The Finance Act 2019 was passed into law earlier this month, giving legislative effect to many of the announcements made by the Chancellor at his Budget in October last year.
One of the most eye-catching announcements he made related to Entrepreneurs’ Relief (ER) and the conditions that must be met in order to benefit from a 10 per cent rate of Capital Gains Tax (CGT) on disposing a shareholding in a business.
Most of the press coverage related to the extension of the time that an individual must have owned shares in the business in order to benefit from one year to two years.
However, there was a more technical change to the criteria, which looked set to make it impossible for holders of so-called alphabet shares – a class of share that assigns varying rights to different shareholders – to claim ER.
Under the Government’s original plans, shareholders claiming ER would have had to have been entitled to a minimum of five per cent of the distributable profits and the net assets of the company in question. This is in addition to the pre-existing requirements to hold a minimum of five per cent of the business and voting rights and to be an employee or officer of the business.
The Government’s original plans would have been a significant impediment to claiming ER for holders of alphabet shares, as they are not necessarily entitled to this level of profit or assets, and so the proposal was opposed vehemently by accountancy bodies, including the ICAEW.
Following these representations, the Government proposed an alternative test to take alphabet shares into account. This test is based on an individual’s entitlement to the proceeds of the hypothetical sale of the entire company.
The test now appears in the legislation as follows:
(3) For the purposes of this Chapter a company is a “personal company” in relation to an individual if—
(a) the individual holds at least 5% of the ordinary share capital of the company,
(b) by virtue of that holding, at least 5% of the voting rights in the company are exercisable by the individual, and
(c) either or both of the following conditions are met—
(i) by virtue of that holding, the individual is beneficially entitled to at least 5% of the profits available for distribution to equity holders and, on a winding up, would be beneficially entitled to at least 5% of assets so available, or
(ii) in the event of a disposal of the whole of the ordinary share capital of the company, the individual would be beneficially entitled to at least 5% of the proceeds.
If you hold alphabet shares, it can be challenging to determine whether you would be entitled to claim ER on the disposal of your shareholding.
Contact us today for a review of your entitlement and advice on the changes needed in order to qualify.