"Ordinary share capital" – when is a preference share really an ordinary share?

17 July 2023

At various points within the UK tax code, the application of reliefs or exemptions depends on a person’s percentage ownership of a company, and in particular their percentage ownership of a company’s "ordinary share capital".

For example:

  • business asset disposal relief (BADR, formerly entrepreneurs’ relief), which provides for a reduced rate of capital gains tax, can be available on the disposal by an individual of shares in a company provided that the individual holds at least 5% of the ordinary share capital of the company in question (among other conditions);
  • the UK substantial shareholding exemption (SSE), which exempts gains realised by a UK resident company on the sale of shares, requires (among other conditions) that the investing company holds at least 10% of the ordinary share capital of the investee company; and
  • a UK tax group for loss relief purposes broadly exists where there is at least 75% ownership of ordinary share capital (again, in addition to other conditions).

Understanding what constitutes "ordinary share capital" is therefore critical to applying these tests, as well as other rules. The definition of ordinary share capital may seem straightforward but there are a number of pitfalls that can lead to unexpected (and sometimes unwanted) results. Preference shares, in particular, should always be looked at closely if there is an expectation either that they will, or that they will not, form part of the ordinary share capital of a company.

There have been some movements in the legal position in this regard in recent years and so we thought it would be helpful to recap on the position.

Generally, "ordinary share capital" means all of a company’s issued share capital (however described), other than shares that have a right to a dividend at a fixed rate and no other right to share in the company's profits. This definition aims to exclude shares that are - in effect – like debt, namely fixed rate preference shares. However, not all preference shares (even fixed rate preference shares) are excluded.

A key distinction between certain kinds of preference shares was drawn by the upper tribunal in HMRC v Warshaw. Here, the taxpayer successfully argued that his preference shares that carried a right to a fixed cumulative compounding preferential dividend were in fact ordinary share capital. The tribunal concluded that although the percentage entitlement was fixed, the amount to which that percentage applied was not (because of the cumulative compounding element) and "a right to a dividend at a fixed rate" means both the rate and the amount to which that rate applies must be fixed.

The effect of this decision is that certain preference shares can count as "ordinary share capital" for the purposes of the reliefs and exemptions mentioned above (as well as others). In some cases, the inclusion of preference shares in a company’s ordinary share capital will be helpful and will widen the availability of such reliefs and exemptions, while in other cases it will have the opposite effect of narrowing their application.

Taking, as an example, the availability of BADR within a private equity fund investment context, the preference share element of a fund’s investment could possibly disturb the BADR analysis for managers. This is because, without care, the fund’s preference shares could unintentionally form part of the ordinary share capital of the investee company, and thereby dilute the manager’s percentage holding of ordinary share capital below 5%.

The practical takeaway, then, is that if you are relying on a relief or exemption being available which depends upon the ownership of ordinary share capital, a proper analysis should be undertaken of what is included within the ordinary share capital of the company, as this is not always intuitive or straightforward.