Much excitement has been generated by the Budget’s announcement of a new capital gains tax relief for investors. The relief applies to shares issued on or after 16 March 2016 and so is already in force. However, the relevant legislation is so far only in draft. Nevertheless, we can see the basic lie of the land and it may be helpful to compare the new relief to entrepreneurs’ relief, the rules of which are better known.
- Both investors’ relief and entrepreneurs’ relief reduce the new capital gains tax rate for higher rate taxpayers (20%) down to 10%. Both reliefs allow for a maximum lifetime amount of £10 million of gains.
- Investors’ relief only applies to shares subscribed for by the investor (or his or her spouse) for cash, which were fully paid up when issued, and which were subscribed for, and issued, by way of a bargain at arm’s length. Entrepreneurs’ relief applies to shares no matter how they were acquired and whether or not they are fully paid up.
- Likewise, investors’ relief is not available unless the shares are issued for commercial reasons and not as part of a scheme or arrangement of which the main purpose or one of the main purposes is the avoidance of tax. Entrepreneurs’ relief has no similar restriction.
- Investors’ relief is limited to companies with no quoted shares (which expression does not include shares on the AIM market). Entrepreneurs’ relief is not similarly restricted and the relief can theoretically apply to quoted shares if the investor has a sufficient holding in the company.
- Investors’ relief only applies if the shares have been held for at least three years (or, for shares issued before 6 April 2016, held until at least 5 April 2019). Entrepreneurs’ relief requires that the shares are held for a minimum period of one year.
- Investors’ relief requires that the company is a trading company (or holding company of a trading group) throughout the ownership period of the shares. Entrepreneurs’ relief only requires that the company has been a trading company (or holding company of a trading group) for the last year in which the shares are held (or for the year ending with the cessation of the trade).
- Entrepreneurs’ relief is generally only available where the shareholder owns at least 5% of the ordinary shares of the company, by virtue of which he or she owns at least 5% of the votes. There is no minimum percentage requirement for investors’ relief.
- Entrepreneurs’ relief is only available where the shareholder is an officer or employee of the company (or a group company). Investors’ relief is not available where the shareholder (or anyone connected with the shareholder) has been an officer or employee of the company (or of any connected company) at any time when the shares are owned.
- Investors’ relief can be unavailable if the shareholder has “received value” from the company in the year before the share issue or the three years following it. These rules are complex and are largely copied from the Enterprise Investment Scheme (EIS) rules. (Beware, though, they are not identical to the EIS rules!) There are no equivalent rules under entrepreneurs’ relief.
So investors’ relief may seem superficially similar to entrepreneurs’ relief, but on analysis they are quite different. Investors’ relief is designed for non-working investors, more akin to EIS relief (and its child, the Seed Enterprise Investment Scheme (SEIS) relief). The major differences between investors’ relief and EIS / SEIS relief are:
- EIS and SEIS relief give a complete tax exemption for capital gains. Investors’ relief produces a 10% tax rate.
- EIS and SEIS investments give income tax relief on the amount invested. Investors’ relief does not.
- There are monetary limits to how much a company can raise via EIS and SEIS investments. Investors’ relief is unlimited from the company’s viewpoint.
- EIS and SEIS shares cannot have certain preferred rights. These restrictions do not attach to shares qualifying for investors’ relief.
- EIS and SEIS relief are subject to many conditions, which investors’ relief is not, eg restrictions on the type of trading activities and non-trading activities, limit on number of employees, requirement for a UK permanent establishment, limit on gross assets, limit on size of shareholding, etc.
- The conditions for EIS and SEIS relief to be available generally fall away after three years – eg the company no longer needs to be a trading company. The conditions for investors’ relief to be available generally last until disposal of the shares – eg the company still has to be a trading company at that date.
Also, EIS relief cannot nowadays generally be claimed by investors who have shares in the company on which they have not claimed EIS (or SEIS or social enterprise) relief. So if an investor claims investors’ relief on a shareholding he or she cannot then subsequently claim EIS relief on further share issues, at least on the basis of the draft legislation.
Investors will have a challenging decision as to which tax reliefs to claim on future share acquisitions.