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Warshaw – preference shares equal to ordinary share capital and taxpayer entitled to entrepreneurs' relief

29 July 2019. Published by Michelle Sloane, Senior Associate

In Steven Warshaw v HMRC [2019] UKFTT 268 (TCC), the First-tier Tribunal (FTT) has confirmed that as the relevant preference shares did not attract a fixed dividend, they could amount to ordinary share capital for the purpose of entrepreneurs' relief (ER).

Background

Mr Warshaw was chairman of Cambridge Education Group Limited (CEG), a holding company, in which he held ordinary and preference shares. 

On 12 March 2012, Mr Warshaw exchanged all of his shares in CEG for shares in Cambridge Education Holdings 2 (Jersey) Limited (CEH2). On 13 March 2012, Mr Warshaw exchanged all his shares in CEH2 for shares in Cambridge Education Holdings 1 (Jersey) Limited (CEH1). 

Following these exchanges of shares, if Mr Warshaw's preference shares were 'ordinary share capital', as defined in section 989, Income Tax Act 2007 (ITA 2007), he would hold 5.777% of CEH1. If they were not, he would hold 3.5% of CEH1 and not satisfy the 5% threshold required in order for the company to be classified as Mr Warshaw's  'personal company', which would enable him to claim ER. 

In December 2013, Mr Warshaw sold his shares in CEH1 and ceased to be a director of CEH1 and chairman of CEG. In 2015, he Warshaw claimed ER on this disposal. 

HMRC opened an enquiry into Mr Warshaw's tax return and in due course issued a closure notice confirming that the capital gains arising on the disposal of the shares in CEH1 did not qualify for ER because CEH1 was not Mr Warshaw's 'personal company', for the purposes of section 169S(3), Taxation of Chargeable Gains Act 1992 (TCGA 1992). 

Mr Warshaw appealed to the FTT. 

FTT decision

The appeal was allowed.

The sole issue before the FTT was whether the preference shares held by Mr Warshaw amounted to 'ordinary share capital', as defined in section 989, ITA 2007. If they did, CEH1 would qualify as Mr Warshaw's 'personal company', for the purposes of section 169S(3), TCGA 1992, and he would be entitled to ER on the disposal of his shares. 

The FTT firstly considered the nature of the shares.  The preference shares were cumulative and attracted a right to a fixed dividend at 10% per year, but if there were insufficient reserves to pay the dividend in one year, payment was deferred to the next year and the dividend would be paid at 10% on the aggregate of the subscription price and the amount compounded. The FTT applied Tilcon Limited v Holland (Inspector of Taxes) [1981] STC 365, which supported the need to take into account both the percentage element and the amount to which it was applied to in order to identify the rate of the dividend. 

If, as was the case here, when the preference shares were issued, the articles of association of the company provided only that the percentage element of a dividend was fixed, then the shares did not have a right to a fixed rate dividend. As such, the shares fell within the definition of 'ordinary share capital', provided by  section 989, ITA 2007, and CEH1 was Mr Warshaw's personal company. As such, he was entitled to ER on the disposal of his shares. 

Comment

This decision confirms that if, at the time the preference shares are issued, the articles of association of the company provide only that the percentage element of a dividend is fixed, so the shares do not have a right to a fixed dividend, the shares will fall within the definition of 'ordinary share capital, in section 989, ITA 2007.

Advisers should consider carefully the precise wording of a company's articles of association and the rights attached to any shares disposed of when claiming ER. 

The decision can be viewed here.