Warshaw and entrepreneurs’ relief: when is a fixed rate not a fixed rate?
Blog Tax Take

On 24 April 2019, the First-tier Tribunal held that a cumulative preference share fell within the definition of “ordinary share capital” (OSC) for entrepreneurs’ relief (ER) purposes.

The decision is of vital importance to Mr Warshaw as it means he held 5.777% of the OSC of the company in question at the time of disposal and therefore would qualify for ER treatment. The CGT at stake was over £1.1m.

The definition of OSC for these purposes is to be found at section 989 of the Income Tax Act 2007. The sole issue in the case was whether the preference shares in question had a right to dividends at a “fixed rate”.  In order for Mr Warshaw’s appeal to succeed, he needed to convince the Tribunal that the preference shares did not carry a right to dividends at a fixed rate.

The Articles of the company in question provided that the preference shares had a right to a “fixed cumulative preferential dividend” at the rate of 10% per annum “on the aggregate of (i) the subscription price of such Preference Share and (ii) the aggregate amount of Preference Dividend that has previously compounded and not yet paid”.

Mr Warshaw’s position was that as the rate of the dividend on the preference shares was calculated by reference to any previous unpaid dividends, they did not carry a right to a dividend at a “fixed rate”. HMRC’s position was that as the 10% was fixed, it made no difference (for the purposes of the definition of OSC) that the compounded element varied.

The Tribunal “on balance” sided with Mr Warshaw and held that it was necessary, for the purposes of identifying OSC, to consider both (i) the percentage rate (which, in this case, was fixed at 10%) and (ii) the amount to which it is applied (which, in this case, varied).

HMRC has only relatively recently made public its views on cumulative preference shares (see our earlier blog here. As this decision goes against HMRC’s published view, HMRC might be expected to appeal against the decision.

Although in this particular case the decision amounted to a taxpayer win, this decision could have adverse implications in other cases (for example, it could have the effect of diluting below the 5% threshold the OSC held by management shareholders in private equity-backed companies).

The decision can be viewed here.