Entrepreneurs’ Relief can offer significant tax savings when selling shares or the whole or part of a business. So how do you qualify? What are the four pitfalls to avoid disqualification? And what are clients asking us about tax planning and Entrepreneurs’ Relief?
BUDGET 2011 UPDATE: On 23 March 2011, the Chancellor announced that the lifetime limit on capital gains qualifying for entrepreneurs’ relief (ER) will be doubled to £10 million from 6 April 2011. Taking into account the increase in the highest rate of CGT to 28%, the relief which started in April 2008 as a modest £80,000 tax saving is now potentially worth £1,800,000. For the latest information on ER, please get in touch with your tax adviser.
We all know that the Government sees the need to encourage entrepreneurs to continually generate wealth, and it has repeatedly turned to the tax system to do so. From retirement relief to business taper relief and now Entrepreneurs’ Relief, the sale of business assets or shares has attracted a measure of relief when compared with the sale of an investment.
When the newest version of these tax incentives, Entrepreneurs’ Relief, was introduced, the benefits were initially comparatively minor – a maximum saving of £80,000 tax for an individual over the course of a lifetime.
But with an increase in both the general rate of capital gains tax (CGT) and the amount of gains that can qualify for relief, you could now potentially save up to £900,000 in tax.
So where there is a sale in the offing it is clearly worth ensuring that you qualify, or seeing if there is anything that can be done to move into a position where you can claim the relief.
Do you qualify for Entrepreneurs’ Relief?
In order to qualify, you must have held the assets being sold for at least 12 months. The relief is then available broadly where there is a disposal of a business, or shares in a company.
Certain other disposals of assets used in the business or by the company can also qualify for relief.
If a company has substantial non-trading activity (that is, more than 20%), then it may not qualify for the relief. If it is shares that are being sold, the individual must have been an officer or employee of the company and must have held 5% of the shares throughout the year before the sale.
Four pitfalls that may disqualify you
1. Significant non-trading activity
As you build up profits in a company, the level of your investments may well increase. This is a problem if the company has significant (more than 20%) non-trading activity, judged by turnover, net assets, profit or time spent by directors.
2. Less than 5% in shares
The shareholder must have held 5% of the shares throughout the 12 months prior to sale. If the company has issued share options that are exercised on a sale, this can create an issue if other holdings are diluted below the 5% threshold as a result of the issue of new shares.
3. Skewed voting rights/share capital
It is not uncommon for a company to have additional classes of shares. These all need to be accounted for when considering whether the individual in question has held the requisite 5% of voting rights and 5% of share capital. Overriding voting particulars (such as taking votes by a show of hands at an AGM) can also create an issue on this front.
4. Transfers to spouse who isn’t an employee
It used to be the case that assets could be transferred to a spouse before sale to enjoy the benefit of their lower tax rates. That can cause an issue for Entrepreneurs’ Relief, as unless they hold the shares for a year and have also been an employee or director of the company, they may well not qualify.
Frequently asked questions
The same questions tend to crop up with Entrepreneurs’ Relief. I’ve given some short answers here, but it is best to get full and professional advice – visit our Private client page for more information or email email@example.com
• What do I do if I don’t quite hold 5% of the shares?
Quick answer: There are tax planning options here, such as creating a new class of shares, but you will need co-operation from other shareholders. Remember, this needs to be done well in advance of a sale.
• Can I preserve my own relief for the next time I make a sale?
Quick answer: Yes, you can use your spouse’s relief instead – with some forward planning. If this makes you nervous, a trust could be set up to hold the shares for the family, provided it is the right sort of trust and there is a ‘qualifying beneficiary’.
• Can I give shares to my children to use their allowances?
Quick answer: Potentially yes, but you may again wish to do this through a trust to avoid children receiving significant sums. It will of course use up some of their lifetime allowance.
If you have any further questions, please do get in touch.