Scott Sands, Partner in the Corporate and Commercial department at Myerson Solicitors, talks us through the risks facing Entrepreneurs’ Relief in the forthcoming Budget and what you should be thinking about now to make sure you’re prepared.
What is Entrepreneurs’ Relief?
Entrepreneurs’ Relief (ER) can reduce the amount of Capital Gains Tax (CGT) payable by an individual on the sale of shares, subject to certain qualifying criteria.
ER was originally introduced in 2008 to encourage the creation of new businesses.
If an individual satisfies the qualifying conditions, ER reduces the rate of CGT payable on the sale of shares in the qualifying company from 20% (assuming a higher rate taxpayer) to 10%.
The relief is not always straightforward but can be extremely valuable where significant gains are realised. ER currently has a lifetime allowance of up to £10m and therefore can be worth £1m.
What are the current conditions to qualify for Entrepreneurs’ Relief?
ER can apply in relation to a disposal of shares of a trading company, or the holding company of a group of trading companies, if:
- the shares have been held for a period of at least two years; and
- the individual selling the shares holds at least 5% of the company’s ordinary share capital, at least 5% of voting rights and is beneficially entitled to either:
- at least 5% of distributable profits and 5% of the company’s assets available for distribution on a winding-up; or
- 5% of the proceeds if the whole of the ordinary share capital of the company were sold for market value; and
- the individual is an officer or employee of the company or one of the companies in the same trading group.
Formal advice should however always be sought on the applicability of ER prior to a sale.
What might the upcoming changes to Entrepreneurs’ Relief be?
The December 2019 Conservative Party manifesto promised to review and reform ER.
Following the December 2019 general election, there is mounting speculation that the Government will follow through on their promise and overhaul the existing ER framework in the March 11 Budget (although there has been speculation this might be delayed following Sajid Javid’s appointment).
The options to change the current ER framework are very wide and no information has been released as yet that would provide an indication of the Government’s stance. The changes could include:
- abolishing ER entirely;
- increasing the rate of CGT (currently set at 20%);
- reducing the rate of relief (currently set at 10%);
- reducing the lifetime limit below £10m (the limit was originally £1m when first introduced);
- increasing the shareholding requirement to qualify (for example, increasing this to 10%, 20% or more); or
- a combination of some or all of the above.
Andrew Marr, Partner at Tax Specialists Forbes Dawson, has speculated on this point:
“This is complete guesswork. However if I were a gambling man (which I am!) my money would be on the following:
- A wholesale scrapping of the relief would be surprising. This relief is now almost embedded into the culture of what it is to be an entrepreneur and wholesale scrapping would be a big disincentive.
- The lifetime allowance of £10m has always been surprisingly generous, although the original allowance of £1m was probably not generous enough. Expect some kind of cut in this allowance to something around the £5m mark.
- Could they make another attack on ‘money boxing’? This is the practice of building up reserves in a company and receiving capital treatment (and ER) in respect of a sale or liquidation. A few years ago, a consultation concluded that this would be too difficult to deal with, but I don’t see why. It would be possible to restrict ER to the extent that proceeds relate to amounts that could have been paid as a dividend prior to sale.
- The ER rate of 10% is very low and so is the general capital gains tax rate of 20%. It would be very easy to add a few percentage points to both of these rates. I would go for about a 5% increase.”
What can you do?
If you are an individual who may sell their shares soon after the March 2020 budget, you should consider what options you have to potentially protect your ability to claim ER in its current form.
This requires detailed tax and legal advice on your options, including whether you are able to crystallise (ie lock in) the current ER rate before the budget. Other taxes such as stamp duty would also need to be considered here.
Crystallising Entrepreneurs’ relief via a share for share exchange?
One potential method for individuals to crystallise the current rate for ER could be to carry out a share for share exchange before the implementation of the March 2020 budget.
A share for share exchange would involve selling shares held personally in a trading company (TradeCo) to a newly incorporated company (HoldCo) in return for new shares in HoldCo.
This may be a useful option for any individual who does not want to dispose of TradeCo (or has not found a willing buyer to purchase it) but still wishes to benefit from the current ER rules.
Another alternative could involve trust planning, if this is suitable for your particular circumstances.
Trust arrangements are specific to the needs of each client and so are beyond the scope of this blog. Our experienced private client team are able to provide tailored legal advice relating to trust arrangements on request. Also this will not always work from a tax perspective and so detailed tax advice should be sought too.
Seek formal advice
In each case, appropriate tax and legal advice based upon the specific circumstances of an individual is necessary before any steps are taken. The options described above would require professional advice on their applicability, including advice on whether anti-avoidance rules may apply to such arrangements. As always Myerson Solicitors are happy to work with other professional advisors to get to the right result.
Scott Sands, Partner, Myerson Solicitors www.myerson.co.uk
This blog should not be considered as financial or legal advice on the applicability of ER or the appropriateness of any method to try to potentially crystallise the rate of ER.