Will Sweeney – Tax Technical specialist
Entrepreneurs’ Relief was introduced in 2008 to stimulate UK entrepreneurship by encouraging successful business owners who sell up to reinvest the proceeds into new ventures and growing early stage businesses.
What is so important about it?
Entrepreneur’s Relief reduces the rate of capital gains tax from 20% to 10% on a ‘material disposal of business assets’, up to a maximum of £10m gains during a lifetime. This means a maximum tax saving of £1m is available – making this one of the most valuable tax reliefs in the statute book.
What can I claim the relief on?
Broadly, ‘business assets’ can include all or part of your business or shares in your personal company, provided certain conditions are satisfied. In both cases, you will need to have met the conditions for 2 years.
DISPOSAL OF SHARES
- The disposal is of shares in a trading company; and
- Is an employee or officer of the company; and
- The shares are in the transferor’s ‘personal company’ or are EMI shares
- Those conditions have been met for 2 years.
DISPOSAL OF WHOLE OR PART OF THE BUSINESS
- Business must be sold as a going concern;
- Business must have been owned by the individual for 2 years prior to disposal.
Disposals of other assets can also qualify for Entrepreneurs’ Relief where they are ‘associated’ with a material business disposal:
DISPOSAL OF PROPERTY ASSOCIATED WITH DISPOSAL OF SHARES
- Where a disposal of an asset (e.g. property) is associated to the disposal of shares in a trading company. This may, for example, be the case where a commercial property is sold at the same time as shares in the company that uses it.
Over the years, the generous nature of ER has encouraged people to challenge ER through the courts, impacting on the interpretation of these rules. We therefore recommend that you undertake a rigorous review of your qualification for this relief.
What is a personal company?
To be a personal company, the shareholder must:
- Hold at least 5% of the ordinary share capital and voting rights in the company;
For disposals since 29 October 2018, the individual must also meet either of the following:
- by virtue of that holding, to be entitled to at least 5% of the company’s profits available for distribution to equity holders and 5% of the assets available for distribution to equity holders in a winding up; or
- in the event of a disposal of all of the ordinary share capital of the company, to be beneficially entitled to at least 5% of the proceeds.
It should be noted that changes were introduced in April 2019 to ensure that shareholders who found their interest diluted below 5% owing to the issue of more shares for cash will be able to crystallise their entitlement to Entrepreneur’s Relief accrued to that point.
What about Trusts?
ER may also be available on the disposal of business assets held in trust. No ER is available to the trustees themselves on a disposal of trust business assets, but they can ‘share’ in a qualifying beneficiary’s (QB) lifetime limit,
Trust business assets include:
DISPOSAL OF SHARES
- The disposal is of shares in a trading company; and
- Is an employee or officer of the company; and
- The shares are in the transferor’s personal company; and
- Those conditions have been met throughout a period of 2 years ending within the three years prior to disposal.
ASSETS USED OR PREVIOUSLY USED FOR THE PURPOSES OF A BUSINESS
- Used for the purposes of a business carried on by the QB throughout a period of 2 years ending within the 3 years prior to disposal; and
- the business must have ceased (or the QB ceased to be a member of the partnership carrying on the business, either on the disposal or within the preceding 3 years.
To be a ‘qualifying beneficiary’ an individual must have an interest in possession (but not for a fixed-term) in all of the trust assets being disposed of. However recent case law has confirmed that this does not have to have been for the full 2-year holding period and the condition can be satisfied by giving the individual an interest in the property immediately before the disposal. It should however be noted that HMRC are expected to appeal.
The problems with ER…
Economically, there is no proven link between ER and business investment, nor with encouraging entrepreneurialism at the outset. In addition, it has been viewed as a tool for tax avoidance with some business owners able to avoid income tax by building up funds in a limited company which are periodically withdrawn by dissolving the company. Business is continued in a new company but tax is paid at 10%, rather than the rates of up to 38.1% that would be chargeable had the money been paid as dividends.
The response to this has seen the ER conditions tightened steadily over the last several years. Measures include:
- restrictions on claiming ER on the value of Goodwill on incorporations;
- efforts to prevent avoidance by tightening the ownership requirements;
- provisions to prevent owners from repeatedly extracting fund at low tax rates by dissolving companies; and
Some business models, such as property development, typically structure each development project as a separate company or SPV however, and so these provisions can cause concern.
What’s next for Entrepreneur’s Relief?
Despite these measures, the relief is still seen as a reward for those who have already built their businesses (and thus are too late too have their actions influenced). In addition, as the lifetime allowance has risen over the years, the cost to the Treasury has risen too, with the latest figures showing that it cost £2.2bn in uncollected tax for 2018-19.
Pressure has grown on the Chancellor to take action, but it would be a big step for a Chancellor to remove any reward to owners for risking their ideas, effort and capital. Since its introduction in 2008, ER, combined with other tax breaks such as R&D tax credits, the patent box, and SEIS & EIS has helped contribute to rapid growth in UK start-ups. While ER may have been exploited for avoidance purposes, or even drawn too widely too achieve its original goals of promoting serial entrepreneurship, that shouldn’t detract from what is a very valuable tax relief. A more pragmatic option may be further reform, to tighten the rules