On 29 November 2016, the First-tier Tribunal9 held that the issue of growth shares to certain key employees had inadvertently caused an existing class of ordinary shares to carry a preferential right to assets on a winding up. The effect of this was that both prior ordinary share issues, and future share issues, failed to meet the requirement of the Enterprise Investment Scheme (EIS) rules.

The company had already issued two rounds of ordinary shares (and had successfully sought EIS relief) by the time it decided to issue the growth shares. As part of the growth share issue the company’s articles were amended so that, on a return of assets on liquidation, the ordinary shareholders would be paid in priority to growth shareholders (up to the amount of a “hurdle” of £8.8m).

The company then sought EIS relief in respect of a third round of ordinary share subscription. This was rejected by HMRC, who also withdrew the earlier EIS relief granted in respect of the earlier two rounds.

The Tribunal held that HMRC was correct in doing so as:

• the effect of the amendment to the articles was that the ordinary shares now carried a preferential right on winding up (contrary to the strict EIS legislation requirements). This was, in the Tribunal’s eyes, the case whether or not the “hurdle” was reached and whether or not the company had intended to give the ordinary shareholder any such preference

• as the articles were amended within three years of rounds one and two, the effect of doing so was that the statutory requirement that no preferential rights may exist throughout the period to the 3rd anniversary of issue was not met. It was therefore correct to withdraw the EIS relief previously given

• the fact that the liquidation of the company (and, therefore, the triggering of the preference) was highly unlikely was, according to the Tribunal, irrelevant.

The Tribunal’s decision confirms the strict nature of the EIS legislation. The inadvertent effects of decisions taken for genuine commercial reasons can, as in this case, result both in future share issues failing to qualify for EIS and in EIS relief being withdrawn for previous share issues. The Tribunal’s decision also appears to go against a view expressed publicly by HMRC.

The decision can be viewed here.