Entrepreneurs' Relief on diluted shareholdings

Published: Friday 16 March 2018

The Chancellor announced during the 2017 Autumn Budget that the government would consult on extending Entrepreneurs’ Relief (ER) to individual’s with diluted shareholdings following a share issue to raise company funds. The objective being to promote enterprise by ensuring that investors are not penalised as a result of planned growth of the company.

A consultation has since been released with further details of how these proposals will work.

ER offers a 10% capital gains tax rate for disposals of qualifying business assets, compared to the higher rate of 20%. Certain conditions have to be met to claim ER including that the individual has held at least 5% of the company’s ordinary share capital for at least 12 months prior to the disposal.

A company looking to grow the business may opt for a share issue to raise additional finance from new investors. This could, however, lead to a dilution in the shareholding of existing shareholders below the 5% requirement.

As a result, the government believe that this could lead to individuals exiting the business early whilst they can still claim ER or not going ahead with the fundraising exercise, both of which could stunt growth and development of the business.

The government has proposed to introduce a new election such that the individual will be treated as selling and then reacquiring their shares on the date immediately prior to the dilution.

ER will then be available on the gain based on the market value of the date of the deemed disposal providing the following conditions are also met:

  • the individual must have satisfied the relevant conditions to claim ER at the time they are deemed to have disposed and reacquired their shares; and
  • the dilution of the individual’s shareholding must be due to an issue of shares made by the company for a genuine commercial purpose.

As this election will essentially create a ‘dry’ tax charge, the government are also proposing that this gain can be deferred until the shares are actually disposed of. At this time, any further gains in excess of the market value on the date of the deemed disposal will be taxed at the standard rate. It is also proposed that relief will be given if the gain is deferred but the shares are subsequently sold for less than the market value at the deemed disposal.

The new rules are expected to apply to gains in shares held at the time of fundraising events taking place on or after 6 April 2019.