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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: rights of action

A right to take court action for compensation or damages is an asset for chargeable gains purposes, see CG12060.

The case of Zim Properties Ltd v Proctor, 58TC371, involved a capital sum which was derived from a right of action. In that case, a company sued its solicitors for negligence on the grounds that a sale of land had fallen through due to errors made by them in the sale contract. The company received a capital sum under the terms of an out of court settlement. The High Court rejected an argument that the capital sum was derived from the company’s interest in the land on the grounds that the land had not been affected or impaired by the failed contract (the fact that the sale of the land had fallen through due to the negligence of the solicitor meant that the taxpayer was still in possession of the land and its value was unaffected). Consequently, the court held that the asset for capital gains tax purposes was the company’s right of action against its solicitors and that the capital sum was derived from that right.

However, the fact that a person receives compensation or damages as a result of court action does not necessarily mean that the capital sum will be treated as having been derived from a right of action. The case confirmed (and the approach was approved in the Court of Appeal case of Pennine Raceways Ltd) that in order to establish where the capital sum was derived from, one must look for the real, rather than the immediate, source of the capital sum. For example:

  • compensation or damages arising from a right of action by reason of any damage or injury to an asset or for the loss, destruction, dissipation or depreciation of an asset will be treated by the recipient as a capital sum derived from his ownership of the asset (Pennine Raceway Ltd v Kirklees Metropolitan Council (No 2) [1989] STC 122), see CG12995;
  • a capital sum received as a result of legal action to enforce a contractual right may fall to be treated, subject to the facts, as having been derived from the recipient’s rights under the contract or from an asset that was the subject of the contract, see CG13000.

Therefore, in any situation where a person receives compensation or damages as a result of a court action (whether by court order, arbitration or an out of court settlement) it is important to establish the facts from any documents or other evidence in order to determine whether the capital sum was derived from:

  • the asset that was the cause of the action or
  • a statutory right or
  • a contractual right or
  • a right of action.

The importance of making an accurate identification of the asset from which the capital sum was derived lies in its implications for the computation of the gain or loss. For example, if the capital sum was derived from an asset that was the cause of the court action any reliefs or exemptions that would have been available on a disposal of that asset would be available in computing a gain or loss under section 22(1), see CG12945.

The distinction between the right of action and the asset that was the cause of the action had important consequences in the Zim case and resulted in the publication of Extra Statutory Concession D33, see CG13020.

In certain circumstances section 51(2) TCGA 1992 prevents gains arising on compensation or damages for any wrong or injury suffered by an individual in his person or profession or vocation from being chargeable gains, see CG13030.