Tax advisers with owner-managed business clients will probably come across entrepreneurs’ relief issues fairly regularly. The relief offers a reduced CGT rate of 10% on total net chargeable gains of up to £10 million. The relief is available on a disposal of business assets as defined in the legislation, but the business assets discussed in this article are those consisting of (or of an interest in) company shares or securities (TCGA 1992, s 169I(2)(c)).
This type of disposal is a ‘material disposal of business assets’ for entrepreneurs’ relief purposes if one of four alternative conditions are satisfied, i.e. condition A, B, C or D in the legislation. This article concentrates on probably the most common of these conditions, which is condition A (in TCGA 1992, s 169I(6)).
Condition A is broadly that, throughout the period of one year ending with the date of disposal, first the company is the individual’s personal company, and is either a trading company or the holding company of a trading group; secondly, the individual is an officer or employee of the company (or, if the company is a member of a trading group, in a trading group member). The ‘trading company’ or ‘trading group’ requirement is probably the best known for entrepreneurs’ relief purposes, and is therefore not considered further in this article.
The term ‘personal company’ is defined for entrepreneurs’ relief purposes in TCGA 1992, s 169S(3). It states:
“(3) For the purposes of this Chapter ‘personal company’, in relation to an individual, means a company—
(a) at least 5% of the ordinary share capital of which is held by the individual, and
(b) at least 5% of the voting rights in which are exercisable by the individual by virtue of that holding.”
(a) Ordinary share capital
So what does ‘ordinary share capital’ mean? Section 169S(5) tells us that ordinary share capital has the same meaning as for income tax purposes in ITA 2007, s 989. That legislation defines ordinary share capital as meaning all the company’s issued share capital, other than capital which gives the shareholder the right to a dividend at a fixed rate, but no other rights to share in the company’s profits. So a fixed rate dividend share is not ‘ordinary share capital’ for entrepreneurs’ relief purposes, but any other type of share may be taken into account. HMRC has confirmed in its Employee Share Schemes Unit manual (at ESSUM23230) that if shares have no dividend rights, HMRC will not contend that they carry the right to a fixed dividend of 0%.
This wide definition of ordinary share capital has the potential to cause problems. For example, in practice I have seen cases where a company’s share capital included shares with little or no rights, such as no dividend or voting rights, and yet the existence of those shares has diluted the holdings of some shareholders below the percentage required for entrepreneurs’ relief purposes. Thus it should not be assumed that just because shares have little or no rights that they can be ignored when counting a company’s share capital.
(b) Issued share capital
Going back to the definition of ‘ordinary share capital’, this term refers to the company’s issued share capital. Another point to consider is whether ‘issued share capital’ means looking at the nominal value of the shares, or whether it means their actual market value. This point was considered in a stamp duty case, Canada Safeway Ltd v Inland Revenue Commissioners  1 CH 374.
The company had two types of shares, i.e. ‘preferred shares’ and ‘common shares’. Canada Safeway Ltd was part of an international group of Safeway companies. American Safeway owned all Canada Safeway’s common shares, but owned none of its preferred shares. The nominal value of the common shares was considerably less than 90% of the total nominal value of the company’s shares (i.e. preference and common shares). However, the common shares were actually worth more than 90% of the total value of the preferred shares plus the common shares.
American Safeway sold to Canada Safeway some shares in another Safeway company, English Safeway. A claim was made for stamp duty group relief in respect of the share transfer (under FA 1930, s 42). The stamp duty group relief claim required that American Safeway must be the beneficial owner of at least 90% of the issued share capital of Canada Safeway. Group relief was claimed on the basis that this ‘90% test’ referred to the actual value of the shares, not the nominal value. However, the court held that the term ‘issued share capital’ actually referred to the nominal value of the shares. American Safeway held much less than 90% of the nominal value, and therefore less than the 90% required for stamp duty group relief purposes. The group relief claim failed.
The Canada Safeway case was a stamp duty case, not a CGT one. However, the approach in the Canada Safeway case was subsequently supported by the Upper Tribunal in HMRC v Taylor and Haimendorf  UKUT 417 (TCC), which concerned the ‘connected person’ provisions for EIS relief purposes, and HMRC has also accepted that nominal value applies for entrepreneurs’ relief purposes as well.
Voting rights, etc
(a) Jointly held shares
A further point regarding the ‘personal company’ definition relates to jointly held shares. Shares can be held jointly by two or more persons, so the question arises how to calculate the entitlement of each joint shareholder in respect of the 5% tests of ordinary share capital and voting rights.
The entrepreneurs’ relief legislation dealing with joint shareholdings for these purposes (in TCGA 1992, s 169S(4)) broadly states that each individual is treated as the sole shareholder of an appropriate number of ordinary shares and corresponding voting rights as is proportionate to the value of the individual’s share.
For example, if husband and wife beneficially own a joint shareholding of 10% in equal proportions, they are treated as each holding 5% of the shares and 5% of the voting rights.
(b) Exercisable or exercised?
With regard to the voting rights, is it necessary for the shareholder to have exercised those voting rights at some point? HMRC guidance in the Capital Gains manual (at CG64050) states that voting rights only need to be ‘exercisable’, and that there is no requirement for the voting rights to have actually been ‘exercised’.
Having said that, watch out for cases where voting rights only become exercisable on the occurrence of a future event. HMRC gives the example of preference shares which only entitle shareholders to vote if the dividend on those shares is six months in arrears at the date of the company’s annual general meeting. Those voting rights will not be ‘exercisable’, and therefore will not count, if the preference dividend never falls into six months’ arrears.
Officer or employee
(a) What do they mean?
As mentioned, there are two parts to condition A in TCGA 1992, s 169I(6) for a disposal of shares or securities to constitute a ‘material disposal of business assets’ for entrepreneurs’ relief purposes. The first part of condition A relates to the ‘personal company’ requirement. The second part of condition A contains the ‘officer or employee’ requirement.
The terms ‘office’ and ‘employment’ for entrepreneurs’ relief purposes (in TCGA 1992, s 169S(5)) both take their meaning from the legislation in ITEPA 2003. An ‘office’ is defined (in ITEPA 2003, s 5(3)) as including any position which exists independently of the person holding the position, such as a company director or secretary. An interesting point is whether a ‘shadow director’ would count as an officer for entrepreneurs’ relief purposes. HMRC might well contend that it does not count, but in any event it would be better to put the matter beyond any doubt by ensuring that the individual is registered as a director or secretary at Companies House.
An ‘employment’ is defined as including any employment under a contract of service (ITEPA 2003, s 4). Whether or not there is an office or employment is essentially a question of fact. HMRC’s guidance on officers and employees for entrepreneurs’ relief purposes (at CG64110) states that there are no specific requirements regarding either working hours or the level of remuneration.
In other words, the employment could be part-time, and there is no actual requirement for the individual to receive a regular salary. Of course, this could cause difficulties in practice if it becomes necessary to convince HMRC that the individual was an employee. For example, a shareholder in an owner-managed company may work for the company in a similar way to a director or employee, to increase the profitability of the company and enhance the value of their investment, but without actually being an officer or employee, or being paid a monthly salary.
In one case seen in practice, the shareholder also had a written contract of employment. HMRC tried to argue that because the company had not complied with certain terms in the contract, and the individual had not been paid at least the national minimum wage, in its view the employment contract was null and void. However, it was pointed out to HMRC that breaching the terms of an employment contract, or even failing to pay the national minimum wage, does not make the contract null and void. The contract itself can still be valid, even if the company has breached its terms. In any case, it is generally necessary to look beyond the terms of any contract, to see what duties the individual actually performed for the company, in determining whether he or she was an employee.
A further point on the ‘officer or employee’ requirement for entrepreneurs’ relief purposes is to watch out for the date when the shareholder’s office or employment is going to end. This should not be before the time of disposal. For example, if an individual resigns as a director and sells his or her shares in the trading company shortly afterwards, the individual will not have been an officer of the company throughout the period of one year ending with the date of the share disposal, and the entrepreneurs’ relief conditions in TCGA 1992, s 169I(6) will not be satisfied. However, if the company ceases to trade before the director resigns and the individual then disposes of his or her shares, entrepreneurs’ relief may still be available under s 169I(7) instead, if those conditions are satisfied.
Finally, the entrepreneurs’ relief conditions (in s 169I) were relaxed by Finance Act 2013 in respect of enterprise management incentive (EMI) shares. Among those changes, there is no ‘personal company’ test, so the normal 5% minimum holding requirement for shares and voting rights does not apply to the EMI shares. In addition, the qualifying one year holding period for the shares runs from the date on which the qualifying EMI option is granted, not the date when the option is exercised and the shares are acquired. These changes apply in relation to disposals of relevant EMI shares on or after 6 April 2013.