With so many ways to manage your cash surplus or increased value on your company’s balance sheet, Entrepreneurs’ Relief might not be something you have tackled beforehand. If you are considering restructuring your company or winding it up, or liquidating some business assets, then this article should explain how you can use Entrepreneurs’ Relief to your benefit.
WHAT IS ENTREPRENEURS’ RELIEF?
Entrepreneurs’ Relief (ER) is a tax relief, first introduced in 2008. This relief was designed to compensate business owners who would have paid a lower rate of Capital Gains Tax (CGT) under the previous taper relief rules. These were abolished in the 2008 Budget which brought in a new flat rate of CGT at 18% on business disposals. The introduction of ER meant that business owners would, therefore, only have to pay an effective 10% CGT rate on qualifying business disposals, with a lifetime ‘allowance’ of £1m.
ER is available to sole traders or partners who wish to dispose of (sell) shares in all or part of their business. The relief is also available to company directors and employees that have a 5% or more shareholding. It results in a 10% tax rate on all gains made on qualifying assets, up to a current lifetime limit of £10 million. There’s no limit to how many times you can claim this relief either and the same rules apply regardless of the rate of income tax you pay.
To claim Entrepreneurs’ Relief, you must meet the qualifying period requirements. This means the share disposal needs to have taken place within two years (24 months) of 6th April 2019. If you have disposed of your company’s shares on or after 6th April 2017, you will qualify. You must meet the following conditions:
- The company must have been trading for at least 24 months prior to the date of disposal.
- The individual disposing of the shares must own at least 5% of the ordinary share capital of the company. It must also entitle them to at least 5% of the votes, 5% of the distributable profits and 5% of the net assets on winding up.
- You must also be an officer or employee of the company, and you must have met all employment conditions for at least the 24 months leading up to the disposal.
If you intend to wind up the company and cease trading, the relief can still be claimed provided any asset distribution in the company is taxed as capital distribution and not income. The distribution must be carried out within three years of the company’s cessation date. All qualifying conditions above must have been met for the 24 months prior to the company ceasing to trade.
RULE CHANGES ANNOUNCED IN THE 2018 AUTUMN BUDGET
The 2018 Autumn Budget brought with it changes to Capital Gains Tax, including amendments to eligibility for Entrepreneurs’ Relief. You are now subject to the new rules on qualifying assets and companies. You’ll need to pass stricter tests now to define a company as a ‘personal company’.
There were two important changes introduced to ER in the 2018 Budget.
Firstly, the holding period for shares held by individual shareholders has increased to 24 months rather than the current 12 months before any ER can be claimed on the disposal of shares. As of 6th April 2019, individuals who have held shares for more than 12 months but less than 24 months at the date of disposal would pay a higher rate of CGT.
The second change introduced further tests to be satisfied before ER is available. This means that in addition to an individual holding 5% of the ordinary share capital and votes of the company (test 1), the individual must also be entitled to either:
- 5% of the profits (dividends) and the assets available for distribution to shareholders on the winding up of the company (test 2), or
- 5% of the sale proceeds had the whole of the ordinary share capital of the company been sold on the day of disposal (test 3)
You will have to now pass two of these tests, rather than one. Most people will be expected to pass Test 1 and Test 2, or Test 1 and Test 3. Any individual who sells shares without meeting the primary 5% tests will not be eligible for ER.
The company must have also traded for the full two years leading up to any disposal. You will, therefore, need to have considered your position as far as two years in advance to be eligible for Entrepreneurs’ Relief on any gains. This shows to HMRC that you have an actual involvement in the growth in value of that business, not just an investor in it.
Failing to meet the requirements as laid out above means that may have to pay more in Capital Gains Tax. You can find more about these changes via HMRC.
WILL ENTREPRENEURS’ RELIEF ON THE SALE OF EMI SHARES BE AFFECTED?
For those individuals owning options over shares which were granted under an Enterprise Management Incentive (EMI) Scheme, you may still qualify for ER. The holding period for EMI shares will also change to 24 months, instead of the present 12 months. However, the changes to the 5% rule that was mentioned above is not likely to impact EMI option holders. Therefore, you do not need to hold 5% of the shares on the same economic value precedent set out above.
Therefore, it is still possible to grant EMI options for non-voting shares without limiting your chances of qualifying for Entrepreneurs’ Relief.
SHOULD YOU USE ENTREPRENEURS’ RELIEF FOR WINDING UP A COMPANY?
Have you decided to retire or to simply bring an end to your company without selling it on as a going concern? If so, you could avail of Entrepreneurs’ Relief here. Many company owners choose to do this as it provides them with a tax efficient way of distributing capital on cancellation of the shares. You might be subject to a significant charge in Capital Gains Tax when you look to dispose of qualifying assets, such as business premises, as you cease to trade. As long as you meet the relevant requirements that were set about above, you could use Entrepreneurs’ Relief to change your tax burden to the flat 10% tax rate on the gain in assets you sell from the business.
If you do not exceed your lifetime gains and you meet the new 2018 Autumn Budget eligibility requirements, this should be considered.
You can claim Entrepreneurs’ Relief in your annual Self-Assessment return in the supplementary ‘Capital Gains Summary’ section for the tax year that the date of any sale or disposal of assets occurs in.
MAKING THE RIGHT DECISION
Selling your shares in a business or disposing of business assets can be a decision that might need a lot of time and patience to work through. If you are unsure about what is right for you, we recommend that you consider seeking professional business advice. Our team at Devonshire Green can guide you to work out if you meet the conditions for Entrepreneurs’ Relief, or how you could best use this relief to your advantage in the future. Contact us today and we can help you to make a difficult decision a little bit easier.