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Market Value and the ‘Subjective Intention Test’

Category Technical Articles
AuthorTechnical Department
All tax advisors are familiar with the concept of ‘connected persons’ and the need to use market value for capital gains tax (CGT) purposes where assets have been transferred between such parties. However, it is important to recognise that the legislation requires the use of market value in a much broader range of circumstances than those involving ‘persons’ within the statutory definition of ‘connected persons’ for CGT.

This article aims to refresh and develop your understanding of how and when the market value rule needs to be applied.

Article by Amanda Rodger, a former Inspector of Taxes who now works for James & Cowper as a member of their Corporation Tax Team. Published in the March 2002 issue of Tax Adviser.

The market value rule is introduced by TCGA 1992, s. 17 in relation to the disposal or acquisition of an asset ‘otherwise than by way of a bargain made at arm’s length’. The section specifies certain circumstances where this would apply:
  • a gift;
  • a transfer by a settlor into a settlement; and
  • a distribution from a company in respect of shares in the company.
Market value must also be used where the acquisition or disposal is:
  • for consideration that cannot be valued; or
  • in connection with loss of office; or
  • in consideration of past services or other service rendered.
It does not apply if:
  • there is no corresponding disposal (e.g. a share issue); and/or
  • there is no consideration in money or money’s worth, or the amount or value of such consideration is less than the market value of the asset.
Connected persons

In TCGA 1992, s. 18 a ‘bargain otherwise than at arm’s length’ is specifically applied to transactions involving an acquisition and a disposal between connected persons. But this section has two other important effects. The first is to restrict the availability of losses on such transactions, while the second concerns the effect on the market value of any rights or restrictions which are enforceable by the person disposing of the asset.

So what is a connected person for the purposes of the CGT legislation? The statutory definition at TCGA 1992, s. 286 considers a variety of circumstances. Briefly these can be summarised as:

In relation to an individual:

  • the husband or wife of the individual; and
  • the husband or wife of a relative, whether of the individual or of the individual’s husband or wife.
In relation to the trustee of settlement:
  • a settlor;
  • a person connected with the settlor;
  • a body corporate connected with the settlement.
In relation to a [business] partner (except for bona fide commercial transactions in partnership assets):
  • a partner;
  • the husband or wife, or relative, of a partner.
In relation to a company:
  • another company under common control;
  • another company controlled by persons connected with whoever controls the first;
  • anyone who has control of it, either alone or with other connected persons;
  • any persons acting together to control a company will be connected with each other.
For the purposes of this section a relative is a brother, sister, ancestor or lineal descendant.

The ‘subjective intention test’

All of this is relatively straightforward and common ground to most tax practitioners. However the Inland Revenue Capital Gains Manual makes reference to another situation which is considered to be ‘otherwise than by way of a bargain made at arm’s length’. This arises in the following circumstances:

  • where one person does not intend to get the best deal for themselves, and
  • has the ‘subjective intention’ of giving some gratuitous benefit to the other person.
The obvious situation occurs where one person makes a gift to another. In most cases a birthday or other present will not give rise to a CGT liability, either because it is a chattel or because the acquisition cost to the donor is the (market) price he has just paid for it in the shop where he bought it. But what if your gift is of something valuable which you have owned for some time?

Consider a situation where Uncle Henry has given his niece, Stella, a painting worth £80,000, which he inherited some 40 years ago when the artist was still alive. There are no untoward circumstances, but he clearly wished to bestow a gratuitous benefit upon his niece, who is not a relative within the terms of TCGA 1992, s. 286. The ‘subjective intention test’ demonstrates that the transaction is ‘otherwise than by way of a bargain made at arm’s length. Henry’s disposal proceeds will therefore be the market value of £80,000 and that will also be Stella’s acquisition cost.

Similarly, if the childless Mr Jordan sells shares worth £100 in his family trading company to Tom, a promising young protégé, at par of £1, there is no connection under s. 286. However, there is the ‘subjective intention’ to confer a gratuitous benefit upon Tom so that the transaction once again becomes a bargain not at arm’s length and the market value rule should be applied. (In this situation, Sch. E would also have to be considered if Tom was an employee.)

A bad bargain

Not every transaction at less than market value will be caught in this way.

For example, if Henry was unaware of the value of his picture and sold it to a more knowledgeable art dealer for £50,000, then he may, nonetheless, have been trying to obtain the best deal for himself. The dealer most certainly would have been buying the picture with a view to making a substantial profit from Henry’s naivety and the deal was therefore a bargain at arm’s length, even though it was a bad bargain from Henry’s point of view.

Separate transactions

The Revenue instructions also remind inspectors of the need to apply the ‘subjective intention test’ to each individual transaction in circumstances where the overall deal may appear to be a bargain at arm’s length. Practitioners, too, would do well to heed this advice in frequently met situations such as if the client is keen to proceed with the sale of a house and adjacent land to a property developer. While the house will qualify for personal private residence relief, any gain on the land will be chargeable and the vendor will be seeking minimise it. The developer may well be happy to buy the house at more than market value in return for paying less for the land.

However, if he pays £400,000 for a house worth only £300,000, he will have conferred a gratuitous benefit upon the vendor. Conversely, by selling land worth £110,000 for only £10,000, the vendor will have conferred a gratuitous benefit upon the developer. In both cases the transactions will therefore be ‘otherwise than by way of a bargain at arm’s length’ and the market value rule should be applied.

No corresponding disposal

A company makes no disposal upon issuing shares, nor conversely, does it make an acquisition when it makes a purchase of own shares (POS) from one of its shareholders. Such situations are not caught by s. 18, which only applies where there is both an acquisition and a disposal. Thus the only way of applying market value to such transactions where they occur between connected persons is to demonstrate the existence of a bargain not at arm’s length. The Revenue would attempt to do this by using the ‘subjective intention test’.

Note that the market value rule is specifically disapplied by s. 17(2) where there is an acquisition with no corresponding disposal and no money is involved or the consideration is less than market value. The application of market value to a share issue is therefore further limited to those situations where the gratuitous benefit is conferred upon the company, that is where the company issues shares at over value. While any excess payment over par would still be regarded as part of the share premium account, and as forming part of the capital payment for the shares for the purposes of the distributions legislation, the acquisition cost for CGT purposes would be limited to market value. If the consideration is less than market value, then the consideration for CGT purposes is the actual amount paid.

Other transactions involving companies

The Revenue instructions also suggest that the ‘subjective intention test’ might be applied to company reorganisations where the newly acquired shares are disposed of at a loss within a short time of issue. This is because there is provision at s. 128(2) to ignore part of the consideration where the issue of shares was otherwise than by way of a bargain made at arm’s length.

With any transaction involving the transfer of assets into and out of a company, advisers should be aware of other pitfalls for the unwary. These might include value shifting or depreciatory transactions, neither of which are within the scope of this article.

An objective measure

The ‘subjective intention test’ is a Revenue concept which is not frequently encountered. It is, after all, unlikely to be a simple task to demonstrate the existence of an intention to confer a gratuitous benefit or ‘give bounty’. Any attempt to do so will require a careful assessment of all the circumstances and the evidence which is available. This may include:

  • the presence or absence of real negotiations between the parties about the terms of the transactions;
  • how the terms of the transaction compare with those used in similar transactions carried out on a commercial basis;
  • whether the parties have separate legal or other professional representation;
  • whether the parties have received independent advice;
  • the character of any comparable dealings between the parties;
  • whether the transaction between the parties may be linked with any other transaction between the same parties; and
  • the relationship between the parties outside the transaction in question.

In taxation, as in any other field of potential conflict, preparation is the best form of defence. If you are aware of the challenges that may be made by the Revenue, you will be in a better position to ensure your clients plan their affairs so as to comply with all aspects of the legislation. Where you are presented with a fait accompli you should at least be able to mitigate any unwelcome surprises in the form of unexpected enquiry letters or tax bills.

The phrase to remember is ‘gratuitous benefit’. If the transaction is not one between connected persons, then this is what will generally turn it into one which is ‘otherwise than by way of a bargain at arm’s length’. Either way, you are likely to be looking at market value.

Technical Department
020 7235 9381

March 2002 by


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