VCM11080 - EIS: income tax relief: the investor: connection: persons interested in capital etc of company

ITA07/S170

An individual is connected with a company if he or she, whether alone or together with any associate (see VCM11100), directly or indirectly possesses, or is entitled to acquire:

  • more than 30% of the ordinary share capital (as defined at ITA07/S989) of the company or any subsidiary, or
  • more than 30% of the issued share capital of the company or any subsidiary, or
  • more than 30% of the voting power in the company or any subsidiary, or
  • such rights as would, either in the event of a winding up or in any other circumstances, entitle the individual to receive more than 30% of the assets of the company which would then be available for distribution to equity holders of the company.

The case of Cook v Billings & Others [2001] STC 16 confirmed that attributing the rights of an associate to the individual is correct when considering the individuals’ connection to the company.

Voting power and other entitlements are ascertained in the first place by reference to the company’s Memorandum or Articles of Association, but note that these can be overridden by any agreement made between the shareholders. Share capital is represented by the nominal value of the shares, excluding any premium paid.

There is one exception to these 30% tests of connection - see below.

References to a subsidiary on this page are to any company which is at any time in period A (see VCM10540) a subsidiary of the company issuing the shares.

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‘Entitled to acquire’ - S170(9)

Individuals are regarded as entitled to acquire something if they are able to acquire it by virtue of a contractual right or through some other arrangement. They might, for example, hold an option which entitles them to require a shareholder to transfer shares to them. References to being ‘entitled to acquire’ something apply both where individuals are presently entitled to acquire it at a future date, and where they will at a future date be entitled to acquire it.

Note that an individual who is entitled to require a company to issue to him share capital that is as yet unissued is not ‘entitled to acquire issued share capital’.

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Possession of share capital - S170(1)

The phrase ‘directly or indirectly possesses’ entitles us to ‘look through’ intermediaries to the ultimate owner.

Example 1

Mrs Carstairs acquires 25% of the share capital of Clear Windows Ltd and company X acquires a further 20%. Mrs Carstairs owns half the issued share capital of company X.

Mrs Carstairs possesses 25% of the shares directly and a further 10% indirectly, so she is connected with Clear Windows Ltd and does not qualify for relief.

Example 2

Mr Crow and Miss Gosling (who are not associates of each other) jointly subscribe £10,000 for 10,000 shares in Cool Shoes Ltd, being 56% of the issued share capital of the company. These shares are registered in their joint names.

In law they hold the shares on a bare trust. For the purposes of ITA07/Part 5 each of them is treated as having subscribed £5,000 for all 10,000 shares (see VCM16040). Neither of them can be said to ‘directly possess’ anything, but each of them ‘indirectly possesses’ rights which entitle them to receive part of the assets of the company available for distribution. Those rights amount to 28% of the total amount each, so, as that is less than 30%, they each qualify for relief.

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Exception to 30% tests

The 30% shareholding tests and the control test are subject to one exception. They do not apply in the period between the incorporation of the company and:

  • the date when it first began preparing to carry on a trade

or

  • the date when it first issued shares other than the subscriber shares,

whichever is earlier. (Subscriber shares are those subscribed for by those who signed the Memorandum of Association; they are treated as issued on the incorporation of the company.)

Example

Rama buys a company ‘off the shelf’ from a firm of company formation agents. There is a single subscriber share, which is re-registered in his name. A month later the company issues shares to a number of investors including Rama, who then holds only 20% of the shares. With the money raised by the issue the company acquires a trade.

Thus during the initial period of one month, which fell within period A related to the share issue, Rama owned the company. But because there were no other changes to the share capital and the company had not yet started preparing to trade, this is disregarded.

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Loan capital - S170(8)

The loan capital of a company or any subsidiary is treated for the purpose of ITA07/S170(8) as including any debt incurred by the company for:

  • any money borrowed or capital asset acquired by it,
  • any right to receive income created in favour of it - for example, where a person contracts to make annual payments to the company in return for a capital sum due at some later date, that capital sum is loan capital,
  • consideration the value of which to the company was (at the time the debt was incurred) substantially less than the amount of the debt (including any premium on the debt).

But loan capital is treated as excluding debts arising on a bank overdraft if the overdraft arose in the ordinary course of the bank’s business. Where a claim is made that a bank overdraft did not arise in the ordinary course of a bank’s business a report should be made to CT Innovation & Growth (CTI&G) before any relief is allowed.

Loan capital does not include normal hire purchase debts.

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Equity holders

Where the 30% test is operated by reference to the rights of an individual in circumstances such as a winding-up, the legislation uses the special concept of equity holders and a special method of computing the percentage entitlement. These are taken from CTA10/PT5, which is concerned with group relief; accordingly ITA07/S170 have to adapt CTA10/PT5 by substituting references to equity holders for references to the parent company where appropriate. Guidance on CTA10/PT5 can be found at CTM81000.

The main consequence of applying CTA10/PT5 for the purpose of measuring an individual’s entitlement to receive assets is that all rights in respect of ‘normal commercial loans’ are excluded from consideration. (Note that most interest-free loans will count as normal commercial loans.) The reason for excluding such loans is that otherwise, under this test, a shareholder who had also lent money to the company could become connected with it simply because it had not prospered and its assets had shrunk to the point where it had enough only to cover the rights of loan creditors, with little or nothing left for the shareholders.

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Control of the company - S170(6) & (7)

An individual is connected with a company if he or she, whether alone or together with an associate, has ‘control’ of the company, or of any subsidiary of the company, within the meaning given in ITA07/S995. Note that this definition is not merely in terms of direct shareholdings and voting rights in the company concerned; shareholdings and voting rights in any company, and powers conferred by the documents regulating any company, can be taken into account.

The reference above to a subsidiary is to any company which is at any time in period A, a subsidiary of the company issuing the shares.

There is one exception to this rule, see above.