The recent case of Castledine v HMRC considered what is meant by “ordinary share capital”
Entrepreneurs’ relief is a relief from capital gains tax which, if applicable, can deliver significant tax savings for anyone selling a business; it reduces the rate of capital gains tax to 10% and is available for up to £10 million of gains. The requirements for entrepreneurs’ relief for an individual disposing of shares or securities of trading companies are, that for the relevant period in question, the individual:
- has been either an officer or employee of the company in question;
- owns at least 5% of the ordinary share capital; and
- exercises at least 5% of the voting rights.
The recent case of Alan Castledine v HMRC (TC 2015/02703) considered the meaning of “ordinary share capital”.
Ordinary Share Capital
In this case, Mr Castledine had disposed of various loan notes in a company of which he was also a shareholder. He claimed entrepreneurs’ relief on the disposal of the loan notes. The company in question had in issue A ordinary shares, B ordinary shares, deferred shares and preference shares. The preference shares did not count as ordinary shares so were ignored in calculating the relevant percentages. On the numbers in question, if the deferred shares were counted as ordinary shares, then Mr Castledine held 4.99% of the share capital of the company. If the deferred shares were excluded from the reckoning, he held exactly 5% of the company’s share capital. The question for the tribunal was whether the deferred shares constituted ordinary shares.
Under the articles the deferred shares had no voting rights and no rights to dividends. Their sole right was to be redeemed at par on a capital realisation after at least £1 million had been distributed in respect of each B ordinary share. Given there were at the time 2,001,985 B shares in issue, the prospect of the deferred shares ever receiving anything was in reality zero. The deferred shares had been created as a mechanism for removing B ordinary shares from senior management after they left the company, as an alternative to the company buying the shares back or the shares being sold to other members of the company. Such shares were then transferred to an employee benefit trust.
The arguments advanced by the tax-payer were that in reality the deferred shares had none of the characteristics of an ordinary share and were ordinary shares only in name. A number of cases were referred to but perhaps the most pertinent is that of Collector of Stamp Revenue v Arrowtown Assets Limited. In this case, non-voting shares with no commercial content were issued by a company in order to artificially create a group for stamp duty purposes. The non-voting shares were held not to constitute issued share capital and accordingly the claim for group relief failed. In Mr Castledine’s case the Revenue’s arguments were that the meaning of the statute was perfectly clear and that there was no need to look beyond the words of the legislation. Whilst sympathetic to the taxpayer’s arguments, the tribunal felt that the deferred shares did constitute “ordinary share capital” for the purposes of the legislation. Accordingly, the appeal was dismissed and entrepreneurs’ relief was not available to Mr Castledine.
The court’s decision and the Revenue’s attitude towards deferred shares do seem to suggest some interesting possibilities as regards the availability of entrepreneurs’ relief. For example, consider the example of a company with 20 shareholders, with 2 classes of shares. One shareholder holds all the A shares, which are entitled to 5% of voting rights, 100% of the dividends, 100% of any assets on a winding up and 95% of the proceeds on sale of the company. The other 19 shareholders each hold 5% each of the B shares and 5% of the voting rights, but with no rights to dividends, no rights to vote on a winding-up, and a right to participation in a sale, only when the A shareholder has received 95% of the proceeds arising on a sale. Furthermore, any shareholder resolutions require the consent of both classes of shares. On the Revenue’s arguments and the tribunal decision, you would think the Revenue would agree that the B shares are entitled to entrepreneurs’ relief. The commercial purpose of issuing the B shares would be to ensure the 19 others were shareholders and had an interest in the business.
The Castledine case also raises an issue about the way that share structures are set up. If instead of the B shares being converted, they had been cancelled, this problem would never have arisen, although other commercial issues may have had to be addressed. Given that management shareholders are unlikely to have much, if any, control over the structuring of the share capital of an institutionally backed company they could fall victim to the unintended consequences of such a structure. By the time anybody realises it’s a problem, it is probably too late to do much about it.