The High Court held that a taxpayer was entitled to deferral relief in respect of certain shares issued to him by a qualifying company under the enterprise investment scheme (EIS) where payments to the company in advance of the issue of shares were to be treated as capital contributions and not loan arrangements which would be caught by the ‘value received’ provisions.

Facts

A company (‘the second taxpayer’) was incorporated in 1998 to operate a sports club. It made several issues of shares to its controlling director (‘B’) (‘the first taxpayer’). He claimed enterprise investment relief (‘EIS relief’) in respect of those shares pursuant to TCGA 1992, Sch. 5B. The Revenue rejected the claim, and both taxpayers appealed. B had invested money informally with the company without a contract of allotment or a share application. The circumstances were such that in some cases money had been paid to the company before any application was made for the issue of shares in respect of that money; and in other cases the issue of shares had been completed before the money was paid in respect of the issue.

The taxpayers contended that they were eligible for EIS relief. New money had been put into the company and shares had been issued. The word ‘issue’ in ICTA 1988 was appropriate to indicate the whole process whereby unissued shares were applied for, allotted and finally registered. In this case the issue was not complete until the money was received and accordingly there was an issue of fully-paid shares. Alternatively, there was an issue of shares subject to the condition precedent that the money was received. Where money was paid in advance of the issue of shares it was part of the subscription for the shares and did not create a debt within the ‘value received’ rules.

The Revenue contended that either money was paid to the company in advance of any subscription for shares, in which case the value received rules applied, or the money was received after the share register was written up, which was the time of issue of the shares, and accordingly the shares were not fully-paid at the time of issue. There was no conditional issue of shares and no evidence to support a conditional issue. The special commissioner (Dr John Avery Jones) decided that where there was a delay in writing up the share register there was a disqualification of the EIS requirements on the basis that the notional discharge of the debt created by the paying of money to the company was a receipt of value in the taxpayer's hands prohibited under TCGA 1992, Sch. 5B, para. 13; where there was a discharge of that debt on the issued shares there was a breach of the requirement that ‘all the shares comprised in the issue were issued in order to raise money for the purpose of a qualifying business activity’; the various share issues which were otherwise separate and which taken in isolation would qualify, should be treated as comprised in a single issue in relation to which the qualifying rules in para. 13 applied thus tainting all of the shares issued, treated as one single share issue ((2007) Sp C 606).

The taxpayers appealed, relying on the decision in Inwards v Williamson (HMIT) (2003) Sp C 371, and arguing that when the moneys were used to pay for the share subscription, even though the money had been provided earlier to the company, that debt was a ‘technical’ debt and B received nothing back from the company as a matter of fact. Alternatively they submitted that the special commissioner's finding that there had been a general intention to subscribe for shares should have led to the conclusion that the moneys received by the company were on account of capital and did not give rise to a loan, relying on Kellar v Williams [2000] 2 BCLC 390.

Issues

Whether the value received rules in TCGA 1992, Sch. 5B, para. 13(2)(b) applied in relation to the share issues; and whether the special commissioner had been right to treat some of the share issues as comprising a single issue of shares.

Decision

Peter Smith J (allowing the appeal) said that the EIS legislation contained various checks and balances to protect against abuse including the value received rules. The purpose of the scheme was to encourage investment by attracting fresh money and any device or arrangement which did not attract new money was not allowable, e.g. a director could not utilise his preexisting loan account in his favour with a company to discharge a debt that would fall on him for a subscription for shares.

In Kellar v Williams [2000] 2 BCLC 390 there was an agreement to increase the capital of the company and the appellant provided funds for that increase. There was no clear indication whether he intended that the moneys would be by way of loan or capital contribution. The funds were treated in the company's records as capital contributions to make up the total of the owners’ equity. The question then arose whether or not on a subsequent liquidation of the company the moneys thereby contributed by the appellant were capital contributions or loans. The opinion of the Privy Council was that where shareholders of the company agreed to increase capital without a formal allocation of shares that capital became like share premium and became part of the owners’ equity. Accordingly a payment made to or on behalf of a company other than by way of payment of shares or by way of a gift was not repayable to the payer. The funds were not by way of a loan.

In the present case, the taxpayers submitted that the first taxpayer was putting the money into the company with the intention of sorting out the issue of shares which was identical to the position in Kellar. In effect, the finding of the special commissioner that there was a general intention to put money into the company in respect of shares, although it could not be treated as an application for shares, meant that the moneys that were received by the company were on account of capital and not a loan. The company could never come under an obligation to repay them; it would become under an obligation to issue shares pursuant to the receipt of that money on capital account. That was the correct analysis on the facts of the case and the moneys paid by the first taxpayer were capital and could not be a loan. The special commissioner's conclusion that the moneys were to be treated as a loan was incorrect and accordingly the appeal succeeded in its entirety (Kellar v Williams [2000] 2 BCLC 390 applied).

If the loan analysis had been correct, the argument that there was merely a ‘technical’ loan would have been rejected. A broad construction of the legislation could not overturn the clear wording applying to loan arrangements, Inwards considered.

The special commissioner held that a number of shares were part of larger issues in relation to which, on his interpretation, the receipt of value provision applied. To obtain relief the entirety of the shares comprising the issue had to be issued in order to raise money for the purpose of the qualifying business activity. If the special commissioner had decided that part of those shares were affected by a return of value then it could not be said that ‘all the shares’ were issued to raise money for the purpose of qualifying business activity. The appellants could not successfully challenge the factual findings of the special commissioner as to whether in fact there were separate issues or whether a set of shares was part of a single issue.

It could not be successfully contended that the moneys provided to the company were impressed with a purpose trust, Barclays Bank Ltd v Quistclose Investments Ltd [1970] AC 567 considered.

Chancery Division.

Judgment delivered 19 February 2008.