In the Budget the UK chancellor announced that entrepreneurs' relief would be restricted from 29 October 2018 so that it would only available to individuals on disposals of shares where they have held at least a 5% interest in both the distributable profits and the net assets of the company available on a winding up. This revised test was viewed as overly restrictive by many commentators.
The government is now proposing an alternative test which would give the relief if the individual is entitled to at least 5% of the sale proceeds in the event of a disposal of the whole of the ordinary share capital of the company, even if the 5% test in relation to distributable profits and assets on a winding up was not satisfied.
"This government amendment will be welcomed as in many cases working out the percentage entitlement to sale proceeds will be much easier than working out the entitlement to profits available on a hypothetical distribution," said Peter Morley, a tax expert at Pinsent Masons, the law firm behind Out-Law.com.
"Where there are a number of different classes of share capital and a number of debt funders, as is common for perfectly commercial reasons in private equity transactions, for example, applying the complex legislation regarding profit entitlements is difficult. The sale proceeds test may give a better result for some individuals, but in many cases it still will not be possible to know whether an individual will qualify for relief until a transaction actually takes place," he said.
The new provision will apply for share disposals from 21 December 2018, the date the Finance Bill amendment was announced. The amendments will be considered when the Finance Bill has its report stage and third reading in the House of Commons on 8 January.
The new test will be subject to an anti-avoidance provision so that in applying the test of entitlement to sale proceeds, arrangements will be ignored if their main purpose or one of their main purposes is to obtain the relief.
Entrepreneurs' relief reduces the capital gains tax payable by individuals on gains realised on disposals of shares in companies to 10% subject to a number of conditions. For the relief to apply the individual must be employed or hold an office in the company or group in which the shares are being sold. Previously individuals could qualify for the relief if their economic interest in the shares being sold fell below 5% because the rules only required shareholders to hold 5% of the voting rights and 5% of the ordinary shares by nominal value.
In the Budget the chancellor also announced that the minimum period shares must be held for the relief to apply would be extended from 12 months to two years for disposals on or after 6 April 2019. This change is not affected by the proposed Finance Bill amendments.
Individuals whose shareholding is ‘diluted’ below the 5% qualifying threshold for entrepreneurs’ relief as a result of a new share issue occurring on or after 6 April 2019 will be able to obtain relief for gains up to that time. This measure was first announced in the 2017 Autumn Budget and is contained in the 2019 Finance Bill. It is designed to help shareholders who satisfy the conditions for the relief when their shares are issued, but cease to hold the required 5% shareholding as a result of subsequent share issues. The measure is designed to ensure that entrepreneurs are not discouraged from seeking external investment to finance business growth in circumstances where their own shareholding becomes diluted.
Affected shareholders will need to make an election for their shares to be treated as disposed of and immediately reacquired at market value prior to dilution, giving rise to a chargeable gain on which they can claim entrepreneurs’ relief. A further election will then enable them to defer the resulting gain until they sell the shares.