Flix Innovations Ltd v Revenue and Customs Commissioners
| Jurisdiction | UK Non-devolved |
| Judgment Date | 05 July 2016 |
| Neutral Citation | [2016] UKUT 301 (TCC) |
| Date | 05 July 2016 |
| Court | Upper Tribunal (Tax and Chancery Chamber) |
Mr Justice Mann, Judge Guy Brannan
Joseph Howard, counsel, for the Appellant
Simon Pritchard, counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents
Income tax – Enterprise Investment Scheme – Ordinary and deferred shares – Whether ordinary shares carried a preferential right to assets on a winding up – Income Tax Act 2007 (ITA 2007), s. 173 – Purposive construction and de minimis rule of interpretation – Appeal dismissed.
The Upper Tribunal found that the statutory wording of the EIS provisions had to be strictly applied in determining whether or not ordinary shares carried a preferential right.
Flix Innovations Ltd (the Company) required further finance in order to meet the costs of developing and marketing the Company's product. In order to make an investment in the company more commercially attractive to other investors, the company's share capital was reorganised to convert some of the share capital held by the two founder shareholders into deferred shares that ranked after the ordinary shares in terms of repayment of share capital on a winding-up (and had no rights to share in any surplus). As the holders of the ordinary shares were entitled to repayment of the nominal value of those shares before the holders of the deferred shares, HMRC considered that the ordinary shares did not meet the requirement in ITA 2007, s. 173(2)(aa) that they should not, at any time in period B, carry any present or future preferential right to the company's assets on a winding-up. HMRC therefore refused to authorise the issue of EIS compliance certificates. The company appealed, on the basis that, on a purposive construction, the term preferential right should be given an ordinary commercial meaning rather than a technical meaning so that an insignificant preferential right would be ignored, and that the de minimis non curat lex principle of statutory interpretation would also ignore the trivial preferential rights. The FTT took the view first that Parliament's failure specifically to provide for small preferential rights in the closely articulated EIS regime evidenced a contrary intention and second that since the obligation to certify compliance with all necessary conditions was placed on the company that issued the EIS shares, it was more likely that the intention was to provide a clearly-worded test that did not rely on principles of statutory construction that were only likely to be understood by lawyers.
On the question of the de minimis principle of statutory interpretation, the Upper Tribunal considered that the wording of ITA 2007, s. 173(2)(aa) excluding shares that carry … any … preferential right, in particular the word any, indicated a contrary intention – i.e., that any right, however insignificant, must be taken into account. With regard to purposive construction, it was less likely that closely articulated legislation should be susceptible to a different, purposive construction, but there was no identifiable principle that would prevent this. However, as set out in R & C Commrs v Trigg (a partner of Tonnant LLP) TAX[2016] BTC 505, it was necessary to distinguish between the policy behind a particular provision and its purpose. If the statutory language of the provision indicated a narrower purpose than the general underlying policy, purposive construction could not give effect to a wider outcome than that given by the statutory language. Hence, although the Upper Tribunal agreed that the general purpose of the legislation was to limit relief to ordinary shares carrying the risks and rewards of ownership, the wording of ITA 2007, s. 173 had imposed a more restrictive test. The appeal would therefore be dismissed.
Although not relevant to the decision, it is interesting to note that the Upper Trbunal did not accept that the preferential rights were de minimis because (unlike the FTT) they considered that the value of the right (entitlement to repayment of nominal value of £933) should be compared to the total nominal value of the company's shares (£1,083) rather than the total market value (c. £2.2m).
[1] The Enterprise Investment Scheme (EIS) gives income tax relief to individuals who subscribe for shares in unquoted companies. Part 5 of the Income Tax Act 2007 (ITA 2007) sets out the detailed conditions that must be satisfied in order to obtain EIS relief.
[2] This appeal concerns the interpretation of one of those conditions, viz whether one class of shares of the appellant, Flix Innovations Limited (the Company), carried a preferential right to the company's assets on a winding up for the purposes of section 173(2)(aa) ITA 2007. The First-tier Tribunal (FTT) (Judge Jonathan Richards) decided that HMRC were correct in refusing to authorise the Company to issue certificates confirming that the ordinary shares in question could benefit from EIS relief. The basis of the Judge's decision was that the ordinary shares carried a present or future preferential right to the company's assets on a winding up. The Company now appeals that decision.
[3] The only issue in this appeal is whether, on a proper construction of section 173(2)(aa) ITA 2007, the Ordinary Shares of the Company carried a preferential right to the Company's assets on a winding up. If they do, it was common ground that the amounts subscribed on the shares do not qualify for EIS relief.
[4] Judge Richards also held that the Company did not have standing to bring an appeal against HMRC's decision to withdraw EIS relief claimed and already allowed in respect of shares that the Company had issued with a termination date falling after 22 May 2013. The Company has not appealed against that decision.
[5] The facts found by the FTT were not in dispute. The following summary of the facts is taken from the FTT's decision and references in square brackets are to the relevant paragraphs of that decision.
[6] The Company carried on a business of developing and providing an Internet-based method of delivering digital content to cinemas.
[7] Initially, before the reorganisation described below, the Company had two classes of shares. The A Shares were held by the founders of the company, Mr Fearn and Mr Phelan (the Founders) [11]. The B Shares were held by other investors. The A and B Shares had a nominal value of £0.0001 per share. There were 5,412,100 A Shares and 3,920,644 B Shares in issue [12]. The total nominal value of all the issued shares was, therefore, £933 [12].
[8] In or around May 2013, it was decided to reorganise the Company's share capital in order to enable investors, other than the Founders, to inject further share capital of approximately £300,000, which was to be employed in the Company's business [15]. Originally, it was planned to cancel a number of the Founders' A Shares, but this plan was abandoned because the Company did not have sufficient distributable reserves [17]. Further, although the Company would have been able to fund the repurchase out of capital, it was considered that the Company might not be able to make the required declaration of solvency [17].
[9] In the light of these difficulties, it was decided that, instead of cancelling 1.5 million A Shares, a similar result could be achieved by converting 1.5 million A Shares into a new class of almost worthless non-voting Deferred Shares [18]. The remaining A Shares and B Shares would then be converted into a single class of Ordinary Shares [18]...
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