Readers may recall our recent tale of Entrepreneurs’ Relief woe regarding the case of Alan Castledine – see here. This was a Tribunal case involving the sale of shares in a company where Entrepreneurs’ Relief (‘ER’) was denied because of the existence of worthless deferred shares which HMRC successfully argued counted as ordinary share capital (and therefore diluted Mr Castledine’s shareholding below the 5% threshold required for ER). Although the deferred shares had no voting rights or rights to dividends, and only an infinitesimal chance of any capital return, the Tribunal found that these were still part of the ordinary share capital.
However, a new case released this month has turned all of this on its head. In M McQuillan and E McQuillan v HMRC, the taxpayers faced a similar scenario. Mr & Mrs McQuillan each held 33 £1 ordinary shares in a company out of the original £100 share capital. However, in order to obtain a development grant, the company had been required to convert a £30,000 loan from the minority shareholders into redeemable shares. That meant that when the company came to be sold there were 30,100 shares in existence. The fundamental issue, as with the Castledine case, was whether these additional shares formed part of the ordinary share capital.
The shareholder agreement in this case was silent on the payment of dividends, but it was understood amongst the shareholders that the 30,000 redeemable shares would have no right to any dividends, and that the shares merely represented the interest-free loan that the minority shareholders had made to the company. Despite this, HMRC argued that the shares formed part of the ordinary share capital. If correct, this meant that Mr & Mrs McQuillan would only own 33 shares out of a 33,100 ordinary share capital – which at 0.001% would mean they failed to satisfy the ER conditions.
The definition of ordinary share capital is found within section 989 ITA 2007 which provides: “ordinary share capital, in relation to a company, means all the company’s issued share capital (however described), other than capital the holders of which have a right to a dividend at a fixed rate but have no other right to share in the company’s profits”. The taxpayers argued that the redeemable shares did have fixed rights to a dividend – at 0%.
In this case, the Tribunal was persuaded that the redeemable shares came within the exemption for shares with fixed dividend rights i.e. that a right to no dividend is a right to a dividend at 0%. Accordingly, the shares did not form part of the ordinary share capital and so the shareholders qualified for ER.
Whilst the decision in this case was favourable for the taxpayer, it creates considerable uncertainty and it will be interesting to see whether HMRC mounts an appeal. It was previously thought that shares with no automatic dividend rights would still be viewed as part of the ordinary share capital. It is notable that the McQuillan hearing was held prior to the Castledine decision being released. Either way, there will be a need to resolve the two seemingly contradictory outcomes.
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