When to join the section 169 Q(ueue)
25th August 2017
Posted in Articles, Business Tax, Featured Articles by Tom Minnikin
“It would be no exaggeration to say that Entrepreneurs’ Relief (ER) has been the most valuable tax relief in recent times.”
Andrew Marr, Tax Journal, Issue 1310
The following example (which comes from a real life case) highlights one of the problems, and potential solutions with ER when share reorganisations take place.
The scenario
Magpie Group comprises of two (standalone) trading companies – Black Ltd and White Ltd. There are a group of common shareholders who own the majority of the shares, but small minority stakes are held in each company by management personnel. Alan is a 5% shareholder in Black Ltd and Les is a 5% shareholder in White Ltd, having been issued with shares at par when the companies formed. Both companies are worth £10 million, valuing their shares at £500,000 each. The two individuals are higher rate taxpayers.
The owners decide to float the company on AIM, selling half their shares to the market. In preparation, the two companies are consolidated under a new holding company, ‘Magpie Plc’, via separate share-for-share exchanges. Clearance is obtained from HMRC that the reorganisation provisions (section 127 TCGA 1992) apply, such that no gains are triggered on the roll-ups (and the new shares stand in the shoes of the old shares). Alan and Les receive 500,000 £1 shares out of a total issued share capital of £20 million.
The issue
Readers will be familiar with the various conditions that have to be satisfied for ER in respect of shares in a company. Broadly, it requires the individual to be an employee/officer of the company, to have held 5% of the ordinary share capital and voting power, and for the company to be trading. Each of the conditions must be met throughout a continuous 12 month period leading up to the disposal of shares.
Whilst Alan and Les clearly qualified for ER in respect of their original shareholdings, they will not qualify for ER in respect of the new shares in Magpie, as they now only own 2.5% of the shares/votes. This is due to the dilution of shareholdings when the two subsidiary companies consolidated.
In normal circumstances it might be possible to get round this by issuing Alan and Les with a separate class of share in Magpie (with a higher nominal value and voting rights) but for various reasons this route was deemed not to be viable.
Electing for ER
Fortunately, this type of situation was pre-empted when the ER legislation was drafted. Under section 169Q, individuals can elect to disapply share-for-share treatment in order to claim ER instead. This is an ‘all or nothing’ election, meaning that the shareholders have to trigger a gain on all their original shares in order to benefit from the 10% tax rate. However, in this instance, Alan and Les were immediately selling half their new shares to the market. By not making the section 169 election it would result in the same, £50,000, upfront liability (£500,000 x 10% under ER vs £250,000 x 20% CGT without ER), but with further CGT to pay on the gain attaching to the shares retained when these are eventually sold. By making the election, these shares will effectively be uplifted in value.
The choice of whether to make the election will vary from case to case. For example, if the gains had been much lower then the conclusion might have been not to claim ER, on the basis that shares could be sold in tranches to utilise additional annual exemptions.
However, the key take home message is that this important election should not be overlooked. The normal time limit of one year from the filing deadline applies to make the claim. It really is no exaggeration …
