The 2018 ER Update (Part 1)

In the first of his four-part article, Peter Rayney covers the latest Finance (No. 3) Bill 2018-19 changes to the entrepreneurs’ relief rules. 

 

The basic entrepreneurs’ relief (ER) legislation has been fairly stable since it was first introduced in 2008, but it seems the Chancellor thought it was due a 10th anniversary revamp!  

 

For company share sales, the key conditions for relief have always required the seller to ‘work’ for the company (as a director or employee) whilst also satisfying the ‘personal company’ test (in TCGA 1992, s 169S(3)). This meant that the seller must hold at least 5% of the company’s ordinary share capital and this holding must carry at least 5% voting rights. The seller is required to meet these two conditions in their own right - holdings and voting rights held by their ‘spouse’ or other associates cannot be included.  

 

The company must also be qualifying trading company or holding company of a trading group as defined in TCGA 1992, s 165A (see also TCGA 1992, Sch 7ZA if a company/group has joint venture interests).  

 

Before the Finance (No. 3) Bill 2018-19 changes (see below), all these conditions had to be satisfied within one year before the date of the share sale. 

 

For shares sold after 28 October 2018, the seller shareholder now has to meet two further tests (which are aimed at ensuring they have a commensurate economic interest in the company). Thus, the seller must (by virtue of their shareholding) also be beneficially entitled to at least 5% of the: 

The tighter rules aim to ensure that shareholders beneficially own 5% of the true economic rights in the company. These provisions will counter a number of arrangements involving shareholdings that satisfied the 5% ordinary share capital/voting rights test but carried less than 5% of the sale proceeds realised on a company sale. 

 

The new further tests are applied by using a modified version of the ‘economic-ownership’ tests used for the corporation tax ‘group relief’ rules (found in CTA 2010, Pt 5, Ch 6). For these purposes, ‘equity holders’ would typically be all the ordinary shareholders (excluding ‘restricted preference shares’) and loan creditors (except those involving commercial loans) (see CTA 2010, ss 160-164).  

 

Unfortunately, in their current form these rules could be difficult to apply in the context of ER. For example, most ‘alphabet share’ arrangements give the board of directors the discretion to propose different rates of dividend on each separate class of shares. In such cases, how would we determine each individual shareholder’s beneficial entitlement to the profits available for distribution to the equity holders?  

 

It is suggested that the deemed allocation of the distributable profits can only be done on a pro-rata basis by reference to the actual shares held by each shareholder (i.e. the discretionary rights of the directors to determine different dividends on each class should be ignored). This would be a logical approach. However, it is hoped that HMRC will consider the various representations that have been made on these draft clauses so that the final legislation will be clearer and fairer to apply.  

 

For disposals made after 5 April 2019, all the relevant ER qualification tests must be met throughout the two-year period ending with the disposal date. The existing one-year ER qualification period remains for disposals made before 6 April 2019. 

 

Shareholders of companies that have different classes of shares should check whether they meet all the various 5% economic tests for ER purposes under the new rules.