In May we highlighted two Tribunal decisions which looked into the issue of whether certain types of share would constitute ordinary share capital for Entrepreneurs’ Relief (‘ER’) purposes (see here). Regular Tax Biters may recall that there was confusion around whether shares with no rights to dividends fell within the definition of ordinary share capital. The two Tribunals were presented with very similar fact patterns yet reached different conclusions.
In Alan Castledine v HMRC the taxpayer held 5% of the ordinary ‘A’ and ‘B’ shares of a company. However, there was a third class of ‘deferred’ shares with no voting rights or dividend rights, and a miniscule right to capital. The problem was that if these shares were taken to be ordinary shares then Mr Castledine no longer had the 5% he required for ER. Unfortunately, the Tribunal decided that these were ordinary shares, with the result that ER did not apply.
Then came the case of M McQuillan and E McQuillan v HMRC. Here the shareholders held 33% of the ordinary £1 shares, but again there was a class of ‘redeemable’ shares, with no dividend or voting rights. If the redeemable shares were treated as ordinary share capital then the McQuillan’s percentage shareholding would have fallen to below 1%. However, in this case the Tribunal concluded that the shares were not part of the ordinary share capital.
Ordinary share capital for ER purposes is defined as (section 989 ITA 2007) “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”. However, the Tribunal was persuaded in McQuillan that shares which had no dividend rights fell within the definition of fixed dividend shares. The argument was that they had a fixed right of 0%!
Most tax commentators agreed that this was a bizarre outcome. How could having no dividend rights be viewed as a right to a dividend at 0%? Quite simply, these shares had no rights at all!
Unsurprisingly, HMRC appealed the matter and a decision was released on 6 September 2017. The Upper Tribunal concluded that the First Tier Tribunal was wrong, and that redeemable shares with no right to a dividend were not shares with a right to a dividend at a fixed rate. Accordingly, the shares formed part of the ordinary share capital, with the unfortunate result that the taxpayers lost their ER.
In our view, this was the correct result and removes the uncertainty caused by the conflicting outcomes of the two cases. It does, however, raise an important point that companies and their advisers should be reviewing the terms of their constitution where unusual types of share capital exist. We are still coming across cases where shareholders are inadvertently finding themselves precluded from qualifying for ER because of there being other types of share which dilute them below 5%. Usually these matters are easily resolvable, but because the conditions have to be met for a full twelve months action is required at an early stage.
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