Entrepreneurs' Relief - Help with ABCs
Having tightened the tests to be met for Entrepreneurs' Relief (ER), without consultation, the Government has now listened to the industry and produced a solution which should work in most cases.
In order to counter tax planning which had the aim of obtaining undeserved ER, by creating "tailored" shares i.e. shares designed to obtain relief without any real commercial downside risk, the test for ER was widened in the October Budget. Shareholders had previously been required to meet the old test for a "personal company" of having at least 5% of ordinary shares by nominal value and 5% of the voting rights of the company deriving from these shares. The new tests added that with effect from 29 October 2018, the individual should also be beneficially entitled to:
i) at least 5% of profits available for distribution to equity holders; and
ii) at least 5% of assets available to equity holders on a winding up.
No-one could argue that this widening would not have restricted the relief, but it had the unfortunate effect of stopping ER being given in common situations where there was no avoidance. One such instance is alphabet stock: if shareholders A, B and C have A, B and C class shares, they would fail this new test. This is because different dividends could be declared on the different classes and therefore shareholders are not strictly entitled to the profits, as they would never know what they were going to receive until the dividends were actually declared. This would have been the case even if A, B and C each owned a third of the ordinary share capital and there were no other shareholders.
After protests from the industry, HMRC announced an alternative test to these new tests. These were announced in December but have effect from 29 October 2018 (Budget day) as if this had been the drafting all along. This alternative test measures "...whether in the event of a disposal of all of the ordinary shares, the individual in question would receive at least 5% of the proceeds." If so, provided the old tests were also met, the relief would be available. Therefore if in our example A, B and C each receive a third of the sale proceeds, then they would obtain ER despite not being technically entitled to dividends and assets on a winding up.
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