If you’re an entrepreneur and have your own business, there may come a day when you decide to exit, either by selling the business or liquidating the assets and closing it down. Understandably, having spent time and investment on starting it up, growing it, and possibly even developing it into a well-established business, the last thing you would want when disposing of it, is to be hit with a large capital gains tax bill.
Capital gains tax (CGT) is tax payable on profits or gains you make when selling an asset. Although CGT is not applicable on the sale or disposal of all kinds of assets, it will apply when it comes to selling a business. Usual rates of CGT on assets (excluding property) is 10% for basic-rate taxpayers and 20% for higher or additional-rate taxpayers.
Entrepreneurs’ Relief (ER) is a valuable tax relief that was introduced to incentivise entrepreneurship in the UK. It specifically targets providing relief for those entrepreneurs who are coming towards the end of a business lifecycle and are looking to exit. ER is tax relief that will help you reduce your CGT bill by allowing higher and additional-rate tax payers to use the 10% rate when selling a business.
Who can Claim Entrepreneurs’ Relief?
In general, ER will largely be claimed by two classes of individuals:
- As briefly explained above, ER is aimed at offering tax relief to those who have started their own business and have reached the point where they are looking to exit. Broadly speaking, this means that ER is available to business owners.
- Employees who own shares in a company could also face a CGT bill when they sell their shares and make a gain. Where they are able to meet certain conditions, it may be possible for them to use ER as well.
A full guide which explains who can claim ER and the requirements they need to satisfy in order to be eligible can be found here.
How to use Entrepreneurs’ Relief
ER can help reduce your CGT bill in various different situations, however there will be certain rules depending on what kind of asset you are selling or how you are looking to exit your business.
- Selling shares.
When it comes to selling shares in a business, this is the one instance where you do not have to be the business owner in order to be able to use ER. Employees or company officers need to meet qualifying conditions at the time of disposing of the shares in order to be eligible to claim.
In addition to the conditions imposed on the individual, there are stipulations as to the types of business ER can be used on. The company must be recognised as a trading company (or a holding company of a trading group). A trading company is one where the company’s main business activity is trading, as opposed to non-trading activities such as licencing arrangements or investments. Companies that operate through a mix of trading and non-trading activities may still qualify for ER where non-trading activity does not exceed 20% of the overall business.
- Selling commercial property.
Business owners who look to sell off company assets which comprise commercial property are able to use ER so long as it coincides with the sale of part of the business and meets similar criteria to those outlined above.
There is a big difference between the sale of residential property and commercial property because the sale of residential property incurs a higher CGT rate of 18% for basic-rate taxpayers, and 28% for higher and additional-rate taxpayers, unless you are selling a home which you have lived in yourself as your main residence.
To lower your CGT rate to 10% using ER, the commercial property must have also been used for business trading purposes. Examples of this can include an office which you or your staff worked out of, or a storage facility you used to keep products in. However, where you receive any form of rent from the property this will likely be seen as holding property for investment purposes and therefore will not qualify for ER.
- Selling part of the business.
There are plenty of reasons why as a business owner you would look to sell only a part of your business. For some people, selling part of the business will allow you to slow down if you’re looking to prepare to retire, or for others, you may be looking to raise capital in order to invest in a different venture. Whatever the reasons, when looking to use ER for the disposal of part of your business, you need to ensure that that part remains commercially viable. If you are selling a part of the business that would be unable to run without the retained part of the business you keep, you would not be able to use ER.
- Liquidating the whole company.
Whilst liquidation is often a term associated with failing businesses, a Members Voluntary Liquidation (MVL) is a process which will allow a business owner to completely wind down and shut their solvent business. Using MVL will involve a liquidator extracting all company assets, ensuring outstanding company liabilities have been paid in full, and then releasing capital distributions to shareholders.
Using MVL is particularly attractive to successful entrepreneurs because the two usual routes to transfer funds from a company to yourself personally are either through paying yourself a salary [which would be subject to income tax], or dividends, which attract dividends tax. For higher and additional-rate taxpayers, using ER means being able to extract capital from the business at a much lower rate of 10% (compared to 40% or 45% as income tax, or 32.5% or 38.1% as dividend tax).
However, to ensure that a company has not been liquidated as purely a means to use ER as a tax advantage, HMRC introduced a Target Anti-Avoidance Rule which sets out certain conditions to prevent this from happening. Any shareholder who received distribution as a result of the MVL cannot be involved with a similar trade business for at least two years. Finally, the intention of the winding-up of the business cannot be for the purpose of receiving a tax advantage. If HMRC finds that ER has been used despite these rules, then the funds received through the MVL may be subject to income tax rates instead.
How to claim Entrepreneurs’ Relief
Once you have disposed of your business or business assets and received payment, you’ll incur CGT on any profits made. It is a legal requirement that you declare your own CGT through a personal tax return which needs to be submitted to HMRC. When completing your personal tax return, there is a specific section for CGT and this is where you would claim ER. The personal tax deadline falls on 31 January every year, but you have a timeframe of the first anniversary of 31 January following the end of the tax year in which you made the disposal. The below examples explain by when you would have to complete a personal tax return.
- Disposal made between 6 April 2019 and 5 April 2020 needs to be claimed by 31 January 2022
- Disposal made between 6 April 2020 and 5 April 2021 needs to be claimed by 31 January 2023
- Disposal made between 6 April 2021 and 5 April 2022 needs to be claimed by 31 January 2024
How much can I claim through Entrepreneurs’ Relief?
Since the Chancellor announced the Spring Budget on 11 March 2020, the maximum amount you can claim through ER has been reduced to £1 million from £10 million. This limit applies to an individual’s lifetime which means you can claim as many times as you like for multiple businesses or business assets so long as you do not exceed the maximum lifetime limit. You will need to ensure that you meet all the required conditions each time you seek to claim ER.
Updates to Entrepreneurs’ Relief
- Mar 2020 – Despite rumours that ER would be scrapped completely this year, the lifetime limit has instead been reduced back to the original lifetime limit of £1 million.
- Mar 2011 – ER is raised to its highest lifetime limit of £10 million.
- June 2010 – After just three months, the lifetime limit increases again £5 million.
- Mar 2010 – The lifetime limit soon increased to £2 million.
- Apr 2008 – ER was first introduced under the Labour government where the lifetime limit was first set at £1 million.