Most trading company owners wishing to claim capital gains tax business asset disposal relief (BADR) (formerly known as entrepreneurs’ relief (ER)) on an eventual sale of their shares need to satisfy certain conditions throughout a two-year period ending with the disposal.
Make it ‘personal’
One of those conditions is that the company is the individual’s ‘personal company’. This means that:
- the individual holds at least 5% of the company’s ordinary share capital;
- that holding gives at least 5% of voting rights in the company; and
- it also gives beneficial entitlement to at least 5% of distributable profits and at least 5% of distributable assets on a winding up, and/or beneficial entitlement to at least 5% of the proceeds in the event of a disposal of the company’s entire ordinary share capital (TCGA 1992, s 169S(3)).
‘Ordinary share capital’ is defined for BADR purposes as ‘…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’ (ITA 2007, s 989).
The condition in the third bullet point was added from 29 October 2018 to prevent perceived abuse of the ER rules. However, even before this tightening of the personal company definition, it was difficult for some shareholders to satisfy it.
Less than 5%
For example, in Hunt v Revenue and Customs [2019] UKFTT 210 (TC), on the sale of a company’s shares in August 2015, the taxpayer held 73,448 ‘E’ ordinary shares, each with a nominal value of 10p, and 100,000 ‘B’ ordinary shares, each with a nominal value of £1. This represented 5.94% of the company’s total issued shares. The taxpayer’s shares gave him 6.21% of the total votes. However, the nominal value of the shares owned by the taxpayer was only 4.16% of the total. The taxpayer claimed ER on his share sale, but HM Revenue and Customs (HMRC) refused the claim.
The taxpayer argued (among other things) that a purposive, multi-factorial approach should be taken to determine whether a person owned 5% of the company from an overall economic point of view. However, the First-tier Tribunal concluded that 5% of a company’s ‘issued share capital’ meant ‘5% of the total nominal value of a company’s share capital’ and dismissed the taxpayer’s appeal.
Out of the ‘ordinary’?
The taxpayer in Warshaw v Revenue and Customs [2019] UKFTT 268 (TC) fared better. In that case, the taxpayer sold his 44,183 ordinary shares, 396,000 cumulative preference shares and 24,660 ‘B’ ordinary shares in a company and claimed ER. If the cumulative preference shares were ‘ordinary share capital’ the taxpayer held 5.777% of the company’s ordinary share capital. But if those shares were not ordinary share capital, he held only 3.5% of its ordinary share capital. HMRC rejected the taxpayer’s ER claim.
However, the First-tier Tribunal broadly held that the cumulative nature of the shares meant that they could not be regarded as having a right to a dividend at a fixed rate and were therefore ‘ordinary share capital’.
For HMRC’s interpretation of ‘ordinary’ in the context of share capital, see the Company Taxation manual at CTM00514.
The above article was first published in Tax Insider (October 2019) (www.taxinsider.co.uk).