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For information of users:
This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.
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CAPITAL GAINS TAX
Entrepreneur’s Relief – watch out for the traps when selling your company
Entrepreneur’s relief (ER) was introduced by way of a Government U-turn in response to a general outcry by the business community over an out-of-the-blue decision to abolish taper relief from 6th April 2008. Reinstating the rules was not a political option, but pressure was mounting. Consequently, the old retirement relief rules were exhumed (with modifications) to become ER as a quick fix. Retirement relief was phased out over a five year period as a result of the introduction of taper relief in April 1998.
The effect of ER is to preserve the 10% tax rate on the sale of a business, but only up to a limit. Only the first £1m of capital gains qualify for the 10% rate – any excess is taxed at 18%. The £1m is a lifetime allowance, rather than per deal. No such constraint was imposed under the taper relief regime.
ER is therefore currently worth up to £80,000 per individual. This is not given automatically and so needs to be claimed.
Assuming your company is being sold as a going concern, the requirements are that throughout the last year:
- The company has been a trading company (broadly not having more than 20% investment activities)
- You have held at least 5% of the ordinary share capital and voting rights
- You have been an officer and employee
Inter-spouse transfers
If you solely own your company, you can consider transferring shares to your spouse with a view to doubling up on the available ER and annual exemption (currently £10,100) on a future sale, i.e. the possibility of an extra +£80,000 tax saving. However, this should be considered carefully as this can result in less relief being available overall. For example, if your spouse sells the shares within 12 months of receiving them, does not own at least 5%, or is not an officer or employee, ER will not be available.
Conversely, if both of you each own less than 5%, but between you own 5% or more, consider combining the holdings in one name.
If your spouse is not an employee or officer of the company, consider appointing him/her as the Company Secretary.
Company takeovers
From 6th April 2008:
If your company is being sold to another company, you will usually find that your sale proceeds will be made up of other elements (which may include deferred consideration) in addition to cash. If you are continuing your employment after the sale, your proceeds may well contain an earn-out element where additional consideration will be paid if the company achieves defined profit targets.
In these circumstances, your capital gains tax liability is deferred to the extent that you receive or may receive non-cash consideration such as loan notes or shares in the purchasing company. This could mean that some of your £1m ER allowance is unused. If for example, the purchaser is a listed company, it will be very unlikely that you will receive at least 5% of the company’s shares. This means that ER will not be due when you come to cash in any loan notes or shares of the purchaser (subject to the following comments).
It may be possible to structure the deal in a more tax efficient manner to avoid a loss of ER. For example, the receipt of a particular type of loan note (i.e. a Qualifying Corporate Bond) can preserve ER, provided a timely election is made. Alternatively, you can make a timely election to treat all proceeds as if they were cash; this would bring forward your capital gains tax payment date in order to secure extra ER. If the elections referred to are made late, ER will be lost. The first possible deadline for these elections will be 31st January 2011, which is relevant if your original shares were exchanged in the 2008/09 tax year.
Before 6th April 2008:
If you are holding Qualifying Corporate Bonds (QCBs) received from the sale of your company, or have deferred your gain by investing in an Enterprise Investment Scheme (EIS) company before 6th April 2008, you will need to make a timely election if you have some unused ER allowance, otherwise ER will be lost!
The trigger point for making the election is when your QCB is first redeemed, or when your deferred gain comes into charge. The deadline is the second 31st January following the end of the tax year in which the trigger event occurs.
If there is a series of QCB redemptions, the deadline is fixed by reference to the first such redemption. If this is not met, all future redemptions will not qualify for ER.
SUMMARY
- ER is much more complicated than the old taper relief and tax strategies that worked under old regime may now be redundant;
- The tax position should be considered at an early stage so that the deal can be structured in the most advantageous way;
- ER needs to be claimed and timely elections are required in certain situations where non-cash consideration has been received;
- Company sales before ER came into effect may also be affected.
If you would like to discuss your personal circumstances, please contact our Tax Director, Daren Peacock on 01270 623731.
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