How to maximise entrepreneurs’ relief and reduce your tax bill when establishing a personal company
Split business ownership to benefit from increased lifetime limits
Consider sharing the ownership with a spouse or family member to extend the benefit of all individuals’ lifetime limits to cover more of the gain when there is a chance of the company growing and generating high value gains in excess of £10m.
Ensure the type, class and percentage of shares you hold qualifies you for ER
From 29 October 2018, to qualify for ER you must hold 5% of share capital and voting rights throughout the relevant period (12 months if sale or cessation was before 29/10/18, or 24 months for cessations or disposals after 29/10/18), and meet condition a. below:
Alphabet shares may qualify
Without the recently added condition b, holders of alphabet shares, or other shares with varying and insufficient dividend rights, could have been denied ER. However, after the December 2018 Bill Amendment, alphabet shares may continue to qualify for ER, as long as they entitle the holder to at least 5% of sale proceeds in the event the business is sold.
Ordinary and preference shares assessed based on the same rights criteria
Whether you hold ordinary shares or preference equity shares is less relevant. It is the rights those shares give that will determine your ER entitlement. There have recently been several cases where the definition of a personal company was challenged by HMRC. The lessons from tribunal hearings were that judges try and adhere to the literal meaning of the terms of the law when ruling on cases when applying the law, although we are yet to see a case involving growth shares.
Relaxed conditions for EMI shares
Shares granted via an EMI scheme always qualify for ER as there are no personal company tests to be met. The test of the qualifying period of 24 months does apply, but the holding period includes the period when you held the options.
Nominal value of share capital, not number of shares matters
When you assess whether or not you hold the required 5% of share capital, you need to establish whether the value of nominal capital you hold amounts to at least 5% of the total value of nominal capital issued. The number of shares you hold is not the correct reference point.
Indirect shareholdings via a personal company
Your personal company may be a member of a JV or partnership. The disposal of your shares in your company is likely to qualify for ER, if it had at least 5% interest in the trading JV or 5% interest in the income, capital and voting rights of the trading partnership for the relevant period.
Optimise business structure from the start
Consider the ownership structure in the context of a potential business disposal right from incorporation, if you can plan this far. Any subsequent share transfers between individuals may trigger stamp duty and capital gains tax (unless business assets relief is claimed which will defer the gain) and unless occurring between spouses.
Each shareholder will need to qualify for ER in their own right. The required 5% stake must be held outright directly for the relevant individual to qualify. Shares held by associates do not 'increase' ownership stake of a director wishing to claim ER.
Take care when altering the rights attached to shares
Any changes to the rights of the shares may impact entitlement to ER. If, as a result of the recent changes in legislation, the rights need to be changed, for example by amending articles, the 24 month period during which the conditions to qualify for ER must be met will commence from the date of change.
Do not lose out when considering the 24 month qualifying period
All three qualifying conditions – (1) personal company, (2) trading company or holding in a trading group, and (3) you must be officer or employee – must be met for the relevant 24 month period.
However, once you meet the personal company condition yourself and qualify for ER, any new shares you acquire will also qualify for ER (even if those newly acquired shares are not held by you for the relevant 24 month period). For example, if the shareholding in your personal trading company is split between you and your spouse, who due to the type of shares does not qualify for ER (for example they are non-voting shares), those shares could be transferred to you. You would qualify for ER on those newly transferred shares, as long as you already qualify for ER on your original shareholding.
Manage the impact of dilution
If a new share issue results in a dilution of your holding below the required 5%, and so at the point of a subsequent disposal your company is not your personal company, not all the benefit of ER is lost.
The gain on disposal is apportioned between the period up to dilution which is taxed at the ER rate of 10%, and the remainder period from dilution to disposal, which is charged at normal CGT rates. You can also elect to defer payment of ER CGT arising on dilution until the shares are actually sold and you receive the proceeds.
Align the ownership of an associated asset and the company for at least three years before you dispose of your shares
Where an asset held outside of the company but used in its business is held jointly but only one of the asset owners qualifies for ER on the sale of company shares, ER on the associated disposal of the asset will be restricted. The asset could be transferred to the director-shareholder but must then be owned and used in the business for at least three years from the date of transfer, otherwise the part transferred later will not qualify for ER. This causes complications if the sale of the shares cannot be sufficiently deferred to allow for the associated asset to meet the three year condition. The rules on ER on associated disposals are complex. Please refer to our guide below.
Manage cash carefully
Factor in the impact of any activities that may be considered non-trading. A company with substantial non-trading activities (usually meaning that the business generates 20% of its turnover or assets (depending on type of business) from those activities) is likely to have ER restricted or denied. Non-trading activities may mean activities such as accumulating excessive cash reserves, actively managing deposits to generate investment returns and making loans. However, this is a grey area and your case will be considered on its individual merits. Obtaining ER non-statutory clearance may clarify your specific circumstances.
Ensure your status as an officer or employee is not challenged
You should ensure your director or secretary status is reflected on Companies House public record and any resignation aligns with the disposal date of the shares. If you are an employee, your employment status must be evidenced by facts. HMRC may seek witness statements to confirm them.
Other available resources
More information on entrepreneurs’ relief, the changes it has undergone and their impacts has been published on our website and in our In Practice magazine. These can be accessed at the following links:
Update on entrepreneurs’ relief charges