The Upper Tribunal (Tax and Chancery Chamber), the UK’s second level tax appeal court, have just published their judgement in the McQuillan case, which considered whether shares with no right to dividends or any other profits are or are not “ordinary share capital” (OSC) for UK tax purposes. There are a number of UK tax rules that depend on how much OSC is held, and OSC is defined as all share capital except for any share capital that carry a right to a dividend at a fixed rate and no other right to share in the company’s profits. This decision concluded that such shares are OSC.
There has been uncertainty about whether shares with no rights to a dividend were or were not OSC – based on whether they had a right to a dividend at the fixed rate of 0% (not OSC) or carried no right to a dividend at all (OSC). HMRC’s published position has been historically that shares with no right to a dividend were OSC. The position was thrown into confusion in 2016, however, when two decisions of the First Tier Tribunal (“FTT”) were published on the same day coming to polar opposite views on ostensibly the same facts. The question in both cases related to the availability of CGT entrepreneurs’ relief (which can apply a 10% rather than 20% CGT rate to qualifying gains), one of the requirements for which is that an individual shareholder wishing to obtain entrepreneurs’ relief must hold 5% of the OSC of the company. In Castledine, the FTT decided that shares with no dividend rights were OSC. In McQuillan, it decided that they were not (because if they were, the taxpayer would have lost their entrepreneurs’ relief in particularly harsh circumstances).
The Upper Tribunal’s decision is not surprising and it is helpful that clarity has now been restored in this area that can have significant consequences if the wrong sort of share capital is issued or changes made without appreciating the full effects. The decision may not be welcomed, however, by anyone whose entrepreneurs’ relief position might have been prejudiced by changes to the terms of other shares in a relevant company. For instance, fixed rate dividend rights are sometimes removed from preference shares to enhance the potential value of other shares held by employees which were subordinate in a company’s capital structure. This can have unexpected (and undesirable) consequences if those preference shares then count as OSC, so that an employee shareholder’s percentage of OSC falls below the required 5% limit, or OSC limits in other tax provisions are affected.
Where dividend rights have been removed and adverse consequences might arise if the shares are now OSC, consideration could be given to amending their terms to add back a right to a low level of fixed rate dividend to take them back out of the company’s OSC.