Business Asset Disposal Relief (Entrepreneurs’ Relief) Explained: Your Complete UK Tax Guide
There are many entrepreneurs who wish to sell or give away their business due to several reasons. Some simply do not have time to manage their well-established business while others are not satisfied with their company or business. Irrespective of what the reason may be, entrepreneurs may gain benefits by selling or giving away their business at a reduced tax rate. This benefit is called entrepreneurs’ relief.
Starting a new business is not an easy task; there are several challenges faced by an entrepreneur at the beginning of their start-up business but some go to succeed selling their businesses, this is where Entrepreneurs’ Relief becomes important. This guide is broken up into several major sections including:
-Entrepreneurs’ Relief explained (ER)
-Are you eligible for ER?
-How does Entrepreneurs Tax Relief work?
-What assets qualify for ER?
-How to claim Entrepreneurs Relief
-How to calculate Entrepreneurs Relief
-Origins of Entrepreneurs Relief
-The future of Entrepreneurs Relief
To maximise your financial gains, you need to be aware of Entrepreneurs Relief (ER). If you are eligible, ER is something you can claim as a way of increasing your financial gains when selling all or part of your business. In essence, it allows you to apply a reduced rate of 10% capital gains tax on the profits you make when you sell qualifying assets (such as your business). It’s also important to note from 2020/21 Entrepreneurs Relief was renamed to Business Asset Disposal Relief.
How Much Entrepreneurs’ Relief Can You Claim in Your Lifetime?
You can claim up to £1 million of Entrepreneurs Relief in your lifetime. You can claim as many times as you like, provided your claims are within this £1 million limit. This makes ER one of the most attractive tax benefits available to entrepreneurs.
Am I Eligible for Entrepreneurs’ Relief?
Entrepreneurs’ Relief is available to individuals, but not to companies. There are certain requirements you need to meet as the person selling the qualifying assets in order to be eligible for ER.
First off, to be eligible for ER, you need to meet certain conditions throughout what is referred to as the ‘qualifying period’.
After 6th April 2019, the qualifying period equates to two years, ending with the date that the share disposal takes place.
This means that all the following criteria must be met to be eligible.
You have been a sole trader, officer or employee of the company.
-In this capacity, you have held 5% or more of the share capital of the company and 5% voting share capital
-You haven’t exceeded your £1 million lifetime limit
There are also some notable differences in eligibility depending on whether you’re selling shares of your business, or whether you are disposing of the business altogether. Whilst both instances can qualify for ER, be aware of the differences.
Selling the Business
When selling the whole of or part of your business, you need to be the exclusive business owner (the sole trader) or a business partner for the duration of the qualifying period. You also need to have owned the business for at least two years.
Selling the Shares
In the case of selling shares, you need not be the company owner, but you must have been an employee or officer in the company, as well as holding the above share capital, for the whole of the qualifying period.
Additionally, to claim on disposal of shares, the company needs to be a trading company (or a holding company of a trading group) and needs to have traded within the qualifying period. To be a trading company, the company’s main activities need to be in trading.
Investors’ Relief
There is one major exception in relation to the qualifying conditions. There is one case in which you aren’t required to be working in the business: here, entrepreneurs relief extends to investors, under an extension called investors’ relief.
Under this initiative, capital gains made by investors will also only be taxed at 10% if they satisfy certain conditions. These conditions are largely the same as those corresponding to entrepreneurs’ relief, but with some minor changes (see Investors relief for more information).
Are you eligible for entrepreneur’s relief according to HMRC?
When it comes to any kind of tax relief, it is easy to get caught out on a technicality. Care needs to be taken in the details. Entrepreneurs have been known to lose £1 million in tax relief due to an oversight on technicality! It’s therefore imperative that you check the HM Revenue & Customs definitions to check your eligibility.
To qualify as an ‘employee’ or ‘officer’ under the HMRC’s definition, there is no requirement with regard to your salary or hours worked as the claimant. They do, however, require evidence of you working in the business. This can be a written employment contract, for example. The HMRC’s definition of ‘officers’ includes non-executive directors as well as company secretaries.
HMRC’s Definition of Trading
In actual fact, there is no set definition of trading given by the HMRC. Instead, the company’s trading status is evaluated based on several factors. It’s worth noting that trade extends to any venture, which can mean a one-off transaction resulting in unexpected profits. Another important thing to note is that a company does not need to make profits to be trading. Trading at a loss will still qualify.
Many businesses operate with a mixture of trading and non-trading activities. Non-trading activities can include licencing arrangements, property development and investment. Companies with mixed business trading can still achieve active trading status, provided that these non-trading activities are not ‘substantial’.
The HMRC considers ‘substantial’ to be anything over 20%. For example, rental income is usually regarded as non-trading. A property company can still qualify as a trading company, and therefore claim entrepreneurs’ relief, provided that its rental income equates to less than 20% of the company’s total trade. HMRC also takes into consideration the time spent by staff on trading activities and the history of the company’s trade.
If your company is cash-rich, you should also take care when applying for entrepreneurs’ relief. Cash-rich companies risk failing the trading status test. In other words, HMRC could deem you a non-trading company if you have a lot of surplus cash. The 20% guideline applies again here: generally, if excess cash equates to 20% or less of the assets, then the company is still considered as having active trade status by HMRC.
It can get complicated if your business has a mix of trading activities or if your company is cash-rich. If you’re unsure on the trading status of your business, you can seek an opinion from HMRC. Whilst this will not guarantee that the disposal qualifies for entrepreneurs’ relief, this can certainly improve your chances of securing entrepreneurs’ relief. Additionally, if the opinion isn’t to your favour, it allows you to make changes which will bring your business within an HMRC approved trading status.
Cessation of Trade
There is one case in which the trading requirements does not apply. If the company has ceased trading over two years before the disposal date but within three years of the disposal date and provided that the company satisfied the trading conditions for an entire year, preceding the date of cessation of trade, you will still be eligible for entrepreneurs’ relief.
How does entrepreneurs’ tax relief work?
The clue is in the title, ‘relief’. Quite simply, a successful claim relieves the amount of tax you would usually have to pay. When selling any assets, you are subjected to pay Capital Gains Tax on the profits. ER works by relieving some of this tax.
What is Capital Gains Tax (CGT)?
When selling any form of asset, businesses are required to pay Capital Gains Tax on the profits. CGT applies to everyone, whether you are an individual or a company, and is applied when selling anything for more than you bought it for, giving you a financial gain. Most personal possessions worth £6,000 or more are subject to CGT, with the main exemption being your car. Any property (excluding your main home) is subject to CGT and, most pertinently for us, so are any business assets.
In business terms, CGT is a tax on any profit you make on the disposal of assets. This includes disposal of shares or business disposal, and even applies when giving an asset away as a gift (unless the recipient is a spouse).
How Much Capital Gains Tax Will You Pay Without Entrepreneurs’ Relief?
You only have to pay CGT on your overall gains over your tax-free allowance, which is £12,000. Above this, the Capital Gains payable tax can be up to 28%, depending on what you’re disposing of and what income tax rate you pay. Most entrepreneurs will be looking at paying 20% CGT on chargeable assets.
By claiming entrepreneurs’ relief, you can reduce the amount of CGT you have to pay on the gains you get from selling your business. Entrepreneurs’ relief reduces the payable tax on gains to 10%. This tax relief results in huge financial gains for entrepreneurs.
What assets qualify for ER?
Entrepreneurs’ relief applies to any material disposal of business assets. These can be shares and securities. It does not, however, apply to the disposal of investment or non-business assets, such as personal assets.
What about EMI shares?
If the shares are from an EMI, they must comply with extra qualifying conditions to fulfil the requirements for an entrepreneurs’ relief claim. EMIs stand for Enterprise Management Incentives and are part of an initiative whereby UK employees can acquire shares. Statutory tax relief is provided on the financial gains of these employees on their shares, meaning they don’t have to pay income tax or National Insurance on their gains.
EMI options are only for smaller companies with assets of £30 million or less. If you are selling your EMI shares, you may still be liable to pay CGT, but therefore may also still be eligible for entrepreneurs’ relief. To be eligible, you must have:
-Purchased the shares after 5th April 2013
-Been offered the option to buy them at least 2 years before selling them
If these qualifying conditions have been met, you may claim entrepreneurs’ relief for the disposal of the EMI shares.
The only exception is the requirement to hold 5% or more of the voting share; this does not apply when it comes to disposing of EMI shares.
Maximising ER
One thing to bear in mind to maximise your entrepreneurs’ relief is that the £1 million limit is per individual. Additionally, Capital Gains Tax does not apply on gifts if these gifts are donated to spouses.
Therefore, if you are in danger of exceeding your ER allowance, it is worth considering transferring assets to your spouse in order to transfer the gain from one party to another. Providing they meet the qualifying conditions; they will now be eligible for ER if they are yet to reach their allowance. This enables you to maximise your relief! Just be sure to make sure that the gift is unconditional to qualify.
Can you claim Entrepreneurs’ Relief on property?
As we know, entrepreneurs’ relief reduces the payable Capital Gains Tax on profits. If the property is your main place of residence and you have lived there throughout your ownership of the property, then it will be exempt from CGT, so claiming entrepreneurs’ relief will not apply. CGT is applicable, however, for other residential properties.
Whether entrepreneurs’ relief is applicable on commercial property is dependent on several factors. Firstly, has the company received any rent on the property in question? If the answer is yes, this will not be eligible for entrepreneurs’ relief, as the property will be considered an investment.
If not – great! The property is classed a business asset and therefore might be eligible for entrepreneurs’ relief. The second factor to consider then is whether the sale of the property is associated with the sale of the whole or part of the business that the property is used in. If it is, then you can claim entrepreneurs’ relief on the sale of the property.
How to claim Entrepreneurs’ Relief
The claim must be made to HMRC. Most often, this is submitted as a claim on your annual Self-Assessment tax return. There’s a supplementary section entitled ‘Capital Gains Summary’, which will be covered in more detail below. Alternatively, you can fill in Section A of the HS275 form, although this is more complicated. It’s always a good idea to seek the advice of an accountant before you make a claim, to check you qualify and avoid any mistakes which could lose you your tax relief.
When do I need to claim?
The claim for entrepreneurs’ relief must be made before the first anniversary of the 31st January following the end of the tax year.
How to calculate Entrepreneurs’ Relief?
As we have seen, entrepreneurs’ relief works by reducing the payable CGT on profits by disposing assets. Follow these steps to calculate entrepreneurs’ relief:-
Work out your total taxable gain by adding together all your capital gains, less any losses
Subtract your tax-free capital gains allowance (£12,000 for individuals)
You will now pay 10% on the remaining figure. The rest is yours!
What if my company is dissolving?
Entrepreneurs’ relief can still be claimed if you intend to close your limited company, provided that the following criteria are met:
-The distribution of any company assets must be taxed as a capital distribution, not as income
-Distribution must take place within three years of the date of cessation of trade
-In the two years prior to the company ceasing to trade, the usual qualifying conditions (as listed above) were met
Similarly, if you are closing your business, you also need to fulfil the same requirements, as per the qualifying conditions, as you would if you were selling all or part of your business; you must either be the sole trader or business partner and must have owned the business for at least two years.
When closing your business, the alternative to paying CGT is to eke out your profits over several years with a traditional small salary of £11-12k per year, plus a Basic Rate dividend (around £33,000 per year), on which only 7.5% dividend tax is payable. For many businesses, it is far more tax-efficient to pay a flat rate of 10% CGT (reduced with entrepreneurs’ relief) on the company’s profits and access the gains straight away, rather than the traditional small salary method. However, it is worth getting an accountant to evaluate this for you first.
Targeted Anti-Avoidance Rule (TAAR)
On this note, it is important to be aware of new legislation aimed to target business closures as a way of reducing tax. If you are closing your limited company by the route of Members’ Voluntary Liquidation, be aware of the Targeted Anti-Avoidance rule introduced by HMRC which took effect in April 2016.
With an MVL, all the company’s assets are turned into cash and distributed to shareholders. These distributions are taxed as capital gains, which makes them eligible to entrepreneurs’ relief. However, this rule prevents individuals from closing companies simply as a way of taking advantage of the tax efficiency of the capital distribution route, rather than an income distribution.
Distributions from the voluntary liquidation of a company may be treated as income distributions in the following circumstances:
-If the company is a ‘Close company’ (a company with five shareholders or less)
-If the shareholder receiving the distributed is involved with a similar trade or activity within two years
-If the intention of winding-up the business appears to be to obtain a tax advantage
In these instances, the distributions could be subject to income tax, and ineligible for entrepreneurs’ relief.
Origins of Entrepreneurs’ Relief
Where did entrepreneurs’ relief come from? Entrepreneurs’ tax relief was introduced under the Labour Party government in 2008, to take effect from the 2008/2009 tax year. It was introduced primarily as an incentive for people to establish businesses in the UK by reducing the rate of Capital Gains Tax on business disposal.
This meant that from April 2008, qualifying individuals would only pay a reduced CGT of 10%, as opposed to the standard 18%, or higher rate of 28%. Initially, the entrepreneurs’ relief was limited to £1 million.
Changes to ER
Since 2008, there have been considerable changes to this amount.
-In March 2010, the entrepreneurs’ relief was up to £2 million
-Three months later, it was raised to £5 million
-In March 2020, the budget was then lowered to £1 million
It is believed that through facilitating entrepreneurs, entrepreneurial culture is to be given a boost which will eventually contribute towards the creation of more job opportunities and acceleration of economic growth.
As the significance of entrepreneurs’ relief for supporting economic growth has been widely acknowledged, the government has taken the initiative to provide further support to entrepreneurs under this policy. The rate of capital gains tax has been reduced to 10% for lifetime capital gains that are within the limit. This modification in the policy has particularly benefited established entrepreneurs, who now wish to explore new pastures or are thinking about retiring.
Sale of Loan Notes
A major impact of the changes to CGT in recent years concerns the eventual CGT position of loan note holders. Those entrepreneurs who might have exchanged their shares that qualified for entrepreneurs’ relief for business loans are advised to re-examine their CGT positions at the eventual sale of their loan notes. There are chances that if the loan note holders proceed to sell these possessions, they may be liable to pay CGT at an increased rate, rather than the expected rate of 10%.
