The surprisingly eventful Budget on 29 October all sounded very positive as it was presented, but picking through the finer detail has revealed a potentially unwelcome trap which could catch out a very large number of family and owner-managed companies.
For some years now it has become normal practice for companies to have a different class of share (commonly known as “alphabet” shares) for each shareholder, as this gives them the flexibility to pay dividends out of profits which do not have to be in proportion to the shareholdings. This is useful, for example, where it is desirable to pay dividends to certain shareholders in lieu of some salary, or based on other criteria such as new business won by an individual or annual performance related dividends.
Entrepreneurs’ Relief has been around for 10 years now, and is designed to tax entrepreneurs at a beneficial 10% rate of Capital Gains Tax when they dispose of shares in a trading company (the intention being to encourage enterprise in the UK economy). One of the key requirements for the relief is that the entrepreneur owns at least 5% of the business.
The Budget contains a provision designed to stop this relief on far more contrived tax avoidance arrangements than this, but these everyday alphabet share structures could end up, apparently unintentionally, being caught in the cross fire.
The rule change requires that the shareholder must not only own at least 5% of the shares, but must also be beneficially entitled to receive at least 5% of the distributed profits. The trouble is that in the vast majority of alphabet share structures, the flexibility permitted by these share classes means that there is no absolute entitlement to at least 5% of the profits (even though in practice these shareholders probably do receive at least this proportion).
We are in the process of trying, in conjunction with the professional accounting and tax bodies, to clarify the impact of this change with HMRC. In the meantime it is to be recommended that businesses discuss their ownership arrangements with their accountant to see if they might be affected by this change, and what they may be able to do about it.
If you have any concerns and would like to discuss your position, please contact James Geary, on 01242 776000 or email firstname.lastname@example.org.