Entrepreneurs’ Relief will be eight years old this year. When it was first introduced in 2008/09, it was worth a maximum of £80,000 over an individual’s lifetime, but that saving is now worth £1m (previously £1.8m when the main rate of CGT was 28%).
Over the last eight years, certain aspects of the Entrepreneurs’ Relief regime have been tweaked and amended, but the key qualification criteria relating to company shares has remained constant throughout.
The three key conditions for the sale of a shareholding to qualify for Entrepreneurs’ Relief are:
• You own at least 5% of the ordinary share capital in the company; and
• Your shareholding entitles you to exercise at least 5% of the voting rights; and
• You are an employee or officer/director of either the company in which you own the shares, or a company within the group.
These conditions have to be satisfied throughout the 12 months immediately prior to the disposal. Whilst the conditions are clear, it is presumptuous to assume that the shareholding will automatically qualify without undertaking some level of review.
A case study
In a recent transaction, the commercial director of a company believed that his shareholding qualified for Entrepreneurs’ Relief based on the presumption that he owned 10% of the shares in the company which entitled him to the same level of votes.
The share capital of the company concerned included a significant number of preference shares, of which the director did not hold any. Normally, the existence of preference shares does not affect the ordinary share capital of the company. The rules regarding Entrepreneurs’ Relief state that shares which have a ‘right to a dividend at a fixed rate but have no other right to share in the profits of the company’ are effectively ignored to determine the ordinary share capital. Unbeknown to the director, the rights of the preference shares had been subtly amended before he had joined the company.
The rights of the preference shares were changed so that they were no longer entitled to receive a dividend at a fixed rate, and could not participate in distributions of the company’s profits, unless the directors resolved otherwise. As the preference shares no longer carried a fixed rate dividend, but had a right to participate in distributions of the company’s profit, albeit at the complete discretion of the directors, this change meant that the preference shares now formed part of the ordinary share capital of the company for the purposes of Entrepreneurs’ Relief.
Given the significant number of preference shares in issue, the director’s shareholding represented less than 1% of the ordinary share capital of the company for the purposes of Entrepreneurs’ Relief. This did not alter the fact that economically, the director would still be entitled to 10% of the sale proceeds by reference to his shareholding in the company. As a consequence, the commercial director did not satisfy the conditions for Entrepreneurs’ Relief and the sale of his shareholding would be assessed to CGT at 20%, and not 10% had Entrepreneurs’ Relief been available. The result was that the director’s CGT liability was £150,000 higher than he expected.
In recent years, HMRC has been paying closer attention to claims for Entrepreneurs’ Relief and checking in detail whether a claim is valid. Given the potential £1 million tax saving associated with Entrepreneurs’ Relief, it is important for shareholders to review whether they meet the qualifying conditions. Ideally, the Entrepreneurs’ Relief position should be considered 12 months in advance of a possible transaction so that any remedial action can be taken and is effective.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
This article has been written by Nimesh Shah, Partner - Private Client at Blick Rothenberg Limited (0207 544 8746, nimesh.shah@blickrothenberg). Blick Rothenberg Limited is regulated by the Institute of Chartered Accountants in England and Wales. (www.blickrotherberg.com)