Update on the changes announced in the Budget to the rules for entrepreneurs’ relief and their impact on employee incentives

Introduction

In the Autumn Budget, the Chancellor had announced that the definition of ‘personal company’ for the purposes of ‘entrepreneurs’ relief’ for capital gains tax purposes would be tightened so that, with effect from 29 October 2018, a company will qualify as a ‘personal company’ only if, in addition to the existing 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.

Amendment to the proposed definition of ‘personal company’ in the Report Stage

In the Report Stage in the House of Commons, an amendment was made to the definition of ‘personal company’, effectively relaxing the requirements proposed in the Autumn Budget (see above).

The amendment would enable an individual to qualify for entrepreneurs’ relief on disposal of shares on or after 29 October 2018 if, in addition to the existing requirements relating to share capital and voting rights, the individual is beneficially entitled to either (or both) of the following:

• 5% of the company’s distributable profits and, on a winding up, 5% of its assets available for distribution to equity holders;

• 5% of proceeds in the event of a disposal of the whole of the company’s ordinary share capital (“5% Proceeds Test”).

For the purposes of determining whether the 5% Proceeds Test is met, the following three assumptions apply:

• the whole of the ordinary share capital is disposed of for market value consideration

• the individual’s share is what the individual would be beneficially entitled to at that time

• the effect of any tax avoidance arrangements would be disregarded.

How does this change affect employee incentives?

The position of EMI Option holders, including holders of EMI Options over ‘growth shares’, remains the same as before i.e. EMI Option holders continue to enjoy the benefits of entrepreneurs’ relief on the disposal of their qualifying shares.
In respect of other employee shareholders, for example, holders of ‘growth shares’ (holding 5% of the issued share capital with voting rights), while the amendment is certainly a relaxation on the changes to the rules originally announced in the Autumn Budget, most such employee shareholders are unlikely to benefit from it.

For more information on employees’ share schemes contact Mike Landon 

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