Capital Gains Tax relief on business disposals - how entrepreneurial do you have to be?

Capital Gains Tax relief on business disposals - how entrepreneurial do you have to be?


Entrepreneurs’ Relief (ER)

The 2011 Budget further raised the stakes for ER. When it applies, ER results in a reduced 10% Capital Gains Tax (CGT) rate on the sale or gift of a business. Since 23 June 2010 the rate of CGT for higher rate taxpayers has been 28%. Only those with combined taxable income and capital gains of up to £35,000 remain eligible to pay CGT at 18%.

The 2011 changes doubled the lifelong ER limit to £10 million in relation to disposals made since 6 April. Currently, therefore, ER can reduce the CGT bill on the disposal of one or more businesses by up to £1.8 million. The limit has increased tenfold from a lifetime limit of only £1 million in early 2010, before the last election. However, the higher level of ER which is now available cannot be carried back to transactions which occurred before 6 April. ER which has been claimed before that date will reduce the amount now available.

The much higher limit is to encourage highly successful and serial entrepreneurs.

Broadly, ER is available in the following circumstances:

* the disposal of some or all of a sole trader's or a partner's business;
* the disposal, within three years of a business ceasing, of assets used by the business;
* the transfer of shares in the shareholder's personal trading company; or
* the associated disposal of assets owned by an individual eligible for ER but used by either their company or partnership.

Requirements for ER

Unlike partners, who face no minimum requirement for their involvement to be eligible for ER, shareholders must work for the company and have a significant equity stake. The shareholder must be an employee or officer of the company, although no particular level of involvement is required. Therefore, non-executive directors and part-time workers can qualify. As well as being involved, the shareholder must own at least 5% of the ordinary shares of the company and carry at least 5% of the voting rights. If they do, then gains on other shares or securities are eligible for ER.

While there is no minimum age requirement for ER, the business interests must be owned for at least 12 months before the disposal, and the involvement in the company must have been for at least the same period.

Only companies and businesses carrying on a trade are eligible for ER. The holding of investments and letting of property are not a trade in this context.

The trustees of life interest trusts where the life tenant meets the qualifying conditions are eligible for ER. However, discretionary trustees cannot obtain the relief.

Although the 2010 changes doubled the amount of ER available to an individual, despite previous speculation it did not water down the qualifying conditions, which are seen by many as a disincentive to invest in family businesses. Under the previous regime of business assets taper relief applying until April 2008, which reduced the then 40% CGT rate to 10% after two years, any shareholder in an unlisted trading company was eligible. The conditions relating to involvement and ownership applied only to quoted companies.

While representations have been made to the Government to relax the rules, as the name suggests ER is not available to many who are disposing of business interests. For example, passive investors in private trading companies and many members of employee share ownership schemes will not qualify. They are given no CGT incentive to invest.

Conversely, the very valuable relief can be obtained by the correct structuring of a business, particularly as regards the qualifying conditions relating to unlisted trading companies.

Consideration should be given well in advance of a sale or gift to any non-trading activities and the minimum period of ownership, where relatively small differences may result in much higher tax liabilities than necessary. Furthermore, in the case of companies the involvement and ownership conditions must be satisfied for at least a year before the sale. Therefore, care must be taken with businesses which have recently been incorporated or if it is proposed that the assets of a company, rather than the shares, should be sold. The timing of transactions needs very careful thought given the amount of ER which can now be claimed, if all the conditions apply.