In John Lewis v HMRC [2016] TC05029 share loss relief was allowed when an undocumented loan was converted to shares and the company ceased to trade shortly after.
The taxpayer’s claim was reduced however as their base cost was held to be overstated.
- The taxpayer’s son formed a company in 2009.
- The taxpayer advanced money over time to this company via his son.
- With a view to attracting new investors, the total loan outstanding at 1 March 2011 of over £100,000 was converted into 99,900 shares of £1 each.
- At this time the company was loss making, but talks with a potential investor were at an advanced stage.
- Shortly after these talks fell through due to a reluctance to cede control of the company and as a result the company ceased to trade on 3 May.
- The taxpayer claimed share loss relief under s131 ITA 2007 on the grounds that the shares became of negligible value when the company ceased to trade.
The Tribunal looked at three key areas in reaching its decision:
1. Whether the shares were qualifying shares for s131 purposes:
- It was agreed that the shares were not EIS shares and that the company was trading.
- The key question was therefore whether the shares had been ‘subscribed for’ by the taxpayer. This turned on whether the loan to the company which was converted had been made by the taxpayer or by his son.
- This was complicated by the fact that the arrangements between the taxpayer, his son and the company had not been documented at the time.
- However, based on the evidence of board minutes from the time the shares were issued and the company’s register of shareholders the Tribunal found as a fact that the shares were issued to the taxpayer.
2. Whether the shares had any value when they were issued:
- The company ceased trading just over two months after the shares were issued, and it was agreed by both parties that they were worthless at that time.
- The Tribunal rejected HMRC’s argument that, given the short period of time, the shares also had no value when issued (and therefore there was no loss).
- This decision was based heavily on evidence given by the potential investor, who was seriously considering making a significant investment in the company at around the time the shares were issued.
3. The valuation of the shares when issued:
- The taxpayer claimed a loss equal to the full nominal value of the shares issued.
- HMRC claimed there was no loss as the shares were valueless when issued.
- The Tribunal disagreed with both propositions, and instead reached its own figure of £60,000 based on what the position would have been immediately after an injection of new capital by the potential investor and discounting for a control premium and the possibility the investment might not proceed.
Comment
This case illustrates the importance of documenting investment arrangements when it comes to family companies.
The evidence presented to the Tribunal as to whether the taxpayer or his son had made the loan was described as ‘confusing and contradictory’. Although the Tribunal acknowledged that a full loan and share sale agreement would not have been necessary, they would have expected a simple exchange of letters at least. The saving grace for the taxpayer was that board minutes and the company’s register of shareholders showed the shares as being issued directly to the taxpayer.
The case also highlights the importance of getting your paper work in order and complying with the formalities of a hearing.
In their decision the Tribunal note that they were not informed in advance that the potential investor would be called as a witness. Accordingly, his evidence was only admitted because HMRC stated they did not object. Given the key role this evidence played the Tribunal’s decision may well have been different if HMRC had objected.
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Loss relief (income tax) disposal of shares
Case reference: John Lewis v HMRC [2016] UKFTT TC05029
