You may have seen from our recent publications following the Budget on 29th October 2018 that the Government has introduced some changes to Entrepreneurs’ Relief (ER) which were effective immediately. Prior to the Budget there had been murmurings that ER may have been scrapped completely and many were relieved that ER was still in existence.
On a first read of the proposed changes they seemed relatively benign; the 12 month holding period had been extended to 24 months and the definition of a ‘personal company’ had been tightened to ensure that a shareholder had beneficial entitlement to at least 5% of the dividend rights and capital rights on a winding up, as well as the existing 5% voting rights and ordinary share capital requirements for trading companies.
On the release of the draft Finance Bill, it is apparent from our review that the impact extended beyond merely tackling abusive structures and would also capture very many normal commercial situations.
Whilst much of the press reporting has focussed upon the Brexit related amendments to the Finance Act, the Government also tabled a significant amendment to those proposed ER changes, potentially narrowing the scope of those affected – this amendment has been approved by the House of Commons and is now passing through the House of Lords, however it is now highly likely that we have the text that will be given Royal Assent and become law unless wider issues call for a change in Government.
As mentioned above, the original changes looked to impose a need for an entitlement to at least 5% of the distributable reserves available to all equity holders and 5% of the assets on wind up. Because of the precise language and approach set out in the legislation, a broad spectrum of shareholders may find these changed conditions difficult to meet on an ongoing basis; companies with shareholders who possess different classes of shares (that do not necessarily carry an absolute entitlement to dividends), growth shares, or some quite common capital structures with shareholder loans may find themselves unable to claim ER.
Although these changed conditions remain within the newly amended legislation, a second alternative condition can be met as a means to qualify for ER. In this sense, shareholders now need to meet either of the following two tests:
- That the individual is beneficially entitled to at least 5% of the profits available to equity holders and, on a winding up, would be beneficially entitled to at least 5% of the assets: or
- In the event of a disposal of the whole of the ordinary share capital of the company, the individual would be beneficially entitled to at least 5% of the proceeds.
The first of these tests remains in line with condition that was originally proposed; however, the inclusion of the second test as an alternative may mean, for many that would otherwise have been denied ER, there is now a qualifying path without the need for significant revision to the capital structure of the Company.
While this amendment to the new rules is obviously welcomed, the change to the core ER qualifying conditions does impose a significant risk that shareholders may no longer qualify. Noting that there is now a two-year holding period before remedial changes can effectively restore ER qualification, reviewing the position as early as possible is still recommended.
If you believe that the proposed changes may impact you, or you would like further advice on this matter, then please do contact us as a matter of priority.