Spring Statement 2018: entrepreneurs’ relief on gains made before dilution

Chancellor Philip Hammond emphasised his desire to encourage an innovative business environment in his Spring Statement, which included the launch of a consultation on changes to entrepreneurs’ relief (ER) designed to ensure that it does not discourage entrepreneurs from seeking external finance for their companies

At present, entitlement to the special 10% rate of capital gains tax may be lost when an entrepreneur’s company issues new shares and as a result causes their personal stake to fall below 5%.

This loss of entitlement to relief could be seen as a perverse consequence of the growth and success of the company. It has been argued that in some cases the risk of losing ER acts as a disincentive for seeking the appropriate finance that would allow the company to grow.

In Autumn Budget 2017 the government proposed to address this issue by allowing individuals to elect to crystallise gains on their shares immediately before their holding is diluted. The effect of making the election will be that the individual is treated as selling and immediately reacquiring their shares at the then market value. The individual can choose to defer the accrual of the gain on this elective disposal, so that ER may then apply to the deferred gain when the claimant comes to dispose of their shares.

The government will introduce legislation in Finance Bill 2018-19 to allow individuals who no longer hold a 5% interest in a company to claim ER, where the reduction in their percentage shareholding is due to that company issuing shares to raise capital for the purposes of its trade. The new rules will apply to gains latent in shares and securities held at the time of fundraising events which take place on or after 6 April 2019.

The consultation announced in the Spring Statement focuses on the mechanism which will achieve this extension of the relief. Individuals will be able to elect to crystallise gains on their shares immediately before their holding is diluted. The effect of making the election will be that the individual is treated as selling and immediately reacquiring their shares at the then market value.

The individual can choose to defer the accrual of the gain on this elective disposal, so that ER may then apply to the deferred gain when the claimant comes to dispose of their shares.

To make this new election, the individual must have satisfied the conditions for claiming ER at the time they were treated as having disposed of and reacquired their shares. To ensure this extension of the relief remains targeted, the dilution of the individual’s shareholding must be a consequence of an issue of shares made by the company for genuine commercial reasons.

The consultation seeks views on the proposals, including their timing and the difficulty of keeping the necessary records for taxation purposes.

David Kilshaw, private client services partner at EY, said: ‘ER can reduce the Capital Gains Tax (CGT) rate on a sale of shares in a private company to 10% on qualifying gains up to £10m. One of the conditions was that the individual owned at least 5% of the company. In practice this often meant the original founders, with the entrepreneurial idea, did not benefit from ER as by the time of exit their share interest was diluted down as their company had to raise funds to build on the early success.

‘From 6 April next year this problem is reduced. The taxpayer can elect to bank his ER before he or she is diluted below the 5% threshold. Moreover there will be no tax charge until the shares are actually sold.

‘The Chancellor is to be congratulated on a practical solution to what was otherwise a hard luck story. This is great news for original thinkers who see their vision come to reality with the help of others.’

The consultation closes on 15 May.

Financing Growth in Innovative Firms: Allowing Entrepreneurs’ Relief on gains made before dilution is here.

Report by Pat Sweet

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