What are Preference Shares?
Preference Shares are shares which have preference over ordinary shares for payment of dividend or return of capital. However, they are junior to all forms of company debt, including debentures, loan notes and bank debt on a winding-up.
A company can be put into administration if it fails to pay interest on its debt, but preference dividends, like ordinary dividends, are paid at the discretion of directors. The level of discretion will depend on the terms of the prospectus with the payment of dividends on some preference shares being mandatory providing certain conditions (for example sufficient distributable reserves and capital adequacy) are met while for others the directors can have absolute discretion. This means that preference shareholders have no recourse to the company in the event of non-payment, although the company will not be able to pay an ordinary dividend until preference dividends have been paid.
Most UK listed Preference Shares pay dividends twice annually. However, most US listed Preference shares pay dividends quarterly (four times a year) with some Euro denominated European listed Preference Shares paying dividends annually (once a year). Dividends are paid net which means that the basic rate Income Tax liability of a UK investor has already been discharged. Most Preference Shares are undated, but one or two have a final redemption date and some have a Call Date which means a date of which the issuer can (but is not obliged to) redeem the shares.
Some Preference Shares are cumulative which means that the company must pay any dividend arrears from previous years before it can pay an ordinary dividend. Most bank Preference Shares are non-cumulative and were issued by banks to boost their tier 1 capital bases.
Purchases of Preference Shares, like ordinary shares, are subject to 0.5% stamp duty. The capital gains and income tax treatment is also the same as for ordinary shares. Preference shares are usually dealt “dirty price” i.e. with accrued dividend in the dealing price, and not dealt separately as with bonds.
There are a few bank preference share issues (such as RBS Series 1 Sterling) which were all issued to a SPV (special purpose vehicle) which then repackaged them as a bond issue.