Entrepreneurs’ relief – What is an ordinary share?

We have written in previous blogs about the need to take care over Entrepreneurs’ relief (ER) and preference shares (see Entrepreneurs’ Relief – 5% Test and Preference Shares) and a recent case heard by the First-Tier Tribunal has shed more light on how the rules are to be interpreted.

One of the conditions for ER is that the taxpayer must hold at least of 5% of the company’s ordinary share capital and voting rights. For these purposes, ordinary share capital is defined as all share capital excluding fixed rate preference shares.

However, in the recent case of M & E McQuillan v HMRC [2016] TC05074 redeemable non-voting shares which did not carry rights to dividends were found to not constitute ordinary shares for ER purposes.  It was found that shares with no rights to dividends could be considered as having a right to a fixed rate of 0% and therefore could be excluded from the calculation of ordinary share capital.

In this case, this provided the right outcome for the taxpayers as they were selling their ‘ordinary’ shares in the company, of which they had 33% each.  Another couple had made a loan of £30,000 which had been converted into the 30,000 preference shares which were redeemable non-voting share capital with no rights to dividends.

Had the 30,000 extra shares have been treated as ordinary share capital, the taxpayers would not have had the required 5% holding.

The case highlights the importance of checking through all the details before making a sale of shares in your company.  In this case, the taxpayers were successful but others will not be so fortunate.  Eaves and Co have extensive experience advising on share sales and Entrepreneurs’ relief and would be delighted to hear from you if you are considering a sale in the near future.

Careful with those Capital Gains Tax deductions

Accountants and clients used to the broad brush “commercial” approach to computing trading profits can get caught out by the different and stricter rules for calculating capital gains.

Payments which may make sense, or even be thought essential from a commercial perspective are not necessarily then allowable for capital gains tax purposes.

This is demonstrated by the recent case of J. Blackwell.  In exchange for £1m, Mr Blackwell agreed to act exclusively in voting his shareholding in BP Holdings in favour of the Taylor and Francis Group who wished to purchase BP Holdings.  Later another prospective purchaser came along for BP Holdings.  In order to extricate himself from the first agreement Mr Blackwell paid Taylor and Francis Group £17.5m which he then claimed under S38 TCGA 1992 as a deduction against his subsequent sale of the BP Holdings shares to the second purchaser.

The Upper Tier Tribunal found against him on the grounds that the expenditure was not reflected in the value of the asset disposed of to the purchaser.  Admittedly, it put him in a position to make the disposal, by releasing him from the previous restrictions, but it did not enhance the value of the shares themselves.  Similarly, the Courts held the payment did not create or establish any new rights over the underlying shares themselves.

This principle can be a factor in helping clients decide whether to accept an offer, by understanding what it would be worth after tax.  It can often be in point where a client is considering an offer from a developer for (say) housing.  On this principle, if the developer is buying a cleared site, where a bulldozer has taken down perhaps years of “enhancement expenditure” on the former trade site, then it is likely HMRC will seek to deny the cost of the previous building works, perhaps increasing the gain by a material amount.

Care in understanding the facts is crucial.

A Camel, a Horse or a Spaceship – Tax Law

The Law is not an ass.  It is a quadruped, designed by a committee, who, over many years and many different committee members, cannot quite recall whether they were designing a camel, a horse or a spaceship.

  1. Hands up all those who believe the Rule of Law is important?
  1. Hands up (in Magna Carta year) all those who think the Law should be applied consistently?
  1. Hands up all those who believe that professional tax advice should be clear and based on proper interpretation of the Law?

Hopefully, I have everyone’s hands up for each question?  At least mentally?  Those too embarrassed to react or having a quiet lunch snooze should, I hope, still have made a genuine twitch towards acceptance.  If not, please say.  I genuinely would be interested to know why.

I now move on to the recent cases of Gemsupa and Trigg.  They would make a superb exam question in terms of ‘compare and contrast’.

In Gemsupa, the Courts agreed with the taxpayer that the CGT legislation was so clear that, even though various steps were taken for tax avoidance purposes, this did not meant that they were ineffective legally (the case was pre-GAAR so query whether those new rules may have an impact?)

And Compare:

Trigg(onometry) and Lawyers

The Trigg case heard in the First Tier Tribunal concerned the definition of Qualifying Corporate Bonds for tax purposes.  This may sound esoteric and technical, but in fact they raise some very interesting issues.  [Remember ‘Tax is Fun’].

Amongst the reasons the case is interesting is that it may have an impact on both future and historic Commercial, Corporate Sale and Purchase agreements where some of the consideration is deferred in the form of loan notes.  As will be generally known, (at least in esoteric tax and legal circles) the loan note form of deferred consideration makes a profound different on the way it is taxed.

In Trigg, HMRC lost, which seems to have widened the definition of QCBs.  This could have a profound impact on Sales and Purchase Agreements so Solicitors need to beware!

Having reviewed many Sales and Purchase agreements over the years, I fear that sometimes matters may be glossed over.  Perhaps so because of infrequent HMRC review of the detailed documentation?  This is understandable, from a commercial perspective.  A precedent has worked in the past, so just tweak it?

The ‘purposive’ approach in Trigg contrasts with the legalistic interpretation adopted by Gemsupa.  Which is correct?  Which ought to be correct?  Bearing in mind most of us just wish to get commercial deals done to help business people achieve their commercial objectives, how many professionals believe the objectives suggested in 1-3 above are being achieved?

As they used to say in exam questions – Discuss!

Divorce – A painful process (S. Sehgal)

One of the problems of trying to design a nice, neat efficient computer system to administer and collect taxes is that the poor, unfortunate officers at HM Revenue and Customs are concerned that they have to deal with people – and as many can confirm, sometimes people can be wayward, forgetful or just act in a different way to that expected…

This leads to Tax Cases…

In S. Sehgal, a lady claimed repayment of capital gains tax on the grounds that she had never made the relevant claim.

However, she had paid the tax, signed her Tax Return, declaring the gain, plus relevant documents had been filed at Companies House showing she had been a shareholder in the Company at the time it was sold.  The documents were filed at the time she was Company Secretary.

She argued she was not beneficial owner of the shares, but had just left everything to her husband to deal with.  The First Tier Tribunal inferred that (before her divorce) she had broadly consented to this pattern.

It is apparent that afterwards she wished she had not, but this was not really the issue before the Court, which is whether she was entitled to overpayment relief under Para 2 Schedule 1 AB TMA 1970.

The courts found she was not because the evidence showed she was the legal owner of the assets sold, and there was no real evidence produced to suggest she was not also the beneficial owner.  Hence, it seemed fair to assume her original tax return was correct and the tax was due.

Interestingly, the Courts also recorded the fact that the share sale and associated tax payment had been raised in divorce proceedings and so had effectively been considered already in the settlement.

Although academic, because of the underlying decision, the Judge found that HMRC had not proven the claim was time barred.

Conclusion

The lessons for professionals advising on family wealth disputes are:-

a) Always consider tax consequences from a commercial/family law context as well as tax compliance.

b) Make sure proper documentation backs up the true intentions of the clients.

Deferred Payments – CGT on Sale of Shares – Tax Advice

A fairly common feature on a sale of shares in a private company is an element of consideration which is delayed, either for a set period of time or based on certain conditions being met.

The tax impact of these innocuous looking payments can often be surprising and can lead to unwanted tax liabilities arising before any funds have been received.  In most cases, the tax will be payable in the year following disposal, regardless of when the deferred proceeds are received.

In a recent case which Eaves and Co have been involved with following an HMRC enquiry, a sale was agreed with an element of the sale price becoming payable only when dividends were paid by the company in the future.  No tax advice was sought at the time the sale was agreed.

HMRC had stated that the contract was unconditional and that the proceeds were simply deferred.

Our analysis was that the payments are contingent, as something has to happen (the payment of dividends) before the amounts are due.  However, having established that the payments are contingent, we then have to determine whether the proceeds are ascertainable or not.

If the proceeds are ascertainable, they will be taxed in full as part of the proceeds of the disposal, despite the fact that they may not become payable until some time into the future.  The position is more complex if the proceeds are unascertainable, as the value of the right to receive the funds in the future is taxed on the original disposal.

In this case, the chances of dividends being declared are thought to be low, and as such the right could potentially be valued at a substantial discount and therefore bring down the initial tax cost.

The distinction between ascertainable and unascertainable can be quite subtle, but the key is whether or not all the events that can affect the amount occur before the disposal.  For example, where the proceeds are based on a percentage of future profits, this would be unascertainable as the future profits are not known at the date of the sale.

We successfully argued that the payments in this case are unascertainable, because whilst there is a limit on the maximum that can be received, there is no way to determine what dividends will be declared in the future.

HMRC confirmed that they accept our position, despite having previously argued that the payments were not even contingent.  We have begun negotiations with HMRC as to the value of the potential right to future consideration and have begun with a low valuation due to the facts of the case and the likelihood that any funds will be received in the future.  The downside to this is that any further receipts would be taxable without Entrepreneurs’ relief being available, however the cashflow benefits are thought to outweigh this drawback.

The key point is that taking tax advice at the time of the disposal would have prevented this unexpected tax treatment, and the contract could have been worded in order to provide a more clear outcome without the expense of negotiating with HMRC.

Top Tax Tips for Owner Managed Businesses – Tip 6 – Entrepreneur’s Relief

Top Tax Tips for Owner Managed Businesses

6. Entrepreneurs Relief on Sale of Shares/Business

Entrepreneur’s relief (ER) allows individuals to pay tax at 10% on the disposal of qualifying assets including shares in trading companies and represents a very important relief for business owners.

ER may be due where in the 12 months prior to the disposal the individual was an employee / officer of the company and held at least 5% of the share capital and voting rights.

An entrepreneur/shareholder may expect the 10% rate of capital gains tax but potential pitfalls are lurking:

  • Shares with restricted rights may not qualify for relief,
  • The relevant conditions must be met throughout the 12 months immediately prior to disposal,
  • The existence of preference shares in the company could complicate the 5% calculation
  • Investments and/or surplus cash could taint the trading status of the company and ER could be lost all together
  • A purchaser of the trade may prefer to buy the trade and assets of the company rather than the shares.  In such a transaction the company will be subject to tax on the sale and additional tax will be payable on extraction of the funds from the company.  Therefore the overall rate would be much higher than 10%.

QCB and Entrepreneur’s Relief

Following the change to the CGT rate in June 2010, the rules for claiming Entrepreneurs’ Relief (ER) were changed so that relief is now given as a 10% tax rate, rather than the previous subtly different mechanism of reducing the gain but applying the normal rate of CGT.

In certain circumstances it may be possible to achieve an effective tax rate of 5.6% on cashing the loan notes or to receive additional ER where the lifetime limit was previously breached (but there is now some available due to the increase of lifetime gains to £10million).

If you or your clients have QCBs issued between April 2008 and June 2010, please get in contact with Eaves and Co Specialist Tax Advisors, Leeds and Southport to see if we can help.

Changes to ESC C16

Extra Statutory Concession  C16 has long been an extremely beneficial and straightforward way to deal with the tax implications of the striking off of a company.

Under the concession, Capital Gains Tax rather than Income tax, is payable and the cost of an expensive liquidation is avoided – as long as conditions are met.

However, a proposed amended law sets out the new condition that any payment at the time of the dissolution will be liable to income tax if it exceeds £4,000.

So  the favourable tax implications of ESC C16 are going to be heavily restricted. If you are conisdering striking off your company to release capital and assets it is better to do it sooner rather than later.

If you are considering potential liquidation of your company please get in touch for a no cost initial discussion.  

Entrepreneurs’ Relief – More Beneficial Than Ever

 

The recent changes in rules on Capital Gains Tax and Entrepreneurs’ Relief mean that it is more important than ever.  With the main rate of CGT now 28% and the rate on assets qualifying for ER remaining at 10%, the benefit of attaining ER is increased to 18% from the previous 8%.  Coupled with the lifetime limit increase to £10m, the overall lifetime value of ER is a maximum of £1,800,000; a significant increase on its initial value of £80,000.

It is therefore more important than ever to fully consider the availability of ER on transactions and ensure that all the conditions are met.