Important changes to the capital gains tax rules relating to sales of businesses by individuals were introduced from 6 April 2008 which have been revised further as of April and June 2010 plus again in April 2011. Although the previous rules relating to “taper relief” were complex, it was possible for many people selling businesses or shares in trading companies or even certain commercial properties to qualify for an effective 10% capital gains tax rate on an unlimited amount of gains. From 22 June 2010 the rate of capital gains tax is 28% (18% to the extent any taxable gain falls within the taxpayer’s basic income tax rate band) and this applies to gains on all types of assets, although of course there will often be various types of reliefs which can be claimed depending upon the type of asset and the circumstances of the individual.
One of these reliefs is “Entrepreneur’s Relief” which is available for the first £10m (£1m to 5 April 2010, £2m in the period 6 April 2010 to 22 June 2010 and £5m in the period 23 June 2010 to 5 April 2011) of qualifying gains claimed during an individual’s lifetime (NB in the case of married couples/civil partners each is entitled to the £10m limit). Up until 22 June 2010 this was done by way of a discount and the effect of the discount was broadly to reduce the rate of capital gains tax to 10%, but subject to the £2m cap. From 23 June 2010 the rate of tax on qualifying disposals has been specifically set at 10%, subject to the £5m (now £10m) cap.
As always with tax reliefs it is important to be sure that the precise conditions of the relief are met and points to watch out for in respect of Entrepreneur’s Relief are:
- Sole traders and partners must have carried on the trading business for at least 12 months prior to the date of sale or up to the date of cessation of trading and the trade itself must have been undertaken in a commercial manner with a view to the realisation of profits..
- Sole traders or partners must sell a trading business or a viable part of such a business capable of operation in its own right to qualify for the relief. Selling an individual business asset will not qualify unless this happens after the business has actually ceased, and within three years of that cessation.
- Entrepreneur’s Relief will only be available on sales of shares where those are shares in a trading company or the holding company of a trading group. Any significant assets or activities within the company or group which are of a non-trading nature (for example the holding of an investment property) could cause problems in this regard and a careful review will be required. Sometimes very large amounts of cash held by a company which significantly exceed business requirements might be regarded by H M Revenue as a non trade cash investment in this context.
- Where a sale of shares is concerned, the company must also be the shareholders “personal” company. This means that they must have at least 5% of the ordinary share capital of the company, 5% of the voting rights in the company and be an officer or employee of the company and they must satisfy those tests for at least 12 months prior to the disposal of the shares. This does not mean that all the shares being sold necessarily need to have been owned for 12 months, provided that the 5% test has been satisfied for the 12 month period. In a family company some shareholders may not be employees or small shareholdings may be held below the 5% requirement. In these circumstances planning ahead of any sale of a company may be important to try and ensure that these requirements can be met in the crucial 12 month period prior to sale.
- If a gain arises on shares in a trading company/holding company of a trading group because it is wound-up after it has ceased trading, then the personal company conditions will have to be met in the 12 months up to the date that trading ceased and the gain will have to arise within three years of the cessation of trading.
Two other areas require special attention with regard to the availability of Entrepreneur’s Relief.
Associated Disposals of Personally Owned Property, etc
It is very common for directors of limited companies or members of partnerships to own certain assets (usually a building) in their own name, but make them available for the use of their company or partnership. Sometimes they charge the company or partnership a rent or they may simply make the assets available rent free.
Entrepreneur’s Relief is only available on a gain made on the sale of such assets (usually land and buildings) where the sale is associated with the disposal of the whole or part of an interest in the partnership, or in the case of a company a sale of shares. In either case the disposal must also be part of the individual’s withdrawal from the partnership or company. Restrictions on a just and reasonable basis apply if the asset has not been used for business purposes for the whole period of ownership or has only been used partly for business purposes. Furthermore the relief is restricted if a rent has been charged from 6 April 2008 for the use of the asset. In these circumstances no relief is due against the proportion of the gain accruing after 5 April 2008 if a full commercial rent has been paid from that date until the date of the disposal or the date that trading ceased if earlier. In cases where a full commercial rent has not been charged for some or all of the period post 5 April 2008 a proportionate amount of relief will be due in respect of the post 5 April 2008 period plus appropriate relief for the preceding period..
Individuals who personally own property in this way and are now charging their partnership or limited company a rent for the use of it, may therefore have to consider whether they should stop doing so in order to protect the availability of Entrepreneur’s Relief on a subsequent sale of the property in the circumstances outlined above. The answer will not always be clear depending upon the likelihood of any future sale of the business in association with a sale of the property and whether the tax saving by obtaining Entrepreneur’s Relief will be sufficient to justify losing the national insurance contribution advantage and income/corporation tax deduction from charging rents on a yearly basis.
There should normally be little or no interval of time between the sale of the partnership interest or shares and the associated sale of personally owned assets given that they should form a single withdrawal from the involvement in the business. However, HM Revenue have stated that they will accept an interval between these disposals if the asset in question is disposed of within one year of the cessation of a business whether or not a rent has been charged or the property used for other purposes during this twelve month period or within three years whether or not the business has ceased, provided the asset has not been leased or used for any other purpose at any time in the three year period.
Sales of Companies Partly for Loan Notes
It is not uncommon for part of the consideration for the sale of shares in a company to be in the form of loan notes which can be redeemed at some future date. Normally the capital gains liability on this part of the consideration doesn’t arise until the date of loan note redemption so the question arises as to whether Entrepreneur’s Relief would be available at that point. This issue is highly technical and involves complex tax legislation. In particular it will depend upon whether the loan notes are in the form of “Qualifying Corporate Bonds” (QCBs) or “non-Qualifying Corporate Bonds” (non-QCBs). Non-QCBs can usually be identified because they will give the holder a right to redeem the notes in a foreign currency, but expert opinion should always be sought when reviewing what the correct classification of the loan note is.
Broadly where the loan notes are QCBs their redemption after 5 April 2008 should qualify for Entrepreneur’s Relief subject to the appropriate lifetime limit and subject to the original sale of the shares meeting the Entrepreneur’s Relief conditions (even if the sale took place prior to 6 April 2008).
Redemption of non-QCBs will only qualify for Entrepreneur’s Relief if in the 12 months up to the date of redemption the “personal company” conditions described above are met in respect of the company which has issued the loan notes. In practice it will often be difficult to meet these conditions so where Entrepreneur’s Relief is important careful thought needs to be given to the type of loan note which will be used.
Loan notes may sometimes be issued in connection with earn out arrangements on the sale of a company. The tax treatment of earn outs is especially complex and expert advice should always be sought but it is worth noting that an earn out right in these circumstances is usually treated as a deemed non QCB. Therefore when any loan notes received in connection with the earn out right are subsequently disposed of Entrepreneurs’ Relief will only be available if the personal and company conditions are satisfied at the relevant time (even though the loan notes ultimately received may be QCBs).
As indicated at the outset, these changes apply to individuals, although Entrepreneur’s Relief may be available in rather limited circumstances to certain trustees. Companies can never qualify for Entrepreneur’s Relief and any gain realised by a company is subject to corporation tax which is calculated as before (broadly on the proceeds received less cost or March 1982 value plus indexation) although in many cases company gains on shareholdings qualify for the substantial shareholdings exemption and gains on goodwill will be taxable under the intangible assets regime.
The conclusion to be drawn from all these changes to the taxation of gains on individuals is that no one should assume that any Entrepreneur’s Relief will be available on the sale of a business or shares. As clearly demonstrated above, there are a number of very important qualifying conditions and in certain circumstances (and certainly without advance planning) it is perfectly possible that these conditions will not be met in a number of cases.