Capital Gains Tax (“CGT”) is payable on the gain arising on the sale of shares, sale of certain assets or on leaving a partnership or LLP. But, if you can benefit from entrepreneurs’ relief you can reduce this rate of CGT from the top rate of 28% (or the flat rate of 18%) to just 10%.
It is well worth checking that the structure of your business will allow you to benefit from this relief. Entrepreneurs’ tax relief is currently available on up to £10 million lifetime gains, so your tax saving could be up to £1,800,000.
A few simple planning steps taken in time could save you substantial amounts of tax. We frequently work with accountants in the background helping them to ensure that their clients do not miss out on the benefits of entrepreneurs’ tax relief on capital gains.
The main areas where we can provide advice on entrepreneurs’ relief include:
Sale of shares in or securities of a trading company – an individual (not companies, partnerships, LLPs or other corporate bodies) can benefit from entrepreneurs’ tax relief on the sale of shares if the company is trading (or the holding company of a trading group) AND the taxpayer has been an officer or an employee of the company (or of a company in the same group) for at least one year (although there are no minimum number of hours that must be worked); AND the individual has held at least 5% of the ordinary share capital enabling them to exercise at least 5% of the voting rights. These conditions also apply on a sale of securities. A company that separates voting shares from dividend bearing shares might accidentally cause an individual to miss out on the benefits of Entrepreneurs’ tax relief and as a result incur an increased capital gains tax liability.
This is the most straightforward case. However, what if there is a share reorganisation whereby a new holding company acquires the shares in your company and in return gives shares in the new holding company, or if your share purchase agreement contains earn-out provisions? These transactions need to be carefully structured to protect the right to claim entrepreneurs’ relief. We can review sale documentation to advise you on these questions.
Sale of whole or part of a business – entrepreneurs’ tax relief is available on the disposal of all or part of a business that an individual has owned for at least one year prior to the date of disposal. The disposal must be of assets comprising the business, and not just of assets used in the business.
There have been a couple of cases in 2012 considering this distinction. In the tribunal case of Gilbert v HMRC, it was held that entrepreneurs’ relief could be claimed on the basis that the 1/9th part of the business sold did constitute a mini business in its own right – it could be run as a separate and individual business. However the high court case of Russell v HMRC did not allow the sale of 35% of farm land to qualify for entrepreneurs’ relief because the court held that the sale did not relate to the sale of a business but was rather the sale of a business asset which did not therefore qualify. The position has historically been that the sale of some of the farmland is not a disposal of part of a farming business – this was unsuccessfully challenged on the basis that 35% of the business was sold in the Russell case.
The test is to look at the nature and extent of the business activities before and after the transaction. If the business is run in exactly the same way both before and after the sale, the sale will probably not be considered as a sale of a business and so will not qualify for entrepreneurs’ tax relief and the standard rate of capital gains tax will be charged on the gain arising on the sale.
Certain assets used in a business which has ceased – entrepreneurs’ relief will apply to a disposal of one or more qualifying assets used for the purposes of a business at the time when it ceased to be carried on, provided both of the following conditions are met: (i) the business has been owned by the individual (whether as a sole trader or in partnership) throughout the period of one year ending on the date on which the business ceases to be carried on and (ii) the business ceased to be carried on in the period of three years ending with the date of the disposal.
Assets held for investment purposes and assets that are not used for the business purposes are excluded from entrepreneurs’ relief. Companies with large cash deposits can be caught. It may be advantageous in such situations to review whether a dividend payment could improve the position for the tax payer.
Certain personal assets used in a business – a disposal by a partner or shareholder of a personally-owned asset that is used in the business will benefit from entrepreneurs’ tax relief provided that certain conditions are met. These conditions include that the disposal is “material” and that the partner or shareholder is withdrawing from the business. A further condition is that the asset was used by the partnership or company for the purposes of its business throughout the period of one year ending with the date of the disposal (and not for unconnected purposes). In many cases partners receiving a capital sum on retirement from partnership can benefit from entrepreneurs’ tax relief providing that the settlement deed is structure correctly.
Couples – couples (i.e. husbands and wives and civil partners, etc) – are each eligible for entrepreneurs relief 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.
EMI options and entrepreneurs’ tax relief – entrepreneurs’ tax 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: (1) the requirement to hold 5% or more of the ordinary share capital does not apply; (2) 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!