Preference Shares and Entrepreneurs’ Relief

Most business owners will be familiar with the concept of “Preference Shares”.  As the name suggests, these are shares which benefit from some sort of preferential treatment, most commonly rights to early redemption or the entitlement to the first call on capital in a winding up.  Such shares may or may not carry the right to receive dividends.

Preference shares arise for many reasons and are a useful tool for both corporate finance and tax planning, but could they inadvertently create a problem when it comes to a company sale?

Entrepreneurs’ Relief

Entrepreneurs’ Relief, if applicable, delivers a 10% rate of tax on a disposal of shares in the holder’s “personal company”.  If an individual has a qualifying shareholding the relief applies to all of the shares they hold including preference shares.  So far, so good –  but let’s consider further the definition of “personal company” for these purposes.

It is necessary to hold at least 5% of the “Ordinary Share Capital” of the company and be able to exercise at least 5% of the voting rights to fall within the definition of “personal company”.

The potential problem

The definition of “Ordinary Share Capital” for the purposes of Entrepreneurs’ Relief refers to “… all the company’s issued share capital other than the capital the holders of which have right to a dividend at a fixed rate but no other right to share in the company’s profits”.  This means that participating preference shares fall fairly and squarely within the definition of “Ordinary Share Capital”.

By way of example, imagine that Mr X holds 50 out of 1000 Ordinary Shares which carry full rights to voting and dividends.  The company also has 20,000 preference shares which have no voting rights but carry the right to a variable dividend.  These preference shares will fall within the definition of “Ordinary Share Capital”.  Mr X thus only holds 0.2% of the “Ordinary Share Capital” (nominal value) and a disposal of his shares will not attract Entrepreneurs’ Relief.

The McQuillan case

However, many preference shares carry only capital rights with no rights to a dividend at all.  Could these then be said to have a fixed rate dividend albeit at 0%?

This very point was the subject of the recent Upper Tribunal case McQuillan which involved shares which had been put in place as part of a loan capitalisation and carried no rights to a dividend.

Mr and Mrs McQuillan argued that these were fixed rate preference shares and thus outside of the definition of “Ordinary Share Capital”.

The Upper Tribunal held that the right to a zero dividend could not be regarded as a right to a dividend at a fixed rate because, in order to be a fixed rate dividend, there has to be an entitlement to a dividend in the first place.  The McQuillans did not qualify for Entrepreneurs’ Relief.

Conclusion

The conclusion is therefore that preference shares which carry no dividend rights are “Ordinary Shares” for the purposes of the Entrepreneurs’ Relief legislation and holders of shares in trading companies with preference shares in place should review their position before planning a sale.

If you would like more details on anything covered in this article, please contact on 0845 880 5678 or email action@wrightvigar.co.uk