The New Entrepreneurs Relief
By Lee Hadnum LLB ACA CTA
The recent Budget provided more details on the new tax relief that will now apply for disposals of businesses and certain shares after 6 April 2008. It's a partial climbdown on the flat 18% rate of capital gains tax that has been introduced, but ignoring the political issues it represents a welcome and important tax relief available to business owners.
How will Entrepreneurs Relief apply?
The relief will apply from 6 April 2008 and will only apply to:
- Gains made on the disposal of all or part of a business (including shares), or
- Gains made on disposals of assets following the cessation of a business
It will operate by ensuring that the first £1 million of gains will be charged to CGT at an effective rate of 10 per cent. Gains in excess of £1 million will be charged at the normal 18 per cent rate.
However before you get too excited this £1 million maximum is a lifetime limit. Therefore if you make a number of capital gains at different times you'll only be able to make claims for relief up to a lifetime total of £1 million.
Any gains in excess of the £1 million limit will be taxed at the normal 18% rate of capital gains tax.
The 4/9 restriction
It's important to note that we're talking about effective tax rates here. There will be no new 10% rate of capital gains tax. It will work by reducing gains liable to CGT (at the single 18 per cent rate) by 4/9ths, resulting in an effective 10 per cent rate (5/9ths × 18 per cent).
Entrepreneurs relief will be given before any capital losses and the annual exemption and will need to be claimed.
Mike sells shares in his trading company and realises a gain of £1 million. If this was his only gain the full amount would be reduced by 4/9 (£444,444) and the remaining gain would therefore be around £555,556. Assuming no capital losses and ignoring the annual exemption this would then be taxed at 18% with the CGT being £100,000.
This equates to an effective rate of 10%.
Even if the gains exceed £1 million Entrepreneurs relief will push the effective tax rate down.
If for example a gain of £1.5 million was realised this would be reduced by £444,444, as above. The remaining gain would then be taxed at 18% giving a CGT charge of £190,000. This equates to an effective CGT rate of just 12.6% which is still a highly beneficial tax rate.
To start with there's no age limit (which distinguishes it from the old retirement relief). So you could sell a business aged 25 and still benefit from the relief.
Entrepreneurs relief will apply to gains on:
- Disposals of the whole or part of a trading business This includes furnished holiday lettings but does not include a property investment business.
- Disposals of shares (and securities) in a trading company provided that the individual making the disposal has been an officer or employee of the company and owns at least 5 per cent of the shares.
The Revenue will continue to define a trading company in the same way as for taper relief purposes. This means that they'll look at the accounts and activities of a company for the past few years to ascertain whether there are any 'substantial' non trading assets or activities. Substantial for this purpose means at least 20%.
Therefore whilst Entrepreneurs relief will apply to disposals of companies, if a company has a large cash balance not required for the trade or has surplus property that is let out it may not qualify as a trading company.
If it doesn't qualify though there will be no partial relief or apportionment and no Entrepreneurs relief will be due.
The relief is to be widened to include 'associated disposals' where there is a disposal of shares. Therefore if you sell shares in a trading company and own the premises personally (as many business owners have done to maximise taper relief) the sale of the property would also qualify for Entrepreneurs relief providing it's at the same time as the disposal of the shares (and subject to the £1 million limit).
General tax planning
Maixmising Entrepreneurs relief on a disposal of shares or businesses will be vital in reducing the tax burden. The kind of things you’ll be looking at include:
If the maximum limit is £1 million per person and this may be exceeded during your lifetime it would make sense to pay careful attention to the ownership of businesses/companies.
You could, for example, ensure that you and your spouse or civil partner both make use of your allowance. This could be arranged as a transfer of an interest in the business or shares before the external disposal.
On a wider level children and other family could be used to hold shares or an interest in a business to increase the total amount of Entrepreneurs relief.
Utilising capital losses
As the relief can be claimed it would be important to ensure that any capital losses in the business were fully utilised and were not wasted.
It could be possible to sell only part of a business whilst UK resident to take advantage of Entrepreneurs relief without being charged at 18% on the excess. The remaining assets could then be sold in the future as a non resident free of CGT (provided any UK business had been incorporated into a company first).
This could also be the case with a shares disposal where property is owned personally. If the gain on the shares would utilize the £1 million limit it may be advisable to retain the property, let it to the company and then sell in the future free of CGT if you were non resident.
Extracting cash or other assets
Given Entrepreneurs relief can be restricted if there are investment assets it should be considered whether it’s worthwhile extracting these a suitable period before the disposal. One of the key points here will be to weigh up the potential capital gains tax saving from Entrepreneurs relief versus the income tax cost of extracting the cash or other assets.
Using a company
If a gain could be significant using a company to hold the investment may be preferred. The key relief to obtain here would be the substantial shareholdings exemption. Providing the company qualified as a holding company the gain could be free of CGT and the proceeds extracted when non resident free of income tax or CGT.