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Ordinary share capital: reconciling the irreconcilable

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Earlier this year, the First-tier Tribunal handed down decisions in two cases concerning the meaning of ordinary share capital, McQuillan v HMRC and Castledine v HMRC. In both cases, the court had to decide whether shares with no rights other than to redemption at par were ordinary share capital. The availability of entrepreneurs’ relief depended on this point. In McQuillan, the court held that the shares were not ordinary share capital; in Castledine, it held that they were. The question is: how did the tribunals end up reaching diametrically opposed conclusions on the same legal question? The answer may lie in the different approach adopted by each tribunal to the process of purposive construction; and the particular purposive constructions sought by the taxpayers regarding the meaning of ordinary share capital.

Never has the adage about waiting for a bus only for two to come at once been better exemplified for tax practitioners than with the recent succession of First-tier Tribunal decisions in McQuillan v HMRC [2016] UKFTT 305 (reported in Tax Journal, 20 May 2016) and Castledine v HMRC [2016] UKFTT 145 305 (reported in Tax Journal, 19 March 2016). Both cases concern the meaning of ‘ordinary share capital’ (OSC), a key term of the tax code, which dates to 1938 but has avoided judicial consideration until now. Unfortunately for the waiting passengers, however, a crash has occurred at the bus stop, as the two decisions are clearly inconsistent. We consider here how this came about and what can be done to mitigate the uncertainties that have arisen.


The McQuillans established a company in association with the Pennicks. On incorporation, the company had an issued share capital of 100 £1 ordinary shares, of which the McQuillans each held 33 and the Pennicks each held 17. Subsequently, the Pennicks made a loan to the company of £30,000. In order to secure government grants, this loan was converted into 30,000 non-voting, redeemable shares of £1 each. The redeemable shares did not carry any dividend rights.
When the company was sold in 2009, the McQuillans claimed entrepreneurs’ relief (ER) on the gain they realised from the sale of their shares. HMRC contended that ER was not available, on the basis that the company was not the McQuillans’ ‘personal company’. Ultimately, this turned on whether the redeemable shares fell within the definition of OSC at ITA 2007 s 989:
‘in relation to a company … all the company’s issued share capital (howsoever 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’ (emphasis added).
HMRC’s contention, consistent with its published guidance (e.g. para ETASSUM43160 of the Employee Tax Advantaged Share Scheme User Manual), was that the redeemable shares, carrying no right to a dividend, could not satisfy the carve-out (highlighted in italics above) from the definition of OSC. It contended that they should therefore be treated as part of the company’s OSC for ER purposes. Consequently, the claims for ER failed.
The tribunal, however, allowed the McQuillans’ appeal, on the basis that:
  • s 989 was not entirely unambiguous and was therefore the proper subject of a common sense (i.e. purposive) approach to interpretation;
  • the purpose of s 989 was to distinguish between things which should be properly regarded as part of a company’s risk capital and that part of a company’s share capital which was more akin to debt (i.e. fixed rate preference shares); and
  • it was consistent with this purpose to hold that shares with no right to a dividend should be treated as shares which carried a dividend at a fixed rate of zero, with the effect that the redeemable shares fell within the carve-out at s 989.
In reaching this conclusion, the tribunal was particularly persuaded by the fact that had the redeemable shares been issued with a right to a miniscule fixed dividend, HMRC would have accepted that they were not OSC. It is clear that the tribunal could see no good policy reason why such shares should not be treated as OSC but zero-dividend shares should be.


Mr Castledine disposed of loan notes issued by a company (DHL) and claimed ER on a heldover gain in respect of the DHL shares he had previously sold. DHL’s issued share capital comprised four classes, including redeemable shares with no voting rights and no rights to dividends. The only right of the redeemable shares was a right to be redeemed at par on a capital realisation after at least £1,000,000 had been distributed in respect of each of DHL’s B ordinary shares.
As in McQuillan, the question before the tribunal was whether the redeemable shares formed part of DHL’s OSC for ER purposes. If they did, then Mr Castledine’s claim for ER failed, on the ground that DHL was not his ‘personal company’.
For whatever reason, Mr Castledine did not raise the argument from McQuillan that a zero-dividend share should be regarded as a share with a right to a dividend at a fixed rate. His argument instead was essentially that ‘parliament would never have intended to categorise as ordinary shares holdings which had none of the characteristics of an ordinary share, or even of a preference share, and were shares only in name’. Thus, applying a purposive construction of s 989 to the facts viewed realistically, the redeemable shares should be disregarded for the purposes of that provision.
This purposive approach was rejected by the tribunal. The taxpayer had failed to adduce any evidence in the form of extra statutory materials to persuade the tribunal that the correct interpretation of s 989 should be a broader (or more nuanced) one going beyond the literal words of that provision. Furthermore, even if a purposive approach were justified, the tribunal was not persuaded that the redeemable shares were shares only in name when viewed realistically. They had been created as part of a wholly commercial arrangement to facilitate the removal of B ordinary shares from the company’s management when they left the company and as such could not just be disregarded. The redeemable shares were OSC.


How did the McQuillan and Castledine tribunals end up reaching diametrically opposed conclusions on the same legal question when faced with fact patterns that were, in critical respects, identical?
The answer may lie in the different approach adopted by each tribunal to the process of purposive construction and the particular purposive constructions sought by the taxpayers regarding the meaning of OSC.
In McQuillan, the tribunal had little difficulty in discerning the purpose of s 989. The tribunal was no doubt assisted in this by the fact that the purported purpose was one that had actually been put forward by HMRC’s counsel. The taxpayer was then able to provide a way of reading s 989 (i.e. that zero-dividend shares should be regarded as having a dividend at a fixed rate of zero) that accorded with the tribunal’s finding as to the provision’s broader purpose.
The tribunal adopted this construction and was thereby able to avoid the anomaly, referred to above, of shares with a miniscule fixed dividend being treated as OSC but shares with no dividend falling outside that definition. Consequently, the redeemable shares in McQuillan (having no dividend rights) were shares with ‘a right to a dividend at a fixed rate’.
The contrast with the approach taken by the tribunal in Castledine is marked. While the Castledine tribunal was willing to speculate on the purpose of s 989, it felt unable to make any findings due to a lack of available extrinsic evidence on this. To infer from Castledine, however, that purposive construction is only available in cases where the purpose of the relevant provision can be gleaned from extra-statutory sources would be mistaken. There are many examples of courts adopting a purposive approach without such aids (e.g. by considering the wider scheme of the relevant legislation).
It seems that the Castledine tribunal was concerned with whether it could fix ‘evident drafting errors’, rather than with purposive construction as that process is more generally understood. Fixing statutory drafting errors requires a court to add, omit or substitute words. In order to do this, the court needs to be certain as to what the substance of the provision would have been but for the drafting error in question. In that case, it is unsurprising that the tribunal was not comfortable ‘rewriting’ s 989 without some form of extra-statutory guidance on what the rewritten section should be.
Furthermore, the construction put forward by the taxpayer in Castledine would have required consideration on a case by case basis of the commercial substance of the shares in question to determine whether they should be regarded as OSC. For obvious reasons, the tribunal was not willing to introduce this level of uncertainty into a well-established part of our tax code. Compare this with the construction adopted in McQuillan, which, while broadening the scope of s 989, does not make it any less certain or prescriptive.
So which decision is the right one? While the findings in McQuillan on the purpose of s 989 are persuasive, it is not obvious that they justify the construction of s 989 adopted by that tribunal. The tribunal may have been right to say that zero is a number and that a rate of zero may therefore be a fixed rate; however, in order to fall within the carve-out at s 989, there needs to be a ‘right’ to a fixed dividend. It is difficult to see how a share carrying no dividend can be said to give the shareholder a right: a right to nothing is surely not a right at all. For this reason, the somewhat reluctant opinion of the authors is that the decision in Castledine is correct, despite the potential unfairness this gives rise to, as demonstrated by the facts of both cases.

Practical suggestions

These inconsistent decisions have created uncertainty. The following practical suggestions on how to approach and deal with this uncertainty may prove helpful:
  • Where shares are intended to fall outside the definition of OSC, it would be prudent to include a right to a fixed dividend, even if the rate is small. Seeking to rely on McQuillan to issue shares with no dividend right so that they fall outside the definition of OSC would be risky, especially in light of Bielckus v HMRC [2016] TC05044, where the tribunal approved the approach to construction of s 989 adopted in Castledine.
  • While including a right to a small fixed dividend solely for the purpose of creating shares that are not OSC may be artificial, HMRC apparently recognises the effectiveness of such structuring (e.g. given its submissions in McQuillan). HMRC takes a similar, practical approach in relation to the use of currency conversion clauses to obtain non-QCB status.
  • Where a right to a fixed dividend is included to secure non-OSC status, it may be necessary to consider whether DOTAS applies, particularly in light of the new ‘financial products’ hallmark, as a result of which notification to HMRC may be required where a term has been included in a ‘financial product’ (such as a share) to secure a tax advantage.
  • Existing arrangements involving deferred, zero-dividend shares should be scrutinised and, if necessary, restructured.
  • Care should be taken by tax advisers in extrapolating HMRC’s approach to OSC in Castledine and McQuillan to other areas of the tax code where that term is used. Whether zero-dividend shares are or are not OSC for the purposes of different parts of the tax code should be considered on a case by case basis; for example, the authors suspect that HMRC may not be willing to treat zero-dividend shares as OSC for the purposes of securing rollover relief under TCGA 1992 s 135. Where the question is critical to a desired tax outcome, early engagement with HMRC is advisable.