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In December 2019, the Conservative party manifesto recognised that some tax measures have not fully delivered on their policy objectives. One of which is Entrepreneurs’ Relief. Reforms are therefore anticipated to be announced in the budget on 11 March 2020. So are entrepreneurs at risk of losing this relief?
What is Entrepreneurs’ Relief?
Entrepreneurs’ Relief is tax relief on capital gains when you sell or dispose of all or part of your business. It applies to limited companies, partnerships and sole traders.
If eligible, Entrepreneurs’ Relief means you will pay tax at the lower rate of 10% on all gains on qualifying assets instead of the usual Capital Gains Tax rate of 20%.
An individual has a lifetime allowance of £10m, so potential tax savings of £1m.
Entrepreneurs’ Relief and Members’ Voluntary Liquidations
Disposal of a business can be facilitated by a sale or closing down a company through a solvent liquidation, known as a Members’ Voluntary Liquidation.
What is a Members’ Voluntary Liquidation?
A Members’ Voluntary Liquidation or MVL is a legal process used to formally wind-up a solvent company’s affairs.
A licensed Insolvency Practitioner acts as Liquidator, who distributes surplus assets and/or cash to shareholders.
A Liquidator’s distributions to shareholders are classed as capital, not income, so are therefore subject to Capital Gains Tax.
Distributions in an MVL enable shareholders to claim Entrepreneurs’ Relief. If eligible and approved by HM Revenue & Customs, shareholders pay 10% tax on the distributions.
More information regarding closing down a solvent company.
Eligibility for Entrepreneurs’ Relief if you are disposing of all or part of your business
To qualify for relief, both of the following must apply for at least two years up to the date you sell your business:
- you’re a sole trader or business partner
- you’ve owned the business for at least 2 years
The same conditions apply if you’re closing your business instead.
For companies, an individual must hold at least 5% of the issued shares which also have voting rights. They also need to have been a director or employee for a period of 2 years.
You must also dispose of your business assets within three years to qualify for relief.
Further guidance on Entrepreneurs’ Relief can be found here: https://www.gov.uk/entrepreneurs-relief
What happens if the company stops being a trading company?
If the company stops being a trading company, you can still qualify for relief if you dispose of your shares within 3 years.
Where gains qualify for Entrepreneurs’ Relief, how do you calculate the tax?
- Work out the gain for all qualifying assets
- Deduct qualifying losses to work out the total gain eligible for Entrepreneurs’ Relief
- Deduct your tax-free allowance
- An individual pays 10% tax on the balance
What was the purpose of Entrepreneurs’ Relief?
Entrepreneurs’ Relief was introduced by the Labour Government in 2008 with the aim of encouraging entrepreneurship and company start-ups.
How much is Entrepreneurs’ Relief currently costing the exchequer?
It is currently reported that Entrepreneurs’ Relief is costing the exchequer £2.4bn per year.
Views on Entrepreneurs’ Relief
The tax relief has been criticised for rewarding already successful business owners and not focusing on helping companies when they are starting up.
Last year the former head of HM Revenue & Customs, Sir Edward Troup, called on the Government to scrap the tax. Sir Edward Troup said the break provided “no incentive for real entrepreneurship”.
The Institute for Fiscal Studies, a think-tank, said last year that the relief was “unfair” and was not successful in its stated aim of encouraging business investment.
However, experts remain concerned that cuts to a tax break for entrepreneurs would be a significant blow and have adverse effects on the UK economy.
What potential reforms could the Government announce?
The Government could be considering any of the following:
- Increasing the rate of CGT from 10%
- Reducing the £10m lifetime limit
- Aligning the lifetime limit with the personal pension limit of £1m
- Removing the relief in its entirety
Who could the rule changes affect?
Entrepreneurs looking to sell or dispose of all or part of their business in the short to medium term may be at risk. Particularly small business owners nearing retirement.
When would the reforms come into force?
If the Government is to change Entrepreneurs’ Relief, it is uncertain when these changes will come into force.
The budget is set for 11 March 2020. Any proposed changes will be announced then.
Potentially any changes could come into force on 6 April 2020, or the date of the Budget.
The Government may introduce anti-forestalling provisions, effectively removing a window of opportunity before any rule changes apply.
How do the anticipated rule changes impact on Members’ Voluntary Liquidations?
For business owners who do not expect to dispose of their business in the short to medium term, then it is probably business as usual. In the event that changes are made to Entrepreneurs’ Relief, business owners should review their business plans and revisit any exit planning. Obtaining professional advice from an accountant or tax advisor is essential.
For business owners in the process of disposing of a business or planning to do so in the short term, then consideration should be given to the potential changes to Entrepreneurs’ Relief and how these might affect them. There may be a window of opportunity before any changes are announced and/or come into force. Consideration should therefore be given to completing a disposal before 11 March 2020 or potentially 6 April 2020.
Are there any other rules entrepreneurs need to be aware of when considering an MVL?
Yes. The targeted Anti-Avoidance Rule.
What is the Targeted Anti-Avoidance Rule
Introduced by the Finance Act 2016, the Targeted Anti-Avoidance Rule or TAAR came into force on 6 April 2016. The rule was introduced to prevent individuals converting what would otherwise be a dividend into a capital payment, and so reducing their overall tax liability. It applies to distributions made to individuals on the winding up of a close company on or after 6 April 2016.
A distribution in a winding up made to an individual on or after 6 April 2016 will be treated as if it were a dividend where certain conditions are met. For the rule to apply, all of the following conditions must be met:
- Condition A: The individual receiving the distribution had at least a 5% interest in the company immediately before the winding up;
- Condition B: The company was a close company at any point in the two years ending with the start of the winding up;
- Condition C: The individual receiving the distribution continues to carry on, or be involved with, the same trade or a trade similar to that of the wound-up company at any time within two years from the date of the distribution;
- Condition D: It is reasonable to assume that the main purpose, or one of the main purposes of the winding up is the avoidance or reduction of a charge to Income Tax.
It is important that shareholders are aware of these provisions as tax planning is an important part of the MVL process.
Entrepreneurs’ Relief is certainly on the Government’s radar, with potential reforms receiving mixed views. Whilst tax savings can be reported, it is extremely difficult to quantify how these savings benefit the UK economy.
Business owners will hope that the Government will consult before making any changes to Entrepreneurs’ Relief. The pressing question is how to decide how best to capitalise on the relief in its current form?
Business owners may therefore intend to capitalise now on the certainty and low tax rates available under the existing rules. For individuals who wish to benefit from current rates, the date on which they make their disposal for Capital Gains Tax purposes will be fundamental. To minimise the risk of anti-forestalling provisions, disposals should be before the budget statement on 11 March 2020. Failing that, by 5 April 2020.
Those who qualify for Entrepreneurs’ Relief in its current form should review their options and take professional advice. The information provided in this blog is for guidance and it is strongly recommended that advice is sought from an accountant or tax advisor as an individual’s circumstances vary.
If you are considering a Members’ Voluntary Liquidation, we can help you. Approved Recovery specialises in providing Members’ Voluntary Liquidations to small companies nationwide.
We offer a free initial consultation to discuss your situation, consider the options available and help you determine the best way forward. Contact us for a free no obligation consultation on 0800 066 2248 or email firstname.lastname@example.org
If you require accountancy or tax advice, we can also help you. Our accountancy and tax practice, Approved Accounting, specialise in helping small businesses and business owners.