Business Assets Disposal Relief – AKA Entrepreneurs Relief
Entrepreneur relief will reduce the rate of tax payable on gains made on shares to 10%. This makes the UK a tax haven for entrepreneurs.
As of March 2020, Entrepreneurs Relief will be referred to as Business Assets Disposal Relief (BADR).
If you have any queries please do telephone us. We are always happy to provide a quote.
From 11 March 2020, the lifetime limit on gains eligible for BADR (ER) will be reduced from £10 million to £1 million.
We are seeing more interest in employee share ownership trusts now that BADR is severely reduced. The benefit of an employee share ownership trust (EOT) is that the sellers can make gains of any amount tax free.
Reasons for deciding to work with us
Our specialist tax solicitors can review your position and let you know where you stand. In some cases we can recommend changes to bring you within the requirements for Business Assets Disposal Relief (ER).
- We specialise in dealing with unquoted shares in private companies and over the years have amassed a strong track record of success stories.
- We can deal with the tax issues and the legal review or drafting of relevant documentation – this cuts down on multiple advisors.
- We are strong negotiators if the need arises.
To help you understand the position we have explained below some of the questions we are often asked.
- Will your share disposal qualify;
- Trading requirements;
- What can go wrong;
- Special position for EMI options; and
- Self employed taxpayers.
Business assets disposal relief and share transactions
You will benefit from Business Assets Disposal Relief (ER) if:
- The company, or the holding company of a trading group, is trading;
- You have been, for at least two years, an officer, director or employee of the company or a group company; and
- In your capacity as shareholder you have held for two years, 5% or more of nominal issued issued share capital and 5% of voting share capital. Some tax payers trip up on this point and it is the area where we particularly recommend care is taken.
- And, you have not exceeded your lifetime limit of £1 million per shareholder – fairly generous.
Definition of officer, director or employee
The HMRC definition of “employee or officer” for Business assets disposal relief (entrepreneurs relief) purposes is simple:
- There is no requirement as to hours or salary but there should be some evidence of working in the business;
- Non-executive directors and company secretaries count as officers;
- A written employment contract is indicative of employment and will assist if there is an HMRC challenge.
Exception to two year shareholding rule
If the share transaction takes place as a company buyback of shares Business Assets Disposal relief (Entrepreneurs’ Relief) may be available. But, you will need to have held qualifying shares for at least five years and be employed or a director for at least two years before the buy back. There are other qualifications to satisfy when considering a company buyback of shares.
If you have not held the shares for five years or more the buy back will be treated as a dividend payment and taxed accordingly. So we are looking at over 38% rate of tax for higher rate tax payers compared with 10% if you qualify for entrepreneurs relief.
Exception to the requirement to be working in the business
Business Assets Disposal Relief (Entrepreneurs’ Relief) has been extended to investors. The extension is known as Investors’ Relief. Under the Investors’ Relief regime capital gains made by investors will be taxed at 10% if they satisfy the requirements for Business Assets Disposal Relief (Entrepreneurs’ Relief) with the following modifications:
- There is no requirement to be an officer, director or employee of the business;
- Investors can’t have any preference arrangements with the business;
- The shares must be newly issued shares which means that transfers of shares from existing owners will not qualify; and
- The shares must have been issued on or after 6 April 2016 and have been held for three years before disposal.
Trading status and Business Assets Disposal Relief (entrepreneurs relief)
There are cases where the question of trading causes a risk that Business Assets Disposal Relief (Entrepreneurs’ Relief) is not allowed. Sometimes we can put things right before it is too late.
Meaning of trade
There is no statutory definition of “trade” but what is established is that “trade” includes any venture in the nature of trade.
- The extension of the “trade” definition to ventures means that one-off or speculative transactions which yield unexpected profits can amount to a trade;
- The company does not have to make profits to be “trading”.
Cessation of trade
The trading requirement will be available if the company has ceased trading provided the company:
- Satisfied the trading conditions for one year ending on the day the company ceased trading; and
- Ceased trading within three years ending on the date of disposal of its assets.
Many businesses include a mix of trading and non-trading activities. Examples of non-trading activities can include:
- Property development;
- Investment activities;
- Licencing arrangements.
The legislation provides that companies and groups with mixed business and non-business trading income can be regarded as trading for the purposes of Business Assets Disposal Relief (Entrepreneurs’ Relief) if the overall business does not include to a “substantial extent” non trading activities. If a company has foreign operations HMRC will consider all company activities, including activities overseas.
Meaning of substantial in practice
Whilst not legislated, it is widely understood that HMRC interprets “substantial” as over 20%. The next question is how non-trading activities are assessed as substantial. The answer is, HMRC considers:
- Income from non-trading activities: rental income is usually non-trading. This means that property companies can qualify as trading companies for Entrepreneurs’ Relief purposes providing other activities such as rental income are less than 20% of the overall trade;
- The asset base of the company. Goodwill can be taken into account in most cases;
- Time spent by staff on trading activities;
- History of the trade;
- Balance of indicators: HMRC considers matters in the round.
Cash retained and entrepreneurs’ relief
Cash rich trading companies can struggle to meet the trading company requirements. We investigate the history of the business and the reasons for accumulated cash to ascertain whether the trading status can be supported. The general view taken by HMRC is that cash built up should be extracted as a dividend and taxed as such.
Holding company for a trading group
Business Assets Disposal Relief (Entrepreneurs’ Relief) is available on the disposal of shares in a holding company of a trading group. The trading status of the holding company will be implied from the trading activities of the subsidiary or subsidiaries provided the holding company owns over 51% of the shares in each subsidiary.
We have seen issues arise where groups trading internationally are precluded under the laws of the home jurisdiction of a subsidiary from controlling as much as 51% of the local business. This is an area we can review for you.
Trading company status and joint ventures
If a company or a member of its group participates in a joint venture the trading status of each company should be considered separately. The trading status of the joint venture company can be “borrowed” by the holding company if the joint venture is considered trading. An individual shareholder holding shares in the holding company will need to establish at least a 5% interest in the trading company.
There are tests set out in the legislation we can run to calculate whether the direct and indirect shareholdings are sufficient to satisfy the conditions necessary to claim Business Assets Disposal Relief (Entrepreneurs Relief).
Obtaining HMRC’s opinion on trading status
It is not uncommon to find that the lines between trading and non-trading status are blurred. Companies can seek HMRC’s opinion as to its trading status. Obtaining an opinion from HMRC may improve the chances of successfully claiming Business Assets Disposal Relief (Entrepreneurs Relief).
An opinion on trading status from HMRC does not mean that the share transaction will qualify for Business Assets Disposal Relief (Entrepreneurs’ Relief). HMRC will not comment on the position of individual tax payers.
If an opinion from HMRC is not good, changes can be made to the business to bring it within a trading company. Given this takes time an opinion should be considered sooner rather than later.
Entrepreneur relief – what can go wrong
There are a variety of pitfalls where tax payers may not qualify for Entrepreneurs’ Relief. Some of the problems can be rectified if they come to light before it is too late.
Typical reasons why entrepreneurs relief is denied
We can flag up problem areas and include suggestions for how you can be put into a better position.
Different classes of shares
The existence of different classes of shares or deferred shares with no capital rights can impact the availability of Business Assets Disposal Relief (Entrepreneurs Relief). A review the shareholding structure and share rights before disposing of shares is recommended. It might be necessary to cancel or convert shares to satisfy the conditions for Business Assets Disposal Relief (Entrepreneurs Relief). Another potential problem area can be redeemable shares which convert to cash before or on business sale.
Deferred buy back
A deferred buy back where the shareholder does not remain an employee of the company until the date of the last tranche.
The shareholders wind up the company and set up a company to carry out the same or similar trade shortly thereafter.
EMI options are not held for a minimum of 24 months.
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. Similarly problems arises with joint ventures if you do not meet the 5% threshold.
Leaving a partnership
Where the partner is leaving a partnership or LLP and under the terms of departure the partner receives a capital payment on leaving – the risk is HMRC view leaving payments as being income.
Lack of appropriate paperwork
No or inadequate paper work meaning an HMRC challenge cannot be disposed of. For example, shares are transferred to spouses in an attempt to claim Business Assets Disposal Relief (entrepreneurs’ relief) but without an accompanying job within the business documented by payslips.
Business Assets Disposal Relief (Entrepreneurs relief) HMRC reporting
Business Assets Disposal Relief (Entrepreneurs’ Relief) has to be claimed and reported to HMRC on the personal tax return for the year in which the gain arises. Failure to claim means failure to secure Entrepreneurs Relief.
Special position for Business Assets Disposal Relief (entrepreneurs relief) under EMI options
Business Assets Disposal Relief (Entrepreneurs’ Relief) is more generous to employees selling shares acquired under EMI option than it is for other taxpayer. There are two differences to the rules where EMI options are involved:
- The requirement to hold 5% or more of the nominal voting share capital does not apply;
- There is no requirement to be a shareholder for two years. But, you have to hold the EMI option for two years. And, all of the other conditions attaching to EMI need to be satisfied.
Business Assets Disposal Relief (Entrepreneurs relief) for self employed tax payers
It is possible to claim Business Assets Disposal Relief (Entrepreneurs’ Relief) where an asset but not the entire business is sold. This means that partners in partnership may be eligible to claim Business Assets Disposal Relief (Entrepreneurs’ Relief) when they leave the partnership. Similarly sole traders can enjoy 10% tax if they sell their business.
To qualify for Business Assets Disposal Relief (Entrepreneurs’ Relief) the asset disposal must be:
- You must be withdrawing completely from the business; and
- The asset must have been used in the trade and the trade has to qualify for Business Assets Disposal Relief (Entrepreneurs Relief).
Often partners, who receive a capital sum on retirement, can benefit from Business Assets Disposal Relief (Entrepreneurs Relief), if the settlement deed is correctly structured.