CGT Entrepreneurs Releif
We have been waiting some time for more details of the new relief for the disposal of businesses and business assets which will apply from 6 April 2008. Now that we have draft legislation and explanatory notes together with questions and answers on the HMRC website, we can be a little more sure what will – and what will not – attract relief.
The relief is very largely modelled on the old retirement relief, that many will remember. However the relief is much broader and much simpler than retirement relief, and is therefore likely to be more widely applicable.
The main form of relief is where an individual makes a material disposal. This includes the disposal of all or part of his business (including an interest in a partnership), and assets which were used in a business (but only a sole trade) which has ceased within the last three years. A material disposal also includes the disposal of shares in the owner’s “personal company” – that is one in which the shareholder owns at least 5% of the ordinary share capital in the company, and as a result can exercise 5% of the voting power, and in which the owner is an officer or employee. The company must also be a trading company or holding company of a trading group – as defined for Business Asset Taper Relief. This means that the company must be carrying on trading activities, and the activities do not include to a substantial extent activities other than trading activities. This retains the “20% test” currently in use for the purposes of Taper Relief.
In all cases, the relief is only available if the conditions have been met for the twelve months leading up to the disposal, or if the individual has been carrying on the business for at least 12 months. It is not clear to what period the trading company test applies, but it may apply only to the last 12 months of ownership.
Relief on a disposal of shares will also be available if the company has ceased being a trading company or member of a trading group within the last three years – this would seem to provide relief against the proceeds where a former trading company is liquidated or struck off after winding down.
Where the material disposal comprises a sale of shares or of a share in a partnership, the disposer can also claim relief against the gains on the disposal of an asset which was used in the business which has been the subject of the material disposal. This is known as an associated disposal and is again, a read – across from old Retirement Relief. The associated disposal can take place within three years of the related material disposal, and must be related to the individual withdrawing from the business concerned, so would not apply with a partial sale of shares where the remaining shares are retained.
What does not qualify
The sale of assets without the sale of the business, or the cessation of trade will not qualify for relief. This will affect farmers who sell off parcels of land, which presently qualifies for BATR, but will not attract relief after 5 April 2008. It would also be an issue where a property used by the owner’s personal trading company is sold either to the company or to a third party without the sale of the shares.
As already announced, the relief will be available against gains on the disposal, and will be a limit of £1 million, which is a lifetime limit. The gains subject to relief will be scaled by deducting 4/9 of the amount, leaving 5/9 in charge, and effectively providing a 10% rate of tax on the gross gains.
However, where a number of business assets are disposed of at the same time (probably as a result of the winding up of a sole traders business) it is a requirement that the net gains after losses on business assets are calculated. If there are losses on business assets, this means that the Entrepreneurs’ Relief will be calculated by reference to the lower amount, and if there is a net loss on the disposal then no relief can be claimed. This would affect those who would have hoped to secure the gross losses for relief against disposal of non qualifying assets in the future.
What we didn’t expect
Those of us thinking about the old relief on which this is modelled may have predicted a restriction in relief in some cases, but the following may be a key trigger to pre 6 April advice.
Where a property has been retained outside of a company or partnership, then the gain on which Entrepreneurs’ Relief can be claimed is restricted under the following circumstances:
- The asset has been in use in the business for only part of the period of ownership
- Only part of the asset has been in use for the business
- The individual has only been involved in the business for only part of the time he has owned the asset, or
- The asset has been provided to the business in return for rent.
It is the last of these restrictions which will cause concern, as it is directly at odds with the current position regarding Business Asset Taper Relief.
For example, a property may have been purchased for use in the taxpayer’s personal trading company, or retained in private ownership when the business was incorporated. The property was purchased with the aid of a mortgage, and in order to benefit from tax relief on the interest paid, rent is charged on the property equal to the interest on the mortgage. Thus, the owner benefits from interest deduction providing a nil tax charge on the rental income, and the company secures a deduction against profits for the rent paid (provided no more than market rent). This arrangement would not prejudice the availability of Business Asset Taper Relief on the disposal of the property.
However, if relief is sought under the Entrepreneurs’ Relief provisions, the gain on the property would not be available for full relief. The percentage of market rent charged during the ownership of the property (including any period before 6 April 2008) will deny relief, so that if the rent charged was 40% of the market rent, only 60% of the gain on the property would attract Entrepreneurs’ Relief. This means that some property owners may prefer to dispose of such a property now, particularly into their trading company, notwithstanding the impact of Stamp Duty Land Tax. This would secure Business asset Taper Relief on any accrued gains to date.
Where a disposal which would qualify for Entrepreneurs’ Relief is in effect a take over by another company, the CGT rules will not treat this as a disposal, but will treat the cost of the old shares as the cost of the new shares. However, this might cause the loss of relief, if the new company did not meet the qualifying conditions. The new legislation allows disposers to “opt out” of Section 127 of TCGA – thus triggering an actual disposal on which relief can be claimed. This is a welcome extension of the relief previously announced.
Further business reorganisation provisions allow for a disposal which qualifies for Entrepreneurs’ Relief but under which QCB’s are acquired to be treated as if the Entrepreneurs’ Relief is applied to the gain on the initial disposal, so that only the net gain resurfaces on a subsequent disposal of the QCB’s.
Transitional relief – the winners
A number of commentators have expressed concern about those who have disposed of business assets on which Taper Relief would have been available, but have taken deferral relief, transferring the gain which would have arisen into a new asset. Of particular concern have been Qualifying corporate bonds (QCB’s) and EIS and VCT investments (although deferral relief is no longer available in relation to VCT investments).
In all three of these cases, transitional relief is now available so that if the original disposal took place before 6 April 2008, and would have qualified for Entrepreneurs’ Relief at the time of the disposal (had it existed) then the gain deferred is treated as the amount after Entrepreneurs’ Relief. The claim will be made on the first disposal (or other occasion of charge) of the QCB or EIS / VCT shares after 6 April 2008.
Care is needed, however, as the transitional relief will only accrue to a holder of QCB’s or other qualifying investments if they were the original disposer of the business assets. Where such investments have been passed, for example, to a spouse or civil partner, transitional relief will not be available. It is, however, open for the recipient to now pass those shares or bonds back to secure relief on a subsequent disposal.
As expected, relief will also be available to trustees on disposals, so those with very large pregnant gains now who are seeking a purchaser can study the legislation to check that passing the business into trust now to secure BATR will subsequently also allow Entrepreneurs’ Relief to be claimed. The conditions largely apply to the beneficiary of the trust – such as the “officer or employee” condition, and the relief is available up to the £1 million limit between the beneficiary and the trustees. So if a claim is made by the trustees in respect of a shareholding acquired pre April 2008, on a disposal after that date, then the beneficiary will be treated as having used up some or all of his lifetime limit.
HMRC’s FAQ’s on this topic
1) Is the £1 million lifetime limit retrospective? / Does the lifetime limit include past disposals?
No. Entrepreneurs’ relief must be claimed. Until a claim is made the £1 million lifetime allowance remains untouched. Claims can be made for disposals on or after 6 April 2008 providing the gains qualify for the relief.
2) I sold shares in my company in July 2007 in return for qualifying corporate bonds redeemable over 5 years. My gain selling on the shares is held over until the QCBs are disposed of. Will I qualify for entrepreneurs’ relief when the QCBs are redeemed after 6 April 2008?
Entrepreneurs’ relief will be available in respect of the held-over gains that become chargeable on or after 6 April 2008 when the qualifying corporate bonds are redeemed (or otherwise disposed of) if the original sale of the shares would have met the conditions for the relief if it had taken place after 6 April 2008.
3) I have a number of flats that I currently let out – will I qualify for entrepreneurs’ relief?
Gains on disposals of let residential properties will not qualify for entrepreneurs’ relief.
4) I am letting a commercial property which currently qualifies for business asset taper relief. If I sell it will I get entrepreneurs’ relief?
By itself a disposal of let property will not qualify for entrepreneurs’ relief. There must be a disposal of the whole or part of a trading business, and commercial property letting is not a trading activity.
However, if the property is let to a trading partnership of which you are a member, or to a trading company of which you are an officer or employee, you may be entitled to a measure of relief on disposal of the property if that disposal is a associated with a disposal of your interest in the partnership, or of your shares in the company and that other disposal meets all the conditions for the relief.
5) I have owned a farming business since July 1987. I intend to sell off some land which has been used in the business – will I qualify for entrepreneurs’ relief?
In order to qualify for entrepreneurs’ relief there must be a disposal of the whole of part of the trading business. The sale of an asset in isolation will not qualify for the relief.
HMRC’s Capital Gains Manual discusses what constitutes the disposal of the whole or part of a business at paragraph CG63530 onwards. These paragraphs relate to the old retirement relief, but we consider the same principles will apply.
6) Do furnished holiday lettings qualify for the relief?
A business of commercial letting of furnished holiday accommodation in the UK will be treated as a trade for the purposes of entrepreneurs’ relief. So the relief will be available provided that all the qualifying conditions are met.
7) I am an employee of a company in which I own 4.9% of the ordinary share capital. Will this be rounded up so that I could qualify for entrepreneurs’ relief?
No. The holding must be of at least 5% of the ordinary share capital (and give at least 5% of the voting power in the company) throughout the qualifying period.
8) I already hold over 10% of the shares in the company. If I acquire another 4% of the shares and sell the whole 14% 6 months later, can I get entrepreneur’s relief on the whole 14%, or only on the 10% I held for the whole of the one year qualifying period?
Relief will be available in respect of the whole 14% holding if the qualifying conditions are met. The requirement is that a 5% stake is held throughout the qualifying period. The particular shares or securities disposed of do not have to be held throughout that period.
9) I am the director of a trading company in which I own 50% of the shares. Do I have to sell all of my shares in order to qualify for entrepreneurs’ relief?
No. A sale of some of the shares will qualify for entrepreneurs’ relief, providing the conditions for the relief are met.
10) I sold my business in July 2003 and reinvested the profits into EIS shares. If I sell my shares after 6 April 2008 will I qualify for entrepreneurs’ relief?
Entrepreneurs’ relief may be available in respect of the deferred gain that comes into charge on the sale of your EIS shares, if the sale of your business would have qualified for entrepreneurs’ relief if that relief had been available in July 2003.
11) I sold my trading company in June 2007 in exchange for loan notes that are not qualifying corporate bonds. Will I qualify for entrepreneurs’ relief if those loan notes are redeemed in June 2008?
Entrepreneurs’ relief will be available only if, throughout the period of one year leading up to the redemption of the loan notes:
the company that issued the loan notes is a trading company or the holding company of a trading group
you own at least 5% of the ordinary share capital and that holding gives you at least 5% of the voting rights in that company, and
you are an officer or employee of that company or, if it is a holding company, of a company in the same group as the holding company.
12) Can non-executive directors and the company secretary qualify for entrepreneurs’ relief?
Non-executive directors and the company secretary are all officers of a company and will be able to qualify for the relief provided that all the other qualifying conditions are also met.
13) How many hours does an officer or employee have to work to qualify for the relief?
There are no rules about the working hours of officers and employees. The condition is only that the individual is an officer or employee of the company throughout the one year qualifying period. However in order to qualify for relief all the qualifying conditions have to be met.
14) If in July 2008 I exchange my shareholding in my trading company for shares or loan notes of another company and any gains will be deferred or rolled over, will I qualify for entrepreneurs’ relief when the shares or loan notes are sold or redeemed?
Entrepreneurs’ relief will be available (provided the conditions for relief are satisfied) but the way it will be given depends upon whether the loan notes are qualifying corporate bonds (QCBs) or not.
If the exchange is for shares of the other company, or for loan notes that are not QCBs, entrepreneurs’ relief will be available only if you choose for the gain to be chargeable to CGT for the tax year in which the exchange of shares for loan notes takes place. So if you exchange shares for shares or non-QCB loan notes in July 2008, entrepreneurs’ relief would be available only if the gain (net of the relief due) was charged for the year 2009-09, even if the shares or loan notes are not sold or redeemed (or otherwise disposed of) until a later tax year. If you do not elect for this treatment the gain could be deferred until the year in which you dispose of the shares or loan notes, but in that case no entrepreneurs’ relief could be claimed if you do not meet all the qualifying conditions for relief in respect of a disposal of shares in or securities of the company that issued them.
If the exchange is for loan notes that are QCBs, there will be no immediate charge to capital gains tax in respect of the shares. Entrepreneurs’ relief will be available on the gains that are brought into charge at the time the loan notes are redeemed or otherwise disposed of.
15) Can I claim entrepreneurs’ relief on a disposal in September 2008 and defer the net gain (after entrepreneurs’ relief) by investing in EIS shares?
Yes, if the disposal meets the conditions for the relief to apply.