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New challenge to entrepreneurs’ relief

7th Oct 2016
Tax Writer Taxwriter Ltd
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HMRC has found a new excuse to deny entrepreneurs’ relief to shareholders who sell their shares back to the company.   

There is now a huge difference between the rates of CGT (10% and 20%) and the higher rates of income tax (40% and 45%). This encourages company owners to extract value from their companies a form which is subject to CGT.

Purchase of own shares

When a shareholder sells their shares back to their company, under a purchase of own shares (POS) arrangement, the proceeds are taxed as income. However, capital gain tax treatment for those proceeds can be achieved if the following conditions are all met:

  • seller has held the shares for at least five years
  • seller is UK resident
  • the purchase is for the benefit of the trade
  • company is unquoted
  • the company is trading or holding company of a trading group
  • seller’s shareholding (including associates’ holdings) are substantially reduced or eliminated by the purchase; and
  • seller and his associates are not connected with the company immediately after the purchase.

The company must apply to HMRC in advance of the POS for clearance that the proceeds will be subject to CGT rather than income tax (see HMRC helpsheet).

Payment dates

If the company has the cash available to pay the shareholder the full amount agreed for his shares, the POS can proceed without further complications.

Where the company can’t pay the full sales value at the date the sale is due to complete, it may need to pay the amount agreed in tranches over a number of years. For a payment by tranches arrangement to be given clearance as a capital distribution, the contract for the acquisition of the shares must contain multiple completion dates which align with the dates on which the proceeds are paid.

How tranches work

The shares are sold back to the company on day one. This is the exchange date for the whole contract and also first completion date. It is on this date that the shareholder loses beneficial interest in all his shares. If the shareholder is a director this is the date on which he should resign as a director.

The shareholder continues to hold the remaining shares until the completion dates for those tranches arrive, but he can’t exercise voting rights or receive dividends in respective of those shares.

HMRC generally agree to a clearance for a POS to be completed in this fashion and secure CGT treatment, but they have recently raised an objection to entrepreneurs’ relief applying to the amount paid in tranches.

Are shares acquired?

HMRC argue that the company does not “acquire” the shares from the shareholder, because it must cancel the shares returned to it under the POS. Thus the provision in TCGA 1992, s 28: time of disposal and acquisition under contact, does not apply. This section fixes the disposal date for CGT purposes as the exchange date of the contract not the completion date, or dates.

HMRC argue that the payments received in tranches after the exchange date are capital sums derived from assets and subject to the provisions in TCGA 1992, s 22. Applying this section, the gain is taxed at the time the proceeds are received, not at the contract exchange date. If HMRC is correct, entrepreneurs’ relief will not apply on the proportion of the gain applicable to shares disposed of in the later tranches, as the shareholder will no longer be a director. 

Replies (21)

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By Ruddles
07th Oct 2016 14:35

I was aware of rumours of such an approach - but what is the authority behind the above article? Have HMRC succeeded at Tribunal, or what?

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Replying to Ruddles:
By Rebecca Cave
08th Oct 2016 11:37

I am not aware that HMRC has aired this arguement at a Tribunal yet, so it is unproven. But I thought it was worthy of airing. I was careful to say "If HMRC is correct..."

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Replying to Rebecca Cave:
By Ruddles
08th Oct 2016 11:43

Thanks - I was just wondering where "HMRC argue" the point?

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Replying to Ruddles:
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By hiu612
10th Oct 2016 13:01

Ruddles wrote:

Thanks - I was just wondering where "HMRC argue" the point?

Yes, me too. Is this the personal experience of the author with regard to a client, or have they published guidance / updated a manual / released an open letter?

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By p.rayney
08th Oct 2016 19:02

When a POS clearance is obtained under s1044, CTA 2010, this simply confirms that the POS is not treated as a distribution. It does not provide any confirmation that entrepreneurs' relief (ER) is available. So the fact that a s1044 CTA 2010 has been obtained is of no real comfort.

However, HMRC's potential argument goes against the currently accepted technical analysis, as demonstrated by every learned article on multiple completion POSs. I do see that there is a 'nice' legal point on the concept of 'acquisition' in the context of a POS. Indeed we would rely on this very point when it comes to claiming a capital loss on a POS (since there is no acquisition the connected party loss rules should not apply).

In my view, multiple completion POSs do not involve any form of tax avoidance. The arrangements simply enable the company to 'defer' part of the purchase consideration in a 'Companies Act' compliant manner. In fact, under conventional analysis, all the CGT is paid up-front on the basis of the contract date per s28, TCGA 1992 - so where is the mischief in that!

So what we have here is HMRC taking a very literal approach to the operation of s28 in a way that was probably never even contemplated by the draftsman or indeed Parliament. I strongly suspect that the reason why this point is being taken has something to do with the denial of 10% CGT entrepreneurs' relief to some innocent' taxpayer.

Furthermore, the then 'Inland Revenue' indicated its agreement to a to a POS being made in instalments with the ICAEW in the ICAEW technical release 745 issued in April 1989. Indeed para 10 (b) of the release states:

'‘They [the Inland Revenue] take the view that as the beneficial ownership of the shares is regarded as passed at the date of the contract, a disposal for capital gains tax purposes will have taken place by the vendor at that time notwithstanding payments at later dates.’'

As far as I am aware HMRC has not retracted its agreement of this statement,so there must be a reasonable 'legitimate expectation' argument to run in relation to multiple completion POSs deals that have already taken place.

If this point was ever taken to a appellate tribunal, I do hope that it would take a reasonable balanced - and purposive - view of what is going on here - an apparent u-turn in HMRC's tax treatment of entirely legitimate POS transactions just to deny ER.

If HMRC succeed in rewriting its CGT analysis for multiple completions, I suspect that more of us will be advising POS sellers to retain a 5% sentimental stake and find a reason for them to stay on for a while as a part time employee! Tax should not really be this taxing!

Peter Rayney

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By Ian McTernan CTA
10th Oct 2016 11:36

This is HMRC at it's worst. There is no hint of any avoidance going on, and yet they want to nitpick and try and force a dodgy interpretation on a taxpayer in order to achieve something that clearly the legislation wasn't meant to imply at all.

And HMRC say it's taxpayers and their agents that make tax so complicated by coming up with schemes, etc....

Another costly exercise for all concerned. There should be a 'common sense' department set up to monitor HMRC (I'll happily apply for a part time role there at the right fee!) that is completely independent that has the legal power to tell HMRC when to drop awful cases like this one.

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By Scott Hallesy
10th Oct 2016 11:45

Please note that the legal position is slightly different in Scotland because the beneficial ownership concept over shares is alien to Scots Law. This means that remaining shareholders will still treat the exiting shareholder as in full ownership of all rights until the shares are extinguished by the Company.

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By mickeyparish
10th Oct 2016 12:36

Have HMRC not yet understood the difference "tax point" - as IN VAT - and settlement date ?

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By johnkcound
10th Oct 2016 14:22

"The company must apply to HMRC in advance of the POS for clearance that the proceeds will be subject to CGT rather than income tax". The legislation says the company "may" apply for clearance that CGT treatment will apply. It is not a condition.

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Replying to johnkcound:
By pridgway
10th Oct 2016 14:38

Furthermore, if the conditions for CGT treatment apply then it is in the CGT regime.

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By Nickob
10th Oct 2016 16:30

I am not clear why, when the shares are paid for over a period of time, the contract for the acquisition of the shares "must contain multiple completion dates". Why can't the entire contract be completed and the outstanding amount be classed as a creditor of the company?

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Replying to Nickob:
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By nicdell
10th Oct 2016 16:56

Where a limited company purchases its own shares, Companies Act 2006 requires that 'the shares must be paid for on purchase'. HMRC takes the view that this means that the shares must be paid for in cash. Their instructions state that:

'To effect a valid purchase the company must make full cash payment on purchase. The transfer of any other asset or the creation of a loan account because, say, the company does not have sufficient cash available does not represent payment. In such circumstances, the shares are not treated as cancelled and legal ownership remains with the seller. The tax treatment following from an invalid purchase of own shares depends upon the actions taken (if any) to rectify matters.'

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Replying to nicdell:
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By Nickob
11th Oct 2016 09:12

Many thanks for clarifying that.

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Replying to Nickob:
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By nicdell
11th Oct 2016 10:42

Pleasure Nickob - the extract I quoted comes from one of the topics in Bloomsbury's Tax Planner Interactive, dealing with company purchase of own shares.

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By pn
11th Oct 2016 11:15

......if HMRC is correct, entrepreneurs’ relief will not apply on the proportion of the gain applicable to shares disposed of in the later tranches, as the shareholder will no longer be a director...

But the conditions listed does not state that the shareholder has to be a director. Perhaps the author should clarify this

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Replying to pn:
By pridgway
11th Oct 2016 11:43

If the disposal takes place under s22 and not 28 then the disposal is at the time the capital sum is received. It is usual for the person to resign their directorship when they enter into the sale contract yet the conditions for ER to apply have to apply at the time of disposal i.e. when the consideration for the particular tranche is received.

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By Coops
31st Oct 2016 18:06

Agreed that this all seems very unfair.

Would a possible solution here be for the contract to say that, rather than cancelling the shares on repurchase, the company will hold the shares as treasury shares following completion of each tranche? Will this be sufficient to give an acquisition as well as a disposal?

[EDIT]

On further research, s195(4) FA 2003 says that the shares are treated as cancelled on acquisition, even if they are not actually cancelled, so my suggestion doesn't seem to work.

S195(2) also says that the acquistion of any of its own shares by the company is not to be treated as the acquisition of an asset.

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By AndrewV12
16th Nov 2016 13:08

I have more than a feeling HMRC are going to win this one, they are on a roll, whats next. Though George would never ever balance the books no matter what he tried. Over all Entrepreneurs relief is very generous, so lets not over worry about it.

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By AndrewV12
16th Nov 2016 13:08

I have more than a feeling HMRC are going to win this one, they are on a roll, whats next. Though George would never ever balance the books no matter what he tried. Over all Entrepreneurs relief is very generous, so lets not over worry about it.

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By pridgway
23rd Feb 2017 16:36

The case that was the subject of the rumour was mine and was due to be heard in Edinburgh last Monday 20th February; however, we had two points the POS and a procedural issue that HMRC had not made a discovery. They informed us a couple of weeks ago that they were withdrawing the assessment and consequently there was nothing left in the appeal which we have since withdrawn. I think the POS point may now have gone away.

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By atul700
06th Nov 2017 13:18

Hi Rebecca/Peter

Is there any update on how HMRC are treating obtaining ER on POS arrangements?

Many thanks

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