On 20th October, the Chancellor announced changes to Entrepreneurs relief (“ER”) which had much wider application and significance than originally thought.
ER, which can effectively reduce Capital Gains tax (normally 20%) for individuals on the disposal of business assets to just 10%, has been a well-used relief for years, and the Chancellor’s recent tweaks to eligibility were an unwelcome, but long-expected, intervention.
In essence, subject to compliance with certain other detailed conditions, a shareholder was eligible for ER if they were an officer of a company, owned at least 5% of the ordinary share capital and controlled 5% of the voting rights for a qualifying period of at least 12 months immediately prior to the date of sale. Each individual has a lifetime limit of £10m of gains, meaning that husband and wife vendors could get up to £20m of gains on qualifying disposals taxed at just 10%.
The main changes:
With effect from 29th October 2018, to qualify for the relief going forward, shareholders must also be:
- Beneficially entitled to at least 5% of the profits available for distribution to the equity holders; and
- They must be beneficially entitled, on a winding up of the company, to at least 5% of the assets of the company available for distribution to the equity holders.
The technical definition of “equity holder” is wider than ordinary share capital, including, for example: preference shares and non-commercial loans. This could, therefore, affect the ER eligibility of those with interests in companies that have large (non-bank) borrowings or convertible loans.
These new regulations could affect companies who are able to differentiate between the classes of shares as to the amount or percentage of dividends payable, for example, alphabet shares. This is because Directors have discretion on the payment and allocation of dividends between shareholders in this approach. As a result, shareholders are not automatically entitled to a divided, and therefore won’t automatically qualify for Entrepreneurs’ Relief.
To clarify, the shares must entitle you to these new rights – for example, being able to receive a dividend equal to 5 per cent of the profits is not the same as being entitled to such a dividend.
The assets available for distribution in a winding up will differ dependent on the financial position of the company as well as other factors. As such. Shareholders could inadvertently breach the rules with the subsequent effect of losing ER – remember these rules will need to be adhered to for every day during the qualifying period (although it is not yet certain how HMRC will seek to monitor this).
The other change which was announced in the budget is that with effect from 6 April 2019, the period during which the qualifying conditions must be met will double, from 12 to 24 months. Changes made now do not have enough time to take effect before then.
What can you do?
We recommend our clients conduct a comprehensive review of their share rights with the help of our tax consultants’, to assess whether the new 5% distributable profits/capital distribution tests are met, and to see if any actions or elections can be taken to sustain eligibility for ER. If entrepreneurs’ relief has been lost as a result of these changes, caution must be taken to correct the tax position, as, dependent on the method for altering the rights, the changes may attract further tax charges.
On a more macro-level, we strongly recommend clients take account of these changes, alongside other considerations such as their company’s performance and trends in the M&A market, in assessing the optimal timing of an exit.
If you need any further advice, please do not hesitate to contact a member of our dedicated team.