Entrepreneurs’ Relief is an important tax relief for individual shareholders of owner managed and family owned companies who wish to sell their company or wind up their company’s business and extract the cash from such business. Gavin Birchall, Tax Partner at Scrutton Bland explains how the adjustments to the legislation will work.
Where Entrepreneurs’ Relief is available, it reduces the Capital Gains Tax rate which applies on such disposals from a 20% rate to a 10% rate.
A number of changes are in the process of being enacted into law which will make it harder for shareholders to benefit from this Relief. These changes include the following:
- an increase in the period in which the shareholding needs to have been owned by the shareholder from 12 months to 24 months (for disposals made after 5 April this year);
- the individual must be entitled to either:-
- 5% of profits (dividends) and assets available for distribution to “equity holders” on a winding up of the company throughout the holding period and this test satisfied throughout the 24 month period (“Dividend and Assets” test); or
- 5% of the sale proceeds had the whole of the ordinary share capital of the company been sold on the day of disposal (“Proceeds” test)
The conditions for obtaining Entrepreneurs’ Relief which applied prior to the Autumn Budget and which required the individual to hold at least 5% of the ordinary share capital and to have at least 5% of the voting rights of the company continue to apply alongside these new conditions.
A number of challenges arise from the additional rules as they are more complex to apply and uncertain in their application.
For example, the rights of a shareholder to net assets and dividends of the company are not always simple to measure. In some companies, there are different classes of shares with varying entitlements to net assets and dividends. In cases where there is a discretion in favour of the Board to decide upon the level of dividend which a holder of a class of shares should receive, it is arguable that there is no entitlement at all to dividends and so the 5% test is not met.
There are also complications in applying the test where a company obtains lending under which the eventual repayment amount is linked to the profitability of the company. This type of lending is particularly common in the context of property development companies and can affect whether a shareholder can be viewed as having a 5% entitlement to the assets of a company.
Thankfully, in many cases where a shareholder is unable to satisfy the “Dividend and Asset” entitlement, they may be able to satisfy the alternative test which requires the shareholder to have an entitlement to at least 5% of the sale proceeds on a sale of the company. Unlike the “Dividend and Asset” entitlement condition, if the “Proceeds” test is met on the date of the individual’s disposal, the test is treated as being satisfied for the whole of the holding period. Consequently, there is no requirement for this test to have been satisfied through the minimum holding period.
In the case of growth shares where a shareholder only accrues economic rights in the company if the value of the company exceeds a set level, the changes will still create uncertainty as that shareholder may only be certain of obtaining Entrepreneurs’ Relief if the eventual sale price is sufficient to enable him or her to meet the 5% Proceeds test.
For those shareholders who acquire their shares pursuant to Enterprise Management Incentive (EMI) Options, the changes to the 5% tests will not affect them and they will continue to be able to benefit from Entrepreneurs’ Relief without needing to satisfy any of the 5% tests.
These new rules illustrate the need for any business shareholder to take expert advice on whether or not Entrepreneurs’ Relief will be available on a potential share disposal.