It may be time for the Government to reconsider the requirement for shareholders to have a minimum stake in a company before they are entitled to favourable rates of tax, says the ATT. This could incentivise more owner managed companies to accept funding to grow.
Entrepreneurs’ Relief (ER) was introduced to incentivise and reward entrepreneurs who grow their own business. When an individual who owns shares in a trading company comes to sell their shares, provided that they meet the conditions for ER, they can benefit from a 10 per cent rate of tax on the gain. One of those conditions is that the individual has held at least five per cent of the company’s shares for at least one year prior to sale.
While companies need to seek external funding in order to grow, a consequence of accepting this funding is often that the original shareholders – commonly the senior management team actually running the company – find that their holdings are ‘diluted’ to below the qualifying five per cent level. These individuals then lose their entitlement to ER.
The Treasury issued a consultation in March which proposes changes to ER to partially address the loss of tax benefits on dilution. The Treasury’s concern is that the current rules do not incentivise owner managed companies to accept funding to grow. The proposal is that entrepreneurs in this position would be allowed ER on the gain on the shares before the new external funding was invested in the company – but not on any gains after that. In its response to the consultation,1 the ATT cautions that the suggested approach will be too costly for many entrepreneurs to benefit.
Yvette Nunn, Co-chair of ATT’s Technical Steering Group, said:
“We do not consider that the Treasury’s proposed changes will help significantly in reducing barriers to growth. We have concerns about some of the practicalities of the proposed new rules, which require the shareholder whose holding has been diluted to obtain a valuation of company shares prior to the investment taking place. Valuing a company is a complex and often expensive exercise, and our concern is that the costs of complying with the conditions will exceed the benefits for many shareholders.
“We think that it may be an appropriate time to consider whether the five per cent minimum holding test for shareholders seeking Entrepreneurs’ Relief remains relevant. This would be a simple solution which would allow all shareholders in eligible companies to benefit from Entrepreneurs’ Relief regardless of the size of their shareholding.
“The downside is, of course, that such a change would increase the cost of the relief to the Treasury and we understand that this is a concern to the Treasury. However, removing the minimum holding would bring the conditions for shareholders more in line with the position for partners in a trading partnership, who are not required to have a minimum holding to qualify for ER. Equally, individuals who acquired shares after 5 April 2013 under EMI scheme can already qualify for ER without the requirement to have a five per cent minimum holding.
“If the Treasury cannot reduce or remove the minimum holding requirement, we have suggested some alternative, cost effective ways for shareholders to calculate the gain made prior to dilution which would be eligible for ER under the proposed rules. This could include calculating the gain on a time-apportionment basis, or allowing the shareholder to value their existing holding based on what the incoming investors have paid for their shares.”
Notes for editors
2. Entrepreneurs’ Relief (ER) allows individuals who make a qualifying disposal of shares in their business within certain time limits to pay a flat rate of 10 per cent capital gains tax rate on the gain. Without ER, a higher rate individual will pay capital gains tax at 20 per cent and a basic rate taxpayer will pay capital gains tax at 10 per cent or at a mix of 10/20 per cent. There is a lifetime limit of £10 million of gains on which the 10 per cent rate can be claimed.
For a disposal of shares to qualify the following conditions must be met for the year prior to disposal (or prior to cessation of trade):
(i) the company must be a trading company (or be the holding company of a trading group)
(ii) the taxpayer must be an officer or employee of the company (or a company in the group)
(iii) the company must be the individual’s personal company – which means that they must have held at least five per cent of the ordinary shares and voting rights
ER is also available for disposals of interests in a trading partnership and for disposals of assets used by the business but owned personally. Further detailed rules apply in these situations.