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Entrepreneurs’ Relief – the potential impact of two recent decisions

13 Jun 2016

As many business owners are aware, Entrepreneurs Relief can reduce Capital Gains Tax (CGT) for individuals on gains arising on sales, including on the sale of company shares, business assets, or on leaving a partnership or an LLP. If the necessary requirements are complied with, Entrepreneurs Relief reduces CGT to just 10%.

The requirements for individuals disposing of shares in a company are:

  • The company or holding company of a trading group is currently trading;
  • The taxpayer has been an officer or employee of the company or subsidiary for at least 1 year; and
  • The taxpayer holds at least 5% of the ordinary shares in the company.

There have been two recent decisions of the First-tier Tribunal (Tax Chamber) which mean that companies must ensure they comply strictly with the 5% shareholding requirement on the disposal of company shares if its shareholders are to benefit from Entrepreneurs Relief.

In the first case, the tribunal held that deferred shares with no voting rights, no dividend entitlement and no realistic expectation of a distribution on winding up fell within the definition of ‘ordinary share capital’ set out in the tax legislation and thus formed part of the ordinary share capital of a company.

This meant that the director concerned, who held 5% of the voting rights and non-deferred ordinary shares, for the purposes of Entrepreneurs’ Relief, had only 4.99% of the ordinary share capital and thus did not qualify for relief. The Director tried to argue that the deferred shares should not be included in the calculation because they had no economic value, which would have resulted in him holding 5% of the qualifying shares. The tribunal rejected his argument and consequently the Director had to pay nearly £200,000 in tax, as without Entrepreneurs Relief he was required to pay CGT at the rate of 28% rather than 10%.

In the second decision, the tribunal decided that a class of redeemable shares with no dividend entitlement were to be counted as fixed rate shares for the purpose of Entrepreneurs’ Relief and did not form part of the ordinary share capital of the company. The Director in this case also failed to qualify for the relief.

These decisions have particular implications for companies that have issued shares without dividend rights and which may have to consider either cancelling or converting those shares. If they plan to take advantage of Entrepreneurs’ Relief on future disposals of their assets, taxpayers should ensure they take into account all the shares their company has in issue, as well as the effect that subsequent share issues or transfers could have on share percentages.

For further information or advice, please contact Jonathan Waters, corporate partner at Hay & Kilner

Call: 0191 232 8345

Email: Jonathan.Waters@hay-kilner.co.uk