13
DIY Investor Magazine
/
September 2016
In order to address this issue a recent development
has been the creation of both bonds and preference
shares that deliver returns linked to a particular index or
measure of inflation to ensure that its effective dividend
is not eroded.
There are other key differences between the rights
bestowed upon their owners by issuers of preference
shares and bonds; if bondholders don’t receive
their interest, they can bankrupt the company, but
preference shareholders do not wield the same power
and prefs are junior to all other company debt such as
debentures, bank debt and loan notes.
If a company is unable to pay its dividend in a
particular year, preference shares are cumulative
and must be paid in full if and when the company is
subsequently able to; however, if the company were to
go bankrupt, you’ll never get your lost income.
In such an eventuality, preference shares rank ahead
of ordinary shares in terms of the company’s capital
structure – but behind bondholders – although when
ordinary shares become worthless, preference
shareholders get nothing and even bondholders
seldom get all their money back.
Dividends are paid out of taxed company profit, so for
the purpose of tax, preference shares are treated the
same way as ordinary dividends, meaning that they
are paid net - basic-rate taxpayers have no more tax
to pay on their income, while higher-rate taxpayers are
effectively taxed at 25%.
Those seeking income may appreciate the security
of having to be paid a dividend before ordinary
shareholders – and cumulative payments if you’re not
paid; investing in this special share class is more about
getting a slightly better income, in return for forgoing
the chance of equity-like gains.
Most preference shares are undated, but some have
a final redemption date, so care must be taken when
considering the redemption yield, but overall preference
shares can deliver a permanent flow of income at a
yield that is likely to hold its own against inflation.
