The recent budget contained a number of important changes, but one that slipped through largely unnoticed at the time of the announcement in Parliament related to changes to the availability of entrepreneurs’ relief.
Background to entrepreneurs’ relief:
Entrepreneurs’ relief is a tax relief that is widely used on the sale of certain qualifying business assets so as to apply a Capital Gains Tax rate of 10% on up to £10 million of gains. In order for a disposal of shares to qualify for entrepreneurs’ relief the seller must be able to demonstrate that the company is the individual’s “personal company” throughout the 12 month period ending on the date of disposal.
For disposals after 29 October 2018 in order to qualify for the relief an individual must be able to demonstrate that he or she is beneficially entitled to at least 5% of the company’s distributable profits and 5% of its assets available for distribution on a winding up.
The government also confirmed its intention to extend the minimum qualifying period from one year to two years, on the justification that a longer term holding is more characteristic of genuine entrepreneurial activity. This change takes effect from 6 April 2019.
The qualifying period for entrepreneurs’ relief for people holding shares through an Enterprise Management Incentive (EMI) option is also similarly increased to two years. This means that the relief will only be available to option holders who sell their shares at least two years after the option was granted.
These changes have a significant impact on directors and employees with an equity stake in their business who will now need to demonstrate not only that they hold 5% of the voting rights, but also an entitlement to 5% of the profits and assets available for distribution on winding up.
Typically, companies with multiple classes of shares (often referred to as “Alphabet Shares”) allow the directors a discretion to determine which classes of shares receive the right to receive a dividend. It would appear from the draft legislation that as a result of the changes none of the shareholders will now qualify for entrepreneurs’ relief (including the founding or majority shareholders).
What action should business owners take?
Business owners considering a sale of their business in the short-term should take urgent steps to review their current arrangements to ensure that their ability to claim entrepreneurs’ relief is not lost or restored. Similarly any companies with Alphabet Shares in issue or with an existing EMI option scheme should review their articles of association and take corrective action, if necessary.