A CAPITAL GAINS TAX UPDATE (TO INCLUDE ENTREPRENEURS’ RELIEF)

1. A CAPITAL GAINS TAX UPDATE (TO INCLUDE ENTREPRENEURS’ RELIEF) Robert Jamieson MA FCA CTA (Fellow) TEP 14 September 2017

2. COMPANY DISTRIBUTIONS • Following liquidation, shareholder will receive capital distribution liable to CGT – preferable to receiving income payment. • Informal dissolutions – S1030A CTA 2010. • Government believe shareholders are increasingly seeking tax advantage of being charged to tax on gains rather than income. • New anti-avoidance – individuals only.

3. COMPANY DISTRIBUTIONS(CONT) • But consultation about more wide-ranging approach to stop future conversion of income to capital (eg. reintroduction of close company apportionments?). • W.e.f. 6 April 2016, new TAAR applies to distributions in respect of share capital on winding up (S396B ITTOIA 2005). • No statutory clearance procedure, but HMRC guidance has now been published.

4. COMPANY DISTRIBUTIONS(CONT) • See Paras CTM36300 – CTM36350. • Treats distribution on winding up as income receipt where: • individual, having interest of at least 5%, receives distribution on winding up; • company was close when it was wound up (or had been at some point in previous 2 years);

5. COMPANY DISTRIBUTIONS(CONT) • within 2 years following distribution, he (or connected person) is involved in similar trade or activity; and • it is reasonable to assume that main purpose, or 1 of main purposes, is avoidance or reduction of income tax liability. • Aimed at “phoenixism”. • HMRC’s original examples:

6. COMPANY DISTRIBUTIONS(CONT) • landscape gardener; • IT contractor; and • accountant. • Exemption from TAAR where distribution received by individual: • does not exceed his CGT base cost; or • only comprises irredeemable shares.

7. ER AND OWN SHAREPURCHASES • Significant difference between rates of CGT (especially where ER is in point) and higher rates of income tax. • This encourages owner managers to extract value from their companies in form of capital gain. • With own share purchases, proceeds are prima facie taxed as income. • However, CGT treatment is available.

8. ER AND OWN SHAREPURCHASES (CONT) • Requirements are: • vendor has held shares for 5 years; • vendor is UK-resident; • purchase was made for benefit of company’s trade (and was not part of any tax avoidance arrangements); • company is unquoted trading company or holding company of trading group;

9. ER AND OWN SHAREPURCHASES (CONT) • vendor’s proportionate shareholding has been substantially reduced – or eliminated – by own share purchase; and • vendor is not connected with company immediately after own share purchase. • Formal clearance procedure. • But what if company cannot afford to pay shareholder in full?

10. ER AND OWN SHAREPURCHASES (CONT) • Customary nowadays to settle payment in tranches spread over number of years. • Known as “multiple completion contract”. • Vendor gives up beneficial interest in shares which are bought back – no further dividends or votes. • He will normally also resign directorship. • CGT payment date.

11. ER AND OWN SHAREPURCHASES (CONT) • HMRC accept that multiple completion contract is valid arrangement – see ICAEW TR745. • Is there new problem for ER claims relating to sale proceeds for second and subsequent tranches? • Company does not “acquire” shares from vendor given that such shares are cancelled, but this is no longer automatic.

12. ER AND OWN SHAREPURCHASES (CONT) • What if S28 TCGA 1992 does not apply? • Payments for second and subsequent tranches represent lump sums derived from asset (ie. subject to tax under S22 TCGA 1992). • If so, gain is taxed when tranche is received rather than at original exchange date. • ER denied where vendor is not director.

13. ER AND OWN SHAREPURCHASES (CONT) • Note that clearance under S1044 CTA 2010 only confirms that transaction is not treated as income distribution. • It does not say that ER is available. • HMRC’s argument goes against all accepted technical analyses of multiple completion contracts – they are not tax avoidance schemes. • Indeed, whole of CGT is paid up front!

14. ER AND OWN SHAREPURCHASES (CONT) • Since ICAEW TR745 has never been retracted, is there possibility of running “legitimate expectation” argument in relation to deals which have already taken place? • Should shareholders be looking to retain “sentimental” 5% stake following own share purchases? • And remaining as part-time employee?

15. TAKE CARE WITHPERCENTAGES • Castledine v HMRC (2016). • In order to qualify for ER on disposal of shares, it is necessary for individual, throughout period of 12 months, to have: • held at least 5% of O.S.C. and voting rights; and • been officer or employee. • Definition of O.S.C. in S989 ITA 2007.

16. TAKE CARE WITHPERCENTAGES (CONT) • O.S.C. 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”.

17. TAKE CARE WITHPERCENTAGES (CONT) • Case concerned disposal of loan notes in company where taxpayer held exactly 5% of ordinary shares. • Unfortunately, company had also issued some deferred shares with no right to dividends or votes. • In reality, these deferred shares were worthless.

18. TAKE CARE WITHPERCENTAGES (CONT) • But they counted as O.S.C. and so taxpayer’s interest in company dropped to 4.99%. • Company was not “personal company” – disposal of loan notes did not qualify for ER. • Consideration of decision in stamp duty case of Collector of Stamp Revenue v Arrowtown Assets Ltd (2003).

19. TAKE CARE WITHPERCENTAGES (CONT) • In that case, issue of deferred shares purely for tax planning reasons was ignored. • Why, then, was decision in Castledine case different? • Important for tax advisers to keep careful eye on shareholders’ percentage interests, particularly where there are unexercised share options.

20. MEANING OF “ORDINARYSHARE CAPITAL” • McQuillan v HMRC (2016). • Company formed in 2004 – initial share capital was: M – 33 ordinary shares; Mrs M – 33 ordinary shares; P – 17 ordinary shares; and Mrs P (M’s sister) – 17 ordinary shares.

21. MEANING OF “ORDINARYSHARE CAPITAL” (CONT) • Subsequently, Mrs P and her husband lent £30,000 to company. • Company prospered. • Company approached Invest Northern Ireland for grant – agreed on condition that loan was converted into shares. • On 12 June 2006, converted into 30,000 redeemable ordinary shares.

22. MEANING OF “ORDINARYSHARE CAPITAL” (CONT) • These shares carried no votes and were redeemable at par (but no earlier than March 2009) – they had no dividend entitlement. • Company was taken over at end of 2009. • Redeemable ordinary shares repaid on 14 December 2009. • Dividend of £700 per share paid on 23 December 2009.

23. MEANING OF “ORDINARYSHARE CAPITAL” (CONT) • Takeover completed on 1 January 2010. • Question: were M and his wife entitled to ER for 2009/10? • HMRC refused claim on ground that redeemable shares counted as O.S.C. and so 5% shareholding test was not satisfied. • Dividend of 0% = dividend at fixed rate? • Comparison with VAT.

24. MEANING OF “ORDINARYSHARE CAPITAL” (CONT) • First-Tier Tribunal decided that it was. • Therefore, redeemable ordinary shares were excluded – Mr and Mrs M allowed to claim ER. • Victory for common sense, but goes against long-standing HMRC view. • Also at odds with decision in Castledine v HMRC (2016) – will HMRC appeal?

25. REIMBURSEMENT OFPURCHASER’S COSTS • S38 TCGA 1992 deals with permitted deductions when calculating gain on sale of property (and other assets). • Normally, these relate to costs which are paid by vendor. • In O’Donnell v HMRC (2017), question before First-Tier Tribunal was whether this also covered vendor’s reimbursement of purchaser’s costs.

26. REIMBURSEMENT OFPURCHASER’S COSTS (CONT) • Fees and other amounts paid for various professional services are expressly allowed, together with transfer or conveyance costs incurred wholly and exclusively for purposes of disposal. • In O’Donnell case, Tribunal decided that vendor’s reimbursement of purchaser’s legal costs qualified for relief – sale was thereby facilitated.

27. REIMBURSEMENT OFPURCHASER’S COSTS (CONT) • However, in order to qualify for this deduction: • any such payment made by vendor must be by way of reimbursement; • amount reimbursed must fall within S38 TCGA 1992; and • there was no reason for reimbursement other than to ensure that sale went ahead.

28. APPROPRIATION TOTRADING STOCK • Where chargeable asset is appropriated for use as trading stock, trader is deemed to have sold asset for current MV. • Potential difficulty of collecting CGT – “dry” tax charge. • Election under S161(3) TCGA 1992: • no gain or loss; but • MV of asset in trading accounts is adjusted.

29. APPROPRIATION TOTRADING STOCK (CONT) • Converts capital gain into trading profit – but is this always desirable? • Time limit for making election. • Hitherto, election has also been valid where there was allowable loss – effect was to replace loss with more flexible trading deduction. • Widely used planning point in recent times for, eg. property developers.

30. APPROPRIATION TOTRADING STOCK (CONT) • However, election facility has been removed for appropriations to trading stock made on or after 8 March 2017 where loss arises. • Loss now has to remain as capital item. • Election can still be made for chargeable gains.