Painting by numbers – Court of Appeal dismisses HMRC's appeal
The Court of Appeal has dismissed HMRC's appeal in Lord Howard of Henderskelfe's Executors v Revenue and Customs Commissioners  EWCA Civ 278 and confirmed that, as the Portrait of Omai by Sir Joshua Reynolds ('the Portrait') was a wasting asset within the meaning of section 44 Taxation of Capital Gains Tax Act 1992 ('TCGA'), no capital gains tax ('CGT') charge arose on its disposal for £9.4m.
Following his death in 1984, Lord Howard's estate included the Portrait. His residence, Castle Howard (the setting for Brideshead Revisited), has since 1950 been owned by Castle Howard Estate Limited ('the Company'), which has run the business of opening part of Castle Howard to the public since 1952. During Lord Howard's lifetime the Portrait and other works of art were included for exhibition in that part of Castle Howard that was open to the public. There was no formal lease or licence allowing the Company to do this and Lord Howard received no hire or rental fee for permitting the exhibitions. The arrangement was terminable by him at will. Following his death, Lord Howard's executors ('the Executors') continued with this arrangement, save for three periods totalling seven months when the Portrait was exhibited in Paris, New York and York. The Executors sold the Portrait at Sotheby's in 2001 for £9.4m.
The Executors submitted a trust and estate return to HMRC showing a chargeable gain on disposal of the Portrait. They later amended the relevant self-assessment on the basis that the disposal was exempt from CGT by virtue of section 45(1) TCGA. HMRC opened an enquiry into the return and issued a closure notice stating that the gain on disposal of the Portrait was chargeable to CGT. The Executors' appealed unsuccessfully to the First-tier Tribunal. Their appeal to the Upper Tribunal was allowed, whereupon HMRC appealed to the Court of Appeal.
CGT is chargeable on a chargeable person who is resident or ordinarily resident in the UK in respect of chargeable gains on the disposal of most capital assets (see sections 1 and 2, TCGA). The amount of any capital gain is computed by taking account of allowable losses and tax reliefs (see Chapter 1, TCGA).
Broadly speaking, section 45 TCGA provides that chattels which are wasting assets are exempt from CGT except where capital allowances were, or could have been, claimed. Section 44 TCGA defines a wasting asset as being one with a predictable life not exceeding 50 years. In this context 'life' means 'useful life, having regard to the purpose for which the tangible assets were acquired or provided by the person making the disposal'. Plant and machinery are regarded as having a predictable life of less than 50 years. In estimating that life it is assumed that the asset's life will end when it is finally put out of use as being unfit for further use, and that it is going to be used in the normal manner and to the normal extent and is going to be so used throughout its life as so estimated. A wasting asset's residual or scrap value is its predictable value at the end of its predictable life.
The Executors contended that the disposal was exempt from CGT by virtue of section 45(1) TCGA, as the Portrait was plant and therefore a wasting asset under section 44 TCGA.
HMRC contended as follows:
- Even if the Portrait was plant in the hands of the Company, it was not plant in the hands of the Executors as the latter did not carry on a trade or business. It was apparent from section 44 TCGA that the exemption was only available where the disposal was made by a trader that had used the asset as plant in its trade.
- If that submission was wrong, the portrait was not plant at all as its use by the Company failed Lindley LJ's 'permanent employment in … business test' (see Yarmouth v France (1887) 19 QBD 647). This stemmed from the fact that the arrangement in question was terminable at will by the Executors.
- There could only be entitlement to the exemption if the interest in the plant held by the Company and the interest in the asset sold by the Executors were identical. There was no identity of interest as the Company's interest was limited (because it was terminable at will) whereas what the Executors sold was the Portrait.
- The Portrait could not be plant within the meaning of section 44 as that section contemplates that what is plant is an asset with a limited life that wastes away with use. An 'old master' worth £9.4m on its 226th birthday could not fit that description.
The Court of Appeal's decision
After considering the phrase 'plant and machinery' in capital allowance cases and the history of the relevant provisions, in particular section 44 TCGA, the Court of Appeal dismissed HMRC's appeal, rejecting HMRC's contentions as follows:
- Nothing in the language of section 44 TCGA justifies a conclusion that the exemption is only available where the disposal was made by a trader that had used the asset as plant in its trade. On the contrary, section 47 TCGA contemplates the possibility of a disposal by someone other than the user or trader. The critical provision is section 45 TCGA, as that provides the exemption. Nothing in that section supports HMRC's case. Rather, the language used points the other way.
- When Lindley LJ referred to 'permanent employment' in the business, he was simply contrasting that with the circulating nature of a trader's trading stock. As to the fact that the arrangement was terminable at will by the Executors, there was no error in law in the Upper Tribunal's conclusion that the Executors and the Company considered that the Portrait would be available to the Company 'for a considerable, albeit indefinite, period, and that is what happened'.
- There was an identity of interest as the plant kept by the Company for use in its trade was not a limited interest, but was the Portrait itself. Anyway, it is not correct that section 45 requires an identity of interest. The disposal of a limited interest in plant held by a trader attracts the exemption.
- What is plant is not identified by the predictable life of a chattel. To be plant the asset must pass the Yarmouth v France test, by which the asset can be plant whatever its predictable life. Once an item qualifies as plant, it is in every case deemed to be a wasting asset by section 44(1)(c) TCGA.
This case provides an example of increasingly apparent reluctance on the part of HMRC to stand back and accept that an argument it wishes to advance can cut both ways. As Rimer LJ and Briggs LJ stated, HMRC should take the rough with the smooth, this being an example of the rough.
What Briggs LJ said about the correct approach to statutory construction is of particular interest. Describing this as a 'wholly extraordinary case', he accepted that it might appear surprising to some that the Portrait should qualify for exemption from tax on the ground that it is either 'plant' or a wasting asset, with a deemed predictable life of less than 50 years. He continued:
"But this is the occasional consequence of the working of definitions and exclusions which, while aimed successfully at one potential inroad into the charge to tax, unavoidably allow others by what the legislators appear to permit as an acceptable if unwelcome side-wind."
He then cited as an example section 263 TCGA, the intention of which is to prevent the disposal of an asset like a passenger road vehicle, which almost always deteriorates in value, from generating an allowable loss. One result, however, is that a tiny number of owners of fabulously valuable classic cars enjoy a tax free gain when they dispose of them in a rising collectors' market.
In such cases it is essential to approach interpretation, not by reference to any such 'oddball example', but by focusing on the purpose for which the relevant provision was introduced. The reference to 'plant and machinery' in what is now section 44(1)(c) was introduced in 1965 for a limited purpose which had nothing to do with exemption from chargeable gains, or even exclusion of allowable losses. It was intended to prevent those disposing of plant and machinery from arguing that, because it had a predictable life of more than 50 years, in computing gains or losses on its disposal, there should be deducted the full acquisition cost rather than the written down cost attributable to wasting assets.