Entrepreneurs' relief changed again
By Donald Drysdale for ICAS
10 January 2019
As the Finance Bill progresses through Parliament, Donald Drysdale reports on a further amendment to the legislation which provides for entrepreneurs’ relief.
Moving goal posts
In my recent article entitled Tax: Entrepreneurs’ relief redrawn, I explained how the relief provides opportunities to reduce the amount of capital gains tax payable on disposals of businesses, or shares in a personal company, by offering a reduced 10% tax rate on up to £10 million worth of lifetime gains.
The relief was introduced in 2008, and the rules governing it have changed several times since then.
Helpfully, the Autumn Budget 2017 announced a relieving measure, to ensure that entrepreneurs would not be discouraged from seeking external investment to finance business growth in circumstances where their own shareholding becomes diluted.
Then the Autumn Budget 2018 on 29 October included some less-welcome proposals. First, the minimum period throughout which certain conditions must be met to ensure eligibility for the relief is to be increased from one year to two years.
Second, in what has been described as an ‘economic test’, two new requirements were simply to be added to the definition of a ‘personal company’, requiring the claimant to have a 5% interest in both the distributable profits and the net assets of the company.
Concerns were raised by practitioners and representative bodies that the strict wording of the new economic test would deny entrepreneurs’ relief even in situations where a vendor was entitled to at least 5% of the sale proceeds of a company. This was not the Government’s intention, and an amendment to correct the position has been tabled during the passage of the Finance Bill through Parliament.
Draft legislation
Draft legislation for the Budgets 2017 and 2018 changes was brought forward in clause 38 and Schedule 15 of the Finance (No 3) Bill 2017-19, published on 7 November. Explanatory notes explaining the changes were published alongside the Finance Bill and can be accessed through the same link.
The new amendment is set out in a House of Commons Notice of Amendments, beginning at page 27, and is explained in a separate explanatory note.
Dilution of shareholdings
As explained in my earlier article, the Budget 2017 measure contained in Schedule 15 paragraph 3 introduces two new elections.
These aim to help individuals whose shareholding is ‘diluted’ below the 5% qualifying threshold for the relief as a result of a new share issue, by allowing them to obtain relief for chargeable gains on their shares up to that time.
Qualification period
Schedule 15 paragraph 1 increases, from one year to two, the period of time during which specified conditions must be met in order for entrepreneurs’ relief to be available when assets are disposed of.
This will have effect for disposals on or after 6 April 2019, except where a business ceased before 29 October 2018.
Qualifying conditions
Schedule 15 paragraph 2 as originally drafted would have introduced two new requirements into the definition of an individual’s ‘personal company’ – both of which would have had to be met throughout the qualification period, along with the two pre-existing tests which require the individual to hold at least 5% of the ordinary share capital and 5% of the voting rights of the company.
Under those new requirements, the individual would have to have held at least 5% interests in the distributable profits and in the assets available to equity holders on a winding-up – not only of the company in question but also of any other company which is a member of the same group.
An alternative economic test
The latest amendment provides an alternative economic test in the case of most disposals on or after Budget Day, 29 October 2018. This generally allows the individual to qualify for the relief even where they cannot demonstrate that they have met the two new requirements, if, instead, in the event of a disposal of the ordinary share capital of the company they would be entitled to at least 5% of the disposal proceeds.
The legislation is detailed and the potential impact of the new amendment on the affairs of any particular taxpayer should be considered with care. However, the general effect of the amendment should be to make entrepreneurs’ relief more readily available – particularly in cases where ‘alphabet shares’ with differing rights or other complex share structures are used.
Note that it can be difficult to determine whether shares constitute ‘ordinary share capital’, and this matter has recently been considered by the courts in relation to entrepreneurs’ relief. In September HMRC agreed that CIOT might publish example scenarios in which HMRC had provided their initial view as to whether certain shares were ordinary share capital or not.
Reasons for the latest amendment
As originally proposed, the Budget 2018 changes to entrepreneurs’ relief were made to improve the effectiveness of ER by ensuring that claimants disposing of shares have a minimum economic stake in the company.
Following the amendment, the original economic test has been retained to provide certainty for those with straightforward company structures. The alternative economic test, allowing claimants to use their entitlement to the sales proceeds of the company as evidence of their economic stake, will help those who are unable to meet the original test for commercial reasons.
Implications for investors
The measures announced in Budget 2018 should not generally have any adverse repercussions for business proprietors and other long-term investors with unrestricted shares which give them full voting rights and rights to the company’s assets on a winding up.
The holders of shares with restricted rights may be adversely affected. However, the new alternative economic test should ease the availability of entrepreneurs’ relief – particularly in cases where complex share structures are used.
Practitioners who have already advised on the likely future availability of entrepreneurs’ relief should look again at what they said. Where they owe a duty of care to an ongoing client, failure to take appropriate action now could cause difficulties.
Article supplied by Taxing Words Ltd