Introduction

The Chancellor has announced two restrictions on entrepreneurs’ relief, which will remove it from two situations where it is currently available.

What is entrepreneurs' relief?

Entrepreneurs’ relief is the lower rate of capital gains tax – 10 per cent – which applies to gains made on the sale of an interest in a business, including shares in certain “trading” companies. The relief is only available for up to £10 million of gains made in the taxpayer’s lifetime, and is subject to various conditions.

Withdrawing relief from some shareholders in trading companies – ‘management’ companies

One of the conditions for relief applies to individuals who own shares in a trading company. Such individuals have to hold at least 5 per cent of the trading company’s shares, even though no equivalent threshold applies to individuals who carry on business through a partnership (such as an LLP). It is possible for shareholders with limited economic rights to satisfy this test, and so qualify for entrepreneurs’ relief.

The Government has announced that entrepreneurs' relief will be withdrawn from a particular class of shareholders, namely those who hold their interest in a trading company through a separate vehicle which does not itself carry on a trade: for example, a company which pools the shareholdings of all of the managers of the business. Currently, the tax legislation allows such a company to be treated as a trading company if it holds at least 10 per cent of the shares in a trading company which has few other shareholders. Such arrangements are not uncommon; and they allow entrepreneurs’ relief to be available for up to 20 managers in a company which is controlled by an outside investor.

This treatment will no longer be available unless the company owned by the managers is itself a trading company or (presumably) holds more than 50 per cent of the underlying trading company. In the future, the management company will have to have a ‘significant’ trade of its own, alongside its shareholding in the underlying trading company. It is unclear whether entrepreneurs’ relief will be denied to all shareholders in such a management company, or just those whose economic interest in the underlying trading company is less than 5 per cent.

The Government is not proposing to introduce a 5 per cent threshold for others, such as those who carry on a business through a partnership, or to tighten other aspects of the 5 per cent test. However, a company will not be able to establish its status as a trading company through the activities of a partnership of which it is a member.

No relief for disposals of certain ‘associated’ assets

Where a person disposes of an interest in a business (or shares in a trading company) which qualifies for entrepreneurs’ relief, the relief is also available for gains on the disposal of certain ‘associated’ assets. These are assets which are owned by the individual personally, rather than by the business.

To qualify for entrepreneurs’ relief, those privately-held assets must have been used for the purposes of the business for at least 12 months; and they must be disposed of as part of the ‘withdrawal of the individual from participation in the business’.

This relief will be retained but only for disposals where the individual is selling a shareholding, or an interest in the assets of a partnership, of at least 5 per cent as part of that withdrawal. The intention appears to be to limit entrepreneurs’ relief for gains on private assets to situations where the individual is also disposing of more than a small interest in the company or partnership in question.

These changes have immediate effect

Both changes are to take effect for disposals on or after 18 March 2015, and there is no indication of whether there will be an exemption for transactions pursuant to conditional contracts entered into before then.