By Lesley Stalker, head of tax, RJP LLPThe Government is always keen to encourage start-ups and help them flourish so HMRC offers a number of reliefs to encourage business owners, often in the form of entrepreneur-friendly policies. Right through the business lifecycle, whatever the stage of development, there is something available.
Phase 1: Starting up
For very young companies, SEIS (Seed Enterprise Investment Scheme) provides reliefs to help make the company attractive to funders. These reliefs are available to many UK trading companies which are carrying on or preparing to carry on a new business in a qualifying trade. The company must have fewer than 25 employees, gross assets must not exceed £200,000 and a maximum investment of £150,000 can be raised during a three-year period.
Phase 2: Scaling upEIS
Slightly larger, more established companies can pursue EIS, (Enterprise Investment Scheme) reliefs to attract growth funding. To qualify for EIS, the company must be unquoted, have fewer than 250 employees and assets of less than £15 million. The maximum amount a company can raise through EIS in a single financial year is £5 million.
Investors’ ReliefA further tax relief, investors’ relief, is available to attract outside investors. This enables them to benefit from lower tax rates of 10 per cent on gains made when they sell their investment, up to a maximum value of £10 million each. Investors’ relief is only available for investments in unquoted companies (an AIM listing is classified as unquoted for this purpose) but there are no restrictions on the amount of investment that can be made.
An investor must subscribe in cash for fully paid-up ordinary shares, which much be retained for at least three years from 6 April 2016 or a later date. Provided the shares are held for at least three years from that date, and they continue to qualify, they will be eligible for the reduced rate of capital gains tax on the investment gains.
There is no requirement to hold a minimum 5 per cent shareholding, but there is a restriction in place preventing any conflict of interests in relation to employment. These rules are complicated but effectively place restrictions on an investor (or any connected person) from becoming a paid employee or director of the shareholding company.
EMIGrowing companies have the challenge of incentivising staff to remain with the company and work towards its growth. HMRC recognises that this is often more difficult for smaller companies and they offer the enterprise management incentive (EMI) share option scheme to assist. This enables employees to participate in the growth of a company without having to ‘buy’ shares initially, and it enables companies to incentivise their employees in a cost-effective way without necessarily introducing a lot of employee shareholders.
Benefits to employees include the ability to share in the ultimate sale proceeds of a company without any initial outlay and being able to claim entrepreneurs’ relief on the disposal of their shares.
Benefits to the company include relatively low-cost access to a share option scheme which will incentivise their employees, and the ability to claim corporation tax relief when the share options are exercised.
Share dilutionGrowing companies often issue equity to investor shareholders in order to benefit from the above reliefs. When they do so, care needs to be taken to ensure that shareholder dilution does not mean that the existing shareholders’ eligibility to entrepreneurs’ relief is jeopardised. To combat this, HMRC is proposing new rules which will enable existing shareholders to elect that their shareholding is deemed to have been sold and immediately re-acquired before it is diluted below 5 per cent.
This will enable the gains arising to that date to qualify for entrepreneurs’ relief with the 20 per cent capital gains tax rate applying only to the gains made after that date. There will also be the opportunity to elect for the tax on the deemed disposal to be deferred until shares are actually sold, and funds are available to pay the tax. If the shares have reduced in value when they are actually sold, the loss arising can be offset against the previous gain. We are hopeful these proposals will become legislation in the near future.
Phase 3: Selling up
A successful exit is the final reward for the many years of hard work involved in starting and expanding a business. To incentivise entrepreneurs to take the risks involved, the Government offers entrepreneurs’ relief.
This was originally introduced to replace business taper relief and it entitles an entrepreneur to pay a reduced rate of 10 per cent capital gains tax on the sale of company shares. The qualifying criteria include that at least a 5 per cent shareholding is owned in a UK trading company conducting a qualifying trade.
Employees who have acquired shares through an approved EMI share scheme can benefit from the 10 per cent tax rate without having to hold a minimum 5 per cent holding. Each individual has a lifetime entrepreneurs’ relief allowance of £10 million and a couple who jointly own a company will each have £10 million, provided they each qualify.
If family members are involved in the running of a business, senior members may retire and gift their shares to younger members. When gifting shares, capital gains tax and inheritance tax must be considered. However, HMRC offers additional incentives in this case by way of gift relief for business assets for capital gains tax purposes, and business property relief for inheritance tax purposes.