Tax advisers and many individual taxpayers will be aware that entrepreneurs’ relief (ER) offers a capital gains tax (CGT) rate of 10% on net chargeable gains of up to £10 million. A claim for ER is available on a material disposal of business assets, such as the disposal by an individual of a company’s shares or securities (or an interest in them).
A disposal of shares will typically involve a sale (or possibly a gift) of the shares. However, for ER purposes a disposal of an interest in shares can also include a disposal that is treated as made by virtue of legislation in TCGA 1992, s 122. Those provisions generally treat capital distributions from a company in respect of shares as consideration for the disposal of an interest in them. Thus (for example) this potentially brings capital payments to an individual for a company purchase of own shares within the scope of ER.
Company purchase of own shares
Generally speaking, when a company buys back its own shares from a shareholder, any payment in excess of the capital originally subscribed for the shares would ordinarily be treated as an income distribution (CTA 2010, s 1000(1)).
However, there is an exception from income distribution treatment on a purchase of own shares in an unquoted trading company (CTA 2010, s 1033). If certain conditions are satisfied (in ss 1034-1043), the transaction automatically falls outside income distribution treatment, and the shareholder is normally treated as receiving a capital payment instead (unless the shareholder is a share dealer, in which case the receipt is treated as trading income).
Company law
A company purchase of own shares must comply with company law requirements (in CA 2006) to be valid. Unfortunately, in practice the company law aspects are often overlooked, particularly where family or owner-managed companies are concerned.
Company law is outside the scope of this article. However, one of the requirements for an unquoted (or ‘off market’) purchase of own shares is that a contract is generally required to be approved in advance (CA 2006, s 693). Either the terms of the contract must be authorised by a company resolution before the contract is entered into, or the contract must provide that no shares may be purchased pursuant to the contract unless its terms have been authorised by a company resolution (CA 2006, s 694(2)) (nb there are separate authority rules for off market purchases relating to employee share schemes, which are not considered here).
Therefore the contract for a company purchase of own shares is not completed until it is duly authorised under company law.
Date of disposal
For CGT purposes, the general rule is that the date of disposal of an asset such as shares is when the contract is made, unless the contract is conditional, in which case the date of disposal is when the condition is satisfied (TCGA 1992, s 28).
In a recent tax tribunal case (see below), the tribunal pointed out that if there is a contract for a company purchase of own shares which is subject to approval by special resolution, the contract has to be a conditional one, and the date of disposal (under s 28(2)) will therefore be the date on which the condition was satisfied.
Entrepreneurs’ relief
The timing of disposals can have important implications for tax purposes. For example, a capital payment to an individual on a company purchase of own shares may be subject to an ER claim where certain conditions are met throughout the period of one year ending with the date of disposal. Those conditions (in TCGA 1992, s 169I(6)) are: firstly, that the company is the individual’s personal company and is either a trading company or the holding company of a trading group; and secondly, that the individual is an officer or employee of the company (or, if the company is a trading group member, of one or more companies which are members of the trading group).
With regard to the second of these conditions (i.e. the ‘officer or employee’ requirement), a possible pitfall for ER purposes on a company purchase of own shares is if the individual resigns as an officer and employee before the date of disposal of the shares for tax purposes.
Timing is everything
In Moore v Revenue v Customs [2016] UKFTT 115 (TC), the taxpayer was a director shareholder of a trading company, who was also employed with the company under a contract of employment. He held 3,000 out of 10,000 issued £1 shares in the company.
Following a dispute between the taxpayer and the other director shareholders, it was agreed that the taxpayer would leave the business. There were unsigned and undated Heads of Terms prepared in February 2009, in which it was agreed that the company would purchase 2,700 of the taxpayer’s shares, and that the other 300 shares would be converted to non-voting shares. It was also agreed that the taxpayer’s employment would be terminated, and that he would resign as a director.
Subsequently, at a general meeting of the company on 29 May 2009, it was resolved that the company would purchase the 2,700 shares from the taxpayer, and that the company would take additional borrowing. On the same day, the taxpayer signed a compromise agreement for the termination of his employment, and also Companies House papers concerning his resignation as a director. However, that documentation stated that the effective date of the taxpayer’s resignation was 28 February 2009.
The taxpayer declared the share disposal on his tax return and claimed ER. However, following an enquiry into the return, HMRC concluded that the taxpayer was not entitled to ER, because he was not an officer or employee of the company throughout the period of one year ending with the disposal of his shares.
The taxpayer originally contended that the disposal of his shares took place on 29 May 2009, and that this was also the date on which he resigned as a director. However, at the First-tier Tribunal hearing the taxpayer accepted that he had ceased employment with the company and was no longer an office holder from 28 February 2009. Instead, the taxpayer argued that the completion of the negotiations for the disposal of his shares resulted in a binding contract for sale in February 2009, and it followed that this was the date of disposal for capital gains tax purposes. The issue for the tribunal to decide was therefore whether there was an unconditional contract for the disposal of the shares by 28 February 2009.
The tribunal said that the case turned on a simple matter of law. Company law (in CA 2006, ss 693-694) required that a contract for a company purchase of shares must be approved in advance by resolution. That resolution was not passed until 29 May 2009. The company was therefore incapable of entering into a valid contract to purchase the shares until the resolution had been passed. Even if the contract terms had been agreed in February 2009, so that there had been a contract at that time, the tribunal considered that it must have been a conditional contract. The date of disposal under a conditional contract (in accordance with TCGA 1992, s 28(2)) would be the date on which the condition was satisfied (i.e. 29 May 2009). The taxpayer ceased to be a director or employee on 28 February 2009. Therefore the ‘officer or employee’ condition for ER purposes was not satisfied for the one year period up to the date of disposal on 29 May 2009, so the taxpayer’s case was dismissed.
A different outcome?
The Moore case illustrates the importance of timing disposals carefully, in terms of ensuring that the conditions for ER are satisfied at that point. For example, if the company had passed its resolution when the Heads of Terms for the taxpayer’s departure from the company were drafted in February 2009, the company law requirement would have been met at that date, rather than in May 2009. This would have strengthened the taxpayer’s claim for ER.
Even though the taxpayer in this case ceased to be a director and employee of the company in February 2009, it might have been possible to argue that he effectively continued to be an employee, based on ER case law. For example, in Corbett v Revenue & Customs [2014] UKFTT 298 (TC), the tribunal decided that the taxpayer was entitled to ER on a sale of shares, as it was held on the facts that she remained an employee of the company despite having been removed from its payroll several months before the shares were sold (albeit that although her employment duties had continued, her remuneration was redirected to her husband).
In another ER case, Hirst v Revenue & Customs [2014] UKFTT 924 (TC), it was held that the taxpayer remained an employee throughout the relevant one-year period ending with the disposal of his shares (notwithstanding that he had previously resigned his position with the company), and so was eligible for ER on the disposal. The tribunal accepted that the taxpayer had not been paid commission entitlements due to personal circumstances at the time, and because his financial needs were satisfied by dividend payments received from the company. The company had also continued to provide him with a phone and laptop, and met the costs of his home internet contract.
In Moore, the taxpayer also continued to provide services to the company after his employment had ceased. Unfortunately, his services were provided through a personal service company, rather than being provided directly. Perhaps unsurprisingly, the taxpayer did not seek to argue that the services he provided through his personal service company amounted to a continuation of his former employment. Once again, the taxpayer’s claim for ER would have been strengthened had he continued to provide his services in a personal capacity.