How changes to Entrepreneurs’ Relief could affect you
Whether you are a partner, director, entrepreneur or business owner, you may have considered your exit strategy from an early stage. Depending on the circumstances, it may have even been predetermined. But, if you’ve not considered planning the sale of your business or equity stake, it’s not too late.
In either circumstance and irrespective of your motivation to sell, there will be Capital Gains Tax (CGT) to consider. There is one saving grace you may already be aware of – Entrepreneurs’ Relief (ER). The only problem is, Chancellor Phillip Hammond is moving the ER goal posts after his 2018 Budget.
What is Entrepreneurs’ Relief?
The intention of ER is to encourage you to start a business or invest in someone else’s. The incentive? Reducing the rate of CGT you are liable for upon exit or disposal of your equity. The key circumstances to qualify for ER, pre-Budget, were:
- The person disposing of the business or shares of a business must be a partner, director or an employee of the business for at least the 12 months leading up to the sale
- The disposer must own at least 5% of the ordinary share capital
- The business must be trading for the 12 months leading up to the sale
Currently, for higher and additional rate Income Taxpayers, the CGT paid when disposing of chargeable assets (excluding residential property) is 20%. CGT in itself is quite complex, and there are various rates, allowances and rules. If you’d like some advice in this area, we are more than happy to help.
Where ER applies, qualifying disposals are taxed at a flat rate of 10% on the capital gain. That is after your personal tax-free Annual Exempt Amount (AEA), which is currently £11,700, has been used.
Introduced by the Chancellor at the time, Alistair Darling, there is also a lifetime limit, which has grown quite considerably over the years. It seems subsequent Chancellors wanted to make their mark and boost entrepreneurial activity:
- £1 million in April 2008
- £2 million in March 2010
- £5 million in June 2010
- £10 million in April 2011
If you breach the £10 million lifetime limit, any subsequent gains are simply taxed at your standard CGT rate.
What changed in the Budget?
Phillip Hammond announced two key changes to Entrepreneurs’ Relief in October’s Budget. Both are highly likely to impact the number of people who benefit. They are:
- 1. A 100% increase of the qualifying holding period, from one year to two. This counts for all disposals on or after 6th April 2019. You will now need to consider your position at least two years in advance of a sale to ensure ER is available and your CGT liability reduced. No more quick wins!
- 2. A tightening of the rules around the minimum 5% share equity, with immediate effect. You must now have a 5% interest in the profit and net assets. This is likely to have wide-ranging implications.Whereas previously you must have held shares equivalent to at least 5% equity and associated voting rights, you must now also be entitled to 5% of the business’ distributable profit and assets available on wind up. The idea is to limit ER to people with a genuine economic interest in the success of the business, rather than making an investment solely with the intention of benefiting from the relief.These additional stipulations will mean equity arrangements will need to be considered and reviewed with much greater detail, and well in advance of a sale to ensure it qualifies. Special consideration will need to be given to businesses which have issued preference or growth shares to incentivise senior executives.
So, if you’re looking to sell your business or dispose of equity, these changes to Entrepreneurs’ Relief are quite likely to affect you. In fact, if you are a Business Angel, the two changes are likely to significantly impact the profile of your potential investments. The increased level of time required to hold equity will undoubtedly impact the level of risk you are taking with your capital. Furthermore, the share structure will need careful consideration.
The good news is you have access to an approachable, highly qualified firm of financial planners in the City and South East. If you’d like to discuss your potential Capital Gains Tax liability, the likelihood of qualifying for Entrepreneurs’ Relief, or planning your exit strategy, please get in touch at a time convenient for you.