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.

We have written in previous blogs about the need to take care over Entrepreneurs’ relief (ER) and preference shares (see Entrepreneurs’ Relief – 5% Test and Preference Shares) and a recent case heard by the First-Tier Tribunal has shed more light on how the rules are to be interpreted.

One of the conditions for ER is that the taxpayer must hold at least of 5% of the company’s ordinary share capital and voting rights. For these purposes, ordinary share capital is defined as all share capital excluding fixed rate preference shares.

However, in the recent case of M & E McQuillan v HMRC [2016] TC05074 redeemable non-voting shares which did not carry rights to dividends were found to not constitute ordinary shares for ER purposes.  It was found that shares with no rights to dividends could be considered as having a right to a fixed rate of 0% and therefore could be excluded from the calculation of ordinary share capital.

In this case, this provided the right outcome for the taxpayers as they were selling their ‘ordinary’ shares in the company, of which they had 33% each.  Another couple had made a loan of £30,000 which had been converted into the 30,000 preference shares which were redeemable non-voting share capital with no rights to dividends.

Had the 30,000 extra shares have been treated as ordinary share capital, the taxpayers would not have had the required 5% holding.

The case highlights the importance of checking through all the details before making a sale of shares in your company.  In this case, the taxpayers were successful but others will not be so fortunate.  Eaves and Co have extensive experience advising on share sales and Entrepreneurs’ relief and would be delighted to hear from you if you are considering a sale in the near future.

Two changes were announced in the Autumn Statement to the treatment of goodwill on incorporation, which had immediate effect from 3 December 2014.

These were as follows:

  • Entrepreneurs’ Relief is no longer available on a sale of the goodwill to a connected party
  • Tax relief on writing off the goodwill (amortisation) can no longer be obtained once in the company.

Both of these changes will reduce the attractiveness of common planning which was undertaken when incorporating a business, but there are still options available to avoid tax becoming a drawback on incorporation.

The use of TCGA 1992, s.162 incorporation relief, in combination with s.165 gift relief where suitable, is still possible in order to avoid upfront capital gains on incorporation.

It should also be noted that the new restrictions only apply where the parties are connected, and there could therefore be situations where suitable planning could be undertaken to prevent the rules from applying.  Similarly, in cases of a management or third-party buy-out, these new restrictions should not apply.

With further tightening of the rules, it will be more important than ever to ensure suitable professional advice is sought before undertaking an incorporation as careful structuring will be needed to avoid unexpected outcomes.

A recent first-tier tribunal case (William S G Russell v HMRC (TC02299)) involved a claim for Entrepreneurs relief (ER) on the disposal of farm land.

Mr Russell was a one third partner in a farming business, run with his brother and sister-in-law.   Some farming land that was disposed by the partnership was agreed as being 35% of the land that that was capable of being farmed.

Mr Russell made a claim for Entrepreneurs’ relief (ER) on the basis that the sale was a material disposal of a business asset.  His main argument was that as there was a fall in profit that tied in with the percentage of land sold and the land sold was still being farmed, it therefore constituted a business.

The tribunal found that the sale did not amount to the disposal of a business, simply a disposal of a business asset.  This was because the business was being run in exactly the same way following the sale.

Interestingly, it might have been possible to successfully claim for Entrepreneurs’ relief had Mr Russell undertaken suitable planning before the sale.  A disposal of even a small part of his partnership share would have allowed the land sale to be an associated disposal.  Incorporation could also have been used in order to effect a cessation of the partnership business, thus allowing a claim for an associated disposal.

Planning before transactions take place is essential to ensure that any potential problems can be identified before they arise.  Please contact us if you are planning to dispose of assets in our Leeds office on 0113 2443502.

 

The recent changes in rules on Capital Gains Tax and Entrepreneurs’ Relief mean that it is more important than ever.  With the main rate of CGT now 28% and the rate on assets qualifying for ER remaining at 10%, the benefit of attaining ER is increased to 18% from the previous 8%.  Coupled with the lifetime limit increase to £10m, the overall lifetime value of ER is a maximum of £1,800,000; a significant increase on its initial value of £80,000.
It is therefore more important than ever to fully consider the availability of ER on transactions and ensure that all the conditions are met.