Selling your company?
The warm sunshine has already added a feel good factor; a perfect antidote to the continuing woes of Brexit.
But for those of you who are dreaming of selling your business, it is important to ensure that you and/or your employees are eligible to claim Entrepreneurs’ Relief (“ER”) following the changes announced in Finance Act 2019.
What is Entrepreneurs’ Relief (“ER”)?
By way of background, ER was introduced in 2008 and it reduces the tax rate from 20% to 10% on qualifying gains of up to £10M on the disposal of shares in your company provided you have been an officer and/or an employee of the company and you hold at least 5% of the ordinary share capital and voting rights. It is a valuable relief and HMRC estimates that the relief cost £2.7 billion in 2017-18.
ER is also available to sole traders and partnerships on the disposal of their business interest and/or associated disposals, however this article only focuses on the disposal of shares.
In addition to meeting the officer/employee condition and the 5% equity and voting requirement referred to above, the following conditions also need to be met:
- shares need to be held for at least 24 months (instead of twelve months) before ER can be claimed;
- the shareholder must also either be entitled to:
- 5% of distributable profits and 5% of the company’s assets available to ‘equity holders’ on a winding up of the business; or
- 5% of the sale proceeds due to holders of ordinary shares on a notional disposal of the company.
Under the new rules, a shareholder can claim ER if his/her interest is reduced to below 5% as a result of a new issue of shares for cash on a commercial basis.
The entrepreneur must elect for their shareholding to be treated as disposed of and reacquired immediately before the point of dilution (thus creating a chargeable gain to which ER may apply).
Alternatively, tax on the gain may be deferred until the actual sale of the shares. However, in this latter case it will be necessary for the shareholder to continue to satisfy the other conditions for ER (notably employment) in order to claim relief. This change protects minority shareholders adversely affected by dilution from equity investment.
All of these new provisions took effect in relation to disposals after 6 April 2019.
What about alphabet shares?
It is not uncommon for a company to issue different classes of shares, for example employees may be issued a different class of shares to the other shareholders.
Instead of having to satisfy the requirements in respect of dividends or assets on the winding up of a company, shareholders can instead opt to show that, in the event of a disposal of the whole of the ordinary share capital, they would be entitled to at least 5% of the proceeds.
Enterprise Management Incentive (EMI) shares?
ER is also available to employees and officers disposing of qualifying EMI shares.
Where a qualifying EMI option is exercised, and it was granted at least two years before the date of the disposal of the EMI shares, ER will be available on a disposal irrespective of the shareholder’s equity interest in the company.
Whilst we can’t predict whether ER will be available for years to come, it is an opportune time to plan for a future share sale and to ensure that you and your key employees continue to benefit from this relief whilst it is available.