17 December 2010
Entrepreneurs' Relief for individuals with shares in trading companies
A summary of the relief as it applies to sole traders was discussed in the December 2009 edition of The Tax Factor. This article looks at the position for shareholders who may hold shares in a qualifying business.
Entrepreneurs’ Relief provides a reduced capital gains tax rate of 10% on qualifying disposals. Each individual has a lifetime limit of £5m, whereby relief may be available.
Entrepreneurs’ Relief can be available on the disposal of certain shares or securities held in a trading company or the holding company of a trading group, provided that it is an individual’s “personal company”.
An individual must satisfy the following conditions for at least a 12 month period ending with the date of disposal. They must:
- Be an officer or employee of the company (or a company in the same group); and
2. Own at least 5% of the ordinary shares and be entitled to at least 5% of the voting rights of the company (thus making it a “personal company”).
In order for a share disposal to qualify for Entrepreneurs’ Relief, a company must either be trading or be the holding company of a trading group. If a company has non trading activities which are considered to be substantial then the shares will not qualify. Note that the shares in a property investment company will not be eligible for relief but shares in a property development company may qualify.
HMRC consider that 20% or more of a business is ‘substantial’ and will apply this test to a number of criteria including the company’s turnover, asset base, expenses, time spent and the historical context. If this limit is breached then it may be difficult to argue that Entrepreneurs’ Relief is available.
Businesses should therefore be careful if building up surplus cash in a trading business that it does not jeopardise the relief. It is important to have documented reasons for the increase in cash reserves and how this is to be used in the trading business.
Disposals of assets which are owned by an individual but used by a personal company for its trade can also qualify for relief. However, it is crucial that the asset is sold as part of the process of selling company shares. The legislation here refers to making a withdrawal from participation in the business.
The term withdrawal from participation is not defined, however it is confirmed that an individual does not have to retire as a director of the company. The key factor is to show a reduction in ownership of the company sufficient for this to be considered as withdrawing participation.. There is no definition or guidance as to what level of shares should be sold to demonstrate such withdrawal, so care is required when considering such action.
If an asset such as a property cannot be sold at the same time as the relevant shareholding, relief will still be given on the property disposal provided that the company ceased trading and throughout the 12 month period ending on the date of the share disposal that property was in use in the business.
In this way, relief on the “associated” asset disposal can still be available for up to 3 years following the cessation of trade provided that it has not been used for any other purpose since share disposal or the trade ceasing.
Entrepreneurs’ Relief will be restricted where:
- Rent is charged to the company; or
- The asset is used only partly in the business.
Individuals should carefully review whether receiving rent is still advantageous.
It may also be worth undertaking a share disposal prior to selling a property used by a company, as an isolated property sale does not qualify for relief. For example, if an individual holds shares which qualify for Entrepreneurs’ Relief, then he could dispose of say 10% of those in order for the gain on property disposal to qualify.
If an individual does not want to sell shares then potentially even a spousal gift could result in relief being given.
In summary, this is a valuable tax relief for individuals with shares in trading companies or trading groups, but it is crucial to plan before making any disposals to ensure that maximum relief can be claimed.