The recent Budget introduced two major changes to entrepreneur's relief which may in particular affect owner-managed businesses. Although the changes have been widely reported, there has in general been little commentary on the adverse effects that the changes could have for many shareholders in companies where there are more than one class of shares.
Ward Hadaway tax partner, Paul Christian, has provided the following brief commentary on the changes.
- The qualifying period for entrepreneurs relief has been extended from one year to two years for disposals after 5 April 2019
- Additional 5% tests have been introduced, requiring the shareholder to have an entitlement to 5% of profits and 5% of assets. This has effect for all disposals after Budget day.
Although the extended two year period is self-explanatory, the new 5% tests could result in many shareholders unexpectedly losing entrepreneur’s relief. Although the aim of the changes are clear – to prevent artificial arrangements to get entrepreneur’s relief where there is no real 5% interest – the effect of the proposed legislation goes much further than this. Shareholders in companies where there is only one class of shares are unlikely to be affected, but where there is more than one class of shares, there could be issues. In particular:
- Entrepreneurs relief could be denied where there is a discretion as to the rights to dividends. In particular, “alphabet shares” arrangements, where the dividends payable on each class of shares are at the discretion of the Board would, on the face of it, prevent entrepreneur’s relief.
- It could prevent entrepreneur’s relief being available to other shareholders where there is a shareholder with preferential rights, either to dividends or on a winding up. The preference may result in shareholders having ordinary shareholdings well in excess of 5% not satisfying the new 5% tests:
- The position is not straightforward as in certain circumstances debt funding will count as equity
- The tests will need to be assessed on an ongoing basis.
How the proposed legislation will work in certain situations is not at all clear at the moment. We are aware that representations are being made to the Treasury about the proposals and that there may be changes or further guidance before the legislation is finalised in the Finance Act 20018/19.
If you require any further information on these changes please contact Paul Christian.