Satwaki Chanda discusses a new tax incentive aimed at business angel investors.
Investors’ relief is a new capital gains tax (CGT) relief introduced in this year’s Finance Bill 2016, intended to complement the existing entrepreneurs’ relief. The latter offers a special 10% rate on capital gains for those individuals brave enough to start their own business. However, this relief is only available for those who take an active part in running the business. Investors’ relief is designed to redress the balance for passive investors, offering the same 10% tax rate on exit.
What are the ground rules?
The relief applies to investments made on or after 17 March 2016. The following conditions must be satisfied (Finance Bill 2016, Sch 14):
- the investor must subscribe for ordinary shares in an unquoted trading company (including the holding company of a trading group);
- the shares must be fully paid up at the time of the subscription, and are paid for wholly in cash;
- the shares must be issued by way of a bargain at arm’s length terms and for genuine commercial reasons (no tax avoidance motive);
- the investor must hold the shares continuously for a three-year period. However, for shares issued before 6 April 2016, the holding period is extended to 6 April 2019;
- the company must satisfy the trading requirements throughout the period for which the shares are held; and
- subject to certain exceptions, the investor must not be an officer or employee of the company itself or of any other company connected to the investee company. This restriction extends to any person connected with the investor.
As with entrepreneurs’ relief, the 10% rate is not automatic – it must be claimed. Furthermore, there is a lifetime limit of £10m worth of gains that can benefit from the relief. Investors who exceed this limit are taxed at the standard CGT rates.
What are the advantages of investors’ relief?
In tax terms, schemes such as the enterprise investment scheme (EIS) look better on paper, as there is a wider range of incentives on offer. In addition to the CGT exemption, EIS shares can be used to shelter capital gains on other assets, and income tax reliefs are also available.
However, the EIS regimes are so complex that it is all too easy to fall foul of the rules and lose the tax breaks. By contrast, investors’ relief is far simpler, with fewer restrictions, both for investors and the companies they invest in. For example, in recent years, the EIS regime has come to favour younger companies engaged in the knowledge rich/technology sectors. Under investors’ relief, more mature businesses will be able to seek funding, irrespective of the type of trade they are involved in. EIS companies are also subject to various financial limits on the amount of funding they can raise.
However, investors’ relief can still throw up the odd trap or two.
A trap for family ventures
Example: An investors’ relief trap
Dick, an inventor, is the CEO of Scarab Limited, a company that specialises in high precision scientific instruments. His sister, Dot, is willing to subscribe for shares in his company, but otherwise has nothing to do with the running of the business.
Unfortunately, Dot is unlikely to benefit from investors’ relief when she sells her shares, because her brother is the CEO of the company – the prohibition against holding an office or employment extends to relatives. But Dick needs to be an officer or employee of his company in order to qualify for entrepreneurs’ relief when he sells his shares.
Practical Tip:
Investors’ relief offers a perfect solution for business angels and passive investors who put up the capital, but take no part in the business. However, careful planning is required when making an investment, taking into account not only the needs of investors, but other participants in the company’s business.
