In Foojit Ltd v HMRC [2019] TC7467, the First Tier Tribunal dismissed a claim for EIS relief on shares with preferential dividend rights. Someone had to decide when the dividends would be paid and this made them excluded shares for the relief.
Individuals subscribing for shares in an Enterprise Investment Scheme (EIS) qualifying company receive tax relief of 30% on the cost of the shares. This is offset against their Income Tax liability for the year in which the investment is made.
To get relief qualifying shares must be issued to a qualifying investor. Under s173 ITA 2007 qualifying shares are:
- Ordinary shares which, at the time of issue and for the following 3 years, do not carry any present or future:
- Preferential right to dividends (s173(2)(a).
- Preferential right to the company’s assets on a winding up, or
- right to be redeemed.
Foojit wanted to issue B shares to raise investment.
- It wanted the ‘B’ shareholders to have enhanced protection as against the ‘A’ shareholders so it amended its articles to give the B shares a right to a prior dividend of 44% of the available distributable profits, “which may not be altered by resolution of the board of directors or the members”.
- It submitted an advanced assurance request to HMRC for the B share issue, which was granted. The request was sent before the articles were amended to include the B shares.
- HMRC refused to issue EIS compliance certificates (EIS1) on the basis that the B Shares carried an excluded preferential right within the relevant 3 year period.
- Foojit’s ground for appeal was that shares with preferential rights are only excluded if the preferential right is one whereby, under s173(2A):
- “the amount of any dividends payable pursuant to the right, or the date or dates on which they are payable, depend to any extent on a decision of the company, the holder of the share or any other person”;
and here the dividends did not so depend. They were provided for by the articles and became payable once profits existed.
The question was one of statutory construction (the facts were not in dispute), and the interpretation of s173(2)(a), that is did the B Shares carry any present or future preferential right to dividends within subsection (2A)?
The FTT dismissed the appeal finding that the B shares did have preferential rights within s173(2)(a):
- The EIS legislation is highly prescriptive and the use of the word “any” preferential right means that any such right, however theoretical or small, should not be ignored.
- As the division of the dividends payable under the preferential rights was fixed and could not be altered by the directors or members, the B shares did not carry a preferential right in relation to the amount of dividends payable.
- The articles were silent about when the prior dividends became payable so the date on which they were payable must be identified in the same way as any other dividend. It requires a decision by the company, shareholder or other person once audited accounts were completed and the distributable profits identified, at which time a declaration or resolution was necessary for the dividends to become payable.
Comment:
As the judge said the EIS (and SEIS) rules are very prescriptive and there is no leeway in applying them. This is not the first time relief has been denied due to an error in the details involving preferential rights. If in doubt, companies should stick with plain and simple ordinary shares with equal rights to all other shareholders.
Links to our guides:
EIS: Enterprise Investment Scheme (Subscriber guide)
SEIS: Seed Enterprise Investment Scheme (subscribers)
Which relief: IR v ER v SEIS v EIS
External link: