On 27 May 2021 the Court of Appeal handed down judgment in the case of Chalcot Training Limited (“Chalcot”). The case concerned an ‘E Share’ tax avoidance scheme and a challenge by the company to effectively reverse the scheme.
The appeal was brought by the company, Chalcot, against its current sole director, its previous director and HMRC. The current director was therefore on both sides of the litigation, and the driving force behind the proceedings. Only HMRC opposed the appeal.
In the High Court in 2020, Chalcot had argued that it could set aside payments it had made to its directors as part of the Blackstar E Share tax avoidance scheme. The original set up of the company’s business was conducted through a limited liability partnership whose members were the directors and Chalcot. The intention being that the profits of the limited liability partnership would be transferred to Chalcot, where the tax treatment of the profit would be at the corporation tax rates. Chalcot then engaged in the E Share scheme with a view to avoiding corporation tax altogether.
The scheme worked in the same way as other Blackstar E Share schemes. Chalcott would make payments to its directors and attach to those payments a requirement that the directors subscribe for shares in the company. Those payments were described as director’s remuneration and were therefore treated as deductible for corporation tax purposes. Further, the attached requirement to subscribe for shares sought to shield the payments from income tax or national insurance contributions as they were not said to be taxable earnings.
The E Share scheme was held by HMRC to be an ineffective tax avoidance scheme and a mechanism for disguised remuneration. HMRC issued determinations in respect of PAYE and National Insurance contributions to Chalcot in respect of the payments. The tax consequences of the scheme remained undecided in the tax tribunal at the time the court heard the parties because it awaited the outcome of the appeal.
Application to set aside
Chalcot then applied to the Court to set aside the payments made under the scheme and for a declaration that the agreements were void and the Company’s share register be rectified to remove its directors as the holders of the shares, arguing that:
- The payments were not remuneration but instead distributions of capital made to its directors in their capacity as shareholders; or
- The payments were an unlawful commission contrary to the Companies Act 2006 Section 552; or
- The payments were an unlawful discount on the shares contrary to Section 580 of the Companies Act 2006; or
- The contract was void by common mistake.
HMRC opposed the application arguing that the payments were remuneration to the company directors and that Chalcot was bound by them.
Decision in the first instance
The High Court determined that the test of whether the payments were remuneration or distributions was subjective. The court must consider whether the payments were a genuine exercise of the directors’ power to award remuneration, the deciding factor being the intention of the parties. In this case the directors had intended to receive payments in their capacity as directors or employees for the scheme to function and the documents were drafted on the assumption that the payments were remuneration or an employment related award. The attachment of the obligation to subscribe for shares did not affect their status as remuneration.
- The court’s finding that the payments were remuneration estopped the contention that the payments had been unlawful distributions to shareholders pursuant to sections 552 or 580 of the Companies Act 2006.
- Notably, the court commented that had the payments been unlawful distributions pursuant to sections 552 or 580, the directors would have had to repay them in any event.
Chalcot’s argument that the agreement fail on the grounds of mistake was also unsuccessful. The judge referred to the test in Great Peace Shipping Ltd v Tsavliris Salvage (International) ltd  QB 679. The argument failed at the first requirement: a common assumption as to the existence of a state of affairs. The judge found that nobody had considered the company law issues, so no assumption could be inferred. It was not sufficient to simply show ignorance of the company law issues. The Court also noted that this was a transaction where the same people were on both sides, and in such circumstances, it was unlikely that the doctrine of common mistake could apply.
Chalcot appealed the Court’s decision on sections 552 and 580 of the Companies Act and its arguments on mistake.
Chalcot submitted that in respect of section 580, the judge had wrongly conflated the question of whether the payments were a distribution, and whether there had been good contractual consideration for the payments. The appeal judge considered that the real question was whether there was good consideration for the shares.
Chalcot argued that if it paid an allottee £100 to subscribe for shares with a nominal value of £100, then it would not receive the required nominal value. The judge found that if on the facts, shares had been credited as fully paid but were actually gifted to the allottee, the shares would have been issued at a discount. However, the court’s finding of fact was that the payments were remuneration. The key to the issue of shares at a discount is whether the shareholder is liable to pay the full amount of the nominal value of the shares. The company’s articles provided for full payment of the nominal value on the occurrence of certain events and therefore, it could not be said that the shares had been issued at a discount to their nominal value.
The judge further commented that section 552 was concerned with payments from company capital, whereas these payments had been made from trading income (as was required for the purposes of corporation tax). The company remained entitled to the unpaid capital on the issued shares and was not caught by the prohibition in section 552
Impact of the case
This appeal provides some judicial clarity in a largely unlitigated area of law. It will be of particular interest to liquidators of companies pursuing a call on the unpaid shares to see that the arguments put forward by Chalcot were ineffective. Though the court’s notes on subjectivity should be noted.
For now, it appears that claims/call for payment of unpaid E Shares remain straightforward and this authority will assist liquidators when pursuing claims against a participant of an e-share scheme. If an individual engaged in the scheme, they will be liable to repay the unpaid share capital and may be liable for any additional losses, suffered by the Company, where their participation in the scheme gave rise to a breach of fiduciary duty.