There are important changes to the conditions that apply in order for a taxpayer to claim Entrepreneur’s Relief (ER) on disposal of their shares in their personal company.
These changes relate to the ownership period, which from 6th April 2019 has increased from 12 to 24 months and also relate to changes in the definition of a ‘personal company’.
Personal Company – what are the qualifying conditions?
Previously, if a taxpayer held at least 5% of the ordinary share capital and held at least 5% of the voting rights then the disposal of the shares entitling the taxpayer to these rights would qualify for ER provided that the taxpayer was also an employee and the company was trading.
The new rules state that throughout the 2 year period prior to the disposal of the shares, a taxpayer must be beneficially entitled to the following:
- >5% of ‘ordinary share capital’ and >5% voting rights and either 5% distributable profits/net assets, or
- >5% of the proceeds of a future sale
In addition:
- The company must be trading
- The taxpayer must be an employee of the company
The new rules will make qualifying for ER difficult for companies with ‘alphabet’ shares or different share classes providing different rights, particularly those with nominal rights. It is recommended that existing shareholder agreements and articles are subject to a review so that any action can be taken to ensure that the conditions are met going forward, particularly in light of the new two year period to qualify.
Growth or ‘sweet’ management shares often contain clauses where there is an entitlement to participate in the future growth of the company should this reach a certain level. This may contradict the new amended rules and each agreement should be carefully reviewed particularly in relation to the ‘end rights’ due on a company sale.
Officer or Employee?
It is often the case that family members work in the business and this can be on an informal basis. Case law has held that in the absence of a contract and without inclusion on the payroll it is still possible to be regarded as an employee however it is recommended that appropriate documents are in place so that ER is not left to chance. Businesses who use complicated or zero hour contracts may also need further advice.
Company secretaries still meet the conditions to qualify for relief.
Company restructuring and external financing?
Previously if an individual who owned 5% experienced a reduction in shareholding as a result of dilution in the overall share capital (for example as a result of a new share issue to raise funds via a private equity investor) that individual would lose ER immediately if they owned less than 5%.
It is now possible to avoid losing ER altogether by making an election to keep the part of the gain that qualified before dilution. The ‘gain’ that has arisen since the shares were owned up until the point of dilution is calculated and held-over until the shares are sold. The overall gain for the total ownership is then split between the period qualifying for ER and the period after the dilution event, so that ER is not lost altogether.
This holdover treatment is also possible on share for share exchanges or qualifying corporate bonds if a company is bought out or subject to restructuring.
If these changes do not apply to you but perhaps apply to your family or contacts please do feel free to send them a link to this article if you believe it will be of interest.
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This tax article was published in June 2019 – please be aware that the information above may have changed in subsequent months. This note is written for the general interest of our clients and is not a substitute for consulting the relevant legislation or for taking professional advice.