Posted by Gary Mackley-Smith on March 13, 2018
From 6 April 2019, shareholders who would otherwise lose valuable Entrepreneurs’ Relief (ER) when their percentage interest in a trading company falls below 5% due to the company issuing shares to raise capital on or after that date will have their tax position safeguarded under new proposals unveiled in the 2018 Spring Statement.
ER can reduce Capital Gains Tax on the disposal of shares in a private company on qualifying gains up to £10m, so long as the individual owns at least 5% of the company. However, some company owners have lost their relief where their holding was diluted due to having to raise funds via a share issue to external funders.
Provisions will be included in Finance Bill 2018-19 to allow affected individuals to “bank” their ER before the dilution takes place, with any tax charge deferred until the shares are eventually sold. Draft legislation will be available in the summer.
The mechanics of how this will work have been set out in a new consultation which will close on 15 May.
An Individual will be able to elect to crystallise the gain on their shares immediately prior to their holding being diluted, so they are treated for tax purposes as selling and immediately reacquiring their interest at the then market value.
The individual can then choose to defer the accrued gain on this deemed disposal, so that ER will apply to the deferred gain when they actually come to sell their shares.
The individual will have to have met the conditions for claiming ER at the time of the deemed disposed and buyback, ER only being protected in this way where the shareholding dilution was a consequence of an issue of shares made by the company for genuine commercial reasons.
The following worked example is based on the consultation document’s explanation.
Angela pays £20,000 for 20,000 £1 ordinary shares in a new trading company of which she is a director. This gives her 10% of the company’s ordinary share capital and 10% of the voting rights.
After 18 months (in September 2023) the company raises working capital by issuing 1.8 million new £1 ordinary shares. Immediately before the new shares were issued, Angela’s shares were worth £3.50 each. She does not subscribe for new shares. Her holding is now 1% of the ordinary share capital and 1% of the voting rights.
If Angela had sold her shares immediately before the new shares were issued, she would have been able to claim ER on their gain of £50,000. Under the government’s proposals, she will be able to elect in her 2023-24 tax return to be treated as having made that disposal and immediately reacquired the same shares at the same price. The return will reflect the gain (along with other relevant gains, losses, reliefs, income etc.) and Angela may claim ER.
Going forward, the acquisition cost of Angela’s shares is equal to their value at the deemed reacquisition. This is the cost which will be used in computing any subsequent gain or loss.
Angela understandably does not want to pay tax on her gain in tax year 2023-24 and so claims for the accrual of the gain to be deferred. The claim is made in her 2023-24 tax return or by other permitted means up to 5 April 2028.
In June 2030, Angela resigns from the company and sells all her shares. By this time the shares are worth £11.00 each. Her deferred gain of £50,000 is treated as accruing, and she may claim ER on that gain – which will be treated as eligible for relief under the terms then applicable.
She will also have another gain on the actual disposal. This will be 20,000*(£11.00 – £3.50) = £150,000. Assuming the present eligibility conditions continue to apply, ER will not be available on this gain because the company was not her personal company (her holding was less than 5%) at the required times.
If, when she sells her shares in June 2030, Angela’s shares were instead worth only £3 each, a loss of £10,000 would accrue (20,000*(£3.00-£3.50): her shares are treated as having been acquired for £3.50 each under the deemed disposal and reacquisition). Subject to a claim, this loss would be available to set against her deferred gain of £50,000 which is also treated as accruing, or against other gains which accrue in the same tax year if that would be a more effective use of the loss.