Rebecca Cave explains that shares are not always all they appear to be.
Several tax reliefs depend on the shareholder holding ordinary shares, or more precisely “ordinary share capital”. For example, to qualify for entrepreneurs’ relief on the disposal of any shares or securities in a company, the taxpayer must hold at least 5% of that company’s ordinary share capital and 5% of the votes relating to those shares.
Where the company has issued various types of shares it is essential to understand which classes of shares are counted as part of the company’s ordinary share capital, to calculate whether the taxpayer held at least 5% for the required 12-month period to the date of disposal.
An ordinary share
This was the issue in Castledine v HMRC (TC04930). In 2011/12 and 2012/13 Alan Castledine disposed of loan notes worth £1.1m in Dome Holdings Ltd (DHL) and claimed entrepreneurs’ relief on the gains. DHL had issued A and B ordinary shares, as well as 2,000 deferred shares, and a large number of fixed rate cumulative preference shares. Castledine held exactly 5% of the total of the A and B ordinary shares, but none of the deferred shares.
The tax tribunal had to decide whether the deferred shares counted as part of the ordinary share capital of DHL. The deferred shares carried no rights to votes or income, and could only be redeemed at par once the B ordinary shares received a distribution of £1m.
The definition of ordinary share capital is now found in ITA 2007, s989: “Ordinary share capital, in relation to a company, means all the 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.”
The tax tribunal agreed with HMRC that the fixed rate cumulative preference shares where not part of the ordinary share capital, but the deferred shares were. Using that as a basis of the valuation of the ordinary share capital, Castledine was found to have held only 4.99% at the time he disposed of the loan notes, so entrepreneurs’ relief was denied.
Not an ordinary share
The definition of ordinary share capital is also relevant for share loss relief (ITA 2007, s131), but you have to look really closely at the definitions in ITA 2007 s151(1) to find it. There it says: “Shares –
a)includes stock but
b)does not include shares or stock not forming part of the company’s ordinary share capital”.
For the definition of “ordinary share capital” you have to go back to ITA 2007, s989 quoted above.
In Bielckus, Arnell & Taylor v HMRC (TC05044) the three taxpayers claimed share loss relief on shares they held in a travel company. Those shareholders initially received 12,500 ordinary shares each and later were each allotted a further 55,000 £1 cumulative redeemable preference shares, which had no rights to share in the company’s profits other than in relation to a 7.5% fixed dividend.
The tribunal accepted that the ordinary shares were qualifying shares for s131, but the judge concluded that the preference shares did not qualify as ordinary share capital as those shares had a right to a dividend at a fixed rate. As a result the shareholders did not receive share loss relief in respect of the value of the preference shares.
Zero is number
Ordinary shares normally carry a right to vote at formal meetings held by the company, but not all the shares that form part of the ordinary share capital of the company will also carry voting rights. This was the case in McQuillan v HMRC (TC05074).
Mr & Mrs McQuillan formed a company with 100 £1 ordinary shares. They held 33 shares each. Another couple: Mr & Mrs Pennick each held 17 shares. At a later stage the Pennicks lent the company £30,000 as an interest free loan. In June 2006 this loan was converted into redeemable non-voting shares as a condition to receive a grant from Invest NI.
On 14 December 2009 the £30,000 non-voting shares were redeemed at par. The company was sold on 1 January 2010, and the purchasers acquired all 100 ordinary shares. The McQuillans claimed entrepreneurs’ relief, but HMRC said the relief was not due as they had not held at least 5% of the ordinary share capital for 12 months to the date of disposal.
HMRC’s analysis was that the £30,000 non-voting shares formed part of the ordinary share capital for 11.5 months of the final 12-month period. This made the total value of the share capital for that period: £30,100. As the McQuillans held 33 shares each, they effectively held only 0.1% of the ordinary share capital for that period.
The taxpayers put forward the ingenious argument that the £30,000 non-voting shares were entitled to a fixed dividend set at 0%, and as such they had “a right to a dividend at a fixed rate.” Amazingly the tax tribunal accepted this argument which meant that the non-voting shares could be ignored in the calculation of ordinary share capital. The McQuillans’ appeal was accepted and they were granted entrepreneurs’ relief.
About Rebecca Cave
Consulting tax editor for Accountingweb.co.uk. I also co-author several annual tax books for Bloomsbury Professional and write newsletters for other publishers.