Welcome changes to the ABC of Entrepreneurs' Relief

The changes to Entrepreneurs' Relief announced in the UK Chancellor's Autumn Budget (discussed here) rang alarm bells for some. So-called “alphabet shares” are often used to provide flexibility on the payment of dividends. The new regime (taking immediate effect on 29 October) had the unwelcome result that ER will not be available where the board has full discretion to allocate dividends between the different share classes.  

A tightening up of the qualifying rules for this important tax relief presented a real problem for those individuals who have shares in a company that has different share classes. In the typical alphabet share approach used to provide flexibility for the payment of dividends between different shareholders, the articles of association will normally give directors discretion on how to allocate dividends. This discretion means the shareholder is not entitled to a dividend and so will not qualify for entrepreneurs' relief.

Corrections made at this stage could have had knock-on consequences on the shares' valuation and relating to the employment-related securities rules.

Boards and shareholders alike have welcomed proposals made on 20 December to address the problem. Under the planned changes to the Finance Bill a shareholder will benefit from ER if the shares they hold:

• Represent at least 5% of the ordinary share capital; AND
• Enable them to exercise at least 5% of the voting rights in the company, AND
• Either:
  • Gives them an entitlement to 5% of the distributable reserves and 5% of the assets on a winding up; OR
  • In the event of a disposal of the whole of the ordinary share capital of the company, entitles them to at least 5% of the sale proceeds.

The new alternative (in bold) means that alphabet shares may still be able to qualify for ER, even if they have no entitlement as such to dividends, provided the other conditions are all met for the qualifying period.