The following two statements relate to the use of preference shares by a UK listed company:

Statement One ‘One advantage of preference shares to the company is that preference share dividends are deductible for corporation tax purposes, whereas ordinary share dividends are not.’

Statement Two ‘Returns to preference shareholders tend to be less risky than returns to debt holders, because preference share dividends have to be paid before any ordinary share dividends can be paid.’

What is the validity of the two statements?

Statement One   Statement Two

	A.	True            True
	B.	True            False
	C.	False           True
	D.	False             False

Answer - D. False False

Reason - Both the statements are false.

Statement 1. One advantage of preference shares to the company is that preference share dividends are deductible for corporation tax purposes, whereas ordinary share dividends are not.:- This statement is false since that share dividends on preference shares is not tax deductible. No tax benefit is given on dividend on any types of shares, neither equity (ordinary shares) nor preference shares. The main reason is that the dividends are not the expenses of a company but the earnings which are distrubed as dividend among the shareholders. The tax deduction is provided on the business expenses and not the earnings, therefore dividends can't be claimed as deductions from the tax return. The preference share dividends are paid after the tax expenses.

Statement 2. Returns to preference shareholders tend to be less risky than returns to debt holders, because preference share dividends have to be paid before any ordinary share dividends can be paid :- This statement is false. In case of settling any claim in the event of liquidation or in case of bankruptcy of a company, equity shareholders are the last in the line to be paid. Preference shareholders are paid before the equity shareholders but after the bondholders. Since, the shareholders (both preference and equity) are paid after the bond holders, returns on bonds are less risky and provide higher returns than the shares.

Bonds pay a fixed rate of interest income while the stocks don't and the interest is also tax-deductible on the bonds because paying interest on bonds is an expense for the company while paying dividends on shares is earning of the company. Because of these factors, bonds are considered safer and less volatile investments than the stocks.

Thus, inspite of the fact that the preference share dividends have to be paid before any ordinary share dividends can be paid, the bonds provide less risky returns.