Fletcher v R & C Commissioners
| Jurisdiction | England & Wales |
| Judgment Date | 29 September 2008 |
| Date | 29 September 2008 |
| Court | Special Commissioners (UK) |
special commissioners decision
Howard M Nowlan
Stephen Matthews, former Director of Articsoft Limited, for the Appellant
Fred Cook, Inspector of Taxes, and Mr Wheeler, senior HMRC officer, for the Respondents
Claim to set capital loss against income under Income and Corporation Taxes Act 1988 section 574s. 574 Taxes Act 1988 - appellant's claim to have a loss of £50,400, resulting from the initial subscription of ordinary shares for £400 and the capitalisation of £50,000 of a loan in return for B ordinary shares with restricted rights - respondents contention that the B ordinary shares were worthless at the point of the capitalisation of the debt, such that the allowable loss was restricted to £400 - rights issue analysis - appeal allowed in full
A special commissioner decided that a shareholder who did not receive any distribution in the liquidation of the company had incurred a capital loss under Taxation of Chargeable Gains Act 1992 section 24 subsec-or-para 2TCGA 1992, s. 24(2) that she was entitled to set off against her taxable income pursuant to Income and Corporation Taxes Act 1988 section 574ICTA 1988, s. 574.
The taxpayer and M were the founders and initial shareholders of a start-up company. Each of them had subscribed 400 of the issued 800 £1 ordinary shares in the company. The company was incorporated in late 2001 and commenced trading, trying to market two or three software products that it had devised and developed, on 1 July 2002. By May 2003, the two directors had advanced between them, from their own resources, approximately £115,000, each of them having advanced at least £50,000. The initial accounts for the eight-month period of trading to the end of February 2003, showed few sales, considerable expenditure and a resultant loss of £104,455.
The company considered that it needed additional finance in order to increase its marketing effort. Following negotiations a lender, SEGF, agreed to inject £250,000, as a first instalment of new capital, in return for £150,000 preference shares and £100,000 A ordinary shares in the company with the intention of subscribing further shares after an interval if initial trading justified the further investment. As part of the deal, SEGF required the two directors each to capitalise £50,000 of their advances to the company by taking 50,000 £1 B ordinary shares to reinforce the preference attaching to both the preference shares and the A ordinary shares that SEGF subscribed, and to ensure that they did not rank behind loan creditors in the event of a liquidation. The company did not succeed in the way hoped, and SEGF did not subscribe the further tranche of capital at the envisaged second stage, and in 2005 the company was placed in liquidation. No distributions were made to any of the shareholders in that liquidation.
Having received no distribution in the liquidation in respect of any of her shares, the taxpayer claimed a capital loss of £50,400 under Taxation of Chargeable Gains Act 1992 section 24 subsec-or-para 2TCGA 1992, s. 24(2) and claimed to be able to set that loss, effectively as an income loss, against her taxable income pursuant to the provisions of Income and Corporation Taxes Act 1988 section 574ICTA 1988, s. 574. The Revenue conceded a loss of £400 in respect of the ordinary shares, but contended that there was no loss in respect of the B ordinary shares. This was on the ground that the B ordinary shares had no value at the point of their acquisition, and that as Taxation of Chargeable Gains Act 1992 section 251 subsec-or-para 3TCGA 1992, s. 251(3) provided that where 'property is acquired by a creditor in satisfaction of his debt or part of it … the property shall not be treated as disposed of by the debtor or acquired by the creditor for a consideration greater than its market value at the time of the creditor's acquisition of it', the base cost of the B ordinary shares (and thus any loss) was nil. No loss arose for capital gains purposes merely because the B ordinary shares had become of negligible value under Taxation of Chargeable Gains Act 1992 section 24 subsec-or-para 2TCGA 1992, s. 24(2), indicating that they had value at an earlier point. The taxpayer appealed.
Whether the taxpayer was entitled to the allowable loss that she claimed in respect of the capitalisation of £50,000 of her loan to the company for 50,000 £1 B ordinary shares.
The special commissioner (Howard M Nowlan) allowed the appeal on the basis that the rights issue analysis in Dunstan v Young, Austen & Young LtdTAX[1989] BTC 77 and Taxation of Chargeable Gains Act 1992 section 126TCGA 1992, s. 126 applied in this case. The capitalisation involved each of the two ordinary shareholders capitalising identical amounts of debt for an identical number of B ordinary shares, both initially holding 400 original ordinary shares. Thus the new issue was plainly in proportion to the holdings of ordinary shares. It was also "in respect of" them, in that it was the very feature that each shareholder held the ordinary shares that rendered it irrelevant whether the value on the capitalisation flowed into the subscribed B ordinary shares alone, or into the combined holding of B ordinary shares and the original ordinary shares. Had one creditor held ordinary shares, whilst the other did not, it was inconceivable that the one with no ordinary shares would have participated in the capitalisation on the basis that he would get worthless shares, and filter value into the ordinary shares held by the other, whilst that other would get a double jump in the value of her ordinary shares. The pre-existing ownership of ordinary shares was thus a vital factor influencing the terms of the capitalisation, so that the new issue of shares was 'in respect of' the existing holdings of ordinary shares, and the transaction was a reorganisation within s. 126.
As regards the valuation of the shares, SEGF acquired shares with preferential rights, but the value of those preferential rights had been over-played by the Revenue. The reality was that SEGF would have realised that they would lose their investment, regardless of the preferential rights, and thus it was only because of the reasonable prospect of success that they invested. That prospect of success was based on a judgment as to the worth of the software concepts, and not on any record of past losses or the lack of tangible assets. The preferential rights did not and could not transform the valuation reality of the shares subscribed by SEGF, and those shares were ultimately only entitled to one third of the proportion of residual equity profits attributable to the original ordinary shares. Thus those shares had a very significant value on 16 May 2003. The capitalisation was done without any thought to taxation consequences. The terms of the third party subscription rendered it inconceivable that the ordinary shares and the directors' loans were valueless in May 2003.
By relinquishing a debt of £50,000 the taxpayer gave consideration of £50,000 in the relevant transaction. Whilst it was true that the company did not have available cash or cash flow with which to repay the debt, it still had the valuable assets and expectations, which enabled it to raise cash. Whilst the new investor was not content to invest £250,000, if £115,000 of its cash was immediately to be applied in repaying the directors' debts, the implicit value that SEGF placed on the software exceeded the amount of the debts, and of course the directors themselves, in searching for new money to fund development and marketing effort, were not seeking to obtain repayment or immediate repayment of their loan accounts anyway. Accordingly, the consideration given by the taxpayer in the capitalisation was £50,000.
Furthermore, the taxpayer's capitalisation increased the value of her combined new holding by £50,000 over the value of her ordinary shares before the capitalisation. Since the capitalisation removed a prior charge of £50,000 (or £100,000 in total) of debts that could have been discharged, the capitalisation did increase the value of the taxpayer's new holding of ordinary and B ordinary shares by that amount over the pre-existing value of the original ordinary shares. Therefore the increase to base cost of the taxpayer's total holding was £50,000 and her loss, in the negligible value claim, was £50,400.
If that was wrong, the stand alone value of the B ordinary shares when subscribed, by reference to their entitlement on a liquidation and to their nebulous dividend right, was only £2,500.
1. This was a case where I considered at the end of the hearing that it would not be possible, whilst applying the law correctly, to confirm the Appellant's entitlement to the loss that she claimed in respect of the capitalisation of £50,000 of her loan to the company, Articsoft Limited ("Articsoft") for 50,000 £1 B Ordinary Shares, and the later feature that all her shares, including her 400 Ordinary Shares in the company, proved worthless. The Respondents had contended that where assets are taken in satisfaction of debt, the base cost of the assets acquired is restricted to the value of those assets. Since the B Ordinary Shares had strangely drafted rights that arguably made them worthless at the point of the capitalisation, the Respondents contended that this meant that the deemed disposal of those shares under Taxation of Chargeable Gains Act 1992 section 24section 24 TCGA 1992 occasioned no loss. Thus there was no capital loss eligible to be set against income under Income and Corporation Taxes Act 1988 section 574section 574 Taxes Act 1988.
2. The case before me was argued almost entirely on a valuation basis, addressing both the value of the company generally at the point of the capitalisation, and the specific rights attaching to the B Ordinary Shares,...
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