Entrepreneurs’ Relief was introduced a little over 11 years ago and business owners have become quite used to the idea of paying a reduced rate of Capital Gains Tax of just 10% on disposals of businesses rather than the usual rate of 20%. The 2018 budget included proposed changes which caused some concern, particularly for those owning companies with ‘alphabet share’ structures. This is a good time to have a look at the Entrepreneurs’ Relief qualification rules and the impact that the changes have had.
A brief overview of the rules before the 2018 budget
Entrepreneurs’ Relief (ER) provides a special 10% Capital Gains Tax rate for qualifying business disposals, subject to a lifetime limit for gains of £10 million. This relief can apply to:
In the case of a disposal of company shares the following conditions apply:
*Prior to the 2018 budget changes a personal company was one in which the taxpayer held at least 5% of the ordinary share capital and was able to exercise at least 5% of the voting rights.
In order to qualify for ER the asset had to be held, and qualifying conditions met, for a one year period prior to disposal.
Changes introduced by the 2018 budget
The 2018 budget announced two changes to the ER rules.
The first point was not a major problem for most taxpayers because those selling business assets have usually held them for more than two years. The second point was, however, a potential major problem for those owing shares in personal companies with ‘alphabet share’ structures. Alphabet shares have long been used as a way to declare differing rates of dividend on separate share classes. However, given that for most companies the articles of association do not specify that any single class of share is beneficially entitled to any set percentage of distributable profits, this led to the question as to whether the budget proposals would cause all alphabet shareholders to cease to qualify for ER.
Concerns were voiced by the professional accountancy bodies and the Chartered Institute of Taxation and the government, realising the problem they had inadvertently caused, included amendments in the Finance Act 2019 to ensure alphabet shareholders were not automatically barred from claiming Entrepreneurs’ Relief. The changes to the definition of a personal service company now allow for two alternative conditions. These require the selling shareholder to be beneficially entitled to either (or both) of the following:
Alphabet shareholders that have full rights on a sale can now remain qualifying for ER – assuming, of course, all of the other conditions are also met! This is a brief overview and there are many complex rules to consider when planning to benefit from ER on a sale.
If you would like to discuss the new Entrepreneurs’ Relief rules in view of your own circumstances, please do not hesitate to get in touch with me on 020 8652 2450 or you can email me at email@example.com