Entrepreneurs' relief and alphabet shares
The Finance Bill effects the intention, announced on Budget Day, to alter the definition of a “personal company” for Entrepreneurs’ Relief (“ER”) purposes. The new rules will require a claimant, with effect from 29 October 2018, not only to possess at least 5% of the ordinary share capital and voting rights in the company but also to be beneficially entitled to at least 5% of profits available for distribution to equity holders of the company and of assets available for distribution in a winding-up of the company.
The problem is that many companies have share structures involving a number of classes of ordinary share (often styled A, B, C etc shares – hence “alphabet shares”) which rank equally in all respects save that dividends may be voted unequally across the classes. This has given valuable flexibility in distributing profits, especially in “quasi partnership” companies. Arguably, however, where the proportion of the total dividend paid that is allocated to any particular share class is completely discretionary (and thus could be anything from nothing to 100%) it is difficult to see how the holder of the share is entitled to any percentage at all of “profits available for distribution”. This would seem to be the case even if as a matter of fact a shareholder has always received at least 5% of amounts distributed.
A related problem may arise where a class of share (typically a class issued to a venture capitalist or other outside investor) has a priority right to a dividend, or to a first slice of assets in a winding-up, or both. In such a case, although a holder of other ordinary shares may be beneficially entitled to more than 5% of what is left, that may not be 5% of the total either of profits or of assets available for distribution in a winding-up.
In many cases, it will be possible to revise the company’s Articles so as to amend share rights and restore the company’s qualifying status. But, crucially, it won’t be restored retrospectively. And the problem is made worse by the lengthening of the ER “qualifying period” from one year to two. Thus, if as a result of the new rules a company ceased to be your “qualifying company” on 29 October and remedial action needs to be taken, any disposal made within the two years after its qualifying status is restored will not qualify for relief.