For owner managed businesses the Chancellor delivered a Budget that showed some consistency with his overall message of ending austerity and driving growth.
The Chancellor resisted calls to abolish Entrepreneurs’ Relief, saying that encouraging entrepreneurs must be at the heart of the Government’s strategy for a dynamic economy. He did however opt to tighten the rules to ensure that those individuals qualifying for the relief have a true material stake in the business. The minimum period for the qualifying conditions to be met will be increased from one year to two years for disposals on or after 6 April 2019. In addition, two new tests around rights to distributable profits and assets on a winding up are added to the conditions for relief on a disposal of shares.
There was also a positive change, which had been previously announced, which applies where shareholdings are diluted below the required 5% qualifying threshold for Entrepreneurs’ Relief. The amendments will allow for situations where a new share issue results in an individual whose shareholding is diluted below the 5% qualifying threshold, as relief for gains up to that time will now be available. This should remove a barrier to growth for firms where a company’s financing efforts risk diluting a founder’s personal shareholding below this threshold.
In order to further encourage investment and growth in business, the Budget included a temporary increase in the annual investment allowance to £1m, providing immediate tax relief for qualifying capital expenditure. Transitional rules will apply for businesses with a chargeable period that spans either the date of the increase on 1 January 2019, or the date of the reversion back to £200,000 from 1 January 2021. The timing of any expenditure could therefore be important from a planning perspective. Balancing this benefit to some extent is the proposed decrease in the writing down allowances provided on the special rate pool from 8% to 6%, and the withdrawal of environmental enhanced capital allowances.
Changes to the National Insurance (NICs) Employment Allowance have also been announced. Currently, employers of all sizes may reduce their Class 1 NICs liability by £3,000 per annum. This claim is available for one employer per group of companies. From 6 April 2020, this relief will only apply to employers who had a NIC liability of below £100,000 in the previous tax year.
The off-payroll working rules that have applied to the public sector from 2017 will be rolled out in the private sector from 6 April 2020. This change shifts the responsibility for ensuring compliance with these rules and applying tax and NICs due from the personal service companies or intermediaries to the party paying the individual’s personal service company. There will be an exemption for small organisations but the measure will have a significant impact for all other companies, and it is not yet clear how small organisation will be defined. There will be increased administration required when taking on contractors, increased national insurance costs for engagers and decreased net income for contractors where the new rules are applicable. Penalties and interest for non-compliance in this area are already a material issue, and care is needed to ensure that this shift in responsibility does not result in substantial additional liabilities for businesses.
For companies specifically, a consultation was announced on limiting the benefit of Research and Development tax relief for small and medium-sized enterprises. The proposal is to reintroduce a cap on the amount of payable tax credit that can be claimed by a company under the relief which will be set at three times the company’s total PAYE and National Insurance contribution payment for the period. Although any loss that a company cannot surrender for a payable credit will be carried forward and can be used against future profits, this could have a detrimental cash flow impact for companies that rely on this important relief.
A number of changes to capital allowances have been announced, the most significant being the temporary increase in the Annual Investment Allowance (AIA) to £1m. A new Structure and Buildings Allowance will be introduced, as well as a reduction in the allowance rate for the special rate pool.
The AIA will be increased from £200,000 to £1m for two years from 1 January 2019 to stimulate business investment.
In addition, a new allowance, the Structures and Buildings Allowance (SBA), was announced, which essentially provides for a 2% capital allowance on the cost of any new non-residential structures and buildings. The allowance will apply where all the contracts for the physical construction works are entered into on or after 29 October 2018.
The special rate of writing down allowances for qualifying plant and machinery will reduce from 8% to 6% from April 2019.
The Government will also update the Energy Technology List and the Water Technology List for the qualifying criteria to qualify for First Year Allowances.
Our comment
"The Government is keen to stimulate capital investment and improve the international competitiveness of the UK's tax system. These changes will provide significantly faster tax relief for qualifying investment and is a welcome change for businesses."
When will it apply?
The AIA will increase from 1 January 2019. The SBA will apply from Budget Day for appropriate contracts. The special rate of writing down allowances for plant and machinery will apply from April 2019
A new limit will be introduced on the amount of payable tax credit that a company can claim under the R&D scheme for SMEs. The limit will be set at three times the company's total PAYE and National Insurance Contributions for the period.
There will be a limit on the tax credit payable under the R&D tax relief scheme for SMEs. The limit will be set at three times the company’s total PAYE and National Insurance Contributions payment for the period.
If there is any loss that a company cannot surrender for a payable credit, the loss can be carried forward and used against future taxable profits.
The Government is entering into a period of consultation in respect of these changes before implementation in April 2020.
Our comment
"Prior to 2012, there was a limit in place that set the amount of credit payable to the PAYE and employer and employee National Insurance Contributions paid by the company during the period. To tackle perceived abuse of the R&D tax credit regime, HMRC now appears to be re-instating this limit but at a higher level. The limit may cause a problem where a company does not employ anyone directly, and therefore does not have PAYE/NIC liabilities."
When will it apply?
The changes will have effect for accounting periods beginning on or after April 2020.
The definition of a personal company for Entrepreneurs' Relief (ER) purposes has been amended to require the entrepreneur to have a 5% interest in both the distributable profits and the net assets of the company.
ER applies on a disposal of shares in a company where the company is the ‘personal company’ of the individual making the disposal.
Previously, a personal company was defined as one in which the shareholder:
is an office holder, director or employee of the company or group company; and
holds at least 5% of the ordinary share capital and of the voting rights of the company.
The shareholder will now also need to hold a 5% interest in the distributable profits and the net assets of the company for the relief to be available on the gain.
Our comment
"ER is a valuable relief reducing the CGT rate from 20% to 10% on qualifying disposals. There were concerns in the run-up to the Budget that there would be restrictions to the availability of ER and some pressure groups had been calling for the relief to be abolished entirely. In this context, the commitment to maintaining the relief and the acknowledgement of its value in supporting the role that entrepreneurs play in the economy is heartening, albeit at the cost of a tightening of the rules. There was a perception that the relief was being accessed by those with voting rights that were disproportionate to their economic interest in the company. It is likely that this was only in limited situations and so the impact of this change is unlikely to be substantial. If the shares were acquired through exercise of an EMI option, they qualified as shares in a personal company even if the 5% interests were not met. It does not appear that this definition of personal company has been impacted by the above changes."
When will it apply?
This change will apply to disposals on or after 29 October 2018.
From April 2020, medium and large private sector organisations will be responsible for assessing the employment status of any contractors whose services are provided under a contract with a Personal Service Company (PSC) or intermediary, accounting for any Pay As You Earn (PAYE) and employees’ and employers’ National Insurance Contributions (NICs) due.
From 6 April 2020, private sector organisations will potentially become liable for PAYE and employer NICs in respect of payments to contractors engaged through an intermediary company or a PSC. This is an extension of the so-called IR35 rules, so that the obligations to correctly operate PAYE and account for NICs will now fall on the engaging company in most circumstances. The rules will apply to all engagements that are in place on or after 6 April 2020 in medium and large organisations. Small companies will be exempt.
The organisation that makes payments to the contractor or intermediary will be responsible for determining the status of the contractor and assessing whether or not PAYE and NICs will apply even where there is no direct contract between the individual and the company making payments.
No details have yet been provided on where exactly responsibility will lie in more complex cases where there are multiple intermediaries in a chain between the end user of services and a contractor. Nor has there been any confirmation of what the definition of a small company will be for these purposes. A further consultation on the detailed operation of the reform will be published in the coming months.
Our comment
"It will be welcome news to the organisations affected that the changes have been delayed until 6 April 2020. Given the extent of the preparations required, however, many companies will already be considering their risk exposure and putting appropriate procedures in place. Significantly, the rules will apply to contractor arrangements already in place at 6 April 2020 as well as new arrangements; therefore, these rules will need to be considered when entering into or extending contracting arrangements over the coming year. For example, twelve-month contracts beginning on or after 6 April 2019 will be affected by the new rules.
This measure will have a significant impact for all companies that do not meet the small company exemption. There will be increased administration required when taking on contractors, increased costs for engagers and decreased net income for contractors where the new rules are applicable. Even a single contractor can easily lead to tens of thousands of pounds of possible exposure, so interest and penalties for non-compliance could also be significant.
In advance of the changes, organisations will need to undertake a review of the contractor relationships already in place, to ensure they will be compliant come April 2020. It will also be necessary to design and implement processes both for assessing new contractor engagements and for reviewing existing engagements on an ongoing basis; HMRC will consider these processes when testing for non-compliance."
When will it apply?
The changes will come into effect from 6 April 2020.
The definition of a personal company for Entrepreneurs' Relief (ER) purposes has been amended to require the entrepreneur to have a 5% interest in both the distributable profits and the net assets of the company.
ER applies on a disposal of shares in a company where the company is the ‘personal company’ of the individual making the disposal.
Previously, a personal company was defined as one in which the shareholder:
is an office holder, director or employee of the company or group company; and
holds at least 5% of the ordinary share capital and of the voting rights of the company.
The shareholder will now also need to hold a 5% interest in the distributable profits and the net assets of the company for the relief to be available on the gain.
Our comment
"ER is a valuable relief reducing the CGT rate from 20% to 10% on qualifying disposals. There were concerns in the run-up to the Budget that there would be restrictions to the availability of ER and some pressure groups had been calling for the relief to be abolished entirely. In this context, the commitment to maintaining the relief and the acknowledgement of its value in supporting the role that entrepreneurs play in the economy is heartening, albeit at the cost of a tightening of the rules. There was a perception that the relief was being accessed by those with voting rights that were disproportionate to their economic interest in the company. It is likely that this was only in limited situations and so the impact of this change is unlikely to be substantial. If the shares were acquired through exercise of an EMI option, they qualified as shares in a personal company even if the 5% interests were not met. It does not appear that this definition of personal company has been impacted by the above changes."
When will it apply?
This change will apply to disposals on or after 29 October 2018.
The minimum period throughout which certain qualifying conditions must be met for an individual to be able to claim Entrepreneurs' Relief (ER) is to be extended from 12 to 24 months. Measures will be included to protect entrepreneurs whose businesses have already ceased by preserving the one year qualifying period for such businesses where cessation was before 29 October 2018.
ER is only available on the disposal of shares in a company where the company is the entrepreneur’s personal company. The personal company conditions previously had to be met for a period of 12 months prior to the sale of the business. A business also currently has to be owned for at least 12 months before sale. These qualifying periods will now be extended to 24 months.
ER can also be claimed where a business has ceased to trade, provided that the qualifying conditions were met during the period prior to cessation and that the disposal takes place within 3 years of the company ceasing to trade. A specific protection will be included to apply the 12-month holding to businesses that ceased (or personal companies that ceased trading) prior to 29 October 2018, to avoid retrospectively penalising entrepreneurs who are in the process of winding up a company.
Our comment
"This is a further tightening of the ER rules, which will limit the availability of the relief for some entrepreneurs.
Although the protection for those whose businesses have already ceased is welcome, this does not extend to those currently negotiating the sale of their business. Where such businesses have new shareholders, it will be necessary to complete these transactions before 6 April 2019 to ensure those shareholders don't lose entitlement to this valuable relief.
We would recommend that all entrepreneurs review their position to consider the availability of ER in the event of a short-term sale and whether or not any planning steps need to be taken now in anticipation of a sale in the medium to long-term."
When will it apply?
This change will apply to disposals made on or after 6 April 2019.
An individual whose shareholding is diluted below the 5% qualifying threshold due to an issue of new shares will still be able to obtain Entrepreneurs' Relief (ER) on gains made up to the time of the dilution.
ER is only available on a sale of shares where an individual disposes of their ‘personal company’. One of the definitions of personal company is one where the individual owns 5% of the ordinary share capital, voting rights and (after today’s announcement) has a 5% interest in both the distributable profits and net assets.
Previously, entrepreneurs whose holdings fell below the 5% qualifying level because new shares were issued as part of a commercial fund raise lost the benefit of ER on their remaining shares.
The new rules will allow the entrepreneur to capture the ER on the growth in value of their shares up to the point of dilution. The relaxation will only be available where the dilution to the shareholding results from the issue of new shares to raise funds for genuine commercial reasons. This excludes, for example, the conversion of debt to equity or the exercise of employee share options.
Broadly, the entrepreneur elects to dispose of and then immediately reacquire the shares at their market value immediately prior to the dilution. ER is then available on the gain arising on this deemed disposal. Also, the entrepreneur can elect for the notional gain to be deferred until the shares are actually sold or otherwise disposed.
The time limit for making these elections will be 12 months after the 31 January following the end of the tax year in which the dilution occurs.
Our comment
"The concern around the rules as they stand is that they risk the entrepreneur choosing either to cease their involvement in the business or to avoid dilution by not undertaking the necessary fund raise. As such, the changes are vital to ensure the entrepreneur community remains involved with businesses as they look to scale up.
The tight deadline for the elections, being based on the dilution event not the sale, means that entrepreneurs will need to be switched on in making the appropriate claims. Also, the fact that the elections are irrevocable means that they should consider detailed advice to ensure that the elections are appropriate."
When will it apply?
This will apply for shares held at the time of fundraising events that take place on or after 6 April 2019.
DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.
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