The Government has announced two changes to the Entrepreneurs’ Relief (ER) regime in the 2018 Budget, both aimed, in the Government’s mind, at ensuring the relief is targeted at genuine entrepreneurs who have a real economic stake in the relevant business prior to a disposal. These changes follow on from the expansion of ER which was announced in the 2018 Spring Statement. Draft legislation has been issued covering each of these two new changes, as well as revised draft legislation, following the initial publication on July 6, 2018, on the application of ER on gains arising before a dilution event.
Definition of “personal company”
The first change adds two further tests to the definition of “personal company” at section 169S(3) Taxation of Chargeable Gains Act 1992 (TCGA). In addition to the requirement that the individual claiming ER holds at least five per cent of the ordinary share capital and voting rights in the company being sold, an individual claiming ER must now also hold at least a five per cent interest in both the company’s distributable profits, and assets available to equity holders on a winding up.
The requirement to meet these new tests applies to disposals occurring from October 29, 2018. Any individuals previously intending or expecting to receive ER on a share disposal should consider whether they meet these additional requirements. The legislation is widely drafted; where there are non-management investors with preferential rights, this may prevent ER being available.
Minimum qualifying period
The period during which the qualifying conditions for ER must be met will be increased from one year, to two years from April 6, 2019. In the context of share disposals occurring after this date, this means the qualifying conditions (including the economic tests set out above) must be met for two years ending at the time of the disposal of the shares. The proposed draft legislation includes specific provisions so that where individuals are disposing of shares which they received as consideration for transferring their business to a company, the pre-transfer period will be taken into account in deciding whether the qualifying period has been met.
Transitional rules will also be included so that the one year qualifying period continues to apply where the individual’s business ceased (or the company ceased to be a trading company or a holding company of a trading group) before October 29, 2018, and the disposal occurs within three years of the cessation.
This change to the minimum qualifying period also applies to individuals disposing of shares acquired under an EMI scheme. ER will only be available where those shares are sold two or more years after the grant date (and all other qualifying conditions are met during that two year period). In line with the proposed transitional provisions, the one year qualifying condition will continue to apply to disposals of shares granted under an EMI option where a company has ceased to be a trading company or a holding company of a trading group prior to October 29, 2018.
Draft legislation published on gains arising before dilution event
A revised version of new Chapter 3A in Part 5 TCGA has also been published, following the initial release of draft legislation in July 2018. There are no significant updates to the drafting; however, there has been further clarification on the treatment of disposals of shares arising following a reorganisation of the share capital of a company. Despite repeated comments in the responses to consultation, there has been no movement from the Government on allowing an individual to automatically defer any accrued gain rather than including the requirement to make an election to avoid a potential dry tax charge, or allowing the exercise of options by employees to qualify as a “relevant share issue” which would otherwise give an individual the benefit of the dilution event protections in such circumstances.
(Capital Gains Tax: Entrepreneurs’ relief: definition of a ‘personal company’ policy paper – 29.10.18)
(Draft Finance (No. 3 Bill) Schedule 1: Entrepeneurs’ Relief – 29.10.18)
(Draft Finance (No. 3 Bill) Clause 1: Entrepeneurs’ Relief – 29.10.18)