Entrepreneur’s relief seeks to reduce the amount of Capital Gains Tax (CGT) payable by an individual who sells a business (or part of it). The relief applies to disposals made by sole traders or individuals in partnerships, but also to those that operate through a company. The main premise of entrepreneur’s relief is to encourage an owner to reinvest profits and continue to grow their business for a long-term gain taxed at a low rate of tax.
Entrepreneur’s relief superseded previous similar reliefs (retirement relief and business taper relief) and came into force by the 2008 Financial Act. The relief reduces the rate of CGT to 10% on qualifying disposals. Unfortunately, there is a lifetime limit on the amount of relief: £10 million; breaching that limit is a lucky problem to have.
How it works
Essentially, entrepreneur’s relief applies a lower rate of CGT to qualifying disposals made by an individual of their business. A qualifying disposal is any disposal which is material. The disposal does not have to be made all at once; an individual could sell their business in tranches and still qualify for the relief so long as the disposals are material.
A material disposal is one of business assets which falls into one of three categories:
- the whole or part of a business
- assets used in a business at the time the business ceased
- shares in or securities of a ‘personal company’ which is either a trading company or holding company of a trading group and the individual was an officer or employee of that company or another in the same group
There are further conditions the material disposal must satisfy depending on the assets being disposed. The main overriding condition is the length of time you have owned the assets. For disposals made after 6 April 2019 the assets must have been owned for at least 2 years. For disposals made prior to that date, the assets must have only been owned for 1 year.
Which businesses qualify for Entrepreneur’s Relief?
The business must be of a trade, profession or vocation and conducted on a commercial basis with a view to the realisation of profits. Businesses comprising of mostly investment activities like property letting will not qualify. There is an exception though: the commercial letting of furnished holiday accommodation in the UK does qualify.
It’s important to note that a business is more than a mere collection of assets. If a business continues unaltered after selling assets, then it’s unlikely that the disposal will be material. It’s important that the assets you are selling form part or the whole of a business otherwise you may not be entitled to the relief.
It is a question of fact and law whether a disposal is a part of a business or merely assets used in the business. There exists a substantial body of case law providing guidance on the issue, but ultimately each case is unique and will turn on its own facts.
Common Pitfalls of Entrepreneur’s Relief
It’s important that the business assets are disposed of within certain time frames either when the assets cease to be used in the business or the business ceases. If certain strict deadlines are not met, then relief can be denied on this basis.
Relief can also be restricted when assets have been used for purposes other than for the business. The restriction is to be made on a ‘just and reasonable’ basis, which will be unique to each asset and to be determined in accordance with the facts.
There’s further pitfalls for those who incorporate their business. Entrepreneur’s relief is not available on disposals of goodwill. Essentially, if you built up your business as a sole trader and subsequently incorporate, entrepreneur’s relief is not available on the value of your business associated with your reputation.
Even more to consider for those who own shares in a trading company they have built up. If you sell off your shareholding it’s important that the company is still considered your personal company. A personal company is any which you hold more than 5% shareholding. If, for example, after many rounds of investment you only retain a 4% shareholding in the company, you will not qualify for entrepreneur’s relief on the disposal of this shareholding.
A more common pitfall is when a company stockpiles cash or makes investments rather than distributing funds for shareholders to spend or invest. Stockpiled cash in excess of that required for working capital or investments may prevent the shares qualifying for entrepreneur’s relief. Another issue is that once a company has acquired investments, restructuring the investments and business to permit the shares to qualify is possible but complicated!
For those whose business property is held in a trust structure there are even further provisions to be aware of governing the applicability of entrepreneur’s relief and who may receive it.
If you are considering selling a whole or part of your business, it’s important that you seek professional advice in good time to ensure you achieve the best return possible and avoid many of the common pitfalls.