Entrepreneurs’ relief (ER) is a very valuable relief for capital gains tax purposes, so it is not surprising that various conditions must be satisfied to be eligible to claim the relief when an individual makes a material disposal of business assets.
For example, an important condition for a shareholder in a trading company in most cases is that the company must have been the individual’s personal company for a specified period of one year (see TCGA 1992, s 169I). There are exceptions to this rule for disposals of relevant ‘enterprise management incentives’ shares, which are not considered in this article.
The definition of ‘personal company’ is broadly a company of which at least 5% of the ordinary share capital is held by the individual, and at least 5% of the voting rights are exercisable by the individual by virtue of that holding (TCGA 1992, s 169S(3)).
The personal company definition looks straightforward, but there are potential traps. For example, ‘ordinary share capital’ is defined for these purposes (TCGA 1992, s 169S(5)) as all of a 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).
Another potential pitfall is that ‘issued share capital’ involves looking at the nominal value of the shares, as opposed to their actual market value (Canada Safeway Ltd v Inland Revenue Commissioners  1 CH 374). The distinction between nominal value and actual value (as well as the actual number of shares) can be crucial.
More shares needed
The nominal value requirement in respect of a company’s shares was considered in Prowting 1968 Trustee One Ltd & Ors v Amos-Yeo & Anor  EWHC 2480 (Ch). In that case, the company’s ordinary share capital comprised the following:
- 1,200,000 ‘A’ shares – Nominal value 50p each (= £600,000)
- 375,660 Ordinary shares – Nominal value £1 each (= £375,660)
- 167,000 ‘B’ Ordinary shares – Nominal value 1p each (= £1,670)
- 346,000 ‘C’ Ordinary shares – Nominal value 52p each (= £179,920)
Thus the total number of the company’s ordinary share capital was 2,088,660 (5% of which is 104,433). The total nominal value of the company’s share capital was £1,157,250 (5% of which is £57,862).
Some of the ‘A’ shares were owned by two settlements. The trustees transferred a total of 115,000 shares to each of two beneficiaries. It was hoped that the transfer would not only entitle the beneficiaries to ER on a later sale of the shares, but also the settlement trustees (under TCGA 1992, s 169J).
However, when considering the number of shares to be transferred to each of the beneficiaries, a financial adviser overlooked the fact that the settlements owned ‘A’ ordinary shares, and that a greater number needed to be transferred to reach the 5% nominal value level required. Whilst 115,000 shares amounted to around 5.5% of the total number of company shares, it only amounted to 4.97% of their total nominal value (i.e. 115,000 x 50p = 57,500, which is approximately 4.97% of £1,157,250).
If at first you don’t succeed…
The calculation error was only spotted shortly before a sale of the company’s shares. By that stage, it was too late (for ER purposes) to transfer additional shares, as they would not have been held for a full year before sale.
Fortunately, the High Court in Prowting allowed a claim to rectify the two share agreements to increase the number of shares transferred by them, so that the settlement beneficiaries would hold 5% of the nominal value of the company’s share (i.e. such that the 5% tests in respect of ordinary share capital and voting rights were both met), and the ER conditions were satisfied on a sale of the shares.
Take care when considering the 5% ‘personal company’ tests for ER purposes, where the nominal values of the company’s share classes are of differing amounts.
The above article was first published in Property Tax Insider (February 2016) (www.taxinsider.co.uk).