Entrepreneurs' Relief changes

Friday, January 4, 2019

There are two major changes to entrepreneurs’ relief (ER) coming down the line in April 2019, and another condition was altered with effect from Budget Day 2018. Don’t get caught out when advising clients who are selling shares or business assets, as the sums involved can be very significant...

What relief is given?

Capital gains tax is currently charged at 10% for taxable gains which fall into the taxpayer’s basic rate band, or at 20% otherwise. However, gains made from disposing of residential property are charged to CGT at 18% within the basic rate band, or at 28% within the higher tax bands. ER rarely applies to gains from residential property as the asset has to be used for a trade, and letting doesn’t qualify as a trade unless it is furnished holiday lettings.

Where a successful ER claim is made, all of the gain is taxed at 10%, subject to the taxpayer’s lifetime limit. This limit restricts the total amount of gains one taxpayer can include in ER claims to £10 million over his lifetime.

Personal Company

When the taxpayer disposes of shares, or of any type of loan note issued by a company, the company must be the taxpayer’s “personal company” for the gain to qualify for ER. This is also applied when the taxpayer disposes of a business asset which has been used in the trade of a company, and disposes of some shares at the same time.

The definition of a “personal company” changed with effect for disposals made on and after 29 October 2018 (Budget Day).

Three becomes five

Where the disposal was made before 29 October 2018 the taxpayer had to meet conditions numbered 1 to 3 below, now he or she must meet these five conditions:

1. Be an employee or officer of the company (company secretary or director).

2. Hold at least 5% of the company’s “ordinary share capital.”

3. Hold at least 5% of the voting rights associated with that ordinary share capital.

4. Be entitled to at least 5% of the company’s distributable profits.

5. Have a right to at least 5% of the net assets of the company available to shareholders on a winding-up.

These new conditions have retrospective effect, as all five conditions must be met for the 12-month period which ends with the date of disposal. If the company ceased trading before the disposal, perhaps in the process of winding-up, the 12-month period runs to the earlier date when the company ceased trading or ceased being a member of a trading group. In that case the shares must be disposed of within three years of the date trading stopped.

Why the change?

The new conditions have been added to ensure that taxpayers who claim ER have a true material stake in the company. The government justified this by saying: “Having such an interest is characteristic of true entrepreneurial activity (as distinct from simple investment or employment), so the measure ensures that allowable claims are limited to those which are within the spirit of the relief.”

Who is affected?

Individuals who have built up their own company, and hold ordinary shares with full voting rights and rights to the company’s assets on a winding-up, should not be affected.

Employees who have acquired shares as part of their rewards from the company, may find that the shares they hold were issued with restricted rights, so will not qualify for ER, even if they hold 5% or more of the ordinary share capital.

Directors and managers who have acquired shares through a management buyout of the company may have few rights to the company’s assets on a winding up, as those asset-related rights will be held by the financers of the MBO deal who hold a different class of shares.

What is ordinary share capital?


It is worth noting that the definition of “ordinary share capital” covers all the shares of a company except fixed dividend shares. In other words, just about any class of shares, however they are described, are included in the definition of “ordinary share capital”. HMRC has recently updated its guidance on ordinary share capital to include examples of situations where the position is marginal between the shares being ordinary share capital or not.

Diluted shares

Individuals who have built up their own company, and hold ordinary shares with full voting rights and rights to the company’s assets on a winding-up, should not be affected.

Employees who have acquired shares as part of their rewards from the company, may find that the shares they hold were issued with restricted rights, so will not qualify for ER, even if they hold 5% or more of the ordinary share capital.

Directors and managers who have acquired shares through a management buyout of the company may have few rights to the company’s assets on a winding up, as those asset-related rights will be held by the financers of the MBO deal who hold a different class of shares.

Period of qualification

The third change to ER also takes effect for disposals of shares or assets made on or after 6 April 2019, and it also has a partially retrospective effect.

Currently all the conditions for entrepreneurs’ relief must be met for at least 12 months ending with the date of sale, or if the business has ceased trading, the period ending with the last day of trading.

From 6 April 2019 all of the qualifying conditions, including the new conditions for a personal company described above, will have to be met for at least 24 months ending with the date of disposal, or the cessation of trading.

If the business ceased trading before 29 October 2018, the 12-month qualifying period will still apply to the gains which arise from the disposal shares or assets after the cessation of the trade.

 

N.B., Article first appeared in the CPAA Member magazine in December 2018 - find out more about member benefits.