Founders' Relief

1) Individual conditions (all of which must be met)

• The individual must have held 25% of the company's ordinary share capital (plus corresponding rights to vote and to distributable profits and assets on a winding up) at the point when the trading activity for which the company was formed commenced, or preparation for that trade commenced.

This condition limits the relief to initial founders and early-stage investors. Accordingly, it will not apply to individuals who are brought onboard in the early stages - but not right at the outset. 

There is seemingly no prohibition on the individual reducing their stake below 25%. Therefore, if later funding rounds dilute the individual's interest below 25% or the individual simply sells down their interest to less than 25%, they will still be eligible for relief provided the other conditions are met.

• The individual must have held the shares or securities for at least five years before their disposal.

These do not have to be the same shares as those that met (or counted towards the meeting of) the 25% requirement. This means that, for example, founders who participate in later funding rounds can still get the benefit of Founders' Relief on the disposal of those later acquired shares.

• The individual must have been UK resident (under the UK's "statutory residence test") for at least five continuous tax years before the disposal.

As drafted the condition does not specify that the five-year period has to be immediately before the disposal.  However, we expect that the residence period will either need to be immediately prior to the disposal or at least overlap to some extent with the period during which the individual owns their shares or securities.

Notably, there is no requirement for the individual to work for the company. Accordingly, the relief potentially applies to individuals who are solely financial backers.

2) Company conditions (all of which must be met)

• The company must be UK tax resident or carrying on business in the UK through a permanent establishment.

This condition, in combination with the following one ("substantial UK presence"), may encourage businesses to keep their centre of gravity in the UK, potentially impacting on the attractiveness of listing abroad.

• The business must have had a "substantial UK presence" for the five accounting periods prior to the disposal.

The government has not explained what "substantial UK presence" means.

• The company must be a trading company or holding company of a trading group, without substantial non-trading activities or "excluded" trading activities.

Importantly, for these purposes, the list of excluded trades will be the same as that for the Enterprise Investment Scheme. This strips out a number of trades, including financial services.

• The company must continue the new trade it was established for when the founder's shares were issued, with no major change in the nature of the trade. In addition, any new trade will be treated in a similar way to an "excluded" trade – which appears to mean that it cannot be substantial. 

This condition significantly limits the company's scope to introduce new business lines.

• The company must have generated turnover of at least £10 million in the accounting period prior to disposal.
  
  
• The company must have employed at least 15 qualifying full-time employees (or possibly full-time equivalent – the Budget documents are unclear) in the accounting period prior to the disposal.

A qualifying full-time employee will be defined as an individual working at least 35 hours per week and paid at least the UK National Minimum Wage. Directors and contract and agency workers will be excluded from this condition.

Helpfully, the government has confirmed that there will be no requirement that the company must be unlisted.  

Growth and innovation conditions (two out of the three conditions must be met)

• Turnover test: annual average compound growth in turnover of 25% across three consecutive accounting periods within the ten years before disposal, with turnover of at least £10m in the accounting period before the first of these three periods.
  
  
• Headcount test: annual average compound growth of at least 25% in qualifying full-time equivalent employees across three consecutive accounting periods within the ten years before disposal, with at least 15 full-time employees in the accounting period before the first of these three periods.

It is unclear whether it is intentional that the 15-employee requirement only takes into account full-time employees whereas the growth in headcount is measured by reference to full-time equivalent ones. 

• Innovation test: the company must:
  
  
  • have incurred qualifying expenditure of at least £1.5m on R&D for which it has met all the conditions to make an R&D tax relief claim; and
  • have claimed R&D tax reliefs for that expenditure for an accounting period or periods ending within the three years before the disposal.

HMRC says that if it is later determined that the R&D relief claim was invalid and the individual has relied on the innovation condition, their Founders' Relief will be withdrawn. This means that they will have to pay the additional tax plus interest.

Individuals will need to claim Founders' Relief in their self-assessment tax return and to include the information HMRC prescribes (potentially in a separate form - HMRC is still thinking about this). The Budget documents do not set out exactly what information will be required, but presumably it will be extensive, allowing HMRC to determine the validity of the claim.

The government realises that much of the information needed to evidence an individual's eligibility for relief will be held by the company. To address this, the government's preferred approach is to introduce a statutory right for individuals to request the relevant information from the company, and any supporting documentation reasonably required to establish their entitlement to the relief. Companies would be required to provide the requested information to the individual within a specified period.

The Founders’ Relief lifetime limit (£10 million) will be reduced by claims to Business Asset Disposal Relief and Investors Relief made from 6 April 2027.  

Policy

Much has been made of the Treasury's own estimate of the number of annual claimants, with the critics arguing that the fact that it is expected there will "only" be about 600 of them shows that the scope of the relief has been too narrowly drawn. However, focusing on the low number of claimants is to miss the point, the relief is intended to be targeted at a relatively small cohort – the government is trying to both pick and encourage winners amongst a crowded field of start-ups.  The bigger issue is whether the relief is correctly designed to do this.

Here a key concern is that the complexity of the conditions and the five-year holding period requirement. It is hard to see how a founder starting up a business can have any confidence that they will be able to claim the relief at least five years down the track, and therefore hard to see why they would be incentivised by it.  They are likely to be uncertain that they will meet all the conditions and, indeed, that the law will not have changed by then.

In addition, businesses may be encouraged to modify their behaviour simply to comply with the plethora of conditions, so as to help ensure that key individuals can ultimately claim relief e.g. employing unnecessary staff to ensure that the headcount test is met. This could potentially result in a misalignment between the interest of the business and wider shareholders, and those of the founder.

Further, the first of the individual conditions (25% stake) does not appear to be well targeted. Why should individuals who come onboard in the early stages, but not right at the immediate outset, not be included? 

It is also unclear why an individual must have a five-year period of UK residence. If the intention is to ensure that high-growth businesses keep a strong UK presence, this should be addressed by the company conditions. As non-residents are unlikely to be subject to CGT on gains from disposing of qualifying companies, the individual residence requirement would seem to discourage founders coming to, or remaining in, the UK unless they are sure the requirement will be met.

In-scope businesses and trades

In addition, it is unclear why some businesses are out of scope. The relief only applies to companies. Many businesses (especially providing professional services) are established as LLPs, and, as currently proposed, the relief simply does not apply to them. In addition, excluding financial services means that it may be hard for businesses in the fintech sector – a key growth area in the UK economy and one where the UK has historically had a global competitive advantage - to access the relief.

The requirement that the company must, in practice, only ever carry out its original trade seems particularly hard to justify. No reason for it is given in the Budget documents. It will discourage flexibility; why open up a new business line if doing so could endanger relief? The requirement may have been included to prevent abuse of the regime, but, if that is the case, a targeted anti-avoidance rule would seem a better approach, and, indeed, HMRC has said that it is considering introducing one.  

Practical issues

There are also real practical difficulties. As HMRC recognises, much of the information that an individual will need to make a claim will be held by the company.  There may be circumstances in which a company will not wish to provide a minority, and quite possibly exiting, shareholder with extensive (and potentially sensitive) information.  A solution here may be to give the company a choice between providing the information or a certificate that the relevant conditions are met. 

In addition, even for companies happy to provide information (or certificates) to founders, there is the question of whether, given the long look back period for several of the conditions, they will be required to retain information beyond the current record keeping requirements.

It is often hard to be completely confident when making an R&D tax relief claim that HMRC will agree that it is valid, indeed it is a common area for disputes - sometimes arising several years down the line.  This may discourage founders from relying on the innovation test, potentially providing an artificial incentive for them to focus on turnover and headcount over R&D.

The 10% rate and £10m lifetime limit may look familiar, as they mirror the old Entrepreneurs' Relief when it was at its most generous.  However, Founders' Relief is much more targeted – aiming to target just key individuals in high-growth companies who invested at the outset. This has led to a maze of conditions being proposed, through which founders will have to navigate, the justification for some of which is hard to discern.

Fortunately, the scope of the current consultation on the regime is wide, with the government seemingly open to significant changes to ensure that the relief better meets its policy objective. 

That being said, for the time being, prudent founders catering for a potential exit should plan on a (pessimistic basis) and assume that the conditions currently proposed by the government will apply.