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Spring Statement - Financing growth in innovative firms: allowing Entrepreneurs' Relief on gains before dilution

Mike Wakeford

As announced in Budget 2017, the Government has today issued a document consulting on how access might be given to entrepreneurs whose holding in their company is reduced below the normal 5% qualifying level as a result of raising capital for commercial purposes by means of issues of new shares.

Entrepreneurs’ Relief is a capital gains tax relief which provides a 10% capital gains tax rate for gains on qualifying business assets, compared with the usual capital gains tax rate of 10% or 20% on other assets (or 18% or 28% on residential property). Broadly, an individual is entitled to claim Entrepreneurs’ Relief on the disposal of shares where they hold at least 5% of the shares and voting rights in the company, they are an employee or office holder in the company and the company’s main activities are in trading. These conditions must be met for the 12 months up to the point of disposal.

Where a company raises funds by issuing shares an individual may lose their eligibility for Entrepreneurs’ Relief due to their own shareholding becoming diluted, resulting in them having a shareholding of less than 5%. Earlier consultation by HMRC raised concerns that individuals were being forced to leave their company early to retain the Entrepreneurs’ Relief rather than staying to support the business after fundraising. This loss of relief could be seen as a negative consequence of the growth and success of a company and HMRC are seeking to address this problem by introducing new rules to allow individuals to retain the Entrepreneurs’ Relief on gains arising up to the date their shareholding is diluted.

The proposed new rules will allow an individual to elect to be treated as disposing and immediately reacquiring their shares at the market value immediately before the issue of the new shares which results in their shareholding falling below 5%. The individual can choose to defer the taxation of the gain until the actual disposal of the shares at a later date and Entrepreneurs’ Relief on the deferred gain will be preserved until that date. If a part disposal of the shareholding is made, then a proportionate amount of the deferred gain will be brought into charge at the date of the part disposal. To be able to preserve the Entrepreneurs’ Relief on the deferred gain the individual must make an election in their tax return for the year in which the shareholding is diluted.

The new rules will apply to gains latent in shares and securities held at the time of a fundraising event taking place on or after 6 April 2019 and the option to crystallise and defer the taxation of the gain will only be available where the individual’s shareholding has fallen below the 5% level as a consequence of an issue of shares made by the company for genuine commercial reasons. It should be noted that the Government does not intend to extend the new rules to trustees.