Entrepreneur’s Relief: Do you still qualify?
Individuals holding shares in a trading company that they expected would qualify for Entrepreneur’s Relief (ER) on a sale may now lose the relief if the relevant company has alphabet or growth shares in issue.
Paul Bricknell, tax partner at Manchester commercial law firm Kuits, explains what shareholders should be doing now to protect their wealth on exit.
ER provides individuals selling shares in a trading company the opportunity to reduce their Capital Gains Tax charge from 20% to 10%. The conditions prior to the Autumn Budget were as follows:
- The shareholder must have been an employee or officer of the company for at least 12 months
- They must have held shares in the company that give them the right to at least 5% of the company (usually by nominal capital) and at least 5% of the voting rights for at least 12 months
However, the Autumn Budget brought in significant changes from midnight on the 29 October. The additional requirements for qualifying for ER relief are now:
- The shareholder must have a right to at least 5% of the profits of the company
- The shareholder must have the right to at least 5% of the company on liquidation
- The ownership period required rises from one year to two years
These unexpected changes are designed to prevent artificial share structures that give shareholders with less than a 5% interest in a company the ability to claim ER. Whilst there was certainly abuse going on, the new rules seem to also catch structures that were not designed to get around the old rules.
Take the following example:
- Trading company owned equally between dad, mum and daughter.
- They each have a separate class of shares (often known as alphabet shares) to allow them to pay a different dividend to each of them depending on their needs.
Under the old rules, they would all have qualified for ER subject to them being employees/directors and the minimum 12 month ownership period. As of midnight on 29 October, the shares would appear not to qualify. The reason for this is that, typically, alphabet shares do not give any shareholder the right to a share of the profits. The share of profits is normally decided on each year by the shareholders and directors.
Planning can be undertaken to allow the shares to qualify for ER in the future but, as the clock has been reset, they won’t qualify for the relief for a further two years. If a sale was to occur within that two-year window the family could end up paying 10% more tax than they had expected.
No doubt the issues here are the unintended consequences of a government trying to tackle tax avoidance, but they do leave many businesses in limbo. You could have been selling your business on 30 October expecting to pay 10% tax and suddenly find yourself paying 20% without an opportunity to mitigate this.
There are already rumours that the treasury will revisit the proposals to prevent these legitimate structures being caught by the new rules, but anyone selling their business in the near future should beware. In addition, anyone who has sold their business since 29 October should check their position.
In essence, shareholders with alphabet structures need to decide whether to reorganise their shareholdings now to fit within the new rules and start the two-year clock, or wait and see whether the new rules are modified and no changes are required. The risk of waiting is that if the new rules don’t change, waiting to review your structure will delay resetting the two-year clock for the shares to qualify for ER again.
If you have alphabet or growth shares in a business and would like advice on Entrepreneur’s Relief, please contact Paul Bricknell on 0161 979 0808 or by emailing firstname.lastname@example.org.