Confusion as to who owns shares will prove costly
When establishing a company, it is important to identify who owns the shares and get the correct paperwork put in place. Failure to do so can result in an unexpected tax bill and worse, as proved to be the case in the First Tier Tax Tribunal case of Terence Raine v HMRC (2016).
Mr Raine, a 69-year old Chartered Engineer, formed his own company, Linkdrive Solutions Ltd, in September 2000. Before this, he had no experience of running a company and therefore knew nothing about shares, dividends or remuneration structures. After a meeting with a pension adviser of a large well-known contractors’ accountant (not QAccounting incidentally) in September 2000, Raine purchased an ‘off the shelf’ company. Raine was told that he would be appointed a director and, his long term partner, Barbara Hamilton, company secretary. The accountant would deal with all necessary procedures and paperwork to formalise the appointments and also deal with the shareholding issues.
The company had two issued shares held by the formation agent, available for immediate transfer which the couple asked to be transferred in the ratio of one each. The accountant, however, did not complete the necessary documentation and technically one ordinary subscriber share remained in the name of the formation agent.
In October 2000, the accountant issued Raine with a ‘Welcome’ pack that contained the company’s Certificate of Incorporation, Memorandum and Articles of Association, a document titled Statutory Registers, Minutes and Share Certificates. None of the registers, minutes or certificates had been completed, however. Raine and Hamilton did not bother to do anything with this pack.
Linkdrive Solutions’ Annual Returns were prepared by the accountant, and these showed Mr Raine as the only shareholder owning two shares, but this was not picked up by Raine.
The company’s accounts referred to Raine as owning two ordinary shares which again went unnoticed by the director.
From the 2003 accounts onwards, the company was stated as being under Raine’s control, until 2009 when the accounts contained an apparently contradictory statement that while being a 50% shareholder, Mr Raine was still the controlling shareholder. Despite having made previous enquiries about the shareholding within the company, this did not register with Raine.
In October 2006, Raine contacted the accountant as he had noticed for the first time that the description of the accounts appeared to conflict with his understanding of how the shares in Linkdrive Solutions were held. He, therefore, requested a copy of the share certificates and the procedure for transferring shares. His accountant responded that they did not have this documentation readily available but that “as for transferring shares we would recommend that you do not do this, as it may alert the Inland Revenue to an investigation under Section 660.” Raine told the Tribunal that while he did not receive a copy of the share certificates, he was comforted that his accountant appeared unconcerned as to the position.
In 2004 Linkdrive Solutions moved into profit and the accountant advised their client to pay dividends. The accountant prepared the dividend tax vouchers which showed dividends split equally between Raine and Hamilton. Both parties, therefore, declared these dividends on their respective tax returns until in March 2011 HMRC wrote to Raine having noted apparent differences/inaccuracies in the amounts of dividend income shown in the company accounts and his tax returns. At this point, Raine said he contacted his accountant who confirmed his understanding that he and his partner were joint and equal shareholders.
Despite amended Company Annual Returns being filed in October 2012 to show that Raine and Hamilton owned one share each, the damage had already been done and HMRC raised tax assessments for the six years ended 5th April 2011 showing tax due of £36,123 together with penalties for incorrect returns totalling £5,417. An assessment could not be raised for 2004/05 as the time limit had expired.
While the Tribunal accepted there might have been some initial confusion as to who the shareholders were, they did not accept that Raine thought shares were held equally with Ms Hamilton. He signed off the company accounts which showed him as owning both shares and giving no mention to Ms Hamilton. Raine should have therefore suspected that his partner was not a shareholder and, as such, not entitled to dividends.
Despite accepting that Raine had no previous experience of running a company and owning shares, the Tribunal judge felt it was reasonable to consider that a layman would ordinarily be aware that dividends are only paid to shareholders and that Ms Hamilton, having checked, was not a shareholder. The appeal was therefore dismissed, and the assessments and penalties of £41,540 confirmed as being payable.
If you have any questions or concerns about the topics raised in this article, or accountancy related matters in general, then please contact our friendly team.
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