Entrepreneurs’ Relief – an update

January 31, 2019

Where available, Entrepreneurs’ Relief can reduce the rate of capital gains tax payable on the disposal of shares to 10% (down from the usual rate of 20%). It can therefore be a very valuable tax relief.

Following recent changes to the conditions for Entrepreneurs’ Relief, it looked as though many individual shareholders who might have expected to benefit from the relief could no longer do so.

But, following lobbying by professional organisations, further amendments are now proposed which would mean that Entrepreneurs’ Relief will now remain available in a much wider range of circumstances.

What has changed?

As an alternative to the two new economic tests originally proposed (which were not straightforward to apply, and could have had unexpected and unwelcome consequences), a new “proceeds of disposal” limb has been introduced. This further limb focuses upon the extent to which an individual shareholder would be entitled to the proceeds on a sale of the whole of the ordinary share capital of the company.  The changes, in the Finance Bill, are expected to receive Royal Assent in the next few weeks and guidance on the new tests is awaited.

Previously, Entrepreneurs’ Relief was potentially available if (during the period of one year prior to the disposal of the shares) the individual shareholder held at least 5% of the company’s ordinary share capital (based upon nominal value) and could exercise at least 5% of the voting rights in the company by virtue of that 5% shareholding.

In respect of disposals on or after 29 October 2018, either of the following further economic conditions (a. or b.) must now also be satisfied by virtue of the 5% shareholding:

a. the shareholder must be beneficially entitled to at least:

  • 5% of the profits available for distribution to equity holders of the company; and
  • 5% of the assets available for distribution to equity holders on a winding up of the company; OR

b. in the event of a disposal of the whole of the ordinary share capital of the company, the shareholder must be beneficially entitled to at least 5% of the proceeds.

From 6 April 2019, the above conditions for Entrepreneurs’ Relief must be met for two years, rather than one. 

What is the effect of the most recent changes?

The introduction of the new “proceeds of disposal” limb (at b.) significantly simplifies the economic test that needs to be satisfied.  Broadly, it simply requires one to determine whether the shares held by the individual shareholder carry 5% or more of the equity value of the company so that, on a sale of the company, the individual shareholder would be entitled to receive 5% or more of the overall proceeds.

Although the two original economic tests (at a.) have been retained, it will be this second “proceeds of disposal” limb upon which by far the majority of shareholders will look to rely.

The benefits of being able to rely on the “proceeds of disposal” limb (rather than having to satisfy the original two economic tests) are that:

  • it will not be necessary to take into account the entitlement of equity holders (which definition extended to certain loan creditors not simply shareholders) –  so only the holders of ordinary share capital in the company need to be considered when determining who is entitled to the ”proceeds of disposal”;
  • the dividend rights attaching to the shares will not be relevant – so difficulties will no longer arise where shares carry a priority or preferential dividend return or shares carry no particular entitlement to a dividend, for example where different share classes have discretionary dividend rights; and
  • it will not be necessary to look at the company’s balance sheet to determine the extent to which equity holders would be entitled to assets on a winding up - so less concerns will arise where other investors have a liquidation preference (or any other priority on a winding up) or the company has minimal assets on the balance sheet.

An individual’s Entrepreneurs’ Relief position will still need to be analysed carefully (particularly given that, broadly, the “proceeds of disposal” limb needs to be satisfied for the entire two year period prior to the disposal).  The following could still affect the availability of the relief:

  • other investors having a preferential return on a sale of the Company;
  • shares carrying rights on a sale which vary over time; and
  • the extent to which any earn out becomes payable or the sale proceeds are effectively reduced as a result of claims under warranties/indemnities,

but the position is much more favourable than before the “proceeds of disposal” limb was introduced.

What are the consequences for you?

Entrepreneurs’ Relief is still no longer likely to be available for:

  • shares where the nominal value has been manipulated and the individual never had a 5% economic entitlement, and
  • growth shares where holders only start to participate above a hurdle amount

Entrepreneurs’ Relief may now continue to be available where:

  • other investors have a liquidation preference or other priority return;
  • there are ‘alphabet’ share classes or other discretionary, restricted or preferential dividend rights; and
  • the company has significant  non-bank debt and/or minimal assets on the balance sheet.

Other than the longer holding requirement, the position for shares acquired under EMI Options is unaffected.

If you have any questions in relation to the above, or would like us to review the position to confirm whether your entitlement to Entrepreneurs’ Relief has been affected, please contact  Emma Bailey or Jo Varia, or your usual Fox Williams contact.


Related pages:

Tax and Incentives more

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Emma Bailey
Partner
Direct dial: +44 (0)20 7614 2560
ebailey@foxwilliams.com

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Joanne Varia
Tax Director
Direct dial: +44 (0)20 7614 2604
JVaria@foxwilliams.com

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