Introduction »

Securing 10% capital gains tax

As announced by the Chancellor in the Emergency Budget there is a significant rise in the Entrepreneurs' Relief (ER) lifetime limit from £2 million to £5 million for qualifying gains arising on or after 23 June 2010. Qualifying gains are taxed at a 10% rate which is very advantageous when compared to the standard 18% rate and the new higher 28% rate which applies from 23 June 2010.

This article recaps on which gains generally qualify for ER and some of the common pitfalls which can catch the unwary.

The whole or part of a business

A self-employed individual who disposes of the whole or part of their trading business interest generally qualifies for the relief.

However, where separate assets (such as a property) used in the business are sold, the key issue is whether such disposals qualify as a disposal of part of the business. If they do not, then any gains on assets will not qualify for ER. Contrast this with the situation where business assets are disposed of after the business has ceased to trade. Generally, gains on these assets will qualify assuming that the asset had been in use in the business at the date the business ceased trading and the assets are disposed of within three years of the cessation of the business.

Shares in a trading company

Broadly, the shareholder needs to own at least 5% of the shares with voting rights and must also be an officer or employee of the company.

Care needs to be taken as the company needs to be a qualifying trading company. A company that carries out trading and non trading activities can cause problems and claims for ER could be denied. HMRC’s view is that non trading activities should not be 'substantial'. Their view is that substantial in this context means more than 20%. A number of indicators are considered including income and expenses, asset base, and time spent by management on different activities. For example, a company which has a trade also lets out an investment property. If the income from the letting is substantial when compared to the combined trading and letting income then the company may possibly not be a trading company. Similarly, if the value of a company’s non-trading assets is substantial in comparison with its total assets then again this could point towards the company being classed as non-trading.

Trading premises

It is fairly common that an individual shareholder/partner may personally own the premises from which the company/partnership trades. In order for any gain arising on the disposal of this asset to qualify for ER the disposal must be an associated disposal. Broadly, this means that the individual makes a disposal of either the whole or part of their interest in the assets of the partnership or their shares in the company and the sale of the premises is made as part of that withdrawal from participation in the business.

Where the property has been rented to the company a restriction in ER may apply. This will only affect periods after 6 April 2008 so owners of premises will need to consider the position on rent going forward. If the owner has borrowed to purchase the property and needs the rent to service that borrowing then they have a difficult decision to take. If they stop the rent they retain the potential ability to obtain ER but will have to find some other route, perhaps less tax advantageous to fund the borrowing.

Note that conditions for the relief in all the scenarios above must generally be satisfied throughout the period of 12 months leading up to the date of disposal. Professional advice is generally recommended before entering such capital transactions to maximise any relief available so do contact us for assistance.

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