Entrepreneurs watching Monday's Budget announcement by Chancellor Philip Hammond may have been pleased to see that, despite speculation that Entrepreneurs’ Relief could potentially be at risk of a number of additional restrictions, or even abolition, the changes announced seemed to be relatively minor.
As many business owners will know already, Entrepreneurs’ Relief allows them to pay a lower capital gains tax rate of 10% on disposals of businesses or shares in a personal company. This compares to the normal rate of 20% and, subject to a lifetime limit of £10 million of gains for each individual, can represent a substantial saving.
‘Fiscal Phil’ announced in his speech that the qualifying period for Entrepreneurs’ Relief would be extended from 12 months to 2 years, with effect from 6 April 2019. For most business owners, entrepreneurs and investors, this shouldn’t be too problematic, given that they are likely to hold their shares for a longer period of time than this in order to achieve a significant gain on the value of their interest.
However, for businesses that may have implemented steps to gear up for an exit, for example issuing shares to key employees to incentivise growth and maximise value on a sale, if these plans were based on the 12-month qualification period then they may now need to be reviewed in light of the longer qualification period.
The decision will be whether to attempt to secure an exit before 6 April 2019 to preserve Entrepreneurs’ Relief for individuals who may have been expecting it or delay an exit until after the new 2-year qualification period. Alternatively, they may, for fear of letting a tax tail wag the commercial dog, decide to press on with any plans regardless and simply accept the tax consequences.
Of course, with Brexit D-Day looming large, the changes to Entrepreneurs’ Relief may prove a somewhat less pressing concern for many businesses in March/April 2019.
The devil in the detail
Although not mentioned in the Chancellor’s speech, looking at the detail of the Budget there is another change to Entrepreneurs' Relief which, for many, could have a much more significant impact than the extension of the qualifying period.
The rules governing what qualifies as a ‘personal company’ have been tightened. In addition to the existing criteria, which require an individual to hold 5% of the nominal share capital and 5% of the voting rights in a company, they must also now be entitled to 5% of the company’s distributable profits and 5% of the company’s assets available for distribution to equity holders on a winding up.
The changes apply immediately and appear to be an attempt to counteract a loophole in the system which allowed the relief to be available to shareholders with no real economic interest in the business. This could be achieved by artificially skewing the shareholder’s nominal value and voting rights above the 5% threshold, whilst leaving their income and capital rights unaffected - a tactic often seen in private equity-backed businesses.
Given the immediate effect of these changes, many people who have implemented specific share rights to obtain Entrepreneurs’ Relief will have just lost it overnight. If you think you may be one of these people, you may wish to consult your tax advisor to clarify your position.
Disclaimer: Anything posted on this blog is for general information only and is not intended to provide legal advice on any general or specific matter. Please refer to our terms and conditions for further information. Please contact the author of the blog if you would like to discuss the issues raised.