What is Entrepreneur’s Relief?
Entrepreneur’s Relief (“ER”) is a tax relief available to individuals upon the disposal of certain business assets that applies an effective rate of capital gains tax of 10% on the realisation of qualifying gains, subject to a maximum lifetime limit of £10 million currently and subject to the satisfaction of certain other qualifying criteria.
When can it apply?
ER can apply upon the disposal of certain business assets by an individual with the most common disposal being of shares in a trading company. However, there are certain conditions that must be met and up until recently satisfying these conditions has been relatively straightforward.
In the October 2018 Autumn Budget, there were a number of changes announced with effect from 29 October 2018 with additional changes coming in to force on 6th April 2019. These changes have muddied the waters in relation to the application of ER and have been the subject of much discussion. Here we seek to set out the recent and incoming changes and the effects they may have for shareholders.
Whilst the list is not exhaustive and individuals should review their own personal circumstances with their relevant tax advisors the key qualifying criteria for ER when disposing of shares is:
So what’s new?
The following additional criteria applied to disposals taking place after 29th October 2018:
The individual must be entitled to:
The individual must be entitled to 5% of the proceeds if the whole of the ordinary share capital of the company were sold for market value on the last day of the relevant period.
With effect from 6th April 2019, the 12 month qualifying period is being increased to 24 months.
Should you be concerned with the changes?
The introduction of the two new tests in October and the new 24 month qualifying period from April this year reduces the relative ease in which ER has, until recently, been enjoyed.
In fact, the new test requiring an individual to be entitled to 5% of the distributable profits may be more pertinent than you may think. It is common for small businesses, particularly owner managed business, to have implemented different share classes (e.g. A shares, B shares etc.) which are often referred to as ‘alphabet’ shares. The primary reason for the introduction of such shares is usually financial flexibility (particularly where dividends are concerned) and ultimately accommodates tax planning.
However, a company’s share structure may not have been set up with the first limb of the additional criteria in mind, but if you satisfy the second limb (being entitled to 5% of the proceeds if whole of the share capital is sold) then there is no need to satisfy the first. In relation to this second limb, care must be taken on the disposal of shares by a minority shareholder to an existing shareholder (and not a third party) under say ‘good leaver’ provisions, as the shares will need to have attributed a proper value and it may be appropriate to have a valuation carried out.
Care should also be taken by participants of company EMI share schemes. Generally the rules are slightly different, for example, shares held by virtue of an EMI option do not need to satisfy the 5% rule if the other conditions are met. The qualifying period also extends to the period in which an employee holds an option and does not run from when that option is exercised. This holding period will still increase from 12 months to 24 months from 6th April 2019.
What does this mean?
You will need to give greater consideration to your exit planning and how you incentivise employees. Review whether you and the company satisfy (or will satisfy) the relevant requirements for ER. Minority shareholders should also proceed with more caution when being allotted shares in the company and should take the appropriate advice and consider their position in the long term.
If you have taken advice prior to 29 October 2018, you should consider reviewing this with your advisor to ensure that you will still qualify for ER. For example, if you have different share classes (A, B, C shares) then you should consider having your company’s constitution reviewed with a view to ensuring that the company does not fall foul of the recent changes.
Please note that the above is a summary of the recent changes in relation to Entrepreneur’s Relief only and is not comprehensive in relation to the requirements of qualifying for Entrepreneur’s Relief. Appropriate advice should always be sought in relation satisfying the requirements for Entrepreneur’s Relief.
Jamie Gill is an Associate Director in Ansons’ corporate and commercial team and will be happy to discuss any matters with you. You can contact him on 01543 431185 or firstname.lastname@example.org