Entrepreneurs’ Relief (ER) is a widely used and valuable relief that can provide substantial and legitimate tax savings for business owners when they sell their shares. If the relief applies, capital gains tax is payable at the lowest rate available, being 10%.
So long as the other qualifications are met, an individual will qualify for ER if the company in which he was selling all or part of his shares is a “personal company”. Up until the Budget announcement earlier this week, this meant that he must hold at least 5% of the voting rights and 5% of the ordinary shares (by nominal value). This was the case even if his economic interest in the profits or capital of the company represented by his shareholding fell below 5%.
In this week’s Budget it has been announced that, with effect from midnight on 29 October 2018, in order to qualify for ER, the individual must hold shares that entitle him to 5% of the distributable profits of the company (dividends) and 5% of assets available on a winding up of the company (capital).
The problem is that, for entirely valid commercial reasons, companies often have complicated share structures that do not necessarily entitle shareholders to a prorated or minimum proportion of economic rights. This can include the lack (or deferral) of entitlements to dividends and/or capital rights that are subordinate to liquidation preferences. These share structures can arise in a variety of different circumstances and, depending on the final drafting, the new rules may prove highly problematic for such arrangements, including for the founders of the business (which it may not have been the intention to catch).
We expect some more detailed analysis and commentary over the coming weeks and will update again shortly. In the interim, companies with more than one share class may want to review their terms to ensure that key shareholders will not cease to qualify for ER.