Capital sums derived from assets: section 22(1) TCGA 1992: contractual rights: warranty and indemnity payments
Giving warranties and making representations are part of the normal process of buying and selling assets. For chargeable gains purposes, we do not distinguish between payments made under a warranty or indemnity contained in the terms of a sale contract and payments made under a warranty or indemnity contained in a separate document as part of the overall terms of a sale agreement.
The essence of a contract for the purchase and sale of an asset is that for an amount of consideration the purchaser agrees to buy and the vendor agrees to sell subject to an agreed description of the asset (the warranties and representations). The purchaser is buying the asset on the basis that it is as described in the contract. If the asset is not as described then a payment will be made under the terms of the contract, ie under the warranty or indemnity. In those circumstances we do not regard the warranties and representations as separate assets and the payment will be derived from the asset which is the subject matter of the contract.
The contract may specify that a payment under a warranty or indemnity is to be made to the purchaser or to some other party to the transaction. The treatment of such payments will vary depending on the person to whom they are made.
Payments under a warranty or indemnity made to the purchaser
A payment made to the purchaser under a warranty or indemnity will represent a capital sum derived from an asset (section 22(1) TCGA 1992, see CG12945+). In practice, the acquisition cost of the asset will be reduced by the amount received, except that where that sum exceeds the acquisition cost the excess will be chargeable, see CG14807.
The terms of a contract for the sale of the share capital of a company may provide that a payment under a warranty or indemnity is to be made to the purchaser of the shares. Where the purchaser directs that a payment under a warranty or indemnity should instead be made directly to the company it should still be treated as having been made to the purchaser and the treatment described in the preceding paragraph will apply.
Payments under a warranty or indemnity made to a target company
Where the share capital of a company (the target company) is sold the terms of the contract may provide that any payment under a warranty or indemnity should be made to the target company itself. The treatment of such a payment will depend on its character:
- if it is a reimbursement of allowable trading expenditure incurred by a target company it is treated as a trading receipt of that company,
- if it is a reimbursement of allowable expenditure incurred by a non-trading target company it is offset against the target company’s management expenses,
- if it is not a reimbursement of allowable expenditure it is treated as a capital sum derived from an asset, ie the contractual rights, of the target company. Any payment received by the target company under a warranty or indemnity will represent a chargeable gain as the contractual rights will have been acquired without any payment of consideration. Although the contractual rights are likely to have been acquired by way of a bargain otherwise than at arm’s length, section 17(2) TCGA 1992 will operate to disapply the market value rule so that the contractual rights are treated as having been acquired at nil cost.
Payments under a warranty or indemnity made by the vendor
Where the vendor makes a payment under a warranty or indemnity his disposal consideration should be adjusted accordingly: TCGA92, s.49, see CG14800+. The adjustment applies irrespective of the treatment of the payment in the hands of the recipient.
Where the vendor is a company, Company A, who has entered into an election under section 171A TCGA 1992 (see CG45355+) so that another company, Company B, is deemed to have made the disposal, an adjustment to the disposal consideration under section 49(2) TCGA 1992 is available in Company B’s computation for any subsequent payments under a warranty or indemnity by Company A.
Payments not made under the terms of a contract for sale of an asset
Where payments are made other than under the terms of a contract for sale of an asset, any sums received by the vendor or the purchaser may, subject to the facts, be identified as capital sums derived from the asset that was the subject of the sale or from the recipient’s right of action against the payer, see CG13015.