Entrepreneurs’ Relief for shareholders – a helpful change to the new rules from HMRC

Max Chassels

Max Chassels

Tax Director

19 February 2019

    Entrepreneurs’ Relief is a well-known tax relief that allows employee / director shareholders to benefit from a 10% rate of capital gains tax (rather than 20%) where certain qualifying criteria are met.

    Following the highly publicised budget on 29 October 2018 and the issue of draft legislation, all of the following conditions must be satisfied (for disposals on or after 29 October 2018) throughout the 12 month (24 months with effect from 6 April 2019) period ending on the date of disposal:

    1. The shares must be in a trading company or holding company of a trading group;
    2. The shareholder must be an employee or director of the trading company or a group company;
    3. The shareholder must hold at least 5% of the ordinary share capital (measured by nominal value) that entitles the shareholder to at least 5% of the voting rights of the company; and
    4. The shareholder must be beneficially entitled to at least 5% of the profits available for distribution, and assets available on a winding-up, to the equity holders of the company.

    Given the difficulty in assessing whether the new condition 4 is satisfied, the draft legislation was amended on 20 December to introduce a new alternative to condition 4 which is:

    • The shareholder must be beneficially entitled to at least 5% of the proceeds available to the ordinary shareholders on a disposal.

    Given that Entrepreneurs’ Relief can yield significant tax savings of up to £1m per person, the update to legislation from HMRC is very welcome and provides clarity over the 5% tests for those who hold alphabet or growth shares.

    The new alternative test 4 is based on disposal proceeds and must also be met throughout the 12/24 month year qualifying period.  The company value used when applying the alternative test 4 is the market value of the company at the date of disposal.  Applying this in practice: if an employee has (i) held growth shares for 12/24 months, (ii) the shares have been entitled to at least 5% of the disposal proceeds available to ordinary shareholders for 12/24 months, (iii) the shares received at least 5% of the proceeds available to ordinary shareholders on an exit, but (iv) the growth shares were “out of the money” 6 months ago, the new alternative test 4 should still be satisfied.

    Given the complexity of the rules and the extension of the  qualifying period from 12 to 24 months from 6 April 2019, advance planning and careful monitoring of the qualifying conditions are essential.  If you are considering a sale/exit in the next 24 months, we would recommend that you review your Entrepreneurs’ Relief qualifying position as soon as possible.  With the exception of the extension of the qualifying period from 12 to 24 months, the new rules should have no impact on holders of Enterprise Management Incentive (“EMI”) share options.

    If you would like to discuss the new rules and how they may impact your Entrepreneurs’ Relief position or EMI share option plan, please do not hesitate to contact either Max Chassels or Andrew Holloway.