The Chancellor’s Budget on 11 March did not quite abolish Entrepreneurs Relief (“ER”) as some predicted but instead made significant changes. Below are our top tips on how to now maximise ER (which is to be re-named business asset disposal relief for the tax year 2020/21 onwards) on share sales.
A successful claim for ER reduces the rate of capital gains tax on the sale of an asset to 10%. Following the Chancellor’s Budget on 11 March 2020, the lifetime limit for capital gains that can be subject to ER has been significantly reduced from £10m to £1m.
How to qualify for ER
Broadly, for a sale of shares to qualify for ER, throughout the period of two years ending with (and including) the date of disposal of the shares, the individual selling the shares must:
- be an employee or director of the company (or a member of its group);
- hold at least 5% of the share capital of the company (by nominal value);
- be entitled to exercise at least 5% of the votes in the company by virtue of that holding; and
- be beneficially entitled to at least 5% of either:
- profits available for distribution / assets on a winding up; or
- the share sale proceeds if all of the ordinary share capital of the company was sold.
The company must also be a trading company or holding company of a trading group throughout that same 2 year period.
Top tips for maximising ER
With the ER qualifying period now being 2 years, shareholders / business owners need to consider well in advance if any steps can be taken to maximise ER. If you will, or would expect to, be impacted by the restriction in the ER lifetime allowance, you may want to consider:
- Splitting shareholdings amongst family members: The £1m lifetime allowance is a per-personal entitlement, so if there are multiple family members who all meet the ER qualifying conditions for the necessary two year period to sale, they could all claim ER.
Tax advice should be sought on any transfers within the family. Generally, inter-spouse gifts of shares should not trigger any adverse tax consequences and it should be possible to avoid tax charges on gifts to other family members by entering into hold over elections. It is important to remember that all transfers must be genuine transfers (i.e. the new shareholder cannot really be holding on behalf of the original shareholder).
- If any of the shares in the company are held in a trust: It should be remembered that trustees can claim ER on a share sale where there is a beneficiary with an interest in possession in the trust property / shares and who himself qualifies for ER in respect of the company.
For example, if there is a beneficiary of the trust who works for the business, then if that beneficiary held 5% of the shares in the company in his own right for at least two years prior to sale, both the beneficiary (on his own shares) and the trustees could claim ER. However the £1m cap would apply in aggregate for those two sales (i.e. the trustee gains use up the beneficiary’s ER lifetime allowance). Thus, if the values are such that the beneficiary will easily use up his £1m allowance on his own holding, this ceases to be relevant.
Where a family member holding a 5% or greater interest does not have a genuine employment role in the business he or she could still qualify for ER if appointed as a director 2 years before the sale. This needs to be considered carefully as the family member will then have to comply with the usual directors’ duties.
Where family members are on the payroll but do not perform any real employment role, there may be issues with corporation tax deductions taken in respect of such payments and also whether the correct rate of PAYE was applied (if the salary was really for the higher rate family member). This can cause problems on the sale of the company as it is likely to come up during a due diligence exercise and the buyer may insist this is disclosed to HMRC. If the employment was not genuine, HMRC may then challenge the applicability of ER.
If you would like to discuss these or any other matters, please contact Mark Tasker ([email protected]) or anyone in our Corporate team.