Loan relationships: shares acting like debt: preference shares
Shares with similarities to debt: example
BY Ltd invests in AX Ltd by subscribing for 100,000 £1 redeemable, cumulative, fixed-rate preference shares. The shares pay a fixed dividend of £10,000 each year. If there are insufficient distributable profits to pay the dividend then the dividend will roll up until distributable profits are available. If AX Ltd goes into liquidation, BY Ltd will be entitled to redeem its shares before the ordinary shareholders.
Alternatively BY Ltd could invest in AX Ltd by lending it £100,000 at interest of 10% per annum.
The effect of each of these two arrangements is exactly the same in terms of BY Ltd’s return - income of £10,000 per year plus repayment of the sum invested.
- AX Ltd’s parent company guarantees the preference shares, and
- it is recognised that the preference shares really do have more of the qualities of a loan than share capital
then the accounts may well show the preference shares as a liability rather than capital. Nonetheless, the obligation is not a loan relationship within the S302 definition.
From 16 March 2005, however, this situation is likely to be caught by CTA09/PT6/CH7 - see CFM45000.