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CG14800 | Contingent liabilities: what is a contingent liability?

From HM Revenue & Customs · Capital Gains Manual

When a person sells an asset they may accept a liability to make payments to the purchaser if certain events happen or if an asset is not as described in the contract. A common example is the warranties that are often found in share sale agreements. The vendors of the shares may agree to reimburse the purchaser if the company has undisclosed tax liabilities or the stock is over valued. The legal liability exists from the date of the agreement. But payment is contingent on the purchaser establishing the seller was in breach of the warranty or commitment.

The effect of making a disposal subject to a contingent liability was considered in Randall v Plumb (50TC392). It was held the value of the consideration brought into the Capital Gains Tax computation should take account of the contingency. That is, the disposal proceeds should be reduced by the value of the possibility that a payment may be due under the contingent liability.

In the case of Randall v Plumb Mr Randall granted a gravel company an option to purchase certain land for £100,000. The company paid Mr Randall 25,000 for the grant of the option but this was repayable after 20 years if the company had not received planning permission. Mr Randall also agreed not to make or concur in any separate application for planning permission on the land. The High Court held that consideration for the disposal was not £25,000 but £25,000 less the value of the possibility that the money may have to be repaid.

This approach to contingent liabilities has two consequences

  • By including an unlikely contingent liability in a sale contract the disposal proceeds brought into the Capital Gains Tax computation can be artificially reduced. For example, a professional person can sell a practice and knowing they had no intention of opening another practice in the area enter into a covenant not to do so.

  • There is no mechanism for adjusting the Capital Gains Tax computation if the valuation of the contingency turns out to be wrong.