What is Business Asset Disposal Relief?

Previously known as Entrepreneurs’ Relief (ER) before 6 April 2020, Business Asset Disposal Relief reduces the rate of Capital Gains Tax on disposals of some assets in which a business holds from 20% to 10%.

In order to create a more diligent process in which to determine validity of claims, a number of changes specific to business owners and their management were introduced in the 2018 Autumn Budget. These changes impacted the number of shareholders allowed to claim.

The ‘holding period’

Individuals (shareholders) will need to hold the shares for at least 24 months before they can claim BADR on the disposal of shares. This change came into effect on disposals made on or after 6 April 2019.

Business Asset Disposal Relief and share transactions

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 two years, an officer, director or employee of the company or a group company;
• In your capacity as shareholder you have held for two 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 £10 million per shareholder.

Definition of officer, director or employee

• 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.

Exception to two year shareholding rule

If the share transaction takes place as a company buyback of shares Business Asset Disposal Relief may be available. But, you will need to have held qualifying shares for at least five 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.

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 Business Asset Disposal Relief.

Exception to the requirement to be working in the business

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 BADR 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.

Trading status and Business Asset Disposal Relief

There are cases where the question of trading causes a risk that BADR is not allowed. Sometimes we can put things right before it’s too late.

Meaning of trade

There is no statutory definition of “trade” but what is established is that “trade” includes any venture in trading.

• 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”.

Termination of trade

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.

Non-trading activities

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

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

Threshold

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 Asset 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.

Meaning of substantial

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. This means that property companies can qualify as trading companies for Entrepreneurs’ Relief purposes providing other activities such as rental income are less than 20% of the overall trade;
• 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.

Trading company status and 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 Entrepreneurs Relief.

Obtaining HMRC’s status on trading

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 Asset Disposal Relief.

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

How can we help?

If you would like to discuss the advantages of Business Asset Disposal Relief or for more information on how we can help, please contact Paul Twydell. Paul is a Partner who heads up our Corporate Tax team, dealing with corporation tax compliance and advisory matters.