HMRC fails to disqualify chairman's special shares from entrepreneurs' relief
The case is one of several recent examples in which HMRC has sought to disqualify a shareholder from entrepreneurs' relief, now called business asset disposal relief (BADR), on the grounds that there was something unusual about the kind of shares held. The question is important because, under s.989 Income Tax Act 2007 (ITA 2007), the person making the disposal qualifies for entrepreneurs' relief only if they hold at least 5 per cent of the company's ordinary share capital. If HMRC can show that some of the shareholder's shares are not 'ordinary', then the claimant may not meet this 5 per cent threshold.
Some of its challenges have succeeded, for example Holland-Bosworth v HMRC (2020 UKFTT 331 TC), in which the First-tier Tax Tribunal (FTT) agreed that shares that do not give the shareholder the right to vote at a company's general meeting do not meet the ordinary share capital requirements of ITA 2007. In others, such as McQuillan (2017 UKUT 344 TCC), it failed, with the Upper Tribunal ruling that shares can be ordinary share capital even if they carry no dividend rights.
In the Warshaw case, the taxpayer was the chairman of Cambridge Education Group. The shares he sold were of the cumulative preference type, giving the owner the right to compound accrued but unpaid dividends at a fixed rate.
HMRC argued that these shares were not 'ordinary' because they had a right to a fixed dividend. The implication was that Cambridge Education was not Warshaw's personal company and thus he could not claim entrepreneurs' relief.
However, the FTT disagreed with HMRC, and the Upper Tribunal has now upheld that ruling. It found that the dividend on Warshaw's preference shares was not 'fixed' because of the cumulative compounding element, which meant that the amount to which the percentage dividend applied was variable. His shares were therefore ordinary share capital under ITA 2007 (HMRC v Warshaw, 2020 UKUT 0366 TCC).
In support of this view, the Upper Tribunal said s.989 ITA was intended to operate only as a 'bright dividing line' between shares that are ordinary share capital and shares that are not. 'We see no principled basis for distinction between a dividend expressed as a fixed percentage of profits and the dividend on the Preference Shares', it noted.
The ruling provides a helpful clarification, said Catherine Hill of law firm Macfarlanes. She notes that if a client holds ordinary shares and another shareholder holds preference shares in the same company, the rights of those preference shares should be checked: if they are part of the ordinary share capital of the company as a result of that decision, they could dilute the client’s shareholding below the 5 per cent threshold.
The decision will also have wider implications, as the definition of ordinary share capital set out above is used in both the individual and corporate tax codes, said Hill. 'It will therefore apply to other reliefs, such as the substantial shareholding exemption and to many grouping tests, such as the chargeable gains grouping test that allows assets to be moved within a group on a no gain, no loss basis.'
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