What is Entrepreneurs' Relief and how can it benefit you?
Posted on 2nd January 2020 at 15:32
Closing, selling or even giving away a business can be stressful both personally (you are moving on from a business you may have spent many years building) and financially. Entrepreneurs’ Relief recognises the efforts put into a business by entrepreneur's and can help reduce the capital gains taxon the closure/sale funds.
Entrepreneurs' Relief can apply when you’re selling or giving away part or all of your business, but there is a fair amount of information you need to understand about this concession, if and how you qualify, and how it is applied.
What is Entrepreneurs’ Relief?
Entrepreneurs’ Relief makes it possible for business owners to pay tax at a reduced rate as low as 10% when they to sell all or part of their business. The policy can also apply to company directors and employees that have 5% or more shareholding in the business.
It can be wise to use Entrepreneurs’ Relief because it has the potential for Entrepreneurs, directors and shareholders to save substantial money when selling or giving away their stake in a business. Entrepreneurs’ Relief is available up to £10,000,000 in lifetime gains.
Who is it available to?
Entrepreneurs’ Relief is available to partners or sole traders, as well as company directors, officers and employees with 5% shareholding or more. It’s important to understand some more about who qualifies and how HMRC might define these titles when deciding whether to grant Entrepreneurs’ Relief.
When defining an office, director or employee, HMRC doesn’t place any requirement on the number of hours they work, or the salary of the individual. However, there does need to be some evidence that a person worked for the business in some capacity.
Any non-executive directors and company secretaries are counted as officers and a written employment contract is indicative of employment relating to an employee with 5% or more shareholding. Providing evidence of such a contract will help if HMRC makes a challenge.
In the event of a company buyback of shares taking place, Entrepreneurs’ Relief can still be used in certain circumstances. For example, in advance of the buyback, you have to have been holding the shares for at least five years. On top of that, you need to be employed by or be a director of that company for at least two years before the buyback happened. If you don’t meet those rules, it will be treated a dividend payment and taxed in the relevant way.
There has also been a recent extension of Entrepreneurs’ Relief to cover investors who are not directors and haven’t worked for the company. This is known as Investors’ Relief and also involves taxing the sales of shares at 10% if the requirements are met. These requirements are that there is no requirement to be an officer, director or employee, there are no preference arrangements with the company, shares must be newly issued and the shares have to have been issued on or after 6 April 2016 and held for three years.
Entrepreneurs’ Relief can sometimes be blocked because of trading issues. The company must be a trading company, not an investment company to be able to make a claim for the relief. As long as the company satisfied the trading conditions for a year before the cessation of trading, and ceased trading within three years, it should still be eligible. It’s best to seek expert advice if you aren’t sure how various trading or investment activities might impact your ability to qualify for Entrepreneurs’ Relief.
HMRC’s opinion matters above all else and the line between trading and non-trading is not always clear. You’ll have a better chance of successfully claiming Entrepreneurs’ Relief if you seek a professional opinion and clarification regarding these matters from HMRC. In the event of a negative response, it is possible to make changes that will improve HMRC’s opinion in the future.
Common reasons for HMRC to reject your application of Entrepreneurs’ Relief
There are various reasons why you might not qualify for Entrepreneurs’ Relief and these problems can often be rectified with the right professional support.
Deferred buybacks can sometimes be a problem if the shareholder doesn’t remain an employee for the required amount of time. If a shareholder winds up the company and then starts another to carry out similar trading activities not long after, this can be a problem that might block Entrepreneurs’ Relief qualification too.
EMI (Enterprise Management Incentive) options can cause problems because they are not held for 24 months, which is the minimum amount of time required. Further, if a new holding company acquires the shares of your company’s, this can cause problems because the person paying the tax may no longer meet the minimum 5% threshold.
When you leave a business partnership, the partner might receive a capital payment which could be considered income by HMRC and, again, this might risk Entrepreneurs’ Relief qualification.
In other instances, it can be as simple as an applicant not having the right paperwork available to them, which is something that HMRC don’t tend to look kindly upon! You should always ensure you keep documentation that will support your application and make it more likely to be successful in the end.
Some people miss out because they simply don’t make the claim correctly, which has to be done on the personal tax return of the individual for the year in which the gains take place. If that doesn’t happen, you can’t secure Entrepreneurs’ Relief at all.
Other things to be aware of
If you are looking to close your limited company and claim Entrepreneur's Relief, there may be further hoops you need to jump through.
If the closure funds exceed £25,000, you will need to appoint an insolvency practitioner to carry out a formal winding up of the company - known as a Member's Voluntary Liquidation (MVL). I will be writing about what an MVL is and involves later this month. We have assisted many clients with this and can advise accordingly. We partner with two fantastic insolvency firms and can support you through the whole process.
You cannot claim Entrepreneurs' Relief and go on to start or continue trading via a new company, in the same business field i.e. if you are providing IT consultancy services currently, close your company to make use of Entrepreneurs' Relief - you could not open another IT consultancy business for 2 years. This is to prevent misuse of the concession.
Please feel free to book a call or drop us an email if you’d like to chat about how we can help you make the most of Entrepreneurs’ Relief and everything it can do for you. It makes sense to enjoy the tax benefits of this concession if you’re a business owner or company director looking to sell your business, either in whole or in part.
Nicola J Sorrell -
Founder | Xero Champion | IR35 Expert
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