Budget 2018: Entrepreneurs’ relief curtailed
Investors who hold shares with restricted rights have lost access to entrepreneurs’ relief, as the definition of a “personal company” for that relief was revised from Budget Day.
For entrepreneurs’ relief to apply to gains arising from the disposal of shares or securities, the company that issued those shares must be the taxpayer’s personal company. The government has added two new conditions of the definition of a “personal company” with effect for disposals made from 29 October 2018.
Three becomes five
The taxpayer must now meet the following five conditions for a 12-month period ending with the date of disposal, or the date the company ceased trading or ceased being a member of a trading group, where the shares are sold within three years of that cessation:
- Be an employee or officer of the company
- Hold at least 5% of the “ordinary share capital”
- Hold at least 5% of the voting rights associated with that ordinary share capital
- Be entitled to at least 5% of the company’s distributable profits
- Have a right to at least 5% of the net assets of the company available to equity holders on a winding-up
The government says that these additional conditions (numbered 4 and 5 above) have been added to ensure that individuals who benefit from entrepreneurs’ relief have a true material stake in the company. The Budget briefing goes on to say: “Having such an interest is characteristic of true entrepreneurial activity (as distinct from simple investment or employment), so the measure ensures that allowable claims are limited to those which are within the spirit of the relief.”
What is ordinary share capital?
Until 29 October 2018, an individual holding shares with restricted rights to dividends or to assets on a winding-up could qualify for entrepreneurs’ relief. This is because the definition of “ordinary share capital” covers all the shares of a company except fixed dividend shares. In other words, just about any class of shares, however they are described, are included. As long as the shareholder also has enough voting rights, the other rights they hold to dividends can be negligible.
HMRC has recently updated its guidance on ordinary share capital to include situations where the position is marginal between the shares being ordinary share capital or not, and has included a number of examples.
Who will be affected
Individuals who have built up their own company and hold ordinary shares with full voting rights and rights to the company’s assets on a winding-up should not be affected.
Employees who have acquired shares through employee share schemes, particularly EMI shares, may find they have suddenly lost their right to entrepreneurs’ relief, as employee shares tend to be issued with restricted rights.
Directors and managers who have taken part in a management buyout who hold shares acquired through the buyout may also have few rights to the company’s assets on a winding up, as those asset-related rights will be held by the financers of the deal who have a different class of shares.
Where an individual sells a business asset in association with a disposal of shares, (an “associated disposal”), the company in which the shares are held must also be the taxpayer’s personal company. So those taxpayers could also be caught be this change in the personal company conditions.
Period of qualification
Another change to entrepreneurs’ relief will be introduced for disposals made from 6 April 2019, but it starts having an effect immediately.
Currently, all the conditions for entrepreneurs’ relief must be met for at least one year ending with the date of sale, or if the business has ceased, to the last day of trading. From 6 April 2019 all of the qualifying conditions, including the new conditions for a personal company described above, will have to be met for at least two years ending with the date of disposal, or the cessation of trading.
If the business ceased trading before 29 October 2018, the one-year qualifying period will still apply to the gains arising from the shares or assets disposed of after cessation.