While the £10m of Entrepreneurs’ Relief is a distant memory (thanks to the reduction in the overall lifetime limit introduced in the 2020 Budget), what remains of it in the form of Business Asset Disposal Relief (BADR) is still worth striving for in the context of private equity transactions and more generally the mergers and acquisitions market.
BADR can be claimed for gains arising from the disposals of businesses, shares in personal trading companies and associated business assets. It operates by applying a lower rate of capital gains tax (CGT) to qualifying assets, up to a lifetime limit of £1m. The rate of CGT applying to BADR qualifying gains is still currently at a flat rate of 10%. However, as part of the Chancellor’s Autumn Budget, delivered on 30 October 2024, HMRC published a paper “HMRC – rates of tax, Policy Paper” announcing a staged increase in the rates of CGT for BADR, such that the benefit of BADR will be reduced by increases to the applicable rates of CGT from 10% to 14% for disposals made on or after 6 April 2025, and from 14% to 18% for disposals made on or after 6 April 2026.
Where shares are exchanged for shares and/ or loan notes, generally and subject to meeting some conditions, there is no disposal at the time of exchange and the new shares/ loan notes simply take on the acquisition history of the old shares. While this position can be a good thing in certain circumstances as tax is deferred into the future, this outcome can be undesirable where the new shares/ loan notes will not qualify for BADR or if gains on the new shares/ loan notes will only attract BADR at rates in excess of 10%. Locking in the benefit of the 10% rate is therefore extremely important in the context of transactions where shares/loan notes form part of the consideration for a share sale and this is where section 169Q elections come in.
Section 169Q elections
Where shares or loan notes are issued by a company in exchange for shares in or loan notes of another company, CGT legislation (subject to the satisfaction of certain conditions) generally treats the transaction as involving neither the disposal of the original shares or loan notes nor an acquisition of the new shares or loan notes issued. Instead, the “original shares/ loan notes” and the “new holding” following the transactions are treated as the same asset, acquired when the original shares were acquired.
Where these rules apply, it is possible that a ‘normal’ disposal of the original shares at the time of the reorganisation, exchange or reconstruction would have resulted in a gain that could either qualify for BADR or qualify at the 10% rate. But the gain on a later disposal of the new holding may not qualify or it could be taxed at a rate in excess of 10% as a result of the changes announced at the Chancellor’s Autumn Budget. This may be because the shareholdings after the reorganisation, exchange or reconstruction are such that the company is no longer the individual’s personal company or because the disposal is treated for tax purposes as occurring after 5 April 2025.
Section 169Q enables an election to be made for BADR to be available on the basis that the ‘no disposal’ treatment which generally applies on a reorganisation, exchange or reconstruction does not apply. The result is that a gain, in respect of which BADR can be claimed, accrues at the time of the reorganisation, exchange or reconstruction because such a transaction is treated as a disposal.
Autumn Budget 2024 – anti-forestalling
A close reading of the Finance Bill confirms that, in some circumstances, the disposal created by a section 169Q election to obtain the benefit of BADR only accrues when the election is actually made and not at the time of the reconstruction, reorganisation or exchange. Mechanically, the section 169Q election can only be made when the seller’s tax return for the relevant tax year is submitted.
Given that the tax return for the 6 April 2024 – 5 April 2025 tax year cannot be submitted until 6 April 2025 at the earliest, it becomes impossible to get the benefit of 10% CGT rate as the effective rate of CGT at the time of the disposal created by the section 169Q election will be 14% (as against the current 10% rate until 6 April 2025). While the 14% rate is still lower than the 18% CGT rate which will be effective from 6 April 2026, it definitely is not as appealing as the 10% rate.
The way out
Very often the main reason for exchanging shares for shares/ loan notes in the buyer’s group company is for the seller to have a stake in the buyer’s business. In this context, a “cash out” and reinvestment may be the way out to lock in the benefit of the 10% CGT rate where BADR applies.
Upon “cashing out”, the seller will receive their share of the net proceeds from the sale (which where BADR applies will be chargeable at the 10% CGT rate), the seller can then reinvest in the relevant company of the buyer group, using these proceeds, either in the form of loan notes or shares. This ensures that the seller obtains the full benefit under the BADR by locking in the 10% rate, provided the disposal for tax purposes (being the sale or the cash out) occurs before 6 April 2025.
As you cannot physically make a section 169Q election before the end of the tax year in which the share sale occurs, this means that to secure the lower 10%/ 14% rate of BADR, the seller should cash out and then reinvest rather than make such an election in respect of a roll into loan notes or shares in the buyer.
In short, it looks like the October Budget has heralded the death of the section 169Q election in the context of BADR, at least for disposals occurring before 6 April 2026.