The meaning of ‘ordinary share capital’ (‘OSC’) mattered greatly to Stephen Warshaw. If certain shares that he held counted as OSC, he was entitled to Entrepreneurs’ Relief on his capital gain of some £6m; if they didn’t, he wasn’t.
In 2019, the First-tier Tribunal had held in his favour: and the Upper Tribunal has recently followed suit, in [2020] UKUT 366 (TCC).
The case is of wider interest than might at first sight appear. This is because the relevant definition of OSC (which is to be found at Income Tax Act 2007 s989) is one that is applied across a wide range of tax provisions, of which Entrepreneurs’ Relief (now re-named Business Asset Disposal Relief) is but one. And, depending on the circumstances and the tax provision involved, it is sometimes (as in Mr Warshaw’s case) HMRC who are arguing for a narrow interpretation of the term, and sometimes the taxpayer.
The (deceptively simple) definition of OSC is that it encompasses all issued share capital of a company ‘other than 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’.
Mr Warshaw’s shares had a right to a 10% preference dividend but no other right. HMRC thought that that looked like ‘a dividend at a fixed rate’, and concluded that the shares were not OSC.
However, things were not that simple. The company’s Articles of Association provided that the dividend was both cumulative and compounded.
It’s not at all uncommon for preference dividends to be cumulative (so that if a dividend is not paid when due, then it remains due – or accumulated – to be paid in a later year). That remains a dividend at a fixed rate: a cumulative dividend does not make shares OSC.
However, in Mr Warshaw’s case the share rights provided also for dividends to be compounded – the amount of any unpaid accumulated dividends would be added to the subscription price for the shares in calculating the base on which the 10% dividend was to be paid in subsequent years.
Mr Warshaw’s advisers successfully argued that a dividend is ‘at a fixed rate’ only if both (a) the rate and (b) the base to which the rate is applied are fixed. The fact that the shares in question provided for the compounding of unpaid dividends inevitably meant that (regardless of whether dividends had in fact been compounded) the base was capable of changing so was not ‘fixed’. It followed that the dividend was not ‘at a fixed rate’; the shares were not excluded from the definition of OSC; and Mr Warshaw was entitled to his relief.
The Tribunal gave short shrift to HMRC’s counterargument that (essentially) the question should be determined by whether the shares looked ‘debt-like’. It’s worth quoting the Tribunal’s response in full:
The definition is by its terms formalistic in nature. It looks solely to the dividend rights and any additional right to share in the company’s profits attached to a share. As stated in Trigg [Trigg v Revenue and Customs Commissioners (2016)], it is not for the tribunal “to seek to equate cases on one side of the dividing line with similar cases falling on the other side by reason of similarity in effect or economic equivalence”. Expressed another way, any process of construing section 989 should not search for whether in any particular case a classification might appear fair or just: as stated in McQuillan [HMRC v McQuillan (2017)], a definition such as section 989 “is apt to produce results which appear unfair”
The decision is thus helpful both in saying how s989 applies to the particular case and in giving guidance on its interpretation more generally.
Meanwhile, HMRC’s views on a range of circumstances in which the status of shares as OSC may be unclear (not yet updated for the Upper Tribunal decision in Warshaw) may be found here.
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