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New proposed changes contained in draft legislation could make it easier for entrepreneurs to claim tax relief on gains, but the timing of transactions will be key.

Under current tax rules a shareholder needs to hold 5 per cent of the ordinary share capital and voting rights for the 12 months up to the date of a disposal (in addition to a number of other conditions) to qualify for entrepreneurs’ relief.

As the law stands now, if the company issues new shares which dilute the shareholder below the required 5 per cent, all relief is lost. There has been a concern that this could discourage entrepreneurs from seeking external investment to finance business growth which results in them being diluted below the threshold. 

There are proposed changes in respect of entrepreneurs’ relief which will mean that even if a shareholder has not always held 5 per cent of the share capital disposed, they may still be able to claim entrepreneurs’ relief on some of the gain. The new legislation is intended to become effective from April 2019 and will be relevant to individuals who are diluted below 5 per cent as a result of genuine commercial arrangements. This is a step forward, but (as expected) due to cost constraints only latent gains up to the fundraising event will benefit from entrepreneurs' relief, not those arising after the dilution. 

The new rules are intended to apply in relation to new share issues after 5 April 2019 which result in a dilution. Therefore, the timing of transactions which result in current shareholders being diluted below 5 per cent could be crucial. Companies and shareholders should carefully consider whether there is merit in waiting until after 5 April 2019 to issue shares which dilute someone below 5 per cent.

As is often the case with new legislation, whilst the headlines are positive, the mechanics of how the legislation actually works in reality will need to be carefully considered on a case by case basis. Individuals will need to make sure they meet all of the conditions to qualify under this legislation and also make the relevant elections so that they don’t miss out.

Noel Guilford