To qualify for ER on shares, the individual must have been an officer or employee of a ‘personal company’ during the two years immediately before sale. For the company to be ‘personal’, it used to be sufficient for the individual simply to hold at least 5% of the ordinary share capital (OSC) and be able to exercise at least 5% of the voting rights.
Finance Act 2019 changes to Entrepreneurs Relief
As a result of the Finance Act 2019 (FA 2019), a personal company must now also meet at least one of the following additional tests:
- The individual must be beneficially entitled to both at least 5% of the profits available for distribution to ‘equity holders’ (shareholders and some types of loan creditor) and at least 5% of assets available on a winding up; or
- The individual must be prospectively entitled to at least 5% of the proceeds on a sale of the whole OSC of the company.
The second and simpler additional test was added at a late stage of the passage of FA 2019 through Parliament, which followed representations to HMRC that the ‘equity holders’ test was too arbitrary in its scope, particularly when dividends were streamed to some, but not all classes of share.
FA 2019 also introduced two types of election, aimed at mitigating the loss of ER when there is a ‘dilution event’, for example the issue of new shares to an outside investor.
If someone’s shareholding consequently falls below 5%, they may make two elections as follows:
- To realise a deemed gain, qualifying for ER, at the point of the dilution event, based on an apportioned market value of the company without minority discount; and
- To defer the accrual of the tax liability on this deemed gain until the actual disposal of the shares (during which time the office-holding and trading conditions still need to be met).
What this could mean for those already claiming ER
The major shareholders of trading companies may be relatively unaffected by the FA 2019 reforms. The ‘dilution event’ elections will be most beneficial to shareholders already near to the 5% minimum who would otherwise lose the relief.
The sale proceeds test also allayed some of the concerns of mid-market advisers. However, there remain situations, such as in the event of target-related share rights, where ER can unforeseeably be lost. You should therefore speak to an expert to check if you do qualify.