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The budget 2020 announcements reduced the lifetime limit for gains qualifying for Entrepreneurs’ Relief from £10 million to £1 million for qualifying disposals made on or after 1 March 2020. So how should you make use of this important tax benefit?
The Government’s rationale for this reduction is the relief has done very little to generate additional entrepreneurial activity, primarily benefitting a small number of very affluent tax payers.
John Cullinane, the Tax Policy Director of the Chartered Institute of Taxation is calling for MPs to look closely at the Government’s plans for Entrepreneurs’ Relief and in particular why the review was not carried out in public. He goes on to say “there are people affected by the March 2020 budget change who have reinvested money in the expectation of the relief that they will no longer receive”.
Under the budget 2020 proposals, Entrepreneurs’ Relief is to be re-badged “Business Asset Disposal Relief”.
Entrepreneurs’ Relief is a Capital Gains Tax Relief available to taxpayers who sell or give away their businesses.
The relief operates by reducing the Capital Gains Tax payable on the gain (or deemed gain in the case of a gift) to 10%. This is regardless of whether the taxpayer is a basic, higher or additional rate taxpayer.
Up until the budget 2020 there was a lifetime limit of the gains qualifying for Entrepreneurs’ Relief of £10 million, but this has now been reduced £1 million.
The relief is available to sole traders or partners selling or gifting the whole or part of their business, company directors and employees who dispose of shares or securities in a personal trading company that they work for and directors and employees who acquired shares under the EMI Option Scheme.
To qualify there must have been material disposals of business assets.
A business asset is defined as:
In respect of assets used in the business at the time the business ceases, the asset must be sold within 3 years of the cessation of trade.
The conditions are that the individual owns at least 5% of the ordinary share capital and at least 5% of the voting rights which is exercisable by the individual by virtue of that holding.
The second condition is that the taxpayer must work for the company or for another company in the same group. This would include full-time or part-time employees or directors. There is no minimum number of hours of work required.
In addition, the shareholder must either be entitled to at least 5% of the distributable profits and 5% of the assets available on the winding up and/or be entitled to at least 5% of the proceeds of disposal of the whole of the ordinary share capital of the company.
The associated disposal rules do not apply to sole traders.
To qualify as an associated disposal a number of elements must be satisfied. You must have made a material disposal of the business or shares and securities in a company. As part of the withdrawal from the business you make a disposal of an asset which has been used in that business for at least 2 years and was acquired on or after 13 June 2016. The asset must have been owned by you for 3 years prior to disposal.
An example: a company director owns at least 5% of the shares of a company and also owns the premises from which the company trades. Provided he sells the building at the same time as he sells the shares, this could be an associated disposal provided the other criteria apply.
Entrepreneurs’ Relief can be claimed on part-disposals of businesses or business assets provided the disposal represents at least 5% of the shareholding (see above) or 5% of partnership assets. Provided the taxpayer has owned 5% or more for three of the eight years prior to the disposal, a material disposal may be of less than a 5% interest provided it is of the whole of the individual’s partnership assets/shareholding.
The associated disposal must take place within one year of the business cessation or within three years, so long as the assets have not been leased or used for any other purpose. If the individual taxpayer has charged the business rent for use of the assets, at its full market rent, no Entrepreneurs’ Relief is available. If less than the market rate rent has been charged for the business, some Entrepreneurs’ Relief will be available. If no rent is charged, then full relief is available.
If you make a material disposal of business assets and you re-invest in a new business, you may look at first to see if there is any Rollover Relief available for the investment in the new business and apply Entrepreneurs’ Relief to any gains remaining after the Rollover Relief has been claimed.
If you transfer your business to a limited company you may wish to consider whether Entrepreneurs’ Relief would be available to you on any gains arising on the incorporation.
The main point to note is, that Entrepreneurs’ Relief will not be available in respect of any gain arising on the transfer of goodwill to the company. Under Section 169LA TCGA 1992 where goodwill is disposed of to a close company and the transfer is of 5% or more of the share capital of the company (or the shareholder exercises at least 5% of the voting rights or the shareholder is a beneficiary entitled to at least 5% of the profits available for distribution and at least 5% of the assets on a winding up or would be beneficially entitled to at least 5% of the proceeds on the disposal of the whole company) then goodwill is no longer a relevant business asset for the purposes of Entrepreneurs’ Relief.
In those circumstances, Entrepreneurs’ Relief would not be available for the value of the goodwill but Entrepreneurs’ Relief would be available where the transferor holds less than 5% of the shares of the company and does not meet any of the other tests listed above. The rationale behind this is that the individual is genuinely selling their business and reducing their involvement in it.
In summary, Entrepreneurs’ Relief is one of the most attractive benefits available to entrepreneurs. You can claim as many times as you like provided your claims are within the £1 million lifetime limit. It is available to individuals, not companies.
If you are selling a business, you have to be the sole trader or a business partner for the two year qualifying period.
If you are selling shares you have to have been an employee or officer in the company as well as owning the shares for the qualifying period. The company itself must be a trading company or the holding company of a trading group and must have traded within the qualifying period.
There is one case in which you are not required to be working in the business under an extension called Investors’ Relief, this has been dealt with under a separate article.
A £1 million tax relief can be lost on a technicality. It is therefore essential that you seek advice within at least two years prior to your retirement and earlier if possible. This is to ensure that you are eligible for the relief and if you are not eligible, to give us time to see what can be done to ensure you become eligible. Do not wait until after you have sold your business interests or your shares before checking.
The sorts of things that you will need to consider are whether you have any evidence that you have worked as an employee or officer for the company because if you can’t prove it you won’t be eligible. It would be sensible to have a written Employment Contract for example.
There is no set definition of trading given by HMRC. A company’s trading status is evaluated based on several factors. Trading can in certain circumstances extend to a one-off transaction resulting in unexpected profits.
Lots of businesses have a mixture of trading and non-trading activities. Companies with mixed business trading can still be eligible for Entrepreneurs’ Relief provided the non-trading activities are not substantial. HMRC considers substantial to be anything over 20%. So for example provided rental income received by the company equates to less than 20% of the company’s total trade and the staff are not spending more than 20% of their time in relation to non-trading activities, then you still may be able to qualify.
If your company is cash rich you could risk failing the trading status test unless such cash has been earmarked for a trading purpose.
The business must be owned for at least two years prior to cessation and the asset must be sold within three years of the cessation. In these circumstances, the asset would qualify for Entrepreneurs’ Relief.
There are additional requirements to comply with if the shares are from an EMI. To be eligible for Entrepreneurs’ Relief you must have:
The requirement to hold 5% or more of the voting share does not apply when it comes to disposing of EMI shares.
One way round the lower limit (the £1 million lifetime limit) would be to consider gifting shares to your spouse, since these are transferred at no gain no loss. Provided your spouse met the criteria, they would also have a full Entrepreneurs’ Relief lifetime limit. This doubles your tax relief.
If you are dissolving your company, Entrepreneurs’ Relief can still be claimed provided:
You will need to discuss this with your accountant but you may find paying the 10% Capital Gains Tax suits you better than seeking out your profits over several years with a traditional small salary of £12,000 or so per year plus dividends on which only 7.5% tax is payable.
There is anti-avoidance legislation that was introduced in April 2016 which prevents individuals from closing companies simply as a way of taking advantage of the tax efficiency of the capital distribution route rather than an income distribution.
Distributions from the voluntary liquidations of a company may be treated as income distributions in the following circumstances:
In these instances, the distributions could be subject to income tax and ineligible for Entrepreneurs’ Relief.
The legislation surrounding Entrepreneurs’ Relief is complex and professional advice should be sought well in advance of retirement, incorporation or gifting of business assets.
Wellers Wealth are very happy to work in conjunction with your independent financial advisor, accountant or legal advisor on such matters.
Please call us on 020 7481 2422 or email us at email@example.com if you would like to know more.
This article was written by Ingrid McCleave and the law is correct as at 24th November 2020. Please note that tax legislation changes frequently, so this article should not be relied upon without seeking further legal advice.
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