Investors’ relief is a new tax incentive applying from 17 March 2016 to investments made in unquoted companies. To qualify, a person must subscribe for ordinary shares in a trading company or group, and must hold on to the shares for at least three years. If the relevant conditions are satisfied, the shares can be sold with any capital gains being taxed at the rate of 10% (see September’s edition of Tax Insider).
The relief applies to individuals and also trustees of a settlement which have at least one person who has an interest in possession. The relief does not apply to corporate investors.
The employee/officer condition
One of the key conditions is that the investor must not be an officer or employee of the company itself, or of any other company connected to the investee company. The restriction extends to any person connected with the investor. This condition is subject to certain exceptions, but the idea behind the rule is that the relief is targeted at passive investors and is not intended for those who have a ‘hands on’ involvement in the company’s business.
Unfortunately, this can lead to some particularly unpleasant consequences.
Which officer/employee? Which company?
In the most straightforward of cases, it will be obvious whether the investor is in breach of the condition. You either hold a position with the company or you don’t. However, the position can be more complex because the prohibition doesn’t apply only to the investor and the investee company, but is extended in two ways:
- firstly, people who are connected to the investor such as relatives, are also bound by this condition; and
- secondly, the prohibition also covers an employment or office held with any company that is connected to the investee company.
The following example illustrates a particularly nasty trap:
On 1 January 2017, Peggy is a director of Amazon Ventures Limited (‘Amazon Ventures’) which holds a 5% stake in Scarab Limited (‘Scarab’). Peggy makes an investment in the latter company and intends to hold her shares until 2 January 2020, after which she will be able to sell her stake and benefit from investors’ relief. The two companies are not connected when Peggy subscribes for her shares, so she satisfies the employee/officer condition.
On 1 June 2017, Peggy resigns her position at Amazon Ventures in order to go on a round the world sailing trip.
In the meantime, Amazon Ventures gradually increases its stake in Scarab by buying out various shareholders, until on 31 December 2019, it has a 51% shareholding in the company. As a consequence, the two companies are connected, but this event has taken place long after Peggy resigned from Amazon Ventures. So this shouldn’t affect her claim to investors’ relief should it?
Unfortunately, it does.
Under the investors’ relief rules, when two companies become connected, the connection is backdated so that it is deemed to exist for the whole of the period for which the shares have been held. And since this period extends all the way back to 1 January 2017 when Peggy was a director of Amazon Ventures, the result is that she loses all entitlement to the relief.
There is actually very little that can be done in the above situation. Investors’ relief is targeted at those people who have very little to do with the running of the business – they are unlikely to be able to prevent or control the situation when the company becomes connected to another company. Investors need to be aware at the very outset that this new relief has its own pitfalls and can be easily withdrawn.
However, it is important to bear in mind that the loss of investors’ relief isn’t the end of the world. Tax breaks are nice if you can get them, but this isn’t a good reason for making an investment. People invest in companies because they believe that there’s a good business out there with good prospects. And this maxim should continue to apply irrespective of any tax breaks that are on offer.
This article was first printed in Tax Insider in November 2016.