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02/11/18
In R Ames v HMRC (2018) UK UT190 the Upper Tribunal found that CGT relief was not available on the disposal of EIS shares where no income tax relief had been claimed on their acquisition but granted judicial review of HMRC’s decision not to allow a late claim for EIS income tax relief.

The circumstances of this case are somewhat unusual. While most investors in Enterprise Investment Schemes (EISs) do so primarily to obtain income tax relief on the investment into the scheme, in this case Mr Ames invested £50,000 in an EIS scheme in 2005, but he did not claim EIS income tax relief. This was because his taxable income for that tax year was only £42 which was considerably less than his personal allowance which meant he had no income tax liability to reduce.

In June 2011 Mr Ames sold his shares for £333,200. He did not include any gain in his self-assessment because he understood that the gain was exempt from capital gains tax (CGT) under the EIS rules.

Following an enquiry, HMRC determined that Mr Ames was only entitled to the exemption from CGT if he had obtained EIS income tax relief on the acquisition of the shares and as he had not done so, he was liable for CGT on the gain. Accordingly, HMRC issued an assessment for a tax liability of over £72,000. Mr Ames appealed, however the First-Tier Tribunal (FTT) found against him.

Mr Ames also wanted to make a late claim for EIS income tax relief but, given that any claim for EIS income tax relief needs to be made not later than the 5th anniversary of the 31st January following the year of assessment, the crucial date for him was 31 January 2011. In fact Mr Ames made his claim in October 2012.

Generally speaking, HMRC has discretion to allow a late claim if a taxpayer has a reasonable excuse for failing to make the claim before the statutory deadline. In this case, however, HMRC did not accept that Mr Ames had a reasonable excuse and so refused to accept the late claim.

Mr Ames then took his case to the Upper Tribunal. The Upper Tribunal (UT) upheld the FTT decision that CGT relief on disposal of EIS shares will not apply unless there had been an income tax relief claim when the investment was first made. However, the UT heard that the decision-making process by HMRC as a result of which it declined to allow a late claim for income tax relief was flawed. HMRC did not properly apply the guidance on when and how it should exercise its discretion. The Guidance Note SACM10040 specifically states that there may be exceptional cases which are not covered by specific guidance relating to particular claims or elections where it may still be unreasonable for HMRC to refuse a late claim or election.

In Mr Ames’ case the exceptional circumstances included the fact that he had almost no income in the relevant tax year and therefore claiming relief would result in no income tax relief being in fact obtained. It would be a pure formality in order to preserve his entitlement in principle in the future to CGT exemption.

The UT accepted that it was perfectly reasonable and understandable for Mr Ames to believe that, given his very small income, he did not have to make a claim for relief. There is in fact no guidance dealing specifically with such unusual circumstances.

Given Mr Ames’ minimal income in that year and the fact that it’s not just a question of a claim but actual relief against income tax that was required in order to benefit from CGT exemption, to achieve that, Mr Ames would have had to waive in whole or in part his personal allowance. This, again, is not dealt with in any guidance.

The UT accepted that the legislation has created an anomaly for investors with taxable income below the personal allowance. In such circumstances the argument presented by HMRC that misunderstanding of legislation or guidance does not justify that a late claim was considered to be too inflexible and a mechanical approach. For this reason, the Upper Tribunal quashed HMRC’s decision from 2015 and remitted it back to HMRC for reconsideration.

Clearly Mr Ames was not a typical EIS investor, namely someone with relatively high income on which relief against income tax is sought in the first place. But this is not the first case where the highly technical EIS rules have come under scrutiny.

Whilst the legislation appears to be clear in that in order to benefit from CGT relief on disposal of the EIS shares there must first be an income tax relief, there is no logical reason why the two reliefs need to be linked. In fact, given that one of the objectives of the EIS reliefs is to increase private investments in the type of businesses which are covered by EIS rules, it seems odd that the CGT relief needs to be linked to the income tax relief. Given the Upper Tribunal’s critical assessment of HMRC’s decision making process when considering a late claim for the income tax relief, it is hoped that HMRC will reconsider and allow Mr Ames' late claim.

The case illustrates how important it is for the investor to be familiar with all the rules relevant to EIS investments before committing themselves.
Author: Technical Connections