In the Budget, the Chancellor announced significant changes to Entrepreneurs’ Relief (ER). As with all changes, there will be winners and losers. Some will benefit where previously they might have lost this valuable relief. When their shareholdings were diluted by funding rounds, the exercise of employee share options or when groups of companies were restructured. However, other changes may be less welcome to entrepreneurs and shareholders in private companies.
As a reminder, the qualification for ER enables the sale of shares of a qualifying trading company (and other business assets but here we’re focusing on the sale of shares), to be subject to Capital Gains Tax at 10% not 20%, which makes this a highly valuable relief.
The changes proposed in the 2018 Budget undoubtedly caused significant concerns for shareholders in companies that have multiple share classes carrying different rights and entitlements (also known as ‘alphabet shares’). With the proposed rules changing the definition of ‘personal company’ in the ER legislation in such a way as to potentially prevent shareholders in a company with alphabet shares from claiming ER.
However, on 21st December 2018, there was a sigh of relief when the Government proposed a significant amendment to their original proposed changes, defining what constitutes a ‘personal company’ for ER purposes. The proposed amendment softens the blow, reducing the number of persons adversely impacted. However, the change in rules should still be reviewed for peace of mind that your shareholdings qualify or what you might do if they don’t. The proposed rule changes also mean that the original Budget Press Release, which stated that the majority of businesses would not be effected by the changes would now be correct.
The revised legislation retains the old qualifying criteria (the shareholder must have at least 5% of the ordinary share capital of the company and 5% of the voting rights) but adds in two new conditions, at least one of which will need to be met:
- The shareholder must be entitled to 5% of the profits available for distribution to equity holders and 5% of the assets available for distribution on a winding up (these were the changes originally announced in the 2018 Budget) and/or;
- In the event of a disposal of the ordinary share capital of the company, the shareholder would be entitled to 5% of the disposal proceeds (the amendment made on 21st December 2018).
Additional points include provisions which set out the process for determining whether the second test is met at any one time. The legislation doesn‘t define the term ‘proceeds’, which implies it may extend to some payments made to debt-holders on a sale of a company.
Also important to note, is the change to the qualifying holding period. In order to qualify for relief, shareholders must have held shares in a company classified as their ‘personal company’ for at least twelve months before they sell them (different rules apply to shareholders who derive their holdings from EMI options). The recent Finance Bill also makes a change here, increasing the holding period to two years, from 6th April 2019.
Private Companies will need to consider if their shareholdings could be impacted by the proposed changes. Whilst the proposed changes are not yet law, and the current political uncertainty may yet impact the Finance Bill. If they do come into force, then the change will be retrospective from 29th October 2018. This is therefore very important for those considering a sale. Many private companies’ articles of association will need to be reviewed with care to establish whether shareholders would meet the qualifying conditions. Changes to company articles of association to remedy any defects could restart the new two-year clock for ER, which in itself may be a problem.
If like some of our clients, you’d like Haines Watts to undertake a review of entitlement to ER for shareholders which would include a view on the company trading status and the impact of the new rules, then please get in touch. We’ll prepare a written summary document confirming whether or not ER’s eligible based on information provided, the current rules and proposals with suggestions on what action should be considered to improve the position where applicable.
The cost of this review is fixed at £750 plus VAT, for family companies. For more information or to book a review, please contact Nigel Syson on firstname.lastname@example.org or 07887 660073.
Want to know more? Call us on 01604 746760 or email email@example.com