Entrepreneurs’ Relief offers exceptional tax-saving opportunities, but despite recent reforms, dangers lurk in the complexity.
For many business owners, Entrepreneurs’ Relief offers an exceptional opportunity to minimise tax when disposing of their company, but new rules around liquidation, introduced in April this year, mean that planning your exit now needs more care than ever.*
Entrepreneurs’ Relief, which was first introduced in 2008, allows tax of just 10% to be paid on lifetime gains when a business (or part of it) is sold off. Subsequent changes in the level of relief available have been at least as important, taking the lifetime limit from below £2 million right up to £10 million, where it has remained since 2011.
Of course, the rate of Capital Gains Tax on most assets is now just 20% for higher rate and additional rate taxpayers, down from 28%, but this is still only half as generous to business owners as Entrepreneurs’ Relief. Moreover, although there is a £10 million limit, spouses and civil partners may also, under certain circumstances, qualify separately for their own relief. Finally, an individual can make as many separate claims as he or she likes, so long as the ceiling is not exceeded.
Entrepreneurs’ Relief can be applied to a number of different kinds of business ‘disposals’ (a term that includes the sale, gift or liquidation of a company). The sale of all or part of a business owned by a sole trader or business partner can qualify for the relief, including:
- The assets of the business
- Company shares in which the seller owns at least 5% of the shares (including voting rights)
- Shares acquired through an Enterprise Management Incentive scheme established after 5 April 2013
- Assets that had been lent to the business by the seller
There are limits to how Entrepreneurs’ Relief can be applied. For example, the business or company involved must be trading at the time of application – although a new rule allows the relief to be claimed so long as the shares are sold within three years of the cessation of trading. Moreover, some business activities, such as property and letting, are disqualified because they are seen as ‘investment operations’ rather than ‘trades’. Sole traders or business partners must have owned the business for at least a year in order for the sale to qualify, and the seller of shares must have been an employee, director or holder of office within the company.
Cutting some slack
In 2015, the government introduced rules intended to crack down on abuses of Entrepreneurs’ Relief, but the 2016 reforms were reckoned by some commentators to be a tacit admission that the 2015 changes had gone too far, and in some cases ended up penalising what had been legitimate tax planning.
The 2016 reforms therefore offered some olive branches to business. The relief was extended to long-term investors in unlisted companies, providing a 10% tax rate for gains of newly issued shares in unlisted companies that were bought on or after 17 March 2016, so long as they are held for at least three years from 6 April 2016. The reforms also reinstated Entrepreneurs’ Relief in the succession of family businesses and joint venture partnerships.
However, the changes have not been able to remove the complexity of calculating whether you qualify – and some of the details of the latest reforms remain unclear. There are particular dangers in the definition of a ‘trading company’. To receive the relief, a company must be trading, and not pursuing other activities to any “substantial” extent. HMRC has confirmed that “substantial” should be taken to mean “greater than 20% by reference to a reasonable measure in the circumstances of the case”.
While Entrepreneurs’ Relief offers a potential boost for business owners, its complexities require careful navigation, and detailed understanding of recent legislation. Individuals looking to rely on the relief would be well-advised to conduct an appropriate tax audit.
The levels and bases of taxation and reliefs from taxation can change at any time. The value of any tax relief depends on individual circumstances.
*Exit Strategies may include the referral to a service that is separate and distinct to those offered by St. James's Place.