Entrepreneurs' Relief - Wider Benefits for Share Schemes
Nobody likes a tax rise, and the increase in capital gains tax (CGT) announced in the 2010 Budget was no exception. However, there was some good news: the retention of Entrepreneurs' Relief and the increase in the lifetime limit to £10 million. And now it seems that the application of the relief to employee share schemes could be wider than first thought.
The normal rates of CGT are now 28%, or 18% for standard rate income tax payers (where the gain doesn't take them into the higher tax bracket). Entrepreneurs' Relief reduces the rate to an effective 10% on the first £10 million of lifetime gains, a massive saving. But the relief is available only to officers or employees of a company who have held at least 5% of a company's share capital, accounting for at least 5% of the voting rights, for a year or more. Update: This is changing in relation to shares acquired under EMIs from April 6th 2012.
At first sight, this would seem to exclude most participants in employee share schemes. Holders of share options, for example in an Enterprise Management Incentive scheme, don't qualify at all since they hold options, not shares. And employees holding shares, for example through a deferred share purchase scheme, won't qualify unless they hold 5 per cent. of their employer's share capital. Most will not.
A closer look at the legislation, however, reveals that the 5% limit refers only to voting shares. The other rights normally attaching to shares, in relation to dividends and capital, are not mentioned. This raises the possibility that employees could be issued with shares having 5% of the voting rights, but very limited rights in other respects. These shares would still count towards the 5% threshold for Entrepreneurs' Relief.
How could this be used in practice? Let's take the case of option holders, who would normally never qualify. One possibility would be to issue them with shares carrying 5% of the voting rights but with very limited dividend or capital rights. Assuming these shares were held for at least a year, then any shares acquired later through option exercise would also qualify for the relief, even if the latter shares had been held for only a short time between exercise of the option and the share being sold (for example on the sale of the company).
A similar technique could be used to benefit the holders of real shares, as opposed to options, but who hold less than the requisite 5%.
Obviously, even shares with voting rights but very limited other rights would have some residual value. The recipient would have to pay tax on that value, either through PAYE when the shares were received or (if there is no market for the shares) through self-assessment. However, if the value was likely to be significant then the shares could be acquired on deferred terms. This would still provide full beneficial ownership but without the employee having to make a significant up-front cash commitment (for further details on deferred share purchase schemes see here).
Any changes to a company's share capital need to be made carefully - there may be legal, tax and other implications and changes may be needed to any shareholder or subscription agreements. There is also an obvious limit on the number of 5% stakes that can be given out without unacceptable consequences for a company's voting structure. If successive 5% issues are made, the later issues will dilute the earlier ones and possibly cause them to cease to qualify. Finally, it must be recognised that this is a "technical" solution. It is possible that the authorities may decide that the legislation was not intended to work in this way and change the rules. It is also possible that they could make the change retrospective, so that shares issued now would later become ineffective for the purposes of Entrepreneurs' Relief. The costs of issuing the shares (including any tax costs) would however already have been incurred.
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