Business Asset Disposal Relief  – When is a Preference Share an Ordinary Share?

16 February 2021

Business Asset Disposal Relief (BADR), previously Entrepreneurs’ Relief, reduces the Capital Gains Tax rate on qualifying BADR Gains to 10%, as opposed to the current 20%.

One of the conditions to qualify for BADR is that the shares in the company which the individual is disposing of must be shares in the individuals ‘personal company’. The personal company test is satisfied if the individual holds at least 5% of the Ordinary Share Capital (OSC) of the company.

Ordinary Share Capital

Broadly, the legislation defines OSC as “any share capital, however described, other than capital with a fixed right to dividends of the company”.

Typically, preference shares would have a fixed right to the profits of the company i.e. a preference share with a dividend rate of 2% per annum would normally fall to be excluded from the definition of OSC.

However, the Upper Tribunal have decided on a recent case (HMRC v Warshaw 2020) that compounding preference shares should also be classed as OSC as the return on these shares could be variable, not fixed.

Case Law

The circumstances of the HMRC v Warshaw case was that the preference shares carried a 10% dividend per annum. Where insufficient reserves were available to distribute the dividends to the preference shareholders, the payment of the dividend would roll forward to the next year (where the dividend would then be paid on the compounded amount of capital plus unpaid dividends/s).

As the rate at which the dividend would be paid would be calculated on an increased or variable amount of capital, the Upper Tribunal ruled that these preference shares could not be classed as ‘fixed’ and that they would fall within the OSC definition.

Consideration

Care should be taken for individuals where preference shares form part of the capital of a company that they hold shares in. Depending on the specific rights attached to preference shares these could either cause entitlement to BADR to be lost where it was thought to be secure and vice versa.

If preference shares are held within your company and you are not sure how this impacts you or for further information, or if you have any questions, please contact Kevin Meaney or your usual AAB contact.

To find out more about AAB's Expertise to Entrepreneurs team, click here

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