Revenue and Customs Commissioners v McQuillan and Another
| Jurisdiction | UK Non-devolved |
| Judgment Date | 06 September 2017 |
| Neutral Citation | [2017] UKUT 344 (TCC) |
| Date | 06 September 2017 |
| Court | Upper Tribunal (Tax and Chancery Chamber) |
[2017] UKUT 0344 (TCC)
Upper Tribunal (Tax and Chancery Chamber)
Mrs Justice Rose, Judge Roger Berner
Marika Lemos, instructed by the General Counsel and Solicitor to HM Revenue and Customs, appeared for the appellants
Joseph Murray, of Joseph Murray Limited, Chartered Accountants and Statutory Auditors, appeared for the respondents
Capital gains tax – Entrepreneurs' relief – TCGA 1992, Pt. V, Ch. 3 – Meaning of personal company – TCGA 1992, s. 169S(3) – Application of definition of ordinary share capital – ITA 2007, s. 989 – Whether redeemable shares with no right to a dividend were shares with a right to a dividend at a fixed rate (of 0%) and thus not ordinary share capital – No – HMRC's appeal allowed.
The Upper Tribunal (UT) held, overturning the decision of the First-tier Tribunal (FTT) (McQuillan [2016] TC 05074), that shares that do not have a right to a dividend cannot be said to have a right to a dividend at a fixed rate and are therefore ordinary shares.
Mr and Mrs McQuillan, together with Mrs McQuillan's brother and sister-in-law (Mr and Mrs Penwick), held all of the 100 ordinary shares in The Streat Franchising Ltd (Streat), a sandwich shop business. Mr and Mrs Penwick also lent £30,000 to Streat which was, as a pre-condition of raising further finance, converted in 2006 into 30,000 redeemable non-voting shares that could not be repaid before 2009. The shareholders' agreement made no provision for the proportions in which dividends would be paid, but the FTT found as a fact that the understanding between the shareholders was that the shares would have no right to dividends and merely represented an interest-free loan. In December 2009, the 30,000 shares were redeemed, and a dividend was paid on the 100 non-redeemable shares before they were sold on 1 January 2010. HMRC refused the McQuillans' claims to entrepreneurs' relief, on the grounds that the redeemable shares were ordinary shares within ITA 2007, s. 989 and since they each held less than five per cent of the ordinary share capital, Streat was not their personal company. The FTT allowed their appeal, on the grounds that shares with no dividend rights could be said to have a right to a dividend at a fixed rate of 0% and were not therefore ordinary shares within s. 989.
The UT disagreed with the FTT's conclusion that there was ambiguity in ITA 2007, s. 989 that permitted more than one answer to the question as to whether “dividend at a fixed rate” could include shares that had no right to a dividend. They considered that the definition of “ordinary share capital” started with the premise that it included all of a company's issued share capital but then provided an exception for capital that satisfied all of the following:
- the holders of that capital had a right to a dividend;
- that dividend was at a fixed rate; and
- there was no right to share in the company's profits.
In their view, the FTT had erred because the redeemable shares did not have a right to a dividend in the first place. However, they also considered that, even if the shares had had a right to a dividend at a fixed rate of 0%, they would not have been excepted by s. 989 because “nil” has no value and is not a number or amount, and that the FTT's reliance on the existence of a zero rate of value added tax (VAT) to illustrate that a right to a zero dividend was a right to a dividend at a fixed rate was flawed because zero-rating for VAT purposes could not properly be described as a rate of tax, as it was simply the mechanism adopted by the UK to allow recovery of input tax permitted by way of derogation. Finally, they considered whether a purposive construction of s. 989 in the context of entrepreneurs' relief could result in the relief being available, but concluded that the “purpose” that had to be identified was the “purpose” of s. 989 only, and that purpose was simply defining ordinary share capital. If Parliament had wished to import a different definition for entrepreneurs' relief purposes it could have done so. In their view, the meaning of s. 989 was clear, and entrepreneurs' relief was not due in this case because the redeemable shares did fall within the meaning of ordinary share capital.
The UT, although finding for HMRC, recognised that the taxpayers were “the kind of entrepreneurs for whom the relief was devised” and also considered that there was a case for the legislation to be reviewed to address what could be perceived as unfairness. However, this was a matter for Parliament, not the Tribunals. The case therefore serves as a warning for both taxpayers and their advisers to ensure that the capital structure of the company is carefully reviewed.
[1] This appeal by HMRC from the decision of the First-tier Tribunal (Judge Christopher Staker) released on 5 May 2016 ([2016] TC 05074), which is brought with permission of Judge Sinfield in this Tribunal, raises a short, but important, point of the statutory construction of the definition of “ordinary share capital” in s 989 of the Income Tax Act 2007 (“ITA”), in the context of its application to the meaning given to an individual's “personal company” in s 169S of the Taxation of Chargeable Gains Act 1992 (“TCGA”).
[2] The statutory context is that of the Entrepreneurs' Relief which was introduced as Chapter 3 of Part V TCGA with effect from 6 April 2008 as part of a range of measures including the abolition of taper relief, the withdrawal of the indexation allowance (for non-corporates) and at that time a flat rate of capital gains tax of 18%. As introduced, the effect of the entrepreneurs' relief, in cases to which it applied, was to apply to chargeable gains an effective rate of 10%, subject to an original lifetime limit of £1 million.
[3] The entrepreneurs' relief applies to certain qualifying business disposals, of which one is the material disposal of business assets (s 169H(2)(a) TCGA). A disposal of business assets includes a disposal of shares in a company (s 169I(2)(c)). To be a material disposal of shares, two conditions (Condition A and Condition B) must be satisfied. For the purpose of this appeal, only Condition A is relevant, and it is set out in s 169I(6):
Condition A is that, throughout the period of 1 year ending with the date of the disposal–
- the company is the individual's personal company and is either a trading company or the holding company of a trading group, and
- the individual is an officer or employee of the company or (if the company is a member of a trading group) of one or more companies which are members of the trading group.
[4] It is thus a requirement that, for the relevant period prior to the disposal, the company is the individual's personal company. That term is defined by s 169S(3), as follows:
For the purposes of this Chapter “personal company”, in relation to an individual, means a company–
- at least 5% of the ordinary share capital of which is held by the individual, and
- at least 5% of the voting rights in which are exercisable by the individual by virtue of that holding.
[5] A “personal company” is therefore defined by reference to a specified percentage of both ordinary share capital and voting rights. We are concerned with “ordinary share capital” which is itself defined by s 169S(5) in the following way:
“ordinary share capital” has the same meaning as in the Income Tax Acts (see section 989 of ITA 2007)
[6] Section 989 ITA provides for the meaning of “ordinary share capital” as follows:
“ordinary share capital”, in relation to a 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
[7] Mr and Mrs McQuillan established a business, described by Mr Murray, appearing for them, as a sandwich shop business, in 1999. In 2004, along with Mrs McQuillan's brother and sister-in-law, Mr and Mrs Pennick, and with a view to franchising the business, they set up a company, The Streat Franchising Limited (“Streat”). The original share capital of Streat consisted of 100 £1 ordinary shares of which Mr and Mrs McQuillan each held 33 and Mr and Mrs Pennick each held 17. At some point, Mr and Mrs Pennick made a loan to Streat of £30,000, shown in the company's accounts as a directors' loan.
[8] The business expanded rapidly, and in early 2006 Streat approached Invest Northern Ireland (“Invest NI”), the regional business development agency, for certain grants. Invest NI offered grants to Streat, but on the pre-condition that Mr and Mrs Pennick's directors' loan be converted into shares in the company, and that there be no repayment before March 2009.
[9] The FTT records, at [5] of its decision, that at a directors' meeting on 12 June 2006 it was resolved that the £30,000 loan would be converted into 30,000 redeemable ordinary shares of £1...
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