Entrepreneurs' Relief – closing the loopholes

Entrepreneurs' Relief (ER) has proved to be a very attractive relief for individuals realising gains on shares and certain assets in their personal companies by reducing the rate of Capital Gains Tax to 10% on the first £10 million of eligible gains. 

However, it has been open to abuse and so measures have been introduced to ensure that this generous tax break is only available to the genuinely entrepreneurial.  

As part of the government’s anti-tax avoidance measures, new tests will be introduced meaning that not only must the individual hold shares representing no less than 5% of the nominal value of the ordinary share capital carrying 5% of the votes, but they must also now carry rights to 5% of the distributable profits and assets available on a winding up. These new measures apply from 29 October 2018, closing down the tax avoidance with immediate effect.

In addition, from 6 April 2019, in order to qualify for the relief, shares must have been held by an employee or officer of the company for a period of 24 months ending on the date of sale, doubling the existing qualifying period. There is an exemption to this new rule where the claimant’s business ceased, or their personal company ceased to be a trading company (or the holding company of a trading group), before 29 October 2018, in which case the existing one year qualifying period will continue to apply.

Finally in a previously announced measure those diluted below 5% by a commercial cash investment will be able to elect to preserve their ER on gains to the date of dilution by treating their shareholding as having been disposed of and reacquired at market value at the time of dilution. It also allows them to defer the gain that results from this until the shares are actually disposed of, thus avoiding a ‘dry’ tax charge.

In summary what does the reform mean for businesses?

• The impact is to remove the use of 'Golden Shares' with disproportionately high voting rights and nominal value to secure ER for employees with a less than 5% interest in the value of the business, or those who participate in the business for a relatively short time.
• The impact on those acquiring shares through enterprise management incentives schemes will be to double the qualifying period to two years, from grant of the option to sale of the shares. In practice this will have very little impact as the majority of share options have a life of more than 12 months from grant of the option to sale of the shares so will not be affected.