When choosing self-employment as a career option, you’re not taking the easier road. In the early years, income may be scarce and cash flow may be a nightmare to manage. Additional responsibilities then come along, all of which have an elemental of risk attached including employing staff, borrowing money to expand (and then paying it back), commercial leases, and much much more. You have far more on your plate than the average full-time member of staff but you don’t benefit from statutory holiday pay, sick pay, pay on parental leave, and so on.
Is this extra risk you take reflected by a more generous tax system? Yes. You can save money on the amount of tax you pay every year if you structure your affairs in the right way (particularly the dividend/wage split for director). And when you come to sell, you can enjoy a major saving through the use of Capital Gains Tax Entrepreneurs’ Relief.
In this article, The Financial Management Centre explains what Entrepreneurs’ Relief is, the conditions you need to meet to qualify for it, and how much you can save when you’ve sold your business.
What is Entrepreneurs’ Relief?
Entrepreneurs’ Relief offers business owners the opportunity to pay a far lower rate of capital gains tax on the shares in the company when you sell them to another person or company.
Higher rate taxpayers pay 20% on their capital gains and capital gains tax becomes payable when you have made £11,700 or more worth of capital gains during the course of a financial year.
Entreprenuers’ Relief reduces the tax paid on the rise in the value of your shares to 10%.
Entrepreneurs’ Relief was originally introduced in March 2010 and offered entrepreneurs the opportunity to pay 10% on capital gains made throughout their lifetime on the sale of company shares up to £2m. The lifetime limit was increased to £5m in June 2010 and then again to £10m in March 2011. The lifetime allowance has remained at £10m ever since.
According to HM Treasury, 50,000 taxpayers pay Entrepreneurs’ Relief every year saving on average £8,000 in capital gains tax per transaction.
Who qualifies for Entrepreneurs’ Relief?
When Entrepeneurs’ Relief was introduced, the requirements for qualification were that you must have held 5% of the ordinary share capital of a company for at least a year and that your share holding must allocate at least 5% of the voting rights to you.
The company in which you have shares must be a trading company (or be the holding company in a trading group) and you must be an officer or employee in that company or any other company in the group.
For disposals that took place on or after 28th October 2018, the rules changed. You must now have held onto the shares for at least two years and the shares you held must have entitled you to at least 5% of the profits made available for distribution to the pool of shareholders over that time. In addition, were the decision to wind the company up taken, your shares must entitle you to 5% or more of the assets available for distribution to the pool of shareholders.
If your business has stopped trading, you can still qualify for Entrepreneurs’ Relief so long as the sale of the shares takes place within 3 years of the date of cessation.
If your shares are part of an EMI scheme, you must have purchased the shares after the 5th April 2013 and you must have been offered the option of buying them a year or more before the date of sale.
Your responsibilities when you sell your company
If the sale is only for part of the shareholding of your business, you will need to let members of staff know about the changes of ownership and any potential consequences which arise from the change, especially if the business will relocate or there are planned redundancies.
If you are selling the whole business, you will need to inform Companies House of the names of the new directors and shareholders before you and other current directors resign. When most companies are sold, any existing finance arrangements do not transfer to the new owner – part of the sales and purchase agreement will involve the buyer settling any existing debt facilities. You must let finance providers know, usually within 21 days, that the sale has taken place, especially if you have property secured against these facilities or if you have personal guarantees on the debt. You will also need to transfer the VAT registration to the new owner as soon as possible.
How to claim Entrepreneurs’ Relief
Entrepreneurs’ Relief is claimed when you file your Self Assessment. For example, if the sale of your business took place in tax year 2018/2019, you would claim Entrepreneurs’ Relief via your Self Assessment form on 31st January 2021.
Entrepeneurs’ Relief – the details
HMRC have recently become increasingly concerned that Entrepreneurs’ Relief is being used by some to artificially avoid tax, particularly by contractors using personal service companies. You should expect that all Entrepreneurs’ Relief claims will be investigated by HMRC, again in a move mainly targeted at contractors, with a view to questioning the legitimacy of use of the scheme.
Entrepreneurs’ Relief offers a significant financial incentive for business owners to sell their companies, paying a level of taxation on the profit they make well below the standard rate of both capital gains tax and income tax.
The existence of the tax relief is coming under increasing scrutiny however and there is no guarantee that it will be available I years to come. The Resolution Foundation called it “the worst relief in the UK” because it costs £2.7bn a year in tax and only 30% of those savings are invested in other businesses.
We’re always here to help here at the Financial Management Centre. Please call us today on 0800 470 4820 or email firstname.lastname@example.org.