Entrepreneurs’ relief anomaly claims another victim in J K Moore v HMRC

Fri 04 Mar 2016

The unfortunate case of John Kenneth Moore v HMRC [2016] TC04903 in the First Tier Tribunal (FTT) shows how important it is to structure transactions correctly to take account of the poor drafting of the entrepreneurs’ relief (ER) legislation. This is not a new problem: the anomaly has been present since ER was introduced in 2008 and catches out employee shareholders who resign or otherwise lose their employment before they can sell their shares.
Mr. Moore (‘JKM’) was a director and 30% shareholder of a company (‘Alpha’), a trading company that was his personal company until a difference of opinion about the company’s future led him to resign his directorship and sell his shares back to the company. He claimed ER on the disposal but HMRC refused the claim on the sole ground that he had ceased to be an employee or office-holder before the disposal took place and so did not meet Condition A in Taxation of Chargeable Gains Act 1992 (TCGA) s 169I (6):
(6)    Condition A is that, throughout the period of 1 year ending with the date of the disposal—
(a)  the company is the individual’s personal company and is either a trading company or the holding company of a trading group, and
(b)  the individual is an officer or employee of the company or (if the company is a member of a trading group) of one or more companies which are members of the trading group.
The sequence of events as set out by JKM in his notice of appeal and before the FTT was confused. At first JKM claimed that his employment ended and the share purchase both took place on 29 May 2009, the date on which his resignation as a director and the company purchase of its own shares were both approved in a general meeting and recorded in Alpha’s statutory records. However, his P45 and other evidence pointed to his employment having terminated on 28 February 2009.
When the case came before the FTT JKM argued that his employment had terminated on 28 February but that the agreement to sell his shares had also been made on that date when Heads of Terms were agreed, so that there was no delay between termination and disposal and Condition A was satisfied.
HMRC argued that it was impossible for the disposal to have taken place on 28 February since TCGA s 28 applies which determines the date of disposal under a contract as being the date of unconditional contract and, as a matter of company law any contract to purchase the company’s own shares requires prior approval by special resolution or must be made conditional on such approval being subsequently given (Companies Act 2006 s 694 (2)).
The FTT decided that the Heads of Terms agreed between Alpha and JKM on 28 February could not amount to an unconditional contract and so the disposal did not take place until 29 May by which time almost three months had passed since JKM’s employment terminated. This meant that JKM did not meet Condition A in s 169I (6) because he did not have 12 months’ unbroken employment with Alpha ending on the date of disposal.
What this case tells us
The case is unfortunate because the loss of ER could have been avoided if the ER conditions had been considered before Heads of Terms were agreed and in particular before JKM’s employment was terminated.
If JKM had been put on gardening leave or a different, reduced-status employment until the sale was ratified by special resolution he would have met Condition A. In fact JKM had continued to work for Alpha after his employment ended but through his own personal service company and not as an employee.
Equally, if Alpha’s board had convened a general meeting and passed the special resolution at the time of termination of JKM’s employment Condition A would also have been met.
Those are easy points to make with the benefit of hindsight and away from the heat of a situation: even in a relatively amicable case such as this opportunities were missed, opportunities that might not have been practical possibilities in an acrimonious parting of the ways. The amount of additional CGT payable by JKM for 2009/10 was £37,384, suggesting that JKM made a gain in excess of £450k. That £37,384 additional tax became due because JKM and Alpha, for whatever reason, did not take proper account of the conditions for ER to apply.
There have been cases where directors who resigned as a director before disposing of their shares still successfully claimed ER on a later disposal.  However, these were exceptional cases where employment genuinely continued after the resignation (see Hirst v HMRC [2014] UKFTT 924 (TC) and TTH 3 October 2014; Susan Corbett v HMRC [2014] UKFTT 298 (TC)) .  That is the only reason why these cases succeeded.  The moral of the story is that where there is an arbitrary but strict statutory requirement here that shareholder/employees hoping for ER ignore at their peril.