Lee Sharpe looks at a recent tax case that considered whether an option to buy something was actually an option or perhaps more importantly, when there was a choice.
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In my article last month (‘Absence of evidence is NOT evidence of absence’), I looked at an interesting case, Raveendran v HMRC [2024] UKFTT 00273 (TC), which helped a family demonstrate that funds provided by a sibling amounted to a loan, rather than a beneficial (CGT-able) interest in the property. Notably, this was despite HMRC’s complaint that the brother was unable to provide contemporaneous evidence that he did not own the property – which could be seen as something of a challenge, even at the best of times.
This month’s article looks at a similar issue in relation to loan funding and where there is ostensibly an option to buy the property acting as collateral.
The legislation
It would seem fairly cut and dried that the owner’s granting to another party of an option to buy the owner’s property amounts to a disposal for CGT purposes; an option is explicitly recognised as an asset within the scope of CGT within the legislation (TCGA 1992, s 21; see also s 144 for more on options and their abandonment).
However, something that states it is an option is not always an option. See Krishnamohans v HMRC [2024] UKFTT 346 (TC) below.
How it started
In Krishnamohans, the taxpayers, a married couple, had built up a decent property portfolio since the early 1990s and were offered a very large property (a farm) for just shy of £6m. While the proposal was significantly more expensive than they had previously dealt with, the couple had formed an understanding from their dealings with the agent that a buyer was waiting in the wings to acquire the property at a substantively higher price just as soon as some pesky agricultural covenants had been lifted or discharged.
While the couple broadly had sufficient collateral in their existing properties, it was a stretch, and their usual lenders would not consider the property because of the covenants. But never fear, for the agent that wanted them to buy the former farm had already introduced them to a specialist lender who would lend against those covenants. However, there was a catch.
The contract
The first agreement between the taxpayers and the specialist lender was to fund the deposit of £600,000 needed for the farm. It was entitled ‘option agreement’ and set out that the taxpayers agreed to grant the lender the option to purchase other properties held as collateral for that £600,000, plus the lender agreed to pay off the existing mortgages on those properties. The collateral properties stood at net equity of around £1.9m, so the lender could broadly treble its commitment of £600,000 on the exercise of that option. Alternatively, the taxpayers stood to lose £1.3m.
Clearly, the couple would not want that option to be exercised, so there was provision in the contract that they could head off that eventuality by paying back the £600,000 plus interest at 18% per annum within the option period (initially 12 months, but extendable).
Notably:
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Assuming the lender did exercise the option but for some reason was unable to complete their purchase, the taxpayers were still obliged to pay back the £600,000 plus interest, thereby protecting the lender.
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The taxpayers each had to provide personal guarantees to cover that sum – again, protecting the lender.
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The taxpayers asked their own solicitors whether the agreement amounted to a loan, or to an option. Their solicitors advised that if the couple paid back the amounts due, then the agreement was a loan, but if they did not pay the amounts due, the agreement would turn into an option.
In summary then, if the couple repaid the capital plus interest, the option would not be exercised, and if the lender did not ultimately follow through with the option to purchase, the lender would get their initial sum back, plus interest. It could be argued that the lender did not really commit anything at the commencement of the ‘option agreement’.
How it turned out
Suffice it to say, after the couple had exchanged contracts on the farm, the prospective buyer withdrew from the scene. The taxpayers also found that the agricultural covenants were basically impossible to remove. There were several further funding agreements on similar terms with this lender and with others, and at one stage, there were charges against the couple’s business and their own home. In the end, they had to sell and re-mortgage several other properties to get out from under these agreements.
But the couple’s sorry tale did not end there. HMRC then decided that CGT was due on the receipt of the £600,000 initial loan and sums from several similar loan arrangements that followed because they were not really loans but grants of options to purchase the collateral properties, with the taxpayer couple acting as grantor, and the lenders as grantee; such options are of course subject to CGT. The taxpayers appealed to the tribunal.
What is an option?
The tribunal judge considered what was required to bring about the grant of an option.
In Gardner v Blaxill [1960] 2 All ER 457, it was held that an option was a ‘choice’.
In Mountford v Scott [1974] 1 All ER 248, it was observed that an option was no more than an offer, coupled with a promise not to withdraw the offer during the period of the option.
The taxpayers argued that the lender was never in a position to make a choice, so long as the taxpayers repaid the loan before the ‘option period’ lapsed. Simply, an option was supposed to give the buyer (the grantee) the choice, not the grantor; the contracts provided for the opposite here.
HMRC disagreed, saying that the couple had bound themselves to the option agreement from the outset and would have to take positive steps to unbind themselves. Critically, however, while HMRC provided several examples where the right to exercise an option was contingent on a future event, it was unable to provide a single example where the courts had found that an option had been granted pending a condition subject to the will of the grantor before it could be exercised by the grantee.
Tribunal findings
The tribunal judge clearly disliked that those several contracts were called ‘option agreements’ but, notwithstanding, found that they did contain an option; however, that option for the lender to purchase the property held as collateral came into existence only if and after the taxpayers had passed up the opportunity to repay the monies borrowed, plus interest.
Throughout the initial 12 months of the option period, it was basically the taxpayers who controlled whether the lenders got a choice to buy their properties, effectively deferring the grant of an option until that period had lapsed so long as the funds had not been repaid. Since the monies were returned, the events triggering an option did not come to pass, so no CGT-able disposal arose on commencement of these contracts.
Conclusion
One can sympathise with the taxpaying couple in this case; an uphill struggle against a series of ostensibly one-sided contracts that they finally paid off at great cost, only to be followed by HMRC demanding CGT on the sums originally borrowed thereunder. Do we have sympathy for the HMRC officer who, on reading these ‘option agreements’, determined that they must, in fact, amount to the grants of options thence subject to CGT? Perhaps.
But then, HMRC is wont to argue, particularly in tax avoidance cases, that we should really look through complex, layered transactions to discern the true economic substance of arrangements. The taxpayers seemed clearly and consistently to believe that they were borrowing money, and they were supposedly dealing with specialist companies that provided short-term lending facilities rather than the kind of ‘business support’ that might make even a 2009-era banker blush.
Kudos to the taxpayers’ solicitor (see (3) above), who discerned they were substantively loans long before they were options.
