The Upper Tribunal case of McQuillan v HMRC has provided important certainty for taxpayers regarding the meaning of "ordinary share capital" in the tax legislation. The definition is crucial in determining the required percentages both for entrepreneurs' relief (ER) and other tax purposes.
"Ordinary share capital" is defined as being: 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. (S.989 ITA).
Advisers have always understood that if a share class has no right to dividends at all, then the share class must always be ordinary share capital. This is because there is no right to a dividend at a fixed rate – which is required to take it outside of the definition.
At the same time, there has been an argument that a right to no dividends at all amounts to a right to a dividend at a fixed rate of 0%, therefore potentially bringing the share class outside of the definition. However, this was not thought to be the correct analysis.
Yet the First-tier Tribunal McQuillan case last year found for the taxpayer (who was claiming ER) on the basis that there could be a right to a dividend at 0%. In this case, the taxpayer could only qualify for ER so long as a new class of redeemable non-voting shares were excluded from being "ordinary share capital". The taxpayer successfully argued that, as the redeemable shares had no right to participate in dividends, there was a fixed 0% right which took the shares outside of the definition and allowed them to claim ER. The decision created a lot of uncertainty in applying the legislation – being contrary to other cases and HMRC guidance.
However, the case was appealed by HMRC and the Upper Tribunal has now found that the tribunal had erred in law and that there is no way that a share class without dividend rights could be said to have a right at 0%: In our judgment, s 989 permits of only one interpretation, and does not countenance a right to no dividend being a right to a dividend at a fixed rate. The court found that there was no basis whatsoever for arguing that a 0% entitlement was a right to a dividend at a fixed rate and, whilst expressly sympathy for the taxpayer who could not benefit from ER, came down decisively for HMRC.
The case has therefore restored certainty regarding the interpretation of "ordinary share capital". Taxpayers and advisers can now be sure about what share classes should and should not be taken into account in determining ER entitlement. Taxpayers should be aware that, if for instance a worthless class of deferred shares is created, there may be an impact on ER entitlement unless the class is given a fixed right to dividends. It is important to take proper tax advice before any such share reorganisation is entered into to prevent unwanted tax consequences.