George Osborne announced in today’s Budget: “We will close loopholes to make sure entrepreneurs’ relief (ER) is only available to those selling genuine stakes in businesses”.
Having now seen the detail of these proposed changes, we find that he has made some targeted changes to the circumstances in which ER can apply but otherwise left the relief intact. The changes will, in particular, affect employees or directors who hold shares in “management company” structures which have been put in place to ensure that the maximum number of employees and directors can qualify for ER.
By way of reminder, ER is a lower rate of capital gains tax that is available in respect of qualifying business disposals. Where ER is available, the first £10 million of qualifying gains (a lifetime limit) is taxed at 10%, with the remainder being taxed (under current rates) at 28%.
Joint ventures – shareholdings in “management companies”
To qualify for ER on a disposal of shares or other securities in a company, there are certain conditions which must be satisfied, one of which is that, throughout the period of one year ending on the date of the disposal of the shares or other securities, the company must be a trading company or the holding company of a trading group.
Another is that, unless the shares are acquired on the exercise of an EMI option, the company must be the “personal company” of the disposing shareholder (i.e. broadly, the individual must hold at least 5% of the ordinary share capital and be able to exercise at least 5% of the voting rights in that company).
When determining whether a company was a “trading company”, it has until today been the case that if a company had at least a 10% shareholding in a “joint venture company” then it was treated as carrying on the appropriate proportion of the activities of that joint venture company and could itself qualify as a trading company. This will no longer be the case. The activities carried on by a joint venture company which a company is invested in, or of partnerships of which a company is a member, will no longer be taken into account for the purposes of the trading status condition. Therefore, a company would need to have a significant trade of its own to be a trading company for this purpose.
In practice, the joint venture rules enabled members of management teams who would not each otherwise satisfy the 5% shareholding condition by virtue of their shareholding in a company to form a “management company” which would itself hold a 10% shareholding in the “joint venture” company. Provided each manager satisfied the 5% shareholding condition in relation to the management company they would each qualify for ER.
This will no longer be possible as a result of the changes announced today which will affect disposals made on and after 18 March 2015.
It is hard to argue against the idea that the “management company” approach enabled ER to apply in circumstances which were not intended by the Government when the legislation was introduced but many have pointed out that the 5% threshold, which was removed in respect of shares acquired on the exercise of EMI options, is arbitrary and should be abolished in order to encourage wider employee share ownership and align employee and management goals of driving growth.
Additional changes were also announced restricting the application of entrepreneurs’ relief to associated disposals and transfers of goodwill, along with a potential expansion of its availability to spin-out companies.