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Budget changes to Entrepreneurs' Relief
- AuthorDanielle Isaac
Budget changes to Entrepreneurs’ Relief highlight benefits of EMI share options
In the Autumn budget 2018, changes to entrepreneurs’ relief were announced which make it harder for companies to give share incentives to employees which benefit from the reduced rate of 10% capital gains tax. Before the Autumn budget 2018, a company could issue shares representing 5% of the share capital and carrying 5% of the voting rights, but not entitling the holder to 5% of the economic right to profit and capital, and these shares would still benefit from entrepreneurs’ relief. From 29 October 2018, that is no longer the case and now the shares must also entitle the holder to 5% of the distributable profits and 5% of the assets on a winding up (the “5% Rule”). However, this 5% Rule does not apply to shares issued pursuant to an Enterprise Management Incentive (“EMI”) scheme and this makes EMI options more attractive than ever.
An EMI scheme is a tax efficient share option scheme that allows companies with assets of up to £30 million to grant options to certain employees to buy shares at a fixed price in the future. EMI schemes are often an effective way of incentivising and motivating a company’s employees to participate in promoting the growth of the company and, potentially, sharing in the successes of the company. These schemes may also be a useful means of attracting new employees.
EMI schemes can have an appealing level of flexibility, enabling the company to select those of its employees who may receive the options, as well as including targets or performance related conditions that must be satisfied before the options can be exercised.
From a tax perspective EMI schemes offer significant benefits for the employing company and the employees:
Provided that certain conditions are met, the company may receive a Corporation Tax deduction on the exercise of EMI options. The relief is given for the accounting period in which the EMI option is exercised and is based on the difference between the market value of the option shares and the price paid for the shares, in each case on the date of exercise.
Under current legislation, provided that the price to be paid for the shares when the option is exercised is not less than the market value of those shares on the date that the option was granted, there will be no Income Tax or National Insurance Contributions (NICs) to pay either when the options are granted, or when the shares are actually acquired.
If the EMI option is exercised and the shares so acquired are sold, any increase in value is subject to Capital Gains Tax (“CGT”). This tax is only triggered when the shares are sold, and there should be cash proceeds available to settle the sums due.
Entrepreneurs’ Relief (“ER”) is a relief from CGT available to individuals (and trustees), which applies to a lifetime limit of the first £10 million of qualifying capital gains on the disposal of a business or certain shares or securities of a trading company. Where certain criteria are satisfied the relief can reduce the rate of CGT applicable to that gain from the current 19% to 10%.
Qualifying Business Disposals (“QBD”)
ER may be claimed in respect of gains made on QBDs such as the following:
- Shares in (or securities of) a trading company;
- The transfer of the whole or part of a business;
- Assets in use on the cessation of a business; and
- Associated personal assets.
The most common QBDs are those of shares in a trading company. ER will apply to disposals of shares provided that, for a period of at least one year ending with the date of disposal, the following conditions are met:
- the company is a trading company (or a holding company of a trading company), which is defined by statute but essentially means that it must substantially conduct its business on a commercial basis with a view to making a profit and carry on trading activities, as opposed to non-trading activities (which may include investment activities);
- the individual must be an officer (either a director or a company secretary) or employee of the company;
- the individual selling the shares holds at least 5% of the company’s ordinary share capital, these shares must give the individual at least 5% of the voting rights in the company and, from 29 October 2019, they must also be entitled to 5% of the distributable profits and 5% of the company’s assets.
Combination of EMI and Entrepreneurs’ Relief
If you grant an EMI option to an employee for the market value of the shares at the date of grant and subsequently sell the company, the employee should only pay 10% CGT on the gain made on the disposal of those shares and there will be no NIC or income tax due. The Company will be able to deduct the gain received by the employee from the sale of the shares from its profits and so reduce its 19% corporation tax liability.
Changes arising from Autumn Budget 2018
The 5% Rule:
It was announced in the Autumn Budget 2018 that for disposals made on or after 29 October 2018, it is not enough to hold 5% of the shares allowing the holder to exercise 5% of the voting rights, they must also be entitled to 5% of the distributable profits and 5% of the company’s assets which are available for distribution if the company is wound up.
Additionally, from 6 April 2019 the holding period, during which the relevant shares must be held before disposal, is being extended from one year to two years.
How do these changes affect EMI schemes?
If shares were acquired on or after 6 April 2012 under an EMI scheme, provided all of the other criteria are met then these shares will qualify for ER even if the shareholder does not hold a total number of shares in the company satisfying the 5% Rule.
Additionally, the required holding period of one year has been extended to two years from 6 April 2019. However, this holding period does continue to include the period from the date that the option is granted, rather than the date on which the option is exercised.
These changes amplify the existing benefits of EMI option schemes making them an even more attractive option for both employers and employees.