Entrepreneurs Relief And Private Company Shareholdings

Before 6 April 2010, capital gains tax entrepreneur's relief was worth a maximum of £80,000 in tax saving. Whilst this was certainly a worthwhile relief, following the 22 June 2010 Budget the position has changed dramatically. Now gains up to a maximum of £5million (life time limit) can now qualify for the relief, and as it may reduce the tax rate from a maximum of 28% to a flat rate of 10%, the maximum value of the relief is £900,000 in tax saving. Clearly it is most important to ensure that nothing is done which prejudices this valuable tax relief.

The focus of this article is the application of entrepreneurs relief on the sale of shares in a private trading company. Preserving the relief on the shareholdings requires some planning ahead and simply reviewing the position a short time before the sale is in prospect may at that stage be too late.

The company

The shares must be in a trading company and the company must not carry on any activities to a substantial extent which are non trading activities. Intra-Group activities are ignored for this purpose. In this context there is no definition of what constitutes substantial but HMRC has a practice of applying a broad 20% test. Thus if 20% of the assets of the company are of a non trading nature, for example undrawn cash reserves not required for future use in the business, there is a danger that the 20% test will not be satisfied. Other factors are brought into account, such as management time spent on trading activities as compared to non trading activities and also the level of trading income as compared to the level of non trading income. The “no substantial non trading activities” test must be satisfied for a one year period up to the time of disposal of shares on which entrepreneurs relief is to be claimed.

Accordingly it may not be sufficient simply just to deal with non trading assets, such as excess cash reserves, just before a sale of the shares just takes place.

The shareholder

There are also requirements as regards the shareholder who intends to claim the relief. He or she must have at least 5% of the ordinary share capital of the company and at least 5% of the voting rights. He or she must also be an officer or employee of the company. Note that any employment does not have to be full time, but it may be simply a part time employment. Acting as Company Secretary suffices for this purpose. Once again these tests have to be satisfied for the one year period up to the time of sale of the shares concerned.

Where husband and wife each have shareholdings, they must satisfy these tests independently and each cannot count in share or voting rights held by the other. If one fails the requirements, but the other has satisfied them for the one year period, tax planning prior to a sale of the shares may involve a transfer of the shares from the non qualifying spouse to the one who does satisfy the conditions for relief.

The requirements for entrepreneur relief in relation to trustee shareholdings are much more restrictive. The relief never applies to shareholdings disposed of by discretionary trustees. Life interest trusts can qualify, but there are very detailed conditions which often mean that in fact relief is not due. One solution, if it suits the circumstances, is to appoint the shares out of the trust prior to the sale, claiming holdover relief, ensuring that the beneficiary receiving the shares already qualifies for entrepreneurs relief by virtue of a personally held shareholding. There is no requirement that the particular shares sold have to have been held for the one year period up the sale.

Other Assets

It is quite common for a shareholder to hold in his or her own name a property which is made available by use by a family company for use in its business. Historically it has generally been advised not to hold the property within the company, as property assets within a company may in fullness of time be subject to two layers of taxation, once in the company when it sells the property and secondly the same value is effectively taxed on the shareholder when the shares are disposed of. This objection to holding the property within a company still remains valid in many circumstances but on the other hand, holding the property outside the company now introduces an additional complication in relation to entrepreneurs relief. A disposal of the property by the shareholder can, subject to conditions, benefit from Entrepreneurs Relief, but not if full market rent has been charged to the company. If a reduced rent has been charged to the company, then there will be a similar reduction in the availability of entrepreneurs relief. There are some points of detail in this area which are not covered here, but the underlying point is that charging rent to the company (notwithstanding its advantages for other tax purposes) will have an adverse impact on the capital gains tax position on sale.

Structuring the Share Sale

When shares in private companies are disposed of, it is not always the case that the purchaser will be willing to make an outright cash payment for the acquisition. It may be preferable for the parties on both sides of the transaction to structure the deal as partly one for cash and partly one for the issue of shares or loan stock in the purchaser company in exchange for the shares. Following the June 2010 Budget statement, a share sale which involves the issue of shares or stock in the purchaser company has now become more problematic in terms of entrepreneurs relief. The relief now has to be claimed in relation to the transactions at the time of the sale of the shares and cannot be deferred to be claimed when any shares or loan stock received in exchange are eventually disposed of (unless the disposing shareholder will satisfy the conditions for the relief in relation to the purchaser company, e.g. has 5% of the shares and is an officer or employee of it).

The vendor can make an election in relation to the share for share or loan stock swap so that it is treated as a disposal for capital gains tax purposes. This then makes it possible for entrepreneurs relief to be claimed in relation to that event. It will be appreciated however that this is not without its drawbacks, since the election will cause a capital gains tax liability to fall due for payment on the transaction. It will therefore be advisable to ensure that there is sufficient cash payment under the terms of the transaction to finance the tax which would be due.

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