Business Asset Disposal Relief

Business Asset Disposal Relief

Business Asset Disposal Relief reduces the rate of capital gains tax on shares to 10%. This makes the UK a tax haven for entrepreneurs.

Since March 2020, Entrepreneurs’ Relief (“ER“) has been renamed Business Assets Disposal Relief (“BADR“) and the maximum gain on which the 10% rate applies was reduced from £10 million to £1 million – that is still a tax saving of £100,000.00.  But, there are rules and regulations to satisfy which is where we can help in helping you to avoid pitfalls.

If you have any queries please do telephone us.  We are always happy to provide a quote.

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.
• We specialise in dealing with unquoted shares in private companies and over the years have amassed a strong track record of success stories.
• We are very experiened with the tax issues and the legal review or drafting of relevant documentation for Business Asset Disposal Relief  – this cuts down on multiple advisors.
• We are strong negotiators with HMRC if the need arises.

BADR qualifying conditions

You will benefit from Business Asset Disposal Relief if:

• The company, or the holding company of a trading group, is trading;
• You have been, for at least 2 years, an officer, director or employee of the company or a group company; and
• In your capacity as shareholder you have held for 2 years, 5% or more of nominal 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.

What are the BADR rules?

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.

What are the 2 year  and 5 year rules?

If the share transaction takes place as a company buyback of shares Business Assets Disposal relief may be available. But, you will need to have held qualifying shares for at least 5 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.  For example with a company buyback there are rules which limit the position where there are associates who are shareholders – the list is long but has an impact where shareholders have been married and there other family shareholders.

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 BADR.

Do investors benefit from BADR?

Business Asset Disposal 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.

How does HMRC deal with Business Asset Disposal Relief?

There are cases where the trade undertaken means that BADR will not be allowed by HMRC.  Sometimes we can put things right before it is too late.  HMRC do offer clearances.

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”.

What happens if the business ceases trading?

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.
• You will need to appoint an insolvency specialist as solicitors are not authorised to wind up companies. There can be tricky issues arising around the question of when the trade ceased which we can help with.

What are non-trading activities for the purposes of BADR?

Many businesses include a mix of trading and non-trading activities.  Examples of non-trading activities can include:

• Property development;
• Investment activities;
• Licencing arrangements.

Qualifying trading activities

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 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.

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.
• 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

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 large amounts of cash built up should be extracted as a dividend and taxed as such unless there is good reason.

Is disposal relief available for 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).

Getting an HMRC 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 .

An opinion on trading status from HMRC does not mean that the share transaction will qualify for Business Assets Disposal 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.

What is the danger with different share classes under BADR?

The existence of different classes of shares or deferred shares with no capital rights can impact the availability of Business Assets Disposal 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.

Why winding up can lose entitlement to BADR

On a winding up the shares have to have been held for at least five years plus various other conditions relating to ownership and status as an employee/director have to be satisfied.  In addition to this requirement HMRC operate what they call anti-phoenix rules.  Put simply, BADR will be denied if within two years of winding up the company the shareholder claiming BADR operates a similar trade.

The anti-phoenix rules are likely to have an impact on IR35 contractors winding up their personal service companies.

But, if the situation is more complex because you are retiring or changing careers or there is a commercial transaction in the background the position is different and you may well be able to claim BADR on the assets in the company held on winding up – please do speak to us.

Claiming and reporting Entrepreneurs Relief

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 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.

Entrepreneurs Relief for self employed

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:

• Material;
• 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.

Employee Ownership Trusts

We are seeing more interest in employee share ownership trusts (“EOTs”) 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.