Entrepreneurs’ Relief – easy as A, B, C?

12 November 2018

What’s happened?

During the Budget, the Entrepreneurs’ Relief (ER) rules were tightened by an extension of the ‘5% rule’. Such that not only would a shareholder be required to hold 5% of the ordinary share capital and be entitled to 5% the voting rights in the company as a result, but they would also need to be entitled to at least 5% the company’s assets on a winding up and 5% of the distributable reserves.

This felt like a typical loophole closure designed to restrict relief where the shareholder didn’t have a true 5% economic interest in the company. HMRC’s background note explaining the purpose of the change echoed this sentiment.

Whether by accident or design, the change in rules appears to go much farther than expected.

Who’s affected?

The requirement is that, by virtue of the rights of the shares held, the shareholder “is beneficially entitled to at least 5% of the profits available for distribution to the equity holders of the company”.

Consider:

A pretty normal company with 100 ordinary shares of £1 each which have been split into 40 A shares and 60 B shares. These ‘alphabet’ shares have identical rights in all respects.

In this scenario it is conceivable, however unlikely, that the directors might only ever pay dividends on the A shares and never on the B shares, or vice versa.

As such, and regardless of any pattern of dividends actually paid, neither class can be said to have a beneficial entitlement to 5% (or indeed any percentage) of the distributable profits.

Read literally, the new rules would mean that neither the holder of the A shares nor the B shares could meet the new ER tests and no shareholder of this company would be entitled to ER on a sale or liquidation.

In other words, any company with more than a single class of ordinary share capital is potentially affected.

When does it take effect?

The legislation makes the changes effective from Budget day, 29 October 2018.

However the legislation is, at this stage, only a Bill and needs to go through Parliamentary debate and approval processes and receive Royal Assent before becoming law.

As such we’re currently in limbo:

  • If the Bill becomes law as it is, then the changes have already happened, but;
  • If the Bill fails to become law (remember the 2017 Finance Bill that went in the rubbish bin when the snap general election was called?) or if the drafting is corrected during its passage through Parliament, then the change won’t come into effect at all

What can I do about it?

As the old adage tells us, hope for the best, plan for the worst.

Whilst we all hope that Parliamentary process will correct the targeting of this rule change, any shareholders of owner managed businesses should make sure they understand the share structure currently in place and the implications on a sale or liquidation, assuming the rule change comes into force.

To discuss the potential impact on your tax affairs, please contact your usual UHY adviser.

Alternatively, fill out our contact form here.