Understanding Entrepreneurs’ Relief and what lies ahead
In 2008, Entrepreneurs’ Relief (“ER”) was ‘introduced to incentivise and reward entrepreneurs who, with significant initiative and risk, play a key role in building and growing a business’.
This relief is extremely valuable and provides relief from capital gains tax for individuals disposing of qualifying business assets, by reducing the tax rate applied to 10% up to a lifetime limit of £10m of qualifying gains.
Over the last few years, ER has been a focus of reform:
- The qualifying period increasing from 12 months to 24 months;
- For dilutions which will result in an individual’s shareholding to drop below the 5% qualification holding, an individual is able to effectively ‘crystallise’ and defer this gain to benefit from ER up to this point; and
- The condition in respect of shareholdings has been extended from the requirement to hold at least 5% of the nominal value of the share capital and voting rights, to also include the requirement to be entitled to receive 5% of the dividends or sales proceeds.
These changes have increased the complexity of the ER rules and can be an expensive ‘mistake’ if interpreted incorrectly.
We have come across cases where individuals have expected to qualify for a relief, only to find out when they are part way through a sale process that they fail one of the conditions and are faced with a higher tax bill than expected.
Therefore, where an individual has invested in a business, we would recommend that they assess whether they qualify for ER on a regular basis and not just when a potential disposal is on the horizon.
Some examples of the areas which have resulted in individuals not qualifying for ER are:
- Shareholders who are not actively involved in the business and hold no role;
- Business structures which involve several different share classes with different nominal values and/or rights; and
- Companies which have investment activities, which may result in the company not satisfying the trading condition.
Often, planning and minor changes to the structure can be undertaken to mitigate the impact of these issues, but it is key that this is considered well in advance of any transaction.
Changes are potentially ahead
With the Budget taking place on 11 March 2020, we should expect further changes to this relief. In their manifesto, the Conservative Party promised to ‘review and reform the relief’.
Whilst we don’t know exactly what this will entail and the government have indicated they do not intend to abolish Entrepreneurs’ Relief, this may mean further restrictions, and therefore complexity. For example, this could mean an increase in the rate applied or a reduction in the lifetime limit.
Watch this space!
The information provided is a very brief overview of what can be a complex area.