Wednesday, May 28, 2014

The Meaning of 'Plant and Machinery' for the Purposes of Capital Gains

The National Gallery describes Sir Joshua Reynolds as the “leading English portraitist of the 18th century” and expert “in the work of Rembrandt, Rubens and van Dyck”. Improbably, the sale of one of his great paintings, the Omai of the Friendly Isles, recently gave rise to an interesting question of income tax law that has also troubled the Indian courts: what precisely does ‘plant and machinery’ mean? The Court of Appeal’s excellent judgment contains a careful analysis of the law on this point and is also a good example of the correct approach to cases in which it appears that the legislature has unintentionally given the taxpayer a windfall: that, on its own, is no reason to strain the language the legislature has employed or artificially find that the tax is payable (and the converse, of course, is true as well: if the payment of a tax appears to cause hardship, that too is a matter for Parliament, not the courts).

Sir Joshua’s Omai painting was part of the art collection that belonged to Lord Howard of Henderskelfe, who died in November 1984. During his lifetime, and after his death, his residence in Yorkshire (‘Castle Howard’) was open to members of the public. The Omai painting was one of the many art works displayed there. The precise way in which this was done is of importance: a company called Castle Howard Estate Ltd (‘CHEL’) ran Castle Howard, was responsible for displaying the pictures and bore the expenses of insurance, security etc. But it had no formal lease or licence and did not pay any hire or rental fee to Lord Howard or, after his death, to the executors, who remained the owner of the Omai painting. As Lord Justice Rimer notes, the executors were the same individuals who were the directors of CHEL.

In 2001, the executors sold the Omai painting at a Sotheby’s auction for £9.4m, thereby making a large profit. As Lord Justice Rimer puts it, a layman may be forgiven for thinking that this obviously attracts capital gains tax: indeed, it seems to be the archetypal case of the sale of an asset for a substantially higher sum than the acquisition cost. The executors, however, argued (successfully) that it was entirely exempt from capital gains tax because it constituted ‘plant’. Sections 44 and 45 of the TCGA 1992 provide as follows:

‘44.           Meaning of “wasting asset”

(1) In this Chapter “wasting asset” means an asset with a predictable life not exceeding 50 years but so that –
             …
(c) plant and machinery shall in every case be regarded as having a predictable life of less than 50 years, and in estimating that life it shall be assumed that its 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;

45.            Exemption for certain wasting assets

(1) Subject to the provisions of this section, no chargeable gain shall accrue on the disposal of, or of an interest in, an asset which is tangible movable property and which is a wasting asset.

On these facts, principally two questions arose. First, was the Omai painting ‘plant’ for the purposes of section 44(1) and secondly, did either section 44 or section 45 contemplate that the disposal of the plant must be by the person in whose hands it was a plant? The classic exposition of the meaning of ‘plant’, of course, is that of Lord Justice Lindley in Yarmouth v France:

"There is no definition of plant in the Act: but, in its ordinary sense, it includes whatever apparatus is used by a business man for carrying on his business, — not his stock-in-trade which he buys or makes for sale; but all goods and chattels, fixed or moveable, live or dead, which he keeps for permanent employment in his business."

Yarmouth v France has been followed on several occasions by the Indian courts. The argument of Lord Howard’s executors was that the Omai painting was used by CEHL as part of its business of displaying art works in Castle Howard to members of the public. At first sight, this appears to be plainly correct (although whether Parliament intended it to have this effect is another matter). But HMRC made two interesting arguments about why it was not plant. First, it was said that the company was not the owner of the painting; nor did it have the benefit of any licence or lease, since the arrangement was terminable at will, and therefore it did not meet the ‘permanent employment’ test outlined in Yarmouth v France. Lord Justice Rimer rejected this argument, pointing out ‘permanent’ relates to the nature of the asset, not the nature of the tenure:

29. In my view, there is nothing in this either. Lindley LJ, when referring to plant as apparatus kept for ‘permanent employment’ in the business, was simply contrasting it with the circulating nature of a trader’s stock in trade, which the trader buys and sells. He was not purporting to identify the type of tenure of the putative plant to which the trader must be entitled in order for it to qualify as plant.

Second, it was said that there was no ‘identity in interest’ between the 'plant' held by the CEHL (the right to display the painting) and the asset sold by the executors (the painting itself) and alternatively that it could not constitute plant because a painting is incapable of being a ‘wasting asset’. Lord Justice Rimer rejected these points as well:

32. There is in my view nothing in this either. The plant kept by the company for use in its trade was not such a limited interest, it was the picture itself. A limited interest in a chattel cannot constitute plant. There was, therefore, a complete identity between the asset used by the company and the asset sold by the executors. In any event, the submission that there needs to be such identity of interest is mistaken. Section 45(1) shows that the disposal of a limited interest in plant held by the trader will entitle the disponor to the exemption.

34. I would reject it. The problem with it is that what is ‘plant’ is not identified by the predictable life of a chattel. It is identified by whether or not the chattel passes the Yarmouth v. France test; and an item is capable of doing so whatever its predictable life. Once an item qualifies as ‘plant’, it is ‘in every case’ deemed by section 44(1)(c) to be a wasting asset; and for HMRC to argue that an item of plant enjoying unusual longevity is not plant at all is to advance an argument that the section expressly excludes and which amounts to no more than a pointless beating of the air.

This point—that the painting is not ‘plant’—was not HMRC’s primary case, as it argued that sections 44 and 45 require the disposal to be made by the person in whose hands the asset was a ‘plant’ and that in this case that condition was not satisfied because the painting was used for the company’s business but sold by the executors. The Court, after a careful analysis of the legislative history, rejected this submission but the point is of limited relevance to Indian law and it is unnecessary to explore it detail.

Finally, it is worth setting out Lord Justice Briggs’ more general observations about the construction of tax statutes in cases where the result contended for appears to have been an unintended consequence of the language used by the legislature:

It is, and despite these judgments will probably remain, surprising to those unfamiliar with the workings of Capital Gains Tax, that a famous Old Master like Omai 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.  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…In such cases it is essential to address an issue of interpretation not by reference to the oddball example, like an Old Master used as plant, or by the vintage car rather than the deteriorating hatchback, but by focusing upon the purpose for which the provision being construed was introduced.

3 comments:

Sowmya said...

Hi Niranjan,

Interesting post!

Just a couple of clarifications: (a) Do you think the court ignored the rest of the definition of wasting asset under sec 44 ("in estimating that life it shall be assumed that its life will end when it is finally put out of use as being unfit for further use") and just stopped short at its being plant and machinery? (b) Was the accounting treatment looked into at all? (c) So, by virtue of this judgment every plant and machinery (whether it is a depreciating asset/appreciating asset per accounting terms) would be CGT exempt?

V. Niranjan said...

Hi Sowmya,

Thanks, those are three interesting questions:

(a) No, I don't, because the effect of the opening words of section 44(1) is that any asset with a 'predictable life not exceeding 50 years' is a wasting asset. 44(1)(c), unlike the other sub-sections, provides that 'in every case' plant shall have a predictable life of less than 50 years, and the sentence you quote governs the estimate of what that life is, but within 50 years, ie, the 'estimating that life' language does not mean that the predictable life of plant can (in any case) exceed 50 years and therefore it is always a wasting asset.

(b) No, perhaps because there is a very specific legislative history to this (which Rimer LJ discusses at [13]-[15] but which I did not summarise in the post). Section 44(1)(c) was actually introduced not to give taxpayers an additional exemption but to prevent loss claims.

(c) Not necessarily: it is actually not usually beneficial for the taxpayer to argue that an asset is a wasting asset because CGT is then computed on the difference between sale price and WDV, rather than the acquisition cost. In fact, the reason for introducing the 'plant' exemption was to foreclose the argument that a particular P&M had a predictable life of 'more' than 50 years and therefore that the acquisition cost should be taken into account for CGT purposes (see Rimer LJ at [14] and Briggs LJ at [39]). It is also worth pointing out that it was an extremely unusual set of facts that enabled the executors to satisfy the Yarmouth v France test: if the Omai painting had been exhibited by an art dealer in his showroom, it would have been stock; and if it had been exhibited simply as part of a house, it would not have been plant because there would have been no business! (eg if Lord Howard had not opened up Castle Howard to the public). The other reason the case might not mean that it is always exempt is the question Rimer LJ left open at [35] ('machinery').

Sowmya said...

Maybe they should have an exception for works of art like land