A significant and welcome change to the Entrepreneurs’ Relief (ER) rules was announced in the Finance Bill 2019 last month. It is aimed at shareholders who would otherwise lose their entitlement to ER as a result of being diluted below the 5% required shareholding.
The draft legislation proposes that individuals whose shareholding is reduced below 5% as a result of a commercial issue of shares can elect to claim ER up to the date of dilution. The rationale for the change is that the tax rules should not provide a disincentive to seeking third party investment by putting the availability of ER in jeopardy. The changes will apply to share issues which take place on or after 6 April 2019.
So what are the five biggest points to be aware of?
- Individuals whose shareholding is reduced below the 5% threshold as a result of a commercial issue of shares must make an election in their tax returns to bring the gain on their shares into charge. They are then treated as having disposed of and reacquired, at current market value, the whole of the taxpayer's holding of shares that would, immediately before the dilution, have qualified for ER. This gain is then brought into account for CGT purposes.
- It is important to be aware that a second election is available to tax payers. This election allows taxpayers to defer payment of the CGT in full (crystallised by the first election) until the shares are actually disposed of rather than pay at the time of the deemed disposal. This then avoids what would otherwise be a dry tax charge.
- Both elections must be made within 12 months of the 31 January following the tax year in which the shareholding is diluted. Therefore, there will be a timing issue to be aware of and the elections may need to be considered well in advance of any prospective sale.
- An election is only possible where there is a share issue is made by a company wholly for cash and for genuine commercial reasons. An election cannot for instance be made if the dilution happens because of the exercise of employee share options or debt for equity swaps.
- The notional disposal value of the shares is determined by reference to the market value of the shares as if the whole of the issued share capital of the company had been sold for a consideration equal to its market value at that time (without any minority discount). This might lead to a situation where the gain brought into account reflects a higher amount than the true value of the actual minority shareholding.
These changes are to be welcomed. They have been brought in to correct an anomaly in the tax rules which might discourage companies from taking in third party investment. However, it is important to be aware of the limits of these rules and of the need to make potentially two elections in order to both claim ER and avoid a dry tax charge. Given the time limits involved, this will need to be considered well in advance of any potential exit.
If you would like any further advice in relation to the changes to ER rules please contact Mark Braude.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at August 2018. Specific advice should be sought for specific cases. For more information see our terms & conditions.