Entrepreneurs' Relief (ER) is a very valuable capital gains tax relief available to taxpayers who make qualifying business disposals.
The main occasions where ER will be available are on the disposal of a trading business or on the disposal of shares in a trading business.
There are some very strict conditions for an ER claim. In the case of a share sale this must include a minimum holding of 5% of the ordinary share capital of the company. Failure to hold 5% will prohibit a claim for ER.
The problem for business owners
Assume that a company wishes to raise funds through a new issue of shares. This can be undertaken in a number of ways. One option is to issue redeemable shares to the value of the funds injected, which carry no capital dividend or voting rights. As the shares do not carry these rights, can they be classed as ordinary share capital? The answer to this is yes, as the case of E McQuillan vs HMRC concluded:
In this case, Couple A each held 33 “normal” shares in the company, with Couple B each holding 17. Couple B loaned £30,000 to the company, and the bank required this to be converted into share capital, so 30,000 redeemable shares, bearing no dividend, voting or capital rights, were issued to the second couple. The company redeemed the shares before being sold.
HMRC argued that the redeemable shares formed part of the company’s ordinary share capital, so the taxpayers held less than 5% so were not entitled to ER.
The First Tier Tribunal found for the taxpayer, which HMRC appealed, and the Upper Tribunal overturned the decision and found in favour of HMRC.
As the above scenario is clearly unfair, HMRC are looking to legislate that where funds are raised for a commercial purpose through the issue of new shares, access to ER where holdings dip below 5% could still be available.
This is a welcome move by HMRC and if implemented will remove what is clearly an unnecessary consequence of the legislation.
You can learn more about ER by reading our factsheet or contacting our tax team on 0161 476 8276 or firstname.lastname@example.org for expert advice.