Castledine v HMRC – Entrepreneurs’ Relief and “Ordinary Share Capital”
The First Tier Tribunal has ruled that deferred shares can be considered ordinary share capital.
The case has important ramifications for anyone seeking to claim Entrepreneurs’ Relief (ER) to reduce their Capital Gains Tax liability.
The taxpayer was brought in to rescue a company in 2008. The company’s finances were restructured to grant the taxpayer 5% of the total ‘A’ and ‘B’ ordinary shares.
The share capital of the company comprised not only A and B shares but also a small number of deferred shares. These were created to facilitate the exit of the existing shareholder management team. The intention was to strip these shares of all economic value; they had no voting or income rights and were only entitled to redemption after distributions of £20 trillion.
On the subsequent sale of his loan notes in the company, the taxpayer made a claim for ER. However HMRC denied the claim on the grounds his shareholding whilst being 5% of the A and B shares was only 4.99% of the total ordinary share capital, including the deferred shares.
A key requirement for ER on the disposal of shares is that the taxpayer must have held ≥ 5% of the ordinary share capital and voting rights for one year prior to disposal.
For these purposes preference shares are excluded from the calculation of ordinary share capital.
The taxpayer contended that the deferred shares did not share the characteristics of ordinary shares and Parliament would not intend for them to be included when considering ER. Instead, the deferred shares should be excluded, as preference shares are.
HMRC contented that the definition of ordinary share capital had existed since 1938 and should be given its plain meaning.
The Tribunal found that Parliament intended a broad definition of ordinary share capital. To apply a more literal definition risked creating an unnecessary layer of meaning.
In this case, the creation of the deferred shares was for commercial reasons. Moreover, the company’s substantial deficit in distributable reserves meant the commercial and economic reality of the ‘A’ and ‘B’ ordinary shares were similar to the deferred shares.
The Tribunal held that the deferred shares should be included when considering the total ordinary share capital of the company. Consequently the taxpayer was denied ER as his holding did not meet the minimum 5% threshold.