Changes announced in the Budget to the rules for entrepreneurs’ relief

Introduction

While there had been concerns whether entrepreneurs’ relief (which reduces the rate of capital gains tax for higher and additional rate taxpayers from 20% to 10% on the first £10 million of an individual’s qualifying lifetime gains) would be significantly reduced, or even abolished, in the Autumn budget, the Chancellor has confirmed that the relief will be retained, albeit with a couple of changes.

Until 28 October 2018, entrepreneurs’ relief was available on the disposal of shares in a trading company (or shares in a parent company of a trading group) by an employee shareholder provided that throughout the period of one year ending with the date of disposal (the ‘qualifying holding period’):

(a) the company is the individual’s ‘personal company’, and

(b) the individual is an officer or employee of the company (or, if the company is the parent company of a trading group, of a group member).

For a company to be a ‘personal company’, the individual is required to hold at least:

• 5% of the issued ordinary share capital of the company and

• 5% of the voting rights of the company.

Changes effective from 29 October 2018

The first change to entrepreneurs’ relief is that, with effect from 29 October 2018, a company only qualifies as a ‘personal company’ if, in addition to the requirements relating to share capital and voting rights, the individual is also beneficially entitled to at least:

• 5% of the company’s distributable profits, and

• 5% of its assets available for distribution to equity holders on a winding up.

How does this change affect employee incentives?

There is no immediate effect on EMI Option holders, including holders of EMI Options over ‘growth shares’ (i.e. a special class of shares which gives the holder the right to share in the growth in value of the company in excess of a pre-determined hurdle). EMI Option holders continue to enjoy the benefits of entrepreneurs’ relief on the disposal of their qualifying shares.

However, other employee shareholders who typically only hold 5% or more of a class of ‘growth shares’ with voting rights will be adversely affected. With effect from 29 October 2018, their rate of capital gains tax on disposal of their shares will increase from 10% to 20%, because they will not meet the two additional requirements of having a beneficial entitlement to 5% of the company’s assets and distributable profits.

These changes have been brought in to counter incentive structures that the Government considers to be tax avoidance, where the incentive arrangement has been designed to comply with the letter but not the spirit of the conditions for entrepreneurs’ relief.

Changes effective from 6 April 2019

The second change to the entrepreneurs’ relief is that, for disposals on or after 6 April 2019, the ‘qualifying holding period’ (see above) has been increased from one year to two years.

In other words,  entrepreneurs’ relief will only be available on the disposal of shares in a trading company (or shares in a parent company of a trading group) by an employee shareholder provided that throughout the period of two years ending with the date of disposal (the ‘qualifying holding period’):

(a) the company is the individual’s ‘personal company’ and

(b) the individual is an officer or employee of the company (or, if the company is the parent company of a trading group, of a group member).

How does this change affect employee incentives?

Practically speaking, this extension to two years is unlikely to have much impact on the majority of employee shareholders (who are otherwise eligible for entrepreneurs’ relief including EMI Option holders). The press release suggests that 95% of disposals already meet the two year qualifying holding period.  To qualify for the relief, an EMI Option holder must not dispose of the shares acquired through the option until at least two years after the option grant date.

Dilution protection

Legislation will also be introduced from 6 April 2019 to protect an individual’s entrepreneurs’ relief entitlement up to the point that the individual’s shareholding is diluted below the 5% qualifying requirement as a result of funds raised for commercial purposes by the issue of new shares.

A new provision will apply where a company has issued shares for cash consideration for genuine commercial purposes, which has caused an individual’s shareholding to fall below the 5% personal company threshold. If gains on share disposals prior to the issue would have qualified for entrepreneurs’ relief, individuals may elect to be treated as having sold and reacquired their shares at market value immediately prior to the dilution, giving rise to a chargeable gain on which they can claim entrepreneurs’ relief.

There will also be a provision for a second election to defer the gain until an actual disposal of (or of interests in) the shares or securities.

For further information contact Michael Landon

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