Entrepreneurs’ Relief (“ER“) allows office-holders and employees to benefit from a 10% tax rate on capital gains if certain conditions are met.
The rate of capital gains tax is 20% (or 10% for individuals with income and chargeable gains below the higher rate income tax threshold of £46,350 for 2018/19). An individual who qualifies for ER, by contrast, is taxed 10% on chargeable gains up to a lifetime limit of £10 million. ER is therefore a very valuable relief for higher rate tax payers as it enables individuals to save up to £1 million of capital gains tax.
So how do you qualify?
For an individual to qualify for ER, throughout the period of one year ending with the date of disposal (two years for disposals after 5 April 2019), the following conditions must be met:
- The company must be the individual’s “personal company”
- The individual must be an officer or employee of the company (or a company in the same trading group)
- The company must be a trading company or the holding company of a trading group
Special Rules of EMI
Special rules apply to shares acquired pursuant to “Enterprise Management Incentive” options. The one year ER holding period (two years for disposals after 5 April 2019) runs from the grant of the EMI option and the personal company test does not apply. The relaxation of the ER rules as they apply to EMI options makes these very attractive. A separate fact sheet is available on EMI (see below).
Special Rules for External Investments Causing Dilution
The Financial Bill 2019 introduces changes to the ER Rules intended to stop the discouragement of new investment.
The new rules will apply after 5 April 2019 where (broadly) an issue of shares for cash causes an individual to be diluted to below the 5% personal company threshold. The individual will be able to elect to trigger a gain which is crystalized when the investment occurs and separately to elect to defer the gain until the ultimate sale of the shares.
The elections will allow the individual to benefit from ER when it would otherwise have been lost. The individual must satisfy all the ER conditions when the investment is made and (with the exception of the personal company test) on disposal.
The election to crystalize the gain must be made on or before the first anniversary of the 31 January following the tax year in which the investment is made and the election to deferral the gain must be made within 4 years of the tax year in which the investment is made. Both elections are irrevocable and advice should be taken as to when to make them.
ER must be claimed on or before the first anniversary of 31 January following the tax year of disposal. If an individual disposes of shares in 2018/19, for example, he or she must claim the relief by 31 January 2021. It makes more sense for cash flow reasons, however, to claim ER when the tax is due so tax need only be paid at 10%.
Application to all Securities
Once an individual satisfies the ER conditions, ER can be claimed on the disposal of any securities or interests in securities in the same company. It would be possible, for example, for an employee who qualifies for ER (because he or she has held sufficient shares for the relevant holding period) to redeem loan notes issued by the same company and claim ER on the redemption.
ER also applies to disposals made within three years after a company ceases trading if the conditions were met in the year prior to cessation.
For more detailed guidance on Entrepreneurs’ Relief please click here.