Entrepreneurs relief and dilution

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Changes have been announced to make it more attractive for business owners to seek new investment. This will be without fear of losing their entrepreneurs’ relief entitlement when dilution takes their holding below the 5% ordinary share capital threshold.  This is not law yet but it could be for fundraising on or after 6 April 2019. 

If you are raising new investment via the issue of shares please do speak to us for the latest position.

How the entrepreneurs relief  special treatment is likely to work

The ability to claim entrepreneurs’ relief will be restricted to the gain arising before the shares cease to qualify.  Individuals will be allowed to:

  • Claim a gain arose before the investment which triggered the dilution taking the individuals holding to less than 5% of the ordinary share capital.  This gain will qualify for entrepreneurs’ relief if the shares are ordinary share capital and the tax payer is either an employee or director of the company who issued the shares or a group company.  The gain is a deemed gain because there has been no disposal of shares – only a dilution to the % of the company’s issued share capital they represent.
  • Defer payment of the tax arising until an actual disposal or sale of the shares.  This avoids the problem for a taxpayer of having to find the money to pay tax on shares which have not been sold.

Taxpayers are required to make an election on their tax return to claim entrepreneur relief

As is the current position, an election will need to be made in the tax return to claim entrepreneurs’ relief.  For many individuals there will be concern relating to what value should be used for computing the gain.  So far there is no guidance on whether the value of the shares is based on the full company value or discounted for a minority interest.  If discounts are to apply the amount of gain on which entrepreneurs’ relief can be claimed is reduced.


Assume the taxpayer Mr T, held shares issued to him at £1 each equating to 10% of the ordinary share capital in a private company.  Following a fund raise in which he did not participate, his holding dropped to 1% of the issued ordinary share capital in company.  Immediately before the investment, Mr T’s shares were worth £3.50 each. The gain arising at the time of the fund raise is £100,000.  Mr T elects to defer the CGT payable on the gain until the shares are disposed of.

At a later date Mr T resigns from the company and sells his shares.  The shares are now worth £11.80 each and his sale proceeds are £472,000.

In calculating Mr T’s CGT bill the gain is divided into the pre-dilution gain and post dilution gain. The pre-dilution gain is £100,000 on which entrepreneurs’ relief is available reducing the rate of tax to 10%.  The second part, the post dilution gain which is £332,000 is taxed at 20%.

Exercise of options

Dilution does not just occur upon a fund raising.  Shareholders’ can find themselves diluted following the exercise of options of any description including EMI options.  Any shareholder in this position will now be able to make an election to preserve entrepreneurs’ relief on the portion of gain arising before the options which caused the shareholding to drop below 5% are exercised.

Share capital table recommended

We always recommend that a share capital table is drawn up before an investor makes a commitment so that the future dilution to share capital triggered if options are exercised is established.

Introduction of new classes of shares

Another set of circumstances where a shareholder can unwittingly drop down below the 5% ordinary share capital threshold for entrepreneurs’ relief is where new classes of shares are introduced.  Difficulties for entrepreneurs’ relief purposes can arise if:

  • Rights attaching to new share classes mean that the existing shares are diluted. A common problem is a shareholder is not left with rights to 5% of the capital or assets on a winding up because a new class of shares has given a lions share to another shareholder which dilutes the rights of other shares.
  • Changes to the share capital can mean that there is no right to a dividend calculated by reference to profits. Shares which carry fixed rights to dividends may not qualify as ordinary shares for the purposes of entrepreneurs relief.

It is likely that the new election procedures will cover such situations.  The problem is likely to be that the tax payer is not aware of the loss of entrepreneurs relief and does not make the claim in time.

Meaning of ordinary share capital for the purposes of eligibility to claim entrepreneurs’ relief

What is and is not within the meaning of ordinary shares has been the subject of tax litigation recently.  The area is something HMRC are looking at very closely when claims for entrepreneurs relief are made.  If a problem is found after the shares have been sold there is nothing the taxpayer can do to improve his position.

The thinking has to be done before the shares are sold or disposed of.  The election facility will not be of assistance because it only covers shares which were initially subject to entrepreneurs’ relief.  It is likely that the new election procedures will cover such situations.