Proposed changes to Entrepreneurs' Relief

Simon Crookston, Partner, Corporate Tax
From 6 April 2019, individuals whose shareholding is diluted below 5% as a result of a new share issue will get relief for gains up to the date of dilution.

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 as it stands

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:

  • both an employee/director, and
  • holds no less than 5% of the issued shares immediately prior to sale.

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.

Changes to Entrepreneurs' Relief

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 shareholder may make an election which will effectively 'bank' their ER up to the point in time immediately prior to the dilution event; a deemed disposal and market value reacquisition is treated as taking place and a 'dry' tax charge (albeit one which benefits from ER) will arise.
  • The valuation method for calculating the capital gain due will be based on a non-discounted valuation of their shareholding based on a pro-rata value of the whole company. No discount is applied for a minority shareholding.
  • If the shareholder does not wish to pay the tax arising, they can then make a second election to defer their gain until they eventually sell their shareholding.
  • When the shareholder then sells, his gain will be treated in two parts; that arising up to dilution and that arising after. For the gain arising up to dilution the shareholder will benefit from the ER rules, although the relevant rules will be those applicable at the time of selling their shareholding, not those which applied at the time of dilution.
  • For all affected gains after the 5% dilution event, ER will not be available under the current rules.

Crowe comment

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.

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Simon Crookston
Simon Crookston
Partner, Corporate Tax