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In this Memorandum we highlight one of the most important capital gains tax (‘CGT’) provisions, the so-called “entrepreneurs’ relief” applying to some – but by no means all – business transactions.
What is Entrepreneurs Relief?
Entrepreneurs’ relief is a tax provision which singles out for favourable treatment capital gains arising on certain business transactions (outlined below) carried out by individuals and by certain trustees. Instead of capital gains being taxed at the taxpayer’s normal CGT rates, 18% or 28% (depending on income levels), the rate to be applied on qualifying gains is reduced to 10%. For example, on a qualifying capital gain of £1 million, the relief amounts to a tax saving of £180,000, i.e. 18% of the capital gain assessable.
The conditions of the relief are, however, often far from being straightforward. This Memorandum sets the scene in the briefest of terms. Any client who thinks he or she may dispose of an interest in a business or make a disposal of one or more business assets in the short or medium term should contact us in the near future to establish whether detailed planning advice is required.
Which gains qualify?
In broad terms, the gains which may qualify for entrepreneurs’ relief arise in the following circumstances:
In each case, there will be qualifying conditions to be met before the 10% rate can be claimed to apply.
The above can be contrasted with gains arising on either investment assets or other assets which have been used in a business but which fail to meet the relevant qualifying conditions.
In particular, a gain arising on an isolated disposal of a business asset, e.g. the owner of a DIY shop selling part of his customer car park but continuing to trade, may well attract the 28% rate of CGT if it does not take place as part of disposal of a business.
While activities deemed to be a trade under the special provisions relating to Furnished Holiday Lettings may have the potential for relief to be claimed (i.e. in the event of the disposal of the relevant properties), gains arising on land or buildings let to unconnected third parties are unlikely to attract the relief.
Different qualifying conditions apply depending upon both the nature of the disposal giving rise to the gain under consideration and the structure of the business in question.
If a sole trader realises a capital gain on the disposal of all or part of his business, he must show that his business has been carried on (on a commercial basis with a view to making a profit) for at least one year prior to the disposal (or part-disposal) in question and that the asset giving rise to the capital gain under consideration was in use in the business at the date of the disposal of the business.
Gains arising on isolated disposals of assets while the business continues will not attract the relief. For example, a farmer who owns 200 acres of farmland and who continues farming after disposing of, say, 5 acres of land with the benefit of planning consent for development, is unlikely to be able to claim entrepreneurs’ relief.
Trading Partnerships (including Limited Liability Partnerships)
Provided that the partnership’s trade or profession has been carried on for at least one year (i.e. by the date of disposal or part-disposal in question), a capital gain arsing on the disposal of the taxpayer’s interest in the firm in question may attract the 10% rate. Likewise, a partner disposing of all or part of his interest in a partnership to another partner, or to an incoming partner, may well be able to enjoy the 10% rate of CGT. A person who has been a member of the partnership for less than one year at the date of the disposal cannot benefit from the relief.
Special rules may apply to situations where, say, one partner personally disposes of the business premises which have been occupied by a partnership (of which he is a member). These rules need particularly careful consideration and only operate where the individual partner’s disposal is associated either with a disposal of the partnership’s business (or to his withdrawal from the partnership). Relief in respect of such ‘associated disposals’ is restricted where rent (or other consideration) has been charged to the partnership for its use of the asset at any time after April 2008.
Company Directors and Employee shareholders
An officer (e.g. a director) or an employee of a company disposing of shares issued by the company in which he works, may be able to enjoy entrepreneurs’ relief in respect of the capital gain arising. Arguably, this is the most complex aspect of the entrepreneurs’ relief rules.
Briefly, for an individual shareholder to pay tax on his gain at the 10% rate, he must be able to show that, throughout the one-year period ending on the share disposal:
If all the above conditions are met, the 10% rate of CGT may well apply.
Special rules may apply to situations where, say, a director personally disposes of an asset which has been made available for use by the company and this disposal takes place at the time where he disposes of shares in the company. These rules need particularly careful consideration. In particular, relief is restricted where rent (or other consideration) has been charged to the company for its use of the asset at any time after April 2008.
Gains made by Trustees
Gains realised on the disposal of assets by trustees are normally taxed at 28% under the current CGT provisions. Provision has been made for trustees to benefit from entrepreneurs’ relief but only in limited circumstances and only in situations where, broadly speaking, there is a beneficiary(ies) entitled to the trust income.
In short, entrepreneurs’ relief can only apply where either:
A claim for relief by Trustees is dependent upon the beneficiary being willing to join in the claim. The beneficiary must also be a ’qualifying beneficiary’ in relation to the trust asset in question which broadly means he must be automatically entitled to any income arising therefrom to the trust.
The entrepreneurs’ relief provisions applicable to trust gains are complex and trustees should seek specific advice from us at the earliest possible date – certainly well before entering into transactions. It may be that simple steps can be taken to maximise the benefit of entrepreneurs’ relief.
Disposals after cessation of trade
Special rules operate to alleviate situations where a business has ceased before the disposal of certain assets in use in the business at the cessation date. In particular:
Maximum relief claimable
When entrepreneurs’ relief was introduced in 2008, the maximum level of gains arising to an individual in his lifetime which could benefit from entrepreneurs’ relief was limited to £1 million. This maximum has been increased three times and, since 6 April 2011, now stands at £10 million. The increased relief is of particular interest to business angels and other serial investors in small and medium size businesses.
A married couple (or members of a civil partnership) may each qualify for relief in their own right provided that each can demonstrate they have complied with the conditions. Complications can arise with jointly owned assets where both spouses are not involved in the business to the extent that they each meet the conditions of the relief.
Time limit for claims
In normal circumstances, the relief will be claimed as part of an individual’s self-assessment tax return but a separate claim can be made after the tax return has been submitted to HMRC.
However, a taxpayer can only benefit from entrepreneurs’ relief if a formal claim (whether contained in a tax return or lodged separately) is made within the prescribed time limit. The relief must be claimed before the second 31 January following the end of the tax year (5 April) in which the disposal giving rise to the qualifying gain in question takes place.
Improving your prospects!
Entrepreneurs’ relief is a simple concept but, as with so much of present-day tax legislation, there are many complications to take on board. Some clients, who may reasonably expect that they qualify for the relief, may be disappointed. That said, with careful planning, it will often be possible to bring about a situation where relief, which would not otherwise be available in respect of a particular disposal, becomes claimable. A simple restructuring of the current position may be all that is required.
However, it is important for readers of this Memorandum to note it will seldom be possible to improve the situation by first examining matters in detail shortly before a sale. Clients who see there is a possibility of a relevant disposal either shortly or in the next few years are recommended to request an early review of their business operations in order to establish whether a more’ entrepreneurs’ relief friendly’ structure is required.
FOR GENERAL INFORMATION ONLY
Please note that this Memorandum is not intended to give specific technical advice and it should not be construed as doing so. It is designed to alert clients to some of the issues. It is not intended to give exhaustive coverage of the topic.
Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.
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