Entrepreneur's relief is a capital gains relief, available on the disposal of business assets, which was introduced with effect from 6th April 2008 and replaced the previous relief, taper relief. Taper relief was available for the disposal of any kind of asset both business asset and non- business asset there being two scales depending on the type of asset. However, entrepreneur's relief is only available for disposals involving business assets.
A business asset for the purposes of the relief is essentially involves a business being carried on as a trade. A trading company for example can carry out non-trade activities. However, if these become substantial then the relief may be in jeopardy. Substantial in this case is regarded as being 20% by reference to such measures as turnover, asset values, expenses and time spent by officers and employees of the business
There have been a number of changes in the short life this relief has been available but essentially the end result is that tax is paid at an effective rate of 10% on the qualifying disposal as opposed to 18% or 28% (depending on the taxpayers marginal rate of tax). With current top rates of income tax at 40% and 50%, this is quite an attractive relief.
Naturally with such a low rate of tax applying, there are a number of conditions which need to be satisfied. It will also be necessary to distinguish between the disposal of a business or part of a business, the disposal of business assets and the disposal of shares in a limited company.
The disposal of a business is straightforward. To qualify the business has to have been run as a trade (this will exclude rental businesses) and has to have been owned for more than 12 months. Typically the sale will be of the goodwill of the business either to a third party or to a limited company set up by the vendor to take advantage of this relief.
If there is a disposal of a business to a limited company set up by the vendor, this will be regarded by H M R & C as a sale between connected parties. In this instance care will need to be taken of the valuation of the goodwill. H M R & C may question the valuation of the goodwill either to realise more capital gains tax or to suggest the goodwill has been overvalued and if the sale proceeds have been left on a director's loan account with the new company (the usual method of operation as the new company will not have the funds to pay for the goodwill) and the funds withdrawn they may suggest the director's loan account has been overdrawn with the tax consequences that arise being relevant.
The disposal of business assets (known as an associated disposal) may be a little more difficult to achieve. Typically this will arise in the situation where the business assets are kept out of the business accounts but are used for the business purposes. For example the property from which a business is run may be held in personal ownership whilst the business is run by a limited company. In these circumstances the entrepreneur's relief will be available only if the disposal of the property arises at the same time as the withdrawal of the taxpayer from the business either by way of the sale of the shares in the relevant limited company or accompanies the sale by the individual of the business or interest in the business concerned.
Particular care does need to be taken with the timing of the disposal of the property or asset if they are to be sold to someone other the acquirer of the shares or business. The disposal of the property prior to the sale of the shares could render the sale of the asset non-qualifying for the relief as it is necessary for the asset to be used for the purposes of the business up to the time of the sale of the shares or business.
Because of this restriction H M R & C will look carefully at the sale of part of a business to determine whether it is in fact part of a business or just the sale of business assets. The rules surrounding the entrepreneur's relief are similar to those which operated with Retirement relief which was withdrawn in 1998 and H M R & C have indicated they will rely on decided cases from the former relief in deciding whether or not entrepreneur's relief will apply to the disposal of part of a business.
If the conditions for the relief are satisfied there may be an apportionment of the gain between qualifying and non-qualifying where for example part of the property is not used for the business purposes or where it has only been used as such for part of the time of ownership. In addition an apportionment will be required where rent has been charged by the owner to the business for the use of the property (but this will only apply after 5th April 2008 due the fact that the previous relief, taper relief, did not impose such restrictions and it was common for rent to be charged as a result)
The final category to consider is the disposal of shares. Again there are restrictions covering this type of disposal as well. These conditions require the company to be trading and the shareholder to hold at least 5% of the ordinary and voting share capital of the company as well as being an officer or employee of the company. However, the legislation implies, in the case of shares, that the disposal of part of a holding will qualify for the relief providing the shares satisfy the qualifying conditions in the 12 months prior to sale.
As we indicated at the outset this is a generous relief and can typically result in sole trader who perhaps has a successful business transferring that business to his own limited company. The value of the business is then left on director's loan account and after 10% tax has been paid the remaining 90% will be available for withdrawal to meet normal day to day living requirements. However withdrawal of these funds for this purpose should only be made once a normal salary has been paid (to ensure there is continuity in the national insurance record) and the payment of a dividend. This fund of money can then be used to top up having only had 10% tax paid or for one off expenditure (funds permitting) without any further taxes being due.
Here at LBW we are able to advise and structure your business activities to enable you to take the best advantage of this relief and to ensure you do not fall foul of any of the pitfalls that can arise. If you feel the relief may be of some benefit to you please contact us and we will be glad to discuss this further with you.