Entrepreneurs Relief can reduce your Capital Gains Tax (“CGT”) on gains arising on the sale of e.g. shares, certain assets, leaving a partnership or LLP. If applicable, Entrepreneurs Relief reduces your capital gains tax from the 20% to just 10%. There are legislative requirements and sometimes planning steps to consider – that is our expertise.
Our services relating to entrepreneurs relief includes:
- Overview of the capital gains tax saving under entrepreneurs relief;
- Trading company share sales and entrepreneurs relief;
- Asset sales and entrepreneurs relief;
- Cessation of trade & commencement of new business;
- Solving entrepreneurs relief problem areas;
- Entrepreneurs Relief under HMRC approved employee share plans; and
- Track record in dealing with claims to entrepreneur relief.
Overview of the capital gains tax saving under entrepreneurs relief
Currently, Entrepreneurs Relief is available for up to £10 million lifetime gains, potentially a £1 million tax saving. A few simple planning steps taken in time is usually sufficient to obtain Entrepreneurs Relief. We often assist accountants ensure their clients obtain entrepreneurs relief.
Couples, i.e. husbands, wives and civil partners, are each eligible for the £10 million of lifetime gains if they each satisfy the relevant conditions at the time of sale. There may be scope for pre-sale tax planning to increase the tax relief available to a couple.
Entrepreneurs relief does have to be reported to HMRC on the personal tax return for the year in which the gain arises.
Trading company share sales and entrepreneurs relief
The taxpayer benefits from entrepreneurs relief if:
- The company, or the holding company of a trading group, is trading;
- The taxpayer has been, for at least 1 year, an:
- Officer of the company or subsidiary, or
- Employee of the company or subsidiary,
- Note, the taxpayer is not required to have actually worked a minimum number of hours; AND
- The taxpayer holds, for a year, over 5% of the ordinary shares, so the taxpayer has over 5% of the voting rights.
Earn outs and entrepreneurs relief
We advise on the implications for entrepreneurs relief where the sale consideration consists of cash on disposal plus further cash if earn out targets or retention periods are satisfied. The difficulty here is if at the time any earn out is paid the tax payer has left the business entrepreneurs relief will not be available. We can provide solutions and structures which bring the earn out within the entrepreneurs relief regime.
Company share buy backs and entrepreneurs relief
If the sale of shares takes place as a Company buyback of shares with some pre-planning and structuring depending upon the facts, entrepreneurs relief may be available.
Asset sales and entrepreneurs relief
We deal with situations where the asset but not the entire business is sold. Typical cases we deal with are where a partner is leaving a partnership or LLP and the terms of the Partnership agreement entitle the partner to a capital payment on leaving. Another scenario is retirement where assets are sold off as part of Succession planning in owner managed businesses.
Entrepreneurs relief applies to a disposal of qualifying assets in a business which has ceased. These assets had to be used for business purposes, when the business ceased to be carried on, if the business:
- Had been owned by the individual continuously for one year, and ended when the business ceased; AND
- Ceased to be carried on for three years, that ended at the date of the disposal.
Assets for investment purposes
Assets excluded from Entrepreneurs Relief include assets:
- Held for investment purposes;
- Not used for business purposes.
This condition can catch companies with large cash deposits. Sometimes a large dividend payment could improve the tax-payer’s position.
We regularly apply to HMRC for a non-statutory clearance on behalf of cash-rich companies.
Partners or shareholders who dispose of personal assets, used in the business, can benefit from Entrepreneurs Relief. The asset disposal must be:
- Material, and the partner or shareholder must be withdrawing from the business;
- Of an asset used by the partnership or company for business purposes for one year ending on the disposal date, and not for unconnected purposes.
Often partners, who receive a capital sum on retirement, can benefit from Entrepreneurs Relief, if the settlement deed is correctly structured.
Cessation of trade & commencement of new business
A hidden feature of Entrepreneurs Relief may enable you to realise proceeds and pay tax of only 10% and still carry on trading under a shift of emphasis. The question is: When does a change in the business constitute the cessation of one trade and the commencement of a new business? Entrepreneur’s relief applies if there is a significant change in the business with chargeable gains arising on, for example, the sale of property such as goodwill, land, assets and other business tools.
What HMRC regards as a change in the trade depends on the facts of the particular case. The recent, First-Tier Tribunal decision of Rice v HMRC provides guidance, but it lacks the authority of the Court of Appeal or Supreme Court.
Rice v HMRC
Rice, the taxpayer, sold luxury second-hand cars, trading from premises he owned. He relied on passing trade for his business. Unfortunately, vandalism became a problem so in 2005 he stopped selling cars but retained the premises. He sold the premises in 2008, making a substantial gain. Rice moved to a new area, and began selling cars via the internet. However, instead of luxury cars, he sold cheaper cars.
HMRC challenged Rice’s claim for entrepreneurs’ relief. To claim, Rice had to establish that:
- The trade ceased in 2005, three years before he sold the premises; and
- The sale of cars via the internet with no passing trade was a new business.
The Tax Tribunal found in favour of Rice. HMRC lost. The Tax Tribunal relied on an established tax authority that the relocation of a local business could give rise to a permanent discontinuance of one trade and the commencement of a different one. The Tax Tribunal also considered that there was a difference between slow and gradual growth and a dramatic change.
Many traditional bricks and mortar businesses have also built successful online business. Thus there may be potential to realise the value of no-longer needed assets, e.g. property, and invest that value in new businesses.
Although Rice v HMRC involved trading premises, the principles could apply to other assets, e.g.
- Intellectual property that is no longer required;
- Customer lists in an area that the business has withdrawn from.
However, the sale requires planning, and the business assets must be sold with three years of ceasing to trade.
Distributing cash as capital not dividends
If a business ceases, the company is liquidated, and assets which are usually cash are distributed. Done right, and the distribution is treated as capital for which Entrepreneurs Relief is available.
Done wrong, the distribution is treated as a dividend, which attracts the higher rate of dividend taxes. So to claim Entrepreneurs Relief, you should:
- Document the sale;
- Maintain records to show the trade has ceased;
- Make the claim on your tax return by the first anniversary of the 31 January, following the tax year in which you make the business disposal.
Solving entrepreneurs relief problem areas
There are a variety of pitfalls where tax payers may not qualify for entrepreneurs relief.
Typical problem areas where entrepreneurs relief can be denied
- The existence of different classes of shares or deferred shares with no capital rights can impact the availability of Entrepreneurs Relief so it is important to review the shareholding structure before disposing of shares. It might be necessary to cancel or convert shares to satisfy the conditions for entrepreneurs relief.
- A share reorganisation whereby a new holding company acquires your company’s shares, offering shares in the new holding company. The tax payer might not meet the 5% threshold;
- No or inadequate paper work meaning an HMRC challenge cannot be disposed of;
- The company enters into a joint venture. The tax payer might not meet the 5% threshold;
- A share purchase agreement that contains earn-out provisions; and
- Sale of part of a business.
We review and provide recommendations to be implemented to qualify a tax payer for entrepreneurs relief. Planning in advance of Selling a business will usually put the tax payer in a stronger position.
Transfers between spouses
We recently heard about a pre-sale transfer between spouses. This sounds like sensible financial planning. The company owner knew there was a buyer on the horizon and quickly transferred 40% of his shares to his wife. Regrettably, the seller failed to hire his spouse as an officer or employee of the company . This oversight cost the couple £56,000 in additional tax.
The HMRC definition of “employee or officer” for entrepreneur relief purposes is simple:
- There is no requirement as to hours or salary;
- Non-executive directors and company secretaries count as officers;
- The officer must take on the responsibilities and duties of the role. However, in the run up to a sale a non-executive director or new employee may be very helpful.
Entrepreneurs Relief under HMRC approved employee share plans
The standard rates of capital gains are reduced for employees disposing of shares received under either an EMI scheme or as Employee shareholder shares. Under the EMI option and Employee Shareholder Shares legislation the requirement to hold 5% of the voting ordinary shares is lifted.
For employees and unpaid directors a reduction in the rate of capital gains tax is available under the Investors relief regime.
Entrepreneurs Relief is more generous to employees selling shares acquired under EMI option than it is for other taxpayers. There are two differences to the rules where EMI options are involved:
- The requirement to hold 5% or more of the ordinary share capital does not apply;
- There is no requirement to be a shareholder for one year as for EMI options the rule is you have to hold the option for one year!
Employee Shareholder Shares
Sale of Employee Shareholder Shares is exempt subject to a lifetime limit of £100,000. After the limit has been exhausted any gain realised on sale of Employee Shareholder Shares is subject to capital gains tax at 20% but if entrepreneurs’ relief is available tax rate can be reduced to 10%.
Track record in dealing with disposals where the tax payer secured entrepreneur relief
We have dealt with a great many sales in our time. Our clients work with us because we not only provide the tax expertise but also deal with the legal review or drafting of the sale documentation for them. A reduction in the number of professional advisors is always a good move. If the transaction is scrutinised by HMRC the availability of good documentation is important and can be the difference between reducing the rate of capital gains tax to 10% or paying at higher rates.
- Acted for the shareholders of a software company being sold for a considerable sum – we reviewed the earn out provisions and advised the shareholders on choices relating to the taxation of earn outs.
- Acted for an entrepreneur who was planning on a sale. We dealt with the transfer of shares to his spouse so that the lifetime allowance for her of £10 million was fully utilised and ensured she was on the payroll in good time.
- Acted for a director shareholder who was leaving the company following shareholder disputes on the taxation of proceeds received following a buy back of shares by the company.
- Dealt with the retirement of a partner from a hedge fund who was paid a sizeable capital payment following the disposal of assets.
- Advised a vet on her exit from the partnership and payment of taxes on the profits she had made.