Entrepreneurs’ Relief (ER) is available to taxpayers on the disposal of the whole or part of their business. ER means that you pay capital gains tax (CGT) at a rate of 10% rather than 20%, subject to a lifetime limit of £10 million.
Following the 2018 Autumn Budget, new conditions have been introduced to ensure shareholders benefitting from ER have a minimum economic stake in the company. According to HMRC, ‘it is designed to support and encourage investment and means that entrepreneurs can keep more of the rewards when their business is successful’.
Who can claim ER?
ER is available to company directors and employees meeting certain conditions, as detailed later. It is also available to sole traders or partners selling or giving away all or a certain part of their business.
The disposal of ‘associated’ assets, such as land and buildings used by a company or partnership but owned by an individual, may also attract ER if the individual chooses to leave the company or partnership.
ER is available on the gains made on the disposals of shares and securities in a trading company or the holding company of a trading group. A trading company is defined as one ‘carrying on trading activities whose activities do not include, to a substantial extent, activities other than trading activities’.
Trading activities are those activities which carry on a trade or profession by buying and selling goods or services with a view to making a profit or surplus.
On the other hand, non-trading activities are those undertaken by a company that may invest, for example in properties or shares.
In order to qualify for ER, the taxpayer must be an employee or officer of the company and hold at least 5% of the ordinary share capital, and 5% of the associated voting rights.
In addition to the existing tests, a new test is introduced whereby the shareholders must also be entitled to at least 5% of the company’s distributable profits and 5% of net assets on the winding up of the company.
However, where the taxpayer cannot demonstrate their entitlement to the profits and assets of the company, a taxpayer can use an alternative test. This is that, in the event of a disposal of the ordinary share capital of the company (i.e. the company being sold), the taxpayer is entitled to 5% of the disposal proceeds.
The above conditions must be satisfied by the shareholders for a period of 12 months until the date of disposal or cessation of the trade. For disposals on or after 6 April 2019, the minimum period throughout which the conditions must be met is increased to two years.
In another change new legislation gives relief where an expanding business raises additional finance by means of the issue of new shares for cash, but as a result, an individual’s shareholding is ‘diluted’ – falling below the 5% needed to claim ER.
For new investment taking place on or after 6 April 2019, shareholders will be able to make an election, treating them as if they had disposed of their shares and immediately reacquired them at market value just before dilution. To avoid an immediate CGT bill on this deemed disposal, a further election can be made to defer the gain until such time as the shares are actually sold. ER can then be claimed in its current form.
The lifetime limit of £10 million remains intact. Additionally, taxpayers continue to benefit from an annual exempt amount of £12,000 in 2019/20, on which CGT is not due.
There are situations where shareholders may not be able to claim ER:
- Directors should remain in office up to the date of disposal of their shares to avoid jeopardising an ER claim
- If a company goes from a trading company to an investment company, shareholders of the company will no longer qualify for ER.