The upper tribunal has confirmed that certain cumulative preference shares can form part of the “ordinary share capital” of a company for tax purposes. This is good news for holders of those shares who hope to benefit from business asset disposal relief (BADR), but could be bad news where large stakeholders hold what are now "qualifying" preference shares, potentially denying relief to manager stakeholders.
BADR (which until recently was known as entrepreneurs’ relief) provides a reduced rate of capital gains tax on the disposal of shares (up to a lifetime limit of £1m of gains), provided certain conditions are met.
One of those conditions is that the person making the disposal must hold 5% of the ordinary share capital of the company in question. Ordinary share capital in this context means all of a company’s share capital, other than shares that have a right to a fixed dividend (and no other right to share in the profits of the company).
The question in HMRC v Warshaw was whether Mr. Warshaw’s preference shares fell within this definition. His shares had a right to a fixed cumulative compounding preference dividend.
The court held that for shares to be entitled to a "fixed dividend" only, both the percentage entitlement and the amount to which that percentage applies must be fixed. The court found that the dividend on Mr Warshaw’s preference shares was not “fixed” because of the cumulative compounding element, which meant that the amount to which the percentage dividend applied was not fixed. His shares were therefore “ordinary share capital”.
This is a helpful clarification from the upper tribunal regarding the definition of ordinary share capital. If you are an individual who holds preferences shares, you may wish to review their rights. If they were to be changed now in order to fall within this decision, you may be able to benefit from relief in two years’ time.
If you hold ordinary shares and another shareholder holds preference shares in the same company, you should check the rights of those preference shares. If they are part of the ordinary share capital of the company as a result of this decision, they could dilute your shareholding below the 5% threshold.
This decision will also have wider implications, as the definition of ordinary share capital set out above is used in both the individual and corporate tax codes. It will therefore apply to other reliefs, such as the substantial shareholding exemption and to many grouping tests, such as the chargeable gains grouping test that allows assets to be moved within a group on a no gain, no loss basis.
As can be seen, it is important to understand exactly which shares within a company’s share capital structure form part of the “ordinary share capital” and which do not. These rights may be able to be adjusted, but there may be a time lag before any such change can result in a relief applying.
We see no principled basis for distinction between a dividend expressed as a fixed percentage of profits and the dividend on [these] Preference Shares.