Tax Talk: Further changes to Entrepreneurs’ Relief

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The Chancellor recently announced further changes to Entrepreneurs’ Relief (ER) or Business Asset Disposal Relief, as it is now known.  These affect disposals on or after 11 March 2020 and certain disposals before that date.

ER reduces the Capital Gains Tax (CGT) rate from the higher rate of 20%, down to the reduced rate of 10%. 

ER is intended to reduce CGT for those individuals disposing of all or part of their business.  From 11 March 2020 the lifetime limit of ER that any individual can claim has been reduced from £10 million down to £1 million.  Therefore, gains over £1 million will be liable to the higher rate of 20% whether qualifying for ER or not.

Importantly, as this is a lifetime limit, the £1 million will be reduced by any previous ER claims made, so some individuals may have already exceeded the reduced lifetime limit.

Qualifying conditions

To qualify for ER, you must meet certain conditions throughout a ‘qualifying period’.  From 6 April 2019, the qualifying period is two years ending with the date the disposal takes place.  The following criteria must be met for the duration of the two-year qualifying period to be eligible for ER:
  • You have been a sole trader or business partner in the business; an officer or an employee of the company disposed of; and
  • The company’s main activities are in trading, or it’s the holding company of a trading group; and
  • You held 5% or more of the share capital of the company and 5% of the voting share capital; and
  • You were entitled to at least 5% of either:
    • Profits that are available for distribution and assets on winding up the company; or
    • Disposal proceeds if the company is sold.
If the company has issued more shares, diluting your share below 5%, there is an election that can be made to be treated as having sold and re-bought your shares immediately, triggering a gain for CGT purposes enabling an ER claim.  However, you must have qualified for ER prior to the date the additional shares were issued.

EMI shares can also qualify for ER, however, the 5% holding requirement for normal shares is not relevant.  For EMI shares to qualify, they must have been bought after 5 April 2013, and the option must have been granted at least 2 years prior to the disposal.

In circumstances where shares are held jointly with another person, for example your spouse or civil partner, you are treated as holding the appropriate proportion of the total shareholding and voting rights.  This means that each person must hold more than 5% of the share capital and 5% of voting rights proportionally. 

Spouses and civil partners are treated separately for ER; thus each person is entitled to a lifetime limit of £1 million.  Importantly, however, to claim ER from the disposal of shares in a company, you must be an officer or an employee of the company for the last 2 years.  You should have an active role in the company throughout those 2 years, and not just be holding a director role for ER purposes.  HMRC has been pursuing this aspect more carefully in recent years.

Changes from 11 March 2020

Special anti-forestalling provisions have been introduced which could mean arrangements entered into before 11 March 2020 are susceptible to the new £1 million lifetime limit.

The anti-forestalling provisions focus on two key areas:

1) Where an unconditional contract has been entered into prior to 11 March 2020, but the conveyance or transfer of the asset does not take place until on or after 11 March 2020.  In this instance, the date of disposal will be deemed to be the date of conveyance or transfer unless:
  • The relevant parties can demonstrate they did not enter into the contract for the purpose of obtaining a tax advantage through anticipation of the recent changes in ER, and
  • Where the parties to the contract are connected, the contract was entered into for wholly commercial purposes
2) Where an exchange of securities has been entered into on or after 6 April 2019 (a share for share exchange, for example) and the individual makes a claim to subject the share element to tax (overriding the default position where the exchange is not taxed), then that gain will be treated as arising when that claim is made, if there is substantial commonality of ownership between the companies, or if the individual has seen an effective increase in shareholdings.  This will prevent gains being realised for transactions already undertaken where prior tax planning may have identified a potential opportunity to lock in the previous Entrepreneurs’ Relief rules in scenarios such as:
  • A pure imposition of a holding company since 6 April 2019 with no change of beneficial ownership, or
  • The imposition of a holding company since 6 April 2019 to facilitate the departure of one or more shareholders, with the remaining shareholders taking a higher percentage interest as a result.
In respect of any transaction occurring after 11 March 2020, including those facilitated by way of share exchange, the new lifetime limit will apply.

If you are unsure whether the new rules apply to you, HMRC has confirmed that taxpayers will be able to seek statutory clearance.

Investor Relief

Although the lifetime limit for ER has reduced to £1 million, at this time, the lifetime limit for Investors’ Relief (IR) remains at £10 million.  This is in addition to the lifetime limit of ER.

IR also reduces the exposure to CGT from 20% to 10%, however has slightly different requirements:
  • The shares must have been invested in on or after 17 March 2016; and
  • The shares must have been held for at least three years from 6 April 2016; and
  • The shares must be ordinary shares; and
  • The company must be an unlisted trading company, or an unlisted holding company of a trading group; and
  • The shares must be subscribed for in cash.
Unlike ER, IR is aimed at “Business Angels”, notably the individual investor must not be actively involved in the business, and there is no minimum percentage shareholding requirement.  The investors (or persons connected to them) must not be officers or employees of the company when the shares are subscribed for.  They may later become unpaid directors, however, they must not receive any value in respect of their shareholdings (dividends are allowed).

Looking forward

In considering future developments to both ER and IR, the impact of COVID-19 on the UK economy, and how the government plans to facilitate a rebound cannot be overlooked.  Changes may be made to further align the system of Capital Gains Tax and Income Tax on the basis of equitable treatment for all taxpayers following the crisis.  Alternatively, the Government may listen to those lobbying that in order to facilitate investment to restart the economy, reliefs such as ER and IR should be both retained and enhanced.

It is too early to speculate what route the Government may take (if any) which will depend on the political climate when the UK Economy has regained some sense of normality, but any developments will be keenly monitored by owner managers if and when they occur.