Investors And Entrepreneurs – There’s A (Tax) Difference!
By Mark McLaughlin
Mark McLaughlin highlights five key differences between capital gains tax investors’ relief and entrepreneurs’ relief.
Individual business owners may be aware that a capital gains tax (CGT) rate of only 10% can apply if entrepreneurs’ relief (ER) is available on qualifying business disposals, up to a lifetime limit of £10 million.
A newer and less well-known relief, investors’ relief (IR), also provides for a reduced CGT rate of 10% on lifetime gains of up to £10 million, subject to the relief conditions being satisfied. IR applies to certain share disposals by individuals (or trustees in some instances), whereas ER can also apply to other business assets.
Despite having the same CGT rates and lifetime limits, IR and ER are separate and distinct reliefs, each with their own set of rules.
Here are five key differences between the reliefs (all references are to TCGA 1992).
1. The shares
For IR purposes, qualifying shares must (among other things) have been ‘subscribed for’ as defined by the person making the disposal and must have been issued on or after 17 March 2016 (ss 169VB(2), 169VU).
There is no subscription requirement for ER purposes (e.g. shares can be bought from another shareholder), and it does not matter whether the shares were issued before or after 17 March 2016.
2. How long?
The IR rules generally require a holding period of at least three years between the shares being issued and the disposal (s 169VB(2)(h)), or slightly longer if the shares were issued between 17 March 2016 and 5 April 2016.
By contrast, for ER purposes shares generally need to be owned by the individual throughout a minimum period of at least one year, ending with the date of disposal (although a longer ownership period may be necessary to secure ER in some cases where the company has ceased trading). However, relief may be due after a shorter ownership period of ‘relevant enterprise management incentives’ (EMI) shares, where the disposal is at least one year after the EMI option was granted (s 169I).
Special IR and ER rules can apply to company reorganisations, which are beyond the scope of this article.
3. Officer or employee
The IR rules discourage investors from being officers or employees of the company issuing the shares (or a connected company). The general rule is that the investor (or a connected person) cannot be a relevant employee of the company at any time in the ‘share-holding period’ (i.e. broadly the period between the acquisition and disposal of the shares) (s 169VB(2)(g); separate rules apply to trustees). A ‘relevant employee’ is broadly someone who has been an officer or employee of the issuing company (or connected company) at any time in the ‘relevant period’ (i.e. the share-holding period).
However, there are two exceptions to this general rule. The first applies to an ‘unremunerated director’ (as defined) of the issuing company (or a connected company) where they (or a connected person) prior to the relevant period have not been connected with the issuing company or involved in carrying on the whole or any part of the trade, business or profession carried on by the issuing company (or connected company).
The second exception is if someone becomes an employee (not a director) of the issuing company (or a connected company) more than 180 days after the commencement of the relevant period where, at the beginning of the relevant period, there was no reasonable prospect that the person would become an employee (s 169VW).
On the other hand, the ER rules require that the individual must have been an officer or employee of the company (or trading group member(s)) throughout a qualifying period of at least one year (see also 2 above).
4. Loss of relief
For IR purposes, if an investor subscribes for shares that are eligible for the relief but receives ‘value’ as defined (other than insignificant value) from the company within a ‘period of restriction’ (i.e. one year before to three years after the shares are issued), the shares are generally treated as being disqualified (Sch 7ZB).
There is no similar exclusion from ER if a shareholder receives value from the company, although relief may be restricted or denied on an ‘associated disposal’ (see below) to the extent that rent is paid to the individual (see s 169P).
5. Personally-owned assets used by the company
No IR is available on an asset owned personally by the shareholder but used in the company’s trade.
By contrast, ER may be available (under the ‘associated disposals’ rules) in respect of a personally-owned asset used for the trade of the individual owner’s ‘personal company’, broadly if there is a ‘relevant material disposal’ of the individual’s ordinary shares and an ‘associated disposal’ of an asset (e.g. trading premises) owned by an individual but used for the purposes of a company’s trade, subject to certain conditions (see TCGA 1992, s 169K).
It is important to note that the above is only a selection of important differences between IR and ER - there are others to consider.