Entrepreneurs’ relief is meant to encourage the owners of successful companies. But owners who raise extra funds to grow their businesses can find that doing so means that they lose their entitlement to relief. The draft bill includes measure to alleviate this problem, but they only come into effect on 6 April next year so business owners need to take great care in the timing of any new fundraising.
On 6 July 2018, draft legislation was published for inclusion in Finance Bill 2019 to allow investors to retain a measure of ER when the result of issuing shares to other investors is that their own shareholding falls below 5%, which is the minimum holding which qualifies for ER. At the moment such a share issue would meant that entitlement to ER is lost completely, even for the period when the qualification conditions were met. From April 2019 this will change. Relief will be preserved up to the date on which the share dilution occurs.
This is achieved by allowing an individual to treat a gain as arising immediately before the share issue, based on the market value of the shares at that date. This gain will qualify for ER. The gain from the date of dilution to the ultimate sale of shares will be chargeable at normal CGT rates without the benefit of ER.
In itself this only gives a partial solution to the problem, because the deemed gain gives rise to a dry charge i.e. no cash is available to pay the tax. So it will also be possible to delay the time that the gain is taxed until the ultimate sale of shares. Again this is not compulsory, but it is hard to think of reasons why people would not do this.
Important points relating to this change are:
It only applies when the shares which cause the dilution are subscribed for in cash.
The subscription must take place on or after 6 April 2019.
Relief will not be available where tax avoidance is involved.
The valuation of the shares immediately before the share subscription can be based on the value of the whole company. It is not necessary to apply the discounts normally required in valuing minority interests.
The relief is not automatic and must be claimed. The time limit for the election to crystallise the gain at the point of dilution is 31 January in the year following the year of disposal. For the election to defer the gain becoming chargeable until the ultimate sale of the shares the limit is four years from the end of the tax year in which the dilution occurred.
Practical implications
This is a welcome change. Although not that many people will be affected it, will be of real benefit to those individuals who have faced the choice between attracting additional funding at the cost of a loss of tax relief or not raising the funding so that they can retain the benefits of ER. The ability to use an undiluted valuation basis in computing the notional gain is a welcome change from the original proposals. Without it the gain on which ER was due would in many cases have been so small that the relief would have ended up having negligible financial benefit.
The immediate action point for advisers is to ensure that the timing of any new share issue is managed. If it is commercial possible to delay the issue of new shares until 6 April this will enable shareholders to get into the new regime. Of course this may not commercially be possible, but at the very least the relevance of the timing of any share issue should be discussed with clients.
The longer-term action point will be that advisers will need to have in place a system to monitor the time limits for making the two different elections. They are fairly generous, but it would be all too easy to overlook them. ER is one of the most valuable of all reliefs and if the actions of an advisor in missing a deadline meant that the client was deprived of potential relief serious professional indemnity consequences could well follow.
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Don’t fall into the entrepreneurs’ relief trap
Entrepreneurs’ relief is meant to encourage the owners of successful companies. But owners who raise extra funds to grow their businesses can find that doing so means that they lose their entitlement to relief. The draft bill includes measure to alleviate this problem, but they only come into effect on 6 April next year so business owners need to take great care in the timing of any new fundraising.
On 6 July 2018, draft legislation was published for inclusion in Finance Bill 2019 to allow investors to retain a measure of ER when the result of issuing shares to other investors is that their own shareholding falls below 5%, which is the minimum holding which qualifies for ER. At the moment such a share issue would meant that entitlement to ER is lost completely, even for the period when the qualification conditions were met. From April 2019 this will change. Relief will be preserved up to the date on which the share dilution occurs.
This is achieved by allowing an individual to treat a gain as arising immediately before the share issue, based on the market value of the shares at that date. This gain will qualify for ER. The gain from the date of dilution to the ultimate sale of shares will be chargeable at normal CGT rates without the benefit of ER.
In itself this only gives a partial solution to the problem, because the deemed gain gives rise to a dry charge i.e. no cash is available to pay the tax. So it will also be possible to delay the time that the gain is taxed until the ultimate sale of shares. Again this is not compulsory, but it is hard to think of reasons why people would not do this.
Important points relating to this change are:
It only applies when the shares which cause the dilution are subscribed for in cash.
The subscription must take place on or after 6 April 2019.
Relief will not be available where tax avoidance is involved.
The valuation of the shares immediately before the share subscription can be based on the value of the whole company. It is not necessary to apply the discounts normally required in valuing minority interests.
The relief is not automatic and must be claimed. The time limit for the election to crystallise the gain at the point of dilution is 31 January in the year following the year of disposal. For the election to defer the gain becoming chargeable until the ultimate sale of the shares the limit is four years from the end of the tax year in which the dilution occurred.
Practical implications
This is a welcome change. Although not that many people will be affected it, will be of real benefit to those individuals who have faced the choice between attracting additional funding at the cost of a loss of tax relief or not raising the funding so that they can retain the benefits of ER. The ability to use an undiluted valuation basis in computing the notional gain is a welcome change from the original proposals. Without it the gain on which ER was due would in many cases have been so small that the relief would have ended up having negligible financial benefit.
The immediate action point for advisers is to ensure that the timing of any new share issue is managed. If it is commercial possible to delay the issue of new shares until 6 April this will enable shareholders to get into the new regime. Of course this may not commercially be possible, but at the very least the relevance of the timing of any share issue should be discussed with clients.
The longer-term action point will be that advisers will need to have in place a system to monitor the time limits for making the two different elections. They are fairly generous, but it would be all too easy to overlook them. ER is one of the most valuable of all reliefs and if the actions of an advisor in missing a deadline meant that the client was deprived of potential relief serious professional indemnity consequences could well follow.
