The cost of getting the wrong structure: entrepreneurs’ relief
A recent first tier tribunal decision concerned entrepreneurs’ relief and whether redeemable shares with no right to a dividend impacted the relief available.
The case outcome was dependent on the share capital and ownership conditions not being met. The judgement highlighted that different rights would have resulted in the shareholders being eligible for entrepreneurs’ relief!
In The Commissioners for HM Revenue and Customs v Michael and Elizabeth McQuillan:  UKUT 0344 (TCC) the First Tier Tribunal findings that previously favoured the taxpayer were overturned with HMRC’s appeal succeeding.
Because of a loan being converted to redeemable shares the share-holding was:
Shareholder number of ordinary shares
Mr McQuillan 33
Mrs McQuillan 33
Number of redeemable shares
Mr Pennick 15,000
Mrs Pennick 15,000
The judgement explains that ‘In their self assessment returns for the tax year 2009-10, Mr and Mrs McQuillan claimed entrepreneurs’ relief in respect of their disposals of their ordinary shares in Streat [their company]. That claim was refused by HMRC, on the basis that neither Mr or Mrs McQuillan had, throughout the period of one year ending with the date of the share sale, held at least 5% of the ordinary share capital of Streat. That conclusion followed from the view of HMRC that the 30,000 redeemable shares were part of the “ordinary share capital” of Streat.'
The FTT stated that there was an 'alternative structure under which those shares would have carried a fixed dividend of a purely nominal amount (the FTT postulated a de minimis yearly dividend of 1/15,000th of a £ per share) to demonstrate that in the latter case it would have been clear that the redeemable shares would have given the holder a right to a dividend at a fixed rate. If that had been the structure chosen, the 30,000 redeemable 20 shares would not have fallen within the definition of “ordinary share capital” in s 989 ITA, Mr and Mrs McQuillan would have owned more than 5% of the ordinary share capital of Streat, Streat would have qualified as their personal company for the purposes of s 169S(3) and they would both have been entitled to entrepreneurs’ relief. The FTT considered that it was 'difficult to see why the redeemable shares in the present case should be treated any differently when the only difference is that instead of bearing a purely nominal fixed dividend, they bear a zero dividend'.
Interestingly, in the summary it is made clear that s989 ITA 'is apt to produce results which appear unfair'. In reaching their conclusion sympathy was expressed for the taxpayer. It was stated in the judgement that there 'will be deserving cases that fail to qualify for relief, and non-deserving ones that do qualify. Such a definition may enable those who are well-advised to fall within its terms, whilst leaving a trap for the unwary. There is certainly a case for the legislation to be reviewed to address what may understandably be perceived as unfairness in particular cases, of which this is one. That will, however, be a matter for Parliament if it determines that such a change should be made.’