Well-known investor Warren Buffet is famously quoted as saying: “Rule number one: never lose money. Rule number two: never forget rule number one.”

When it comes to deposits to purchase an asset, it is possible to lose the deposit, but never own the asset to which it relates; effectively ‘money for nothing’. This article focuses on the tax treatment of lost deposits received and paid by individuals in respect of properties, based on the example ‘Going… going… gone!’ (See below)

Going… going… gone!

In January 2022, Joanie contracted with a landowner to buy a disused barn in the Norfolk countryside, which she intended to convert into a residential property. The cost of the barn (including surrounding land) was £1m.

A deposit of 10% (£100,000) was payable on the date of the contract, which provided for a stage payment of £150,000 30 days later, and completion three months thereafter. The contract also provided that if Joanie failed to make the stage payment by the specified date, the seller could repudiate the contract and retain the deposit.  

Unfortunately for Joanie, she was unable to secure the necessary finance to make the stage payment on time. The seller repudiated the contract and Joanie therefore forfeited her deposit.

Receipt: income or capital?

There are two sides of the forfeited deposit coin. On the receipts side, the first consideration for tax purposes is whether the receipt would be treated as income, which would take precedence over capital treatment (s37(1), Taxation of Chargeable Gains Act 1992 (TCGA 1992)).

If the recipient in the example was a property trader, HMRC may well regard the forfeited deposit as a trading receipt, on the basis that it is received as part of the individual’s trade. In Elson v Prices Tailors Ltd [1963] 40 TC 671, a customer paid a deposit to a tailor for a made-to-measure garment, but did not take delivery of it. The High Court held that the deposit was security for completion of the purchase and was the tailor’s trading income, in the year of receipt.  

If the recipient individual is not a property trader (eg, a landlord or owner-occupier), the forfeited deposit may be a capital receipt instead. For capital gains tax (CGT) purposes, a forfeited deposit on an abandoned property sale falls to be treated in the same way as the consideration for an option binding the vendor to sell the property where the option is not exercised (s144(7), TCGA 1992).

The grant of an option to acquire a property is generally treated as the disposal of a separate asset (ie, the option) by the individual selling the property (s144(1), TCGA 1992). This treatment as a separate asset broadly applies unless the option is exercised, whereupon the whole proceeds are chargeable as a gain (Strange v Openshaw 57 TC 544). However, if the option is not exercised, there has been a deemed disposal of the option and the property seller is liable to CGT on the proceeds from granting the option. The gain (net of any allowable expenditure) is chargeable when the contract is rescinded and the property seller receives the forfeited deposit.

If a forfeited deposit is received in respect of the seller’s only or main residence, the receipt will not be eligible for private residence relief for CGT purposes. While the forfeited deposit has some connection with the residence, it is not the disposal of an interest in the residence (see HMRC’s Capital Gains Manual, at CG64609).

How is the payment treated?

What about the tax treatment for the individual who pays a deposit that is forfeited? If the individual paying the forfeited deposit is a property trader, the expenditure might be an allowable deduction from profits, on the basis that it was ‘wholly and exclusively’ incurred for trade purposes where the property would have been a trading asset if acquired.  

Otherwise, a forfeited deposit generally falls to be treated as an option binding the grantor to sell that is not exercised. The abandonment of an option does not (subject to certain exceptions, which are not relevant here) constitute an asset disposal by the individual paying the deposit (s144(4), TCGA 1992). The individual who paid the forfeited deposit will therefore potentially incur a non-allowable capital loss.

In Hardy v HMRC [2016] UKUT 0332 (TCC), the taxpayer entered into an agreement for the purchase off-plan of a leasehold property; a deposit of 10% of the purchase price was payable on entering into the contract. However, funds were not subsequently available to complete the purchase. The vendor refused to wait until the necessary funds were raised to complete; they rescinded the contract and retained the deposit. HMRC subsequently sought to disallow Mr Hardy’s offset of the resulting economic loss against his capital gains.

The Upper Tribunal (UT) considered that when a seller and buyer enter a contract for the sale of land, the seller does not dispose of an asset and the buyer does not acquire one. The asset (which is the land) is disposed of by the seller and acquired by the buyer when completion takes place (albeit that s28(1), TCGA 1992, then deems the date of the transfer to be the date of the contract). The UT held that the First Tier Tribunal (FFT) was correct to conclude that the appellant did not acquire an asset for CGT purposes when he entered the contract. He therefore had no chargeable asset to dispose of when the contract was rescinded.

Land of confusion

More recently, in Drake v Revenue and Customs [2022] UKFTT 25 (TC), the appellant entered a contract with the seller to be granted a lease of a property that was under construction in London. Completion was to take place shortly after building work was completed. A deposit was to be paid by the appellant on the date of the contract, equal to 10% of the lease premium (ie, £2.2m), less a reservation fee (ie, £5,000). A stage payment (ie, 10% of the premium) was payable by him 12 months later and the balance of the premium was payable on completion. If the appellant failed to pay either the deposit or stage payment, the seller could treat such conduct as a repudiation of the contract.

The appellant paid the deposit (£215,000) when due, but did not pay the stage payment because of difficulties raising finance. Consequently, the seller treated the appellant as having repudiated the contract and the seller kept the deposit (and reservation fee). The appellant claimed a capital loss of £220,000 in respect of the deposit paid under the contract. However, HMRC sought to disallow the loss.

On appeal, the issues included whether Hardy was binding authority or distinguishable from the present case. Rather confusingly, in Lloyd-Webber & Anor v HMRC [2019] UKFTT 717 (TC), it was common ground that based on the Court of Appeal’s decision in the earlier case Underwood v HMRC [2008] EWCA Civ 964 the decision in Hardy was ‘per incuriam’ (ie, broadly a wrong decision due to some oversight).

However, the FTT in Drake did not consider that the ‘ratio’ (ie, reasoning) in Underwood had any bearing on the ratio in Hardy, and certainly did not render Hardy per incuriam. The FTT concluded that Hardy (being an UT decision) was binding authority. The rescission of the contract due to the appellant’s breach did not constitute an asset disposal for capital gains purposes.

Interestingly, in case the decision in Hardy was per incuriam, or if Hardy was not binding authority in the present case, the FTT indicated that contractual rights to acquire land were potentially assets for CGT purposes, but that forfeited monetary deposits did not constitute the disposal of a capital asset.

About the author

Mark McLaughlin, CTA (Fellow), ATT (Fellow), TEP is editor and a co-author of Tax Planning (Bloomsbury Professional)