Entrepreneurs’ Relief

Entrepreneurs’ relief can reduce the capital gain on disposals of certain business assets, giving a 10% effective rate of tax on the first £1 million of lifetime gains.

A flat rate of capital gains tax (CGT) of 18% was introduced from 6 April 2008 and at the same time many of the previous reliefs, such as taper relief, were removed. Under the previous regime, many people with full business asset taper relief would have had an effective CGT rate of 10%. Entrepreneurs’ relief (ER) was introduced from 6 April 2008 to provide an effective rate of tax of 10% on ‘qualifying business disposals’ by reducing the gain by 4/9ths. However, unlike taper relief, ER only applies to the first £1 million of lifetime gains.

What is a ‘qualifying business disposal’?

In order to qualify for ER there must be a qualifying business disposal. The following are qualifying business disposals:

• A material disposal of business assets
• A disposal of trust business assets
• A disposal associated with a relevant material disposal

What is a material disposal of business assets?

• A disposal of the whole or part of a business – where the individual has owned the business for the year leading up to the date of disposal
• A disposal of assets in use for the purposes of the business where the business ceases to be carried on – if the disposal is made within three years and the individual owned the business for the year preceding the cessation
• A disposal of shares or securities of a company – where one of the following conditions is met:

Condition A – throughout the year preceding the disposal (ie 12 months):

• the company is the individual’s ‘personal company’
• the company is a trading company or holding company of a trading group, and
• the individual is an officer or employee of the company (or of one or more companies that are members of the trading group).

Condition B – where the company has, within the three years preceding the disposal, ceased to be either a trading company or a member of a trading group, the conditions above must be satisfied throughout the year preceding the cessation.

For the purposes of ER, an individual’s personal company is one in which they hold at least 5% of the ordinary share capital of the company and have at least 5% of the voting rights in the company.

A trading company or trading group is defined as one which carries on trading activities and does not carry on other activities to a substantial extent. This is the same as the definition that applied for taper relief purposes.

What is a disposal of trust business assets?

Trustees can benefit from ER if the trust makes a disposal of ‘settlement business assets’, there is a ‘qualifying beneficiary’ and the ‘relevant condition’ is met.

Settlement business assets

There is a disposal of settlement business assets where the trustees dispose of settled property consisting of shares or securities of a company or assets used (or previously used) in the business.

Qualifying beneficiary

There needs to be a qualifying beneficiary who has an interest in possession trust (which is not for a fixed term) in the whole of the settled property or in a part of the settled property that contains the assets disposed of.

Relevant condition

Where there is a disposal of shares or securities in a company, the relevant condition is that throughout a period of one year ending within the three years prior to the date of the disposal:

• the company is the qualifying beneficiary’s personal company
• the company is a trading company or the holding company of a trading group, and
• the qualifying beneficiary is an officer or employee of the company (or of one or more companies which are members of the trading group).

Where there is a disposal of assets that have been used for the purposes of the business, the relevant condition is that:

• the assets are used for the purposes of the business carried on by the qualifying beneficiary throughout the period of one year ending within the three years up to the date of the disposal, and
• the qualifying beneficiary ceases to carry on the business at some time during that three year period.

What is an associated disposal?

Where an individual makes a material disposal of business assets which is either the disposal of the whole or part of an individual’s interest in a partnership or the disposal of shares or securities in a company, then ER can be claimed on the disposal of business assets owned personally if the following conditions are also satisfied:

• The disposal is part of the individual’s withdrawal from the business
• Throughout the period of one year immediately preceding the disposal (or cessation of the business, if earlier) the assets are being used for business purposes

How is the relief given?

The relief is given by way of a 4/9ths reduction of the gain up to a lifetime limit of £1 million of gains. Individuals can claim relief for gains made on multiple occasions up to a cumulative total of £1 million and then they will pay 18% on any further gains. Disposals before 6 April 2008 do not affect the lifetime limit. Gains and losses made on the disposal of a business are netted off before applying the reduction for ER. Any other allowable losses (either in the same year of assessment or brought forward) and the annual exemption are deducted before calculating the tax at 18%.

Each individual is entitled to their own lifetime limit of £1 million. Where there is a disposal of trust business assets the trustees can make use of the individual beneficiaries’ limits. Where relief is given to the trustees this will reduce the beneficiary’s £1 million limit.

A claim for ER must be made on or before the first anniversary of 31 January following the tax year in which the disposal is made. In the case of a disposal by a trust the claim must be made jointly by the trustees and the qualifying beneficiary.

Example – Mr A sells his trading business in 2008/09, realising a gain of £1,200,000 (before ER). £1 million of the gain is reduced by 4/9ths to £555,555 and the balance (£200,000) is chargeable in full. This results in a chargeable gain after ER of £755,555. Assuming Mr A has no other gains or losses in the year , he would then deduct his annual exemption (£9,600 for 2008/09) and calculate the tax at 18%.

Are there any restrictions?

Other than for a disposal of shares or securities, relief is restricted to ‘relevant business assets’. For these purposes goodwill is a relevant business asset. Excluded assets are shares and securities and any other assets held as investments.

The amount of relief may also be restricted for certain trust disposals (where another beneficiary, as well as the qualifying beneficiary, has an interest in the trust property) and certain associated disposals. For associated disposals, the relief is restricted where the asset is not used wholly for business purposes or where the individual has only been involved in carrying on the business for part of the period during which the asset was used for business purposes. Relief may also be restricted where the individual received rent for use of the asset. However, rent received before 6 April 2008 will not affect the relief.

How does ER apply to loan notes?

This will depend on whether the loan notes are Qualifying Corporate Bonds (QCBs) or non–Qualifying Corporate Bonds (non–QCBs).

Qualifying Corporate Bonds

Where there is an exchange of securities for QCBs, there is no immediate charge to CGT in respect of the securities, and the gain on the securities is deferred. ER is available on the gains that are brought back into charge at the time the QCBs are redeemed or otherwise disposed of provided the conditions for ER were satisfied at the time the securities were exchanged for loan notes.

Transitional rules apply in respect of securities that were exchanged before 6 April 2008, where the deferred gains become chargeable on or after 6 April 2008. ER is available on the gain that comes back into charge if the original sale of the securities would have met the conditions for the relief, had such a relief existed at the time.

Non–Qualifying Corporate Bonds

Where securities have been exchanged for shares in another company or for non–QCB loan notes, then ER will apply to the original share disposal where the gain on that disposal is charged to CGT at that time. An election may be required in order to trigger this gain, however this means that tax may then become payable before the shares or non–QCBs are sold/redeemed. The election must be made on or before the first anniversary of 31 January following the tax year in which the reorganisation takes place.

If no election is made then the gain will be deferred until a time when the new shares or non–QCB loan notes are disposed of. In this case ER will only be available if the subsequent disposal meets the conditions for the relief. For example, in the case of loan notes, the issuing company would need to be the holder’s personal company ie they would also need to hold at least 5% of the ordinary share capital of the company and have at least 5% of the voting rights in the company. These are difficult restrictions to overcome.

How does ER apply to gains deferred by an investment in EIS shares?

Where a qualifying subscription is made in Enterprise Investment Scheme (EIS) shares then a capital gain can be deferred. ER applies to gains such that it is possible to defer the net amount of the gain (after ER) where a qualifying EIS share subscription is made.

As with QCBs, transitional rules apply where a gain was deferred before 6 April 2008 by reason of a qualifying investment in EIS or Venture Capital Trust shares and all or part of the deferred gain comes back into charge on or after 6 April 2008. Where this occurs, ER can be claimed if the relief would have been available in respect of the disposal that first gave rise to the deferred gain.

Who should I contact for assistance?

If you would like advice on any of the points covered by this factsheet please contact the person at Grant Thornton who normally advises you, or the contact shown below.