Will Size Matter to the Entrepreneur?

In order to continue to promote enterprise and encourage growth HMRC have recently published a consultation to allow individuals to retain their Entrepreneurs’ Relief (“ER”) entitlement where certain qualifying conditions are no longer met.

Since its introduction in 2008, ER has established itself as a valuable relief for individuals disposing of shares held in eligible companies, allowing for gains achieved to be subject to Capital Gains Tax (“CGT”) at a lower rate of 10%. In order to claim ER, both the investor as well as the shares being disposed of are required to meet certain eligibility conditions, amongst these are that the investor must have held a “qualifying interest” in an eligible company.

In order to meet the “qualifying interest” test the investor is required, during the 12 month period prior to disposal, to be an employee or officer as well as hold at least 5% of the ordinary share capital and voting rights. In scenarios where a company has undertaken fundraising efforts involving the issue of new share capital, shareholders can see their interest dilute below the 5% ER minimum holding and voting requirement, and subsequently lose their eligibility to claim ER on an exit event.

Given ER was originally introduced to incentivise and reward entrepreneurs for having made higher risk investments, the UK Government are now reviewing whether ER continues to meet its original objectives and in particular are considering protection against dilution in certain circumstances.

Under current proposals where an investor is aware that their shareholding will be diluted below 5%, due to the issue of shares for commercial purposes, an election can be made to crystallise the underlying gain on their shares at that date and claim ER on this gain.

In order to avoid a dry tax charge on the crystallised gain, the consultation also proposes that the individual can elect to defer the tax liability until a future disposal event.

The consultation is open until 15 May and AAB’s Expertise to Entrepreneurs division (E2) will be providing comments to HMRC on the questions raised in the document.

For more information on the current Government consultation, or how we can assist with making a successful claim for ER, please contact Lynn Wilson (lynn.wilson@aab.uk) or your usual AAB contact.