Incoming Changes to Entrepreneurs’ Relief
Incoming Changes to Entrepreneurs’ Relief
Entrepreneurs’ relief is an attractive means for owner managers to reduce the tax payable on their gains should they choose to exit their business on a sale. A number of our clients rely on the availability of this relief to maximise their exit proceeds.
Historically, the test to qualify for the relief was simpler than today and in the Autumn 2018 Budget the government published plans to reform the existing eligibility criteria which may prove problematic for some of our clients.
When is the Relief Available?
ER applies a rate of capital gains tax of 10% to qualifying gains up to a lifetime limit that is currently set at £10 million per individual. This is rather more favourable than the 20% rate that would otherwise apply (subject to an individual’s taxable income rate for the year).
The existing eligibility test requires the officer or employee applicant to show that they held at least 5% of the ordinary shares entitling them to 5% of the voting rights in the business, for a minimum holding period of one year prior to the date of the disposal.
The New Test
The draft legislation published after the Budget stated that, in addition to the 5% threshold, an applicant would need to be beneficially entitled to:
(a) 5% of the company's distributable profits; and
(b) 5% of its assets available for distribution to equity holders on a winding up.
The new criteria could have caused confusion for shareholders of companies having multiple classes of shares with differing rights to distributable profits and liquidation preferences (commonly called ‘alphabet shares’). For example, if directors have discretion to authorise the payment of dividends to some shareholders and not others, it would be difficult to say that at all times during the minimum holding period a shareholder had a right to “5% of the company’s distributable profits”, thereby excluding individuals who would otherwise be eligible for the relief.
Perhaps recognising the widespread negative commentary on the reform, the government has since proposed an alternative test, requiring the individual to instead be beneficially entitled to:
(a) 5% of the company's distributable profits and, on a winding up, 5% of its assets available for distribution to equity holders; or
(b) 5% of proceeds in the event of a disposal of the whole of the company's ordinary share capital.
Whilst the revised test does not completely address the concerns around distribution rights, it is not cumulative, so only one limb needs to be satisfied. This should allow greater flexibility for companies with more complex share structures as described above.
It is important to note that these new threshold criteria must be satisfied for ER to be available on disposals after 29 October 2018 (the date of the Budget), irrespective of when the individual acquired the shares. This means that, if the legislation is passed, some individuals previously qualifying for ER will no longer do so after the Budget date.
The Budget also increased the minimum holding period from one year to two years for disposals occurring on or after 6 April 2019.
There are less stringent rules that apply to disposals of shares obtained through EMI option schemes and the new threshold criteria introduced by the Budget will not apply to disposals of such shares.
There is a common misconception that the minimum 5% threshold requirement is also applicable to EMI option shares; however this was scrapped for disposals of EMI shares acquired on or after 6 April 2012.
So long as the minimum holding period is met (which for EMI shares, includes not only the period for which the shares are held, but also the period for which the option was held prior to exercise), ER will be available on the disposal of any number or percentage of EMI option shares.
The Finance Bill 2019, which will enshrine the new threshold criteria in statute, has its second reading and debate in the House of Lords on 7 February 2019.
With the UK’s current uncertain political climate and Brexit looming, it is unclear when the legislation will be finalised and whether any further changes can be expected. If there is a general election before the passage of the legislation, the existing law will remain in place.
We strongly advise that those wishing to apply ER to any disposals, whether those disposals are presently contemplated or not, should take specialist professional advice once the legislation is passed to ensure that the new criteria are met.
If you have any questions on the content of this article or require general corporate advice, please contact a member of the corporate team: