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Spring Statement 2018 - Financing growth in innovative firms

When an individual sells shares at a profit they normally have to pay Capital Gains Tax (CGT). The rate of tax is usually 20% but can be 10% if the disposal qualifies for Entrepreneur’s Relief (ER). To qualify for ER a number of conditions need to be met:

  • the claimant has held at least 5% of the company’s ordinary share capital;
  • the claimant has been able to exercise at least 5% of the voting rights in the company;
  • the claimant has been an employee of or office-holder in the company, or in one or more companies which are members of the trading group; and
  • the company is a trading company, or the holding company of a trading group.

All of the conditions need to be met at the time of sale and for the previous 12 months.

A problem with this is that one of the main ways a company has for raising funds to finance its growth is to issue shares. This dilutes the existing shareholders which means a person with over 5% of the shares can suddenly find themselves with less than 5% and at no fault to themselves they suddenly cease to be eligible for ER. This loss of relief can act as a disincentive to raising funds by way of issuing more equity.

HMRC have today issued a consultation document on a possible way to deal with this issue. Their proposed solution is to allow the shareholder to elect (the election) to crystallise a gain immediately before the dilution. The shareholder is then treated as disposing of their shares and reacquiring the shares at market value. The immediate gain will be eligible for ER as they will hold 5% or more of the shares. When the individual comes to sell their shares there will be a further gain on the shareholder on the proceeds received less the market value at the date of election which will not be eligible for ER (as less than 5% of the shares will be held). The election would be made in the individual’s self-assessment return for the tax year of the deemed disposal.

An issue arising from this proposal is that when the election is made as there is only a deemed disposal the shareholder may not have the funds to pay the tax. As such it is also proposed to allow an election to defer that taxable gain until a specified event or time the conditions of which are subject to discussion and consultation.

One thing that strikes me with these proposals is that there will be a requirement to value the shares immediately before the valuation. The valuation of private shares is an art rather than a science and one can foresee a number of disputes going forward with HMRC, though if the deemed disposal is just before a share issue the new share issue may provide an indication of price.

It should be emphasised that this is only a consultation at present. HMRC are looking for views by 15 May 2018 and propose issuing draft legislation in the summer of 2018 with the proposals taking effect from April 2019.

If you would like to discuss the disposals of shares, please get in touch with me or your usual contact at Mercer & Hole.

 

 

Date: 13th March, 2018
Author: David Hadley

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