The March 2015 Budget contained important changes to the Entrepreneurs’ Relief (‘ER’) rules affecting clients with management holding companies. Action may urgently be required to ‘repair’ affected structures.
Tax Biters will be familiar with the main ER requirements in relation to shares i.e. that throughout the period of 12 months leading up to a disposal of the shares:
(a) The company must either be a trading company or holding company of a trading group; and
(b) The individual must hold 5% of the ordinary share capital and voting rights and be an officer or employee of the company.
Previously it was possible to use a holding company to allow managers to satisfy the above requirements whilst being entitled to less than 5% of the economic value of the company (the test being by reference to ordinary share capital as opposed to dividend/capital rights etc.).
E.g. Say a company (‘Tradeco’) wanted to issue a 10% shareholding to 5 key managers (i.e. 2% each). To get round the 5% rule the managers would group together into a holding company (‘Holdco’) and it would subscribe for 10% of the shares in Tradeco. Provided Holdco held at least 10% of the ordinary share capital of Tradeco then (under special “joint venture” rules) Holdco would be treated as carrying on a proportionate amount of Tradeco’s activities. If Holdco did nothing else it would be treated as wholly trading and as the managers would each have a 20% shareholding in Holdco they would also satisfy the 5% test required for ER.
From 18 March 2015 the joint venture rules are specifically disapplied for ER purposes with the consequence that Holdco no longer satisfies the requirement of being a trading company. Any clients with this type of structure may find that their ER tap has been turned off overnight!
How do we turn ER back on?
Whilst Holdco now no longer qualifies as a “trading company” this does not matter if it satisfies the definition of a holding company. The rules here are unchanged – the company simply has to own 51% of the ordinary share capital of one or more subsidiaries. As the definition of “ordinary share capital” is by reference to nominal share capital (i.e. not including share premium) one solution would be to issue Holdco with further shares with a high nominal value to ‘bump’ it up to the 51% threshold.
e.g. In the above scenario, assume Holdco originally held 10 of the 100 £1 shares issue. By issuing 10 new £10 ‘B’ shares to Holdco it would own shares with a nominal value of £110 out of a total share capital of £200 (55%) and therefore qualify as a holding company.
Careful consideration needs to be given to undertaking a reorganisation of shares, and particularly to ensure that other shareholders reliefs are not prejudiced.
There are other possible solutions such as replacing the managers’ shares with EMI options (any size shareholding of which can now qualify for ER).
The key message is that if ER has been switched off as a result of these changes action will urgently need to be taken to restart the 12 month clock.
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