In the 2018 Budget the Chancellor announced two key changes to entrepreneurs’ relief which are likely to have a significant impact on the number of individuals/shareholders benefitting from the relief.
The two key changes are broadly:
- An extension to the qualifying holding period from one year to two years; and
- A tightening of the rules governing the definition of a personal company – so the share rights an individual must benefit from before they qualify for the relief – introduced with immediate effect. This change requires the claimant to have a 5% interest in both the distributable profits and the net assets of the company.
Looking at these two changes in more detail:
The extension of the qualifying holding period from one year to two years will mean that individuals/shareholders need to consider their position at least two years in advance of any potential transaction to ensure their position is protected.
This measure will have effect for disposals on or after 6 April 2019, except where the business ceased before 29 October 2018. In cases where the claimant’s business ceased, or their personal company ceased to be a trading company (or the holding company of a trading group), before 29 October 2018, the existing one-year qualifying period will continue to apply.
The tightening of the rules regarding the definition of a personal company which essentially governs the share rights to which an individual must be entitled will have wide-ranging implications.
Previously, in order to qualify for entrepreneurs’ relief, an individual must:
- Be an employee or officer of the company;
- Hold at least 5% of the “ordinary share capital”; and
- Have at least 5% of the voting rights by virtue of that holding of ordinary share capital.
However, in tightening up these rules, from 29 October 2018, the shares must also entitle the holder to 5% of the company’s distributable profits and five percent of the assets available to equity holders on a winding up.
This means that going forward, in order to qualify for entrepreneurs’ relief, the individual must:
- Be an employee or officer of the company;
- Hold at least 5% of the “ordinary share capital”;
- Have at least 5% of the voting rights by virtue of holding that ordinary share capital;
- Be entitled to at least 5% of the company’s distributable profits; and
- Have a right to at least 5% of the net assets of the company available to equity holders on a winding-up.
The government has said that this change ensures a shareholder must benefit from a genuine economic entitlement to 5% of a company in order to qualify for entrepreneurs’ relief.
This means that shareholders will be required to continually monitor their position to ensure they qualify for relief.
For disposals before 6 April 2019, these additional requirements will apply for one year to the date of disposal. For disposals on or after 5 April 2019, these additional requirements will apply for two years to the date of disposal, except where the company ceased trading before 29 October 2018.
The draft legislation also confirms that proposals will be introduced from 6 April 2019 to protect an individual’s Entrepreneurs’ Relief entitlement up to the point they are diluted below the 5% qualifying requirement.
The definition of “ordinary share capital” covers all the shares of a company except fixed dividend shares.
So, in practice, before 29 October 2018, pretty much any class of shares, however they are described, could have qualified for entrepreneurs’ relief. Provided the shareholder also had sufficient voting rights, the other rights they held to dividends could be negligible.
While these changes are likely to affect many shareholders, those who have built up their own company and as such hold ordinary shares with full voting rights as well as rights to the company’s assets on a winding-up should not be affected.
However, those who may for example, have taken part in a management buyout, may find that they have less rights to the company’s assets on a winding-up so are likely to be affected.
As always, advice will be essential to determine whether relief will be available going forward.
Through our Professional Network we have built up an expert team of legal and tax advisers to guide you through the process of selling your business. We will be happy to direct you to the right expert to get the advice you need.
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