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Investors relief was introduced in Finance Act 2016 and forms a number of reliefs intended to stimulate and support the economy, by reducing the risk and incentivising the flow of capital into Small-Medium Enterprises (“SMEs”).
The relief compliments entrepreneurs’ relief by providing relief on the sale of ‘qualifying shares’. It is designed to offer a greater risk-to-reward ratio to those fronting capital by way of equity investments into high-risk ventures.
The key distinction between entrepreneurs’ relief and investors’ relief is that investors’ relief is not available to employees and directors.
The mechanics work in much the same way as entrepreneurs’ relief, with a Capital Gains Tax (“CGT”) rate of 10% on disposals of qualifying shares within a lifetime allowance of £10m and must be claimed no later than 31st January following the tax year of the disposal.
With that said, we consider the key conditions required to benefit from investors’ relief. It will be noted that the conditions draw on elements of both entrepreneurs’ relief and the enterprise investment scheme – together with their potential pitfalls and traps.
Investors relief is available where:
1) A qualifying person disposes of shares in a company;
2) Immediately before the disposal, some or all the shares are’ qualifying shares’
3) A claim is made by 31st January following the tax year of disposal
Who is a Qualifying Person?
• An individual or trustee
• The investor, nor a person connected with him, can not be a relevant employee within the shareholding period (see below)
• A relevant employee includes employment of office with the issuing company or a connected company except where;
– A person becomes an employee (not a director) of the company (or connected company) after 180 days and there was no reasonable prospect of him becoming an employee at the date of the initial investment;
– The investor is an unremunerated director of the issuing company or connected company, provided (s)he was not involved in the business at any time before the shareholding period.
What is a Qualifying Share?
• Ordinary shares of an unlisted trading company (or holding company of a trading group) issued on or after 17th March 2016
• The shares must be subscribed for fully paid up and in cash
• The shares must be subscribed for genuine commercial purposes and on arm’s length terms
• The shares must be held continuously for three years
A point to bear in mind is that shares must be fully paid up and in cash – something which takes its roots from enterprise investment scheme and can often catch out unsuspecting investors.
One must ensure the cash is received at (or around) the time the shares are issued – for EIS purposes, this is when the investors are entered into the register of members.
If the cash is not received on the same day for, say, logistical or commercial reasons, it would be prudent to minute and note the reasons for this.
As might be expected, the legislation enables shares to be transferred between spouses who are living together without prejudicing the ‘continuous’ three-year shareholding by deeming the shares to have been subscribed for by the recipient spouse.
There are other provisions which carry over the relief where a share reorganisation has taken place, provided of course that the new shares and the new company continue to meet the criteria. If preferred, an election can be made to disapply this and instead trigger the capital gain at this point.
Unsurprisingly, as noted above, HMRC have included a general anti-avoidance condition.
The shares must be subscribed for genuine commercial purposes and on arm’s lengths terms – this will be a subjective point and the reasons for the investment should be minute and evidenced at the time they are made.
Contemporaneous evidence is the point of the day – particularly given HMRCs appetite for denying entrepreneurs relief and enterprise investment scheme claims, something which will no doubt extend to investors relief.
If an investor (or associate) receives value of more than £1,000 from the company or any person connected with it in the period of one year before to the end of the three-year holding period, any qualifying or ‘potentially qualifying’ shares are excluded from relief.
These rules effectively mirror those rules found in enterprise investment scheme. One should be cautious where there is any prospect of a receipt of value received from the company or a connected party. This could include the provision of a benefit, loan repayment or making of a loan any other transaction at less than market value.
The receipt of value rule applies to value received directly or indirectly – as such, the recipient need not necessarily be the investor.
The relief is an extension the existing framework which aims to stimulate and support the business economy. However, one should be cautious not to fall foul of the rules, particularly as this relief draws on elements of enterprise investment scheme and entrepreneur’s relief for which HMRC are notorious for ‘taking the point’.
The potential pitfalls are plentiful, and whilst they may seem extraneous to the unassuming investor, the current venture capital schemes and entrepreneurs’ relief case pool clearly evidences HMRCs increasingly strict approach to the conditions.
As stated above, contemporaneous evidence is the order of the day. Ensure decisions at the time of the subscription and any subsequent action taken are recorded so that, in the event of an enquiry by HMRC, hard evidence is available.