Mark McLaughlin highlights a case where imprecision in a share transaction nearly cost a taxpayer the loss of tax relief.
Most trading company owners wishing to claim capital gains tax (CGT) business asset disposal relief (BADR) on an eventual sale of their shares need to satisfy certain conditions throughout a two-year period ending with the disposal.
The 5% tests
One of those conditions is that the company is the individual’s ‘personal company’ (TCGA 1992, s 169S(3)). This broadly means that:
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the individual holds at least 5% of the company’s ordinary share capital;
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that holding gives at least 5% of voting rights in the company; and
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it also gives beneficial entitlement to at least 5% of distributable profits and at least 5% of distributable assets on a winding-up, or beneficial entitlement to at least 5% of the proceeds in the event of a disposal of the company’s entire ordinary share capital.
These 5% personal company tests are absolute. For example, in Kavanagh v Revenue and Customs [2022] UKFTT 193 (TC), a taxpayer whose registered share ownership and voting rights amounted to 4.997285706531% was unsuccessful in his entrepreneurs’ relief (ER, now BADR) claim, as there was insufficient evidence to support the taxpayer’s claim that other shareholders held the balance making up 5% on trust for the taxpayer.
Putting it right
However, failing a 5% test for BADR purposes is not necessarily the end of the matter. In some cases, the legal principle of ‘rectification’ for mistakes might save the day.
For example, in Cooke v Revenue and Customs [2024] UKFTT 272 (TC), two individuals (BR and JC) founded a company (ISGH). It was agreed with BR and JC that the taxpayer would buy 5% of the company. The taxpayer was focused on holding at least 5% because he knew this was a condition for obtaining ER on a subsequent disposal. In February 2019, the taxpayer disposed of his shares in ISGH to a third party, realising a gain. The taxpayer claimed ER on his tax return, but upon enquiry by HM Revenue and Customs (HMRC), he became aware for the first time that his shareholding was only 4.9998%.
The taxpayer appealed against HMRC’s refusal to allow ER. He argued that in High Court proceedings, the court would order the rectification of documents to secure that during the relevant time preceding the disposal the taxpayer held at least 5% of the ordinary share capital in ISGH; furthermore, the FTT should proceed as if such rectification had been ordered. The taxpayer relied on the Upper Tribunal’s decision in Lobler v HMRC [2015] UKUT 152 (TCC) regarding the FTT’s jurisdiction. The FTT (following the decision in Lobler) considered that the FTT had jurisdiction to consider what the High Court would do, were rectification for mistake to be requested of it.
The FTT noted the oral evidence from all parties that a minimum of 5% was a “clear red line” for the taxpayer, because he wanted to qualify for ER. However, the company paperwork did not reflect the parties’ intentions. The FTT concluded that the High Court would, if asked to consider the matter, grant rectification of the documents. The major effect of this would be that the conditions for ER would then have been met.
Practical tip
The taxpayer in Cooke arguably had a lucky escape. Prevention is better than cure – so ensure that the 5% tests are satisfied before the shares are acquired.
