Bad Tax Advice-EIS CGT Deferral on Gift Into Trust

Has Old Tax Adviser Given Bad Advice on EIS CGT Deferral on Transfer Into Settlement? HMRC Reaction?

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Well before this elderly 40% client came to me, she was sole shareholder and director of her private trading company with a total share capital by 2012/13 of around £1.2 million. About a third of that share capital was raised during 2002/03 through an EIS investment in her company made from the proceeds of sale of an older trading company she previously owned. Client claimed EIS deferral relief of around £400,000 on the 2002/03 sale of the older company in relation to her 2002/03 investment in her newer company. This was all approved by HMRC years ago.

On advice from the former tax adviser, there was a share reorganisation during 2012/13, and her ordinary shares were reclassified as, say, 300,000 A, 300,000 B and 600,000 C shares ranking pari-passu. On the same date as the 2012/13 share reorganisation, the 300,000 B shares were gifted to the husband, and the 600,000 C shares were gifted into discretionary settlement. She retained the 300,000 A shares for herself.

In the 2012/13 personal (very detailed) CGT calculations submitted to HMRC as part of her SA tax return, the former tax adviser showed the EIS deferred gain of £400,000 being apportioned between the A, B and C shares in the proportion £100,000:£100,000:£200,000 (i.e. 3:3:6)

So, the EIS deferred gain attached to client's retained A shares remain attached to them. And the deferred gain attached to the B shares now sits with her husband. But I have a problem with the way the former tax adviser has treated the C share deferred gain of £200,000.

The former tax adviser has attached the £200,000 deferred gain to the C shares owned by the trustees as if that EIS deferred gain is automatically held over onto the trustees. My reading of the legislation is that the client can certainly hold-over ORDINARY capital gains on transfer into settlement, but I cannot see anything to suggest she can hold-over the special EIS deferred gain of £200.000. In point of fact she did make a S260 CGT holdover claim in relation to the smaller ordinary gains on transfer of the C shares into trust.

It therefore appears to me that the 2012/13 gift into trust triggered a chargeable event for CGT purposes in relation to the £200,000 EIS deferred gain element.

As a separate matter, I acknowledge that although trustees themselves can realise gains, it is they themselves who have to make the qualifying EIS investments and EIS reinvestment relief claims if they wish to claim CGT deferral. This has NOT happened in this particular case. They have merely received the C shares from the settlor.

Therefore, I believe the £200,000 deferred gain should have been subject to CGT on the individual client back in 2012/13 at whatever CGT rate was applicable, maybe subject to Entrepreneurs Relief. But 2012/13 is now out of time, surely.

What troubles me is that HMRC have had all the detailed 2012/13 CGT calculations which they have failed to take issue with. It seems that the £100,000 plus £100,000 deferred gains for wife and husband will disappear on their deaths. But the £200,000 deferred gain will (INCORRECTLY) sit with the trust's C shares until goodness knows what chargeable event arises in future.

I really do not know what to do here. I would love to be wrong. If I am correct, should I tell HMRC. Should I tell the client (I did not create the problem). Should I inform the former adviser. Or should I just bury my head in the sand. Will the penny eventually drop with HMRC and could they open up 2012/13 and ask client to pay the CGT plus interest and penalties. Or is HMRC now out of time.

Help!

 

Replies (10)

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By Wycher
01st Oct 2021 09:51

Maybe I have misunderstood the situation (very late night with family illness) but does the investment in her new company not fail the EIS rules anyway as she is the owner/sole director of the company in which she is claiming the EIS investment?

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Replying to Wycher:
By penelope pitstop
01st Oct 2021 13:31

Thanks. It is important not confuse the rules for:
i) EIS income tax relief,
ii) EIS CGT relief, and
iii) EIS CGT deferral relief.

In relation to iii) above (CGT deferral relief), in respect of shares issued after 5 April 1998, major changes were made to the relief. Importantly, it is no longer required for the shares to qualify for income tax relief and neither that the investor be UNCONNECTED the company. The changes were also extended to trustees.

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By Tax Dragon
01st Oct 2021 11:42

s260(3) "the amount of any chargeable gain which, apart from this section, would accrue to the transferor on the disposal"

para4(1) Sch5B "a chargeable gain shall be treated as accruing at the time of the event"
para5(1) "The chargeable gain which accrues... shall be treated as accruing... to the person who makes the disposal"

What Sch5B lacks is the clause "on the disposal" (except of course in relation to the original disposal, eg at para1(1)(b)).

Compare:

s116(10) the... chargeable gain... shall be deemed to accrue on a subsequent disposal...

I pick out s116(10), of course, because of s260(6).

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By OurPlace
01st Oct 2021 14:05

.

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By More unearned luck
01st Oct 2021 16:25

If there was an insufficiency in the 2013 tax return (which there appears to be as a disposal of the shares to the trust - a hold-over election fixes the proceeds /cost of the transaction crystallises the gain) then HMRC can only assess the tax if a) there is an open enquiry into the return (probably unlikely) or b) if they allege and prove that the TP or someone acting on her behalf deliberately brought about the loss of tax. The consequences of accountants filling in their clients' return wrongly because they misunderstood the law or were ignorant of it was dealt with by the SC in Tooth earlier this year. It seems, from what you say that HMRC were fully informed so only have themselves to blame.

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Replying to More unearned luck:
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By Tax Dragon
01st Oct 2021 17:14

More unearned luck wrote:

a hold-over election fixes the proceeds /cost of the transaction crystallises the gain

I think that must be one of those things we get taught/accountants use as a shorthand computation that, actually, isn't what the law says. Both s165(4), which I didn't quote, and s260(3), which I did, reduce the gain on the disposal. (They also both reduce the deemed consideration paid for the purpose of establishing the base cost of the giftee - which of course isn't how deferral relief works, so, even if the 2012/13 claim was valid*, it sounds to me as if the computations were wrong.)

* This is the only question I am addressing. I think it wasn't valid, because of "on the disposal". It's there in s260(3); it's there in s116(10)**; it's absent from the charging part of Sch5B.

** Incidentally, this also gets fingered in s165 - ss3(c).

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Replying to Tax Dragon:
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By More unearned luck
01st Oct 2021 19:19

OK, but the issue you are ducking is the one that matters in this case. Unless HMRC want to try their hand at alleging deliberate conduct the question of the correctness of the comps/returns and why they might be wrong is academic.*

I'm suggesting that Penny has little to fret about when it comes to historical tax liabilities.

*Except, of course, as regards the trustees' base cost. Can they can amend that figure by 'adding back' the deferred gain leaving only the held-over gain deducted? Or is it too late to make this change?

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Replying to More unearned luck:
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By Tax Dragon
01st Oct 2021 19:46

Questions I see you have yourself ducked. Though, to be fair, without sight of what was submitted and agreed (by all parties), there's possibly no answering them - although, as below, I am curious about how and why this issue has arisen now, as, possibly (my WOTD), that speaks to the answers.

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By Tax Dragon
01st Oct 2021 18:17

My point is that, if a deferred gain coming back into charge is a gain on the disposal that triggers it, then it can be held over under s260. The 2012/13 claim would thus be valid.

Admittedly, the gain comes into charge as a result of the disposal and is charged on the person making the disposal. But I think the clause "on the disposal" has meaning, and for the deemed gain (resurrected gain, whatever you want to call it) to be "on the disposal", the charging provision would have to say so. Whereas s116 does, Sch5B doesn't.

That's why s260 - and indeed s165, as I noted - both finger s116. (This kind of shows, to my mind, that the legislators don't want deferred gains becoming heldover gains.) But s260 and s165 don't mention Sch5B - they don't need to.

Hopefully a bit clearer?

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By Tax Dragon
01st Oct 2021 18:36

May I ask: why has this question arisen now?

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