Preserving the relief
Entrepreneur’s relief – the benefit on exit
If you’re eligible for entrepreneurs’ relief then you pay just 10% CGT on a sale of your shares (up to a lifetime gain allowance of £10m) rather than 20%.
Stricter share requirements
Hitherto 29th October 2018, holding 5% of the company’s shares providing you with 5% or more of the votes has been sufficient to qualify for entrepreneur’s relief (ER). From the day of the Budget, without warning, those share must also provide the holder with the other basic economic rights. These are to receive 5% or more of dividends (if declared of course) and 5% of more of the company’s assets on a theoretical winding up.
What’s known as grandfathering does not apply: pre-budget shares do not remain eligible post-Budget by virtue of law in place when the shares were acquired (ie pre-Budget law) but must in addition meet the requirements of the new law - assuming the Government is able to pass it into legislation.
Articles of association – capital structure
The rights attaching to shares are contained in the company’s articles of association so it is this document that must be revisited to check if there is, or is not, a problem. Because of internal economic arrangements, outside investment or other reasons, the capital structure may well be that not all the pre and post-Budget required elements are provided to management or other the ER shareholder.
Henceforth, ER shares, if now deficient, will not attract relief on a sale unless the articles are amended. This will entail a re-organisation where either rights attaching to existing shares are varied or new qualifying shares are issued in place of the old. A re-organisation to augment shares held by some members is likely to entail diminution to shares held by other members so some negotiation may be required.
The practical implications of these changes will need to be considered too. For example:
- how the new conditions are to be applied where the economic rights attaching to shares in a company vary depending on the amount to be distributed (for example, where a taxpayer holds "promote" shares that participate in the economics only once a distribution is sufficiently large that the shareholders in another class will meet an agreed "hurdle"); and
- the extent to which other types of equity holders (such as preference shareholders) must be taken into account when testing the new conditions.
Duration of holding – timing of sale/ exit
We then come to the second key change. For sales before 6th April 2019 the shares if then held for at least 12 months and eligible for relief under both the post-Budget and the pre-Budget regime, all is fine. If the same shares are instead sold the day after on 6th April or later they must have been held for 24 months.
If you hold shares that from the day of the Budget became inadequate as described earlier and re-organisation is undertaken to augment rights and to remedy, the computation of time runs from the date of the re-organisation, not the date of original acquisition. The 12 months requirement will not be completed before 6th April 2019 as there remains insufficient time. Your sale or exit, if entrepreneur’s relief is to be sought, will have to be postponed until the 24 month requirement is accumulated.
Shares acquired or to be acquired through an enterprise management incentive (EMI) option scheme, if eligible for entrepreneur’s relief under pre-Budget law, will continue to have the benefit of the relief on eventual sale unaffected by the above. This is because the 5% in number requirement does not apply to shares acquired by this method and thus the additional 5% requirements imposed by the 2018 Budget do not apply. So if holding EMI options or shares you should not worry about the character of your shares in this context.
Contact our Business and Company Sale Lawyers Birmingham, London, Cambridge, Oakham & Loughborough
The entrepreneur’s relief share capital rights as set out in your company’s articles of association may no longer qualify shareholders for ER as a consequence of the 2018 autumn Budget changes. For an assessment of this or any prospective company sale, merger or acquisition contact us today by calling 0845 094 9000 or email firstname.lastname@example.org and we will get back to you right away.