Holders of so-called ‘funny shares’ are being urged to review the rights attaching to the unlisted company shares they hold or risk missing out on the beneficial 10% Capital Gains Tax rate with Entrepreneurs’ Relief (ER) tax rate on any share sale.

Friend Partnership Limited explains that new ER provisions were buried in the ‘fine detail’ of the Chancellor’s October budget.

Funny shares are typically those acquired by shareholders as a result of corporate reorganisations or structuring, where the aim is simply for the shareholders to receive capital on a sale, and these shares often do not carry a right to dividends.

In his Budget, the Chancellor announced a change to the ER qualifying conditions, by extending the qualifying holding period for shares from 12 months to 24 months for all qualifying disposals after 5 April 2019.  If shares are sold after 5 April 2019 and before the shares have been held for 24 months, then any capital gain arising will be taxed at a rate of 20%.

HMRC’s reason for this extension is to counter tax avoidance, but what the Chancellor didn’t make clear was that for individuals owning shares, there would be additional conditions on top of those already in place.

With effect from 29 October 2018, the date of the Budget, the shares they hold would have to also give them a right to dividends in order to qualify for the 10% rate of tax with ER.

The existing qualifying conditions for a successful claim to ER on a share disposal are: individuals must hold at least 5% of the ordinary share capital and have at least 5% of the votes, and have held the shares for at least 12 months at the date of sale and the shares sold must now give the individual a right to 5% of the dividends if an ER claim is to succeed.

Companies must also meet certain conditions throughout the same 12-month period.

If a right to dividend is not created by changing the share rights, then on any sale the tax rate will always be 20%. If changed, to give a right to dividends, then the individual would still need to wait until 24 months have passed before a 10% rate would be available – assuming all other qualifying conditions are met – so holders of ‘funny shares’ need to approach the company in which they hold the shares to see whether they would be happy to change the share rights. If they are the rights should be changed as soon as possible to start the 24-month clock running.

For any disposals after 5 April 2019, the new requirement to have held the shares for 24 months at the date of sale is unlikely to cause any problems.

This is unless a newly formed company has done so well in its first year that there is the prospect of an immediate sale. If this is the case, individuals may need to focus on the timelines – for instance, could a sale be concluded before 5 April 2019, or if not, when after 5 April 2019 could a sale be concluded, which would give the sellers a full claim to ER because 24 months have passed since acquisition.

As always, the devil is in the detail, and the ER legislation, especially that relating to shares is tortuous with a number of commentators suggesting that it needs to change; in its current form, it is potentially unworkable.

In my view it is a shame that the ER legislation seems to be aimed at denying relief rather than allowing it. It is also a pity that the dividend change was not put off until 6 April 2019 to allow those with funny shares to consider what, if anything, they could do to address the changes.

Individual private company shareholders will need to review the ER legislation very carefully so that they are clear on the issues. They may need to consider further planning well in advance of any share sale.

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