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Capital gains tax

Tribunal disagrees with HMRC’s guidance on entrepreneurs' relief

The First-tier Tribunal has found that cumulative preference shares constituted ordinary share capital for entrepreneurs' relief purposes. Why did HMRC get it wrong?

Case facts. In Warshaw (W) v HMRC, the taxpayer (W) had claimed entrepreneurs' relief (ER) in respect of a capital gain on a mixture of ordinary and preference shares. One of the qualifying conditions for ER is that a taxpayer holds at least 5% of the ordinary share capital and W would only meet this condition if his preference shares were included. HMRC decided that W’s preference shares did not constitute ordinary share capital based on the definition in s.989 Income Tax Act 2007 and demanded over £1m in tax.

Appeal. W appealed to the First-tier Tribunal (FTT) on the basis that his cumulative preference shares did meet the definition of ordinary share capital because he was not entitled to a dividend at a fixed rate. As the shares were cumulative, W was entitled to a dividend of 10% which was deferred until a later year where there were insufficient reserves. During those years the 10% would be calculated on an increased amount. HMRC argued that the rate was fixed at 10% whereas W argued that the rate was not fixed because it was calculated in reference to any previous unpaid dividends.

Decision. The FTT held that both the percentage element and the amount to which it applies need to be taken into account to identify the rate of a dividend. In this case the articles provided that the percentage rate was fixed, but the amount it applied to may vary and so the preference shares did not carry a right to a dividend at a fixed rate. The shares therefore met the definition of ordinary share capital and the appeal was allowed.

Tip. This decision contradicts HMRC’s guidance which can be found here https://www.tax.org.uk/sites/default/files/180918_OSC%20Aide%20Memoire%20with%20caveats.pdf. This highlights the importance of reviewing the applicable legislation and case law in priority to HMRC guidance.

The full transcript can be found here http://financeandtax.decisions.tribunals.gov.uk/judgmentfiles/j11071/TC07107.pdf.


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