Budget 2016: Entrepreneurs’ relief and investors’ relief

London Street
Donald-Drysdale By Donald Drysdale for ICAS

21 March 2016

The latest Budget developments around entrepreneurs’ relief deserve close attention, explains Donald Drysdale.

Correcting past mistakes

Before last year’s General Election, there were concerns that the then Finance Bill 2015 was rushed through Parliament without proper scrutiny. Enacted as the Finance Act 2015, it made a number of changes to the rules relating to entrepreneurs’ relief (ER) for capital gains tax (CGT).

Representations made to the government argued that some of these changes were inappropriate (because they produced unfair results) and others were unworkable. On this occasion reason has prevailed. Amendments were announced in the recent Budget, retroactively correcting what was perceived to have gone wrong.

Associated disposals

FA 2015 changed the conditions which had to be met for an individual to claim ER on a disposal of assets held privately but used in a business carried on by a partnership of which they were a member, or by a company in which they were a shareholder. It required that on or after 18 March, 2015 such a disposal must be associated with a significant reduction in the claimant’s participation in the business in terms of their interest in the partnership’s assets or their shareholding in the company.

The FA 2015 changes prevented abuse but had an unintended consequence by denying ER on associated disposals when a business was sold to members of the claimant's family under normal succession arrangements.

Subject to conditions, relief will now be allowed on an associated disposal of a privately-held asset on or after 18 March, 2015 when the accompanying disposal of business assets is to a family member. The requirement that the material disposal of business assets is 5% or more of the claimant's share in a partnership or holding in a company does not apply where the claimant disposes of the whole of their interest and has previously held a larger stake.

Disposals of goodwill

FA 2015 also amended the provisions for computing ER on certain disposals of businesses by an individual or a member of a partnership to a company. It sought to remove a tax incentive to incorporation by providing that, on disposals on or after 3 December, 2014, ER would not apply to gains on the business goodwill. Gains on other business assets were unaffected.

Subject to conditions, relief will now be allowed on gains on disposal of the goodwill of a business when that business is transferred on or after 3 December, 2014 to a company controlled by five or fewer persons or by its directors. The principal condition is that the claimant must hold less than 5% of the shares and less than 5% of the voting power in the acquiring company. However, relief will also be due where the claimant holds 5% or more of the shares (or voting power), if the transfer of the business to the company is part of arrangements for the company to be sold to a new, independent owner.

‘Trading company’ and ‘trading group’

To combat abuse of ER, FA 2015 changed the meaning of ‘trading company’ and ‘trading group’ as used for the purposes of ER. It introduced new rules with effect from 18 March, 2015 requiring that the status of a company or group would be determined by reference to that entity’s own activities. Under these rules, activities of joint venture companies in which a company holds shares would no longer be treated as carried on by the shareholder company, and activities carried on by a company in its capacity as a partner in a firm would not be treated as trading activities.

The government has now admitted that the FA 2015 provisions were unduly restrictive in denying relief to investors in some types of genuine commercial structures where tax avoidance was not a main motive.

For disposals on or after 18 March, 2015, new definitions of 'trading company' and 'trading group' will apply. A percentage of the activities of a joint venture company will be treated as carried on by a company which holds shares in that company. Trading activities of a company in its capacity as a partner in a firm may be taken into account as trading.

Where a joint venture company exists, the new definitions will apply on a disposal of shares if the person making the disposal possesses, either directly or indirectly, at least 5% of the shares and voting rights in the joint venture company. Where a partnership with a corporate partner is concerned, the new definitions will apply if the person making the disposal is entitled to at least 5% of the partnership’s assets and profits, and controls at least 5% of the voting rights in the corporate partner.

For example, person A holds 20% of company B, which does nothing but hold 40% of the shares in trading company C; person A will be treated as holding 8% (20% x 40%) of company C, and 40% of company C’s activities will be taken into account in deciding whether the person’s shares are shares in a trading company for ER purposes.

Extension to long-term external investors

The recent Budget announced that ER will be extended to external investors in unlisted trading companies. This new ‘Investors' Relief’ will apply a 10% rate of CGT to gains accruing on the disposal of ordinary shares in an unlisted trading company or an unlisted holding company of a trading group.

The claimant must be an individual, other than an employee or officer of the company, and provisions will extend the relief to trustee holdings where the individual is the beneficiary. The shares must be newly issued to the claimant on or after 17 March, 2016, on subscription for new consideration for genuine commercial purposes and not for tax avoidance. They must have been held continuously throughout a period of at least three years starting on or after 6 April, 2016 and ending with the date of disposal.

An individual's qualifying gains for Investors' Relief will be subject to a lifetime cap of £10m. This is separate from their £10m lifetime cap for ER.

Looking ahead

The Chancellor’s admission that several FA 2015 changes were too restrictive is to be welcomed. The changes now proposed will ensure that ER is more readily available in particular circumstances. Practitioners should note the importance of reviewing transactions which have taken place on or after 3 December, 2014 or 18 March, 2015 (as applicable) to ensure that retrospective claims to ER are now submitted where appropriate.

With the recent Budget cutting the higher rate of CGT from 28% to 20% with effect from 6 April, 2016, the differential between that and the effective rate of 10% after ER has almost halved. Nonetheless, ER remains an important relief.

The introduction of the new Investors’ Relief for CGT, modelled on ER, is an important development. It aims to help companies access the capital they need to expand and create jobs. For individuals, investing in unlisted companies involves particular risks but the favourable CGT regime should offer a valuable incentive.

Article supplied by Taxing Words Ltd

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