In a recent decision, Prowting Trustees v Amos-Yeo, the High Court ordered the rectification of a share transfer entered into in 2012, allowing a disposal of the shares in 2014 to qualify for entrepreneurs’ relief. There was clear evidence that the 2012 transfers failed to implement the agreed intention of the transferors and transferees: they intended to transfer slightly more than 5% of the company’s ordinary share capital to each of the individual transferees, but the number of the shares transferred was calculated incorrectly. Although based on its own facts, the case may be a helpful starting point for others who find themselves in a similar situation, where an inadvertent mistake in the documents means that a transaction fails to achieve a favourable tax result.
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Much as it pains me
as a lawyer to say it, I have to admit that on rare occasions our carefully-crafted documents do not do quite what was intended, or do not achieve what was expected. What to do?
The recent decision of the High Court in the Trustees of the Prowting settlements v Amos-Yeo and Amos-Yeo [2015] EWHC 2480 (Ch) (18 August 2015) is a salutary lesson of what can go wrong, and – if you are very lucky – how things can be put right.
The context for the case was a disposal of shares, and entrepreneurs’ relief. If entrepreneurs’ relief applies, capital gains of up to £10m are subject to CGT at a reduced rate of only 10% rather than the headline rate of 18% or 28% that would otherwise apply, potentially reducing a tax bill by up to £1.8m.
The conditions for an individual to claim entrepreneurs’ relief are reasonably simple. In broad terms, for a disposal of shares to qualify as a ‘material disposal of business assets’ (TCGA 1992 s 169I), then, for a period of at least one year ending on the date of the disposal (or ending on a cessation of trade within the previous three years):
Trustees of a settlement can claim entrepreneur’s relief where similar conditions are met, if it has a qualifying beneficiary who is employed by the relevant company or group
Based on the decision in Canada Safeway Ltd v IRC [1973] Ch 374, in relation to the conditions to claim relief from stamp duty under FA 1930 s 42, HMRC interprets the requirement to hold a minimum percentage of ordinary share capital as being calculated by reference to the nominal value of the company’s issued share capital. The calculations are easy if there is just one class of shares in issue, or all shares across different classes have the same nominal value (with voting rights pro rata), but some care is needed if there are different classes of shares with differing nominal values, or carrying different voting rights.
In outline, Banner Homes Group Plc was the holding company of a trading group with a house construction business. The company had a rather complicated share capital, with several classes of shares with different nominal values. A significant number of shares were held by the trustees of two trusts settled by the founder of the company, and several members of the settlor’s family were beneficiaries of the trusts who worked for the company.
Although it is not clear precisely why – possibly to ensure that the maximum amount of entrepreneurs’ relief was available for each trust and for each individual taken separately – it was decided that some of the holdings in the trusts should be transferred to two beneficiaries who were employees of the company. The shares were transferred in October 2012. The trustees calculated the number of shares to transfer so each individual should qualify for entrepreneurs’ relief, and to ensure that the trusts would also continue to qualify for entrepreneurs’ relief.
About 18 months later, in March 2014, all of the company’s shares were sold to an unconnected third party purchaser, Cala Homes. Unfortunately, shortly before the sale was completed, it became clear that there had been an error, and the individuals held just 4.9% of the ordinary share capital, not the required 5%. How could that be?
Certain other individual shareholders, employed by the company as managers, held 114,795 shares which represented 5.43% of the company’s share capital. To be sure that the trustees would transfer sufficient shares to the beneficiaries to qualify for entrepreneurs’ relief, they bumped up the number slightly to 115,000 – after all, as contemporaneous correspondence recorded, ‘it would be terrible if they ended up at 4.999999%’. However, the trustees did not notice that the trusts held A ordinary shares with a nominal value of 50p, but the other individual shareholders held some ordinary shares of £1 and some C ordinary shares of 52p (just to complete the picture, there were also some B ordinary shares of 1p in issue). Taken together, the holding of a certain number of £1 and some 52p shares was sufficient to pass 5% of the total nominal value of share capital in issue, but a slightly larger number of 50p A ordinary shares was just under 5%.
To everyone’s embarrassment, it seemed that the disposal in March 2014 would not qualify for entrepreneurs’ relief. What to do? It was too late to transfer a few more shares just before the sale to Cala Homes, as entrepreneurs’ relief would not be available until another 12 months had passed. Could a legal remedy be found that would retrospectively amend the transfers in October 2012, so that the qualifying conditions were met for more than a year and entrepreneurs’ relief could be claimed?
Fortunately, the equitable relief of rectification provided a possible legal mechanism to retrospectively adjust the October 2012 transfer, to make sure that the disposal in March 2014 qualified for entrepreneurs’ relief.
To bring a successful claim to rectify a legal document, the court must be persuaded that the relevant parties had a common continuing intention that the relevant document was intended to implement, but (through common shared mistake) the document failed to reflect the common intention. A classic example of an error that can be rectified is a clerical or typographical mistake, but rectification can go wider, and critically it binds third parties such as HMRC.
At first blush, the document itself is presumed to contain the best evidence of the intention of the parties, so a claim for rectification needs to be supported by clear and independent evidence of a different common intention which persisted at the time the document was executed. The document must fail to implement the agreed transaction: it is not enough that the legal consequences of the document are not what the parties expect, if the document does not in fact ‘misimplement’ the parties’ intentions. Intention is distinguished from motive, although the two can be hard to separate. The judge referred to a ‘continuum moving from a formulation of a general intent or objective to a specific understanding of how that objective is to be achieved in documentary form’.
In this case, the judge accepted (perhaps surprisingly) that there was sufficient evidence that the parties intended to transfer such number of shares as would enable the transferees to claim entrepreneurs’ relief, and not a smaller number. There was a mistake in the calculation of the number, somewhat similar to a pure typographical error, which meant that the documents did not implement the transaction that the parties had intended. As result, that mistake could be corrected by ordering a rectification of the number of shares transferred in 2012.
Although an unusual case based on its own facts, it may be a helpful starting point for others who find themselves in a similar situation. It seems clear that the trustees made an error, more a sin of omission than commission, but that was not a bar to rectification: the trustees did not miscalculate the nominal value of the shares, but rather did not calculate the nominal capital at all, implicitly assuming, wrongly, that the nominal value of all of the shares was the same. The court did not consider the impact of rectification on the sale of the company in 2014, but the effect of rectification is to retrospectively change the number of shares held by the individuals during the year before the disposal, so entrepreneurs’ relief should be available.
HMRC was informed of the proceedings and confirmed it was happy for the claim to proceed without its involvement. Historically, HMRC took a similar approach to proceedings under the so-called rule in Hasting-Bass [1975] Ch 25, under which the court was able to retrospectively invalidate decisions made by trustees where the trustees had not given proper consideration to relevant matters when reaching their decision, including the tax consequences of their decision. HMRC would usually wait for the facts and legal consequences flowing from the court’s decision to be determined before applying tax law to the results.
Over a period of time, use of Hasting-Bass widened considerably, with a consequent unwinding of fiscally unattractive results in a series of reported cases. Eventually, HMRC intervened in several cases, with the result that the scope of the rule has been narrowed significantly. The decision of the Supreme Court in Futter v HMRC [2013] UKSC 26 makes it clear, in English law at least, that trustees’ decisions can only be voided where the trustees acted outside their powers, and that decisions within their powers but taken without considering the correct factors are only voidable if the error amounts to a breach of their fiduciary duties. However, as the Prowting case demonstrates, where the facts allow, there may still be a possibility of claiming there was a mistake about the legal effect of a transaction (not its consequences) which can be rectified.
The overall message, of course, must be to get it right first time; but if matters do go awry, all may not be lost.
