To be (a preference) or not to be (a preference): that is the question. More accurately, that was the question before the Upper Tier Tribunal (UTT) last week regarding Foojit, a company whose EIS compliance statement was rejected by HMRC.
The court had to decide whether to uphold a decision made by the First Tier Tribunal (FTT) in 2019 that the right to receive 44% of dividends payable up to a limit, presumably aligned to investment delta, constituted “a preferential right to dividends” and therefore agree with HMRC. It did.
The case was intricate. Essentially, the UTT agreed with the premise of the FTT’s findings that there needed to be some deliberate action or decision on the part of the company to enable or initiate the dividend declaration. This, coupled with the clear position – accepted by both sides – that the quantum of the dividend was a preference, meant that the shares requirement for EIS compliance was not met. Interestingly, the UTT corrected the focus of all parties (including the FTT without so naming it) that it is not enough to consider the updated Articles. Rather, where there are model Articles in place, it is incumbent on the reader to consider both documents.
There is a disparity in the EIS legislation regarding preferences: the test looks at both assets and dividends and, whilst prescriptive regarding the latter, leaves the former undefined. This, coupled with HMRC’s long established, if counter-intuitive, position that rights to assets are only “preferential” if they enable one share class to receive before another share class irrespective of quantum, means that it is commonplace to award 99.99% of assets up to a hurdle to the EIS share class, so long as dividends are equal between all share classes. Note, all share classes. Users of deferred and growth share classes beware.
The UTT did provide some offer some hints at what it would have found acceptable, such as had the dividends been predetermined to be payable and then crystallise as a debt if unpaid, but I think that it would be a brave company that relies on that as offering a binding precedent. In reality, the overwhelming majority of EIS companies will never get to be dividend paying whilst owned by the investors; successful companies will create IP and resultant large negative reserves before turning the corner and being acquired, or the less successful will fail. As such, my advice would be to lean toward pragmatism; leave dividends well alone. Don’t try to be too clever over rights that are not likely to be effective in practice. Focus on asset rights, which will make a difference to the investors rather than risk suffering the slings and arrows of outrageous fortune.