UK: Entrepreneurs' Relief - August 2015

Last Updated: 1 September 2015
Article by Smith & Williamson

Introduction

Entrepreneurs' relief (ER) can reduce the rate of UK capital gains tax (CGT) to 10% on some disposals. The rules are complex and fairly restrictive. We can help you plan so as not to undermine overall tax or commercial efficiency.

Background

There is a lifetime cap on the value of qualifying gains that can benefit from ER. For a disposal to qualify, it must come within one of three tightly drawn categories and the qualifying conditions have to be met continuously for a year in advance of any disposal.

ER can only be claimed by individuals or through a joint claim made by a qualifying beneficiary and the trustees of a life interest trust. Corporate entities cannot claim ER.

ER was introduced in 2008 with a lifetime on gains which could qualify set at £1m. However this limit has since increased and is now set at £10m with effect from 6 April 2011.

Non-ER gains for individuals are charged at either 18% or 28% depending on whether total taxable income and gains exceed the basic rate threshold, but all ER qualifying gains are subject to a flat rate of 10%.

ER gains can impact on the tax rate applicable to non-qualifying gains where an individual's total taxable income is less than the upper limit of the income tax basic rate band. This is because ER gains are deemed to use up any spare basic rate band in priority to other gains meaning it is more likely that the 28% rate will apply to other gains.

Which disposals qualify for ER?

In general terms, there are three mutually exclusive qualifying disposal categories. For the purposes of ER, a business includes an interest in a partnership, including a limited liability partnership. An ER claim on the disposal of the whole or part of a business or business assets cannot cover assets held as investments. Further restrictions to the availability of ER were introduced in FA2015.

Qualifying category 1 – material disposal of business assets

Broadly, to qualify, a disposal must fall within one of three sub-categories.

a) Disposal of the whole or part of a business

The business must be owned by the individual throughout the period of one year ending with the date of the disposal. The definition of a disposal of whole or part of a business is not straightforward and Smith & Williamson can advise in this area.

b) Disposal of interests in assets in use for the purposes of the business at the time at which the business ceases to be carried on.

The disposal of a business asset will only qualify for relief where:

  • the business was owned by the individual throughout the period of one year ending with the date of cessation; and
  • the date of the disposal is within the period of three years beginning with the date of cessation.

c) Disposal of (or of interests in) shares in or securities of a company

The rules are strict and must be met in full:

  • shares or securities will only qualify for ER where the company is a trading company or the holding company of a trading group;
  • the individual must be an officer or employee of the company or of another group company, and the company must be the individual's personal company;
  • a company will only qualify as the personal company of an individual where the individual is the holder of at least 5% of the ordinary share capital, and can exercise at least 5% of the voting rights by virtue of that holding; and
  • The company and the individual must generally meet the above conditions throughout the period of one year ending with the date of the disposal. There are variations to this rule where the company is being wound up or where it leaves a trading group. We can advise on these situations.

Note that the 5% stake in the company condition is relaxed in respect of shares acquired on exercising enterprise management incentive (EMI) qualifying options, or replacement shares, provided a year has passed since the option was granted and the individual has been an employee throughout. The other conditions still have to be met.

Qualifying category 2 - disposal of settlement business assets

Trustees can also benefit from ER, but only in limited circumstances:

  • the disposal must be of settlement business assets;
  • a beneficiary must have an interest in possession (other than for a fixed term) in the settlement business assets;
  • the beneficiary has to have unused lifetime ER allowance that the beneficiary must agree to allow the trustees to use .The amount used by the trustees reduces the amount available for the individual to use himself.

Smith & Williamson can advise on the definition of 'settlement business assets' and the detailed qualifying conditions.

Where the trustees own shares in a company, ER will only be available where the company is a trading company or the holding company of a trading group.

For relief to be available the beneficiary must be a qualifying individual in his own right. This means they must have been an officer or employee of the company throughout the qualifying period and have had a personal holding in the company which met the specific 5% conditions with respect to voting rights and percentage interest in the company's ordinary share capital. The percentage holding of the trustees is irrelevant.

As a result of the narrow wording of the ER provisions for trustees, a detailed review should be undertaken to consider whether the assets or shares owned in a settlement will benefit from ER.

Qualifying category 3 – disposal associated with a relevant material disposal

To qualify for ER under this category, there must be both an 'associated disposal' and a 'relevant material disposal' that the associated disposal is connected with. A relevant material disposal is:

  • the disposal of the whole or part of the individual's interest in the assets of a partnership; or
  • the disposal of (or interests in) shares in or securities of a qualifying company.

An associated disposal is the disposal of an asset held personally by the individual that was used either in the trade of the partnership or of the company. The associated disposal must be made as part of the withdrawal by the individual from participation in the business carried on by the partnership or by the company (or a company which is a member of the trading group).

The provisions are complicated and relief is restricted in certain cases, chiefly where the asset (or part of the asset) has not been used for business purposes throughout the period of ownership.

Relief is also restricted where, for the whole or part of the period of business use, the availability of the asset was dependent on the payment of rent. Where an individual owns a property used by his/her partnership or personal company, Smith & Williamson can review whether the loss of ER that is caused by receiving rent is offset by other tax advantages.

Changes introduced by FA 2015

Finance Act 2015 restricts the availability of ER in certain situations:

  • With effect for disposals made on or after 18 March 2015, in order to qualify as an associated disposal (category 3 above), the individual will need to dispose of an interest of at least 5% to satisfy with withdrawal condition. The presence of 'connected persons' (which includes relatives) can disqualify an ER claim not withstanding that a disposal of a 5% interest is made.
  • With effect for disposals made on or after 3 December 2014 no ER is given if the relevant asset otherwise qualifying for relief is goodwill and the transfer is to a close company where the transferor is a related party in relation to the close company. There is a limited exception from this exclusion for retiring partners. Related party relationships can, amongst other situations be present where family members control or have a major interest in the company.
  • With effect for share disposals made on or after 18 March 2015, no ER is available if the shareholding is held through a joint venture company unless the joint venture company is a trading company in its own right. A company would not be a trading company in its own right for this purpose if it only met that condition by reference to the joint venture provisions deeming certain holding companies with interests of less than 51% in other companies to be trading companies.

We have taken care to ensure the accuracy of this publication, which is based on material in the public domain at the time of issue. However, the publication is written in general terms for information purposes only and in no way constitutes specific advice. You are strongly recommended to seek specific advice before taking any action in relation to the matters referred to in this publication. No responsibility can be taken for any errors contained in the publication or for any loss arising from action taken or refrained from on the basis of this publication or its contents. © Smith & Williamson Holdings Limited 2015

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