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Understanding the new rules concerning Entrepreneurs’ Relief

By RJP LLP on 17 January, 2019

One of your objectives for the coming year may be to formulate an exit strategy or succession plan for your company.  Changes announced in the autumn 2018 Budget necessitate that even more long-range planning is required now than in the past, if company shareholders and directors want to be eligible for entrepreneurs’ relief.

What is Entrepreneurs’ Relief (ER)?

ER is a special tax relief available for business owners when they sell shares in their company.  It entitles them to pay capital gains tax on gains they make at the lower 10% rate regardless of whether they are higher rate tax payers or not and is available for lifetime gains to a maximum value of £10 million.

In the recent Budget, the qualification criteria were tightened and whereas in the past, shares must have been held for a minimum of 12 months, the required time period has been extended to 24 months. This will apply for all share disposals taking place from 6 April 2019, hence the importance of forward planning.  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.

More recently, the government has clarified some other changes announced in the 2019 Budget that also affect business owners hoping to qualify for ER.

 

Clarification over Alphabet Shares and ER eligibility

Originally, the Chancellor stated that in addition to the extra holding timeframe needed, shareholders must also have an entitlement to 5% of a company’s distributions (i.e. dividends). This caused a stir as it was quickly appreciated that in many cases, shareholders own different classes of shares (known as ‘alphabet shares’).  This could have meant there was no automatic entitlement to dividends for any shareholder because the voting of dividends on different classes of shares is dependent upon the company’s directors.

Now following representations, the Government has tabled an amendment to the draft legislation, inserting an alternative test based on a shareholder’s entitlement in the event of a disposal of the whole of a company’s ordinary share capital. This alternative test is that the shareholder must be beneficially entitled to at least 5% of the sale proceeds, having regard to all the circumstances existing at that time.

This requirement is in addition to the existing requirement to hold at least 5% of the issued share capital and voting rights, but it is an alternative to the original Finance Bill requirement of an entitlement to at least 5% of the distributable profits and assets on a winding up.

This new condition clarifies matters surrounding alphabet shares, meaning the existence of alphabet shares will not cause shareholders to lose their entitlement to ER, providing they are entitled to at least 5% of the proceeds on a sale of the company’s shares.

However, taking this situation a stage further, when shares are exercised following the grant of options under a qualifying EMI scheme, the minimum 5% shareholding is not a requirement.

If you are considering a sale of your company we recommend taking early advice to ensure you are eligible to benefit from ER.

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31 December 2020 - Review disposals of chargeable assets to avoid a possible CGT increase

Capital gains tax is due to be reviewed by the government and if a CGT rise is announced, the new rates may become effective from the next tax year on 6 April 2021. Take advice now if you are thinking of selling property or have other assets giving rise to a capital gains tax liability.