All change – Partial Parliamentary U-turn on the Entrepreneurs Relief Changes
Cassandra Graham, Tax Manager at Bates Weston comments on the amendment tabled in parliament to the qualifications to Entrepreneur's Relief announced in the Autumn Budget.
"The 2018 budget introduced new conditions for Entrepreneurs’ Relief on the disposal of shares in a personal company which raised the question over eligibility for certain shareholders. The original changes effective from 29 October 2018, stated that the individual has to hold 5% of voting rights and 5% of the ordinary share capital of the company (as before) and there was a new third test introduced where the individual has to be beneficially entitled to at least 5% of the distributable profits AND 5% of the assets on a winding up.
Alphabet shares have been widely used as a way to declare differing rates of dividend on separate share classes. This is subject to the caveat that the alphabet shares are commercially justified. Given that many articles of association are written such that no single class of share is ‘beneficially entitled’ to distributable profits or a set percentage of those profits, the question arose whether the initial changes inadvertently caused all alphabet shareholders to no longer qualify for Entrepreneurs’ Relief. Surely this was not the intention of the draftsmen? More worryingly, when we asked this question to HMRC, they confirmed that this analysis was correct.
However, it has since been announced that an amendment to the new legislation has already been tabled. Now the legislation is to state that the third test is that either or both of the following conditions are met:-
- The individual must be beneficially entitled to at least 5% of the distributable profits and on a winding up be beneficially entitled to at least 5% of the assets, OR
- In the event of a disposal of the whole of the ordinary share capital of the company, the individual would be beneficially entitled to at least 5% of the proceeds.
Provided the articles of association are drafted such that the shares rank pari passu with regards to their capital rights on a disposal, alphabet shares which meet the tests above should then qualify as they would receive 5% on a sale.
However, there could be some complexities where there is multiple types of consideration for different shareholder classes or different capital rights. Growth shares, for example, might allow for an individual to receive a share of the proceeds above a pre-determined level. There may be circumstances where a growth shareholder receives 4% of the proceeds and doesn’t qualify for Entrepreneurs’ Relief but if they had received 5% their tax rate would be halved. This seems like an odd result but under a strict reading of the law seems to be the result.
Also if one shareholder agrees to an earn-out as part of their consideration, depending on the valuation of the earn-out this could lead to a dilutionary effect on a shareholder on the threshold of receiving 5% of the total proceeds. It will therefore be necessary to pay more attention to the value of non-cash consideration going forwards.
This is another example of tax law growing tentacles and advice should be sought early in a transaction to ensure there are no tax nasties encountered later.
If you need our help to clarify your own position, please do get in touch with Cassandra at email@example.com.
An update on the impact of the Autumn Budget on Entrepreneurs Relief.
Richard Coombs, Tax Partner at Bates Weston comments:
“Whilst some commentators were predicting that the Chancellor would end the very generous capital gains Entrepreneurs Relief, he stopped short of that in the Budget and instead just tinkered with it. Entrepreneurs Relief reduces the tax on qualifying capital gains on business assets to 10% (from the usual rate of 20%) and most business owners, rightly or wrongly, expect to get the relief when they sell their business. However, the devil is in the detail and there are numerous instances of business owners being denied the relief due to poor planning prior to sale. The further changes in the Budget have therefore made pre-sale planning all the more important. The main additional changes introduced can be summarised as follows:
- The minimum qualifying holding period of the asset being sold has been increased from one year to two years
- The shares must be entitled to at least 5% of the assets of the company on a winding up. We have already seen one instance where this could potentially cause a problem where the articles of a company had different rules for allocation of proceeds on a winding up compared to a company sale. Without further planning this would now deny the main shareholders of getting the relief
- The shares must also be entitled to 5% of the reserves available to pay as dividends. This test has been poorly written in the draft legislation and is already creating some discussion amongst tax professionals about how the test should be applied, but at a minimum it is vital that the shares have dividend rights to at least 5% of the reserves.
The main message to all business owners is to ensure that they perform a regular Entrepreneurs Relief “MOT”. If you wait until you want to sell the company, it may well be too late to change anything due to the two year qualifying period and therefore we strongly advise all shareholders to review their position in light of the changes. Our tax team would be happy to review your structure to give you the comfort that you need.”