Changes to entrepreneurs’ relief
From Shipshape March 2019 | Uploaded 7th March 2019
Capital gains tax is normally charged at 20% for higher rate taxpayers. However, disposals that meet the conditions for entrepreneurs’ relief (ER) are subject to tax at 10%, up to the lifetime allowance of £10m. The relief can cover a sole trader or partner’s sale of all or part of a business, and a shareholder’s disposal of company shares.
However, the Finance Act 2019 includes alterations to these ER rules. Previously, the person disposing of shares had to have been an employee/director who held at least 5% of the company’s shares for a minimum of 12 months prior to the disposal. In the case of shares acquired under Enterprise Management Incentive (EMI) options, the options had to have been granted at least 12 months prior to the time of disposal.
For disposals made on or after 29 October 2018, the 12-month period for both tests has now been extended to 24 months.
The 5% test is also amended for disposals after 5 April 2019 – but not for shares acquired under EMI options. The old rule was that a shareholder had to hold at least 5% of the ordinary share capital and 5% of the voting rights.
Ordinary share capital in this context means 'all issued share capital other than capital which has a right to a dividend at a fixed rate but has no other right to share in the company’s profits'. In 2017, an Upper Tax Tribunal accepted HMRC’s argument that non-voting shares that were not entitled to a dividend at all were not entitled to a fixed dividend and hence counted as ordinary shares (McQuillan v HMRC). This continues to apply but, in addition, one of either of the following conditions must also have been met throughout the 24-month period:
a) The shares must have entitled the shareholder to at least 5% of the dividends paid to equity holders' and 5% of the assets available to equity holders on a hypothetical winding up, or
b) If the entire ordinary share capital in the company were sold, the shareholder would receive at least 5% of the proceeds, 'having regard to all the cicumstances at the time'.
The precise definition of equity holders for the purposes of new condition (a) differs from the definition of ordinary shares. It includes ordinary shareholders and loan creditors where the loan is not a normal commercial loan, such as a convertible loan. Ordinary shares do not include restricted preference shares (those that either have no right to dividends or entitlement to a fixed rate that is no more than a normal commercial return). So the shares mentioned in the McQuillan v HMRC case above would not count as equity holders despite being ordinary shares.
For condition (b), it must be assumed that 5% of the proceeds means 5% of the proceeds paid to the ordinary shareholders and that the definition of ordinary shares is as applied in McQuillan v HMRC. Having regard to all the circumstances means that provisions in the Articles of Association and in any Shareholders’ Agreement or similar agreement will be taken into account.