Ordinary Share Capital and Entrepreneurs' Relief
In Castledine v Revenue and Customs Commissioners it was determined that shares may fall within the definition of ordinary share capital contained in section 989 of the Income Tax Act 2007
Even where they contain none of the characteristics usually associated with ordinary shares.
Background
Mr Castledine held exactly 5% of the shares labelled A and B 'ordinary' shares in Dome Holdings Limited (DHL) and, relying on this being the case, claimed entrepreneurs' relief in respect of disposals of loan notes in 2011 and 2012.
In addition to the A ordinary and B ordinary shares there also existed a number of shares in the company labelled 'deferred' shares, which under DHL's articles of association had no voting rights or rights to dividends. These 'deferred' shares were created solely as a hassle-free mechanism to remove shares from senior management in certain circumstances. Under the company's articles, B ordinary shares are automatically converted into 'deferred' shares on the occurrence of certain events, such as bankruptcy or death of the owner, thus being stripped of any economic value.
However a number of DHL's financial reports classed the 'deferred' shares as 'ordinary' shares. If the deferred shares were to be counted as ordinary shares then Mr Castledine's shareholding would be 4.99% of the ordinary share capital of DHL and he would therefore not be eligible for entrepreneurs' relief.
The First-Tier Tribunal's Decision
For the purpose of determining eligibility for entrepreneurs' relief, section 989 of the Income Tax Act 2007 defines ordinary share capital as 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. On a strict reading this would include the 'deferred' shares of DHL as part of the company's ordinary share capital.
The Tribunal considered the argument of counsel for Mr Castledine that the 'deferred' shares were shares in name only and that it could not have been parliament's intention to categorise shares with none of the characteristics of ordinary shares as ordinary shares.
However the Tribunal did not feel it was justified in departing from the plain meaning of the text of the statute and as such concluded that the deferred shares did fall within the definition of ordinary share capital contained in the Income Tax Act 2007.
This meant that Mr Castledine held only 4.99% of the ordinary share capital of DHL and therefore did not meet the conditions for eligibility for entrepreneurs' relief as stated in the Taxation of Chargeable Gains Act 1992.
Best Practice
When Mr Castledine's shares were allocated to him, the intent was to allocate to him 5% of the ordinary share capital of the company. The case demonstrates the importance of paying close attention to statute when trying to determine or, as in this case, trying to ensure eligibility for entrepreneurs' relief. Had the parties done so in this case, it would have been a simple matter of allocating to Mr Castledine a number of additional shares with no rights or value, in advance of the disposals of his loan notes, in order to bring his shareholding up to the required proportion of the company's share capital.