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On Being Well - Connected

"As any fule kno", relief under the Enterprise Investment Scheme fails if the investor is or becomes "connected" with the company. One of the principal stumbling blocks is the "30% test" – more specifically where "…the individual directly or indirectly possesses or is entitled to acquire more than 30% of -

the ordinary share capital of the company or any subsidiary of the company
the loan capital and issued share capital of the company or any such subsidiary, or
the voting power of the company or any such subsidiary…"

The definition in (b) above has come under scrutiny in the recent Upper Tribunal case of Revenue & Customs Commissioners v Taylor & Haimendorf (FTC/43/2010). HMRC contended that the loan capital and share capital should be aggregated when calculating the 30%; the claimants argued that the legislation meant 30% of share capital and 30% of loan capital calculated separately and that both limits would have to be breached before the relief was denied.

The First Tier Tribunal had found for the individuals and HMRC appealed to the Upper Tribunal. Roth J considered the matter in some detail and decided two points:-

the relevant measure of "issued share capital" was the nominal or face value, and
HMRC's interpretation was correct, the share capital and loan capital should be combined into a single composite category and the 30% limit applied to that.

So where does this leave us? Well in a sense back where we started - the Judge’s decision reinforces the view HMRC have always taken, however it makes a change to at least have some clarity.

To take an example – John pays £10,000 for 100 £1 shares in EISco giving him 10% of the issued share capital. He also lends the company £100,000 and the other investors together put up another £200,000 of loan.

John has only 10% of the share capital but has 33% of the loan capital. When the two are combined his total is over 30% and so he is connected with the company despite having only 10% of the shares.

Just remember that making a loan can make you well-connected.