Insights

In the Budget the Chancellor announced a widening of the qualifying conditions for shares to qualify for entrepreneurs’ relief (ER).

These changes, and the draft legislation that has subsequently been made available, are causing serious uncertainties for shareholders in companies that have different classes of shares in issue (commonly termed ‘alphabet’ shares). It is likely that representations will be made to HMRC to clarify the position, but there will necessarily be a time of uncertainty before HMRC’s intentions in applying the legislation are clarified.

The changes which are causing particular difficulties apply with effect from 28 October 2018 and are:

• With immediate effect, in addition to the requirement to hold 5% or more of the issued ordinary share capital and voting rights in a company, shareholders must also be entitled to at least 5% of the distributable profits, and 5% of the assets on a winding up of the company. Failing either of these tests will mean that ER is lost; and

• When considering if an individual is entitled to 5% of the distributable profits or assets on a winding up, the draft legislation uses a definition that covers more than just ordinary share capital. It is therefore now possible that an individual could hold more than 5% of the ‘economic’ value attributable to ordinary shareholders, but still fail to qualify for ER based on the company having other instruments in place that fall within the definition of ‘equity’. This is likely to affect shares in companies that have growth shares in issue, or shares on which no dividends, or very little dividends are paid, and those with ratchet share structures and convertible securities.

The reason for the difficulties now caused is that where a company has more than one class of shares in issue, whether a particular class of shares receives a dividend (‘distribution’) is usually at the discretion of the directors unless the Articles give a particular class of share a right to dividends. As a result, no individual share class carries an absolute  ‘entitlement’ to at least 5% of the distributable profits – i.e. the directors could vote dividends to one particular share class and not to another.

The legislation as currently drafted therefore suggests that no shares will be eligible for ER in a company in which different classes of share are in issue, unless the Articles state that all shares rank equally for distributions or provide each share class with a right to a proportion of every dividend declared. This is the case even if, historically, dividends have been received.

Even if steps are taken in a company to now correct this position, there will be a gap in the qualifying holding period, which will then commence anew.

Whilst shares acquired under EMI option are unaffected by these changes, if those shares are of a different class, their existence could affect the ER entitlement of other shareholders.

In addition to the above, the minimum holding period for ER to apply is being extended from 12 months to two years for disposals made on or after 6 April 2019.

Please contact us directly to discuss this matter further.