Entrepreneurs’ Relief – Two Important changes
Prior to the October Budget, the two key current conditions for being able to claim entrepreneurs’ relief on a share sale are that throughout a minimum period of at least 12 months before the sale:
- the taxpayer held at least 5% of the voting rights and 5% of the ordinary share capital of the company; and
- the taxpayer was a director, officer or employee of the company.
However, the chancellor announced in the Budget two important changes to these requirements:
Firstly the minimum period required to satisfy the conditions for entrepreneurs’ relief is being doubled to 24 months in respect of disposals after 5 April 2019. There is no transitional relief so anyone who acquired shares between 6 April 2017 and 5 April 2018 will be immediately affected by this change, and remember that it is the date of exchange that counts for these purposes, not the date of completion.
Secondly the definition of a ‘personal company’ was changed with immediate effect from 29 October 2018. In addition to the ordinary share capital and voting rights thresholds, it will now be necessary for the taxpayer to have held an interest of at least 5% in the “economics” of the company throughout the minimum two-year holding period. To satisfy the new condition, the draft amendments specifically require the taxpayer to hold at least a 5% interest in both:
- the profits available for distribution to the ‘equity holders’ of the company; and
- on a winding up, the assets of the company available for distribution to its ‘equity holders’.
These changes will appear relatively minor and will not affect most long-term major shareholders in family companies. However, for many others the availability of Entrepreneurs’ Relief has suddenly been removed because the starting point is that a company’s equity holders will include all of the following:
- ordinary shareholders
- preference shareholders except for those entitled to a fixed rate of dividend; however note that there are certain instruments that although being commercially perceived as fixed rate preference shares may nevertheless be treated for these purposes as being entitled to a variable rate. For example, a fixed rate preference share where the coupon compounds if not paid could give rise to an issue. Similarly, if the coupon is calculated as a fixed percentage of the subscription price of the preference shares (rather than the nominal value of the shares) then they will be treated as variable rate preference shares for these purposes.
- holders of convertible loan notes, warrants, or other debt securities with ‘equity-like’ features
This means that the new 5% condition will be much harder to satisfy for entrepreneurs holding shares in companies that have issued these sorts of instruments or preference shares.
Other structures will also be adversely affected where the shareholding does not entitle the shareholder to a 5% stake in the economics of the company, such as:
- Company’s using growth shares or promote shares to reward management teams
- Company’s being funded through non-fixed rate preference shares
The new conditions need to be reviewed carefully and may trigger a restructuring for some companies.