The dilution of an individual’s shareholding must be as a result of an issue of shares made by a company for genuine commercial reasons. Further explanation or guidance on what constitutes “genuine commercial reasons” is not provided in the consultation document. It would be assumed that a third party fund raise to finance the business, or an issue of shares to attract managers to join the business is accepted as being for commercial reasons.
For these changes to be effective, it will be important that no taxpayer is prejudiced by making an election and having a “dry” tax liability – where a tax charge is calculated by reference to a higher figure than the ultimate cash proceeds. If this is done, it seems unlikely that the option to pay tax on the deemed disposal at the time of dilution will be exercised in practice, unless for instance there were reliefs available to offset the gain.
Once an election has been made claiming ER for a deemed gain prior to dilution, ER will not be available on any gains that follow that loss of eligibility. The consultation document is not clear on whether this is the case even where the individual later meets the ER eligibility requirements. Individuals will therefore have to consider carefully whether there is any possibility they may, in the future, meet the 5 per cent shareholding, and therefore be able to claim ER on the gain made on final disposal of the shares.
Shareholders’ agreements commonly include provisions which have the effect of putting restrictions on managers’ shareholdings being diluted below the 5 per cent threshold, in order to ensure that ER eligibility is maintained. The introduction of these changes may result in these sort of provisions appearing much less frequently in shareholders’ agreements for new and growing companies.
The consultation runs to 15 May 2018, following which we expect to see draft legislation and further guidance on the application of these proposed changes.