HMRC challenges Entrepreneurs’ relief

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Gannons successfully defended an entrepreneur’s claim to entrepreneurs’ relief against an HMRC’s challenge.

The entrepreneur was a founder and shareholder of a software development company. He had acted as a director of the company for many years. His wife fell ill, so he took a sabbatical to look after her and resigned his directorship. He was out of the business for a number of years, during which his shareholding was severely diluted.

He later returned to the business on a part-time basis to develop the strategic direction of the business and find a buyer for it. Upon his return, he did not draw a salary or take benefits. After a number of years, they secured a buyer for the whole company. Our client received a significant capital gain from the sale of the business. However, for this capital, HMRC sought to assess our client on the basis that he was not an employee of the company. They wanted to impose a Capital Gains Tax (CGT) rate of 28% upon him, rather than the 10% he would correctly owe thanks 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.

Proceeding with the case

We were instructed by our client, and moved into action. Firstly we challenged the authorities that HMRC relied upon. Then we provided HMRC with sufficient evidence to confirm that our client was indeed an employee. Finally we sought letters from the company and its individual officers as evidence for the arguments we put forward.

On the basis of our work and negotiation, HMRC withdrew their initial assessment. Our client gained entrepreneurs’ relief and paid CGT at 10%.

Problems with the evidence

There were complications with his case. Our client produced his service agreement, however, he lacked a signed version. This is fairly common in cases such as this. Additionally, he could not recreate the history of his shareholding showing how it was diluted. By the time HMRC made their assessment the business had been sold on again. As such, the missing evidence could not be re-created because the new buyer did not know where the records were stored. The records of Companies House were also incomplete.

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.

HMRC’s challenge to Entrepreneurs’ Relief

HMRC initially refused the claim for entrepreneurs’ relief. They refused his claim for entrepreneurs’ relief on the grounds that the company had taken the entrepreneur off PAYE after he gave up his directorship. HMRC also argued that a 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

Obtaining the assessment from HMRC to CGT at 10% for our client required us to use our unique blend of employment and tax law knowledge. We wrote a letter persuading HMRC that our client satisfied the requirements for Entrepreneurs’ Relief.

Sabbatical employment

A person taking a sabbatical, as our client was, is still employed at the company. Neither party has yet terminated the employment relationship. Therefore, the period of the taxpayer’s sabbatical should be included in calculating the length of employment for the purposes of Entrepreneurs’ Relief.

Employment with unwritten contracts

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 proving that the company still retained him as an employee after his directorship ceased. We pointed out that an employment agreement can be verbal as well as written.

PAYE

The removal of the taxpayer from PAYE before the sale of business does not end employment for the purposes entrepreneurs’ relief .

Employee duty

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.

Criteria to receive entrepreneurs’ relief

We pointed out to HMRC that the taxpayer in this case met the compulsory entrepreneurs’ relief criteria. He held at least 5% of voting shares in the company and he had held the shares for at least 12 months before the sale. Additionally he had been an officer or employee of the company for at least 12 months before the sale.

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.