Today’s Budget continued the recent trend of announcing changes to the ER regime. However, unlike previous Budgets, today’s changes generally expand the situations in which ER will be available.
The main change is the extension of ER to shares held by individuals who are external investors rather than employees or directors.
The Budget materials also contain details of three other amendments to the ER regime which reduce the scope of previous measures introduced to target perceived avoidance. In each case, the Government has recognised that the previous change impacted on genuine commercial transactions and so has announced amendments to the relevant legislation which will take effect from the date the original change was made.
Extension of ER to non-employees
ER on the disposal of shares in a company is currently only available to individuals who are directors or employees of the company (or of another company in the same group). The Chancellor today announced the extension of ER to disposals of shares by external investors, referred to in Budget materials as “investors’ relief”. Investors’ relief will apply where:
- the company is an unlisted trading company or unlisted holding company of a trading group;
- the shares are acquired by the individual by way of a subscription for shares and the individual gives new consideration for the shares;
- the shares are held for a continuous period of three years commencing on or after 6 April 2016; and
- the shareholder is neither an employee or director of the company or of another company in the same group.
The extended ER will only apply to shares issued on or after 17 March 2016 and so will not benefit existing shareholders. The stated aim of the extended relief is to attract new capital into companies. The requirement that the shares are acquired for new consideration has been included to ensure a taxpayer cannot simply exchange existing shares for new shares in order to fall within the extended ER.
Today’s announcement explains that investors’ relief will be subject to a £10m lifetime cap. The suggestion seems to be that this £10m lifetime cap is in addition to the existing ER lifetime cap of £10m which is consistent with the Chancellor’s reference to a “brand new 10% rate on long term external investment in unlisted companies, up to a separate maximum of £10 million of lifetime gains.” Whether or not there will be two £10m lifetime allowances working in parallel should become clear once the draft legislation is released.
Trading status – impact of joint ventures and partnerships
ER on the disposal of shares, and investors’ relief, are only available in respect of shares in trading companies or holding companies of trading groups. A company or group is not considered to be “trading” if it carries on “substantial” non-trading activity. HMRC’s way of testing this is to consider whether 80% or more of a company’s activities/assets are of a “trading” rather than an “investment” nature.
The Government previously tightened the ER rules so that the activities carried on by a “joint venture company” which a company is invested in, or by a partnership of which a company is a partner, are treated as investment assets when applying HMRC’s 80% tests.
The Government has recognised that the previous changes to the ER legislation, which were aimed at particular structures which aimed to exploit ER in a way the Government considered inappropriate (as described in our previous blog), were too widely cast and impacted on genuine commercial arrangements and today announced a relaxation of the previous changes. Broadly, the new changes will mean that the trading activities of a joint venture company or partnership will be taken into account (for the purposes of HMRC’s 80% tests where the person disposing of the shares has at least a 5% interest (directly or indirectly) in the joint venture company or partnership. Based on the description of the changes in the Budget materials it appears that:
- in the case of a joint venture company, a taxpayer will only be able to take into account the activities of a joint venture company when establishing whether he or she hold shares in a trading company or trading group provided that the taxpayer has a direct or indirect interest in at least 5% of the shares of the joint venture company and directly or indirectly controls at least 5% of the voting rights in the joint venture company.
- in the case of a partnership, a taxpayer will only be able to take into account the activities of the partnership when establishing whether he or she hold shares in a trading company or trading group provided the taxpayer has at least a 5% indirect interest in the assets and profits of the partnership, and directly or indirectly controls at least 5% of the voting rights in the company which is the partner in the partnership.
Accordingly, whilst these changes will benefit some taxpayers who hold shares in companies which have invested in trading companies and partnerships, it appears that the impact is likely to be limited. For example, where a company has entered into a 50:50 joint venture or partnership, a shareholder in the company will only be entitled to take into account the trading activities of the joint venture company or partnership if the shareholder holds at least 10% of the shares in the company (i.e. giving indirect ownership of at least 5%). It is not uncommon for a company to hold a number of sub-50% stakes in a number of trading companies, and so in this scenario it will only be the major shareholders who will benefit from the changes. The changes will also give rise to the unusual result that a company which has invested in a joint venture company may be regarded as a trading company for one shareholder but not for another.
The legislation dealing with joint venture companies and partnership, which will be amended as a result of today’s announcement, is complex and so the precise impact of the changes will only become clear once the draft legislation is released in the draft Finance Bill (due to be published next week).
The changes will take effect from 18 March 2015 and so taxpayers who previously did not qualify for ER due to the trading status of a company should re-examine the position and may be able to make a retrospective claim for ER.
Transfers of goodwill
Finance Act 2015 introduced restrictions on the availability of ER in relation to goodwill where the goodwill is sold to a ‘related’ company. As identified in our previous blog, the wide definition of ‘related’ means these changes prevent a taxpayer claiming ER on the disposal of goodwill where part of the consideration is shares in the purchaser company.
The Government has today announced an amendment to the ER legislation to deal with this situation. The restrictions on goodwill will now only apply where the taxpayer holds 5% of the ordinary share capital and voting rights in the purchaser company. Whilst this will assist a seller whose business is acquired by a larger purchaser and so their consideration shares will not represent 5% of the ordinary share capital or votes, there may still be situations where the purchaser is not so large that the consideration shares fall below these thresholds.
The Government has also recognised that in certain situations a business, whose assets include goodwill, may first be transferred into a company in order that the shares in the company can be sold to a third party. The Government announced a further relaxation to the restrictions on transfers of goodwill, so that ER will be available if the transfer of the goodwill to a company is part of arrangements for the company to be sold to a new, independent owner.
The changes announced today will take effect from 3 December 2014, the date the original restrictions on transfers of goodwill were implemented.
It is relatively common for assets used in a business, including premises, to be owned by a shareholder or partner in their personal capacity. The ER legislation recognises this by extending ER to “associated disposals”, that is, disposals of personal assets used in the business if the disposal is associated with the disposal of all or part of the individual’s interest in the business, partnership or company.
As discussed in our previous blog, the Government was concerned that some taxpayers had been claiming ER on associated disposals of personal assets without any significant reduction in their participation in the business and so amended the ER legislation to deal with this situation. The changes, introduced with effect from 18 March 2015, limit ER on associated disposals to situations where the taxpayer is withdrawing from a business and is disposing of at least a 5% stake in the business or company and the purchaser is not connected to the taxpayer (and there are no other arrangements for the taxpayer or any connected person to buy back what is sold or otherwise to increase his or her stake).
These changes created difficulties for family owned businesses. Where an interest in the business, together with assets held in the owner’s personally capacity, were sold to members of the taxpayer’s family when the taxpayer retired, the owner’s family would normally be connected to the owner for tax purposes and so ER would be unavailable in respect of the associated disposal.
The Government had recognised this difficulty and today announced changes to the ER legislation. ER will be available where the disposal of a 5% stake is to a connected person or the arrangements for a connected person to buy back what is sold or otherwise to increase his or her stake existed prior to, and independent of, the sale of the taxpayer’s interest in the business or company.
The Government also announced a further relaxation to the associated disposal rules so that where a taxpayer disposes of the whole of his interest in a company or business, an associated disposal will qualify for ER even if the interest sold is less than 5% of the company or business provided that the taxpayer previously held a “larger stake”. The Budget materials do not explain precisely what is meant be a “larger stake”, but we assume it means a 5% stake.
These changes will take effect from 18 March 2015, the date the previous changes were introduced, and so taxpayers who were disadvantaged by the previous changes will be able to make a retrospective claims for ER.