Entrepreneurs relief & HMRC challenge
- Catherine Gannon
- Updated: Mon, 19th Dec 2016
We successfully defended an entrepreneur’s claim to Entrepreneurs’ Relief against HMRC’s challenge. HMRC sought to assess our client to a CGT rate of 28%, on the basis that he was not an employee. We stepped in.
How our challenge succeeded
We were instructed by the individual, and:
- Challenged the authorities relied on by HMRC.
- Provided HMRC with sufficient evidence to confirm that our client was indeed an employee.
- Sought letters from the company and its individual officers confirming our arguments put forward.
HMRC withdrew the assessment following our negotiation. Our client paid CGT at 10%.
Background to the case
The entrepreneur was a founder and shareholder of a software development company. He acted as a director for a number of years. His wife fell ill, so he took a sabbatical to look after her and resigned his directorship.
Employee status for entrepreneurs’ relief
He was out of the business for a number of years during which his shareholding was severely diluted. He returned to the business on a part-time basis to develop the strategic direction of the business and find a buyer. Upon his return, he did not draw a salary or take benefits. After a number of years, a buyer was secured and the whole company was sold. Our client realised a significant capital gain.
Problems with the evidence
There were complications with his case. As is fairly common in these cases, the client could find his service agreement but could not produce a signed version. Also, he could not recreate the history of his shareholding and how it was diluted. The missing evidence could not be re-created because the new buyer would not know where the records were stored. By the time HMRC made their assessment the business had been sold on again. Companies House records were also incomplete.
HMRC’s challenge to Entrepreneurs’ Relief
When the entrepreneur approached us, the inquiry into his self-assessment had been open for three years. His accountants had failed to reply to HMRC correspondence for two years. The entrepreneur faced a significant tax adjustment, plus interest and penalties.
HMRC initially refused the claim for entrepreneurs’ relief. The refusal was based on the fact that the entrepreneur was taken off PAYE after he gave up his directorship. HMRC argued that lack of salary meant he was not an employee for entrepreneurs’ relief purposes. They also argued that the lack of employment contract precluded the entrepreneur from being an employee.
How we obtained Entrepreneurs Relief
Defending the assessment to capital gains tax at 10% required a blend of employment and tax law knowledge unique to Gannons. We persuaded HMRC that our client satisfied the requirements for Entrepreneurs’ Relief, because:
- A person taking a sabbatical is still employed at the company. The employment relationship has not been terminated by either party. Therefore, the period of the taxpayer’s sabbatical should be included in calculating the length of employment for Entrepreneurs’ Relief purposes.
- The lack of a signed employment contract does not preclude the existence of employment relationship. Therefore the fact that the tax payer did not have a contract should not defeat his claim for entrepreneurs’ relief. Our client had a verbal employment agreement which proved that he was employed at the company after his directorship ceased. We pointed out that an employment agreement can be verbal as well as written.
- The removal of the tax payer from PAYE before the sale of business does not end employment for entrepreneurs’ relief purposes.
- Our client’s hard work and dedication after he returned to the business matched, if not exceeded the amount of work expected of an employee. We relied on confirmed decisions to argue that the case law indicates that the court will look at whether a taxpayer has performed duties of an employee to determine whether the taxpayer was an employee for entrepreneurs’ relief purposes.
- We advanced to HMRC that the tax payer in this case met the compulsory entrepreneurs’ relief criteria, i.e. he held 5% or more of voting shares in the company which he held for at least 12 months before the sale and that he was an officer or employee of the company for at least 12 months before the sale.
- To tackle the problem relating to the lack of evidence, we obtained retrospective assurances from the former CEO and approached Companies House to recover lost files.
Following our letter, HMRC accepted the claim for entrepreneurs’ relief and closed the inquiry into entrepreneur’s self-assessment.
Catherine Gannon heads the tax team at Gannons. The experience is not just limited to defending HMRC inquiries when they arise, but ensuring the corporate structure and paperwork is in place before the inquiry can be raised.