Judgments - Jerome (Appellant) v. Kelly (Her Majesty's Inspector of Taxes) (Respondent)

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    29.  The Court of Appeal took the view that Park J had wrongly ignored the general law of England as to sales of land, and in particular the significance of a contract for the sale of land being (in general) enforceable by the equitable remedy of specific performance. If and so long as the contract is enforceable in that way, the seller becomes in some sense a trustee for the buyer; the buyer has an equitable interest of some sort in the subject-matter of the contract; and the contract (if protected by the machinery appropriate to registered or unregistered titles, as the case may be) is enforceable (by specific performance) against a third party who becomes owner of the property.

    30.  These are the matters which the Court of Appeal had in mind when referring to the general law. But Mr Venables QC for the appellant taxpayer has criticised the Court of Appeal's exposition of the general law. Sir George Jessel MR did indeed refer, in Lysaght v Edwards (1876) 2 Ch D 499, 506 (a case about the equitable doctrine of conversion) to what had been settled doctrine since the time of Lord Hardwicke:

    "What is that doctrine? It is that the moment you have a valid contract for sale the vendor becomes in equity a trustee for the purchaser of the estate sold, and the beneficial ownership passes to the purchaser, the vendor having a right to the purchase-money, a charge or lien on the estate for the security of that purchase-money, and a right to retain possession of the estate until the purchase-money is paid, in the absence of express contract as to the time of delivering possession".

    But he went on to explain that the trusteeship is not an ordinary trusteeship, and that point has been made in many other well-known cases. In Shaw v Foster (1872) LR 5 HL 321, 338, Lord Cairns said:

    ". . . that the vendor, whom I have called the trustee, was not a mere dormant trustee, he was a trustee having a personal and substantial interest in the property, a right to protect that interest, and an active right to assert that interest if anything should be done in derogation of it".

    Similarly in Rayner v Preston (1881) 18 Ch D 1, 6, Cotton LJ said:

    "An unpaid vendor is a trustee in a qualified sense only, and is so only because he has made a contract which a Court of Equity will give effect to by transferring the property sold to the purchaser . . ."

    31.  There is a useful summary in the judgment of Mason J in Chang v Registrar of Titles (1976) 137 CLR 177, 184:

    "It has long been established that a vendor of real estate under a valid contract of sale is a trustee of the property sold for the purchaser.

    However, there has been controversy as to the time when the trust relationship arises and as to the character of that relationship. Lord Eldon considered that a trust arose on execution of the contract (Paine v Meller; Broome v Monck). Plumer M.R. thought that until it is known whether the agreement will be performed the vendor 'is not even in the situation of a constructive trustee; he is only a trustee sub modo, and providing nothing happens to prevent it. It may turn out that the title is not good, or the purchaser may be unable to pay' (Wall v Bright). Lord Hatherley said that the vendor becomes a trustee for the purchaser when the contract is completed, as by payment of the purchase money (Shaw v Foster). Jessel M.R. held that a trust sub modo arises on execution of the contract but that the constructive trust comes into existence when title is made out by the vendor or is accepted by the purchaser (Lysaght v Edwards). Sir George Jessel's view was accepted by the Court of Appeal in Rayner v Preston.

    It is accepted that the availability of the remedy of specific performance is essential to the existence of the constructive trust which arises from a contract of sale".

    See also the judgment of Jacob J at pp189-190, concluding that,

    "Where there are rights outstanding on both sides, the description of the vendor as a trustee tends to conceal the essentially contractual relationship which, rather than the relationship of trustee and beneficiary, governs the rights and duties of the respective parties".

    32.  It would therefore be wrong to treat an uncompleted contract for the sale of land as equivalent to an immediate, irrevocable declaration of trust (or assignment of beneficial interest) in the land. Neither the seller nor the buyer has unqualified beneficial ownership. Beneficial ownership of the land is in a sense split between the seller and buyer on the provisional assumptions that specific performance is available and that the contract will in due course be completed, if necessary by the Court ordering specific performance. In the meantime, the seller is entitled to enjoyment of the land or its rental income. The provisional assumptions may be falsified by events, such as rescission of the contract (either under a contractual term or on breach). If the contract proceeds to completion the equitable interest can be viewed as passing to the buyer in stages, as title is made and accepted and as the purchase price is paid in full.

    33.  Section 27 is intended to provide a simple rule to resolve what would otherwise be a highly debateable point. But the contingent way in which section 27 (1) operates creates an obvious problem for a taxpayer who has entered into a contract to sell an asset, with completion postponed until a later tax year. Should he assume that the contract will be duly completed and, on that assumption, return a chargeable gain accruing on the date of the contract? The Revenue acknowledge that this is a flaw in the capital gains tax legislation. Good legislative practice requires that a taxpayer should not be left in doubt as to whether or not he has incurred a tax charge. This problem arises however the present appeal is to be resolved; this appeal simply presents it in an acute form because the parties chose to frame as an unconditional contract a bargain whose outcome was, as a matter of economic reality, unpredictable, and capable of remaining in uncertainty

for several years.

    34.  I see some force in the appellant's criticism of the Court of Appeal's rather abbreviated exposition of the general law, at any rate to the extent that it was reflected in criticism by the Court of Appeal of the reasoning of Park J. I think the Court of Appeal tended to oversimplify (and so misunderstand) Park J's reasoning in attributing to him (in a passage in para 75 of the judgment of Jonathan Parker LJ from which I have already quoted) the theory that "pending completion of a contract for the disposal of an asset, the owner of the asset is to be regarded for capital gains tax purposes as continuing to enjoy full ownership of it, free from the rights of the other contracting party". But that by itself does not solve the problem of how the admitted flaw in the capital gains tax legislation is to be dealt with, or the gap filled. If (as seems likely) Parliament never addressed this problem at all, the answer may have to be derived from the scheme of the legislation, and Lord Wilberforce's well-known guidance (in Aberdeen Construction Group Ltd v Inland Revenue Commissioners [1978] AC 885, 892-3) as to how the legislation should be interpreted. Park J was, I think, taking the same approach when he observed (para 24) that he would always tend to favour a statutory analysis under which the taxable results correspond with the actual results. By that I take him to have meant the commercial (or economic) consequences.

    35.  The different conclusion reached by the Court of Appeal proceeds partly on the view that section 27 (1) is not a deeming provision, or at any rate not a positively fictional deeming provision (see para 70 of the judgment of Jonathan Parker LJ). The Court of Appeal seems to have viewed it as operating (in line with the general law, in the case of a sale of land in England) as a confirmation (with hindsight gained on completion) that the seller ceased to be beneficial owner on the date of the contract, and so made a disposal on that date. Underlying the Court of Appeal's decision (but not, I think, clearly articulated in it) is the thought that just as nemo dat quod non habet, so an owner can only dispose of a single asset once. If the taxpayer and his wife are now known, with hindsight, to have disposed of the property on 16 April 1987, they had no interest in it to dispose of to Codan on 15 December 1989.

    36.  That argument has an attractive simplicity but I do not think it is the correct solution to the problem. After 16 April 1987 the taxpayer and his brother, as trustees for sale, were bound by an unconditional contract to sell the land (for simplicity, I am ignoring the additional land). But although unconditional in legal terms the contract was attended by many commercial uncertainties centring on the application for planning permission. There was a very strong likelihood, indeed a near-certainty, that the buyer would rescind the contract if outline planning permission in a satisfactory form was not obtained within seven years. Until the planning appeal was allowed the open market value of the land, whether subject to and with the benefit of the contract, or free from the contract, was almost certainly a good deal less than £4.465m.

    37.  While the contract subsisted, it would probably have been a breach of contract for the trustees to sell the land to another purchaser, or indeed to make any transfer of it (other than one necessitated by the appointment of new trustees). Even though the contract was protected by registration, the sellers would have been acting contrary to their contractual duty in depriving themselves of their personal power to complete the contract. But there was no inhibition on any of the sellers making an assignment of his or her own beneficial interest, and that is what the taxpayer and his wife did (as to part of their respective interests). The land remained vested in the same trustees for sale, who continued to be bound by the contract with Conder (and Crest as its assignee) but there was a partial change of beneficial interest. The assignments executed by the taxpayer and his wife used the traditional conveyancing form (now obsolete since the coming into force of the Trusts of Land and Appointment of Trustees Act 1996),

    ". . . all that one eighth of the Assignors' said one equal half share of the net proceeds of sale and the net rents and profits until sale of and in [the relevant parcels of land]".

    The assignments did not identify the contract of 16 April 1987. Nevertheless (as the agreed statement of facts and issues records) they were effective as assignments of beneficial interests (and not merely of a share of the purchase money if and when received). Codan as trustee of the Bermuda settlements became entitled, so long as the contract remained uncompleted, to an appropriate share of the net rental income of the land. There is no finding that there was any rental income, but if there was the assignments carried a share of it.

    38.  But for section 27 (1), and by the operation of section 46 (1), the capital gains tax analysis of the assignments would be straightforward. The taxpayer and his wife each made a part disposal affecting their respective undivided shares in the land. As the assignments were not arm's length transactions, the part disposals had to be treated as made at open market value. As already noted, that would have been a fraction of a sum probably much less than £4.465m. The contract provided a rough guide as to the land's maximum value, subject to possible adjustments, but the minimum value was existing use value and the open market value was somewhere between the two.

    39.  Does section 27 (1) prevent this straightforward analysis of the effect of the assignments? Park J thought that it does not, and I agree with him, although no analysis of the successive transactions is without its difficulties. Before turning to those difficulties, and explaining why I consider Park J's answer to be the least unsatisfactory solution to a fairly intractable problem, I must deal with a new point which (if sound) avoids, rather than resolving, most of the difficulties.

    40.  In this House, and with some encouragement from your Lordships, Mr Venables argued for the first time that section 27 (1) is not applicable at all because the disposals effected by the three transfers on 1 November 1990, 23 December 1991 and 7 December 1992 were not made "under" the contract dated 16 April 1987. This argument proceeds by treating the disposals as having been made (in relation to the relevant undivided shares, and by the effect of section 46 (1)) by Codan. Codan was not a party to the contract. Indeed, for capital gains tax purposes, by the effect of yet another deeming provision in section 52 (1), it is apparently to be treated as not having been in existence before the Bermuda settlements were made in 1988, whenever it was actually incorporated. Therefore, it is said, the disposal made by Codan cannot have been a disposal under the contract.

    41.  Mr Henderson QC described that argument as remarkably paradoxical, since in fact the contract was entered into by three individuals (the taxpayer, his wife and his brother) and in due course those same individuals (as trustees for sale) completed the transfers precisely in accordance with the terms of the contract, without any novation, variation or deviation (apart from the assignment of the benefit of the contract from Conder to Crest). I agree with Mr Henderson. I do not consider that section 46 (1) has such a far-reaching effect. The acts to be attributed to the beneficial owners include both the making of the contract and its eventual completion according to its terms. I am not persuaded that the intervening change in beneficial ownership effected by the assignments had the result that completion did not take place under the contract. There is no suggestion that Crest knew anything about the assignments or that they affected the completion of the contract in any way. Section 27 (1) applies to the timing of Crest's acquisition as well as to the sellers' disposals. Crest is presumably taxed as a developer and may not be concerned about any possible liability to corporation tax on chargeable gains. But if that were an issue, it would be bizarre if the date of its acquisition of the land were affected by actions which it could not possibly control, and probably did not even know of.

    42.  I return to the difficulties of applying simultaneously three deeming provisions: the timing provision in section 27 (1), the equation of their trustees and beneficial owners in section 46 (1), and the requirement in section 52 (1) that Codan as trustee of the Bermuda settlements should be regarded as a single and continuing body of persons distinct from Codan's normal corporate personality. The first difficulty (quite apart from section 52 (1)) is the notion that Codan should be treated as making a disposal on 16 April 1987 of an asset which it acquired on 15 December 1989. The Court of Appeal regarded as absurd the notion that the disposal of an asset for capital gains tax purposes might precede its acquisition. But that is just what happens whenever a speculative investor sells short (that is, contracts to deliver shares which he does not then own) in the hope of making a gain by acquiring the shares at a lower price before the time for delivery under his sale contract. That may or may not be a socially or economically useful activity but it is not absurd that any gain which he makes (if not within the scope of income tax under Schedule D, Case I) should be taxed by deducting the (later) acquisition price from the (earlier) sale price. The observations of my noble and learned friend, Nicholls LJ as he then was, in Kirby v Thorn EMI Plc [1987] STC 621, 626 were made in a different context, that of an asset which did not exist at all (in anyone's hands) before its disposal. I cast no doubt on those observations but they were not directed to this sort of case.

    43.  If it is accepted as a general proposition that a person's disposal of an asset may sometimes precede his acquisition of it, is it nevertheless inconsistent with the rule which section 27 (1) lays down in relation to a completed contract? That rule works neatly only if the person who makes the disposal was also the maker of the contract (but for reasons already mentioned, I consider that section 27 (1) cannot be treated as simply inapplicable).That is the second difficulty. Park J was troubled by this point, and especially by the possibility that the new beneficial owner (C in his imaginary example) might not have existed at the date of the contract. His concern would probably have increased if it had been pointed out that, because of section 52 (1), Codan must apparently be treated as not having existed for capital gains tax purposes on 16 April 1987, regardless of the date of its incorporation. Park J suggested that the answer might be to take the earliest date at which Codan would have been capable of making a disposal. It is hard to find any warrant for that in the statute, but it seems to involve less violence both to the statute and to common sense than any other solution which has been suggested. Your Lordships do not have to decide this point, which is material only as a test of the coherence and practicality of a legislative scheme which has admitted flaws. I would, without enthusiasm, provisionally adopt Park J's suggestion. In reaching this conclusion I am not treating the deeming provision in section 27 (1) as having any general power to trump that in section 46 (1). But I am, I think, following the general guidance as to the application of deeming provisions given by Peter Gibson LJ in Marshall v Kerr [1993] STC 360, 365-6, approved by this House on appeal at [1994] STC 148, 164 (although the appeal was allowed on other grounds).

    44.  I would summarise my view of the matter as follows. What happened on completion, by stages, of the contract was that the taxpayer, his wife and his brother executed three Land Registry transfers of three separate pieces of land. Although they were expressed to be transferring "as beneficial owners" (as the contract required) they were necessarily transferring the legal estate in their capacity as trustees for sale (and it was probably unnecessary for Mrs Jerome to join in the transfer of Plot 3, which did not include any of the additional land). They sold under the contract of 16 April 1987, which had bound them from first to last. The fact that Codan was not a party to the contract does not alter that. Section 27 (1) made the disposals of beneficial interests by the taxpayer, his wife and his brother, relate back to 16 April 1987, and so to the 1987-8 tax year. Section 46 (1) required the trustees for sale to be treated as nominees for Codan to the extent of the interests which that company had acquired, as trustee, on 15 December 1989. But section 27 (1) could not and did not produce the absurd result that the interests which Codan had acquired on 15 December 1989 were instead disposed of by the Jeromes to Crest on 16 April 1987. Codan's disposal was not an occasion of charge, because of its non-resident status, but the disposal may in due course have consequences under special provisions first enacted in the Finance Act 1981.

    45.  Mr Henderson for the Revenue relied on three main arguments against that conclusion. I can deal with them briefly because I have already covered much of the ground. First, it was said that the interests acquired by Codan were not the same assets as the assets contracted to be sold (to Conder), because the contract of sale to Conder (and its consequences in equity) had intervened. That is so, in a sense, but I do not think that it helps the Revenue. Capital gains tax is on the whole (and subject to exceptions which I need not detail) concerned with assets, not with contractual rights over assets. The corporeal land was the same and (as already noted) the contract, because of its unusual terms, had only a vague bearing on the open market value of the land before planning permission was obtained on appeal. The essential point is that the contract, until completed, was not either a disposal or a part disposal.

    46.  Second, the Revenue tried to turn to its advantage the absurdity of backdating Codan's acquisition to a time when it had no beneficial interest in the land at all (and might not even have been in existence). I agree that that would be an absurdity, but the way to avoid the absurdity is to give a less drastic operation to the deeming provisions, not to distort other parts of the analysis so as to accommodate the absurdity. In my opinion the Court of Appeal was wrong in supposing that it was giving section 27 (1) a simpler and more limited effect than Park J had given it.

    47.  Third, the Revenue sought to treat each of the assignments to Codan as no more than an assignment of the consideration due under a contract, which does not alter the capital gains tax liability of the person making the disposal (see Burca v Parkinson [2001] STC 1298, a decision of Park J in favour of the Revenue). But as already noted, the assignments had a more immediate and far-reaching effect as assignments of beneficial interests in property.

    48.  For these reasons I would allow the appeal with costs and restore the order of Park J.

LORD BROWN OF EATON-UNDER-HEYWOOD

My Lords,

    

 
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