Maximising Capital Gains Tax Entrepreneurs’ Relief for Shareholders
It is well known that capital gains tax Entrepreneurs’ Relief (ER) can deliver a tax rate of just 10% on qualifying capital gains of up to £10m (for disposals after 5 April 2011) during an individual’s lifetime. For disposals prior to 6 April 2011, lower limits applied.
In many cases it is clear whether or not the capital gain will qualify for the relief but there are traps for the unwary. This article looks at the main conditions and identifies some of those more common traps.
Basic Conditions for ER
The basic conditions which both the individual and company must satisfy for relief to be given are, on the face of it, straightforward.
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These are that throughout a period of least 12 months leading up to the date of disposal:
- The company must be a trading company or the parent company of a trading group, i.e. the company or group must not have substantial non- trading activities, in practice taken as more than 20% of overall activities.
- The shares must give the shareholder at least 5% of the voting rights and represent at least 5% of ordinary share capital.
- The individual must be an officer or employee of the company or a group member.
Relief will apply to all shares held by a shareholder if the above conditions are met. So, for example, a director who holds 10% of ordinary voting shares throughout the 12 months up to sale, and who exercises options over a further 2% immediately prior to sale, can expect to benefit from ER on the entire 12% shareholding even though some of his shares have been owned for less than 12 months.
How might ER be lost?
Problems are regularly encountered which can lead to a loss of relief. Examples are as follows:
- The company might have diversified its activities and be more than 20% non-trading.
The test is similar to that for Inheritance Tax Business Property Relief, though in that case the company only needs to be mostly trading for relief to be given. The ER hurdle is therefore considerably higher.
- There might be different classes of shares whose rights vary.
- The individual might not be an officer or employee, such as where an individual has either transferred shares to their spouse, or transferred them into joint names for income tax planning purposes without that spouse becoming an officer or employee.
- Shares might be held in trust; trustees cannot qualify for relief in their own right.
- New shares are issued to other shareholders, diluting a shareholder’s interest to below 5%.
Where the individual shareholder qualifying for ER also owns the business premises, which are made available for use in the company, relief might also be available against the capital gain arising on the disposal of those premises.
For relief to apply the disposal of the premises must be ‘associated’ with a disposal of shares which qualify for the relief. The premises must be both owned by the individual and used for the purposes of the company’s/group’s business for at least the 12 months leading up to the date of disposal.
Problems are also often encountered in practice with associated disposals, including:
- The premises might be sold too long before or after the shares so that the disposal is not ‘associated’ with the disposal of those shares.
- The property has not been wholly used throughout the period of ownership for the purposes of the company’s/group’s trade.
- Rent or other consideration is received for the use of the premises, though this restriction only applies to rent received after 5 April 2008.
Where relief is to be restricted, this is on a ‘just and reasonable’ basis’.
What happens when a company ceases trading?
Finally special rules apply to situations where the company has ceased to be a trading company prior to the disposal of the shares. Relief might still be available notwithstanding that the disposal of the shares (e.g. in liquidation) or the premises takes place up to three years after the cessation of trading status, so long as the necessary conditions set out above apply for the 12 month period leading up to the date of cessation.
This is a very valuable relief but as this summary demonstrates it cannot be taken for granted. The potential tax cost of getting it wrong (up to £1.8m per individual) makes professional advice as early as possible essential.
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