In the Autumn Statement, the Chancellor announced important changes to the tests to qualify for Entrepreneurs’ Relief (‘ER’). These changes have the potential to have a significant impact on the employees who have received employee incentives structured as Growth Shares.
Growth shares are a class of shares that are entitled to benefit only from the growth in the value of the company above a threshold amount specified when the shares are issued. Typically, the equity value of the company on the issue date will be less than the threshold and the value of the growth shares would be low.
Previously, to qualify for ER a shareholder had to be an officer or employee a company in the same corporate group as the company that issued the shares and that issuer company must have been their ‘personal company’ for at least twelve months ending on the date of disposal (see below for the definition of a ‘personal company’). In the case of shareholders who acquired their shares on the exercise of a qualifying EMI option, the only test was that at least twelve months had to have passed between the date that the option was granted and the date of disposal.
Before the Autumn Statement, a company was considered to be a shareholders’ ‘Personal Company’ if the shareholder:
- held at least 5% of the ordinary share capital (meaning all of the company’s shares except fixed rate preference shares) of the company; and
- was able to exercise 5% of the voting rights by virtue of their shareholding.
The draft Finance Bill proposed increasing the holding period from one year to two, as well as adding two further tests to meet the definition of ‘Personal Company’:
- The shareholder must be beneficially entitled to 5% of the profits available for distribution to the equity holders; and
- The shareholder must be beneficially entitled on a winding up to 5% of the assets available for distribution to the equity holders.
These changes potentially had a serious impact on a significant number of people holding shares in private companies, especially where there was more than one class of shares in issue.as it was unclear whether this particular group of shareholders would qualify under the new rules.
It is evident that the government are trying to crack down on the abuse of ER, but these measures could be seen as not having been fully thought through, as they could prevent genuine entrepreneurs qualifying for relief.
Amendments following industry consultation
Following significant lobbying by industry and professional groups, an amendment to the tests was published on 21 December 2018, the Friday before Christmas. The amendment introduced an alternative to the tests that were originally included in the Finance Bill.
The new rules set out a new test that measures a shareholder’s entitlement to the proceeds of the sale of the company. The shareholder will meet the test if his or her holdings of ordinary shares would 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, assuming that the entire company is sold for its market value on the last day of the qualifying period (ie the date of disposal of the shares/ assets which are the subject of the ER claim). This ignores anti-avoidance rules for the purpose of this hypothetical sale.
The tests introduced in the Budget remain in the current drafting of the Finance Bill, despite being essentially redundant following the introduction of this amendment.
This change resolves the uncertainty that attaches to companies with multiple share classes.
However, the position is less clear for employees and other shareholders who hold growth shares: a growth share may initially have a very limited entitlement to capital when it is issued, but its entitlement may be far more substantial at the point that the company is sold.
It is not necessary for the shares to have the 5% entitlement to proceeds throughout the entire two-year qualifying period, because the new test measures the share of the proceeds at the point that the shares are sold.
For example, employee A is issued growth shares that entitle him to 20% of the company’s value in excess of a threshold of £3m. At the time that the growth shares are issued, the company is valued at £2.5m. Four years later, the company is sold for £9m and the employee receives proceeds of £1.2m (i.e. (£9m-£3m) x 20%). Because A received c.13% of the proceeds of sale, she will be entitled to claim ER – there is no need to go back to value the company to establish whether A’s shareholding would have entitled A to more than 5% of the proceeds two years before the company was sold.
The new tests to determine whether a company is a shareholder’s ‘personal company’ apply for disposals on or after 29 October 2018.
The extension of the qualifying holding period from one year to two years will be introduced for disposals that take place on or after 6 April 2019. For example, if employee A was issued growth shares on 15 March 2018 and disposed of them on 1 April 2019, and assuming she met the ‘personal company’ tests, she would be eligible for ER. If employee B was also issued growth shares on 15 March 2018 but disposed of them on 10 April 2019, she would not be eligible for ER.
For more information on this matter, please contact Thomas Dalby or Liam Hawkins on 0845 4900 509 or email us on firstname.lastname@example.org.