By Mike Hayes, Tax Partner, Kingston Smith LLP

It is true that trustees, as well as individuals, can benefit from the 10% rate of capital gains tax afforded by entrepreneurs' relief (ER). However, there are specific rules that must be adhered to for qualification; the relief is not available for all trusts.

The following key matters should be considered before ER can be claimed by trustees:

• There must be an individual with an interest in possession in the business assets being disposed of, known as the ‘qualifying beneficiary’. This means that ER is never available if the assets concerned are subject to discretionary powers over the distribution of income. This, in turn, prevents a large number of trusts from ever qualifying for ER. It should also be noted that the interest in possession cannot be for a fixed term.

• The trustees do not have a separate £10 million lifetime limit for ER. If the trustees potentially qualify on a disposal, they actually share part of the qualifying beneficiary’s £10 million limit; so the claim has to be made by way of a joint election by the qualifying beneficiary and the trustees. The time limit for this is the same as for an individual.

So, how does this apply to different types of business assets?

Shares in trading companies
Firstly, the company has to be a trading company or the holding company of a trading group, applying the normal criteria for ER as described in part II of this series of articles. Secondly, the company must have been the qualifying beneficiary’s personal company throughout a 12 month period ending not earlier than three years before the disposal date. For the company to be the beneficiary’s personal company, s/he must own 5% of the ordinary shares that also provide 5% of the votes. Thirdly, the qualifying beneficiary must have been an officer or employee of the company, or of at least one of the group companies, throughout the period mentioned above.

Other business assets
The settlement business assets must have been used for the purposes of a business carried on by the qualifying beneficiary throughout a period of one year ending not earlier than three years before the date of the disposal. The qualifying beneficiary will need to cease to carry on the business on the date of the disposal or have done so within three years before that date.
For the purposes of this category of assets, a business carried on by the qualifying beneficiary can be a partnership of which s/he is a member or an LLP. Ceasing to carry on the trade either means the trade ceasing completely or the qualifying beneficiary ceasing to be a member of that partnership or LLP.

Typical problems
A number of problems can arise to prevent ER from being available to trustees. To illustrate this, here are two fictional examples:

The Smith Family Trust owns 50% of the shares in a trading company and John has an interest in possession in those shares. However, although he is an employee of the company, he has no personal shareholding. The trustees will not qualify for ER as result.

The solution here would be for the trustees to appoint sufficient shares to John so that the company becomes his personal company (the 5% test). For this purpose, it is assumed that any capital gain arising on this appointment can be held over. If this is a relevant property trust then inheritance tax will need to be considered and there may be an exit charge, although business property relief will usually be available. If it is not a relevant property trust then there will be no transfer of value in any case.

The Jones Family Trust owns 40% of the shares in a trading company and Daniel owns 5% of the shares in that company as well, which is sufficient to entitle him to ER. He is also a beneficiary of the Jones Family Trust, but it is a discretionary trust.

The trust will not qualify for ER as there is no qualifying interest in possession. The trustees could appoint an interest in possession in the trust shares in favour of Daniel and this would bring them within the scope of ER. Such an appointment would create a charge for inheritance tax, for which business property relief would usually be available. If the trust is not already a relevant property trust, exercising this power of appointment would make it so - or at least to the extent of the assets in which Daniel has an interest in possession.

While ER can be claimed by trustees, the situation is more complex than for individuals as there are additional rules to consider. In addition, the trustees have to take into account their fiduciary duties towards all beneficiaries. For example, maximising the availability of ER by favouring one beneficiary who works for the company could cause a breach of those duties if other beneficiaries are disadvantaged.

More than one beneficiary
It may be the case that there is more than one beneficiary that has an interest in possession in the business assets owned in the trust. If the second beneficiary is not a qualifying beneficiary then the amount of ER is restricted to reflect the qualifying beneficiary’s interest in the trust assets.
All trustees owning business assets are advised to review whether or not they qualify for ER.

Next time: Mike Hayes reviews how the structure of a sale can affect whether entrepreneurs’ relief is available