Craig Simpson, Tax Partner at Bates Weston, looks at the changes announced to Entrepreneurs’ Relief in the Budget and the anti-forestalling measures introduced to counteract attempts to bank the £10m lifetime limit before the change.
The article is necessarily technical in nature. If you would like to discuss your own position with regard to Entrepreneurs’ Relief, please do get in touch with Craig.
“The whirlwind of speculation surrounding the abolition of Entrepreneurs’ Relief (“ER”) finally came to an end when The Chancellor of the Exchequer, Rishi Sunak, announced the he was reducing the lifetime limit on qualifying gains from £10m to £1m.
There will be many entrepreneurs who plan to sell in the short term who will be annoyed by this change but it will not be a surprise to the well advised.
The change was immediate and applies to disposals on or after 11 March 2020. There were no changes to the definitions of qualifying gains. Two anti-forestalling measures have been introduced to counteract attempts to bank the £10m lifetime limit before the change.
Draft legislation has been published and details the proposed anti-forestalling legislation to stop utilisation of the old lifetime limit of £10m. References are to the Taxable Chargeable Gains Act (TCGA) 1992 unless otherwise stated.
The rules apply in two circumstances (subject to conditions being met):
- Where a s.169Q election is made to disapply the non-disposal fiction of a share exchange transaction that occurred between 6 April 2019 and 11 March 2020; and
- Entering into an unconditional contract to fix the date of disposal to before the change to the ER limit, which is completed on or after the 11 March 2020.
The first of the anti-forestalling rules applies where there is an exchange of shares or securities within s.135(1) and either condition a) or b) are met:
- a) The share or security holders of Company B immediately after the exchange are substantially the same as Company A immediately before the exchange; or the share or security holders who had control of the company A immediately before exchange have control of Company B immediately after the exchange.
- b) The relevant shareholders, taken together, hold a greater percentage of the ordinary share capital of Company B immediately after the exchange than they held in Company A immediately before the exchange; and on 11 March 2020 Company B is the individual’s personal company and is either a trading company or the holding company of a trading group, and the individual is an officer or employee of Company B or one or more group companies.
For these purposes, Company B is the acquiring company and the shares or securities in Company A are the shares or securities being exchanged for shares or securities in Company B. The relevant shareholders are shareholders of Company B immediately after the exchange, and immediately before the exchange also held shares in Company A.
If the exchange falls within the above tests then if a s.169Q election is made on or after 11 March 2020 the anti-forestalling rules apply.
To recap, a s.169Q election is used so that the non-disposal fiction of a transaction that falls with s.135 can be disapplied. The most common transaction under s.135 is the insertion of a holding company by way of share for share exchange. The impact of the election is to trigger a gain at the date of the share exchange. This rebases the shares to the market value at the time of the share swap. The election is not often made, as unless there is an onward share sale that generates cash there would be a dry tax charge (i.e. tax bill with no proceeds).
Where an election is made under s.169Q on or after 11 March 2020 in the circumstances where the share exchange falls into the tests above then, for the purpose of the ER lifetime limit only, the disposal is treated as arising on the date the election is made. The actual disposal date does not change for CGT purposes, just the application of the lifetime limit to ER. The practical impact of this is that, unless the s.169Q election was made before 11 March 2020, any gain arising under a s169Q election in the tax year 2019/2020 will be subject to the £1m ER limit.
Looking at a typical example, a new holding company (“Holdco”) is inserted above Tradeco on 30 June 2019 to separate non-core investment assets away from the trading company. Tradeco was worth £4m at the time. HMRC clearance was applied for and subsequently granted prior to the transactions being implemented as set out in the clearance application. Holdco has one shareholder with a negligible base cost. It is assumed the shares in Holdco qualify for ER and a claim for ER is made on the tax return.
The company is marketed for sale early in 2020 and an offer is made with the shares in Holdco being sold on Friday 13 March 2020 for £5m cash, unlucky for some. There was just no way of getting the deal over the line before Budget day.
Without the anti-forestalling rules the tax position could have been:
- a) Pay CGT at 10% on £1m and 20% on £4m with a disposal date of 13 March 2020. A total tax cost of £900,000, an increase in tax of £400,000 on the pre-Budget position; or
- b) Elect under s.169Q to disapply the share exchange provisions. This triggers a disposal of the shares on 30 June 2019 when the shares in Tradeco were worth £4m. The effect of the election being a £4m gain on 30 June 2019 (Tradeco shares) taxed at 10% and £1m gain (on Holdco shares) taxed at 20%. An overall tax cost of £600,000, representing a £300,000 saving.
HMRC have closed the door on that idea immediately with the anti-forestalling rules as drafted, stating that unless the s.169Q election was made before 11 March 2020 then the lifetime allowance available is only £1m in calculating the tax on the gain on 30 June 2019 and 13 March 2020. This results in an overall tax cost of £900,000, as if the election had never been made.
The draft legislation does not apply to s.135 transactions arising in 2018/19 nor on face value does it apply to transactions under s.136 – demergers for example. Where a company has been demerged for sale then it appears a s.169Q election may still be possible.
One other angle that might have been employed by the taxpayer could have been to argue the share exchange was for tax avoidance reasons and rely on the provisions of s.137 to disapply the share exchange provisions on s.135. The gain would then be triggered. That approach would not need a s.169Q election. The legislation also deals with this eventuality and states that s.137 cannot apply where a clearance has been granted for the transactions. That makes sense as it would be disingenuous, having submitted a clearance with a commercial rationale, to now argue differently. Interestingly though, it would appear that it could be argued that s.137 could be applied if no clearance was obtained. That must be quite a rare scenario and I would also anticipate a greater risk of a transaction in securities counteraction if the circumstances allow HMRC to take that line.
Readers may be familiar with the unconditional contract planning technique used to bank taper relief when it was abolished in 2008. Broadly, exchanging on an unconditional contract fixes the date of disposal date to the date of exchange of contract under s.28(1); and if that date is before the ER change the actual disposal is not triggered until the contract is completed. This would be after the ER limit change. A contract would be entered into, often with a settlor interested trust, and left uncompleted until an onward disposal. More detail is beyond the scope of this article but I expect there will be a number of unhappy shareholders who are now facing the costs of unwinding structures and a ½% Stamp Duty Reserve Tax liability they cannot recover. There must be some considerable doubt over whether such planning would have been effective in any case.
This anti-forestalling rule applies where an asset is conveyed or transferred on or after 11 March 2020 under an unconditional contract made before that date.
The rule does not apply where
- a) the parties are not connected,
- b) the contract was not entered into to take advantage of the disposal date rules for an unconditional contract; and
- c) the person making the transfer makes a claim which includes a statement that the condition in b) doesn’t apply.
The rule also doesn’t apply where
- a) the parties are connected,
- b) the contract was entered into wholly for commercial reasons,
- c) the contract was not entered into to take advantage of the disposal date rules for an unconditional contract; and
- d) the person making the transfer makes a claim which includes a statement that the conditions in b) and c) are met.
The claim and statement are presumably required so that HMRC have the opportunity to track and scrutinise the transactions.
If a transaction is caught, for the purpose of the ER lifetime limit only, the disposal is treated as arising on the date the contract is completed. The actual disposal date does not change for CGT purposes, just the application of the lifetime limit to ER. In the circumstances there would only be a lifetime limit of £1m available to set off against the gain.
In all reality I expect there will be few cases where a contract has been entered into that meets the conditions for the anti-forestalling not to apply.
The result of the reduction in the ER lifetime limit will be a greater focus on family tax planning going forward. It is possible that a number of family members may own 5% of the share capital of a trading company, making sure they pay attention to the qualifying conditions for ER of course.
It may then be possible to equalise the shareholdings close to a sale transaction to utilise a number of £1m ER limits. Where applicable, attention should be paid to holdover elections for transferring shares and any restrictions that apply for non-trade chargeable assets in calculating the held-over gain.
It is disappointing a consultation was not announced on a more targeted and effective relief. Whilst ER was criticised for not being effective, it won’t be effective if the relief stays the same and the limit is just reduced. The change feels somewhat like a revenue raising sticking plaster and more action is needed to fully reform tax reliefs to encourage people to set up their own business. Whilst ER might not have encouraged entrepreneurialism, I am not sure it was ever meant to, it was more akin to a reward for risk taking and wealth generation. The tax system can be an extremely effective tool to drive behaviour in the right direction and it is the writer’s opinion that reform to measures designed to encourage entrepreneurialism should be central to our thriving and fantastic owner managed business sector.”
Disclaimer: The information given in this article is generic in nature. You should take no action based upon it without consulting ourselves or an alternative professional advisor.