Budget changes to Entrepreneurs’ Relief (“ER”) and Alphabet Shares


An unexpected announcement in the autumn Budget means that business owners who hold alphabet shares, which had previously qualified for Entrepreneurs’ Relief, may wish to look into new qualifying criteria, particularly when considering the sale of their business or shares.

ER reduces the capital gains tax payable on the disposal of shares in a taxpayer’s business on gains of up to £10 million during their lifetime, subject to certain conditions.

Alphabet shares are simply different classes of shares. Although they often rank side by side with each other in some respects (i.e. they have the same voting rights on winding up, for example), they are often used as a planning tool because income can be voted separately for each class of shares. This avoids the use of dividend waivers, which HMRC sometimes attack under the settlements legislation (they suggest that the person giving up their right to a dividend has settled their income rights on the other shareholders.)

Under new rules introduced in the Budget, a shareholder must be entitled to at least 5% of a company’s distributable profits and assets if the company is wound up to qualify for ER. This is in addition to the existing rule by which the shareholder must hold at least 5% of the issued share capital and voting rights.

Where a company has alphabet shares, whether classes of shares are paid a dividend is usually dependent on the discretion of the directors. As a result, none of the share classes has an entitlement to income, so under the new rules, all the shares would fail the new test and not be eligible for ER.

This can be remedied by putting dividend entitlements in place, however the shares will need to be held for a further two years before they can satisfy the ER ownership period requirements. (The ownership period qualification was extended in the Budget from one to two years for disposals on or after 6 April 2019.)

Caution needs to be exercised as to whether a shareholder qualifies under the 5% of distributable profits and assets requirements because the draft legislation uses a definition of “equity” covering more than ordinary share capital.

It would be wise for all business owners share and debt structures (that is, debt other than ordinary bank finance) to be reviewed in the light of this change with a view to mitigating the impact of the new rules.

We understand that it is likely that representations will be made to HMRC on the effect of the new rules; the comments posted here are on the draft legislation as it stands.

If you would like to discuss your options with one of our Tax experts, please contact Richard Proctor, Chris Richardson or Sally Farrow on 0330 024 0888.

Richard Proctor
Partner – Tax Advisory

Author:

Richard Proctor