Entrepreneurs’ Relief: How it works and how to maximise it
If you’ve recently sold or are considering selling all or part of your business then Entrepreneurs’ Relief (ER) is an extremely important factor that you need to consider.
Entrepreneurs’ Relief, now officially known as Business Asset Disposal Relief, is a long-standing tax break designed to encourage entrepreneurial investment that many businesses have depended upon to optimise their tax planning when disposing of some or all of their assets. However recent Government changes to ER and the negative economic impact of COVID-19 and Brexit are casting doubt as to whether this scheme will continue unchanged for much longer.
This article summarises the key elements you need to know about Entrepreneurs’ Relief including:
- What is Entrepreneurs’ Relief?
- How much can you claim from Entrepreneurs’ Relief?
- Are you eligible for Entrepreneurs’ Relief?
- What assets qualify for Entrepreneurs’ Relief?
- How to maximise Entrepreneurs’ Relief
- Deadlines for claiming Entrepreneurs’ Relief
- The future of Entrepreneurs’ Relief
- How to claim Entrepreneurs’ Relief
What is Entrepreneurs’ Relief?
In short, ER reduces the amount of Capital Gains Tax payable when you sell shares in all or part of your business. If you’re eligible, ER is a well-used and effective way to maximise your net financial gains.
It essentially allows you to apply a reduced rate of 10% Capital Gains Tax on the profits you make when you sell qualifying assets regardless of the rate of income tax that you pay.
How much can you claim from Entrepreneurs’ Relief?
Currently there’s no limit to how many times you can claim ER but each person can only claim up to a maximum of £1 million of relief during their lifetime.
Prior to April 2020, the lifetime limit of ER was £10 million so the potential benefit has already been reduced significantly.
Are you eligible for Entrepreneurs’ Relief?
To be eligible for ER, you need to meet certain criteria in the ‘qualifying period’. The qualifying period means that the share disposal needs to have occurred within 2 years from the end of the relevant tax year.
Those applying for ER must meet all of the following conditions:
- The person selling the shares must own at least 5% of the ordinary share capital of the company. This must entitle that person to at least:
- 5% of the voting shares.
- 5% of the distributed profits.
- 5% of the net assets on winding up.
- The person selling or disposing of the shares must be either an officer or registered employee of the company for at least 2 years leading up to this point. Make sure this can be evidenced.
- The company must have traded in the 2 years leading up to the share sale.
Importantly ER can also be claimed if a company has ceased trading and been dissolved providing that:
- The three qualifying conditions above were met in the 2 years prior to the company ceasing to trade.
- Any assets in the business are taxed under capital distribution and not as income.
- Distribution occurs within three years of when the company ceased trading.
However, in this scenario, it is important to be aware of HMRC’s Targeted Anti-Avoidance Rule (TAAR) which aims to prevent business closures from being used as a way of avoiding tax.
As you can see, the ER rules are complex so it is important that you, or your tax advisor, check the HMRC qualification criteria to validate your eligibility.
What assets qualify for Entrepreneurs’ Relief?
ER applies to all material disposable business assets including shares and securities. Although, it doesn’t apply to the sale of investment or non-business assets like personal assets.
If your shares were granted through an Enterprise Management Incentive (EMI), they must also comply with extra qualifying conditions to enable you to claim ER. EMI options only apply to smaller companies with assets of up to £30 million. If you’re selling EMI shares you might be liable to pay Capital Gain Tax in which case you may also qualify for ER. To be eligible, you must have:
- Purchased your shares after 5th April 2013
- Been offered the option to buy them at least 2 years before selling them.
Providing the 3 standard ER qualifying criteria are also met you may claim ER, although for EMI assets the requirement to hold 5% of the voting shares does not apply.
How to maximise Entrepreneurs’ Relief and get the biggest benefit
Early tax planning is always worthwhile so reviewing your personal circumstances well before you have any intention of selling all or part of your business can save you considerable tax costs in the longer term.
Where possible plan the ownership structure from the outset so that you are best positioned for a potential disposal.
Once the company is established be careful to consider how new share issues or changes to the rights of shares might affect your eligibility for ER. If your ownership is diluted below the 5% limit, or your voting rights drop below the same figure, then you may no longer be eligible for ER.
Remember also that the lifetime ER limit (£1 million) is applicable per individual. If you’re likely to exceed the limit of your ER allowance, it might be worth considering transferring assets to your spouse, which is free of CGT, to utilise their lifetime limit, providing that they also meet the qualifying conditions.
If your spouse is already a shareholder in the business there may be an opportunity to exploit the fact that, once you have met the qualifying criteria, ER can be applied to any additional shares that you acquire even if you have not held them for the full 2 year qualifying period. So, for example, if your spouse is a shareholder but does not qualify for ER, transferring their assets to you would enable you to claim additional ER.
Deadlines for claiming Entrepreneurs’ Relief
To benefit from this lucrative incentive, you need to claim ER by the first anniversary of the 31st January following the tax year of the disposal shares:
- Disposal in 2018/19 tax year – deadline to claim is 31st January 2021
- Disposal in 2019/20 tax year – deadline to claim is 31st January 2022
- Disposal in 2020/21 tax year – deadline to claim is 31st January 2023
The Future of Entrepreneurs’ Relief
Since the general election in 2019, ER has been in the crosshairs for both the leading political parties. The Labour Party Manifesto for the last election threatened to abolish ER altogether. Perhaps more worryingly is how the current Conservative Government may change its stance on this highly political tax relief. In March 2020 Rishi Sunak, the new Chancellor, radically reformed the scheme, reducing the maximum lifetime value of the relief from £10 Million to £1 Million. The reason for retaining the relief at this level was because many small business entrepreneurs had long planned to use the relief as a means to fund their retirement.
However, concern remains that the Government may still decide to scrap the relief completely or further constrain the eligibility criteria because of the worsening economic climate. Since the last budget, the UK has had to face the massive economic shock of the COVID-19 pandemic which has caused Government borrowing to grow to previously unheard of levels. An already difficult financial situation may get even worse if there is a ‘No Deal’ Brexit at the end of the year. As a result, the Government is having to consider all options to improve the public finances and even well-established tax policies are coming under scrutiny. For example, the Government recently scrapped the long-standing VAT relief for foreign visitors which is expected to have a significant detrimental impact on the UK retail sector, even though the gain to the Treasury is expected to be relatively small.
In the current economic climate, there can be no guarantees that Entrepreneurs’ Relief will survive the next budget untouched.
How to claim Entrepreneurs’ Relief
You can make a claim on your annual Self Assessment Tax Return in the supplementary ‘Capital Gains Summary’ section, however we strongly advise seeking expert tax advice whenever considering any significant financial event such as claiming ER. Morphose Captial Partners can introduce you to a suitable expert if required.
If you are considering selling your business and would like to discuss the implications of ER on your exit management strategy please contact Morphose Capital Partners.