There are various tax regimes designed to incentivise managers to invest in and grow the companies they work for. In particular managers who hold a 5% or greater interest in a trading company can qualify for entrepreneurs’ relief so that they are only subject to capital gains tax at the rate of 10% on the first £10 million of lifetime gains, a potential saving of up to £1m at no cost to the other shareholders.

However, great care needs to be taken to ensure that the conditions for relief are satisfied. This issue needs to be considered not only when the manager first subscribes for shares, but also when other shares in the company are issued or when share rights are altered.

In particular, an individual shareholder must hold at least 5% of the company’s ordinary share capital by nominal value and must be able to exercise at least 5% of the voting rights. Ordinary share capital is defined for these purposes 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.” This means that deferred or redeemable shares with little or no economic value may need to be taken into account in deciding whether the test is met. Consequently, it is all too easy for a manager to lose their entitlement to entrepreneurs’ relief if additional shares with the wrong sort of rights are issued or the rights of existing shares are changed.

Two recent cases have considered the question of whether shares which have no right to receive dividends are ordinary share capital for the purposes of determining whether or not a shareholder is entitled to entrepreneurs’ relief. In Castledine v HMRC [2016] UKFTT 145 (TC) the First Tier Tribunal held that deferred shares with no rights to dividends were not fixed rate preference shares and so were ordinary share capital. This meant that the taxpayer in that case was not entitled to entrepreneurs’ relief as he only held 4.99% of the issued share capital taking those deferred shares into account.

However, in McQuillan v HMRC [2016] UKFTT 305 a differently constituted First Tier Tribunal held that shares bearing no voting rights, no right to dividends and which were only redeemable at par did carry a right to a dividend at a fixed rate and so were not ordinary share capital. This meant that the holders of the other ordinary shares, carrying all the economic rights, were entitled to entrepreneurs’ relief. Clearly the decisions are contradictory. Decisions of the First Tier Tribunal are not binding precedents so the law remains unclear at least until a higher court considers the issue. HMRC’s published view and advisers’ practice has to date followed the Castledine position.

As a practical matter, the assumption should be that shares with no rights to dividends or to a premium on redemption risk being ordinary share capital and thus need to be counted in determining whether or not a manager is entitled to entrepreneurs’ relief.

It is thus important to consider the possible effect on the entrepreneurs’ relief position of managers whenever new shares are issued or existing shares have their rights changed. It may also be helpful for other parties to look after the interests of the managers when any transaction that might be relevant to their entrepreneurs’ relief entitlement is being considered.

In any event, and given the current uncertainty on the point, it will be simplest to ensure that deferred shares carry a right to (a) a small fixed rate dividend if the intention is that they are not ordinary share capital when they become deferred shares or (b) a small amount of variable profit if the intention is that they are ordinary share capital when they become deferred shares.