This briefing explains the capital gains treatment of family business disposals since the reform to the capital gains tax rules in 2008. It focuses mainly on the availability of Entrepreneurs’ Relief in a range of scenarios and the conditions required for maximising the available tax savings.
Since 6 April 2008 the calculation of a capital gain for an individual mainly consists of a relatively simple comparison of sales proceeds versus acquisition costs. There is now no recognition of inflation so indexation allowance is no longer available (for individuals). Similarly, business asset taper relief is no longer applicable to the calculation of capital gains since April 2008.
An annual exemption is still available for each individual to reduce chargeable gains. This is £11,300 for 2017/18 but will be ignored for the purposes of illustrations throughout this briefing. Broadly speaking, all capital gains are charged at the flat rate of 10% or 20% (for higher rate taxpayers) unless the gain relates to the sale of residential property in which case the rates are 18% and 28% respectively. The precise tax rates will depend upon the individual’s total income for the relevant tax year as the tax rate is determined by the amount of gain that falls within each income tax bracket when it is added to the individual’s total income for the year.
There is an exception to the general rule for the diposal of qualifying business assets such that all qualifying gains are taxed at a flat rate of 10% rather than potentially 20% or a hybrid rate dependent upon income levels. This 10% tax rate is given by way of a claim for Entrepreneur’s relief against hte qualifying disposal.
Which disposals qualify for relief?
There are four situations in which a disposal of business assets by an individual may qualify for relief:
In addition, certain disposals by trustees may qualify but due to the special conditions which apply, this is not considered further in this briefing. Do contact us if this may be relevant to you.
A business means a sole trader or partnership trading business. Professions and vocations are also included in the term trade. A property business is only included if it is a ‘furnished holiday lettings’ business.
A qualifying business disposal
ER applies to the gains on the disposal of either the whole or a distinct part of a trading business. The individual must have owned the business or partnership interest for one complete year up to the date of a disposal.
The disposal of a property used in the trading business will not qualify if it is not considered to relate to the disposal of the whole, or part, of the business.
For example, the sale of some land by a farmer would not qualify for relief as neither the whole, nor a part, of a business has been sold. Rather, it is a business asset only that has been sold.
This rule is considered to apply whether the business is operated as a sole trader or through a partnership and can be tricky so please contact us for further advice on this area. What is acceptable as a disposal of a part interest is where a partner reduces his overall interest/ share in the business say from 45% to 30% or when an existing sole trader forms a partnership.
Is there an alternative relief?
If a trading property is sold in a situation where a replacement trading asset is acquired within a qualifying time period then the gain may be deferred using another relief known as rollover relief. Although deferring a gain is not as beneficial as exempting part of a gain, it is useful in a situation where a chargeable trading asset is sold because the business wants to expand into larger premises or relocate. The gain will then subsequently be chargeable on the disposal of the replacement asset in the future.
Ceasing to trade?
Where a sole trader or partnership ceases to trade and sells off the assets used in that trade then ER will be available provided that:
Similar provisions apply where a company ceases to trade, sells the assets and capital distributions are made to the shareholders.
The relief will apply to gains on disposals of shares (and securities) in a trading company (or the holding company of a trading group) provided that the individual making the disposal:
The relief is not available where the company is classed as a non trading company.
If your trading company has used surplus funds to invest in non trading assets, such as an investment property, it may be deemed to have substantial non trading activity if the asset value or the income exceeds what is known as the 20% threshold. Contact us for further guidance on this aspect.
Provided that each individual meets the basic requirements above, they can have further shares added to their holding and those shares will qualify for ER even if not held for a complete year. Where shareholders are spouses or registered civil partners, some last minute planning may enable a better ER position to be obtained so please contact us if this affects you.
For many years commercial property owned by an individual but used by any trade (even where rent charged) enjoyed the favourable business asset status. The availability of such a generous relief was not the only reason for keeping property ownership in the hands of an individual rather than in a company but was certainly a valuable one. Now such gains are primarily charged at the standard rate of 10%/20% in line with general capital gains tax rates.
The introduction of ER does not do much to reduce the problem. The only situation in which ER is generally available on the disposal of commercial property is by means of an ‘associated disposal’.
The disposal of an asset may qualify for ER if:
The relief is aimed at situations where the person running the business holds an asset personally which is used by the business.
Richard Bull has run a company for a number of years and holds 55% of the shares. He has personally owned the premises from which the company trades. He sells the shares for a gain of £100,000 and the premises for a gain of £800,000. His son is to take over as managing director but he is going to continue as a director for a further year or so.
The gain on the shares qualifies as a material disposal for ER and he will obtain relief on that.
The disposal of the premises also qualifies because there has been a material disposal. It represents part of his withdrawal from the business and the premises have been used in the business. HMRC state that it is not necessary for him to withdraw from operational involvement although in many situations this will reduce over a period of time.
If the purchaser wants to buy only the premises and not the shares, Richard will get no ER because there will not be a material disposal.
In certain circumstances, even though the main conditions are met, the relief for the associated disposal may be restricted. These include situations where the:
In addition, if the availability of the asset depends on the payment of rent, for periods from 6 April 2008 onwards, then relief will only be allowed to the extent to which rent is less than market rate.
If Richard had let the premises to his company to trade from at a market value rent, since 6 April 2008, then no relief would be available on the premises when they were sold.
There are many businesses which use premises owned by the proprietor personally and for which a rent is charged. The rules only restrict ER where rent is paid from 6 April 2008 onwards, so consideration should be given to possibly stopping the rent.
If you feel that this situation may apply to yourself, please get in touch as soon as possible to discuss your options.
Considerable care will be needed in planning to obtain the benefit of ER. There are a number of traps for the unwary.
As ever, tax is not straightforward. If you would like to discuss ER in detail and how it might affect your business, please do get in touch.