HMRC have announced measures designed to ensure that 'entrepreneurs are not discouraged from seeking external investment to finance business growth in circumstances where their own shareholding becomes diluted'.
Entrepreneurs' Relief (ER) applies a flat rate of 10% capital gains tax on the sale of shares in a trading company or group where the shareholder is:
After a consultation, HMRC has concluded that the loss of ER might prevent growing businesses seeking new funding if a shareholder's interest in a company is diluted below 5% as a result of new shares having been issued for cash.
In brief, certain shareholders will be able to bank ER up to the time of the dilution event and will have an option to defer the tax payment if they wish. The benefit of deferring the tax liability will have to be weighed against the risk of a change in circumstances (for example retirement) and/or a change in the ER rules, which may prevent the relief from applying.
In more detail, where the dilution event takes place on or after 6 April 2019, the proposed legislation, as currently drafted, will operate as follows:
The new proposals are welcome and operate in a clear way to remove a disincentive to seek external growth finance.
That said, our preference would be to revert to the rules that existed under Business Asset Taper relief whereby the 10% rate applied to all employees shareholder gains, aligning the tax treatment for the whole workforce. This would remove the need to introduce these rules.