In relation to a sale of shares, the main conditions for ER which need to be satisfied at the time of sale and throughout the period of 12 months ending with the date of disposal are that:
Calls to scrap ER in its entirety were rejected by Philip Hammond in Budget 2018 which is good news for individual shareholders. The chancellor acknowledged that ‘encouraging entrepreneur members must be at the heart of our dynamic economy’.
Although ER has been retained, two key changes were announced at Budget 2018 which tighten the conditions.
Individual shareholders will now need to hold longer-term investments before qualifying for ER.From 6 April 2019, the qualifying conditions set out above must now be met throughout the period of 24 months ending with the date of disposal. This will mean that any shareholder who has met the 12 month holding period in the last 6 months will no longer be eligible on 6 April 2019 when the holding period is extended. For example, a shareholder who acquired qualifying shares on 1 September 2017 will have become eligible for ER on 31 August 2018, however, from 6 April 2019 relief will not be available until 31 August 2019.
Prior to the changes announced in Budget 2018, the shareholding requirement set out above did not consider economic rights. Therefore, it was possible to have a class of shares with less than 5% economic rights which still qualified for ER. However, with effect from 29 October 2018, individuals must also be entitled to at least 5% of the distributable profits and net assets of a company to claim ER. This change will be especially relevant for founders of venture capital backed companies who will often hold just over 5% of the share and voting rights but are not entitled to 5% of the distributable assets because of the distribution waterfall set out in the company’s articles. A close review of all rights attaching to different share classes will now need to be undertaken to determine whether the shareholding requirement is in fact satisfied.
At the same time there is an extension to ER which may be welcomed by some individual shareholders.
There is concern that the 5% shareholding requirement has held back family businesses from seeking external funding in order to grow their businesses. The extension is designed to preserve ER for gains arising to individuals who no longer hold a qualifying 5% interest in a company as a consequence of the issue of new shares when raising external funding.
From 6 April 2019, a shareholder will be able to elect to be treated as disposing and reacquiring their shares immediately before the issue of new shares which would otherwise lead to a dilution of their shareholding.ER can then be claimed on any such gain realised from the deemed disposal (with any gain from the date of dilution to the actual sale of the shares being charged at normal capital gains tax rates without the benefit of the relief). On its own, this position would result in a ‘dry’ tax charge but the rules go further and enable the shareholder to make a separate election to defer the tax charge on the gain up to the point of dilution until there is an actual disposal of the shares.
For some businesses this will be a welcomed extension to ER designed to remove the difficult choice which entrepreneurs have previously had to make between raising external funding to assist in growing their business at the cost of losing their entitlement to ER or not raising external funding so that they can preserve their ER position.
Unfortunately, this extension will do little to alleviate the impact of the new shareholding requirement which will restrict the availability of ER for individual shareholders.
For further information please contact Sarah Illidge.
Tel: 0114 228 3277
Please note this information is provided by way of example and may not be complete and is certainly not intended to constitute legal advice. You should take bespoke advice for your circumstances.