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.

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Photo of Catherine Sear Catherine Sear

Catherine Sear is a partner in the Tax Department and a member of the Private Funds Group. She specializes in the tax aspects of structuring and investing in private investment funds including private equity, venture capital, infrastructure, debt and real estate funds, funds…

Catherine Sear is a partner in the Tax Department and a member of the Private Funds Group. She specializes in the tax aspects of structuring and investing in private investment funds including private equity, venture capital, infrastructure, debt and real estate funds, funds of funds, secondary funds and other investment partnerships.

She advises sponsors and investors on a wide variety of UK and international tax issues related to private investment funds and their operations, including tax aspects of:

  • structuring and raising private investment funds
  • structuring carried interest and executive coinvestment arrangements
  • restructuring existing private investment funds
  • establishment and operation of fund management businesses
  • investments by institutional investors in private funds
  • separate accounts for institutional investors, acting for both fund managers and investors
  • secondary transactions, both buy-side and sell-side
  • coinvestment structures

Catherine advises on a broad range of UK tax issues including VAT, employment tax, capital gains tax in relation to partnerships, withholding taxes and tax rules relating to carried interest. She also has considerable knowledge of international tax issues arising for investment structures with a cross-border dimension and experience with multijurisdictional fund management teams.

Photo of Robert E. Gaut Robert E. Gaut

Robert Gaut is a tax partner and head of our UK tax practice in London.

Robert provides advice on a full range of UK and international tax issues relating to fund formation, private equity deals, finance transactions and private equity real estate matters…

Robert Gaut is a tax partner and head of our UK tax practice in London.

Robert provides advice on a full range of UK and international tax issues relating to fund formation, private equity deals, finance transactions and private equity real estate matters, including experience with non-traditional equity transactions, such as debt-like preferred equity and co-investments for private credit investors.

Robert is highly-regarded for his ability to provide sophisticated tax advice to many of the world’s preeminent multinational companies, sovereign wealth funds, investment banks and private equity and credit funds. Clients have commented to legal directories that Robert is “really technical and knows his stuff,” and “has a very strong knowledge of the various tax laws, but also presents more innovative techniques and strategies.”

He is consistently recognized by Chambers UK and The Legal 500 United Kingdom, and has been recognized by Chambers Global as a leading individual in tax. The Legal 500 comments that Robert has “vast experience in a range of matters, including corporate tax structuring, real estate tax and fund formation.”

Photo of Stephen Pevsner Stephen Pevsner

Stephen Pevsner is a tax partner and a member of the Private Funds and Private Equity M&A Groups. Stephen’s practice covers the broad range of corporate and individual tax advice, with particular emphasis on private fund formation across a wide range of buyout…

Stephen Pevsner is a tax partner and a member of the Private Funds and Private Equity M&A Groups. Stephen’s practice covers the broad range of corporate and individual tax advice, with particular emphasis on private fund formation across a wide range of buyout, debt and infrastructure asset classes, as well as UK and international M&A transactions (often private equity backed). He has wide experience in corporate reorganisations, structured finance, investment funds and new business set-ups, and also advises regularly on a wide range of employee and fund manager incentive arrangements arising from these transactions.

Stephen is a member of the BVCA tax Committee and, according to Chambers UK, he is a notable practitioner in the corporate tax field, praised for “his ability to master the intricacies of tax law and understand the commercial aspects of the deal”.