien v Benson’s Hosiery (Holdings) Ltd 53TC241, see CG12040, a company received a payment in return for waiving one of its rights under a director’s service agreement.

The House of Lords found that the bundle of contractual rights to which the company was entitled under the service agreement was a form of property and, therefore, an asset within section 21(1) TCGA 1992 By agreeing to release the director from the terms of the service agreement the company had obtained a capital sum by waiving its contractual rights. Therefore, the receipt of the payment was an occasion of a disposal within section 22(1). In reaching its decision the House of Lords did not rule out the possibility that the capital sum derived from a specific contractual right which was capable of being separated out from the bundle of contractual rights.

Failure to meet contractual obligations

A receipt of a capital sum as compensation where a party to a contract alleges that another party has failed to meet their contractual obligations will normally fall to be treated as a capital sum derived from the recipient’s contractual rights.

However, this may not be the case where the subject matter of the contract is itself a form of property, ie an asset, and one party is suing the other for some type of loss or damage in connection with that asset. In that situation it is more likely that the asset from which the compensation was derived was the damaged or lost asset, see CG12985.

Contractual rights that can be separated from the bundle of rights under a contract

In Marren v Ingles 54TC76, see CG12080, the High Court identified another type of right, ie the right to receive deferred payments as part of the consideration for the disposal of shares. This right was described as “a possible liability to pay an unidentifiable sum at an unascertainable date”. The value of the right to the future sum was included in the consideration for the disposal of the shares.

The court concluded that the right to receive future unascertainable payments was a ‘chose in action’. In those circumstances the right was incorporeal property and an asset for CG purposes, see CG12010+, which could be separated out from the bundle of rights in the contract. When the future amounts were ascertained and received they fell to be treated as capital sums derived from a chose in action within the charge under section 22 TCGA 1992.

Guidance on the treatment of deferred consideration is given at CG14850+.

Forfeited deposits

Section 144(7) TCGA 1992 brings forfeited deposits of purchase money within the charge to tax on capital gains. It provides that section 144 shall apply in relation to a forfeited deposit as it applies in relation to the consideration for an option which is not exercised. The effect is to treat the forfeit of a deposit as a deemed disposal of an asset separate and distinct from the asset which was to have been disposed of under the contract, see CG12390.