Entrepreneurs’ Relief is a Capital Gains Tax (‘CGT’) provision designed to reduce the burden of taxation otherwise payable on capital gains realised by individuals (and some trustees) in respect of certain business assets disposed of in circumstances falling within the conditions laid down.
Broadly speaking, entrepreneurs’ relief applies primarily to gains realised by individuals on the disposal of certain qualifying business assets where it can be shown that the assets in question have been realised in the course of disposing of all or part of a business (or where the asset is disposed shortly after the cessation of the business in which it was used). Although entrepreneurs’ relief is conceptually quite simple, the structure of the provisions gives rise to many anomalies.
Trustees do not have an entitlement to entrepreneurs’ relief in respect of trust gains. Trusts can be entitled to entrepreneurs’ relief if the beneficiaries are entitled in their own right.
Lifetime Allowance (Overriding Entrepreneurs’ Relief Limit)
Finance (No 2) Act 2010 remodelled both the extent and nature of the relief in respect of disposals made after 22 June 2010. For disposal made on or after 23 June 2010, gains of up to £5 million during an individual’s lifetime can be benefit from the remodelled relief. The nature and extent of the relief – including the major impact of the Finance (No 2) Act 2010. Suffice to say in this introduction:
- For the period from 6 April 2008 to 22 June 2010 inclusive, entrepreneurs’ relief was given effect by reducing the otherwise chargeable capital gain by 4/9ths (so as to give an effective rate of 10% on gains attracting relief), whereas
- Gains attracting relief in respect of disposals on or after 23 June 2010 are not so reduced. Instead, post 22 June 2010 eligible gains are to be taxed a special lower rate of capital gains tax, i.e. the 10% CGT rate (see revised Section 169N(3) TCGA 1992).
Which Gains Can Potentially Attract Entrepreneurs’ Relief?
Entrepreneurs’ Relief is due only in respect of a capital gain arising on what is referred to as a ‘material disposal of business assets’ (Section 169I). In relation to an individual, such disposals can, broadly speaking, be summarised as set out below. In each instance, reference to a business carried on is a reference to a business carried on for not less than one year:
- A disposal of the whole of a business carried on by a sole trader,
- A disposal of part of a business carried on by a sole trader,
- A disposal of the whole of a business carried on by a trading partnership
- A disposal of part of a business carried on by a trading partnership
- A disposal by a partner of the whole of his interest in a trading partnership,
- A disposal by a partner of part of his interest in a trading partnership,
- A disposal of one or more assets previously used in a business carried on by a sole trader where the asset disposal takes place not more than 3 years after the cessation,
- A disposal by a former partner of one or more assets previously used in a business carried on by a partnership of which he was a member where the asset disposal takes place not more than 3 years after the cessation of the partnership business in question,
- A disposal of shares in (or securities of) a company which, throughout the relevant one-year period, was either a trading company or a holding company of a trading group, made by an individual who throughout that same one-year period can show that:
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he was either an officer or employee of the company (or of one or more companies in the group), and
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can demonstrate that the company is his personal company (as defined),
10. A disposal by an individual (usually referred to as an ‘associated disposal’) of one or more assets owned by him which is made in association with a disposal falling within (3), (5) & (9) above, as part of the taxpayer’s withdrawal from the business in question. (Note: the relief available in respect of such associated disposals may well be subject to restrictions).
Earn-Outs
When agreeing a sale of shares it is possible to receive the consideration in two parts:
- A fixed payment on completion
- A future payment(s) based on the future results of the business – an “Earn-Out”.
In order to claim Entrepreneurs’ Relief on the earn-out proceeds, you must include the expected amount to be received in the original calculation of the gain and pay capital gains tax at that time.
If you chose not to put it in the original gain but instead pay capital gains tax when you receive the earn-out payment then you wouldn’t get Entrepreneur’s Relief on those payments, so each £125k would suffer capital gains tax at 28% or £35k.
Earn outs are complex and specific advice should be taken if they are being contemplated.
Definition of a Trading Company
This is a company carrying on trading activities which does not include ‘to a substantial extent activities other than trading activities.’
Non-trading activities include investment in property, share portfolios, bonds etc.
HMRC also say that excess cash deposits may constitute a non-trading activity. They will accept that if the cash is being accumulated for future use in the trade then it is classed as trading. Also, if cash is simply held on deposit, it may not in fact involve much ‘activity’ in managing it.
HMRC says ‘substantial extent’ means more than 20%. Whilst this can cover many things, it is generally accepted that the 20% test should be applied to:
- Turnover
- Asset base or balance sheet
- Expenses
- Directors’ time
Each company should consider which of the above measures are appropriate for the company’s activities – some, all, or a combination could be used to determine whether the company is a trading company.
Conclusion
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