Castledine
| Jurisdiction | UK Non-devolved |
| Judgment Date | 01 March 2016 |
| Neutral Citation | [2016] UKFTT 145 (TC) |
| Date | 01 March 2016 |
| Court | First Tier Tribunal (Tax Chamber) |
Judge Malachy Cornwell-Kelly, Mr Ian Menzies-Conacher FCA
Mr Jeremy Woolf instructed by Clarke Willmott LLP appeared for the taxpayer
Mr Alan Hall of HM Revenue and Customs appeared for the Crown
Entrepreneurs relief – Meaning of ordinary shares – Principles of statutory construction – Taxation of Chargeable Gains Act 1992 (TCGA 1992), s. 169S – Income Tax Act 2007 (ITA 2007), s. 989 – Appeal dismissed.
The First-tier Tribunal found that a holding of ordinary shares that could only meet the 5% ownership test necessary to satisfy the personal company condition in TCGA 1992, s. 169I(6) by ignoring the existence of deferred ordinary shares did not qualify for entrepreneurs' relief.
The appellant held A and B ordinary shares in the holding company of a trading group. He was an employee of a trading company that was a member of the group. In addition to the A and B ordinary shares, there was also a class of deferred shares into which any B shares held by an employee were automatically converted on ceasing to be an employee. The class of shares had been created to remove any economic right to participation in the company for former employees. They carried no rights to income or capital, and would only be repaid at par after at least £1,000,000 per share had been distributed to each B shareholder. Realistically, given the substantial deficit on the profit and loss reserves shown in the balance sheet, this made the deferred shares worthless. If the deferred shares were categorised as ordinary share capital, the appellant's percentage ownership of ordinary share capital would be 4.99%; if they were ignored he would own exactly 5%, therefore sufficient for the company to qualify as his personal company (TCGA 1992, s. 169S(3)).
It was argued on behalf of the appellant that although the deferred shares fell within the definition of ordinary share capital in ITA 2007, s. 989, being all the issued share capital 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, Parliament could not have intended that shares that carried no rights at all therefore did fall within the definition of ordinary share capital.
The First-tier Tribunal pointed out that, in view of the company's economic situation, the A and B shares were equally unlikely to obtain any sort of return. They also considered that the value of a company's shares could be affected by any number of factors, whether as a result of legal constraints or commercial circumstances and therefore it was not surprising that Parliament had drawn a simple, clear and predictable distinction between ordinary and non-ordinary shares, so that it was possible to establish an interpretation of the statute that could be applied generally, without the need for separate investigation of each individual case. They were not therefore able to depart from the plain meaning of the legislation, with the result that the deferred shares did fall to be treated as ordinary shares and the appeal failed.
Given that the deferred shares had been created for purely commercial reasons and with the intention of stripping them of economic value (whilst avoiding pitfalls associated with other mechanisms for achieving this when a member of the management team ceased to be an employee), it seems ironic that they should nevertheless form part of the ordinary share capital for entrepreneurs' relief purposes.
[1] This appeal concerns claims by Mr Alan Castledine for Entrepreneurs' Relief for the years 2011/12 and 2012/13 in respect of the disposal of loan notes in Dome Holdings Limited (DHL). The only issue is whether the test for eligibility for the relief stated in section 169S(3) of the Taxation of Chargeable Gains Act 1992 is met.
[2] In addition to the usual documentary evidence, we received the sworn evidence of Mr Castledine. We find the following facts proved at least on the balance of probabilities.
[3] The question to be resolved concerns the classification of the shares in DHL. At the material time, the shareholdings in that company were as follows:
Issued |
Held by Mr Castledine |
|
A ordinary shares £1 |
1,895,482.00 |
94,775 |
B ordinary shares £0.01 |
20,019.85 |
1,001 |
Deferred shares £0.01 |
2,043.54 |
nil |
Totals |
1,917,545.39 |
95,776 |
£1 preference shares |
165,088,062.00 |
6,785,137 |
[4] If the deferred shares are counted as ordinary shares Mr Castledine held 4.99% of the share capital of DHL; if the deferred shares are excluded from the reckoning, Mr Castledine held exactly 5% of the company's share capital. In the former case, Mr Castledine would not have qualified for the relief on a strict reading of the legislation; in the latter case, he would qualify, even on a strict reading. The question in this case then is: do the deferred shares count as ordinary share capital?
[5] A witness statement made by Mr Castledine indicates that he is the commercial director of Park Resorts Limited which was acquired by DHL in March 2007. Mr Castledine retired in September 2007 leaving loan notes in DHL under an existing financial structure. In Mr Castledine's absence however the business did not prosper and he was called back in December 2008 to assist in rescuing it from bankruptcy. The rescue was successful, but it included a restructuring of its finances in which Mr Castledine was allocated 5% of the ordinary shares, which he still holds. On 29 July 2011 and 31 July 2012, Mr Castledine disposed of loan notes in DHL worth £600,303 and £505,009 respectively, the disposals giving rise to the chargeable gains in respect of which relief is now sought.
[6] The rights attaching to the deferred shares are prescribed by article 5.7 of DHL's Articles of Association. Under this article, the deferred shares have no voting rights and no rights to dividends: their sole value is in the right to be redeemed at par on a capital realisation after at least £1,000,000 has been distributed in respect of each B ordinary share. Given that there were at the material time 2,001,985 B shares in issue, the deferred shares had, according to Mr Castledine, in reality no rights.
[7] Mr Castledine explained that the class of deferred shares was created as a mechanism for removing B ordinary shares from the senior management team of DHL, which had been awarded to them while they were working, when they left the company. This was done on legal advice that it avoided potential problems associated with other mechanisms for removing shares from shareholders, such as forcing them to sell back to the company. Under article 14.1–4, ordinary B shares are automatically converted into deferred shares in the case of four conversion events, namely the bankruptcy, death or leaving of employment of the holder or in certain circumstances in an insolvency; such converted shares are then automatically transferred to the Employee Benefit Trust for a nominal consideration.
[8] Mr Castledine said that the commercial objective was to find a way of removing the individuals as shareholders of the company, removing any influence over the running of DHL or receiving any financial benefit from the company; the intention was, he said, to strip the shares of economic value. Under this scheme, Mr Castledine himself could not hold deferred shares as he continued to be an employee of the company, though he was no longer a director of it. The notes to DHL's Consolidated Financial Statements and Directors' Report for the years to 31 March 2011, 2012 and 2013 all however show the deferred shares classed as ordinary shares.
[9] The rights of the various classes of shares, in what is a fairly complex and evolving structure, fit together as follows–
Share class |
Voting rights |
Income rights |
Capital rights |
Preference |
None, save for matters affecting class |
12% fixed and cumulative (=£19,810,567pa) |
First call on assets, to repay at par plus any accrued dividends |
A Ordinary |
One vote per share, save in relation to any Key Change |
Once Pref. shares are paid, may receive a dividend up to the Threshold Amount |
Next call on assets, to pay up to the capped Threshold Amount |
B Ordinary |
One vote per share, in relation to any Key Change 80% in favour is required |
None, unless or until the Investors have received Proceeds equal to the Threshold Amount |
The balance of any remaining assets |
Deferred |
None |
None |
Redemption at par, but only once each B Ordinary has received a distribution of £1m |
Investors |
Threshold Amount |
||
means GIP Group, any holder of Initial Loan Notes from time to time, any holder of A Ordinary Shares from time to time, any holder of Preference Shares from time to time, any Affiliate of any of them and any transferee of any of them |
means the greater of (i) the sum (if any) which it would be necessary to add to the Cash Flows as an amount received by the Investors as at the Reference Date so as to ensure that the IRR is at the Specified Rate and (ii) £0.01 |
[10] Whilst the structure is complex and the rights attaching to any class far from normal, the overall aim is clearly to create a hierarchy whereby the likelihood of receiving anything diminishes as one moves down the various classes of shares. The accounts show deficits on the Profit and Loss Reserves of £167,620,000 in 2010, £122,553,000 in 2011 (flattered by an exceptional write back of £68,050,000 due to a reclassification of the preference shares as equity and hence a write back of previously accrued dividends), £160,214,000 in 2012.
[11] Section 169S(3) and (5) of the Taxation of Chargeable Gains Act 1992 provides:
(3) For the purposes of this Chapter personal company, in reference to an individual, means a company–
a) at least 5% of the ordinary share capital of which is held by the individual, and
b) at least 5% of the voting rights in which are exercisable by the individual by virtue of that holding.
…
(5) In this Chapter–
…
ordinary share capital has...
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