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Budget creates unintended tax trap for Entrepreneurs’ Relief hopefuls

Article posted: 18th December 2018

When an individual sells shares in a private company, they will often be able to claim Entrepreneurs’ Relief (ER) in respect of the profit they have realised and their rate of capital gains tax payable will be reduced from the normal rate of 20% to just 10%.

Until the Budget on 29 October 2018, the following three conditions had to be satisfied throughout the year before sale, namely:

  • The company must have been wholly a trading company;
  • The individual must have been an officer or employee of the company; and 
  • The individual must have owned at least 5% of the ordinary share capital and voting rights.

In the Budget the one-year qualifying period was extended to two years for most disposals after 5 April 2019. This change is not unreasonable given the generosity of the relief.

A further change in the Budget is designed to prevent people claiming ER in circumstances where it is not intended to be available because their shares do not amount to a 5% economic interest in the company but they satisfy the 5% test explained above.

The recently published Finance Bill clause to implement this change for disposals from Budget Day onwards, provides that the shares must also entitle the seller to at least 5% of both:

  • The profits available for distribution; and
  • The assets available for distribution on a winding up.

This will not normally create problems where there is only one class of equity (ordinary) share. However, many companies have more than one class of equity share, such as ‘alphabet’ shares, in order to create flexibility to pay different rates of dividends on separate classes of share.

In many of these situations the entitlement to dividends is at the discretion of the directors/shareholders and so none of the share classes has ‘entitlement’ to ‘the profits available for distribution’ and therefore none of the shares can qualify for ER!

We believe that this hastily prepared draft legislation could adversely affect entitlement to ER in many ‘innocent’ situations and that the offending clause needs re-drafting before it becomes law.

However, for the present, there is potentially a problem with ER eligibility in many deserving situations and shareholders need to be aware that changes to share rights might be desirable if the final legislation does not rectify the problem.

As ER can be so valuable (worth up to £1m), and there are numerous ways in which entitlement can be compromised, it is advisable for shareholders to review their entitlement. Of course, McBrides is well placed to help in this way.

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