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The First-tier Tax Tribunal has recently held that cumulative preference shares can constitute ordinary share capital for the purposes of entrepreneurs’ relief. This is contrary to HMRC’s opinion, expressed in recently issued guidance. Broadly, the definition in the legislation is that ordinary share capital means all of a company’s issued share capital other than fixed rate shares. HMRC argued that, because the rate of the dividend remained fixed (at 10%), the shares could not be ordinary share capital.
The Tribunal agreed with the taxpayer’s argument that, in determining whether a right to a dividend is at a fixed rate, it is necessary to have regard to two elements: the percentage rate, which is fixed, and the amount to which it is applied, which in this case was variable, as the company’s Articles allowed for compounding of unpaid dividends in years when there were insufficient reserves. This meant that elements of the payment were not ‘fixed’ as they could include unpaid amounts from previous years (if there were insufficient reserves to pay the dividends in respect of those shares in a particular year, payment was deferred to a subsequent year. Therefore, the rate at which the dividend would be paid, 10%, would be calculated on an increased amount which was the aggregate of the subscription price and the aggregate unpaid dividends).
On that basis and having tested that this gave logical results in a variety of situations, the Tribunal concluded that the preference shares constituted ordinary share capital.
It is notable that this decision is contrary to the view expressed in HMRC’s recent guidance. It is not yet known whether HMRC will choose to appeal – it has 56 days from the date of the decision to do so, should it wish to.
Practically, and in addition to the October 2018 budget changes, it further increases the need to review existing share ownership structures to understand the impact of the recent developments on the qualification for entrepreneurs’ relief.