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Entrepreneurs' Relief Update - A welcome relief

Napthens - February 19th 2019

Back in December we highlighted some important changes which apply to the availability of Entrepreneurs’ relief (ER).

ER is a tax relief which in general terms reduces the rate of capital gains tax on the disposal of shares in a private company from 20% to 10%.  The November budget outlined two important changes:

  1. individuals now need to hold shares for 24 months rather than the current 12 months before they can claim ER and this change will apply to disposals made on or after 6 April 2019; and


  1. the budget introduced a further test before ER is available, in that as well as the existing requirement that an individual holds 5% of the ordinary share capital and votes (“Test A”), the individual must also be beneficially entitled to either 5% of the dividends and assets of the company on a winding up (“Test B”)

As flagged in our last bulletin, this created difficulties as rights to net assets and dividends are not always simple to measure and this could give rise to complications when assessing Test B.  These complications are particularly pronounced with the use of alphabet shares, as these often give a discretion over whether a shareholding has the right to the payment of a dividend and so can cause the failure of the test.

For these reasons a new “Test C” has been introduced to the legislation which requires the shareholder to be entitled to 5% of the sale proceeds if the whole of the ordinary share capital of the company is sold.  In order to secure ER, the shareholder must now satisfy Test A and either of Test B or Test C. Test C should be more straightforward to comply with than Test B as it avoids the dividend complication.

Some companies have incentivised key people through "growth" or "flowering" share schemes. This is where the existing value of the company is "ringfenced" and a new shareholder (usually a senior executive charged with creating growth) is given relatively low value shares which only accrue value as the company's worth increases above the "ringfenced" value. Despite the introduction of Test C, the concern remains that if the return received does not equal at least 5% of the whole value from the first pound then the growth shares will not attract ER. This might be addressed by offering a percentage above the ringfenced amount which is well in excess of 5% if that is acceptable commercially.

Please note that in certain circumstances it may be possible for a shareholder who has previously met the 5% test to still qualify for entrepreneurs’ relief if they no longer meet that test due to being diluted by the allotment of new shares.

It is also possible for share option holders who have been granted share options under an enterprise management incentive (“EMI”) plan to qualify for entrepreneur’s relief on the disposal of shares acquired under the plan.  The new two year requirement in respect of the holding period will affect EMI option holder’s who dispose of their shares after 6 April 2019 but the draft legislation in respect of the 5% rule does not appear to affect an EMI option holder, which means that it should still be possible to grant EMI options over non-dividend bearing/non-voting/growth shares and still potentially qualify for ER.

ER can significantly reduce an individuals liability to tax so professional advice should be sought a significant amount of time prior to an anticipated share sale, to ensure the availability of the relief.