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A Potential Pitfall for EIS Companies & Recent Cases in the First-Tier Tribunal

A case in the First Tier Tribunal, Flix Innovations Ltd. v HMRC ([2015] UKFTT 58), has highlighted the fact that EIS shares must not, inter alia, carry “any present or future preferential right to a company’s assets on its winding-up” (see s173(2) ITA 2007), however insignificant. This has highlighted the need to ensure, when drafting the rights attaching to a special class of ‘growth shares’ in a company which has in issue shares qualifying for EIS relief, that the restricted rights attaching to the growth shares do not have the effect of causing the EIS shares in issue to acquire such a preferential right. This might occur if, for example, the holders of EIS shares are, upon a winding-up, to acquire repayment of the nominal capital on their shares in preference to the holders of growth shares receiving the nominal capital on their shares.

Also in the Tribunal…

Cyclops Electronics Limited and Graceland Fixing Limited vs HMRC – a 2004 tax avoidance scheme using loan notes

The First-Tier Tribunal has held in favour of HMRC in [2016] UKFTT487(TC) in two lead, cases heard, together relating to a scheme for the avoidance of income tax and NICs on the acquisition of redeemable loan notes in a specially-formed company. The arrangements were structured in a manner which echoed that of the arrangements in the UBS/Deutsche Bank cases: the loan notes issued to the employees were intended to be ‘forfeitable securities’ and drafted so as to be subject to a short-term risk of forfeiture such that s425 would apply and there would be no charge to income tax on acquisition. Likewise, the securities were disposed of in circumstances which (under the legislation in force at the time) provided for an exemption from charge under Chapter 2, Part 7 ITEPA. The Tribunal held that there was no business or commercial purpose for the inclusion of the forfeiture provisions within the terms of the Loan Notes. Those provisions were commercially irrelevant and designed only to secure the benefit of the exemption in s425. In the UBS/Deutsche Bank case the Supreme Court had formulated the correct approach to the construction of s423 (definition of restricted securities) in terms of the “business purpose” of the relevant forfeiture provisions and not in terms of whether particular transaction steps were pre-ordained or not. The employees received a “payment” of “earnings” in the form of cash equal to the principal amount at the time they received the Loan Notes.

Pett, Franklin & Co. LLP are experts in employee share schemes, share valuations and executive incentives. To find out how we can help you or your client, please call Stephen Woodhouse on 0121 348 7878 or email Stephen at stephen.woodhouse@pettfranklin.com.