EIS relief denied: shares had preferential rights

In Foojit Ltd v HMRC [2021] UKUT 0014, the Upper Tribunal (UT) confirmed that HMRC were right to refuse to issue compliance certificates allowing EIS relief on shares with preferential dividend rights. Although advanced assurance had been given, the company later changed its articles.

Individuals subscribing for Enterprise Investment Scheme (EIS) qualifying shares receive Income Tax relief of 30% on the cost of the shares and there are further benefits on disposal.

To get relief qualifying shares must be issued to a qualifying investor. Qualifying shares are:

• Ordinary shares which, at the time of issue and for the following three years, do not carry any present or future:
  • Preferential right to dividends of a type prescribed by legislation (s.173(2A) ITA 2007).
  • Preferential right to the company’s assets on a winding-up.
  • Right to be redeemed.

Foojit wanted to issue B shares to raise investment.

• It wanted the ‘B’ shareholders to have enhanced protection compared to the ‘A’ shareholders so it amended its articles to include further clauses in addition to supplement those in the Model Articles it had taken on incorporation. These gave 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 Amended Articles were submitted 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 three-year period.
• Foojit argued that while the shares had preferential rights, they were provided for by the Amended Articles and became payable once profits existed. They did not, therefore, meet the requirement in s.173(2A) that;
  • “The amount of any dividends payable pursuant to the (preferential) 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” (emphasis added).

The FTT dismissed the appeal finding that the preferential rights were of the type described in s.173(2A):

• While the amount of the dividends payable on the B shares were fixed and did not depend on a decision by the Company the date of payment did. 
• The Amended Articles did not give shareholders a right to a dividend, they gave a right to a dividend if one was paid.
• The date for dividend payment on the B shares was not prescribed by the Amended Articles so it was necessary to look at the Model Articles.
• Those Model Articles stated the payment of a dividend required declaration by the directors of the company and that was sufficient to render the dividend dependent to any extent on a decision of the company, the holder of the share or any other person, thus meeting the conditions in s.173(2A).

The taxpayer appealed to the UT arguing that:

• The Amended Articles provided for 'trigger events' making the dividend on the B shares mandatorily payable, making the dividend declaration process in the Model Articles irrelevant and requiring no decision of the company, the holder of the share or any other person.

The UT dismissed this argument finding that:

• The Articles and Model Articles were intrinsically linked and both needed to be reviewed.
• The Amended Articles did not supersede the dividend payable routes in the Model Articles which required decisions being taken by the company.
• While the intention was for the EIS relief to be available to the company’s investors that should not lead to a favourable reading of the documents.

The appeal was dismissed.

Links to our guides

EIS: Enterprise Investment Scheme (Subscriber guide)
When can EIS relief be claimed?  What are the conditions for EIS relief?  What are the benefits of EIS relief?

SEIS: Seed Enterprise Investment Scheme (subscribers)
When can SEIS relief be claimed?  What are the conditions for SEIS relief?  What are the benefits of SEIS relief?

Which relief: IR v BADR v SEIS v EIS
What is the difference between Business Asset Disposal (Entrepreneurs') Relief (BADR) and Investors' Relief? How do they compare to investments in the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS)?

Issuing New Shares (planning and pitfalls)
A practical guide on how to issue new shares in a company together with a summary of some of the pitfalls if an issue fails to qualify for tax purposes.

Share Capital: What's an ordinary share?
What is an ordinary share? Why is it important?

Internal link

Foojit Ltd v HMRC [2019] TC7467

External link

Foojit Ltd v HMRC [2021] UKUT 0014