The retitled Entrepreneurs’ Relief has been around since April 2008, but the question of whether it is available to a shareholder or not, is not as straightforward as one would assume.

Breaking it down in its basic form:

Throughout the period of two years ending with the date of the sale:

• The company is the shareholder’s personal trading company/group; and
• The shareholder is also an employee or officer of the company/group.

Key Definitions

Personal Company = the individual must hold at least 5% of the ordinary share capital of the company; by virtue of that holding at least 5% of the voting rights and in the event of a disposal of the whole of the ordinary share capital of the company, the individual would be beneficially entitled to at least 5% of the proceeds (a further economic test is available).

Ordinary shares = 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. Here we look at the nominal value of the shares rather than the number.

Trading = we must consider the activities of the company and determine whether any investment activities taint the overall trading nature of the company. Very generally, HMRC will consider 80% (trading)/20% (investment) as a trading company; applying this test to turnover, profit, time employed, assets of each activity.

We have noted below some common pitfalls when strategizing about share equity, whether considering succession, employee ownership or incoming investors. Anti-avoidance provisions are in place where the individual does not appear to have a genuine 5% economic stake in the company, as always let commercial factors drive the design rather than tax!

Growth shares
The very nature of growth shares means that the hurdle (the point where value starts to accrue) may not be breached until closer to the date of sale, nor sufficient to meet the 5% test. Conversely, the value of these shares could negatively impact a minority ordinary shareholder.

Share classes with different nominal value
In this example you would be forgiven for thinking that both share classes if owned by separate individuals, would satisfy the 5% test. Unfortunately 400 * £0.01 = £4 and 100 * £1 = £100, meaning that £4/£104 represents only 4% (not 5%) of the company’s ordinary share capital.

400 A Ordinary £0.01 shares
100 B Ordinary £1 shares

It is also worth noting that 5% means exactly that, not 4.99% or less.

Preference shares
The name of a share class does not preclude shares from the ordinary share capital definition. This may or may not be a positive when designing equity interests, but it is important to clarify their classification when seeking BADR. The coupon rate and mechanism will dictate this.

EMI options

The 5% tests are not required to be met by an EMI option holder; however the options must have been granted at least two years prior to the sale for BADR to be available. If the options are exercised outside of the 90 day disqualifying event window, these shares will not qualify for BADR under the EMI rules.

While this is an attractive HMRC approved share scheme designed to motivate, retain and reward key employees, they can dilute minority shareholders below the 5% threshold.

Trusts
Trustees require a qualifying beneficiary who is prepared to forgo part of their BADR lifetime allowance, alternatively they may decide to appoint some of the trust shares to the individual in order to utilise their lifetime allowance. Otherwise the higher 20% Capital Gains Tax rate will apply to trustee capital gains.

Whilst this 10% tax rate provides a lower amount of relief than it has done historically, the tax tribunals are kept busy with reviewing the specific terms of BADR and it is therefore important to seek tax advice when issuing or reorganising share capital and contemplating an exit.