HMRC have recently been take to the First-tier Tribunal (FTT) twice based on their interpretation of the qualifying conditions for Entrepreneurs’ Relief. Whilst one decision ruled in their favour (Hunt vs HMRC), the second case went against them. What is clear from these challenges, is those advising individuals on their investments must be careful and certain of the rules to avoid their clients being ineligible for the relief on disposal.
Hunt vs HMRC
Background
A taxpayer became chairman of a company and invested £50,000. The share capital existed of shares with a nominal value of £1 per share. One of the company’s lawyers advised the taxpayer to subscribe for share with a nominal value of 10p and not for those with £1. The theory behind this is it would be easier than issuing £1 shares with would require the existing shareholders permission. According to the lawyer, the 10p shares would have no impact on his economic interest or voting rights. Having acquired more shares over the years, at the time the company was sold the taxpayer held 5.94% of all shares, qualifying him for entrepreneurs’ relief.
HMRC
HMRC’s view was that an individual must hold at least 5% of the share capital by nominal value, not the number of shares issued. The taxpayer therefore was declined Entrepreneurs’ Relief as, when calculating the nominal value of his shares, he only owned 4.16%. The result of this meant a rise in the tax due of almost £200,000.
FTT Decision
Upon appealing HMRC’s decision through the FTT, the decision was upheld with the FTT finding that the statutory definition refers to a percentage of the “issued share capital”. As the provisions are so detailed, it is impossible to bypass a condition based on the general purpose of the legislation or import other factors to replace it.
The ruling highlights the need to ensure clients have 5% of the issued shared capital by nominal value therefore, where clients’ fail on this requirement, a recapitalisation of shares will be required.
Warshaw vs HMRC
Background
A taxpayer who claimed entrepreneurs’ relief held 5% of the share capital when including his preference shares. HMRC declined his relief based on the fact that the preference shares did not constitute ordinary share capital based on the definition in s.989 Income Act 2007. The result of which meant the taxpayer liability increased by over £1m.
The Argument
The taxpayers appeal was based on his cumulative preference shares not having an entitlement to a fixed dividend rate. The 10% dividend entitlement was dependant on the company having enough reserves to pay, where this was not the case the dividend was deferred to a later year. During those years the 10% would be calculated on an increased amount. HMRC argued that the rate was fixed at 10%, not that the rate was flexible because it was calculated in reference to any previous unpaid dividends.
FTT Decision
When considering both the percentage element and the amount to which it was applied, the view was that the percentage rate was fixed. However, as the amount it was applied to varied, the preference shares did not carry a right to a dividend at a fixed rate. The shares therefore met the definition of ordinary share capital and the appeal was allowed.
