Entrepreneurs’ relief can offer significant tax savings when selling shares or the whole or part of a trading business. It’s an example of the government’s commitment to reward entrepreneurs who take risks to generate wealth. However, a recent policy paper from the Liberal Democrats suggests there is a chance that, in future, it may be more difficult to qualify for this tax relief.
What is Entrepreneurs’ Relief?
Entrepreneurs’ relief is a capital gains tax (CGT) relief available to taxpayers who make a qualifying business disposal (essentially selling or giving away a trading business). It operates so as to apply a rate of CGT of 10% to any such disposal up to a lifetime limit of £10 million. If entrepreneurs’ relief were not applicable on such a disposal, any gains on the sale would be taxed at 18% if the individual’s taxable income for that year falls below the basic rate band upper limit (i.e. £32,010 for 2013-2014), and 28% on the balance.
Both the lifetime limit and the method by which the effective rate of 10% tax are achieved have changed since entrepreneurs’ relief was first introduced in 2008.
How do you qualify for Entrepreneurs’ Relief?
In summary, and subject to the facts of each case, entrepreneurs’ relief will apply to a disposal of shares in a trading company provided that, during the period 12 months prior to the disposal:
- the company is a trading company (or the holding company of a trading group);
- the relevant individual holds at least 5% of the company’s ordinary shares (which covers at least 5% of the voting rights in the company); and
- the relevant individual is a director or employee of the company.
It’s worth nothing that there are other scenarios in which entrepreneurs’ relief may be available, including (i) the transfer or disposal of certain business assets (including the transfer or disposal of a business or interest in a partnership); and (ii) where shares have been acquired on exercise of qualifying EMI options.
At the Liberal Democrats’ 2013 autumn conference, a policy paper entitled ‘Fairer Taxes, Policies for the Reform of Taxation’ was endorsed by the party, which included the following statement:
“We wish to focus entrepreneurs’ relief to better serve the purpose for which it is intended; incentivising entrepreneurs and start-up business owners, and prevent it from simply being used as a way for wealthy investors to reduce their tax bills. We would therefore increase the shareholding requirement to 25%.”
It is unclear whether this will be included in the Liberal Democrats manifesto for the 2015 General Election, to be held on 7 May 2015. Of course, for this to become government policy, as the Liberal Democrats are unlikely to win the next General Election, not only would they have to be asked to join a coalition with the Conservatives or Labour, but also this policy would need to be adopted by the future governing party.
Labour’s policy on this matter is also interesting. In contrast to the Liberal Democrats’ position, the final version of their March 2013 Small Business Taskforce report actually wishes to widen the ambit of entrepreneurs’ relief. The report makes two notable recommendations:
“Extend entrepreneurs’ relief beyond capital gains to dividends, in order to remove the incentive for entrepreneurs to dispose of their businesses rather than grow them. Reduce the 5% threshold for entrepreneurs’ relief to 1% or below to allow more employees to benefit from investing in the high growth companies they work for.”
Labour Party leader Ed Miliband “warmly welcomed” the report upon its publication; however, it is unclear whether these recommendations will form part of the party’s manifesto at the 2015 election.
Although the Conservatives’ intentions regarding entrepreneurs’ relief are unclear, in the absence of any policy statements, we would expect the party to maintain the status quo.
The Liberal Democrats’ proposed increase in the qualifying share ownership threshold from 5% to 25% for entrepreneurs’ relief to apply is clearly bad news for smaller shareholders in trading companies. It also does not sit well with the Liberal Democrats stated aims to increase share ownership at the employee level – put simply, this policy means that fewer people would be able to take advantage of this tax relief, although it is by no means certain whether these changes would ever become law. Further, Labour’s proposals should be welcomed by business, although it is far from clear whether they would ever be adopted as official party policy for the 2015 General Election.
Entrepreneurs thinking about selling their company within the next 18 – 24 months may be wise to consider accelerating this process, and aiming to complete the disposal before the next General Election. By delaying, and if the next government does indeed change the rules for entrepreneurs’ relief, sellers may be affected by a higher tax bill for capital gains than previously was the case.
Fox Williams LLP are experts at advising entrepreneurs and businesses. For more information as to how Fox Williams can help you (including arranging a free consultation) or for further information on the issues discussed in this article, please contact your usual Fox Williams contact.