Extension of Entrepreneurs' Relief
A Solution to Dilution
Many entrepreneurs will be aware of entrepreneurs’ relief as a means, subject to fulfilling the necessary criteria, of paying a reduced capital gains tax rate of 10% on a disposal of shares.
One of the key criteria is that the individual must have held at least 5% of the company’s ordinary shares and at least 5% of the voting rights in the company for a least 12 months ending on the date of the disposal. Early employees of start-ups and high growth companies can find this tricky to maintain, particularly when external investment is obtained as such individuals can find their shareholding / voting powers diluted to below 5% in circumstances where venture investment is taken on to assist with the company’s growth.
The government recognised that this 5% shareholding / voting criteria was acting as a disincentive to accept external investment and announced in the Autumn 2017 Budget that it intended to consult in Spring 2018 on how entrepreneurs whose holding in their company is reduced below the qualifying 5% levels could still access entrepreneurs’ relief.
Some concerns were raised in the consultation that shareholdings can be diluted other than as a result of a commercial issue of shares, such as the conversion of debt to equity or the exercise of employee share options. However, HMRC made it clear in the consultation response that the purpose behind extending the relief was not to assist an individual shareholder but rather to remove any disincentive to commercial capital-raising.
Earlier this month, draft legislation was published which proposes to include the following provisions in the Finance Bill 2019:
- an individual can elect to be treated as having disposed of and reacquired their shares at market value immediately before the relevant share issue which would cause them to fall below the 5% shareholder / voting threshold
- any gain realised on that deemed disposal will then attract entrepreneurs’ relief
- an individual can also elect for the gain to be deferred until eventual disposal of the shares
- elections would be irrevocable
- elections would need to be made within 12 months of the 31 January next following the tax year in which the shareholding is diluted
This is a welcome extension of entrepreneurs’ relief and will hopefully enable entrepreneurs to remain involved in their businesses following receipt of external investment.
If you would like more information on Entrepreneurs' Relief, please contact Kirsty Simmonds, or you can give us a call on 0345 070 6000.