Have you lost your Entrepreneurs’ Relief?

8 November, 2018
by: Cripps Pemberton Greenish

The dust has barely settled on the Chancellor’s budget speech, but significant problems have emerged with the new stringent tests for qualifying for Entrepreneurs’ Relief (ER).  If implemented as per the draft legislation, thousands of shareholders may have lost the benefit of ER as of Budget Day (29 October) and may only be able to recover it by amending existing documents, introducing new documentation, or a combination of both.


The new rules

The draft new rules provide that in addition to being an employee/director, having 5% of the votes and 5% of the ordinary share capital, the shareholder must now be entitled to:-

  • 5% of the profits available for distribution; and
  • 5% of the assets a vailable for distribution on a winding up.

The rules were aimed at ER planning (carried out mostly for key managers in private equity-backed companies) which involved the creation of special classes of shares which met the 5% tests for share capital and voting rights, but which had no entitlement to dividends and less than 5% of the capital distribution rights. This planning enabled the individuals to get ER on share percentages of much less than 5%. 

It was clearly the intention of the Government to put a stop to this and its impact note accompanying the draft legislation said that less than 1000 individuals would be affected by the changed rules.


The problem

The problem is that the new rules won’t just remove ER in the situation described above.

Companies commonly have more than one class of shares, mostly for entirely commercial reasons and under the articles of association of such companies or a shareholders’ agreement, such share classes may not specifically prescribe the ‘entitlement’ to the dividends and capital returns required by the new rules. In these circumstances ER may have been lost in situations going far beyond the specific structures the government was looking to target. 


Alphabet Shares

A significant concern is for those whose companies have ‘alphabet shares’. Typically used by family companies, such shares enable the directors to determine which class of shares, in any given year, is paid a dividend. In such a case, it would be impossible to say that any share class was entitled to 5% of profits available for distribution, so on the face of it ER has been lost by all shareholders.


Waiver of Dividends

It is not uncommon in a shareholders’ agreement or as part of the covenants given in respect of a loan that a class of shareholders, or all shareholders, agree to forgo dividends until repayment is made of certain preferred shareholders or until a loan is repaid.    Depending on the exact terms of those agreements, it might be said that those shareholders were not entitled to 5% of profits available for distribution.  

In small companies, one shareholder often waives dividends to benefit another – those with ongoing waivers will have to consider whether the wording of the waiver is such that they are relinquishing an entitlement to dividends and thus risking losing their ER.


Dividends linked to underlying trades

A company may have share rights where different classes of shares receive unequal dividends depending on the profits of underlying trades (e.g. divisions of the business or subsidiaries). Such share classes may not be entitled to 5% of profits available for distribution.


What to do?

It is becoming clear that the draft legislation goes far further than anticipated, or perhaps intended.  As we can anticipate significant lobbying against this change, we would hope that either the legislation is amended as it passes through Parliament, or HMRC issue guidance confirming that non-avoidance situations, such as those above, are not targeted.

For those with shares that are affected, and if a sale is in view, we suggest taking advice as to whether any changes can be made to articles of association or other commercial agreements to correct the position as soon as possible.

For those who can wait and see, it may be best to hold fire to see if the draft legislation is withdrawn or  amended in the committee stages of the Finance Bill.


How can we help?

We will be monitoring the situation closely and will be writing to HMRC to ensure we are at the forefront of any announcements, or changes to the draft legislation.  If you would like to receive updates from us on changes to ER, please contact sam.jones@crippspg.co.uk.

We will also be advising clients requiring early advice on any changes to the legislation, to improve their ER position.


If you need further advice on your entrepreneurs’ relief on your share rights please contact elizabeth.middleton@crippspg.co.uk, craig.bowers@crippspg.co.uk, or your usual Cripps contact.