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Updates from the Clayton & Brewill team.
Entrepreneurs’ Relief explained
Entrepreneurs’ Relief is a tax relief available to those selling or gifting all or part of their business. It reduces the amount of capital gains tax to 10%, up to a lifetime limit of £10 million per individual.
Clayton & Brewill’s Neil South (pictured) considers the main rules in respect of both family businesses and individual shareholders in limited companies.
To be eligible for Entrepreneurs’ Relief (ER), an individual must have been an officer or employee of the company throughout the year leading up to the disposal of the shares and have owned at least 5% (with voting rights) of the company’s share capital during that period.
Additionally, the company must have been a ‘trading company’ – more on this later.
It is critical that the above tests are met throughout the 12 months up to the date of disposal.
This means that some forward planning is needed for anyone planning to sell their business.
The term ‘officer of the company’ is not defined, so being an unpaid company secretary would, for example, meet the definition. The same issue applies to employment in that the term is not defined – being paid to work two hours per week would be good enough. However, this is an area HMRC is increasingly interested in.
If you are a family-owned company and considering an exit, then you need to ask yourselves:
‘If there was a sale of the company today – what would be the maximum amount of Entrepreneurs’ Relief available to us?’
The ideal answer should be £10 million per shareholder – assuming of course that the company has accrued sufficient value.
If this isn’t the answer then we need to consider what steps to take to make sure that ER can be maximized.
For example, consider a business run by Mrs X, with a joint shareholding between herself and her husband, Mr X. She qualifies for ER but her husband is neither an officer nor employee of the company and so does not qualify.
If they receive an offer for her business and want to accept, then they need to act quickly to transfer Mr X’s shares to Mrs X so that they can maximize the ER they can claim as a couple. Bear in mind of course that this will only be valuable up to the £10 million limit.
Provided that an individual already meets the basic conditions of entrepreneurs’ relief then they can have further shares added to their holding within that final 12 month period and the disposal of those shares will also qualify for Entrepreneurs’ Relief.
What is a trading company?
One of the key requirements for Entrepreneurs’ Relief is that the company must be a ‘trading company’. There is a fairly woolly definition of this, namely that a trading company is:
‘…a company carrying on trading activities whose activities do not to any substantial extent include activities that are not trading activities.’
Equally there is no definition of ‘substantial’ and so this is an area of some uncertainty. The general rule of thumb is however that a trading company is one where the trading activity is at least 80% compared to its investment activity. In deciding on the trading status of a business, HMRC can assess areas such as turnover, profits, and how the directors spend their time.
By way of a simple example:
Mr Y runs a small property development business. He decides to stop doing any more property development work and just retain the last five houses he built in order to provide a rental income in retirement.
This means that the company will no longer be a trading company, and Mr Y would no longer qualify for ER.
Assessing whether or not a business qualifies as a trading company can be tricky. If you are unsure about your own situation we recommend you talk to your adviser or accountant.
Is Entrepreneurs’ Relief available if a company goes into liquidation?
ER is available if there is a gap between the last trading date and the disposal of the shares, provided that the shares are sold or gifted within three years.
This enables distributions in a liquidation to potentially qualify for ER as the distributions are treated as part disposals of the shares.