Update on 2018 Budget Changes
In our previous article we updated you on the draft changes to Entrepreneurs Relief (‘ER’), announced by the Chancellor in late 2018, which could have had a profound impact on those holding alphabet shares who were expecting to claim ER on a sale of those shares. For further information, please refer to our previous article (see below)
We are pleased to report that the draft legislation has now been amended, following representations by the accounting and tax professions, and the revised legislation became law on 12 February 2019.
The two new tests still exist but there is now an alternative test which can instead be satisfied. This alternative test requires the individual to be beneficially entitled to at least 5% of the proceeds in the event of a disposal of all of the share capital of the company.
The intention of this alternative test is to allow individuals to use their entitlement to sales proceeds as evidence of sufficient economic interest in the company, where they cannot demonstrate sufficient entitlement to the profits and assets on a winding up of the company.
This new alternative test must again be satisfied throughout the two years (for disposals on or after 6 April 2019) prior to disposal. Helpfully, this requirement is deemed to be met where the test is satisfied at the time of disposal of the shares, and it would be reasonable to expect that the individual would have satisfied the test had a disposal of all of the shares occurred at the same market value throughout the preceding two year period (one year for disposals up to 5 April 2019).
This alternative test is subject to an anti-avoidance provision so that in applying the test of entitlement to sale proceeds, arrangements will be ignored if their main purpose or one of their main purposes is to obtain ER.
Those holding growth shares are still impacted by the new legislation to the extent that they cannot satisfy one of the new tests.
What do we recommend?
Our recommendation is that you should take advice from us well in advance of selling your shares, on whether you are likely to qualify for entrepreneurs relief, and, if not, if there is anything that could be done to remedy this.
If you have any queries about the above, please contact us.
In the recent Budget Statement the Chancellor announced changes to Entrepreneurs’ Relief (‘ER’) which could have a significant impact on shareholders of private trading companies which have different share classes (or ‘alphabet shares’) in issue.
By way of recap, where the conditions for ER are satisfied an individual will pay 10% instead of 20% tax on a gain arising on the disposal of their shares, a saving of £100,000 per £1m of gain.
One of the conditions which must be satisfied for ER is that the shareholder must have held their shares for at least twelve months before they sell them. The Chancellor announced that this 12 month holding period will increase to 2 years for disposals from April 2019.
While this will be a cause of frustration for some shareholders, the bigger concern arises from the two new tests which must now be satisfied, namely:
- The shareholder must be ‘beneficially entitled’ to at least 5% of the profits available for distribution to the equity holders of the company; and
- The shareholder must be beneficially entitled on a winding up to at least 5% of the assets available for distribution to the equity holders of the company.
Importantly, the term ‘equity holders’ does not only include ordinary shareholders. Preference shares or loan notes with terms that mean they are not simply securities with a market rate return, can also be ‘equity’ for the purpose of the above test.
The impact of these new tests is that it is questionable that where there is more than one class of shares in issue that any one shareholder has a beneficial entitlement to any given proportion of the company’s profits. Accordingly, where this is the case there is a significant risk that none of the shareholders will be entitled to claim ER if the company is sold regardless of the size of their share ownership in the company. Unfortunately, it appears that any rights to dividends which may exist in a document other than the articles of association, such as a shareholders’ agreement, cannot be taken into account.
For completeness, the draft legislation would also appear to potentially catch those with growth (or ‘waterfall’) shares, even where they are not alphabet shares, unless the shareholder would be beneficially entitled on a winding up to 5% of the assets available for distribution to the equity holders.