The Government acts on concerns raised about its October 2018 changes to entrepreneurs’ relief.

In the 2018 Budget the Chancellor announced two key changes to entrepreneurs’ relief which are likely to have a significant impact on the number of individuals/shareholders benefitting from the relief. In answer to concerns raised, the Government is now amending the draft Finance Bill to broaden the new definition of a personal company for shareholders looking to obtain entrepreneurs’ relief.

The two key changes were broadly:

1. An extension to the qualifying holding period from one year to two years; and
2. A tightening of the rules governing the definition of a personal company – so the share rights an individual must benefit from before they qualify for the relief - introduced with effect from 29 October 2018. This change requires the claimant to have a 5% interest in both the distributable profits and the net assets of the company.

However, alarm was raised about how the new rules governing the definition of a personal company would operate in practice as the changes seemed to result in a range of potential unintended consequences. As a result, the Government has tabled an amendment to the new Finance Bill wording, details of which can be found here.

The rules regarding the definition of a personal company essentially govern the share rights to which an individual must be entitled in order to qualify for entrepreneurs’ relief. The above change means that an individual must:

• Be an employee or officer of the company;
• Hold at least 5% of the “ordinary share capital”;
• Have at least 5% of the voting rights by virtue of that holding of ordinary share capital; and

from 29 October 2018, either:

• Be entitled to at least 5% of the company’s distributable profits; and
• Have a right to at least 5% of the net assets of the company available to equity holders on a winding-up; or

if the above Government amendment is passed into law:

• Be entitled to at least 5% of the proceeds in the event of a disposal of the whole of the ordinary share capital of the company.

Further guidance on the changes is expected from HMRC. However, the Chartered Institute of Taxation has received the following comment from HMRC:

“Thank you all for taking the time to share your concerns about and suggestions on the recent entrepreneurs’ relief changes with us, whether at the meeting last week, or in writing. I’m writing to let you know that on the basis of your advice and recommendations, the government has now tabled an amendment to Paragraph 2 of Schedule 15 of the Finance Bill, which contains the changes to the definition of ‘personal company’ for ER purposes. The amendment will add an alternative test based on the shareholder’s entitlement to proceeds in the event of a sale of the whole [of the ordinary share capital in the]* company, which can be used instead of the tests based on profits available for distribution and assets on a winding up. The original tests have been left in to provide certainty to those with straightforward company structures, but the new test will help those who are not able to meet the original test for commercial reasons and does not rely on the definitions in the Corporation Tax Act 2010.”

*Addition by CIOT for clarification.

For disposals before 6 April 2019, the additional requirements set out above will apply for one year to the date of disposal. For disposals on or after 5 April 2019, these additional requirements will apply for two years to the date of disposal, except where the company ceased trading before 29 October 2018.

In cases where the claimant’s business ceased, or their personal company ceased to be a trading company (or the holding company of a trading group), before 29 October 2018, the existing one-year qualifying period will continue to apply.