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Business Tax  •  Personal tax

Two critical changes to Entrepreneurs’ Relief – Ensure you qualify

By RJP LLP on 15 November, 2018

Growing a successful business can be very hard work.  The government recognises this and provides shareholders who sell their companies with a valuable tax incentive in the form of Entrepreneurs' Relief (ER). This enables qualifying shareholders to pay Capital Gains Tax (CGT) on the disposal of their shares at the rate of 10%, rather than at the standard rate of 20%, on gains of up to £10 million over their lifetime.

Strict qualifying conditions have always applied in order to qualify for ER and these were amended in the 2018 Budget. All entrepreneurs and shareholders should be aware of what has changed, because it may affect an individual’s future entitlement to ER.

 

What has changed?

Two new ‘5%’ conditions to meet

Effective since 29 October 2018, two additional conditions must be met in order for some shares to qualify for ER. To understand what has changed, you should appreciate that there has always been a qualifying condition whereby an individual must usually own 5% of the issued ordinary share capital of the company (measured at its nominal value); and

5% of its voting rights. The exception to this is for employees who exercise share options granted through an Enterprise Management Incentive (EMI) share option scheme.

Now, the rules are a little more restricting for cases that do not involve an EMI scheme. In addition to the 5% holding requirement, shareholdings outside an EMI plan must have the following two additional entitlements:

 

  • The shares must have an entitlement to 5% or more of the company’s distributable profits (dividends); and
  • They must have an entitlement to 5% or more of the company’s assets on a winding up.

 

There is currently uncertainty surrounding the draft legislation and its effects on the shareholders of companies which have alphabet shares in issue. This is because dividends relating to alphabet shares are voted on any individual share class at the discretion of the directors, meaning that no shares have such an entitlement.

Please see our related technical article about alphabet shares and ER after Budget 2018.

 

Longer shareholding period

For share disposals taking place with effect from 6 April 2019, the minimum holding period and working requirement for ER to apply is to be increased from 12 months to two years. This means that all shareholders must have a two-year qualifying period immediately leading up to a sale of shares, and EMI option holders must have been granted their options at least two years prior to a sale of their shares.

It is worth noting that a recent Tribunal case (George v HMRC) highlighted that having the relevant paperwork in place documenting share ownership is vital to be able to qualify for ER.

 

In this complex case

Mr George had been appointed a director in a family-owned company, Thornton & Ross Limited (TLR), which was jointly managed by one of the family members as well as by Mr George. A few years after joining the company, Mr George was allowed to acquire shares which represented 6.9% of the nominal value of the company’s ordinary share capital, but did not carry voting rights. Following a failed attempt to sell TLR, at which time Mr George was advised that he did not qualify for ER because his shares did not carry any voting rights, Mr George and Mr Thornton agreed that shares would be given voting rights, so as to secure ER. However, the change was not documented immediately and for various reasons, the written agreement was not finalised until 12 months later. Despite the verbal agreement being in place, this delay affected Mr George’s entitlement to ER and he was unable to benefit from the 10% tax rate.

Obviously, this case pre-dates the new ‘24 month’ legislation, but it serves as a powerful reminder of how strictly HMRC enforces both the time period ruling and the need for all agreements over shareholdings to be appropriately documented.

 

Next steps

If you are thinking about selling your company and would like to ensure you can qualify for ER, please contact us to discuss your circumstances in detail. We can also advise on establishing an EMI share option scheme.

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