By Nadine Jayes, Solicitor, Blandy and Blandy LLP
Over the past few years there have been significant changes to the Capital Gains Tax regime which have had a considerable impact on the way in which business owners and shareholders in trading companies are taxed on the disposal of their interests, either by way of gift or sale.
The changes were first announced in Alistair Darling’s Pre-Budget Report of October 2007 which indicated that Taper Relief was to be abolished, for disposals after 6 April 2008, and that all gains after this date would be charged to Capital Gains Tax at a flat rate of 18%. There were winners and losers as a result of these proposals. The winners were taxpayers making gains on non-business assets with the losers being business owners making gains on their business assets. Due to the availability of Taper Relief, historically the marginal rate of tax on such business assets had been 10% and the proposed changes increased the tax burden significantly. There was considerable lobbying on behalf of the business community, which resulted in the introduction of Entrepreneurs’ Relief in the Finance Act 2008. Although this has gone some way to address the balance, the conditions to claim the Relief are more restrictive than the Taper Relief rules.
Entrepreneurs’ Relief can be claimed where an individual makes a material disposal of business assets that have been owned for a least one year prior to disposal, or on a disposal which is associated with such a material disposal. This includes the situation where a sole trader or a partner sells the whole or part of their business interest or where there is a sale of shares, by a director or company employee, in their personal trading company. In order to qualify as their personal trading company the individual must own a 5% holding in the company entitling them to exercise at least 5% of the voting rights.
Originally Entrepreneurs’ Relief could only be claimed on the first £1 million of relevant lifetime capital gains. The limit was increased to £2 million on 6 April 2010 and then was further increased to £5 million on 23 June 2010. Since the last increase in the Relief, the qualifying gains are simply charged to capital gains tax at a flat rate of 10%. As a result, the Relief available is now quite generous; however, this should be contrasted to the Taper Relief position where there was no such limit.
Another area where Entrepreneurs’ Relief does not compare favourably with the previously available Taper Relief is that it does not apply to the disposal of a single asset. In certain scenarios it will therefore be important to establish whether there has been a disposal of a part of a business, in which case Entrepreneurs’ Relief will be available, as opposed to the disposal of an asset of the business in which case no relief will be available. A further area where the Relief is more restrictive by comparison to Taper Relief is in cases where shares have been acquired by employees as a result of their participation in share option or share incentive schemes. Prior to 2008 such shares used to constitute business assets for Taper Relief purposes. Unfortunately, now in most cases the shares will not benefit from Entrepreneurs’ Relief as the employee will not have the requisite 5% holding in order to satisfy the conditions for the Relief.
Although there are some instances where Entrepreneurs’ Relief is not as generous as the previous Taper Relief provisions it is a very valuable Relief for business owners especially in light of the recent increases in the limit. It is therefore very important that the availability of the Relief is maximised and there are various planning steps which can be taken in order to ensure this in a number of scenarios. Firstly, with reference to a family trading company, the structure of ownership should be carefully reviewed to ensure that various family members employed by the company have the necessary 5% holding, in order to qualify for the Relief. In a basic scenario, if a husband owns a 3% holding and the wife owns a 2% holding consideration should be given to the wife transferring her 2% holding to the husband, or vice versa, on a no gain/no loss basis, so that the Relief will be available on the eventual sale of the shareholding. Additionally, where a family company has a significant value, the Entrepreneurs’ Relief available in the family could be maximised by transferring shares so that the holding of each family member qualifies for the Relief.
It is also important to carefully review the position in circumstances where a sale of a company is anticipated and there are outstanding share options in existence. In such circumstances it is important to ensure that the transaction is structured so that the exercise of any such options does not dilute the 5% ownership requirement, thereby prejudicing the availability of the Relief on the disposal of the shares.
Finally, there are also planning opportunities in relation to unincorporated businesses. For instance, if a husband and wife jointly own an asset, such as a property, which is used in the husband’s trade consideration should be given to making the wife a partner in the business at least one year prior to the sale. This would ensure that on the eventual sale the wife’s gain would qualify for Entrepreneurs Relief, whereas this would not be case if the sale of the business was by the husband alone.
Now the rate of Capital Gains Tax is 28% for higher rate taxpayers the new limit for Entrepreneurs’ Relief of £5 million gives a potential tax saving of £900,000 per taxpayer on the disposal of relevant business assets. In view of this significant potential saving it is essential that business owners review the structure of their businesses to ensure that they not only qualify for the Relief but also take maximum advantage of it.