Entrepreneurs' Relief (ER) is a valuable tax relief for those disposing of a business. It can give access to a 10% rate of capital gains tax, subject to a £10 million lifetime limit. ER is potentially available to company shareholders, owners of unincorporated businesses and trustees. But for a claim for ER to be successful, close attention to the detail of the rules is critical - and important new conditions have recently been added.
New ownership period
Ownership conditions apply throughout the period up to the date of disposal. Budget 2018 brought change 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. Where the claimant's business ceased, or their personal company ceased to be a trading company (or holding company of a trading group) before 29 October 2018, the one-year qualifying period still applies.
Company shareholders and trustees
For company shareholders, and trustees who are company shareholders, there are new rules on what constitutes a 'personal company'. 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 and
be able to exercise at least 5% of the voting rights and
satisfy either the distribution test, or the proceeds test.
The conditions in the last bullet point are the new conditions added recently.
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 proceeds test.
For disposals on or after 29 October 2018, Budget 2018 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 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. The existence of preference shares could also affect the outcome.
To address this, the government introduced an alternative test, based on proceeds on disposal.
For disposals 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, but the test will need to be met throughout the two-year holding period (one year for disposals before 6 April 2019). 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.
These changes will impact many claims for ER, and we would strongly recommend 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 needed. Please do not hesitate to contact us to discuss whether you need to act to ensure ER will be available on any future disposal.