Accounting and Tax

Dividends on preference shares

22 March 2019
2 min read

Companies are often incorporated with a class of preference shares, usually in addition to ordinary shares. Preference shares enjoy preferential rights which are defined by the constitution or the terms of issue of the shares. Examples of these preferential rights can include: set dividend rates, priority upon liquidation or special voting/non-voting rights. For close family companies, these could be used to ensure that trust shareholders are entitled to preferential treatment, in terms of dividends, as a way of building wealth in the trust. In wider companies, this mechanism will often be used for rewarding specific contributions.

A preference share may be cumulative or non-cumulative as to dividend. Cumulative shares entitle the holder to a dividend at a fixed rate. Where there is a fall in profits in one year and the full rate of dividend cannot be paid then this deficit is made up in later years. Non-cumulative means if there are insufficient funds to pay a dividend then that entitlement simply ceases.

Unfortunately, it is not always specified whether a dividend right is cumulative or non-cumulative. This is best illustrated in the recent High Court case of_Cadre Investments Ltd v Activedocs Ltd [2016] NZHC 1489._ The Court held that where the terms on which preference shares were issued were ‘silent’ as to whether the shares were cumulative or non-cumulative as to dividend, there is a presumption that they are cumulative.

This outcome is perhaps somewhat different to the prevailing commercial view. It is an interesting result and one that should prompt all companies with a class of preference shares to revisit their terms. Given that there is now a presumption that, under certain circumstances, a dividend at a fixed rate must be ‘made up’ over time there could be a potential impact on future cash flows for companies. Furthermore, there could be financial exposure arising from previous years that needs to be addressed.

For more information, please contact your Findex Adviser.