A new tax relief for investors in private companies can secure a 10% tax rate on qualifying capital gains.
In his 2016 Budget speech, the Chancellor, somewhat confusingly, suggested that he would be introducing an“extension” of Entrepreneurs’ Relief (ER). Although the new relief delivers a similar 10% capital gains tax (CGT) rate to ER, the criteria for receiving it are quite different.
Very broadly, Investors’ Relief works as follows:
John Brown made a gain of £7 million when he sold his stake in a successful business. The gain was taxed at 10% due to ER. John invests some of the proceeds in a new venture run by his friend, Bob and subscribes for 10% of the ordinary share capital as an external shareholder. After 6 months, Bob offers him a position on the Board which John accepts. Three years later,the business is sold realising a gain for John of £500,000.
If John is not paid for his role as director, his shares should qualify for Investors’ Relief. Additionally, as an officer of the company he could also qualify for ER and so has the choice of which relief to use.
In this example, John still achieves an effective tax rate of 10% on his gain but it demonstrates that care will be needed when investors wanting to benefit from Investors’ Relief, acceptemployment or board positions.
The new relief will be attractive to investors not intending to get actively involved with the running of the business or who are directors but on an unpaid basis. It can apply where an individual has already exhausted his lifetime entitlement to ER or does not satisfy the qualifying conditions for ER.
Some investors in this category will also be eligible for Enterprise Investment Scheme (EIS) relief, an established tax incentive. EIS is more generous exempting the entire gain on sale from CGT with no £10m cap on relief. However, it has more stringent conditions and the new Investors’ Relief will apply in a whole range of situations where EIS will not.
It is now quite hard to make generalisations about who will benefit from the 10% CGT rate. For instance, ER favours business involvement so that to qualify for the 10% tax rate an investor with a 5% shareholding must also be an employee or officer. With Investors’ Relief, paid business involvement is discouraged so that to qualify for the 10% tax rate an investor acquiring a 3% shareholding normally must not be an employee or paid officer.
Individuals looking to invest in businesses should take appropriate advice to ensure that they understand whether they meet the conditions to qualify for one of these reliefs.
For further information, see the Investor Relief page here or the Entrepeneurs' Relief page here
David Furness. Director, Private Client
Liz Henderson. Senior Manager, Private Client