The Budget announced changes to ER – this is what management teams and investors need to know.
Entrepreneurs' Relief (ER) is a valuable relief that can mean an individual pays Capital Gains Tax (CGT) on the disposal of shares in their employer at 10%, rather than at the standard rate of 20%.
To qualify for ER, certain conditions must be met during a ‘holding period’ that, in most cases, ends on the date of disposal of the relevant shares.
However, two important changes were announced at the Budget that impact management equity:
These are discussed below.
Broadly, to qualify for ER an individual must hold at least:
These requirements, as well as certain other conditions, must be met during the relevant ‘holding period’.
However, these ‘5% requirements’ do not apply to shares acquired on the exercise of Enterprise Management Incentive (EMI) share options. Additionally, the ‘holding period’ for EMI shares – during which certain other conditions must be met – begins on the date on which the relevant options are granted, rather than on the date on which they are exercised.
However, from 29 October 2018, in addition to the ‘5% requirements’ set out above, shareholdings acquired outside an EMI plan must also confer an entitlement to at least:
As these changes do not apply to shares acquired on the exercise of EMI options, it remains possible for such shares to attract ER regardless of their voting or economic rights.
Additionally, from 6 April 2019, the ‘holding period’ during which the relevant ER conditions must be met will increase from one to two years.
Where management’s shareholdings were acquired outside an EMI plan, the economic rights that attach to those shares should be reviewed in order to confirm whether ER will still be available on disposal.
For shares that have complex economic rights, for example under a private equity style ‘waterfall’, ratchet, or other ‘growth share’ arrangement, it might be necessary to undertake a modelling exercise to assess whether the new requirements are met at all material times.
As the new economic tests are measured by reference to amounts available to ‘equity holders’, rather than shareholders, the rights of investors holding other financial instruments might also need to be taken into account.
Where management will have held shares or EMI options for between one and two years by 5 April 2019, consideration should be given to the likely timing of a future transaction event. By delaying the implementation of the new 24 month holding period requirement, HMRC are providing shareholders with the opportunity to make a qualifying disposal before the rule change in April 2019.
Additionally, for management who ‘rolled-over’ ER qualifying equity into replacement shares that will not now attract ER, the legislation provides the opportunity for some shareholders to elect to disapply CGT relief on that exchange, and claim ER up to the date of the transaction.
Companies which are implementing new management equity should ensure that, where possible and appropriate, ‘growth’ share rights are structured so as to:
EMI plans are now likely to be even more attractive in this context.
KPMG has extensive experience of advising management teams, employers and investors on all personal and corporate tax aspects of structuring management equity.
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