The trouble with rescindable contracts
16th August 2024
Posted in Articles by Andrew Marr
Once again taxpayers are quaking in their boots about the prospect of a possible increase in capital gains tax. The most pessimistic forecasters are predicting that the new Labour Government may even go so far as to align capital gains tax rates with income tax rates. The prospect of a sale which will trigger a tax charge of up to 45% of the proceeds really does focus the mind! In this environment it is natural for taxpayers to seek ways of locking in existing rates before any rise and this is where the rescindable contract comes in.
How rescindable contracts work
Broadly, the idea relies on the capital gains tax legislation (TCGA 1992 section 28) which dictates the time of disposal and acquisition where an asset is disposed of under a contract. This states that the time of a disposal is when an unconditional contract is made (and not, if different, the time at which the asset is conveyed or transferred). If it is a conditional contract, then the disposal date is the time when the condition is satisfied.
However, with an unconditional contract this rule does not mean that there is still a tax charge (or disposal) if the contract never completes – it just dictates the time of disposal for a completed contract.
This kind of planning therefore usually involves a disposal to a related party (often a settlor-interested trust) with an unconditional contract but with the prospect of the contract being rescinded if completion does not take place before some longstop date. Here the taxpayer hopes to ‘have their cake and eat it’. If rates go up, then they complete the contract hoping to be taxed at lower rates (and the trust would have a market value base cost for future disposals). If rates stay the same, then the contract is rescinded (and ‘disappears’) because completion does not take place by the longstop date.
Possible problems
One possible problem is that without careful drafting the power to rescind could make the contract conditional. This issue can probably be overcome by careful drafting and relying on a case (Jerome v Kelly) where recission was allowed if planning permission was not obtained; the court found that this was not a conditional contract. The main reason for this conclusion was that the planning position was seen as a ‘condition subsequent’ rather than a ‘condition precedent’ and presumably this would be the case for a longstop date too.
Tax Counsel Patrick Soares has mentioned that helpful clauses to avoid a conditional contract would be as follows:
“(1) completion of this contract shall take place on or before the longstop date;
(2) the contract to sell and purchase the Property is not subject to any conditions precedent”
Notwithstanding the above points, we also need to be alive to the risk of any anti-forestalling legislation specifically attacking this kind of planning. This happened in March 2020 when the Entrepreneurs’ Relief (now Business Asset Disposal Relief) allowance was decreased from £10m to £1m. Here they put in a special rule that made completion the time of disposal for tax purposes in contracts deliberately designed to take advantage of the section 28 rule – to trigger a disposal which was earlier to the completion date – thus rendering any such planning ineffective.
Forbes Dawson view
There is probably limited downside in a person undertaking this kind of planning in anticipation of an increase in capital gains tax rates. If rates rise, then the taxpayer will hope to complete and trigger a gain at the current rates and then the new (related) owner of the asset will not have significant gains on a sale in the near future. However, they need to be prepared for this planning to be scuppered by anti-forestalling rules, similar to that used in 2020.
The position is likely to be different for certain third-party deals which, despite binding terms having been entered into, may not be able to complete by budget day on 30 October 2024. Here, it may be possible to include appropriate ‘conditions subsequent’ which give rise to an unconditional contract which is nevertheless commercially acceptable for both the buyer and seller. These kind of deals are more likely to accelerate the tax point without falling foul of any retrospective anti-avoidance legislation.
