New rules re Entrepreneurs’ Relief
What is entrepreneurs’ relief?
Entrepreneurs’ relief is a form of tax relief for certain business owners. It was introduced in 2008 to support business investment and to boost the growth of new enterprises.
If eligible for the relief, taxpayers may be able to pay less Capital Gains Tax – i.e. they’ll pay (capital gains) tax at (the lower rate of) 10% on all gains on the sale of an interest in a business, including shares in a trading company. The relief is only available for up to £10 million of gains made in the taxpayer’s lifetime.
Rules set out the criteria which must be met for the relief to apply. The rules differ for shares acquired on the exercise of EMI share options.
Changes to the rules in relation to the disposal of shares were announced in the 2018 Autumn Budget. These changes will apply from 6 April 2019 by virtue of the Finance Act 2019.
The period of time during which the specified conditions must be met in order for the relief to be available when shares are disposed of has increased – from one to two years.
This means that from 6 April 2019, for at least 2 years prior to the sale of the shares:
- The company has to be a trading company;
- The individual has to be an employee or officer of the company; and
- The individual has to hold at least 5% of the company’s ordinary shares and at least 5% of the voting rights in the company.
New conditions were also added (which have applied as from 29 October 2018) whereby:
- The individual has to be entitled to at least 5% of the distributable profits and 5% of the company’s net assets available for distribution on a winding up; or
- (if the distributable profits and net assets test is not met) the individual has to be entitled to at least 5% of the proceeds of sale if the whole of the ordinary share capital of the Company were sold for its market value.
These new (i.e. from October 2018) conditions must be met, along with the other conditions, throughout the two-year period in order to qualify for the relief.
What about the shares acquired under an EMI share option scheme?
The same conditions for entrepreneurs’ relief apply except that:
- The individual does not need to hold at least 5% of the company’s ordinary shares or hold at least 5% of the voting rights in the company;
- The extension of the required holding period to 2 years includes the period of the EMI share option held by the individual before the exercise of the option; and
- The new conditions (which have otherwise applied from 29 October 2018) do not apply to shares acquired under an EMI share option scheme
Dilution due to investment
There is also a new extension to entrepreneurs’ relief where an individual’s 5% shareholding is reduced as a result of raising funds for commercial purposes by means of an issue of new shares after 6 April 2019.
Individuals can make an election to claim entrepreneur’s relief on that part of the capital gain that arose before the shareholding was diluted below 5% even if they dispose of their shares after dilution. For the purposes of calculating the gain at the date of dilution, the minority shareholding will be valued as a percentage of the total value of the company, without discount.
This change seeks to ensure that entrepreneurs are not discouraged from seeking external investment to finance business growth in circumstances where their own shareholding becomes diluted (allowing these individuals to treat their shareholding as having been disposed of and reacquired at market value at the time of dilution). It also allows them to defer the gain that results from this until the shares are actually disposed of, thus avoiding a ‘dry’ tax charge.
What can you do?
If you own shares in a company it is worth checking with your professional advisers that you will continue to meet the requirements for entrepreneurs’ relief. William Ngan, Associate here at HRC Law LLP, would be happy to provide advice on this, or any other legal corporate tax issues.
This bulletin contains general overview information only. It does not constitute, and should not be relied upon, as legal advice. You should consult a suitably qualified lawyer on any specific legal problem or matter.