24 July 2019 by Russell Cockburn
This month’s column looks at a few recent tax case judgements of interest to those involved in the owner managed business sector and in particular the nature of the voting rights and other rights attributable to shares when determining whether or not capital tax reliefs can be claimed.
In S Warshaw V HMRC [TC7107] the chairman of a holding company held both ordinary and preference shares.
In March 2012 he exchanged all his shares for shares in another company and one day later exchanged them again for shares in a further company, CEH Ltd., in which he became a director in October 2012.
The shares were sold in December 2013 and Mr W resigned as a director. He then claimed entrepreneurs’ relief in respect of the capital gain but HMRC refused it on the basis CEH Ltd was not his "personal company as defined in TCGA 1992, s 169S(3))".
The case turned upon whether or not the preference shares came within the definition of ‘ordinary share capital’. If they did Mr W held 5.777% of CEH Ltd. but if they did not then he held only 3.5%.
The tribunal decided that under the company’s articles of association, in this case Mr W’s shares, the shares did not have a right to a fixed rate dividend and as such could be regarded as ordinary share capital, (as defined in in ITA 2007, s 989). It was therefore a logical conclusion to draw that CEH Ltd was indeed the claimant’s personal company and that he was entitled to Entrepreneurs’ Relief on the disposal of the shares, thus his claim under the appeal was allowed.
A scrutiny of the articles of association showed that in this case the preference shares did carry the right to a fixed 10% annual dividend at 10% a year but if the circumstances arose that there were insufficient reserves to pay it then it would be deferred until it could be paid.
In these circumstances the Tribunal took the view that the earlier case of Tilcon v Holland  STC 365 could be taken to support the view that under this company’s articles, because only the payment percentage was fixed and not the amount to which it ought to be applied from time to time then the shares could be within the definition of ordinary shares.
As the Entrepreneurs' Relief legislation continues to go through statutory revision, with changes in both the 2017 and 2018 Finance acts and again this year, it becomes more and more apparent that the adviser and shareholders need to take careful note of the percentages rules which are applicable in determining entitlement to the is most valuable of capital gains reliefs and the case is a clear indicator of this.
Another such recent judgement is P Hunt v HMRC,  UKFTT 210 in which the Tribunal confirmed that when considering the 5% test which determines whether or not a company is indeed someone’s personal company for the purposes of the Entrepreneurs' Relief rules it is the nominal value of the issued share capital in the relevant company which must be taken into account.
When an individual sold his shares in a company it was claimed that he held 5.894% of the total shares issued but this only amounted to 4.16% of the 'nominal value' of the total issued share capital at that time. So that HMRC disputed his entitlement to the relief against his capital gains tax liability.
The tribunal reviewed statute and case law and ruled that because the statutory definitions was 'issued share capital' not 'issued shares' the 5% test is therefore to be applied to the total nominal value of the shares owned by the claimant compared to company’s total issued share capital and whilst Mr Hunt might arguably have been within the purpose of the legislation he actually failed to satisfy its precise terms and so could not have the relief he had claimed.
Now whilst it might be argued that this is an extraordinarily narrow interpretation of the legislation, it is becoming clear that HMRC is increasingly looking very closely at the conditions of entitlement to this relief so that anyone claiming will need to take careful note of how it applies in cases where they have small shareholdings but a large potential gain.
For some years now a much vexed area of argument among professionals and between professionals and HRMC has been the valuation of goodwill of professional businesses and whether indeed such business can actually be said to have any saleable or free goodwill separable from
the individuals who own and run the business at all?
In R Villar V HMRC [2019} UKFTT 117 the owner of a medical practice sold it to a buyer for £1 million and the vendor maintained that this amounted to a capital gain.
However, unusually, HMRC argued that the disposal gave rise to an income tax liability on the basis that the payment he had received arose from goodwill which could not have been sold because it was attributable solely to the vendor personally, i.e. it could not be separated from and as such payments arising from it must in effect have amounted to income from its exploitation.
The core of HMRC’s argument was that the vendor has effectively commuted the exploitation of his personal goodwill in exchange for a lump sum instead of a future income stream.
The Tribunal however took a much more straightforward approach concluding that the taxpayer here had undoubtedly considered that he had sold a business and as such this was clearly the disposal of his chief capital assets as part of the sale of that business.
A secondary argument was then raised by HMRC that the payment received should be taxed under the anti-avoidance provisions of section 773 ITA 2007, (charge to income tax on capital sums received to exploit an individual’s earning capacity).
However, the Tribunal again took the view that the taxpayer had simply intended to sell his business and had no intention to continue to work in it or receive 'income' from it so that this legislation could also not be applied; the vendor had clearly not intended to continue to receive the profits of his
practice after the sale.