This first-tier tribunal decision in Robert Brown (TC03118), which was published on 22 December 2013, considers the availability of income tax relief on losses on shares in a private trading company which have become of negligible value.
The question considers the principles of valuation that should be applied, with reference to TCGA 1992, s 272, in determining whether the shares in question had become of negligible value. The principle enunciated in the FTT decision in the case of Barker, Harper & Wickes  UKFTT 645 (TC) was applied:
“It was common ground between the parties that ‘negligible value’ means ‘worth next to nothing’ but not ‘nil’ and that the concept has no room for any notion of materiality in which the previous value of the asset would be taken into account by way of comparison with the value which is said to be negligible. The test in that regard is therefore an absolute one, the same for an asset worth a million pounds and an asset previously worth much less… to speak of an asset which has become of negligible value as having a market value makes no sense. The very fact that it has no market value is why it is said to be of negligible value; if the asset has a market value, then its value cannot be negligible.”
Robert Brown had invested £250,000 in shares in Microsharp Holdings Limited, which was developing software initially for an encryption system and later for medical screening software. Initially, in April 2002, he subscribed for 500 10p shares at £100 a share, and a few weeks later subscribed for a further 500 10p shares at £400 a share. He had been encouraged to invest because the company was developing saleable IP, and it had hoped to secure lucrative contracts with Microsoft and with the Bank of England, although neither came to fruition.
In October 2003 Mr Johnson, the principal shareholder and director, resigned and Mr Coates, who was at that time a minority shareholder, bought out Mr Johnson’s shares taking over control of the company. Mr Coates recognised that the company was in serious financial difficulties and injected further funds into the company, but presented to the other shareholders an optimistic vision for the company’s future.
However, the company’s financial problems persisted, and it offered new shares for sale at £1 a share in October 2005, but only Mr Coates subscribed, investing a further £2.1m into the company.
In December 2005 the company sold its IP in its medical screening software to Mr Coates’ company in order to raise further funds. Mr Brown amended his 2006 return in January 2008, claiming that his shares had become of negligible value on 5 April 2006. The question is whether the shares had a value on that date.
HMRC took the view that in 2006 the company had valued its shares at £1 each, Mr Coates had injected more funds into the company and remained optimistic about the company’s prospects. HMRC accepted that the shares were worth considerably less than what Mr Brown had paid for the shares, but his investment was not of negligible value. Mr Povey, representing Mr Brown, took the view that at that date, viewed realistically, the shares had a nil value and there was no market for them.
1. The company had always made a loss
HMRC said that the company had always been loss making, so nothing had changed in April 2006 to make the shares of negligible value. However, Mr Povey and the tribunal took the view that a company cannot continue to be loss making without affecting its value, but being loss making does not prove one way or the other whether the shares had become of negligible value.
2. The investment was high risk
HMRC pointed to many factors demonstrating that Mr Brown knew that the investment was high risk. However, the tribunal did not think that this was relevant to whether the shares had become of negligible value.
3. The company continued to trade after 2006
The tribunal and Mr Povey took the view that whether the company continued to trade does not answer the question whether the shares had a value at that date.
4. Mr Brown’s view of the value of the shares
HMRC took the view that as Mr Brown was not prepared to sell his shares for less than 10p a share, the shares must have a value. However, the tribunal and Mr Povey felt that the question was whether anyone would be prepared to pay anything for the shares, not what Mr Brown would be prepared to accept for the shares.
5. The company’s own valuation of its shares
HMRC took the view that as the company had offered new shares for £1 a share the shares did not have a negligible value. However, the tribunal considered that this would be evidence only if someone had actually bought the shares at that price. Mr Coates had been prepared to inject further funds into the company at that price, but that is very different from saying that he would have been prepared to buy shares from another shareholder at that price. He was a pre-existing shareholder and was not disinterested in the company’s fate and he had repeatedly given an optimistic message to other shareholders. He had a reputation and his already significant investment to consider.
6. Earnings valuation
Mr Povey’s case was that a company should be valued either on the basis of net present value of its assets or of its earnings potential. The company had not paid any dividends, and would not be in a position to do so until losses of about £15m had been recouped. The earnings value must, therefore, be nil. The company’s liabilities exceeded its assets by about £2m, so on an asset basis the value must be nil.
7. Hope value
HMRC contended that notwithstanding its accumulated losses and net liabilities the shares still had a hope value. However, part of the IP had already been sold, and what remained had been written off in the accounts two years previously. A prospective purchaser would recognise this situation, and would not, therefore, recognise hope value.
HMRC took the view that Mr Brown’s 1,000 shares were worth £1,000 as this is the price at which shares were offered by the company. Mr Povey’s view was that a prudent purchaser would not be prepared to pay anything for those shares. The tribunal concluded that no one apart from Mr Coates would have been prepared to take the risk of putting money into the company, and no one including Mr Coates would have been prepared to buy shares from another shareholder at any price. There were no new investors, and there would have been no market for pre-existing shares because the market did not consider that the shares had hope value.
In order to make a negligible value claim the shareholder must be able to demonstrate that the shares have become of negligible value. This means that there must be no market for the shares. The tribunal decided that Robert Brown’s shares had become of negligible value because no one was prepared to pay anything for them.
The tribunal took the view that this was the case even though the company continued to trade, albeit at a loss, after the relevant date, the main shareholder was prepared to subscribe for further shares in order to provide further funds to the company, and Mr Brown had indicated that he would not be prepared to sell his shares for less than £1 a share (having paid substantially more than that). These factors did not alter the fundamental point that there was no market for the shares at any price.
If you would like further information in relation to claims for negligible value please contact the TaxDesk on 0845 4900 509 and ask for Paul Howard.