HMRC have published further changes to Entrepreneurs’ Relief (ER) in response to consultation with the professional bodies over the changes brought in with the Budget in 2018.

As we noted in our post, HMRC Challenges on Entrepreneurs’ Relief and Dividend Planning – BEWARE, the original changes had the potential to prevent ER from applying in situations where there were different classes of shares with potentially different dividend rights.

The new amendments are designed to combat this, although unfortunately the way in which they are implemented is perhaps not as clear as it could have been.

The changes relate to qualifying as a ‘personal company’ which is one of the requirements for ER to apply on sales of shares.  For a company to be the seller’s personal company the shareholder must meet four conditions with regard to their shares:

  1. hold at least 5% of the ordinary share capital
  2. control at least 5% of the voting rights
  3. have a right to at least 5% interest in the distributable profits
  4. have a right to at least 5% of the net assets due to the equity holders on a winding-up of the company.

The new tests 3) and 4) were brought in from 29 October 2018 and have now been joined by a further new test per the amendments of 21 December 2018 to the Finance Bill at , Sch 15, para 2.

This adds an alternative test for a “personal company” based on the shareholder’s entitlement to proceeds in the event of a hypothetical sale of the whole company and requires the shareholder to instead be entitled to at least 5% of the proceeds in the event of such a disposal of the whole company. This test can be used instead of tests 3) and 4), however those tests remain in force as well.

This new test can have interesting implications in certain cases, and may be particularly relevant in buy-out situations where the terms provide for certain additional proceeds on a future sale depending upon meeting certain targets.  Being entitled to a larger share of the profits could then conceivably make the difference between obtaining ER or not.  The exact treatment will depend on the exact situation and terms, and so advice on these aspects will be vital in ensuring any expected ER is maintained.

To add to the complication, any disposals made between 29 October 2018 and 20 December 2018 must apply tests 3) and 4) and cannot apply the new test which only applies to disposals after 21 December 2018.  This means the position could change in certain circumstances depending upon whether the sale was before, during, or after this interim period.

These changes make it more important than ever that professional advice is sought before making a disposal.  This way, the position can be ascertained in advance, with suitable planning undertaken where necessary/possible to improve the position.  Eaves and Co would be delighted to assist if you or your clients have any queries in the area.

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Keeping up to date with technical developments is difficult, especially with so many updates these days, when it is difficult to sort the wood from the trees.

With the possibility of dividend planning many companies have chosen to have different classes of shares. In our experience they have not always thought through the wording of the proposed amended Articles or had legal advice, which has led on occasion to HMRC challenges. Many though have probably not been subject to HMRC enquiries so have muddled through, because the parties internally ‘knew what they meant to say’.

Attacks on dividend planning are now getting more ‘fashionable’ with HMRC seems to be the underlying message, taking in certain arrangements with ‘alphabet shares’ and dividend waivers.

The latest development may go beyond those arrangements and affect long term capital gains tax planning.

The current Finance Bill contains provisions whereby if there are different classes of shares in a company it may be difficult for a shareholder to show he has met all the new requirements to qualify for Entrepreneurs’ Relief. Of course, this is not yet law, but checking the position on such a valuable relief would be prudent. With the new qualifying period due to increase to 2 years from 1 year it would be wise to do this sooner rather than later, so as to implement any changes necessary as early as can be managed.

Or is HMRC undermining it?

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  1. “Everyone” knows a capital gain on your own residence is “tax exempt”.

 

  1. “Everyone” knows offshore gains are “tax exempt”.  Isn’t this in the Press on a regular basis?

 
Hence, people with “circumstances” which in reality encompass an awful lot of the nation, may actually discover that they need professional advice, because what they thought was tax exempt is not – in reality.
 
Things which may affect the above “tax exempt” analysis potentially include:-
 
a).   Being UK tax resident.
 
b).  Not being UK tax resident, but having property here.
 
(That just about covers everyone!)
 
Crucially, Private Residence Relief is a relief for qualifying periods of ownership.  This may (or may not) include the whole period of ownership as case law shows.  It is a very complex area; plus the changes in the October 2018 Budget may reduce the length of qualifying periods, particularly for those involved in “strange” lifestyle matters, such as moving house for career, inheriting property, getting divorced etc.
 
For many people their family home is the most valuable asset they will ever own.
 
There are opportunities to plan to mitigate tax.  Such steps are lawful and (presuming you love and respect your family more than HMRC) I believe, appropriate.
 
The only thing to note is, when you accidentally fall into assumptions (1) or (2) noted above, not only will HMRC lawfully demand the tax, plus interest for not paying on time, but also penalties.  The penalties may be up to 200% of the original tax, so you could be paying 3x the original undeclared bill.  For those not of an arithmetic mind, for a typical 28% tax rate on a residential property that is 84% of the gain, going to the Government.  In other words on a gain of £100,000, that is £84,000 plus interest that could go to the Government, just because you assumed ….
 
Of course, some people may say well that still leaves 16% of the gain, but that excludes interest, and experience says trauma and cost of getting caught.  Plus those who actually wished to use the money may have to sell their dream home.  Maybe leading to further complications?
 
However, with appropriate planning and making the right tax elections in some circumstances, the gain may be legitimately eliminated altogether.  A much better result!
 

  1. Get advice.
  2. Get it right.
  3. Document it.

 
No one likes spending money on professional advice – until they haven’t!