In the 2018 Budget the Chancellor announced that two additional conditions would apply with immediate effect to the definition of a “personal company”, to ensure that only shareholders with true material stake in the company can claim entrepreneurs’ relief on their shares. These new conditions are codified in 5,000 or so words in the Finance (no.3) Bill Sch 15, para 2 which will amend to the entrepreneurs’ relief rules in TCGA 1992, s169S.
For disposals made from 29 October 2018 the shareholder must meet four conditions with regard to his shares:
- hold at least 5% of the ordinary share capital
- control at least 5% of the voting rights which are exercisable by virtue of that shareholding;
- have a right to at least a 5% interest in the distributable profits; and
- have a right to at least a 5% of the net assets due to the equity holders on a winding-up of the company.
Tests c) and d) are the new additions, but these concepts have proved to be difficult to
codify into law. Instead of thinking the problem through from first principles the legal drafters have repurposed provisions in CTA 2010, part 5 chapter 6 (equity holders and profits or assets available for distribution) into the entrepreneurs’ relief rules.
The result of this cut and paste is not ideal, and in some cases the strict reading of the law would deny the relief to certain shareholders because of the mismatch of accounting periods and the qualifying period for ER. The original legislation in CTA 2010, s 165 is intended to prevent abuse of group relief and concentrates on the period of account for companies, but the entrepreneurs’ relief conditions must be met throughout a period of 12 months ending with the date of disposal. This qualifying period will extend to two years for disposals on and after 6 April 2019.
The professional bodies, and a number of individual firms, have had discussions with HMRC over the wording of the draft legislation, and late on 21 December 2018 the Government tabled an amendment to the Finance (no. 3) Bill 2019, Sch 15, para 2. This amendment adds an alternative test for a “personal company”, based on the shareholder’s entitlement to proceeds in the event of a hypothetical sale of the whole company.
This new test is essentially: “will the shareholder be entitled to at least 5% of the proceeds in the event of the disposal of the whole of the ordinary share capital of company?” It assumes that the entire company is sold for its market value on the last of the qualifying period (ie the date of disposal of the shares/ assets which are the subject of the ER claim), and ignores anti-avoidance rules for the purpose of this hypothetical sale. This new test doesn’t rely on the definitions in the Corporation Tax Act 2010, and it can be used instead of the tests c) and d) above.
However, the new tests c) and d) have been left in the draft Bill, apparently to “provide certainty to those with straightforward company structures”.
What we have is a fudge to make the new conditions operate in the way the Chancellor intended. The taxpayer who wants to claim ER will have to know (or guess) the value of the whole company, in order to prove that the value of his shareholding is worth at least 5% of that hypothetical total value.
Finance (no. 3) Bill 2019, Sch 15, para 2 amendments to ER https://tinyurl.com/ERamdsSCH15