CGT Expenditure: Section 38 Rules, Okay?

Most readers will be aware that capital expenditure cannot be offset as an expense against income.

There is a huge body of case law concerned with the (sometimes fine) line to be drawn between capital and revenue expenditure. One of the founding principles was stated by Viscount Cave in Atherton v British Insulated and Helsby Cables Ltd, HL 1925,10 TC 155, describing capital expenditure as being “made, not only once and for all, but with a view to bringing into existence an asset or advantage for the enduring benefit of the trade”.

Allowable Expenditure

Whether such expenditure may instead be allowable for capital gains tax (CGT) purposes most frequently arises when the asset in question is disposed of. TCGA 1992, s 38 (‘acquisition and disposal costs’) is regarded as definitive in this respect. If expenditure is within the wording of section 38, it is allowable; if not, then it is not.

There are three categories of allowable expenditure within TCGA 1992, s 38:

• acquisition costs;
• enhancement expenditure; and
• incidental costs of acquisition and disposal.

Acquisition costs are relatively straightforward, being the amount or value of the consideration given wholly and exclusively for the acquisition of the asset.

Enhancement Costs

Enhancement costs can be a bit trickier. The expenditure must be incurred wholly and exclusively on the asset for the purpose of ‘enhancing the value’ of the asset, but it must also be reflected in the ‘state or nature’ of the asset on disposal. Included in this category are also costs of establishing, preserving or defending the title to or rights over the asset.

HMRC stresses the importance of the words in italics and makes the point that expenditure may be incurred in connection with an asset, but not on the asset itself. The example given concerns payments made as compensation by a parent company to officers of a subsidiary to secure their resignations, as required by the purchaser of the subsidiary. The payments are made in connection with the sale of the shares in the subsidiary but not on the asset (the shares) itself (see HMRC’s Capital Gains Manual at CG15180).

In another example given by HMRC, the owner of a plot of land builds a tennis court at a cost of £5,000 but later demolishes it and builds a swimming pool at a cost of £20,000. The cost of the swimming pool is allowed as enhancement expenditure on disposal of the land but not the cost of the tennis court, which is, of course, not reflected in the state or nature of the asset at the time of disposal (see CG15190).

One might also question whether either the tennis court or the swimming pool were constructed wholly and exclusively for the purpose of enhancing the value of the asset (the land).

Incidental Costs

The incidental costs of acquisition and disposal must (again) be wholly and exclusively incurred for that purpose, but are quite narrowly defined as:

• fees, commission, or remuneration paid for the professional services of a surveyor, valuer, auctioneer, accountant, agent or legal adviser;
• conveyancing and transfer costs (including stamp duty, stamp duty land tax (or devolved equivalents));
• advertising costs to find either a buyer or a seller; and
• in the case of a disposal, any costs of making a valuation or apportionment for the purpose of working out the gain.

Again, if the incidental costs in question do not fit within these categories, they are not allowable and are, in effect, tax ‘nothings’.

Practical Tip

In a recent piece of advice on this very subject, I found some items which had been treated as ‘capex’, which could have been claimed as a trading expense. Apart from applying generally accepted accounting principles and tax rules correctly, it is advisable to retain contemporaneous evidence regarding significant items disallowed as capex in order to distinguish allowable CGT expenditure in future.