20 April 2022
Two business owners have been found to owe capital gains tax on an additional £1.1m from the sale of shares in their business, despite never receiving the cash proceeds.
In the case of McEnroe and another v Revenue and Customs Commissioners, the two owners of a residential care home business, Kingly Care Partnership Limited, agreed to sell the shares in their company for £8m. However, the company owed £1.1m to the bank so the true value of the company, excluding debt, was £6.9m.
Ordinarily in these circumstances, the company’s shares would be sold for £6.9m, rather than £8m, reflecting the fact that £1.1m of bank debt that would need to be paid off by the buyer.
This was broadly the intention in the McEnroe case, but the legal documents specified that the selling shareholders be paid £8m. The solicitors dealing with the transaction withheld £1.1m of their personal proceeds to settle the bank debt and paid the remaining £6.9m to the selling shareholders.
The First Tier Tribunal found that regardless of the true intentions behind the transaction and that the sellers did not receive £8m in reality, the contract was 'very clear' that the sellers were entitled to £8m. As a result, and despite the court acknowledging that it appeared 'extremely unlikely' that they would ever receive the extra £1.1m, they remained taxable on these extra proceeds. The sellers had, in effect, 'voluntarily discharged the bank debt'.
Assuming that the taxpayers qualified and claimed for Entrepreneurs’ Relief to apply, the additional tax payable is likely to be in the region of £110,000 but in the absence of this relief, it could be as high as £308,000 (as the highest capital gains tax rate in the 2013/14 tax year when this transaction originally took place was 28 per cent). This case highlights the potential bear traps that lay in wait for taxpayers if they choose the wrong path. The fair answer isn’t always the correct one for tax and different routes can result in a lot more tax being due, even if you ultimately end up at the same destination.
What appears clear from the case is that this was a costly mistake. In some instances, it can be possible to appeal on grounds that a mistake has been made. In this particular case, an argument could potentially be made that the contract was drafted incorrectly and didn’t reflect the intentions of either party so the contract could be 'rectified'. However, this is not a straightforward process and courts have been known to reject such claims when they are for tax reasons.