As an entrepreneur, either on your own or part of a company set up, you are used to taking risks in the name of business growth. With that risk comes the possibility of huge rewards, but cash flow can be critical to your success or failure. Sometimes a business venture will stop working for you, and you will decide to sell up to fund a new start-up or invest in a new business.
If you are thinking of selling a business asset or your business in its entirety you should make sure that your company is structured in such a way to make you eligible for Entrepreneurs’ Relief on any gain made.
What is Entrepreneurs’ Relief?
Entrepreneurs’ Relief is an allowance which reduces the rate of capital gains tax payable for those eligible to 10%. For higher rate taxpayers this can mean a reduction in tax payable on any gain made of 50%. You can apply throughout your life as an entrepreneur, although you can only claim Entrepreneurs’ Relief for gains up to a lifetime cap of £10,000,000. For successful entrepreneurs, this can mean a saving of £1,000,000 in tax payments over their lifetime.
Who is eligible for Entrepreneurs’ Relief?
You don’t have to have sole control of a business to take advantage of Entrepreneurs’ Relief, you can also be a partner in the business – but in each instance you must have owned the business for at least one year before you sell.
What can you dispose of?
You can dispose of all your business or part of it if you are a sole trader or a partner and be entitled to relief. Under certain circumstances, you can also be entitled to the relief on gains made on the selling of shares and securities. Shares you gained through an Enterprise Management Incentive (EMI) scheme can also qualify. EMI is where an employee is granted an option to acquire ordinary shares in his employers’ company. The price of the shares is fixed when the options are granted and notified to the HMRC. Disposal of assets that you lent to your business can also qualify.
- Disposal of all or part of your business
If you are selling your business then not only must you be a sole trader or partner, but you have to have owned the business for at least one year before the date that you sell it. The same conditions apply if you are simply closing it, although, in that circumstance, you must also dispose of your business assets within three years to qualify.
- Sale of assets you lent to the business
To qualify for Entrepreneurs’ Relief, you must have sold at least 5% of your part of the business, or your shares in a personal company. A business is a personal company if you own 5% of the shares and voting rights. Also, you must have owned the asset but let your business or personal company use it for at least a year up to the date that you sold your business or shares, or for a year before the date that the business closed.
- Disposal of shares or securities
If you are selling shares or securities of a company to qualify for Entrepreneurs’ Relief, you must own at least 5% of the shares and voting rights. Also, for the one-year period before the sale, you must be an employee or office holder of the company.
- Disposal of shares obtained through an EMI scheme.
To qualify for Entrepreneurs’ Relief, you must have been an employee or office holder for a one-year period before the sale. You do not require to own the shares throughout that period physically, but you must have had the option to buy them for a year before their sale.
For disposal of shares or securities, whether through an EMI scheme or not, the business must be a trading company or a holding company of a trading group. The definition of a trading company focuses on its main activities. They require to be ‘trading activities’. If the company stops being a trading company, you may still be eligible for Entrepreneurs’ Relief if you sell your shares within three years.
What are trading activities?
One of the biggest stumbling blocks in accessing this relief is establishing that the business is a trading company. There is no definition of trade in tax legislation, although it is known to cover ventures which seems to extend the definition to profitable one-off transactions. Conversely, a company does not have to make a profit to be defined as ‘trading’. The HMRC seem to be more transparent on what is not a trading activity. Examples include:
• Property development;
• Investment activities;
• Licencing arrangements.
However, businesses, or groups, which have a mix of trading and non-trading activities can still be classed as trading for Entrepreneurs’ Relief as long as the business does not include non-trading activities to a ‘substantial extent’. Substantial extent is thought to mean no more than 20% of activities to be non-trading.
In general cash-rich companies encounter difficulties proving that they are a trading company, as the HMRC take the view that cash should properly be extracted as a dividend, upon which most taxpayers would pay tax at a higher rate than 10%.
An experienced legal adviser can look at the structure of your company to make sure it is compatible with the trading requirements. You can also make an application to the HMRC to obtain an opinion on whether your company is a trading company. By using an experienced legal adviser, any response can be scrutinised and steps put in place to make changes to your company to bring it within that definition if that is possible.
There are many reasons why you might not qualify for Entrepreneurs’ Relief. By being aware of what they are, you can structure your business to avoid them. A legal adviser will be able to advise how to do that, so you don’t miss out on this tax break.
Common problems include:
• Different classes of shares: This can impact on the availability of Entrepreneurs’ Relief in many ways. You can consider a restructuring that holds open the possibility of relief should you sell.
• Deferred Buyback: This can impact on whether or not you remain an employee for the required period.
• Winding up: Particularly if another company is set up shortly afterwards to carry out the same trading activities.
• Leaving a partnership: Receipt of a capital payment can be viewed as being income, rather than a gain.
• Lack of appropriate paperwork: Particularly where shares are transferred to family members.
When should you take legal advice?
At first glance, the rules surrounding Entrepreneurs’ Relief may seem straightforward. However, with no strict definitions of many of the key qualifying factors, and the risk of attracting unwanted HMRC scrutiny, ensuring your sale falls within the parameters outlined by the legislation can be difficult. Given that the potential gains could be huge this is not something that can be left to chance. Do not sell without first consulting with a specialist Entrepreneurs’ Relief legal adviser. They will be able to review your company and it’s structure and consider whether there are any changes that could be made pre-sale to ensure that you benefit from this tax relief.