Entrepreneurs' Relief: gains before dilution

The Government proposes to allow individuals, whose shareholding in a trading company is diluted below 5% by an issue of shares to raise funds, to elect to claim Entrepreneurs’ Relief by reference to a deemed disposal of the shares at that time.

Following the Chancellor’s 2018 Spring Statement, the Government has released a consultation paper, entitled “Financing growth in innovative firms: allowing Entrepreneurs’ Relief on gains before dilution”, proposing to allow taxpayers who cease to have a 5% holding in a company as the result of that company issuing shares to raise capital to elect to claim Entrepreneurs’ Relief (ER) by reference to latent gains held at the time of the capital raising event.


One of the requirements for claiming ER (which provides a 10% rate of CGT on qualifying disposals of business assets subject to a lifetime limit of £10m) on a disposal of shares is that the claimant has held at least 5% of the company’s ordinary share capital for the twelve months before the disposal.

Responses to the Government’s earlier consultation on ‘Financing growth in innovative firms’ expressed concerns with the current 5% minimum shareholding requirement. Some considered that the requirement was causing individuals to exit their company early to retain the relief, as opposed to continuing to support and grow the business after fundraising, or was acting as a deterrent to seeking additional financing required by the company in question. Respondents suggested solutions such as reducing the minimum percentage required, or removing the condition entirely.

At Autumn Budget 2017, the Government announced that changes would be made to ER to ensure that entrepreneurs are not discouraged from seeking external investment to finance business growth in circumstances where their own shareholding becomes diluted. In particular, it was pointed out that one of the main options a company has for raising funds to finance its growth, issuing shares to new or existing shareholders, can adversely affect a person entitled to ER. If an existing shareholder does not purchase any (or enough) new shares, then when a round of fundraising has been completed their stake in the company will have been diluted. It follows that an individual who held over 5% of the company’s shares before a round of fundraising may fall below this threshold afterwards, even though they have not disposed of any shares. This is not only perverse, but it has been argued that it acts as a disincentive for seeking finance to fund the growth of businesses.

Proposed change

The Government has rejected calls to extend ER to situations where a shareholding is diluted below the qualifying level for ER. However, the Government proposes to address this issue by allowing individuals to elect to crystallise gains on their shares immediately before their holding is diluted. The effect of making the election will be that the individual will be treated as selling and immediately reacquiring their shares at the then-market value. The individual will be able to defer the accrual of the gain on this elective disposal, so that ER may then apply when the deferred gain crystallises on a later disposal of those shares by the claimant. One point to note here is that since the deferred gain crystallises at the time of a later disposal, any losses on that later disposal (due to a subsequent fall in the value of the shares) would be available to set against the deferred earlier gain.

The focus of the dilution will normally be on the percentage share of an individual’s holding in a trading company or holding company of a trading group. However, the ER rules also require an individual to have 5% of the voting rights in such a company. The consultation suggests that the option to crystallise and defer gains will also be available where voting rights drop below 5% but the share of ordinary share capital remains above 5%, but it would be helpful for HMRC to clarify this given that the position is not wholly clear from the document.

The proposed change also gives rise to a number of other points of detail that will need to be dealt with in the legislation. For example, since the gain will not crystallise until a later disposal, it seems clear that further deferrals may be possible if the claimant later disposes of their holding by way of a share for share/loan note exchange (indeed paragraph 4.4 appears to contemplate this situation). In addition, there are will be issues around identifying relevant disposals where shares are pooled if further shares later enter the pool of shares. The consultation indicates that the Government is likely to link crystallisation of the gain with the first disposal of pooled shares in such cases.

For the new rules to apply, the dilution must arise as a result of an issue of shares made by the company for genuine commercial reasons. As such, it will be a condition for election that the issue of shares by the company be part of a commercial scheme or arrangement which has as its main purpose, or one of its main purposes, the obtaining of capital as new consideration subscribed for the issue of new shares.


The Government intends to introduce the new rules in the Finance Bill 2018/19 to take effect in respect of new fundraising events which take place on or after 06 April 2019.

It should be noted that the Government does not intend to apply the relief to other situations in which an individual loses the ability to claim ER, for example where there is a loss of employment even if an individual’s employment is terminated without cause.

The consultation paper is open for responses until 15 May 2018, which should be sent to PCR.ER.Consultation@HMTreasury.gsi.gov.uk.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.