Entrepreneurs’ Relief: Does Your Business Disposal Qualify?

Malcolm Finney takes a look at some of the entrepreneurs’ relief conditions, and highlights a recent tax tribunal case.

Entrepreneurs’ relief (ER) is a relief (available to individuals and possibly trustees) under which the normal rates of capital gains tax (CGT) of 18% and/or 28% are reduced to 10%.

ER basically applies to gains arising on a disposal (whether by way of sale, sale at undervalue or gift) on or after 6 April 2008 of the whole or part of a business; or of one or more assets in use for the purposes of the business at the time at which the business ceases to be carried on; or of one or more assets consisting of shares or securities of a company. In each case various conditions need to be satisfied (see below).

Example 1: ER on share sale

Terry Tot sells his shareholding in his unquoted trading company for £90,000 making a capital gain of £72,000 in May 2013. Terry is entitled to claim ER on the sale.

Terry’s capital gain subject to CGT is: [£72,000 – £10,900] x 10% = £6,110.

Disposal of the whole or part of a business

On the disposal of the whole or part of a business (whether by a sole trader or partner in a partnership) the business disposed of must have been owned by the individual throughout the period of one year ending with the date of the disposal.

Difficulties typically arise in identifying whether a sale of a part of the business or just a sale of assets has occurred (the latter failing to qualify for ER). No pro-rating of ER applies if the business has been owned for less than the one year period.

Cessation of the business and asset disposals

A disposal by an individual of one or more assets in use for the purposes of the business at the time at which the business ceases to be carried on, qualifies for ER; if the business has been owned by the individual throughout the period of one year ending on the date on which the business ceases to be carried on and the date of the asset disposals is within three years after the date the business ceases.

Particular care is needed in identifying precisely when the cessation occurred and the three year period commences.

Disposal of one or more assets consisting of shares or securities of a company

The disposal of shares or securities qualifies for ER if throughout the period of one year ending with the date of disposal the company concerned was a trading company; the individual owned at least 5% of the ordinary share capital and voting rights; and the individual was an ofﬁcer or employee of the company.

There is no requirement for the individual to cease working for the company. Thus, for example, the individual may continue to work for the company possibly in a consultancy capacity after the sale of the shares. In addition, if an individual sells parts of his shareholding on separate occasions ER is available on each separate sale, assuming that at the relevant times (i.e. the date of each sale) the various conditions are satisfied.

Example 2: Officer or employee status is vital

HT Ltd is a family trading company and its shares have been held beneficially for 10 years as follows:

Nos. of shares % holding

Tim 2,750 55

Bob 1,500 30

Anita 250 5

Sarah 250 5

Toby 250 5

5,000 100

Tim is the Managing Director and Chairman; Bob is a director; Anita is an employee; Sarah and Toby are the adult children of Tim but are not employees.

The company is to be sold and the ER position for each of the individuals is as follows:

ER is available to Tim, Bob and Anita who each own at least 5% of the company and are also officers/employees.

Whilst Sarah and Toby own the requisite minimum 5% shareholding they are not officers/employees and thus no ER is available to either of them.

Corbett v HMRC

In a recent case decided by the First-tier Tribunal (Corbett v HMRC [2014] UKFTT 298 (TC)), the tribunal had to consider whether an individual was in fact an employee of the company (whose shares were sold) for the requisite one year period, having received a form P45 prior to the share sale. The tribunal accepted that the condition had been satisfied and that ER was due. However, the case has limited general application, as the tribunal’s decision turned on the very specific facts of the case and was perhaps surprising.

Denial of ER

Two issues worth noting which will lead to a denial of ER are, first, incorporation of a sole trader business (i.e. typically receiving shares in the company in exchange for the sole trader’s business) and the subsequent sale of the shares within one year of incorporation; and, second, allowing the trading company’s activities to include non-trading activities to a substantial extent (substantial means more than 20%).

Claim for relief and lifetime allowance

ER must be formally claimed by the individual on or before the ﬁrst anniversary of 31 January following the tax year in which the qualifying disposal is made. However, ER is not unrestricted, and with respect to disposals effected on or after 6 April 2011 a lifetime allowance (i.e. limit) of £10 million applies.

Practical Tip:

Prior to making any sale of a business, assets or shares make sure that the requisite ER conditions are satisfied before entering into any sale discussions.