Entrepreneurs' Relief (ER) has been with us for many years and provides a valuable relief - only a 10% rate of CGT on lifetime gains of up to £10m. However, as with everything in the world of tax, there are always niceties to be observed in order to ensure that you qualify for ER.
HMRC have been criticised by Parliament for not checking enough ER claims and it appears that HMRC are now taking more interest in such claims. The main area which HMRC seem to be focusing on is ER claims on share disposals. Briefly, ER will apply to gains on disposals of shares (and securities) in a trading company (or the holding company of a trading group) provided that the individual making the disposal:
- has been an officer or employee of the company, or of a company in the same group of companies; and
- owns at least 5% of the ordinary share capital of the company and that holding enables the individual to exercise at least 5% of the voting rights in that company
throughout the year leading up to the disposal of the shares.
Two recent cases illustrate the dangers of failing to meet these criteria.
In the first, the company concerned was formed in 1995 and the taxpayer was one of the founding shareholders and directors. In 2009 it was agreed that the company would purchase the majority of the taxpayer's shares. It was also agreed that the taxpayer's employment would be terminated, that he would receive an ex-gratia payment and that he would resign as a director.
In May 2009 a general meeting approved the share buy-back. However, all the documents suggested that the employment had terminated as at February 2009. After opening an enquiry HMRC concluded that the taxpayer was not, throughout the period of one year ending with the disposal of his shareholding, either an officer or employee of the company and this was upheld by the Tribunal.
In the second case, two couples owned a company equally. The couple concerned owned 33% of the shares, with the balance being owned by the second couple, so at this stage they clearly met the 5% test. However, the problem arose when a loan of £30,000 by the other shareholders was converted into 30,000 new shares.
HMRC argued that the taxpayers had not, throughout the period of one year ending with the date of the share sale, held at least 5% of the ordinary share capital of the company. This was because during part of that one year period, the ordinary share capital had included the 30,000 new shares, so that each of the taxpayers had held only 33 of 30,033 £1 shares, 0.001% of the ordinary share capital, not the 5% of the ordinary share capital and at least 5% of the voting rights required by the ER legislation.
The taxpayers used a clever argument to negate this argument but HMRC don't agree and have appealed the case to a higher court.
Of course, if either of the above problems are identified pre-sale, a further 'clean' 12-month period can be completed but, in reality, this may be easier said than done. ER is important to many so a quick review of your clients' affairs may nip any problems in the bud.