Zero-dividend shares ARE ordinary shares for ER says Upper Tribunal in McQuillan

Zero-dividend shares ARE ordinary shares for ER says Upper Tribunal in McQuillan

Tue 17 May 2016

[This post from May 2016 has been updated in September 2017 to reflect the appeal decision]

The Upper Tribunal (UT) has now decided (HMRC v McQuillan [2017] UKUT 344 (TCC)) that s 989 was not ambiguous and a dividend entitlement of £0 could not be regarded as a fixed dividend. Therefore the shares in question in this case were to be regarded as ordinary share capital and the McQuillans would lose their Entrepreneurs’ Relief claim.  While they could see the unfairness in this instance, the UT’s view was that any corrective action was a matter for Parliament.

Implications:  Taxpayers might now consider setting a nominal fixed dividend at an extremely low level (e.g. 0.00001p per share), unless tax avoidance is involved. The McQuillans may yet appeal this UT ruling but the lesson to be taken from this case is that shareholders wishing to claim ER need to be sure their company’s share structure permits that. If in doubt Mazars can undertake a review for you.

The Background and previous decision of the First Tier Tribunal:

The case of Michael and Elizabeth McQuillan v HMRC highlights the arbitrary way in which tax rules sometimes operate, especially in relation to classes of shares. The McQuillans’ appeal against HMRC’s refusal of entrepreneurs’ relief (ER) was only allowed because the First Tier Tribunal (FTT) judge decided the relevant statute was ambiguous and should be interpreted favourably to the taxpayers.

ER has been available for disposals of shares in an individual’s personal trading company since 6 April 2008. To qualify as shares in their personal trading company the McQuillans each had to have owned ordinary shares making up at least 5% of the company’s ordinary share capital and entitling them to 5% of the company’s voting rights throughout the year ending on the date of sale of their shares. Until shortly before it was sold there had been two classes of shares in the company:

• £1 ordinary shares of which the McQuillans each owned 33 out of the 100 issued shares, while another couple, the Pennicks, owned 17 each of the remaining 34; and
• the Pennicks also owned 30,000 redeemable non-voting (NV) shares which were not entitled to any dividend.

The NV shares had been created in 2006, i.e. before ER had even been conceived, by conversion of loans previously made by the Pennicks because that was a condition of the company receiving a grant from the Government which wanted to ensure that the grant could not be used to clear the loan and would be sure to be used for its intended purpose of investment in the business.

The McQuillans sold their shares in January 2010, less than a year after the company had redeemed the Pennicks’ NV shares. HMRC opened an enquiry into the McQuillans’ tax returns for 2009/10 and issued a closure notice rejecting the ER claim on the basis that the company was not their personal company because they had not owned the required 5% of its ordinary share capital throughout the period of one year immediately preceding the sale, as required by Taxation of Chargeable Gains Act 1992 (TCGA) s 169I.

The parties agreed that the only ground on which ER could be denied was if the NV shares had to be counted as ordinary share capital, in which case the McQuillans’ holdings would have been less than 0.001% each of the ordinary share capital, i.e. far short of the minimum 5% required.

The definition of ordinary share capital used for ER, and most other tax purposes, is provided by Income Tax Act 2007 (ITA 2007) thus:
“ordinary share capital”, in relation to a 5 company, means all the 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,”
The McQuillans’ case was that the NV shares were entitled to a dividend but at a zero rate and so fell within s 989.

HMRC argued that because the NV shares were not entitled to dividends at all they were not entitled to a dividend at a fixed rate because s 989 unambiguously required an actual positive rate of fixed dividend to be payable. HMRC quoted an earlier FTT case, Dyson v Revenue & Customs [2015] UKFTT 131 in which shares providing no dividends had been held to be ordinary share capital and referred to their Employee Share Schemes User Manual (ESSUM) paragraph 43230.

In its judgment the FTT was sympathetic to the McQuillans’ plight but was bound to apply the meaning of the statute, but was not satisfied that s 989 was unambiguous in its meaning. The Judge said he was not obliged to follow Dyson and observed that that judgment had been very short and he was not persuaded by it. He then commented unfavourably on HMRC’s reference to its manuals, pointing out that they do nothing more than state HMRC’s opinion and as such have no authority which the Courts are obliged to follow. On the specific paragraph quoted (ESSUM 43230):

“Ordinary Share Capital” is defined in Section 989 ITA 2007. … The following may be accepted as ordinary share capital:
• shares with no dividend rights (we do not contend that they carry the right to a fixed dividend of 0%).”

He observed that even HMRC’s interpretation of s 989 allows for shares that carry no dividend rights to be treated as having a fixed dividend of 0% but they “do not contend” that to be the case.

The FTT decided that the rationale behind s 989 is to distinguish between shares that genuinely participate in the commercial fortunes of the company and those that do no more in practice than represent loan capital. In this case it was clear that as the NV shares had only been created as a means of redefining the Pennicks’ loans in a way that enabled the company to obtain grants while giving the Pennicks no more rights or expectations than they had had through their loans, the NV shares were quasi-loan capital.

Therefore “On the very limited information before it, the Tribunal is persuaded that in the particular circumstances of the present case, a right to no dividend is a right to a dividend at a fixed rate for purposes of that definition.”

The FTT took care to phrase its decision as a decision of fact but it would be open to HMRC to appeal on the basis that the FTT had misdirected itself as to the law. If HMRC chooses not to appeal the decision the ambiguity will remain and McQuillan cannot be taken as setting a precedent for other cases, merely a strong indication that the FTT may, where there is no suggestion of ulterior (i.e. tax-driven) motives on a claimant’s part, be prepared to reach a judgment that it sees as fair.


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