Mark McLaughlin looks at a key condition for capital gains tax entrepreneurs’ relief in many instances, and highlights a recent case in which the court allowed taxpayers a ‘second bite of the cherry’ on a share transfer.
Entrepreneurs’ relief (ER) is a very valuable relief for capital gains tax purposes, so it is not surprising that various conditions must be satisfied to be eligible to claim the relief when an individual makes a material disposal of business assets.
For example, an important condition for a shareholder in a trading company in most cases is that the company must have been the individual’s personal company for a specified period of one year (see TCGA 1992, s 169I). There are exceptions to this rule for disposals of relevant ‘enterprise management incentives’ shares, which are not considered in this article.
Personal company
The definition of ‘personal company’ is broadly a company of which at least 5% of the ordinary share capital is held by the individual, and at least 5% of the voting rights are exercisable by the individual by virtue of that holding (TCGA 1992, s 169S(3)).
The personal company definition looks straightforward, but there are potential traps. For example, ‘ordinary share capital’ is defined for these purposes (TCGA 1992, s 169S(5)) as all of a 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 (ITA 2007, s 989).
Another potential pitfall is that ‘issued share capital’ involves looking at the nominal value of the shares, as opposed to their actual market value (Canada Safeway Ltd v Inland Revenue Commissioners [1973] 1 CH 374). The distinction between nominal value and actual value (as well as the actual number of shares) can be crucial.
More shares needed
The nominal value requirement in respect of a company’s shares was considered in Prowting 1968 Trustee One Ltd & Ors v Amos-Yeo & Anor [2015] EWHC 2480 (Ch). In that case, the company’s ordinary share capital comprised the following:
- 1,200,000 ‘A’ shares – Nominal value 50p each (= £600,000)
- 375,660 Ordinary shares – Nominal value £1 each (= £375,660)
- 167,000 ‘B’ Ordinary shares – Nominal value 1p each (= £1,670)
- 346,000 ‘C’ Ordinary shares – Nominal value 52p each (= £179,920)
Thus the total number of the company’s ordinary share capital was 2,088,660 (5% of which is 104,433). The total nominal value of the company’s share capital was £1,157,250 (5% of which is £57,862).
Some of the ‘A’ shares were owned by two settlements. The trustees transferred a total of 115,000 shares to each of two beneficiaries. It was hoped that the transfer would not only entitle the beneficiaries to ER on a later sale of the shares, but also the settlement trustees (under TCGA 1992, s 169J).
However, when considering the number of shares to be transferred to each of the beneficiaries, a financial adviser overlooked the fact that the settlements owned ‘A’ ordinary shares, and that a greater number needed to be transferred to reach the 5% nominal value level required. Whilst 115,000 shares amounted to around 5.5% of the total number of company shares, it only amounted to 4.97% of their total nominal value (i.e. 115,000 x 50p = 57,500 which is approximately 4.97% of £1,157,250).
If at first you don’t succeed…
The calculation error was only spotted shortly before a sale of the company’s shares. By that stage, it was too late (for ER purposes) to transfer additional shares, as they would not have been held for a full year before sale.
Fortunately, the High Court in Prowting allowed a claim to rectify the two share agreements to increase the number of shares transferred by them, so that the settlement beneficiaries would hold 5% of the nominal value of the company’s share (i.e. such that the 5% tests in respect of ordinary share capital and voting rights were both met), and the ER conditions were satisfied on a sale of the shares.
Practical Tip:
Take care when considering the 5% ‘personal company’ tests for ER purposes, where the nominal values of the company’s share classes are of differing amounts.
