In the first of his four-part article, Peter Rayney covers the latest Finance (No.3) Bill 2018-19 changes to the entrepreneurs’ relief rules.
The basic entrepreneurs’ relief (ER) legislation has been fairly stable since it was first introduced in 2008, but it seems the Chancellor thought it was due a 10th anniversary revamp!
Existing rules
For company share sales, the key conditions for relief have always required the seller to ‘work’ for the company (as a director or employee) whilst also satisfying the ‘personal company’ test (in TCGA 1992, s 169S(3)). This meant that the seller must hold at least 5% of the company’s ordinary share capital and this holding must carry at least 5% voting rights.
The seller is required to meet these two conditions in their own right - holdings and voting rights held by their ‘spouse’ or other associates cannot be included.
The company must also be qualifying trading company or holding company of a trading group as defined in TCGA 1992, s 165A (see also TCGA 1992, Sch 7ZA if a company/group has joint venture interests).
Before the Finance (No.3) Bill 2018-19 changes (see below), all these conditions had to be satisfied within one year before the date of the share sale.
The new 5% economic ownership tests
The original proposed ‘economic interest’ provisions introduced in the original Finance (No.3) Bill 2018-19 created considerable uncertainty. Fortunately, after consultation with the various professional bodies, etc., HMRC announced a revised ‘economic test’ on 21 December 2018.
Under the improved rules, which apply for shares sold after 28 October 2018, shareholders are required to meet one of two alternative ‘economic interest’ conditions – (for simplicity, we will call them ‘Economic condition 1’ and ‘Economic condition 2’).
Economic condition 1
This reflects the original proposed rule, which requires the seller shareholder to be beneficially entitled to at least 5% of the:
• profits available for distribution to the company’s equity holders; and
• company’s assets available for distribution to its equity holders on a winding-up.
For these purposes, the legislation applies a modified version of the ‘economic ownership’ tests used for the corporation tax ‘group relief’ rules (found in CTA 2010, Pt 5, Ch 6). ‘Equity holders’ would typically be all the ordinary shareholders (excluding ‘restricted preference shares’) and loan creditors (except those involving commercial loans) (see CTA 2010, ss 160-164).
Economic condition 2
The alternative (new) test is likely to be easier to apply. Based on the assumption that the entire ordinary share capital of the company is sold, the seller must reasonably expect to obtain at least 5% of the total disposal proceeds. The seller must meet this condition throughout the ER qualifying period. However, in applying this provision, the sale value of the company is taken to be the market value at the end of that period. In those cases, where the seller is selling as part of a disposal of the entire company, it is expected that the arm’s length sale price would be used.
The allocation of the ‘market value’ sale price is based on the arrangements in place at any time in the qualifying period.
Two-year qualifying period
For disposals after 5 April 2019, all the relevant ER qualification tests must be met throughout the two-year period ending with the disposal date. The existing one-year ER qualification period remains for disposals made before 6 April 2019.
Practical Tip :
Shareholders of companies that have different classes of shares should check whether they meet all the various 5% economic tests for ER purposes under the new rules.
