Rules surrounding entrepreneurs relief have narrowed considerably with 2015’s Budget. This valuable capital gains tax relief entitles company directors who own at least 5% of a company to benefit from a 10% tax rate on eligible disposals (up to a lifetime limit of £10 million) – as opposed to the 18% or 28% rate of CGT what would be payable without the relief.
Prior to the Chancellors clampdown, a small loophole existed in the scheme allowing some directors to avoid paying a higher rate of tax when a company was sold. George Osborne sought to tackle this, implementing changes in order to ensure the relief was “only available to those selling genuine stakes in businesses”. This was no doubt in response to what has become common practice whereby members of a management team who did not individually pass the 5% ‘personal ownership’ test, teamed up with others to form a management feeder company – structures which clearly caught the Chancellor’s eye.
By investing collectively in a feeder company that, in turn, invested in the trading company, the management shareholders effectively invested in the trading company indirectly. By ensuring each owned more than 5% of the share capital, entrepreneurs’ relief could be enjoyed.
In order to qualify as a ‘trading company’, the feeder company was required to hold an investment (of at least 10% of the ordinary share capital) in a joint venture company. However, to the extent that a management company is a joint-venture company, the availability of entrepreneurs’ relief may now be restricted due to amendments to the definition of ‘trading company’.
Such amendments have, for example, resulted in activities carried out by joint-venture companies, into which a company has invested, no longer being taken into account. This change was implemented with immediate effect for disposals on or after 18 March 2015. Thus companies will now need to have a significant trade of their own in order to be considered trading companies for the purposes of entrepreneurs relief.
Many have commented that this years’ Budget has been somewhat unkind to entrepreneurs relief. Although it is difficult to criticise the closing of a loophole per se, it is vital to remember that such structures are not only set up by those wishing to exploit the relief in a manner not intended by the government, causing many innocent parties to have been caught by surprise by these changes. The hurdle of meeting the new definitions of a trading company may be problematic for some and of course enacting these changes with immediate effect will have affected many individuals who previously expected to be eligible for entrepreneurs relief on gains which have accrued, but not yet been realised.
With the prospect of increased tax bills looming, those who have adopted this structure will no doubt be considering the need to restructure their affairs and as ever, effective tax planning will need to be engaged. Please do not hesitate to contact andrew.rand@thompsontarazrand.co.uk or telephone 01223 461044 for advice or assistance in this respect.