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The Conservative Party’s 2019 election manifesto contained a promise to ‘review and reform’ Entrepreneurs’ Relief (“ER”) and claimed that the relief has not ‘fully delivered on its objectives’. This is a further blow to ER following restrictions on qualifying eligibility which were introduced by the 2018 Budget.

The Chancellor has announced he will give his first budget on 11 March 2020. How, and the extent to which, ER could be reformed therefore remains to be seen, however we can be fairly certain that any changes will not be beneficial to the taxpayer and many commentators are predicting the total abolition of the relief.

This article covers the following matters:

  • An overview of the existing ER rules;
  • Possible changes which could be implemented by the government in 2020;
  • Action to take to mitigate any increased Capital Gains Tax (“CGT”) exposure.


ER is a CGT relief available to individuals on the disposal of trading businesses, interests in partnerships and shares in trading companies. This article will deal exclusively with issues concerning shares and securities held in trading companies.

The higher rate of CGT is currently 20%, however where ER is available, the rate is reduced to 10% on the first £10m of eligible gains realised by a taxpayer in their lifetime. The relief is therefore extremely valuable to business owners and management shareholders and can ultimately save an individual up to £1m in tax.

A brief history of ER

ER was introduced in 2008 to replace Business Asset Taper Relief. For a number of years, a shareholder was eligible for ER if, for 12 months prior to a share disposal, they held 5% of the ordinary share capital of a trading company by nominal value, 5% of the voting rights and were an officer or employee of the company.

In October 2018, restrictions to the relief introduced. The new rules are fairly complex, however the key purpose from HMRC’s perspective was to ensure that a shareholder claiming ER holds at least 5% of the economic rights and entitlements rather than merely 5% of the votes and 5% of the share capital by nominal value.

One of the key effects of these changes was to  significantly curtail the tax benefits of “growth shares” i.e. shares on which capital value would only be received above a certain hurdle and which can be issued to employees much more cheaply and without existing shareholders disposing of any of their inherent value.

The qualifying period was also extended from 12 months to 24 months from April 2019.

It should be noted that the rules set out above do not apply to qualifying Enterprise Management Incentive (“EMI”) shares or share options. An EMI shareholder can qualify for ER with less than a 5% interest in the company as long as the options were granted two years prior to a disposal of the shares.

The government also introduced in 2018 a protection for individuals who held at least a 5% shareholding but whose shareholding was then subsequently diluted below 5% by a fresh share issue. In these circumstances, the shareholder could elect to crystallise the capital gain in their shareholding up to the point the shareholding is diluted. This will often result in a “dry” tax charge i.e. a liability when sale proceeds have not actually been received, and so there is an additional election available to defer the tax liability until the time the shares are actually disposed of.

Reasons for the restriction of the relief

One of the key reasons for the introduction of ER was to incentivise and reward genuine entrepreneurship. Furthermore, it was anticipated that reduced CGT rates on business assets would incentivise entrepreneurs and business owners to invest more in their businesses and stimulate economic growth.

A report published in October 2019 by the Institute for Fiscal Studies (“IFS”) called for ER to be scrapped and claimed that the relief is not achieving its intended purpose. The report argued that, rather than motivating business owners to reinvest into the growth of businesses, ER is instead encouraging the stockpiling and retention of profits in a company so that the funds can be extracted at a 10% tax rate on an eventual sale rather than being subject to higher rates of income tax on dividends.

The IFS estimates that ER costs the government £2.4bn annually relative to taxing capital gains at the full 20% CGT rate. The cost to the government would be even higher if calculated relative to the taxation of dividend income or increased employment taxes inevitably generated by business growth.

Furthermore, it has been noted that business owners benefiting from ER on the sale of their businesses are not necessarily using the net proceeds to reinvest in other trading businesses and stimulating economic growth, but are more likely to make non-trading investments such as growing commercial or residential property portfolios. Given the introduction of Investors’ Relief in 2016 and other reliefs such as the Enterprise Investment Scheme and Venture Capital Trust reliefs, there are, arguably, reliefs more focused on encouraging entrepreneurship than ER.

Potential upcoming changes

Total abolition

A number of commentators have interpreted the government’s proposed ‘review and reform’ of ER to mean total abolition. If this were the case, capital gains on the disposal of shares in trading companies would be subject to CGT at 20%, effectively doubling the tax liability on a business owner selling a business for up to £10m.

Lifetime allowance reduction

It may be the case that the relief is not killed off entirely, but further curtailed. Having already attacked and increased the qualifying period and the economic value of the equity holding, the Chancellor may turn towards the lifetime limit, for example by reducing the £10m allowance. It should be noted that from 2008 – 2010, the lifetime limit was £1m, and was increased to £2m and then £5m before being set at £10m from April 2011. This would allow the Government a positive political message of reducing the value of tax reliefs for the very wealthy but may have limited impact in practice since most claimants of ER use only a fraction of their lifetime limits.

Increased shareholding requirement

Alternatively, the definition of ‘personal company’ could be restricted further by increasing the 5% threshold to, say, 25%. A number of commentators have questioned whether an employee shareholder who holds 5% of the equity in their employing company can genuinely be classed as an ‘entrepreneur’ – a 5% stake does not give any significant influence over the management of the business and is not necessarily indicative of the individual having taken a significant commercial risk associated with entrepreneurship.

HMRC interpretation of diluted shareholdings

The Chartered Institute of Taxation have recently stated their intention to ascertain HMRC’s view concerning the dilution of shareholdings prior to a company sale following a recent change to HMRC’s guidance.

This concerns situations where an individual’s shareholding is diluted to below 5% on the day of a sale of the shares. The most common scenario for this to occur would be on the exercise of share options by management immediately prior to a transaction.

Previously, HMRC’s view was that the dilution of an individual’s shares by the exercise of options, or a similar event, on the day of the sale, which resulted in the shareholder owning less than 5% of the share capital, would not prevent ER from being available. However, following the changes to ER introduced in October 2018, HMRC have changed their interpretation such that a same-day dilution could prevent a shareholder from qualifying for ER.

The shareholder may still be able to crystallise ER using the protective anti-dilution elections set out above, though it should be noted that the election is only available when the newly issued shares are issued for consideration consisting wholly of cash and are issued for genuine commercial reasons.

Protective action which could be taken

It is obviously difficult to determine any action which can be taken ahead of any changes to the relief in the 2020 Budget. It is currently unknown whether changes will take effect immediately, from the start of the new tax year, or whether they would be subject to prolonged consultation before any legislative changes are implemented. However, based on the expected and potential changes to ER, some of the key issues for shareholders to consider are as follows.

Diluting shareholdings

Companies in which employees hold share options should review the share capital structure to determine the percentage shareholdings held by all shareholders on a fully enlarged and diluted basis. This will enable shareholders to determine whether their ER position may be at risk in the event of option holders exercising their options and diluting them below a 5% holding. We would advise clients and shareholders to whom this is relevant to contact Claritas to discuss any specific action which could be taken.

Loan note holders

A number of business owners may hold both shares and loan notes in their company as a result of an historical transaction such as a management buy-out or external investment. Typically, if a shareholder is eligible for ER, they would have held over the gain on the previous transaction which means that loan notes are only subject to tax when they are redeemed.

However, an election can be made to pay tax on the loan notes from the date of the transaction. This may be valuable to loan note holders as a method of banking ER and protecting against a change to the rules which would tax loan note repayments at higher rates. It should be noted that the election will result in a dry tax charge and the tax will carry late payment interest, however in many cases this will be attractive if the alternative is an increased rate of CGT in the future.

Loan note holders have until 31 January two years following the end of the tax year to make the election. Therefore, individuals who hold loan notes as a result of transactions which took place between 6 April 2017 and 5 April 2018 will have until 31 January 2020 to make the election. We would advise any client in this position to get in touch with their contact at Claritas as soon as possible.

Loan note holders who acquired their loan notes before 6 April 2017 could consider whether their loans could be redeemed prior to the changes taking effect in order to accelerate the tax charge.


Finally, shareholders who are able to control the destiny of their shares and the timing of any disposal may wish to undertake a transaction before the changes take effect.  This could include, for example, accelerating the sale of shares to managers or family members as part of a succession plan.

Finally, for those who are unable to do anything to claim ER, we can only offer the cold comfort that CGT rates are still far lower than income tax rates and are lower than the rates which applied prior to the introduction of the old Business Asset Taper Relief in 1998.  They are also considerably lower than would have been the case had John McDonnell been presenting the Budget this year!

If you would like to discuss this further, please contact your usual Claritas contact or call us on 0121 726 1717 or 0161 270 3011.

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