When Preference Shares Are Ordinary

When Preference Shares Are Ordinary Shares – Entrepreneurs’ Relief

When Preference Shares Are Ordinary Shares – Entrepreneurs’ Relief is a post arising from the case of Revenue and Customs v Stephen Warshaw [2020] UKUT 366 (TCC).

The taxpayer Mr Warshaw succeeded in having his Preference Shares being affirmed as Ordinary Shares. He had succeeded in the first instance in his claim to Entrepreneurs’ Relief after HMRC denied his claim. However, HMRC appealed. They lost.

In order to qualify for Entrepreneurs’ Relief you require to have at least 5% of the ordinary shares and 5% of the voting rights.

In order to qualify the company in which the shareholding is held needs to be a ‘personal’ company of the individual:

That term is defined by section 169S(3) Taxation of Chargeable Gains Act 1992 (“TCGA”) as follows:

For the purposes of this Chapter ‘personal company’, in relation to an
individual, means a company —
(a) at least 5% of the ordinary share capital of which is held by the
individual, and
(b) at least 5% of the voting rights in which are exercisable by the
individual by virtue of that holding.

A “personal company” is defined by reference to a specified percentage of both ordinary share capital and voting rights. The “ordinary share capital” is defined by section 169S(5) in the following way: “ordinary share capital” has the same meaning as in the Income Tax Acts (see section 989 of ITA 2007).

Section 989 Income Tax act 2007 (“section 989”) defines “ordinary share
capital” as follows: “ordinary share capital”, in relation to a company, means all the company’s issued share capital (however described), other than capital the holders of which have a right to a dividend at a fixed rate but have no other right to share in the company’s profits.

The key issue therefore on this appeal is whether the Preference Shares were actually Ordinary Shares:

If the Preference shares were “ordinary share capital” (as defined in section 989 Income Tax Act 2007), Mr Warshaw held 5.777% of the “ordinary share capital” of the Company. However, if the preference shares were not “ordinary share capital”, he held only 3.5% of the Company’s “ordinary share capital”…The sole issue in this appeal, as it was before the FTT, is whether or not the Preference Shares carried a “right to a dividend at a fixed rate”. If the answer is affirmative, then the Preference Shares are excluded from the definition of “ordinary share capital”, the Company was not Mr Warshaw’s “personal company”, and he was not entitled to entrepreneurs’ relief. If, as the FTT determined, the answer is negative, 20 the contrary consequences would ensue, and HMRC’s appeal must fail.

The Upper Tribunal had the following to say about fixed rate shares:

In our opinion, it is clear that a fixed rate dividend right does not cease to be fixed rate merely because it is cumulative. The right remains a right to a dividend at a fixed rate. Indeed, the strength of the right is arguably increased by an express right of cumulation. The fact that an accumulated fixed rate dividend may be payable and therefore paid after the due date is relevant to the timing of the payment but does not have the result that either the percentage or the amount to which it is applied is not fixed.

….Ordinary share capital was defined in section 526, as originally enacted, as excluding share capital “the holders whereof have a right to a dividend at a fixed rate or a rate fluctuating in accordance with the standard rate of income tax, but have no other right to share in the profits of the company”. The additional restrictions introduced into the group relief rules in 1973 to apply requirements in relation to “equity holders” (in addition to ownership of a certain percentage of ordinary share capital) included within the definition of equity holder a holder of ordinary shares. “Ordinary shares” were defined for this purpose as “all shares other than fixed rate preference shares”, and, so far as material, fixed rate preference shares were defined as shares which “do not carry any right to dividends other than dividends which…are of a fixed amount or at a fixed rate per cent of the nominal value of the shares”.

The question is what is meant in section 989 by a right to a dividend “at a fixed rate”. In our opinion, “rate” in this context describes the relationship between two variables or different units of measurement, expressed as a ratio. It is clear in our opinion (and accepted by both parties), that a “fixed rate” requires the rate of dividend to be expressed as a fixed percentage or amount per share. So, a dividend right of 1% plus Libor is not a right to a dividend at a fixed rate….The issue is whether it is also necessary for the rate to be fixed as to the amount to which it is applied. Applying the principles which we have described, we consider that the answer must be yes….HMRC accept, as they must in our view, that a dividend right of 10% of the 10 company’s profits is not a right to a dividend at a fixed rate, because although the 10% is fixed, the amount to which it is to be applied will vary.

This post When Preference Shares Are Ordinary Shares – Entrepreneurs’ Relief is not legal advice and not to be relied upon as such.