Changes announced in the Budget to the rules for entrepreneurs’ relief and their impact on employee incentives
Entrepreneurs’ relief reduces the rate of capital gains tax from 20% to 10% on the first £10 million of an individual’s qualifying lifetime gains. It is 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* (see below) ending with the date of disposal:
(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).
Until 28 October 2018, for a company to be a ‘personal company’, the individual was 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
With effect from 29 October 2018, a company will qualify 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 affected as, 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 other two requirements re having a beneficial entitlement to 5% of the company’s assets or 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.
Note also that the Government has announced proposals to introduce new legislation, applicable to disposals after 5 April 2019, increasing from one to two years the holding period that must be met. This change will affect holders of EMI options, who after 5 April 2019 will need to have held their EMI options (or shares) for at least two years before their disposal for Entrepreneur’s Relief to be available.
* Also for disposals after 5 April 2019 the requirements that need to be met throughout the period of one year* ending with the date of disposal (referred to in the Introduction above) will need to be met for a period of two years ending with the date of disposal.