Ken Moody looks at some potential capital gains tax entrepreneurs’ relief pitfalls for company shareholders seeking to claim the relief on disposal of their shares.
For a short bit of legislation, capital gains tax entrepreneurs’ relief (ER) has more than its fair share of quirks, as highlighted by two recent cases.
In the case of an employee or director, the requirements for ER are:
- the company is the individual’s ‘personal company’, and
- the individual is an officer or employee of the company or group.
These conditions must be met throughout a period of one-year ending with the disposal.
Personal company
A company is an individual’s ‘personal company’ where the individual owns 5% or more of the company’s ordinary share capital and voting rights.
Where shares are acquired under enterprise management incentives share options the personal company condition does not apply, and the minimum holding period condition is relaxed in that it is necessary only that the option was granted at least one-year before the disposal. This is useful, in that if the option were exercisable in the event of the imminent sale of the company (for example), obviously the shares themselves would be held only for a very short period.
Officer or employee
The case of Moore v Revenue and Customs [2016] UKFTT 115 (TC) concerned a company purchase of own shares where a dispute between shareholders led to one director shareholder entering into a compromise agreement on 28 February 2009 and the company contracting to buy back his shares. However, a special resolution for the buy-back was not passed until 29 May 2009. The director had argued the date of disposal to be when the company agreed to buy back his shares. However, until the special resolution was passed the company could not enter into a valid contract. The director, therefore, was no longer an officer or employee at the date of disposal so ER was not available.
It is worth mentioning for completeness, however, that ‘employee’ is not defined. In Corbett v Revenue and Customs [2014] UKFTT 298 (TC) and Hirst v Revenue and Customs [2014] UKFTT 924 (TC), ER was allowed; there was an ‘employment relationship’ where the individual in each case continued to work for the company informally at the time they sold their shares.
The case of Castledine v Revenue and Customs [2016] UKFTT 145 (TC) concerned the personal company requirement and the definition of ordinary share capital (by reference to ITA 2007, s 989). Ordinary share capital is any share capital other than capital carrying a right to a dividend at a fixed rate but with no other right to share in the company’s profits. So preference shares are ‘out’ and loan stock or debentures are not share capital anyway: but anything else is ‘in’. The shareholder owned 5% of the ordinary share capital and also held loan notes from a previous takeover, which he disposed of.
Practical Tip:
ER is available for a disposal of ‘business assets’ which is also a ‘material disposal’. There are three categories of business assets, the third being ‘assets consisting of…shares in or securities of a company’. This is slightly deceptive in that while loan notes may, therefore, qualify as business assets the disposal must also be a ‘material disposal’, which involves the personal company test. The problem for the taxpayer in Castledine was that the company had issued some deferred shares, which were considered to be worthless but nevertheless were within the definition of ordinary share capital. Taking the deferred shares into account diluted the taxpayer’s holding to less than 5% of the company’s ordinary share capital as defined, and so the tribunal really had no option but to deny relief.
