HMRC challenges Business Assets Disposal Relief (Entrepreneurs relief)

Gannons successfully defended an entrepreneur’s claim to Business Assets Disposal Relief (entrepreneurs’ relief) against an HMRC challenge.

The entrepreneur was a founder and shareholder of a software development company and had served as a director for many years. When his wife fell ill, he took a sabbatical to care for her and resigned his directorship. He remained away from the business for several years, during which his shareholding was substantially diluted.

He later returned on a part-time basis to help shape the company’s strategic direction and find a buyer. He received no salary or benefits. Several years later, the entire company was sold, generating a significant capital gain for our client. HMRC challenged his claim to Business Asset Disposal Relief (BADR), arguing that he was not an employee of the company. This exposed him to a potential Capital Gains Tax (CGT) rate of 28%, rather than the 10% rate applicable under the rules in force at the time.

When the entrepreneur approached us, HMRC’s enquiry into his self-assessment had been open for three years, and his accountants had not responded to HMRC correspondence for two years. He faced a significant tax adjustment, together with interest and potential penalties.

Proceeding with the case

We challenged the authorities relied on by HMRC and provided evidence to demonstrate that our client remained an employee. We also obtained supporting letters from the company and its officers.

Following our representations and negotiations, HMRC withdrew its initial assessment, accepted our client’s claim to BADR and applied the 10% CGT rate.

Problems with the evidence

There were several evidential difficulties. Our client had a service agreement but no signed copy, a common issue in cases of this kind. He was also unable to reconstruct the history of his shareholding and how it had been diluted.

By the time HMRC issued its assessment, the business had been sold again. The new buyer could not locate the missing records, and the Companies House records were incomplete.

To address these gaps, we obtained retrospective confirmation from the former CEO and approached Companies House to recover the missing files.

HMRC’s challenge to Business Assets Disposal Relief (Entrepreneurs’ Relief)

HMRC initially refused the BADR claim because the company had removed our client from PAYE after he resigned as a director. HMRC also argued that he was not an employee for BADR purposes because he received no salary and had no signed employment contract.

How we obtained Business Assets Disposal Relied (Entrepreneurs' Relief)

Securing the 10% CGT treatment required us to draw on our employment and tax law expertise. We submitted a detailed letter explaining why our client satisfied the relevant requirements for BADR.

Sabbatical employment

We argued that taking a sabbatical does not necessarily terminate employment. Where the employment relationship continues, the period away from the business may count towards the relevant employment period for BADR purposes.

Employment with unwritten contracts

The absence of a signed employment contract does not, by itself, prevent an employment relationship from existing. Our client had a verbal employment agreement, and we argued that the company had continued to retain him as an employee after his directorship ended. We explained that an employment agreement can be verbal as well as written.

PAYE

We argued that removing our client from PAYE before the sale did not, by itself, establish that his employment had ended for BADR purposes.

Employee duty

Our client’s work after returning to the business demonstrated that he continued to perform substantive duties. We relied on relevant case law to argue that the nature of the duties performed was important in determining whether he qualified as an employee for BADR purposes.

Criteria to receive Business Assets Disposal Relief (entrepreneurs' relief)

We explained that our client met the applicable BADR criteria in force at the time of the sale. He held at least 5% of the company’s voting shares and had held them for at least 12 months before the sale. He had also been an officer or employee of the company for the required period.

Following our representations, HMRC accepted the BADR claim and closed its enquiry into our client’s self-assessment.

Catherine Gannon heads the tax team at Gannons. Our experience extends beyond defending HMRC enquiries to helping businesses put the appropriate corporate structure and documentation in place to reduce the risk of future challenges.