Entrepreneurs’ relief (ER) is one of the most valuable tax reliefs. It reduces the rate of UK capital gains tax (CGT) to 10% on the disposal of qualifying business assets, which can produce tax savings worth up to £1m. Consideration of the detail is vital and we can help navigate the complex and restrictive rules to maximise your ability to claim this valuable relief.
ER qualifying gains (up to a lifetime allowance of £10m of gains) are always taxed at a 10% rate. By contrast, ordinary capital gains for individuals are currently taxed at 20% (or 28% for certain types of gain, including disposals of residential property and carried interest). A reduced rate of 10% (or 18%) can apply depending on whether combined taxable income and gains together exceed the basic-rate income tax threshold.
ER can be claimed only by individuals or jointly by a qualifying beneficiary and the trustees of a life interest trust. To qualify, the gain must fall within one of three tightly-drawn categories and other qualifying conditions must be also met in the period prior to disposal.
Which disposals qualify for ER?
ER applies to disposals of business assets, on the condition that the business is being carried on commercially with a view to profit. There are three main categories of disposal that qualify:
1. Disposal of business assets of a settlement
Trustees can benefit from ER when disposing of settlement business assets, but only if the beneficiary separately qualifies for ER and has an available unused lifetime allowance.
2. Material disposal of business assets
This category includes the disposal of:
- The whole or part of a business;
- Interests in assets used in a business at the time the business ceased;
- Ordinary shares or securities of a trading company (or holding company of a trading group);
- Relevant shares acquired through an Enterprise Management Incentive (EMI shares).
3. An ‘associated disposal’ associated with a ‘relevant material disposal’
An ‘associated disposal’ is the disposal of an asset as part of the withdrawal of the individual from participation in the business. The asset must be held personally by the individual throughout the relevant one year period (increased to three years for disposals of assets acquired on or after 13 June 2016) and be used for business purposes in either in the trade of the partnership.
A ‘relevant material disposal’ involves, broadly speaking, an individual disposing of at least a 5% interest in shares/securities in a qualifying company or the whole/part of a partnership business. Relief is restricted where the availability of the asset was dependent on the payment of rent or was not used wholly for business purposes.
Additional qualifying conditions
- The business assets must be held for a period of two years before ER is available. This may be the period ending with the date of disposal or the date of cessation of trade. In the latter case, the disposal must take place within three years of the cessation of trade.
- For disposals of shares or securities, there is generally a need to hold a direct or indirect interest in 5% of the ordinary shares and voting rights of the company. Finance Act 2019 introduced a further condition that an individual must also be entitled to either:
(i) 5% of the distributable profits and assets available on a winding up; or
(ii) 5% of the proceeds in event of a disposal of the whole ordinary share capital.
There are two notable exceptions to the above conditions:
- For EMI shares, there is no 5% minimum interest limit and the period the EMI option was held prior to exercise can be included when considering the two-year holding requirement.
- From 6 April 2019 shareholders falling below the 5% threshold as a result of issuing new shares may retain entitlement to ER if appropriate claims are made.
How can Smith & Williamson help?
The conditions to qualify for ER are strict and a number of significant changes have been introduced to the legislation in recent Finance Acts, which in some circumstances limit the availability of the relief.
We can give specialist advice to ensure the relief is correctly obtained where the conditions can be met and make recommendations for correctly structuring the business in cases where conditions are not currently being met. Where the company has multiple classes of share (including preference shares), particular care is needed to ensure that the share capital structure does not prejudice the entitlement of all shareholders to claim the relief.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.