Accountants and lawyers beware – the recent changes to Entrepreneurs Relief will catch out the unwary adviser.
12th February 2019 by Fiona Hotston Moore
The rules regarding Entrepreneurs Relief (ER) have existed since 2008 and have not changed much in ten years. The tax legislation regarding Entrepreneurs Relief is relatively straightforward and yet, as forensic accountants, we assist on a number of professional negligence claims in this area of tax.
However, with the recent changes, which were announced just prior to Christmas 2018, I anticipate we will see many more potential professional negligence claims against accountants and lawyers in the future. The rules are now considerably more complex both in the transition and in the longer term.
In overview, until the 2018 changes, where shares were sold in a trading company (or the holding company of a trading group) then for ER to be available, the following had to be met throughout one year up to date of sale (“the qualifying period”):-
- The company must have been a qualifying trading company / group;
- Must have been individual’s “personal company”; and
- Individual must have held at least 5% of ordinary share capital, entitling them to at least 5% of voting rights.
The more straightforward change, announced in the 2018 Budget, was to extend the length of the qualifying period to two years for disposals after 5 April 2019.
The second change announced in the Budget was much more controversial.
ER was proposed to only be available if the individual held 5% of the ordinary share capital of the company, and by virtue of that holding –
- may exercise at least 5% of the voting rights in the company;
- is beneficially entitled to at least 5% of the profits available for distribution to the equity holders of the company; and
- would be beneficially entitled, on a winding up of the company, to at least 5% of the assets of the company available for distribution to equity holders.
This change would have impacted “alphabet” shares as well as potentially venture capital structures and management buy outs.
Just ahead of Christmas the Government announced the second change would be revised such that ER is potentially available if an individual holds at least 5% of the ordinary share capital and at least 5% of the voting rights and meets one of the following conditions throughout the two year period:-
- the individual is entitled to both 5% of the profits available for distribution to the company’s equity holders and assets available for distribution to its equity holders in a winding up; or
- in the event of a disposal of the ordinary share capital of the company, the individual would be entitled to 5% of the disposal proceeds (which would therefore be based on valuations, not the Balance Sheet).
The “Or” is very important and the second test (above in bold) is very welcome.
Alphabet shares should now potentially qualify for ER if it can be shown that the requirement to 5% of disposal proceeds is met, say via the company’s Articles or a shareholders’ agreement, and the Balance Sheet issue is also overcome. Growth shares or those with a ratchet may still qualify.
There are a number of nuances and transitional rules and it is therefore imperative that advisers look at the detail of the legislation when it is published. Advisers can no longer tell at a glance if ER will be available and it will take twice as long to correct an error!
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