Changes to Entrepreneurial Relief

CHANGES IN THE OCTOBER 2019 BUDGET MAY HAVE AFFECTED YOUR ENTREPRENEURS RELIEF QUALIFICATION

Background

As you may be aware there were changes announced by the Chancellor in the recent budget which amended some of the rules regarding Entrepreneurs Relief (‘ER’).
Not only did the Chancellor extend the period of qualification from 12 months to 24 months, he also introduced a requirement for those claiming the relief to have an economic ‘entitlement’ to 5% of the distributable reserves as well as 5% of the assets on a winding up. This may mean that those individuals with ‘Alphabet shares’ or ‘Growth shares’ may now not qualify for the relief.

Why does it matter?

It matters in the event that you wish to sell your business in the future. By claiming the relief, the tax that you will pay on the disposal of a business asset will be 10% on the first £10m of proceeds and 20% thereafter. If you don’t qualify the tax on the first £10m effectively doubles to 20%.
Previous to the changes the requirements for ER were as follows:-
-The company must be a trading company or the holding company of a trading group.
-The shareholder must be an officer or employee of the company for 12 months.
-The shareholder must hold 5% of the nominal share capital for a period no less than 12 months and,
-Hold 5% of voting rights for a period no less than 12 months.
By manipulating the rights attached to the shares it was possible to obtain the benefit of ER without any real capital risk. In order to counteract this the Chancellor announced two new conditions to the four listed above, effective immediately:
-Shareholders must be entitled to at least 5% of the company’s distributable profits.
-Shareholders must have a right to at least 5% of the net assets of the company available to equity holders on a winding-up.
– The holding period is now 24 months rather than 12

That seems quite straightforward, so what’s the issue?

Individuals who have one class of shares and whose Articles state that shares rank ‘pari passu’ on a distribution and a winding up, will not be affected as it can be demonstrated that they have a right to at least a 5% of the capital on a winding up and at least 5% of any distributable profits.
But what about individuals with Alphabet shares?  How confident can a shareholder be that they are ‘entitled’ to 5% of the company’s distributable reserves when in fact one shareholder could receive 100% of the distribution by virtue of the provisions in the Articles?
Also, what about growth shares where a ratchet exists which pays out others a fixed amount, on a winding up without specific reference these individuals are not ‘entitled’ to at least 5% on a winding up.
In fact, we believe that ER is at risk in all the following circumstances:
-Growth shares (where the shares benefit only on a proportion of an uplift in value)
-Low or nil dividend paying shares
– Ratchet share structures (where capital is received after a ring-fenced amount)
– Shares with different nominal values
– Convertible securities, preference shares and certain financing arrangements with shareholder loans
– Shareholder or investment agreements referring to restrictions on voting or dividend rights
In the above scenarios the tax rate for the individual post 28th October just doubled.
It is not believed that this was an intended effect but without further clarification from HMRC a significant number of individuals will have just lost the ability to claim ER and with a 2-year qualifying period, those directors intending to sell will need to amend their articles and hold the shares for a 2-year period before the tax rate reverts to 10%

Next Steps

It is possible that HMRC will issue further clarification over the next couple of months and therefore you may wish to wait for this ahead of acting. However if you are concerned that you may be selling your business and wish to ensure that you qualify for ER we would recommend that the Articles of Association and Shareholders Agreements are reviewed and if there is ambiguity they are amended to ensure that the ‘clock starts ticking’ again on your ER qualification. If HMRC clarify after amendment you will be in no worse position as changes should not displace ER from being available. However if HMRC don’t clarify you may need to make the changes at some point to begin the qualification period.
If you should have any queries in respect of the above please do not hesitate to contact your usual relationship partner.
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This article is for general guidance only. It provides an outline, and may not include points which are important to your situation. You should not depend on this blog without taking advice based on the full facts of your case. The information given was correct at the time of publication.