When Is Share Capital Not Share Capital?

The Upper Tribunal (UT) has allowed an appeal by HM Revenue & Customs in a case concerning the meaning of “ordinary share capital”. The decision has important implications not only for entrepreneurs’ relief, but also for tax-advantaged share schemes, enterprise investment schemes and seed enterprise investment schemes.

In the case of McQuillan v HMRC, the UT has decided that redeemable shares which carry no right to a dividend should be treated as “ordinary share capital” under section 989 of the Income Tax Act 2007. Section 989 defines “ordinary share capital” as, broadly, all the issued share capital of a company, however described, other than share 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.

The First-tier Tribunal (FTT) had decided that shares with no right to a dividend should be regarded as having a right to a dividend at a fixed rate of 0%. They would therefore not be treated as ordinary share capital. The effect, on the facts in the McQuillan case, was to reduce the total number of ordinary shares in the company concerned, enabling taxpayers to reach the entrepreneurs’ relief threshold of 5% of the ordinary share capital.

The FTT decision gave rise to considerable uncertainty since it was viewed as inconsistent with other related tax cases and with HMRC published guidance.

The UT has now overturned that decision, holding that a right to a dividend at a fixed rate of 0% is either a right to nothing or no right at all. Shares of such a class should not, therefore, be treated as carrying a right to a dividend, and so are part of a company’s ordinary share capital.

The UT decision has restored certainty of tax treatment in this area; we are now back to where we thought we were before the FTT decision. Although the taxpayers were unsuccessful in the McQuillan case itself, the UT decision is, in fact, favourable to taxpayers more widely. For example, it will allow the use of shares without dividend rights to be used for tax-advantaged share schemes which require shares to be part of a company’s ordinary share capital.

This remains, however, a complex area where valuable tax reliefs can be lost as a result of a misunderstanding or oversight.

Specialist tax advice should be sought to avoid unintended tax consequences.