Partner Piece – Fletcher Day
November 23, 2018
Is this the beginning of the end for Entrepreneurs’ Relief?
Considering an effective business structure even before a business has been established is essential for any entrepreneur.
An efficient corporate structure tailored for specific circumstances is essential. An important part of the structuring process – whether before incorporation or after many years of trading – is maximising the use of available tax reliefs.
Entrepreneurs’ Relief (“ER”) is one of the most appealing tax benefits an entrepreneur can obtain in the UK.
By taking appropriate steps, entrepreneurs can, on a sale of the whole or part of a trading business, substantially reduce their potential liability to Capital Gains Tax to 10%. This can be especially valuable for higher rate taxpayers, where they can potentially save up to a maximum of £1 million in tax.
The name “Entrepreneurs’ Relief” may seem a little misleading as there is no requirement for the business to be new, innovative or risky (there are other tax reliefs available for those businesses) – although not all business transactions will qualify for the relief.
So how does it work?
Firstly, there must be a sale of a trading unquoted business, in whole or in part. It can apply to a sale of assets or a sale of shares.
If certain conditions are met and ER applies, then chargeable gains are taxed at a special flat rate of 10% (from 20%, for higher rate income tax payers).
ER will only apply up to the first £10 million of lifetime gains. This cap is a lifetime restriction, meaning only £10 million of gains qualify for the relief for each individual, whether those gains arise from just disposal or from several transactions spread over time.
The Big Change
ER is now 10 years old.
In recent years, speculation has been growing amongst the professional community as to whether ER will be axed or tweaked.
On 29 October 2018 – the last Budget – the change finally came.
Before we look at the changes, let’s briefly remind ourselves at how ER looked on 28 October 2018, before Budget Day.
As a reminder, on 28 October 2018 the relief was available on a disposal of shares where the following conditions were met throughout the period of one year ending with the date of disposal:
- Firstly, for ER to apply, the individual must have held at least 5% of the ordinary share capital in the company (by nominal value) and at least 5% of the voting rights being exercisable by the individual by virtue of that shareholding;
- Secondly, the company must have been a trading company or the holding company of a trading group; and
- Thirdly, the individual must have been an officer or employee of the company (or a company in the same trading group).
The New ER
The Chancellor announced three key changes to ER:
- With immediate effect (for disposals on or after 29 October 2018): A tightening of the rules governing the share rights an individual must benefit from before they qualify requiring the claimant to have a 5% interest in both the distributable profits and the net assets of the company.
- For disposals on or after 6 April 2019: An extension of the qualifying holding period from one year to two years.
- For disposals on or after 6 April 2019: An entitlement to qualify for entrepreneurs’ relief despite an individual shareholding in a company being reduced to less than 5%. The relief will only apply to the reduction being as a result of the company raising funds for commercial purposes by means of an issue of new shares.
So what does this mean to business owners looking to sell?
Firstly, plan ahead. The extension of the qualifying holding period from one year to two years means that shareholders need to consider their position at least two years in advance of any potential transaction to ensure their position is protected.
Secondly, examine your share structure, and the rights attached to the shares, to ensure they entitle the holder to 5% of the company’s distributable profits and 5% of the assets that would be available to the shareholder if the company was wound up.
Word of Warning
We recommend those entrepreneurs who have exchanged their shares that qualified for ER for business loans re-examine their CGT positions. It is possible that if the loan note holders proceed to sell their interest, they may be liable to pay CGT at an increased rate, rather than the reduced rate of 10%.
Another area of concern is for companies which issue different classes of shares. This relates to shares that do not rank on an equal footing with respect to their capital and dividend rights – for example where dividends may be declared on one class of shares but not on another at the directors’ discretion.
Special consideration should also be given to any company which has incentivised key management with ‘growth shares’.
A Final Word
With the introduction of these changes, it is important that equity arrangements are reviewed in advance of a transaction to better understand whether shareholders can expect to benefit from the relief.
If the business is already operational, we recommend shareholders who qualified for ER previously to review their positions as soon as possible in order to confirm whether they should still qualify. Thereafter shareholders will need to continually monitor their position to ensure they qualify for ER.
It is clear ER has, and continues to cost the Exchequer a great amount, and now with these recent changes, could this be the start of the gradual decline of ER? Time will tell.
Kyri Papantoniou is a Partner and Head of Corporate at Fletcher Day, a full service commercial law firm. Kyri specialises in corporate finance and advising entrepreneurs in buying and selling businesses.
DDI: 020 7870 3878 | Mobile: 07765 881 210 | Email: kyri@fletcherday.co.uk
