Entrepreneurs’ Relief may be claimed by individuals or trustees who sell shares or securities in a trading company or dispose of the whole or part of a trading business, providing certain conditions are met.
The relief is available on up to £10 million of lifetime gains arising from 6 April 2008. Gains realised before 6 April 2008 do not restrict the availability of the lifetime limit. As the relief can reduce the effective rate of tax from 28% to 10%, it can be worth up to £1.8 million in tax savings for each individual.
The relief is not mandatory and must be claimed on or before the first anniversary of 31 January following the tax year in which the qualifying disposal is made. Where, for example, a gain is made in 2014/15 the claim must be made by 31 January 2017.
The qualifying conditions to claim the relief vary depending on whether an individual is selling shares in a trading company or disposing of an interest in a business. In addition there are different criteria where trustees are seeking to claim the relief.
Shares or securities
In order to claim the relief on the sale of shares, the following conditions must be met:
-The shares must be held in a trading company or in the holding company of a trading group; and
-The individual vendor must be an officer or employee of the company or a company within the same group; and
-The vendor must own at least 5% of the company’s ordinary share capital and be able to exercise 5% of the voting rights within the company. (unless the shares were acquired under a qualifying EMI share option)
-All of the above conditions must be met throughout the 12 month period leading up the date of disposal where the company continues to trade to that time; or
-Where the company ceases to trade, the conditions must be met throughout the 12 month period immediately prior to the date of cessation, provided the shares are sold within 3 years of the date of cessation.
Accordingly it is possible to claim the relief where perhaps a company has ceased to trade and entered voluntary liquidation, but capital distributions are made by the liquidator to the shareholders within 3 years of the company ceasing to trade.
You do not have to sell all your shareholding to qualify for the relief. For example, if you own 40 shares out of a total issue of 100 and sell 20 shares, retaining 20, you could claim Entrepreneur’s Relief on the disposal. You can remain a director or employee after the disposal, and in fact would probably prefer to do so in order to remain qualifying for the relief on a future disposal of the retained shares.
When you come to sell the remaining 20 shares, Entrepreneur’s Relief is available on that gain, provided you continue to meet the conditions and subject to a maximum lifetime allowance of £10m.
When agreeing a sale of shares it is possible to receive the consideration in two parts:
A fixed payment on completion
A future payment(s) based on the future results of the business – an “Earn Out”.
In order to claim Entrepreneurs’ Relief on the earn-out proceeds, you must include the expected amount to be received in the original calculation of the gain and pay capital gains tax at that time.
For example, if you sell 20 shares on 1 March 2015 for £1m plus an earn out which may pay a further £125k on each of 1 March 2016 and 2017, you have a maximum total proceeds of £1.25m.
If you are confident of receiving this, you should put the £1.25m gain on your tax return, claim Entrepreneur’s Relief and pay £125k tax on 31 January 2016.
As you can see, you are paying tax on proceeds which you won’t have received at that time.
If you chose not to put it in the original gain but instead pay capital gains tax when you receive the earn-out payment then you wouldn’t get Entrepreneur’s Relief on those payments, so each £125k would suffer capital gains tax at 28% or £35k.
Earn outs are complex and specific advice should be taken if they are being contemplated.
Definition of a trading company
This is a company carrying on trading activities which does not include ‘to a substantial extent activities other than trading activities.’
Non-trading activities include investment in property, share portfolios, bonds etc.
HMRC also say that excess cash deposits may constitute a non-trading activity. They will accept that if the cash is being accumulated for future use in the trade then it is classed as trading. Also, if cash is simply held on deposit, it may not in fact involve much ‘activity’ in managing it.
HMRC says ‘substantial extent’ means more than 20%. Whilst this can cover many things, it is generally accepted that the 20% test should be applied to:
-Asset base or balance sheet
Each company should consider which of the above measures are appropriate for the company’s activities – some, all, or a combination could be used to determine whether the company is a trading company.
Entrepreneurs’ relief should be available on the disposal of shares in a trading company but care should be taken to ensure all the qualifying conditions are met.
In particular, if there are concerns over the trading status of a company, HMRC do offer a ‘non-statutory’ clearance process whereby a taxpayer can ask for confirmation the company qualifies as a trading company.
For further advice on entrepreneurs' relief and how it works or any aspect of corporate tax please call me on t. +44 (0) 207 240 9971 or email firstname.lastname@example.org.