Entrepreneurs' Relief – Relaxation
Much has been made of the recent changes introduced to crack down on the perceived manipulation of the 5% test for entrepreneurs' relief ("ER") and the extension of the ownership test from 12 months to 24 months. However, sitting alongside this legislation was a relaxation to the ER conditions that has the potential to be very valuable for minority shareholders.
This amendment covers the situation where a shareholder drops below the 5% threshold as a result of the company raising external equity. Not all equity raising events will be included. In order to fall within this legislation, the equity raise has to be:
- for genuine commercial reasons; and
- wholly in consideration for cash consideration.
It should be noted that falling below the 5% threshold as a result of share options being exercised is excluded.
If the equity raise falls within the above and shareholder's shareholding drops below the 5% threshold, the shareholder can make one of two elections.
The first election is to treat the shares as sold and immediately reacquired at market value. The gain then attracts ER and tax is paid.
The second election defers the gain, calculated in the same manner as above, until the shares are eventually sold. However, ER will only be due if all of the other ER conditions continue to be met up until the point that the disposal is made. The 5% shareholding threshold is deemed to be met in these circumstances.
As the second election defers payment until there is cash with which to pay the tax, it is likely that in most cases that will be the route taken. However if for example the shareholder intends to cease to be an officer or employee between the equity raise and the final disposal date, it would be worth considering electing to pay the tax upfront in order to benefit from ER
The above is only a brief overview of the legislation change in this area and if you require more details please contact Brian Garner.
This article is for general information only and does not, and is not intended to, amount to legal advice and should not be relied upon as such. If you have any questions relating to your particular circumstances, you should seek independent legal advice.