Posted by Matthew Pyke, Trainee Solicitor
Court of Appeal ruling on allotments at a discount and prohibited commissions under the CA 2006
A recent Court of Appeal ruling has reaffirmed the adage – invoked by the judge in the preceding High Court case – that if something looks too good to be true, it probably is.
In Chalcot Training Ltd v Ralph  EWCA Civ 795, the court considered an appeal in regard to a tax avoidance scheme under which employee director-shareholders received payments totalling almost £6m over three years in return for offering to subscribe for company shares.
The court considered claims from the appellant company that the scheme:
- constituted an unlawful allotment of shares at a discount contrary to s580 of the Companies Act 2006 (“CA 2006”); and
- involved the payment of company shares or capital money in consideration of an agreement to subscribe for shares and hence was an unlawful commission under s552.
Dismissing the appeal, the court held that payments made under the scheme were remunerations for services and that there was neither an unlawful allotment of shares under s580 nor an unlawful commission under s552.
Background to the case
The two director-shareholders of the company took up the scheme in 2011 and subscribed to a new class of E shares. Payments were made to the directors who immediately paid back an amount equal to 1% of the nominal value of their subscribed shares (£1) which were allotted as partly paid. The remaining 99% was credited to their directors’ loan accounts.
Following the failure of the marriage of the two directors and a 2016 investigation by HRMC, the sole remaining director and the company proceeded to try to cancel the share issue by repaying the money received under the first iteration of the scheme and cancelling the credits applied to the director’s loan account under the second two iterations. They then commenced proceedings in the High court claiming, amongst other things, that:
- payments and credits made to the directors under the scheme should be regarded as distributions of assets to shareholders and should therefore be set aside on the grounds that they were unlawful; or
- alternatively, the payments and credits made under the scheme amounted to unlawful commission under sections 552 and 553 of the CA 2006 or unlawful discounts contrary to section 580.
High Court Decision Chalcot Training Ltd v Ralph  EWHC 1054 (Ch)
The High Court ruled that the payments were remunerations for services meaning that they could not be set aside as unlawful distributions. This also rendered the claims in regard to unlawful commission under s552 or unlawful discounts under s580 unnecessary.
Despite the fact that company’s accounts disclosed these payments as “an employment expense”, other scheme documentation tellingly described them as remuneration “in recognition of the services of the Employee”. The company’s articles of association also stated the directors were “entitled to such remuneration as the directors determine” thereby framing remuneration as legal right.
The view of the Court of Appeal
Issue of Shares at a Discount under s580 of the CA 2006
S580 states that:
(1)A company’s shares must not be allotted at a discount.
(2)If shares are allotted in contravention of this section, the allottee is liable to pay the company an amount equal to the amount of the discount, with interest at the appropriate rate.
In considering this section, the judge stated that the “critical question [was] whether the investor remains liable up to the limit represented by the nominal value of a share”.
He took the view that the allottees remained ”liable to pay the whole amount of capital uncalled”. Therefore, considering that “for every £1 share the allotee pays precisely £1” it was held that there had been no allotment at a discount under s580 (1).
Furthermore, the court held that, even if an allotment at a discount had been made, because the payment came out of trading income and not the company’s capital it did not fall “within the mischief against which section 580 is directed”.
Prohibited Discounts – S552 of the CA 2006
S552(1) states that
(1)Except as permitted by section 553 (permitted commission), a company must not apply any of its shares or capital money, either directly or indirectly, in payment of any commission, discount or allowance to any person in consideration of his—
(a)subscribing or agreeing to subscribe (whether absolutely or conditionally) for shares in the company, or
(b)procuring or agreeing to procure subscriptions (whether absolute or conditional) for shares in the company.
The judge considered the leading authority in relation to s552 (Hilder v Dexter  AC 474) in which Lord Davey clarified the meaning of the words in this section. In summary, Lord Davey took the view that:
- “apply its shares or capital money” means “apply its capital, either […] in the form of shares before issues […] or in the form of money derived from the issue of its shares”;
- “In payment of any commission, discount, or allowance” […] means “payment by the company; and
- “discount or allowance” means “the same thing, namely, a rebate on what would justly be due from the subscriber on his shares”.
In light of this authority, the judge held it was clear that this section is, like s580, “directed at the company’s capital”. As payments had been made from the company’s trading profits, the company was consequently still fully entitled to the unpaid capital on the shares and the payments were not caught under the prohibitions under s552.
In the High Court case, the judge confirmed “this is a complicated area on which there is no modern authority”. This highlights the significance of this latest appellate ruling which provides some much needed clarity in regard to the court’s interpretation of s580 of the CA which can be unexpectedly nuanced in its application.
The ruling also reiterates the view of Lord Davey in Hilder which permits section 552 to be read more simply as prohibiting a company from using its capital in the payment of any outstanding share capital due from a shareholder (or party acting on behalf of a shareholder) and as such should reduce the potential for wilful or inadvertent misinterpretation in subsequent disputes.
What this case ultimately illustrates very clearly is that the courts continue to remain uncompromising when it comes to enforcing the provisions of the CA 2006 in order to safeguard the of a company’s capital maintenance.
It also serves as a warning to any would-be architects of tax-free profit extraction schemes highlighting that, to use another time-worn expression, that there is no such thing as a free lunch when it comes to facing up to tax liabilities.
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