Entrepreneurs' Relief

HM Revenue & Customs (“HMRC”) has at last published the draft legislation setting out the detail of the new entrepreneurs’ relief. The new relief was originally announced by the Chancellor on 24 January 2008 in response to the persistent and loud outcry against the central plank of the Chancellor’s measure on CGT reform - the abolition of taper relief and its consequent increase in the tax rate from 10% (for those qualifying for maximum business taper relief) to 18% (the rate that will apply generally to disposals made after 5 April 2008). Click here to read about the CGT changes that are to come into effect on 6 April 2008 and what action may need to be taken before then.

The new Entrepreneurs’ Relief

• It is available for qualifying disposals made on or after 6 April 2008
• It is available on a disposal of shares or securities in a trading company, or the holding company of a trading group, where throughout the period of one year ending on the date of disposal, the person making the disposal:

(a) has been an officer or employee of the company (or a company within the same group); and

(b) owns at least 5% of the ordinary share capital (and is entitled to exercise at least 5% of the voting rights).

An officer includes a non-executive director. The legislation does not specify a minimum number of hours that an individual must be engaged as an officer or employee. However, the office or employment would, of course, have to be genuine.

• Where, in the 3 years prior to disposal of the shares, the company has ceased to be a trading company or member of a trading group, the relief will still be available provided that the officer/employee and 5% holding requirements were met throughout the period of one year up to cessation.
• The relief is also available on a disposal of the whole or part of a trading business by a sole trader and on a disposal of a share in a partnership carrying on a trading business.
• Where the shares/securities in the company or the interest in the business is held in trust the relief will be available on a disposal by the trustees provided that the qualifying beneficiary (one with an interest in possession) has the appropriate involvement in the relevant business.
• Relief is only available in respect of the first £1M of lifetime gains; gains arising prior to 6 April 2008 do not count towards the lifetime limit unless gains from pre-6 April 2008 disposals have been deferred and the relief may be, and is, claimed when the gain is triggered after 5 April 2008.
• Where the relief is claimed, the gain is reduced by 4/9ths so as to give an effective tax rate of 10%. The new standard rate of 18% will apply to gains in excess of the £1M limit.
• Relief goes to reduce the gain before any losses or annual exemption.
• The relief must be claimed (it is not given automatically). Claims must be made by the second anniversary following the tax year in which the disposal is made (for example, for a disposal made on 1 December 2008, a claim must be made by 31 January 2011). A disposal made by a trustee, requires the claim to be made jointly by the trustees and the qualifying beneficiary (see below).

Exchanging of shares for loan notes in the new environment

Shares are often exchanged for loan notes to defer a capital gain. The legislation affords different tax treatment to loan notes according to whether they are qualifying corporate bonds (QCBs) or non-qualifying corporate bonds (NQCBs). Loan notes can be structured in either way. In recent years loan notes have tended to be structured as NQCBs where at the time of exchange full business asset taper relief has not accrued but it is envisaged that the conditions for obtaining business asset taper relief will continue to be satisfied during the period of holding the loan notes. Where this is the case the taper relief clock continues to run so that full business taper relief is obtained by the time the loan notes are redeemed and the capital gain is taxed. In contrast where the loan notes are QCBs the taper relief clock stops on exchange.

Post 5 April 2008 exchanges

Different rules will apply for QCBs and NQCBs. Capital gains will still be able to be deferred but the date at which the conditions for entrepreneurs’ relief need to be satisfied differ and therefore the decision to take QCBs or NQCBs will continue to be an important one.

In the case of QCBs the new relief will be available if at the time of the share for loan note exchange the conditions are satisfied. Accordingly, when the QCBs are subsequently redeemed the relief will be available even though the conditions (in particular, the conditions that the taxpayer is an officer or employee of the company and holds 5% of the ordinary shares in the company) are not satisfied at the date of redemption (as long as they were satisfied at exchange).

In the case of NQCBs the taxpayer would have to satisfy the conditions as at the date of redemption. However, the taxpayer may elect to disapply the normal reorganisation treatment (under which the gain on the shares is rolled over into the loan notes and therefore deferred) so that the gain becomes chargeable on exchange and the relief claimed at that point. In that case, tax may become payable before the notes are redeemed.

Going forward we are likely to see loan notes structured as QCBs. This will ensure both tax deferral and availability of the relief being determined at exchange rather than redemption of the loan notes (where it is less likely that the taxpayer will satisfy the conditions).

Pre-6 April 2008 exchanges where the loan notes are to be redeemed after 5 April 2008

Where the loan notes received were QCBs the gain on the shares held over would be eligible for the relief if the conditions for the relief were met at the time of the exchange. In the case of NQCBs the relief would only be available if the conditions are satisfied at the date of redemption.

Therefore, in these circumstances, the relief would only be available if throughout the period of 1 year up to the date of redemption:

(a) The issuing company is a trading company or the holding company of a trading group;

(b) The taxpayer owns at least 5% of the ordinary share capital of that company (and those shares give at least 5% of the voting rights); and

(c) The taxpayer is an officer or employee of that company (or a company within the group)

EIS reinvestment relief

EIS reinvestment relief is available (subject to various conditions) where an individual reinvests the sale proceeds from the disposal of a capital asset in acquiring shares in a qualifying company. The gain on the sale of the asset is deferred until the disposal of the shares in the qualifying company. Where a gain that has been deferred is triggered after 5 April 2008 entrepreneurs’ relief may be available where the sale of the original asset would have met the conditions for the relief at the time of the original sale.