While the autumn Budget is now a distant memory for many SMEs, the changes to entrepreneurs’ relief are still front of mind. Stephens Scown corporate law solicitors discuss the relief and its impact.
What is entrepreneurs’ relief?
Entrepreneurs may sell or give away their business and claim entrepreneurs’ relief. Entrepreneurs’ relief is available for up to £10,000,000 lifetime gains. This certain amount of money is called entrepreneurs’ relief for a reason. Entrepreneurs gain tax relief at a reduced rate of 10%. It is a tax relief which benefits 52,000 people each year, the majority of which are the owners of small and medium sized enterprises (SMEs). But whilst the relief still exists, its availability has been significantly curtailed.
In August 2018, the Resolution Foundation think tank called on the Chancellor Philip Hammond to scrap entrepreneurs’ relief, claiming it benefitted only a few wealthy individuals. Thankfully, the Autumn 2018 Budget did not go so far as to abolish entrepreneurs’ relief altogether.
Requirements before the Budget
Prior to 29 October 2018, the requirements to qualify for entrepreneurs’ relief on the sale of shares were:
- the company must be a trading company, or the holding company of a trading group;
- the seller must hold at least 5% of the company’s ordinary share capital;
- the seller’s shares must allow them to exercise at least 5% of the voting rights in the company; and
- the seller must be an officer or employee of the company, or of another company in the company’s group.
These all had to be satisfied for at least one year before the disposal.
Whilst these requirements must all still be satisfied, the Chancellor has added further hurdles for the seller to overcome.
Requirements after the Budget
For any disposal of shares on or after 29 October 2018, to qualify for entrepreneurs’ relief the seller must now also be beneficially entitled to:
- 5% of the company’s distributable profits; and
- 5% of the company’s assets available for distribution on a winding up.
For share sales on or after 6 April 2019, the previous requirements as well as the new requirements must have been satisfied for at least two years prior to the disposal.
Also, where a business is disposed of through an asset sale, the business must now have been carried on for at least two years directly prior to the disposal.
What does this actually mean for SMEs?
These changes apply to every individual seeking to claim entrepreneurs’ relief, but in particular will affect the following:
- Shareholders holding “alphabet shares”;
- Individuals who acquired shares or business assets on or after 6 April 2017; and
- Company officers or employees holding EMI share options granted on or after 6 April 2017.
Shareholders holding “alphabet shares”
It is common for SMEs to split their share capital into “alphabet shares” with the directors having authority to declare differing dividends for different classes of shares. This is used by some SMEs to give the directors discretion on how dividends are distributed in order that the shareholders receive the most favourable tax treatment, for example where one shareholder is a higher rate taxpayer and the other is a basic rate taxpayer.
Previously on the sale of alphabet shares, the sellers would have been eligible to claim entrepreneurs’ relief provided they met the requirements which existed before the Budget. However, the sale of such alphabet shares may no longer qualify the seller for entrepreneurs’ relief. There is a risk that HMRC may now treat the fact the directors have discretion on how the dividends are paid, even if the shareholder routinely receives the majority of the company’s profits, as indicative that the shareholder is not entitled to 5% of the company’s profits.
If such shareholders know that an exit is planned in the next few years, it may be sensible to ask the company to change the rights attached to their shares to ensure the holder has the right to 5% of the company’s distributable profits and 5% of the company’s assets on a winding up. This would have to be done at least two years in advance of any disposal where the disposal occurs on or after 6 April 2019.
Individuals who acquired shares or business assets on or after 6 April 2017
Where shares or business assets were acquired on or after 6 April 2017, the new requirement of holding the shares for at least two years will not have been met when the new rules become effective on 6 April 2019. As a result, the individual will be required to have held their shares or assets for a longer period before they will qualify for entrepreneurs’ relief.
To avoid this requirement, individuals could sell their shares or business assets prior to 6 April 2019 as they would only have to have held their shares for one year prior to the disposal.
Company officers or employees holding EMI share options granted on or after 6 April 2017
The rules for entrepreneurs’ relief for the holders of EMI shares have also been changed to reflect the changes to entrepreneurs’ relief more generally.
To receive the relief, the EMI option holder must have been granted the option at least two years prior to the disposal of the EMI shares where the disposal occurs on or after 6 April 2019.
For now, entrepreneurs’ relief still remains. But given the growing pressure on government finances and the desire for increased tax revenue, it is not clear how long the relief will remain.
The corporate team at Stephens Scown is among the best in the region and has top tier ranking in independent legal guides Legal 500 and Chambers UK. For further information, please get in touch on 01392 210700 or firstname.lastname@example.org.