Entrepreneurs’ Relief: What classes of shares count towards the threshold?
Recent experience reminds us of the need to be careful when looking at the Entrepreneurs’ Relief requirements in relation to companies with preference…
Our recent experience reminds us of the need to be careful when looking at the Entrepreneurs’ Relief (“ER”) requirements in relation to companies with preference shares.
For disposals of shares and securities in a company by an individual to qualify for ER, the company must be the “individual's personal company” throughout the period of 12 months ending on the date of disposal.
The company will be the "individual personal company" if:
- The company is a trading company (or the holding company of a trading group);
- The individual holds at least 5% of the ordinary share capital of the company (by reference to nominal value) and that holding gives them at least 5% of the voting rights in the company; and;
- The individual is an officer or employee (full or part time) of the company or, if the company is a member of a trading group, of one or more companies which are members of the trading group.
It is this second requirement, that the individual holds 5% (by nominal value) of the ordinary share capital, which can cause problems where there are preference shares. This is because there is a natural tendency to assume that preference shares are not ordinary share capital.
For ER purposes however ordinary share capital is defined as “all the company’s issued share capital (however described), other than capital the holders of which have a right to a dividend at a fixed rate but have no other right to share in the company’s profits.”
Because of this rather narrow exclusion, many shares that are described as preference shares are nevertheless ordinary share capital for these purposes and hence must be taken into account when looking at the 5% nominal value requirement.
For example, if the preference shares have a dividend rate that is linked to LIBOR or a bank base rate, they do not carry a right to a dividend at a fixed rate as the rate will fluctuate depending upon LIBOR or the bank’s base rate. Such shares will be treated as ordinary share capital.
On the other hand, a share carrying a right to “tiered” dividends will not necessarily be regarded as part of the ordinary share capital for ER purposes if the rate at each tier is fixed e.g. a right to a fixed rate dividend of 8% rising to 10% on or after a certain date or event.
If however, on a return of capital or exit, the preference shares entitle the holder to a return greater than issue price and accrued dividends, this could also be regarded as a “right to share in the company’s profits” and such shares may therefore have to be taken into account in determining availability of ER.
The moral of the story is that in looking at whether on a disposal of shares you will qualify for ER you need to look at the rights attaching to all the classes of share in the company in order to determine whether you hold 5% of the ordinary share capital.
If you are interested in finding out more about this or any other tax issue, please contact Haydn Rogan, Partner in the Corporate department, on 0161 242 0517, or email firstname.lastname@example.org.