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Jennifer Adams reflects on Capital Gains Tax Entrepreneurs' Relief, now more than a year on since it was originally introduced.

Introduction

The Dutch Government has the right idea – in their September 2009 Budget for 2010 was a package of measures specifically designed to encourage innovation (in other words ‘Entrepreneurship’); their belief being that it is non-bank business that will lift their country from the depths of recession and as such they were to be given help and encouragement in the form of tax breaks. Here in the UK the Federation of Small Businesses had to fight for a concession to the recast Capital Gains Tax regime and for their troubles they were rewarded with the rather grand-sounding  ‘Entrepreneurs' Relief’.

Matthew Hutton’s article Entrepreneurs' Relief in February 2008 covered the rules for eligibility and now that we are more than a year down the line it is clear that the legislation is more complex than it originally appeared or, possibly, was even intended. As Matthew states, it is estimated that the Relief will cost the Government £200 million; even so, anyone who makes a gain subject to these rules in excess of £17,280 will be worse off than if they had been taxed under the Tapering Relief rules of the ‘old’ regime.

Entrepreneurs' Relief - Problem Areas

As a reminder, the rules state that in order to be eligible for the relief the seller needs to ensure that he makes what is called a ‘qualifying business disposal’. The main heading of such a disposal is a ‘material disposal of business assets’ (TGGA 1992 s 169I). This heading is sub-divided further as being:

1. a disposal of all or part of an unincorporated trading business
2. a disposal of assets previously used for a trading business which has now ceased and
3. a disposal of shares or securities in certain trading companies

Disposals by Executors 

It is under heading (3) where most of the confusion and anomalies appear to be surfacing. Take, for example, a not unusual situation of the disposal of shares in a company owned by a shareholder who has died. The company shares will be registered in the name of the executor. The Relief is specifically NOT available to executors, therefore the gain on sale will be taxed at the full 18% unless the shares are transferred to the legatee who will then have to become an officer or employee with 5% voting rights and even then have to keep the company going for 12 months before becoming eligible.

Joint Shareholdings

Another difficulty arises for joint shareholders where each individual is deemed to have an appropriate proportion of the share capital and voting rights (TCGA 1992 s 169S (4)). In other words a joint holding of 8% will mean relief being declined as each individual will hold 4% (i.e., less than the 5% limit); shares held in a trust for the benefit of the shareholder are not included in the calculation. In a family owned business this may mean that in order to be eligible, shares would need to be gifted so that the extra 1% is gained.

The shareholder must have worked for the company for 12 months. The qualifying period being the 12 months ending on the date the shares are sold where the company does not cease to trade or, if the company does cease to trade, on the date of cessation providing the shares are sold within 3 years of the date of cessation. The shareholder does not have to be a full time employee or director of the company and this is where the rules are of benefit as there are no restrictions as to the number of hours worked. However, to ensure that the relief is available it is suggested that a formal contract of employment be drawn up as evidence plus the shareholder be included on the payroll even if no salary is taken.

Entrepreneurs' Relief therefore appears to have been aimed more at the unincorporated ‘owner-managed businesses’ as the FSB wanted with the company owner being included as an afterthought. Indeed, in the rush to bring in the Relief there are two types of company shareholders who appear to have been forgotten, where the rules are of little assistance and in fact place the owners at a disadvantage.

Management Buyouts and Enterprise Management Incentive Shareholdings

Whether it was intentional or not the serious losers of the new rules are firstly shareholders in a management buyout where the 5% equity needed would not usually be possible and, secondly, the employee who holds Enterprise Management Incentive share options. Under the previous Taper Relief rules it was usual for such employees to exercise their option (after the two year wait had passed) and then sell the shares on the next day to receive an immediate 75% Taper Relief because Taper Relief on such shares accrued from the date of grant rather than the date of exercise.

This practice is no longer possible as Entrepreneurs' Relief will only start to accrue once the employee has acquired the shares (i.e., this will be the date that the option is exercised) and even then the employee will have to hold the shares for 12 months plus own the 5% equity – something which would be unlikely.

As Peter Harrup, tax partner of PKF said at the time the ‘Enterprise Relief’ was announced, ‘It really looks like change for the sake of change’.