Business Asset Disposal Relief (BADR) for 4.9% shareholdings?

When shareholders seek to claim the special 10% BADR capital gains tax rate it is a fairly well-established principle that they need to have held a qualifying shareholding for two years prior to the disposal.

The issue

To be a ‘qualifying shareholding’ the following conditions need to be met:

1. 5% of ordinary share capital is held (note that preference shares with a fixed annual return are not ordinary share capital).
2. 5% of voting rights are held.
3. Entitlement to 5% of profits available for distribution and 5% of assets on a winding up of the company.
4. If 3 does not apply (for example, if different classes of shares do not have dividend entitlements) then the conditions will still be met if there is an entitlement to 5% of proceeds if the company were sold.

HMRC have taken a strict approach to these rules and have pressed the point where shares with little commercial value have disturbed the position.

In the case of Castledine v HMRC [2016], it was held that deferred shares with no commercial value should be defined as ordinary share capital. When the deferred shares were included, the shareholder’s proportionate interest was pushed below 5%.

Furthermore, in the case of HMRC v M & E McQuillan [2017], it was (ultimately) determined that zero coupon preference shares should also be treated as ordinary share capital. In that case, the shareholder was ‘swamped’ out of BADR (Entrepreneurs’ Relief (ER) back then) by the preference shares.

Against this strict environment, there has been a surprisingly lenient First Tier Tribunal (FTT) case...

The case of Cooke v Revenue And Customs [2024]

This was actually an ER case too and it involved a shareholder who sold all his 4.99998% (!) shareholding in a company, realising a £600,000 gain. HMRC (unsurprisingly) challenged the ER claim on the basis that the 5% condition had not been met.

The shareholder argued that he should be allowed ER on the basis that:

1. If appropriate proceedings were brought in the High Court, it would order the rectification of certain documents in such a way as to secure that during the year preceding the disposal, the shareholder held at least 5% of the ordinary share capital in the company, and

2. The First Tier Tribunal should proceed as if such rectification had been ordered.

It was clear in this case that the intention had always been for Mr Cooke to acquire a 5% shareholding and it was only when he came to sell his 245,802 shares that he realised that he was one share short. This had been caused by rounding in an excel spreadsheet. There were all sorts of complicated discussions about whether a court would allow rectification so that Mr Cooke could be treated as having the extra share. The Tribunal concluded that it would allow rectification, and therefore Mr Cooke could have his ER.

Hamilton Rose's view

To our knowledge, this is the first time a taxpayer has successfully claimed ER/BADR without having the requisite 5% shareholding. We will be watching with interest to see whether HMRC appeals this case.

Notwithstanding the apparent success of the taxpayer in this case, a useful practical lesson is not to fall into the ‘excel rounding trap’. This can be avoided by ensuring that there are some decimals over and above the required 5%.

The main interest of this case has nothing to do with ER/BADR at all. It presents a possible filing position in cases where there has been some kind of ‘mess-up’ which was clearly counter to the intentions of the parties involved.

Any appeal by HMRC should provide further clarification of the issues but may lead to a worse result...