Entrepreneurs’ Relief (ER) is a valuable tax relief for individuals seeking to dispose of their business. It can give access to a 10% rate of capital gains tax (CGT), subject to a £10 million lifetime limit. ER is potentially available to company shareholders, trustees, and owners of, or partners in, unincorporated businesses.
However, important new conditions have recently been added – are you up-to-date?
A look at the new ownership period
Ownership conditions apply throughout the period up to the date of disposal. The 2018 Autumn Budget brought changes affecting all business owners and shareholders looking to claim ER. For disposals on or after 6 April 2019, the necessary qualifying period of ownership is extended, becoming two years, rather than one.
‘Personal companies’ – a definition
New rules have been published on exactly what constitutes a ‘personal company’. Under these rules, an individual must, throughout the relevant qualifying period:
- be a company employee or office holder
- hold at least 5% of the company’s ordinary share capital
- be able to exercise at least 5% of the voting rights; and
- satisfy either the distribution test or the proceeds test.
Note that for trustees who are company shareholders, the qualifying beneficiary of the trust must (had they owned the shares personally) fulfil these criteria and pass either the distribution or the proceeds test.
Analysing the distribution test
For disposals made on or after 29 October 2018, the 2018 Autumn Budget introduced the requirement that an individual must satisfy the distribution test. By virtue of their holding, an individual must be entitled to at least 5% of the company’s profits available for distribution to ‘equity holders’ and 5% of the assets available for distribution to equity holders in a winding up. Note that the basis is profits available to equity holders, rather than shareholders: this has a wider impact.
Unfortunately, this could impact companies genuinely issuing different classes of shares – sometimes known as ‘alphabet’ shares – to different shareholders. As different classes of shares have different rights, alphabet shareholders may not meet the distribution test, especially if those shares are not pari passu.
Examining the proceeds test
To address this, the government introduced an alternative test, based on proceeds on disposal.
For disposals made on or after 29 October 2018, the individual must, in the event of a disposal of the whole of the ordinary share capital of the company, be beneficially entitled to at least 5% of the proceeds. Here, the 5% threshold is computed by reference to the market value of the company at the end of the qualifying period. This could mean – in situations where the new distribution tests are not met – that it would not be apparent whether ER will be available until shares are actually disposed of.
Check your eligibility now
These changes will impact many claims for ER, and we advise that you review your eligibility for ER now. If your current shareholding fails to qualify under the distribution test, and may not qualify under the proceeds test, your qualifying ownership period has ended. To reactivate eligibility for ER, action to change shareholding will be required.
To discuss whether you need to act to ensure ER will be available on any future disposal, please get in touch.