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Budget stuff • Business Tax • Capital Gains Tax • Entrepreneur's Relief • Personal tax • Share Schemes • Tax Planning • Tax Relief
Cap on CGT-free relief for ESS share scheme participants
By RJP LLP on 25 April 2016
New rules came into effect on 17th March 2016 that restrict the tax relief available on shares awarded through the Employee Shareholder Status (ESS) share scheme. ESS has been popular with companies that do not qualify for other HMRC approved share schemes such as EMI; for example, those in excluded sectors such as professional services or those having in excess of 250 employees. We have blogged about ESS and the pros and cons of this scheme vs EMI in detail in the past.
Until this change, the ESS enabled an employee who received a share award of up to £50,000 in value to receive unlimited gains on disposal which were free of capital gains tax. In return, the employee waived certain statutory employment rights, for example redundancy rights and an entitlement to take their employer to employment tribunal. The ESS rules have now been restricted and only the first £100,000 of gains are tax free with any remaining gains being taxed at the relevant rate of capital gains tax. This change was introduced in the Budget 2016 and took effect from midnight on 16th March. All ESS share awards are now governed by the new rules, however shares issued prior to the 17th March 2016 will not be subject to the new restriction.
New rates of capital gains tax and the impact
In addition to this change, there was also a reduction in the rates of capital gains tax; from 6th April 2016, gains on qualifying capital investments will be taxed at 20% where they fall within the individual’s higher rate tax bracket (previously 28%) and at 10% where they fall within the individual’s basic rate tax bracket (previously 18%). These reduced rates cover all circumstances with the exception of chargeable residential property disposals by individuals, which remain taxable at the previous rates of 28% and 18%.
ESS shareholders may also of course qualify for entrepreneurs’ relief if the company is a trading company in which they are a 5% shareholder and employee.
The effect of the restriction to relief on ESS gains, coupled with the reduction in the rates of capital gains tax, means that employees receiving ESS shares will effectively be trading certain employment rights for maximum tax relief of £10,000 (£100,000 x 10% if they are entitled to entrepreneurs’ relief) or £20,000 (£100,000 x 20% if they are not entitled to entrepreneurs’ relief).
Example showing interplay between ESS and ER taxation
The following example highlights how ESS and ER work together:
- Bill Jones is a senior director at ABC Ltd, a private equity owned software company. He is awarded shares with a value of £30,000 through the ESS and holds onto them for 5 years. After this time, the private equity firm sells ABC Ltd to another software provider for £100,000,000. Bill’s shares have significantly increased in value and his total gains are £200,000. He pays no capital gains tax on the first £100,000 of gains because he can exercise his ESS exception. Then, he pays 10% on the remaining gain, because as an employee he is able to use entrepreneurs’ relief within his lifetime £10m entitlement. His final tax bill is therefore £10,000 on a total gain of £200,000.
To discuss employee share schemes such as ESS and EMI, or to consider the impact of a share disposal following the recent Budget, please contact Lesley Stalker by emailing las@rjp.co.uk.
