As part of his Budget, the Chancellor has confirmed two significant changes to the availability of entrepreneurs’ relief (ER). ER allows individuals to reduce their tax liability on a disposal of their “personal company”. So long as the shares being sold meet the qualifying criteria, an individual will pay capital gains tax at a reduced rate of 10% (rather than the normal rate of 20%), up to a maximum lifetime limit of £10 million of gains.

Although initially designed to encourage entrepreneurial investment, ER has become a staple feature of private equity- and venture capital-backed deals involving management.

The two changes are as follows:

  • Longer holding requirement. Currently, an individual must meet the conditions for ER for a minimum period of 12 months before being able to take advantage of the relief. From 6 April 2019, this will double to two years. The longer period applies to disposals on or after that date, so shares held today may well become subject to the new two-year period.
  • Economic requirement. Currently, to qualify for relief, the individual must hold at least 5% of the share capital and voting rights in the company in question. However, from 29 October 2018, an individual will also need to be entitled to at least 5% of the company’s profits distributable to “equity holders”. Broadly, this is designed to exclude preference shares from the calculation. However, in running this calculation, it is important to note that the concept of “preference share” for ER purposes is narrow and does not include some instruments that might traditionally be considered preference shares. Moreover, certain equity-like instruments, such as convertible notes, may also qualify as equity for ER purposes. Failing to take these kinds of instrument into account when calculating the economic requirement could result in an individual appearing to satisfy the threshold when in fact they hold an economic entitlement of less than 5%. Although the economic requirement only kicked in on 29 October 2018, it applies to all shares held as at that date. The result is that some shares that would otherwise have qualified for ER on that date may no longer qualify if they do not satisfy the economic requirement. The changes mean that much fewer individuals will benefit from ER than before. Anyone expecting to benefit from the relief should review their arrangements to confirm whether they are still eligible.