Entrepreneurs' Relief: What you need to know

Entrepreneurs' Relief is a capital gains tax relief available to those selling or giving away their business.

Tolley Guidance has provided a digest of tips to help you get to grips with this key business relief. 

Entrepreneurs' Relief: The lowdown

Entrepreneurs' Relief reduced the amount of CGT paid on a disposal of qualifying business assets on or after 6 April 2008. 

This relief will be available to: 

  • Sole traders and partners selling or gifting the whole or part of their business 
  • Company directors and employees holding at least 5% of ordinary shares and voting rights in a qualifying company who will share or gift all or part of their shareholding

In 2010, the relief changed to qualifying gains arising from 23 June 2010 being taxed at a flat rate of 10%, with the previous need to reduce the gain by 4/9ths being removed. 

Continued...

» Register now

The full article is available to registered AccountingWEB members only. To read the rest of this article you’ll need to login or register.

Registration is FREE and allows you to view all content, ask questions, comment and much more.

Comments

Trust assets    2 thanks

Steve Carlson | | Permalink

I noticed that the article only mentions this is in passing without further explanation which is a bit misleading as the qualifying criteria is not applied in the way most people think.

ER is only available in very limited circumstances on the disposal of trust business assets.

There needs to be a beneficiary who has an IIP in the trust's qualifying business assets, and that beneficiary also needs to have a direct interest in the business / 5% of the company.

If the whole business was placed into trust, or part of it was for the benefit of people other than the business owner, then ER would not be available. 

Business assets are frequently placed into a discretionary BPR trust for estate planning purposes, but it's often not appreciated that without any planning, if the business is subsequently sold then CGT will be payable @ 28% even if all of the beneficiaries are working for the business.

 

pridgway's picture

Sole traders and associated disposals    1 thanks

pridgway | | Permalink

The reason the associated disposal rules do not apply to sole traders is because they can't and don't need to.

A sole trader cannot withdraw from the business otherwise than by ceasing to carry on the business.  A partner or shareholder holding a 50% interest can reduce it to 40%.  A sole trader has a 100% interest and cannot reduce it to 80% and still be a sole trader.  If they reduce it to nil then they have ceased trading as a sole trader and a disposal of an asset will be a material disposal following cessation. 

Secondly, in the case of Gilbert the Tribunal held that the disposal of part of a business as a going concern was a sufficient but not necessary condition for there to be a sale of a part of a business.  This leaves open the possibility of other disposals qualifying.

Trusts and other points

Paulsoper | | Permalink

The entitlement of a trust is not an independent one - not only, as Steve pointed out, must there be a beneficiary with a relevant interest but the relief is conditional on a joint election being made by the beneficiary and the trust under which the trust uses part of the relief available to the beneficiary.

The real problem with ER is that it was created by borrowing the old retirement relief rules with only minor modifications - including the restriction where a property is owned outside a partnership or company and the occupation by the company or partnership is dependent on the payment of rent.  This restriction did not apply to taper relief and so it is possible that from 2008 onwards rent has continued to be used as a means of NIC-free withdrawal from a company with potentially catastrophic effects on entrepreneurs' relief.

So investments don't qualify ?

Eddystone | | Permalink

 

 

 

Entrepreneurs' Relief is only given in respect of relevant business assets, i.e. assets used for business purposes such as premises.

I have a client who is thinking of closing her company and retiring, the main assets remaining are investments of around £300k built up over the years out of taxed profits. Does this mean that ER won't be available on the realisation of her shares ?

 

 

    

No

Steve Carlson | | Permalink

If the main assets are investments which are not being used in the trade, then she will fail the 80/20 rule and won't be classed as a trading company, which means ER won't be available on any of the disposal.

If she is HRT then she would pay 28% CGT on disposal which is higher than the additional 25% on a dividend up to ARB, although at least half would be over that and taxed at an additional 36.11%.

If there are business assets in the company, then it might be worth going over the numbers to see if she might be better off selling the investments and paying herself a dividend/making an in specie dividend so she can get capital treatment and ER on  the rest of the company when she closes it.  

A pension contribution might be a good way to get some of the money out of the company in a tax efficient way although the company would need some profits to offset against the contribution to get the tax relief, or if she made it herself then she would need relevant earnings to the same level which often isn't the case with company directors taking dividends.

pridgway's picture

Investments

pridgway | | Permalink

In order to qualify for relief the company has to be a trading company.  A trading company is one which does not to a substantial extent carry on non-trading activities (non the wiser but a lot more informed).  When looking to the status of a company one has to look at its activities over a period not merely take a snapshot in time (IRC v Farmer, IRC v Brander, both BPR cases but equally applicable). When you say investments what has the company invested in?  If it has merely put the funds on deposit or short term investments it might still be trading, presumably it is still treated as a trading company by HMRC?  A cash build up does not necessarily mean that trading status is lost.  There was a very good article in Taxation recently by Kevin Slevin on the point.  However, investment in property and other long term investments might mean relief is not available.

You need to take a view on whether its a trading company, if yes file on that basis claim ER and see if HMRC challenge. If not then you probably need to do the numbers take income out at the basic rate and then put into MVL and stagger distributions so as to get a few year's cgt exemptions and the 28% rate.

Many thanks for the helpful

Eddystone | | Permalink

Many thanks for the helpful advice, chaps. 

Oh yes, the company is still theoretically trading but work has virtually dried up due to the recession (high-end interior design incl. executive jets, etc) and although still actively looking for work, she's thinking of taking the opportunity to retire although this does to some extent depend upon the outcome of ER.

Early days yet and she's still mulling, going to winter in warm places with the jet set and see if she can drum up business, but if nothing results then she'll probably give up and we'll have to get to grips with things then. 

The investments are generally shortish term things, mostly income bonds.

Short term investments

Steve Carlson | | Permalink

Pridgway made some very good points.  

My comment was based upon the incorrect assumption that they were long term investments.

If the investments are short term in nature and are a means of retaining cash that might be needed for future business, then it could be worth documenting it with a board minute or having some kind paperwork trail in place.

If there is some evidence that the money is being retained for cashflow purposes for contracts that your client is trying to win at the moment, then you might still be able to get full ER on disposal and full BPR should the unexpected happen.

Thanks Steve

Eddystone | | Permalink

That could at least be argued, Steve, as the situation is pretty much as you say. The intention of these bonds was to give the company some income so that business could continue to be sought.

I suppose the sooner she makes a decision as to whether to apply for ER the better, as the further away we get from the last point of sale, as it were, the more difficult it becomes.

It may just be my bad luck, but personally I've found the ER / CGT people very awkward, almost as though they have instructions to automatically deny ER initially and then fight tooth & claw. I even have a case at the moment where they're claiming a farmer hasn't actually retired, depite selling all his land & livestock and having nothing to farm on or with !

Thanks again.

 

Sale buy back for gradual withdrawl of owner

awoodj | | Permalink

If a director with a shareholding in a private limited trading company wants to exit the business through selling his shares back to the company (but not all at once if possible) does this qualify for ER?

Scenario example Person A owns 75% of business and wants to sell their share in business back to the company at say 25% per annum over 3 years, payments would be made via distributable profits (assuming they are made) can they get ER on this. If not would a single sale of their 75% back to the company qualify?

Thanks for any information as I can't find this specific scenario detailed anywhere.

ER

White | | Permalink

 

My problem is very similar and some advice would be appreciated.

Person A and his family owned a food manufacturing company from some time in 2004. Their shareholding was in the holding company, the group consisting only of the holding company and the trading company.

Because of cash flow problems their ownership was steadily diluted by an outside interest and a number of rights issues but not loss of control. Person A was both a director and company secretary throughout this time.

In 2009 the financial situation was sufficiently precarious for a further rights issue to take place, but one to which Person A and his family would not be able to subscribe. The rights issue took place in March 2009 when the outside interest put in £1m on the understanding that there would then be a new shareholders agreement and that person A would resign from his directorship and as company secretary. The latter was effected in April 2009.The new shareholders agreement was such that the value of the holding of the family was prejudiced.

 

Negotiations then took place for the outside interest to buy all the shares of the family and this ultimately occurred in 2011.

 

Person A's problem is that he was no longer a director and secretary in 2011 and my question is whether the events that took place on 2009 et al above can be the basis of a claim for ER, i.e that there was an associated event at that time and that person A effectively "disposed" of his shares because they were in practice valueless. 

 

 

Last two comments

Paulsoper | | Permalink

awoodj - To achieve a purchase of own shares which qualifies as a gain the holding must be reduced by 25% minimum - 25% per annum over three years won't work.  Before the first sale you have 75%, after the 25% buy back you have 50/75ths - 66.667%, the following year 25/50ths - 50% and the last year 0/25ths is the only one which works.

The further danger is that you could fall within the transactions in securities rules as until the third sale you do not have a fundamental change of ownership.

White - you are quite right no ER will be available as the condition of BOTH 5% and being a part-time employee/director will not be satisfied.  I hope you didn't advise on this change of ownership, the simple precaution is to retain the qualification by being a part-time employee which the purchaser surely should not object to.

Look at the Burt v HMRC case for a scenario where (retirement) relief was given on the sort of exit you describe because the transaction two years later was the completion of a contract entered into when the resignation took place.  I don't think that will work in your case as the shareholder agreement, although prejudicial, was, in your own words followed by subsequent negotiations which led to the disposal.

 

ER on exit

Steve Carlson | | Permalink

Awoodj

As Paul pointed out, the first question would be whether the transactions qualified for capital treatment, and only if it did could you consider whether ER or standard CGT rates were applicable to the gain.

To qualify for capital treatment, it must be for the benefit of the trade, and a retiring director/shareholder can fulfil that criteria.  The issue you have with spreading it over 3 years means that you have 3 transactions, so there isn't one transaction which is enabling the retirement.  

There are a few other considerations for deciding whether you can get capital treatment and you can get advance clearing for any POOS transaction from HMRC as to whether the transaction would be capital or would be classed as a dividend payment.

If it was one transaction and you fulfilled the capital treatment criteria, then you could get ER on the transaction providing he was employed at the time and it was a qualifying trading company. If it was done in one transaction, then full consideration would have to be given at the time.  If money was short, then the company may be able to borrow the money, pay for the shares, and then the director could immediately loan the money back to the company with the loan being repaid over 3 years from profits.

The downside to this is that a price has to be fixed now, the funds need to be available (at least in the short term) and your client would have to pay CGT on the full amount, even though he may only have access to 1/3 of the money now as the rest was loaned back to the company.  

One thing to note would be the amount of cash reserves the company has, as if they are substantial and represent more than 20% of the companies assets, then it may not be classed as a trading company and thus ER would not be available.

What you really need to consider is tax efficient profit extraction from the company which may involve trying to get capital treatment, although there are far more effective methods that may be used depending upon the circumstances such as pension contributions and the use of specialist investments.

My apologies as I have only brushed off the issues and I know I have missed out a lot of detail, and other potential solutions, but I hope I have given you a flavour.  

I help people in these situations, but as well as knowing the tax law around the situation, I am also regulated by the FSA so I have more options at my disposal to help with tax efficient profit extraction and business exit strategies, and this probably isn't the place to go into too much detail.

 

 

Officer of the Company and ER

tcbananas | | Permalink

I am a director of our company but do not receive any salary.  Would I still qualify for ER as an 'officer of the company' purely by being a director or is a salary required as well?

Any advice gratefully received.

 

Entrepreneurs Relief

Paulbrodie | | Permalink

I am a Director and 20% Shareholder of a long established Property Investment Company wishing to sell either the assets or shares of the Ltd Company. Our assets are both residential and commercial properties deriving a strong rental stream. As an Investment Company will I be eligible for Entrepreneurs Relief at 10% or will I have to pay the full 28% CGT?

 

gavin.fernandes's picture

re Paul Brodie query - on ER

gavin.fernandes | | Permalink

hi Paul,

I think you are looing at 28% CGT as I think property investment businesses are specifically excluded, but please take professional advice on your particular case before completion.