Entrepreneurs' Relief and preference shares

Posted by RM2 at 14:41 on 19 Jun 2019

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There has been a slew of entrepreneurs’ relief (ER) cases lately as ER comes under increasing scrutiny in view of the tax lost to HM Treasury. (To recap, ER is a capital gains tax relief which taxes an individual’s qualifying total lifetime gains of £10m at a rate of 10 per cent.) In the most recent case, Warshaw v HMRC [2019] UKFTT 268 (TC), HM Revenue & Customs (HMRC) have lost their appeal at a First Tier Tribunal as the preference shares sold by Mr Warshaw were found to meet the requirements for ER.

Facts of the case

For ER purposes ‘ordinary share capital’ means all shares which do not have a right to a dividend at a fixed rate. The preference shares held by Mr Warshaw carried ‘no rights to participate in the profits and assets of the company except as provided in the articles’. The articles went on to further define a preferential dividend as the ‘right to a fixed cumulative preferential dividend’. On an initial reading, it is hard to see how HMRC lost this case at the First Tier Tribunal such that by including the preference shares, Mr Warshaw met the relevant 5% tests for ER and qualified for a 10% tax rate.

Fixed dividends

Both HMRC and the appellant’s counsel referred to cases which they considered demonstrated that the rights of the preference shares either indicated whether or not they were ordinary shares for ER purposes.

The judge agreed with the arguments put forward by the appellant’s legal counsel on the basis that whilst ‘the percentage element is fixed and the amount to which the percentage is to be applied may vary, those shares cannot be regarded as having a right to a dividend at a fixed rate and are therefore ordinary share capital’.

Individual shareholders should always seek appropriate advice on whether their shares are likely to meet the requirements for ER. We do not give tax advice at RM2, but it is important to note that the 5% tests for ER are not relevant where shares are acquired by an employee via an Enterprise Management Incentive (EMI) plan. An employee must hold their qualifying EMI option for two complete years prior to exercise and sale to qualify for ER.

Please do contact us on 0208 949 5522 / enquiries@rm2.co.uk if you would like to discuss EMI further and whether it might be appropriate for your company.