Entrepreneurs’ relief, alphabet shares and personal company definition resolved

Owners of alphabet shares will have been concerned by wording in Finance Bill 2018-19 which had threatened their entitlement to Entrepreneurs' Relief (ER). Further to considerable input from ICAEW and other professional bodies, an amendment to the Bill has been tabled by the government to protect this relief.

ER was introduced in 2008 as a replacement for taper relief, which in turn had replaced retirement relief. ER has much in common with retirement relief; provided the necessary conditions are met, the gain on disposal of a qualifying asset is taxed at 10%.

Generally, to qualify for ER on the sale of a company, the requirements are that

  • at least 5% of the business and voting rights were owned by the vendor, and
  • the vendor was an employee or officer of the company, and
  • these conditions had to be met for at least a year before sale.

The changes announced in the Autumn budget increase the minimum holding period to two years for sales on or after 6 April 2019. In addition, from 29 October 2018, shareholders must be entitled to at least 5% of the distributable profits and net assets of the company, in addition to the existing requirements on share capital and voting rights.

Prior to the change, a company qualified as a personal company for ER purposes if at least 5% of the ordinary share capital was held by the individual and at least 5% of the voting rights were exercisable by the individual by virtue of that holding, s169S Taxation of Chargeable Gains Act 1992.

The draft Finance Bill 2018 to 2019 added two new conditions to the definition. These require the individual to be beneficially entitled to at least:

  • 5% of the company's distributable profits and
  • 5% of its assets available for distribution to equity holders in a winding up.

This change has caused a considerable level of anxiety as it excludes owners of alphabet shares where dividends have not been paid equally to the shareholders. The papers released at the time of the Budget indicated that about 1,000 companies would be affected by the change, but we estimated it would be considerably more than that. It seemed therefore that the way the clauses had been drafted had unintentionally cast the net considerably wider than the policy had intended.

We have been working with a few of our volunteers and the Chartered Institute of Taxation and have had meetings and discussions with HMRC to outline our concerns.

We are delighted to say that an amendment to the Bill has been tabled (page 28) in relation to the personal company definition. The original ownership and voting conditions remain as do the proposed Budget amendments, but with an alternative to the new test:

“either or both of the following conditions are met—

(i) by virtue of that holding, the individual is beneficially entitled to at least 5% of the profits available for distribution to equity holders and, on a winding up, would be beneficially entitled to at least 5% of assets so available, or

(ii) in the event of a disposal of the whole of the ordinary share capital of the company, the individual would be beneficially entitled to at least 5% of the proceeds.”

This second part to the new test means that where a company with alphabet shares is disposed of, then provided the shareholder receives at least 5% of the proceeds they can qualify for ER, even if they have not received equal dividends.

We have received the following from HMRC:

“Thank you all for taking the time to share your concerns about and suggestions on the recent entrepreneurs’ relief changes with us, whether at the meeting last week, or in writing. I’m writing to let you know that on the basis of your advice and recommendations, the government has now tabled an amendment to Paragraph 2 of Schedule 15 of the Finance Bill, which contains the changes to the definition of ‘personal company’ for ER purposes. The amendment will add an alternative test based on the shareholder’s entitlement to proceeds in the event of a sale of the whole company, which can be used instead of the tests based on profits available for distribution and assets on a winding up. The original tests have been left in to provide certainty to those with straightforward company structures, but the new test will help those who are not able to meet the original test for commercial reasons, and does not rely on the definitions in the Corporation Tax Act 2010.

Thank you again for your advice and input on this matter, which has been very helpful in resolving it.”

HMRC will be publishing revised guidance in due course, but in the meantime this amendment will help remove anxiety from those in the process of disposing of their company.

  • What about those companies that wind up after cessation of trade.Will those with alphabet shares still receive ER if the receive 5% of the assets on wind up even if they did not receive 5% of dividends voted during the time the company was trading. It is by choice in most case that some shareholders do not have dividends because they are higher rate taxpayers