Investors’ Relief

Investors’ Relief can be a powerful tool to reduce your capital gains tax bill when investing in unlisted trading companies, but navigating the complex rules and qualifying conditions can be challenging.

What is Investors’ Relief?

Capital gains tax (CGT) relief for investments in qualifying shares of a trading company was introduced in Finance Act 2016. Investors’ Relief (IR) was introduced to provide an incentive for external investors to invest in unlisted trading companies over the medium to long-term.

Investors’ Relief reduces the rate of CGT charged on disposals of qualifying shares to 10%, subject to a £10 million lifetime limit. The maximum potential tax saving under IR is therefore £1 million. The relief is available to both individuals and trustees where certain conditions are met.

IR is intended to encourage and reward new investment over the medium to long-term and so there are conditions to ensure that new ordinary shares are subscribed for with new money that benefits the company and the shares are held for at least three years. The relief is targeted at external investors so will not usually be available where the investor, or an individual connected with them, is an officer or employee of the company.

Interaction with Business Asset Disposal Relief (formerly Entrepreneurs’ Relief)

IR works in a similar way to Business Asset Disposal Relief (BADR). It’s a separate tax relief (with a separate higher £10 million lifetime limit; the lifetime limit under BADR was reduced from £10 million to £1 million in March 2020) and there are no specific interaction provisions. Shareholders could be eligible for both IR and BADR, but only in very limited circumstances (eg unremunerated directors).

Unlike BADR there is no minimum shareholding requirement in order to qualify for IR, but there are various conditions that must be met in order to qualify.

Consideration should be given to the availability of both IR and BADR prior to any investment to gauge which of these reliefs may be available to investors.

By way of illustration, if an investor had a genuine choice whether or not to become a non-executive director (NED) of the company after their investment was made, taking a small salary for these NED services, the investor may decide to not take the NED role and potentially be eligible for future 10% CGT on £10 million of gains under IR rather than the lower £1 million under BADR. If it was possible to structure the NED role so that the investor was not entitled to any payment for the provision of NED services, then it might be possible for the investor to claim 10% CGT up to £11 million under both IR and BADR.

Interaction with reliefs under the Enterprise Investment Scheme (EIS) and SEIS

As IR is targeted at external investors, there is likely to be some crossover with EIS and SEIS tax reliefs.

The tax breaks will be more beneficial under EIS and SEIS eg there is a CGT exemption rather than a reduced rate of CGT, but as these reliefs have the same upfront criteria (there needs to be a subscription for new ordinary shares wholly in cash and fully paid up at the date of issue) then it might be possible for IR to apply to an investment that has failed to meet the ongoing EIS or SEIS qualifying conditions. IR could also potentially apply to an external investment that does not meet the stricter qualifying conditions for EIS or SEIS from the outset.

Qualifying conditions for Investors’ Relief

Some of the main conditions of IR are:

• The qualifying shares must be new unquoted ordinary shares acquired by subscription and were issued on or after 17 March 2016,.
• The new ordinary shares must be subscribed for by the investor wholly in cash and must be fully paid up at the time of issue,
• There are anti-avoidance rules which state that the shares must be subscribed for and issued by way of a bargain at arm’s length, for genuine commercial reasons and not as part of an arrangement where one of the main purposes is to secure a tax advantage to any person,.
• The company must be a trading company or holding company of a trading group throughout the ownership period (there is an 80% test to measure the company’s trading activities compared to its non-trading activities),.
• The investor, or a person connected to the investor, cannot be an officer (eg director or company secretary) or employee of the company, or a connected company, at any time in the ownership period (except in very limited circumstances),
• The ordinary shares must be held by the investor continuously from subscription to disposal and the ownership period must be at least three years, and
• IR won’t be available if the investor (or an associate of the investor) receives value, other than insignificant value, from the company (or a person connected with the company) at any time in the period beginning one year before the date the shares were issued and ending immediately before the third anniversary of the issue date. The rules are wide-ranging and so any amounts intended to be paid by the company to the investor should be carefully checked to ensure they do not fall within these value received rules.

Where only some of the shares in a holding which are disposed of qualify for IR, any capital gain is pro-rated so that the gain on the qualifying shares attracts IR.

Investor relief rules

Special identification rules operate to preserve the maximum potential IR for future disposals, for example treating qualifying shares and excluded shares as disposed of in priority to any potentially qualifying shares held for less than three years. These identification rules are complex and care will need to be taken to ensure the capital gains matching rules are followed.

For IR to apply to a disposal made by trustees there must be at least one individual who is an eligible beneficiary and who has an interest in possession that includes the holding of shares immediately before the disposal and throughout the period of three years ending with the date of the disposal. In addition, the eligible beneficiary must not have been a relevant employee of the company. The trust gains qualifying for IR will utilise the £10 million lifetime limit of the eligible beneficiary and, as such, a joint election must be made between the trustees and the eligible beneficiary in order to claim the tax relief.

IR is not automatic and must be claimed. The time limit for making the claim is 12 months after 31 January following the end of the tax year in which the disposal took place.

Going forward

Investors’ Relief is a potentially valuable tax break for external investors who are looking to invest in unlisted trading companies over the medium to long-term. However, the rules are complex and should be considered at the time the shares are subscribed for and regularly monitored thereafter.

For advice regarding any of the issues raised here, please get in touch with Zena Hanks.

This factsheet is based on law and HMRC practice at 1 August 2024.