Changes to Entrepreneurs’ Relief Rules

Changes to Entrepreneurs’ Relief Rules

One point in the recent budget meant that shares which previously qualified for Entrepreneurs’ Relief (ER) will no longer do so.Action is urgently required to review potentially affected structures.

The Issue

ER applies to shares in a trading company (or holding company of a trading group) where the individual owns 5% of the ordinary share capital and voting power.  The definition of a trading company and trading group is set out in the legislation.  Where a company owns shares in a ‘joint venture company’ (JV) special rules apply to treat the company as effectively carrying on an appropriate portion of the JV’s trade.  To qualify the company has to own at least 10% of the shares, and 75% of the shares must be held be no more than five persons.

These rules have historically offered a useful way of obtaining ER for employee shareholders where they otherwise would not have met the 5% test.

e.g. Simon is setting up a new business (“1D Ltd”) and wants to give five employees a 2% stake.  If they hold shares in 1D they won’t qualify for ER.  Instead, the employees set up a shell company, 1D Holdings Ltd with 20% each, which in turn holds 10% of 1D.  Applying the above rules, 1D Holdings qualifies as a trading company and the 5% test is met, therefore the employees qualify for ER.

What’s changed?

 HMRC say that allowing ER in these circumstances is inconsistent with the policy objective of giving relief to stakeholders who hold a substantial interest in a business.

Consequently, from 18 March 2015 the definition of a trading company for ER purposes is modified so as to exclude the JV rules.  The arrangement described above would therefore no longer work unless 1D Holdings qualified as a trading company (or holding company of a trading company) in its own right.

However, in addition to the above, new rules also apply to companies who are members of non-incorporated joint ventures (i.e. partnerships).  From the same date activities which a company carries on through a partnership (including an LLP) are to be treated as wholly non-trading activities.

It is the second of these changes which could have the biggest impact by effectively turning any partnership arrangement which a company is party to into a non-qualifying activity, regardless of whether, viewed holistically, the ultimate stakeholders hold the necessary 5% interest.

e.g. Tom Minnikin sets up 1D Ltd and enters into a joint venture agreement with 1D Holdings Ltd with profits to be split 90/10.  1D Ltd has no other activities.  Under the new rules 1D Ltd is treated as wholly non-trading and (even) Tom Minnikin does not qualify for ER (despite the fact he effectively owns 90% of the business).

Action required

These new rules could have far reaching impact for any type of joint venture arrangement.  The following is a (non-exhaustive) list of structures which could be affected:

  • Management/employee holding companies where the company owns less than 51% of the shares;
  • Trading partnerships where one or more of the partners is a company (including fully corporate partnerships).
  • Joint venture arrangements where one or more of the JV partners is a company.

Advice is required as soon as possible on these structures if the ER status is to be preserved.

 

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