New way for preference shares to jeopardise Entrepreneurs’ Relief

The issue

A key requirement for shareholders to enjoy Entrepreneurs’ relief (ER) is that they have owned 5% of the ordinary share capital for two years. Whereas ‘normal’ shares may have a relatively low nominal value (sometimes as low as £100) preference shares are typically for much higher amounts and can run into millions. Therefore, if an individual invests in preference shares the other shareholders will be keen to avoid being ‘crowded out’ from ER.



A, B, C and D are individuals who own 25 £1 shares each in a trading company. There is a proposal for Mr E to subscribe for 1M £1 preference shares. If these preference shares represent ‘ordinary share capital’ for the purposes of ER then A, B, C and D would be denied ER in the future.

Fortunately, for the purposes of ER, ordinary share capital does not include ‘capital the holders of which have a right to a dividend at a fixed rate but have no other right to share in the company’s profits’. On the face of it this should avoid the problem shown above for traditional preference shares with a fixed dividend. However it is not as simple as this because previous cases have decided that preference shares with no dividend rights do not fall within the exclusion (and therefore can crowd the other shareholders out). There has also been a recent case which has added an extra dimension to this well-known problem.


HMRC v Warshaw

In this case the tax payer wanted his preference shares to qualify as ordinary share capital because that was the only way that he would meet the 5% condition. Here, his ‘cumulative preference shares’ entitled him to a dividend of 10% of the capital but also 10% of any dividends that had not been paid in prior years. He argued that the dividends were not fixed because they could vary subject to the dividend payment pattern. Perhaps surprisingly he won the case, although as this was only a First Tier Tribunal decision HMRC could appeal.

The key message of this case was that it is not just the percentage which must be fixed but also the amount on which any percentage is applied.


Our comment

This case should provide a good reason for companies to review their capital structures in an ER context. Although the tax payer in the above case will be pleased to have won, there will be many more shareholders who will be adversely affected by the ruling. In fact, for this reason, it will be interesting to see if HMRC decline to appeal the case. If the law is allowed to stand here then it could be quite a money-spinner for HMRC in cases which involve ‘funny’ preference shares.




Sign up for our newsletter

Interested in receiving the latest tax planning ideas?

Sign up to Tax Bites – our weekly update offering practical but effective tax saving tips.

Contact Us

You can use this form to request us to give you a call or if you prefer just leave us a message. Please be sure to leave us a contact number or email address for you and we will get back to you as soon as we can.

0161 927 9277


Fairbank House
Ashley Road
WA14 2DP