In yesterday’s Budget, the Chancellor introduced a number of changes to Entrepreneurs’ Relief which may have immediate, significant and expensive implications for anyone who is hoping to qualify for the relief. The most significant change is the addition of a 5% economic ownership test but the requisite ownership period was also doubled from 12 months to two years.
Entrepreneurs’ Relief halves the amount of capital gains tax payable on the disposal of qualifying holdings, reducing the rate from 20% to 10%. The relief is subject to a lifetime limit of £10m, so in cash tax terms is worth £1m for each individual.
For disposals taking place from yesterday, in order to qualify for the relief, in addition to the pre-existing requirements, an individual will need to have been beneficially entitled to 5% of the profits available for distribution to equity holders and to 5% of the assets of the relevant company on a winding up, in each case from the relevant company for the requisite holding period.
While this is a common economic test in other aspects of tax legislation, this test will not be easily applied to more complex equity/ratchet structures that frequently govern private equity and venture capital investment returns, and will considerably reduce the availability of the relief. To the extent that the return to each class of shareholder is affected by the equity value at the time of a disposal, applying such a waterfall over a sustained historic period (to demonstrate the test has been satisfied throughout the holding period) will bring considerable challenges.
The doubling of the hold-period to 24 months has effect for disposals taking place on or after 6 April 2019.
As a result of this combined change, individuals who previously expected to benefit from the lower rate of tax afforded by Entrepreneurs’ Relief will have their tax burden on exit doubled if they no longer satisfy these new requirements. Investors should therefore urgently consider the impact the change may have on their equity structures.
The extended holding period will also apply to EMI Options, so that the underlying option must – from 6 April 2019 – have been held for at least 24 months before being exercised and the resulting shares sold to qualify for Entrepreneurs’ Relief.