Entrepreneurs relief is a key concern to anyone selling their business. Entrepreneurs relief is a CGT relief applying to a limit of £10m in qualifying capital gains, effectively reducing the rate of capital gains tax payable from 28% to 10%. The limit is a lifetime limit and is cumulative but it is an individual limit, meaning couples such as husbands and wives can each benefit.
Although there are other scenarios where Entrepreneurs Relief can apply, when selling a business sellers are generally focused on entrepreneurs relief arising:
1. On disposal of shares (or securities) of a trading company or holding company of a trading company;
2. On disposal of the whole or part of a business as a going concern (whether as a sole trader or partnership);
It is important to note that Entrepreneurs Relief must be claimed – there is no automatic application of the relief. The claim (usually via a tax return) must be made before the 31 st January after the tax year of disposal.
In order to claim Entrepreneurs Relief the following criteria must be met:
ER on a sale of shares in a trading Company
1. In case of a disposal of shares the individual must have:
- been an employee or officer of the company throughout the period of one year before the disposal;
- held at least 5% of the ordinary share capital of the company carrying at least 5% of the voting rights
2. When looking at who is an employee or officer of the company there is no criteria as to salary or hours worked and non executive directors will also satisfy the requirements.
3. Where an individual holds shares that are part of an Enterprise Management Scheme they may qualify for entrepreneurs relief even if they are not part of a holding that represents 5% of the shares in the Company. In addition there is no requirement for EMI holders to have held the shares for 1 year or more, provided they have held the option for that period.
ER on a disposal of a business as a going concern:
1. In order to qualify for ER on a disposal of the whole or part of a business:
- the business must have been owned by the individual (whether as sole trader or partnership) throughout the period of one year ending with the date of disposal.
- Shares, securities and other assets held by the business for investment purposes will not qualify for relief.
ER on share buybacks
Where shares are being acquired as part of a company own purchase of shares Entrepreneurs Relief can still apply, subject to a Seller satisfying the relevant criteria for obtaining capital treatment. However, care must be taken where a buyback is being staged in tranches to ensure that the outgoing shareholder remains a director or employee of the company until all of his/her shares have been repurchased.
Where a seller of shares (who otherwise qualifies for ER) receives deferred consideration as part of the transaction via loan notes, unless he holds 5% of the voting shares and an office or employment with the purchasing company he/she will be unable to claim ER on a subsequent disposal. The seller must therefore think carefully about whether he wishes to defer the gain (thereby paying full CGT on the deferred element of consideration) or elect to treat the full consideration as payable as at the date of disposal and therefore achieving ER on the total consideration. This is not an easy decision for a seller to make, a seller could effectively end up paying tax on consideration that is never received.
If there is an earn out provision in a share sale the effect is the same as with deferred consideration (see above), leaving the seller with a decision as to whether to crystallize a tax charge at completion or whether to defer the taxation by having an earn out that can be satisfied only by way of loan notes of shares. Due to the nature of earn outs a seller is sometimes able to negotiate terms that will see him retain employment and some voting shareholding in the purchaser until such time as the earn out has been satisfied. This may have an effect on how any deal is structured.
Related article: How long can you count on Entrepreneur’s Relief?
Our Corporate Team at ORJ work closely with accountants and tax advisers to ensure that when you are considering a route to exit, or negotiating a transaction, we look closely at any tax implications and ensure as far as possible that your exposure is limited and the most tax efficient method of disposing of your business is achieved. If you would like to speak to somebody about selling your business or entrepreneurs relief please contact Lorraine Smith or Patrick Tedstone on 01785 223 440 or email Lorraine.firstname.lastname@example.org.