A retired business owner has won a buyback of shares dispute with HMRC that would have increased his tax bill by more than £1m.
John Boulting had appealed against HMRC’s decision that a company purchase of shares should be taxed as a distribution and not as a capital gain, for which Entrepreneurs’ Relief could be claimed.
The First-tier Tax Tribunal (FTT) has now backed the taxpayer, ruling the purchase of own shares was for the “benefit of a relevant trade”.
Here, I explore the case and give my view on the decision and what it means for taxpayers and tax agents.
Background to the John Boulting v HMRC tax appeal
In 2013, it was decided John Boulting (JB) would retire as a director of PSC Training and Development Group Ltd (PSC) to allow his son Mark (MB) to take forward a new management strategy. It was proposed JB would give 38 shares to MB and sell eight shares to the company. He would retain four shares to be given to his grandchildren.
In January 2015, PSC bought JB’s eight shares for £4.8m through a company purchase of own shares (CPOS). These shares were then cancelled.
The company’s accountants told HMRC in February 2015 the purchase had been completed in accordance with the clearance.
But HMRC opened an enquiry into JB’s self-assessment tax return for the 2013-2014 tax year, which led to a closure notice that treated the sale as subject to income tax and not capital gains tax (CGT). This meant Entrepreneurs’ Relief (now Business Asset Disposal Relief) couldn’t be claimed. The amendment increased JB’s tax liability by £1,008,621.
HMRC said the share value used by the company was materially greater than market value and, because this hadn’t been disclosed in the clearance application, the tax body wasn’t bound by the clearance.
The relevant law in the capital gains tax appeal
Section 1033 of the Corporation Tax Act 2010 (CTA 2010) sets out the conditions for a payment by a company in respect of its own shares to be treated as a capital gain and not a distribution.
The only point in dispute was whether the relevant part of Condition A was met, i.e. the purchase is made wholly or mainly for the purpose of benefiting a trade carried on by the company or any of its 75% subsidiaries.
There was no dispute that a relevant trade was carried on within the PSC Group.
The arguments
HMRC argued the purchase wasn’t necessary to benefit the relevant trade. It said there was no clear evidence the purchase was essential to unlock investment or resolve deadlock.
The tax body described the price as “excessive”, and said the purchase was a mechanism to remunerate JB for his historic investment and risk in the business, not to benefit the ongoing trade.
But for JB, the price paid wasn’t viewed as “excessive”. It was argued the purchase was wholly or mainly to benefit the trade because it removed a majority shareholder who had been blocking investment and who wouldn’t relinquish key decision-making responsibility.
What was the purpose of the share purchase?
The FTT found the aim of Mr Boulting’s retirement as a director and relinquishing control was to benefit the relevant business by enabling investments to be made and resolving related management level disputes and tensions.
The tribunal said: “For the avoidance of doubt, we are not conflating effect with purpose: the evidence was clear that the share purchase was undertaken in order to remove Mr Boulting from the business. Whilst the share purchase did not achieve his exit in isolation, it was a prerequisite for the rest of the arrangements to take place and the legislation does not state that the purchase must achieve the purpose in isolation.”
Extraction of cash reserves and valuation
The FTT said: “We do not consider that the share price agreed upon was intended by the company to provide any non-trade benefit: we consider that the evidence shows that the price was arrived at following negotiation and that the board believed that this was the price required to obtain Mr Boulting’s agreement to sell his shares.”
The tribunal added that when deciding what the purpose of the share purchase was, it wasn’t simply about why the company paid £4.8m for eight shares. “That is a factor which may be relevant in considering the test,” it said, “but it is not the statutory test which needs to be applied.”
It also disagreed with HMRC’s argument that the purpose of the share purchase was to extract cash reserves. “That was an effect of the purchase but not, considering all of the evidence before us, the purpose of the purchase,” it said.
FTT ruling on the John Boulting v HMRC tax case
The tribunal found Condition A had been met and therefore allowed the taxpayer’s appeal, which means JB can claim for what is now Business Asset Disposal Relief (BADR).
My reaction to the tax appeal decision
This case is interesting because HMRC argued the share purchase wasn’t necessary to benefit the trade.
This is often a tricky area because many CPOS transactions are used as a mechanism for removing ageing shareholders who may have played (and might still play) a significant part in the business. So, it’s important to consider the purpose of a transaction and whether it’s for the benefit of the trade.
Capital treatment isn’t given to transactions that are simply to help the individual concerned. There must be a real benefit to the trade for removing the shareholder.
Thankfully, the First-tier Tax Tribunal made the correct decision in this case. If the tribunal had reached a different conclusion, it might have affected many future and past transactions.
My advice for taxpayers and tax agents
By default, a company purchase of own shares is taxed as a distribution, making it subject to income tax.
So, for a payment to be treated as a capital gain, you must meet certain conditions and get your clearance application with HMRC right.
