Claiming Entrepreneurs’ Relief

Pay attention to the detail when claiming Entrepreneurs’ Relief

Once a contractor has decided to call time on their company there is the important matter of getting their hands on what remains left in the company, which is normally a large pile of cash – hopefully. This can either be extracted as a dividend or as capital. With dividend taxation rates reaching as high as 32.5% for higher rate payers and 38.1% for additional rate payers, the attraction of treating the final distribution as capital, claiming Entrepreneurs’ Relief (ER) and paying Capital Gains Tax at a rate of 10% will be rather more appealing.

A claim for ER can only succeed however if certain conditions are met. Throughout the period of one year ending with the date of disposal the company must be the individual’s personal company, which is a trading company, and the individual is an officer or employee of the company. ER could therefore be lost if a contractor resigns as a director/officer before disposing of their shares. This is exactly what happened to Mr John Moore when, earlier this year, the First Tier Tax Tribunal upheld HMRC’s decision to deny the taxpayer ER costing Mr Moore nearly £37,500 in tax.

Background

Mr Moore had been the Sales and Marketing Director in Alpha Micro Components Ltd (Alpha) and was employed under a contract of employment. He also held 3,000 shares in the company.

During the course of 2008 the direction of Alpha became a matter of dispute between Moore and the other shareholder directors and it was agreed that Moore would leave the business. Settlement talks took place in November 2008 which lasted for a few months, until on 17th February 2009 Alpha set out the terms for contractual settlement in an unsigned and undated document that was delivered to their solicitors by e-mail. This stated that Alpha would purchase 2,700 of Moore’s shares, with the remaining 300 shares to be converted to non-voting shares. Furthermore, Moore’s employment would be terminated for which he would receive an ex-gratia payment and he would resign as a director.

On 29th May 2009, there was a general meeting of the company where it was resolved that Alpha would purchase 2,700 shares from Mr Moore. That same day, Moore signed a compromise agreement for the termination of his employment and Companies House papers concerning his resignation as a director. However, the documents stated the effective date of Moore’s resignation as being 28th February 2009.

HMRC refused Mr Moore’s ER claim on the share disposal on the grounds that he was not an officer or employee of the company throughout the period of one year, ending with the disposal of his shares on 29th May 2009. Moore therefore appealed and it was left for the Tribunal to decide upon the matter.

Tribunal hearing

In his initial appeal to the Tribunal, Moore stated that he had disposed of his shares on 29th May 2009, which was also the date he resigned as a director. Incumbent directors also gave written evidence to that effect. However, Moore changed his tune and by the time of the hearing he had accepted that he had ceased employment with Alpha on 28th February 2009. He had even set up his own company, JM Technology Solutions Ltd, on 23rd March 2009, to provide services to Alpha.

The only matter for the Tribunal to decide therefore, was whether or not there was an unconditional contract for disposal of the shares by 28th February 2009. If so, then this would be the date the share disposal took place and a claim for ER would succeed.

Sections 693 and 694 of the Companies Act 2006 requires any contract for a company’s own purchase of shares be approved in advance by a special resolution. In this case, resolution was not passed until 29th May 2009 and the company was therefore incapable of entering into a valid contract to purchase the shares until that resolution had been passed. This meant that the disposal of shares did not take place until 29th May 2009 and because Moore had ceased to be a director on 28th February 2009, he did not satisfy the test of being an officer or employee for the one year up to 29th May 2009. Moore therefore lost his appeal.