The Entrepreneurs’ Relief (ER) landscape has become far more complex. Failing to meet the conditions could land you with an unexpected tax liability – or even a penalty.
Introduced to encourage investment in high-growth businesses, Entrepreneurs’ Relief (ER) has proven an expensive tax incentive from HMRC’s point of view.
The relief is aimed at individuals with a material interest in a trading company – ‘material interest’ being set at 5 percent ownership. But as originally drafted, the rules allowed people able to benefit when entitled to less than 5 percent of a businesses’ economic rights.
So in the Autumn 2018 Budget, the Chancellor acted to prevent this.
ER sets capital gains tax (CGT) at 10 percent for shareholders owning 5 percent or more of a trading company when they sell their shares. That’s half the usual CGT rate of 20 percent.
To qualify, shareholders must be officers or employees of the company or group in question.
An individual can claim up to £10 million of ER in his or her lifetime, therefore saving up to £1 million in CGT. Married couples can claim £20 million between them, jointly saving up to £2 million.
The changes announced in The Budget have significantly tightened the qualification criteria for claiming ER, with the rules on the 5 percent threshold being altered with immediate effect.
This now applies to the economic value of the business, not just the nominal value of its share capital. As such, shareholders must be entitled to either:
That’s on top of the existing requirement to hold 5 percent of the ordinary share capital (tested by nominal value), and 5 percent of voting rights in the company.
The thinking behind this move is to ensure that ER claimants have a meaningful stake in the businesses in which they own shares – in keeping with the guiding spirit behind the relief.
Another important change introduced by the Chancellor doubles the holding period for share ownership – from 12 to 24 months. This change did not come in with immediate effect, but applies for disposals from 6 April 2019. The upshot being that shareholders looking to benefit from ER should review their position at least two years ahead of time.
To further complicate the picture, a tribunal case recently lost by HMRC has altered the definition of ordinary shares. The tribunal ruled that preference shares (with a fixed but compounding coupon) are part of a company’s ordinary share capital.
The impact of this decision is yet to be fully understood – not least as HMRC will probably appeal. But it could have fundamental implications for share ownership structures and ER eligibility – especially in private equity-backed companies, where compounding preference shares are commonplace.
The rule changes and tribunal decision add up to a significant shifting of the ER landscape. They leave many people who met the previous qualifying conditions no longer able to claim the relief.
They’ve also made the task of gauging eligibility far more complex. So seek expert advice well ahead of any share disposals – particularly if the company in question has more than one class of share in issue. Preference and growth shares can be particularly problematic where ER is concerned.
Without a careful review of your share ownership structures, you may find yourself with a larger than expected CGT liability. Or worse, you might end up claiming ER you’re not entitled to, which could lead to a penalty charge from HMRC, over and above the additional tax to pay.
The KPMG tax team can examine your share ownership and advise on whether you’re still eligible for ER. We may also be able to restructure your shareholdings to maintain your eligibility – though the new rules restrict the scope to do so.
What is clear is that for companies that qualify, the use of Enterprise Management Incentives (EMI) options are more attractive than ever.
Acquiring shares on the exercise of qualifying EMI options, while still subject to the two-year holding period (from the date of grant), they’re not subject to the ‘economic value’ test that has been attached to the 5 percent threshold.
If you’d like to discuss your ER position in light of the recent rule changes, please contact our experts on:
Director, Shareholder Advisory
Tax and Pensions
T : +44 (0) 20 7311 4682
Senior Manager - Private Client Advisory
Manager - Private Client Advisory
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